To Be or Not To Be - or Why a Trading House Needs
Modern Financial Instruments
Close to three quarters of world merchandise trade in primary
commodities passes through several service providers. Most
Shamik Bhose is a commodity
commodity trade contracts are worth much more than the traders'
trader and Deputy General Manager
with Adani Exports. He deals in capacity to hold risk. Issues of capital leverage, risk transfer and credit
futures and physicals for soft access are thus of crucial importance to traders. The ways to deal with
commodities, including coffee, sugar, these issues are changing, due to the growing fragmentation of trade.
oils and oilseeds, and grains. His While resources in origin countries are being privatized, markets
work includes hedging on futures become more and more interlinked, leading to a growing need to
markets, risk control, and all compete and to carve out market niches.
elements of cash trading, such as
logistics and financing. He Commodity traders, like currency traders, are quick to perceive a
specializes in long-term contracts
change in conditions, and profit from it. However, traders' room for
and special purpose trades in these
commodities; such trades manoeuvre is largest when the macro-economic and political
incorporate trade finance or forfaiting environment is stable, which is not always the case. Then, in order to
as part of the structure, and the create workable arrangements for credit provision, price discovery, and
underlying commodity price risk and risk transfer, traders, transporters, bankers and insurance companies
currency risk are hedged. Shamik need to build structures which allow producers to receive a fair price,
writes regularly for KnightRidder, and consumers to pay not more than necessary.
Dow Jones Markets and the
Economic Times. In this respect, the conditions for
credit provision are very important. In today's trading environment,
Adani Exports Ltd. is India's largest
As traders need to leverage their credit providers worry seriously
trading house, and India's thirteenth
largest service company. It has seen own capital, most trade is financed about the risk of default, and
a compounded annual rate of growth through credit. In today's trading security on the credit has become
of 135% in the five years up to 1998. environment, credit providers essential: commodities,
The company has been given the worry seriously about the risk of
status of Superstar Trading House by default and, therefore, sufficient warehouse receipts, or forfaited
the Indian Government. Adani security on the credit has become documents.
Exports is engaged in commodity essential for commodity trade-
trade (soft commodities, minerals
financing banks, particularly in the form of commodities, warehouse
and energy), infrastructure
development, terminal operations, receipts, or forfaited documents.
transport services and allied
activities. It has a private port with Collateralized credit provides new options to reduce risk, facilitates
tank terminals, warehouses and price discovery, and helps to secure trust in the quality and quantity of
material handling systems. The goods offered for sale. Any commodity which is freely traded, and
company is diversifying into power preferably traded on an exchange, is potentially good collateral,
generation. Adani Exports is a especially if it is durable. However, this potential can only be realized
member of GAFTA, FOSFA, COFEI if the commodity is located in an environment which allows for clear
and other trade associations.
title. Furthermore, there must be the potential for risk transfer: the right
type of insurance needs to be available under reasonable conditions, and
sovereign risk, currency risk and commodity risk need to be
Companies in emerging markets need a system of determining such
risks and information on the best practices in managing them.
Inspection and collateral management companies can increase the
comfort levels of all involved, and they are indeed much used to allay
fears on particular aspects of commodity trade. Surveys like that of
UNCTAD on commodity price risk management instruments help to
improve awareness of the use of these market-based tools.
Adani Exports has found that one particularly effective way of
facilitating trade finance is forfaiting, which provides risk cover and
benefits both the purchaser of receivables (the forfaiter) and the shipper
(the exporter). Preshipment or even pre-production finance can also
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come through the forfaiting route. The debt instruments created are
traded in the secondary market as credit derivatives, and are used by
many banks to balance their credit profile and free up regulatory capital
for more effective use.
Commodity traders commonly use warehouse receipts-based financing.
Sometimes, commodities like coffee or crude oil which have not yet
been produced or processed can be assigned as collateral.
Warehouse receipts and the pledge of trade receivables are probably the
most practical ways of commodity financing, along with forfaiting
quality paper. If such finance can be hedged through futures or options,
then an even less risky long-term commodity transaction can be created.
A viable warehouse One-off structured financing deals, especially out of emerging markets
receipt-based financing and arranged with good counterparties, can also set the precedent for
system is a must for less structured forms of finance in the future.
A viable warehouse receipt-based financing system is a must for
emerging markets. Economies like Argentina, Brazil, China, India,
Indonesia, Russia, etc., which have a wide and large, but fragmented
agricultural and mineral sector, can benefit hugely. The receipts can be
a tool for investing, forward trading, and reducing interest rates,
particularly for small-scale players. The commodity movement, i.e.,
logistics chain, will benefit from wide use of warehouse receipts.
