Martin Edwards has a 45-year banking / financing track record spanning Asia, Europe and the Middle East. Martin’s product specialisation is Commodity and Structured Trade Finance. He has 23 years of hands-on experience in this area and ran the Commodity and Structured Trade Finance business line in Asia for both J P Morgan Chase and Credit Agricole. He is based in Singapore and is also a Director of our affiliates GBRW Consulting and GBRW Learning.
Hin Leong and Agritrade – a tough Summer for trade finance
Corporate banking is not a simple field and Commodity and Trade Finance (CTF) banking is particularly demanding. It involves not only familiarity with general and specialist banking techniques and products but also a deep knowledge of the clients, and the markets for the products which CTF banks are financing.
This is not a business simply handled from an office. It requires hands-on client visits, inspection of stocks, processing operations and transport facilities conducted by well-trained marketing, operational and risk specialists working as a team.
Anything less than a fully committed and highly skilled operation risks exposing a bank (and therefore its depositors and shareholders) to an unacceptably high degree of risk, potentially large losses, and the severe business disruptions caused by having to deal with problem loans.
This is what CTF banks in Singapore are experiencing at present.
In the past five months, two major commodity traders - Hin Leong Trading and Agritrade International - have defaulted on facilities provided by 41 banks and totalling over US$4.5 billion amid rumours of fraud and forgery. Banks in Singapore are struggling to get to grips with an increasingly complex web of lawsuits related to CTF transactions and several international banks are either exiting or scaling back CTF activities.
In response a working group of about 20 banks has been formed to propose new guidelines to encourage best practices in Commodity and Trade Finance banking. This move is supported by the Monetary Authority of Singapore (MAS), together with Enterprise Singapore (ESG), the Accounting and Corporate Regulatory Authority (ACRA) and the Association of Banks in Singapore (ABS)
In fact, a combination of traditional and new factors is required to address the current situation.
The “Four Ks”
Firstly, banks should re-visit basic banking principles, the most important of which is KYC (Know Your Client). This core principle is at the heart of all good banking practice and is of vital importance when handling CTF banking, where there is a high scope for fraud, forgery, and concealment of trading losses (for example, in the futures markets).
To this must be added KTM (Know The Market) for the commodity the bank is financing. Price movements of commodities can often be volatile and the bank should be aware of the underlying market dynamics in order to assess whether the transaction that it is being asked to finance makes commercial sense, or if it represents too much risk for the company (and therefore the bank) to take on.
CTF banking products can be far more technical than a simple commercial loan or overdraft. Every CTF banker (both marketing and product specialists) must KTP (Know The banking Products). A bank’s product specialists are expected to have first class knowledge of the specialised instruments involved in CTF, such as Letters of Credit, Letters of Indemnity, futures and other derivatives. However, the Marketing Officers calling on clients and assessing transactions must also have a comprehensive understanding of these areas in order both to assess risk and to propose solutions which limit the bank’s exposures.
Many companies operating in this field finance transactions on a trade by trade basis, which means that they have a limited pool of available capital to absorb unexpected losses. In practice, banks engaging in CTF are often relying on the collateral of the underlying goods pledged and the associated purchase and sale contracts. The fourth K is therefore KTE (Know The Escape route). If the transaction goes wrong, and the bank is left holding the collateral, how can it sell this discreetly and quickly to repay the exposure without alerting the market to the bank’s situation (and depressing the price).
Visit, look, ask, listen, check, learn
As I have said above, good CTF banking is not done from an office. It involves frequent “rolled-up sleeve” visits during which the banker looks, asks, listens and learns. It involves investigating every link of a trade transaction from supplier to buyer via processing and storage (if these are involved). The chain is only as strong as its weakest link. The bank must identify the weak links and ensure that they will not disrupt the transaction and (ultimately) threaten repayment of its loans. That is the job of the CTF Relationship Manager supported by Product and Risk specialists.
“Front and Back Offices”
The most successful CTF banks have an integrated team of “front office” Marketing Officers and “back office” Product Specialists. Product Specialists will typically have years of product experience to draw on and will sometimes alert the team when something simply does not “smell right”: unusual terms of trade for the commodity concerned? An unusual origin or perhaps time of year for the trade to be taking place?
The New World
While nothing replaces hands-on practical experience, CTF banks are increasingly being helped by technology. The current Covid-19 pandemic has accelerated processes for reducing paper transactions. Blockchain is being embraced by banks as a way of tracking and validating transactions. Credit and cargo registries will help banks validate exposure and security. Artificial Intelligence is in some cases being used to review transactions and identify ‘unusual’ events.
Lessons from the current crisis
The credibility of the CTF sector will be restored through a combination of traditional principles and new technical resources. Technology will certainly help and must be adopted quickly. The key factor, however, is the human element; bankers working hard to understand and manage professionally the full range of challenges that CTF brings while focusing on the Four Ks.
The factors I have described above place a number of demands on expert witnesses and advisers in the CTF field. In many cases, both front office and back office experts may be required – many CTF problems are attributable to transactions “falling through the cracks” between these two areas. As the lawsuits proliferate, we anticipate an increase in demand not only for experts in banking practices, but also in the markets for petroleum and soft commodities, futures market hedging techniques and (a growth area in recent years) credit insurance products relating to CTF.