By Michelle Biggs, U.S. Agribusiness Trade Manager
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With the harvest season nearing, U.S. exporters and Chinese buyers are hard at work planning this fall-winter wave of soybeans westward over the Pacific. According to a USDA report issued in September, large forward sales to China in late July and August pushed U.S. new crop soybean sales over 20MM MTs by the end of August, up 14 percent from last year's record. The U.S. is projected to ship 37.3MM MTs of new crop soybeans to China between October 2013 and February 2014. Much of the hard work is done: tenders have been issued, bids placed and accepted, prices set, even vessels identified or secured. However, one thing may still be unfinished: negotiating payment terms.
Of all the factors that drive any agricultural trade flow, focus is usually and rightfully placed on fundamentals, including crop volume, quality, and stock levels. Sometimes secondary factors such as freight costs and exchange rates are mentioned, but rarely is trade finance. In the case of U.S. soybean exports to China in recent years, that has been an oversight. Formal metrics are not available, but plentiful and inexpensive trade finance has contributed to the wave of soybean exports.
The U.S.-China soybean trade has been the most competitive and dynamic market for agricultural trade finance over the past few years for two reasons:
- The deals are very high in value by agricultural trade finance standards. Higher soybean prices and larger vessels have driven the value of a single bulk shipment transaction to $30-45 million. Thanks to growing Chinese demand, these large transactions are happening more frequently. For banks, large deals hold the prospect of enhanced profitability because fixed costs become immaterial.
- The creditworthiness behind the soybean deals has generally been considered good and improving over time. The major soybean processors in China are sizeable, stable, and coveted clients by Chinese banks. They have had relatively easy access to bank credit. In turn, the Chinese banks, which issue the trade transactions and act as the credit counterparty to the U.S. banks, have also generally been growing and improving in their reported credit profiles. That is particularly true of the largest "Tier 1" Chinese banks.
The combination of large deal size and creditworthy counterparties attracted U.S. banks in droves, including Wells Fargo. For any given bulk soybean transaction from a Tier 1 Chinese bank, an exporter may receive trade finance bids from two dozen U.S. banks. The competition has driven down trade finance pricing to rock-bottom levels. Ninety-day financing of a $40,000,000 vessel of soybeans — enough to cover shipment and some processing time — can cost as little as $100,000-$200,000. For even the most creditworthy Chinese company, regulated domestic interest rates put the comparative cost at $600,000-$800,000. U.S.-based trade finance has been, and remains, very attractive to soybean processors in China — attractive enough to have been part of those companies' purchasing decisions, and of building the annual U.S. soybean wave.
As we head into this post-harvest export season, the basic underpinnings of the U.S.-China trade finance market remain the same: large deals, good creditworthiness (despite the slowdown in Chinese economic growth), and lots of competition. However, there are some new wrinkles in the implementation and delivery of trade finance. In general, U.S. exporters are ceding their role as the conduits of and gatekeepers to U.S.-based trade finance for the Chinese buyers. Whereas U.S. exporters used to include trade finance costs in their tender offers to Chinese buyers, now the buyers are often arranging financing directly with U.S. banks.
The largest Chinese soybean processors are tapping U.S. trade finance by establishing U.S.-based subsidiaries. These processors are also setting up subsidiaries in Hong Kong and Singapore. Although the processors' purchase contracts are typically negotiated by staff in the China headquarters, the U.S. subsidiary is named as the buyer. The U.S. supplier is expected to sell to the U.S. subsidiary on sales terms more customary for a creditworthy domestic buyer: payment in full and in cash about five days after shipment. The Chinese parent then "purchases" the product from the subsidiary using a 90-day deferred payment letter of credit, the most common mechanism for tapping trade finance. This lets the Chinese companies avoid any additional financing costs or fees that the U.S. supplier may charge.
This change in payment terms generally represents higher risk to the U.S. exporter. When the U.S. exporter receives a letter of credit supporting a shipment, as was standard in the past, its credit counterparty is the Chinese bank that issues that transaction. The Chinese bank commits to pay as long as the exporter fulfills the transaction requirements. (Often a U.S. bank such as Wells Fargo will "confirm," or add its own commitment to pay, the transaction contingent upon the exporter fulfilling its requirements.) In the new scenario, the U.S. exporter's credit counterparty is either the Chinese parent company or its U.S. subsidiary. While these companies are seen as creditworthy — most are said to have unblemished payment records for several years — they cannot have the same counterparty risk profile as a large, state-owned Chinese bank. Nevertheless, U.S. exporters are proving to have the confidence in the Chinese buyers to make the switch. Competition among the U.S. suppliers is no doubt a factor. Finally, the new process results in payment to the U.S. supplier in one-half to one-third of the time it takes under a trade transaction.
Some medium-sized Chinese soybean processors that have not (yet?) established U.S. subsidiaries are finding another way to access well-priced trade finance directly rather than through their U.S. suppliers. The company, the Chinese bank that provides them credit, and a supporting foreign (non-Chinese) bank in China collectively negotiate trade finance terms. Ultimately the Chinese bank issues a letter of credit trade transaction to the U.S. supplier (via a U.S. bank), but it calls for prompt payment to the U.S. supplier rather than 90-day deferred payment. The post-shipment financing is handled between the banks and the company in China, typically at rates at or near U.S.-based trade finance levels. Feed millers in China have also been using this transaction structure for Distillers' Dried Grains with Solubles (DDGS) purchases from the U.S. It is a favorable transaction for the U.S. supplier because the credit counterparty remains the Chinese bank (again, often supported by a commitment from a U.S. bank).
These new payment structures are making their way into more and more U.S. export contracts this season, demonstrating that attractive trade finance continues to be a driver of export volume. We may only realize its full impact when its advantages slip away. Eventually international interest rates, particularly LIBOR, will rise to more normal levels, and the differential between trade finance and domestic financing rates in China may narrow. The incentive for Chinese buyers to use trade finance may abate, taking at least some purchase incentive with it.
Michelle Biggs leads Wells Fargo's Agricultural Trade Team in North America, part of the International Trade Services division, International Banking Group. She works with domestic trade finance specialists, and with her commodity trade colleagues in Shanghai, Seoul, Singapore and London to build Wells Fargo's global agricultural trade finance portfolio. She started her career in the International Banking Group at CoBank, part of the U.S. Farm Credit System, in the U.S. and Singapore. Michelle also brings agriculture industry experience, with 5 years in credit and trade finance with Ste. Michelle Wine Estates.
Michelle holds a B.A. in economics and international relations from Lehigh University in Bethlehem, Pa. and an M.B.A. in international business from McGill University in Montreal.
Wells Fargo Agricultural Industries presents this analysis as a complimentary service to its employees and customers. It cannot guarantee the accuracy of all the sources of data. And, commodity prices are extremely volatile based on unforeseeable changes. These estimates will change with all new market changes.