Collateral management agreement (CMA) is a method of securing fund against physical commodities and provides better flexibility for import and export trade. A Collateral Management Agreement entrusts a collateral manager to take custody and control of stock until the commodity is used, exported and/or borrower has repaid the debt. Most times, it is a three-party agreement between the assignee/owner/borrower, the collateral manager and a bank. Succinctly, under CMA, commodities are held by the collateral manager under management on the order of the bank on account of the assignee. It consists of receiving physical commodities into storage and retaining control over the said commodities until such time, the collateral manager is instructed by the parties to release them in accordance with the terms of the agreement. Also, CMA is important and useful in the commodity trading ecosystem.
The use of the Collateral Management Agreement has the potential to increase the availability of funding for trade in Nigeria and Sub-Africa. Because of the region/market’s risk peculiarity, many banks feel reluctant or constrained extending credit to borrowers, so CMA could help the banks get comfortable when structuring Africa-based trade financing.
Trade finance is an umbrella term that covers many financial products and instruments that banks and companies use to make trade transactions feasible. It makes it easier for importers and exporters to transact business through trade. Trade finance covers different types of activities such as issuing letters of credit, lending, export credit and financing and factoring. Parties in trade financing include the buyer, seller, financier, export credit agencies and insurers. Trade finance helps to reduce non-payment risk from importers as well as non-delivery/shipment risk from exporters. It has thus helped to bridge the financial gap between importers and exporters. For example, to an extent, with trade finance, an exporter is no longer afraid of an importer defaulting in payment and an importer is sure that all goods ordered will be delivered as ordered.
Notwithstanding, exporters/importers may still be exposed to international trade finance risks depending on the type of trade of finance; cash in advance, bills for collection, letters of credit, etc. These inherent risks can be mitigated using specialized collateral management products. In bills for collection or sight letter of credit transactions, buyers may become fraudulent by not paying for goods received even if the goods meet agreed standards or rescind accepting and taking possession of the shipped goods. In these situations, specialized and tailored collateral management services can be used. For instance, in sight letters of credit transactions, Export Protective Agency Service can be used. Here, the exporter can appoint an export protective agent, who will circumspectly document and clause the Bills of Lading to enable the exporter bank have control over the shipment, its delivery and proceeds. Also, the Shipper/exporter can clause the Bills of lading to “Order” This means the cargo is not deliverable to any specified person, but as to be instructed by the shipper.
In bills for collection, the bills of lading can be claused to the order of the bank with the Collateral Manager as the first notify party or the shipper can use manifest-clause House bill of lading. In House Bills of Lading, the cargo can only be released on presentation of the house of bill of lading, which may contain certain conditions, which are expected to be met by the importer/receiver of the cargo. Also, the exportable cargo can be warranted in a bank chosen warehouse and land tank (for wet cargo). In some cases, the warrants can attract 80 -100% offshore prepayments in a situation of Red Clause Credit for Nigerian exports.
For cash in advance transactions, though, it seems the safest way for exporters to be sure they will get paid for the goods they are selling to their importers, but it is unsafe for importers. When cash is paid in advance, many things could go wrong. The exporter may decide to become fraudulent, by not delivering or shipping goods paid for or get to ship bad or substandard goods to their buyers. To mitigate this, Red Clause Letter of Credit can be used. A Red Clause of Credit partially pays the exporter before the goods are shipped or the parties can mutually agree and appoint an inspection agent to inspect the goods at the exporter’s warehouse before the importer makes payment.
Collateral management products and warehousing can also be used to secure trade finance commodities as inventories and collateral, especially in a situation where the importer is unable to provide the required/acceptable collateral needed for local or offshore banks to finance the import. There are different types of collateral management products that can be used depending on the transaction dynamics and as may be decided by the parties, especially the bank (financier). They include tripartite collateral warehousing agreement, tripartite collateral mortgage warehousing agreement, bilateral bailment warehousing agreement, tripartite joint lock stock supervision agreement, import protective agency for banks, export protective agency for banks, quadripartite ship discharge protective agency agreement, tripartite escrow agency services, etc. Each has its peculiar features and is suitable for specific transactions.
Irrespective of the type of Collateral Management Product chosen, key CMA guiding principles have to be followed, which include nomination and approval of warehouse by the bank, noting of warrant to the interest of the bank on quantity received, release of stock to the order of the bank, provision of all risks insurance on the premises, property (stock) and personnel by the assignor, etc.
Collateral management and warehousing service is equally important in the commodity trading ecosystem. The Commodity Trading Ecosystem is an organised environment within which commodities trading takes place, directly or indirectly. It comprises various elements such as commodity exchanges, farmers, merchants, commodity markets operators, warehouse operators, collateral managers, banks, insurance, clearing houses, logistics companies, etc. For the ecosystem to function optimally, these elements have to be fully developed, efficient and effective.
For instance, a well-developed warehousing system fosters the development of warehouse receipt system and as such necessary for the commodity futures trading.
Warehouses form the basic platform of delivery-base trading in commodity futures. An investor will be willing to trade commodities on the exchange if the investor is assured that the commodity will be available when and anytime he/she needs or wishes to exercise his/her secured right. The warehouses have to be dependable, secure and must satisfy standard conditions. In essence, the warehouses have to be licensed by an Exchange or the SEC and controlled by a party (Collateral Manager), independent of either the seller or buyer of the commodity. In recognition of this, Security and Exchange Commission has registered commodities exchange warehouses, located in some states: Adefu Echara in Ebonyi State; Anyigba and Shinkafi in Kogi State; Kasuwandagi and Wanke in Zamfara State; Gidangona and Gada Maiwa in Bauchi State, etc. These registered exchange warehouses are open to farmers and owners of commodities who intend to trade their commodities on the exchange.
On the import of commodity exchange and collateral management in the commodity trading ecosystem, AFEX was granted license in 2015 with the cardinal objectives of establishing a Warehouse Receipt System (WRS) and Commodities Exchange. Warehousing receipts system, according to M/s Panos Varangis and Jean Saint-Geours, is a system that enables a warehouse operator to issue receipts as evidence that specified that commodities of stated quality and quantity have been deposited at a particular location by named depositor” Under this system, the warehouse operator holds the goods and issues a receipt to the depositor, who in turn can use the receipt as a collateral to borrow money from banks. In some cases, the commodity warehouses are owned by another party other than the collateral manager. For instance, last year, NEXIM bank partnered with AFEX (as Collateral Manager) for the financing of identified agriculture linked projects, in the CBN’s Export Stimulation Facility (EST), which includes N50billion Direct Intervention Fund for NEXIM to boost non-oil exports.