The co-head of global commodities at Credit Suisse talks to Geraldine Lambe about building the bank’s commodities platform in a market that is booming and showing evidence of increasing maturity.
Last year was a boom time for commodities. Volumes in New York Mercantile Exchange (Nymex) energy and metals products that were traded on the Chicago Mercantile Exchange’s Globex platform more than tripled to an average of 757,000 contracts per day, and grew by 130% in Q4 alone.
Returns have been good, too. The GSCI commodity index last year returned in excess of 30%, for example. Compare that to the average equity or bond return and it makes commodities more than an attractive diversification play.
This is welcome news for banks at a time when good news is a bit thin on the ground. Many hope that it will be the same, if not better, this year and that growing revenues from the bull market in commodities will help to offset the shrinking earnings from more troubled sectors.
Bull market predictions
Although unwilling to make such predictions, Adam Knight, appointed co-head of global commodities at Credit Suisse (alongside Beau Taylor) in October last year, is at least confident that the commodities bull market is set continue. “The story differs by product: oil rose to all time highs while zinc prices dropped by 40% last year. However, the major themes underpinning the sector look set to continue for the foreseeable future,” he says.
“For example, the strong growth in emerging markets, especially in BRIC [Brazil, Russia, India and China] countries, is no flash in the pan; ongoing industrialisation is fuelling increased wealth and consumer appetite, and this, set against a constrained supply outlook, is driving higher long-term average prices for many commodities.”
Commodities are also an expanding asset class: the complexity of trades that can be done is increasing, and the tenor and number of commodities that can be traded is rising too. So there is a broader range of players putting more money to work.
“Last year, if you had asked someone to trade in iron ore or cobalt, it would have been almost impossible; you could get a physical contract with a producer, that was all. Now, we trade swaps in each of those commodities. This is evidence of increasing maturity and development of the commodities business,” says Mr Knight.
This means that market participants can fine-tune their exposure. Previously, if they wanted exposure to iron ore, they would have to buy shares in the big three producers, Rio, BHP and CBRD, for example, but, because those firms have also got large aluminium and other commodity exposures, it was not a pure iron ore play. “Now [investors] can [get the exposure they want] and that’s very attractive to pension funds and hedge funds. As liquidity increases, more and more people are willing to express their interest. All of these factors are combining to perpetuate the boom,” says Mr Knight.
Hedging opportunities
As a greater number of markets across the commodity spectrum become increasingly liquid, the ability for corporates to hedge their risk more accurately increases, he says. “There are now more and more opportunities for players to disaggregate their risk and hedge around specific exposures.”
For banks, such buoyant activity makes the commodity sector a very attractive space, and many are building out commodity platforms. However, this brings its own problems. “Almost everyone is expanding and that is a challenge,” says Mr Knight, who himself was lured to Credit Suisse from commodities behemoth Goldman Sachs in April 2007, originally to build out the Swiss bank’s metals franchise.
“Commodities has not traditionally been a sexy area in banking, so there is a fairly limited talent pool. This has put good people at a premium and pushed the cost of hiring up to a level that can make it difficult to build a profitable business,” he admits.
This is not good news for a bank that is still rebuilding a platform that was largely dismantled during the John Mack era. Mr Knight acknowledges that Credit Suisse still has “a long way to go”: metals is in the late stages of the build-out, with the essential pieces in place; oil is still at the early stage – about 20% of the way there, he says; investor products (for sale to private banks, etc) is about 80% completed; the agricultural products build has only just begun.
Challenges and advantages
While he does not underestimate the challenges ahead, Mr Knight believes that Credit Suisse has a couple of advantages twinned with a good strategy. He believes that commodities sits well with Credit Suisse’s existing businesses and that this will give the bank’s commodities push an edge over that of some competitors.
Because entry barriers are high and expensive, Mr Knight says the business plan needs a short-term “shot in the arm” that generates revenues quickly enough to finance the initial build; any long term strategy must enable the business to continue putting growth capital in.
