Trade financing in Africa: new structures for the future

With the dismantling of most commodity boards in Africa in the 1990s, trade liberalisation was introduced in the continent. But liberalisation came without the necessary accompanying infrastructure, and legal and regulatory framework. At the same time, liberalisation left a vacuum: small-scale exporters and small-scale producers, which predominate in Africa, were unable to access finance in the same way as they could before. Banks were not so willing to step into that vacuum and sometimes, when they did step in, they encountered fraudulent activities and got their fingers burnt.
Today, despite those obstacles, with a burgeoning demand in China, India and other emerging economies for all kinds of African commodities, bankers and governments have been moving back into trade financing and creating new financial structures to mitigate the risks. Chief among these structures is warehouse receipt financing, whereby receipts are issued by warehouse managers as collateral for capital advanced to farmers and commodity producers that is later defrayed by goods delivered to the warehouse.
This form of financing is expensive, however, because of the risks involved. And, because there are legal and regulatory weaknesses in Africa, it also raises questions about the need for banks to do much more than financing, including even controlling and/or owning parts of the supply chain.
At the same time, international and African bankers are raising questions about a fundamental development issue in the continent: whether exports of raw materials and commodities are the key to development or whether there should be more processing or value-added of commodities taking place on the ground in Africa.
A debate on structured trade and commodity finance in Africa therefore encompasses many topics: the direction of African development; new structures for financing trade; the risks of structured trade and commodity finance; initiatives to mitigate those risks; the all-important role of China in Africa’s current commodity trading; and the general perception of risk associated with Africa.
These were the topics of a round table discussion under the auspices of The Banker between seven key participants:

Kehinde Durosinmi-Etti, deputy managing director of Lagos-based Skye Bank

Michael Gondwe, president of regional development bank the Eastern and Southern African Trade and Development Bank (PTA Bank), based in Nairobi

Shankarnarayan Rao, executive director of the Export-Import Bank of India (Exim India), for which Africa is a focus area in its work financing and promoting India’s international trade

Jean-Louis Ekra, president of the African Export-Import Bank (Afrexim), which has financed trade totalling $10bn since its creation in 1993

Brad Woodhouse, vice-president of US-based RZB Finance of Raffeisen Zentralbank of Austria, who is head of US ExIm Bank Group programmes financing US exports to Africa and other countries

Jean-Pierre Benichou, director of structured trade finance in Africa at Standard Chartered Bank of the UK

Chris Newson, deputy chief executive of personal, business, corporate and investment banking at Standard Bank Africa, Africa’s biggest bank.

Brian Caplen, the editor of The Banker, chaired the discussion. The debate was sponsored but this article was independently edited and written.
THE ISSUES:

• Changes stemming from the abolition of the commodity boards and basic risks facing banks and buyers.
• The informal underpinnings of structured trade finance in Africa
• A weak legal framework adds to the risks
• Adding value is the preferred course of action
• Other initiatives to overcome risks
• China’s impact on Africa’s trade in commodities is considerable but is it sound and sustainable?
• Is the general risk perception of Africa accurate?

