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Commodity Trade Finance in Africa: Changes and Challenges

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Nicolas-Clavel

Introduction

Nicolas-ClavelCommodity Trade Finance, normally short-term loans to help fund the purchase and/ or movement of goods, is arguably one of the oldest forms of finance in the world. It is also one of the most vital components to the global supply chain since it ensures the supply of everything from primary inputs for the steel industry to the food on our tables.Yet what was once a fairly simple and low-cost affair has been put under intense pressure due to the changing regulatory environment following the implementation of the Basel III rules. Over the past decade, rising demand for primary commodities from emerging markets such as China and India has in turn caused the price of these commodities to rise, directly impacting the amount of trade finance required to support the underlying transactions.

As domestic resources dry-up and prices rise fast-growing, resource-hungry nations are turning to one of the last relatively untapped sources of mineral wealth: Africa. What was once a relationship dominated by Europe and America is quickly being replaced by new customers.For example, China-Africa trade reached $166.3 billion in 2011, of which around $93 billion were African exports . While China is today Africa’s largest trading partner, other countries such as South Korea are also entering Africa with increased speed.

The type of commodities in high demand from Africa is changing. Both African and foreign businesses are expanding across the vertical supply chain using value-added processes such as refining oil or processing cereals in addition to extraction of said commodities, thereby increasing the value of commodities before being sold into their target market. Africa is in turn becoming a two-way trade area as it imports to develop these new industries, importing for example cement for buildings and fertiliser to increase agricultural yields. More exports are allowing Africa to invest more in infrastructure, which in turn is aiding the development of their economy. This is helping to increase consumption, which, in turn is boosting imports, as well as making local production cheaper and more efficient, again boosting exports.

Technology is also simplifying finance in Africa. A key development that continues to make its presence felt is the advent of the mobile telephone. By the close of 2013 it is widely predicted that mobile phone penetration will surpass 80% on the continent . From small scale farming, a cornerstone of many African economies to paying teachers in the countryside, mobile phone usage has spread knowledge of prices and simplified the transfer of money from urban to rural areas to no end. Indeed, although some countries such as the UK are only just beginning to use mobile payments, it already has widespread use thanks to African telecoms firm Safricom and its M-Pesa platform. This has now expanded with savings products offered under the M-KESHO brand in Kenya. More basically it has allowed collateral and logistics managers to keep in constant contact with their goods throughout the transaction process. The advent of photo messaging has meant stock can be photographed, providing visual confirmation of the location of goods. For trade finance, this will continue to provide vital information to traders and financiers.

The Challenge: Risk profiling Africa’s potential
One would think that with growing global demand and untapped economic potential, the nations of Africa and the local companies operating within would be spoilt for choice in terms of finance.However, the continent is disproportionately penalised in risk assessments with regards to credit risk.

According to research conducted by the World Trade Organization, this disproportionate penalisation is due to many Sub-Saharan banks’ limited reputation and the turning away of tier-1 banks from their less developed cousins in the global banking community despite relatively healthy balance sheets.As a result, large firms requiring financing for their operations in Africa have received preference from the major international banks, which has restricted lending opportunities for many smaller, albeit well-managed companies that have had their short-term credit lines cut overnight.This is despite the fact that the Letter of Credit default rate in emerging markets was 0.8% and the rate of loss was 0.08% according to research

Another reason for this disproportional penalisation is the limited amount of financial and other data available on Africa. Since a great deal of on the ground knowledge that cannot come from desk research is necessary to make good business decisions, especially in the area of Trade Finance into, out of, and intra Africa, this can prove frustrating for those looking to expand into these promising markets.

The risk calculation is not entirely reliant on assessing companies either. The surge of new infrastructure and private, communal and government-led projects means that information pertinent to investorsis constantly changing. If a journey from a mine to a porton Benguela railway in Angola is renovated or put back into service, journeys that would take 3 weeks on an old road can happen in now in one week. This dramatically impacts both the type of financing and the amount of capital required by the would-be borrower, in addition to creating wealth as well as jobs

A challenge can also arise in the final stage of the transaction: the remittance of funds. Reforms and changes in currency controls (a virtually non-existent problem in the West) can cause major delays in the remittance of funds from profits accrued in countries such as South Africa.On the macro-side, even though some countries have lower debt-to-GDP ratios than their European counterparts, this is not reflected in mainstream risk calculation. The vast geographical expanse of nations within Africa is also poorly reflected in risk assessment: whilst certain areas like Kanu in Nigeria are prone to terrorism and disruption, other provinces like Lagos have none of these issues. Further still, while certain transactions such as imports may be prohibitively difficult, the same may not always hold true for other similar transactions such as exports.

