Commodity traders must improve preparations for margin calls by improving their liquidity risk management, including by holding more liquid assets and conducting stress tests, the Financial Stability Board (FSB) has said. 

Following an analysis of market disruptions, including the price volatility that caused “turmoil” in the commodities markets in 2022, the FSB has today issued several recommendations on how traders should increase their protection against liquidity stresses. 

Spikes in commodity prices can prompt margin calls, whereby traders must provide additional funds to cover short positions or other exposures, either from their own reserves or using credit lines. 

The G20 watchdog says traders should assess their exposure to and appetite for liquidity risks, and conduct stress testing for “extreme but plausible” market conditions.  

They should also establish well-documented strategies for managing liquidity shortfalls, including plans for obtaining funding and reducing exposures, it says. 

“Available evidence supports the need for non-bank market participants to enhance their liquidity risk management and governance to be better prepared for spikes in margin and collateral calls,” it says. 

Traders should also ensure they have “adequate levels of liquidity as well as diversified and reliable contingent funding sources, and efficient decision-making processes” to cope with times of stress. 

The FSB is consulting industry participants on the recommendations until June 18 this year. 

In 2022, geopolitical and market pressures combined to propel energy-related commodity prices upwards, sending shockwaves throughout the trading sector. 

Russia’s invasion of Ukraine sparkled a scramble to find alternative energy sources for European importers, amid growing demand during the post-pandemic recovery as well as shortfalls in supply elsewhere. 

Norway’s Equinor estimated at the time that European companies would need around €1.5tn to cover exposures to those price increases, and in some cases European governments stepped in to offer loans and guarantees to companies struggling to generate additional liquidity. 

Just months earlier, FSB chairman Klaas Knot had written to G20 finance ministers and central banks to warn the commodity trading market was the “epicentre” of price volatility in financial markets, placing many traders under significant strain. 


Price pressures

The price volatility of 2022 has not returned, and windfall profits generated by larger traders in the last three years have enabled them to build up huge cash reserves, bolstering their resilience to liquidity pressures. 

However, a McKinsey report published in February last year estimated that demand for working capital from commodity traders was expected to treble in the near future, generating margin calls totalling US$1.5bn in the energy sector alone. 

There are also signs of uncertainty in other commodities, particularly where rising demand or shortfalls in supply could cause prices to spike. 

In agricultural commodities, cocoa and coffee futures have risen to record highs this week following supply issues in West Africa and Vietnam respectively. 

And in metals, industry insiders are concerned that accelerating demand for electrical power will propel copper demand well beyond previous estimates. 

“On copper, we think there’s a significant supply deficit that is emerging by the end of this decade,” said Saad Rahim, chief economist at Trafigura, speaking at the Financial Times Commodities Global Summit in Lausanne last week. 

“We’re getting closer to that point, and on top of that, we’re now adding even more sources of demand.” 

Rahim gave the examples of data centres and artificial intelligence as drivers of previously unforeseen demand for copper. 

“You could add potentially up to another million tonnes of copper demand just from growth in these areas, and that’s on top of what we had as a 4 to 5 million tonne deficit,” he said. 

Rohitesh Dhawan, chief executive of the International Council on Mining and Metals (ICMM), said at the same event that increasing copper supply is more challenging than for other materials, such as lithium. 

“Copper grades in Chile, the world’s most important copper supplier, have decreased by 30% in the last 15 years,” he said. “You’re not really going to bring the new mass of copper mines onstream very quickly in a place where it’s getting harder and harder to find new deposits.” 

The FSB says commercial banks are excluded from its proposed recommendations, although separate work on enhancing transparency and liquidity preparedness is underway. 

It warned last year that bank exposure to commodity traders has likely jumped in recent years, as market volatility prompted larger firms to evolve hedging strategies. 

It also said increased concentration in the market could increase contagion risks, while a move by traders into more opaque over-the-counter derivative markets could pose counterparty risks.