Collateral management in industry
COLLATERAL management has taken over the Zimbabwean manufacturing landscape by storm resulting in a win-win situation for both the foreign supplier and the local producer.
The seed of this opinion piece emanates from my transition from public practice to being involved directly in financing operations for an agriculture-based organisation that heavily depends on stock holding in preparation for an agriculture season.
Collateral management, loosely referred to as “CMI”, allows suppliers, in particular, foreign suppliers or traders to import finished product or raw material into a warehouse in-country, could be a third-party warehouse or even the eventual company warehouse.
A CMI representative is stationed at the warehouse with the sole purpose of controlling product receipt and release. A release by CMI is triggered upon instruction from the supplier either when payment has been confirmed or other arrangements finalized, for an example, receipt of a confirmed Letter of Credit.
The primary advantage of collateral management function is the mitigation of credit risk. In this regard, collateral held protects against the negative impact of counterparty defaults where it acts as a buffer against incurring a loss at the point of insolvency.
Another advantage to firms collateralising their trades is providing them access to markets or counterparties that would otherwise be unreachable.
Credit risk increase
Zimbabwe was bedevilled by economic issues ranging from currency instability, exchange rate volatility, poor rainfall patterns and lack of foreign direct investment.
The agriculture value chain was left in shambles and for many players in this space from my observation and general market sentiment. Retooling and capital raising for restocking to many players remained a distant thought in the horizon.
The periods of economic stagnation left many producers in the agricultural space with significant foreign obligations which they could not service.
Government interventions like price controls and the laws around the 1:1 parity between the local currency and the United States of America dollar essentially destroyed value for a foreign supplier, leaving the local manufacturer with real US dollar foreign liabilities, which were not immunised against the local developments.
Many foreign suppliers were left in a disastrous position, and plausibly some people were fired by their companies for letting their exposure to the Zimbabwean market grow to the levels it had grown.
Believe you me, the same foreign suppliers made a lot of money during the USD era in the country as the market was ripe and it was easy to repatriate profits.
At the height of this boom, foreign companies like Omnia South Africa spread significantly in this market, and in a short space their retail presence was all over the country.
The Omnia Group in its 2017 published annual report reveals there had one manufacturing centre and one distribution centre, while in their 2019 report they boasted of 50 distribution centres.
Other significant names like Rawfert International, Triomf Fertilisers, Sasol Limited, Irvines South Africa, Afrox South Africa and Swiss Singapore directly or indirectly were doing lots of trades in this market.
A dark day dawned on foreign suppliers when the Nostro accounts suddenly became local dollars and repatriation of dividends or foreign payments ceased — arguably a move many did not see coming.
A new reality many awoke to was money locked in the country, and dividend payments outside the borders of Zimbabwe was now unimaginable.
Excess capacity could also have been a possibility to many of these suppliers as they were pushing significant volumes into the country, which they were forced to halt or curtail a bit due to ballooning debt. Local companies could not pay foreign supplies as their USD balances in the banks were now at a parity of 1:1 with the USD and it is a possibility that they could not easily offload the product to a new market.
The government through the Reserve Bank of Zimbabwe came up with various policies to address the disaster — the country began importing finished agricultural related products, maize and wheat topping the list not to mention the usual suspects i.e., fuel and electricity.
One of the measures was the ring-fencing of foreign obligations as published in the RBZ’s exchange control circular no.8 of 2019, where companies applied to be considered on the “blocked funds” arrangement, which in principle, a local company submitted proof of debt and the related local dollars were surrendered to the central bank on a 1:1 parity with the US dollar.
The promise was the bank would then settle your liabilities and it was restricted to transactions for a period from January 2016 to February 2019.
This was met with enthusiasm from local players. However the reality in our heads was we all knew the central bank needed to get the foreign currency from someone or somewhere to extinguish these liabilities.
Accountants debated with marketers and engineers who now wanted this debt off the books of accounts since it had been taken over by the RBZ- we all know what happened, even up to today there is still no cohesion on this matter.
A shift and its impact on credit risk Fast-forward, 2020 saw a good rainfall season and the same was envisaged for 2021/22. It was clear that the agriculture value chain needed to step up.
Closure of borders involuntarily imposed as a result of measures to stop the widespread of the new devil in the name of Covid-19 even presented a good haven for retooling and increasing local capacity under the buy Zimbabwe campaign.
The government spearheaded the National Development Strategy 1 (NDS1) implementation and amongst its core is agriculture re-investment and resuscitation of local manufacturing industries.
The lurking truth was and is most agriculture value chain players’ key raw materials are not locally sourced. For instance, in the fertiliser space, Sable Chemical Industries Limited is the sole producer of
Ammonium Nitrate, whose key raw material is ammonia, which we do not have locally, hence for any agriculture to take off, the country needs to import ammonia or ammonium nitrate.
On average, the country requires 240 000 tonnes of ammonium nitrate and the price per tonne ranges from US$500 and has peaked to over US$900 in 2021.
