19 December 2013

Risk.net: Insurers eye opportunities in commodity trade finance

CTF is an umbrella term for a wide range of assets used to finance the production and transportation of physical materials around the world, secured by the underlying commodities themselves. The current size of the market is $18 trillion.

Investment specialists say CTF is likely to become a core asset class for insurers in the medium term. "We are aware of at least one very large UK insurer looking to invest in the mass-end of the trade finance market", says Yasheen Rajan, London-based partner and chief operating officer at Utility Capital Group (UCG), an independent fiduciary manager and specialist provider of investment advice to financial institutions.

CTF allows firms to tap a sector of the economy that is otherwise inaccessible, as typically commodity trading companies are not publicly quoted. The withdrawal of some banks for the trade finance sector has cleared the way for insurers to invest in this class.

James Stuart-Smith, co-chief executive of UCG in London, says the banking sector is reluctant to finance commodity transactions undertaken by smaller traders, opening space for other institutions to enter the market. "There is a general theme of banks lending less. Factors such as Basel III forced them to reconsider the way they measure their risks, and therefore they end up lending against the higher-quality borrowers rather than traders with small balance sheets", says Stuart-Smith.

In some areas of CTF, banks are working with insurers to create bespoke investment vehicles that suit their risk profile.

Konrad Wälti, managing director of CTF at Credit Suisse in Zurich, explains: "Certain banks can leverage insurers to increase their own risk appetite for CTF. For example, we have always placed in the insurance market commodity-related risks, including project finance, simple trade transactions and selling commodities on letters of credit. What is new, though, are products that are tailor-made for non-bank institutions to invest in."

These products include default swap structures, where an insurer is paid for taking on the bank's risk from a CTF transaction, and credit-linked notes where the underlying cashflow is based on loan repayments from a range of commodity traders.

The flexibility of these products is expected to generate a broad interest in CTF in the years to come. "A clear benefit with trade finance is that you can tailor your investment to match your specific needs as an insurer. In addition, transactions are short term and liquidate naturally so investors can see returns being realised quite quickly without getting locked in", says UCG's Rajan.

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