In record time, banks appear to have stepped up and deployed much-needed liquidity to global commodity traders, especially to metal traders affected by unseen circumstances in the LME (London Metal Exchange). For Mihai Andreoiu, Senior Director at Redbridge, the current crisis re-surfaces some older questions, like can commodity traders keep relying mainly on bank (uncommitted) lending?
A few months ago, I was writing about “From Bust to Boom” and trading companies needing to pay increased attention to their liquidity in a rising commodity prices environment.
Four months later, and we have now witnessed unprecedented almost black swan like events. Past the luxury of accordion features, commodity trading houses had to arrange emergency extra liquidity (underwritten in a matter of days) not to entertain additional business, but to simply keep the existing business’ hedge positions in place. Not a “nice to have” line increase on profits, but a “must have” to ensure the appropriate risk management, vital for such companies’ business and even survival.
Banks are stepping up
With banks stepping up and deploying liquidity to metal traders affected by the unseen circumstances in the LME, they have earned substantial additional fees while lending and reinforcing their commitment to their favorite clients.
Overall, the current conflict in Ukraine has triggered strict reviews and monitoring of banks’ exposure to Russia and Ukraine. While the sanctions, so far, have had a moderate impact on the commodity flows, the bank market stance is more than cautious. Both traders’ and banks’ side compliance and credit teams have come under stress to make sure the situation is well mastered.
The trouble is far from over
At a time of already increased commodity prices in a no longer transitory, but now inflationary environment, such shock increased volatility across the board and drove the market to a mere head-line reaction state. The implications have been broad, in the very short run, and the trouble is far from over, but both commodity houses and their banks seem to have weathered the initial storm. Even the hedging model came under stress as well with brokers demanding higher initial margins for their contracts.
Some of the older questions re-surfaced: can commodity traders keep relying mainly on bank (mainly uncommitted) lending? Can the same volume of physical business be maintained at these price levels with increased volatility and changing broker and exchange practices? Will the profitability of trading businesses remain attractive with the increased cost of borrowing? Is there certain trading business that deserve more capital? Will the banks’ “flight to quality”, better said flight to large balance sheets, be permanent with smaller players having an even harder time obtaining the needed financing?
While “this too shall pass” is applicable to a substantial part of the current developments, other aspects are here to stay. The free money party is coming to an end with the bill being paid by producers, traders, and end users. However, if properly managing their credit book, and not being affected too much by conflict related exposures and loss of business in Russia, banks’ financing commodity trading firms should very likely be headed for a strong year, especially with credit lines at historic high utilization levels. Something to keep in mind when deals come up for renewal!