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UNDERSTANDING RISKS IN COMMODITY BASED LOANS

Some of the primary risks associated with commodity based loans and the way we minimize it is given below:

 

1. Market Price Risks 

All our loans are collateralized by the underlying commodites for which the trade is being done. Commodity prices are just like any other financial instrument and can have varying degrees of volatility. The usual factors which affect the commodity prices are supply factors (such as crop yields, weather, infestation etc); demand factors (GDP growth) and policy factors (such as international trading treaties, import taxes etc). The value of our collateral will fluctuate with the underlying commodity prices and there might be a scenario that in the case of a default, the collateral value is not sufficient to cover the capital+interest promised to the investor. We cover for this risk by using the following measures:

  • We calculate the predicted minimum value of the collateral over the loan duration using a proprietary algorithm. We then apply a 25% haircut on top of this predicted minimum value as the total loan value
  • We do a daily revaluatio of the collateral using our proprietary algorithm. The inputs to this algorithm are the collateral details itself as well as real time price feed from all major futures and spot exchanges and marketplaces. If the value of the collateral falls below a certain threshold, we issue margin calls to the borrower
  • On a case to case basis, we would also hedge the long commodity exposure via suitable futures and swaps instruments traded on commodity exchanges such as CME, Liffe and LME

 

 

2. Counterparty Risks

A trade is complete when the Seller succesfully delivers the agreed commodities, the buyer accepts the goods and an invoice is generated by the seller for the buyer to make payment. if any of the counterparty fails to fulfil their obligation, we have a counterparty risks. The usual reason for a seller to default is if he is able to deliver his goods to someone else at a much higher price than what has been agreed with the counterparty. The reverse is true for the buyer, they may default (not take delivery of goods), if they are able to source goods from someone else at a much lower price. 

We minimize the counterparty risks by the following means:

  • We do a stringent KYC on all the parties who onboard our system. Any firm with a history of defaults will not be onboarded
  • We have a network of commodity traders who would be willing to offtake or supply goods in case one of the party to an agreed contract defaults
  • For exchange traded products, we hedge by taking an opposite direction futures contract. this allows us to deliver (or take delivery) to the exchange if one of the party defaults

 

 

3. Operational Risks

International commodity trading comprises of complex logistical operations and things can go haywire at times. The most important criteria in managing the operational risk is to have real time end to end visibiltiy on the supply chain so that preventive measures can be taken before things go wrong. At Satoshi Systems we use the following means to manage the operational risks on the physical trades for which we arrange finance:

  • Ensure that only the most reliable service providers (freight, warehouse, quality test etc) are used for executing the trade
  • All service providers use our online portal to provide status of their tasks and upload necessary information
  • We use emerging technologies such as IoT combined with GPS to traack in real time the location and movement of commodities
  • We use Machine Learning to predict supply chain disruptions. Please note that ML will become increasingly reliable as the underlying trade volume and data on our platform increases
  • Employing independent inspectors where monitoring through technology is not feasible
  • Finally, taking insurance for all events on which we have no control
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