Critical minerals: where export licensing meets inventory finance

Over the past two years the list of materials whose export from China requires a licence has lengthened: several rare earth elements and the magnets made from them, gallium, germanium, antimony, certain graphite products and the processing technologies behind them. The licences are, in the main, granted. But they are granted on the authority’s timetable, with documentation requirements on end use and end user, and the interval between order and delivery has become both longer and less predictable.

For a European manufacturer of motors, sensors, power electronics or defence equipment, the consequence is not a shortage in the conventional sense. It is a supply chain in which a critical input arrives on a schedule the buyer does not control. That is a familiar kind of problem to a trade finance desk, and it has a familiar kind of answer: hold more, and finance the holding properly.

From price risk to timing risk

Before licensing, the risk in these inputs was mostly price. Prices were volatile, but material was available to anyone willing to pay, and the treasury response was to hedge where instruments existed and to pass through where they did not. Licensing changes the character of the risk. The price may be stable; the delivery date is not. And there is no derivative that hedges a delivery date.

The instrument that manages timing risk is inventory. Manufacturers who have moved from six weeks of cover to six months are behaving rationally. What is not rational is the way that inventory is frequently financed: on the general revolving facility, crowding out other working capital and showing up as a deterioration in the ratios lenders watch, when it is in fact a deliberate strategic asset with a clear liquidation value.

There is no derivative that hedges a delivery date. The instrument that manages licensing risk is inventory, and inventory should be financed as what it is: a strategic asset with a liquidation value.

China Everbright Bank Europe — Trade Finance Desk

Financing the buffer

Structured inventory finance — a facility secured on identified stock of licensed inputs, sized against its market value with an appropriate haircut and held in a monitored location — separates the strategic buffer from operating working capital. It is priced on the quality of the collateral, which for materials with deep global markets is good, and it keeps the revolving facility available for what it was designed to do. For manufacturers with a substantial buffer, it is also a conversation worth having with the credit rating agencies, who will otherwise read the inventory build as a deterioration rather than a decision.

• Separate strategic inventory of licensed inputs from operating stock in the management accounts, so that it can be financed and explained separately.
• Use a secured inventory facility sized against market value rather than the general revolver.
• Agree the valuation source and haircut in advance; these materials have reference prices but thin spot markets at times.
• Explain the buffer to lenders and rating agencies as a decision, with the financing to match.

Documentary credits and licence conditions

On the transactional side, buyers increasingly want payment conditional on the export licence having been granted. The instinct is sound and the execution often is not: a credit that calls for ‘evidence of export licence’ without specifying the issuing authority, the document type and the data it must show is a credit that will generate discrepancies. The workable pattern is the same one we described for carbon border documentation in July: specify the licence requirement in the sale contract, and have the credit call for a specifically described document that examiners can check on its face.

Diversification of supply — new mines, new processors, recycling — is the long-run answer and it is under way, supported by Union programmes for critical raw materials. But it is a project measured in years, and inventory finance is what bridges a manufacturer from here to there. Our trade finance and corporate lending teams structure both sides of that bridge.