BNP Paribas Strategy: Meeting the Financial Needs of the Energy Sector
by Will Acworth
How did a French bank end up with one of the biggest operations at the New York Mercantile Exchange? By focusing on providing risk management to corporate clients in the energy business.
BNP Paribas, the world's third largest bank by assets, has established itself as one of the leading providers of corporate finance to the global energy sector. Its office in Houston is one of the largest lenders to U.S. oil and natural gas companies, and its teams of specialists in the Americas, Europe and Asia consistently top the rankings in providing trade finance, project finance and other types of credit facilities to a host of companies in the energy sector. Providing risk management for these customers is the raison d'être for its energy futures business.
"Futures for us are definitely part of a broader franchise," explains Jean-Marc Bonnefous, head of commodity derivatives at BNP Paribas. "We are focused on delivering a full range of lending, risk management and structured products to our clients in the energy sector, and our organizational structure reflects this sectoral approach."
New York and London
The bank's energy futures business is housed in BNP Paribas Commodity Futures, a full service futures commission merchant registered with the Commodity Futures Trading Commission in the U.S. and the Financial Services Authority in the U.K. The FCM's New York office has approximately 40 staff, many of whom have been at the firm for a decade or more, and maintains one of the largest execution teams on the floor of the Nymex as well as a 24-hour electronic brokerage desk.
BNP Paribas Commodity Futures is also a major player on ICE Futures, the second largest energy futures exchange in the world and an important price discovery hub for the global energy trade. Last year the firm ranked first in the execution of crude oil products at ICE Futures, according to Bonnefous. The firm is also a member of the London Metal Exchange and provides clearing services to an expanding range of products in the European energy complex, such as emissions, power and freight.
The commodity derivatives division as a whole consists of 120 people in three locations New York, London and Singapore. In addition to running the futures desks at the exchanges in New York and London, the division is very active in the over-thecounter energy derivatives business, providing swaps and options to energy companies as part of their financing vehicles as well as structured notes to investors seeking exposure to energy prices. Bonnefous says this part of the commodity derivatives business is growing extremely rapidly, and adds that it generates additional transaction flow for the futures side of the division.
Long-Term Relationships
The energy business by nature is a cyclical business, and right now the sector is booming. Prices for oil and natural gas set record highs last year, and institutional investors are pouring billions of dollars into the energy markets. For intermediaries such as BNP Paribas, these are great times except that success always attracts more competition.
In the last few years, a sizeable number of commercial banks have invested heavily in expanding their ability to trade energy derivatives both futures and over-the-counter instruments. In some cases, the banks started from scratch, hiring entire teams away from established houses to jump-start their trading desks. As a result, competition for deals is fierce, and the margins are very tight.
To thrive in this environment, BNP Paribas relies on several competitive advantages. First is the strength of its balance sheet. Rather than trying to gain an edge through proprietary trading or acquiring physical assets, as some investment banks have done, BNP Paribas has concentrated on meeting its clients' needs for long-term and short-term financing. The bank has been involved with the oil and gas business for over 40 years, and it has been a member of Nymex since 1985. Through thick and thin, its focus has been on the physical players the companies that drill, refine, process and transport energy products. Relationships with these companies are the heart of the bank's energy business, and the foundation for its commodity futures operation.
A second competitive advantage is its organizational structure. Rather than being part of the bank's fixed income or equity divisions, as is the case at many other global banks, Bonnefous and his teams in New York, London and Singapore operate within a double sponsorship between the bank's equity and derivatives division and a unique structure created in 2002 called the Energy Commodities Export Project. This ECEP structure, which brings together the talents and resources of 1,200 people across the bank's global organization, offers a variety of financial products for companies involved in the production, handling and trading of commodities such as oil, natural gas, power and metals. The commodity derivatives division is fully integrated into this structure, while at the same time its relationship to the equity and derivatives division brings access to investor business distribution channels and advanced analytical risk management processes.
