The financial uncertainty in the Eurozone continues to cause metal and other commodity trading companies to closely monitor their market and counter-party risk on contracts exposed to that region.
After the collapse of global financial markets in the latter half of 2008 and the recessions that followed, international trade in many commodities seems to have regained much of its lost ground in price and confidence. Indeed, generally speaking, physical commodity markets have been considered a relatively safe haven for investment. Historically riskier investment prospects, such as emerging markets, have also been ripe targets, as the traditionally lower risk continental markets have continued to be affected by the Eurozone’s problems.
Early November 2011 has seen both the Greek and Italian governments restructured to allow new policy on government debt problems. Such policy is aimed at reducing debt levels by introducing far-reaching public spending cuts. Of course with this comes the risk that deep cuts can significantly impact on short to medium-term economic growth. Other European countries in a similar debt position will be watching developments in Greece and Italy very closely. Some companies have already fallen victim to the Eurozone financial uncertainty.
MF Global, the US brokerage firm, filed for Chapter 11 bankruptcy proceedings at the end of October 2011. It has been reported that the company took long positions on sovereign bonds issued by European countries. Those positions have met with the ongoing uncertainty in the Eurozone and seemingly caused the company to realise significant losses.
The successful metals brokerage arm of the MF Global business has been brought down as a result. This has caused major turmoil in metals markets, in view of MF Global’s significant position as an LME ring-dealer (with approximately 10,000 clients as reported by Metal Bulletin). Many LME traders used MF Global as an exclusive broker and have had to transfer positions to new replacement brokers. This can take some time as replacement brokers undertake usual client compliance checks. There have also been issues generated with client assets such as warrants, due to the suspension of warrants in the custody of MF Global.
MF Global UK is the first ‘investment bank’ to test the Special Administration Regime (SAR) which came into statutory effect in the UK in February 2011 following the collapse of Lehman Brothers. Under SAR, the special administrator has three objectives: the return of client assets as soon as possible; timely engagement with market infrastructure bodies/authorities; and to rescue the firm as a going concern or wind it up in the best interests of the creditors. As the MF Global administration plays out, there will be searching questions of compliance officers as to whether client money was held on segregated accounts (and where those accounts are located), and early reported indications suggest there may be significant shortfalls on client money. According to the London administrators based on investigations so far, such shortfalls would appear to be restricted to the US and are not a London issue. Nevertheless, there is no prospect of early return of client money as the administrators have to satisfy themselves on all the details of the pool of client money available for distribution and the client money claims. Client assets (other than money) might be returned earlier if clearly identified. The SAR’s objectives are sure to be tested and more developments seem likely to follow on this aspect.
This corporate collapse will also provide support to those hoping to implement the Volcker Rule, the proposed US Act aimed at restricting investment banks from proprietary trading. The proposed Volcker Rule is currently open for public comment until 13 January 2012, with the relevant Regulations due to come into effect on 21 July 2012, subject to the consultation process. The MF Global example brings into sharp focus how successful core parts of a business, such as the metals arm in this instance, can be undone by speculative proprietary trading.
The Franco-Belgian bank, Dexia, has also struck difficulty for similar exposure to sovereign debt and has been rescued by French and Belgian taxpayers. The question now remains whether the ongoing financial issues within the Eurozone will result in another squeeze on credit and consequent market correction, leading to a rise in market default cases especially from derivative markets.
In the meantime, trading companies with exposure to those uncertain markets are well advised to be prepared to move quickly to protect and close-out (if necessary) their contractual positions, including taking urgent action to obtain security for any contract claims, in the event of counter-party collapse or negative market volatility. This is of course in addition to the many commercial solutions that are available, such as diversity in trading portfolios and geographical markets.
Based on our experience, it can be useful for traders to seek early legal advice as even apparently minor contractual issues arising during the performance of commercial contracts can be an indicator of a more serious problem. Issues such as delays in opening letters of credit, unjustified product quality criticisms, difficulties obtaining investment, requests for price renegotiations or shipment date extensions - can sometimes be symptoms of deeper financial instability.
Of course, there can be no substitute for fostering long-standing commercial relationships and knowing your counterparty - including where appropriate assessing your counterparty’s susceptibility to wider market movements. Adopting a robust and legally informed position during early negotiations and throughout the life of a contract can help to avoid the prospect of adversarial proceedings. Such an approach should also guard against any potential rise in market default cases.
For more information, on such early and ongoing contract negotiation strategies, please contact Andrew Ridings, Partner, on +44 (0)20 7264 8158 or andrew.ridings@hfw.com, or Luke Zadkovich, Associate, on +44 (0)20 7264 8157 or luke.zadkovich@hfw.com, or your usual contact at HFW.
