Understanding Trade Finance

Capital → Banking Structure → Commodity → Settlement

A commodity transaction can involve several stages before final payment is made. This distinction is fundamental to our approach to commodities risk.

1. Capital is available to the strategy
   The Fund raises capital that can be allocated to eligible commodity transactions and supporting activities in accordance with its investment mandate.
2. Capital is held within the banking structure
   Rather than immediately transferring cash to a commodity supplier, funds can remain with banking partners and support the relevant trade-finance arrangements.
3. A transaction is agreed
   The commodity, quantity, price, supplier, purchaser, delivery requirements, inspection conditions and settlement terms are established.
4. Banking arrangements support execution
   Depending on the transaction, a banking partner may provide a letter of credit, credit facility or other appropriate trade-finance arrangement.
5. The commodity moves through the supply chain
   Relevant shipping, inspection, title, delivery and other transaction documents are produced according to the contractual requirements.
6. Payment occurs according to agreed conditions
   Supplier settlement is linked to satisfaction of the relevant contractual and banking conditions rather than an unsecured payment being made at the beginning of the transaction.

Controlling Payment Rather Than Simply Advancing Cash

Trade finance has developed over centuries to address a basic problem in international commerce.

A supplier wants certainty that it will be paid. A purchaser wants certainty that the contracted goods will be supplied before relinquishing its capital.

Banks and trade-finance instruments can sit between those two requirements.

For our commodities activities, the objective is to structure payment so that capital is not unnecessarily transferred to a supplier before the agreed transaction conditions have been met.

Depending on the transaction, those conditions may include shipping documents, inspection certificates, evidence of title, delivery documentation or other requirements established under the relevant contract and banking instrument.

The precise structure varies from trade to trade.

A Conditional Banking Mechanism

A Letter of Credit, or LC, is a bank-issued undertaking to make payment when specified documentary conditions have been satisfied.

The Fund does not itself issue the LC. Where an LC is appropriate, it is arranged through an external banking partner subject to that bank’s underwriting, documentation and approval requirements.

This creates separation between the underlying commodity contract and the banking mechanism used to control settlement.

For example:

Fund capital / banking facility
↓
Bank issues LC
↓
Supplier performs against agreed trade terms
↓
Required documents are presented
↓
Bank determines documentary compliance
↓
Settlement occurs in accordance with the LC

The purpose is not to eliminate risk. It is to create a more controlled payment process than simply transferring cash directly to a supplier before performance.

Different transactions can require different structures.

Letter of Credit – LC

Used as a conditional payment mechanism under which the issuing bank pays against specified documentary requirements.

Standby Letter of Credit – SBLC

A bank undertaking that may become payable if the relevant party fails to perform an underlying obligation, subject to the terms of the instrument.

Bank Guarantee – BG

May support particular payment or performance obligations where required by the commercial transaction.

These instruments are issued by banking institutions rather than by the Fund itself and remain subject to the issuing bank’s requirements and the terms of each transaction.

Not every trade requires every instrument.

Keeping Capital Within a Controlled Framework

A key feature of our approach is the relationship between investment capital and the banking system.

For selected transactions, USD capital may be retained or blocked with a banking partner to support trade-finance or credit facilities rather than being immediately transferred into the underlying transaction.

The bank can then provide the appropriate facility or instrument required to execute the trade.

This means there is an important distinction between:

capital being held or encumbered within the banking structure, and

cash being paid directly to a commodity supplier.

While blocked or pledged capital is not risk-free and may be subject to the terms of the banking facility, this structure can reduce the need to make unsecured advance payments to trading counterparties.

Why We May Retain Capital in USD

Cross-border commodities introduce another important consideration: currency risk.

Many internationally traded commodities are priced or referenced in US dollars, while the underlying purchase, distribution or sale may involve a local currency.

Our approach can therefore involve retaining or blocking capital in USD with selected banking partners and using that capital to support an overdraft or other credit facility denominated in the local currency.

Conceptually:

USD capital retained with banking partner
↓
USD supports banking facility
↓
Local-currency facility is made available
↓
Local transaction is executed
↓
Trade settles and facility is repaid

This can allow the underlying USD capital to remain in a major international currency while providing the local liquidity required to execute the transaction.

It can also assist currency-risk management because USD generally has deeper and more developed hedging markets than many emerging-market currencies.

The appropriate structure depends on prevailing interest rates, foreign-exchange conditions, banking terms, transaction economics and the currency in which the underlying trade is ultimately settled.

Managing Where Currency Exposure Sits

Converting investment capital directly into a local currency can expose the strategy to movements in that currency while the capital remains deployed.

In markets where currencies can experience greater volatility or where hedging markets are less developed, that exposure can materially affect the economics of a trade.

Where commercially appropriate, retaining the underlying capital in USD and accessing local currency through a banking facility can provide another way of managing where that currency exposure sits.

