International Firms of Mystery: Commodity Trading Firms and … · 2014-10-26 · Traditional...

InternationalFirmsofMystery:TheEconomicsofGlobalCommodityTradingFirmsandTheirPotential

ContributiontoSystemicRisk

CraigPirrongProfessorofFinance

BauerCollegeofBusinessUniversityofHouston

I. Introduction

IntheaftermathoftheGreatFinancialCrisis,macroprudentialregulatory

authoritieshaveundertakenasearchingreviewoffirmsthroughoutthefinancial

marketstoidentifythosethatcouldposesystemicrisks.Thisreviewhasextended

beyondlargebankstoencompassmoneymarketmutualfunds,insurance

companies,financecompanies,andassetmanagers.Ithasevenextendedtoinclude

firmsnottypicallythoughtofaspartofthefinancialsector,evenbroadlyconstrued.

CommodityTradingFirms(CTFs)areaprominentexample.Questionsaboutthe

systemicriskposedbythesefirmswerefirstraisedbyTimothyLane,Deputy

GovernoroftheBankofCanada.1MoreovertheFinancialStabilityBoardevaluated

whetherCTFsaresystemicallyimportant,andtheUK’sFinancialConductAuthority

haspublishedaguidediscussingregulatorystrategiesandchallengesinvolving

commoditytraders.

Atpresent,regulatorsaremainlyaskingquestionsaboutwhetherCTFsare

systemicallyimportant.Thesequeriesaresomewhattentative,whichreflectsthe

auraofmysterythatsurroundsthesefirms,manyofwhichareprivatelyownedand

operateoutofSwitzerland..Thispaperattemptstopenetratethataura,inorderto

1TimothyLane,FinancingCommodityMarkets.SpeechgiventotheCFASocietyofCalgary,25September2012.

provideabetterunderstandingofwhatthesefirmsdo,andonthebasisofthis

understanding,toevaluatewhethertheyposesystemicrisksthatwouldjustify

subjectingthemtoregulationssimilartothoseimposedonotherentitiesdeemedto

besystemicallyimportant.

CTFsareamajorlinkinthesupplychainconnectingcommodityproducers

withcommodityprocessorsandultimateconsumers.Thecentralityofthesefirms

intheglobalcommoditysupplysystemraisesseveralquestions.Whatwouldbethe

effectofafailureofoneofthesefirmsontheglobaleconomy,andtheeconomiesof

individualcountries?Whattypesofeconomicshockscouldleadtothefailureofa

CTF?WhatfeaturesofCTFsmakethemvulnerabletotheseshocks?Arethere

interconnectionsbetweenthesefirmsandthefinancialmarkets,particularly

throughtheirfinancingrelationshipswithbanksandtheshadowbankingsystem,

whichmakesomeCTFssystemicallyimportant?

Thispaperpresentsaneconomicanalysisoftheseissues.Theanalysis

providesaconceptualframeworkforevaluatingtheeconomicfunctionsofCTFs,the

riskstheyincurinexecutingthesefunctions,connectionsbetweenthesefirmsand

thefinancialsectorandtherealeconomy,thepotentialforCTFstobethesource

systemicriskscommunicatedthroughtheseinterconnections,andthevulnerability

ofCTFstosystemicshocks,especiallythosearisinginthefinancialsector.

Threebasicconclusionsarisefromtheanalysis.First,itisunlikelythata

largelosssufferedbyasingleCTF(due,forinstance,toalosssufferedonalarge

speculativeposition)posesasystemicthreattothebroaderfinancialsystem.

Second,althoughafinancialcrisis(orotherlargemacroeconomicshock)thatleads

toasubstantialfallinthedemandforcommoditiesalsoreducesthedemandfor

many(butnotall)oftheservicesCTFssupply,thenatureofcommoditytrading,and

thestructureandcapitalstructuresofcommoditytradingfirmsmakesthem

substantiallymorerobusttosuchshocksthansystemicallyimportantfinancial

institutions.Third,althoughcommoditytradingfirmsengageinvariouseconomic

transformations,theytypesoftransformationstheyperformaresubstantially

differentfromthoseundertakenbysystemicallyimportantfirms,whichmakesthem

lesssystemicallyrisky.Therefore,itisinappropriatetoimposeonthemaregulatory

regimesimilartothatimposedonlargebanksandinsurers.

Theanalysisispredominatelyqualitativeinnature.Thisreflectstheneedto

layoutabasicconceptualeconomicframeworkthatcanbeutilizedtounderstand

betterthefunctionsandrisksofcommoditytradingfirms.Italsoreflectsthe

relativepaucityoffinancialdataonmanyCTFs,manyofwhichareprivatefirmsnot

requiredtodisclosebasicfinancialinformation.

Theremainderofthispaperisorganizedasfollows.SectionIIdescribesthe

basiceconomicfunctionsofcommoditytradingfirms,emphasizingtheirroleas

transformersofcommodities.SectionIIIidentifiesandanalyzesmajorrisks

incurredbyCTFs.Thissectionalsodescribesthebasicriskmanagementstrategies

employedbyCTFs.SectionIVidentifiesmajorpointsofinterconnectionbetween

CTFsandthefinancialmarkets.SectionVanalyzesthesystemicriskinessofCTFs.

Specifically,itexamineswhether(a)individualCTFsposebroadersystemicrisks,

and(b)CTFsarevulnerabletosystemicshocksarisinginthefinancialsectororthe

realeconomy,andthisvulnerabilitycoulddisruptglobalcommoditytradewith

furtheradverseconsequencesfortherealeconomy.SectionVIaddressestheissue

ofthetransparency(orlackthereof)ofCTFs,andhowthisnecessitatescautionin

evaluatingthesystemicriskposedbythesefirms.SectionVIIusestradeflowdata

toidentifypotentiallysystemicallyimportantcommodities.SectionVIII

summarizes.

II. TheEconomicsofCommodityTradingFirms

Commoditytradingfirmsareinthebusinessoftransformation.They

transformcommoditiesinspace,time,andform.Spatialtransformationsinvolve

thetransportationofcommoditiesfromregionswheretheyareproduced(supply

regions)totheplacestheyareconsumed,orundergosomeinterimtransformation

inform.Temporaltransformationsinvolvethestorageofcommodities.Seasonal

regularitiesinproductionorconsumption(e.g.,foragriculturalproductsorheating

fuels)orrandomsupplyanddemandshocksmeanthatitisseldomoptimalto

matchtheamountconsumedatanyinstantwiththeamountproducedatthat

instant;storagebridgesthegapbetweenoptimalconsumptionandproduction

timing.Transformationsinforminvolvetherefiningorprocessingofacommodity,

suchascrushingsoybeanstoproduceoilandmeal,orrefiningcrudeoilinto

gasoline,diesel,andotherproducts.

Thevalueofthesetransformationsvariesovertimeduetoshockstosupply

anddemandthataffectpricelevels,andcrucially,relativeprices/price

relationships.Forinstance,agoodharvestinoneregionoftheworldresultsina

pricedeclinethere,relativetootherregions,thatprovidesanincentivetoincrease

exportsfromthatregiontoconsumptionlocations.Asanotherexample,aglobal

recessionthatreducescurrentdemandtendstomakecommoditiestemporarily

abundant,therebymakingitefficienttostorethemforfutureusewhendemand

rebounds.Forwardpricesadjusttothesedemandshockstoprovidetheincentive

tomakethistemporaltransformation.

Commoditytradingfirmsspecializeintheproductionandanalysisof

informationaboutsupplyanddemandpatterns,pricestructures(overspace,time,

andform),andtransformationtechnologies,andtheutilizationofthisinformation

tooptimizetransformations.Inessence,CTFsarethevisiblemanifestationofthe

invisiblehand,directingresourcestotheirhighestvalueusesinresponsetoprice

signals.Giventhecomplexityofthepossibletransformations,andtheever‐

changingconditionsthataffecttheefficientsetoftransformations,thisisan

inherentlydynamic,complex,andhighlyinformation‐intensivetask.

Tradingfirmsalsoinvestinthephysicalandhumancapitalnecessaryto

transformcommodities.Commoditytradingthereforeinvolvesthecombinationof

thecomplementaryactivitiesofinformationgatheringandanalysisandthe

operationalcapabilitiesnecessarytorespondefficientlytothisinformation.

AlthoughtheforegoingdescribestheoperationofCTFsingeneral,eachfirm

isunique.Somefirmsspecializeinarelativelysmallnumberofmarketsegments.

Forinstance,thetraditional“ABCD”firms‐ADM,Bunge,Cargill,andDreyfus‐

concentrateinagriculturalcommodities,withlesserornoinvolvementintheother

majorcommoditysegments.Asanotherexample,someofthelargesttradingfirms

suchasVitol,Trafigura,andMercuria,focusonenergycommodities,withsmalleror

nopresenceinothercommoditysegments.Onemajortradingfirm,Glencore,

participatesinallmajorcommoditysegments,buthasastrongerpresenceinnon‐

ferrousmetals,coal,andoil.

CTFsthatfocusonaparticulararea,e.g.,agricultural,alsoexhibitdiversity

thespecificcommoditiesandcommoditytransformationsthattheytrade.For

instance,whereasOlamparticipatesin18distinctagriculturalsegments,Bunge

focusesontwoandothermajorfirmsareactiveinbetween3and7different

segments.

Furthermore,firmsinaparticularsegmentdifferintheirinvolvementalong

themarketingchain.Somefirmsparticipateupstream(e.g.,mineralproductionor

land/farmownership),midstream(e.g.,transportationandstorage),and

downstream(e.g.,processingintofinalproductsorevenretailing).Others

concentrateonasubsetoflinksinthemarketingchain.2

III. TheRisksofCommodityTrading

Commoditytradinginvolvesamyriadofrisks.Whatfollowsisarelatively

highleveloverviewoftheserisks.Notethatsomeriskscouldfallintomorethan

onecategory.

Pricerisk.Traditionalcommoditytradinginvolveslittleexposureto“flat

price”risk.3Inthetraditionalcommoditytradingmodel,afirmpurchases(orsells)

2ForamorethoroughdescriptionandanalysisofCTFs,seeCraigPirrong,TheEconomicsofCommodityTradingFirms(2014).3The“flatprice”istheabsolutepricelevelofthecommodity.Forinstance,whenoilissellingfor$100/barrel,$100istheflatprice.Flatpriceistobedistinguishedbetweenvariouspricedifferences(relativeprices),suchasa“timespread”(e.g.,thedifferencebetweenthepriceofBrentfordeliveryinJulyandthepriceofBrentfordeliverythefollowingDecember),ora“qualityspread”(e.g.,thedifferencebetweenthepriceofalightandaheavycrude).

acommoditytobetransformed(e.g.,transportedorstored),andhedgesthe

resultingcommoditypositionviaaderivativestransaction(e.g.,thesaleoffutures

contractstohedgeinventoryintransit)untilthephysicalpositionisunwoundby

thesale(orpurchase)oftheoriginalposition.Thehedgetransformstheexposure

tothecommodity’sflatpriceintoanexposuretothebasisbetweenthepriceofthe

commodityandthepriceofthehedginginstrument.(Idiscussbasisriskinmore

detailbelow).

Ofcourse,hedgingisadiscretionaryactivity,andafirmmaychoosenotto

hedge,orhedgeincompletely,inordertoprofitfromananticipatedmoveintheflat

price,orbecausethecostofhedgingisprohibitivelyhigh.

Moreover,particularlyassomecommodityfirmshavemovedupstreaminto

mining,orintocommoditieswithlessdevelopedderivativesmarkets(e.g.,ironore

orcoal),theytypicallymustaccepthigherexposuretoflatpricerisks.

Commoditypricescanbeveryvolatile,andindeed,canbesubjecttoboutsof

extremevolatility.Therefore,firmswithflatpriceexposurecansufferlargelosses.

Thisdoesnotmeanthatflatpriceexposureisanecessaryconditionforafirmto

sufferlargelosses:asanexample,tradingfirmCookIndustrieswasforcedto

downsizedramaticallyasaresultoflargelossesincurredonsoybeancalendar

spreadsin1977.Indeed,many(andarguablymost)oftheinstancesinwhich

commoditytradingfirmswentintodistresswerethenottheresultofflatpricerisk

exposures,butbasisorotherspreadrisks:aspreadorbasispositionthatisbig

enoughrelativetoafirm’scapitalcancreateamaterialriskoffinancialdistress.

BasisRisk.Hedginginvolvestheexchangeofflatpriceriskforbasisrisk,i.e.,

theriskofchangesinthedifferenceofthepricebetweenthecommoditybeing

hedgedandthehedginginstrument.Suchpricedifferencesexistbecausethe

characteristicsofthehedginginstrumentareseldomidenticaltothecharacteristics

ofthephysicalcommoditybeinghedged.Forinstance,afirmmayhedgeacargoof

heavyMiddleEasterncrudewithaBrentfuturescontract.Althoughthepricesof

thesetendtomovebroadlytogether,changesinthedemandforrefinedproductsor

outagesatrefineriesorchangesintankerratesoramyriadofotherfactorscan

causechangesinthedifferencebetweenthetwo.

