Response to consultation on RTS on specialised lending exposures
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1. Monitoring and controls
Reference should be made to the monitoring and controls that are provided in commodities transactions by transaction monitoring teams. By failing to make any reference to a transaction monitoring unit, a balance sheet lending predicated against receivable or inventory could be classed as commodity finance, despite there being no controls around it and it really being just clean lending.
By way of explanatory background, the monitoring and control of commodity finance transactions is proposed to address the 'eligible credit risk mitigants' criteria under Basel 2, whereby any security or collateral provided by a borrower has to fulfil certain requirements in order for it to be effective in reducing any risk weighting. Consequently, the lender should be able to demonstrate an appropriate transparency, due diligence and level of control over any underlying physical collateral and/or receivables (these being the types of security commonly offered by a commodity finance borrower).
Considerations to be evidenced include: 1) Legal Certainty - Documentation); 2) Legal Enforceability (Right to Liquidate and Take Legal Possession of Collateral; 3) Valuation of Collateral; 4) Insurance of Collateral; 5) Recognition of Physical Collateral - Markets and Prices; 6) Legal Enforceability – Receivables; and 7) Risk Management – Receivables.
In order to be effective, this would benefit from commodity finance lenders having a dedicated Transaction Management Unit or similar to monitor and control the integrity and flow of financed transactions, which would include the due diligence, monitoring and control over physical commodities as well as over their receivables - and, where applicable, the due diligence, monitoring and control over any agents appointed by the bank such as Collateral Managers.
2. Income generated by assets
The reference to income generated by assets" should be amended to "receipts generated by assets", to ensure there is no confusion that the reference is to the receivable due from the sale of the commodity. "Income" could infer, for example, bank margin, thus confusing any calculation of exposure. We would also like to stress that a commodities financing is generally self-liquidating, in that the proceeds of the sale of the commodities provide an independent source of repayment for the financing.
3. Reference to "Exchange-traded"
We support the reference to "exchange-traded", its application being necessary to differentiate those commodities for which there is a recognised and established price determinant and delivery mechanism. Whilst it is often the case that, although the commodity is exchange traded, the underlying transactions may be for a form of commodity which is not deliverable to an exchange, because they are in a form or size not fully meeting the exchange's criteria, it is a step too far to say "exchange deliverable". This is because commodities, for the most part, remain bought, sold and exchanged in their raw or semi-processed state within the physical supply chain, rather than being delivered up against futures contracts, which is often seen as a last resort. We would therefore recommend that the "exchange traded" language is retained.
In addition, we are keen to ensure that the reference to “exchange-traded” is also not construed too narrowly to mean that the actual commodities being financed were in fact being traded on an exchange. In many financings this will not be the case and the commodities will be bought and sold within the supply chain. We would therefore suggest it may be more accurate to say “commodities of a type capable of being traded on an exchange.”
Finally, we would propose extending the definition of commodities finance to include “production” and “transportation” alongside “reserves, inventories, or receivables” to cover, for example, pre-export or tolling financings and on-vessel financings. “Export” might also be relevant for inclusion as many commodity financings involve cross-border movement of the commodity.
In light of the points raised in 1-3 above, we would suggest that Article 2(2)(d) be amended to the following:-
" a specialised lending exposure shall qualify as ‘commodities finance' where the funding is used to finance production, reserves, inventories, transportation or receivables of commodities of a type capable of being traded on an exchange, including, in particular, crude oils, metals, or crops, where the proceeds generated from the sale of the commodities are typically used as an independent source of repayment of the financing, and where such financed commodities are duly monitored and/or controlled by a dedicated transaction management unit or party appointed on behalf of the financier.""
Question 3: Do you agree with the classification of specialised lending and the descriptions given?
Looking specifically at the description of 'commodities finance', we would make the following observations.1. Monitoring and controls
Reference should be made to the monitoring and controls that are provided in commodities transactions by transaction monitoring teams. By failing to make any reference to a transaction monitoring unit, a balance sheet lending predicated against receivable or inventory could be classed as commodity finance, despite there being no controls around it and it really being just clean lending.
By way of explanatory background, the monitoring and control of commodity finance transactions is proposed to address the 'eligible credit risk mitigants' criteria under Basel 2, whereby any security or collateral provided by a borrower has to fulfil certain requirements in order for it to be effective in reducing any risk weighting. Consequently, the lender should be able to demonstrate an appropriate transparency, due diligence and level of control over any underlying physical collateral and/or receivables (these being the types of security commonly offered by a commodity finance borrower).
Considerations to be evidenced include: 1) Legal Certainty - Documentation); 2) Legal Enforceability (Right to Liquidate and Take Legal Possession of Collateral; 3) Valuation of Collateral; 4) Insurance of Collateral; 5) Recognition of Physical Collateral - Markets and Prices; 6) Legal Enforceability – Receivables; and 7) Risk Management – Receivables.
In order to be effective, this would benefit from commodity finance lenders having a dedicated Transaction Management Unit or similar to monitor and control the integrity and flow of financed transactions, which would include the due diligence, monitoring and control over physical commodities as well as over their receivables - and, where applicable, the due diligence, monitoring and control over any agents appointed by the bank such as Collateral Managers.
2. Income generated by assets
The reference to income generated by assets" should be amended to "receipts generated by assets", to ensure there is no confusion that the reference is to the receivable due from the sale of the commodity. "Income" could infer, for example, bank margin, thus confusing any calculation of exposure. We would also like to stress that a commodities financing is generally self-liquidating, in that the proceeds of the sale of the commodities provide an independent source of repayment for the financing.
3. Reference to "Exchange-traded"
We support the reference to "exchange-traded", its application being necessary to differentiate those commodities for which there is a recognised and established price determinant and delivery mechanism. Whilst it is often the case that, although the commodity is exchange traded, the underlying transactions may be for a form of commodity which is not deliverable to an exchange, because they are in a form or size not fully meeting the exchange's criteria, it is a step too far to say "exchange deliverable". This is because commodities, for the most part, remain bought, sold and exchanged in their raw or semi-processed state within the physical supply chain, rather than being delivered up against futures contracts, which is often seen as a last resort. We would therefore recommend that the "exchange traded" language is retained.
In addition, we are keen to ensure that the reference to “exchange-traded” is also not construed too narrowly to mean that the actual commodities being financed were in fact being traded on an exchange. In many financings this will not be the case and the commodities will be bought and sold within the supply chain. We would therefore suggest it may be more accurate to say “commodities of a type capable of being traded on an exchange.”
Finally, we would propose extending the definition of commodities finance to include “production” and “transportation” alongside “reserves, inventories, or receivables” to cover, for example, pre-export or tolling financings and on-vessel financings. “Export” might also be relevant for inclusion as many commodity financings involve cross-border movement of the commodity.
In light of the points raised in 1-3 above, we would suggest that Article 2(2)(d) be amended to the following:-
" a specialised lending exposure shall qualify as ‘commodities finance' where the funding is used to finance production, reserves, inventories, transportation or receivables of commodities of a type capable of being traded on an exchange, including, in particular, crude oils, metals, or crops, where the proceeds generated from the sale of the commodities are typically used as an independent source of repayment of the financing, and where such financed commodities are duly monitored and/or controlled by a dedicated transaction management unit or party appointed on behalf of the financier.""