Commodity trade finance house of the year: Tramontana

The elegance of environmental markets is that they put a financial and economic value on a beneficial activity – the avoidance of pollution, or the generation of a carbon-free unit of energy – that was hitherto unvalued. The largest of these markets have created billions of euros of liabilities that need to be managed, and billions of euros’ worth of assets that can be used for financing – creating balance sheet headaches and investment opportunities in equal measure.

This is where Tramontana comes in. The specialist investment firm offers novel trade finance vehicles that allow its corporate clients to hedge their environmental market exposures off-balance sheet or use allowance inventory to raise financing. It does so by creating collateralised notes that offer institutional investors exposure to environmental markets, explains Henry Hart, assistant vice-president at the firm.

“Lots of the companies involved in the energy transition have huge forward carbon exposure,” he explains, by dint of their obligations under the EU Emissions Trading System (ETS). Many have hedged this exposure by buying up EU allowances (EUAs) in the 2010s when they were very cheap but, since EUAs have risen in value, they have sought less balance sheet-intensive hedging strategies – tending to sell physical EUAs and buy exchange-traded EUA futures.

However, this can expose them to variation margin risk in volatile markets and, because liquidity in EUA futures is concentrated in the front year, to costs and risks from periodically rolling over the futures position. “This is not as efficient as entering into a longer-term derivative,” Hart says. “This is where we come in.”

Tramontana’s transactions allow its clients to lock in a forward price, eliminate the balance sheet burden of exchange margin requirement for several years and save on the slippage and execution costs of rolling futures hedges.

Over the past five years, Tramontana has written some $7 billion in notes, typically of three to five years in tenor, that collateralise corporates’ environmental market assets in exchange for low-cost financing. On the other side of the trades are investors looking for exposure to environmental markets, but which are much more comfortable with structured notes than entering into the underlying derivatives.

“There are a lot of non-specialist investors who want to get … involved in the energy transition, but they can’t book complex financial products like derivatives,” he explains. “The investor gets a fixed income note that acts like a bond and, on the corporate side, they get a long-dated derivatives that hedges their exposure.”

The evolving regulatory environment for banks promises to provide tailwinds to the business, Hart says. A corporate would normally go to its relationship bank for derivatives financing, but the Basel IV rules are making it more expensive in terms of capital provision for banks to hold longer-dated commodity derivatives. “Because our notes are bought by real-money investors, and are routed through special-purpose vehicles, these kinds of capital charges don’t apply,” he says.

“The other advantage we have is that we are small and nimble, so we can execute things quickly and cheaply,” he says. “Our challenge is that we have to convince corporates that we can put these structures in place – having a few billion under our belts helps with that.”

Hart acknowledges that bearish sentiment in carbon markets, caused by an energy transition that is now widely expected to be “longer and slower” than that anticipated a few years ago, has reduced demand for hedging among corporates.

Tramontana also sees opportunities in other environmental markets and in the underlying commodities. “We’re always looking at different asset classes,” he says, noting that the company is now a licensed gas shipper in France, allowing it to use stored natural gas as collateral in its notes.

The company is also looking at novel environmental markets. “When you start digging into it, there are loads of them,” he says. He gives as examples markets in road transport fuel certificates in the UK, to encourage the supply of low-carbon fuels, and a German market in environmental certificates linked to its heating and transport sectors. “All these markets operate in different ways, with different risks,” he notes.

He also remains confident that, while slower progress notwithstanding, he expects the EU ETS and similar systems to persist. “I think that everybody who’s involved in the carbon market understands that they are probably the best system for eventually achieving net zero.”