Throughout Asia, the economic recovery from the crises has gained momentum. Unfortunately, the business sector in the region will remain very vulnerable to outside influences for several years to come. This vulnerability is mainly due to the inability of corporations to fully restructure their liabilities and, more importantly, to the unchanged situation of the fragile financial infrastructures in almost every Asian country.
For companies engaged in the production and trade of commodities, this means, despite recovery, continuing hardship to maintain or regain an acceptable and efficient business volume. It is evident throughout the world: when a contemplated trade transaction involves a region with an underdeveloped or destabilized financial system, be it on a temporary or permanent basis, the routine matter of buying and selling becomes a considerable problem, because conventional financing methods fail.
In these regions, and today the largest part of Asia is considered to have either a destabilized or underdeveloped financial system, the traditional balance sheet lending will fail. However, as long as there is an international trade flow - for many companies this is the only way out of the turmoil, they have no choice than to continue producing and selling their products for export - there will be a financing need.
Today in Asia, this financing need is more visible than ever before. It has even grown due to the fact that trade flows have picked up. Yet, the situation of local financial institutions has not significantly improved: they bear high volumes of non-performing loans and their single customer's lending limits remain reduced or full. Furthermore, international banks offering mainstream banking products have not returned to the stage due to their inadequate perception of the risks involved. Combined with a considerable reduction in country risk limits, the ongoing threat of bank mergers and financial problems in several other markets of the world, these international financiers are bound to need a lot of time before regaining their strength and confidence in Asian markets.
International trading companies, local commodity producing companies and also multinational companies active in the region turn in vain to their traditional banks. These banks are not able to offer any assistance. Unless the bank is a financial institution that can deliver on the basis of more unconventional trade-finance methods, geared to find suitable solutions to deal with the payment and transfer risks in relation to destabilized markets.
One of those unconventional trade-finance methods involves "Structured Commodity Finance" elements and enables the bank to regard the macro-economic situation of the respective country and the balance sheet of the commodity producing company - if at all physically available - of secondary importance.
Structured Commodity Finance is simply a function of risk and the perception thereof. Financing on the basis of export of commodities exists only because the traditional payment methods have proven to be disturbingly unsuccessful. Structured Commodity Finance is therefore likely to gain importance throughout Asia in the coming years.
Unconventional approach: Structured Commodity Finance
A bank involved in Structured Commodity Finance takes a different view on risks to the mainstream capital markets. This bank takes a view on the flow of goods and its origins, rather than on the flow of money and the sources this money comes from. Now it is structured finance based on the export of commodities that we are dealing with.
The technique behind Structured Commodity Finance is mainly one of having this fresh view on risks combined with an extensive knowledge about the production of and trade in the individual commodities.
The result is that, by means of the structures that are designed for each situation separately, the volume of financing available for commodity transactions in these higher risk markets can be considerably enhanced. Structures whereby the unacceptable payment and transfer risks of companies and countries are transformed into acceptable production, transport and delivery risks of good performing commodity producers.
Liquidity and Risk Management through SCF programs
A wide range of companies is able to benefit from Structured Commodity Finance programs and use these alternative financing solutions that the bank offers either as liquidity management tool or as risk management tool. The main beneficiary of a "liquidity management tool" SCF program is the local producer of commodities. Working capital to buy raw materials or other essentials necessary to produce a wide range of commodities becomes available. On top of this, the producing company may use the SCF programs to finance its need for spare parts or essential rehabilitation of the production facilities.
In the eyes of the bank this commodity producer however has to meet three important criteria. The first one is that the commodity producer must be able to produce good quality commodities of international standard. Another is the condition of the technical facilities of the producing company. As SCF programs largely rely on exports of commodities as the main mechanism for repayment, the bank has to be to a certain extent convinced that exports will take place.
The third eligibility criterion is a financial criterion. The bank has to be reasonably certain that the producing company has, together with the financing through the envisaged SCF program, enough liquidity to continue the production during the term of the financing facility.
Another important beneficiary of SCF programs is the vast group of international and regional commodity trading companies, which carry out their trading activities in various emerging markets. When trying to successfully perform a trading business, the trading companies often encounter two sorts of financial difficulties, a liquidity problem or a risk problem.
When sourcing the commodities in emerging markets, the trading company may consider to accommodate a commodity producer with an advance payment for goods to be delivered sometime in the future. The ratio behind the advance payment is to secure a trade flow of quality commodities. However, such future delivery may create liquidity problems for the trading company. It needs a bank to finance this advance payment in order not to endanger the continuity of other trading activities.
The risk management tool for a commodity trading company comes in when the advance payment financing is obtained from the bank on a limited recourse basis. The volume of business can thus be enhanced by the trading company, without an unnecessary increase in the market, commodity and political risk that is involved in dealing with higher risk environments.
Yet another beneficiary of SCF programs is the international equipment manufacturer who wants to sell his equipment in high risk markets without having the possibility to use insurance cover from western Export Credit Agencies. Using the same limited recourse financing that is available for trading companies, these suppliers of usually expensive but quality equipment have a ready tool for risk management. Furthermore, such multinational companies can find the use of SCF programs a suitable risk management tool in support of strategic investments in emerging markets.
The Structured Commodity Finance approach is the beginning of a whole range of alternative financing solutions. These solutions, however, have one essential thing in common: they all provide assistance in markets in which, for whatever reason, conventional payment methods fail.
Willem Klaassens is Singapore regional head Asia for structured commodity finance, Westdeutsche Landesbank Girozentrale.
