R Lakshmi Anvitha

1226213102
COMMODITY FINANCE
ABSTRACT
The importance of trade finance for commodity trade was highlighted during the recent financial
crisis, which led to a very rapid reduction in available pre-export and pre-shipment finance. The
scarcity of finance was a major factor in the ensuing severe decline in actual trade flows. Export
volumes from China to Europe and the Americas, for example, fell by 40 per cent. Trade finance
experts present at the Forum warned that despite this important function, trade finance is likely to
be severely affected by the new financial regulatory regime that is being put in place. This could
potentially create a sizeable barrier to the global economic recovery that is expected to be driven
by international trade

INTRODUCTION
Commodities have attracted considerable interest as a financial investment in recent years.
Commodities generate trade flows that in turn generate financing needs at all stages of the
Supply chain:
Producers / exporters
Trading companies
Processors
Importers
End users / distribution

 Commodities trade flows intervene at an early stage of industrial processes and economic life
in developed and emerging countries. They are therefore highly strategic for most countries,
industrial companies and end users.
Financings linked to commodity trade flows have demonstrated a high level of resilience and
robustness, particularly during economic down cycle.
REACTION OF COMMODITIY TRADERS TOWARDS FINANCING
The commodity traders are moving towards the development on four basic imperatives:
1) They are preparing themselves towards development and impact of regulatory changes in
trade financing of commodities.
2) Trying to adopt new technologies towards seizing the upcoming opportunities.
3) Rather than depending on commodity financing traders should also look at managing
their balance sheets and finding new sources of capital
4) Traders should develop exploring new areas of availability of material in new geographic
regions.
KEY REGULATIONS THAT ARE EFFECTING COMMODITY FINANCING
1) BASEL III
Due to implementation of Basel III the banks need to maintain maximum leverage,
minimum capital, minimum liquidity ratio and adjustments in credit valuations. The
impact of these was on traders as tightening access to trade financing as banks lowering
their trade finance exposures, less availability of LCs to the higher risk counterparties,
difficult to raise loans and higher costs across all trade finance products.
2) Dodd Frank Act

This is an act brought forth in US and the main impact of this act is on commodity traders
seeking finance. It introduced limitations on leverage and stricter requirements on
transparency, risk management and governance. This act has not yet taken place
completely till date. This act also avoids specific investments made by the traders in other
products.
Almost all G20 countries are trying to implement the Dodd frank act, i.e. Singapore in this
February stating that it is going implement Dodd frank act and all the regulations under it will be
strictly followed.
PRODUCT FROM IFC
IFC initiated Commodity Finance as a collaborative solution to maintain and extend the
availability of financing for the trade of critical commodities in emerging markets. Under this
initiative, IFC can provide commodity-based financing across part or all of the trade value chain
-- from logistics to purchase and sale of commodities -- with relatively predictable cash
flows. This product takes a project-by-project approach to provide liquidity and risk mitigation
for primarily real sector beneficiaries including processors, importers, and distributors primarily
in the agricultural and energy sectors. Projects typically consist of a secured revolving short-term
trade facility, with a bank partner acting as facility and security agent managing the daily
operations and doing documentary verification and control. While the Critical Commodities
Finance Program requires a diversified portfolio of obligors across various markets and sectors,
the Structured Trade Commodity Finance initiative can be used for a single obligor operating in
one or more countries.
CHALLENGES

As role of trading company grows, liquidity requirement increase in order to:

Grow volumes and meet price increases
Invest in infrastructure to improve logistic and add efficiency to global markets
Add the uncertainties created by
Regulatory pressures (Basle III, Derivatives regulations)
Long term price trends based on fundamentals
The industry needs to mutate and innovate in the ways it finances itself:
IPO
Public ratings
PE fund structure
Trade finance funds

SUPPORT INSTITUTIONS FOR COMMODITY FINANCE

Insurance
Commodity trade finance relies on a number of support institutions to function efficiently.
Among these, credit insurance plays a major role by facilitating risk management for financial
institutions engaging in commodity trade finance. Speakers noted that, in recent years, there has
been an explosive increase in the use of credit insurance, especially by banks. This is partly due
to the favorable treatment of credit insurance in Basel II regulations.
As a result, the number of insurers offering credit insurance for commodity trade has nearly
doubled, and premiums are currently estimated to be worth in excess of $10 billion.
The credit insurance industry was strongly and premiums are currently estimated to be worth in
excess of $10 billion. The credit insurance industry was strongly tested by the global crisis.

Claims on credit insurers more than doubled between 2008 and 2009. Claims made on political
risk insurance in 2009 and 2010 alone were worth nearly half of all claims made over the past 25
years. Overall, the insurance market responded well and it is estimated that 95 per cent of nonpayment claims were paid in full. The impact on the insurance market was considerable, but
recovery prospects are good. The capacity of insurers is expanding and experts affirmed that
private insurers had come out of the crisis even stronger than they entered it. There is
nonetheless a risk that new regulations emerging from Basel III will reduce the attractiveness of
credit insurance for banks, thereby severely affecting the prospects of insurers.
Inspection
Inspection companies perform important risk management functions in commodity trade finance.
By monitoring commodity transactions at a variety of key points in the value chain, they provide
an essential service for many stakeholders. The role of inspection companies is changing in
many areas as they specialize more intently on pure monitoring activities. This is driven by a
general movement of all stakeholders involved in commodity trade transactions towards greater
specialization. There are still many regions, however, where commodities trade markets remain
poorly developed. Against this backdrop, the time tested collateral-management-agreement
approach, whereby the inspection companies control the entry and exit of physical goods from
warehouses, remains the operative standard.

Documentation
The increasing complexity of commodity trade transactions generates a large volume of
documentation. Even simple transactions involve a dozen different parties, generating an
intricate web of documentation. At present, these documents are generally not standardized and

there is a considerable amount of duplication. Increased standardization of key documents

therefore can lower the transaction costs involved in commodity trade transactions. Similarly,
moving towards common dematerialized platforms could improve efficiency significantly.
Overall, the insurance market responded well and it is estimated that 95 per cent of non-payment
claims were paid in full. The impact on the insurance market was considerable, but recovery
prospects are good. The capacity of insurers is expanding and experts affirmed that private
insurers had come out of the crisis even stronger than they entered it. There is nonetheless a risk
that new regulations emerging from Basel III will reduce the attractiveness of credit insurance
for banks, thereby severely affecting the prospects of insurers.

REFERENCE
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http://www.tradefinancemagazine.com/Sectors/23008/Commodity-Finance.html
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ustries/Financial+Markets/Trade+and+Supply+Chain/Structured_Trade_Commodity_Finance/
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http://unctad.org/Sections/wcmu/docs/gds2011d01_en.pdf
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