A global demand for food soars, newcomers to soft commodity financing scramble to gain market share. Eleanor Wragg reports.
The explosion of a new, more affluent middle class in emerging markets such as Brazil, India and China, combined with a surge in the global population, is boosting demand for soft commodities, including grains, dairy products, meat and cooking oils.
Against a backdrop of credit tightness led by the European debt crisis, the commodity finance market faces unprecedented challenges in both remaining liquid and rising to the challenge of supporting flows in soft commodities to feed a growing world.
Although commodity trade is, in the main, a dollar business, European banks have long been a leading source of financing for raw materials trade across the globe, underwriting major revolving credit facilities and pre-export finance loans to large global commodity trade houses as well as producers.
Today, the incoming Basel III rules mean that banks will be forced to monitor the physical flow of goods, which represent the main collateral in commodity deals, as well as deal with higher minimum capital requirements as a percentage of risk-weighted assets.
“Many European banks have had to make tough decisions in order to meet capital requirements by next June,” says German Vegarra, IFC global head of agribusiness and forestry. “I don’t believe any asset class was saved from the deleveraging, but trade and commodity finance, given its uncommitted nature, is always the first to feel the effect.”
“It’s not really a liquidity crunch; it’s more a very cautious approach because a lot of players don’t seem to have a good clear view of how liquid, deep and wide the market is due to lots of mixed feedback from banks. There’s certainly a little less capacity in the market, and it’s also more expensive to raise financing than, for example, a year ago,” says Thomas Oehl, head of commodity trade finance at WestLB.
This uncertainty about the ability of European banks to attract sufficient dollars has “translated into a mud bath of unclear liquidity premiums,” adds Karel Valken, global head of trade & commodity finance at Rabobank.
“The financial crisis has also put more emphasis on risk management, especially contract default risk. As a result of this, trading patterns are more hand to mouth, and a shorter tenor in the trading book causes margin erosion. All companies are still doing relatively well, but not as well compared to the last two to three record years.”
French banks, including BNP Paribas and Société Générale, have been the most visible in reducing their capital requirements. This has created opportunities for other banks to pick up some of the commodity loan books that are currently on sale, with banks such as Hinduja Group’s Swiss-based private banking arm said to be amongst those snaffling clients.
Some of the assets with reasonable structures are at attractive pricings in the secondary market, which allows smaller banks to build up new relationships. In addition, the gap left by the pull-back of traditional banks is leaving space for others to enter the market.
“We see American banks moving into the commodities arena, but they have a history of moving in and out of this sector, which leads some companies to question their long-term commitment,” says Rick Torken, global head of agricultural commodities at ABN Amro.
One way companies are ensuring they secure their funding needs without being subject to the vagaries of the market is by moving toward committed facilities.
“The rationale behind that is the clients are seeking to mitigate and manage liquidity risks, partly to support their margin call financing due to the high volatility,” says Rabobank’s Valken. “Because of the relative lack of liquidity in the different markets, an important objective of customers is to make themselves less dependent on banks, so the objective is also the diversification of funding.”
One recent example of this is a US$700mn deal selected by Bunge under a global trade receivables securitisation programme from Rabobank, Crédit Agricole, HSBC and BNP Paribas, which closed on June 1, 2011 and effectively replaced three local securitisations and five factoring facilities in North America and Europe.
Another seemingly obvious solution to tight dollar liquidity would be to move to euro-denominated tranches. A case in point is Glencore, which is currently selling a six-year, euro-denominated bond in the area of 250 basis points over midswaps. But it’s not always that simple.
“Borrowers in principle are open to euro tranches within financings up to a certain extent. Looking at some of the commodity trade finance facilities that closed lately, there are tranches which are in euros to attract more capacity from the European banks and allow them to enter into these facilities. These clients then swap that part of that euro funding into US dollars,” explains Oehl at WestLB.
“However, realistically there are certain limitations as to how much you can raise in euros because you cannot totally swap your US dollar base, as there’s an underlying risk you have to manage to which you do not want to overexpose yourself.”
Recognising the role that European banks play in supporting the export and import of critical agricultural commodities, the
IFC launched its Critical Commodities Finance Programme (CCFP) last January. The CCFP is a risk funded or unfunded participation agreement where the IFC and the partner bank share risk of a pre-agreed portfolio of clients working in the emerging markets.
The first deal, a US$500mn facility with Société Générale, closed in February, and a further US$500mn facility was closed with Rabobank in March.
“These two facilities alone are expected to support commodities flows of about US$4-5bn over three years,” says Vegarra, who adds that the IFC is currently in discussions with four other banks.
As commodity-hungry Asia grows at break-neck speeds, a permanent change in the commodity financing space is the increased presence of Chinese banks which are increasingly able to take large tickets in deals, and tend not to look at price and structure in the same way as a Western bank.
