Financing of the commodity traders at risk

The world's banks' funding of commodities trading is drying up at a rate not seen in more than 20 years and is the greatest threat to small and medium-sized businesses, according to banks and trade sources.
Many banks are pulling back after the coronavirus crisis led to the failure of some trading houses, which are also contract brokers for oil, metals and agricultural goods and connect producers and end users. A number of cases of fraud have been discovered. This week, the Dutch bank ABN Amro ABNd.AS, one of the largest commodity trade financiers, gave up its business after the bank became one of the worst hit by the insolvency of Hin Leong, one of the largest oil traders in Asia, in the amount of 3.8 billion US dollars -Dollar Affected. That happened over and over again, but now the pendulum is at an extreme that hasn't been seen since the late 1990s.
About 80% of world trade is brokered through trade finance, which covers credit mostly in the form of a letter of credit (LC), which is crucial for the movement of goods from wheat to gasoline and which reduces the risk of payment for counterparties when goods change hands.
Credit facilities allow traders to juggle multiple transactions, but as competition between banks declines, the cost of borrowing will increase for trading houses, which typically have high levels of indebtedness and rely on trade finance.
Large banks looking to reduce exposure to trade finance are likely to prefer lending to established large independent dealers. Smaller players will likely find their options limited and their borrowing costs increased as they are forced to turn to tier two banks.
"Exiting banks will create a massive black hole for small traders and increasingly put the oil market in the pockets of the big ones," said a senior oil industry source.Trade and banking sources say other ABNs may follow suit and that some banks have frozen pre-existing lines of credit, letters of credit and new business.
Large traders have been users of revolving credit facilities (RCFs), where a syndicate of banks allows a company to borrow repeatedly up to an agreed maximum threshold. However, banks do not like these loans as they are not only cheap for the borrower but also unsecured and have short terms of usually no more than a year that need to be renewed.
"ABN was not an individual failure, it was a market failure," MacNamara said, adding that traders had pushed for cheap, unsecured RCFs at a time when commodity financing was inconsistent with forward-looking accounting modeling regulators. The outsourcing has undermined the experience of back and middle office employees at banks, which are crucial for issuing checks in less transparent emerging markets.
While traders said the loss of a line of credit was not felt now as many were boosted by record quarters this year due to the extreme volatility in oil prices, others believe the pain will come later as commodity prices recover and credit line usage increases .
Trading houses usually only use 50-75% of their bank lines of credit, leaving a cushion in case commodity prices rise. "The RCF pool is getting smaller and costs are going to rise. We saw a Covid-19 premium in the last round," said a senior natural resources banker. RCFs have short terms, typically no more than a year, and must be renewed on an ongoing basis. As a result of the coronavirus crisis, banks have asked for higher interest rates.
Asian banks are unlikely to be able to fill the funding gap left by European lenders, who have dominated the business for years, as they are unable to handle the volume. Some traders are now looking for special funds.
"If existing or new banks don't fill the void, trade finance funds could be added ... We'd love to have a fund if they have a good risk appetite," said Siva Pillay, CEO of metals trader Ocean Partners.
However, funds often fail to cover all of the trade finance needs like LCs, Pillay added, and would be better suited to cover transactions that regular banks consider riskier, and therefore justify higher interest rates. Typically a fund has a handful of people involved in trade finance and therefore lacks the bandwidth to monitor many loans.
Depending on how many banks are giving up or cutting back on their commodity funding, even large traders are not immune and may propel those with assets into the capital markets. But even this would not be enough to close the entire gap.
"The volume of the bank lines is so large that a trading house cannot replace them with bonds under any circumstances," said Jean-Francois Lambert of the consulting firm Lambert Commodities.Bankers are already facing further regulation, with new requirements likely to have unintended consequences, even though they do not focus on trade finance. Basel IV seeks to standardize how banks calculate risk-weighted assets in order to protect them from losses. According to bankers, this makes raw material financing even less attractive.

Hansa Terminhandel GmbH
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