Innovative forms of financing

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Innovative forms of financing and their
relevance for the Pacific region An
introduction
Regional UNCTAD workshop Nadi, Fiji, 18-20
September 2001
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Structure
Relevance Structured commodity finance general
principles Applications Pre- and post-export
finance Import finance Bringing finance closer
to the producers
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Financing aspects in commodity exports
actors
Phases requiring finance
Traditional providers of finance
Deferred payment by buyer
Local bank
Transport (CIF)
Exporter/bank
Pre-export storage
Bank/exporter
Transport to port
Exporter
Exporters
Storage of processed product
Processor/bank/exporter
Local processors
Processing
Processor
Storage of raw material
Trader/processor
Local traders
Transport
Local trader
Local storage
Producer/trader
Producers
Production
Producer
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What improvements structured finance provide?
Deferred payment by buyer
Longer-term, lower-cost finance, in several ways
Transport (CIF)
Pre-export storage
Transport to port
Exporters
Credit at international rates, for a longer-term
and at lower rates, revolving and for a larger
part of the value of the commodities.
Storage of processed product
Local processors
Processing
Storage of raw material
Local traders
Transport
Farmers can obtain affordable pre- and
post-harvest credit
Local storage
Producers
Production
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Import finance, and finance on the back of other
foreign exchange earnings
Structuring techniques can also improve - the
financing of commodity imports (e.g., oil
products, cereals, sugar, fertilizers), or
commodity-like imports (e.g., spare parts), or
imports of equipment to produce commodities. -
the benefits drawn from regular and predictable
hard-currency revenue streams (e.g., fishing
rights, overfly rights, landing rights, oilfield
royalties, migrant remittances, tourists credit
card payments, telephone receivables). - the
ability to invest in commodity-related activities
with a structured finance boost
The Orogen model
Assignment of part of export receivables or
earnings streams
Orogen
Orogen
SPV
Capital market
Capital market
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An example of using revenue streams migrant
remittances-based finance
Off-shore
In-country
International Bank (arranger)
US 40 million
Debt Service Reserve account
Debt Service Reserve Account build-up (over first
6 months)
Acknow-ledgement of assignment of receivables
Assignment of all receivables from migrants
remittances
Debt service
Collection account
Sighting account
US 3 mn/month
Surplus over US 3 mn/month
Development Bank
Money Transfer Company
Money Transfer Agency Agreement
Orders for money transfer (hard currency)
Country risk can be mitigated through structured
finance arrangements
Migrant workers
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Using revenue streams
Off-shore
In-country
International Bank (arranger)
Financing
Debt Service Reserve account
Debt Service Reserve Account build-up
Acknow-ledgement of assignment of receivables
Assignment of all receivables from credit card
payments
Debt service
Collection account
Sighting account
Debt service
Surplus
Development Bank
Credit Card Company
Agency Agreement
Credit card payments
Tourists
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Using revenue streams
Off-shore
In-country
International Bank (arranger)
Financing
Debt Service Reserve account
Debt Service Reserve Account build-up
Acknow-ledgement of assignment of receivables
Assignment of all receivables from airline
companies
Debt service
Collection account
Sighting account
Debt service
Surplus
Development Bank
International Airline Companies
Obligation to pay overfly rights
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Using revenue streams
Off-shore
In-country
International Bank (arranger)
Financing
Debt Service Reserve account
Debt Service Reserve Account build-up
Acknow-ledgement of assignment of receivables
Assignment of all receivables from fishing
companies
Debt service
Collection account
Sighting account
Debt service
Surplus
Development Bank
International Fishing Companies
Obligation to pay fishing rights
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Using revenue streams
Off-shore
In-country
International Bank (arranger)
Financing
Debt Service Reserve account
Debt Service Reserve Account build-up
Acknow-ledgement of assignment of receivables
Assignment of all receivables from postal
companies
Debt service
Collection account
Sighting account
Debt service
Surplus
Development Bank
International Postal Companies
Regular purchase of postage stamps
and so ontelephone receivables, landing rights,
oilfield remittances, royalty payments...
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Through use of structuring techniques, financiers
can control their level of risk
Without secured/ structured finance
With structured finance
With secured finance
financier
financier
financier
Will he produce?
Will the collateral disappear?
Will he reimburse?

