Citibank APAC sector insights September 2015: Commodity trading inemergingmarkets: balancing risks and opportunities @ Golden Agri

Institutionalising and Internationalisation of treasury, trade and structured finance practices and management while balancing growth, seizing opportunities and risk management. 

Commodity Trading in Emerging Markets:Balancing Risks and Opportunities

Volatile commodity prices, depreciating local currencies, evolving regulations and higher financing costs in emerging markets are presenting both challenges and opportunities for treasurers. Against this backdrop, how are Asia’s leading companies balancing their risk management and growth objectives?

Working Capital Hurdles

The commodity trading industry is experiencing margin compression due to volatile prices, increasing number of players, price transparency and capital requirements. At the same time, supply chains continue to evolve and globalize, creating a significant degree of complexity and risk. The longer and more interconnected the supply chain, the greater its vulnerability to business disruptions.

For commodity companies, mitigating credit and market risks while capturing untapped opportunities has always been a balancing act.Particularly in emerging markets, treasurers have additional considerations since credit profiles of counterparties and service providers (including banks) could be opaque, and access to liquidity is limited.

Furthermore, the industry is confronted with various working capital challenges, which include resource allocation and optimization of inventory and supply chain.

While many trading companies have capitalized on opportunities in emerging markets with currency volatility and capital controls to arbitrage between interest rate curves of onshore and offshore financing markets, the heavy reliance on onshore funding presents a credit risk from a balance sheet perspective. In light of this, more traders are considering ownership of physical upstream assets, which are capital intensive and illiquid in the short term. 

Their balance sheets have expanded as a result. Increasingly, profit generation hinges on balance sheet optimization and continued access to sources of capital and financing. This is especially important for origination and structuring of commodities and export finance transactions.

Regulatory Changes

In times of tightened oversight, treasury teams of commodity companies are now preparing themselves for regulatory changes. For instance, Basel III is expected to drive up financing and transaction costs of trade finance products across all banks, especially for clients with higher credit risk rating.

Moreover, central banks are working overtime to contain domestic inflation, manage export competitiveness and support industry growth by implementing regulatory changes from time to time so that they can better manage both fiscal and monetary economic agendas.

In April 2015, Indonesia implemented a new regulation requiring exporters of key commodities to use letters of credit (LCs) for their shipments. The affected commodities include coal, palm oil, palm-kernel oil, oil and gas, and minerals, which account for about 41% of the country’s exports. The measure aims to help authorities monitor the exports more accurately by documenting the pricing of shipments. The new LC requirement came into force despite opposition from many trading companies since it would impose additional costs.

Fuelling Growth

As domestic consumption increases with the rise of middle class in the developing world, trading of strategic commodities around the globe will continue to be fuelled by emerging demand. Transacting highly strategic commodities, such as palm oil for food products and biofuel, have shown resilience and robustness despite economic downturns.

Leveraging Citi’s secured credit line or financing structures backed by the underlying commodity, many companies have been able to capitalize on this attractive asset class.

Whether used individually or together, Citi’s full suite of innovative solutions are designed to help companies manage risks and optimize cash flows, with the end goal of enhancing financial flexibility, increasing supply chain liquidity, reducing trade-flow risks and better management of cross-border business flows.

As commodity trading companies expand their businesses abroad, leveraging a globally consistent platform, reliable transactional services and secured funding is essential to capture trade opportunities.

As domestic consumption increases with the rise of middle class in the developing world, trading of strategic commodities around the globe will continue to be fuelled by emerging demand.  Transacting highly strategic commodities, such as palm oil for food products and biofuel, have shown resilience and robustness despite economic downturns.

Case Study: Golden Agri-Resources’ Success in Managing Risks

As the world’s second largest palm oil planter, Golden Agri-Resources Limited (“GAR”) manages about 484,500 hectares of oil palm estates in Indonesia and produces close to three million tonnes of palm products yearly. Listed on the Singapore Exchange, the integrated plantation company that also manufactures and markets palm-based edible oil

and fats and oil-based consumer products has experienced rapid business growth globally, with revenues reaching USD7,619 million in 2014.

