What is the Code?
The Code aims to articulate key principles governing prudent commodity trade financing practices, underpinned by two key themes, namely:
- at a macro level, Lenders’ understanding of the corporate governance, risk management practices, business and transactions of a trader that obtains commodity financing from a Lender (a Trader) through due diligence and policy requirements; and
- at a transactional level, Lenders obtaining sufficient transparency and control over the financed transactions, goods and receivables.
The Code achieves this by setting out five general principles to guide commodity finance lenders when carrying out credit risk assessments and structuring transactions to ensure appropriate risk mitigation. In summary, these are:
- Corporate Governance: Lenders should ascertain that each Trader has appropriate corporate governance policies and practices based on its size, complexity and structure.
- Risk Management: Lenders should ascertain that each Trader’s risk management policies and practices are commensurate with its business strategy, turnover, complexity of operations and risk appetite.
- Business Due Diligence: Lenders should conduct proper and adequate business due diligence to obtain comprehensive information on each Trader’s operations, business and relevant aspects relating to commodity trade financing for credit risk assessment and mitigation purposes.
- Transparency and Control: Lenders should adopt and/or impose measures to ensure sufficient transparency and control over (1) transactions and the underlying goods that are subject to finance and (2) receivables associated with the sale of such underlying goods.
- Industry Collaboration: Where relevant, Lenders should participate in industry initiatives that aim to further strengthen the commodity trading sector in Singapore.
The general principles set out in the main body of the Code are supplemented by specific, non-exhaustive, non-prescriptive examples of good practice contained in Appendices to the Code that Lenders are encouraged to adopt as applicable and appropriate, taking into account the risk, scale and complexity of the profile of a Trader and the financing activities undertaken.
Does the Code apply to you?
If you are a financial institution regulated by MAS that offers any loan, advance, credit or other financial accommodation to a Trader (a Lender, as defined by the Code), the Code will directly apply to you.
A Trader is defined in the Code as a person, or an entity, who buys, sells or trades in any produce, item, goods or article which is fully or substantially fungible with an efficient price discovery market and is identified by a Lender as a Trader based on that Lender’s internal policies. If you are a Trader or a financial institution or other lender which is not regulated by MAS, the Code will not directly apply to you, but the Code may practically affect you to the extent that:
- you wish to obtain commodity finance from a Lender; or
- you wish to provide commodity finance in a syndicate with a Lender or sub-participate in commodity finance provided by a Lender,
as the Lender may require you to cooperate with certain practical measures to ensure the Lender can comply with the Code, as further outlined below.
Is the Code legally binding?
Whilst the Code is not legally binding, it is intended to serve as a set of guidelines to provide broad guidance to Lenders and it states that “MAS may refer to the Code in its supervisory oversight of the Lenders’ business and risk management activities”. This effectively makes the Code very similar to codes and guidelines issued directly by MAS, and we expect that the industry will generally seek to comply with it. By analogy, other important codes issued by the ABS include the Code of Consumer Banking Practice and the Private Banking Code of Conduct, both of which enjoy broad adherence across the banking industry.
What constitutes Commodity Finance for the purposes of the Code?
Commodity finance is defined in the Code as any loan, advance, credit or other financial accommodation offered by a Lender to a Trader (Commodity Finance).
The Code does not detail the specific Commodity Finance products that would fall under this definition. However, in light of the principles underlying the Code, namely prudent commodity trade financing practices, it would be reasonable for you to assume that the Code is intended to cover the full range of trade and commodity finance products, including some products that would not typically be classified as commodity financings. Some of the products that you can assume are included are:
- the issuance of letters of credit and bank guarantees by Lenders at the request of Traders, which we understand to be captured by the reference to “credit or other financial accommodation”;
- all conventional lending products offered to Traders, including not only products involving loans financing the purchase of commodities and/or secured by commodities, but also those involving loans secured by receivables, which are explicitly referenced in the Code;
- receivables purchase products such as factoring, forfaiting, invoice discounting and other forms of supply chain finance, as the Code sets out specific guidelines in respect of the assignment of receivables by way of a sale in Lenders’ favour; and
- structures involving the physical ownership of commodities such as “repos” and inventory monetisations, as if structures involving the physical ownership of receivables are covered by the Code, it would follow that those involving the physical ownership of commodities are also intended to be covered.
What are the implications of the Code for a Trader’s policies and practices?
If you are a Trader that wishes to obtain Commodity Financing from a Lender, you can expect there to be heightened scrutiny of your corporate governance policies and practices, including an expectation that:
- roles and responsibilities within your board of directors or equivalent are segregated and assumed by individuals with sufficient experience;
- decision-making and exercising of judgments by the board of directors are sufficiently independent, including through the use of independent non-executive directors; and
- clear policies covering conflicts of interest, conduct and remuneration are in place, which support a sound risk culture and encourage accountability.
You can also expect Lenders to require information regarding your risk management policies and practices, which the Code expects to be commensurate with your business strategy, turnover, complexity of operations and risk appetite and include:
- segregation of roles and responsibilities among various functions, with defined and documented accountability and responsibilities of these functions, including with a view to avoiding conflicts of interest and reducing instances of undetected errors and opportunities for abuse;
- adoption of systems and/or processes to support timely identification and measurement of risks;
- establishment and regular monitoring and independent review of trading limits and risk position limits, with performance indicators and compensation of traders aligned to these limits;
- controls to protect the integrity and security of information, including through a robust IT support system; and
- measures to mitigate price and trade risks, including through appropriate hedging methodologies and practices.
To the extent that your policies and practices fall short of a Lender’s expectations, as guided by the Code, that Lender may require that you address those shortfalls before it is willing to provide you with Commodity Financing.
