Commodity markets provide tools for producers, processors, and traders to manage price risk. [1] Structured finance techniques help transfer risks from parties less able to support risks to those more equipped to do so. [2] Key hedging tools include futures, options, and swaps traded on exchanges or over-the-counter. [3] While these tools can effectively hedge price exposure, their use also brings complexity, margin requirements, and other challenges.

1. Commodity
Financial and Risk Management
Iwan Budhiarta
Commodity Trading Adviser
Malaysia, Dec 2011

2. I. Commodity finance
• Introduction
• Traditional finance vs Structured finance
• Examples

3. Introduction: access to finance in
commodity trade and development
• Importance of the commodity sector for developing economies and
financial constraints:
- Over 2 billion people are estimated to derive their livelihood from
production and trade of commodities;
- More than 50 developing countries and LDCs depend on three or less
leading commodities for at least half of their export earnings.
• Commodity trade and production is credit-intensive.
• Risks in commodity finance.

4. • Traditional finance (balance sheet based) vs
Structured finance (transaction based)
Economics, and political events that have global implications, especially in
emerging markets, have compelled financiers to develop and adopt innovative,
structured financing techniques to mitigate their risks and adapt to globalization
and privatization of commodity trading activities.
- Until the onset of the Latin American financial crisis in the mid-80s, banks involved
international commodity finance relied on balance sheet lending and government
guarantee.
Structured finance, on the other hand, is based on the transaction for which the
finance is provided.
- Such techniques aim to transfer risks in financing transaction from parties less
able to support those risks to those more equipped to support them in a manner
that ensures automatic reimbursement of advances from the underlying assets
such as inventory and export receivables... This forms the pillar of structured trade
finance.

5. Through use of structuring techniques,
financiers can control their level of risk
Without structured With secured With structured
finance: finance: finance:
financier financier financier
Will the How to Will the
borrower $ control borrower $
reimburse? collateral? produce?
Potential Potential Potential
Goods Offtake
borrower borrower borrower
r

6. Practical use of structured trade finance:
There are no distinct standardized types of structure trade finance
transactions since one essential principle of these transaction is the
ability to tailor a structure that will satisfy the needs and
circumstances of all parties involved, provided that perceived or real
risks are mitigated. We are going to present some basic forms of
structured finance, their concept, and transactions flow.
1. Export receivables-backed financing
2. Supply Chain finance
3. Warehouse receipts finance

7. Success Factors Along The Value Chain
Transport
Transport
Manufacture/
Storage
Storage
Agri Agricultural Agricultural Commodity Further Wholesale/
Value Chain Inputs Production Sales Processing/ Distribution
Packaging
Financing Production /
Trade / Export Wholesale
Stages Processing
• Local producers & processors;
• Local producers & processors •Small commodity traders • Local distributors
Agri • Commercial farmers;
•
•Commercial farmers •Large commodity traders • F & B ultinationals
m
Players • International input suppliers. suppliers
•
International input • Wholesalers.
Producers Commodity Buyers
Processors Traders
• Input financing; • Working capital;
•
Working capital/liquidity; • Trade finance;
• Working capital/basic cash • • Price risk management;
Structured trade finance
Financing • Crop risk management and collateral management, • Structured finance:
Needs weather insurance • etc.;
Price risk management; receivables-back finance, pre-
• Structured finance: payment etc.
• Foreign exchange. • Foreign exchange.
WRS/inventory based finance,
etc..
Pre-shipment finance Post-shipment finance

8. Export receivables-backed financing
This model entails the provision of pre-export loans or advance
payment facilities to an exporter, with repayment being obtained
from the exporter’s receivables resulting from the sale of the pre-
financed exported commodities.
Under this model, banks take the following combined measures:
(a) Taking security over the physical commodities in the form of a
local-law pledge or similar security interest;
(b) Assigning the receivables generated under the commodity
export contracts;
(c) Establishing an escrow account in a suitable (usually offshore)
location into which buyers of the commodity are directed to pay the
assigned export receivables.

