In todays bulk commodity market there is often little, no or even negative margin when buying in an origin country Free On Board (FOB) and selling back-to-back into destination Cost Insurance Freight (CIF).
Many larger commodity traders have found a way to increase their margin by using a clever routing of ownership documentation.
Commodities are traded on documentation rather than physical delivery and with this in mind, cargoes can be routed through countries that will never actually take physical delivery and yet for finance purposes appear to do just that.
The key is to identify countries where the onshore currency is controlled by a central or reserve bank and where there is also an active offshore NDF market. This has to be opportunistic, as the onshore/offshore forward rate spread is not always in favour of the trade.
An example I will use is India, a country well known for this play in the past.
So, I have a cargo of soybeans which is bought FOB Paranagua Brazil to be loaded in 3 months time and sold CIF Nanjing China. I insert into the documentary flow an additional trade in India, such that the cargo is bought and simultaneously sold by an onshore Indian entity.
Where is the advantage?
Because the documentation will show that a cargo is being imported by an Indian entity, it will be possible for that entity to enter into a 3 month forward onshore hedge with the approval of the RBI against the dollar value of the cargo.
Simultaneous to the purchase of the cargo into India which is hedged onshore, there is a sale of a cargo from India and this is hedged in the 3 month forward offshore NDF market which is simultaneously trading at a spread to the onshore rate.
The beauty of this is that the offshore NDF will mature at the same rate as the spot onshore market in 3 months time when the transaction takes place and so this creates an effective arbitrage profit. Be aware that to a structured finance team ‘arbitrage’ is a very dirty word due to its regulatory implication and the preferred terminology is ‘opportunity’.
The mechanics and administration of such a structure is rather more complex than the brief description above due additional costs and many regulatory and legal issues to be avoided but the basis of the structure is simple and can be repeated wherever there is a realisable onshore/offshore spread.
It is not uncommon to add 2-5$/mt to margin through STF and it can turn an otherwise negative margin calculation into a profitable flow.
There are a number of other ways that structured trade finance can bolster margin and I will come back to that in a later blog. If you would like more details or even investigate how to set up these structures for a particular commodity flow then get in contact.
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