Innovative forms of financing and their relevance for the Pacific region An introduction Regional UNCTAD workshop Nadi, Fiji, 18-20 September 2001
Structure Relevance Structured commodity finance: general principles Applications: Pre- and post-export finance Import finance Bringing finance closer to the producers
Producers Local traders Local processors Exporters actors Phases requiring finance Production Local storage Transport Storage of raw material Processing Storage of processed product Transport to port Pre-export storage Transport (CIF) Financing aspects in commodity exports Deferred payment by buyer Traditional providers of finance Producer Producer/trader Local trader Trader/processor Processor Processor/bank/exporter Exporter Bank/exporter Exporter/bank Local bank
What improvements structured finance provide? Longer-term, lower-cost finance, in several ways Credit at international rates, for a longer-term and at lower rates, revolving and for a larger part of the value of the commodities. Farmers can obtain affordable pre- and post-harvest credit Producers Local traders Local processors Exporters Production Local storage Transport Storage of raw material Processing Storage of processed product Transport to port Pre-export storage Transport (CIF) Deferred payment by buyer
Import finance, and finance on the back of other foreign exchange earnings Structuring techniques can also improve - the financing of commodity imports (e.g., oil products, cereals, sugar, fertilizers), or commodity-like imports (e.g., spare parts), or imports of equipment to produce commodities. - the benefits drawn from regular and predictable hard-currency revenue streams (e.g., fishing rights, overfly rights, landing rights, oilfield royalties, migrant remittances, tourists’ credit card payments, telephone receivables). - the ability to invest in commodity-related activities The Orogen model Orogen Capital market … with a structured finance boost Orogen Capital market SPV Assignment of part of export receivables or earnings streams
Development Bank In-country Off-shore Migrant workers Money Transfer Company Money Transfer Agency Agreement International Bank (arranger) US$ 40 million Acknow-ledgement of assignment of receivables Collection account Sighting account Debt Service Reserve account Orders for money transfer (hard currency) Debt service Debt Service Reserve Account build-up (over first 6 months) Assignment of all receivables from migrants’ remittances US$ 3 mn/month Surplus over US$ 3 mn/month Country risk can be mitigated through structured finance arrangements An example of using revenue streams – migrant remittances-based finance
Development Bank In-country Off-shore Tourists Credit Card Company Agency Agreement International Bank (arranger) Financing Acknow-ledgement of assignment of receivables Collection account Sighting account Debt Service Reserve account Credit card payments Debt service Debt Service Reserve Account build-up Assignment of all receivables from credit card payments Debt service Surplus Using revenue streams
Development Bank In-country Off-shore International Airline Companies Obligation to pay overfly rights International Bank (arranger) Financing Acknow-ledgement of assignment of receivables Collection account Sighting account Debt Service Reserve account Debt service Debt Service Reserve Account build-up Assignment of all receivables from airline companies Debt service Surplus Using revenue streams
Development Bank In-country Off-shore International Fishing Companies Obligation to pay fishing rights International Bank (arranger) Financing Acknow-ledgement of assignment of receivables Collection account Sighting account Debt Service Reserve account Debt service Debt Service Reserve Account build-up Assignment of all receivables from fishing companies Debt service Surplus Using revenue streams
Development Bank In-country Off-shore International Postal Companies Regular purchase of postage stamps International Bank (arranger) Financing Acknow-ledgement of assignment of receivables Collection account Sighting account Debt Service Reserve account Debt service Debt Service Reserve Account build-up Assignment of all receivables from postal companies Debt service Surplus … and so on…telephone receivables, landing rights, oilfield remittances, royalty payments... Using revenue streams
Through use of structuring techniques, financiers can control their level of risk Without secured/ structured finance: financier financier Potential borrower Potential borrower With structured finance: Will he reimburse? financier Potential borrower With secured finance: Will the collateral disappear? $ goods Will he produce?
The relevance of structured finance (1): shifting the risk Credit risk on the borrowing company Risk on another party, e.g., warehousing company Secured finance Structured finance converts credit risk into production risk, diversion risk and country risk.
Example - how would structured finance for Tonga’s squash exports look like? Past scheme Development Bank Exporters/input providers Farmers Reimbursement Input provision Request for inputs on credit Advice on credit provision Granting of credit for input provision Disadvantages - Serious credit risk - Weakening of bargaining position of farmers vis-à-vis exporters
Example - how would structured finance for Tonga’s squash exports look like? Past scheme Development Bank Exporters/input providers Farmers Reimbursement Input provision Request for inputs on credit Advice on credit provision Granting of credit for input provision Current scheme Development Bank Exporters/input providers Farmers Reimbursement Input provision Payment for inputs Disadvantages - Serious credit risk - Farmers without sufficient collateral do not have access to credit Credit provision
Example - how would structured finance for Tonga’s squash exports look like? Past scheme Development Bank Exporters/in-put providers Farmers Reimbursement Input provision Request for inputs on credit Advice on credit provision Granting of credit for input provision How could it look like with structured finance? Development Bank Exporters/input providers Farmers Reimbursement obligation Sale of squash; payment reduced by debt service Credit provision - 10% cash, 90% in the form of a ‘credit line’ for the purchase of inputs Development Bank Exporters/in-put providers Farmers Reimbursement Input provision Payment for inputs Current scheme Credit provision Request for inputs on credit Input provision Agreement providing credit lines for input supply, and exporters acting as collection agents of debt
The relevance of structured finance (2): The asset conversion cycle Commodities “ Paper” (e.g., warehouse receipts) Money To turn commodities into money, they need to pass through a financial transformation - they need to be replaced by “paper” which represents the commodities. Structured finance More
Example - revolving finance for fishermen and a fish processing plant more
A certain bank got a financing request from a fish processing plant in a small West African country. The plant processes fish bought from local fishermen and exports to reputable overseas buyers. The plant’s ability to export larger volumes is constrained by the limited supply from the fishermen. It therefore, decided to obtain bank financing to enable it make advances to the fishermen and thus boost their supply.
