Use of collateral management is no longer reserved to the developing world. It is increasingly being seen as a tool that can offer banks much-needed capital relief. Liz Salecka reports.
Although collateral management services have strong roots in developing countries, evolving bank regulatory requirements, coupled with banks’ own tougher stance on credit risk management, has led to their increased take-up in the western world.
“Traditionally collateral management was a product used in the developing world – in Asia, Africa and South America – and while the structures and the legal environments differed, the needs and the end-product were pretty much the same in all of these locations,” explains Adam Slater, CEO, CWT Commodities.
“Today, however, there is strong demand for collateral management across the board because of Basel II and III requirements; mergers between banks; and the tightening of liquidity. Because of Basel II and III, we are now seeing new growth in fi rst world economies such as Europe and the US.” Christine Grolimund, vice-president, collateral management services, SGS Société Générale de Surveillance, confirms:
“The global financialcrisis forced banks to reinforce the acceptance criteria for their provision of credit. Demand for collateral management shifted to new countries where there was just no need for it before, such as Portugal and Spain.”
The use of collateral management services to guard against losses to, or deterioration in, the physical collateral used to support credit offers a number of benefi ts. In the first instance, the ongoing monitoring of collateral ensures that providers of commodity finance are kept aware and assured of the collateral’s actual physical existence and location; its quantity and quality; as well as parameters such as the adequacy of storage facilities used. This enables them to assess the cover ratio of their loans, and request adjustments when needed. In an adverse event, such as a default by the borrower, finance providers can also take steps to secure the underlying collateral, and take ownership, while it still covers their exposures.
“Collateral management agreements (CMAs) can play an important role in the provision of trade finance because they offer a guarantee like cash cover or fi xed assets.
CMAs can also reduce fi nancing costs but this depends very much on the nature of the transaction and the place of storage,” says Grolimund. And she adds: “Banks are also provided with the security that their borrowers will not dispose of the financed goods without them (the banks) being paid. In the case of nonpayment, a bank can retain the property.”
The requirements of both Basel II and Basel III have also led to an increased focus on collateral management services because by seeking collateral as loans, and taking measures to ensure its security, banks can reduce their own capital requirements under both sets of regulation. Here, Matthieu Delorme, chief operating officer, commercial, Cotecna Trade Services, explains that collateral management services can help banks comply with several requirements of the Basel II framework (which Basel III complements), which lay down criteria determining whether physical collateral is eligible as a risk mitigation tool. If it is deemed eligible, this will lower the capital requirements of a trade finance loan.
“It may be the case at the end of the day, that the better collateralisation of risk reduces the capital required for a transaction, and that this then brings down the cost of the financing,” he adds, pointing out that it may also make a trade finance transaction possible, thereby benefiting both the lender and the borrower.
“However, generally, the use of collateral management is more about facilitating the availability of trade finance.” For collateral managers themselves, the Basel III requirements are also expected to bring new business opportunities.
“The requirements of Basel III will make it harder for banks traditionally involved in trade finance to increase their exposures, giving other banks access to this market. For collateral managers, this offers the chance to expand their activities with new partners, and into new geographies,” says SGS’s Grolimund. There are also indications that the practice of using collateral managers could be extended further into the supply chain finance space.
Delorme believes that the added security provided by their services could be leveraged to enable banks to offer early finance against other types of goods held in warehouses. “In supply chain financings, the provision of financing usually takes place postshipment and revolves around the invoice. I think there is a strong case for the earlier purchase order financing of all types of inventory, which is ready for shipment and being held in a warehouse.”
A role in warehouse receipt financing Collateral management services are also expected to support the development of warehouse receipt fi nancing schemes in countries experiencing rapid growth in commodities trade.
In 2010, the IFC launched its global warehouse finance programme to help farmers and other agricultural producers gain access to bank finance, secured on commodities deposited in warehouses, in a move geared at allowing them greater fl exibility in the timing of their sales.
This model is now taking off in African countries, such as Nigeria, Ghana, Kenya, Uganda, Tanzania and Ethiopia, where it is helping local producers and trading companies achieve this same goal.
To gain earlier access to working capital, they are issuing warehouse receipts, against their warehoused commodities, which are being bought by investors, commodity wholesalers, traders and other market players.
