Download REPOs And Agricultural Commodities – Part I

REPOs And Agricultural Commodities – Part I
The use of repurchase agreements (REPOs) as
an alternative to traditional commercial loan
financings is becoming increasingly popular in
the agricultural sector. This is the first in a series
of articles discussing issues relating to the use of
REPOs.
Classic REPO Structure
A classic REPO transaction is similar in many
respects to a bilateral loan agreement. There are
two parties to the transaction: the
company/borrower, in its capacity as the seller
of the commodity, and the bank/lender, in its
capacity as the buyer of the commodity.
However, in a classic REPO, the bank does not
make a loan to the company that is secured by
the commodity. Rather, the bank purchases the
commodity at an agreed-upon price and the
company agrees to repurchase the commodity,
on a specified date, at an agreed-upon
repurchase price plus accrued interest.
Accordingly, under a REPO the purchase price
paid by the bank for the commodity is the
equivalent of the principal advanced under a
commercial loan.
determined, on a daily basis, on public
exchanges and the relevant commodities can be
purchased on the open market easily.
For those trading companies with international
operations, often their inventory is located in
countries with undeveloped legal systems, which
makes it difficult for the banks to obtain a
reliable security interest. Further, even if such a
security interest is obtainable, there may also be
significant political risks in actually foreclosing
on the commodities and realizing on its value. In
a REPO, on the other hand, since the bank
actually owns the commodity (versus making a
loan that is secured by the commodity), these
risks are substantially reduced and banks have
greater latitude in making credit available.
REPOs and Soft Commodities
REPOs are also more cost efficient than
traditional loans. Under Basel II and III, the
amount of capital that banks must set aside for
REPOs is less than the capital required to be
maintained in respect of commercial loans. In
addition, the transaction costs for REPOs are
substantially less than for commercial loans,
since REPOs can often be documented by using
short-form agreements that are not subject to
significant negotiation.
While REPOs can be used for many assets
classes, they work especially well with those
asset classes that are highly liquid, which is the
case with soft commodities – prices can be
REPOs also have the further benefit of allowing
banks to reduce their credit exposure by
entering into offsetting hedging arrangements.
The banks accomplish this by selling futures in
Mayer Brown | 1
an equivalent number of the commodities it
purchases under the REPO.
The next article will discuss in greater detail how
REPOs are structured and related issues.
..........................................
If you have any questions, please contact:
Jeffrey L. Dunetz
Mayer Brown LLP
(212) 506-2670
[email protected]
For more information about the Mayer Brown
Agribusiness Practice Group, go to
http://www.mayerbrown.com/public_docs/Agri
business-Brochure.pdf
_______________________________________________________________________________________________________________________________________________________________
Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the “Mayer Brown Practices”). The Mayer Brown Practices are: Mayer Brown LLP and Mayer
Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales
(authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a
Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. “Mayer Brown” and the Mayer
Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.
This Mayer Brown publication provides information and comments on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the
subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
© 2012. The Mayer Brown Practices. All rights reserved.
Mayer Brown | 2