The Challenge

Compared with three years ago, GAR’s sales volume surged by 30% and the company renewed its focus on the expanded downstream business in refinery, marketing, international merchandising and supply chain.

Selling to a large number of traders in Africa, China, India, Pakistan, Bangladesh and the Middle East, exposed GAR to the country, credit and financial risks of these markets where it receives high volume of letters of credit (LCs) issued by the smaller local banks. As such, GAR’s treasury team was actively seeking a holistic financial solution to mitigate risks when

trading in these developing markets.

The Solution

Citi implemented an integrated cash management and trade finance solution for GAR:

• An LC advising facility was established in Indonesia in light of new regulatory requirements for exporters to use LC for selected commodities.

• In Singapore, GAR is able to upload its remittance advices onto Citi’s system for further processing. The cost-effective solution enables the company to do without the need to connect its processes and systems to external stakeholders.

• Citi set up an overdraft facility in Singapore, providing good value for cross-border transactions. This solution works well with GAR’s cash management system for buyers to transfer funds to Indonesia, on same day basis. The good value,

cross-border fund transfer allows the company to transact high-value trades and settle them in the same-day across Citi’s global banking platform.

• In Indonesia, a notional pooling structure was established, allowing treasury to optimize liquidity and working capital for the group’s entities.

In addition to Citi’s integrated cash and trade solutions servicing GAR’s end-to-end trade flows, the bank has provided the company with a credit line for trading in new territories, whilst optimizing working capital cycle through more efficient use of operating cash.

As the emerging markets increasingly became the core of GAR’s trading portfolio and the driver of its global business growth, GAR has utilized Citi’s LC confirmation service to mitigate its exposure to the sovereign and financial risks of the buyer’s countries.

With a presence in more than 100 countries and a vast network of 3,000 correspondent banks, Citi carefully conducts in-depth liquidity analysis and assesses the credit profiles of the LC-issuing banks in these emerging markets in order to confirm their LCs. The solution has given GAR peace of mind to enter into high-value trades, enabling treasury to

generate cash quickly to meet the company’s operating needs.

“These are difficult markets. Therefore, having a bank partner providing expertise in terms of local regulation, credit profiles of local banks and companies and risk mitigation solutions really has made a lot of difference.” said Gopul Shah, Director of Corporate Treasury and Trade Structured Finance at Golden Agri International Trading Pte. Ltd. in Singapore.

As GAR’s trade volumes continue to grow, it had to ensure quick turnaround of its cash flow in the system to settle high-value trades immediately. Citi’s robust credit facility for GAR’s global entities enabled the company to execute intraday, in-country payment transfer to mitigate value date leakage. This capability has reduced GAR’s working capital

requirement significantly since reserve funds are no longer needed, and no residual funds are left idle. 

“If you have millions of dollars of transactions happening every day, one-day value leakage can make a huge impact on the company’s working capital and cost of financing. Taking the interest rate of any point in time, if a few million dollars are stuck in the system, the interest savings is substantial,” Shah explained. Without the credit facility, GAR would have to hold back on big-ticket transactions or draw down loans to cover such trades, which incur additional interest costs.

The Results

Partnering with Citi, GAR is now able to access cross-border cash balances on an intraday basis, with true end-of-day cutoff timing to remit time-critical payments and achieve optimal use of operating cash.

By deploying the same bank to provide cash and trade services, GAR can leverage streamlined and consistent processes to achieve operational efficiency for its entire value chain: allowing the movement of cash agnostic of the bank’s underlying products and systems across cash and trade, thus achieving simplified and automated processing.

“In today’s challenging environment, not all banks are able to provide all the solutions at the same time. If you are able to leverage the same bank for cash, trade and credit services, it does make a lot of difference. Citi’s advisory and treasury services are the best-in-class and respective experts have proactively reached out to GAR to offer various solutions from advisory on bond issuance and participation in syndicated loans to working capital loans and foreign exchange hedging solutions. They understand our business well and have added sustainable value throughout the banking relationship that started more than 10 years ago to help institutionalize and internationalize GAR’s treasury, trade and credit management.” Shah said.