Is a behemoth commodity trader such as Glencore International PLC too big to fail? Bank of Canada deputy governor Timothy Lane is wondering.
"Could the failure of one of the large trading houses cause serious disruption in the commodities markets in which it played a market-making role?" Mr. Lane asks in a speech Tuesday to the CFA Society of Calgary. "Could the losses that trading house incurs through the positions it has taken in commodities have significant knock-on effects on the financial system? We are far from having answers to those questions, but they need to be addressed."
Mr. Lane didn't mention Glencore, or any other trading firm, by name. But he's clearly been spending some time wondering what a misstep by a trader of Glencore's size would do to the global financial system and commodity prices. The latter issue is especially important for Canada, where natural resource industries account for about a fifth of gross domestic product and about half of all exports.
The commodities business is changing. European banks used to underwrite up to 80 per cent of the trading of commodities globally, but now account for only 50 per cent, Mr. Lane said. U.S. and Asian banks haven't completely filled the void. That means it has become more expensive to trade commodities.
Trading houses are responding by changing their funding models, Mr. Lane said.
Some are going straight to capital markets for the first time: sales of investment-grade bonds by commodity companies are up 90 per cent from a year ago, and commodity-linked junk bonds have risen 40 per cent this year, according to Mr. Lane. Some also are participating in a "wave of mergers and acquisitions that has been sweeping the commodity-trading sector," Mr. Lane noted. (Glencore is attempting to buy miner Xstrata PLC, for example.)
The reason for Mr. Lane's concern that the biggest commodity traders could pose systemic risk is the "financialization" of commodity markets. Oil, wheat, copper and other commodities now trade in close correlation with stocks and bonds thanks to the explosion of exchange-traded funds linked to commodities.
That has allowed individual and institutional investors to participate in the commodity "supercycle" of the past decade or so. But it also means the financial system and commodities markets now are linked. Stressed credit markets now have the potential to affect commodity prices; commodity prices now have the potential to affect consumer confidence through portfolio wealth effects. And of course, commodity prices play an outsized role in determining a country like Canada's overall economic health.
Mr. Lane was not specific about where he intends to take his inquiry into the changing nature of commodities markets. But indicated the central bank will be watching.
"Given the importance of commodities to the Canadian economy, the Bank of Canada is monitoring these developments, with a view to safeguarding the economic wellbeing of all Canadians," he said.