Collateral Management Agreements and Stock Monitoring Agreements: Managing the risks
“Collateral Management Agreements (CMAs)” regulate how goods that are pledged to a financial institution as security against a loan, or remain owned by the original seller, are stored, checked and released against specific instructions.
These goods, “the collateral”, can more or less be anything, but usually include metals, a wide range of soft commodities and of course oil products.
When being held under a Collateral Management Agreement the physical goods are often in the hands of a third party, not directly under the control of either the bank or the commodity trader.
In practice, the physical distance between the owner, buyer and the goods themselves creates an environment in which opportunities for misappropriation, fraud and theft are likely to occur.
When the goods are the other side of the world, in a storage facility you’ve never seen, how can you ensure that the Collateral Manager is fulfilling their obligations? How can you know the goods are still where they are supposed to be, and in saleable condition?
The answer is with difficulty. Goods are often stored in countries with poor infrastructure, where corruption is a fact of life and where wages are microscopic compared to the value of the goods being stored.
These conditions can be a precursor to fraud. Opportunity, incentive and rationalisation – exist in abundance.
But there are some steps you can take to mitigate the risk.
You will be less at risk if the collateral manager you appoint:
- Is the owner / in control of the storage facilities
- Is able to evidence contractual rights in relation to those storage facilities
- Is separate to the party conducting the surveying / verification element of the stocks
- Can ensure or guarantee adequate segregation of goods
- Does not subcontract their responsibilities to unknown others
- Is an expert in the material/goods that is being stored
- Has sufficient resource to exercise proper control
STOCK MONITORING AGREEMENTS
Given the inherent risks, Collateral Management Agreements (CMA) have shown signs of falling out of favour.
In some cases people have been turning to Stock Monitoring Agreements instead.
However, a Stock Monitoring Agreement offers even less protection if something goes wrong.
Key differences between a CMA and a SMA
Under a Stock Monitoring Agreement (SMA) an inspection company will observe the situation in the warehouse and provide the SMA counterparties with daily, weekly or monthly stock reports.
Crucially, unlike a CMA, an SMA is only there to monitor. They will not issue any warehouse receipts, control / lease the warehouse, arrange for storage and segregation of the goods or take any active role in the process for the release of goods. They will not be present on site 24/7 either.
The SMA will also not insure the goods, or be responsible for their safety, control or security.
SMA providers typically limit their liability to the level of the charges for the services (negligible) or a multiple thereof.
While an SMA will almost certainly be cheaper than a CMA its scope is narrower and its protections weaker.
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