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An emerging market
Structured commodity finance has remained the exclusive purview of a small group
of banks.
February 2005
By Tony McAuley
The world of structured commodity financing has resisted any impulse to become
trendy, and with good reason. Though it may seem to be at the swashbuckling
frontier of finance-facilitating commodities trade from exotic emerging marketsevery deal does, in fact, require the laborious analysis of a menu of risks. They are
all bespoke deals, and though the margins for the banks can be high, the volume of
deals remains low. In banking, a low volume of transactions isn't sexy.
Two trends may perk this up, however. For one thing, there is broad-based recovery
in the economies of the emerging markets, especially those in the former Soviet
Union and Asia. Usually some region lags when others are growing, but this time
around Latin American economies are moving ahead at nearly 2% GDP growth, while
in Russia and Asia it is running at between 7% and 8%. But perhaps the more
immediate factor causing excitement is the new Basel II regime for banks, which
doesn’t go into effect until December 2006 but is already driving the way banks lend,
especially in Europe. Among other things, it tightens rules on counterparty risk in
trade financing.
“The first thing Basel II is doing is making financing for commodity traders in the
traditional way far more difficult,” says Prabhat Vira, head of the global commodity
finance group at ABN Amro.
The bulk—perhaps 95%—of commodity finance for metals, oil and gas, grains and
other “softs” is provided in the form of bank lines, either “clean lines” or “borrowing
base lines” (with some loose collateral stipulation), to mid-sized trading houses, Vira
explains. Very few of these will have any formal debt ratings, never mind
investment-grade ratings. As Basel II comes into force, the capital risk weighting
against these bank lines will squeeze them out.
John MacNamara, managing director of structured trade and export finance at
Deutsche Bank in Amsterdam, says “Basel II is the major business opportunity for
commodity trade finance this decade.”
From a base of between €20 billion and €30 billion now, bankers estimate that the
market could double in size because of the bank changes.
The Basel II committee at the Bank for International Settlements “is forcing
companies, especially in emerging markets and especially non-rated companies, to
be more creative,” says Karel Valken, finance director of Nidera, a privately owned
agri-business trader based in Rotterdam. “Our deal is an illustration of that because
we had some other alternatives,” he says, referring to a $150m (€115m) “pre-export
financing” he did for Argentinian grain at the end of 2004.
Risk assessment
Valken explains the basic rationale for the deal: “Financial markets make the
distinction between transfer risk and performance risk. If a borrower in a country is
only selling domestically the bank has difficulty getting paid because of transfer risk
issues. Financing exporters, the risk is limited to performance risk. In a crisis
environment, no country will restrict exports.” For Nidera, the guarantee of
sustainable export flows allows it to raise long-term financing, thus optimising
working capital. “You are basically getting long-term funds using inventories,” says
Valken.
Nidera this year is expecting to do a financing of $300m, double the size of last
year’s deal. It is also looking at more complicated transactions, incorporating the
storage of grain for a deal in Egypt, also financing the sale of soy beans to crushers
in Asia and the repurchase of the soy oil. But Valken says the risks that make the
market possible also put limitations on it.
He recalls that two years ago, Nidera tried to do a kind of securitisation with Marsh &
McLennan, the insurance group, that would have provided the credit-enhancement
on a bond issued by a special purpose vehicle. “But ultimately investors still really
didn’t feel familiar with this business” and the deal never got off the ground, Valken
says.
Taking the complicated risk out, however, can destroy the rationale for the market,
as Lamon Rutten, chief of finance and energy at the UN Conference on Trade and
Development in Geneva, explains: “In Russia, several of the large metal, oil and
diamond companies used to rely on structured finance. Many moved out and into the
corporate bond markets once they became better known to investors. Structured
finance can become uncompetitive very fast.”
Tony McAuley