The pullback of several big players from the commodity financing market has prompted trading houses to diversify their funding sources. Melodie Michel reports.
When BNP Paribas and Crédit Agricole announced their intention to reduce their exposures in commodity financing as a result of a lack of access to US dollars, analysts predicted a global shortage of funding in the sector. Fears emerged among small trading houses, who are struggling to grow their business in a market dominated by the likes of Cargill, Glencore and Trafigura, and who rely largely on bank financing.
The two French banks used to finance almost half of the world’s commodity trade flows, but according to the people still involved in the market, the change has not been as dramatic as expected – at least for established players.
Diversification of financing
First, BNP and Crédit Agricole have not completely withdrawn from the market. They have mainly reduced their lending limits, but have kept their relationships with most of their clients. A commodity banker who prefers to stay anonymous explains: “The perception we have is that they reached a point where they made a selection of which clients they wanted to continue to bank and the other clients approached the other banks, which wanted to work with them because their business models were perfectly bankable.
“I haven’t heard of a single exit. Whereas they used to be one of the larger lenders, they have reduced their share but continue to bank most of the clients.”
In fact, Trafigura’s chief financial officer, Christophe Salmon, tells GTR that the company gets about 85% of its financing from banks, and that the European share in this has not decreased at all. “We’ve been able to maintain the same level of credit lines with our traditional long-term partners, namely the large European banks,” he says.
But not all trading houses have been immune to BNP and Crédit Agricole’s cutbacks, and this has generated opportunities for other banks present in the market – Société Générale (SG), UBS and Credit Suisse all admit that they have registered an increase in commodity business, although no official figure has been released.
But new players are also coming in to fill the gap. Citi announced the launch of a commodity trading unit in September. At the time John Ahearn, global head of trade at the bank, explained to GTR that American banks could use their easy access to US dollars as a competitive advantage, and that the deleveraging experienced by European banks ahead of the implementation of Basel III had made for great timing.
Salmon says Trafigura has done some business with American banks, but that they lack the expertise necessary to become a leader in the commodity financing business. “When you do invest into this sector, it cannot be done in a couple of months, you need to have the proper knowledge, system education and management support at the top level of the bank to make sure that you become not only a participant, but part of the leaders in this market. To be absolutely honest, these American banks have not reached this stage yet,” he tells GTR.
Other banks have expanded or launched their commodity business in the past few months. At a Loan Market Association conference in London at the end of September, panellists pointed to the emergence of Asian banks waiting to jump on the opportunity to gain market share in the business. Simon Tyler, head of corporate banking for China Construction Bank, said that the Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China, and China’s Bank of Communications, among others, were talking about moving to London in order to develop their relationships with European-based players.
Middle East banks also want their share of the pie, and are starting to feature more frequently in syndicated loans. In October, Trafigura renewed its Asian syndicated revolving credit and term loan facility at an oversubscribed US$1.24bn, with a total of 29 banks, including a number of new banks for the trader, located in the Middle East, as well as Russia and Taiwan. For traders, the emergence of new players means more flexibility and less reliance on sole European lenders. Trafigura’s Salmon points out: “Going forward we want to continue to grow our volumes and to make sure we can accommodate our working capital whatever the level of the commodity prices; we need to diversify our banking pool.
“In the countries where we operate we’ve seen the emergence of regional players that are newcomers to the commodity trading industry, for example in Latin America, the GCC and Africa. These regional banks have shown more and more appetite and somehow been able to cope with the growth of our business when the traditional European commodity banks showed reluctance to increase their exposures to these sectors.”
Different funding sources
In the meantime, traders are also looking at alternative types of financing. Salmon adds: “Diversifying from bank financing is also part of our financing strategy. We have a sizeable securitisation programme of US$3bn which is financed through capital market products. We are regular issuers of capital market bonds and products, so this is a second type of diversification from the bank financing.
“We are also putting in a lot of effort in conjunction with our asset management arm [Galena] to package trade finance assets and develop a product that can either relieve the capital or the liquidity consumption from the banks. We hope that in a couple of months we will be successful in creating a new asset class for investors that will at the end of the day benefit not only Trafigura, but the whole commodity trading industry.”
These are medium-term changes, but if these types of products are successful, Salmon says the share of Trafigura’s bank financing could decrease from the current 85% to 70-75%.
Commodity trading software provider Brady has also noticed a trend towards turning to funds – whether external or in-house – among its clients. The firm’s CEO, Robert de Picciotto, tells GTR: “We see more and more funds being created – I don’t know to what level of success, but people are trying to structure new forms of financing.”
Asia-focused commodity trading fund Eurofin is following this trend: it is set to launch a European fund based in Geneva by the end of 2012. François Dotta, the fund’s head of trade and commodity finance, explains: “There was a clear push on the brakes from the very active banks in that area of the world, so the demand is mostly driven by the tighter access to credit for the middle-segment trading companies which have a foot in Europe, the UK and the CIS markets.”
