At the moment it is difficult to gauge the full extent of the impact of Covid-19 (coronavirus) on trade and commodity finance, although it is clear that the pandemic is both severe and widespread, particularly in Organisation for Economic Co-operation and Development (OECD) countries.¹ Many millions of people have already been affected and more will follow, while Italy’s decision to impose a nationwide lockdown was soon replicated by many other countries. Economists, who initially projected that global economic growth would slow sharply, quickly adjusted their forecasts to a sharp recession.² Having said all this, in assessing the impact of coronavirus it is worth trying to define what the scope of trade and commodity finance is. That way it is possible to consider the likely effects.³

Trade and commodity finance comes in different shapes and sizes. It can provide finance to the whole of the physical supply chain; extending from growers and producers through to processors, exporters, storers and transporters right through to wholesalers, retailers and, ultimately, consumers. The more adventurous financiers will make funds available to producers by way of pre-export and prepayment finance, which takes production and performance risk on those parties. There is no commodity at this point.

Perhaps a little less adventurous are those who will finance emerging market commodities that are already at the warehouse, on board vessels, or in store at their final destinations . One issue here is whether the commodity can be sold, delivered and paid for. Some look only to the end of the physical supply chain and provide finance (by way of loan or receivables purchase) to the strong buyers who act as importers, wholesalers and retailers in OECD countries. Here, the arrangements can benefit a supplier who is pressed for cash while their buyer negotiates longer payment terms. This is called supply chain finance.

Ironically, supply chain finance could be affected first. The business depends on buyers continuing to buy from suppliers. The more committed the buyer is (will they irrevocably agree to pay?) the better the finance possibilities. Thus, the supplier has sold the commodity and has a receivable to sell. Supply chain finance means the financier will pay the supplier as early as possible, so long as the buyer has agreed to pay. However, we are now seeing cases of buyers not wanting to buy, as they may be unable to sell the product they have committed to purchase. Some are even claiming that coronavirus is a force majeure event, which relieves them from the obligation to buy. If this situation becomes more widespread, then the supply chain market could well slow down.

There are arguments on either side as to whether this is a reasonable position to take, and much may depend on the wording of the force majeure clause. Reviewing these provisions in purchase agreements where financiers are funding the payable will be more important. Financers will need to ensure that they only agree to purchase and meet payables that have the commitment of the buyer.

Turning to the other end of the physical supply chain the answer may be different. The world needs commodities, especially in the agricultural sector, and those grown and processed will be a useful area to finance. If a financier can be satisfied that the commodity is being grown – and the other parties involved in the physical supply chain can perform so that the commodity is produced, processed, transported and delivered – then this would remain a good area for trade and commodity finance.

A successful financing requires people or machines that can work across the whole physical supply chain. That being the case, what stops the financiers? The answer is risk appetite. There is a different view taken of risk than there once was. If one could mitigate the performance risk of the various parties in the transaction, then the financing could be secure.

However, many financial institutions cannot − or will not − consider SMEs in emerging markets. This is because their compliance departments do not allow for on-boarding of these companies, which has meant that major banks are not exploiting these opportunities. Should they change their minds and if regulators help them, there is much to finance.

Indeed this huge, unfinanced trade gap, an estimated US$1.5trn⁴, would provide fertile ground for financing. It is strange but true that if the regulator releases banks from compliance requirements then trade and commodity finance could increase, rather than reduce.

Others in this space, such as smaller banks, non-bank financial institutions and funds, have found good opportunities. These transactions could well continue and indeed increase, although the attendant risks could yet increase in the current environment. An issue then will be to assess those potential risks and how to deal with them.

Before looking at how to increase trade and commodity finance it is worth exploring what to do with existing transactions that might be adversely affected. This would also help in considering how to participate in new transactions.

Force majeure and coronavirus

Force majeure provisions come in all shapes and sizes. Different legal systems have specific approaches; in some, force majeure and contract frustration – meaning the contract is impossible to perform – get confused. Under English law, it is unlikely that the coronavirus would constitute contract frustration, resulting in a need to explore what has been provided for in the contract. Civil law jurisdictions may well have force majeure determined within their commercial code. China, where claims of force majeure started as the outbreak gathered pace, simply closed factories and ports. This means de facto non-performance, which would have to be addressed.

