20 March 2017

Commodity traders have topped the TXF Data borrower leagues with large revolving credit facilities, which they partly use to finance small and medium-sized producers that are now struggling for liquidity. Does this present a systemic risk? It’s actually all part of the ecosystem.

Was 2016 the year of the commodities trader when it came to TXF Database recorded commodity deals? It would appear so according to a closer look at the commodities totals for 2015 and 2016.

An examination of the top ten commodity finance borrowers of 2016 reveals that six are traders, with Trafigura and Glencore between them accounting for 12 recorded transactions and more than US$25bn between them (see Figure 1).

One of the drivers for this, says Deutsche Bank’s Managing Director of Structured Commodity Trade Finance, John MacNamara, is that “the retreat of the banks under regulatory pressure means that the big traders are doing the really heavy lifting when it comes to financing the small and medium-sized commodity enterprises”. He continues, “A large part of this borrowing comes in the form of revolving credit facilities (RCF) used on deals they can insure, but they cannot bank. Even though they have got this RCF money which is cheap, the secured borrowing base financings were more highly priced than the RCFs for a number of the big trading houses.”

Not only was 2016 the year of the trader, but it also heralded the recovery of commodity merchants such as Olam and Noble after what had been a difficult few years. Noble’s share price had halved following the publication of the Iceberg Research blog in February 2015 i . Olam’s accounting practices were attacked in 2012 by short seller Muddy Waters before it was rescued by Singapore state investor Temasek ii.  Now they are back, re-capitalised, re-energised and…re-RCFised.

fig2
______________________
Source: TXF Data

Balance of power?

TXF Data has been collecting export finance and commodity finance deals via its Tagmydeals portal since 2014, with datasets from 2015 and 2016 now having sufficient critical mass to provide meaningful indicators of the state of the market. It is for this reason that Deutsche Bank has supported Tagmydeals from inception and using it to conduct market analysis.

Admittedly, the database cannot be entirely comprehensive – it is hardly going to attract counterparties of bilateral deals to share their transactions – but it does hold a mirror mainly to the announced, syndicated or club deals that would always be in the public domain. And that mirror is reflecting an increasing trend of commodity trading houses dominating the bank borrowing league tables, underlining their systemic importance to the industry and their close relationship with the commodity banking sector.

The tendency towards vertical integration caught the eye of The Economist in 2014, when it reported, “Commodity trading houses, most of which began life as simple middlemen, are getting ever more deeply involved in the extraction, shipping and refining of raw materials.” (6 September 2014). And this means having a wider source of liquidity, and for traders that are not listed on stock exchanges this will more often than not take the form of debt finance – although the large quoted houses also gravitate to large borrowings in preference to equity dilution.

“Let’s face it, the reason the traders get cheap liquidity is that they are easier to deal with because of their scale, professionalism and knowledge. You won’t waste time trying to renegotiate the Loan Market Association template wording in a documentation meeting, rather you focus immediately on the important stuff that characterises the deal. It is a rather less painful exercise to deal with a counterpart who negotiates this stuff all day long, than it is to deal with one whose last deal was some years ago in a very different market, or whose experience may be more capital markets than structured trade,” reflects MacNamara.

Some might argue this is an unhealthy balance of merchandise flow control but it is difficult to see how else oil/gas, iron ore, copper and grain (to name a few of the critical commodities) would get from well to pump or farm to fork otherwise.

According to Philippe Chalmin, Professor of Economic History and Commodity Markets at Paris-Dauphine Unversity, the world will always need commodity traders to move commodities around the world and to “assume all the risks linked to those operations not only on the financial side, but, above all, on the physical side of the trade”. He adds, “More than purely “screen traders”, we are still in need of traders able to manage commodity trade flows and to adjust to demands on the ground iii.”

