Maintaining strategic agility during seismic financial regulatory shifts
Alexandra Dobra, Kinetic Partners, London
As financial regulatory and compliance requirements (i.e.: EMIR, Dodd-Frank Act, REMIT, MiFID II, MAD/MAR II, etc.) have become a top challenge for commodity trading houses, and given also the wider market movements, how can commodity trading houses secure their strategic agility by maintaining their reputation, remaining competitive, reducing risks, protecting franchise value and capturing market opportunities?
State-of-the-art compliance strategy
The very fact that financial regulation has been identified as a top agenda concern for the C-Suite for 2014 reinforces that most companies have silo-based approach for responding to financial regulation, characterized by a reactive execution that leads to continuously increasing compliance costs and compliance risks. In addition, with the increasing expansion and increasing complexity of commodity trading houses, through acquisitions and internal growth, a silo-based compliance function proves to be even more inadequate. On the other hand, a holistic regulatory compliance function is the only solution for managing the ever-changing financial regulatory landscape. Such a function unifies fragmented structures, systems and processes. It can reduce costs by identifying and eliminating overlapping and redundant assessments, controls, reports and tests, ensure resilience by aligning risks and controls effectively and adapting these as the business changes, increase agility by supporting operating model changes and foster a proactive approach towards financial regulation.
In addition, a holistic compliance function must be effective and result in optimization and costs savings through support from: (i) a robust financial regulatory program management; (ii) an integrated IT landscape; and (iii) the promotion of an ethical culture. An integrated IT landscape aims to consolidate the systems landscape, optimize data usage, reduce manual workarounds, and reduce costs. An integrated IT landscape can save up to 35% of the cost per trade basis and can increase intra-group homogeneity by establishing consistent data taxonomy. The importance of having strategic IT investments is further reinforced by the fact that commodity trading houses often have legacy systems requiring constant manual workarounds that reduce cost efficiency and increase risks. Furthermore, an integrated IT landscape should be supported by IT investments focused on implementing trading surveillance systems and data analytics to ensure data quality and integrity and allow sophisticated risks modelling. Lastly, promoting an ethical culture is aimed at resulting on the medium-term to bring a cultural shift in the approach towards financial regulation and it therefore can reduce the risks of non-compliance.
Redefining the business strategy
Commodity trading houses will need to re-evaluate their current business models based on sophisticated scenario-selection and sensitivities definition tools (that would assess the impact of various regulations) and build on the operational focus and geographic footprint of the organization. As such, commodity trading houses can decrease both their flexibility in terms of traded contracts and their footprints in certain geographic areas to reduce cost-structures and to decrease the level of their exposures in heavily-regulated hubs by restructuring some of their core operating entities. However, as regulatory agencies are actively tackling the case of regulatory arbitrage, such a move might entail advantages on the short term only. Lastly, commodity trading houses through the implementation of new methodologies and metrics can improve their risk exposure and their performance management function in order to improve the cost to income ratio.
As access to capital and to sources of funding is becoming scarcer and more expensive, commodity trading houses will need to optimize access to capital and funding. One basic measure is to calculate the profit velocity and allocation of capital by trading books and prioritize those with the strongest potential for increased profit margins. Independent commodity trading houses will also continue to increase their investments in upstream assets, however this will make them more vulnerable to resource nationalism. In addition, commodity trading houses moving towards a more integrated business model will need to balance the short-term-term investment capital with the long-term investment capital approach. Finally, as investment banks are deleveraging their commodity trading practices, commodity trading houses could find an opportunity for tacking these over and therefore optimizing their access to capital. However, turning this into a market-making opportunity will depend on the balance sheets of the commodity trading houses. Another market-making opportunity can also arise with the development of alternative energy sources and the related financial market that will grow in both volume and scope.
Another option is to optimize funding through securitization and new asset classes, such as the securitization commodity trade loans offered by BNP-Paribas since 2013 or to access funding through investors such as sovereign wealth funds (SWFs). As SWFs are looking to capitalize on the expected long-term commodity prices, they play an increasingly important role in driving M&As and alongside offer the possibility to commodity trading house to sell minority stakes. Examples of the role of SWFs include the Qatari Wealth Fund which bought positions in Total and has also accelerated the takeover of Xstrata, in which its stakes were above 10%, Plc by Glencore International Plc. SWFs have also played a pivotal role in the acquisition by Sinopec of Addax Petroleum and the investment in Teck Resources by China Investment Corp. Commodity trading houses can also boost their access to secured funding with low beta exposure through setting up independently managed commodity trading funds (i.e.: Black River for Cargill).
About the author
Alexandra Dobra is a senior associate at Kinetic Partners, a division of Duff & Phelps, working on financial regulation and risk. Her experience is in financial regulatory strategy, risk and research (quantitative and qualitative). Previously, Dobra worked at Accenture in London in the Institute for High Performance and in the Commodity Trading and Risk Management practice. She was also part of the FIA-ISDA MiFID II/R working group on commodities, which acts as an industry response group to the European Securities and Market Authority. She has interned with Ellington Technology Group, where she advised on a post-IPO expansion strategy and at the European Parliament where she advised on economic policy. Dobra is a recognized thought leader and has been selected in "30 under 30" by Forbes. She obtained her MPhil in International Affairs from Cambridge and her BA(Hons) from York.
