The SIPA liquidation proceeding of MF Global resulted in customers being required in many instances to post additional collateral to maintain their open commodity positions, and caused uncertainty as to the availability of funds already on deposit with MF Global. To give producers, grain elevators and processors additional liquidity and reduce their concentration of risk, the following credit structures and risk management strategies may be considered by producers, elevators, processors and their lenders:
Accordion and Protective Advance Features in Revolving Credit Facilities
The sudden and unexpected need to post additional collateral in the days after MF Global required quick action and coordination between producers and lenders. Credit facilities that featured “accordion” provisions — provisions that permit a borrower to request an increase to a credit facility on an expedited (and often paperless) basis — allowed producers to quickly increase the maximum amount of credit available to them. Accordion provisions can be drafted in a manner that permits quick lender approval and does not require a borrower to incur any additional fees until the accordion increase is exercised. Although lenders are not required to grant a borrower’s request for an increase, the accordion feature provides a structure for responding to rapid market changes and the need for increased liquidity, for example, to cover margin calls. In addition, syndicated credit facilities may also include provisions that allow an administrative agent to make protective advances exceeding the borrowing base in certain situations. Accordion and protective advance provisions are not only useful in unusual situations such as the MF Global liquidation, but can also be important tools during periods of market volatility.
Borrowing Base Advance Rates for Commodity Accounts
The net equity maintained in commodity accounts is an integral part of the borrowing base for many producers with revolving credit facilities. Producers should work with their lenders to ensure that the advance rates under their revolving credit facilities provide them with sufficient working capital. Lenders may want to review their valuations of various commodity accounts to ensure they are adequately protected in the event they need to foreclose on such accounts. In addition, lenders may want to explicitly reserve the discretion to reduce advance rates on accounts maintained at any “ineligible” FCM or remove such accounts from the borrowing base in their entirety.
Periodic Sweeps of Excess Equity
Many producers keep excess equity in their commodity accounts to avoid the time and expense associated with coordinating daily wires in and out of their commodity accounts. As described above, this excess equity may be a component of a producer’s borrowing base. To encourage producers to limit the amount of equity maintained in their commodity accounts, lenders may want to limit the maximum amount of net equity that may be valued in a borrowing base (or consider imposing a covenant wherein the producers agree they will not maintain net equity in excess of this maximum amount). Producers may also want to examine whether the convenience and cost savings of maintaining excess equity in their accounts is worth the additional risk, or whether they want to employ periodic sweeps of their excess equity.
Maintaining Additional Accounts
Being locked out of the futures markets for even a short period of time can expose producers to unacceptable levels of price risk. The ability to hedge inputs and outputs is a vital part of a producer’s business model, and relying solely upon one FCM to serve this function can be risky. Producers should examine whether this risk can be reduced by maintaining commodity accounts with additional FCMs. Lenders may also want to consider whether to limit the percentage of futures contracts its borrowers may maintain with any one FCM.
Risk Management Policies
The MF Global liquidation should be a catalyst for producers to review their current risk management policies and ensure the policies are appropriate for their current business. Lenders should also review their borrowers’ risk management policies and work with their borrowers to revise any policies that may not be acceptable to the lender.
As part of producers’ risk management policies, producers should examine the financial condition of their FCMs to ensure they are financially stable. Early detection of financial instability could result in producers avoiding future problems.