Despite buoyant market conditions, Middle East commodity exporters are struggling to get financing as banks look for maximum security in trade transactions. Melodie Michel reports.
While the Arab Spring has been catastrophic for North Africa’s economies, the Middle East’s commodity sector has been thriving. Due to the turmoil affecting their neighbours, the more stable governments in the region have refocused their efforts on internal production and investments, developing infrastructure and generally enhancing efficiency in the industry.
Moreover, the socio-political havoc shaking Libya led the country – the sixth petroleum producer in the region – to cut its oil output, creating a gap that has been filled mainly by countries of the Gulf Co-operation Council (GCC). In fact, the value of oil exports from the GCC reached an all-time high in 2011 at US$648bn, almost double from 2009 (US$341bn). And with Libya still topping the list of risky countries for 2013, the trend is set to continue.
Just as surprisingly, the financial crisis did not hit exports from the Middle East as much as it could have, the reason being that most commodity exports from the region go to ever-growing Asian countries, mainly Japan, China, India and South Korea.
Imre Gorzsas, assistant general manager, global transaction banking at Qatar National Bank (QNB), explains: “The Arab Spring hasn’t had a significant impact on the volume of the commodity flows in the GCC region as the key export products are crude oil, gas, oil products and petrochemicals. These commodities are mainly exported to Asia. The key markets for GCC countries are Japan, China and Korea and they haven’t really been affected by the Arab Spring and kept on growing almost constantly during the last decade despite of the global economic downturn.”
And while the discovery of shale gas reserves in the United States – the fifth biggest importer of Middle East oil – scared exporters, the effect on trade flows remains to be seen. Despite the country’s objective to reach energy self-sufficiency by 2035, the US energy department revealed in March this year that US oil import volumes reached a record in 2012, with 25% coming from the GCC – a nine-year high.
With relative stability in the oil sector, governments have been making efforts to diversify exports. Iron ore and aluminium trade has grown exponentially, and the GCC aims to become a trading hub for all sorts of commodities.
Qatar’s growing liquefied natural gas (LNG) production is helping the region diversify from oil exports. The country is now the second supplier to LNG-hungry Japan, accounting for around 15% of its imports.
In the UAE, the Dubai Multi Commodities Centre (DMCC) has implemented guidelines for the ethical trade of gold and diamonds, which resulted in a massive increase in volume and value.
Paul Boots, director, Tradeflow at the DMCC, tells GTR: “On the GCC side, what we are doing within the DMCC is trying to help Dubai diversify from the oil trade. We have a lot of efforts on the diamond and gold side, where we are working on a global standard around Dubai gold delivery, which helps traders assess the quality of gold.
“In 2002, when the DMCC was established, diamond trade was around US$5mn a year. Last year, Dubai did over US$30bn worth of diamond trade. So this shows how much it has grown with the support of the government and the DMCC to create an environment where diamond trade can flourish within the right regulations and the right infrastructure.”
On the re-export side, the DMCC has also launched the Dubai tea trading centre, helping global tea traders import goods into Dubai and increase their margins through added-value activities performed there.
And while experts agree on the fact that the Middle East is unlikely to become a strong agricultural producer, they acknowledge the potential of the region as a food processing and re-exporting centre, giving it scope to export value-added food products.
Security in financing
But despite a healthy commodity sector, Mena exporters are struggling to close trade finance transactions as the Arab Spring and the eurozone crisis, though virtually harmless for trade flows, have hampered banks’ appetite and pushed them to look for increased security.
As a result, bankers have observed a much wider variety of structures in the commodities market in the GCC, and the cost of transactions has gone up due to the possibility of default. Gorzsas points out: “Demand has grown in the region for secured import financing structures (under documentary letters of credits, standby letters of credits) in the last few years due to the combination of increased political and economic risk. This movement resulted in open account transactions and supply chain finance solutions offered by banks becoming less attractive.”
Demand for trade credit insurance (TCI) has also increased exponentially. AIG just expanded its TCI offering to the GCC, looking to capitalise on the demand for more security. The firm’s UK head of trade credit insurance, Will Clark explains: “While doing research on the region, we were surprised by the level of take-up, and the welcome we’ve had from brokers and bankers is very encouraging; they are telling us that we need a presence in this region.”
And as banks and corporates try to handle the opposing needs for security and flexibility, solutions previously unseen in the region are picking up. For example, the International Finance Corporation (IFC) is encouraging the use of warehouse receipts as collateral to facilitate access to financing. However, Shehzad Sharjeel, regional head, Mena at the IFC, warns that a regulatory framework is critical in establishing warehouse receipts and to reassure players on the safety of the procedure. “Unless you have a credible system, banks won’t trust you. Government bodies bring credibility to the warehouse receipt system,” she says.
