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Commodity traders in DoJ’s sights as probes tarnish boom times



The past year has been one of the best on record financially for big commodity traders that took advantage of the storm whipped up by the coronavirus crisis to rack up huge profits in the oil market.

The same cannot be said of efforts to cast off a reputation for shady business practices that has dogged the industry since the days of Marc Rich, the godfather of modern commodity trading.

In the latest incident to cast a shadow over the sector, a Gunvor employee who became an agent for the company in 2018 pleaded guilty in a New York court to paying more than $22m in bribes to win business in Ecuador between 2012 and 2020. He faces up to 20 years in prison.

The incident underscores the challenge of supervising risk-hungry traders and the dangers of using agents or intermediaries to win business in resource-rich countries. It also highlights the heightened interest in the sector by the Department of Justice and other US regulators, which is expected to become even more intense under Joe Biden’s administration.

“Expect more scrutiny and increased enforcement,” said Kim Zelnick, partner at Freshfields Bruckhaus Deringer. “The DoJ really means business. Combating corruption is a priority, and they are going to go looking where there is a real risk and an incentive for people to engage in misconduct.”

Gunvor is one of a small group of companies, including Vitol, Glencore and Trafigura, that help power the global economy by linking supply of raw materials with demand. They have surfed a wave of globalisation and emerging market growth to build businesses that have revenues larger than many banks.

Last year Vitol, the world’s largest independent oil trader, earned record profit of almost $3bn on revenues of $140bn. Trafigura, Gunvor and Glencore also enjoyed record trading results.

However, the business of linking oil producers and consumers often involves operating in countries that have been hotbeds of corruption, or where it is difficult to secure business without agents who work on commission and network with government officials to help land deals.

These relationships have been a repeated source of legal problems for the sector, which has been trying to open up and become more transparent.

Vitol agreed at the end of last year to pay more than $160m as part of a deferred prosecution agreement with the US DoJ after it admitted to bribery schemes in Brazil, Ecuador and Mexico involving employees and agents.

Authorities are also investigating Glencore and Trafigura on similar allegations in Brazil. Glencore has said it is cooperating with the investigation while Trafigura has denied the allegations. Glencore is also facing a wider DoJ investigation.

“Given the tremendous size and impact of the natural resource and energy industries, it’s natural to see an increase in attention from US regulatory authorities,” said Matthew Kluchenek of law firm Mayer Brown.

Others view the US scrutiny as being more cynical.

John MacNamara, a former trade finance banker who now runs consultancy Carshalton Commodities, said the profits generated by the big commodity trading houses had made them a target for US regulators, which have wrung tens of billions of dollars from the banking sector in fines and settlements over the past decade for manipulating Libor, currency and other markets.

“The well is beginning to run dry as the banks finally got their act together. But the government’s need for money remains,” he said. “And so who is their next target? It is the traders. Are they guilty? They are probably guilty in the same sense that the banks used to have lots of practices that you would not want to write home about.”

A series of fraud cases last year involving oil traders in Singapore has made banks even more nervous of lending to companies that depend on access to large credit lines to buy and sell millions of barrels of crude.

“It does make us a bit gun-shy,” said one senior trade finance banker. “We can’t go all in with these companies.” The banker said his company was braced for more lurid headlines to emerge from DoJ and Brazilian Car Wash investigations.

For Gunvor, the scheme uncovered by the DoJ marks a setback in its efforts to move on from a previous investigation. The Geneva-based company paid $95m in 2019 to settle a long-running bribery case involving payments to middlemen in West Africa.

In the wake of that settlement Gunvor co-founder and chair Torbjorn Tornqvist said he never wanted to find himself in the same position again, and the company last year announced it would cease working with agents for “business origination and development purposes”.

Rivals have also cut back their use of intermediaries or stopped using them altogether. Trafigura ended the use of agents for business origination and development in 2019, while Glencore has replaced intermediaries in some countries with its own staff who work on government contracts.

Vitol said this month it was working hard to “mitigate compliance risks” across its business.

Anti-corruption campaigners, however, say the recent bribery and corruption cases cast “serious doubt” on the credibility of such claims.

Court documents in the Gunvor case describe how employee-turned-agent Raymond Kohut and two consultants plotted to conceal the bribery and money-laundering scheme from compliance personnel at Gunvor in late 2019 and early 2020.

“This isn’t a question of rogue employees but these practices are really fundamental to the way the sector has done business in the past,” said Natasha White of Global Witness. “We really welcome the fact that the US is taking an increasingly strong stance and call other jurisdictions to do the same.”

Gunvor said it had terminated its relationship with the “intermediary agent” for compliance reasons before being notified of the DoJ investigation.

“Gunvor takes compliance very seriously and maintains a zero-tolerance approach, which is why the company has since also banned outright the use of agents for business development purposes,” it said in a statement. “Gunvor has been fully co-operating with the DoJ investigation and will continue to do so.”