Althoughthebasistendstobelessvariablethantheflatprice(whichiswhy

firmshedgeinthefirstplace),thebasiscanbevolatileandsubjecttolarge

movements,therebypotentiallyimposinglargelossesonhedgingfirms.Andas

notedabove,itispossibletotakeapositioninthebasis(orspreadsgenerally)that

issufficientlyriskyrelativetoafirm’scapitalthatanadversebasis(spread)change

canthreatenthefirmwithfinancialdistress.

Basisrisksgenerallyarisefromchangesintheeconomicsoftransformation

duringthelifeofahedge.Changesintransportation,storage,andprocessingcosts

affectrelativepricesacrosslocations,time,andformthatresultinbasischanges.

Sometimesthesebasischangescanbeextremewhentherearelargeshockstothe

economicsoftransformation:forexample,theexplosionofanaturalgaspipeline

thatdramaticallyreducedtransportationcapacityintoCaliforniainlate‐2000

causedamassivechangeinthebasisbetweenthepriceofgasattheCalifornia

borderandattheHenryHubinLouisiana(thedeliverypointforthemostliquid

hedginginstrument).

Local,idiosyncraticdemandandsupplyshocksareubiquitousincommodity

markets.Adroughtinoneregion,oranunexpectedrefineryoutage,orastrikeata

portaffectsupplyand/ordemand,andcausechangesinpricerelationships‐changes

inthebasis‐thatshouldinducechangesintransformationpatterns,andCTFsplay

anessentialroleinidentifyingandrespondingtotheseshocks.

Basisriskscanalsoarisefromtheopportunisticbehaviorofmarket

participants.Inparticular,theexerciseofmarketpowerinaderivativesmarket‐a

cornerorasqueeze‐tendstocausedistortionsinthebasisthatcaninflictharmon

hedgers.4Forinstance,itwasreportedthatGlencorelostapproximately$300

millioninthecottonmarketinMay‐July,2011duetoextrememovementsinthe

basisthatwerelikelycausedbyacorneroftheICEcottonfuturescontract.Basis

andcalendarspreadmovementsareconsistentwithanothersqueezeoccurringin

cottoninJuly,2012.Squeezesandcornershaveoccurredwithsomeregularityin4Thesubjectofcornering(aformofmanipulativeconduct)isobviouslyhugelysensitiveandcontroversial,butitishasbeenamatterofcontentionsincemoderncommoditytradingbeganinthemid‐19thcentury.Rigorouseconomicanalysiscanbeusedtodistinguishunusualpricemovementsandpricerelationshipsresultingfromunusualfundamentalconditions,andthosecausedbytheexerciseofmarketpower.CraigPirrong,DetectingManipulationinFuturesMarkets:TheFerruzziSoybeanEpisode,6AmericanLawandEconomicsReview(2004)72.StephenCraigPirrong,ManipulationoftheCommodityFuturesMarketDeliveryProcess,66JournalofBusiness(1993)335.StephenCraigPirrong,TheEconomics,Law,andPublicPolicyofMarketPowerManipulation(1996).CraigPirrong,EnergyMarketManipulation:Definition,Diagnosis,andDeterrence,31EnergyLawJournal(2010)1.Usingtherigoroustheoreticalandempiricalmethodssetoutinthesepublicationsitispossibletoidentifyseveralrecentepisodesinwhichitwasextremelyhighlylikelythatpricesandbasisrelationshipsweredistortedbytheexerciseofmarketpower.Itisimportanttoemphasizethatthesemethodscanbeused‐andhavebeen‐torejectallegationsofmanipulation.

virtuallyallcommoditymarkets.Inthelasttwoyearsalone,therehavebeen

reports(crediblysupportedbythedata)ofsqueezes/cornersincocoa,coffee,

copper,andoil.

Spreadrisk.Fromtimetotimecommoditytradingfirmsengageinother

kindsof“spread”transactionsthatexposethemtoriskofloss.Acommontradeisa

calendar(ortime)spreadtradeinwhichthesamecommodityisboughtandsold

simultaneously,fordifferentdeliverydates.Spreadsarevolatile,andmovein

responsetochangesinfundamentalmarketconditions.5Spreadscanalsochange

duetoopportunistic,manipulativetradingofthetypethatdistortsthebasis.

MarginandVolumeRisk.Theprofitabilityoftraditionalcommodity

merchandisingdependsprimarilyonmarginsbetweenpurchaseandsaleprices,

andthevolumeoftransactions.Thesevariablestendtobepositivelycorrelated:

marginstendtobehighwhenvolumesarehigh,becausebothareincreasinginthe

(derived)demandforthetransformationservicesthatcommoditymerchants

provide.

Thedemandformerchandisingisderivedfromthedemandandsupplyofthe

underlyingcommodity.Forinstance,thederiveddemandforcommodity

transportationandlogisticsservicesprovidedbytradingfirmsdependsonthe

demandforthecommodityinimportingregionsandthesupplyofthecommodityin

exportingregions.

5Forinstance,anunexpectedincreaseindemandordecreaseinsupplytendstoleadtoariseinpricesfordeliverynearinthefuture,relativetotheriseinpricesforlaterdeliverydates.

Thisderiveddemandchangesinresponsetochangesinthedemandandthe

supplyforthecommodity.Adeclineindemandforthecommodityintheimporting

regionwillreducethederiveddemandforlogisticalservices.Themagnitudeofthe

deriveddemanddeclinedependsontheelasticityofsupplyintheexportingregion.

Thelesselasticthesupply,thelessoftheunderlyingdemandshockreducesthe

deriveddemandforlogisticalservices;thisoccursbecausethebulkoftheimpactof

thedemanddeclineisbornebythepriceintheexportingregionratherthanthe

quantitytraded,leavingthemarginbetweenpurchaseandsalespricesandthe

quantityofthecommodityshippedonlyslightlyaffected.

Thismeansthatvariationsinthequantityofcommodityshipments,as

opposedtovariationsincommodityflatprices,arebettermeasuresoftheriskiness

oftraditionalcommoditymerchandisingoperations.(Similaranalysesapplytothe

effectsofsupplyshocks,orshockstodifferentkindsoftransformationsuchas

storageorprocessing.)

Itshouldbenotedfurtherthatmanycommodityfirmsbenefitfromself‐

hedges.Forinstance,adeclineinthedemandforacommodity(e.g.,thedeclinein

thedemandforoilandcopperduringthe2008‐2009financialcrisis)reducesthe

demandforlogisticalservicesprovidedbycommoditytradingfirms,but

simultaneouslyincreasesthedemandforstorageservices.Afirmthatsupplies

logisticalservicesandoperatesstoragefacilitiesthereforebenefitsfromaninternal

hedgebetweenitsstorageandlogisticsbusinesses;thedeclineindemandinoneis

offsetbyariseindemandintheother.

Theseconsiderationshightlightthedangerofconfusingtheriskinessof

commoditypriceswiththeriskinessofcommoditytrading,i.e.,theprovisionof

commoditytransformationservices.Althoughchangestounderlyingsupplyand

demandforcommoditiesaffectsdemandfortransformationservices,thelattertend

tobelessvolatile(especiallywhenunderlyingdemandandsupplyarehighly

inelastic),andtherearefrequentlynegativecorrelations(andhenceself‐hedges)

betweenthedemandsfordifferenttypesoftransformations.

OperationalRisk.Commodityfirmsaresubjecttoavarietyofrisksthatare

bestcharacterizedas“operational”,inthesensethattheyresultfromthefailureof

someoperationalprocess,ratherthanapricerisk.Thelistofpotentialoperational

risksislarge,butafewexamplesshouldsufficetoillustrate.ACTFthattransportsa

commoditybyseaisatrisktoabreakdownofashiporastormthatdelays

completionofashipment,whichoftenresultsinfinancialpenalties.

Aparticularlyseriousoperationalriskisroguetraderrisk,inwhichatrader

entersintopositionsinexcessofrisklimits,withouttheknowledgeorapprovalof

hisfirm.Thefirmcansufferlargelossesifpricesmoveagainstthesepositions.A

roguetradercausedthedemiseofonecommoditytradingcompany‐Andre&Cie.

ThecoppertradingoperationofSumitomosufferedalossinexcessof$2billiondue

toroguetradingthatlastednearlyadecade.

ContractPerformanceRisk.Afirmthatentersintocontractstopurchase

orsellacommodityisatrisktothefailureofitscounterpartytoperform.For

instance,afirmthathasenteredintocontractstobuyacommodityfromsuppliers

andcontractstosellthecommoditytoconsumerscansufferlosseswhenthesellers

default.Inparticular,sellershaveanincentivetodefaultwhenpricesrise

subsequenttotheircontractingforasalesprice,leavingthecommoditytradingfirm

toobtainthesuppliesnecessarytomeetitscontractualcommitmentsatthenow

higherprice,eventhoughtheyareobligatedtodeliveratthe(lower)previously

contractedprice.

Thisisachronicprobleminthecottonmarket,andthisproblembecame

particularlyacutebeginninginlate‐2010.Initially,manycottonproducersreneged

oncontractstosellcottonwhenpricesrosedramatically.Subsequently,cotton

consumersrenegedoncontractswhenpricesfellsubstantiallyAsaresult,several

CTFssufferedlargelossesincottonthathadmateriallyadverseeffectsontheir

overallfinancialperformance.

MarketLiquidityRisk.Commoditytrading(includingspecificallyhedging)

frequentlyrequiresfirmstoenterandexitpositionsquickly.Tradingrisksare

lower,totheextentthatitispossibletodothiswithouthavingalarge,adverse

impactonprices.Thatis,tradingislessrisky,andcheaper,inliquidmarkets.

Liquiditycanvaryacrosscommodities;e.g.,oilderivativemarketsare

substantiallymoreliquidthancoalorpowerderivativesmarkets.Moreover,

liquiditycanvaryrandomly‐andsubstantially‐overtime.Liquiditycandecline

precipitously,particularlyduringstressedmarketperiods.Sincemarketstresses

canalsonecessitatefirmstochangepositions(e.g.,toselloffinventoryandliquidate

theassociatedhedges),firmscansufferlargelossesinattemptingtoimplement

thesechangeswhenmarketsareilliquidandhencetheirpurchasestendtodrive

pricesupandtheirsalestendtodrivepricesdown.

Asfrequenttraders,commoditytradingfirmsarehighlysensitiveto

variationsinmarketliquidity.Declinesinliquidityareparticularlycostlytotrading

firms.Moreover,firmsthatengageindynamictradingstrategies(suchasstrategies

tohedgefinancialorrealoptionspositions)areespeciallyvulnerabletodeclinesin

marketliquidity.Furthermore,totheextentthatdeclinesinliquidityareassociated

with(orcausedby)marketdevelopmentsthatcanthreatenCTFswithfinancial

distress,ascanoccurduringfinancialcrises,forinstance,liquidityisaformof

“wrongway”risk:undertheseconditions,CTFsmayhavetoadjusttradingpositions

substantiallypreciselywhenthecostsofdoingsoarehigh.

FundingLiquidityRisk.Traditionalcommoditymerchandisingishighly

dependentonaccesstofinancing.Manytransformations(e.g.,shippingacargoof

oilonaVLCC)areheavilyleveraged(often100percent)againstthesecurityofthe

valueofthecommodity.Acommoditytradingfirmdeprivedoftheabilitytofinance

theacquisitionofcommoditiestotransport,store,orprocesscannotcontinueto

operate.

Riskmanagementactivitiescanalsorequireaccesstofundingliquidity.A

firmthathedgesacargoofoilithaspurchasedbysellingoilfuturesexperiences

fluctuatingneedsfor(andavailability)ofcashduetothemarginingprocessin

futures.Ifpricesrise,thecargorisesinvaluebutthatadditionalvalueisnot

realizedincashuntilthecargoissoldatthehigherprice.Theshortfuturesposition

suffersalossasaresultofthatpriceincrease,andthefirmmustimmediatelycover

thatlossofvaluebymakingavariationmarginpayment.Thus,evenifthemark‐to‐

marketvaluesofthehedgeandthecargomovetogetherinlockstep,thecashflows

onthepositionsarequitedifferent.Maintainingthehedgerequiresthefirmtohave

accesstofundingtomeetpotentialmargincalls.

Firmscansufferfundingliquidityproblemsduetoidiosyncraticfactorsor

market‐widedevelopments.Asanexampleofthefirst,afirmthatsuffersan

adverseshocktoitsbalancesheet(duetoaspeculativeloss,forinstance)maylose

accesstofundingduetofearsthatitmaybeinsolvent.Asanexampleofthesecond,

ashocktothebalancesheetsoftraditionalsourcesoffunding(e.g.,afinancialcrisis

thatimpairstheabilityofbankstoextendcredit)cansharplyreducethefinancing

availabletocommodityfirms.