9. EXAMPLE: Receivable-Based
Financing
1. Underlying transaction: To trade naphtha
and crude oil.
2. Lender: XYZ Bank.
Shipment Buyers (Oil
3. Facility Amount: US$ 50 million for credit Exporter
Refineries)
facility.
Letter of
4. Exporter: Oil company Acknowledgment
Letter of Undertaking
5.. Importers: oil refineries worldwide. (remedial procedures in
Payment at case of non-performance) Payment after
7. Tenor: 30-90 days from B/L date. shipment 30-90 days from
B/L date through
8. Collateral: Outstanding account an escrow
receivables. account
XYZ Bank
Assignment of
9. Facility Period: 1 year. contract/A/R etc..
10. Each transaction amount: Over US$5
million.
This financing is given to the exporter once goods are shipped and repayment is done
automatically by importer through an escrow account.
This creates an automatic reimbursement procedure.
This enables exporters to use future trade flows to raise self-liquidating export-based financing
at better cost and tenor. It also enables financiers to externalize country and credit risks by the
assignment of export contracts and receivables, and by receiving payment in an offshore escrow

10. Example - revolving pre-export finance for fishermen and a fish
processing plant
Foreign
Local Monitoring bank
bank Loan used
for buying oil
Diesel oil
Reimbursement
Diesel
Processor/
Fisher
Fish freezing Fish Foreign
men
plant buyers
Fish
Local
market

11. A simple warehouse receipt finance scheme - open to various depositors. This
can act as a model to reach farmers - who are often willing to pay high interest rates.
4. Provide credit
3.Lodges receipts with bank
Farmer Banks
1. Deposits
products
5.Signs sales
Guarantee, insurance,
contract
2.Issues Warehouse etc.
receipts Guarantee
9. Delivers
agencies
receipt; Approves
warehouse Warehouse Government
makes delivery
Trader regulator
6. Reimburses credit; in return, bank transfers receipts

12. An example of using a collateral manager to finance
South-South trade
Acceptable payment will
allow rice to be released
Bank
from import warehouse
Payment when goods enter
into warehouse controlled by
the collateral manager
Rice Rice
Warehouse Warehouse
exporter Importer
Collateral manager takes full control from moment on that
goods enter export warehouse, until release (as authorized by
the bank) from the import warehouse. The bank will have
recourse to him for most losses during this period.
Collateral management Collateral
agreement manager

13. Commodities will increasingly
become a financial asset – any
commodity will be like a Commo-
Money
currency. dities
Financial markets will develop
around these new “currencies”.
Independent entities will be
doing the leg work to convert
commodities, as they move
through the value change, into
financial assets. “Paper”
Technology will link it all
together – through a Global
Commodity Receipt system.

14. WRS in Tanzania
- The CFC funded Coffee and Cotton marketing development project which
was launched in 1999.
- Tanzania has passed a Warehouse Receipts Act (2005) and Warehouse
Regulations (2006),
- and has designated a Licensing Board in the Ministry of Industry, Trade and
Marketing
-This has registered some 20 warehouses (12 for cashew, 5 for coffee, 2 for
cotton and 2 for paddy rice), and plans to establish a fully-fledged licensing
regime.

15. WRS in Tanzania
Commodities Finance includes:
- Traditional crops (coffee, cotton) has expanded their loans portfolio at
ground level.
The WRS has taken off with coffee since the latter 90s and 25% - 30% of the country’s exports
are reported to pass through the system, much of it supplied by POs (farmer business groups,
primary cooperative societies etc.) that bulk on behalf of their members.
- Non traditional crops such as Paddy (MF-linked approach, with upward of
10,000 tonnes being stored by farmers per year), Maize and sunflowers are
recognized and getting finance from the bank.
- Cashew nut WRS initiative emerged in 2007. More than 168 primary
cooperative societies in cashew nuts sub sectors are financed in in the
business of raw cashew nuts. Total loan portfolio in cashew nuts WRS finance
exceed U$50 million.

16. II. Price risk management
• Describing briefly organised and over-the-
counter markets
• Hedging tools

17. Hedging
Market used for risk management is divided in two part
Market used for risk management is divided in two part
Commodity Over-the-counter
exchange market
Although the basic ways to use these tools can easily be learned, hedging strategies can
become quite complex.
{
The need to pay margin deposits/guarantees
Even with a good mastery of Margin calls, which could be required, and which
these instruments, some can be high
difficulties exist, due to:
The fact that in some countries, intermediaries do not
really exist, or even use of these markets is banned

18. Tools for Commodity Risk Management
• Specification of price or minimum price in contracts
for sale of commodities by farmers or processors at
future date
• Forward and futures contracts
– Forward contracts negotiated on individual basis
– Futures contracts specified on commodity exchanges
– Options is right and not obligation to purchase or sell a
commodity at a a ”strike” price on or before a specified
date – pay a premium at time contract signed

19. Concept of price risk management
Financial markets provide possibilities to hedge against price risks. These
hedging instruments are:
Futures
Options (put, call)
Swaps

20. Futures
Futures are kind of standardised contracts for future delivery of an asset (that could be
commodity). There are:
Helpful to Useful for some An ideal
hedge price risk marketing benchmark
exposure strategies price
Lock-in a future price Initial position can easily be reversed Give a good benchmark
price to barter
Protect the value of inventories Delivery is not necessarily implied
or finance storage
No need to negotiate contract
specifications
These kinds of contracts are regulated by exchange’s authorities, and there execution are guarantee by
clearing houses.

