Structured commodity finance involves financing international commodity trade, with market participants including financial traders, commodity producers, investment bankers, and risk management professionals. It is used when doing business with developing economies, with risks including political and economic tensions affecting product delivery. Financing is based on a company’s ability to honor an agreement to deliver products, and lenders must perform background checks to determine the likelihood of delivery.
Structured commodity finance is a complex way to obtain financing for international commodity trade. Market participants include financial traders, commodity producers such as energy companies and farmers, as well as investment bankers and risk management professionals. It involves trade in certain products, ranging from oil to metals and agricultural products. There are unique risks associated with structured commodity finance, although this exposure is what drives activity. A transaction may involve a party extending a financial loan to a developing nation in exchange for future delivery of some commodity.
This form of financing is generally used when a market participant is doing business with a developing economy. Risks include the possibility that, even after a loan has been issued, an exporting nation may not be able to continue to deliver the product due to political or economic tensions. This is a departure from traditional risk, which surrounds the possibility that a borrower may not be able to repay a lender financially.
In traditional forms of financing, access to capital may be provided based on the financial stability of the client. Commodity structured finance offers a different approach that instead focuses on a company’s ability to honor an agreement to deliver products. That track record, especially in adverse external conditions caused by a government or economy, can open the door to financing companies in developing countries that otherwise would never have been possible.
On one side of a deal in structured commodity finance is a lending institution. This bank typically designs structured products based on individual transactions. The party representing the other side of this transaction in a developing country could include an oil producer or farmer.
It is the responsibility of the lender to perform sufficient background checks to determine the likelihood of a delivery of products. Since a producer might operate in a nation where a financier does not have a presence, a third-party company might need to be involved to provide this assessment. Some of the conditions that can be evaluated include the realistic ability of a supplier to produce the proper allocation of products. The viability of the exporter’s operations must also be considered, including ensuring that a company has sufficient resources to compensate employees who deliver products.
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