To a physical commodities trader, Eddy Murphy’s down-and-out character in 1983’s film “Trading Places” became a futures trader, a speculator, and a paper trader. To him, I would be described as a cash trader, a physicals trader or spot trader (despite frequency or negotiating long-term, forward contracts), who focuses on the underlying market. Physicals traders buy the oranges (oil) from the producer and sell to the processor (refiner). Then we hedge our price risk in the futures market.
I designed a platform in 2000 to trade physicals online. Then and now, the most common feedback that I hear when demonstrating the system goes as follows: “It’s the best system we’ve seen. I can clearly see how it brings my trading team more optionality and operating efficiency. But we don’t want to support a system that brings more transparency.”
Yet these markets — from US crude to world sugar — are already transparent. The major players are holding onto an old notion that transparency kills margins, using a scant number of examples with smaller clients to support their theory. In fact, even the CEO of Cargill, Inc., admitted this in 2013 in the keynote address at the Financial Times Commodity Summit:
“Today every one of us has enormous amounts of information available and at our fingertips, instantaneously. There is no time and date advantage. Everything is totally transparent. The skill today is in the analysis, interpretation and the insight derived from that openly available mountain of knowledge.”
So why aren’t these markets online today? And if markets are already transparent, what are we asking for from regulators?
Why Physicals Markets Are Not Online Today
- No one wants to be revolutionized. Remember the dot com mayhem? There were scores of “online trading” companies professing that they would overhaul the steel market or the coffee market, etc. as we know it. A viable solution should begin as a trading tool for its customers. Over time, it becomes the best source for the best prices, but the process will be evolutionary.
- Poor functionality. What technology could and should do for these markets is still misunderstood. We have a gross misuse of terms such as “straight-through-processing” and “end-to-end” trading. Both of those should not require human intervention, yet these companies were offering nothing more than a fancy bulletin board with take-it-or-leave-it bids and offers, or a glorified RFP process (one-to-many). Neither offered a counterparty management system unless clearing was involved, but that is cost-prohibitive in most of these markets.
- Technology shouldn’t emulate the offline world, it needs to go where phone brokers can’t. Examples include counterparty management but anonymity while negotiating, hidden price tolerances, if/then optionality, etc.
- Provide added value for all players large and small. For the smaller players, it’s a seat at the table with the major players. For the majors, it’s having instant, actionable and accurate information to make trading decisions.
More Transparency…of What?
Whether it’s US natural gas prices or world market grains, what do we need to see that we don’t have now? I believe the goal is affirmation that neither the major physical traders nor the speculators are manipulating prices. More specifically, transparency concerns range from a) issues with today’s price reporting mechanisms[2, 3], b) high frequency trading that has no correlation to the underlying markets , and c) the subsequent fear of burdensome regulations[5,6]. These are all valid points.
Still in 2015, we rely on brokers and reporters to aggregate data on the day’s traded values. In energy markets, these are compiled by Price Reporting Agencies (PRAs) with sophisticated methodologies to calculate settlement prices. In smaller markets like grains and softs, the best option is to simply take the average of the bid/ask of the most popular phone broker. Yet in both cases, the rest of the economic world is relying on the major traders to report their opinion of where they think values are. Subjectivity issues aside, these traders’ reluctance to speak on record is not unfounded. And still, the question remains about sheer volume of futures trades and whether the institutional traders are influencing the market at the consumers’ expense.
It’s been more than 30 years since the Trading Places characters caused the orange juice market to spike with manipulated data. Was the plausibility of the scheme one of the reasons for the movie’s success? It still seems so today, which is why confirming the true market value of any underlying, physical commodity still seems complex. Yet technology provides the simple solution. If the traders have a platform that increases profitability and operating efficiency, we have a vehicle to illustrate the true supply, demand and price of any commodity. This is actual deal flow, so neither price nor quantity can be manipulated. A good platform should also be able to protects its members’ identities in public and obviate the need for onerous regulations. The latter could squeeze out the much-needed smaller player and still fail to provide the correlation of the futures prices to the underlying supply and demand.
Transparency will not be the death of profits. Burdensome regulation could be, however. It is impossible to have a healthy futures market without a healthy underlying market and the more tools we can provide to increase liquidity, the more the global economy wins. Let’s get in front of this issue.Julie Lerner is the Founder and CEO of PanXchange, Inc. She is the only physical commodity trader who has designed an electronic physical commodity trading system in use today.
 The Price of Responsibility Greg Page, CEO Cargill, Inc.
 Commodity Prices Wrong as Often as 27% of Time for Traders -Bloomberg
 Fears grow over benchmarks reform after Libor scandal -Financial Times
 High-frequency trading generated about 61% of all futures-market volume, WSJ.
 Oil & Gas Financial Journal, Continuing Impact of Dodd-Frank
 WSJ: Banks Should Disclose Physical Commodity Holdings
 PanXchange has researched many markets—from US shelled eggs to crude oil worldwide—and continually learns about traders’ reporting or booking a very small quantity at a distorted price that favors their book.