21. Differences between Forward and Futures Contracts
Forward Contracts Futures Contracts
Most are traded OTC Are traded on organized exchanges
through clearing houses
Can be tailor-made to match specific Have standardized contract terms
hedging needs
Require cash transfer only at maturity of Require initial transfer for margin
contract payments and may require daily
settlements to adjust margins to adverse
price movements
Involve a high degree of counterparty risk Imply very little counterparty risk because
because no clearing house facility exists the clearing house guarantees the
fulfillment of contractual obligations
Contain the expectation of physical Only a small fraction of futures contracts
delivery result in actual delivery of the underlying
commodity

22. Options
Options contracts give the right (but not the obligation), to purchase or sell a specific asset at a
predetermined price on or before a specified date. There are two kinds of options contracts:
Call option Put option
US call: the right to buy at any time US put: the right to sell at any time
during the period. during the period.
European call: the right to buy, but only European put: the right to sell, but only
at the end of the period. at the end of the period.
Main use are for:
Obtaining short- Part of Protection against
term finance marketing unfavourable price
strategy movements
An over-the-counter In regard of longer-term Limits the size of the maximum loss but
financing trade relationships do not eliminate the opportunity to take
advantage of favourable price movements

23. Swaps
A swap is a purely financial instrument under which specified cash-flows are exchanged
at specified intervals.
Obtain easier Lock in long-
Guarantee and cheaper term prices
income streams access to capital
From financial operations or No or less-strict margin calls Long term instrument
new investments
Low administrative costs once Combination of price
structured hedging and investment
securization
Tailor-made
It should be noticed that swaps are purely financial tools, which means that no delivery of physical
are requested.

24. Coffee Cooperative in Tanzania
• Multiple payments to farmers throughout the year
– Minimum price when deliver coffee
– Supplementary payments based on price at which coffee
sold on world market
• Risk to cooperative of setting initial price
– Too low, farmers sell elsewhere
– Too high, lose money
• Mitigated through hedging in futures market

25. The practicalities of
risk management: the
markets

26. Commodity exchanges
Commodity exchanges are financial organised market Main Commodity Exchange around the world:
where commodities are traded on standard contract. Main Commodity Exchange around the world:
There exist a several commodity exchanges around Chicago Board of Trade (CBOT)
Chicago Board of Trade (CBOT)
the world, each place trading a certain part of New York Mercantile Exchange (NYMEX)
New York Mercantile Exchange (NYMEX)
commodities. Coffee Sugar and Cocoa Exchange (CSCE)
Coffee Sugar and Cocoa Exchange (CSCE)
New York Commodity Exchange (NYCE)
New York Commodity Exchange (NYCE)
Commodity exchanges provide London Metal Exchange (LME)
London Metal Exchange (LME)
International Petroleum Exchange (IPE)
International Petroleum Exchange (IPE)
Standardised contracts London Commodity Exchange (LCE) MATIF
London Commodity Exchange (LCE) MATIF
(Paris)
(Paris)
Strict controlled financial streams
Efficient market (due to the As shown, main commodity exchanges are located in USA
normally great volume of trade, and UK. There are the most efficient and can therefore
clear information, control...) provide good international benchmark prices for the
commodity they trade.
Good international benchmark
prices for the traded commodities
Secured trade

27. Over the counter market
The need for more sophisticated and specific hedging instrument has lead the over-the-
counter market to be more and more used. This is mainly due to the fact that this kind of
market provide:
direct interaction between client and intermediary (bank,
trade house, brokerage firm…)
contract uncontrolled by a clearing house
tailor made contract
long term hedging instruments
Nevertheless, it should be paid attention to the following fact:
this market is not transparent
once entered into a transaction, it is very difficult to reverse
margin are not about to decrease, since contracts are not
standardised (i.e. intermediaries try to keep contract highly
tailor made then not competitive).

28. Thank you
Iwan B.,
CTA, CPM, Dipl.FP, BBA, MSc(Strat), MEng
wealthmanagementadvisor@gmail.com