The services offered by the various teams within the ECEP range from providing simple letters of credit for shipments of crude oil to arranging large syndicated loans and highly complex structured finance for utilities, refineries and other large companies. In many cases, these financial transactions have a hedging component, and that leads directly to the bank's derivatives desks.
Risk Management
In some cases, the risk is managed directly with futures; in other cases an OTC product may be better suited for the customer's needs. A typical structure might be a credit facility with an embedded swap or collar to limit the effects of swings in energy prices on the borrower's repayment capacity.
For example, a number of the bank's clients have called on it to provide financing for a major corporate transaction, such as the construction of a new production facility or the renegotiation of its existing lines of credit. In such cases, BNP Paribas will negotiate the terms of the credit facility and organize a syndicate of other lenders to provide the funding. To maintain the value of the cash flows underlying the transaction, the bank will include a hedge program that may go out several years.
The boom in energy prices has contributed to an upswing in mergers and acquisitions among energy companies, and that has helped boost the derivatives business. Acquisitions usually require some sort of long-term financing, and that creates a demand for a hedge to lock in the cash flows. BNP Paribas, with its integrated approach to energy finance, can offer the equivalent of one-stop shopping.
Not all of the FCM's business comes from these complex deals, however. A large amount of the day-to-day transaction flow comes from executing and clearing trades for the huge number of companies involved in the physical side of the energy business. These companies are exposed to price risk every day, and they rely on futures and options on futures to hedge that risk.
The downside of this sectoral approach that the bank is not very well positioned to meet the needs of investors seeking access to multitude of futures markets around the world. A global macro hedge fund, for example, might want to trade energy futures today, but tomorrow its target market could be futures based on foreign exchange or government bonds. BNP Paribas does have a separate securities subsidiary that handles financial futures, but this unit operates independently of the commodity derivatives unit and is focused more on cash and OTC markets. So compared to the global infrastructure players, BNP Paribas offers a much more narrow capacity to execute and clear futures.
On the other hand, its focus on the energy sector, combined with its decision to make futures part of an integrated client-facing unit of the bank, means that it is especially responsive to the needs of the energy sector. Perhaps the best example of this is OTC clearing, one of the biggest drivers of new business for the futures unit in the last two years.
OTC Clearing
Both Nymex and ICE introduced OTC clearing in 2002. This type of facility combines the transactional advantages of the over-the-counter derivatives markets, principally the ability to negotiate on a principalto- principal basis, with the risk reduction advantages of the futures markets, namely the ability to move credit risk to a clearinghouse. Initially market participants resisted the concept, but in early 2004 the volume of OTC transactions presented to Nymex and ICE for clearing began to take off. Clearing is now pervasive in the U.S. natural gas market and increasingly common in other parts of the energy complex.
BNP Paribas was one of the first FCMs to offer OTC clearing. Initially some FCMs were worried that clearing OTC products might be too risky. Others were too distant from the energy market to recognize the potential opportunity, or worried that OTC clearing might undermine traditional execution business. But BNP Paribas, with its expertise in the energy sector, was willing to take on the risks. The bank also recognized that OTC clearing would give the energy trading business a much sounder foundation, and give its client base a better way to handle counterparty risk.
Louis Caiafa, the head of BNP Paribas Commodities' New York office, says OTC clearing has jumped from around 10% of the unit's overall business at the end of 2004 to nearly 45% of its business at the beginning of 2006. That's not because the FCM's exchange-traded business is declining. Quite the contrary, traditional execution and clearing have been on a very healthy upswing. Rather, he says, it reflects the large-scale migration of OTC business to the clearinghouse environment. In fact, the clients are demanding that the list of OTC products available for clearing be expanded.
Exchange Competition
Looking ahead, one of the biggest issues affecting all energy market participants is the competition between Nymex, still primarily an open outcry exchange, and ICE, now fully electronic. With ICE Futures now competing head to head with Nymex in crude oil futures, market participants are looking forward to a new era of lower fees and more electronic trading. Chicago Mercantile Exchange reportedly is poised to jump into the energy futures exchange business as well, bringing further competition to this trading arena.