In a similar move, the DMCC has launched Tradeflow, a commodities receipt service meant to reduce the financing risk for UAE traders. Boots explains: “It allows commodity traders to represent the ownership of their goods in a warehouse, with a legal document of title, the DMCC Tradeflow warrant, and they are able to pledge that warrant to a bank in return for working capital finance. These Dubai traders are now able to use their warehoused goods as collateral for a loan, which of course stimulates the liquidity.
“We’ve seen great growth in demand and have done over 170 of these pledges already, which was much more than what we expected.”
The local solution
Not only did the Arab Spring and financial crisis increase the need for security in trade transactions; they prompted the withdrawal of a lot of European liquidity from the market, leaving a gap that was partly filled by local banks through syndications.
QNB’s Gorzsas says: “The commodity prices have been increasing over the past couple of years so there is more need for financing, but regional banks are catching up with the global market; they are more inclined to provide funding not only just for local firms, but also to global companies involved in commodities business.” One example of this is the US$400mn loan signed between Trafigura and a consortium of Arab banks in October 2012.
Gorzsas explains that as traders are traditionally funded in US dollar, a currency that has become scarce in Europe, American and Middle East banks have taken the lead in the market. However, he believes the perception of Middle Eastern banks being ‘flushed with liquidity’ is somewhat erroneous: “There is a strong US dollar influx in the region coming from mainly oil and gas exports. Further to it, the aluminium export is also picking up, as well as steel and petrochemicals, but at the same time the growth of the region has increased the need for imports, which also require foreign currency funding. The foreign asset investment activity of the GCC sovereign wealth funds is also funded in foreign currency; therefore it’s important for regional banks to make sure that their balance sheets have adequate liquidity in foreign currency.
“There are also a lot of corporate and private individual investments from the region into other countries, mainly GCC firms acquiring assets from European corporates, so again there is a high need for foreign currency.”
The rise of local banks in commodity funding, combined with the need for more secure and flexible financing, has pushed Islamic financing to the fore, as shariah-compliant services match commodity trading requirements in their structure.
Krishnakumar Duraiswamy, head of trade finance at Abu Dhabi Commercial Bank (ADCB), tells GTR: “Whenever it is linked to commodity financing there is always a demand for Islamic finance. It’s easier to structure from the client’s perspective. The focus is on balance sheet, with banks taking over the inventory.”
Credit rating firm Moody’s has observed a lot of corporates diversifying their funding sources to tap into a wide area of debt instruments, including sukuk or Islamic bonds, and expects this to continue in the near future. Senior analyst Martin Kohlhase says: “Islamic financing will continue to grow. It also offers moderate yield pick-up compared to conventional financing, which is a plus for investors looking for extra yield.”
The International Islamic Trade Finance Corporation (ITFC) recently opened its first representative office in Dubai, in line with Sheikh Mohammed’s plan for Dubai was to become the global Islamic finance hub, and expects the number of Islamic finance transactions to double by 2015. “During the economic crisis, Islamic banking was proven to be sound and effective,” says ITFC deputy CEO Hani Salem Sonbol.
However, bankers in the market point out that a lot of Islamic banks are new to cross-border trade, making it difficult to set up bilateral partnership. Moreover, pricing and understanding of how the products are structured remain challenging, and there is a degree of uncertainty when it comes to the efficiency of shariah-compliant financing.
Gorzsas explains: “In the long run there is a big space for Islamic finance in the commodities market, because it is based on selling and buying the actual products, which is what trade finance is facilitating. So in the long run we expect more trade finance transactions using Islamic finance products in the region with local banks, but also on a global scale.
“The only question is that the global markets have limited experience with courts’ decisions on Islamic finance disputes, so there is a strong need to create international Islamic trade finance standards potentially with the help of International Chamber of Commerce (ICC) or other globally respected organisation. The opportunity is there, but there is a need to create the appropriate environment for Islamic finance in terms of making sure the corporates trust the structures, that there is legal enforcement and the appropriate ICC regulations and standardisation. This will take time but as a financing alternative, it’s really there. Islamic finance is over US$1tn already in terms of bank assets, so there is definitely a big space for it.”
Dubai: The Middle East’s Geneva?
Perfectly located between Europe, Africa and Asia, Dubai aims to become a major global trade hub, attracting commodity houses with a business-friendly tax system exempt of corporate and personal income tax.
Following various initiatives to raise Dubai’s profile on the global commodities market, the Dubai Multi Commodities Centre (DMCC), registered 2,033 new members in 2012, bringing the total number of businesses to 5,720. In parallel, the Dubai Chamber of Commerce and Investment saw its new membership grow by 20% to 12,733 in 2012, up from 10,634 in 2011.
But experts speaking at Exporta’s Middle East trade and export finance conference in February warned that the emirate still needs to overcome certain competitive disadvantages, particularly its high trade finance costs, in order to grow on the global scale.
V P Nagarajan, executive director of construction and engineering firm ETA Group, said: “Dubai has to compete against lower rates in Singapore for example, so there is a competitive advantage for companies there. If Dubai is to become the Switzerland of the Middle East, the cost of financing has to come down.”