Fundingliquidityisoftencorrelatedwithmarketliquidity,andthesetypesof

liquiditycaninteract.Stressedconditionsinfinancialmarketstypicallyresultin

declinesofbothmarketliquidityandfundingliquidity.Relatedly,stressesin

fundingmarketsareoftenassociatedwithlargepricemovementsthatleadto

greatervariationmarginpaymentsthatincreasefinancingneeds.Moreover,

declinesinmarketliquiditymakeitmorecostlyforfirmstoexitpositions,leading

themtoholdpositionslonger;thisincreasesfundingneeds,orrequiresthe

terminationofotherpositions(perhapsinmoreliquidmarkets)toreducefunding

demands.

CurrencyRisk.MostcommoditytradingtakesplaceinUSD,butCTFsbuy

and/orsellsomecommoditiesinlocalcurrency.Thisexposesthemtoexchange

ratefluctuations.

PoliticalRisk.Commoditiesareproduced,andtosomedegreeconsumed,in

countrieswithpoliticalandlegalsystemscharacterizedbyaweakruleoflaw.

Commoditytradingfirmsthatoperateinthesejurisdictionsareexposedtovarious

risksnotpresentinOECDcountries.Theseinclude,interalia,theriskof

expropriationofassets;theriskofarbitrarychangesincontracttermsatwhichthe

firmshaveagreedtopurchaseorsellcommodities;andoutrightbansonexports.

SuchrisksexistinOECDeconomiesaswell,thoughtoalesserdegree.For

instance,OECDcountriessometimesinterveneincommoditymarketsinattemptsto

influenceprices.Thus,thereisacontinuumofpoliticalrisks,andalthoughsome

countriesposeveryhighlevelsofsuchrisk,itisnotabsentinanyjurisdiction.

Legal/ReputationalRisk.Variousaspectsofcommoditytradinggiveriseto

legalandreputationalrisksforcommoditytradingfirms.Manycommoditiesare

potentialenvironmentalhazards,andfirmsaresubjecttolegalsanctions(including

criminalones)iftheirmishandlingofacommodityleadstoenvironmentaldamage.

Theseriskscanbeverylarge,particularlyinoiltransportation.Notethe200million

EurofineimposedonTotalarisingfromtheErikaincident,orExxon’smassive

liabilityintheExxonValdezspill;althoughthesearenotcommoditytradingfirms,

CTFsthatengageinoiltransportationareexposedtosuchrisks.

Furthermore,commoditytradingfirmsfrequentlyoperateincountriesin

whichcorruptionisrife,makingthefirmsvulnerabletorunningafoulofanti‐

corruptionlawsintheUnitedStates,Europe,andelsewhere.Moreover,

commoditiesaresometimesthesubjectoftradesanctions‐whichcreateprice

disparitiesofthetypethatcommodityfirmsroutinelyprofitfrom;thiscreatesan

enticementfortradingfirmstoattempttoevadethesanctions.Asafinalexample,

commoditytradingfirmsmayhaveopportunitiestoexercisemarketpowerin

commoditymarkets;indeed,theirexpertiseregardingtheeconomicfrictionsin

transformationprocessesthatmakesuchkindsofactivitiesprofitableandtheirsize

makethemalmostuniquelypositionedtodoso.Theexerciseofmarketpowerin

thiswayissometimesreferredtoasmanipulation,orcornering:suchactionscause

pricestodivergefromtheirfundamentalvaluesandleadstodistortionsin

commodityflows.

TherearerecentexamplesinwhichCTFshavebeenaccusedofeachofthe

foregoinglegaltransgressions.Thishasexposedthesefirmstolegalsanctionsand

reputationaldamage.Theseriskscanbesubstantial.Forinstanceinlate‐June,2012

aclassactionwasfiledintheUnitedStatesaccusingonmajorcommoditymerchant

withcorneringcottonfuturescontractsinMayandJune2011.AlthoughtheCTF

hasvigorouslydeniedtheallegation,thepotentialexposureislarge(inthe

hundredsofmilliondollars)andisthereforeamaterialriskthatillustratesthe

potentialforcontingentliabilitiesarisingfrommanipulationclaims.Giventhe

currentenvironmentinwhichmanipulationgenerally,andcommodity

manipulationspecifically,isthesubjectofconsiderablepoliticalandregulatory

attention,thisisarealriskattendanttocommoditytrading.6

RiskManagement

GlobalCommodityTradingFirmsengageuniformlytouttheirexpertisein,

andemphasison,riskmanagement.Theyutilizeavarietyoftoolstoachieverisk

controlobjectives.Mostnotableamongthesearehedgingusingderivatives(e.g.,

6Thereareexamplesofcommoditytradingfirmspayinglargesumstosettleclaimsofmarketmanipulation.TheseincludeFerruzzi(insoybeans)andSumitomo(incopper).

sellingcrudeoilfuturesoracrudeoilswaptohedgeacargoofcrudeoil)and

diversificationacrosscommoditiesandintegrationofdifferentlinksinthevalue

chain.

Asnotedabove,hedgingtransformsthenatureofafirm’sriskexposurefrom

flatpricerisktobasisrisk.Thesebasisriskscanbematerial,alsoasnotedabove.

Diversificationacrosscommoditiesmakesfirmfinancialperformanceless

dependentonidiosyncraticeventsinanyparticularcommodity.Giventhenatureof

commodities,particularmarketsorsubmarketsarepronetolargeshocksthatcan

seriouslyimpairtheprofitabilityofoperatinginthosemarkets.Diversificationisa

wayofreducingtheoverallriskinessofaCTF.Thisisparticularlyimportantfor

privately‐heldfirmsthathavelimitedabilitytopassidiosyncraticrisksonto

diversifiedshareholders.

MostlargeCTFsarewidelydiversified.Manysmallerfirmsaremore

specialized,andlessdiversified.Thelatterareobviouslymorevulnerableto

adversedevelopmentsinaparticularmarket.

Toquantifythepotentialbenefitsofdiversification,Ihaveevaluateddataon

worldtradeflowsbycommoditycode.Specifically,Ihavecollecteddataonworld

importsandexportsof28majorcommoditiesforthe2001‐2011periodfromthe

InternationalTradeCentreUNCTAD/WTO.Usingthisdata,Icalculatecorrelations

inannualworldimportsandexportsacrossthese28commodities.Icalculatetwo

setsofcorrelationsbetweenpercentagechangesintradeflowsacrosscommodities.

Thefirstsetisbasedonnominaltradeflows,measuredinUSdollars.Thesecond

setisbasedondeflatedtradeflows.Tocalculatedeflatedtradedflows,Idividethe

nominaltradeflowinagivenyearbythenominalpriceofthecommodityin

question,scaledsothatthe2001valueis1.00.8Thedeflatedtradeflowisa

measureofthequantity(e.g.,barrelsofoilortonsofcoal)ofeachcommoditytraded

inagivenyear.

Correlationsofnominaltradeflowsacrosscommoditiesaregenerally

positive.Themediannominalimportandexportcorrelationiscloseto50percent.

However,deflatedtradeflowpercentagechangesexhibitmuchlowercorrelations.

Themediancorrelationfordeflatedimportpercentagechangesis.065,andthe

mediancorrelationfordeflatedexportpercentagechangesis.031.Approximately

40percentofthecorrelationsbasedonthedeflatedflowsarenegative.

Asnotedelsewhere,thederiveddemandfortheservicesofCTFs,andtheir

profitability,isdependentonthequantitiesofcommoditiestraded,ratherthan

prices.Therefore,thecorrelationsbasedondeflateddataaremorerelevantfor

evaluatingthepotentialbenefitstoCTFsofdiversificationacrosscommodities.The

lackofcorrelationgenerally,andtheprevalenceofnegativecorrelationsindicate

thepotentialbenefitsofdiversificationacrosscommoditiesinreducingthe

variabilityofCTFrisk.

Integrationinthevaluechainalsotendstoreducerisk.Asnotedearlier,

therecanbeself‐hedgesinthevaluechain,asinthecaseofstorageontheonehand

andthroughput‐drivensegmentsontheother.Moreover,shocksatonelevelofthe

8ThenominalpriceforeachcommodityisbasedondataprovidedintheWorldBankCommodityPriceData(PinkSheet)annualaveragecommodityprices.Forcommodities(suchasoil,coal,orwheat)wheretherearemultiplevarietiesorgradesreported(e.g.,BrentandWTI;Australian,Columbian,andSouthAfricancoal),Iutilizethesimpleaverageofthe2001=1.00deflators.

valuechainoftenhaveoffsettingeffects(oratleast,cushioningeffects)atothers.

Forinstance,asupplyshockupstreamthatraisespricesofrawmaterialstendsto

depressprocessingmargins.Integratingupstreamandprocessingassetscan

stabilizeoverallmargins,therebyreducingrisk.Again,thisisparticularlyusefulfor

privatelyheldfirmsthatcannotreadilypassonrisksthroughtheequitymarket,or

forfirmssubjecttootherfinancingfrictions.Moreover,itismorevaluableacross

segmentsofthemarketingchainwheremarketsarenotavailabletomanageprice

riskatthesestagesofthechainarerelativelyilliquid(e.g.,ironore,aluminaand

bauxite,orcoal).

Diversificationandintegrationareprimarilyusefulinmanagingrisks

idiosyncratictoparticularcommoditiesorcommoditysubmarkets,e.g.,adrought

thataffectswheatproductionandhenceprices.Theyarelesseffectiveatmitigating

systematicshocksthataffectallcommoditymarkets,e.g.,aglobalfinancialcrisis,or

adeclineinChinesegrowth(becauseChinaisamajorimporterofallimportant

commodities).9

Althoughcommoditytradingfirmsemphasizetheirriskmanagement

orientationandprowess,theyhaveconsiderablediscretionintheirabilityto

manage‐andassume‐risks.

Riskmeasurementisacrucialcomponentofriskmanagement.Most

commoditytradingfirmsutilizeValue‐at‐Riskasariskmeasurementtool.The

limitationsofthismeasurearewellknown.Inparticular,commoditytradingfirms9Therearesomeexceptions.Asnotedpreviously,somecommoditytradingactivitieslikestorageareprofitablewhencommoditydemandisloweventhoughsuchdemandshockstendtoreducetheprofitabilityofothertradingcompanyoperations

incurmodelrisk(includingrisksassociatedwiththeestimationofparameter

inputs).Suchmodelriskshavebeenimplicatedinlargelossesinvirtuallyevery

marketandtypeoftradingfirm(e.g.,banks,hedgefunds),andtheymustbe

consideredaseriousconcernforCTFsaswell,especiallygiventhefactthatthese

firmshaveextensiveinvolvementincommoditiesandmarketsforwhichpricing,

volatility,andcorrelationinformationisparticularlyscarce(especiallyin

comparisontofinancialmarkets).

IV. GCTFsandSystemicRisk

A. Introduction

Afirmcanbesystemicallyimportantifitsfinancialdistressimposes

externalities(“spillovers”)ontootherfirms,andthesespilloversreduceoutputin

therealeconomy.Thereareavarietyofchannelsthroughwhichtheseexternalities

canpropagate.Theseincludedestructiveandcontagiousrunssufferedbyafirm.

Alternatively,theycanpropagateviacounterpartycreditlosses.Here,afirm’s

bankruptcycausestheinsolvencyofthefirm’screditors,andperhapsthefirm’s

creditors’creditorsandsoon:thecounterpartycreditlosscanalsotriggerrunson

thecounterparties.IconsiderthesusceptibilityofCTFstoeachofthese

mechanisms.Ialsoexaminethevulnerabilityofcommoditytraderstoshocksinthe

financialsectorandtherealeconomy,andwhethertheyposeariskofspreading

thoseshockstootherpartsoftheeconomy,orfeedingbacktheshockstothe

financialsystemorrealeconomyinadestabilizingway.Ithenanalyzetherelevance

tocommoditytradingfirmsofotherfactorsidentifiedbytheFinancialStability

BoardFinallyascontributingtosystemicimportance.Finally,Ireviewafew

historicalepisodesinwhichcommodityfirms‐andevenanentirecommoditysector‐

haveexperiencedlargelossesandfinancialdistress,withnospillovereffectstothe

financialsectororthebroadereconomy.

B. ContagiousRuns

1. Overview

Somefirmsaresubjecttoinefficient“runs”duetothenatureoftheircapital

structure.Inarun,creditorswithdrawfundsfromthefirmwhentheyquestionits

solvency,orrefusetorenewmaturingloans,leavingthefirmunabletomeetits

obligationsortofundoperations.10Runsleadtotheinefficientliquidationofthe

firm’sassetsorinefficientlimitationsonitsoperations.Iftheseinefficienciesare

limitedtothefirm,itisunlikelytobesystemicallyimportantunlessitisverylarge

andcentraltothefinancialsystem,butitispossiblethatthefirm’sproblemsmay

adverselyimpactotherfirms.Thesecouldbeothercommoditytradingfirms,orthe

creditorsofthefirm(s)sufferingarun.

