Financing Agriculture Value Chains: A Growing Mismatch
Re-published with permission from clarmondial.com February 23, 2016
During the first four years of Clarmondial, most of our work was focused on advising investors, from family offices and fund managers to companies and foundations, on their deal sourcing, due diligence and management. Gradually, and especially from late 2013, we switched our attention to working with project developers and companies.
The main reason for this shift was that, although we were successful in providing interesting investment options to our clients, we kept on hearing that there was “not enough good quality deal flow” (both direct deals and product) to allow our clients to expand their portfolios to a meaningful scale.
Prominent investors confirmed our perception that they are facing severe constraints to allocate sizeable portfolios into themes such as sustainable agriculture in emerging markets (particularly sub Saharan Africa), food security and climate change. This also became apparent when we led the creation of sector-specific guidance for the food, agriculture and land-use related sectors under the Climate Bonds Standard, which we developed for the Climate Bonds Initiative (CBI) with several leading international banks, asset managers and corporates including Rabobank, Credit Suisse, Olam, Banorte and Hancock NRG.
Taking this as a call to action, we proactively started working with credible projects and companies in our networks, in order to deepen our understanding of their financing needs, fund availability and credit risk. Over the past two years Clarmondial worked with a number of large and small agribusinesses and their supply chains.
In parallel, we screened hundreds of investors, looking at their general and specific deal interests. The figure below was extracted from our database. It presents a snapshot of some of our discussions with potential investors in the context of a direct equity investment in a sub Saharan African farming business.
Our conclusion is that there is still an impressive gap in seasonal credit, in particular given the current interest rate environment. At first this credit gap may seem strange, but upon further analysis of some key stakeholders the picture becomes clearer.
Corporates: large agri-businesses have been benefitting from a low interest rate environment, allowing them to bypass the banks and take on increasing amounts of corporate debt at a reduced cost. For example, Nestlé’s bond yields traded at negative rates in 2015 – the first ever negative interest rate corporate bond!¹ This trend has generally resulted in companies adding debt to their balance sheets, often acting as a commercial bank towards their suppliers. However, this does not necessarily mean that credit has been more easy to come by for smaller players, particularly in emerging markets, in both local and hard currency – in several African countries, we’ve heard of local banks asking for collateral of more than 125%, very high interest rates and currency swaps, etc.
Banks: regulations imposed on the banking sector as a result of the last financial crisis have constrained bank lending and made it more difficult for them to act as market makers. The capital requirements in Basel II and III has been leading to various banking downsizing, or simply abandoning, their trade finance activities for example. Amongst other things, this has severely limited bank balance sheet optimization alternatives, and resulted in the growth of shadow banking², including credit aggregation and peer-to-peer (P2P) platforms, and more recently in fintech solutions. According to the UK Financial Stability Board (FSB), the shadow banking sector grew by almost 10% per year on average from 2010 – 2014 to reach ca. USD 80 trillion.³
Asset managers & investors: developed country asset managers are craving yield and liquidity. The current environment has pushed investors to take more risk, and encouraged investments in corporate bonds and in index-linked ETFs (Exchange Traded Funds). However, there are concerns about this in the long-term, in particular around asset managers’ ability to properly screen corporate bonds and manage such portfolios, and the illusion of liquidity of bond derivatives and ETFs in case of an altered market sentiment leading to a swathe of concurrent redemptions – and in particular given the restriction on banks as liquidity providers. A number of investors are reputed to anticipating this and making arrangements. This to us also signals the need for development of alternative fixed income products, that are not necessarily correlated with ETF or corporate bond portfolios.
What does all of this mean?
Generally, these seem to have created exceptional opportunities, with investors more open to innovative product structures, in particular where there is true liquidity and a minimum yield. As investors and companies become more cognizant of the potential for social and environmental factors to undermine performance, we believe taking a commercial yet responsible (impact) investment approach adds an extra angle to entice new investors.
Additionally, we have seen a general interest of new types of partnerships form to create such product, e.g. between companies, donors and foundations, as a positive step to bringing new products to market and mainstreaming them.
At Clarmondial, we are excited about continuing to build on the partnerships we have established to launch new financial products, and to continue to collaborate to build scalable channels for affordable financing, from investors to responsible agri-businesses operating within established supply chains.