Bonnefous is careful to avoid expressing a preference for one exchange over the other, or for electronic trading over open outcry. He says BNP Paribas has built its business around what the clients want, and as long as clients prefer open outcry, it will remain committed to that method for executing trades. "It is not up to us to dictate where customers should trade," he says.
That said, he emphasizes the importance of the entire transaction processing chain, covering not only how a trade is executed but also how positions are monitored and confirmations are delivered. There is a segment of the customer base that cares a great deal about how trades are processed, he says. "The challenge for FCMs is to optimize the costs and throughput."
This does not mean, however, that computers will replace human beings in the handling of customer orders, Bonnefous believes. ICE Futures converted to all-electronic trading in April 2005, but quite a few of the firm's customers still want human traders on the other end of the phone, he says. "The commodity industry, especially oil and metals, is very idiosyncratic. Even with electronic trading, there is still a need for personal contact with someone who has market expertise. We are offering commodity-focused risk management, and our success depends on both the quality of the processing chain and the quality of our relationships with customers."
Stepping into Softs
With both Nymex and ICE rapidly expanding the list of OTC products available for clearing, the FCM is looking at a very full pipeline of business. But this isn't the only area where BNP Paribas sees potential for growth in the futures business. After Refco collapsed in October 2005, the French bank hired a team of seven ex-Refco traders specializing in the "softs", i.e., tropical commodities such as sugar, coffee and cocoa. The team, which is particularly strong in the sugar futures market, is headed by Jeff Bauml in New York and includes staff in London and São Paulo, Brazil. In conjunction with the addition of this expansion, BNP Paribas has become a member of the New York Board of Trade, one of the leading marketplaces for these commodities.
Bonnefous says BNP Paribas plans to apply the same business model to the softs business, integrating the futures clearing and execution business with the bank's commodity finance operation, which has an existing base of corporate clients involved in the production, processing and distribution of these commodities. He is especially intrigued by the potential correlations between the sugar and energy markets. Brazil, one of the world's leading producers of sugar, is converting an increasing amount of sugar into ethanol as an alternative to gasoline, and the consequent reduction in the supply of sugar has helped drive sugar prices to record highs in recent months. Bonnefous sees interest among some of the bank's customers in trading strategies based on correlations between sugar, ethanol and gasoline prices.
Structured Products
Another important driver for growth in the futures unit is the growth of the commodity structured note business. Although this is primarily an OTC business, the building blocks for these notes are exchange-traded futures and options. The structured notes are based on commodity indices or custom-built commodity baskets, with the prices generally derived from the futures markets. Typically these notes include a guarantee on the principal to protect the investor from loss, and may include complex payout formulas that resemble call and put options. For example, a structured note can be designed to pay a certain rate of return over a specified number of years, plus an additional amount based on the movement of a commodity index or basket of commodities.
Bonnefous says this business has had "phenomenal growth" in the past two years, with demand coming primarily from institutional investors and high net worth clients who see the commodity markets as an alternative asset class. In a sense, the structured note business marries two different areas of expertise within BNP Paribas: complex financial engineering skills developed by its equity and fixed income derivatives specialists, and its in-depth knowledge of commodity markets. The derivatives specialists are experts at understanding the correlations in a basket of instruments and breaking out the different elements of risk and return, while the commodity specialists provide the market expertise necessary to create these products, deliver the returns, and hedge the embedded risks. So the more that the bank sells structured notes based on commodities, the more business it generates for the FCM.
"Every deal in that pot [the structured note side] ends up going into the futures business," says Bonnefous. "The exchange-traded products are the basic foundation for the commodity structured note business."