Onewaythatthiscanhappenisinformationcontagion.Creditorsofother

firmsdrawadverseinferencesaboutthesolvencyofthesefirmsfromtherunonthe

distressedcompany.Theythenrunfromthesefirms,causingthemtocontractor

fail:thiscanthensparkaroundofrunsonotherfirms,includingothercommodity

firmsortheircreditors.

10Runscanalsooccurdueto“sunspots.”ThecanonicalanalysisofbankrunsisDouglasDiamondandPhilDybvig,BankRuns,DepositInsurance,andLiquidity,91J.PoliticalEcon.(1983):401.Theliteratureonglobalgamesalsoprovidesinsightsonthecausesofbankrunsandtheinefficienciestheycause.SeeStephenMorrisandHyunSongShin,GlobalGames—TheoryandApplications,inM.Dewatrapoint,L.Hansen,andS.Turnovsky,eds.,AdvancesinEconomicsandEconometrics(2003).

Anotherwaythiscanoccuristhrough“firesales.”Thefinanciallydistressed

firmsellsassetstomeetthedemandsofwithdrawingcreditorsforfunds,orbecause

itcannotrenewthefundingnecessarytocarrytheseassets.Iftheseassetsarenot

perfectlyliquid,thesesalesdepresstheirprices.Thisreducesthemarketvalueof

theseorsimilarassetsownedbyotherfirms,whichcanforcethemintofinancial

distress,leadingtorunsonthemandyetmoreassetsales.

2. CTFCapitalStructure

Afirm’scapitalstructuredeterminesitssusceptibilitytoruns.Firmsthatare

(a)highlyleveraged,and(b)engageinsignificantmaturity,credit,orliquidity

transformation.Abankisofcoursethecanonicalrun‐proneentity.Theyarehighly

leveraged,andmaturity,creditandliquiditytransformationsaretheirprimary

economicfunctionsaremostsusceptibletoruns.

CTFcapitalstructuresdonotexhibitthefeaturesthatmakefirmsvulnerable

toruns.

First,incomparisontobanksinparticular,commoditytradingfirmsarenot

heavilyleveraged.Onemeasureoftotalleverageistotalassetsdividedbybook

valueofequity.Table1presentsthismeasurefor2012for18tradingfirmsfor

whichdataareavailable.Thisratiorangesfrom2.38(ADM)to111(E.OnGlobal).

Theaverage(whichissomewhatmisleading,duetothepresenceoftheoutlier

E.On)is18,andthemedianis4.

Thismeasureofoverallleverageofcommoditytradingfirmsissomewhat

higherthannon‐financialcorporationsintheUnitedStates.Asoftheendofthe

thirdquarter,2013,theratioofassetstoequityforsuchcorporationswas2.06.11

Themoreasset‐heavyfirms(e.g.,Cargill,ADM,Bunge)haveleverageratiosthatare

similartothosefortheUSnon‐financialcorporationsasawhole:themoreasset‐

lightfirmsaremoreheavilyleveraged.Moreover,aswillbediscussedinmore

detailbelow,theheavierleverageofthemoretraditionaltradingfirmsissomewhat

misleading.Muchofthisdebtisshort‐termandassociatedwithliquid,short‐term

assets.Thenetdebtofthesefirms(totaldebtminuscurrentassets,whichisa

bettermeasureoftheirtrueleverage)isquitelow.

Notably,tradingfirmsaremuchlesshighlyleveragedthanbanks,towhich

theyaresometimescompared:somehavearguedthatcommoditytradingfirms

shouldbesubjecttoregulationssimilartobanks.Specifically,forUSbanksthat

havebeendesignatedSystemicallyImportantFinancialInstitutions(“SIFIs”),the

meanleverageis10.4andthemedianis10.ForEuropeanSIFIbanks,themeanis

20.6andthemedianis22.5.

Second,themostimportantfactorcontributingtofinancialcrisesthroughout

historyisthefactthatbanksengagein“maturitytransformation”,butcommodity

tradingfirmsdonot.Maturitytransformationoccurswhenbanks(orshadow

banks)issueshort‐termliabilitiestofundlong‐termassets.Thisrequiresthebanks

torolloverdebtsalmostcontinuouslyinordertofundtheirassets.Whenlenders

11BoardofGovernors,FederalReserveBoard,FinancialAccountsoftheUnitedStates,TableB.102.9December,2013.Thiscalculationisbasedonhistoricalcostdata,whichmakesitmorecomparabletotheaccountingdatausedtodetermineleveragefortradingfirms.Basedonmarketvalues/replacementcostsofnon‐financialassets,theratioissomewhatsmaller:1.75.Sincemarketvaluesorreplacementcostsoftradingfirmassetsarenotavailable,Icannotcalculateananalogousfigureforthem.

suspectthatabank,orthebankingsystemingeneral,isfinanciallyunsound,they

maynotagreetorolloverthebank’s(orbanks’)short‐termdebtsastheycomedue.

Thisrendersthebank(orbanks)unabletofundtheiroperations,andtheycollapse.

Indeed,balancesheetdataindicatesthatmajorbanksdoengageinsuchmaturity

transformation.

Instarkcontrast,availablebalancesheetinformationalsoindicatesthat

commoditytradingfirmsdonotengageinbank‐likematuritytransformation.

Indeed,totheextentthatcommoditytradingfirmsengageinmaturity

transformation,itisthereverseoftheborrowshort‐lendlongtransformationthat

makesbankbalancesheetsfragile,andwhichmakesbanks(andotherfinancial

intermediaries)subjecttorunsandrolloverrisk.Specifically,forall17ofthe

commoditytradingfirmsIhavestudied,currentassetsexceedcurrentliabilities.

Themedianratioofcurrentassetstocurrentliabilitiesis1.26.Consequently,one

measureofnetdebt(totalliabilitiesminuscurrentassets)isnegativefor8ofthe17

firms.Furthermore,themedianratioofnetdebttoshareholderequityisverysmall,

takingthevalueof.014.Sincecommoditytradingfirmcurrentassets(primarily

hedgedinventoriesandtradereceivables)tendtobehighlyliquidand/orofhigh

creditquality(asisdocumentedbelow)thesefiguresstronglysuggestthatasa

whole,commoditytradingfirmsrunfarlessliquidityriskthandofinancial

intermediarieslikebanksorshadowbanks.

Third,whereasrunproneinstitutionsoftenengageinliquidity

transformation,commoditytradingfirmsdonot.Forinstance,somebankliabilities

(e.g.,deposits)areusedtofundilliquidassets,buttheholdersoftheseliabilitiesuse

themasasubstituteforcashtomeetliquidityneeds.Thesestructuresarefragile

andrunprone.

Commoditytradingfirmliabilitiesaregenerallynotusedascashsubstitutes.

Moreover,theshort‐termliabilitiestheyissuetendtofundshort‐termassets(such

ashedgedcommodityinventories)whereaslongterm,illiquidassetstendtobe

fundedwithlong‐termliabilities(eitherbankloansordebtsoldincapitalmarkets).

Specifically,thereisastrongnegativecorrelation(‐.51)betweentheratioofcurrent

liabilitiestototalliabilities,andfirms’fixedassetintensity:fixedassetsarelikelyto

belessliquidthanotherassetsontradingfirmbalancesheets(suchasinventories).

Relatedly,thereisastrongcorrelationbetweenthefixedassetintensityof

commoditytradingfirms,andtheirleverage:morefixedasset(longtermasset)

heavyfirmstendtobelessleveraged.For2012,thecorrelationbetweentheratioof

fixedassetstototalassetsandtheratiooftotalassetstobookvalueofequity

(leverage)is‐.55.Thus,tradingfirmsthatareassetheavytendtobelessheavily

leveragedthanthosethatareassetlight.Putdifferently,puretradingfirmsthat

ownrelativelyfewfixedassetstendtobemorehighlyleveragedthanfirmsthatalso

engageinprocessingorrefiningtransformationsthatrequireinvestmentsinfixed

assets.

Thus,firmsengagedinmorefixedassetintensivetransformations(suchas

processing)haveagreaterproportionoflong‐termliabilitiesandlowerleverage

overall.Thereisthereforeanalignmentbetweentheassetandliabilitystructuresof

commoditytradingfirms’balancesheets,andthisalignmentdemonstratesthat

thesefirmsdonotgenerallyengageinliquiditytransformation.

Fourth,thestructureofcommoditytradingfirmdebtdiffersfromthatof

financialinstitutionsthathaveprovedvulnerabletorunsorrolloverproblems.

Theseinefficienciesaretheresultofacoordinationproblemamongcreditors.

Thesearemostlikelytooccurwhentherearemanycreditorswhoact

independently:depositors,ormoneymarketfundsthatinvestinshort‐termbank

debtarecanonicalexamples.Incontrast,thebulkofunsecuredcommodityfirm

debtisintheformofrevolvingcreditlinesextendedbysyndicatesofbanks.

Syndicationfacilitatescoordinationamongcreditors.

Fifth,althoughcommoditytradingfirmsengageinsomeactivitiesthatare

analogousto“shadowbanking”,thesestructuresarenotvulnerabletorunsinthe

waythatsomeshadowbankingactivitiesprovedtobeduringtheFinancialCrisis.

TheliabilitiesthatprovedtoxicduringtheCrisis(e.g.,assetbackedcommercial

paper)wereusedtofundlong‐termilliquidassets.Incontrast,facilitieslike

Trafigura’ssecuritizationoftradereceivablesissueliabilitieswithmaturitiesthat

aretypicallygreaterthanthematuritiesofthesecuritizedassets.Moreover,these

assetstendtobeofhighquality:defaultratesontradecredittendtobeverylow.12

3. ThePotentialForInformationContagion

Althoughrun‐pronecapitalstructuresareanecessaryconditionforsome

formsofcontagion,theyarenotsufficient.Forthefinancialdistressofarun‐prone

12AnInternationalChamberofCommercestudyofdatafrom2005‐2009foundthatfortradecreditgenerally(whichincludesnotjustcommoditytradefinance),defaultratesaveraged.02percent,andthattherateofdefaultsdidnotriseappreciablyduringtheperiodofthecrisis.TheOfferingCircularfromasecuritizationofTrafigurareceivablesfrom2012reportsdefaultratesontheGCTFsreceivablesfromNovember,2004‐February,2012.Defaultratesarelessthan.1percent,anddelinquencyratesneverexceed2.4percentandaretypicallylessthan.1percent.

entitytohavesystemiceffects,thisdistressmusthavespillovereffectsonother

firms.Onespilloverchannelisinformational.Thereissomedisputeastowhether

thischannelhasactuallybeenrelevantinpractice,andinparticularduringthe

recentFinancialCrisis.Moreover,thefactthattradingfirmsaregenerallynotrun

pronemeansthatthecontagiousrunmechanismisunlikelytooperatehere.

Nonetheless,itisworthwhiletoconsiderwhetherinformationspilloverscanoccur,

thatis,whetherthefinancialdistressofonecommoditytradingfirmhave

implicationsforthesolvencyofothercommoditytradingfirms.

Commoditytradingfirmscanexperiencefinancialdistressforavarietyof

reasons.Manyofthehistoricalepisodesoffirmfailuresinvolvedcircumstances

uniquetothefirmsthatdidnothaveimplicationsforthefinancialconditionsof

otherfirms.

Onereasoncommodityfirmscanfailisalargespeculativeloss.These

speculativelossesareoftenassociatedwitharoguetraderproblem.Sumitomo’s

$2.4billioncoppertradinglossisoneexample.ThefailureofSwisstraderAndre&

Cieisanother.ThebankruptcyofSEMGroupisathird.

Suchepisodesarespecifictothefirmsufferingtheloss.Theyhavefew,ifany,

ramificationsforthefinancialhealthofothertradingfirms.Thus,alargespeculative

loss(particularlyifitisprimarilyattributabletoanoperationalorcontrolfailureat

thefirm)isextremelyunlikelytoinducecreditorsofothertradingfirmstorevise

downwardstheirestimationsofthesefirms’financialconditionorrunonthem.

Indeed,totheextentthatthespeculativelossatonefirmimpairsitsabilityto

supplytransformationservices,competitorsprovidingsimilarservicescould

actuallybenefitfromitsproblems.

