Commodity Trade Finance: Challenging, exciting, and here to stay

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“Commodities are at the crossroad between geopolitics, financial markets, demography and economics. Understanding their dynamics provides a very useful key to understand the world we live in and its future.”

Jean-Francois Lambert is a key industry voice in the world of commodities. He is Founder and Managing Partner of Lambert Commodities and was previously Global Head of Commodity and Structured Trade Finance at HSBC. He teaches Commodity Market Dynamics at Sciences Po in Paris, authored the ICC Trade Academy course on Advanced Commodity Finance, and regularly speaks at London Business School. In this interview he gives a comprehensive introduction to commodity trade finance and explains why he thinks it is a brilliant career choice.

Q. What is commodity trade finance and how does it differ from other areas of trade finance?

Lambert: Commodity trade finance is not in form very different from so-called other areas of trade finance. The instruments used are by and large the same: letters of credit, stand-by’s, guarantees, payment undertakings, loans, and so on. The substance differs, for the risks are different: price volatility of the commodities or the fact that traders may not have as strong financial structures as the players in the manufacturing sector, notably the smallest ones. More scrutiny is therefore needed to assess, manage, and control trade finance applied to commodities.

Besides, there are some specific techniques used to support commodity flows: they are known as Structured Trade Finance and encompass notably pre-export financing, pre-payments, and inventory financing. In such transactions, one relies either on the performance of the various players on the supply chain. That can mean the ability to produce for a supplier, the commitment to off-take from a buyer, or it can depend on the sheer marketability and liquidity of the commodity, be that crude oil, cotton, or copper.

Q. Who are the main players in this industry? Will new technologies such as blockchain disrupt them?

Lambert: Two different questions: Not every bank is actively financing the commodity supply chains. The reason for this is that specific skills are required both to assess risks and manage them. A bank without such knowledge should simply stand aside of this business. The commodity savvy banks as I call them are a handful. However there is often a confusion made in this definition. Some banks are acting as principals in the commodity supply chains and are actually trading commodities. These banks are not necessarily the most actively financing the commodity supply chains. Goldman Sachs or Macquarie are good examples. Amongst banks financing commodity trades are most of the large European banks, most notably banks from the Netherlands (ABN AMRO, ING, Rabobank) and France (Société Générale, BNP Paribas, Natixis), large Japanese banks (MUFG), and Citi (from its European offices), as well as HSBC and Deutsche Bank. Some regional banks, notably in Singapore and Switzerland, as well as large Chinese banks also have a meaningful presence.

Blockchain will essentially contribute to streamline the paper process for both banks and trading houses. This is welcome as it will keep cost down and hopefully makes the document flow faster than the physical flow (which is not the case hitherto). Commodity trade finance as well as other forms of trade finance are enjoying slim margins and costs management through these new techniques is not an if but a when issue. Could blockchain techniques induce non banks to compete on trade? Sure, but in the commodity trade finance space, I am not convinced they can disrupt a market which is almost totally reliant on banks: a sugar trade requires $20 to $30 million per shipment. A crude oil trade requires $100 to $200 million a piece. Who is going to finance this besides banks? And would banks provide finance without access to ancillary revenues?

Q. Can you give an example of a typical transaction?

Lambert: A few examples:

1. A bank issues a $100 million letter of credit for the purchase of crude oil to Saudi Aramco, payable 30 days B/L.

2. A bank confirms the 60 days payment undertaking of a refinery purchasing crude oil from BP. It may also discount it without recourse.

3. Another bank finances stock of wheat under a tripartite agreement with a collateral manager.

4. A consortium of banks prepay the Ghana Cocoa Board for future deliveries of cocoa to large buyers under the assignment of these contracts.

5. A trader asks for the issuance of letter of credit to purchase steel. Financing is provided against the security of future contracts assigned materialised by export letters of credit.

Q. Banks are increasingly risk averse; Environmental, Social and Governance (ESG) considerations are also increasingly guiding their activities. Between rising geopolitical risk and a series of recent scandals by commodity producers and traders, will banks remain committed to financing commodities?

Lambert: I certainly hope and believe so! As mentioned earlier, commodity savvy banks are a handful but the good news is that their track record in managing risks is good. The expertise pays off.

These banks are in their comfort zone. Where this becomes more challenging is for newcomers or banks that do not understand the sheer dynamics of commodity markets. The odds that these get hurt and withdraw are high.

Commodity trade flows represent 20 to 25 percent of the global trade flows of goods. This is massive, but also completely strategic; without these 20-25 percent of trade supported, how much of the 70-75 percent would exist? Commodities are essential and I do not doubt that they will always be supported. Do we have a choice?

Q. What do you read to keep up with developments in the commodity markets?

Lambert: The Financial Times, Bloomberg, Reuters, and Capital Economics material form the core of my readings.

Q. What excites you the most about the commodities industry and what advice would you give to someone keen to learn more about it?

Lambert: To students I would say that commodities are at the crossroad between geopolitics, financial markets, demography and economics. Understanding their dynamics provides a very useful key to understand the world we live in and its future.

To young professionals willing to add value and interested by what is the most strategic for the world, I would suggest to consider joining a commodity firm. Markets are extremely transparent nowadays and price discovery is actually quite easy. One can get a very accurate price of a commodity at any time on a smartphone! Margins are slim. To actually generate money whilst bringing the commodity from origin to destination is not easy and requires incredible skills: one has to manage the physical dimension (logistics, costs, timing) as well as the financial market dimension to protect/enhance the physical trade. There are not many jobs requiring the mastering of sophisticated financial markets and the ability to negotiate commercial contracts and handle physical trade flows!