Trading houses continue to tap low-cost financing from Asia-based banks, whose commodity finance teams are seeing several key market changes, writes Kevin Godier.
The key paradigm related by John Corrin, global head of loan syndications at ANZ Bank, is one of major commodity firms across the globe actively looking to attract Asian domestic banks to be part of their banking groups, as they tap the Asian debt market for liquidity. “Major trading houses such as Wilmar, Mercuria, Trafigura, Ecom and Cargill flushed the market with large financings in 2013, when the average deal size for borrowings by commodity trading firms increased to US$1bn, versus US$640mn in 2012,” he says.
“Because the size of the business ebbs and flows with commodity prices, which have been lower in the last 12 to 18 months, this market is characterised by increasingly larger volumes, longer tenors and tighter pricing, supported by the abundant liquidity and oversubscription in most cases. And commodities firms are returning for refinancings in 2014,” he points out, citing Wilmar International’s move in March 2014 to increase its revolver to US$2.49bn from US$1.75bn “after 30 lenders piled onto the facility despite slightly lower pricing”.
According to Frank Wu, Deutsche Bank’s Asia Pacific head of structured commodity trade finance (SCTF), “there is unabated appetite for Asia exposure from traditional commodity banks, as Asia moves further onto the radar against a backdrop of rising risk elsewhere in the world”. Wu says a key physical trend is the import demand coming from China’s huge economy, despite its slowdown, followed by Japan and Korea, for commodities flowing from markets such as Australia, Indonesia and Mongolia, and led by base metals, iron ore, coal and agriculture products.
“Base metals still generate the lion’s share of the deal flow in the region, with a concentration in the copper markets and delivery in LME exchanges,” observes Thomas Horn, Hong Kong-based head of commodity finance at Barclays. “The search for higher returns has also led the market to seek more opportunities in the iron ore sector – and to a lesser degree coal – which has been facilitated by greater overall liquidity. From a client perspective, we continue to see medium-sized companies lead the market as the smaller companies are deemed too risky and the large companies are well funded at low, and in some cases, subsidised, rates.”
Among the most salient and observable market trends of the last couple of years, Horn lists an increasing interest in off-balance sheet financing through SPV structures, plus a move to less structured deals. Wu highlights that pockets of the market are nonetheless looking at SCTF deals. “Australia’s mining industry has been impacted by China’s slowdown, in particular the junior mining companies which once had access to clean bank loans and bonds. We have run into some keen interest as they have shifted to look at the STCF product.”
Corrin acknowledges that SCTF deals have been more of a European phenomenon: “The key behind structured commodity deals is to get people familiar with the structures. The Asian markets have tended to be more vanilla, but will undoubtedly see more SCTF business.”
At law firm Simmons & Simmons, which recently acted for lenders on an agri-financing, partner Dan Marjanovic notes that “use of STCF structures became more noticeable in Asia during the Asian economic crisis of the late 1990s, first as a way of getting working capital into companies during that credit squeeze and then subsequently used in a more conventional manner”.
He has also observed an increased use more recently of STCF structures to fund Australian commodities producers, in parallel with a move by some banks away from more complex commodity financing structures to more conventional structures. “This has created opportunities for more aggressive banks to come in with more structured products,” he emphasises. “However, commodity prices continue to be subdued and this has had a corresponding impact on overall deal flow,” Marjanovic adds.
The pullback by some investment banks from physical commodity trading has been well-documented. JP Morgan has sold its physical commodities business to Mercuria, for example, and Morgan Stanley has sold its oil business to Rosneft.
Conversely, one bank which has recently expanded its support to the commodity finance sector, Commonwealth Bank of Australia (CBA), has seen more buyers requesting settlement in Chinese yuan, and increased requests for up to 360 days settlement terms under letter of credit (LC), says Chris Boadle, head of global trade and transaction services, South Asia. “China continues to be the dominant buyer in the market. CBA has also set up a physical commodities trading desk in Singapore recently, looking mainly at base and precious metals and is actively supporting yuan-denominated transactions,” he says.
Asian export business
Wu flags up Deutsche Bank’s support for Chinese steel exports, in the form of a series of structured pre-payment financings for Tangshan Iron & Steel Group Company (Tangsteel), based around the company’s exports to Duferco Asia. “Tangshan operates the biggest steel mill in China. It was facing domestic over-capacity, so it took the export option, and has now secured three landmark financings totalling US$1.3bn from Deutsche Bank since 2012.”
The process began with a US$200mn club loan from a small group of banks in May 2012, under which Duferco acted as the exclusive offtaker of the finished steel products exported under the arrangement, and a 10% risk guarantor. Tangsteel then secured US$300mn in February 2013, adding more lenders, followed by a further US$800mn, eight months later. This deal, which carried a 24-month tenor, was provided by 11 banks, and was touted as the largest structured commodity trade financing facility ever completed for a Chinese company. “It shows that market appetite is plentiful for the right type of risk,” Wu underlines.
