Nicolas Clavel, chief investment officer of Africa-focused asset manager Scipion Capital, talks to GTR’s Melodie Michel about how hedge funds are filling a gap in commodity trade financing.
GTR: How has your business evolved in the five years since Scipion’s creation?
Clavel: When it became evident that the proposed Basel III capital adequacy requirements would force the banks to put more capital aside for trade finance, I could perceive that there was going to be a gap between what was on offer from the banks and what was needed by the commodity traders. This was exacerbated by the financial crisis and by increasing prices in many commodities produced on the African continent. Banks have shrunk their lines a little bit, but more importantly they have focused on the big companies. So the very large trading houses are finding very competitive credit, but the smaller ones are finding very little; that’s the main evolution we have seen in commodity trade finance in recent years.
Five years ago if I had been asked if I could get to £1bn I would have hesitated, but today I’m quite confident that yes, we could reach £1bn. In the past 12 months our business has more than doubled and we expect to increase it by another 200 or 300% in the next six months.
GTR: What are the main factors affecting your business?
Clavel: The main factor is to get investors on board – any hedge fund is about gathering assets. They are essentially high net-worth individuals, family offices and some institutional investors like funds of funds, but also increasingly insurance companies and potentially pension funds.
In terms of placing the assets, we have a very long pipeline of transactions that we complete as we get new funds. We are not very interested in one-off transactions. We’re interested in creating a new flow of transactions so we know that every month or two there will be a new shipment, because that reduces the amount of due diligence that you have to do on the transaction.
In terms of commodity prices, as all of the deals that we do are transactional supply chain financing with a buyer and a supplier that have already either agreed a price or a price formula, the fluctuations in prices are slightly less important to us. If it’s a fixed price contract we always look at the risk of one party defaulting because the price is going against them. In most cases you’d have a hedge on the actual commodity to reduce the risk, and if we don’t take the hedge we ask the trader to ensure that he has taken the hedge and monitor the hedging book of our borrower.
GTR: How do hedge funds like Scipion work with banks in terms of trade finance? Are you in competition or do you complement each other?
Clavel: Commodity trade finance typically has been the preserve of banks and large trading houses. Now that banks have restricted their credit lines to a lot of medium-sized traders, there is a need to help traders along, particularly in ‘up-country’ kinds of situations.
BNP Paribas for example, is shrinking its books from €120bn to €80bn, exiting small and medium-sized businesses. In fact, some of the relationship managers tell their clients to go to funds like Scipion, because they’ve been told from above not to accept traders with a capital of less than €50mn or €100mn, but they don’t want to exit the strategy. It’s not really their perception of risk which is at play; it’s the interpretation or application of Basel II and III. A banker may think the business is extremely sound and very comfortable but he has to follow the rules and doesn’t have a choice.
We’ve got bankers who say ‘I can only help this guy once the goods are on the ship, but he really needs the funding for the previous 10 days to bring the goods to the ship’, so this is a source of transactions for us. Some bankers see us as competition, but most of them see that we can add value to their business and help them keep their clients by offering things that they cannot do themselves within their credit approval process. We’re very happy with that, and it allows us to get a good return. In fact, over the past five years we’ve averaged 12% of net return per year.
Also, because of capital constraints, a lot of emerging market banks have lost their letter of credit (LC) confirming and treasuring lines from European banks. It’s not that they bear a worse risk – if anything it’s the European lenders that bear a worse risk – but nevertheless that has constrained their ability to meet all kinds of demands.
You have banks across the African continent that may have asked for 10% cash collateral to do an LC in the past, and now ask for 50% due to the knock-on effect. Therefore the demand for cash and for margins has increased and that’s another source of transactions for us. We try to work in conjunction with African banks, each providing a certain amount. For the bank, the plus is that the deal has not gone to a competitor, they still keep it in-house, and we’re not perceived as a competitor because we’re not a local bank. We’re there to provide the funds for a given transaction.
GTR: What sorts of transactions do you do most?
Clavel: We have quite a fair flow of transactions from South Africa at the moment, especially in ores (chrome, iron ore and manganese), and most of this goes to China. What we often find is that traders will have lines of credit for goods being exported from Africa, but only on the way out from a big port. Very often, financing is required a bit further up-country or even within the port, but a lot of banks are finding it difficult these days to go through their credit committee with this type of deal, so this is where we provide financing, for example from a mine to a port. This is the kind of transaction that we do quite a lot: short-term bridge financing to allow a trader to basically negotiate his LCs.
The big traders now have sufficient power to dictate what they want to do. For example if manganese ore was US$100 a tonne at the mine and US$200 at the port, a big trader might offer to take it from the mine at US$80, knowing there’s very little competition. Our main role is to allow the small traders to get in there and offer to take the goods from the mine to the port, at a price where we make a decent return. The trader makes a decent return and the miner has a better deal. This middle market is increasing in size and in demand because of the banks’ contraction.
GTR: What sectors do you see as most promising?
Clavel: At the moment we are very optimistic towards mineral commodities. Initially the focus was purely on agriculture, but during the crisis of 2008 we had a very strong shift towards essential commodities (coffee, tobacco and salt for example), and for the last two years we have seen a lot of demand for ores: chrome, manganese, iron, copper, cobalt and all kinds of ores
used in technology.
A lot of it is going to China and of course we follow what’s happening there with great attention. In spite of an expected slowdown in the Chinese economy, we keep seeing very robust demand from there.
GTR: How optimistic are you that emerging markets in Africa will continue to attract investors?
Clavel: Out of the top 10 country growth rates in the world, six or seven are in Africa. Some people might argue it is because they started from a small base but having said that, the trend is your friend in that business. The continued improvement in infrastructure makes transactions that three years ago would have been completely unrealistic become realistic.
We were having a meeting last week about a project in Sierra Leone, 250km inland, where a new road has made it possible to set up a processing plant for cashew nuts. Three years ago, it would have taken days to travel this 250km, and now it’s a matter of hours. All of these changes have a multiplying effect, including on demand, with an emerging middle class. It’s cheaper to employ people in India than in many African countries, which shows that the purchasing power is actually higher in Africa than in some other regions.
Moreover, with interest rates at zero, as we have in all major currencies, anybody who does asset allocation has got to start thinking about how to earn money on their capital, and emerging markets with growing economies are a good place to get a return on your money.