In our webinar of 23 March 2023, Sam Fowler-Holmes and I looked at some common structures in trade finance.
When discussing structuring warehouse financing, we mentioned that one key mitigator of risk in such structures was the role of a collateral manager or stock monitor.
As an independent third party in any transaction where the sale of the inventory is the primary source of repayment of the financing a collateral manager or a stock monitor can provide an added layer of comfort to the financier.
This is of particular relevance in the case of inventory financing – where the borrower requests financing for the purchase of goods which are to be stored in a specified location – which has, over the last few years, seen a period of upheaval as a result of significant fraud.
When financing stock held in a warehouse, the financier will generally be concerned with two things:
- That the stock does indeed exist; and
- That the stock is of the exact specification that the borrower has represented to the financier under the financing agreement.
These are both things that either a collateral manager or stock monitor could have responsibility for and be in a position to confirm. So what are some of the key differences between a collateral manager and a stock monitor?
If you wish to go above and beyond these confirmations, then you may wish to engage a collateral manager over a stock monitor.
A well drafted Collateral Management Agreement ("CMA") is capable of granting the financier a right to possession of the goods, regardless of the validity of a security contract, by way of a bailment claim.
Under a CMA, the borrower, acting as original bailor, bails the goods to the collateral manager, who, as bailee, acknowledges the transfer of possession of the goods to the financier and agrees to hold the goods on behalf of the financier. The key is to ensure that this attornment is properly created.
In relation to security, CMAs aim to provide the financier with constructive possession, which is key when taking an English law pledge. The collateral manager is legally responsible for the storage, security and monitoring of the goods, and is generally responsible for issuing warehouse receipts to the order of the lender (which are documents of title in some jurisdictions) and will only be permitted to release the goods if the financier consents.
The main divergence between the two roles is possession.
Unlike the collateral manager, a stock monitor does not take possession of the stock. Stock monitors are often used where the borrower in the transaction is holding the stock in its own warehouse or where there is less focus on demonstrating that a third party has control of the financed goods on behalf of the financier. Whereas a collateral manager is able to take possession, a stock monitor will confirm to the financier that the stock has been received in the warehouse and when it leaves the warehouse. They can also provide reports on stock levels at agreed intervals.
There is a cost-benefit analysis to undertake before deciding which route to go down. Yes, you will likely get more by way of risk mitigation with a collateral manager, but it will also be comparatively expensive. You should weigh up whether in the context of your transaction, you need this level of service.
So, what questions should you be asking?
- Do you need to have security over the goods whilst they are held in a warehouse?
- Do you need to establish possession for that security in the jurisdiction of the location of the warehouse?
- Does the jurisdiction of the warehouse recognise CMAs or Stock Monitoring Agreements ('SMAs')?
- Who is the owner of the warehouse? If this is the borrower, do they have systems, such as regular staff rotation, to avoid fraud risk and collusion?
- Have any standard terms and conditions of the warehouse (if applicable) been considered in the context of your CMA or SMA?
- Does the CMA or SMA accurately set out the services you require?
- Is the collateral manager or stock monitor able to competently perform the services required?
A collateral manager or a stock monitor alone is unlikely to be enough to protect against fraud in the absence of proper due diligence on the parties (including in relation to the collateral manager or stock monitor) and the transaction itself. However, utilising a collateral manager or stock monitor can be a method of risk mitigation.
For more information on risk mitigation in trade finance structures, please register for our webinar on 20 April 2023, here.