The request as presented contained obvious risks capable of scaring any financier, especially the fact that there is no guarantee that the fishermen will employ their advances judiciously. However, a closer look at the sector reveals that the major constrain for the fishermen is that they need diesel foe their boats and can only obtain this against cash payments. This cash limitation therefore hinders them from deep sea fishing for richer catches.
Further inquiry reveals that the fishermen take their diesel from two terminals, where they enjoy some subsidy. Investigations also indicate that it is possible to lease these terminals and thereafter recruit a reputable local bank to control the stocks.
This is a firm basis to provide financing. Oil import financing could be provided such that the fishermen would be provided diesel on credit and on delivery of fish to the processing plant, the cost of the diesel would be deducted from their payment. The processing plant thereafter exports the processed fish to the foreign buyers who pay into an escrow account created for the reimbursement of the oil import facility.
Obviously, there are still many details to be worked out, but there is a structure with strong incentives on all parties not to default.
Example - revolving finance for fishermen and a fish processing plant
Hedging often helps to improve financing Why manage price risk? Firstly, because it has a development impact. Oil price increases Oil import bill increase Pressure on the currency Pressure on the government budget Oil import rationing Crowding out of other imports Worsening of debt service capacity Increase in energy and transport costs Pressure on energy-intensive industries The terms of trade of farmers producing export crops deteriorates Public transport requires even larger part of the expenditure of the poor Social and political unrest
There are many ways to hedge price risk. The principal ones: - hedging on any of the established futures and options exchanges - entering into a risk management contract on the over-the-counter market - building hedging into physical contracting - building risk management into a lending programme. E.g., subsidized credit scheme Traditional Development Bank Farmers Development Bank Farmers Risk management market Subsidized credit at 5% interest Subsidized credit at 10% interest, but if prices fall, debt is forgiven Lay off price risk With risk management
Repo-financing involves the true transfer of inventory title from the customer to the bank. The bank becomes the owner of the commodities. The bank would normally be hedging its price risk using the futures markets. This can be done for any commodity for which:
a recognised futures exchange exists, and,
which are on ‘exchange warrant’, certificate, or other exchange equivalent and,
are therefore deliverable against an exchange futures contract in its current form.
The bank and the customer agree on a commercial trade transaction, whereby the bank buys from the customer a certain quantity of commodities for a fixed period.
The bank establishes a hedge in the relevant futures contract and delivery month, usually via an EFP (or other recognised exchange mechanism) with the customer.
Financing farmers: an overview Rural finance is risky. Many banks are therefore not keen on lending to farmers, and much of the lending done in the past has been by state-owned banks or under government instructions. Banks could use some form of security. This could be an outside credit guarantee (credit guarantees have been used in many past approaches), but could also be collateral. Immovable collateral (real estate, land) is often difficult to use – farmers do not have many fixed assets, and use of land as collateral is often impossible or difficult. One approach that has in recent years become of interest to developing country banks is the use of the commodities that farmers produce as collateral for loans. Such collateralized lending can have three components, that can be used separately, or can be combined: 1. crops still in the field as collateral 2. crops already produced as collateral 3. crop sales as collateral. Banks are generally unwilling to lend solely on the basis of crops still in the field (although there are exceptions, particularly for larger plantations). Apart from quantity risks, it will also be difficult for banks to take possession of the crops and sell them. Therefore, this form of movable collateral is normally used in conjunction with warehouse-receipt backed finance. Warehouse-receipt backed finance is the major form of lending against crops which have already been produced. Once crops have been produced, it becomes crucial for banks to actually control the stocks – diversion would otherwise be too easy. The standard method for doing so is the use of an independent warehouseman, who takes control over the crops, and assumes liability for their loss from the warehouse. The warehouseman will issue a receipt on deposit of the commodities into the warehouse (or upon his taking over control over the warehouse), and this receipt can be pledged to a bank. Without the bank’s cooperation, delivery of the commodities out of the warehouse should then not be possible. When these crops are sold they generate either immediate cash, or more commonly, a payment obligation by a trader (or processor). These payment obligations can, in themselves, be used as collateral (this is called “receivables financing”), but can also be used in conjunction with the other two forms of financing on the basis of movable collateral. Large traders could just acknowledge the assignment of their payments to the bank; in the case of smaller buyers, the bank could request the opening of letters of credit. If all three forms are used together, this provides a seamless system for agricultural financing right through to the farm level, with the bank reimbursed by payments from buyers. These could well be located in OECD countries; in such cases, the bank can raise hard currency for its loan, and on-lend to farmers with credit rates which are more closely related to the (fairly low) international rates than to the (often very high) local rates. Obviously, such an agricultural financing system has organizational, legal and regulatory requirements.