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Risks In Commodity Trade Finance & Ways To Manage Them

Aug 03, 2022 - 05:22 AM Author - Axios Credit Bank

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Importing-exporting goods overseas are associated with a variety of questionable concerns for global traders. From receiving payment on time by the importers to getting the delivery of ordered goods by the exporters, trade finance is full of overseas complications. Commodity trade finance services eliminate all these risks by guaranteeing timely payment & performance of T&C of the contract. But these aren’t the only risks in commodity finance.

The commodity trade industry is prone to various risks that can make a huge difference in how global commodity traders perceive growth in their businesses while importing-exporting goods overseas. It can disrupt the trading operations of a company as well as financial performance. These risks often result in currency fluctuations and affect every business engaged in global commodity trading. Therefore, incorporating a solid risk management system is essential to ensure smooth trade operations. 

Here, we have accumulated a few common commodity trading risks and ways to manage them. Take a look:

How To Manage Commodity Trade Finance Risks?

Commodity trade risks are vital to be noticed and addressed for an organization dealing in international trade transactions to further avoid future complications between the associated parties. Every global trader needs to understand both the causes and ways to resolve them.

1. Price Risks/Currency Fluctuations/Price Volatility

By seeing a variety of names, you may have probably understood its significant involvement in commodity trading. The currency fluctuates every other day and variations in commodity prices lead to one of the most common risks in commodity trade finance. Import & export businesses that are engaged in global trade transactions are more prone to face these risks such as producers, manufacturers, and consumers, etc. No one can predict exactly how the price will move in the future. 

How To Manage? - Both the parties-to-the contract should agree on the issuance of a Letter of Credit where every important detail related to trade is mentioned. For example, types of goods, currencies to be used, payment date & time, etc. All the parties should abide by the T&C of the contract. It will help eliminate the risks of price movements and trade their products at an acceptable price.

2. Quantity Risks 

Mainly producers and manufacturers are those trading parties who are prone to face these risks. It says that producers should be sure about the complete & timely selling of the quantity of the products they are planning to produce by expecting high demand. In simple words, they should have a crystal-clear idea that the goods which they are producing will be fully utilized till the date. Otherwise, they can experience small profit or even loss if they have left with an ample amount of products for which there is no demand. 

How To Manage? - One of the most effective ideas to prevent quantity risks in commodity trading is by selling upcoming invoices to the banks or FIs. It is known as Factoring. 

3. Quality Risks 

Different from quantity risks, importers in global trade often face these risks. When they buy/order goods in bulk from exporters, they aren’t sure of receiving the goods of the same quality they have ordered. For example, he/she can receive damaged or faulty goods from the suppliers.

How To Manage? - Both the parties should enter into a valid contract where every important thing is well-written. They can get a Bank Guarantee issued as an essential trade finance product. Or a Sight Letter of credit can also be issued that will inform that the buyer cannot deny the payment or reject the ordered goods. However, they can complain about the wrong delivery of the products.

4. Counterparty Risks 

While entering into a trade deal with global traders, there is always a risk of payment default by the other party. Since both the parties aren’t aware of each other’s financial capabilities, there is a threat of the other party not meeting his/her financial agreements. These are counterparty risks being experienced by both small & big traders. 

How To Manage? - The best way to manage this commodity trading risk is to get a Standby letter of credit issued by a trusted bank or financial institution. Here, the issuing bank guarantees timely payment to the exporter only if the importer defaults and the exporter submits the proof of such default to the confirming bank. This way, both parties are secured.

5. Credit Risks 

On one hand, where counterparty risks are about the failure of payment by the importers, credit risks deal with the importer's failure of meeting the T&C of the financial contract. In simple words, when buyers fail to abide by the rules & guidelines mentioned in a trade deal, it is a credit risk. 

How To Manage? - A suitable trade finance instrument can be issued in the interest of both the parties ie. importers & exporters. It can be an LC, SBLC or BG, etc.

Wrapping Up!!

Commodity trading is prone to various risks and controlling or reducing them is a key to witnessing safe, & profitable international trade transactions. When both the importers-exporters get peace of mind while executing a trade deal, the chances of expanding their businesses increase. It helps boost global trade. 

Axios Credit Bank Ltd is a popular & trusted financial institution that can help & advise you upon choosing the right financial solution for your business.