Commodity price collapse fuels trade finance fraud
Falling commodity prices have led to higher fraud claims. Banks might have to implement stronger trade finance criteria as a result.
The impact of falling commodity prices is being felt across transaction banking, and could be responsible for rising allegations of fraud.
The International Chamber of Commerce (ICC) Global Survey 2015, which was published in December, found that 18.5% of respondents reported experiencing an increase in allegations of fraud. Some 16.1% saw an increase in the number of court injunctions.
Vincent O’Brien, ICC
Vincent O’Brien, chair of the ICC Banking Commission Market Intelligence, says: “It is true that the 2015 report shows increasing allegations of fraud. But the important thing to note is this is not a verified rise in the proven cases of fraud.”
The distinction is important, as it comes down to the difficulty in or reluctance to make the payment, rather than the transaction being created with the intention to defraud the seller. O’Brien believes the primary reason for this change is the drop in commodity prices.
“A lot of the allegations are driven by the market conditions and collapses in the commodity prices," he says. "If the importer can’t get the supplier to renegotiate on the price, they may go to court and to obtain an injunction to stop or delay payment of the import letter of credit. This is a troublesome trend, but in many cases it can be driven by genuine hardship circumstances.”
Fraud is having a notable impact in some cases, especially on smaller corporates.
“We have seen an increase of fraud cases in the market,” says Sander Stuijt, head of EMEA sales, structured commodity trade finance, global transaction banking at Deutsche Bank. "This has in some instances led to full bankruptcy and credit losses."
ICC's O’Brien, explaining why some importers are finding themselves in this position, says: “There are many cases where the importer could be importing iron ore at a price agreed with the supplier months ago for payment 180 days after the goods are shipped. But what if the commodity price has dropped 50/60% between the time of the contract and the payment date?”
Sander Stuijt, Deutsche
The problems might also be exacerbated by FX volatility.
“The importer will have huge problems if they pay the original contract price linked to the letter of credit which was issued to cover the import,” says O’Brien. "Quite possibly the currency of the importer may also have fallen against the US dollar, the currency in which commodity contracts are mostly denominated.”
There has been rising demand for confirmations on letters of credit to ensure that payments will be made, regardless of changes to circumstances.
“If a court injunction is issued based on the case of exporter or beneficiary fraud, it will be addressed to the issuing bank in the importers country,” explains O’Brien.
“In practically all cases, the court order injunction will not cross the border to the jurisdiction of the confirming bank. The exporter gets his money under the separate undertaking of the confirming bank. Even now we are continuing to see increasing demand for confirmations and in some jurisdictions an increase in dispute cases between confirming and issuing banks.”
The ICC survey found 66.1% of banks are either implementing or considering implementing stricter criteria for trade finance transactions as they respond to market uncertainty. However, so far the impact has been muted.
Kris Van Broekhoven, Citi
“There needs to be a new normal," says Kris Van Broekhoven, global head of commodity trade finance at Citi. "As far as the banks are concerned in the commodities space, they are not changing what they do or how they do things. The products will remain the same.”
Banks are, however, taking a hard look at how products are structured.
Van Broekhoven says: “Banks don’t have to reinvent the product, but they have to readjust their planning and budgeting to take into account the lower commodity price environment. They also need to do more work before deciding to give new credit lines to an exporter.
"The due diligence has to go deeper into stress testing. It takes longer to get a deal through.”
And there will inevitably be restructuring. “If they don’t make the same top line revenues anymore then it is possible the banks will decide they have to cut expenses to work out the bottom line,” he adds. "The industry right now is seeing this phase of rationalization.”
Deutsche’s Stuijt says banks will refocus and adapt to pursue a different market segment, adding: “A crisis can be good for the structured commodity finance business.
"We see companies that used to borrow unsecured now moving to the structured commodity finance market as this is potentially one of the only pockets of liquidity that still is open to them. Companies that would have gone to the bond market may now find it closed, especially in emerging markets.”
He adds: “There is a need to be more selective. The good thing from our region – EMEA – is there is still a large pool of high-quality borrowers and issuers who would not normally come to our market. So the business outlook is good, but what you see from the bank sector is that everyone is being more careful.”