The next paradigm in commodities: Trade houses vs banks

Agri-business services are dominated by two industries: First, trade houses provide services that vertically integrate from farmers to consumers. Second, financial institutions horizontally integrate the value chain by facilitating an efficient transfer of capital.

There is a sweet spot where these two industries intersect in their service offerings: Risk management and Trade financing. The last two years have witnessed a lot of activity in this point of intersection where there has been a flight of human and financial capital from banks to trade houses. In this article, I will focus on the key reason on such a paradigm shift, and also predict a futuristic scenario how these two service industries will evolve given the technological advance.

Banks traditionally have been financiers and providers of sophisticated risk management products that trade houses lacked the capacity to originate and distribute. Unfortunately, the structure of the banks’ business has led to a decline in their ability to contribute much to their clients. Banks’ organisational structure attracts people with deep knowledge of industry/quantitative mind into research, trading or structuring functions. This leaves behind the sales role to be filled with people who have little freedom both in terms of the type and the cost of products they sell to their clients. Worse, this brings a stress on both the bank and its clients.

On the other hand, people who have a great deal of knowledge in the client’s business and the products they sell to them fulfil the sales role in trade houses.

Trade houses have little incentive to develop their own tools both in financing and risk management areas to compete head-on with banks. This meant that sales people had little incentive to stay with trade houses both from on the compensation side and the intellectual satisfaction side. In the last couple of years, these paradigms have changed. Banks have started leaving the arena of commodities and trade houses have positioned themselves take advantage of this gap. This change benefits a question, what next?

In my opinion, smart machines will replace people to both innovate products and service clients better. Banks and trade houses are well positioned to take advantage of data science to service their clients with the necessary solutions and products. This shall lower the human capital cost structure institutionally, while enhancing productivity. Trade houses and banks will compete to deliver these data science solutions going forward to their clients. They can either grow this platform, organically or inorganically.

My initial reaction is that banks will try to build it organically, while trade houses will be consumers of these services. This will be the time banks will get into this business with the promise of cross selling and higher margins, while trade houses will look like followers. The advantage is in waiting and building data science firms inorganically. The key reason is that there are too many unknowns, and any expectations on returns will be premature and immature. In both cases, investment in inorganic opportunities is the best bet in the short run. The key take away is that commodity industry has seen a big shift and consolidation among trade houses. Machines will remove any inefficiency created by men but the key question is who gains to benefit: Banks versus trade houses?

The writer is based in London and is the founder and Managing Director of OpalCrest. Views are personal.