Traders move commodities in time and space. Additionally, at each occurrence of a time lag or an element of risk between the purchase and the sale in a chain of contract, commodity traders synthetically lend until the self liquidation of the contract.
They neutralize the commodity price delta, find a satisfactory counterparty for the banks who cover the payment risk from the time encompassing the loading, transportation, delivery and payment of the commodity.
This rate (R) at which a trader move a “commodity in time and space” equals the rate (r*) at which banks finance the commodity trade plus m, a margin covering the costs and a profit for the transaction.
When R is ≤ r*+m, the traders doesn’t trade or alternatively may lend at r* to another counterparty.
This is one of the concepts postulated in “Jacques, S. and Simondet, A. (2016) “Traders of Commodity Finance Banks”.
Transmar Commodity Group is a softs trader that went into liquidation in December 2016, demanding the U.S court protection from its creditors and owing more than $400 million to banks and other institutions.
TIMELINE OF TRANSMAR COMMODITY GROUP
January 2016, Tokyo-based Itochu acquires a 20% minority stake into the cocoa trader Transmar and lend money (secured by asset pledges) to the trader.
Transmar (U.S) turned back to a syndicate of banks to get unsecured trade loans.
May 2016, $400M is lent to Transmar (U.S), ABN AMRO is the deal arranger and agent.
November 2016, the trader subsidiary, Euromar Commodities GmbH, filled for bankruptcy in Germany and defaults on its commodity contracts.
December 2016, The trader filled for chapter 11.
In the United States $313M of collateral is missing and was transferred to Europe according to ABN AMRO.
January 2017, we learn that the trader biggest client was its own subsidiary in Europe.
Transmar (U.S), was feeding cocoa beans to its European subsidiary Euromar Commodities GmbH.
Meanwhile, Euromar financial position has deteriorated in 2016 with processing margins near or close to zero.
The default of Euromar and its inability to pay for the cocoa beans and products it contracted ultimately led to the Transmar bankruptcy.
This is wrong-way risk in the commodity contract chains as alluded in Jacques, S and Simondet, A. (2016)*
“Prices have contracted, therefore the banks’ exposure has increased and the credit spreads of the
traders have worsened.
This wrong-way risk in the commodity contracts chain arises from a co-dependence between the credit quality and the exposure to that counterparty.
Wrong-way risk defined by the International Swaps and Derivatives Association (ISDA) is the risk that occurs when “an exposure to a counterparty is adversely correlated with the credit quality of that counterparty.”*
What has transpired is that the Banks lending to Transmar were also lending to a trader synthetically lending to its subsidiary to buy its own products…
The outcome would have been different if the counterparties covered were claused in the trade facility ( delimited to Nestle, Barry Callebault…)
Institutions have developed over the years methodologies in order to finance the commodity traders. Example: a bank will seek to finance a trader in softs commodities with a minimum $15M in net equity.
Perhaps ABN AMRO, the deal arranger took the balance sheet “AS IT”.
The growing trade volume in the recent years and the money injection by ITOCHU, early 2016, may had given a false sentiment of comfort to the deal arranger.
It is predictable that the deal arranger and the participants (in their defense) will now say that the book, net equity and collateral initially presented were misrepresenting the true financial conditions of the group of companies when they leveraged the trader with the unsecured facility.
Yet, it shows that they hadn’t fully apprehended the source of risk stemming from financing Transmar Commodity Group.
Transmar’s filing also lists Tokyo-based Itochu Corp. as an owner of significant equity.
Traders die but commodities always flow.
It wouldn’t be astonishing if the U.S Court finds a suitor for the assets and that Transmar cocoa reappears the business unit of Itochu in the coming months.
Simon Jacques is a certified Energy Risk Professional, as distinguished by the prestigious Global Association of Risk Professionals.
1-226-348-5610 advising the producer, processor and end-user in North America.
Jacques, S (2016)“Traders or Commodity Finance Banks ? Part V– Wrong-Way Risk in Commodity Trade , Navigating the commodities markets with Freight and Spreads , February 6, 2017.