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February 11, 2011

Casino pushes away gamblers: banks warn regulators

After a 154-percent rise in the price of cotton futures contracts during the past year, the Intercontinental Exchange may require financial speculators to show “economic necessity” to buy more than 30,000 bales of contracts. Both hedge funds and index funds have jumped into the cotton market with no plan whatsoever to own the cotton long enough to take delivery on it. They are overwhelmingly betting “long,” i.e., for prices to increase, reports Gregory Meyer at the Financial Times. Nevertheless, according to a February 8 Reuters article, John Baffes of the World Bank said that there is no “conclusive evidence” that anything but supply and demand fundamentals explain the price climb in cotton and many other commodities over the longer term.

The larger backdrop of this extraordinary scene, where a major exchange is pushing away trades and their fees, is regulatory trench warfare in the U.S. Commodity Futures Trading Commission (CFTC) and the European Commission (EC). In both the U.S. and the EC, regulatory agencies are rewriting rules to regulate commodity trading as part of larger financial market reform efforts. Those who contend that there are no data to show that excessive financial speculation has been a major driver of commodity prices claim that  “overregulation” will drive trades to unregulated venues. European banks have warned EC regulators that the banning of any trading practices in the revision of its Markets in Financial Instruments Directive (MiFID) could “exacerbate systemic risks.”

IATP responded to an EC request for comments on 148 questions regulators posed in a consultation paper about MiFiD. The questions covered the regulation of both financial and commodity markets. Europe does not have the equivalent of a U.S. CFTC, although the government of France has proposed that the EC develop legislation to create a European commodity regulatory authority. IATP suggested to the commission that the European Securities Market Authority, designed to coordinate the regulation of stocks and bonds, had neither the expertise nor adequate resources to coordinate the enforcement of market rules in the 27 EC member states.

The CFTC has requested comments on a proposed interim rule to limit the percentage of contracts that any one entity can control during a trading period. If approved by a majority of the CFTC commissioners, CFTC enforcement of the rule will prevent excessive speculation in the commodity contracts to which the rule applies. The initial position limits will be based on the exchange-traded data reported daily to the CFTC. As the huge volume of over-the-counter (OTC, non-exchange) trades are reported to the CFTC, a much larger trade data base will form the basis for setting more precise limits, to be revised annually as the volume and value of all trades in a commodity contract change. The deadline for comment is March 28. Under the authority of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the CFTC must approve 30 major rules by July 16, 2011.

CFTC Commissioner Michael Dunn, in Geneva to speak at a January 31–February 1 U.N. Conference on Trade and Development Global Commodities Conference, issued a statement through the U.S. Mission. Commissioner Dunn said that there was “little empirical data to support the commonly-repeated view that speculators caused the oil price spike in 2008.” In 2008, the CFTC exempted OTC energy traders from reporting their trade data to the CFTC, as is required daily of exchange traders, e.g., through the Enron loophole. Opponents of position limits have argued that no major commodity market regulatory reform is necessary, because there is no “empirical data” to show that excessive speculation caused and continues to cause extreme price volatility. IATP has argued since 2008 that there is plenty of very strong circumstantial evidence, including data analyzed in an article in the current Federal Reserve Bank of St. Louis Review, to show that excessive financial speculation has been a major commodity-price driver.

Steve Suppan

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