Earlier this month, the commodity trading industry was rocked by its latest scandal. One of Singapore’s largest fuel oil traders, Hin Leong Trading, filed for bankruptcy protection revealing hidden losses to the tune of almost a billion dollars.
Commodity trading has largely escaped the scrutiny of financial regulators. Almost a decade ago, experts, including the deputy governor of the Bank of Canada, began to pose questions about the sector’s threat to global financial stability. The debate petered out. At Global Witness, we think it should be restarted. Here’s why.
Traders sit at the intersection between financial and physical commodity markets. They borrow huge sums from banks to finance their buying, selling and moving of goods. Glencore, one of the world’s largest commodity traders, has already recorded almost $15bn in bank credit for 2020.
Traders also act as creditors to other companies and countries, often in the form of resource-backed loans. In other words, they engage in shadow banking (non-bank financial activity) — and their role here is growing. Trafigura, another trading behemoth, recently reported a 600 per cent rise in its lending activity from 2013 to 2019, from $700m to $5bn. The sector was able to capitalise on the heightened scrutiny of banks in the wake of the 2008-09 financial crisis, the company explained.
Over the past decade, traders have replaced banks as lenders to some of the riskiest of sovereigns and enjoyed little external oversight of these practices.
Now, as the coronavirus crisis hits the developing world, commodity traders rightly face calls from the G20 and IMF to join in providing debt relief. Private creditors, including traders, account for 32 per cent of Africa’s external public debt, according to research by the Jubilee Debt Campaign. In some countries, like Chad, South Sudan and Republic of Congo, traders account for a big share and their loans have helped compound domestic debt crises.
The scale of traders’ financial activities, their interconnectedness with financial markets and their pivotal position in global supply chains mean that the collapse of one company could arguably cause serious commodity market disruption with knock-on effects for financial markets globally.
The recent global oil price crash and its impact on financial markets has illustrated the domino effect in motion. Hin Leong’s demise, for example, began with a run on its credit, as banks became spooked by a series of defaults by other oil traders. Shortly after, their fears were confirmed, as the company revealed it had hidden $800m in losses on the instruction of its founder, leaving the banks with a $3bn-plus debt exposure. The company’s collapse has left the likes of HSBC, ABN Amro and Société Générale facing hundreds of millions of dollars in potential losses.
Some argue that the fallout from Hin Leong will be contained in Singapore, but I beg to differ. We live in an interconnected world, particularly when it comes to finance and commodities. Commodity traders run a risky business model with heavy leverage and razor-thin margins. In past low oil-price scenarios, storage has helped them weather the storm — but it is fast running out. Banks, already edgy, will be keeping a close eye on movements in the sector globally.
Financial contagion under all guises is what standard-setting bodies like the Financial Stability Board are mandated to watch and contain. Domestic regulators in turn use FSB guidance to formulate rules to protect their own economies.
Global financial stability and the corruption concerns associated with the commodity trading sector, which Global Witness and others have repeatedly documented, dovetail in the need for enhanced transparency, scrutiny and ultimately regulation.
As the coronavirus shutdown stretches far into the distant horizon, we enter uncharted territory. It is time the G20, its FSB and domestic regulators turned their attention to the sector to mitigate the risks to global financial stability it may pose.
Natasha White, Senior oil researcher at Global Witness
The Commodities Note is an online commentary on the industry from the Financial Times
Source: Economy - ft.com
