Collateral management meets Godzilla

Introduction 

This is a summary of the Collateral Management Agreement (CMA) industry, how it started, the highs and lows, a sprinkling of ‘war stories’, where we now find ourselves and the hopes of where we might be headed with a professional, regulated minimum service requirement. 

Purpose

We start with what is the actual purpose of the CMA, which at times has not been clear. In its pure form it should be a 24/7 ‘Policeman’ at a processing plant, terminal, storage facility, or port often in far flung parts of the world, acting for and on behalf of the lender or owner of the goods. A good CMA is not only the controlling force but predicts, reacts, reports, teaches, cajoles, manages to ensure that operations run efficiently and to stop any unauthorised movements.

The CMA’s services and obligations must be transparent with no T’s & C’s (terms & conditions) hidden in microscopic print. The CMA contract and appendices are the T’s & C’s and should clearly identify the operational, reporting and reactive services that the CMA provider will offer and what should be expected by the lender. 

The CMA is an operational service, in some ways it is a quasi-military structure, inserted into projects to bring greater discipline to bear.    

Birth 

The Collateral Management Agreement (CMA) appears to stretch back into the annuls of time, however in reality it is but 25 years old. 

Born to three parents’ being the banker, trader and insurer, all from the start had overlapping interests, yet very different views as to how the CMA was to develop. This has therefore over the years resulted in confused messaging and ultimately allowed operational flaws to develop. 

From the start there were also two clearly differing types of CMA company. Firstly, those who were established specifically to offer CMA, where operational management and control over commodities was in their DNA. Then there were companies whose genetic makeup was inspection or logistic services and who then developed a CMA platform.  

Development

The original CMA companies in the 1990’s and early 2000’s were almost exclusively in the service of the international commodity traders, in their charge into the former Soviet Union, Asia and South America. The risks were clearly greater, the rule of law at times weaker, the application of the law debatable and hence the CMA was integral to developing their footprint and retaining control. The interaction between the trader and the CMA provider had to be immediate and continuous. 

As an example of the immediacy required in the early days, I am reminded of one specific trader, a former parachute regiment officer, who telephoned at 2am and after much shouting demanded “where’s my bloody sugar?” On the face of it he had a point, as he was referring to a train full of white bagged sugar which was heading in completely the wrong direction, to the wrong customer. This was dealt with the following morning with a full presentation of release & shipment instructions, load and dispatch reports, rail reports and a rail authority stop/hold confirmation, which had been sent regularly by the collateral manager to the trader’s office. There followed an immediate investigation in the trader’s offices and a prompt apology, as the fault had been an internal issue. Stressful, however clear to everyone what was expected. 

Most importantly during this period the chain of command and payment structure was transparent, as the CMA worked for the trader and the trader paid the fees.   

The CMA market has undergone several fundamental changes over the past 15 years and remains in transition, which I will summarise: 

• The CMA is now not solely a trader service. The banks and currently alternative financiers are driving the usage of the CMA, not only in the ‘emerging or more exotic markets’ but globally and throughout the EU. The CMA is obviously geared to inventory financing, however this is developing rapidly, with the CMA now increasingly inserted as a ‘set-up’ for borrowing base financing, or retrospectively inserted into a borrowing base facility when concerns arise about the borrower. Thus, the CMA is now becoming a financial risk mitigant as well.
• The contractual relationships are also now more convoluted. In a quad-partite contract between a bank, borrower, storage facility and CMA provider, where the CMA is there to protect the bank’s interests, it is the borrower or potentially the storage facility who pays for the CMA. This has weakened the ‘chain of command’ as the borrower or storage facility can perceive a degree of authority over the CMA as ‘he who pays the piper calls the tune’. This is evidenced if you study the frauds of the past 12 months (and for that matter the past 15 years) where the borrower has, in almost every case, been permitted to mandate a local cheaper service provider, with the resulting consequences.
• The contractual obligations within a CMA are becoming ever more onerous resulting in an exodus from the CMA market by non-core CMA companies who have felt the ‘risk reward ratio’ does not justify the exposure. 
• The changes in the insurance market have also had a significant effect. Insurers have retrenched, hardened and some would say ‘run for the hills’ over the past five years.  The marine cargo market started this process with underwriters effectively hanging up the ‘closed’ sign in 2014/15 after yet more frauds & losses.  Renewals and maintaining the insurance coverage required, is now at best a challenge and for most a major headache. 

