Banking on Commodities


“A distinguishing feature of the commodity markets is the broad range of types of participants, from universal banks to specialist commodity firms. There have always been ebbs and flows in the


prominence of differing segments of market participants and, currently, the trend is towards a decline in the activity of the banks and a rise in the role played by commodity trading companies.”


David Lawton, Director of Markets, Financial Conduct Authority


WESTERN BANKS ARE under pressure from US and European politicians – as well as consumer lobbies and NGOs – to part with their commodity operations, following complaints of inflated prices and market manipulation. Many are already doing so in the face of increased regulatory and capital pressure. Much of this stems from the US Federal Reserve “reviewing” a landmark 2003 decision that first allowed regulated banks to trade in physical commodity markets. Following the Great Recession,


the pendulum


has swung from a hands-off approach to banking regulation. And Wall Street banks particularly are responding to heightened scrutiny from banking regulators and politicians, as well as increased financing and capital costs. With many heralding the end of the current commodity supercycle many banks may just be changing their strategies, retrenching or retreating altogether from the sector. “... sentiment-driven and largely directionless


markets, alongside declining client interest, has seen total revenues for the leading ten commodities investment bank businesses across the globe fall to just below a third of their peak, from $14.1bn in 2008 to $4.5bn in 2013, with no foreseeable prospect of recovery,” the UK’s Financial Conduct Authority, said in its February report.1


... we have seen firms both completely exit the field and substantially reduce the scope of their activities


“At the same time, there has been a rise


in regulatory costs and risks associated with undertaking this business, as one of the asset classes most affected by regulatory change,” the report added, “This has translated into business model challenges and we have seen firms both completely exit the field and substantially reduce the scope of their activities, particularly moving away from physical activities ...” We have known for some time that leading US banks are looking to hive-off their commodity


24 March 2014


businesses. A number of European banks have followed. None of this will come as any surprise to commodity derivatives users. Several banks have scaled back or pulled out entirely from physical commodity markets over the past year or so – a move that some have attributed to new regulations – and industry participants have been warning about the affect this may have on market dynamics for some time. Accordingly, the headcount in commodities roles


within the leading ten investment bank businesses across the globe has fallen by over 20% – from 2,794 employees in 2010 to 2,176 in 2013.2 Morgan Stanley’s commodity net revenues fell 38% last year, a second straight annual drop, in what the bank described in its annual report to the Securities and Exchange Commission as “challenging market-making conditions.” Banks like JPMorgan Chase, Deutsche and


Barclays have sold or shuttered some or all of their physical commodities operations. Deutsche announced it would pull out of energy, agriculture, base metals and dry bulk commodities last year, while retaining a presence in financial derivatives and precious metals – although in January it also announced the bank’s withdrawal from the panels setting the gold and silver fixings. But Morgan Stanley and Goldman Sachs have indicated they still see opportunities in the sector. Goldman’s CFO reaffirmed in a January earnings call the bank’s intent to remain in the commodities trading business, deeming it “too important” to clients to exit. Morgan Stanley, once one of the most active bank


in physical oil markets recently sold the bulk of its physical crude oil trading operations to Russian oil giant Rosneft (although it still owns several power plants in the US and still trades power, gas and crude oil). Commodity powerhouse Goldman Sachs is still confident in retaining much of its physical presence in the sector, notwithstanding the possible sale of its metals warehousing arm. “During


the relentless in their


supercycle, many banks were pursuit


of growth in the


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