Glencore has put out a funding fact sheet on Wednesday in a bid to settle nerves over the scale and scope of its market-dependent leverage.
You can find the statement here.
The notable points are:
Terms and conditions, related to committed, unsecured facilities
No financial covenants, no rating events of default or rating prepayment events, no material adverse change events of default or material adverse change prepayment events.
Everything, essentially, is at the goodwill of the market. But there’s also a section worth reading about how the funding of Glencore’s “readily marketable inventories” (RMI) works:
Readily Marketable Inventories (“RMI”) Represents those marketing inventories that are contractually sold or hedged. At June 30 2015, total inventories were $23.6 billion, of which Marketing RMI were $17.7 billion. For corporate leverage purposes Glencore accounts for RMI as being readily convertible to cash due to their very liquid nature, widely available markets and the fact that price exposure is covered by either a forward physical sale or hedge transaction.
Which relates to this section about Glencore’s dependency on letters of credit, our emphasis:
As part of Glencore’s ordinary sourcing and procurement of physical commodities and other ordinary marketing obligations, the selling party (or Glencore voluntarily) may request that a financial institution act as either a) the paying party upon the delivery of product and qualifying documents through the issuance of a letter of credit or b) the guarantor by way of issuing a bank guarantee accepting responsibility for Glencore’s contractual obligations.
The LC is not incremental exposure to that already reported in the financial statements. An LC is only a “contingent” obligation, disclosed as such in Glencore’s financial statements i.e. becomes a liability in the event that Glencore does not perform on an already recorded liability. The underlying transaction / procurement liability is recognised within “Trade Payables” in Glencore’s balance sheet. At 30 June 2015, $17.9 billion of such LC commitments have been issued on behalf of Glencore, with the respective liabilities reflected within the $28.1bn of recorded accounts payables. The contingent obligation settles simultaneously with the payment for such commodity. Availability is substantially higher, such that the vast majority of these Glencore facilities remain undrawn.
It should be stressed that none of the above is unusual. The entire commodity trading world depends on LC availability.
A letter of credit is supposed to protect a commodity supplier from counterparty failure in the event that a commodity purchaser receives delivery of said commodity, but then refuses to pay up according to the terms originally agreed — say because the price of commodities has fallen a lot since the point of purchase and delivery.
Most commodity traders demand LCs when supplying customers in countries with dubious credit track records. Chinese banks, for example, became major players in the LC provision market. The CME even accepts Chinese LCs as collateral.
On the flip side, if you’re the purchaser of commodities you may need an LC to convince the market you will honour the price you agreed to pay even if the market turns against you. If for some reason the LC guarantors walk away, that’s a contingent liability you have to deal with directly.
But the information which would really have been helpful? What sort of banks exactly have been providing LCs to underpin Glencore’s operations — or rather — to whom exactly does Glencore have exposure, and with respect to what might be fairly out of the money deliveries by now? And what exactly is the split between hedged and LC guaranteed inventory in their pile, or, alternatively, to what extent is it a bit of both?
Here, for background purposes, is some Simon Hunt (veteran metals commodity analyst/consultant) on the Letter of Credit arbitrage play of the last 7 years:
The third part of this equation was the massive growth in trade finance that grew with China. This started out as an arbitrage on interest rates using commodities as the collateral but then was expanded massively into the use of Letters of Credit whether for 90, 180 or 360 days for Chinese companies to revolve continuously to hide negative cash flows from their banks.
No one really knows how large was this business but our friends in Beijing think it was as much as 15-25% of GDP, or between $1.6-2.1 trillion. Early this year the PBOC stamped on this trade following the Qingdao scam that alerted them to the practice. The business models of the banks and merchants active in trade finance were blown out of the water. The skeletons both domestically in China and internationally are now surfacing.
It shows up in the bond prices, if not share prices, of merchants and banks that plied this business actively and in Chinese companies that used this facility and/or speculated on rising copper prices which many did since second half 2012. The fourth element is that early in 2015 many market participants expected copper and other metal prices to rise on the back of China stimulating the economy. The leadership did not and prices have fallen ever since. Some are holding large long physical positions that if liquidated would cause prices to fall even more and impair other assets that they own.
Contingent liabilities, letter of credit edition – FT Alphaville