This does not remove foreign-exchange risk. Rather, it is intended to make that risk more identifiable and manageable within the overall transaction structure.

Connecting Payment with the Commodity

Our preference is to avoid exposing capital through unsecured prepayment where an appropriately structured trade-finance mechanism can be used.

Transactions can therefore be structured around defined milestones relating to the underlying commodity, which may include:

contractual evidence of shipment or delivery;

independent inspection or certification;

title and shipping documentation;

confirmation of quantity and specification;

custody, storage or terminal documentation; and

other conditions required under the relevant transaction.

Where the commercial structure permits, the objective is to achieve control over, or appropriate evidence relating to, the commodity before supplier cash settlement occurs.

It is important to recognise that banking instruments generally operate against specified documents and conditions. They do not themselves eliminate the physical, operational or counterparty risks associated with commodity trading.

For that reason, banking controls form only one part of the broader risk-management process.

Using the Commodity Cycle to Manage Working Capital

Some supplier arrangements may provide deferred settlement following delivery.

Depending on the transaction, payment terms may extend for periods such as 30, 60 or 90 days.

This can allow a commodity to be delivered, stored, distributed or sold before the corresponding supplier payment becomes due.

Where available and commercially appropriate, deferred settlement can reduce the period for which Fund capital must be deployed and improve working-capital efficiency.

The availability and terms of deferred settlement depend on the supplier, banking arrangements, credit assessment and individual transaction.

No Single Control Is Relied Upon

We do not view a bank instrument alone as sufficient risk management.

Commodity transactions can involve several different risks, and the structure should address them at the appropriate point in the transaction.

Counterparty Risk

Assessment of suppliers, purchasers, financial institutions and other transaction counterparties.

Payment Risk

Use of controlled settlement mechanisms rather than unnecessary unsecured advance payments.

Delivery Risk

Contractual documentation, inspection, shipping and delivery requirements appropriate to the transaction.

Currency Risk

Managing the currencies in which capital is held, facilities are drawn and commodities are purchased and sold.

Banking Risk

Use of appropriately selected banking and correspondent relationships, subject to transaction and jurisdictional requirements.

Commodity Price Risk

Assessment of purchase price, sale arrangements, market exposure and the duration for which price risk is carried.

Operational Risk

Oversight of logistics, storage, documentation, regulatory requirements and transaction execution.

Liquidity Risk

Managing the timing between capital commitments, banking facilities, commodity settlement and investor obligations.

The objective is to create multiple layers of control rather than relying on any single protection.

Investment Capital Connected to Real-Economy Transactions

The EM3 Commodities Fund provides an investment framework through which capital can support selected commodity, trade-finance and infrastructure opportunities.

That capital may support the banking arrangements and working-capital requirements necessary to execute eligible transactions rather than simply being advanced as unsecured lending.

This creates an important distinction between the strategy and conventional direct lending.

The investment exposure is connected to identifiable commercial activity involving commodities, counterparties, banking arrangements and transaction documentation.

Independent Financial Infrastructure

Banking partners are an important part of the execution framework.

Depending on the jurisdiction and transaction, different local, international and correspondent banking relationships may be used for:

Holding and controlling cash
Providing credit and overdraft facilities
Issuing trade-finance instruments
Processing cross-border settlement
Supporting foreign-exchange transactions
Facilitating local-currency liquidity

We do not rely on a single banking relationship for every transaction. The appropriate banking structure is determined by the jurisdiction, currency, counterparty, transaction requirements and available banking facilities.

All arrangements remain subject to the relevant bank’s onboarding, KYC/AML, credit, compliance and transaction requirements.

Understanding Where the Risk Sits

The commodities strategy should not be understood simply as the Fund handing investor money to a commodity trader.

The objective is to use investment capital within a structured commercial and banking framework in which payment, delivery, currency and counterparty risks can be identified and managed at different stages of the transaction.

In practical terms, our approach seeks to:

retain control of capital for as long as commercially practicable;

avoid unnecessary unsecured prepayment to suppliers;

connect settlement to defined contractual and documentary conditions;

use banking facilities and trade-finance instruments where appropriate;

manage the currency in which investment capital is held and deployed;

connect financing to identifiable underlying commodity transactions; and

apply multiple risk controls throughout the trade lifecycle.

These measures are designed to manage risk and protect investor interests, but they cannot eliminate investment, banking, counterparty, foreign-exchange, commodity-price, operational or other risks.

Commodities can provide attractive opportunities, but successful execution depends on considerably more than identifying a product to buy and sell.

It requires understanding the commodity, the counterparties, the banking structure, the movement of funds, the movement of goods, the currencies involved and the point at which each risk arises.

That is the philosophy behind our approach to trade finance.

Structure the transaction. Control the movement of capital. Understand where the commodity sits. Manage the risks at each stage.

This framework supports the Group’s broader commodities capability across physical trading, trade finance, investment management and selected infrastructure opportunities.