What are the implications of the Code for a Lender’s policies and practices?
If you are a Lender that provides or wishes to provide Commodity Financing to a Trader and to comply with the Code, you will need to ensure that the due diligence that you carry out on that Trader is comprehensive enough to obtain the necessary information on, and to carry out the necessary assessment of, the corporate governance and risk management policies and practices of the Trader as further detailed above.
In addition, you will need to conduct proper and adequate business due diligence on each Trader in order to assess and mitigate credit risk on an holistic and informed basis. The Code states that you may leverage or rely on the business due diligence and credit risk assessment conducted during the course of your global relationships, although you are expected to maintain adequate information on Traders locally.
As a Lender, you are also expected to participate, where relevant, in industry collaboration initiatives that aim to further strengthen the commodity trading sector in Singapore. The Code gives as an example initiatives that leverage on technology to authenticate underlying trade transactions financed by Lenders. A recent example of that in Singapore is the blockchain-based Trade Finance Registry that was launched in October and is, among others, also supported by the MAS, ESG and ABS. The Trade Finance Registry’s aims are similar to those of the Code, in that it aims to mitigate the risk of fraud and to increase transparency.
What are the implications of the Code for Commodity Finance structures?
The Code requires that Lenders adopt and/or impose measures to ensure sufficient transparency and control over transactions and the underlying goods that are subject to finance and receivables associated with the sale of such underlying goods. In the context of Commodity Finance, this may include the appointment of a collateral manager or collateral monitor and/or access rights in respect of facilities in which commodities being financed are stored; the receipt of title and/or transport documentation and the ability to track vessels in respect of commodities being shipped; and audit rights, the ability to contact the debtors directly in respect of receivables being financed and/or independent payment undertakings from debtors to Lenders in respect of receivables being financed.
The Code requires that Lenders procure that any assignment of receivables (whether by way of security or sale) in its favour is notified to the debtor of such receivables and that Lenders use reasonable endeavours to procure that the fact of such assignment is recorded in all relevant invoices issued to such debtor. This notification requirement is intended to reduce the risk of fraud in receivables financing, but could affect your structuring of certain transactions, in that:
- this would not permit the use of undisclosed invoice discounting as a product;
- this would not permit loans secured against receivables if the assignment of such receivables is not notified to every debtor, which is not always a Day One requirement, particularly where a Trader has assigned debts from a large number of debtors for the purposes of, for instance, a borrowing base facility; and
- this would require notification of an assignment of receivables, even when that assignment is being used as back-up security and the Lender is not relying on that assignment of receivables for credit risk mitigation purposes.
For commercial reasons, it is not always practical for a Trader’s debtors to be notified on every receivables financing, so this requirement of the Code may present some challenges for Lenders and Traders.
Despite the focus on control over the underlying goods, the Code does contemplate that in certain circumstances Commodity Finance Lenders may receive letters of indemnity or undertakings (or any other similar documents) in lieu of original title and/or transport documents in respect of goods. so transactions will not need to be restructured to avoid this. The Code requires that such letters of indemnity or undertakings (or other similar documents) must be issued in favour of the Lender and/or such party as the Lender may require or agree to.
What are the implications of the Code for Commodity Finance documentation?
In addition to the Code’s Day One requirements in respect of the information that you must obtain as a Lender, there are ongoing requirements:
- to procure updates of the information provided by each Trader in relation to corporate governance and risk management;
- to procure regular management reporting by each Trader; and
- to obtain independent verification of information provided by each Trader in respect of the Lender’s business due diligence, where determined by the Lender to be necessary on a risk-based approach.
If you are Lender, you will need to consider whether you will receive the requisite information through your global relationship with a Trader or if your Commodity Finance documentation needs to include specific provision for that information to be provided to you by the Trader on an ongoing basis. Consideration will also need to be given to who bears the cost of any independent verification and whether the disclosure provisions in your documentation permit disclosure to any party carrying out that independent verification. Your documentation may also need to be revisited to ensure that Traders are providing representations and warranties as to the veracity and completeness of the information that has been provided.
In order to ensure that sufficient measures are in place to enhance transparency and control, if you are a Lender you may wish to consider whether additional representations, warranties and undertakings should be given by the Trader. The Code includes a number of examples of additional representations, warranties and undertakings that may be appropriate on certain transactions, such as a declaration that the transaction subject to finance is a trade transaction involving a genuine sale of goods in consideration of payment made or to be made for such goods or a prohibition on a Trader entering into arrangements amounting to a set-off, deduction, withholding, counterclaim and/or pay-when-paid in respect of a transaction subject to finance.
Whilst not specifically contemplated by the Code, if you are a Lender, you may wish to consider whether, in addition to enhanced information in relation to corporate governance and risk management, you should seek to include additional representations, warranties and/or undertakings to ensure that if the standard of a Trader’s policies or procedures deteriorates over time, you have a means of ceasing to provide that Trader with finance.
If you are a Lender, these are considerations that you should bear in mind not just for new Commodity Financings, but also for your existing Commodity Financings if an opportunity arises to amend them. This opportunity could arise because a Commodity Financing is uncommitted and you can make any further financing conditional on making any requisite amendments or because a Trader requires an extension or other amendments to be made to those documents.
Reed Smith LLP is licensed to operate as a foreign law practice in Singapore under the name and style, Reed Smith Pte Ltd (hereafter collectively, "Reed Smith"). Where advice on Singapore law is required, we will refer the matter to and work with Reed Smith's Formal Law Alliance partner in Singapore, Resource Law LLC, where necessary.
In-depth 2020-621