Trade finance for mid-market commodity flows

The mid-market trade-finance gap

There is a tier of commodity transaction that sits awkwardly in the trade-finance market. It is too large to be financed informally — out of the buyer's working capital, against a single supplier credit, on a personal guarantee from a principal. It is too small to be of meaningful interest to the structured commodity-finance desks of the major trade-finance banks, whose minimum economic transaction size has crept upward consistently over the last decade. It sits, instead, in the territory of regional trade-finance specialists, non-bank trade-finance funds, and the occasional private banking facility extended to a commodity client whose primary banking relationship is elsewhere.

The transactions in this tier are real, the volumes are substantial in aggregate, and the economics are workable for participants who understand the structure. They are not, however, accessible through retail banking channels, and they are not accessible to intermediaries who have not done the work to build a relationship with one or more institutions that operates in this space. Most retail commodity intermediaries find this out the hard way, after they have brought a deal to a stage where it requires financing and discovered that their high-street bank has no relevant facility, no relevant team, and no interest in acquiring either.

The instruments

The instruments themselves are well-understood and have been in their current form for decades. The complication for mid-market work is not the instrument but the institutional appetite to issue it. A DLC is a bank product. The bank that issues it has to be willing to extend its credit on behalf of the applicant, and that willingness is a function of the bank's relationship with the applicant, the underlying commodity exposure, the structure of the transaction, and the bank's broader commodity-finance posture in the moment. None of these factors is in the gift of an external intermediary.

Why retail brokers can't access institutional facilities

The trade-finance teams at the institutions that operate in this market are not in the business of taking on new applicant relationships in support of single transactions. They are in the business of building portfolios of applicant relationships that they have underwritten, KYC'd, and built credit files on, and then writing facilities for those applicants over multi-year horizons. A retail broker who arrives with a single deal and a request to issue a DLC against an unrelated applicant is asking the institution to absorb the fixed cost of onboarding a new applicant for the variable benefit of a single transaction. The institution will, almost without exception, decline.

This is the structural reason why the mid-market trade-finance gap exists, and it is the reason why the gap is bridged, where it is bridged, by intermediaries with established relationships rather than by intermediaries with the best deal. The relationship is the asset. The deal is the use of the asset. Intermediaries who have spent twenty years putting transactions through a small number of institutional facilities find that those facilities remain available to them for new transactions on roughly the same terms. Intermediaries who have not done that work find that the same facilities are not available to them at all.

The bid-ask on trade finance

The bid-ask spread on trade finance for mid-market commodity transactions is wider than it is for either retail or institutional flows, and the reasons for the spread are worth understanding. On the bid side, the institutions that operate in this market price for the cost of the underlying credit, the cost of the regulatory capital they have to hold against the exposure, the cost of the operational handling, and a margin that reflects the relative scarcity of issuers in this segment. On the ask side, the alternatives available to mid-market commodity counterparties are limited, and the willingness to pay for an instrument that actually closes the deal is, in consequence, relatively high.

The spread that emerges from these dynamics typically runs to several hundred basis points more than would apply to an equivalent transaction at institutional scale, and to substantially more than would apply to a transaction backed by the buyer's working capital. The spread is the price of access. Intermediaries who insist that the spread is excessive are usually telling you that they have not understood the economics of the institutions they are trying to access. The spread reflects the cost of running the institutional infrastructure, and that cost is real.

What this means in practice

For an intermediary who is bringing a mid-market commodity deal to market, the financing structure should be considered no later than the structuring of the offer itself. A deal that is priced to leave room for a trade-finance margin is a deal that can move forward to financing. A deal that is priced as if trade finance were a costless utility — as is depressingly often the case in off-market offers — is a deal that will fail at the financing stage and waste the time of every party that engaged with it. The discipline of pricing for financing from the start is one of the markers that distinguishes intermediaries who close deals from intermediaries who circulate offers.

The role of credit insurance and ECA cover

One of the underused components of mid-market trade finance is credit insurance and export credit agency cover. The major ECAs — UK Export Finance, the Export-Import Bank of the United States, Euler Hermes acting on behalf of the German federal government, COFACE on behalf of the French government, Atradius on behalf of the Dutch, and the corresponding institutions in the other major exporting economies — provide cover for export receivables, for buyer credit facilities, and for political-risk exposures that commercial insurers will not write at scale. The cover is not free, and the eligibility criteria are demanding, but where a transaction qualifies, the ECA cover fundamentally changes the financing economics.

An ECA-covered receivable can be discounted by the seller's bank at substantially better rates than an uncovered receivable, because the underlying credit risk has been transferred to a sovereign-backed insurer. This produces trade-finance pricing for mid-market transactions that, in some cases, approaches institutional levels. The work to qualify for the cover — documenting the underlying export, satisfying the local-content and origin requirements, completing the political-risk underwriting — is real, but for exporters with regular flows into the qualifying corridors, the investment in the qualification work pays back across many subsequent transactions.

Bank correspondent networks

The other point that intermediaries in mid-market work routinely underestimate is the importance of bank correspondent relationships. A letter of credit issued by a bank in jurisdiction A, to be advised through a bank in jurisdiction B, depends on the correspondent relationship between the issuing and advising banks. If the relationship does not exist, or if it has been narrowed in response to de-risking pressure, the LC cannot move through the standard channel and the transaction has to be restructured to use a third-bank confirmation. The restructuring is feasible in most cases but adds cost and time, and is the kind of complication that surprises retail intermediaries who are accustomed to assuming that all banks talk to all other banks. The correspondent network has been narrowing for several years in response to the cost of sanctions compliance, and the practical consequences of that narrowing are now showing up in mid-market transactions in many emerging-market corridors.

The pre-export finance structure

For producers in emerging-market jurisdictions, pre-export finance is one of the most useful trade-finance structures available. The mechanism is straightforward in principle: a financier advances funds to the producer against a forward sales contract with a creditworthy off-taker, and the advance is repaid through the proceeds of the underlying export. The structure aligns the financing with the export flow, secures the financier against the off-taker's covenant rather than against the producer's balance sheet, and provides the producer with working capital that would otherwise be unavailable at acceptable cost. The structure is widely used in agricultural commodities, in oil and gas exports, and in certain segments of the metals trade.

The complication for mid-market producers is that pre-export finance providers concentrate on a relatively narrow set of off-takers — the major international trading houses, the principal national oil companies, the established refiners and end-users — and require the off-taker to acknowledge the financing through a tripartite assignment of receivables. An off-taker that is not familiar with the structure, or that resists the tripartite arrangement on internal-policy grounds, will derail the financing even where the underlying contract is otherwise solid. Producers seeking to use pre-export finance therefore need to consider the financing acceptance of their off-taker as a criterion in selecting the off-taker, not as an afterthought once the supply contract is in place. This sequencing is one of the practical implications of bringing financing into the structuring discussion at the start rather than at the end.

Working with us

CMW Consultants works with mid-market commodity counterparties on trade-finance access through institutional channels we have built over many years. We do not extend credit ourselves and we do not act as a financier. We originate, structure, and place transactions where the underlying economics support a workable financing solution. To discuss a mid-market commodity flow or a financing structuring exercise, reach us at cmwconsultants.com/contact/.