Similarconsiderationsholdforothereventsthatcanimposelargelossesona

tradingfirm,suchasanenvironmentaldisasteroralegalproblem.13

Onefactorthathasarguablycausedinformation‐basedcontagioninpast

crisesissimilaritiesinassetholdingsacrossfirms.Alargelossatasinglefirm

relatedtoaparticularassetcansupportinferencesthatotherfirmsareatriskto

similarlargelossesbecausetheyarebelievedtoholdthesameorsimilarassets.14

Manycommoditytradingfirmassets,notablyinventories,aretradedin

liquidandtransparentmarkets,meaningthatthepricesofcompanies’holdingsof

theseassetscanbedeterminedwithsomeaccuracy.Thus,therevelationofalarge

lossataparticularcompanyduetothedeclineinthevalueofitsinventoryholdings

isunlikelytoprovidenewinformationaboutthevalueofothercompanies.

Similarly,thevalueofotherassetsoroperationsofcommoditytradingfirms

aredrivenbywidelyobservablefactors.Forinstance,soybeanprocessingmargins

canbemeasuredwithsomeaccuracybasedonpubliclyavailableprices,andare

likelytobehighlycorrelatedacrossfirms.Alossdrivenbyasharpdeclinein13Somelegalactionsmayhaveimplicationsformultiplefirmstotheextentthattheyrevealillicitpracticesarewidespreadintheindustry(e.g.,pricereportingfraud)orindicateincreasedlegalandregulatoryscrutinyoftradingactivities.TheSECinvestigationofDynegy’saccountinginApril2002isapossibleexample.Thecollapseoftheentiremerchantenergysectorcommencedwhentheinvestigationwasannounced.TheSECclaimedthatDynegyhadoverstatedcashflowsfromoperationsusingfinancialtransactionsthatwerecommoninthemerchantsector.Thiscastdoubtonthefinancialresultsofotherfirms.14Thiseffectisoftenhardtodistinguishfromthefiresalechanneldiscussedbelow.Moreover,therecognitionofalossmayrevealinformationaboutthefirm’sassetholdings,ratherthanthepriceofthoseassets,whichisoftenobservableifthoseassetsaretraded.

processingmarginswouldbehighlypredictableconditionalonobservableprices,

andrevelationofdistressataparticularfirmcausedbyacollapseinmarginswould

itselfprovidelittlenewinformationabouttheprospectsofotherfirms.

Thecharacterofcommodityfirmcreditorsalsoreducesthepotentialfor

contagiousruns.Asnotedearlier,banksaretheprimarylenderstocommodity

traders.Moreover,majorlenderstotraderstendtoextendcredittomultipletrading

firms.Thus,abankcreditorofatradingfirmislikelytohaveprivateinformation

aboutthatfirm,andothersimilarfirms.Thisprivateinformationreducesthe

lender’sneedtorelyonapubliclyavailablesignalaboutthesolvencyofonefirm

whenevaluatingthecreditworthinessofothers.Thisreducesthepotentialfor

contagiousruns.

Putdifferently,onerecenttheoryoffinancialcrisesisthatinformation

insensitivecreditisanimportantsourceoffinancialfragility:adverseshocksmake

debtdesignedtobeinformationinsensitiveinformationsensitiveinstead,resulting

inrunsonthisdebt.15Commodityfirmdebttendstobeinformationintensivebank

debtprovidedbybanksthatislessvulnerabletosector‐wideruns.

Arecenteventcouldprovideonepossibleexampleofwhatcouldgiveriseto

informationcontagionincommodityindustriesisthemetalswarehousingscandal

inQingdao,China.Itwasrevealedthatthesamecollateralstoredintheportofthat

cityhadbeenusedtobackloansmadebyaparticularcommoditytradingfirm.This

immediatelyledtosuspicionsthatothertradingfirmsactiveintheport,andin

Chinagenerally,couldhavealsobeenvictimizedbythefraud.15GaryGortonandAndrewMetrick,SecuritizedBankingandtheRunonRepo,inMarketInstitutionsandFinancialMarketRisk(2010).

Insum,theimportanceoftheinformationcontagionchannelhasbeen

disputedinpreviousfinancialcrises,andislikelytobeevenlessofaconcernin

commoditytrading.

4. ThePotentialForFireSales

Distressedfirmsoftensellassetstoraisecashtomeetfinancial

commitments.Moreover,securedlenderssometimessellthecollateralbacking

loanstofailingorfailedfirms.Totheextentthattheseassetsare(a)heldbyother

firms,and(b)aretradedinimperfectlyliquidmarkets,thefiresalescandepress

pricesandimposelossesonthevalueofotherfirms’holdingsoftheseandrelated

assets.

Firesaleexternalitiesaremostseriouswhenafirmholdsassetsthatare

sufficientlyliquidtobetradableonamarket,butnotsoliquidthatthatlargesales

donothaveapriceimpact.Aconsiderationoftheassetsideofcommoditytrader

balancesheetsstronglysuggeststhatfiresaleproblemsareunlikelytobeaserious

concern,especiallygiventhewaytheseassetsarefunded,bankruptcylaw,andthe

factthatmanycommodityfirmassetsarehedged.

Considercommodityinventories,whicharetypicallythelargestandmost

liquidassetsheldbycommoditytraders.Itiscommonfortraderstofinancenearly

100percentoftheseholdings,withtheinventoriesservingascollateralforthe

loans.Thefirmthereforecannotfreelyselltheseinventories.Moreover,under

bankruptcyandinsolvencylawinmostjurisdictions,thelendercannotimmediately

seizeandsellthatcollateral.(ThiscontraststorepocollateralintheUS.)

Moreover,commoditytraderstypicallyhedgetheirinventories.Thus,evenif

thesaleofinventorybyadistressedfirmdepressesprices,otherholdersof

inventoriesofthecommoditiesthedistressedfirmsellsareprotectedagainstsome

oftheeffectofthepricedecline:thecounterpartiestothehedgingtradesbearthe

loss,whichmeansthatmuchofthepriceimpactisabsorbedbythebroadercapital

markets.Moreover,commodityderivativesmarketsaresmallrelativetoderivatives

marketsoverall,andtocapitalmarkets.Thismeansthatanyfiresaleeffectis

unlikelytoimposecripplinglossesonthosebearingtherisk.

Onlytotheextentthattheinventoryfiresalesaffectthebasis,andother

firmshavethesamebasisexposuresasthedistressedfirm,willtherebeafiresale

effect.Giventhegeographicandqualityheterogeneityofcommodities,andthefact

that(asnotedabove)majortraderstendtobediversifiedacrosscommodities,basis

exposurestendtoexhibitrelativelylowcorrelationacrossfirms.

Othercommodityfirmassetsarenottradedoreventradable.Forinstance,

grainsilosoroilterminalsorsoybeanmillscannotbesoldlikesecuritiesor

inventories.Thus,theyposenomoreofafiresalethreatthanthephysicalassetsof

afinanciallydistressedmanufacturingortransportationcompany.

C. TheCounterpartyCreditChannel

1. Introduction

Thefinancialdistressofafirmcanimposecreditlossesonitscounterparties.

Iftheselossesaresufficientlylarge,thecounterpartiesmayincurfinancialdistress

costs,andmaythemselvesbecomeinsolvent,whichimposeslossesandcostson

theircounterparties.Thus,counterpartycreditlossesareonepotentialsourceof

systemicallyimportantspillovers.

Theselossesaremorelikelytobesystemicallyimportantwhenthe

counterpartiesarefragile,runproneinstitutions(e.g.,banks,moneymarketmutual

funds),and/orwhentheobligationsdefaultedonarepartoflongintermediation

chains.

Iconsiderdebt,derivatives,andsecuritizationaspotentialsourcesof

counterpartycreditexposures.Thenatureofcommoditytradingfirmliabilities,and

theircounterparties,makesitunlikelythatfinancialdistressatatradingfirmor

tradingfirmswillhavesystemicconsequencesviathecounterpartycreditchannel.

2. Debt

Commoditytradingfirmsborrowextensivelytofinancetheiractivities.I

havealreadydemonstratedthattradingfirmindebtednessiscomparabletothatof

industrialfirms,andthattheyuseshort‐termbankdebttofundcurrentassets(like

inventories)andlonger‐termdebttofundfixedassets.

Intermsofcounterpartycounterpartycreditlosses,short‐termcommodity

debttendstobesecuredbyinventories,orinsomecases,receivables.Moreover,the

inventoriestendtobehedged.Thesecurednatureofthisdebtlimitsthepotential

forcreditlosses.

Moreover,thisdebtisnotpartoflongintermediationchains.Instead,

commoditytradersborrowdirectlyfrombanks,whichretaintheseclaimsintheir

bankingbooks.

Mostlong‐termdebtisbankdebt,frequentlyintheformofrevolvinglinesof

creditwithbanksyndicatesconsistingofalargenumberofbanks.Thislimitsthe

exposureofanyinstitutiontoatradingfirm.Theremainderofcommodityfirmdebt

israisedthroughcapitalmarkets,andislargelyheldbynon‐fragile,unlevered

entities,includingsovereignwealthfunds,pensionfunds,insurancecompanies,and

highnetworthinvestors.

3. Derivatives

Commoditytradingfirmsusederivativesextensively,primaryasahedgefor

theircommodityinventories,andpricedpurchasesandsales,andsecondarilyfor

speculativepurposes.Defaultsonderivativespositionswouldimposelosseson

derivativescounterparties,whichifsufficientlylargecouldhavespillovereffects.

However,thevastbulkofderivativesthatcommoditytradingfirmsuseare

exchangetradedandcentrallycleared.Centralclearingcounterpartiesrequirethe

postingofmargin.CCPsoperateonthe“loserpays”principle,andrequirethe

marginstobesufficienttocovertradinglossesinallbutthemostextreme

circumstances.Thissubstantiallyreducescounterpartycreditexposures,and

therebysubstantiallyreducesthesystemicrisksviathederivativeschannel.

Commoditytradingfirmssometimesenterintoover‐the‐counter

transactions.Thesetransactionsaretypicallycollateralized,atleastthrough

variationmarginandoftenthroughinitialmargin.Justaswithclearedderivatives,

marginonOTCcontractslimitscounterpartycreditlossesarisingfromOTC

derivatives.

4. Securitization

Commoditytradingfirmshaveengagedinlimitedsecuritizations,mainlyof

tradereceivables.Outstandingamountsoftheseliabilitiesaresmall,whichlimits

theirsystemicsignificance.Moreover,defaultlossesontradereceivableshave

historicallybeenquitesmall,evenduringtheFinancialCrisis,whichfurtherlimits

thepotentialforcounterpartycreditlosses.Inaddition,asnotedearlier,thesefirms

notengageinFinally,thesesecuritizationstendtobepurchasedbynon‐fragile,

unleveragedinvestors.

D. TheVulnerabilityofCommodityTradingFirmstoFinancialSystemand

MacroShocks

1. ShockstotheFinancialSystemandtheMacroeconomy

Commoditiesaresubjecttodemandshocks.Thesedemandshockscanbe

commodityspecific,orcanbemacroeconomicinnature,andthereforeaffecta

broadswatheofcommodities(especiallyenergyandnon‐preciousmetals).The

lattertypeofshocksaremorelikelytogiverisetosystemiceffectsoperating

throughoronCTFsbecausetheyarenotdiversifiable,soIwillfocusattentionon

them.Indeed,Iwillnarrowtheanalysisevenmoretoconsiderademandshocks

acrosscommoditiesasawholethatarisefromafinancial/creditcrisis,becausesuch

criseshaveimplicationsforboththedemandforCTFs’services,andtheirabilityto

obtainthefundingnecessarytoperformtheirmerchandisingfunctions.Thatis,

suchashockispotentiallythemostthreateningtoCTFsasawhole.

Adeclineindemandforacommodityleadstoadeclineinthe(derived)

demandforsometransformations,notablytransportation/logisticsand

processing/refining,butanincreaseinthedemandforothers,notablystorage.The

declinesinderiveddemandtendtoresultindeclinesinbothvolumesandmargins,

therebyreducingtheprofitabilityofthefirmsthatengageintheadverselyimpacted

transformations.TotheextentthataGCTFalsostorescommodities,itbenefitsfrom

aninternalhedgethatoffsetsthelossesfromsupplyingtransformationsinspace

andtime.

Themagnitudesofthesechangesinderiveddemandsdependonthe

magnitudeofthedemandshock(andhencetheseverityofthefinancialcrisis)and

theelasticitiesofsuppliesoftheunderlyingcommodities.Sincemanycommodities

arehighlyinelasticallysupplied,especiallyintheshortrun,theeffectsonmargins

andvolumes,andhencetradingfirmprofits,canbemodest.

Tradedataprovidesomeinsightsontothissourceofrisktocommodity

tradingfirms.Figures1through4depictdatarelatingtoworldexportsby

commodity.(Datarelatedtoworldimportsbycommoditybehavesimilarly,soI

onlypresentchartsonexports.)Figure1graphsnominalexportsbycommodity

reportedintheITCdatafor2001‐2011.Notethelargedownturnsinnominaltrade

volumesin2009,reflectingtheimpactofthefinancialcrisis.Duetothelargesizeof

oilandsteelandironexportscomparedtothoseforothercommodities,Figure2

graphsnominalexportsforallcommoditiesexceptoilandironandsteel.Virtually

allcommoditiesexhibitanoticeabledipin2009.