Market transparency, the legal security of contracting, and price
discovery will improve as well. If risk can be transferred or
The use of warehouse consolidated, it can be managed better. The whole commodity chain
receipts and pledges of can benefit from having a structure which enables the use of warehouse
receipts, and other uses of commodities as collateral. Unfortunately,
receivables has enabled State interference often impede the private sector from developing these
Adani Exports to refinance necessary mechanisms, in particular in emerging markets.
itself at a cheaper rate, and
for a longer tenor. The use Adani Exports has used UNCTAD's paper on "Collateralized
of futures markets allows commodity financing with special reference to warehouse receipts" to
make up its mind on the use of these instruments. Adani is now actively
greater flexibility in taking using futures contracts and approaches banks to offer finance against
positions. warehouse receipts and the pledge of receivables. This has enabled us
to refinance ourselves at a cheaper rate (compared to interest rates at
origin), and for a longer tenor. The use of futures markets allows us
greater flexibility in taking positions. Some of the financing acquired
can be used to provide for margin cover against the futures contracts.
Simultaneously, Internet e-mail has brought down our
telecommunications costs, and trading screens are providing us with
valuable information on a real-time basis. We have taken advantage of
our port terminal, logistical capacity, ideas on the arranging of freight,
Adani has been able to
and our local procurement abilities to create further assets. We have
add value by using banks, been able to avoid selling FOB or CIF, because we were able to
shipping companies, maximize potential and minimize risk by offering cargoes of
futures brokers, and tank agricultural commodities ex-warehouse in the consuming countries.
and warehouse operators Adani has been able to add value by using banks, shipping companies,
futures brokers, and tank and warehouse operators to go further down
to go further down the
the marketing chain.
Surprisingly, the risk was Surprisingly, we found that the risk was minimal (other than for fraud,
minimal. which can happen in any case): all the contractual obligations involved
in our going further down the commodity chain were transparent, and
enforceable. A GAFTA or FOSFA contract to ship soft oils or grains,
and a charter party document for freight provides one form of
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Protection, proper insurance, and proper documentation for the warehouse
receipts/pledge of receivables, as arranged by our banks in the consuming
countries where our commodities are stored, another. Daily reports through
Physical trade, shipping email and price benchmarking against listed prices on the computer screen
and warehousing, futures allow us to actively monitor our positions. By selling futures against a
and options, collateral and physical position, or a cash long position, we could convince our banks to
finance a greater percentage of a cargo's value. The underlying structures are
credit, Internet and trading solid, with only some risks if markets suddenly become extremely volatile.
screens, price discovery Physical trade, shipping and warehousing, futures and options, collateral and
and market research all credit, Internet and trading screens, price discovery and market research all
come together to create come together to create added value.
Companies in emerging markets can improve their possibilities to make use of
these modern financial instruments by a number of means. One is to form a
trade financing/forfaiting association, at an international level - similar to the
existing trade associations like GAFTA. The creation of a common
information web warehouse, or a databank on the internet, would also be of
much use. Note that, for example, the creation of the Bandx Exchange on the
internet has created the possibility to trade telecom band width (and in the
future, similar systems may enable the trade of customized weather options).
Traditional ideas and Such a web site can allow companies to browse for the best deals in
commodity financing, trading warehouse receipts, renting warehouse space and
practices have been swept so on. It could furthermore act as a central clearing house for all information
away by the fax, email related to commodity trade finance, posting factual histories of default and
and trading screens. A fraud, highlighting country risks, and allowing service providers and users to
web site can allow interact cheaply and effectively.
companies to browse for
It is no longer possible for traders and bankers to act in isolation. The futures
the best deals… markets have become more competitive: investment banks and hedge funds are
on the prowl looking for arbitrage possibilities, and they bring awesome fire
power to the trading floor. Traditional ideas and practices have been swept
away by the fax, email and trading screens. The information revolution has
made the market transparent and, in a way, is leading to a new "Global
Paradox": that of specialization versus consolidation. The new global
commodity trading environment gives room to small niche market players, but
Traders will also to large integrated companies. All are connected. Ultimately, a collection
increasingly have to of small, regional commodity futures exchanges will come up and connect with
make their profits by the established ones. National banks and insurance companies will merge; but
absorbing a larger part trading companies and trading banks will specialize. In this whole process, the
State is withdrawing from primary trading functions in all emerging markets.
of the value-added in
But what looks like a wild frontier today could be the genesis of a new horizon
the commodity chain. tomorrow.
Only the best can survive in the reality of a global market. The best need not
be the biggest, but size and reach do help. Large traders will fill the gaps left
by the withdrawal of the State and change the trading system by investing in
the integration of origin and final destination. In other words: they need to
master logistics, financing, and the various resources required for shipping and
marketing commodities. This is compelling traders to invest in assets, which is
a risky business. However, as these assets will be used to leverage future
earnings, good trade banks can provide financing solutions, such as structured
commodity bonds, or pre-export finance against specific production or
contracts as collateral.
Old value-added chains
have been destroyed. Those economies which do not tune into this reality are missing the paradigm
Pretending this change shift. Old value-adding chains have been destroyed; economies follow the
capital markets, not vice versa, while telecommunications, travel and
did not occur, and hang information have transformed commerce. The "Borderless World" is a reality.
on to old, fossilized Pretending this change did not occur, and hang on to old, fossilized systems,
systems, would be suicidal would be suicidal for emerging economies. The siren has already sounded -
for emerging economies. are all emerging economies paying attention?
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