Signs are emerging that global commodities are finally rebounding from multi-year lows seen last year.
Prices of agricommodities have recovered since the troughs of 2016, as India increasingly picked up the slack in Chinese demand, while gold rose to a one-year high in September due to growing geopolitical concerns, as well as expectations of a slower rate hike trajectory by the US Federal Reserve.
Meanwhile, global crude oil prices have remained stuck near the $50 mark over the past few months, as the production cuts initiated by oil exporters group Opec were counterbalanced by the threat of rising US shale output.
However, this recent short-term recovery does not change the fact commodities remain in a downwards cycle if viewed with a longer-term lens, forcing the likes of Morgan Stanley and JP Morgan to scale down their exposure to the sector. Barclays shuttered its energy trading business late last year, while in July, Goldman Sachs announced a wholesale review of its commodities business due to significantly poor results over the first half.
While many firms have reduced their exposure to Asia, Standard Chartered has remained at the forefront of innovation in the region, able to tap into new opportunities and take up market share despite continuing challenges in the commodities business. Its commitment to the region is underscored by the fact that, between July 2016 and June 2017, Asia accounted for 64% of the UK lender’s total commodities business.
Suppressed commodity prices means a greater emphasis on moving beyond traditional risk management techniques. To deal with this, the bank successfully helped consumers obtain better-than-market entry levels with structured derivatives and advised commodity producer clients to sell into attractive contango markets in order to lock in their forward margins.
“One of the unique things, and our compelling advantage, is our unrivalled ability to deploy on-the-ground resources to reach our clients in this region, as well as to serve our commodity clients across the full spectrum – base metal, energy, agriculture products, structured products, inventory finance – in most parts of Asia,” says the bank’s global head of financial markets commodities Cengiz Belentepe. “The focus has been on developing our relationship with clients to a point where they can leverage the bank’s considerable capabilities.”
Amid a challenging market environment, the bank has made strides in Asia thanks to strategic initiatives to increase its geographical footprint. Aside from adding new major clients in Japan and Australia, Standard Chartered has also expanded its commodity client base from core commodity companies such as miners and refiners to broader industries, such as infrastructure and transportation companies that have some exposure to commodities.
On the other hand, navigating an environment where the market foresees limited upside in commodities prices is a unique challenge in itself. “Take crude oil, for example. Broadly speaking, we are at the high end of the $40–$55 dollar range, but taking a multi-year view we are at the lower end of the price cycle and also on the corporate side,” says Belentepe.
Dronodeb Raychaudhuri, Standard Chartered’s regional head of commodity structuring, says the bank’s focus has been on increasing its product line-up based on the feedback of its clients.
“One important factor is the increase in the amount of new underlyings our clients have asked about in terms of a solution, particularly in the energy and soft commodities space. The latter in particular involves some exotic cashflows and risk management, and this is quite different from what we have seen in previous years,” he says.
To this end, Standard Chartered has made a concerted effort to enhance its capabilities. Over the past 12 months, it has broadened the range of underlyings it offers in the energy space, adding petrochemicals and middle distillates to the mix. It also developed numerous new underlyings and exotic payoffs on rubber, cocoa and canola in the soft commodities space.
Its status as a leading international participant on the Shanghai Gold Exchange has been a particular highlight. The bank was further aided by its gold importer status in China and its international risk management capabilities, enabling it to provide unique solutions to clients that may not be attainable elsewhere.
“We are active traders of base metal and bullion. We had a view that onshore China physical premium would be going higher given the strong demand. However, without a physical presence in China or membership of SGE it is difficult to express that. Standard Chartered’s solution allowed us to express this view,” says a senior executive for a major base and precious metals trader in Singapore.
In this deal, Standard Chartered, which has direct access to the Chinese gold market as an SGE member, was able to set up a mechanism to allow the client to seamlessly and efficiently access SGE prices. This allowed the client to obtain direct exposure to China gold premiums without the need for an onshore entity. Additionally, the trader was able to settle in the offshore renminbi market without being exposed to the settlement risk.
In another transaction, which also showcases the bank’s capability in the China gold arena, a large domestic precious metals consumer expressed interest in borrowing gold as part of its physical metalworking capital requirements. The company had excess cash in its offshore entity in Hong Kong and wanted to use this as collateral.
“Standard Chartered is an important participant on the SGE across both the main and international board. Combined with our ability to import gold bullion into China, we are able to generate innovative financing and hedging solutions for our clients. With Standard Chartered’s long and detailed understanding of the domestic markets and regulations, we are able to provide comprehensive coverage and effective solutions across various parts of the commodity risk management and financing cycle,” says Raychaudhuri.
One Chinese client, who used Standard Chartered to provide a security for an onshore loan, says, “The structure helped us generate cheaper onshore liquidity through the gold platform. The cash in our Hong Kong entity was used to secure the transaction while not losing the benefits of the higher deposit rates in Hong Kong.”
Standard Chartered also demonstrated its ability to innovate when providing bespoke financing solutions. In another deal, a leading international commodity trader with a significant portfolio of commodity repo transactions was looking for a way to unlock additional funds for working capital purposes.
In a regular repo transaction, the client would buy back the commodity by paying cash. But in this instance, Standard Chartered sold the commodity to the client with deferred payment terms. As part of this deal, the client provided Standard Chartered with a deferred letter of credit from another bank. By using its formidable distribution network, Standard Chartered was able to get the letter of credit discounted on a nonrecourse basis from third-party banks. Normally, Standard Chartered does not give any credit terms when selling commodities, but with this product it was able to give between three and six months of additional payment terms without any incremental credit risk.
“This kind of transaction has seen significant uptick in activity this year. By giving the letter of credit the client gets longer payment terms, which give them an advantage in their physical trading. For us, instead of taking the credit risk on the client, we are actually taking the credit risk of the bank that issues the letter of credit because it is a payment instrument,” says Raychaudhuri.
This transaction allowed the client to receive additional financing for their working capital at very competitive rates. Furthermore, since the financing does not require any additional credit lines or capital, it represented a scalable source of liquidity for the client, while at the same time allowing Standard Chartered to maintain significant balance sheet liquidity. “In aggregate, it is the combination of our abilities that allows us to undertake these transactions,” says Raychaudhuri.