In recent weeks Lempriere Grain went into administration, taking with it debts of A$18.8m. This is not the first grain company to fold and will not be the last.
We felt like it was an opportune time to revisit counterparty risk in light of recent industry rumours of a number of grain traders at risk.
Is counterparty risk a major issue, and how can you protect against it?
The recent loss of Lempriere has raised questions around the issue of counterparty risk. I thought it was important to understand the extent of the impact of insolvencies on the Australian grains industry.
By examining the reported insolvencies over the past two decades we can see the scale of potential impact. Table 1 is a list of the major insolvencies since the turn of the century. The total loss since 2000 has been A$155m which is a small impact on the overall industry. To give this more perspective, the country has produced a combined total of 619mmt of Canola, Wheat and Barley during the same period. The insolvencies, therefore, equate to around 25¢/mt.
Two things to note on this table. Firstly, it is not an exhaustive list, there are some other minor insolvencies which I have been unable to get concrete information on. Secondly, these are the overall debts including those held by other traders and banks. The impact on ‘grower’ returns would be further reduced to approximately 12-17¢/mt
The issue is small to the overall industry but is a huge burden to the individual farming businesses impacted by the insolvency when they have unpaid grain contracts.
There are several propositions being put forward to the industry as solutions, from compulsory levies to blockchain, however, in the meantime, It is worth outlining some individual strategies and red flags to be aware of.
Choose your partners
The grain industry in Australia has the benefit of a great degree of competition, however, a cursory glance through this list shows that they are all relatively small players.
There is an element of security to dealing with the larger multinationals. Although selling to a major multinational provides added security by their large balance sheets, it only minimizes the risk.
If possible, attempt as much due diligence as possible on any sellers who you may consider risky:
- Talk to others in the industry, are they paying on time?
- Is the seller making outlandish claims and/or talking their book?
- Perform a credit check, although in a volatile market a healthy exposed company can become insolvent overnight.
- Does the business have assets? If they go bust, will there be anything to sell to recoup debts?
Paying well above the market
It is better to receive a lower price but be paid. In many instances, traders have been paying substantially higher than market levels, then gone bust.
In a recent example, a company was offering $25/mt higher than all other participants in the marketplace, subsequently, they went bust. The market is the market and most traders tend to price around similar levels.
If a small trader is offering substantially higher than the larger traders, you have to question how they are able to pay at inflated levels.
Spread your risk
This one should apply to all marketing of your grain both with how you market and who you market to. It is important that your eggs are not all in one basket. Spread your sales around several buyers as in the case of a business failure, you will have reduced the volume of grain at risk.
There are several selling opportunities which provide some protection when dealing with unknown counterparties.
- Brokers with counterparty insurance
There are brokers who have counterparty coverage over the sales which they broker. This will typically provide coverage of a percentage of any loss. If using one of these services, ensure that you have a copy of the cover policy.
- Clear Grain
The Clear Grain system provides protection as title is not transferred to the buyer until payment is made. This provides a high level of protection for grain traded through the bulk handling system and some private storages.
However, at present, there is no ability to trade ex-farm/delivered parcels.
- Crop Connect
Graincorp has introduced an online physical grain sales platform called Crop Connect. This provides growers with the ability to sell grain held within the Graincorp storage system to the trade.
This system provides the ability to set a secure payment where title is retained until funds are received.
- Counterparty insurance
It is possible to take out your own counterparty insurance. The insurance will give you surety that if the buyer becomes insolvent you will be protected from a major loss.
These policies can be quite complex compared to the insurance packages a farm typically takes out, and it would be advisable to use an insurance broker to ensure that you have the right fit for your transaction.
- Payment Terms
The quicker you are paid, the lower your risk to insolvency. In recent years payment terms have decreased with many of the major traders moving to <5 days. There is still risk, as the buyer may go bust within that five days, however, it is a lower risk than within thirty days.