Structured Commodity Finance: Structured Commodity Finance Commodity Futures Market in India Assocham, New Delhi July 14, 2005


Agenda: Agenda Why structured commodity finance ? Commodity linked structures Regulatory changes required


Agenda: Agenda Why structured commodity finance ? Commodity linked structures Regulatory changes required


Banks - Credit risk mitigant: 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


Borrowers – structured funding: 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


Agenda: Agenda Why structured commodity finance ? Commodity linked structures Regulatory changes required


Warehouse receipt financing: Warehouse receipt financing Pledge of Stocks Ware House Receipt Conventional WRF- Upto 70%


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


Warehouse receipt financing: Warehouse receipt financing Cereals, sugar, oil products, fertilizer in transit Commodities in central storage Commodities in retail sites Working capital needs for an importer without warehouse receipt finance Cereals, sugar, oil products, fertilizer in transit Financed by bank Commodities in central storage Financed by bank Commodities in retail sites Working capital needs for an importer with warehouse receipt finance Warehouse receipt finance can facilitate imports


When is warehouse receipt financing not possible?: 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


Commodity price linked financing: 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


Commodity price linked financing: 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


Fixed-to-floating swaps: 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


Zero cost structures: 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


Agenda: Agenda Why structured commodity finance ? Commodity linked structures Regulatory changes required


Warehouse Receipts: 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


Constraints faced by Banks : 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


Thank You: Thank You