Issue

What to consider

1.  

Perishability and food/feed safety  

The perishability of soft commodities should remain a key consideration throughout the due diligence process along with requirements of food and feed (feed meaning animal feed) traceability, genetically modified organism (GMO) regulations, food/feed safety, and freedom from harmful materials. Do you understand sufficiently these constraints and how they affect your target business?

The nature of the goods is perhaps the key distinction in transactions involving soft and hard commodities. It affects each part of the structure of an agricultural commodity trading business: from planning, production and processing, logistics and storage, to access to finance and insurance.

Consider the extent to which the target business has contingency plans in the event of the unexpected deterioration of the commodities traded, produced or stored or to cover health scares/food and feed safety issues, and the traceability of the supply chain. Does the target have robust policies, procedures, and safeguards to ensure the safety of all products bought, sold and produced?

2.

Jurisdiction

Local legislation governing mergers and acquisitions, or the bureaucracy surrounding access rights or export rights for certain commodities in a particular jurisdiction may be a significant risk factor.

Given the importance of agricultural commodities to most nation states, due diligence should be undertaken to determine the scope and cost of the obligations, licences, approvals or consents that the government or other relevant authority may impose upon the buyer of a target business.

3.

Title to land

Land title and tenure systems have particular significance for upstream asset acquisitions in certain jurisdictions, and highlight a need for certainty and clarity in land ownership and rights.

Due diligence should aim to discover the security, availability and competition for use of land, as this will be essential for both long-term investments and scaling up operations that may require additional land usage. A thorough analysis of the risk of state expropriation should also be considered.

Local advice should be taken on any registration requirements or stamp duty equivalent, when land forms part of the contemplated acquisition.

4.

Infrastructure

Infrastructure includes both logistics and production facilities. Trading in agricultural commodities relies upon access to logistics to ensure the transition of the commodity from the gate to the end-user in merchantable condition.

The quality of the infrastructure and logistical services provided will vary materially from jurisdiction to jurisdiction. Consider access to usable roads, railways, storage and shipping ports, and whether the infrastructure is state or privately owned. Furthermore, consider investigating if there are any barriers to access (e.g., to foreign companies), the level of charges for use, and how robust the infrastructure supporting the target is against adverse weather (e.g., droughts).

In terms of production, much of the profit in soft commodities is in refining from crude oil to refined oil, processing from wheat to flour, barley to malt and so on. Does your target have these production facilities or have secure long term access to them?

5.

Storage

Due to the perishable and bulky nature of soft commodities and farmers’ relative lack of control over harvest yields, adequate provision for high quality storage is often a key consideration for agribusiness seeking time arbitrage opportunities.

The spoilage of commodities in storage due to fungi, mould, insects and mites is a common issue in agribusiness and fumigation is often logistically difficult and highly regulated. Therefore, it is important to ensure that any target storage assets are suitable for the proposed business activities; i.e., are in good condition and in possession of all appropriate licences or certifications. This may include due diligence ‘on the ground’ prior to the acquisition, and the post-acquisition engagement of a reputable third party inspection-and-analysis service provider to deliver regular reports on the condition of any stored commodities.

Should the target business have storage agreements in place with a third party, due diligence of the agreements also will be necessary to ascertain whether they can be assigned or novated, the cost of any such assignment or novation, their fitness for purpose and the remaining term.

Also, if a substantial part of the assets are inventory in storage, “on the ground” due diligence is important to confirm that the commodity is in store and in good condition.

6.

Insurance

The nature of trading agricultural commodities means it is likely that the target business will have insurance covering storage, transit, credit risks, political risks, food and feed safety (perhaps including recall insurance). Due diligence relating to insurance for the goods, contracts and logistics is therefore critical.

Consider which risks are covered by the target’s current policies, the extent of the coverage, if the target has been paying the premium, and whether those policies are transferable, or if a new policy altogether will be required.

Consider the insurance policies of third parties the target business may engage to facilitate its trades, such as freight forwarders, and the target’s access to claim on those policies.

Insurance is an especially pertinent issue when trading in jurisdictions with a high risk of bribery and corruption (see further No. 8 below), as the risk of misappropriation of assets is also increased.

7.

Environmental/GMO considerations

The deforestation in regions such as South East Asia to accommodate the rise in demand for palm oil is but one example of agribusiness’ perceived negative impact on the environment.

Producers of food and feed are under increasing pressure from governments and consumer groups to ensure that the sources of their products (i.e., the base commodities) are from sustainable and ethical sources. Similarly, genetic modification of crops, organic production sources, and the traceability and certification of premium “GMO free” or organic commodities are important for most agribusinesses. A buyer needs to understand these issues to properly evaluate the target business, and ensure that the target business has appropriate controls in place to comply with GMO free/organic requirements.

8.

Bribery and corruption

Many of the producers of agricultural commodities are located in jurisdictions in which the actual or perceived risk of bribery and corruption is deemed to be very high. Transparency International publishes an annual ‘heat map’ of such jurisdictions.

Therefore, due diligence should be conducted to ascertain whether the seller, or a company in the seller’s group, has connections with local government or other public officials; and, if such links exist, whether, and to what extent, they have been relied upon to obtain any necessary consents or approvals. Review accounts to ensure any payments made to the target business have been properly accounted for.

When applying for any consents or licences from local governments or other authorities post-acquisition, consider not only the local anti-bribery and corruption legislation but also the UK Bribery Act regime (and other relevant equivalents which may apply to the buyer’s business), which impacts upon any interactions with foreign officials, and is regarded as one of the most stringent anti-corruption regimes.

Buyers should also consider investigating, as far as possible, any third parties (e.g., brokers and storage facility operators) upon which the target business is reliant, in order to ensure their compliance with applicable anti-corruption legislation, or at least the compliance programs in place to notify the target’s counterparties of the importance placed on such compliance.

9.

Conflict and sanctions

Food and sanctions have been constant issues over the past 20 years. All international sanctions seek to carve out food (and sometimes feed) from their ambit to avoid public criticism. But this poses endless problems for the agri sector in following what is/is not permitted and how to get paid for what is permitted. “Food for oil” in the 1990s has been followed by endless difficulties in supplying Iran, Russia, Syria, Libya and Sudan to name a few.

Advice should be obtained concerning the existence or threat of international sanctions in the jurisdictions where the target business is located and/or will operate post-acquisition, and the main markets (e.g. Iran) where the target supplies commodities to. A recent example affecting agribusinesses are the sanctions imposed by the EU and the United States upon Crimea following its annexation by Russia, which have restricted the export of commodities from the Ukrainian port of Mariupol.

Care should also be taken to ensure suitable force majeure provisions are inserted into all sale and purchase agreements, to mitigate political risk as far as possible.

Check that appropriate sanctions provisions are included in all of the target’s sale and purchase agreements, as well as all of the related commercial contracts of the relevant commodity.

10.

Integration

The use of technology in trading soft commodities has risen sharply in the past year, as agribusinesses attempt to remove some of the natural volatility in the agricultural markets (e.g., adverse weather conditions) by using algorithmic trading systems. Due diligence of the target’s use of technology, such as computer software, and its compatibility with the buyer’s existing operational platform is prudent to ensure smooth integration. In addition, the use of algorithmic trading systems will become highly regulated following the coming into force of Directive 2014/65/EU on Markets in Financial Instruments (MiFID II) on 3 January 2018. The use of such systems may limit the ability of a business which has hitherto enjoyed little or no regulation to be exempt from MiFID II. Therefore, an analysis should be conducted when acquiring a business using an algorithmic trading system to consider the post-acquisition position of the business from a regulatory perspective.