What Is Structured Commodity Finance?

Structured commodity finance is a complex way of obtaining financing for the international trade of commodity products. Market participants include financial traders, producers of commodities such as energy companies and farmers, as well as investment bankers and risk management professionals. It involves the trade of certain commodities, ranging from oil to metals and agricultural products. There are unique risks associated with structured commodity finance, although this exposure is what drives activity. A transaction might involve one party extending a financial loan to a developing nation in exchange for the future delivery of some commodity products.

This form of financing typically is used when a market participant is doing business with a developing economy. The risks include the possibility that, even after a loan has been issued, an exporting nation will not be able to follow through with product delivery because of political or economic strains. This is a shift from traditional risk, which surrounds the chance that a borrower cannot make a financial repayment to a lender.

In traditional forms of financing, access to capital can be provided based on the client's financial stability. Structured commodity finance offers a different approach that instead focuses on a company's ability to follow through with an arrangement to deliver products. That track record, especially under harsh external conditions caused by a government or economy, can open the door to financing for companies in developing nations that otherwise might never have been possible.

On one side of a deal in structured commodity finance is a lending institution. This bank typically designs structured commodity products based on individual transactions. The party that represents the other side of this transaction in a developing country might include an oil producer or farmer.

It becomes the responsibility of the lender to perform sufficient background checks to determine the likelihood that a commodity delivery will in fact be made. Given that a producer might operate in a nation where a financier does not have a presence, a third-party firm might need to be involved to provide this assessment. Some of the conditions that can be evaluated include a supplier's realistic ability to produce the appropriate allocation of commodities. The viability of the exporter's operations also must be considered, including ensuring that a business has enough resources to compensate employees who are delivering commodities.