Banks struggle to adapt or survive in commodities – by Dmitry Zhdannikov (Reuters U.S. – November 5, 2012)

http://www.reuters.com/

LONDON – (Reuters) – Stick, twist or fold? Like card players, the top five banks in global commodities trade have reached the point where they must decide to hold strategy, adapt, or give up and get out.

The boom in resource markets that started 10 years ago attracted many big banks to trade oil, metals and agriculture, but the 2008 financial crisis forced a painful retreat and tighter regulation now means some banks may throw in the towel.

Decisions rest on whether the banks believe their business models can be changed to keep them sufficiently profitable under the rising oversight of regulators, after four years when their revenue from commodities was halved.

“The total wallet back at the peak was about $14 billion for the banking sector in commodities trading. I’d imagine this year it’ll be about $7 billion. There were 10-14 banks when it was at $14 billion, now there are really five relevant ones,” said David Silbert, who leads commodities trading at Deutsche Bank.

Deutsche, together with Barclays and J.P. Morgan, broke into the commodities arena in the last decade with acquisitions or aggressive growth to challenge established veterans Goldman Sachs and Morgan Stanley.

J.P. Morgan’s entry charge to the club was the $1.7 billion it paid to buy trading house Sempra and its infrastructure to store and ship oil and metals.

Today, the five banks control 70 percent of the commodities trading pot with the rest split between mid-sized players such as Credit Suisse and Bank of America/Merrill Lynch, the latter having fallen out of the top division since the financial crisis.

The halving of revenue is largely due to a regulatory crackdown on proprietary trading, when deals are done by banks for themselves rather than on behalf of clients. Regulators say banks should focus on serving the clients and helping the economy with credit.

Also taking a toll is the reduction of risk appetite for capital intensive businesses such as commodities because of stricter capital rules.

As a result, commodities business at banks is increasingly dominated by hedging of producers and consumers from sharp volatility, as well as sales of commodity-related indices to investors.

The proportion of physical trading is shrinking – especially dealing for the bank’s own books – which irks regulators. That is estimated to constitute one fifth of total flows today as opposed to four fifths five years ago, say traders.

A further drop would be hard for banks to swallow. They say they need the scale and depth in the fray of daily business to know markets and serve clients properly.

“In today’s volatile markets, knowledge and understanding of both the financial flows and the physical market fundamentals are vital,” Credit Suisse says about its commodities team.

Understanding physical markets without trading them is close to impossible, said Silbert, a U.S. gas trader in the 1990s, who joined Deutsche from Merrill Lynch in 2007.

“In commodities you don’t have a client business if you can’t allocate risk capital. As soon as we stop taking a point of view and stop participating in the market in that way, then we restrict the ability to help our clients,” he said.

FIGHTS

Banks argue they benefit commodities markets by improving transparency and helping producers and consumers to lower risk.

For the rest of this article, please go to the Reuters Canada website: http://www.reuters.com/article/2012/11/05/us-banks-commodities-idUSBRE8A40QC20121105

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