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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.

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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

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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

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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

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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,

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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).

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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.

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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

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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.

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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.

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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.

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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

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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.

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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

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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.

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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

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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).

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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

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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.

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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

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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

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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).

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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

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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.

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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

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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.

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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.

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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

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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.

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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).

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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.)

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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

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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.

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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

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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

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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

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averagepriceequals1.00).Theimpactofthe2008‐2009financialcrisisismuch

lessnoticeableinthedeflatedexportsthanthenominalexports.Onlyironandsteel

exhibitsapronounceddip.Figure4presentsthedeflatedexportsforall

commoditiesstudiedexcludingoilandironandsteel.Thesesmallercommodities

donotexhibitapronounceddeclineindeflatedexports(aproxyforquantity)in

2009.

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

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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

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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),

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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

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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

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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.

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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

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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.

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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

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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.

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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.

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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

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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).

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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

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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.

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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

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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

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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.

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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).

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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.

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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   

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0

2

4

6

8

10

12

14

16

18

20

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

2001

=1.

00

Year

Figure 1Nominal Exports by Commodity 2001=1.00

0

20000000

40000000

60000000

80000000

100000000

120000000

140000000

160000000

180000000

200000000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

1000

US

D

Year

Figure 2Nominal Exports Ex. Oil, Steel

0

50000000

100000000

150000000

200000000

250000000

300000000

350000000

400000000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Def

late

d E

xpo

rts

(200

1=1.

00)

Year

Figure 3Deflated Exports 2001-2011

0

20000000

40000000

60000000

80000000

100000000

120000000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

2001

=1.

00

Year

Figure 4Deflated Exports Ex. Oil, Steel