Bankers say there is no doubt business practices have improved markedly since the swashbuckling days of Marc Rich but lessons still needed to be learned.

“In the 1980s in emerging markets you did not get out of the airport unless you came out with the brown envelope,” said MacNamara. “There has been a steady move away from that but challenges remain.”

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Vale chief rejects talk of iron ore supercycle




Iron ore is not on the cusp of a new supercycle, according to the head of one the world’s biggest mining companies, who expects demand for the steelmaking ingredient to flatten out after a couple of years of the current tightness.

Eduardo Bartolomeo, chief executive of Brazil’s Vale, said the record surge in iron ore prices over the past year was very different to the boom of the early 2000s, which was driven by China’s rapid industrialisation. 

“In the last supercycle we had urbanisation in China. It was a structural change. A shock in demand,” he told the Financial Times. “We are not talking about a huge shock in demand now. I would say it is marginal. It is not a shock.”

But he added that, with big global economies revving up and iron producers running at or near capacity, prices could remain elevated until 2023.

“Although there is strong talk about cuts, production is still going up in China and now you have Europe coming back and the US announcing a huge stimulus package. There are also restrictions on supply,” he said. “This market is going to be tight for a while. At least two years.”

Iron ore has spearheaded a broad-based rally in commodities over the past year, rising more than 150 per cent to a record high above $230 a tonne last week, mainly on the back of strong demand from steel mills in China, before paring gains and hitting $209.35 on Friday.

As China’s steel production continues to expand analysts believe prices can remain around current levels but say the market will be highly volatile.

Iron ore’s turbocharged performance has been a boon for big producers including Vale, which require a price of only about $50 a tonne to break even.

It has fanned talk of a new commodities supercycle — a prolonged period where prices remain above their long-term trend, usually triggered by a structural boost to demand to which supply is slow to respond.

Following a deadly dam disaster two years ago that killed 270 people, mainly company employees and contractors, Vale was forced to curtail production.

Its output fell from a planned 400m tonnes a year to about 300m tonnes in 2019 and 2020, and the company lost its position as the world’s largest iron ore producer to Rio Tinto, which has managed to produce about 330m tonnes in each of the past two years.

Bartolomeo said Vale eventually needed to increase production to 400m tonnes because iron ore was a “high fixed-cost business”. However, he said the company would do so in a “very paced way”, mindful of safety.

Erik Hedborg, analyst at the CRU consultancy, said Vale’s journey to 400m tonnes would take time because it required the “restart of many mines, which will go through several complex licensing processes”.

Over the medium term — from 2025 to 2030 — Bartolomeo said Vale expected diminishing demand for iron ore from China because of increasing use of scrap in electric arc furnaces.

“Everybody talks about the circular economy. Scrap is going to come to China. It has to. We see it diminishing demand for iron ore from China.”

Bartolomeo said there would also be a shift to higher-quality iron ore as the steel industry sought to reduce emissions by moving to less polluting methods of steelmaking such as hydrogen-based production.

“All the roads lead to high-quality iron ore and Vale is very well positioned for that,” he added. 

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US banks could cut 200,000 jobs over next decade, top analyst says




US banks stand to shed 200,000 jobs, or 10 per cent of employees, over the next decade as they manoeuvre to increase profitability in the face of changing customer behaviour, according to a banking analyst. 

“This will be the biggest reduction in US bank headcount in history,” Wells Fargo analyst Mike Mayo told the Financial Times. If his forecast bears out, this year would mark an inflection point for the US banking sector, where the number of jobs has remained roughly flat at 2m for the past decade.

The jobs most at risk are those in branches and call centres as banks prune their sprawling networks to match the new realities of post-pandemic banking, Mayo’s report found. That is consistent with Department of Labor statistics that predict a 15 per cent decline in bank teller jobs over the next decade.

Historically, lay-offs, particularly for lower-paying jobs, have been a contentious issue for the banking industry, which is often held up by progressive politicians as an example of a wealthy industry prioritising profits over people.

But the threat of technology companies and non-bank lenders chipping away at the business of payments and lending, which have traditionally been dominated by banks, has intensified over the past year, making job cuts necessary, Mayo said.

“Banks must become more productive to remain relevant. And that means more computers and less people,” he said.

Most of the reductions can be achieved through attrition over the next 10 years rather than cuts, reducing the risk of a backlash, Mayo said.

The new research, reported first by the FT, comes on the heels of disappointing jobs data that showed the US economy added just 266,000 jobs last month, sharply missing estimates of 1m. Structural elements of unemployment like accelerated automation that took place during the pandemic could pose stronger than anticipated headwinds to a recovery in the labour, economic officials said following the report. 

Pandemic activity pushed headcount up roughly 2 per cent last year as banks hired staff to meet the sudden demand for labour-intensive mortgages and government-backed small-business loans. But that trend is likely to be reversed in the near-term as lenders refocus on efficiency to compete more effectively with technology companies that increased their share of business during the health crisis. 

