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The future of online commodity trading


31-Oct-12 16:49

Headlines about the physical commodity markets have surged in recent weeks and all of them point to the need for further transparency.

 

The article causing the most buzz seems to be the Oliver Wyman report entitled: The Dawn of a New Order in Commodity Trading which states “… the long-term trend of rising commodity prices and financing costs will force the industry though its largest transformation in 30 years.” The report goes on to describe how traders are “masters of optionality…” in a way that “producers and end users are often unable or unwilling to do.”

 

Make no mistake; a successful online platform should not attempt to render trade houses obsolete. They will continue to provide essential market liquidity, moving commodities form surplus to deficit regions. They will take counterparty risk where financial institutions cannot or will not. They will finance margin calls and entire purchases.

 

But they don’t have to be the only users who can take advantage of optionality. Technology not only provides procurement leaders with desired transparency, it provides them with opportunities for greater market access and pricing opportunities.

 

First, let’s look at why online trading hasn’t succeeded to date. Primarily, it’s due to a failure to address the markets’ needs. Specifically, the three most familiar models are:

 

1.) A fancy bulletin board. A take-it-or-leave-it system of bids and offers. Procurement executives are likely the first to dismiss this type of system, as the word “commodity” is often a misnomer. Over a dozen different terms must be negotiated before confirming a contract. Many are not deal-breakers, but all affect price. A discussion is needed.

 

2.) Auctions. In the old days, this was called “one to many” trading, yet it’s nothing more than a fancy RFP. Technology should add value, not mimic the offline world.

 

3.) Instant messaging as a misnomer for online negotiations. Again, no different than pre-internet procurement practices.


So what works online for physical commodities? Let’s start with the acknowledgement that that one purpose of the Web is equal access. Physical commodity markets are thin and fragmented. The system not only needs to invite all players, it needs to provide each with added value. I believe the following functionality is crucial to build online markets:

 

1.) The ability to be a market maker without revealing their book or full identity.

 

2.) The ability to manage their counterparty risk with granularity, in real-time.

 

3.) The ability to see the entirety of the market activity, even if it comes from a counterpart you will not accept.

 

4.) Completely open negotiations; open to all trade-enabled market participants on a first-come-first-serve basis

 

5.) Offer what phone brokers and/or other procurement practices cannot; a) a global reach, b) operating efficiency, c) discretionary pricing mechanisms that yield opportunities for better pricing, and d) efficiency in mid-and back-office operations.

 

So why will procurement executives drive this change online? Because they have the most incentive. End buyers today have the least control over their pricing without technology. They may shop around, but they ultimately accept what the market dictates. However, the right platform will provide buyers:

  • Confidence in best prices without moving the market. CMDirect’s discretionary pricings feature allows buyers to show a conservative bid with an aggressive absolute price; be a market maker without driving up the price
  • Sourcing transparency and greater shareholder accountability. Real-time and historical data to illustrate how well procurement decisions were handled on any given day while adhering to the Credit department’s counterpart exposure.
  • More accurate mark-to-market accounting. No longer depend on subjective trader and broker reports. Online values are accurate and verifiable.

Technology today can provide tremendous opportunity for market access and price discovery. Those who embrace it are sure to thrive.

 

Julie Lerner is CEO of CMDirect.


Julie Lerner by Julie Lerner

 
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