We expect the banks to continue to fund the firms’ margin calls because the liquidity pressure, although serious, should be temporary, and commodity traders are a good source of profit for the banks in normal times. Much of the lending is to top-tier firms that have sound business models and operate with large liquidity buffers and diverse financing pools, which mitigates the risks to the banks.
Commodity prices reached record highs this month, leading to increased margin requirements from central clearing counterparties. This resulted in higher liquidity needs at commodity trading firms. However, the risks have eased as prices have moderated and we do not expect the exposure to put material pressure on major banks’ asset quality or revenue.
European banks with large wholesale banking activities and international reach have material exposure to commodity traders. ING, Societe Generale, Rabobank, Credit Agricole, Groupe BPCE and UBS are the main European banks that appeared most frequently as lenders in syndicated facilities to the large trading firms Trafigura, Glencore, Gunvor, Vitol and Mercuria Energy in mid-March 2022, according to Bloomberg data. This does not necessarily reflect the size of the banks’ exposures, but it indicates their involvement in commodity trading. Banks are typically exposed to commodity traders through syndicated credit facilities, project finance lending, letters of credit and derivatives.
Positively, most of the big European banks have shifted their focus to large, top-tier commodity traders in recent years, with some significantly reducing their trade and commodity financing activities. This puts them in a better position to withstand a potential stress in the sector and should mitigate any resulting pressure on asset quality. The impact on banks of a commodity trading sector stress would also be allayed by collateralisation of some of the credit facilities with readily marketable inventory and by loan covenants.
Commodity traders generally enter into derivative contracts to hedge against commodity price risks on their commercial activity. In most cases, these are exchange-traded and centrally cleared. Increases in commodity prices have been amplified by the Russia-Ukraine war. Higher prices are generally positive for commodity traders’ revenues but they force the firms to post substantial cash collateral, largely sourced from committed bank credit facilities, to sustain out-of-the-money positions in derivatives.
