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Use of structured commodity derivatives by Asian businesses

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Be aware! I recently was chairman at a conference about Structuring, Selling and Trading Commodity Derivatives that took place in Singapore. This gave a good insight in the use of all kind of structured commodity contracts by the Asian corporates. This could range from the use of vanilla contracts such as futures, swaps, puts and calls to structured contracts such as collars, extendibles, three ways, accumulators, equity index contingent puts and whatever fancy names these contract structures might have.

What became apparent is that the banks, commodity trading houses and energy companies that would like to offer these kind of deals to their customers should make a clear geographical division. The interesting countries are Japan, Singapore and Malaysia. Thailand offers relatively good opportunities, but is also risky through its particular business customs.

Surprisingly enough China is not very interesting as most Chinese companies are not facing commodity exposures that are linked to an international, transparent and liquid index. For instance, coal from Mongolia is not benchmarked against the API 4 or Newcastle index price, but uses some inland index that is impossible to use as a hedge.

India is a very interesting market as its commodity exchanges belong to the most heavily traded ones in the world. However, it also has its clear limitations as banks and foreign companies are not allowed to trade in Indian derivatives.

A question that was not answered is whether businesses actually do need these kind of complex structured deals to hedge their risks. My experience is that banks are always keen on selling all kind of structured products to their clients. First of all because they cannot make money from a client that uses futures offered on an exchange and secondly they offer these kind of structured contracts in order to make money by simply benefiting from a knowledge advantage. The structure offered is not always in the best interest of the buyer. Although it will certainly offer some kind of protection against their exposures, the final net result of the hedge is probably not the best one that could have been achieved. In other words, by making these kind of structures so complex the banks hope that their clients do not fully understand its impacts, so the bank can make extra profits.

If you are a producer or a buyer of commodities and you need to hedge your risks, please make sure that you fully understand the implications of the structured deal offered to you and that you have the necessary framework in place to manage the risks involved. In case of any doubt; do not do it!


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