War stories 

We were asked to insert a few war stories, which after 25 years has been a challenge to choose relevant, or that matter printable ‘nuggets’. I have therefore chosen a number covering CMA, stock checking, loss investigations to highlight the various issues our personnel face on the ground. 

No. 1. CMA – CIS 

Background: A good example of how simple and straightforward the service can be if the CMA personnel act immediately.  

• The project involved 3 x teams working 24/7 in a refinery
• Revolving financing over 18 months with no incidents up to this point
• Changes in warehouse and senior management had been observed and rumours that the borrower had cash-flow issues, reported
• The CMA provider reported unusual activity and indications the borrower might attempt a substantial ‘spot-sale’ to a local buyer, as wagons were being shunted into the facility
• The team leader questioned warehouse personnel, administration and requested an immediate meeting with the refinery director 
• While waiting for the meeting the inspectors were physically assaulted by ‘armed’ refinery security and forcibly ejected from the refinery 
• The local gendarmerie were unsurprisingly waiting outside and arrested the team and the new team arriving for shift change. All were detained, no charges were explained, yet it was clear that they would remain in detention until the suspected ‘spot-sale’ had been completed
• The customer was immediately notified and received ‘situation reports’ on the hour, every hour
• The site survey preceding the CMA had identified that legally ‘if a representative of the pledgor be in physical contact or in the vicinity of the pledged goods, they could not be removed’ without the prosecutor sanctioning any action by the refinery 
• The off-duty team were therefore briefed, and that night scaled the perimeter, using ladders entered the finished goods warehouse and climbed onto the pledged goods in the warehouse. This prevented the facility from continuing with their loading operations 
• Head office and our customer then jointly notified the regional police headquarters (the next level up and not associated with the refinery management) plus the prosecutor’s office and after a number of hours the refinery was legally forced to open the doors and the prosecutor confirmed (if grudgingly) that the pledge was ‘intact’ and the refinery could not move the goods. 

No. 2. Scrap metal – CIS

Background:  A site survey and stock count of scrap metal prior to CMA operations being inserted.

• A scrap trader asked DRUM to verify the goods and identify if CMA operations could be inserted
• The collection point was in port against presented Forwarder’s Certificate of Receipt (FCR)
• Inspection proceeded and apparently all goods were in place, albeit stored in a disorganised manner. The goods were clearly marked with a name plate as being owned by the trader 
• The inspector then visited the port administration offices to cross check various documents
• Several documents were missing and hence the inspector decided to return to the port pier area to confirm various details
• On returning to the pier he witnessed a number of ‘front loaders’ moving the scrap metal to the neighbouring pier, where conveniently the name of another trader was already on the name plate. 

There was a degree of good fortune in being in the right place at the right time with a highly professional inspector.  Within a CMA this type of borrower activity, whether intentional or by accident is simply impossible. 

No.3. Steel mill – Southern Europe 

Background: The CMA was active, the borrower and bank had a long-term relationship. Again, a straightforward example of the value of an effective CMA. 

• There were no indications that the borrower was in difficulty and at no point did they communicate with the bank a need to restructure to allow them to survive 
• Local legislation had required additional measures to be in place for the CMA to protect the pledge in favour of the bank, as technically the borrower or bailee would nullify a pledge if they were able to physically handle or touch the goods. 
• A notarised and registered segregation plan plus lease by DRUM had therefore been imposed from the outset 
• Without warning the borrower filed for a ‘chapter 11’ style protection from creditors
• The bank acted immediately and jointly with the CMA team presented to the authorities and creditors proof that the goods under CMA were to be excluded and could not be expropriated
• The CMA remained in situ and managed the sale of the goods by the bank for a further three months.