Asnotedabove,however,althoughchangesinnominalflowsreflectchanges

inbothflatpricesandquantities,quantitiesarethemajordeterminantsof

commoditytraders’marginsandprofits.Figure3depictsannualnominalexports

foreachcommoditydeflatedbyitsaverageannualprice(scaledsothatthe2001

averagepriceequals1.00).Theimpactofthe2008‐2009financialcrisisismuch

lessnoticeableinthedeflatedexportsthanthenominalexports.Onlyironandsteel

exhibitsapronounceddip.Figure4presentsthedeflatedexportsforall

commoditiesstudiedexcludingoilandironandsteel.Thesesmallercommodities

donotexhibitapronounceddeclineindeflatedexports(aproxyforquantity)in

Thesechartsstronglysupporttheconclusionthatalargedemandshock

primarilyaffectscommodityprices,andhasamuchsmallerimpactonthequantities

ofcommoditiestraded.Inasmuchastheprofitabilityofcommoditytradingfirmsis

primarilydrivenbyquantities(totheextentthatthesefirmshedgeprice

exposures),theriskthatalargedemandshock(likethatexperiencedin2008‐2009)

posestotheviabilityofCTFsislimited.

Demandshocksarisingfromamacroshocksuchasafinancialcrisisalso

affectthefundingneedsofcommoditytradingfirms.Crucially,adverseshocksof

thisnaturetendtoreducefundingneedsandliquiditystresses.Adversedemand

shocksreduceprices,therebyreducingtheamountofcapitalnecessarytocarry

inventoriesofcommoditiesastheyundergotransformationprocesses.Moreover,to

theextentthatcommoditytradingfirmsaretypicallyshortderivativeinstruments

(whichmaybemarked‐to‐marketonadailybasis)ashedgesofcommoditystocks,

pricedeclinesgeneratemark‐to‐marketgainsonderivativesthatresultinvariation

margininflows.Thisprovidesasourceoffundstorepaycredittakentoacquirethe

inventories.Thatis,thesepricedeclinestendtoresultincashinflowspriorto

obligationstomakecashpayments,whichfurthereasefundingneedsofcommodity

tradingfirms.Moreover,sincebankloansbackedbyhedgedinventoriesare

typicallymarked‐to‐marketaswell,sothetradingfirmspassthroughthemargin

inflowstotheirlenders.Thisprovidesasourceofcashtothebanks,whichis

particularlyvaluableduringperiodsoffinancialstress.Ineffect,thespeculators(or

longhedgers)whotakepositionsontheothersideofthetradingfirmshedging

inventoryprovidecontingentliquiditytothebankingsystem.

Figures1‐4illustratethisclearly.Thenominalvalueofvirtuallyall

commoditiestradeddeclinedsharplyin2009,butquantities(asproxiedforby

deflatedexports)didnotdeclinesubstantially,oruniformlyacrosscommodities.

Thisdeclineinnominaltradereflectsthepronouncedpricedeclinesthatoccurred

inlate‐2008tomid‐2009.Moreover,thesharpdeclineinthenominalvalueofa

relativelystablequantityofexportsmeansthatthefinancingneededtocarryout

suchexportsdeclinedsharplyaswell.

Thedeclineinfundingneedsduringperiodsofsharpdemanddeclines

resultingfromashockarisinginthefinancialsystemisparticularlybeneficial,

inasmuchasfinancialshocksconstraintheavailabilityofcredit.Inthisregard,

however,itshouldbenotedthattheliabilitiesthatCTFsissuetofundtheir

transformationactivitiesaremorerobustthantheliabilitiesthatproved

catastrophicallyfragile(suchasABCPandauctionratesecurities)intheprevious

financialcrisis.Thedegreeofmaturitytransformationinmuchcommodityfinance

isquitelimited:short‐term,andinsomecaselong‐term,liabilitiesareutilizedto

fundshort‐term,“self‐liquidating”assets.Moreover,evenintheeventofdefault,

thefundedassetsareoftenreadilysoldorhedgedinliquidderivativesmarkets;this

limitslenders’risk.Similarly,asymmetricinformationproblemsarelesssevere

withcommoditycollateral(ascompared,forexample,toCDOsheldbySPVsduring

thecrisis),whichfurtherreducesthepotentialforarunbyfunders.

Thenon‐bank(orshadowbank)fundinginstrumentsusedbyCTFsalso

comparefavorablytoshadowbankliabilitiesthatprovedproblematic‐or

disastrous‐duringthecrisis.Asnotedabove,someofthesenon‐banksourcesof

creditarebackedbycommodityinventories,andothersbyreceivables.Liquidityof

theunderlyingassetsandlackofinformationasymmetryfacilitatecontinuedsupply

offundingoftheseassetsevenduringtimesoffinancialstress.Similarly,the

receivablesbackingsecuritizationsissuedbyGCTFstendtohaveveryshort

maturities,andverylowratesofdefault,evenduringtimesoffinancialmarket

stress.

Therisksoffundingdependprimarilyonthetypeofcommodity.More

heavilytradedcommoditieswithbroadanddeepderivativesmarkets(e.g.,oil,corn,

somenon‐ferrousmetals)posefewerfundingrisksthanothercommoditieslacking

suchmarkets(e.g.,coal,ironore).

TheforegoinganalysisimpliesthatGCTFsshouldberelativelyrobust,even

tolargeshocksemanatingfromthefinancialsystem.Thisimplicationistestable,

usingdatafromthe2007‐2009financialcrisis.IhaverevieweddataonADM,

Bunge,Cargill,Vitol,LouisDreyfus,MercuriaEnergyTrading,Glencore,Olam,

Wilmar,Trafigura,andNoble.

Allofthesefirmsremainedprofitablethroughoutthe2007‐2009commodity

boom‐bustcycle.Between2007and2009(thenadirofthecommoditypricecycle),

netincomechangesrangedbetween‐57percent(Bunge)and224percent(Wilmar)

withamedianofbetween44percent(Cargill)and113percent(Noble).

Thissampleisdominatedbyfirmsthatarefocusedonagricultural

commoditytrading.Glencoreisfocusedonmetalsandenergy,twonotably

procyclicalcommoditysectors:itsprofitdeclined24percentoverthecycle.

Trafiguraisfocusedonenergy:itsearningsrose85percentovertheboom‐bust

cycle.Vitolisanotherenergy‐focusedtradingfirm,anditexperienceda91percent

increaseinincomeoverthecycle.Athirdenergy‐focusedfirm,MercuriaEnergy

Trading,sawitsincomerise122percent.Thesefiguresareworthnoting,giventhe

substantialrise,decline,andsubsequentriseinoilpricesover2007‐2009.This

performancelikelyreflectsthefactthateconomicvolatilitycancreatearbitrage

opportunities,andseriouseconomicdownturnscanincreasethedemandforsome

transformationactivities,notablystorage.

Thevariabilityinperformanceacrossthefirmsforwhichdataisavailable,

withsomecompaniessufferingsubstantialdeclinesinearningsandother

substantialrisesoverthe2007‐2009commoditycycle(andfinancialcrisiscycle),is

inconsistentwiththehypothesisthatGCTFfinancialperformanceishighlysensitive

toglobaleconomicconditions.ThisisinstarkcontrasttootherSIFIs.GCTFswould

bemorelikelytocreatesystemicriskif,likeSIFIs,theirearningswerehighly

correlatedoverthecycle.

Thisistrueoflargebanks,whoseprofitscollapsedduringtheCrisis.Total

profitsforthe8USSIFIbanksplungedfrom$58billionin2007toalossof$9.8

billionin2008,andrecoveredonlyto$40billionthefollowingyear.EuropeanSIFI

banksearnedaprofitof$114billionin2007,butsufferedalossof$16.5billionin

2008,withprofitsreboundingto$58billionin2009.Thisperformancediffers

starklyfromthatofcommoditytradingfirmsoverthisperiod.

InsofarasGCTFsbeingachannelbywhichshocksoriginatinginthefinancial

sectoraretransmittedtocommodityproducersandconsumers,andviathemtothe

realeconomy,thereisanecdotalandsurveyevidence,andsomeempiricalevidence,

thattherecentfinancialcrisisledtoacontractionintradecredit.Theanecdotal

evidencespecificallysuggeststhattherehasbeenacontractionoftradecreditin

commoditiesspecifically;thesurveyandempiricalevidenceshowsthattradecredit

contracted,andbecamemoreexpensiveduringthecrisis.16Further,itiswell‐

documentedthatinternationaltradecontractedmoresharplythanGDPgenerally

duringthecrisis,andthereissomeevidencethatthistradecontractionwas

“excessive,”inthesensethattradedeclinedmoreduringthecrisisthanwouldhave

beenpredictedgiventhedeclineinGDP.17Althoughthetradefinancechannelhas

beensuggestedasthereasonforthisexcessivedeclineintrade,mostempirical

evidencedoesnotsupportthishypothesis.18Theempiricalevidencefocuseson

16InternationalMonetaryFund(2009),“SurveyofPrivateSectorTradeCreditDevelopments”(Washington,D.C.,InternationalMonetaryFund,February),www.imf.org/external/np/pp/eng/2009/022709.pdf.

17MarkWynn,TheFinancialCrisis,TradeFinance,andtheCollapseofWorldTrade,FederalReserveBankofDallas,GlobalizationandMonetaryPolicyInstitute2009AnnualReport.18InessaLove,TradeCreditversusBankCreditduringFinancialCrises,inJean‐PierreCauffour(ed.),TradeFinanceDuringtheGreatTradeCollapse(2011).AndreiLevchenko,LoganLewis,andLindaTesar,TheRoleofTradeFinanceintheUSTradeCollapse:ASkepticsView,inCauffour(2011).AnalternativeviewisprovidedbyDavinChorandKalinaManova,OfftheCliffandBack?CreditConditions

internationaltradegenerally,ratherthancommoditiesspecifically.Someevidence

showsthattheeffectsofthetradecreditcontractionweremostpronouncedinfirms

withfewcollateralizableassets.Giventhatmanycommoditiesandcommodity‐

relatedassetsarereadilyusedascollateral,thissuggeststhatanyimpactofatrade

creditcontractionwouldbelesssevereincommoditytradesthanintradegenerally.

Itfurthersuggeststhateffectswouldbemoresevereforfirms,commodities,or

nationsforwhichcollateralizationismorecostly(e.g.,injurisdictionswhere

perfectingaccesstocollateralisriskierduetothenatureofthelegalsystem).

Insum,commoditytradingfirmsareunlikelytocontributetoapositive

feedbackinwhichashockarisingelsewhereinthefinancialsystemorthereal

economyimposeslosesonthetradingfirms,whichinturnimposesnegative

externalitiesonotherfirms(e.g.,banks).Thisistruefortworeasons.First,

commoditytradingfirmsarerobusttoevenlargeshocksinthefinancialsectorand

realeconomy.Second,asnotedearlier,financialdistressinthecommoditytrading

sectorisunlikelytohaveseriousexternaleffects.

2. SupplyShocks

Aglobalsupplyshocktoamajorcommodityposessubstantiallydifferent

riskstoGCTFs,theircreditorsandtheirtradingpartners.Adeclineinsupply,can

arise,interalia,fromconflict(e.g.,oilintheMiddleEast),naturaldisaster(e.g.,a

droughtthatdevastatesamajorwheatproducingregion),orpoliticalaction(e.g.,an

exportembargo).Suchashockcausespricestorise.SuchapricerisetendstoandInternationalTradeDuringtheGlobalFinancialCrisis(2009)http://ssrn.com/abstract=1502911.

causespikesinfundingneedsforhedgedinventories,andanincreaseinfunding

needsgenerallyasduetoinelasticdemandformostcommoditiesadeclineinsupply

leadstoalargerpercentageincreaseinprices,therebyincreasingthemarketvalue

ofthecommodity.Italsotendstoreducetheprofitabilityofcommodity

merchandising,byreducingbothmarginsandvolumes.Thus,whereasdemand

shocks‐especiallythosethathitmultiplecommodities‐havesomeeffectsthat

cushiontheimpactonGCTFs,alloftheeffectsofsupplyshockstendtobe

detrimentaltoGCTFs‐reducingtheirmarginsandvolumes,increasingfunding

needs,andpotentiallyraisingfundingcosts.

Asupplyshockislikelytooccurinasinglecommodityatanyparticularpoint

intime,whichmitigatestheirimpactondiversifiedcommodityfirms,andhenceon

theircreditors,customers,andcounterparties.Moreover,themarketsformany

commodities,evenimportantones,suchasgrains,arenotlargeenoughrelativeto

overalleconomicactivitysuchthatasupplyshockwillhavemacroeconomicimpact

thatcanaffectfinancialmarketsandcreditconditions.Thislimitsthepotentialfor

adversefeedbackloops.

