Structured Commodity Finance – Does it Promote Growth?

1. NOT AN OFFICIAL UNCTAD RECORD 8th Africa Oil and Gas, Trade and Finance Conference Structured Commodity Finance – Does it Promote Growth? Paul Starling, Regional Head Africa, GSF-Commodity Finance April 29th, 2004

2. 8th Africa Oil and Gas, Trade and Finance Conference Itinerary • Structured Commodity Finance • Pre-Export Financing • Hypothesis • Analysis • Conclusion

3. 8th Africa Oil and Gas, Trade and Finance Conference Structured Commodity Finance • In Structured Commodity Finance (SCF) facilities, lenders tend to draw comfort, primarly from the commodity itself or from the revenues generated by the sale of such commodity. • Hence in SCF transactions lenders are ususally secured by a pledge over an already produced commodity or an assignment of the future receivables generated by the sale of such commodity. • SCF transactions are ususally closed-end and self-liquidating financing structures. Hence there is a given sequence of goods and cash flows which lead to the repayment of the credit.

4. 8th Africa Oil and Gas, Trade and Finance Conference Pre-Export Financing 1/4 • Pre-export financing facilities are one of the most commonly used SCF transactions. • Pre-export financing is based on the the pre-financing of the sale of commodities which are typically (i) not yet produced and (ii) will be sold to an export off-taker under contract. • The borrower is usually the producer and the exporter of the commodity in question. Typically, we find that there are a number of off-takers under contract to buy the commodity. • The lender is primarily secured by the assignment of the borrower/ producer‘s rights and benefits under the export contract, in particular the rights to the receivables.

5. 8th Africa Oil and Gas, Trade and Finance Conference Pre-Export Financing 2/4 • Conventional credit facilities are simply based on a credit agreement which state that the terms under which a borrower must repay its loan. Typically a borrower is expected to generate enough sales revenues such that after covering expenses, there is sufficient free cash flow produced, such that the loan can be repaid. Further all sales revenues are collected by the company (and hence the country in which it is domiciled) which is also responsible to manage these funds. • Pre-export financing facilities combine the features of commercial as well as financial agreements. The basic assumption is that the borrower/ producer has a strong commercial incentive to sell the commodity to a pool of off-takers. Failure to do so would materially harm the borrower.

6. 8th Africa Oil and Gas, Trade and Finance Conference Pre-Export Financing 3/4 • The assignment of the seller‘s rights under the export contract enables the lender to collect the receivables under the assignment and place the received funds into a Collection Account, which is usually assigned to the lenders. Repayment of the pre-financing are made from the Collection Account prior to repatriation of the funds to the borrower/ producer. • Such channelling of export proceeds mitigates (i) the transfer risk and (ii) the corporate credit risk of the borrower/ producer. • In a pre-export finance facility the loan will be repaid when (i) the goods are produced and exported and (ii) the off-taker pays for them over the given term of the financing. • Hence an SCF lender rather than focussing on the pure credit risk of the borrower will assess (i) the performance risk of the borrower (i.e. its ability to produce and perform under the export contract) and (ii) the payment risk of the off-taker (i.e. the ability of the off-taker to pay for commodities received under the export contract).

7. 8th Africa Oil and Gas, Trade and Finance Conference Pre-Export Financing 4/4 • In other words under pre-export financing a lender seeks to transform an unacceptable credit risk into an acceptable performance risk. • The lender relies not only on the incentive to a borrower/producer to repay a loan but also to produce and sell its products. • History has shown that this combination of financing as well as commercial incentives prove much more robust than in conventional credit transations. • Banks who understand this incentive scheme have managed to lend money to a large number of borrowers i.e. commodity producers) who would otherwise have had no or very restricted access outside finanicng.

8. 8th Africa Oil and Gas, Trade and Finance Conference Hypothesis 1/2 • Natural Resources • A country which is endowed with natural resources has the advantage that such commodities can be used to (i) supply the domestic economy and in addition(ii) export such excess commodities to generate export revenues. • Know How and Capital • In order to exploit natural resources a country has to build up or purchase the know how required to produce and deliver commodities to the international market. • Also it has to raise the financial means needed. • Production, Revenues and Profits • Once a country has successfully managed to produce and sell its commodities it will be able to generate profits.

9. 8th Africa Oil and Gas, Trade and Finance Conference Hypothesis 2/2 • Profits and Investment • Profits generated from the sale of commodities may be invested in the economy to (i) increase the production of such commodities and (ii) make investments in other parts of the economy. • Investment and Growth • More investment means more economic growth. • Growth and Wealth Distribution • Economic growth may lead to additional benefits for all citizens of an economy provided that the additional wealth created is distributed in an equitable way. • Hence more production and sale of a commodity will lead to more economic growth, provided that there is sufficient demand for such commodity.

10. 8th Africa Oil and Gas, Trade and Finance Conference Analysis 1/2 • A borrower should be able to raise SCF financing provided that • an on-going production of commodities exists and can be sustained over a given period. • there is a significant excess production of a commodity over domestic consumption • a strong dependency of the country on the receivables of certain commodities - Is it a one product country? • a significant external demand for such commodity. • If SCF finance is available it can be used to finance investments for the economy. • Being one of its key drivers such investments may generate economic growth.

11. 8th Africa Oil and Gas, Trade and Finance Conference Analysis 2/2 • Hence one of the crucial questions will be how efficient the monies raised under SCF financing schemes are used for investments. • Only efficiently used funds will translate into useful investments and hence economic growth.

12. 8th Africa Oil and Gas, Trade and Finance Conference Conclusion • SCF can provide a solution to financing in situations in which no other means of financing are available. • The responsibility of using the funds raised under an SCF financing efficiently cannot be taken away from the borrower. • SCF may help to induce further economic growth, but there is obviously no guarantees of its success. • Even if investments are chosen and executed in a way which induces economic growth this still leaves open questions with respect to the distribution of such newly generated wealth.

13. 8th Africa Oil and Gas, Trade and Finance Conference Conclusion • Since to what extend should commercial lenders be concerned with the use of funds borrowed from them? • Since economic growth does not necessarily mean equitable distribution of wealth should commercial lenders seek to influence the use of such funds?