When Freight Becomes a Financing Problem

Logistics and Trade Execution

When people talk about freight costs, they usually mean a line item on a shipping invoice. In structured trade finance, freight matters for more than that. It can change the financing need behind the whole transaction.

Recent events show how fast this can happen. Security risks on some of the world’s key shipping routes have pushed tanker freight and war-risk insurance costs sharply higher in recent weeks. For some buyers, transport has gone from a modest share of the delivered cost to a much bigger one. Some rates have eased from their peaks, but they are still high while the risk continues.

A trade is structured on assumptions

When a transaction is put together, the structure rests on a set of working assumptions: the purchase price, the selling price, the cost of moving and insuring the goods, how long the cargo will be in transit, and when the buyer will pay. Together these set the trader’s margin, the amount of working capital needed and how long it is needed for.

When freight and insurance costs rise after the trade has been agreed, several things can change at once:

·       Landed cost goes up. If the selling price is already fixed, the extra cost comes straight out of the trader’s margin. Margins in physical commodity trade are rarely wide enough to absorb a large shock.

·       The financing need grows. A higher cost base means more capital is needed to carry the same volume of goods.

·       Inventory stays funded for longer. Rerouting, port congestion and waiting for vessels add days or weeks to the trade cycle. Every extra day is another day of financing cost and another day the collateral is in transit.

·       The risk profile changes. Longer voyages, different routes and different insurance cover can change exposure to loss, delay and price movements, even when the commodity and the counterparties have not changed.

A trade that looked sound when it was structured can become tight, or even unviable, without anything going wrong with the buyer, the seller or the goods.

The question nobody asked at the start

Every trade needs a clear answer to one question, and it should be answered before the goods move: if transport costs change after the deal is agreed, who carries the difference?

The answer usually depends on the contract terms. Incoterms, freight clauses, price-adjustment mechanisms and insurance cover all decide where the extra cost falls. In practice, many smaller importers and exporters only find out the answer once the cost has already landed on them.

For SMEs this matters a great deal. A large trading house may be able to absorb a sudden jump in freight across a diversified book. A smaller business moving a single cargo often cannot. The extra cost turns up as a cash-flow strain at exactly the point in the cycle when cash is already committed.

What disciplined structuring looks like

Nobody can prevent a freight shock. It can be planned for, though, and a sound structure planned for it from the start. In our experience, that comes down to a few practical steps:

1.         Stress-test logistics, not just credit. Ask what happens to the margin and the financing need if freight doubles or transit time stretches by three weeks, and whether the trade still works.

2.         Be clear on cost allocation. Know, before shipment, which party carries freight, insurance and demurrage risk under the contract, and make sure the financing structure reflects it.

3.         Match tenor to reality. Facilities sized around a best-case voyage leave little room when conditions change. Build in realistic buffers for time as well as cost.

4.         Keep control of the collateral. When goods spend longer in transit or storage, constructive possession, proper insurance cover and visibility over the cargo become even more important.

5.         Keep talking. Changes in logistics are easier to manage when financier and client discuss them early, not at settlement.

The bigger picture

Physical trade has always been exposed to the routes it travels. What has changed is how quickly the cost of using those routes can move. For financiers and traders alike, freight and insurance can no longer be treated as fixed background costs. They are part of the transaction’s risk and part of its working-capital requirement.

At Teybridge Capital, we structure short-term, asset-backed transactions around actual commodity flows and the entire trade cycle. When the cost of moving goods changes, the financing has to be ready for it.

Thursday 22 October