With all these irregular quirks and complications, it becomes easy to dismiss Africa as just too ‘boutique’ to design trade finance solutions for. This judgment would be a mistake. Rather than being viewed as the ‘final frontier’ that is off limits to all but those with the greatest risk appetite, Africa should be viewed as comparable to Latin America in terms of Legal Framework but with weaker infrastructure. The risk profile is comparable to Eastern European Commonwealth of Independent States but with a far more robust legal infrastructure that continues to be heavily influenced by English and French law.In this light, whilst Africa is a challenge it is no more so than other countries with the right private sector partners.

As the continent continues on the long march to prosperity, financing requirements, both short and long term will be needed. The key to success in this is a detailed understanding of what risks African clientele will face rather than just selling them a shrink-wrapped slightly modified arrangement that would work in the Midwest USA.We have already seen this in the consumer sector with international companies designing specific products for the African market. For example, Samsung has created a fridge that continues to operate even when there is a power failure, a problem that faces many African households.

As we have seen, Africa has its set of challenges but these are by no means insurmountable.Financiers who are sitting on the side waiting for the ‘normal data’ they need as opposed to actively seeking it out run the risk of being left behind and overstating the threats they envisage on the ground. For those who engage now and are up to the challenge, the reward will be greatest.

Nicolas Clavel is CIO of Scipion Capital, a commodities hedge fund manager and Africa investment specialist. The Scipion Commodities Trade Finance Fund provides financing for a range of minerals in African markets from mining and also soft commodities assets such as cocoa, salt, tea and coffee.

Further References
World Trade Organization: Supply of Trade Finance:
http://www.wto.org/english/thewto_e/coher_e/whatis_situation_e.htm
M Auboin and M Engemann, ‘Trade Finance in Periods of Crisis: What have we learned in Recent Years?’ World Trade Organization Staff Working Paper, ERSD-2013-01, 2013
http://www.wto.org/english/res_e/reser_e/ersd201301_e.pdf

 

 

 

 

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How has the online trading landscape changed in 2020?

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How has the online trading landscape changed in 2020? 1

By Dáire Ferguson, CEO, AvaTrade 

This year has been all about change following the outbreak of coronavirus and the subsequent global economic downturn which has impacted nearly every aspect of personal and business life. The online trading world has been no exception to this change as volatility in the financial markets has soared.

Although the global markets have been on a rollercoaster for some time with various geopolitical tensions, the market swings that we have witnessed since March have undoubtedly been unlike anything seen before. While these are indeed challenging times, for the online trading community, the increased volatility has proven tempting for those looking to profit handsomely.

However, with the opportunity to make greater profits also comes the possibility to make a loss, so how has 2020 changed the online trading landscape and how can retail investors stay safe?

Lockdown boost

Interest rates offered by banks and other traditional forms of consumer investments have been uninspiring for some time, but with the current economic frailty, the Bank of England cut interest rates to an all-time low. This has left many people in search of more exciting and rewarding ways to grow their savings which is indeed something online trading can provide.

When the pandemic hit earlier this year, it was widely reported that user numbers for online trading rocketed due to disappointing savings rates but also because the enforced lockdown gave more people the time to learn a new skill and educate themselves on online trading.

Dáire Ferguson

Dáire Ferguson

A volatile market certainly offers great scope for profit and new sources of revenue for those that are savvy enough to put their convictions to the test. However, where people stand the chance to profit greatly from market volatility, there is also the possibility to make a loss, particularly for those that are new to online trading or who are still developing their understanding of the market.

The sharp rise in online trading over lockdown paired with this year’s unpredictable global economy has led to some financial losses, but with a number of risk management tools now available this does not necessarily have to be the case.

Protect your assets

Although not yet widely available across the retail market, risk management tools are slowly becoming more prevalent and being offered by online traders as an extra layer of security for those seeking to trade in riskier climates.

There are a range of options available for traders, but amongst the common tools are “take profit” orders in conjunction with “stop loss” orders. A take profit order is a type of limit order that specifies the exact price for traders to close out an open position for a profit, and if the price of the security does not reach the limit price, the take profit order will not be fulfilled. A stop loss order can limit the trader’s loss on a security position by buying or selling a stock when it reaches a certain price.

Take profit and stop loss orders are good for mitigating risk, but for those that are new to the game or who would prefer extra support, there are even some risk management tools, such as AvaProtect, that provide total protection against loss for a defined period. This means that if the market moves in the wrong direction than originally anticipated, traders can recoup their losses, minus the cost of taking out the protection.

Not a day has gone by this year without the news prompting a change in the financial markets. Until a cure for the coronavirus is discovered, we are unlikely to return to ‘normal’ and the global markets will continue to remain highly volatile. In addition, later this year we will witness one of the most critical US presidential elections in history and the UK’s transition period for Brexit will come to an end. The outcome of these events may well trigger further volatility.

Of course, this may also encourage more people to dip their toes into online trading for a chance to profit. As more people take an interest and sign up to online trading platforms, providers will certainly look to increase or improve the risk management tools on offer to try and keep new users on board, and this could spell a new era for the online trading world.

