A Practitioner’s Guide to Trade and Commodity Finance: Review

While the majority of the newly-issued ‘A Practitioner’s Guide to Trade and Commodity Finance’* is written by lawyers in the trade and export finance group, there are also contributions from practitioners in other related areas including lawyers practicing in securitisations, Islamic trade finance, insurance and regulatory matters. The guide is for trade finance lawyers, bankers, traders and others involved in the trade and export finance business. It is of use to those new to the law and practice of trade and commodity finance, as well as those who have worked in that area for longer. 

The guide is the first comprehensive publication looking at trade and commodity finance and related areas. While written after the financial crises of 2007-08, it addresses issues and solutions that applied both before, at the time of and subsequent to those crises.

The introduction and overview to the guide immediately addresses one of the key elements of trade and commodity finance; namely that it was, and remains, a relatively safe form of lending. It emphasises the fact that over the years there have been many statistics, which show that losses on trade finance loans – and indeed across the world of trade finance generally – are very low.

It helpfully explains how such a position can be obtained and indeed why this should be the case. One key issue is how trade debt could be defined, against the background as to why losses should be so low. The introduction explores issues such as should trade debt (once defined) have a priority treatment in any insolvency of the obligor, and should that priority treatment be recognised by law or by practice? This is not an easy area in which reach to reach conclusions, although one that is drawn by the guide is that a well-structured trade finance transaction should achieve its own priority without the need for changes in the law.

The guide explains a number of the key concepts in trade finance. These include letters of credit (L/Cs), guarantees and other instruments used in the day-to-day financing of trade. It addresses other instruments, both existing and to be launched, including guarantees under the uniform rules for demand guarantees and bank payment obligations (BPOs). It also focuses on various forms of structured trade and commodity finance. One section deals with the financing of the production and sale of goods from emerging markets into developed markets and the various forms that that financing can take. The guide explains the various structured forms of financing, including pre-export finance; prepayment finance; and certain other forms of structured trade finance. 

Pre-export finance and prepayment finance have, over the years, been the mainstays of the provision of financing directly or indirectly to producers in emerging markets. Having explanations of the structuring documentation used, as well as diagrams, assists in understanding how to structure this sort of financing. It also puts the taking of security into context. While there are less detailed explanations of other forms of financing, it does cover tolling facilities and borrowing base facilities. 

These financings are again explained by way of diagrams, as well as by written explanations. Coupled with references to other forms of finance, it means that the guide provides insight into how finance might be provided, particularly in emerging markets. It covers areas such as warehouse financing and explains issues and potential solutions in financing goods that have been transported to, held in and delivered from warehouses. Financing of goods in transit and in warehouse forms a huge part of the needs of the trade finance world. Looking at solutions and potential problems means that there should be a greater understanding on the part of both the financer and the recipient of finance to enable such transactions to be completed. 

In order to help analyse the structure of trade finance transactions, the guide looks at the issues from a legal, commercial and practical perspective. In doing so, it analyses how to manage and mitigate risks and how to deal with problems if they arise. It takes a transaction from its inception right the way through to the repayment of the financing. In the process, it looks at the lifecycle of a transaction from the production, or manufacture, of goods to their ultimate sale. The sale of the goods produces the receivable which, when paid to the bank, assists in repaying the financing.

Red Flags

In recognition that some financing transactions can run into problems, there are chapters that deal with waivers, standstills and workouts in a trade finance context and a separate chapter dealing with insolvency and related final insolvency procedures. The guide also analyses how to take security and whether it can, or should, be taken in any transaction. This analysis looks at how security can be taken over goods, receivables and bank accounts. Not only is the taking of security in emerging markets covered, but also issues regarding enforcement of security are dealt with should that any of these ever arise.

The guide also covers other ways to finance trade. One key area that has a chapter specifically devoted to it is commodity ownership and variations on that subject. It covers the growing market whereby certain banks, instead of financing a commodity and taking security over it, have a preference for owning the commodity. Sometimes this ownership includes the purchase and re-sale to the same entity (a repo). The chapter analyses concepts like whether such a sale would be considered a ‘true sale’ and consequently not re-characterised as a financing transaction. It includes an analysis of these risks and how to deal with them.

Other areas covered include the securitisation of trade finance receivables and the application of Islamic structures to trade finance transactions. Both methods of financing assist in the potential growth of funds available to finance trade and its receivables. The advantages of these types of structure means that other parties beyond trade finance banks would be able to participate in financing transactions. 

In looking at the financing of receivables, the guide devotes a chapter to forfaiting, factoring and invoice discounting and considers the relative advantages and disadvantages of each of these products. It is timely in that it assists in looking at forfaiting through the eyes of the soon-to-be-adopted uniform rules for forfaiting.

Regulatory issues in trade and commodity finance are addressed. Even though the regulatory market remains a dynamic and moving area there is an attempt to look at how trade and commodity finance are affected by the developing regulatory environment and how trade could continue to benefit from recent changes. There are pointers to potential problems that trade finance must overcome to achieve regulatory benefits, which means this part of the guide is worthwhile reading for those involved in reporting how banks in particular are complying with the regulatory regime.

Other areas related to regulation are addressed to assist the unwary in getting involved in transactions without checking key issues such as fraud, bribery and corruption and issues involving sanctions, both from an anti-money laundering (AML) and anti-terrorism perspective. There are clearly risks, both perceived and real, where financings are extended into emerging markets and counterparties may not be as well-known, or as well regulated, as those in the developed markets. The guide seeks to assist in outlining how problems can be overcome by finding solutions to these issues.

A related issue, which is clearly of assistance to those structuring trade and commodity finance transactions, is that of risk mitigation and risk transfer.  A section of the guide covers insurance issues as they relate to trade and commodity finance, including how insurance products can assist in risk mitigation and transfer.  This section aims to be an explanation of how to do transactions, the applicable legal concepts and how to avoid problems and pitfalls.

Summary

The starting point of the guide, and in many ways its message, is that trade finance is an inherently good and relatively safe business. The financing of trade should be permitted to grow. Problems that might prevent that growth are addressed. In order to achieve the best results, being informed is highly desirable if not essential. Given the position of the guide in the market as being comprehensive in the areas that it covers, it should be a very useful read for anyone wishing to be involved (or to stay involved) in trade finance. This includes the financer and the recipients of finance as well as their advisers and other parties.

As with any guide, there are areas not covered in as much detail but perhaps subsequent editions might do that. How to finance trade will continue to be a changing environment, so the guide itself will not stand still.

*‘A Practitioner’s Guide to Trade and Commodity Finance’, which was recently published by Sweet & Maxwell, was written by members of the SNR Denton Trade and Export Finance Group.

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