Other Asian commodity exporting markets that could require financing support include Mongolia: its landlocked character means China remains the sole offtaker of the country’s copious volumes of coal. “Funding is the key to expanding the minimal infrastructure that now exists, but coal is a low-value, bulk commodity, so Mongolia faces challenges in raising investment finance. Banks need to find innovative solutions for Mongolian mining companies,” stresses Wu.
Any financing mechanism would have to overcome land transportation issues, possibly by using a collateralisation arrangement,” he indicates.
Indonesia, meanwhile, is likely to need capital to build domestic processing facilities for its metals resources, Wu adds. “From January 2014, raw metals exports were banned, which is why the nickel price is rising this year. The government is looking to upgrade its own processing industries.”
Market observers see sufficient appetite among banks to cover the ongoing Asian commodity market needs. “There have been banks that have pulled out of physical commodity trading but not out of commodity trade finance,” says Calvin Tan, a Simmons & Simmons managing associate in Singapore. “The traditional European powerhouses have made a return to Asia, and they now find themselves in competition with the Asian banks such as the local Singaporean banks and the Chinese banks which entered the trade financing market post-2009 when the liquidity crunch hit. We have noticed banks opening or re-opening dedicated structured inventory financing desks in Singapore, or re-allocating personnel from Hong Kong to Singapore.”
The new entrants, according to Wu, include non-commodity players and all of the major Australian banks. “Furthermore, appetite in SCTF can now be seen among Chinese commercial banks such as China Minsheng Bank and China CITIC Bank, which are building commodity teams,” he says.
Corrin underscores that banks are now so involved in the market that 2013 transactions generated an average of 20 banks per deal. “Borrowers have consequently enjoyed tighter pricing. Cargill, for example, sealed a more than 100%-oversubscribed US$1bn 364-day revolver this year at a margin of 30bp over Libor with 23 banks. Last year it paid 55bp.” One driver, he explains, is the potential for cross-selling to the bigger names, addressing needs in areas such as trade finance, foreign exchange hedging and cash management.
Horn says that Barclays has observed a shift in the maturity of loans within the commodity finance loan market from a more than three-year average life just two years ago to a below three-year average life more recently. “Similarly, there appears to be a disproportionate amount of incremental new financing coming from trade finance departments of commercial banks, which typically cater to more short-term financing needs. The inevitable conclusion is that trade finance is encroaching on the turf of commodity finance, but this is hard to prove.”
Willem Klaassens, CFO at the Singapore-based Clearsource, which trades physical oil and non-ferrous base metals, is adamant that banks can still choose which customers to finance. “They have not seen the need to evolve in order to service different business. This will change however, as the commodity markets are changing,” he predicts. Klaassens says alternative funding providers have stepped in. “These days there are several alternatives to bank financing, in particular commodity traders which are financing producers or processors.” He cautions that “the costs of using these alternative financiers seem to be on the high side”.
Tan corroborates this option. “We see trading companies providing financing solutions to commodities producers where traditionally such solutions would have been provided primarily by banks. Being in the commodities business themselves, trading companies have a strong grasp of the operational issues and may be more flexible with the practical aspects of the structure.” Marjanovic says trading companies have been “an important additional source of direct funds in the junior commodity producer space”, adding that commodity and trade financing funds have also played a role in filling the funding gap faced by producers.
Wu notes that major commodity traders – such as Cargill, Noble, Trafigura or Glencore – have always had SCTF teams offering financing solutions to their supply chains. “They need commercial banks to raise their funding through revolving credit facilities, which continue to increase in size.”
Corrin says the trading houses may also need banks when they run into their credit limits against other traders. “They might ask banks to confirm LCs if they have become full on each other. One natural alternative here is STCF, while lots of these companies are looking to follow their peers such as Glencore in accessing new equity.”
Horn singles out two specific macro trends that, he believes, “are transforming the commodities industry generally and the commodity finance sector specifically”. Firstly, he cites the increased regulatory scrutiny upon the banking sector and the concomitant increase in capital requirements that result, adding that “the increased sensitivity to reputational risk” is a major accompaniment. “This is not to say that these macro trends are not justified or irrational, but it is undeniable that they are driving generational changes in the commodities industry.”
Tan’s view is that the tighter banking regulations “seem to have encouraged bank activity in the commodity finance sector as banks generally need to allocate less capital under regulatory requirements for structured inventory products”. Corrin agrees, and adds that, although Basel III capital requirements on banks will eventually lead to greater urgency in portfolio management and sales that is likely to increase secondary trading, this has not yet occurred. Asia Pacific secondary loan volume was down roughly 15% in 2013 from the previous year’s US$17.7bn.
Horn sees reputational risk as a major game-changer. “In general, based on my experience in the region, the returns on commodity finance deals are substantial enough to survive any increase in risk-weighted assets or capital. However, reputational risk has shifted the competitive landscape by pushing out or marginalising some players while at the same time making room for either new players to get in or existing players to expand their footprints,” he concludes.