BNP Paribas Commodity Futures
Will Acworth is the editor of Futures Industry magazine.
www.futuresindustry.org/d...pr_BNP.pdf
by Will Acworth
How did a French bank end up with one of the biggest operations at the New York Mercantile Exchange? By focusing on providing risk management to corporate clients in the energy business.
BNP Paribas, the world's third largest bank by assets, has established itself as one of the leading providers of corporate finance to the global energy sector. Its office in Houston is one of the largest lenders to U.S. oil and natural gas companies, and its teams of specialists in the Americas, Europe and Asia consistently top the rankings in providing trade finance, project finance and other types of credit facilities to a host of companies in the energy sector. Providing risk management for these customers is the raison d'être for its energy futures business.
"Futures for us are definitely part of a broader franchise," explains Jean-Marc Bonnefous, head of commodity derivatives at BNP Paribas. "We are focused on delivering a full range of lending, risk management and structured products to our clients in the energy sector, and our organizational structure reflects this sectoral approach."
New York and London
The bank's energy futures business is housed in BNP Paribas Commodity Futures, a full service futures commission merchant registered with the Commodity Futures Trading Commission in the U.S. and the Financial Services Authority in the U.K. The FCM's New York office has approximately 40 staff, many of whom have been at the firm for a decade or more, and maintains one of the largest execution teams on the floor of the Nymex as well as a 24-hour electronic brokerage desk.
BNP Paribas Commodity Futures is also a major player on ICE Futures, the second largest energy futures exchange in the world and an important price discovery hub for the global energy trade. Last year the firm ranked first in the execution of crude oil products at ICE Futures, according to Bonnefous. The firm is also a member of the London Metal Exchange and provides clearing services to an expanding range of products in the European energy complex, such as emissions, power and freight.
The commodity derivatives division as a whole consists of 120 people in three locations New York, London and Singapore. In addition to running the futures desks at the exchanges in New York and London, the division is very active in the over-thecounter energy derivatives business, providing swaps and options to energy companies as part of their financing vehicles as well as structured notes to investors seeking exposure to energy prices. Bonnefous says this part of the commodity derivatives business is growing extremely rapidly, and adds that it generates additional transaction flow for the futures side of the division.
Long-Term Relationships
The energy business by nature is a cyclical business, and right now the sector is booming. Prices for oil and natural gas set record highs last year, and institutional investors are pouring billions of dollars into the energy markets. For intermediaries such as BNP Paribas, these are great times except that success always attracts more competition.
In the last few years, a sizeable number of commercial banks have invested heavily in expanding their ability to trade energy derivatives both futures and over-the-counter instruments. In some cases, the banks started from scratch, hiring entire teams away from established houses to jump-start their trading desks. As a result, competition for deals is fierce, and the margins are very tight.
To thrive in this environment, BNP Paribas relies on several competitive advantages. First is the strength of its balance sheet. Rather than trying to gain an edge through proprietary trading or acquiring physical assets, as some investment banks have done, BNP Paribas has concentrated on meeting its clients' needs for long-term and short-term financing. The bank has been involved with the oil and gas business for over 40 years, and it has been a member of Nymex since 1985. Through thick and thin, its focus has been on the physical players the companies that drill, refine, process and transport energy products. Relationships with these companies are the heart of the bank's energy business, and the foundation for its commodity futures operation.
A second competitive advantage is its organizational structure. Rather than being part of the bank's fixed income or equity divisions, as is the case at many other global banks, Bonnefous and his teams in New York, London and Singapore operate within a double sponsorship between the bank's equity and derivatives division and a unique structure created in 2002 called the Energy Commodities Export Project. This ECEP structure, which brings together the talents and resources of 1,200 people across the bank's global organization, offers a variety of financial products for companies involved in the production, handling and trading of commodities such as oil, natural gas, power and metals. The commodity derivatives division is fully integrated into this structure, while at the same time its relationship to the equity and derivatives division brings access to investor business distribution channels and advanced analytical risk management processes.
