Commodity traders can no longer be ‘unregulated’

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For the first time in many years, the commodity trading industry has captured the attention of policymakers and regulators. They are not happy.

In a series of recent reports, letters and confidential memos from major central banks and global financial regulators, a few words slip in: “opaque” and “unregulated”.

Anyone familiar with commodity trading would be forgiven for thinking this is obvious. It is, but don’t dismiss this new attention. Coming from some of the world’s most powerful institutions, from the US Federal Reserve to the Financial Stability Board to the International Monetary Fund, it heralds a new era for the industry – one of greater scrutiny, at all less, if not outright regulation.

For decades, policymakers have focused on the more transparent side of commodity markets – futures and options – and paid little attention to the darker corners: above all, over-the-counter derivatives. privately traded over-the-counter and physical markets. Any additional oversight fell on what was already fairly regulated and transparent. This inability to dig in the dark has allowed major commodity trading firms, such as Vitol Group, Trafigura Group, Glencore Plc and Cargill Inc., to grow without the burden of additional regulation.

The Russian invasion of Ukraine and the resulting spike in commodity prices has since drawn attention to “the resilience of corners of global financial markets that were little known to the general public only a few weeks ago.” , as the IMF put it.

It wasn’t just the general public. Regulators themselves knew little. The Bank of England was quite candid about this: “Risk assessment has been made more difficult by the relative opacity of commodity derivatives markets” and the fact that some “large physically settled transactions are not not reportable to trade repositories”.(3) The UK central bank added that several “significant” commodity companies were not subject to the transparency rules put in place after the global financial crisis.

What’s to come is probably similar to what Wall Street faced after 2009: a lot more supervision. More regulation was a given after energy traders asked for help. In a letter to governments and regulators, the lobby group of European energy traders warned in March of “intolerable liquidity pressure” across the sector and called for financial support from taxpayers. Central banks, including the European Central Bank(4) and the Fed, have said no to the bailout. Only the German government decided to use a public bank to support its public services, some of which are large traders. But policymakers have been rather alarmed that energy traders, who have always pushed for self-regulation, have asked for help.

Now the Financial Stability Board, a body created in 2009 by the G-20, has promised a “thorough analysis” of vulnerabilities that have arisen in the wake of Russia’s war in Ukraine, “with particular emphasis on financial markets. raw materials”. In a letter last week, Klass Knot, chairman of the FSB and head of the Dutch central bank, highlighted two areas of interest for regulators: (2) the link between commodity traders and the banks that finance them, as well as the potential for a major commodity trader to go bankrupt if commodity prices rise again.

Commodities trading companies depend on bank loans to buy oil, metals and foodstuffs, which means they often risk very little on their own equity, but their health is linked to that of the banking sector which finance them. As the IMF put it, banks “play a crucial role and have significant exposures” in commodity markets, “including providing liquidity and credit to a small group of large energy trading companies. which operate globally, are largely unregulated and are mostly private.”(6)

Let me emphasize a few words of these words: “small group of large companies”, “unregulated” and “private ownership”. This is the kind of stuff that makes policymakers sweat – they point to concentrated risk in an opaque corner of the market that has received little attention so far.

The Fed, through its Dallas branch, has placed a similar emphasis in ruling out a bailout. “The threshold for central bank intervention in unregulated markets is high,” he said(1). Instead, he recommended that the sector consolidate its finances rather urgently. “It would be prudent for companies active in commodity markets to proactively assess and further strengthen their liquidity profiles.”

Now regulators must follow — and resist likely industry lobbying efforts.

A first step is to increase understanding. As the Bank of England has said, many corners of the commodity trading industry are opaque. Before the application of any regulations, greater transparency is needed. So shed light on the OTC derivatives markets, by imposing disclosures similar to those already in place for the futures and options markets. The recent chaos in the nickel market was exacerbated because regulators failed to realize the size of OTC positions, having mistakenly assumed that looking at positions on the London Metal Exchange was enough.

Physical markets also need disclosures. Here is an idea: the G7 countries could agree to set up a register of international oil transactions. Revolutionary? Well, that’s what they agreed to do in 1979(5). This was never implemented because oil traders defeated all attempts at regulation.

Regulators also need to look at the level of risk commercial banks are taking in underwriting the commodity trading industry, and in particular whether traders are backing the loans they take out with a sufficient share of their own funds. Commodity traders may need to raise more capital to stay in business, as the Fed has previously suggested.

For the past decade, commodity traders have been under the microscope of law enforcement, with the US Department of Justice in particular cracking down on corruption and money laundering. It is time for financial regulators to put them under the magnifying glass as well.

(1) Bank of England, Summary of financial policy and minutes of the meetings of the financial policy committee of March 9 and 18, 2022

(2) European Central Bank, Confidential note on “Financing problems related to the functioning of energy markets”, March 30, 2022

(3) Financial Stability Board, Letter “To G20 Finance Ministers and Central Bank Governors”, April 2022

(4) International Monetary Fund, ‘Global Financial Stability Report’, April 2022

(5) Commodity finance markets shaken by Russian invasion; Monitoring for US Financial Stress, Federal Reserve Bank of Dallas, April 2022

(6) G7, Declaration, June 29, 1979

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Javier Blas is a Bloomberg Opinion columnist covering energy and commodities. He was previously the Commodities Editor at the Financial Times and is the co-author of “The World for Sale: Money, Power, and the Traders Who Barter the Earth’s Resources.”

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