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After a stellar performance over the last two years, commodity traders have accumulated cash reserves of as much as US$120bn, research suggests – yet their banking partners do not seem to be reaping the rewards of this spectacular market growth. 

A report published last week by management consultancy Oliver Wyman finds that while 2023 did not match the record heights of the previous year, it still proved the second-most profitable year on record for commodity traders. 

Despite a return to normality after the price volatility and supply chain disruption that characterised 2022 – a situation that proved highly lucrative for larger, more sophisticated traders – the gross margin generated from commodity trading worldwide still totalled a sizeable US$100bn last year. 

Coming off the back of steady growth since 2018, Oliver Wyman suggests commodity traders have used this period to build up a “huge reserve” of cash retained on their balance sheets. 

“By providing stability to existing supply chains and support for emerging supply chains, traders gained influence in the reconfigured landscape,” the consultancy says. “This position enabled traders to accumulate about US$70bn to US$120bn in cash over successive years of strong performance.” 

But for traditional commodity finance lenders, this situation presents a challenge. Many larger banks have spent the last few years focusing on the larger end of the market, shutting their doors to smaller and mid-sized traders, in a bid to maximise returns and de-risk their portfolios. 

Now, with ample cash reserves, those larger traders have little need to borrow at the scale their banks would like – especially as interest rates remain high. 

Many traders “keep less asset value on the balance sheet, and therefore require less borrowing”, says Walter Vollebregt, whose company Vollebregt Advisory works with commodity traders to boost access to financing. “Maybe more importantly, because of the high interest rates, it is more unprofitable to carry a lot of inventory.” 

Vollebregt tells GTR: “With less inventory and generally shorter asset conversion cycles, you need less funding. Everyone is trying to shorten their conversion cycle, which leads to smaller balance sheets, and so traders do not need as much from overdrafts, borrowing or transactional finance. 

“As soon as those bigger traders start to shorten their balance sheets, those banks – especially the ones that don’t offer a lot of added value in structuring or services – start getting a lot less business.” 

Speaking at a GTR event last year, held under the Chatham House Rule, one senior commodity finance banker said there were signs larger traders were finding it cheaper simply to use their own funds. 

“If the clients need us, then we’re there,” they said. “But I can’t force a client to borrow money. I wish I could.” 

 

Size difference 

On the face of it, an obvious solution for banks might be to reopen their doors to smaller and mid-sized traders, rather than continue focusing on a small number of mammoth trading houses. 

“There is massive concentration of lending on this handful of names,” says John MacNamara, chief executive of trade advisory firm Carshalton Commodities. 

“Everyone else, even well performing mid-tier traders with ‘mere’ hundreds of millions in equity, turnover in single or low double digit billions, and decades of track record of good behaviour, have been losing banks hand over fist for the last five years.” 

But the underlying drivers of this so-called flight to quality – a term coined by larger traders whose access to finance has remained robust – are deeply established. 

A string of fraud scandals in 2020 and 2021 sparked panic across the trade finance sector, and in many cases, litigation continues as some banks seek to recoup heavy losses. 

MacNamara says this experience, alongside challenging regulatory requirements and concerns over further price volatility, creates a “triple whammy” for risk-averse lenders. 

Capital requirements are one such pressure.  

Jean-François Lambert, founder and managing partner of Lambert Commodities, says: “More generally, the bank herd is much less open to exploring new businesses with uncertain risk profiles than before, as capital requirements have fostered ultra-prioritisation of their funding to traders. 

“Cash is therefore still king by necessity.” 

Vollebregt says he is seeing little sign banks are looking at smaller traders or “more exotic markets, though notes there could be opportunities in emerging areas such as carbon trading. 

“There is an increasing amount of value being traded there, though these businesses are still only a small part of the loan book,” he says. 

 

Prioritising cash 

Large traders are by no means shunning the banking sector, however. Commodities giants continue to seal oversubscribed multi-billion dollar revolving credit facilities (RCFs), across a range of markets and currencies, and having that strong liquidity base is increasingly considered more useful than transactional finance. 

Most larger traders now “make more money than their banks, with 10% of the headcount”, meaning they have little difficulty obtaining such facilities, MacNamara tells GTR. 

“They can borrow unsecured, at term, and freely do so across all capital markets”, MacNamara says. 

“Their unsecured RCFs are not just jumbos but mega-jumbos. Their cash piles alone are greater than the equity bases of many of their mid-tier banks.” 

Lambert tells GTR that whenever traders can access banks for working capital, “this remains their preferred route”. 

Building up a cash buffer is a top priority for traders, Lambert adds, as it helps protect them from market volatility and margin calls “even at harrowing times”. 

Cash is also useful in facilitating more challenging transactions, such as those with supply chains in higher-risk markets, which may lie beyond the appetite of a typical trade finance lender, he says. 

And working capital reserves are also useful in preparing for the energy transition. Traders are uniquely positioned to support ongoing demand for fossil fuels while supporting renewables “for which the profitability outlook may still be uncertain for investors and banks”, Lambert says.