Changes stemming from the abolition of the commodity boards and basic risks facing banks and buyers
When commodity boards existed, because they were monopolies, deliveries of coffee, cocoa, cotton and so on eventually reached international markets, whatever banks did or did not do, said Mr Ekra. However, with the abolition of most boards (a few remain for oil and gas, and different minerals and metals), bankers and buyers faced significant performance risks (for example, a crop failure due to bad weather), in particular at the production and initial delivery end of the supply chain. To try to overcome these risks, and with large international trading clients in mind, banks started to develop warehouse receipt financing, to bring the financing of commodities trading to the first stage of the supply chain. But warehouse receipt financing is only as good as the warehouse (or warehouse manager) that is issuing it, said Mr Ekra. And a key problem associated with the system is that “many big international companies that deal with warehouses have been using subsidiaries in Africa that are limited liability companies.” As a result, warehouse companies have sometimes been so undercapitalised that they cannot repay the banks that have raised the capital for the production and delivery of a certain amount of goods when a delivery falls short or goes missing, he said. So a crucial challenge facing this type of finance is finding ways to manage and/or mitigate that particular risk. One solution that Afrexim found was to ask the international trade companies to guarantee the local warehouse, or subsidiary, so that it could repay the bank if needed, said Mr Ekra. Mr Newson said the risks associated with warehouse receipt financing and structured trade finance in Africa go beyond the risks of delivery. “It is about the quality of the delivery; it is about price risk; it’s about country risk; it’s about distribution risk.” But, he says, “ultimately it’s like any banking transaction: frankly, it’s about the quality of your counterparties”.
The informal underpinnings of structured trade finance in Africa
Mr Ekra said that there are reasons why the risks are biggest at the earliest stages of the supply chain in African trade finance. There is still anecdotal evidence of unprofessional, unreliable and even fraudulent behaviour by warehouse, or collateral, managers, he said. And, despite liberalisation, Mr Gondwe said that Africa’s trade with the rest of the world remains “pathetic in terms of volume”. He also reminded the participants that when talking about structured trade finance in Africa, it is important not to lose sight of its informal “underpinnings”. “You are talking about giving a guy a dollar to go up country and the result is he brings something that will be a dollar less. These are the casual underpinnings.”
A weak legal framework adds to the risks
A further complication is that warehouse receipts are not a legally binding contract in all African countries or markets. So, as part of a drive to improve the business climate, PTA Bank and CFC Bank of Kenya recently started a project in a few African countries to study ways of making sure warehouse receipts are recognised by law as good collateral, said Mr Gondwe. PTA Bank and Afrexim have also been attempting to harmonise different countries’ legal regimes so that they provide sufficient comfort to investors that when something goes wrong with a warehouse delivery, there is a legal means of dealing with the problem. Mr Rao said the issue is not just about providing comfort in legal terms, but about demonstrating the enforceability of the law, having independent arbitrators and the amount of time it takes for a settlement. “Settlements [need to be] done in weeks and months, not years,” he said.
Adding value is the preferred course of action
The round table participants said they were not entirely averse to Africa sticking to its traditional role of exporting raw materials and unprocessed commodities. Canada and Australia developed on the back of selling raw commodities, and Africa could do the same, especially in the current circumstances, when international prices for most commodities are soaring and oil is selling at above $90 a barrel. But, despite this, Mr Gondwe, Mr Durosinmi-Etti, Mr Ekra and Mr Benichou all said that adding value to commodities is the way forward in Africa today. Mr Gondwe at PTA Bank, which is a development bank, might be expected to take such a position. “Africa has got to produce and add value to its commodities and then it will be able to get a better value” from abroad, he said. Similarly, Mr Durosinmi-Etti said that Skye Bank set up and invested in five cocoa processing plants in Nigeria, one of which is leased to an Indian company, Olan, which is now one of the biggest agricultural exporting companies in Africa. Mr Rao at Exim India suggested one way to achieve added value in a particular commodity is for the buyers and the sellers to collaborate and set up joint ventures. One such joint venture that Exim India supported in Morocco, between a Moroccan supplier and an Indian buyer, resulted in the establishment of a phosphoric acid plant; previously the Indian buyer had bought phosphates from Morocco in rock form. It is one thing for African banks, whose shareholders are African, to want to add value to their own countries, but another for an international bank, which is answerable to shareholders from outside Africa, to want the same. Nevertheless, according to Mr Benichou, a key demand in the 15 African countries served by Standard Chartered is to bring added value to improve the gross domestic product of each country. “I think banks have a role [of] adding to the value chain and that’s what we try to do in a small way,” he said. “With some institutions, we try to build up things inside the country and also build up a large customer base outside.”

