Commodities house of the year

Bharath Manium

Barclays

Barclays set itself apart from the commodities crowd once again this year, impressing clients with its range of solutions and providing innovative answers to the investment and hedging challenges faced by strategists and fund managers.

This year's innovations from Barclays included its first option on the spread between aluminium and the cost of energy used for production, which was a bespoke solution created for a European aluminium smelter. Launched in February 2012, the trade worked by allowing the client to lock in the ratio of its power costs relative to aluminium revenue for the first year, by buying physical power and selling a swap on aluminium. For a further year, the client was then able to improve the level by selling an option on the same ratio for the following year, for a total notional amount equivalent to 10% of their production.

"Clients' business models are extraordinarily complex. For aluminium, for instance, how they sell and buy each contract is different, with different risks and nuances. This creates an opportunity. If you can solve the problem you can monetise in the real business," says Bharath Manium, managing director for commodities structuring at Barclays in London.

"As well as investing in innovation, we also invest a lot in education and research. Innovation itself is worthless unless it's communicated," says Manium. At the end of March, the bank's eighth annual conference, held in London, attracted around 300 existing and prospective clients, from a range of sectors, including pension funds, private banks, hedge funds and asset managers. "We organise similar seminars in New York every year," adds Manium.

In a further bid to inform clients about movements in the commodities market, Barclays produces a suite of 14 publications and reports covering the fundamentals of the energy, metals and agricultural markets, and an analysis of investment flows. These circulate to more than 12,000 clients.

These in-house strategy documents proved particularly useful when providing quotes to a Germany-based commodity fund manager at a major European bank that has Barclays as one of its main partners. "Barclays tends to be very flexible in respect to our requirements for structured products and over-the-counter commodity derivatives, and we run a number of funds where we use it as a swap counterparty as well. It tends to be quite responsive to our needs," he says.

Another key trade for the commodities derivatives team this year was to find a solution for a European bank that had exposure to the Thomson Reuters/Jeffries CRB Commodity Index and the negative roll yield that came with it, leading to underperformance. The problem was that this is not a common index, the implementation of the investment was relatively costly and it was not a Ucits fund.

The technique used to mitigate these problems was based on the optimum roll yield methodology, first used by Barclays in October 2008. It aims to invest along the curve where the roll yield is most favourable, in a bid to offset the effects of negative roll yield. The trade used the same weights as the CRB Commodity index, which created a better beta strategy, while the custom index was given a Ucits IV wrapper. "We solved all of those [problems] in one shot and managed to engineer a
low-cost solution to make it Ucits compliant. It was less simple in terms of the rolling mechanism, but still managed to track the same benchmark," says Manium.

The Barclays commodities structuring team worked out a swap using the client's illiquid positions in local currency bonds for an allocation in gold, which is eligible as an asset in its central bank reserves. "Working around the central bank regulations was a challenge for us, and to take account of the regulator's view on what assets are eligible we had to work closely with emerging markets colleagues to agree on pricing," adds Manium.

Impressed by all aspects of the UK bank's commodities franchise, Citadel Asset Management in South Africa deals solely with Barclays. "It the widest product range and applies the most resources, especially in the commodities space," says George Herman, senior strategist at Citadel in Pretoria. "The research that comes from them is phenomenal. They have a lot of client interactions here in South Africa, as well as several conferences, and their processes are very transparent," he says.

Citadel often provides clients with bespoke solutions created in partnership with Barclays. "The biggest problem is often buying straightforward beta in the commodities space," says Herman. "This isn't as simple as it sounds, because often, participating in the derivatives markets if they are in severe backwardation makes owning the front contact exceptionally expensive. [You need] smart strategies to gain Beta exposure."

Citadel uses several suppliers to source its structured products, but reckons Barclays is "head and shoulders above the rest in commodities". The relationship has been in place for about 10 years.