Global Trade and Commodity Finance: The Next Emerging Securitization Asset Class?

Abstract

There was approximately $18 trillion of cross-border trade in 2012. The volume of commodity trade is directly correlated with world population and generally retains a share of approximately 30% of total trade. Historically, commodities recover faster than any other sector in an economic crisis. Commodity trade finance is done in U.S. dollars and generally refers to three “families” of commodities: 1) energy, 2) metals and mining, and 3) “softs,” including grain, cotton, and various tropical products (e.g., palm oil and sugar). Critically, commodity trade finance focuses on logistics and not speculation. The commodities have already been sold, import and export letters of credit are normally established, and hedging and insurance are typically arranged. Relatively low-margin commodity trade financing has largely shifted from banks to capital markets as banks have been subject increasingly stringent leverage and liquidity coverage ratios. Withholding taxes, local taxes, and local bankruptcy laws are important factors in the planning of a multi-jurisdictional commodity financing transaction. Fraud risk, mitigated by strong client knowledge, is the biggest risk in commodity trade finance, followed by operational risk, especially involving export and import letters of credit; market risk, which can arise from transportation delays or broken contracts but can be mitigated through commodity hedging and advance ratios; country risk, which can be mitigated through hedging or insurance; and credit risk, which is mitigated by short tenors and the marketability of the underlying collateral.