The commodity finance market is divided. Nervous after a string of fraud scandals and losses during 2020, banks have increasingly restricted financing to smaller trading houses – yet at the larger end of the market, business is booming.

In May, agri trading giant Cargill disclosed record earnings to bond investors. Its US$4.3bn in net income over the first nine months of the financial year was already higher than its previous record of just under US$4bn, set in 2008.

The previous month, Glencore also reported record earnings of US$3.3bn for the year. Geneva-based Mercuria had its best ever year in 2020, posting profits of nearly US$800mn, while Trafigura is expected to report record gains after making US$2bn in just six months, up to the end of March 2021.

Christophe Salmon, group chief financial officer at Trafigura, said at an industry event last year that despite reports of bank de-risking, financing options remained widely available for larger players. Since then, large commodity traders have announced a string of often oversubscribed revolving credit facilities and other deals.

Echoing comments made by Glencore executives in August last year, Salmon characterised the trend as a “flight to quality” across the banking sector.

However, smaller or medium-sized traders do not appear to be reaping the same rewards. In Hong Kong, publicly listed traders revealed net losses last year following a tightening of credit facilities, which they attributed to bank nervousness after a series of commodity finance fraud incidents, particularly in Singapore.

Smaller traders are often cautious of speaking publicly about difficulties accessing finance, wary that it could further worsen their image in the eyes of lenders, but there are signs those issues are continuing.

“Anecdotally, a lot of traders have told me they’re struggling to obtain financing,” says Baldev Bhinder, managing director of Blackstone & Gold, a Singapore-based law firm specialising in energy and commodities.

“There are also more queries on that side from non-bank lenders, which have higher interest rates, so that also suggests banks are being a lot more conservative with their lenders. The banks are being very selective on who they lend to, and I get the impression there has been a broad-brush approach affecting all but the largest traders.”

The collapse of Singapore-based Hin Leong in March 2020 was particularly alarming for banks. It soon emerged that the company – a home-grown operation that went on to become one of Asia’s largest independent trading houses – had constructed a Ponzi scheme-like dependency on fake trades, forged documents and dubious financing, in order to cover earlier losses.

Rajesh Johar, co-founder and managing director at Singapore-based commodity trader Avani Resources, says he believes a lot of the difficulties facing traders stems from that scandal in particular.

“Banks had a concentrated risk there which blew up,” Johar tells GTR. Hin Leong’s liabilities to banks and other creditors stood at around US$3.5bn at the time of its collapse.

“If Hin Leong had not happened, I don’t think so many banks would have taken such drastic decisions, exiting a whole load of trading clients.”

ABN Amro announced in August last year it would shutter its entire trade and commodity finance business, in part after booking impairments of over US$1.8bn arising from major fraud scandals. Its exposure to Hin Leong was estimated to stand at US$300mn, second only to HSBC.

Other notable lenders to have withdrawn or scaled back trade and commodity finance activities include fellow Dutch lenders ING Bank and Rabobank, as well as Paris-headquartered BNP Paribas.


Not the whole story

Trade and commodity finance veteran Jean-François Lambert, founder and managing partner of Lambert Commodities, agrees that access to finance for smaller traders “has proved increasingly difficult” since 2020.

“Banks don’t want bad news – and trust built up over years can be shattered in two minutes – so they will fly to quality to avoid the risk,” he tells GTR. “But that’s not the whole story.”

Beyond banks withdrawing financing lines, smaller players typically lack the means to finance hedging positions, meaning their overall returns are lower.

“They might be aggressive, they might take risks, but in order to make money in the commodity world, you have to take positions in the financial markets to optimise your books,” he says.

Larger traders have the liquidity, expertise and technical capabilities to complement their trade finance activities with other financial instruments, such as currency swaps and hedging, whereas smaller traders lack the financing lines to do the same thing.

One consequence is that can leave them in a difficult financial position, pressuring them into making questionable decisions.

“If you start to face margin calls, and you need liquidity, you might decide to start tampering with your books,” he says. “That’s often how these fraud stories start. A small player might have access to trade finance lines but not access to liquidity in the financial markets. Then, if the market starts to turn against you, you’re in trouble.”

For Avani’s Johar, the pressure on traders to turn to financial market instruments such as currency swaps marks a significant departure from “classic commodity trade finance” – a transaction-specific form of financing where a trader’s balance sheet is not considered significant.

“Banks don’t always like that,” he says. “They want to move faster, grow fast and build revenue, and so they moved onto balance sheet-based lending, offering to finance swap lines for example.

“That is not new, but if you’re mixing trade finance with leverage on commodities, it can become a toxic mix and that classic trade finance can get dragged in.”

Another issue at the smaller end of the market is the drastic changes in commodity prices since the start of the Covid-19 pandemic. An initial slump in demand, propelled by virus containment measures, helped drive prices down – particularly in crude oil.

Since then, however, prices across almost all commodities have risen above pre-pandemic levels. The World Bank’s most recent Commodity Markets Outlook, published in April, reported soaring prices across metals, agriculture and crude oil.

An immediate challenge for smaller traders is simply that rising prices means more financing has to be raised from the banking sector. However, beyond that, Lambert points out that larger players can also widen the gap over their smaller rivals through their financial market access and liquidity, allowing them to “make real money on the volatility in pricing”.

“If you’re a smaller trader who can’t do that, and the cargo goes from US$10mn to US$25mn, you need to find another US$15mn to finance that cargo,” he says.


Looking ahead

In the short term, Johar urges banks to view traders’ risk profiles with more nuance. He points out that a company that buys from one trader and sells to another presents a higher market risk than one that buys from a producer and sells to an end user. Banks “have to make a distinction” between those models, he suggests.

But further ahead, he is optimistic that alternative financing options could become available – even if traders have to look beyond their home markets.

“The European banks leaving Singapore left a hole and created a sense of panic that hasn’t gone away yet, but as the pandemic ends and travel restarts I think a lot of mid-size companies will be looking outside Singapore,” he says.

“Banks in other jurisdictions, be it the Middle East or Switzerland, will probably still provide lines, even if you have to set up a presence on their home turf. Many traders would be open to setting up new offices or subsidiaries in order to get lines – it looks like that’s how things could evolve.”

Lambert says he believes the market is still moving in the same direction, with the “bigger players becoming even bigger”.

Though that could hypothetically change – if, for instance, authorities take major enforcement action against a large trader and banks are challenged on why they provided it with financing – that would still be unlikely to open the door to smaller traders looking to break into the top end of the market.

However, he suggests the energy transition – with companies and lenders around the world facing intense pressure to cut financing to carbon-intensive industries – could prove a more fundamental change.

“None of us have a clue about how energy trading will be profitable 20 years from now, where it will be hydrogen, water, wind, biofuels and so on,” he says.

“If you have a niche that nobody else has, you can suddenly find yourself with a huge competitive advantage, so maybe we’ll see new players coming in that nobody is expecting at the moment, and maybe some of the large traders we know today won’t be successful in adapting.”