Despite recent political and economic events we have seen an increase in volume of trade finance facilities, especially in pre-export finance and pre-payment finance over the months.
This overview explains the structure, parties and risks that are involved in basic pre-export finance and pre-payment finance transactions.
A PXF facility provides finance to producers of goods and commodities based on proven orders from buyers.
In a classic PXF transaction, the borrower (and seller) uses funds to meet its working capital needs to cover the purchase of raw materials for production and costs in relation to storage and transport of goods. Most borrowers have many PXF in place and most PXF facilities finance 80-85% of production.
Commodities that are subject to PXF transactions are split into two types; soft and hard commodities. The term soft commodities generally refers to commodities that are grown, such as coffee, sugar, rice, nuts, seeds and livestock, whereas hard commodities are mined such are gold, copper and oil.
In a basic PXF transaction the borrower enters into a sales contract with a buyer and a facility agreement with the lender. The subsidiaries and the parent of the borrower typically provide guarantees in favour of the lender though depending on the facts of the transaction the borrower may be the sole security provider. The borrower uses the funds to produce and export goods to the buyer. The buyer then sends the payment directly to the lender, and the lender deducts the charges and interest associated with the loan before sending the payment to the borrower’s account.
A basic PXF transaction involves (i) an assignment of the sales contract made between the borrower and the buyer, (ii) a mechanism to collect payments under the sales contract for the benefit of the lender (i.e. bank account charges), and (iii) a pledge over goods in store, in transit and in ground.
The lenders consider various factors including production and delivery risk as the repayment of the loan is contingent on the production and sale of goods. Payment under the sales contract is another important issue as the buyer may fail to pay in time and in full even though the seller provided the goods in accordance with the terms of the sales contract. The lenders also consider the political risks associated with the transaction. In certain countries a borrower is required to purchase political risk insurance which would cover the event of sanctions, expropriation, changes of law and war for both the borrower and the lender.
Parties set up mechanisms for the payments to be made for the lender’s benefit, to monitor commodity value and to call for additional commodity in the event of a shortfall. A shortfall in the cover ratios may be cured by one of the following options:
- prepayment of the loans,
- increase of volumes under the sales contracts,
- introduction of additional sales contracts, and
- providing cash cover to the debt service reserve account.
The lenders also require regular reporting on the production and sale of the goods or commodities.
In our experience, parties generally use the standard form Single Currency Term Facility Agreement for Pre-Export Finance Transactions published by The Loan Market Association (LMA PXF document) or their internal facility documents. The LMA PXF document took as its starting point its leveraged facility document and adapted it to provide for a classic pre-export finance transaction. Because of the inclusion of different options for the parties and the provisions that have been left blank, the document is usually heavily amended and negotiated. Of course, further changes may be made to the document depending on the facts of any transaction, especially further to local law advice.
Prepayment finance transactions started historically to address the producers’ funding concerns especially in countries where exchange control regulations apply,
In a prepayment finance transaction the borrower uses the facilities to prepay for goods or commodities to be supplied to it by the producer of those goods under a sales contract. The borrower enters into an off-take agreement and a prepayment agreement with the seller. The borrower advances the prepayment and the seller uses the proceeds of the prepayment funds to produce the goods. Outstanding amounts under the prepayment agreement accrue interest, and delivery of goods by the seller are applied against the outstanding prepayment amount.
The borrower enters into a facility agreement with the lenders to finance prepayments, and repays loans once the seller has delivered the goods under the off-take agreement. Often the seller will deliver the goods to a subsequent buyer on the instruction of the borrower who will have already contracted to sell on the goods.
A typical prepayment finance transaction involves an assignment of the lender’s rights under the prepayment agreement and the buyer’s rights under the off-take agreement. Security may also be taken over the goods and the bank account into which the off-taker makes the payment.
Prepayment finances are particularly important for producers located in a country which has exchange control regulations or restrictions in respect of direct lending to producers by overseas financial institutions. A typical prepayment finance facility has a tenor of between one and five years, but it is common for facilities to be amended and restated and extended throughout their life.
The lenders often share the production and sale risks as the borrower may seek to limit the lenders’ recourse to it under the facility agreement. Political risk, again, is one of the risks the lenders should consider.
Please do get in touch with us for more information in relation to any of these financing methods or other trade finance structures.