Bank of England takes deep dive into 'opaque' commodities

Regulators have sight of UK-traded energy and metal markets, but there are data gaps relating to some traded commodities.
Ore at Zapolyarny mine of Medvezhy Ruchey enterprise, a subsidiary of the world's leading nickel and palladium producer Nornickel, in the Arctic city of Norilsk, Russia, 24 August 2021.
Ore at Zapolyarny mine of Medvezhy Ruchey enterprise, a subsidiary of the world's leading nickel and palladium producer Nornickel, in the Arctic city of Norilsk, Russia, 24 August 2021.

The Bank of England (BoE) said on Tuesday it will conduct an in-depth analysis to enhance surveillance of "opaque" commodity markets after Russia's invasion of Ukraine left the central bank without a full picture of risks and vulnerabilities.

Just as the global financial crisis threw a spotlight on unregulated so-called shadow banks, commodity price spikes this year have rung alarm bells among regulators on the need to plug data gaps in the sector as households struggle with rocketing energy bills, stoking inflation.

"Heightened uncertainty following the Russian invasion means there is significant risk of further disruption in commodity markets," the BoE's Financial Policy Committee said in its half-yearly report on risks to Britain's financial system.

Big UK banks have up to £140 billion ($168.39 billion) or 50% of their total core capital of gross exposure to commodity producers, suppliers, and traders, and to commodity derivatives.

Around £110 billion of UK bank exposures are on their lending books.

Banks have enough capital to continue supplying credit to commodity market participants, it said.

"If disruption is prolonged and uncertainty increases, banks may become even less willing to extend credit to commodity market participants," the BoE said.

Regulators have sight of energy and metals markets traded in Britain, but commodities such as grains are traded elsewhere in the US and France.

In addition, a large part of commodity market activity is traded over the counter or privately, off an exchange. Physical production and inventory, which are largely unregulated and poorly reported, also make it hard to build up a full view.

Nickel prices on the London Metal Exchange (LME) hit a record high of more than $100,000 a tonne after Russia, a major producer, invaded Ukraine, with trading suspended for a week in March and the LME's clearing house forced to nearly double its default fund.

The BoE and Financial Conduct Authority opened reviews into the LME and its clearing arm.

Separately on Tuesday, the European Union's securities watchdog, the European Securities and Markets Authority, said a stress test of clearing houses in the bloc showed they were resilient to major shocks but that "gaps" in safety buffers were uncovered in commodity derivatives.

Opacity and fragmentation

The UK's economic outlook has deteriorated materially in part because of higher commodity prices, and the BoE is making it a priority to get a better grip of underlying activity that is interlinked to the wider economy and financial system.

"Due to opacity and lack of data in some markets, quantifying the size and scale of these fragilities and interconnections remains challenging, and addressing this globally should be a priority," the BoE said.

Trade repositories for reporting transactions were set up in the aftermath of the global financial crisis over a decade ago, but it is still cumbersome to draw on data from them to build up a snapshot of who is exposed to a particular commodity.

"I think it's important that the market structures keep up and reflect the change in the supply-demand balance in these markets," BoE Governor Andrew Bailey told a news conference.

There are gaps in reporting, with the granularity of data limited in some markets, with some physically settled off-exchange transactions not even reported to repositories.

Improvements to data reporting should be done in a coordinated manner globally to enable enhanced surveillance of these markets by authorities, Bailey said.