The Circle of Opportunity

"Dr. Kirchmayrs´ book, International Structured Trade & Commodity Finance "STCF", is a comprehensive state-of-the art introduction to STCF. By using a thoroughly analytical approach, the author succeeds in providing in depth insights into both the fundamentals and the techniques of STCF. A number of carefully selected case studies, based on the author´s ample professional experience in this field, give the reader a step by step insight as to how STCF problems can be dealt with and solved in practice. Those readers less familiar with International Trade will welcome supplementary chapters on commodity markets, INCOTERMS, documentary credit techniques, hedging and other technicalities required for successfully managing STCF.
The admirably well written monograph truly fills a gap in a hitherto regrettably neglected area of managerial decision making: It can be warmly recommended to all practitioners as well as to those academics working in the field."

o.Univ.Prof. Dr. Edgar Topritzhofer
Vienna University of Economics and Business Administration

"This book combines theory and practice in an easily understandable way and gives an excellent overview of the variety of financial solutions in commodity trade finance to both experts and newcomers."

Dr. Angelo Rizzuti
Global Head of Structured Trade & Export Finance - Unicredit Group

"I strongly recommend subject monograph to the participants at all levels of the "STCF - Circle of Opportunity", and particularly to those who want to play a more important role. To those who want to delve into this area, I encourage you to not only read "STCF - Circle of Opportunity", but to discuss and share the specific topics with your colleagues."

Univ.Prof. Dr. Aleksej Evgenevich Nikiforov
CFO - Byelorussian Steel Works

"Substantial credit facilities must be extended in order for International Commodity Trading firms to finance their transactions to a successful conclusion. A major portion of such funding continues to be provided by banks in the form of structured trade transactions. The publication "STCF -­­ The Circle of Opportunity" sets forth and establishes, in a unique practical manner, the requisite Know How to insure that the Circle of Opportunity possibility indeed becomes a reality."

Dr. Jugendra Raghav-Singh
Chairman of the Stork Group

Preface 11

Introduction to STCF
1.1. The Purpose and Mission of STCF 18
1.2. STCF Considerations Lending and Repayment Prospects 23
1.3. Differing Lending Philosophies 28
1.3.1. Balance Sheet Lending 28
1.3.2. Cash Flow Lending 36
1.3.3. Asset Backed Lending 43
1.3.4. Mix of Lending Philosophies 45
1.4. Classical Financing Structures versus STCF Patterns 48
1.5. STCF - Potential Participants - Potential Structures 52
1.5.1. The Circle of Opportunity 52
1.5.2. Commodity Producer 55
1.5.3. Off Taker/Trader 55
1.5.4. Final Buyer/End User 56
1.6. Relevant Factors and Considerations - Due Diligence 57
1.7. Most popularly used Financing Structures 60
1.7.1. STCF Modular System 60
1.7.1.1. Module: Pre (Export) Financing 62
1.7.1.2. Module: Warehouse and Transport Financing 66
1.7.1.3. Module: Tolling Financing 68
1.7.1.4. Module: Accounts Receivable Financing 70
1.7.2. The Barter Structure 76
1.7.3. The Countertrade Structure 78
1.7.4. The Securitization Structure 81
1.8. Conclusion 85
Commodities
2.1. Commodities and Raw Materials 89
2.1.1. Metals 90
2.1.2. Energy 92
2.1.3. Softs 93
2.1.4. Others 94
2.2. The Development of Commodity Trading 95
2.2.1. Overview 95
2.2.2. Medium of Exchange, the role of Metal as Money 96
2.2.3. The Concept of a Location for the Exchange of Goods 97
2.2.4. Futures Trading as the Backbone of Modern Day C ommerce 99
2.3. Conclusion 102

STCF Characteristics and Risk Consideration
3.1. Categories of Risk in the Context of STCF 111
3.2. Evaluation of Performance and Payment Risks 118
3.3. Payment Security Methods 120
3.3.1. Open Account 122
3.3.2. Draft/Bill of Exchange 122
3.3.3. Documentary Collections 124
3.3.4. Letters of Credit 126
3.3.4.1. Revocable Letter of Credit 128
3.3.4.2. Irrevocable Unconfirmed Letter of Credit 128
3.3.5. Bank Guarantee 129
3.3.5.1. Direct bank guarantee 130
3.3.5.2. Indirect bank guarantee 131
3.3.5.3. Standby Letters of Credit 135
3.3.6. Irrevocable Confirmed Letter of Credit 136
3.3.7. Cash in Advance 136
3.4. Frequently used Letters of Credit in STCF structures 137
3.4.1. Silent Letters of Credit 137
3.4.2. Back-to-Back Letters of Credit 137
3.4.3. Red and Green Clause Letters of Credit 138
3.5. INCOTERMS - International Commercial Terms 142
3.6. Risk inherent to the Off Taker/Trader and Buyer/End User 147
3.6.1. Assessing the Off Taker/Trader 148
3.6.2. Assessing the Buyer/End User 148
3.7. Hedging of Commodity Transactions 152
3.7.1 Derivative Instruments 153
3.7.2. Futures 155
3.7.3. Options 160
3.7.3. Swaps 164
3.7.4. Caps/Floors 165
3.8. Sources of Security/Collateral 166
3.9. Danger Signals 170
3.10. Conclusion 173