To date, the newcomers are receiving a warm welcome from the market, with a few caveats.
“You have to hand it to these players and their regulatory bodies. They appear to have done their homework: they are very well capitalised, and are decently funded,” says Oehl.
“It’s healthy competition and it keeps liquidity in the market. Where some European banks do currently have issues it allows clients to plug that hole and be able to raise the financing they need. Certainly Chinese banks will be learning very fast and becoming quite a strong competitor in commodity and trade finance as they’re strongly focussed on this sector. To which extent it becomes over-competitive or perhaps even subsidised by the Chinese state remains to be seen.”
There’s also the point that the Chinese banks tend to have the ability to arrange transactions which European banks canonly dream of, given their connectivity to the political and corporate environment in China.
Sovereign wealth funds
But it’s not just new banks which are spreading into the space. The growing need for food and basic staples in emerging markets is also spurring sovereign wealth funds to look at ways to secure supplies for their local populations, which includes investing in producer countries.
One obvious choice for investment is Africa. The rush for land by Middle Eastern and Asian countries is proof of the region’s enormous agricultural producing potential, which has so far not been fully realised as a result of past policy and institutionalised failures.
“Increasingly we note opportunities and inquiries by our customers in Africa. Investments are taking place in palm and rubber plantations, fertiliser production and flour mills.
These investments are predominantly made by Asian groups so far, but there is interest from Europe and the US. While this market is quite fragmented due to the size of the continent and the complexity of dynamics including logistics we feel that selectively there are opportunities,” says Valken at Rabobank.
One bank which is capitalising on the need for more capacity in Africa’s agricultural sector is Standard Chartered, whose structured agricultural finance portfolio in the continent is valued at over US$2bn.
This includes a facility provided to the Export Trading Group (ETG) in Mozambique which provides infrastructure for more than 80 agricultural storage and distribution depots, supporting 25,000 small-scale farmers with technical expertise, inputs, storage and a market-related price for their crops; as well as facilities in Zambia and Nigeria.
“One of our finance models includes structured input finance, a product developed specifically to meet the needs of farmers in Africa, who often struggle to obtain adequate input finance to support optimal crop yields.
This input finance model is unique in that the bank uses the commodity as collateral, as opposed to more traditional agri-financing methods where the farmer’s fixed assets are sought as security,” says Pradeep Iyer, head of commodity traders and agriculture for Africa at Standard Chartered.
It’s not just Africa that’s in the sights of investors. The IFC, for example, is currently supporting the government of Moldova in streamlining food safety regulations to enhance export competitiveness; in India, it supported the privatisation of silos in Punjab. It is also working with supply chain integrators like Ecom and Armajaro to develop solutions that help increase farmers’ output while reducing their operating costs through competitive access to finance and inputs
“Medium to long-term assets which play an important role in the commodity value chain need to be financed,” says Harris Antoniou, global head of energy, commodities & transportation at ABN Amro. “Unless those investments take place, the supply of agri-commodities is threatened or interrupted, and that’s an area where we see more risk as banks move away from long-term funding.”
“The shape it will have is in sovereign wealth funds taking shareholdings in certain companies in emerging markets where food production is expected to come from. We see the movements taking place and we know there are going to be some deals announced on that in the coming months,” adds Torken at ABN Amro.
As sovereign wealth funds, as well as private equity firms, tend to look for bank partners who are willing to provide the debt portion of any financing, this trend will most likely lead to the formation of symbiotic relationships across different markets, rather than creating more competition for banks.
A growing risk that banks do have to deal with, though, is protectionism. As an example, commodity-rich Brazil recently implemented a 6% financial transactions tax on medium-term loans offered to exporters by banks, a critical tool used by major commodity producers across the globe to finance their operations.
“This of course has a huge effect, and that’s a market which is probably going to be undersupplied now,” says Antoniou. “Many people, including ourselves, are looking at ways to bridge that gap.” Even if European banks are feeling the pinch due to ongoing volatility and liquidity risks, the flow of deals has not dried up, and European bankers appear to be responding to the current environment by focussing on lending to core clients instead of spreading their slightly scarcer resources too thinly.
“If you look at the commodity trade finance facilities, revolving credit facility (RCF) margins have been stable or even increasing. In structured commodity finance. Although we haven’t seen that many facilities in the market, we’re seeing quite a substantial increase in margins in the ones which are being discussed now,” says WestLB’s Oehl.
“Looking forward, we are cautiously bullish, because the underlying fundamentals in the agri-industry continue to be strong,” adds Valken.
Despite many barriers, commodity trade finance is in a far better position than many areas of the banking sector, even if much of that strength is due to the simple fact that the underlying demand for foodstuffs and basic staples is only set to increase over the coming years.
There’s no doubt that in the future there’ll still be a place at the table for European banks, but whether that place will be at the top of the table remains to be seen. GTR