Onepotentialexceptionisoil.Severalpeerreviewedeconomicarticles

presentempiricalevidencethatadverseoilsupplyshocksmaycause

macroeconomiccontractions,althoughitshouldbenotedthatthisevidenceis

somewhatcontroversialbecausethetransmissionmechanismisnotwell

understood.Moreover,evidenceforsuchalinkpost‐1991isweakerthanforthe

1970sand1980s.19

Economiccontractionsalsotendtocausedeteriorationsincreditmarket

conditions.Thus,thereisapotentialforfeedbacksinvolvingCTFsintheaftermath

ofanoilshock.Suchashockhasadirectadverseimpactontheprofitabilityofoil

tradingfirms(asjustdiscussed),butthemacroeconomicimpacttendstoreducethe

demandforcommoditiesgenerally,andthecreditmarketimpacttendstoraise

fundingcosts.Theseeffectsaffectcommoditytradingbusinessesmorebroadly,

withpotentialknock‐oneffectsincommoditytradingvolumes.

Thissuggeststhatamajoroilsupplyshockispotentiallyasourceofriskto

CTFsgenerally,andviathem,commoditytradeandaggregateeconomicactivity.

Theseverityofthisriskdependson(a)theprobabilityofoilsupplyshocks,and(b)

theeffectofoilsupplyshocksonaggregateeconomicactivity.

Oneconsiderationoffsetsthis.Largesupplyshocksoftendisruptestablished

marketingchannelsandsupplychains.Thisincreasesthedemandforfirmslike

CTFsthatspecializeinmatchingbuyersandsellers,andwhohavespecialized

knowledgeonthecapabilitiesofproducersandthelocationsofsupplies,andthe

needsofbuyers.Relatedly,largesupplyshocksoftenresultinlargeandsometimes

temporarychangesinrelativepricesacrossspace,time,andvariety:CTFsspecialize

19EvidenceontheconnectionbetweenoilshocksandUSeconomicactivityissummarizedinJamesHamilton,OilandtheMacroeconomy,inS.DurlafandL.Blume(eds.)NewPalgraveDictionaryofEconomicsandtheLaw(2008).InternationalevidenceispresentedinRebecaJiminez‐RodriguezandMarceloSanchez,OilPriceShocksandBusinessCyclesinMajorOECDEconomies(2008).Thereissomeevidencethattheimpactofoilpriceshocksoneconomicactivityhasdeclinedinthepasttwodecades.

inmonitoringrelativepricesclosely,andidentifyingcircumstancesinwhichrelative

pricesdivergefromtransformationcosts.Theycanthusprofitablyexploitrelative

pricevolatility.Thus,althoughreductionsinvolumesresultingfromsupplyshocks

tendtodepresstraders’margins,theincreaseddemandforintermediationand

relativepricevolatilitythataccompaniessomesupplyshockstendstohavean

offsettingeffect.

E. FSBCriteria

1. Introduction

TheFinancialStabilityBoardhasestablishedfivecriteriaforevaluating

whethernon‐bank,non‐insurer(“NBNI”)firmsaresystemicallyimportant.They

are:size,interconnectedness,substitutability,complexity,andglobalactivities.I

havealreadyaddressedseveralofthese.Inowturntotheothers.

2. Size

TheFSBhasidentifiedassetsof$100billionasasizethresholdindicating

possiblesystemicimportance.Onlyonecommoditytraderexceedsthatthreshold.

TheassetsofGlencore,thelargestcommoditytradingfirm,(whichhasevolvedinto

averyassetheavyminingfirm,morecomparabletoaRioTintoorBHPthanaVitol

orTrafigura,orevenanADM)totalslightlymorethan$150billion:priortoits

mergerwithXstrata,aminer,itsassetswere$105billion.IfCargill,thesecond

largesttradingcompanyintermsofassets,werepubliclytradeditwouldrank

approximately450thintermsofassets.Comparingjusttomajorbanks,Glencore’s

assetsareapproximatelyequaltothe50thlargestbank(byassets)intheworld.

ThebanksofsimilarsizeincludeBankLeumiandBankHapoalim,hardlyhousehold

namesoutsidetheirhomecountries.Cargilliscomparableinsizetothe65thlargest

bankintheworld.

FocusingonSIFIs,themedianEuropeanSIFIbankhasassetsof$1.3trillion,

andthemedianUSSIFIbankhasassetsof$1.18trillion.Thus,mostbanksthathave

beendesignatedasSIFIshaveassetsthatareanorderofmagnitudelargerthanthe

largestcommoditytradingfirms,andtwoordersofmagnitudelargerthanmost

commoditytradingfirms.Thus,thefinancialdistressofeventhelargestcommodity

tradingfirm,orevenseveralofthem,wouldbeunlikelytohavethesamedisruptive

impactonthefinancialsystemasthecollapseofamiddling‐sizemajorbank,let

aloneabehemothlikeDeutscheBankorJPMorgan.20

3. Substitutibility

TheFSBstatesthatanentityismorelikelytobesystemicallyimportantif“it

isdifficultforotherentitiesinthesystemtoprovidethesameorsimilarservicesin

aparticularbusinesslineorsegmentintheglobalmarketintheeventofafailure.”

Severalfactorsaffectsubstitutability,includingtheconcentrationoftradingfirmsin

agivenmarketsegment,theredeployabilityofafirm’sassets,andtheextentto

whichatradingfirmextendscredit.Iconsidereachinturn.

Inthelargestandmostsystemicallyimportantcommoditysectors,no

tradingfirmhasaverylargemarketshare,meaningthatthelossorimpairmentofa

particularfirmwouldreducetransformationcapacityonlymodestly.Forinstance,20InJanuary,2014theFSBproposedtouseanassetvalueof$100billionasathresholdtodeterminewhetheranon‐bankfinancialcorporationshouldbedesignatedasaSIFI.Sincesuchcorporationstypicallyhavefarmorefragilecapitalstructuresthancommoditytradingfirms,andsincemostcommoditytradingfirmshaveassetslessthan$100billion,bytheFSBcriteriaeventhelargestcommoditytradingfirmsarenotSIFI.

inthecrudeoilmarket,thelargestandsystemicallymostimportantcommodity

sector,twoofthelargesttraders(VitolandTrafigura)eachaccountforabout6

percentoffreelytradedoil.Glencoreaccountsforapproximately3percent,and

Mercuria3percent.21ConcentrationsaresomewhathigherinmetalsGlencore

tradesabout60percentoffreelytradedzinc(althoughtheterminationofitsoff‐

takeagreementwithNyrstarundertermsimposedbytheEuropeanCommissionto

secureapprovalofitspurchaseofXstratareducedthisconcentration);50percentof

freelytradedcopper;and22percentoffreelytradedaluminum.22Thecompany

alsoaccountsforalargefraction—approximately28percent—oftheglobalthermal

coaltrade.Thus,thenon‐ferrousmetalsmarketsaremoreconcentratedandhence

moresusceptibletoasingletradingfirm’sdistress,thantheoilmarket.

Itisimportanttonotethatconcentrationissmallincommoditiesthat

representarelativelylargefractionoftrade,andthatthemarketsinwhich

concentrationissometimeslargerepresentverysmallfractionsoftrade.For

instance,dependingontheregion,oilrepresentsbetween3and10percentof

imports.Thisisanappreciablefraction,butconcentrationinoiltradingisquitelow,21Thesefiguresarefromreportsonthesecompanies’websites.22ThesefiguresarederivedfromGlencore’sIPOProspectus.Glencoreutilizespubliclyavailabledataanditsownestimatestodeterminethe“addressable”quantities“thatareavailabletoathirdpartymarketersuchasGlencore.”Forinstance,commoditiesproducedandconsumedbyaverticallyintegratedfirmareexcludedfromthecalculation.DomesticChineseproductionisalsoexcluded,asarevolumessolddirectlyfromaproducertoanend‐userwithoutuseofanintermediary.Asanexample,whencalculatingitsshareofthermalcoaltrade,Glencoreutilizesseabornevolumeof692millionMT,outofatotalworldoutputof4,556mMT.The“addressable”marketistypicallyfarsmallerthantotalglobaloutput.Basedontotalglobaloutput,Glencorecalculatesitsmarketsharetobe13percentforzinc,10percentforzincconcentrates,7percentforcopper,4percentforcopperconcentrates,8percentforalumina,9percentforaluminum,and4percentforthermalcoal.Glencoreconsidersthetotaloilmarkettobeaccessibletotraders.

withthelargestfirmshandlingonlyaround6percentoftrade.Incontrast,other

commoditiesrepresentmuchlessthanonepercentofimports(orexports),meaning

thatevenifoneofthedominantfirmsinaconcentratedmarketweretodisappear,

thepotentialeffectonoveralltradeandeconomicactivitywouldbetrivial.This

conclusionisreinforcedwhenoneexaminestradeincommoditiesasafunctionof

GDP:evenoilimportsarelessthan2percentofGDPforallregionsexceptAsia,

wheretheyarelessthan3percentofGDP.

Thismeansthatthefailureofacommoditytradingfirmisunlikelytodisrupt

severelythetradeinanymajorcommodity.

Thisconclusionisstrengthenedbythefactthatthefinancialdistressofa

commoditytraderdoesnotlossinthelossofitstransformationcapacitybecauseits

assetsarereadilyre‐deployable.Muchofthephysicalandhumancapitaldeployed

incommoditytradingishighlyre‐deployable.Intheeventofdistressofatrading

firm,itsphysicalassetsandemployeescanmovetootherfirms.Moreover,

insolvency/bankruptcylawsgenerallyfacilitatethecontinuedoperationof

financiallydistressedfirms,sotheycancontinuetoprovidetransformationservices

evenwhileinfinancialdistress(althoughperhapslessefficiently,dueforinstance,

tohighercostsoffunding,thelossofskilledemployees,andpoorincentives).These

factorslimitthedurationoftheimpactofthefirm’sdistress.Whileredeploymentis

occurring,orifafirmoperateslessefficientlywhileinbankruptcy,customersofthe

distressedfirmwillbeadverselyimpacted.Thiseffectwillbemostacuteifthe

distressedfirmhasalargeshareofforaparticularcommodityorgeographicregion.

However,sincesuchconditionsaremostlikelytooccurforsmaller‐volume

commoditiesandregions(becausethereislessconcentrationinthetradeofmajor

commoditiesinmajormarkets),thebroadersystemicimplicationsofsuch

disruptionswillbeminor.

Onereasonthatbankfailurescanbesystemicallycatastrophicisthecentral

roleofbanksinthesupplyofcredit,andthefactsthattherearefewsubstitutesfor

banklendinggenerally,andthatsomeborrowersaredependentonparticular

banks.Ifbanksfail,orbecomefinanciallydistressedinlargenumbers,theyreduce

theamountofcreditthattheysupply,whichreducesinvestmentandconsumption

(especiallyofdurablegoods)intheeconomy.Substitutibilityislimitedbecause

bankspossessborrower‐specificinformationthatcannotbetransferredeasily,or

utilizedefficientlybyafinanciallydistressedbankthatcannotobtainthefunding

necessarytoextendcreditatpre‐distressscale.23

Commoditytradingfirmsdoissuecredittocommodityconsumersand

producers(intheformofprepays,forinstance),butultimatelythesourceofthe

bulkofthiscreditisbanks.Commoditytradingfirmscommonlypurchasepayment

guaranteesfrombankswhentheyextendcredittocustomers:inthecaseof

Trafigura,forinstance,approximately80percentofthecredititextendsisbacked

bypaymentguaranteesorinsurancefrombanks.Thus,banksbearthebulkofthe

creditrisk,andhenceareultimatelythesourceofcredit;thetradingfirmsare

basicallyconduitsbetweenbanksandcustomers.Totheextentthataparticular

tradingfirmhasacomparativeadvantageinservingasaconduittosomecustomers

(because,forinstance,itsknowledgeofthecustomers’businessallowsittomonitor23See,forinstance,BenBernanke,NonmonetaryEffectsoftheFinancialCrisisinthePropagationoftheGreatDepression,inEssaysontheGreatDepression(2000).

themmoreeffectively),thefirm’sfailurewouldimpairtheflowofcredittoits

customers.Buttherearealternativewaysofprovidingthiscredit(othertrading

firmscanstepinthebreach,orthecustomerscanborrowdirectlyfrombanks),and

thismitigatestheimpactofthefailureoftheindividualfirm.

4. GlobalActivitiesandComplexity

Commoditytradersobviouslyundertakeactivitiesinmultiplejurisdictions,

whichmeansthattotheextentthatthereareexternalitiesfromthefailureofa

commoditytradingfirm,theywillbewidespread.Onefactorthatdistinguishes

commoditytradersfrombanksdeservescommentinthiscontext,however.

