Trade Finance

Trade finance provides the instruments and services that enable companies to buy and sell goods across international borders. It primarily addresses the fundamental challenge in global trade: a seller’s desire for guaranteed payment and a buyer’s need for assurance that goods will be delivered as specified. By mitigating these risks and providing necessary funding, trade finance helps businesses expand into new markets and manage their working capital efficiently.

The Relationship: Commodity Finance, Trade Finance, and Structured Finance

A key distinction in modern finance is the relationship between these terms, which are often used in specific contexts:

• Commodity Finance is the broadest category, covering financial activities across the entire value chain for bulk raw materials like metals, energy, and agricultural products.

• Commodity Trade Finance is a subset focused specifically on financing the physical exchange of these commodities from a supplier to a buyer.

• Structured Trade Finance (STF) is another specialized subset. It applies tailored financing techniques, often for longer periods, to manage risks in complex transactions, frequently within commodity trade. Its core principle is structuring a deal around the value of the traded goods, inventory, or future receivables rather than relying solely on a company’s general credit rating.

Commodity Trade Finance: Structures and Approaches

Financing for commodities varies based on the borrower’s needs and the lender’s required level of control and security. Banks typically offer a spectrum of structures, as shown below:

Structured Trade Finance (STF) in Practice

STF is a self-liquidating, collateral-backed approach used to facilitate the movement of physical goods, particularly in sectors like oil and gas, metals, and agriculture. Traditional STF structures include:

• Pre-Export Finance: A loan to a producer (exporter) secured by the assignment of their future export contract (offtake agreement). Repayment comes directly from the export sales proceeds.

• Prepayment Finance: A financier provides funds to a buyer (offtaker), who prepays a producer for future goods. The goods are then delivered and sold, with proceeds repaying the financier.

• Warehouse Financing: Financing provided against commodities held in a secured warehouse, using the warehouse receipts as collateral.

• Receivables Financing: This includes forfaiting (selling a receivable at a discount without recourse) and invoice discounting (borrowing against invoices, typically with recourse to the seller).

Participants in STF must manage various risks, such as counterparty performance, commodity price swings, fraud, and political instability. They also navigate “recharacterisation risk,” where a transaction could be misclassified as a disguised loan subject to different regulations.

Letters of Credit: Current Types and Uses

Letters of Credit (LCs) remain a cornerstone instrument, with a bank guaranteeing payment to the seller upon presenting compliant shipping documents. Common types include:

• Irrevocable LC: Cannot be changed unless all parties agree.

• Confirmed LC: Includes a guarantee from a second bank (the confirming bank) in addition to the issuing bank.

• Transferable LC: Allows the beneficiary to transfer part or all of the credit to another supplier.

• Standby LC: Functions more like a guarantee, payable if the buyer fails to fulfill their payment obligation.

• Sight LC vs. Deferred Payment LC: A critical practical distinction. A Sight LC requires payment as soon as compliant documents are presented. A Deferred Payment LC specifies payment at a future date (e.g., 60 days after shipment), helping the buyer manage cash flow.