When Bank of China International decided to set up its commodities business seven years ago, it believed it could succeed in the market by leveraging the bank’s wider client base. As markets became more challenging for players across the industry, those roots have anchored the business, allowing it to weather the rougher seas.
“We already had very strong strategic relationships and deep understanding of our Asian client base, from credit in commercial banking to mergers and acquisitions, and bond issuance in capital markets,” says Kng Hwee Peng, head of energy trading, Singapore, at BOCI. “Headquartered in Asia with strong local presence and commitment from senior management, we have a clear competitive edge in servicing our Chinese clients, and this distinguishes us from our western competitors who have been dominating the commodities space.”
However, it is the firm’s ability to deliver product based upon those relationships that has made it stand out. Many end-users are looking for crude hedging, and as the number of refiners in China increases, banks have to both support their hedging needs and provide education for firms in order to understand how the hedging market works.
For more sophisticated firms, these transactions can become more complex, requiring BOCI to innovate. For example, when one of the largest crude oil importers in China asked the bank for support with an oil repurchase agreement, BOCI proposed and executed a highly sophisticated, bespoke transaction. The deal set the standard for the bank, which has taken part in a number of similar transactions.
“The repo transactions we conducted are quite different from those done by our industry peers,” says Raymond Lau, chief operating officer of BOCI Global Commodities. “They typically provide repo for cargos on oil tankers, but we have accepted inventories in Chinese onshore warehouses at our clients’ facilities. Based on a strong understanding of our clients’ operations, we are able to tailor-make more flexible financing solutions.”
However, this poses a particular challenge to many banks, which have limited experience in handling physical cargoes and the environmental, transportation and storage risks that entails.
“As we have a long-standing relationship with these clients and a strong commitment to serve them, we managed to structure these trades such that we transfer part of the operational risk into credit risk,” says Lau.
There is no physical movement of the oil, but there is a legal transfer of ownership, which would make the bank liable for operational risks. However, through the use of an insurance policy and total direct loss transfer, by way of the risk transfer terms as stipulated in a side letter, operational risk is limited to booking the repo transaction.
The bank also trades across the barrels in the over-the-counter swaps market to help clients in the price discovery process across crude, distillates, fuel oil, mogas and other light end-products, while also dealing in cross-product differentials such as gasoline/fuel and gas oil/fuel to support customer hedging requirements. Because of the large volumes that can be involved in these orders, they test the bank’s ability to handle large-scale trades and limit information leakage. To handle this workload requires dedicated personnel.
Being able to work both with domestic and international exchanges has been critical to BOCI because of the range of products and services it provides to clients.
“The ability to innovate and stay on top of new product developments across the domestic and global markets – and to work seamlessly between the two – will continue to drive the growth of our business,” says Arthur Fan, global head of commodities at BOCI.
Looking ahead, Fan sees a great deal of potential in a renminbi-denominated crude oil benchmark, which looks set to launch on the Shanghai International Energy Exchange sometime in the not too distant future.
“We have been working closely with the INE in Shanghai regarding the upcoming oil futures contract for quite a few years,” he says. “We will be in a good position to participate and structure solutions for our clients on this. Combining our deep understanding of the Chinese domestic market and our comprehensive international platform, we aim to bridge the gap, so as to provide foreign participants with better insight into the Chinese onshore market and vice versa. I believe this will be a key area not just for the energy sector, but for the commodities market as a whole.”