Potential borrower
Potential borrower
Potential borrower
goods
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The relevance of structured finance (1) shifting
the risk
Credit risk on the borrowing company
Risk on another party, e.g., warehousing company
Structured finance converts credit risk into
production risk, diversion risk and country risk.
Secured finance
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Example - how would structured finance for
Tongas squash exports look like?
Past scheme
Advice on credit provision
Development Bank
Exporters/input providers
Granting of credit for input
provision
Request for inputs on credit
Input provision
Disadvantages - Serious credit risk - Weakening
of bargaining position of farmers vis-à-vis
exporters
Reimbursement
Farmers
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Example - how would structured finance for
Tongas squash exports look like?
Past scheme
Current scheme
Advice on credit provision
Development Bank
Exporters/input providers
Development Bank
Exporters/input providers
Granting of credit for input provision
Request for inputs on credit
Payment for inputs
Input provision
Input provision
Farmers
Reimbursement
Farmers
Reimbursement
Credit provision
Disadvantages - Serious credit risk - Farmers
without sufficient collateral do not have access
to credit
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Example - how would structured finance for
Tongas squash exports look like?
Past scheme
How could it look like with structured finance?
Advice on credit provision
Development Bank
Exporters/in-put providers
Agreement providing credit lines for input
supply, and exporters acting as collection agents
of debt
Granting of credit for input provision
Request for inputs on credit
Development Bank
Exporters/input providers
Input provision
Farmers
Reimbursement
Sale of squash payment reduced by debt service
Request for inputs on credit
Input provision
Current scheme
Development Bank
Exporters/in-put providers
Reimbursement obligation
Farmers
Payment for inputs
Credit provision - 10 cash, 90 in the form of a
credit line for the purchase of inputs
Input provision
Reimbursement
Farmers
Credit provision
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The relevance of structured finance (2) The
asset conversion cycle
More
Money
Commodities
Structured finance
Paper (e.g., warehouse receipts)
To turn commodities into money, they need to pass
through a financial transformation - they need to
be replaced by paper which represents the
commodities.
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Example - revolving finance for fishermen and a
fish processing plant
more
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Example - revolving finance for fishermen and a
fish processing plant

• A certain bank got a financing request from a
  fish processing plant in a small West African
  country. The plant processes fish bought from
  local fishermen and exports to reputable overseas
  buyers. The plants ability to export larger
  volumes is constrained by the limited supply from
  the fishermen. It therefore, decided to obtain
  bank financing to enable it make advances to the
  fishermen and thus boost their supply.
• The request as presented contained obvious risks
  capable of scaring any financier, especially the
  fact that there is no guarantee that the
  fishermen will employ their advances judiciously.
  However, a closer look at the sector reveals that
  the major constrain for the fishermen is that
  they need diesel foe their boats and can only
  obtain this against cash payments. This cash
  limitation therefore hinders them from deep sea
  fishing for richer catches.
• Further inquiry reveals that the fishermen take
  their diesel from two terminals, where they enjoy
  some subsidy. Investigations also indicate that
  it is possible to lease these terminals and
  thereafter recruit a reputable local bank to
  control the stocks.
• This is a firm basis to provide financing. Oil
  import financing could be provided such that the
  fishermen would be provided diesel on credit and
  on delivery of fish to the processing plant, the
  cost of the diesel would be deducted from their
  payment. The processing plant thereafter exports
  the processed fish to the foreign buyers who pay
  into an escrow account created for the
  reimbursement of the oil import facility.
• Obviously, there are still many details to be
  worked out, but there is a structure with strong
  incentives on all parties not to default.

