Societe Generale’s (SocGen) closure of its commodities business is confirmation of a downward trend between large banks and the commodities market, say industry analysts and market participants.
“The share prices told you that SocGen were one of the worst performers over the past couple of years – earnings and profits going the wrong way, and the main culprit being very clearly the investment bank,” says Bloomberg intelligence analyst, Jonathan Tyce.
“The environment for revenues has not been what anyone thought it would do, including most analysts. We didn’t think that we would be here in early 2019, with the ECB probably telling us that rates in Europe won’t go north of more than about 10 or 20 basis points for another two years,” he says.
“If you look at the way the finance industry is positioning itself away from energy exposures and particularly the more traditional energy; oil, gas, and that sort of thing, and you look at the Goldmans, or Barclays that has been out of this business for four of five years – it’s been a bit of a trend that we have seen across the industry.”
On March 9, SocGen announced that it was closing down its over-the-counter (OTC) commodities business, and its proprietary trading subsidiary.
The bank said the decision was part of “strategic adjustments on order to always better meet clients’ expectations while structurally improving its profitability.”
The European Central Bank (ECB) 2018 report repeated the Governing Council’s statement that interest rates would remain at their present levels through the summer of 2019, and “for as long as necessary to ensure that the evolution of inflation remained aligned with expectations of a sustained adjustment path.”
In its 2018 report, SocGen stated that revenues for fixed income, currencies and commodities were down 16.8% compared to 2017. They were down 28.8% in the final quarter of last year compared to the same time in 2017.
The reduction in size of Europe’s investment banks is concerning for particular asset classes, says Tyce.
“The commodities market is huge and SocGen isn’t that big a trader within it. Clearly as we’ve seen, investment banks brought back levels of liquidity and client facilitation. Investment banks, particularly in Europe, have shrunk and that has become more of a problem and in certain asset classes there are liquidity concerns,” says Tyce.
However, this is not a reflection of the commodities markets, says Sameer Soleja, CEO of Molecule software, but rather large banks’ position with it, and it is a trend that will continue.
“Large banks have been struggling with commodities for many years. But it is not like we see less people trading, we just see fewer large banks trading. I think that commodities and the complicated logistics related to it may not be as suited for purely financial institutions as they are for specialized businesses,” says Soleja.
“It could be that in a situation where banks are having to make opportunistic decisions about where they send their cash, they are realizing that they don’t have a comparative advantage on commodities and that is where they choose to pull the plug. From what we hear at large banks trading commodities it is not like they are the ones really banking on them, and at this point I don’t even think Goldman is an exception,” he says.
For Doug Gyani, principal consultant at Principia, there will be a liquidity impact, but in the long-term it will probably be better for the over-the-counter (OTC) commodities markets.
“The banks will continue hopefully to provide paper trades and hedges around OTC, but again this is a multi-layered problem because if you want to hedge with paper, ten years ago you would have to go to a bank, now you can just go to the exchanges like ICE and CME and you book those commodity trades bi-laterally, even using your margin accounts and you don’t need to necessarily call up banks, call up brokers to do it. That just plays into the fact that these guys just don’t have a lot of places to make money anymore,” says Gyani.
Molecule’s Soleja believes there is still money to be made in speculative trading in parts of the market for those who are clear about their objectives.
“There is still plenty of money to be made in pockets of the market in speculative trading. For those banks that have the mandate to do that, and to do that clearly, to push capital into speculative trading. The challenge for large companies trading in commodities is to be very clear what their mandate is, whether speculation trading is permitted, and if so there is a lot of money to be made,” says Soleja.
However, Principia’s Gyani disagrees.
“Being an ex-trader, if you don’t have an asset that you are going to leverage and you are going to bring to market and trade around an asset, you are really just speculating the market. That just doesn’t work anymore especially for banks who are spending millions of dollars a quarter just to stay compliant,” says Gyani.