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Trading Strategies

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Trading Strategies 2

By Paddy Osborn, Academic Dean, London Academy of Trading

Whether you’re negotiating a business deal, playing a sport or trading financial markets, it’s vital that you have a plan. Top golfers will have a strategy to get around the course in the fewest number of shots possible, and without this plan, their score will undoubtedly be worse. It’s the same with trading. You can’t just open a trading account and trade off hunches and hopes. You need to create a structured and robust plan of attack. This will not only improve your profitability, but will also significantly reduce your stress levels during the decision-making process.

In my opinion, there are four stages to any trading strategy.

S – Set-up

T – Trigger

E – Execution

M – Management

Good trading performance STEMs from a structured trading process, so you should have one or more specific rules for each stage of this process.

Before executing any trades, you need to decide on your criteria for making your trading decisions. Should you base your trades off fundamental analysis, or maybe political news or macroeconomic data? If so, then you need to understand these subjects and how markets react to specific news events.

Alternatively, of course, there’s technical analysis, whereby you base your decisions off charts and previous price action, but again, you need a set of specific rules to enable you to trade with a consistent strategy. Many traders combine both fundamental and technical analysis to initiate their positions, which, I believe, has merit.

Set-up

What needs to happen for you to say “Ah, this looks interesting! Here’s a potential trade.”? It may be a news event, a major macro data announcement (such as interest rates, employment data or inflation), or a chart level breakout. The key ingredient throughout is to fix specific and measurable rules (not rough guidelines that can be over-ridden on a whim with an emotional decision). For me, I may take a view on the potential direction of an asset (i.e. whether to be long or short) through fundamental analysis, but the actual execution of the trade is always technical, based off a very specific set of rules.

To take a simple example, let’s assume an asset has been trending higher, but has stopped at a certain price, let’s say 150. The chart is telling us that, although buyers are in long-term control, sellers are dominant at 150, willing to sell each time the price touches this level. However, the uptrend may still be in place, since each time the price pulls back from the 150 level, the selling is weaker and the price makes a higher short-term low. This clearly suggests that upward pressure remains, and there’s potential to profit from the uptrend if the price breaks higher.

Trigger

Once you’ve found a potential new trade set-up, the next step is to decide when to pull the trigger on the trade. However, there are two steps to this process… finger on trigger, then pull the trigger to execute.

Paddy Osborn

Paddy Osborn

Continuing the example above, the trigger would be to buy if the price breaks above the resistance level at 150. This would indicate that the sellers at 150 have been exhausted, and the buyers have re-established control of the uptrend.  Also, it is often the case that after pause in a trend such as this, the pent-up buying returns and the price surges higher. So the trigger for this trade is a breakout above 150.

Execution

We have a finger on the trigger, but now we need to decide when to squeeze it. What if the price touches 150.10 for 10 seconds only? Has our resistance level broken sufficiently to execute the trade? I’d say not, so you need to set rules to define exactly how far the price needs to break above 150 – or for how long it needs to stay above 150 – for you to execute the trade. You’re basically looking for sufficient evidence that the uptrend is continuing. Of course, the higher the price goes (or the longer it stays above 150), the more confident you can be that the breakout is valid, but the higher price you will need to pay. There’s no perfect solution to this decision, and it depends on many things, such as the amount of other supporting evidence that you have, your levels of aggression, and so on. The critical point here is to fix a set of specific rules and stick to those rules every time.

Management

Good trade management can save a bad trade, while poor trade management can turn an excellent trade entry into a loser. I could talk for days about in-trade management, since there are many different methods you can use, but the essential ingredient for every trade is a stop loss. This is an order to exit your position for a loss if the market doesn’t perform as expected. By setting a stop loss, you can fix your maximum risk on a trade, which is essential to preserving your capital and managing your overall risk limits. Some traders set their stop loss and target levels and let the trade run to its conclusion, while others manage their trades more actively, trailing stop losses, taking interim profits, or even adding to winning positions. No matter how you decide to manage each trade, it must be the same every time, following a structured and robust process.

Review

The final step in the process is to review every trade to see if you can learn anything, particularly from your losing trades. Are you sticking to your trading rules? Could you have done better? Should you have done the trade in the first place? Only by doing these reviews will you discover any patterns of errors in your trading, and hence be able to put them right. In this way, it’s possible to monitor the success of your strategy. If your trades are random and emotional, with lots of manual intervention, then there’s no fixed process for you to review. You also need to be honest with yourself, and face up to your bad decisions in order to learn from them.

In this way, using a structured and robust trading strategy, you’ll be able to develop your trading skills – and your profits – without the stress of a more random approach.

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Economic recovery likely to prove a ‘stuttering’ affair

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Economic recovery likely to prove a ‘stuttering’ affair 3

By Rupert Thompson, Chief Investment Officer at Kingswood

Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.

As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.

Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.

We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.

Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.

Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.

China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.

Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund.  As is almost always the case, a messy compromise will probably end up being hammered out.

An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.

Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.

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