Case Studies
4.1. Case 1 - Transport and Accounts Receivable ("A/R") Financing (Cotton) 177
4.1.1. Transaction Background and Purpose 177
4.1.2.Pertinent Details 177
4.1.3. Transactional Graph Details 178
4.1.4. Risk Analysis 181
4.1.5. Conclusion 182
4.2. Case 2 - Pre-Export Financing (Steel) 183
4.2.1. Transaction Background and Purpose 183
4.2.2. Pertinent Details 183
4.2.3. Transactional Graph Details 184
4.2.4. Risk Analysis 186
4.2.5. Conclusion 187
4.3. Case 3 - Tolling Financing (Oil – Oil Products) 189
4.3.1. Transaction Background and Purpose 189
4.3.2. Pertinent Details 189
4.3.3. Transactional Graph Details 190
4.3.4. Risk Analysis 193
4.3.5. Conclusion 194
4.4. Case 4 - Red Clause Letter of Credit Financing (Aluminium) 195
4.4.1. Transaction Background and Purpose 195
4.4.2. Pertinent Details 196
4.4.3. Risk Analysis 198
4.4.4. Conclusion 199
4.5. Case 5 - Mix of Lending Philosophies (Paper) 200
4.5.1. Transaction Background and Purpose 200
4.5.2. Pertinent Details 200
4.5.3. Transactional Graph Details 201
4.5.4. Conclusion 204

General Conclusion 206

List of Graphs 209

Bibliography 211

Abstract 217

The author, Dr. Rudolf Kirchmayr, is the Founder and Managing Director of FIS Finance and Investment Services GesmbH, a Vienna based financial and investment services company, actively engaged in the niche of international structured finance and investment financing. FIS Finance and Investment Services GesmbH, Vienna has established its reputation as an expert in the theory and practice of International Structured Trade and Commodity Finance ("STCF"). It has made a clear commitment to its clientele to provide comprehensive advice and assistance, touching on every aspect of this financing technique.

In conjunction with his above reference activities, the author is sought after as a participant and as speaker in industry specific workshops. Additionally, he is active as a panellist as well as trainer in seminars, and has published on matters dealing with general as well as specific topics relative to International Structured Trade and Commodity Finance. By virtue of these varied activities, the author has contributed to as well as enhanced the existing body of literature and resource materials dealing with STCF matters. This commitment and involvement have led him to make the following observations:

By virtue of the rapid changes over the past decades affecting STCF traditional financing techniques - primarily caused by crises in various countries of Latin America, Asia, as well as in Russia (1998) - the existing STCF literature is not up-to-date and partly irrelevant.

The most recent developments in STCF theory and practice, and the resultant interface with other forms of structured financing techniques, are not present or available in the existing literature. In the best case, such topics may appear in diverse trade publications such as the Trade Finance Magazines. They are often based on incomplete information and examples, all of which does little to enhance the theoretical and conceptual knowledge as well as understanding of STCF.
Industry specific topics, which have come about in connection with the above mentioned changes, (for example, self-liquidation, performance risk, STCF due diligence, STCF sources of security, etc.) are frequently absent from the present, available literature, and when they do appear, they are only mentioned in general terms or are wrapped in the actual cases.

A STCF risk analysis formula, specifically focused on and germane to STCF financing techniques and risk definitions, such as risk awareness, risk analysis and risk mitigation, is non-existent.

These transformations, coupled by other material changes, have motivated the author in the accompanying publication to seek answers to as well as to analyze several theoretical questions that are to be found in and are integral to the world of STCF:

How will STCF be positioned in the future in terms of conventional finance assessments, and which trends, which changed applications, respectively, have affected the STCF transactions during the past 20 years?

In what manner or how will the various STCF financing techniques, in theory as well as with respect to content, be properly distinguished, defined, and separated based on a due diligence model or format?

How will it be possible for risk definitions, perceptions of risk allocation and risk mitigation - all related specifically to STCF transactional financing, in theory - to be demonstrated (or revealed, presented) and explained?

Can the present theoretical assessments be illustrated and supported by means of relevant examples?

The next logical steps, the methodology employed by the author in explaining the STCF, in this publication, are to clearly present and define the purpose and mission of the STCF; describe and analyze the lending and repayment prospects; as well as to thoroughly examine and explain the differing lending philosophies that are to be found in, and are integral to, the STCF model. Classical financing structures are closely reviewed, discussed, and also compared in practical terms to the existing patterns found in the STCF model. Potential structures and potential participants in the STCF are presented, thoroughly analyzed, and in this context the most popularly used financing structures and their applicability to STCF are explained. Several relevant factors, including due diligence matters, are examined, reviewed, and included according to their applicability to the STCF model.

It is the author's intention to provide the reader with an introduction to the established and accepted patterns, to the theory presently existing in the STCF. The practical applications found in the STCF model provide the basis, a template, for a discussion and review of its applicability as a modern flexible financing tool, a means for the facilitation, if not the promotion of trade.

Dr. Rudolf Kirchmayr

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