The services offered by the various teams within the ECEP range from providing simple letters of credit for shipments of crude oil to arranging large syndicated loans and highly complex structured finance for utilities, refineries and other large companies. In many cases, these financial transactions have a hedging component, and that leads directly to the bank's derivatives desks.
Risk Management
In some cases, the risk is managed directly with futures; in other cases an OTC product may be better suited for the customer's needs. A typical structure might be a credit facility with an embedded swap or collar to limit the effects of swings in energy prices on the borrower's repayment capacity.
For example, a number of the bank's clients have called on it to provide financing for a major corporate transaction, such as the construction of a new production facility or the renegotiation of its existing lines of credit. In such cases, BNP Paribas will negotiate the terms of the credit facility and organize a syndicate of other lenders to provide the funding. To maintain the value of the cash flows underlying the transaction, the bank will include a hedge program that may go out several years.
The boom in energy prices has contributed to an upswing in mergers and acquisitions among energy companies, and that has helped boost the derivatives business. Acquisitions usually require some sort of long-term financing, and that creates a demand for a hedge to lock in the cash flows. BNP Paribas, with its integrated approach to energy finance, can offer the equivalent of one-stop shopping.
Not all of the FCM's business comes from these complex deals, however. A large amount of the day-to-day transaction flow comes from executing and clearing trades for the huge number of companies involved in the physical side of the energy business. These companies are exposed to price risk every day, and they rely on futures and options on futures to hedge that risk.
The downside of this sectoral approach that the bank is not very well positioned to meet the needs of investors seeking access to multitude of futures markets around the world. A global macro hedge fund, for example, might want to trade energy futures today, but tomorrow its target market could be futures based on foreign exchange or government bonds. BNP Paribas does have a separate securities subsidiary that handles financial futures, but this unit operates independently of the commodity derivatives unit and is focused more on cash and OTC markets. So compared to the global infrastructure players, BNP Paribas offers a much more narrow capacity to execute and clear futures.
On the other hand, its focus on the energy sector, combined with its decision to make futures part of an integrated client-facing unit of the bank, means that it is especially responsive to the needs of the energy sector. Perhaps the best example of this is OTC clearing, one of the biggest drivers of new business for the futures unit in the last two years.
OTC Clearing
Both Nymex and ICE introduced OTC clearing in 2002. This type of facility combines the transactional advantages of the over-the-counter derivatives markets, principally the ability to negotiate on a principalto- principal basis, with the risk reduction advantages of the futures markets, namely the ability to move credit risk to a clearinghouse. Initially market participants resisted the concept, but in early 2004 the volume of OTC transactions presented to Nymex and ICE for clearing began to take off. Clearing is now pervasive in the U.S. natural gas market and increasingly common in other parts of the energy complex.
BNP Paribas was one of the first FCMs to offer OTC clearing. Initially some FCMs were worried that clearing OTC products might be too risky. Others were too distant from the energy market to recognize the potential opportunity, or worried that OTC clearing might undermine traditional execution business. But BNP Paribas, with its expertise in the energy sector, was willing to take on the risks. The bank also recognized that OTC clearing would give the energy trading business a much sounder foundation, and give its client base a better way to handle counterparty risk.
Louis Caiafa, the head of BNP Paribas Commodities' New York office, says OTC clearing has jumped from around 10% of the unit's overall business at the end of 2004 to nearly 45% of its business at the beginning of 2006. That's not because the FCM's exchange-traded business is declining. Quite the contrary, traditional execution and clearing have been on a very healthy upswing. Rather, he says, it reflects the large-scale migration of OTC business to the clearinghouse environment. In fact, the clients are demanding that the list of OTC products available for clearing be expanded.
Exchange Competition
Looking ahead, one of the biggest issues affecting all energy market participants is the competition between Nymex, still primarily an open outcry exchange, and ICE, now fully electronic. With ICE Futures now competing head to head with Nymex in crude oil futures, market participants are looking forward to a new era of lower fees and more electronic trading. Chicago Mercantile Exchange reportedly is poised to jump into the energy futures exchange business as well, bringing further competition to this trading arena.
