Trade finance in 2016: time to enrol in the club?
Club facilities, where a small group of banks combine to provide a facility to a borrower, had fallen out of favour in the commodities trade finance market. However, the last 12 months have seen a noticeable return to this form of financing.
Responses from the commodities industry to a survey carried out in 2015 by Commodities Now, the trade magazine and online resource for the global trade commodity markets, indicated that industry participants wished to see a return to closer, more responsive and more trade-related club relationships. This in itself is not particularly surprising given that club deals allow for more focused and efficient discussions between lenders and borrower as well as offering greater flexibility to a borrower, both in terms of covenants and (re)payment structures.
The industry response to the Commodities Now survey may have been driven by the significant growth in syndicated financing over recent years, perhaps without much consideration as to whether syndicated finance was appropriate for commodities trade. Borrowers may now view syndicated deals with a degree of apprehension for a number of reasons.
First, there is little or no emphasis on relationship banking with syndicated facilities. Large syndicates can be unmanageable from the outset, struggling to meet unanimity requirements (which are required for various key decisions such as extension of maturity) and losing track of business purpose. Banks also tend to sell down their participations in syndicated facilities to other entities, such as hedge funds, very quickly post-completion. This means both that a borrower may not be very, or at all, familiar with the parties actually involved in the deal and that those becoming part of the syndicate may not be specialist commodities lenders.
Next, most syndicated deals usually have a one year tranche and trade finance may often be needed for longer as some assets may be longer term investments which cannot be liquidated quickly if a demand for payment is made. One year maturities also require annual renewals, which in turn will trigger a yearly assessment of the borrower’s credit risk by the syndicate members.
Further, syndicated deals usually make the whole amount of the facility available immediately and this may not be suitable for trade finance participants for whom a tranche structure would be more sensible. The tranche structure allows a borrower to plan projects and purchases when the next drawdown is available, rather than dealing with all funds immediately, and allows a lender to monitor usage and performance pre-drawdowns.
A number of club deals signed in 2015 were highlighted in the commodity finance press. These are indicative of a movement towards the favouring of club facilities to fill the gap between the types of financing available and the needs of borrowers in the commodities market.
Whilst a return to club financing is to be welcomed, caution should be exercised to ensure not only that club deal documentation is fit for purpose, but also that the problems associated with syndicated financing are not replicated in club deals. For instance, one club deal last year involved 19 international banks and another eight banks. It is not hard to imagine that club deals could replicate the problem of large syndicates becoming unmanageable in these circumstances.
As club deals are seemingly becoming more common, there is an argument that the documentation which currently exists for this type of financing should be updated for the modern club facility, in much the same way that the Loan Market Association (LMA) offers a suite of documentation for syndicated lending. However, to draw up such agreements from scratch, with no market consensus, would be both time consuming and costly. Whilst we would certainly not advocate completely standardised documents for club facilities - this would defeat the personal and bespoke nature of the club facility - there are large sections in a club facility which the industry should be able to agree on and standardise, including representations and warranties, general covenants, financial covenants and events of default. This would allow club deal documents to be produced more efficiently going forward. This process would replicate the standardisation of syndicated facility agreements carried out by the LMA, which led to considerable time and cost savings for industry participants.
As we progress into a new year it would be prudent to pick up where the commodities trade finance market left off in 2015 and consider the merits that club deals can offer.