What Is the Relationship between Commodity and Trade Finance?

The relationship between commodity and trade finance is best understood by understanding what the two terms mean. Commodities are goods not completely unique to their producers, and trade finance is the management of funds and payments during the export and import of the commodities. This includes securing payment and obtaining verifiable shipping information, so that the transaction is relatively secure.

A commodity is something that does not differ from other same commodities, regardless of who makes or sell it. Common commodities are oil, beef, and gold, as well as grains, metals, and natural gas, many of which are raw materials for other products. Quality may be slightly different from others, but basically they are the same.

Commodity and trade finance relate to one another through international trade. As the commodities are imported and exported, trade finance manages the capital for the smoothest trading possible. An exporter wants goods prepaid or otherwise guaranteed in order to minimize risk, while the importer requires proof of shipment to minimize that risk.

The importer promises payments in various ways. One is a letter of credit, which is a drafted letter from the importer’s bank guaranteeing payment. Other methods of payment might be an open account with the exporter, and the export may participate in forfaiting, which is the sale of these accounts in order to obtain funds more quickly. Export factoring is similar, but instead sells the invoice to one of the available export credit agencies to manage collection. The credit agency may discount the invoice for the buyer to achieve swift collection.

Before making payment, the importer wants to ensure receipt of the commodity. In the case of an open account, the importer may wait until the product is received or the balance is due to make payment. If a letter of credit is drafted, a bill of lading may be required. This is a detailed list of what is included in the shipment, typically given by the carrier, which banks will likely require. Other documentation may be a contract to detail the responsibilities of all involved parties.

Commodity and trade finance go through other procedures during the transaction. Either party might require trade credit insurance. This is offered by a private insurance company to further secure the importer and exporter.