Bonnefous is careful to avoid expressing a preference for one exchange over the other, or for electronic trading over open outcry. He says BNP Paribas has built its business around what the clients want, and as long as clients prefer open outcry, it will remain committed to that method for executing trades. "It is not up to us to dictate where customers should trade," he says.
That said, he emphasizes the importance of the entire transaction processing chain, covering not only how a trade is executed but also how positions are monitored and confirmations are delivered. There is a segment of the customer base that cares a great deal about how trades are processed, he says. "The challenge for FCMs is to optimize the costs and throughput."
This does not mean, however, that computers will replace human beings in the handling of customer orders, Bonnefous believes. ICE Futures converted to all-electronic trading in April 2005, but quite a few of the firm's customers still want human traders on the other end of the phone, he says. "The commodity industry, especially oil and metals, is very idiosyncratic. Even with electronic trading, there is still a need for personal contact with someone who has market expertise. We are offering commodity-focused risk management, and our success depends on both the quality of the processing chain and the quality of our relationships with customers."
Stepping into Softs
With both Nymex and ICE rapidly expanding the list of OTC products available for clearing, the FCM is looking at a very full pipeline of business. But this isn't the only area where BNP Paribas sees potential for growth in the futures business. After Refco collapsed in October 2005, the French bank hired a team of seven ex-Refco traders specializing in the "softs", i.e., tropical commodities such as sugar, coffee and cocoa. The team, which is particularly strong in the sugar futures market, is headed by Jeff Bauml in New York and includes staff in London and São Paulo, Brazil. In conjunction with the addition of this expansion, BNP Paribas has become a member of the New York Board of Trade, one of the leading marketplaces for these commodities.
Bonnefous says BNP Paribas plans to apply the same business model to the softs business, integrating the futures clearing and execution business with the bank's commodity finance operation, which has an existing base of corporate clients involved in the production, processing and distribution of these commodities. He is especially intrigued by the potential correlations between the sugar and energy markets. Brazil, one of the world's leading producers of sugar, is converting an increasing amount of sugar into ethanol as an alternative to gasoline, and the consequent reduction in the supply of sugar has helped drive sugar prices to record highs in recent months. Bonnefous sees interest among some of the bank's customers in trading strategies based on correlations between sugar, ethanol and gasoline prices.
Structured Products
Another important driver for growth in the futures unit is the growth of the commodity structured note business. Although this is primarily an OTC business, the building blocks for these notes are exchange-traded futures and options. The structured notes are based on commodity indices or custom-built commodity baskets, with the prices generally derived from the futures markets. Typically these notes include a guarantee on the principal to protect the investor from loss, and may include complex payout formulas that resemble call and put options. For example, a structured note can be designed to pay a certain rate of return over a specified number of years, plus an additional amount based on the movement of a commodity index or basket of commodities.
Bonnefous says this business has had "phenomenal growth" in the past two years, with demand coming primarily from institutional investors and high net worth clients who see the commodity markets as an alternative asset class. In a sense, the structured note business marries two different areas of expertise within BNP Paribas: complex financial engineering skills developed by its equity and fixed income derivatives specialists, and its in-depth knowledge of commodity markets. The derivatives specialists are experts at understanding the correlations in a basket of instruments and breaking out the different elements of risk and return, while the commodity specialists provide the market expertise necessary to create these products, deliver the returns, and hedge the embedded risks. So the more that the bank sells structured notes based on commodities, the more business it generates for the FCM.
"Every deal in that pot [the structured note side] ends up going into the futures business," says Bonnefous. "The exchange-traded products are the basic foundation for the commodity structured note business."
BNP Paribas Commodity Futures
Will Acworth is the editor of Futures Industry magazine.
www.futuresindustry.org/d...pr_BNP.pdf