Different legal systems have different approaches to force majeure
Geoffrey Wynne

English law requires force majeure to be spelled out in order to rely on it. Coronavirus may well not constitute an event in itself. However, more importantly, the question is better framed in the following terms: if performance must be excused because of an outside event, then what happens? The provisions should be checked to see if performance is suspended or cancelled. The former is a better solution for a financier relying on a contract to secure performance and then payment.

Banks that issue documentary letters of credit evidencing payment and standby letters of credit covering non-performance will be examining the rules governing their issue. Coronavirus is not likely of itself to render any of these documents frustrated, nor would the provisions in rules like Uniform Customs and Practice for Documentary Credits and International Standby Practices necessarily be capable of stopping payment. That means that banks that issue or confirm letters of credit will need to consider carefully if they are having to pay, and how they might be reimbursed. The practical problems of delivering documents to an issuing bank or an applicant to be reimbursed will be a growing problem if lockdowns continue.

The law and interpretation of it may have to try to run to catch up with the practical problems of delivering documents in a lockdown. Indeed, how to execute and deliver documents where the population is working from home will again be challenging. Force majeure may be a reality in the sense that this pandemic will stop what is needed without parties agreeing to change how they can process transactions. At the same time, trade and commodity finance is a physical world. Goods can still be produced and delivered. Whether they can also be accepted and paid for are challenges to come. A flexible approach to dealing with how to evidence payment obligations will also be important.

There is another related area to consider in documentation and that is the material adverse change clause. It generally refers to a material adverse change affecting performance by an obligor. The remedies in the hands of a financier are to stop further utilisations and/or to require an obligor to repay the financing. This may not be helpful; in a similar way to a nuclear weapon it sits in the armoury, but threatens utter devastation. It is not necessarily useful to use in these circumstances, should it apply. Requiring someone to pay – or withholding finance at a time when tolerance is needed – are arguably not the best solutions.

The first step should be to look at current documentation and transactions – which are still running, and will they be affected by any of the issues outlined above? If they are potentially affected, then what could happen, and are the provisions in the documents resilient enough to cover the scenario?

This is the time to calmly review and seek to preserve the structure of the transaction. That might mean flexibility on when payment or performance is expected. There seems no point in simply terminating the transaction and making claims that cannot be met. Restructuring any existing transaction offers a better approach.

Flexibility in dealing with issues, such as accepting satisfactory documents and the signing of documents, is paramount. That may be challenging, given legal constraints such as what could be difficulties in signing and the delivery of documents. Imaginative legal solutions may be needed. This need will continue if lockdowns and working from home persist. It remains relevant assuming that the physical supply chain can still deliver.

The challenge would then be to keep transactions going where there is to be further utilisation, and indeed to create new transactions where there needs to be signing of documents. In each case, the question will be how to achieve performance. Where possible, it would be useful to amend documentation to allow for electronic signature and delivery of what might technically only be copies, but treating them as originals. This approach can keep transactions running and allow for new transactions to be concluded.

Assuming there remains physical trade and commodity business then there is every reason for that to be financed. There should be no reason to stop entering into, or allowing, performance of trade and commodity finance transactions. Performance may have to change, and financiers may need to be more flexible to enable transactions to continue. Coronavirus will affect certain transactions and documentation will have to be reviewed and, in some cases, amended.

The fundamental message is that we should not allow this potentially lethal virus to kill trade and commodity finance, which has always been able to adapt to changed circumstances. This is an opportunity to reconfirm that ability.

Have a detailed look at how best to enter into and maintain transactions and how to carry them out, but do not stop them.

Geoffrey Wynne is Partner and Head of the Trade and Export Finance practice at international law firm Sullivan

Sources

¹ See https://oecd.org/coronavirus at oecd.org/coronavirus
² See https://db.com/flow for more background on the macroeconomic issues
³ See A guide to Trade Finance at corporates.db.com
⁴ See https://bit.ly/2RjkuWa at adb.org