MAS Outlines Supervisory Expectations of Governance and Risk Management of Commodity Financing, Especially Oil and Gas Sector

The Monetary Authority of Singapore (“MAS“) completed its thematic inspections in 2024 to assess the governance and risk management of their commodity financing (“CF“) business, with a focus on lending standards and practices for the commodity trader client segment within the oil and gas sector. MAS has published its findings in the Information Paper titled “Governance and Risk Management of Commodity Financing” (“Paper“), which outlines MAS’s supervisory expectations, identifies areas for improvement, and highlights good practices that banks and finance companies (collectively, “banks“) should adopt. MAS’s inspections focused on three themes:

1. Governance and Management Oversight – governance and senior management oversight, organisational set-up, and risk appetite and strategies for the commodity sector;

2. Customer-Level Controls and Monitoring – credit approval and structuring, credit risk assessment and due diligence; and

3. Transactional-Level Controls and Monitoring – monitoring of transactional and lending conditions, collateral management and valuation, and trade deviations/exceptions approval and reporting.

By way of context, CF exposes banks to operational, credit, and money laundering risks, which are heightened by price volatility, large transactions, and manual documentation. The Association of Banks in Singapore launched the Code of Best Practices – Commodity Financing (“Code“) to provide an industry benchmark of the relevant bank lending standards, setting out the key principles governing prudent commodity trade financing practices. 

Overall, the banks reviewed had generally established frameworks to provide oversight of CF activity and processes to monitor the risks undertaken. MAS’s thematic inspections revealed that there is room for banks to raise their risk management standards and enhance the use of systems and tools. Banks are also beginning to pay more heed to the need to augment their risk management with post-transaction monitoring and surveillance capabilities. MAS encourages banks to make use of technology advancements to improve risk management, commensurate with the nature and scale of their business activity.  

A summary of MAS’s key supervisory expectations in each area is set out below.  The Paper also provides details of MAS’s observations and areas of improvements for banks. There are also examples of good practices which banks can adopt. Banks should closely review the Paper and benchmark their governance and risk management practices against the Paper, addressing any gaps and implementing necessary measures proportionate to their organisational structures, business models, scale of operations and risk profiles.  

Key Supervisory Expectations

Governance and Management Oversight

In brief, MAS expects banks to have frameworks setting out clear CF strategies and risk appetite, and establish robust control policies and reporting structures. A bank should also regularly review the effectiveness of its frameworks and policies, taking into consideration market and industry developments.

1. Governance Structure: Banks should set up management committees or forums with clear mandates and terms of reference and representation from relevant functions. They should meet regularly to oversee risk exposures and material issues in CF activities, and ensure timely remediation.

2. Risk Appetite and Strategies: Banks should establish clear risk appetites and strategies for CF activities, considering the scale, nature, and complexity of their portfolios, as well as market and industry developments. This ensures consistent and proportionate risk management across business units and control functions. 

3. Portfolio Reviews: Banks should conduct timely periodic portfolio reviews and stress tests to evaluate the impact of macroeconomic and industry events on CF risk exposures. This helps identify vulnerabilities early, enabling timely corrective actions. 

4. Implementation of Code Principles (at Governance Level): Banks are expected to apply the Code on their CF portfolios in a risk-proportionate manner, as part of good risk management practices, and exercise prudence if any customer segments are assessed to be out-of-scope.

5. Organisational Set-Up and System Support: Functions responsible for credit and transactional risk control and monitoring should be adequately resourced, maintain sufficient independence, and have clear mandates shown in their reporting structure. MAS assessed and made recommendations on (i) reporting lines, (ii) operating mandate and scope, and (iii) systems and tools. 

Customer-Level Controls and Monitoring 

In brief, MAS expects banks to actively manage credit risks for their CF portfolios to remain resilient. Key aspects include instituting frameworks to assess the risk profile of CF customers and providing guidance on the appropriate credit structuring and key lending principles to be observed.

1. Credit Approving Authorities: Banks should implement a clear authorisation structure for granting CF facilities. Any discretionary powers given to business units should be risk-proportionate and measured. Credit risk managers must effectively review and challenge decisions during the credit approval process. 

2. Credit Risk Assessment and Lending Structure: Banks’ credit risk assessments should align with the nature and profile of various commodity customer segments. Credit facilities should be structured based on these assessments and the bank’s risk appetite for the commodity sector, and provide key lending principles and risk parameters to guide staff. Banks must also holistically assess fraud risk at the customer level and identify customers with heightened risk for appropriate mitigation. MAS assessed the banks in (i) various areas of credit risk assessment and structuring, (ii) credit risk rating, (iii) fraud risk assessment, and (iv) peer benchmarking, and recommended good practices based on its observations.

3. Implementation of Code Principles (at Credit Due Diligence Level): Banks are expected to incorporate key principles of the Code when conducting business due diligence on their commodity trading customers and in assessing corporate governance and risk management practices. Banks are also expected to monitor the implementation of the Code principles at the customer level. Overall, the Code raised banks’ credit risk management and due diligence standards for this customer segment.