“This is taking off across Africa and is progressing rapidly in countries such as Ethiopia, where collateral management is being used to support warehouse receipt fi nancing structures,” explains Christian Bain, managing director, Coronet, pointing out that warehouse financing is being used prominently by the coffee and cotton industries in Tanzania, and that there is also strong government interest in setting up such structures in Rwanda.
And here he points out that one of the key benefi ts of warehouse financing structures for both commodity producers and traders in Africa is that it allows them more time to sell their goods, meaning that they can seek out the best price.
“They are no longer being forced to sell their inventory immediately – and are now in a better position to allow the time needed to reach out to more lucrative markets.” Banks too are benefi ting from warehouse financing structures, and other structured solutions, where collateral management services are deployed.
“Financial institutions don’t have the manpower to continuously go and manage each facility that is under their care, and this is where collateral managers fit into the picture.
By supplying daily reports to the bank, indicating stock movements and security or storage issues that may arise, the collateral manger acts as the ‘eyes and ears’ of the financier – working alongside traders but never reporting to the traders,” explains Duncan Oliphant, co-founder and general manager of Sub-Saharan Africa-based Titan Collateral Services. He points out that the majority of structured financing facilities in Africa are being put together by private banks – and collateral management is key to the success of these structures. “As part of many structured trade facilities throughout the continent, warehouse receipt financing is increasing the level of new business for collateral managers in Africa,” he says.
“In the past, long-term relationships between financialinstitutions and traders in, for example, tobacco or sugar trading, were covered by the balance sheets of the traders involved. The need for the services of reliable collateral managers has increased with facilities such as warehouse receipt financing.”
There have been suggestions that the growth of warehouse fi nancing structures in Africa may be limited by the fact that commodities move relatively quickly in and out of warehouses due to their more perishable nature.
However, Coronet’s Bain points out: “Commodities such as grain can be stored for six to nine months so long as there are inspections and certain protocols are maintained, and this is where collateral managers really come into the picture.
“Collateral management can play a big role with the tenor of the financing arranged, enabling producers to store commodities in warehouses for longer so they can ultimately market it to larger and more lucrative markets than normal.”
Middle Eastern promise In the Middle East, Dubai has taken full advantage of the opportunities presented by warehouse receipt financing as part of major government initiatives to support commodity trade flows through the emirate. (DMCC) first launched its Global Multi Commodities Receipt Market as a commodity risk mitigation platform in 2004, and then developed it further, in the wake of the financial crisis, to create TradeFlow, an electronic system that brings together all the parties involved in inventory-based financing.
The platform, which was developed in consultation with financial institutions, commodity traders and warehouse companies, allows owners of commodities, stored in rated warehouses in the UAE, to request warehouse keepers to issue ‘Tradefl ow warrants’.
These warrants can be used by the owners to pledge benefi cial ownership or transfer title of the stored goods to financiers as collateral in return for working capital.
“We looked at the legal framework, and recognised that the most important thing was to ensure that a warehouse receipt financing involved a pledge in favour of the financier so that it could take charge of the commodities used as collateral.
“We established rules and regulations to allow the creation of enforceable pledges,” explains Paul Boots, director, DMCC Tradeflow.
He points out that the DMCC itself has also become the enforcing party in the event of a default. “In this event, we go to the warehouse concerned and actually secure the goods and make sure they do not disappear. We then work with other parties to liquidate the assets and – in a very structured way – distribute the proceeds to the interested parties.”
Although banks initially started to use the platform for small amounts, the size of pledges is getting larger and larger, according to Boots. “
There has also been a huge amount of interest from local, regional and international banks,” he says, pointing out that banks are benefiting from reduced risks; the ability to lend with more confidence; take on new customers; and also increase their credit lines.
Commodity traders, meanwhile, have been able to access early financing – and increase their credit lines, while warehouse companies too have benefited from the initiative because it has encouraged the stocking of goods in warehouses. “Some of our users – international trading companies – are using the platform in a different way to what was first envisaged,” adds Boots.
“As the warrants (electronic documents) issued by the warehouse keepers serve as evidence that the goods are warehoused here, they can be traded between companies and used to transfer ownership of the commodities.”
The DMCC is considering developing this concept to support the fi nancing of a range of warehoused inventory.
“There is a real opportunity here because of the central location of Dubai and the huge growth we are seeing in both imports and exports. Physical goods are moving in and out of Dubai on ongoing basis and there is growing demand from companies for working capital to finance this process,” says Boots. GTR