No. 4. Loss recovery & investigation - Europe

Background: Various banks were financing soft commodities in port. On receipt of goods the forwarder and warehouse issued FCRs and the borrower mandated an independent stock monitor to confirm received quantities. The goods were stored until sufficient quantities were accumulated, prior to the borrower paying the banks and nominating a vessel. DRUM was mandated by the banks to initially undertake a stock check and then investigate. 

• From the outset the borrower, forwarder and warehouse hindered full and ‘unfettered access’ to the port and warehouses
• DRUM was very briefly permitted access as no official port pass had been issued, yet it was clear that there was shortage in relation to the FCRs issued and stock monitor reports
• The findings were immediately presented to the banks who then mandated a phased investigation to identify the circumstances, individuals and legal status. 

Phase I 

• The forwarder, warehouse operator and the ship’s agent were registered at the same address. 
• A shareholder of the borrower was a shareholder of the ship’s agent hence all are interconnected
• The same shareholder was affiliated with the companies supplying the grains as a general director and/or shareholder. These companies had been liquidated [unknown to the banks] before the bank financing started.

 Phase II

• Duplicate FCRs were issued to different banks for the same quantity of goods and in most cases supported by the inspection report 
• Analysis of the accounting documents issued in relation to the forwarder and warehouse evidenced +/- 15% of the quantities financed by only one of the banks, there was nothing to identify the remaining banks
• The stock monitor’s reports were flawed throughout with the wrong warehouse address
• The reports inflated the warehouse capacity as the geometric volume of the dome-shaped warehouses was calculated based on the gable height. This was an impossibility as the building would have collapsed outward
• Stock insurance, arranged at the outset of the financing, had expired at the time of the loss without banks noticing it.  

Where are we and current weaknesses  

As mentioned above the CMA market is in transition. One of the key issues is that there is still no CMA governing body, or standardised minimum service, or key operational guarantees, or cross auditing (where another CMA provider audits operations on goods on a quarterly basis). Additionally, the insurance offered is inconsistent, with exceptions not covering fraudulent activity by the CMA provider. The policy must include terminology such as “a physical loss, as a result of any action or inaction by the CMA provider”. The ‘action or inaction’ is vague, but a ‘catch all’ clause that will cover fraud by the CMA provider.  

Without sounding like a ‘grumpy old man’ I would like to return to the losses that have occurred not only in 2020 but over the past 15 years. In almost every case the borrower chose and paid for a local CMA provider. If we step back and look at this logically, let us accept that the local CMA provider was professional and has trained and employed highly committed personnel. My question is, how can one expect a local inspector from the same town as the borrower (who is likely to be a major employer), to put himself, his home or his family in danger, when the borrower puts pressure on the inspector or chooses to default or commit fraud? The pressure on the inspector in a project is at times acute and hence the need for independence by rotating inspectors, to protect all concerned. There is obviously a cost equation, however you simply cannot expect a Rolls Royce if you have paid for a Robin Reliant! 

Looking forward

On a positive note we are now seeing signs that the CMA is increasingly valued for its individual components. Firstly (and prior to a CMA being considered by either party), the site, technical surveys are not just a ‘fit for purpose’ check list, but now part of the lender’s KYC or final signing off process. The CMA itself is recognised as being a management mitigation service, where at its best it is the window into the key operations and events within the borrower.  

Another positive is that the CMA on occasions is now being referenced in the financing documentation as a key part thereof, thereby giving the CMA some ‘teeth’ and not just as an addendum, or after thought. 

In the ideal world the new blockchain developments would secure the documentary chain, working with and reliant on, the traditional CMA to ensure that heaven [the blockchain] and earth [the CMA] are in sync and thereby preventing this eternal cycle of frauds. This development may just be the driver to formalise the CMA market and to ensure that all purchasing the services are clear that what ‘is on the tin is actually inside’.