Thefailureofalargeinternationalbanksopotentiallydifficulttoresolveis

thatthesefirmsareverycomplex,withsubsidiariesandaffiliatesoftennumbering

inthehundredsspreadacrossdozensofjurisdictions.Incontrast,althoughmost

majorcommoditytradingfirmshavesubsidiariesandoperationsinmultiple

jurisdictions,theytendtobemuchsimplerinstructurethanmajorbanks.This

facilitatestheirresolutionorrestructuringintheeventofinsolvency.

F. HistoricalExperience

1. Introduction

Theforegoinganalysiscastsseriousdoubtonthesystemicimportanceof

commoditytradingfirms.Historicalexperienceprovidesfurtherreasonstodoubt.

2. LargeCommodityTradingFirmsHaveSufferedLargeLosses,andSometimesFailed,WithNoSystemicEffects

Therearefew,ifany,instancesinwhichthedistressofalargefirminthe

aftermathofalosssufferedbythatfirmhasmetastasizedintoafinancialcrisisthat

threatenedotherfirms:indeed,therearemanyinstancesoflargelossesthatdidnot

resultinspillovers.Incommoditiesinparticular,largelossesatFerruzzi($4

billion),Metallgesellschaft(over$1billion),Sumitomo($2billion),Constellation(a

$10billionlossinmarketcapitalization),orAmaranth($6billion)didnothave

broadersystemicconsequences.

ThebankruptcyofEnronin2001isparticularlyillustrative.Eventhoughthe

firmwasthelargestparticipantinNorthAmericangasandpowermarkets,andthe

counterpartytomyriadderivativesandphysicaltransactions,itsbankruptcydidnot

resultinacascadeoffailuresamongitscounterparties,orthecounterpartiesofits

counterparties.24

3. TheMeltdownoftheMerchantEnergySectorintheUSHadNoSystemicConsequences

IntheimmediateaftermathofEnron’sfailure,themerchantenergysectorin

theUnitedStatesunderwentacrisisin2002.Therearesomesimilaritiesbetween

GCTFsandmerchantenergycompanies.Merchantenergycompanieswereinthe

businessoftransformation.Theirtransformationsincludedprovidinglogistical

servicesmatchingcommoditysupplyanddemand,e.g.,assemblingportfoliosof

naturalgassupplyandportfoliosofnaturalgasconsumers.Theyalsoincluded

transformingfuels(gasandcoal,primarily)intoelectricity.Theyalsoviewed

themselvesasbeinginthebusinessofprovidingriskmanagementservicestotheir

suppliersandconsumers.Theywere,inessence,commodityintermediaries,justas

GCTFsare.24ThemerchantenergysectorinwhichEnronoperateddidexperienceextremedistresssomemonthslater,asdiscussedbelow.Thiswastheresultofadversemarketconditionsaffectingtheentiresector,ratherthanacounterpartycontagionbeginningwithEnron’sdemise.

Themerchantenergymodelwasborninthelate‐1980s,boomedinthe

1990s,andcollapsedignominiouslyin2002.Theinitialharbingeroftheindustry’s

demisewasthecollapseofEnroninlate‐2001,butEnron’sfailurewasinlargepart

duetofailuresinnon‐energyventures.Beginninginlate‐April,2002,therestofthe

sectorunderwentaprecipitouscollapse.From25April,2002throughtheendof

Mayofthatyear,theequityvaluesofaportfoliooflargeenergymerchantsdeclined

byapproximately91percent.Thecreditratingofeveryenergymerchantfirmwas

downgraded.Manyfirmsexitedthebusiness,andoneprominentfirm(Mirant)

declaredbankruptcy.

Theimplosionoccurredbecauseenergymerchantfirmswereexposedtoa

narrowsetofcommonrisks.Inparticular,merchantenergyfirmswereallexposed

to“sparkspreadrisk”:theywereall,toonedegreeoranother,shortfuel(primarily

gas)andlongpower.Whensparkspreadscollapsedduetoacombinationof

economicweaknessintheUSpost‐911andamassiveincreaseingeneration

capacitythathadbeenbuiltinanticipationofcontinuedstronggrowthinelectricity

demand,allofthefirmsinthesectorwereadverselyaffected.

Althoughmerchantenergyfirmsweredevastatedbythecollapsein2002,it

isimportanttonotethat(1)therewerenoknock‐on/contagioneffectswith

financialinstitutions,and(2)therewerenopronounceddisruptionsinthedelivery

ofphysicalenergy.Thiswasdespitethefactthatmerchantenergyfirmstendedto

berelativelyhighlyleveraged,andalsohadcreatedavarietyofshadowbankinglike

liabilities.25

Thelossesinthesectorweresubstantial:thelossinequitymarket

capitalizationwasapproximately$100billion,andinadditiontherewere

substantiallossesonthedebtofthesecorporations.(Indeed,thesefirmswere

highlyleveraged,generallymorehighlyleveragedthantheGCTFsforwhich

informationisavailable.)Buttheselosseswereborneprimarilybyrealmoney

investorsratherthanleveragedandsystemicallyimportantfinancialinstitutions.

Duringandafterthecollapse,assetsandcontractswererepriced,andeither

transferredtosolventownerscapableofoperatingtheassetsandperformingon

contracts,oroperated/performedonbyrestructuredenergymerchantfirms.

Indeed,someassetsandcontractswereacquiredbyfirmsoutsidethemerchant

energysector;largefinancialinstitutions,includingsomeSIFIs,tookoverportions

ofmerchantenergyfirm’sactivities.Thisillustratesthatsubstitutabilityoperates

onaneconomicallymeaningfultimescaleincommodities,andthatinassessingthe

degreeofsubstitutability,itisnecessarytoconsiderfirms(mostnotablylarge

financialinstitutions)outsidethespecificcommoditytradingsectorunder

consideration.26Thus,alargefinancialdisruptiontoanimportantgroupoffirmsin

25Forinstance,EnronandDynegyusedprepaidswapstructuresandspecialpurposeentities.Indeed,anannouncementthattheSECwasinvestigatingtheaccountingofoneofDynegy’sprepaidswapandSPEstructuresinitiatedthecollapseofmerchantenergystockprices.26Asanotherexample,ahedgefund(Citadel)andabank(J.P.Morgan)acquiredtheportfolioofthehedgefundAmaranthafteritsufferedlargetradinglosses.Similarly,theassetsandcontractsoffailedenergytradingfirmtheSEMGroup,wereacquiredbyfinancialinstitutions,mostnotablyBarclays.(Thetermsofthisacquisitionarecurrentlythesubjectoflitigation.)Inthisregard,itshouldbenotedthatrestrictions

thecommoditytransformationbusinessneednotresultinapronounceddisruption

intheflowofcommoditiesfromproducerstoconsumers

4. ALossofTransformationCapacityDoesNotNecessarilyHarmtheRealEconomy

Asnotedthroughout,oneoftheprimaryfunctionsofcommoditytrading

firmsistomaketransformationsinspaceandtime—logisticaltransformations.

Althoughtheforegoingsuggeststhatfinancialdistressdoesnotmateriallyreduce

transformationcapacity,eveniftheassetsutilizedbyadistressedtradingfirmto

makethesetransformationsarenotredeployedimmediately,theimpactonthe

broadereconomywillalmostcertainlybeminor.Recentexperiencedemonstrates

thatevenamajordisruptionofthelogisticalsysteminamajoreconomicregion

doesnotcauseanappreciabledeclineintheworldeconomy.Specifically,the

Japaneseearthquakeandtsunamiin2011wreakedmassivehavoconthesingle

mostimportanttradingregionintheworld,butthishadonlyverysmalleffectson

theworldeconomy.Thesenaturaldisastersseriouslydisruptedproductionat

numerousfirmsthatplayedacentralroleinglobalsupplychainsforhighvalue

manufacturedoutput.AreportpreparedundertheauthorityoftheDirectorate

GeneraloftheTreasuryofFranceconcludedthat:

Japanisakeyplayeringlobalproductionchains,particularlyinhigh‐technologysectors.Japanesefirmsaccountforover70%ofglobalproductioninatleast30technologicalsectors...Thetripledisaster,whichledtoanearly8%reductioninJapaneseproductsexportsinQ2,alsocaused

ontheabilityofcommercialbankstoparticipateincommoditymarketsreducessubstitutabilityandtherebyincreasescommoditymarketspecificrisk,andpotentiallysystemicriskaswell.Restrictionsonbankparticipationincommoditymarkets,whicharecurrentlybeingconsideredbytheFederalreserve,createtheriskoflimitingsuchremediesinthefuture.

disruptionstoglobalsupplyinsomesectors,particularlyinelectronicsandtheautomotiveindustry.

JapanalsoplaysakeyroleinAsiantradewhereproductionchainsarehighlyintegrated.Schematically,JapansuppliessophisticatedintermediategoodstoandbuysfinalgoodsfromitsAsianpartnersincludingChina,thepivotofthenewinternationaldivisionoflabor,whichperformsassemblyandtransformationofthesemi‐finishedproducts.Giventhenetworkstructureofproductionprocesses,ashockaffectinganupstreamproducercancausestrongfluctuationsintheeconomyasawhole,throughcascadeeffectsfromonefirmtoanother.27

Nonetheless,theFrenchTreasuryconcludedthattheeffectofthe

catastropheonaggregateoutputwassmall,eveninAsia.Itestimatesthattheeffect

was.1pointofGDPinChinaand.2percentagepointsforother“Asiandragons”in

Q22011.Furthermore,itconcludedthat“theimpactisverylow”inEuropeandthe

US.Furthermore,itfoundthat“virtuallyzero”impactforthefullyear2011,

becauseofthe“restorationofbothJapaneseproductioncapacityandglobalsupply

chains.”

TheIMFJapanSpilloverReportalsofoundthattheeffectsoftheearthquake

weremodest(outsideoftheautomobileindustry)andshortlived(evenintheauto

sector).28

TheJapanesenaturaldisastercausedthedestructionofproductioncapacity.

Theaffectedcapacitywasanessentialelementofacomplexsupplychaininhigh

value‐addedindustries.Evenso,thespillovereffectsofthisdestructionweresmall

andfleeting.Thisdemonstratestheresilienceofeconomicactivitytothedisruption

oftrade.

27TheimpactofJapan’searthquakeontheglobaleconomy.Tresor‐EconomicsReportNo.100(2012)28InternationalMonetaryFund:JapanSpilloverReportfortheArticleIVConsultationandSelectedIssues(2012).

Thefinancialdistressofatradingfirmwouldnotresultinthedestructionof

anyproductiveassets(althoughitcouldimpedetheefficiencyoftheiruse);the

assetswouldbeavailabletoberedeployed,oroperatedbythosewhocontrolthe

distressedfirm.Nosinglefirm,orevenmultiplefirms,isascriticalintheglobal

supplychainforlarge,highvalueaddedindustries(suchasautosandelectronics)as

theJapanesecompaniesaffectedbytheearthquakeandtsunami.Thus,theeffects

onthebroadereconomyofthefinancialdistressofalargecommoditytradingfirm,

orevenmultiplefirms,wouldalmostcertainlybesmaller,andshorterlived,than

thesmalleffectsofthesenaturaldisasters.

V. SummaryandConclusions

Globalcommoditytradingfirmsplayanessentialroleinfacilitatingtheflow

ofvitalcommoditiesfromproducerstoconsumers.Theirimportanceintheglobal

commoditytrade,andtheimportanceofcommoditytradingtothebroader

economy,makeitvitaltounderstandtherisksthatthesefirmsposetothebroader

economy,andthepotentialthatmacroeconomicdevelopmentscandisruptthe

abilityofthesefirmstocarryouttheirintermediationfunction.

TounderstandthesystemicimportanceofCTFs,itisessentialtorecognize

theirbasiceconomicfunction:totransformcommoditiesinspace,time,andform.

Thesetransformationsaredifferentincrucialwaysfromthematurityandliquidity

transformationsthatsystemicallyimportantfinancialinstitutionsundertake.The

typesoftransformationsCTFsperformaremorerobustthanthosethatSIFIs

undertake,implyingthatCTFsposelesssystemicrisk.

Table1TotalAssets/BookValueofEquity

ArcadiaEnergy 17.51ADM 2.39BPInternational 5.32Bunge 2.51Cargill 2.37E.OnGlobal 111.07EDFTrading 4.56EniT&S 35.09Glencore 3.08LouisDreyfus. 3.74Mercuria 84.16NobleGroup 3.80Olam 4.02ShellTrading 12.09Trafigura 7.94Vitol 4.00Wilmar 2.76

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Figure 1Nominal Exports by Commodity 2001=1.00

20000000

40000000

60000000

80000000

100000000

120000000

140000000

160000000

180000000

200000000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Figure 2Nominal Exports Ex. Oil, Steel

50000000

100000000

150000000

200000000

250000000

300000000

350000000

400000000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Figure 3Deflated Exports 2001-2011

20000000

40000000

60000000

80000000

100000000

120000000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Figure 4Deflated Exports Ex. Oil, Steel

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