Commodity traders and hedge funds have been urged by the Financial Stability Board (FSB) to enhance their preparations for margin calls through improved liquidity risk management, which includes holding more liquid assets and conducting stress tests. The FSB, after analyzing market disruptions like the 2022 commodities market turmoil, has issued recommendations aimed at bolstering traders’ defenses against liquidity stresses.
Margin calls, prompted by spikes in commodity prices, necessitate traders to furnish additional funds to cover short positions or other exposures, either from their own reserves or through credit lines.
The FSB emphasizes the importance for traders to evaluate their exposure to liquidity risks and conduct stress testing for “extreme but plausible” market conditions. Additionally, it advises establishing well-documented strategies for managing liquidity shortfalls, including plans for securing funding and reducing exposures.
The FSB’s consultation on these recommendations with industry participants is open until June 18 this year.
In 2022, a combination of geopolitical and market pressures drove energy-related commodity prices upward, leading to significant challenges in the trading sector. The invasion of Ukraine by Russia spurred a quest for alternative energy sources for European importers, amidst increased demand during the post-pandemic recovery and supply shortages elsewhere. European governments intervened with loans and guarantees to assist companies facing liquidity challenges due to exposure to price increases.
Earlier, FSB Chairman Klaas Knot had alerted G20 finance ministers and central banks about the commodity trading market’s role as the “epicenter” of price volatility in financial markets.
Although the extreme price volatility of 2022 has subsided, larger traders have accumulated substantial cash reserves, enhancing their resilience to liquidity pressures. However, there are concerns about rising demand or supply shortages in other commodities, which could lead to price spikes. Cocoa and coffee futures have surged to record highs due to supply issues, while accelerating demand for electrical power is expected to drive up copper demand significantly.
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The FSB’s recommendations focus on non-bank market participants, with separate efforts underway to enhance transparency and liquidity preparedness among commercial banks. Increased concentration in the market and traders’ move into more opaque over-the-counter derivative markets are identified as potential risks.
