Opinions and Analysis brought to you by Commodity Merchant Trading and Shipping Advisory Services
Credit: aegfi
Systematic Risk in Commodity Trading
[“the business of moving commodities is markedly different to trading or speculating derivatives”, “unlikely to assist in optimising energy market” whether opinions are right/ wrong it has to be more critical]
[The aforementioned fundamental differences between physical commodity markets and financial markets, as well as the frontiers in-between commodity markets in reality might no longer really exist. I theorized that risk is commoditized and extremely fungible]
Systemic risk:
The risk that the financial system as a whole may not withstand the effects of a market crisis.
In recent years, attention has been focused on emerging derivatives markets, where a handful of players dominate trading. The concern is that the failure of any of these might have serious and widespread consequences for others in the market. The economic crisis and credit market contraction that developed in 2008 raised concerns about financial institution collapses and resulting systemic risk. [1]
[Systematic Risk has many definitions but commonly systematic risk is proportional to the level of volatility.]
[Furthermore, Economists and Researchers in finance (in a mathematical sense) are very aware of systemic risk and its nuances: it’s a critical issue in economic research.]
[Both recent events (the biggest financial crisis since the great depression) and research suggest that models of systemic shocks do not account for the increasing complexity of the financial market e.g it’s not only just about volatility]
[Thinking about complexity, systemic risk exists inside commodity trading firms when off-the-book liabilities are backing derivatives, weapons of mass destruction.
[The bulk of the activities in commodity trading mostly relies upon trade finance, it’s a transactional based approach in which the credit of the trader is substituted by the credit of a bank: it’s off-the-book but will work quite well if the trader is hedging.
However, this assumption that commodity trading firms trade derivatives in order to exclusively hedge physical exposure should be only ascertained on a CASE-by-CASE basis.[2]
Company domiciled in the EU must comply to a plethora of rules but the application of these rules starts by the classification of the commodity trader.
The Non Financial Company classification of a EU-based company allows the commodity trader to skip a number of EMIR obligations (such reporting their derivatives and physical positions to centralized trade repositories) potentially masking the real nature of its operations and of its market exposure to the commodity paper market {through Inventory Repos to achieving excessive leverage and risk taking, pure speculation positions etc…}
Help could come from the existing and incoming new regulations that are reshaping the financial markets.
[Trafigura doesn’t even want to be rated by a credit rating agency such S&P]
[We note that nowhere you will find their credit rating in their 136 pages 2014 annual report]
[Trafigura securitization Finance PLC packages receivables into Assets-back-securities (ABS) and CDOs (also enhanced by the credit of a bank) to be offered privately to hedge funds appealed by HY. Rating on tranches can be anything from AAA to BB (Junk). One key element to remember: this type of financing and the underlying rating is based on performance, not credit]
[Let’s use very simple words: finance that is not based on credit is off-the-book.]
[Unfortunately, subordinated financial bonds aren’t compliant with the new Basel III regulatory regime. The stricter regulatory environment in which banks and hedge funds are now operating supports credit investors, not what is off-the-book.]
A double-edged knife…
[The industry has opted to get attention, using the media spotlight to repeat “commodity companies are not systemically risky”.]
[The PR campaign to bring them out of regulators’ crosshairs is a delicate operation as more people in the room are able to get the balance sheet mechanics behind their trade.] [3]
Macro-prudential overlays and new rules such risk-adjusted capital ratios are forcing Geneva under Basel III to fully reconsider its credit risk in the commodity trading
Banks Are Scaling-Down Commodity Trade Finance because of new capital ratios and stricter criterions for Tier-1, L/Cs must now be totally unleveraged. (from 20% to 100%). [4]
[Trafigura (and very probably Gunvor SA) will be forced to sell assets / find a what they call a ” strategic investor” to raise cash]
[The only way to deal with the problem is to change the business model. First of all by stopping to rely on off-the-book financing, but apparently it is something they are very reluctant to do or know they can’t do because at the moment they start doing it they will get stopped.]
Finally what are the impacts of this double-edged knife agenda ? Commodity traders universally put an emphasis on their expertise in managing risk and creating long-term value. Here are the rating of 6 well-known traders:
Cargill: (S&P: A) Privately-Held company
Flint Hills Resources, LLC (S&P: AA-) Privately-held company [5]
Koch Resources, LLC (S&P: AA-) Privately-Held company
Noble Group (S&P: BBB-) Public
Glencore (S&P:BBB) Public
Trafigura ? Privately-held company
Mainly because of:
I) Their capital structure.
II) They’ve always maintained a disciplined financial health.
III) Their B/S can better absorb shocks in this new macro-prudential context.
The 3 first names above the list are all set to acquire the trading book & assets.
Some will get stopped by the cash margin call, riches will get richer.
[unless one group of people succeeds in changing global regulations ?]
[The Swiss Gray-Zone Approach to the sanctions:]
[Quite compelling read on how a government try to maintain its credibility with regards to international sanctions]:
[BNP Paribas vs U.S Departement of Justice shows that SECO and FINMA do not preclude Swiss banks/traders to illegally trade/process financial transactions for countries subject to U.S. Economic Sanctions.]
[BNP has a huge energy franchise with over 200 back-office professionals in Montreal, New York, London and Singapore financing the production, the transformation and the commodity marketing. The bank’s global client franchise in commodities includes LDC Commodities, Vitol and major French-Swiss Trading Houses.
[In addition to being fined $8.9 Billion, a New York based regulator has suspended the French IB from clearing USD transactions in energy trade finance for the whole of 2015.]
[While this restriction only applies to Energy, this is a significant mishap for BNP and I hear that J.P Morgan has approached the French IB been to take over the clearing for the world energy/commodity business]
The ideological distortion of the commodity economics by politics and economics sanctions will continue to prevail. Even if Switzerland praises its relative neutrality and an independent diplomatic stance, the country is a lightweight in the world geopolitical chessboard.
Today in the age of information, it is easy to track assets, commodities or money as never before. Banks or traders can’t get away with it, getting sued ex post facto well beyond national boundaries. This is why they must anyhow mitigate everything encompassing economic sanctions/corruption, market manipulation/ tax-evasion internally and become a model other companies can look to as a benchmark.
Sources:
[1] http://www.risk.net/energy-risk/glossary/2041669/systemic-risk
[2] Crude Oil Trade Transactional and Financing Timeline.
[3] See FT Commodities Summit
[4] Banks Are Scaling-Down Commodity Trade Finance.
[5] If it may serve for a proxy for Koch S&T
Credits: Aegfi, Mirabaud, U.S DOJ, BIS, Cargill, Glencore, Koch Industries, Trafigura, Standard & Poor’s
Commodity Merchant Trading and Shipping Advisory Services
© 2015 Navigating the commodity markets with Freight and Spreads
The author has many years of experiences in Commodities Transactions, Financial & Risk Analysis bringing together the know-how of the Dry/Wet Cargoes Transportation and the Commodity Trade Administration. He consults full-time with hedge, traffic and logistics desks in commodity trading and end-user firms.
Navigating the Commodity Markets with Freight and Spreads 