(Thomas Mak)
Even before the emergence of COVID-19, commodities markets around the world were already facing ample challenges. With the US-China Trade War substantially weakening the demand for base metal commodities, coupled with the US dollar strengthening back in 2018 after Trump imposed generous tax cuts, global markets witnessed extreme price volatility that unsettled commodity producers and traders.
BNP Paribas’ decision to scale back its commodity operation has systemic impact on the world of trade finance. Traditionally, commodity importers and exporters rely on credit lines and loan facilities to protect themselves against risks like political instability and currency fluctuations. Without big lenders like BNP Paribas providing consistent credit support, importers and exporters lost their valuable safety net.
But how should we interpret BNP Paribas’ retreat? Should commodities analysts be concerned about other banking giants following BNP Paribas’ path? Or was it a mere strategic move from BNP Paribas designed to relocate its resources?
2014 – the beginning of the end
BNP Paribas was once among the biggest name in commodity trade finance, pioneering some of the most innovative financial products that enabled the oil trading industry to grow rapidly. For example, BNP Paribas was the first bank to use letters of credit to finance oil trading in the 1970s. But unfortunately, BNP Paribas’ status as a commodities powerhouse was undermined by legal woes.
In 2014, BNP Paribas pleaded guilty to two criminal charges of breaking US sanctions against trading commodities (oil in particular) with Sudan, Iran, and Cuba. After the United States of America v. BNP Paribas S.A. case confirmed BNP Paribas’ guilt in violating the International Emergency Economic Powers Act and the Trading with the Enemy Act, the US Department of Justice fined BNP Paribas $8.9bn.
To date, the 4th largest fine in the history of banking. Considering that BNP Paribas’ entire 2013 pre-tax income was $11.2bn, needless to say, sacrificing almost 80% of annual income to legal fines has reduced BNP Paribas’ appetite for commodities trading.
Thus, before the Trade War and COVID-19 even came into the picture, BNP Paribas already has a compelling reason to retreat from the commodities market. The Paris-based bank’s legal troubles back in 2014 support the case that the decision to scale back its commodity operation was a strategic move designed to save the bank’s reputation.
2020 – accounting irregularities and insolvency troubles
Six years later, BNP Paribas’ commodities division continues to face daunting challenges. The collapse of oil prices, coupled with COVID-19 suppressing commodities demands, have driven several banks to reduce their exposure to commodities trading.
Take GP Global as an example, one of BNP Paribas’ clients that specialises in oil trading as well as operating several refineries at the UAE, is facing its own legal trouble. During the process of restructuring, FTI Consulting (GP Global’s restructuring adviser) discovered accounting irregularities in its books. This is a fatal blow for GP Global, because if there are news related to questionable trading practices and accounting irregularities, it is unlikely that GP Global can find a white knight to prevent the company from entering Chapter 11.
While GP Global’s accounting scandal has exacerbated the gravity of the situation, but the root of GP Global’s downfall was the rapid decline of oil prices back in April. In Q22020, the price of crude oil crashed from $18 a barrel to $-38 due to global economic stagnation. For BNP Paribas, who has been one of GP Global’s biggest lenders, the downfall of GP Global would further reduce the bank’s appetite in commodities finance – FTI Consulting has already made it clear that lenders can only recover a maximum of 27.5% of their loans to GP Global.
Apart from the oil industry, the pandemic also created a negative impact on the coffee sector. One of BNP Paribas’ US-based clients, Coex Coffee has decided to proceed with liquidation after 40 years in business. Compare to GP Global, Coex was even more reliant on BNP Paribas’ credit support because BNP Paribas’ Swiss unit was Coex’s biggest lender. Now, given that Coex has formally started the insolvency procedure at court, it is highly unlikely that BNP Paribas can recoup the $55 million loan in full because the total value of secured claims from all lenders exceeds Coex’s assets by almost $100 million.
BNP Paribas is not the only bank suffering from heavy losses in commodities finance. After Hin Leong Trading – Singapore-based oil trading firm – got charged for forging documents to secure $56 million in trade finance from various financial institutions, Société Générale started the process of closing its Singapore commodity-finance sector. ABN Amro Bank went even further by announcing that it will stop providing services related to commodity trade finance.
Strategic priorities
COVID-19, the collapse of oil prices, and the prevalence of financial crime are making the banking & finance industry question the profitability of commodities finance. Nonetheless, one can argue that BNP Paribas’ decision to retreat from the commodities market is not necessarily related to these negative factors.