Both Mr Benichou and Mr Durosinmi-Etti said they believe that adding value, as well as owning different bits of the supply chain, is a way of controlling the risks and/or the pricing of warehouse receipt finance. “If you can own part of the process it improves the result,” said Mr Durosinmi-Etti.
Mr Ekra said Afrexim has a responsibility to promote African trade and “the key is bringing added value”. “Everyone knows if you bring added value to where the production is, then you don’t suffer so much volatility” in the price, as when the raw materials are sold directly on international markets, he said.
THE KEY ISSUE: Banks play an important role in trade finance that goes beyond financing
In trade finance, banks play a big role beyond financing, in terms of advice, risk guarantees and control of the supply chain.
Mr Benichou said that when warehouse receipt financing started in Africa about 10 years ago, “we fully understood that this type of financing – structured trade financing – was a good mechanism to bring additional leverage to good counterparties and mitigate perceived performance and payment risks”. Aimed from the start at large international trading companies, to do warehouse receipt financing it is necessary to engage in “supply-chain financing”, Mr Benichou said.
Such financing includes identifying suppliers that are positioned near the source of the production of maize, cocoa, palm oil and so on; slicing the financing in such a way that more cash is brought to the first part of the supply chain, where it is needed most; developing networks with the support of banks, insurance companies and logistical companies; contracting a collateral manager or using a clearing and forwarding company; and providing risk management, price guarantees and price mitigation, said Mr Benichou.
After an international buyer declares an interest in a specific cargo, because of the recent privatisation of some African ports, a delivery can now be conveyed by container and picked up in the African heartland, which cuts down on risks, time and costs, he said.
It is not only big international traders, though, that have stepped into the vacuum following the abolition of commodity boards. A new layer of intermediaries, or agents, has emerged and they are often also the suppliers of the initial seed, and capital, to farmers and producers. Mr Newson said that a chief way to reduce risks in the business is “to understand people like collateral managers, the role they can play and who are the best in the market that you can rely on” and to find “enough credible middlemen, who can add value to the farmer (or commodity producer) and be able to advise”.
Mr Rao said it is necessary to have “a holistic approach” and look at the entire supply chain. “We look at the state of control available; the participants in the supply chain; and where there are a number of participants, the state of co-ordination between them; the specific steps that have to be taken to strengthen the operations along the supply chain, which could be advisory services, which could be research and development, which could be seed capital, which could be venture capital; and then, ultimately, how the goods are delivered to the buyer,” he said. “All elements have to be taken into account.”  
Mr Woodhouse said the US ExIm Bank Group runs programmes exporting US used trucks, trailers and other transport equipment that can benefit companies in Africa with their exports. The programmes “can be very cost-effective for the [African] companies to use and generally very economic compared with the competitors,” said Mr Woodhouse.
Other initiatives to overcome risks
One initiative that is being tried out to mitigate risks in structured trade finance is putting in commodities funds at the production end of the supply chain, said Mr Ekra. “We believe it is one of the ways to mitigate some of those risks. As everybody knows, the risk is at the up-country level, where transactions are cash-based, at the beginning of the chain, at the warehouse.” Mr Gondwe said that the Common Market for Eastern and Southern Africa, with support from the World Bank, has set up a Trade Insurance Agency to mitigate risks. “We are [now] trying to have the agency cover the rest of Africa, with continued support from the World Bank. I think that is the way to go because once it [the insurance] is there, I think the banks can do the rest of it.” Mr Newson said that one difficulty in risk mitigation provided by export guarantees is that export credit agencies “by their very nature are set up by their countries to facilitate that country’s trade. [But] how do you regionalise some of those principles, to help support a regional initiative,” he asked. Mr Ekra agreed that it is difficult to see how country-specific export guarantees – which cover the risk of the exporter and usually the payment risk and the country risk – can be expanded into regionwide guarantees. “There is no real future for an export guarantee scheme for exports of African goods to Europe or the US,” he said. However, he also said that export credit guarantees are “a very relevant mechanism” when it comes to Africa’s trade with the BRIC nations (Brazil, Russia, China and India) and other emerging economies. “They are the new exporters of manufactured goods. That’s where export credit guarantees go [to manufactured goods]. They are [also] new partners and we don’t know them very well.”
Mr Rao said that a number of African governments have started discussions with representatives of India’s Commodities Exchange to find out if they can establish a similar exchange in their countries or region, rather than having commodities exchanges overseas, and replicate India’s successful experience.
China’s impact on Africa’s trade in commodities is considerable but is it sound and sustainable?
Trade between Africa and China is roughly balanced at the moment, according to Mr Newson. However, imports from China – now worth about $50bn a year – are expected “to double in the next two to three years”, he said. The nature of the trade also differs sharply. While “a good 70%” of the exports from Africa are commodities, imports from China are mainly capital goods for the telecoms and software industries, and manufactured goods, especially clothing and textiles, said Mr Newson. China, India and Brazil all have similar strategies towards Africa and it is the demand in these countries, and emerging economies generally, that is driving up the price of commodities worldwide, said Mr Ekra. In that sense, Africa’s fortunes are de-coupling from the US and the EU, where economies are slowing down because of the current crisis in credit markets. On the back of its trade with the BRIC nations, Africa is diversifying its trade and in the past decade those nations have invested more in Africa, comparatively speaking, than the continent received in foreign investment in the previous 30 years, he said. Mr Gondwe said that almost every African country has been affected by trade with China. “South Africa was a huge textile exporter but not any more. And, even the shoes sold in South Africa are now Chinese-made,” he said.

According to Mr Newson, so far China has demonstrated that it is principally interested in buying African raw materials and selling value-added products to Africa, which is the same trade pattern that Africa had with other trade partners in the past. However, he said there are examples of China adding value and developing infrastructure (for example, setting up a number of Chinese textile factories in Lesotho that created economic activity and jobs), and he believed that the trade is sustainable and sound. However, the big challenge is to make sure that the proceeds from this trade are used in a way that diversifies African countries away “from a single-commodity rut”, he said.
Is the general risk perception of Africa accurate?
Mr Ekra said that in the past 25 years, Africa has been through all forms of structural adjustment, which has had a huge human cost, and a line should now be drawn and the continent’s improvements acknowledged. “Out of 53 countries, only a few are having real political problems. The environment is much better. Yes, there is a long way to go in terms of the legal and regulatory environment but the numbers are appealing. So I believe we should have a better appreciation and a better perception of where Africa is today,” he said.