(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)
By Kevin Allison
LONDON, July 8 (Reuters Breakingviews) - It was July 2015,
and Global Materials Partners (GLOMP), an unlisted Swiss
commodities trader, was in trouble. Data showing a rapid
slowdown in the Chinese economy had pushed the copper price down
15 percent in two days. Then one of GLOMP's star traders came
clean: over the past several months, the former back office
worker had built up a huge, unauthorised long position in copper
GLOMP struggled to unwind the bad trades but the trader's
losses quickly chewed through its thin capital, tipping it into
bankruptcy. Its lenders' credit default swaps ticked higher as
panicked investors struggled to assess the damage, sparking
fears of a broader crisis.
This may be fantasy. But there are many reasons why
real-world commodity traders should now be attracting greater
scrutiny. Regulators think it's risky for investment banks to
trade commodities. They are pushing banks out of proprietary
trading in commodity derivatives, or forcing them to hold more
capital against trades. Investment banks' retreat has left a
bigger share of the commodities business in the hands of
independent trading houses and other non-bank institutions. The
question is whether these unregulated, often opaque firms – from
secretive Swiss commodity houses to the marketing arms of the
oil majors – could be a source of hidden risk.
But we're different
How could a commodity crisis start? The perception is that
traders hold big positions, financed by borrowed money. But the
reality is that traders like Glencore Xstrata (GLEN.L),
Trafigura and Vitol [VITOLV.UL] more closely resemble logistics
companies than financial speculators. They make money not by
betting on price movements, but by moving stuff around.
A metals trader might be aware that a mine operator in Peru
is willing to sell copper for $100 below the benchmark London
Metals Exchange price, while a customer in China is willing to
pay $200 above the LME price. The margin on each such trade may
be small, but by borrowing to finance many similar trades, a
small team of well-connected traders can reap huge profits.
Despite the liberal use of leverage, in theory it's a pretty
safe business. A trader might not be able to match a buyer and
seller straight away, or customers may refuse shipments if
prices fall sharply during transit. But such risks can be hedged
in the derivatives markets. In fact, price volatility just
increases the opportunities for profitable arbitrage.
That, at least, is the ideal. Occasionally, things go wrong.
No hedge is perfect. In 2011, Glencore lost $330 million trading
cotton after a series of wild price swings led to ineffective
hedging, difficulty securing supplies, and some buyers refusing
shipments. The financial hit was small – less than 10 percent of
operating cashflows that year. Had the merger with Xstrata
already taken place, it would have been less than 2 percent of
the combined group's 2011 EBITDA.
The bigger worry is what happens when traders make outright
bets on price moves. In 1999, a rogue trader at Andre & Cie, a
big grain merchant, lost an estimated $200 million betting on
soybean futures. It proved a terminal blow to the secretive
120-year-old family firm. The collapse wasn't immediate, but in
2001, after a failed turnaround bid, Andre's lenders threw in
the towel. When it succumbed, Andre & Cie had $400 million of
debt spread between 40 banks. Glencore Xstrata reported
pro-forma net debt of $29 billion at the end of 2012, spread
across more than 100 lenders.
In theory, even a struggling trader should be more resilient
than a flailing bank. Banks and commodity houses both rely on
short-term funding, but traders' assets tend to pay back faster
– about a few weeks, or the time it takes for a cargo of ore,
oil or grain to cross an ocean. The ability to unwind books
quickly may be one reason the industry made it through 2008
without a big crisis.
Regulators need a hedge, too
The fact that the industry weathered the financial crisis
fairly well doesn’t mean it is truly safe. The sample size is
too small and the history of modern, globally connected traders
too short to rule out a blowup infecting the financial system or
even the real economy. Trading companies have huge influence
over the flow of essential raw materials. Disruptions to world
trade could be significant, if only temporarily.
There are a few things overseers could do to make the
industry safer. Standardised and rigorous rules for risk
reporting, even for unlisted firms, could identify where tension
is building up in the system. Extending new financial regulation
to limit trading houses' use of use of derivatives to
old-fashioned price hedging would be another obvious place to
start. If the financial crisis taught regulators one thing, it's
that they shouldn't rely on self-interested industry players'
assurances that they have a handle on risk.
SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS:
- Morgan Stanley (MS.N) last month said it would exit some
areas of commodity trading, including agricultural products,
freight and some European power and gas markets, marking the
latest pullback in commodities by a big investment bank.
- The head of JPMorgan’s (JPM.N) oil unit left the bank to
join Noble Group (NOBG.SI), a Singapore-listed commodity trader,
SparkSpread.com, an industry website, reported on July 2.
- Reuters: Morgan Stanley to exit some commodities markets
- Reuters: Report for banks finds they pose more risk than
commodity traders [ID:nL6N0DU40U]
Trading up [ID:nL3E8L45S8]
- For previous columns by the author, Reuters customers can
click on [ALLISON/]
(Editing by Chris Hughes and Sarah Bailey)
Keywords: BREAKINGVIEWS COMMODITIES/TRADERS/
(C) Reuters 2012. All rights reserved. Republication or redistribution of
Reuters content, including by caching, framing, or similar means, is
expressly prohibited without the prior written consent of Reuters. Reuters
and the Reuters sphere logo are registered trademarks and trademarks of
the Reuters group of companies around the world.