Commodities trader Trafigura, in its recent prospectus to a €500 million bond issue, the world’s second largest metals trader and third biggest oil trader is quoted by a recent FT article by Neil Hume as saying, “[The Centre for European Policy Studies report, in which trading houses like Trafigura and Glencore were found to pose systemic risks] was widely seen as a tactic by some banks active in the commodity trading space as a way of creating more equality between market participants by seeking to usher in further restrictions on pure commodity trading companies.”
They noted that commodity traders typically fund volumes of “yet-to-be” produced commodities in exchange for receiving the products when produced or extracted; this is far from being a securitization in the way banks rolled up dodgy mortgages and sold them (collateralized debt obligations or CDOs) with triple-A ratings to investors ignorant of the real risks.
“The (traded) products are essentially collateral for the financing provided to purchase future production,” the argument in the prospectus goes, adding, “the performance and the credit risks of the producers are covered in most instances by insurance policies limiting the exposure of the commodity firm extending the credit.”
Do they have a point?
It is easy to see why the banks would seek to “level the playing field” with their more free-wheeling trading competitors in the commodities space as they have come under ever greater scrutiny. But as the article points out, given the rapid growth of commodity traders over the past decade – the cumulative net income of the largest trading houses since 2003 surpasses Goldman Sachs, JPMorgan Chase and Morgan Stanley combined – means this isn’t a debate that is going to go away any time soon.
Our view is that traders’ ownership of physical assets actually reduces the risk to the system as it gives them an underlying anchor to the real world, rather than just operating with financial instruments, but some argue the large-scale financing of products that do not yet exist, the yet-to-be assets, represents a systemic risk of sorts due in part to the sheer size of modern commodity traders’ role in the global marketplace.
Critics conveniently overlook the insurance and hedging techniques employed by trading companies, the sophistication of which puts the CDO/SIV market to shame and has helped traders deliver positive returns, even in years of declining commodity prices and considerable instability.
Nevertheless, the debate has a way to run, with much to gain on both sides and with regulatory authorities nervous of accusations that they didn’t see the next big thing coming, scrutiny and regulation will likely increase.