Structured Commodity Finance

1
Structured Commodity Finance

• Commodity Futures Market in India
• Assocham, New Delhi
• July 14, 2005

2
Agenda
Why structured commodity finance ?
Commodity linked structures
Regulatory changes required
3
Agenda
Why structured commodity finance ?
Commodity linked structures
Regulatory changes required
4
Banks - Credit risk mitigant

• Standard credit facilities
• Exposure on balance sheet-real value of balance
  sheet?
• Performance of borrower
• Difficult to enforce banks rights
• Structured commodity finance
• Externalize the credit risk
• Commoditize the transaction
• No exposure to the balance sheet
• Relevant to new entities without track records

5
Borrowers structured funding

• Leverage the strength of commodity by using it as
  primary collateral
• Structured as off-balance sheet funding
• Structured pricing which is more attractive than
  normal working capital or short term loans
• Get financing in tranches aligned with stock
  build-up schedule
• Repayment schedule aligned with actual usage

6
Agenda
Why structured commodity finance ?
Commodity linked structures
Regulatory changes required
7
Warehouse receipt financing
Pledge of Stocks
Ware House Receipt
Conventional WRF- Upto 70
8
Warehouse receipt financing

• Warehouse receipt finance for commodity
  processing industry

Working capital needs for a processor without
warehouse receipt finance
Raw commodities awaiting processing
Commodities in processing pipeline
Processed commodities awaiting sale
Working capital needs for a processor with
warehouse receipt finance
Raw commodities awaiting processing Financed by
bank
Commodities in processing pipeline
Processed commodities awaiting sale Financed by
bank
9
Warehouse receipt financing

• Warehouse receipt finance can facilitate imports

Working capital needs for an importer without
warehouse receipt finance
Cereals, sugar, oil products, fertilizer in
transit
Commodities in central storage
Commodities in retail sites
Working capital needs for an importer with
warehouse receipt finance
Cereals, sugar, oil products, fertilizer in
transit Financed by bank
Commodities in central storage Financed by bank
Commodities in retail sites
10
When is warehouse receipt financing not possible?

• Commodity
• is perishable, or
• degradation in quality is possible
• Warehouse agent presents a credit risk for the
  Bank-do they offer performance guarantees or
  insurance bonds?
• Inappropriate licensing and monitoring systems
• Absence of adequate grades and quality standards
  for the commodity

11
Commodity price linked financing

• Financing corporates at rates that are linked to
  commodity prices. Eg.Aluminium price linked
  financing for an Aluminium producer
• The structure would help the corporate directly
  match his revenues and interest costs
• Corporate pays lesser interest rates when
  commodity prices fall and higher interest rates
  when commodity prices rise

12
Commodity price linked financing

• Benefits to
• Corporate
• Debt service payments proportional to revenue
  stream
• Reduces cash-flow volatilities
• Bank
• Reduce risk of corporate default (separate market
  risk from credit risk)
• Assured fixed return on the loans (though
  corporate pays floating rate linked to the
  aluminium prices)
• Improving asset quality

13
Fixed-to-floating swaps

• Transforming existing fixed rate liabilities into
  floating rate liabilities linked to commodity
  prices
• Corporates can take advantage of directional
  movements in commodity prices and reduce interest
  costs

14
Zero cost structures

• Corporate can enter into zero cost collar
  structures where it
• Buys put option at 90 of Spot (price protection
  level) and
• Sells call option at 125 of Spot (profit sharing
  level)
• Corporate can take advantage of fall in commodity
  prices but has to give up the upside of rise in
  commodity prices
• Bundled with WRF
• Can allow greater funding by Banks since value of
  collateral is protected

15
Agenda
Why structured commodity finance ?
Commodity linked structures
Regulatory changes required
16
Warehouse Receipts

• Negotiability/transferability issues
• Negotiable Warehouse Receipts Act being
  formulated
• Private warehouse receipts not funded due to
  credibility and lack of appropriate systems
• De-mat warehouse receipts
• Not recognized by Warehousing Act or Depository
  Act
• NCDEX-CSDL successful implementation

17
Constraints faced by Banks

• Restriction on commodity exposure by banks
• Not allowed to deal in commodity derivatives for
  hedging
• BR Act to be amended
• Options on commodities not allowed
• FCRA to be amended

18
Thank You