To consolidate its status as one of the leading Eurozone banks, BNP Paribas has adopted a countercyclical strategy during the pandemic.
During the peak of the pandemic, we saw evidence of US giants pulling out of the European market to cut cost: JPMorgan stepped back from lending to BASF (German chemicals group), while Goldman Sachs declined to take part in a 12 billion euros syndicated loans for German carmaker Daimler. But instead of pulling back like its US counterparts, BNP Paribas saw this as a valuable opportunity to increase its market share in the syndicated loan market.
Between mid-March and the end of May, BNP Paribas not only underwrote an emergency €3bn credit line for German conglomerate Siemens, but also re-opened the syndicated loan market with a $10bn facility for BP (UK).
(Source: Google Finance)
BNP Paribas’ countercyclical strategy proved to be effective. The French bank is currently leading the European syndicated loan market with a 16.8% market share. By gaining a competitive advantage in the syndicated loan market, BNP Paribas recorded a net income of €2.3bn, beating analysts’ expectations of €1.5bn despite the adverse economic impact of COVID-19. This has benefited BNP Paribas’ stock performance, the share price of €40.95 is the highest-level BNP Paribas has recorded since March 2020.
Given that BNP Paribas is eager to take advantage of the US giants’ retreat, it became necessary for the French bank to slash cost at less profitable divisions to ensure that the bank has sufficient capital to execute the plan of dominating the European syndicated loan market. Since the commodities market have been ravaged by the Trade War and financial crime scandals, commodities finance became an easy target for BNP Paribas’ cost-cutting programme.
Concluding remarks
With BNP Paribas, Société Générale, and ABN Amro Bank decided to retreat from commodities finance, investors’ confidence in the profitability of the commodities market inevitably decreased. However, we should not have an overly pessimistic attitude on the future of commodities finance. After all, during an economic crisis, every banking division is facing difficult challenges: for the currency division, quantitative easing and the prospect of no-deal Brexit would likely result in currency depreciation. And for the emerging market division that invests heavily in project finance, government-imposed lockdowns and social distancing measures will push back the completion date of infrastructure projects.
That said, there are some urgent issues national regulators need to address in order to protect the integrity of their own commodities trading market(s). The emergence of financial crime at commodity trading houses based in Singapore and the UAE sends an alarming message to regulators around the world. Without robust legal and regulatory oversight to deter financial crime, attracting foreign investment will become more difficult.
Currently, the FCA only regulates commodity derivates transactions, but not the underlying physical markets. To protect the integrity of the London Metal Exchange market, the FCA must increase its regulatory coverage.
Industry jargons
Systemic risk/impact – A negative ripple effect created by the failure of one institution that subsequently triggered further failures of other institutions and significantly disrupts the functioning of a market.
Letters of credit – A payment mechanism used in international trade to provide an economic guarantee from a creditworthy bank to an exporter of goods.
White knight – A friendly investor that acquires a corporation at a fair consideration with the support from the corporation’s board of directors and management.
Chapter 11 – A form of bankruptcy that involves a reorganization of a debtor’s business affairs, debts, and assets.
Bibliography
Almeida, I., Batista, F., Perez, M-G.
2020. US Coffee Trader Coex Plans to Liquidate Firm After 40 Years. Bloomberg Law. pp. 1-2.
Ambrose, J.
2020. Oil prices dip below zero as producers forced to pay to dispose of excess. The Guardian. pp. 1-2.
BBC News.
2014. BNP Paribas to pay $9bn to settle sanctions violations. BBC News. pp. 1-2.
Farchy, J., Di Paola, A.
2020. Adviser Highlights ‘Accounting Irregularities’ at GP Global. Bloomberg Markets. pp. 1-2.
Hume, N., Walker, O.
2020. BNP Paribas pulls back from financing commodity traders. Financial Times. pp. 1-2.
Reed, J., Sheppard, D.
2020. Founder of Singapore oil trading firm Hin Leong charged with forgery. Financial Times. pp. 1-2.
Rusi, M.
2018. BNP Paribas Named Commodities Derivatives House of the Year 2018. BNP Paribas official webpage. pp. 1-4.
United States Government
2014. Judgement of United States of America v. BNP Paribas S.A. Department of Justice. pp. 1-6.
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