GTR’s Melodie Michel catches up with Gavin Lavelle, CEO of commodity trading software company Brady, on how recent changes in the market have increased the need for strong compliance systems for traders.
GTR: Tell us more about what Brady does to facilitate the financing of commodity trade.
Lavelle: Brady is one of the leading commodity and energy software trading companies headquartered in Europe. We deal with the processing, trading and financing of commodity goods. We have around 300 clients using our software for things like metals, energy and soft commodities.
As credit lines are generated for our clients, our software allows them to see the magnitude of the credit facility. When a credit line is issued, the transactions can be monitored and checked against limits and we also deal with the regulatory and compliance reporting for the facility.
GTR: What are the main factors affecting your business?
Lavelle: One of the key drivers in recent years has been the credit crunch. Our clients deal with physical commodities, for which they need financing from the banks, but bank finance has been much tighter; there’s been a lot of focus on the upcoming regulations, particularly Basel III.
In March, UK banks were required to increase their capital requirements by £25bn, that’s clearly tightening the credit conditions for the banks. One minute governments say we need to extend finance to companies and in the next breath they say banks have to increase their capital requirements. So financing has been constrained, and the main effect for us is a shift from a balance sheet credit facility (offering an overall credit line to a particular commodity trading company) to transaction-led finance.
Our software allows pre-conditions for the trade; logistics for the transactions; and when it comes to inventory, clients can manage each step of the way the value of the goods and the collateral on a real-time basis. As the good starts to move, we’ll generate alerts and reminders, for example when the letter of credit is due.
GTR: What has changed since the crisis in the way banks finance commodity trade?
Lavelle: We’ve been dealing for over 20 years in software to help with the financing of commodity transactions, and I think what we have seen happening as a consequence of the credit crunch is that the banks extending the finance want to ensure that the commodity trading company has effective systems in place. Commodity companies are required to show they have their financing and liquidity under control, that they’ve got good counterparty risk management, they’ve got operational risk under control so they know where the goods in transactions are, and that they know about market risk, so a lot of focus is on risk management and the requirement is to ensure you’ve got the systems to support that.
Invariably there are cycles where the market is moving along in good condition, people are making lots of money and then there is a massive crash and everyone tries to figure out where the money went. It’s much better to have effective controls and compliance in place at the beginning so you know exactly where you are.
We are also seeing a lot of news coming out from the regulators in Switzerland in particular, saying they want to have more transparency for commodity trading, so either the industry can anticipate the change that is going to come and work with the regulators or they can resist it, but in general it’s better to be on board with them.
GTR: Is it more difficult for smaller traders to get financing now?
Lavelle: We have over 8,000 traders using our software, ranging from the very large commodity traders to small organisations and across the board, risk management and regulatory compliance have been strong drivers. Particularly for small organisations, demonstrating that they’ve got good systems in place, good processes and good control is now a prerequisite to getting finance from the banks. Trying to run a business on a spreadsheet is no longer going to be tolerated by the banks extending finance.
GTR: After they pulled back from the market during the crisis, we’ve heard a lot about the return of French banks into the commodities space. Is that something you’ve noticed?
Lavelle: It’s definitely something we’ve noticed. These have been extremely challenging times for many industries, and the banks pulling out their credit lines while the credit crunch is in full flow is understandable. But if you look ahead, the commodities market presents very interesting investment opportunities, and despite the sell-off in many asset classes, some of the commodity prices are at, or close to, all-time highs, so the investment interest is there. People can live without credit default swaps, but they can’t live without food, energy and metal. There is underlying demand for the products and that presents very good opportunities for the banks to extend finance and generate good margins on the commodity business.
GTR: There is a lot of talk about commodity traders using alternative sources of finance, such as hedge funds. Is that also something that you’ve noticed, and do you cater for that type of financing?
Lavelle: Clearly as the credit conditions tightened, people started to look for alternative sources of finance and we have seen a couple of our clients looking at hedge funds for funding, but it’s still a very low percentage at this point. The large bulk of the financing is coming from the banks. I do think that going forward we will also see increased transparency with the hedge funds themselves, so it will be interesting to see how this develops. We’re monitoring the situation but at this point it’s still a relatively small part of the business as we see it.
We basically deal with anybody who operates in this marketplace, whether it’s sell-side or buy-side, so hedge funds are also an important part of our overall value chain.
GTR: Where would you say the financing is going to come from in the next few years?
Lavelle: The bulk of the financing will still come from the banks, but we will always see creativity in terms of finance. I’m always very impressed by the creativity, whether in London, Geneva or New York, in terms of extending products and financing. The underlying demand for commodities is good and strong, and therefore the financing will become available. I’m sure we’ll see the banks ease their credit conditions to extend financing for good investment cases.
GTR: Do you think Geneva will remain the global hub for commodities or will Singapore take over?
Lavelle: Commodities is a global market and all the counterparties we deal with have trading facilities either in Switzerland or London, but also in the US, and we’re increasingly seeing Singapore as a financing hub. The goods are moving around the world; a lot of the commodity trading happens in and around Southeast Asia so I see that area growing, but I don’t think that commodity trading is going to disappear from the European space.