Producers in the stock-feed and oil processing on top of their list there is soya beans, sunflower, cotton seed all these are imported, and your foreign suppliers become handy again. Petrol and Diesel are another key component and we do have large stock holding facilities e.g., the pipeline in Msasa.
Nearly 90% of fuel consumed in Zimbabwe is transported into the country via Mozambique’s CPMZ Holdings operated pipeline from Beira, to Feruka in Mutare and further via Government owned Feruka Oil Pipeline to storage tanks in Mabvuku and Msasa.
The conundrum was how do we move forward when we owe these foreign suppliers — at the same time the foreign supplier needs this market to push volumes.
Months or years later, the central bank has started to reduce the foreign obligations under these blocked funds and that move could not have come at a better time.
Of late it has been observed in most industry fora that payments are being made especially in key sectors like agriculture, and this has started to unlock the rebuilding of the burnt bridges with the foreign suppliers.
For the country to have a good season, we need the stocks before the start of the farming activities, and someone needs to fund the stockholding as local banks are incapacitated or are averse to such and government is heavily stretched.
As an agricultural player you are guaranteed that with good rains, fertiliser will be needed. As a vegetable oil manufacturer, you are guaranteed that if you can have stocks of cooking oil, people will certainly buy the same. For a fuel company or distributor, cars need to be on the road and one way or the other they will get the fuel from you.
A new possible solution
Collateral management has come in as the saviour to this impasse as it can be the ideal solution in this problem. It is broadly defined as the process of two parties exchanging assets in order to reduce credit risk associated with any unsecured financial transactions between them.
This has worked spectacularly in the agriculture value chain as there are now reputable collateral management companies which can be the middlemen in the transaction and control movement of products once payment is confirmed.
The beauty of this is the instant access to product for the local manufacturer or retailer, the guarantee to the supplier that only paid or agreed product is used up.
Some foreign suppliers are allowing the local manufacturer to draw down on the CMI product even before payment and when sold, the latter settles the debt, and further releases are then made.
In other instances, to generate trust, local players will get finance first i.e., you get a local Zimbabwean dollar (ZWL) facility that allows you to participate on the RBZ auction system.
Once a bid is approved, some foreign suppliers are accepting that confirmation to trigger release of raw material from the CMI warehouse.
Others wait for the swift confirmation of the payment to trigger release. This has been a game changer in the agriculture space.
The Afreximbank backed letters of credit have also come in handy. The local supplier through their bankers applies and gets cash-backed lines of credit (LC) facility, which is very much acceptable by foreign suppliers.
On confirmation, the product is released from CMI. Instead of waiting to do the payment outside the country and then send transporters and all the border delays for a manufacturer to eventually receive the raw material-lead time is drastically reduced through the CMI arrangement.
There are CMI arrangements where the foreign supplier can allow you to draw down the raw material before payment, produce the finished product and put it back in the CMI warehouse. Once funding and payment is confirmed, the product is instantly released on the market.
A variation to the above arrangement is whereby instead of using property as collateral for loan finance of a credit facility, stock is the security and it is held as CMI until payment is made.
So, the supplier and the manufacturer can arrange release of this stock into the market at controlled times, facilitated by a third party CMI company.
This efficient tracking of products can be a game-changer to unlocking credit facilities and taking advantage of market demands.
The overwhelming drive for the use of collateral is to provide security against the possibility of payment default by the opposing party in a trade.
Key fundamentals
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Right people — a CMI arrangement needs knowledgeable people to structure the deals, a competent and reliable CMI company who is reputable and can be trusted by foreign suppliers.
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Proper accounting systems and processes to track CMI deals and releases and payments
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Communication — a clear and effective communication is needed between the three parties to create trust and reduce the counterparty risk. Real time communication is needed for instance the supplier needs to know real time whenever a release from CMI warehouse is done. The manufacturers require the supplier to communicate messages to CMI timely for all product release
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Legal agreements — robust agreements needs to be in place on the terms of the CMI arrangement and its enforceability
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Backing from a financial institution and the RBZ — its very imperative that exchange control is aware of such arrangements beforehand when foreign suppliers are involved as it provides confidence to the supplier and facilitates ease of payments.
In conclusion, as local industries we can take advantage of collateral management opportunities before the year ends.
Increasing uncertainties due to pandemics, wars (for instance recent tensions between Russia and Ukraine) makes it imperative to have CMI as a cushion as definitely there will be delays.
However, with such an arrangement you cut back on the increased financing cost which is inevitable in view of the supply chain disruptions.
The advent of Covid-19 virus of the cyclical resurgence of the virus which often is accompanied by knee jerk reactions by governments in terms of immediate lockdowns or travel restrictions which hamper movement of raw materials.
A robust CMI arrangement could provide an alternative solution that could avert the delays in movement or access to raw materials.
CMI is not a panacea to the issues facing manufacturers but can be an alternative or an added option to timely secure raw materials.
Makwara is a chartered accountant with both local and international experience having most of his career in audit and currently is working as the group financial manager of a local listed entity.