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Hedging often helps to improve financing
Why manage price risk? Firstly, because it has a
development impact.
Pressure on the currency
Pressure on the government budget
Oil import bill increase
Oil import rationing
Crowding out of other imports
Worsening of debt service capacity
Oil price increases
Pressure on energy-intensive industries
The terms of trade of farmers producing export
crops deteriorates
Increase in energy and transport costs
Public transport requires even larger part of the
expenditure of the poor
Social and political unrest
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Cant you anticipate commodity price movements?
No. E.g., crude oil.
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There are many ways to hedge price risk. The
principal ones - hedging on any of the
established futures and options exchanges -
entering into a risk management contract on the
over-the-counter market - building hedging into
physical contracting - building risk management
into a lending programme.
Lay off price risk
With risk management
Traditional
E.g., subsidized credit scheme
Risk management market
Development Bank
Development Bank
Subsidized credit at 5 interest
Subsidized credit at 10 interest, but if prices
fall, debt is forgiven
Farmers
Farmers
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Repo finance combined with hedging

• Repo-financing involves the true transfer of
  inventory title from the customer to the bank.
  The bank becomes the owner of the commodities.
  The bank would normally be hedging its price risk
  using the futures markets. This can be done for
  any commodity for which
• a recognised futures exchange exists, and,
• which are on exchange warrant, certificate,
  or other exchange equivalent and,
• are therefore deliverable against an exchange
  futures contract in its current form.
• The bank and the customer agree on a commercial
  trade transaction, whereby the bank buys from the
  customer a certain quantity of commodities for a
  fixed period.
• The bank establishes a hedge in the relevant
  futures contract and delivery month, usually via
  an EFP (or other recognised exchange mechanism)
  with the customer.

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• Practical applications
• Post-export finance
• Financing goods at the port
• Import finance
• Financing processors
• Financing cooperatives and local traders
• Financing farmers
• Financing for the government

For more info Lamon.Rutten_at_unctad.org
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Financing farmers an overview
Rural finance is risky. Many banks are therefore
not keen on lending to farmers, and much of the
lending done in the past has been by state-owned
banks or under government instructions. Banks
could use some form of security. This could be
an outside credit guarantee (credit guarantees
have been used in many past approaches), but
could also be collateral. Immovable collateral
(real estate, land) is often difficult to use
farmers do not have many fixed assets, and use of
land as collateral is often impossible or
difficult. One approach that has in recent years
become of interest to developing country banks is
the use of the commodities that farmers produce
as collateral for loans. Such collateralized
lending can have three components, that can be
used separately, or can be combined 1. crops
still in the field as collateral 2. crops
already produced as collateral 3. crop sales
as collateral. Banks are generally unwilling to
lend solely on the basis of crops still in the
field (although there are exceptions,
particularly for larger plantations). Apart from
quantity risks, it will also be difficult for
banks to take possession of the crops and sell
them. Therefore, this form of movable collateral
is normally used in conjunction with
warehouse-receipt backed finance. Warehouse-recei
pt backed finance is the major form of lending
against crops which have already been produced.
Once crops have been produced, it becomes crucial
for banks to actually control the stocks
diversion would otherwise be too easy. The
standard method for doing so is the use of an
independent warehouseman, who takes control over
the crops, and assumes liability for their loss
from the warehouse. The warehouseman will issue
a receipt on deposit of the commodities into the
warehouse (or upon his taking over control over
the warehouse), and this receipt can be pledged
to a bank. Without the banks cooperation,
delivery of the commodities out of the warehouse
should then not be possible. When these crops
are sold they generate either immediate cash, or
more commonly, a payment obligation by a trader
(or processor). These payment obligations can,
in themselves, be used as collateral (this is
called receivables financing), but can also be
used in conjunction with the other two forms of
financing on the basis of movable collateral.
Large traders could just acknowledge the
assignment of their payments to the bank in the
case of smaller buyers, the bank could request
the opening of letters of credit. If all three
forms are used together, this provides a seamless
system for agricultural financing right through
to the farm level, with the bank reimbursed by
payments from buyers. These could well be
located in OECD countries in such cases, the
bank can raise hard currency for its loan, and
on-lend to farmers with credit rates which are
more closely related to the (fairly low)
international rates than to the (often very high)
local rates. Obviously, such an agricultural
financing system has organizational, legal and
regulatory requirements.