The ABS Code of Best Practices for Commodity Financing (the "Code") was launched on 30 November 2020 by the ABS, with the support of the Monetary Authority of Singapore ("MAS"), Enterprise Singapore, and the Accounting and Corporate Regulatory Authority. As the first of its kind in the commodity trading industry, the Code seeks to provide a set of best practices for commodity financing to rebuild and strengthen Singapore's reputation as a global commodity trading hub. Some of the best practices can also be adopted for other forms of financing.
Following the high-profile collapse of oil trader Hin Leong Trading and the descent of other Singapore-based commodity traders, the commodity trading industry announced in July that it would be launching the Code as one of two initiatives to raise industry standards for commodity financing. It was developed with the support of government agencies and by an industry working group of 28 banks, which represent the majority of commodity-financing banks in Singapore, in consultation with trading companies of various sizes. The Code seeks to boost corporate transparency and the trust between banks and traders, thereby promoting accountability and upholding the integrity of the commodity trading sector.
Introduction to the Code
The Code is designed to provide broad guidance to banks and to be used as a benchmark for lending standards in the commodity trading industry. It is underpinned by two key themes:
- at a macro level, it encourages banks to understand traders' corporate governance, risk-management practices, business and transactions through due diligence and policy requirements; and
- at a transaction level, it advocates for banks to obtain sufficient transparency and control over financed transactions, goods and receivables.
It is intended for the Code to be observed by any financial institution ("Lender"), which is regulated by the MAS and is offering to provide any form of commodity-financing to a person or entity who is identified as a Trader, both by its definition in the Code and based on the Lender's internal policies. 'Trader' is defined as a general reference to 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.
Accordingly, Lenders will be expected to ensure that it has the appropriate policies, procedures and controls in place to fulfil the principles in the Code in a risk proportionate manner.
Click here for easy access to the Code on ABS' website.
5 Principles of the Code
This section outlines the principles of the Code and their respective guidelines for Lenders.
A. Principle 1: Corporate Governance
It follows that good corporate governance encourages proper management and conduct of the business and affairs of Traders, thereby achieving greater accountability and transparency.
As part of their credit risk assessments, Lenders are recommended to consider the corporate governance policies and modus operandi of the Trader's business and trading as part of its credit assessment. As a minimum, Lenders should ascertain that each Trader has established policies and practices that address:
- the segregation of roles and responsibilities within the board of directors or such other equivalent governance body and that there are defined and documented accountability and responsibilities of the various roles; and
- sufficient independence in the decision-making and exercising of judgements by the Trader's board of directors or such other equivalent governance body.
Appendix 1 of the Code details examples of good corporate governance policies and practices for reference.
B. Principle 2: Risk Management
Lenders are recommended to ensure that Traders' have appropriate risk management policies and practices to manage identified risks as part of their credit risk assessments.
This involves checks to ensure that each Traders' risk management policies and practices correspond with its business strategy, turnover, complexity of operations and risk appetite. As a minimum, the policies and/or practices should address:
- the segregation of roles and responsibilities among various functions with defined and documented accountability and responsibilities of these functions;
- adoption of systems and/or processes to support timely identification and measurement of risks;
- regular monitoring or trading limits and risk position limits;
- controls to protect the integrity and security of information; and
- measures to mitigate price and trade risks.
Examples of good risk management policies and practices have been set out in Appendix 2 of the Code.
- Principle 3: Business Due Diligence
Lenders should conduct regular business due diligence to procure information on each Trader's operations, business and relevant aspects relating to commodity trade financing. Lenders should also require independent verification of information to be provided by each Trader pursuant to this Principle, if they consider this to be necessary.
Reference can be made to Appendix 3 for examples of areas of information that Lenders may request for its purposes of conducting business due diligence.
- Principle 4: Transparency and Control
On a transactional level, Lenders should have measures in place to ensure that there is sufficient transparency and control in respect of the financed transactions, goods and receivables, particularly with respect to:
- transactions and underlying goods that are subject to finance;
- receivables associated with the sale of such underlying goods.
For instance, letters of indemnity or undertaking (or any other similar documents) are sometimes used as a replacement for the original title and/or transport documents in respect of goods subject to finance, which might call into question the authenticity and validity of ownership. To mitigate against this risk, it is recommended for Lenders to require the letters to be in such format acceptable to it, and issued in its favour and/or such party as it may require or agree to.
Separately, if Lenders are granted assignments of receivables, it should be insisted for notice of their security interest to be given to the relevant third parties, such as debtors of the receivables that have been assigned to the Lenders. Lenders are also encouraged to use reasonable endeavours to have their interest recorded in all relevant invoices issued to such debtor.
More examples of measures that Lenders may adopt with regards to this Principle can be found in Appendix 4 of the Code.
- Principle 5: Industry Collaboration
Under this Principle, Lenders are encouraged to participate in industry collaboration initiatives, which aim to further strengthen the commodity trading sector in Singapore. Such initiatives could include leveraging on technology to authenticate underlying trade transactions financed by Lenders and to enhance their assessment of the credit worthiness of corporate entities.
Other best practises beyond the Code
Lenders can also consider the following best practices beyond of the Code:
- Prohibition against assignment of contracts and receivables – Lenders should check if there are such prohibitions which will require the consent of the counterparties. If consent cannot be obtained, other forms of security interest (other than an assignment) and other practical safeguards should be considered.
- Segregation and identification of financed goods – Financed goods should be clearly segregated and identified. This mitigates the risk of commingling which may compromise a lender's interest in the financed goods.
- Enforceability of security in foreign jurisdiction – Proper legal advice should be obtained in relation to the validity, legality and enforceability of security in foreign jurisdictions. Lenders should also understand the enforcement process and time lines as well as any practical enforcement issues.
- Collateral management and stock monitoring – Collateral management and stock monitoring arrangements can be considered in jurisdictions where there are fraud and enforcement issues.
- Fund flows – Lenders should constantly monitor fund flows between the various trading parties to detect any suspicious or fraudulent activities.
- Custom and market practice – Lenders should appreciate the custom and market practice of the relevant industry and structure their financing accordingly.
- Credit enhancement structures – Credit enhancement structures and products can be considered to enhance credit and mitigate risk. These include bankruptcy remote SPV structures, conditional transfer and sale arrangements, powers of attorney, put and call options and insurance and credit solutions.
The Code is timely in light of the recent corporate failures involving commodity and trading companies. More importantly, it provides guidance and confidence to all the stakeholders in commodity and trade finance as we emerge from the pandemic.
However, the Code is not meant to be exhaustive or prescriptive. Lenders should continue to strengthen and enhance their internal policies and processes which should adopt the principles of the Code, comply with any legislation, regulations or guidelines issued by the relevant authorities, and observe the evolving industry standards, practices and customs.
It is equally critical to ensure the proper implementation of these polices and processes through constant training, monitoring, supervision and audit. These policies and processes should thereafter be periodically reviewed, modified and supplemented for specific traders and transactions, as well as to cater to the evolving commodity and trade structures.
Lastly, some of the best practices recommended by the Code are also relevant to other forms of financing, and can be modified and adopted accordingly.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.