Credit Suisse’s shot in the arm comes by way of its private bank, where it still had a commodities business. “Private banks are fairly big buyers of commodities-based products, whether straightforward products such as gold certificates, or more sophisticated products like principal guaranteed structures that have pay-outs depending on performance, such as taking a view that is bearish on base metals but bullish on agriculture,” says Mr Knight.
“A lot of new wealth is being generated in countries with commodities-based economies, so many high-net- worth investors are comfortable with commodities as an asset class. They may even be hedging their own exposure [that of their business], so having a strong private bank is definitely a big advantage in building a commodities business.”
Mr Knight is not willing to give specific figures about how much product is sold to private banks, but he says it is considerable. “[The private bank] is certainly a significant contributor to our business. Volumes are comparable to our hedge fund clients. Given the size of our private banking platform [$642bn according to Scorpio Partnership’s 2007 Private Banking Benchmark], they have a considerable pool to invest in commodities-based products.”
Long-term strategy
The longer-term strategy is to leverage the bank’s strong emerging markets presence. The premise behind this is that because BRIC countries are driving the commodities business, a bank with a serious emerging markets franchise is in the best position to generate a lot of business.
Coming from Goldman Sachs, one of the biggest commodities houses, Mr Knight also knows the strengths and weaknesses of the key players and therefore how best to position Credit Suisse. Most competitors have a gap somewhere, whether it be presence in a particular market or lending capacity. These are gaps that Mr Knight intends to exploit.
“A lot of elements of the commodities business dovetail with our structured lending and emerging market businesses. There are still not many firms on the Street that can bring the complete package together: understanding the tax implications, ability to raise the money, syndicate that out, and strength in commodities. We can provide all this and create a tailored package for our clients,” he says.
A key element of Credit Suisse’s offering is its alliance with natural resources company Glencore International, which began in February 2006 with energy products and was later extended to cover metals, he says. Glencore shares physical information and provides access to all the markets in which it operates in return for a share of Credit Suisse’s net profits.
The alliance also means that Credit Suisse is able to take physical products from clients and pay them for it, rather than giving them a benchmark hedge. This eliminates the basis risk created by the differential between where the product (aluminium billets, for example) trades and the benchmark price on the London Metals Exchange. More precise hedging reduces the cost of hedging overall.
“The alliance with Glencore allows us to offer a lot of things that most other banks can’t,” says Mr Knight. “We can not only do hedging versus a benchmark, but we can also [hedge] the exact product clients are producing. And for producers – say, a smelter of metal – we can deliver the ore and take the metal at the other end.”
Credit Suisse is not the only one with this strategy and some institutions have taken it a step further: Morgan Stanley, for example, owns a fair number of physical operators, and Royal Bank of Scotland took a 50% share of Sempra last July.
Commodities’ attraction
Mr Knight says that the credit crunch has had surprisingly little impact on commodities, other than to attract more money to the sector. And, whereas in some other areas, assets have returned to haunt banks, risk transfer means risk transfer, he says.
“There are no special-purpose vehicles that we sell risk to. We trade principal to principal; there is a real transfer of risk. Core commodities investors do not seem to have been significantly affected. There were some bearish bets initially and products with lots of bells and whistles are less in favour but, overall, emerging markets and commodities have performed well so commodities funds have seen quite a lot of inflows,” he says.
CAREER HISTORY:
2007: Appointed co-head of global commodities, Credit Suisse.
2007: Joined Credit Suisse as head of the metals trading alliance with Glencore.
2004: Appointed head of global metals trading, Goldman Sachs.
2001: Rejoined Goldman Sachs as head of global base metals option trading.
2000: Joined Kiodex, a web-based commodity risk management software company.
Responsible for business development and system design.
1996: Joined Goldman Sachs as an analyst in base metals options and GSCI options
trading, first in London, then New York.
1996: Graduated with a BA in Economics from St John’s College, Cambridge, UK.
