The global financial crisis of 2008-09 made clear that large global banks, such as Goldman Sachs, are just too big to fail.
Could a future crisis in the commodities market reveal that trading houses such as Glencore pose a similar problem?
The question of whether these institutions have become so large and embedded in the economy that policymakers cannot let them collapse is critical.
The big trading houses underpin global trade in raw materials – buying commodities from producers, transporting them and selling them to consumers. They also play an important role in extending credit to producers, from miners to farmers.
Global policymakers are starting to worry they may be overlooking where the next "too big to fail” threat might emerge.
Timothy Lane, deputy governor of the Bank of Canada, articulated these concerns in a recent speech*.
He said the increasingly prominent role played by large trading houses and the physical trading operations of some large investment banks "raises the possibility that some of these institutions are becoming systemically important”.
His words are being studied closely by commodity trading executives around the globe as they could presage the introduction of some oversight in a currently unregulated sector. Mr Lane did not name the companies he was talking about, but trading houses such as Glencore and Vitol are among the largest.
He asked: "Could the failure of one of the large trading houses cause serious disruption in the commodities markets?”
The question is not mere conjecture. Two leading trading houses have failed over the past 12 years: Enron, a prominent trader of US natural gas and power at the time of its collapse in 2001, and André & Cie, one of the largest traders of agricultural commodities when it failed the same year.
Their collapse did not cause big problems. But some of the largest trading houses have since got much bigger and more integrated.
Their business model is changing as they move from a "middleman’s role” into vertically integrated groups. Glencore’s proposed merger with Xstrata is emblematic of the trend.
A lack of available information is fuelling worries about the impact of the potential collapse of a major commodities trading house. Regulators admit they know little about the trading houses, particularly about the crucial composition of their balance sheets. This regulatory concern is filtering into policy action.
The Financial Stability Board, the Basel-based body that co-ordinates financial regulators, is looking into the issue of "too big to fail” in commodities in two areas.
First, it is exploring the role of trading houses in the shadow banking world. Second, it is looking at whether some top commodities traders should be included in its list of systemically important non-bank financial institutions, joining hedge funds and asset managers.
The sole focus on the financial sector appears misdirected, however. The role of the trading houses in the shadow banking world is limited, even if they do sometimes bypass banks by extending credit. However, with some traders moving into the securitisation of commodity trade finance, this may change.
Their inclusion in the list of systemically important non-bank financial institutions makes more sense. The collapse of, say, Glencore is unlikely to trigger a domino effect in the financial sector similar to that sparked by the Lehman Brothers failure, because trade depends on credit rather than the reverse.
Yet the FSB is looking at systemic risk to the financial market, where the houses have little impact, and to the broader economy, where traders do play a significant role.
The main danger is that a distressed or failing trading house could cause significant disruption to global economic activity via the supply of raw materials. In the worst case scenario, oil flows could be severely disrupted, agricultural commodities could rot in the fields and metals could get stuck in ports.
The 2008 spike in commodities prices offers lessons on the effect of difficult trading conditions. As prices leapt, some big energy trading houses almost stopped taking fresh oil cargoes as they had used up their credit lines.
Cargill, the world’s largest food commodities trader, stopped buying corn from farmers in forward contracts for the first time in its near 150-year history due to rising prices and the gigantic margin calls it was facing every day.
These incidents occurred when traders became distressed. An actual failure would have multiplied the problems.
Thus, although the likes of Glencore, Cargill, Vitol and Trafigura do not fit completely into the "too big to fail” category, they are certainly too important to ignore.
Copyright The Financial Times Limited 2012