Increased competition from unregulated companies such as PayPal and Amazon entering financial services was one of the principal concerns JPMorgan Chase chief executive Jamie Dimon outlined in his annual letter to shareholders last month. 

Mayo estimates that banks currently represent just a third of the overall financing market.

“Digitisation accelerated and that played to the strength of some fintech and other tech providers,” Mayo said. 

Many of the bank branches that were closed during the pandemic will probably stay that way, and even those that remain open are likely to be more lightly staffed as branches become more focused on providing advice than facilitating transactions. A large amount of back-office roles also stand to be automated but those numbers are harder to quantify, the report said. 

Mayo said his team 20 years ago was twice as large and responsible for half as much. Doing more with less was the new norm across the industry.

“If I was giving advice to my kids, I’d say you probably don’t want to go into the financial industry,” Mayo said, adding that technology and customer or client-facing roles are probably the only areas that will see growth. “It’s likely to be a shrinking industry.”

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Inflation wild card unsettles markets




Regime changes usually take a while to fully register among investors. The big talking point in markets at the moment surrounds the potential return of a more troublesome level of consumer price inflation and what protective action investors should take.

The underlying trend of inflation matters a great deal for financial markets and investor returns. The rise in both equity and bond prices in recent decades has occurred during a long period of subsiding inflation pressure and from recent efforts by central banks to arrest disinflationary shocks since the financial crisis. 

A year after the global economy abruptly shut down, activity is duly picking up speed. The logical outcome has been a surge in readings of inflation and this week, a measure of US core prices recorded its largest annual gain since 1996, running at a pace of 3 per cent*.

Core readings exclude food and energy prices and are deemed a smoother gauge of underlying inflation pressure, a point that many people outside finance find baffling when budgeting the cost of groceries and petrol.

So the significant jump in the core measure, and even accounting for the base effect of the pandemic’s brief deflationary shock a year ago, has understandably generated plenty of noise.

This will remain loud in the months ahead as activity recovers from lockdowns with a hefty tailwind of fiscal stimulus working its way through the broad economy.

But muddying the waters for investors is that the outlook for inflation is still difficult to judge at this stage.

“There is so much dislocation in the economy from the reopening and base effects from a year ago that it will take at least six to 12 months before we get a clear view of the underlying inflation trend,” said Jason Bloom, head of fixed income and alternatives ETF strategies at Invesco.

Investors who are now worried about an inflation shock face a dilemma. Some assets seen as traditional hedges against such a risk, like inflation-protected bonds and commodities, have already risen appreciably. Effectively a period of inflation running hot has been priced in to some degree.

And history does provide a cautionary note for those moving late to buy expensive inflation protection.

Past inflationary alarms, as economies recovered in the wake of the dotcom bust in the early 2000s and the financial crisis of 2008, proved false dawns. After a mercifully brief pandemic recession, the powerful and well entrenched disinflationary trends of ageing populations and falling costs associated with technological innovation are by no means in retreat.

For such reasons, a number of investors and the US Federal Reserve expect inflationary pressure this year will prove “transitory”. But stacked against deflationary forces is the immense scale of the monetary and fiscal stimulus of the past year.

The effects of monetary and fiscal stimulus means “inflation may settle into a pace of 2.5 per cent (annualised) and that would be different from the average of 1.5 per cent before the pandemic”, said Jason Pride, chief investment officer of private wealth at Glenmede Investment Management. “Inflation will be higher. At a dangerous level? No.”

In an environment of firmer growth and moderate inflation pressure, equities will benefit, led by companies that have earnings more influenced by the economic cycle. Investors also will seek companies that have the ability to pass on higher prices to customers in the near term and offset a squeeze on profit margins.

Still, a troublesome period of elevated inflation cannot be easily dismissed. The “transitory” argument could be challenged if economic growth continues to run hot into next year, accompanied by a trend of higher wages from companies finding it hard to attract workers.

Before reaching that point, expected inflation priced into the bond market may well push past the peaks of the past two decades and enter uncharted territory in the US and also for other developed markets in the UK and Europe.

Bond market forecasts of future inflation pressure over the next five to 10 years have already risen sharply in recent months. But the rebound is from a low level and for now, expected inflation is not far beyond the Fed’s long-term target of 2 per cent.

“It is the change in inflation expectations that drives asset returns,” said Nicholas Johnson, portfolio manager of commodities at Pimco. Assessing almost 50 years of data, a portfolio holding equities and bonds underperforms during bouts of elevated inflation, while real assets including inflation-linked bonds and commodities prosper, according to the asset manager.

“Most investors have not experienced a period where inflation surprised to the upside,” added Johnson. Clients are asking more questions about insulating their portfolios, but their present exposure to commodities and other assets show that in broad terms investors are “not paying much of an inflation premium”.

That can change and the prospect of inflation regime change remains a wild card for investors.

*The value of core inflation has been changed since first publication.

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