Have Large Commodities Trading Houses Become Too Big to Fail?

on Oct 10, 2012
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It would seem that large commodity traders such as Glencore (LON:GLEN, HKG:0805) have been fuelling worries among regulators, with the Financial Times reporting on 9 October 2012 that trading houses may have become so big and influential to markets that policymakers cannot let them collapse. Concerns about large trading companies were recently addressed in a speech by Timothy Lane, deputy governor of the Bank of Canada.

**Role of Commodities Trading Houses**
As noted in the FT article, big trading houses underpin global trade in raw materials by means of buying commodities from producers, transporting them and selling them to consumers, meaning that the collapse of a large trading house could for instance seriously damage global economic activity by disrupting the supply of raw materials. Commodity houses also play an important role in extending credit to producers such as miners and farmers.

In addition, as their business model changes, commodity traders move from a “middlemen’s role”, to vertically integrated groups, with the Glencore’s proposed merger with miner Xstrata (LON:XTA) being indicative of this new trend.
**Bank of Canada Warning**
Concerns about large commodities trading houses were articulated by Bank of Canada’s Mr Lane in his speech before the CFA Society of Calgary at the end of September. Speaking about the relationship between commodity markets and the financial system, Mr Lane noted that it was worth asking whether the losses incurred by a trading house, or the failure of a house would have a significant knock-on effect on the financial system as a whole.

>!m[](/uploads/story/553/thumbs/pic1_inline.png)“Just as the 2008 financial crisis revealed the need to assess the systemic importance of institutions that play a central role in particular financial markets, we should be asking the same questions about institutions that are interconnected with various commodity markets,” pointed out Mr Lane in the speech, published on the Bank of Canada website.

**Trading Houses Becoming “Systematically Important”**
In his speech, Mr Lane commented that the increasingly prominent role played by both large commodities trading houses and the physical trading operations of some large investment banks raised the possibility that some of those institutions were becoming “systematically important”.
Although Mr Lane did not name the companies he had in mind, he did note that a “wave of mergers and acquisitions” was “sweeping the commodity-trading sector,” with that remark being interpreted as a reference to the Glencore-Xstrata merger.

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**Regulator Concern**
As noted in a recent Reuters article, Mr Lane is among the first to suggest that some of the commodity market’s most active players may have become so important that they may benefit from the tougher scrutiny applied to the world’s biggest banks. Since the 2008 financial crisis which revealed that global banks were too big to fail, regulators have been imposing stricter rules on the banking industry such as a tougher set of standards for banks designated as being “systemically important”.
The FT reports that regulators admit that they know little about commodities trading houses, and particularly about their balance sheets. It would be interesting to observe if and how this concern will translate into policy action.
“A number of big institutions, the systemically important potentially large commodity trading houses that I talked about are mostly not Canadian,” Mr Lane commented in remarks following his speech, as quoted by Reuters. “They’re operating in an environment globally where interest rates are expected to remain very low for a long time. And that environment is one that involves the build up of risk.”

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