Transparentizing the Commodity Trading Sector: Why Trading Companies Must be Subject to Mandatory Payments Disclosure

Commodity trading companies (CTCs) mainly operate as middlemen in a business model called “transit trade,” where CTCs administer the delivery chain for primary economic products (energy, metals, agriculture, etc.) from the extraction site to the ultimate buyers. Though CTCs rarely have physical possession of these commodities, the CTCs are the ones that typically build connections with foreign officials and politicians, pre-finance extraction activities by indebted governments (often through loans pledged on future commodity deliveries), and sell raw materials across the globe. Because of CTCs’ frequent interaction with foreign governments and state-owned enterprises, their complex structure, and the opacity of the commodities market, the corruption risks—particularly in the markets for “hard” commodities like oil, gas, or minerals—are especially large, as a few recent cases have highlighted (see, for example, here, here, and here). Politically exposed persons (PEPs) also take advantages of the opacity in commodity trading to launder illicit proceeds derived from corruption.

Yet in stark contrast to the focus on the corrupt activities of those companies engaged directly in extractive activities, as well as by the ultimate purchasers “upstream,” corruption by CTCs has not received much attention. This oversight should be corrected, in part by covering CTCs under the “Publish What You Pay” (PWYP) laws of their home countries—laws that usually only mandate payment disclosures relating to exploration, extraction, and processing, and that often explicitly exclude payments related to “commodity trading-related activities.” This exclusion is a mistake, as there are at least two good reasons to apply PWYP rules to CTCs:

  • First, CTC payments disclosure is useful in identifying a type of corruption scheme that is unique to (or at least especially common in) the commodity trading sector. The scheme works like this: A small private CTC arranges for the initial purchase of commodities from governments or national oil companies (NOCs) at a low purchase price, and then immediately resells these commodities to a larger and better-known CTC at a higher price (a practice known as “flipping”); though the small CTC may claim to provide logistics services or other expertise, in fact the true owner of the small CTC is a government official or that official’s close associates, and the profits earned from the “flip” are, in effect, bribe payments orchestrated by the large CTC. Moreover, these small CTCs act as buffers that dissociate the bigger CTCs from fishy deals, so these larger, more reputation-conscious firms need not disclose in their filings transactions with corrupt governments or high-risk regions. Subjecting CTCs to PWYP law would make these schemes more difficult, as watchdogs and citizens would have access to payment information that would enable them to monitor CTCs and exert pressure on them. More specifically, payment disclosures by CTCs would allow the public to compare the purchase price of commodities sold to the small CTCs with those “flipped” to the big CTCs, exposing such suspicious transactions and making bribery more difficult to hide.
  • Second, mandatory payment disclosure by CTCs would hold CTCs accountable for facilitating kleptocratic behaviors in swap deals – another type of high-corruption-risk transaction particularly common in commodity trading. In a swap deal, rather than conducting a monetary transaction, the CTC swaps refined products (such as gasoline) for a primary product (such as crude oil) of equivalent value with the producing country, or the CTC lifts a certain amount of crude oil from the country, refines it offshore, and delivers the final products back to the country. In-kind payments such as in swap deals are highly context-specific, with the terms negotiated by the parties, and there is no benchmark estimate or other objective standards against which to measure their value. NOCs can only publish high-level figures for the products supplied by the CTCs or the crude oil that has been lifted; therefore, without disclosure from CTCs, there is no way to compare NOCs’ figures with the value of the refined products. Any discrepancy between revenue remitted to the country and the actual value of the crude indicates a loss of national oil wealth, from which many CTCs are profiting. This lost wealth, unsurprisingly, often finds its way into the pockets of kleptocrats who are the true beneficial owners of the CTCs. Payment disclosure by CTCs would allow auditing or investigative authorities, anticorruption watchdogs, and advocates to compare the accounts of NOCs and those of CTCs, which would shed light on crucial questions such as whether CTCs have supplied all the crude that has been lifted under the swap contract, and whether they have done so with a fair value. If discrepancies between the two accounts are not due to differences in timing of payments and cannot be explained by the disclosing CTCs, they are likely red flags for oil theft or corruption.

Opacity in commodity trading sector is a huge corruption risk. Some of the bigger and more transparency-conscious CTCs have already started to make a business case for CTCs to disclose payments to government, and by voluntarily disclosing such payments. Some regulators, including the EU in its new Markets in Financial Instruments Directives (MiFID II), have started to extend reporting obligations under financial regulations to CTCs. But this approach is extremely technical, costly, and challenging, and still leaves lots of leeway for CTCs to stay under the radar. In contrast, mandatory payment disclosure is a more straightforward and effective transparency measure to foreclose the possibilities of CTCs gaming the system. It is high time and the right time for policymakers to step in and mandate that CTCs disclose their payments.

4 thoughts on “Transparentizing the Commodity Trading Sector: Why Trading Companies Must be Subject to Mandatory Payments Disclosure

  1. Helen, thanks for this illuminating post, highlighting an issue I previously knew nothing about. The current situation seems highly problematic. You mention that the EU has begun to make some initial forays into regulating these CTCs. Do you know of any other jurisdictions that have begun to do this, or are CTCs still operating in the regulatory equivalent of the “wild west?” Additionally, does EITI (https://eiti.org/) have a position on this, as far as you know, or is it just far enough away from their mandate that they haven’t really weighed in? I wonder if one of the reason why this seems like an underreported issue is that CTCs lie in the crevice between different advocacy areas and so as yet not many advocacy organizations are working on highlighting the money-laundering and corruption risks inherent in this industry. (An alternative explanation for why this issue seems “new” to me might just be my own ignorance, of course). Thanks!

    • Thanks, Jason, for your thoughtful comments. To my knowledge, EU was quite ahead of the curve when they first started advising governments on targeted actions to transparentize the sector, despite that the EU countries — such as Switzerland — was unwilling to commit their commodity traders to disclose the payments (at least not before other major trading hubs agree to do the same). Even though the financial regulations in Europe attempt to cover some aspects of the commodity trading, it still leaves may leeway/exceptions that CTCs can take advantages of.
      EITI has a very firm position on this – it encourages the CTCs to voluntarily disclose their payments to the governments; and in fact, many big CTCs does follow the initiative.
      I agree with you that the fact that CTCs are hidden in the crevice of many fields making it difficult for each advocacy group to zero in on this issue; and perhaps in each and every field, CTCs’ problems are trivial compare to other actors’. Only when we look at this sector from a holistic perspective, the opacity and corruption emerges. Another reason I could think of is that the operation of this sector is highly technical and obscure, requiring one to have both legal and financial knowledge to decipher. I would not say I am an expert on this – as I am not – but my experience of researching this sector was rather arduous.

  2. Great post. Subjecting CTCs to disclosure regulations seems like it makes perfect sense, so why have they been specifically excluded from PWYP laws? Are there any legitimate arguments against disclosure for these kinds of entities? Or is the disclosure gap due to something like lobbying, self-interest of politicians, or inadvertence?

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