Helps companies link market and financial intelligence to remain competitive

From the middle of the last decade, large banks world-wide got involved in business far removed from their traditional lending activity – trading in physical commodities.

Currently, these banks are retreating from this activity. The shift is empowering commodity trading houses to consolidate their control over supply chains for food, oil and metals.

Commodity traders are rapidly expanding from the traditional intermediary business model of buying and selling, where margins are very thin, to “asset-backed trading models”, where they are investing in production, processing, and logistics.

This new trend has been triggered because across the traditional commodity market, the competitive advantage from superior price information has largely disappeared, and to protect margins, the traders are seeking to own and operate physical assets and arrange an end to supply chain solutions. These supply chains provide unique profit pools.

Some traders are also venturing into territorial specialisation such as distribution system supply and operatorship which gives them unique access to exclusive and unpublished market information.

Integrated framework

By developing deep insights into all the fundamental value-drivers in a trading portfolio, an integrated framework is providing the radar to identify the market and credit developments to which the firm’s financial performance and liquidity are particularly sensitive.

As trading houses are investing greater amounts in industrial and agricultural assets, they are being forced to raise more capital from outside investors, which in turn is threatening the private ownership model, historically favoured by the industry. In some cases sovereign funds and para-statal agencies are investing in the large trading houses. A few traders are already publicly-listed companies while others are considering floats. A few of the companies are using hybrid strategies of tapping capital markets and simultaneously seeking strategic investors while maintaining the flexibility.

The asset-backed trading is a style of commodity trading which is used to seek and exploit market volatility in order to monetise the operational assets owned by the trading entity.

It views physical assets as portfolios of traded instruments. Today, companies are linking manufacturing excellence to market and financial intelligence to remain competitive. No doubt, it poses a challenge on the business process as well as on the IT landscape.

An asset-backed trading strategy consists of control over the production (e.g. mining, plantation), processing (e.g. extraction, refining) and logistics (warehousing, tankage, railway, shipping) along with control over physical commodity.

Along with an appropriate set of financial hedges not necessarily subject to physical risk, this contributes to margin through operating efficiency and flexibility, utilisation and turnaround. Taking all these together, it is intended to extract value from market price movements and add to the valuation of trading entities.

(This article was published on June 4, 2014)
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