Exchange Brokers
Brokers facilitate access to the various exchanges on which we hedge commodities. The word broker often conjures up images of bad movies about stock brokers from the 80s and 90s cold calling 100s of people a day and trying to screw over clients. Luckily, the world of commodity broking is a far cry from those scenes and the relationships I built with brokers went a long way in creating the knowledge I have today.
Brokers are an integral part of the risk mitigation process. If you want to execute a futures trade, you cannot simply call up the LME or CME and ask to sell one lot of aluminum or copper. Brokers are set up to offer clients various appropriate resources to reduce price risk. Some brokers actively take speculative risks on the markets they serve, and others are straight pass-through services, meaning they simply make markets and execute trades. Whatever their internal setup, they work seamlessly with the exchanges and their clients to provide price discovery and efficiencies that would otherwise not be possible.
Choosing which brokers to work with often comes down to personal preference, but when it comes to the LME, there are certain advantages to working with Cat 1 brokers. These are the teams that sit in the ring and take part in the official sessions each day. They process the most volume of trades by far and the information flow they see can help companies make better decisions regarding their own trading.
Of course, a large part of the information benefit comes from actively building relationships with brokers. Everyone knows how important relationships are on the physical side of the business, but often this aspect is overlooked on the derivative side. Whatever broker(s) you are working with, I highly recommend taking the time to talk with them daily about the markets to gain key insights into what they are seeing. Without naming names, brokers love to talk (about the markets and themselves!) so they will always make time for you and it’s these conversations that will serve you well in the long run.
Brokers can offer credit lines for initial and variation margin to companies that meet certain financial standards, allowing companies to free up capital that can be better allocated elsewhere. While the ease of access to credit has decreased in the wake of Covid and the high-rate environment we’ve seen over the last 2 years, this is still a vital part of hedging that companies rely on. In fact, it is in part due to the structure of the LME where money owed for executed trades is not required until the date of settlement that allows brokers to offer out credit lines to physical commodity merchants (a full post on exactly how this works will come at a later date).
Most brokers work on a commission structure, whereby a company will pay a fee for each trade that the broker executes for them. This could be a percentage of the value of the trade, or a fixed $/mt fee depending on the commodity. While these costs are relatively small, they still need to be accounted for when considering P&Ls. Commissions also become a factor of position management - the fewer times you have to carry a futures position from one date to another, the less commission you will pay. Some brokers simply build their commission into the price of the futures trade, which may be preferable if a company can pass that price on to a customer.
Some brokers now have online platforms covering a vast array of information. If Covid showed us one thing it’s that the ability to access information from anywhere is hugely important. If a client wants on-demand access to position reports, P&Ls, live market information, trading strategies, or trade execution, some brokers are actively providing these systems to set themselves apart from the competition.
Whether it is simple trade execution, or a company is looking for a complete guide to the exchange, market insights, and the various risk mitigation products on offer, brokers serve as a key part of the commodities industry. Brokers’ knowledge and willingness to share it is often paramount to the success of a company’s hedging desk.
