Managing trade risks

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Published: January 16, 2015 1:29:30 AM

All trade transactions are conceived with measures to minimise market risk.

All trade transactions are conceived with measures to minimise market risk. To mitigate risks, traders take cues from governments’ policies, use the services of banks, hedge in future exchanges, appoint surveyors for quality assurance and cover unforeseen events through insurance companies. There is also a financial supervision of the corporates with which many aggressive traders are uncomfortable. This column trashes the commonly-held belief that the above-mentioned intermediaries are foolproof arrangements of success in trade and maps out some emerging trends.

The biggest risk comes from “acts of government”. These governments often defy their own professed principles that uphold transparent trade regimes. Aren’t the US and Saudi Arabia not manipulating crude oil prices beyond supply-demand equilibrium to hit West Asia and Russia, and thus destabilising the world’s financial markets?

Hasn’t India’s 80:20 rule for gold import encouraged smuggling and distorted bullion trade? Is fixing state-advised prices for sugarcane, irrespective of the market realisation from sugar and its by-products, not fundamentally flawed? Then, there could be umpteen judicial interventions that might rattle trade. Governments, thus, are the most potent source of risks for trade.

The commonly-held perception that a letter of credit (LC) from a first-class bank is the safest mode of payment is misplaced. The LC is only an assurance from the bank (and not a binding commitment of performance) that the buyer is solvent enough to pay. It simply implies that, given stable market conditions and compliance with the requirements for obtaining the LC, the payment to the seller is secure.

If prices fall, the probability of the buyer finding an alibi for non-compliance with the terms of credit is high. In that event, the seller is at grave risk. If prices sky-rocket, then despite having a workable LC, the seller may invent excuses to renege from the deal to maximise market-driven gains elsewhere. Sellers’ anxieties heighten when the LC is under negotiation due to the fear of documentation discrepancies and delayed payments. In the FOB business, buyers’ anxieties rise when their boats are waiting at ports for want of cargoes from sellers. If one of the parties elects to abandon the deal, the LC, becomes merely a piece of paper.

Futures exchanges discover daily prices of a commodity. Profits and losses can be hedged. In India, delivery-based exchanges face the limitation of massive volumes and lack of reliable warehousing. The quality/quantity of the commodity is suspect, given the insect-infested, insanitary storages. Indian banks do not accept warehouse receipt as a formal negotiable instrument. Our exchanges need greater depth before they can be fully relied upon for hedging purposes. The recent National Spot Exchange episode exposed infirmities in warehousing of commodities, which is critical for working of such delivery-based exchanges.

Contracts generally stipulate quality-quantity thresholds at the loading port that is to be certified by a surveyor or an inspection agency. Can surveyors be hauled up if the quality at the discharge port is different from the one certified? In the fine-print of the reports, it is clearly stated that they are based on the samples collected from the warehouse or at the pre-loading stage. What is actually loaded in the ship’s hatches is not in their control or their liability. Surveyors’ fee varies from 50c-70c per tonne, and thus the risk-reward ratio does not justify any claims of millions of dollars on them. They are enabling agencies and not determining agencies for the morality of the contract or breach of trust between buyer and seller, unless criminal negligence is proven against them.

Insuring goods is a brilliant idea. But claiming losses from insurance is the wretchedness of the worst kind. What the insurance companies write in small prints about the quantum of indemnity when insurance is brokered, none can figure out. The type of documentation, deductibles, exclusions, waiting period, third-party liabilities, etc, that are to be grappled with are nightmarish. Retired insurance officers hired by private trade for insuring cargoes and claiming the insured amount find themselves foxed not by the rules alone but by the suspicion on the genuineness of the claim. Even if the insured amount is encashed, the procedural agony can be paralysing.

So, what is the way forward? Trading is getting complex because of new technologies, including information systems that give real-time data from around the world. Finance departments or controllers of trading companies can be “penny-wise, pound-foolish” if they remain inflexible. Unless corporates are decisive, the risks of trade cannot be tamed.

Conventional trading transactions have to be reinvented as creative deals for risk management. Alertness and ad hoc measures are the new rage in doing business, to which bureaucracies and corporates are inimical. That must change.

Some recent variations from conventional trade are: traders are increasingly making “positional” deals rather than back-to-back bargains; optional-origin trading instead of only India-centric approach; establishing subsidiaries overseas for stock-keeping and sales or forming JVs for risk aversion and to develop brand; suppliers’ or buyers’ credits of 180/365 days for export or import through banking channels; buyers covering demand 4-5 months in advance for price advantage; hedging in future exchanges abroad through offshore firms, barters backed by escrow account arrangements, etc. Likewise, the Indo-Iran rupee payment agreement, from which India has derived tremendous benefit, is another creative mechanism to sustain bilateral trade despite international sanctions.

The author is a grains trade analyst

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