But although the tendency among trading houses to diversify their pool of financiers has grown significantly over the past two years, funds remain minor financiers in the market. SG’s global head of natural resources and energy financing, Federico Turégano, says: “There’s appetite and interest from alternative investors because, after the liquidity issues of 2011, banks and clients are realising that it would not be a bad idea to educate funds, insurance companies and institutional investors on the commodities business. But it’s still very marginal.”
Besides, some argue that not all traders have the capacity to move away from bank financing. SG’s deputy global head of natural resources and energy financing, Dominique Beretti says: “Tapping different liquidity pools is only good if you’re in the advantageous position of being an emerging medium-sized or very large player. The small traders will have to stick to the banking market because that’s where they get the best deals for their money.”
Big players’ hegemony
The current state of the commodity trading world is such that big players are virtually immune to any changes in legislation or in the market, but smaller traders are finding it more and more difficult to get the resources they need to grow their business. And with negotiations progressing towards a merger between Xstrata and Glencore, the imbalance is only likely to grow further.
As banks have scaled back their involvement in commodities, commodity trading houses have grown in importance and have changed their funding models, making greater use not only of innovative financing tools such as capital market bonds, but also of mergers and acquisitions.
Big traders are getting bigger, and consequently, small traders are struggling to maintain their market share. SG’s Beretti doesn’t believe that it is more difficult for small players to find funding, but explains that it depends more on their historical relationships with clients and banks. “If a trader comes to us saying they have just been granted their first contract, it’s unlikely that we will finance them since it is not SG banking practice to finance a company without having performed a due diligence. However if a trader has been in the market for a longer time and credentials are available we are prepared to study the way to finance their business depending on their risk profile. When performed properly this due diligence protects the bank when it extends transactional self-liquidating credit to a niche player.”
Turégano adds: “Looking only at the top 10-15 commodity traders in the world may be fine for a bank that is new to the business, but anybody that has been in the business as long as we have needs a balanced portfolio across industries, clients and geographies.”
But for Brady’s De Picciotto, the situation is tough for those who are not leaders. “It’s more difficult especially for small and new entrants in the market; they have a lot of difficulty in finding financing. It’s really an issue for them to justify [the loans] and make sure they have good collateral for their operations,” he says.
Besides, trading companies could soon have to adapt to looming regulations in the sector. Many in the market feel that the commodity and financial markets are increasingly intertwined due to the push by big trading houses towards self-financing. In this context, and seeing as banking regulations are getting tougher and tougher, the regulation of the so far very liberal commodity world seems inevitable.
“All the regulations around money laundering, commissions and ethical business practices are well implemented in banks, and so far have been a little bit on the sideline for trading companies, but some of the big traders are moving more money than banks. It’s the very beginning of it, but it’s going to come as a stronger and stronger point in the months to come,” adds De Picciotto.
And when the regulations do come into force, small traders will again be the most vulnerable to the changes. “They are bound to have more difficulty because it’s not going to become easier for banks to lend money, so that will force some consolidation. For the ones that have enough access to capital from other activities maybe it’s going to be easier but for the small ones it’s going to be more and more difficult,” he says.
Geneva: In or out?
The reduction of some European banks’ commodity lending limits has been seen by some as a blow to Geneva’s dominance as a trading hub, and with several traders recently announcing their decision or intention to relocate to Asia (among which Trafigura and Vitol), it is possible to ask whether Switzerland still offers the best conditions for business.
Historically, Switzerland’s liberal commercial environment, tax optimisation and its wide variety of banking institutions are what drew trading houses to Geneva and the Lemanic region.
But today, Singapore is offering a more attractive tax environment for corporates, whereas Switzerland, under pressure from European officials fighting tax havens, has had to be tougher in negotiations. Moreover, the growth of Asian trade is encouraging companies to move closer to the action, and Asian banks have shown increased appetite for commodity trading transactions.
Traders are also attracted to the US dollar-liquidity-flushed Middle East, but according to experts, Geneva is likely to stay the major commodity hub for some time to come. Brady CEO Robert de Picciotto says: “There is a trend towards Singapore and Dubai, but the combined difficulty of getting financing probably makes it easier to get it in Switzerland than somewhere else. I believe Geneva is still one of the best choices for trade finance – all the decision-making and financing still remains in Geneva.”
For banks, traders’ decision to move their headquarters from Geneva has more to do with logical business strategy than anything else. Société Générale’s deputy head of natural resources and energy financing, Dominique Beretti says: “Geneva continues to be very attractive as it is where you find a pool of skills and talent. It is still the hub by far, and much to the trouble of the Singapore-based banks it will continue to be. Moreover, Singapore banks are not that interested in doing African, Middle Eastern and European business.