4. Credit Risk Control and Monitoring (at Facility Level): Banks should have processes to ensure that credit is granted within their risk appetites and allow them to monitor the incremental impact of exceptions and deviations (if any) on their credit risk exposures. 

Transactional-Level Controls and Monitoring 

Upon the approval and granting of CF credit facilities, the credit limits would typically be utilised through the financing of the underlying commodity transactions of the customers, such as financing an import trade. Where the facility structure is relied upon to mitigate risk exposures, the utilisation would be subject to the fulfilment of terms and conditions imposed at the transactional level as part of credit structuring.  Banks generally set up transactional control (or middle office functions) to provide robust control and monitoring procedures and processes to ensure that these terms and conditions imposed at the transactional level are adhered to, as well as to detect any trade irregularities.

1. Transactional Control/Middle Office Function: Banks should establish a proper control function to conduct effective transactional control and monitoring processes, supported with adequate systems and tools. These processes should be guided by relevant policies and procedures. The banks’ risk management frameworks must be robust enough to handle the high operational and credit risks, as well as increasingly complex risks of fraud of CF transactions.

2. Compliance Checks with Transactional Terms and Conditions: Banks should put in place adequate processes to verify that customers’ CF transactions are aligned with approved terms and conditions before processing, as well as during the transaction lifecycle to the completion of the transaction flow and liquidation of financing. Banks should assess the risks of any exceptions from approved terms and conditions, and flag such exceptions to appropriate parties for approval.

3. Price Checks and Monitoring Processes: Commodity trade pricing significantly impacts the assessment of the economic viability of the underlying trade flows and consequently the banks’ credit risk exposures, especially given large transactional values and pricing volatility. The complexities in pricing increase fraud potential through exploiting pricing irregularities. Banks should have adequate processes to perform price reasonableness checks on customers’ transactions, as well as collateral monitoring systems and processes to robustly manage their risk exposures that are subject to price risk.

4. Controls over Warehouse/Storage Financing: Warehouse/storage financing exposes banks to risks like theft and physical commodity deterioration. The eventual buyer may not be identified at the point of financing, and the value of the commodities held in storage could decline due to price changes or physical deterioration. There is also reliance on third parties for collateral management. Banks should closely monitor the inventory level and value of the physical collateral held in storage, and be rigorous in their third-party due diligence to safeguard their interest.

5. Vessel Movement Checks: Banks should perform vessel movement checks as part of transactional due diligence to verify the genuineness of shipment and guard against credit and fraud risks, aside from sanctions and money laundering risks.

6. Post Transaction Reviews: Banks should put in place processes to track and report trade exceptions and deviations, including red flags and anomalies, to facilitate transactional trends and patterns analysis and support transactional reviews at customer level. Trade anomalies and unusual transactions should be robustly flagged for attention to appropriate parties/forums to promote proactive discussions and raise staff risk awareness. As part of customer surveillance, banks should also develop capabilities to systematically detect potential anomalies and red flags in the transactions between customers and their counterparties.

7. Implementation of Code Principles (at Transactional Level): In granting CF facilities, banks should establish clear guidance that will allow transactional transparency and controls over the underlying receivables and goods. Banks are expected to adopt these measures in a risk-proportionate manner. 

Concluding Remarks

The Paper underscores MAS’s expectations of banks engaged in CF lending, specifically in the oil and gas sector. It also underscores MAS’s endorsement of the Code Principles, issued in late 2020 following a spate of high-profile collapses of oil trading firms in Singapore, with rampant allegations of fraud.

While one of the aims of the Paper may have been to highlight good practices, one of its potential unintended effects could be the creation of additional legal risks for banks. For example, in future enforcement actions, banks may be faced with extensive disclosure requests, and defences anchored on a bank’s failure to mitigate, and/or contributory negligence, premised on the allegation that the bank failed to strictly adhere to the Code and/or best practices highlighted in the Paper.

It is also anticipated that the trend in recent enforcement CF enforcement actions, of the Courts investigating the underlying financing structure, and what the banks knew of the borrowers trading activities, is likely to continue. Specifically, in actions to enforce pledges over movable assets, banks may be exposed to allegations that they knew, or at least acquiesced, to a potential dilution or destruction of their security interests in light of any transactional monitoring, or vessel monitoring, undertaken by banks.

For commodity traders, the Paper is likely to reinforce the potential perception that banks will continue to undertake a perceived “flight to safety”. Commodity traders can also expect a broader and deeper scope of enquiry from banks, whether during the onboarding process, or as part of annual or periodic credit reviews. Such enquiries from banks, justified on the basis of enhanced due diligence, or compliance with the Code or best practices identified by MAS, may contribute to the creation of a secondary CF market where larger commodity traders, who have access to CF from banks and/or large pockets of liquidity, act as financiers to other commodity traders who are unable to obtain CF directly from banks. Banks’ lack of visibility into such a secondary CF market, and the fact that such lenders may fall outside MAS’s supervisory jurisdiction, may be another risk factor to be considered.