When Marc Rich needed $ 100 million to buy Iranian
and to kick-start what would become the world’s largest commodities trader, he turned to French bank Paribas. When a group of traders needed the money to take over Vitol and make it the largest oil trader, they turned to Dutch bank ABN.
Over the past half-century, a small group of European banks have funded trade in natural resources, forging a symbiotic relationship with commodity traders that has placed them at the heart of a huge expansion in global trade.
Now this trend is in reverse. ABN Amro Bank NV has announced that it will quit commodity trade finance. BNP Paribas SA is re-examining its involvement and may close its specialist unit, Bloomberg announced earlier this month. The Rabobank group is also reviewing the activity. They’re not alone: After a series of meltdowns and scandals that cost banks billions of dollars in losses, nearly every major lender is once again looking into its presence in the industry.
For commodity traders accustomed to paying for tens of billions of dollars’ worth of oil, metals or agricultural shipments using cheap bank lines, the shift in European banks can be a calculating moment. , increasing costs, forcing them to seek new forms of financing, or removing small businesses from the industry altogether.
“Commodity finance as we know it today will not exist in any meaningful way in five to ten years,” said Walter Vollebregt, former head of metals and minerals trade finance for Rabobank, who is now industry consultant. “The corporations are hardly ready for what is to come. ”
A dozen commodity trading executives told Bloomberg News they expect the withdrawal of European banks to increase their funding costs. While some large trading companies believe they will benefit from an industry disruption, others fear that a rush to exit banks will hurt everyone.
The involvement of European banks in commodity trading has its roots in the colonial history of the continent. One of ABN Amro’s predecessor companies was the Netherlands Trading Society, founded in 1824 to trade in coffee, sugar and tea in Asia. Many French banks got involved in trade through the former French colonies in Africa.
The modern commodity trade finance business took off when Paribas began financing pioneers of the petroleum trade like Marc Rich from his Geneva office in the 1970s. Using the cargoes of the financed commodities as collateral, traders were able to obtain financing at a cost barely greater than the banks’ own funds.
But while it may have been viable when everything was going well, a series of explosions rocked the industry. Most notably, fuel oil trader Hin Leong Trading (Pte) Ltd. collapsed in April amid fraud allegations, leaving 23 banks on the hook for $ 3.5 billion.
“It doesn’t help that the low interest rate environment has forced them to provide the service for less charge and they have all tried to increase the volume to compensate for the drop in income. To increase the volume you unfortunately have to start dealing with lower quality counterparts, ”says Ernesto Leon-Gambetta, former head of commodities at Noble Group, who has traded coffee for over 30 years and is now at the retirement.
Coalition Development Ltd., a consultancy firm, estimates that banking sector revenue from commodity trade finance fell 29 percent in the first half of this year. “In the last five or six years, with the provisions, the net result for the major European commodity banks is zero or negative,” Vollebregt said.
Recent losses are not the only problem. Increasingly stringent banking regulations – including Basel 4 – make commodity trade finance less attractive, according to Jean-François Lambert, a consultant and former trade finance banker. “Every bank has to reassess its portfolio,” he said. “The herd effect is going to be significant. ”
The Dutch company ING Groep NV is one of the leaders in the sector, with just over € 20 billion in exposure at the end of June. It remains committed to financing trade in commodities, but is more cautious about its loans to the sector.
“Over the years you see that the structures have weakened to some extent,” Managing Director Steven van Rijswijk told investors. “We are reintroducing the strict structures. ”
Among French banks, Societe Generale SA is also strengthening risk control and is taking a step back from Asia with the closure of its Singapore office. Natixis SA has also reduced its exposure to the financing of energy and natural resources trade, said Nathalie Bricker, Chief Financial Officer.
“Banks are clearly much more selective, as they probably always should have been,” said Steve Kalmin, CFO of Glencore Plc this month. “There is a contraction, there is I would say a flight to quality. ”
Merchants in a hurry
The cuts are already stifling some small and medium-sized commodity traders. A commodities trade finance official said customer usage of its lines of credit, which is typically around 35%, has nearly doubled since June.
“It’s going to affect all level 2 and 3 players overall,” Lambert said. “They will face a situation where, unless they have a perfect balance sheet, perfect systems, perfect governance, they will have more and more difficulty in borrowing. ”
Commodity companies are particularly worried about the exit of French banks, many of which finance small exporters from the largest cocoa producer, Côte d’Ivoire.
Executives at several midsize trading houses have said they are looking to expand their pool of lenders, while others are paying additional fees to get lines committed with their banks. Some even plan to survive without bank financing.
While some Swiss banks are still interested in expanding their presence in the sector, few others are looking to fill the void left by those leaving. This suggests that traders will have to resort to more expensive non-bank finance, or simply negotiate less.
Even among industry giants, it is recognized that costs will rise. Companies such as Trafigura and Mercuria, two of the world’s five largest oil traders, have offered ‘Covid-19 bonuses’ to lenders under recent deals, raising the interest rate they pay.
Most executives of large trading houses are now relaxed about the situation, saying their ability to access larger debt and equity markets should give them a competitive advantage over smaller players. Nonetheless, after five years in which oil trading volumes at the top three traders increased by 70%, any further growth seems unrealistic. The drop in demand induced by the coronavirus is part of it; but it is also the case of the decline of the banks.
Ultimately, unless many other banks follow ABN Amro’s path, the impact on the flow of commodities around the world could be minimal. But consumers and producers will pay through slightly less efficient markets.
“If tomorrow there is no bank to finance trade, you can issue bonds, you can increase equity. You have other ways to get financing, ”said Jean-Pierre Adamian, managing director of metals trader Transamine, adding that his company currently has a lot of bank financing. “They might be a little more expensive, but it’s the same for everyone. In the end, the producers will pay.
But traders’ composure can quickly wane if oil prices rise significantly. The low prices mean that each shipment is worth less, and this has alleviated the financing needs just as the banks have pulled out. If prices rise, the need for finance for traders will also increase.
“If suddenly the price of oil goes from $ 45 to $ 80, then we’re definitely going to have a problem for everyone,” Lambert said.