Structured commodity finance and price risk management: their relevance for investment and trade

1. Structured commodity finance and price risk management: their relevance for investment and trade Lamon Rutten Coordinator, Commodity Marketing, Risk Management and Finance, UNCTAD; and Senior Advisor, International Task Force on Commodity Risk Management in Developing Countries, The World Bank UNCTAD/CFC Workshop on Enhancing Productive Capacities and Diversification of Commodities in LDCs, and South-South Cooperation Geneva, 22 March 2001

2. Why does price risk matter? Leads to conservative behaviour: less investments, incl. by farmers Reduces predictability Risk Exports Can lead to unpleasant surprises Imports Investments Government budget

3. Unexpected price developments have an impact on economic development. For example: 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

4. Many price risks can be managed The capacity to manage price risk creates better predictability, and makes it possible to avoid many potential bad surprises. The markets for price risk management are very liquid for many, but not all commodities. The cost of “insuring” one`s price risk exposure on liquid markets is very low. Main problem: lack of capacity in developing countries to access these markets. And so far, there has been virtually no support for the development of such capacity.

5. Why does structured finance matter? Without structured finance: With secured finance: With structured finance: financier financier financier Will the collateral disappear? Will he reimburse? Will he produce? $ Potential borrower Potential borrower Potential borrower goods

6. Secured finance: using warehouse receipts can have major benefits It enables farmers, including those who otherwise would have no access to credit, to access more bank finance at a better interest rate and for longer terms, thus giving them more opportunity to invest and more flexibility in their sales. E.g., farmers participating in a warehouse receipt credit programme implemented by a US NGO, TechnoServe, in Ghana's Brong Ahafo Region were able to increase, from 1992 to 1996, their profit on grain sales by an average of 66 percent per annum. This was despite the fact that only local bank finance (at 42% interest rates) was used.

7. Warehouse receipt finance can revive commodity processing Working capital needs for a processor without warehouse receipt finance Raw commodities awaiting processing Commodities in processing pipeline Processed commodities awaiting sale Working capital needs for a processor withwarehouse receipt finance Raw commodities awaiting processing Financed by bank Commodities in processing pipeline Processed commodities awaiting sale Financed by bank

8. Warehouse receipt finance can facilitate imports Working capital needs for an importer without warehouse receipt finance Cereals, sugar, oil products, fertilizer in transit Commodities in central storage Commodities in retail sites Working capital needs for an importer withwarehouse receipt finance Cereals, sugar, oil products, fertilizer in transit Financed by bank Commodities in central storage Financed by bank Commodities in retail sites

9. Some potential applications of structured finance 3 financier Country A 1 Slaughter houses Livestock producers 2 Country C Country B

10. Some potential applications of structured finance (2) 2 Ministry assigns payment of fishing rights to financier financier Country A 1 Fishing companies Fishing rights Ministry of Fisheries Country C Country B

11. Some potential applications of structured finance (3) 2 Bank assigns forex payments of migrant remittances to financier financier Country A 1 Migrant remittances Bank regularly processes migrant remittances Bank Country C Payment of local currency equivalent of migrant remittances Country B

12. The under-exploited potential of secured and structured finance Regular income streams for commodities and for “commodity-like” services and financial flows should not be only income streams. They should also be used to generate cheap medium- to long term finance. And even the potential to generate such income streams can be enough to obtain finance, which then can be used to turn this potential into a reality. This is perfectly doable, including in “difficult” countries. In effect, the potential gains in such “difficult” countries are particularly large.

13. How to make more use of the opportunities of secured and structured finance • be open to considering legal/regulatory reforms. • E.g., currency repatriation and export licensing rules should permit effective assignment of commodities and export receivables; taxation rules and rules on use of notaries should not create unnecessary costs. • Organize capacity- and institution-building activities. Convince donors to finance work in these areas, focusing both on government officials and on the private sector.

14. For papers and powerpoints on commodity risk management and structured finance: WWW.COMMRISK.NET/UNCTAD (TRAINING)