Traders are taking more risks to save money

Several top banking regulators in the world have warned that some cash-strapped commodity traders have begun hedging less since last year's unprecedented market turmoil - a technique that could leave them more vulnerable to price spikes in the future.

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According to the Financial Stability Board, which investigated the ructions in global commodities markets that followed Russia's invasion of Ukraine, the widespread use of leverage caused some physical traders to face liquidity stress as prices jumped because of all the leverage used. Members of the board include representatives from the Federal Reserve and the European Central Bank. 

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There have been calls for a closer regulatory examination of the role that physical traders play in the global financial system as well as the risks they pose to it as a result of the upheaval in energy, metals, and agriculture markets. As the FSB stated last year, traders faced huge margin calls in recent years, and this warranted particular attention on their part. 

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With the exception of nickel, the commodity markets continued to function despite the price surges in the market on Monday, according to the agency. There are, however, ongoing concerns regarding traders' extensive use of leverage and the sector's ability to withstand further bouts of volatility, which the group has called for monitoring. 

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"The purported reduction of the amount of hedging activity, along with the possibility of the quality of those hedges being reduced, can be seen as an increase in the level of market risks associated with commodities," the report stated. “This could reduce the resilience of commodity traders' and producers' balance sheets because they could become more vulnerable to losses that may occur due to fluctuations in the price of commodities as a result of this.” 

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There has been a sharp decline in prices during the last year, but some traders in Europe seem to have been cutting back their hedging activity in an effort to reduce the amount of collateral they need to backstop their trades, according to the group.

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Over-the-counter derivatives are also becoming more popular in place of exchange-traded contracts.

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FSB also said that the investigation had been hindered by a lack of reliable data on some key aspects of the commodities markets, including trading in OTC derivatives and the precise funding needs of large physical traders, which hampered its investigation. As part of the panel's recommendations, the relevant authorities were encouraged to make better use of existing data and examine ways to address the market's underlying opacity. 

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It also offered insights into areas of the industry that are notoriously hard to probe, such as the extent to which banks are involved in the markets, according to the report. Among the key sellers of oil, natural gas, and wheat were Goldman Sachs Group Inc., JPMorgan Chase & Co., BNP Paribas SA, Morgan Stanley, and Societe Generale SA, along with specialist commodity brokerages such as Marex Group Plc and ADM Investor Services Inc. 

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A study conducted by the Financial Services Board (FSB) of about a dozen large trading houses, revealed that Trafigura Group had an asset-to-equity ratio that was more than double that of most of the firms in its peer groups and that it was the second-highest reliant on short-term debt after GrainCorp Ltd., an agricultural trading company.

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“Commodity traders often choose to keep little liquidity while trading physical commodities, which is a balance sheet intensive activity.” The FSB said.