Track record borrowers

fig2
______________________
*Volumes in millions of US$ 
Source: TXF Data

Falling commodity prices have understandably raised questions about sources of loan repayments. Despite oil improving from a 14-year low of sub US$30/bbl in early 2016, the halcyon days of US$100+/bbl seem a distant memory, and trading companies do have the track record and the collateral. This is very important for banks when making decisions when assessing the overall risks of a deal. However, banks and rating agencies do this using the previous year’s information. “All through 2016 you were looking at 2015 results which were horrible. The prices collapsed at the end of 2014, 2015 they had too high costs and a low sales price, but cut costs all year. By 2016 the cost base is quite low, but the price starts going up, so profitability improved substantially and the outlook gets better for a lot of them. But it’s not quite as good as you hoped because so many of them hedge so you don’t quite catch the upside you could have done,” says MacNamara.”

This does explain why the data reveals a number of borrowers who borrowed in 2016 that did not in 2015. The prices went up, but some were challenged on the low prices through 2015.

A big chunk of the deals from very well-established traders were unsecured, in the form of revolving credit facilities (RCFs) – such was the confidence of their bankers. Figure 2 demonstrates how trader RCFs peaked in 2015 at US$42bn (73.4% of all trader deals), with a drop in 2016 to US$37bn (58.2% of trader deals). And although 2016 was generally tough in commodities, it can be seen that traders borrowed more in 2016 than they did in 2015.

Figure 3 demonstrates how producers were ahead of the traders when it came to RCFs in 2015, but scaled these back compared with the traders in 2016.

fig2
______________________
Source: TXF Data

In his updated chapter to the Loan Market Association’s ‘Years in the Loan Market’ published in 2016 iv  (extracted in Trade & Forfaiting Review magazine and available to download here), MacNamara observed, “Traders today are of a wholly different order of financial magnitude from the more timorous beasties of 20 years ago, and frequently make more profit than most of the banks”.

His article reminds reader that structured trade and commodity finance does not just “mitigate the traditional targets of credit risk, market risk or country risk” but also addresses “the new focus on non-financial risk, with possibly the best solutions available to any form of investment”. “STCF has always been about knowledge,” explains MacNamara. “The great thing about the commodities space is that there is a huge amount of data. Commodity pricing is easily discovered. There are established patterns of trade and market norms. Production, shipping, storage and even processing and consumption are all matters of record.”

Deutsche Bank support

fig2
______________________
Source: TXF Data
fig2
______________________
Source: TXF Data
fig2
______________________
Source: TXF Data

While Deutsche bank has increased its support across the commodity corporate universe (see Figures 4 and 5), not all banks support the market’s enthusiasm for RCFs. Cautionary tales such as UK steel trader Stemcor’s US$2bn restructuring v  together with the need to know with some precision what borrowers are actually using the money for are deterrents. “Deutsche Bank is careful about how it targets its RCF support and has not kept pace with the burgeoning RCF bonanza,” says MacNamara.

He adds that the bank has never gone after volume in the commodities business. “As good Germans, we have always targeted quality,” he states. When asked about the slide from fourth to seventh place in the STCF rankings for 2016 (in other words excluding RCFs – see Figure 6), he confirms that it had been a good year, “in line with our strategy of picking the right deals with the right risk profile in a tough climate of falling commodity prices and economic uncertainty”.

Note: John MacNamara, Global Head of Structured Commodity Trade Finance is a speaker at TXF Amsterdam 2017, 10–11 May, now in its fourth year. Deutsche Bank is a TXF partner at this event.


______________________
iSee TFR’s coverage here
iiSee Reuters, 28 August 2015 here
iiiSee ‘Rise and fall’ in Trade & Forfaiting Review, June 2016
iv See extract entitled ‘The Renaissance of STCF’ published in TFR (February 2016) here.
vSee Reuters, 15 September 2015 here

Philippe Chalmin

Professor of Economic History and Commodity Markets at Paris-Dauphine University

Philippe Chalmin

You might be interested in