Commodity Traders: Market Outlook
Traditionally, commodity traders use two main sources of capital to fund their needs outside of their own cash reserves. These main sources are namely trade credit, the extension of payment terms from seller to a buyer or vice versa, and financing credit, usually in the form of revolving lines of credit, letters of credit and bank guarantees.
These traditional types of funding allow traders to have significant leverage on their balance sheet. And although, these sources of funding may be considered in the past as flexible and efficient, market crises have led to a shortage of liquidity in which commodity trading firms need it the most. Hence, the 2007 / 2008 financial crisis together with the European debt crisis in 2012 have intensified the fears of reduction in traditional source of funding. Moreover, in response to this uncertainty, trading firms have sought to diversify their funding sources. This search has been augmented by innovative technology supporting the movement, sale and financing of commodities.
Traders are shifting to alternative sources of funding rather rather than traditional banking institutions. In fact, in a report presented by Allen & Overy last 2016, it showed that 53% of traders have recently used alternative lenders while 47% have not. However, the remaining 47% expressed their interest in alternative lenders and said that they are considering this in the near future. These alternative lenders offer credit lines and other non-traditional financing.
One of the significant reasons for turning to alternative lenders has been their higher risk appetite which allows trading firms to remain competitive in the global market.
Although access to non-traditional source results in higher rates, many traders have seen the advantage of these alternative lenders. In fact, many commodity receivable securitizations have assets that are more liquid than the longer-dated liabilities funding them. The challenge in these structures is often less about liquidity risk and more about replacing the portfolio of receivables as they mature to ensure they do not carry excess cash.
Several banks are pulling away from trade finance to focus on core businesses which makes traders’ access to liquidity more challenging. However, with the rise of alternative lenders, we now see a viable solution which can support commodities transactions in the global economy.
References:
Birnbaum, A. (2017). The Rise of Alternative Financing Strategies: Trade Receivables Securitization – Brown Brothers Harriman. Retrieved March 7, 2019, from https://www.bbh.com/en-us/insights/the-rise-of-alternative-financing-strategies–trade-receivables-securitization-23516
Commodity Finance Market Report – Allen & Overy. (2017, May 03). Retrieved March 5, 2019, from http://www.allenovery.com/SiteCollectionDocuments/Commodity_Finance_Market_Report_May_2017.PDF
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