Structured Commodity Finance Does it Promote Growth

1
Structured Commodity Finance Does it Promote
Growth?
NOT AN OFFICIAL UNCTAD RECORD

• 8th Africa Oil and Gas, Trade and Finance
  Conference

Paul Starling, Regional Head Africa,
GSF-Commodity Finance April
29th, 2004
2
Itinerary
8th Africa Oil and Gas, Trade and Finance
Conference

• Structured Commodity Finance
• Pre-Export Financing
• Hypothesis
• Analysis
• Conclusion

3
Structured Commodity Finance
8th Africa Oil and Gas, Trade and Finance
Conference

• In Structured Commodity Finance (SCF) facilities,
  lenders tend to draw comfort, primarly from the
  commodity itself or from the revenues generated
  by the sale of such commodity.
• Hence in SCF transactions lenders are ususally
  secured by a pledge over an already produced
  commodity or an assignment of the future
  receivables generated by the sale of such
  commodity.
• SCF transactions are ususally closed-end and
  self-liquidating financing structures. Hence
  there is a given sequence of goods and cash flows
  which lead to the repayment of the credit.

4
Pre-Export Financing 1/4
8th Africa Oil and Gas, Trade and Finance
Conference

• Pre-export financing facilities are one of the
  most commonly used SCF transactions.
• Pre-export financing is based on the the
  pre-financing of the sale of commodities which
  are typically (i) not yet produced and (ii) will
  be sold to an export off-taker under contract.
• The borrower is usually the producer and the
  exporter of the commodity in question. Typically,
  we find that there are a number of off-takers
  under contract to buy the commodity.
• The lender is primarily secured by the assignment
  of the borrower/ producers rights and benefits
  under the export contract, in particular the
  rights to the receivables.

5
Pre-Export Financing 2/4
8th Africa Oil and Gas, Trade and Finance
Conference

• Conventional credit facilities are simply based
  on a credit agreement which state that the terms
  under which a borrower must repay its loan.
  Typically a borrower is expected to generate
  enough sales revenues such that after covering
  expenses, there is sufficient free cash flow
  produced, such that the loan can be repaid.
  Further all sales revenues are collected by the
  company (and hence the country in which it is
  domiciled) which is also responsible to manage
  these funds.
• Pre-export financing facilities combine the
  features of commercial as well as financial
  agreements. The basic assumption is that the
  borrower/ producer has a strong commercial
  incentive to sell the commodity to a pool of
  off-takers. Failure to do so would materially
  harm the borrower.

6
Pre-Export Financing 3/4
8th Africa Oil and Gas, Trade and Finance
Conference

• The assignment of the sellers rights under the
  export contract enables the lender to collect the
  receivables under the assignment and place the
  received funds into a Collection Account, which
  is usually assigned to the lenders. Repayment of
  the pre-financing are made from the Collection
  Account prior to repatriation of the funds to the
  borrower/ producer.
• Such channelling of export proceeds mitigates (i)
  the transfer risk and (ii) the corporate credit
  risk of the borrower/ producer.
• In a pre-export finance facility the loan will be
  repaid when (i) the goods are produced and
  exported and (ii) the off-taker pays for them
  over the given term of the financing.
• Hence an SCF lender rather than focussing on the
  pure credit risk of the borrower will assess (i)
  the performance risk of the borrower (i.e. its
  ability to produce and perform under the export
  contract) and (ii) the payment risk of the
  off-taker (i.e. the ability of the off-taker to
  pay for commodities received under the export
  contract).

7
Pre-Export Financing 4/4
8th Africa Oil and Gas, Trade and Finance
Conference

• In other words under pre-export financing a
  lender seeks to transform an unacceptable credit
  risk into an acceptable performance risk.
• The lender relies not only on the incentive to a
  borrower/producer to repay a loan but also to
  produce and sell its products.
• History has shown that this combination of
  financing as well as commercial incentives prove
  much more robust than in conventional credit
  transations.
• Banks who understand this incentive scheme have
  managed to lend money to a large number of
  borrowers i.e. commodity producers) who would
  otherwise have had no or very restricted access
  outside finanicng.

8
Hypothesis 1/2
8th Africa Oil and Gas, Trade and Finance
Conference

• Natural Resources
• A country which is endowed with natural resources
  has the advantage that such commodities can be
  used to (i) supply the domestic economy and in
  addition(ii) export such excess commodities to
  generate export revenues.
• Know How and Capital
• In order to exploit natural resources a country
  has to build up or purchase the know how required
  to produce and deliver commodities to the
  international market.
• Also it has to raise the financial means needed.
• Production, Revenues and Profits
• Once a country has successfully managed to
  produce and sell its commodities it will be able
  to generate profits.

9
Hypothesis 2/2
8th Africa Oil and Gas, Trade and Finance
Conference

• Profits and Investment
• Profits generated from the sale of commodities
  may be invested in the economy to (i) increase
  the production of such commodities and (ii) make
  investments in other parts of the economy.
• Investment and Growth
• More investment means more economic growth.
• Growth and Wealth Distribution
• Economic growth may lead to additional benefits
  for all citizens of an economy provided that the
  additional wealth created is distributed in an
  equitable way.
• Hence more production and sale of a commodity
  will lead to more economic growth, provided that
  there is sufficient demand for such commodity.

10
Analysis 1/2
8th Africa Oil and Gas, Trade and Finance
Conference

• A borrower should be able to raise SCF financing
  provided that
• an on-going production of commodities exists and
  can be sustained over a given period.
• there is a significant excess production of a
  commodity over domestic consumption
• a strong dependency of the country on the
  receivables of certain commodities - Is it a one
  product country?
• a significant external demand for such
  commodity.
• If SCF finance is available it can be used to
  finance investments for the economy.
• Being one of its key drivers such investments may
  generate economic growth.

11
Analysis 2/2
8th Africa Oil and Gas, Trade and Finance
Conference

• Hence one of the crucial questions will be how
  efficient the monies raised under SCF financing
  schemes are used for investments.
• Only efficiently used funds will translate into
  useful investments and hence economic growth.

12
Conclusion
8th Africa Oil and Gas, Trade and Finance
Conference

• SCF can provide a solution to financing in
  situations in which no other means of financing
  are available.
• The responsibility of using the funds raised
  under an SCF financing efficiently cannot be
  taken away from the borrower.
• SCF may help to induce further economic growth,
  but there is obviously no guarantees of its
  success.
• Even if investments are chosen and executed in a
  way which induces economic growth this still
  leaves open questions with respect to the
  distribution of such newly generated wealth.

13
Conclusion
8th Africa Oil and Gas, Trade and Finance
Conference

• Since to what extend should commercial lenders be
  concerned with the use of funds borrowed from
  them?
• Since economic growth does not necessarily mean
  equitable distribution of wealth should
  commercial lenders seek to influence the use of
  such funds?