WHOLESALE COMMODITY BROKERS
Commodity Markets – The Attraction for IDBs The reasons why commodity markets have been propelled into the
mainstream as a financial investment class are well documented. Just as importantly, the latest demand-driven cycle for commodities came at the same time as supply was stagnating. This was as a consequence of the lack of investment in projects throughout the 1980s and 1990s, limited access to resources, rising production costs, low R&D expenditures, high taxes, and shortages of specialised finance and labour among them. It also coincided with growing interest in alternative assets after the Dot-Com boom and stock market crash post 9/11, propelling commodity markets into the spotlight.
Investors (and speculators) began to re-assess their portfolio
allocations and trading strategies in search for alpha and diversification. The theoretical benefits of commodities also became lauded and better understood. Encouraged by the major investment banks and empirical research, money managers began to accumulate commodity assets and exposures on a scale never seen before in search of superior returns and protection against traditional assets. A new Super-Cycle in commodities was established – an asset class in its own right.
Once the preserve of ‘niche’ specialists, an army of new servants
has pushed this marketplace into the mainstream. Investment banks particularly foresaw many of these developments and began beefing- up their commodity operations and product offerings, developing new ways of gaining direct access to the commodity story. The number of commodity exchanges has also expanded, rolling out new and improved contracts for risk transfer and offering clearing and STP facilities.
At the same time, specialist providers of index products, exchange
traded products (ETPs), specialised commodity funds and trusts have also added to the clamour of providers now active in the sector. A new class of securitised commodity products has emerged offering easy access and enhanced investment, trading and risk management opportunities. And investment flows have accelerated at an unprecedented rate in the last decade.
The financial crisis has highlighted the need to better understand
and regulate risk in interconnected financial systems. Commodity price swings – together with a wide range of other variables including political, currency, transport, weather etc. – now require companies to protect their operating incomes as they strive to maintain competitiveness. They need to dynamically manage commodity price risks in the face of escalating relative input prices – with hedging costs a vital component of budgeting and inventory management.
The commodity sector, therefore, has become a ripe opportunity
for wholesale commodity brokers that provide ‘colour’ to the market, bringing liquidity, specialised services and cross-asset trading. They provide the essential conduit for information and prices in markets that are liberalising and moving to shorter-term pricing mechanisms. The emergence of higher growth markets – emerging economies and commodities – and the evolving regulatory environment presents both opportunity and risk for IDBs. The leaders remain committed to expanding their networks, geographies, technology and product reach as overall trading volumes increase and greater demands are made for automation and new workflow processes, including post trade services. At the same time, this also presents an opportunity for smaller players and electronic platforms.
16 June 2012
As a consequence, commodities as an asset class have a growing appeal to IDBs, proving lucrative rewards for the ‘middlemen’ of the markets. Indeed, their role remains pivotal in many commodity transaction management sectors, especially where standardised products don’t exist or where liquidity is limited. At the same time, IDBs have
benefitted from the strength of emerging markets and continuing turbulence in the world’s financial sector where volatility has increased across asset classes. This has manifested itself in the interconnectedness of markets with credit shocks continuing to be felt across assets, blurring the distinctions between them. Indeed, commodity investments (according to some) are no longer the portfolio diversifiers they once were as these markets have become just another element of the broader ‘risk on/risk off’ trade. What is now required by clients is a multi-product macro view of markets and one which IDBs like Marex Spectron have looked to seize. Earlier this year they appointed Dr. Guy Wolf as a macro strategist to complement a new sales desk offering cross-asset class research and execution.
This unwinding of longer-
term pricing mechanisms
...is the ‘sweet-spot’ for wholesale commodity brokers
For some IDBs (e.g. ICAP), commodity
markets are just one part of a full service ‘diversified business model’ with the aim of being the main infrastructure provider to the world’s wholesale OTC markets. Other IDBs take a more selective approach as ‘pure’ commodity market intermediaries. “We are commodity guys who came into the finance world,” explains Javier Loya, Chairman and CEO of OTC Global Holdings. For him, the market has been largely serviced by brokers from the finance world who don’t fully understand their underlying physical aspects. OTCGH’s partnership model brings together a pool of broker resources (18 firms at last count) under the holding company umbrella. It’s web- based hybrid EOXLive trading platform has seen growth of 25% year-on-year
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