US may tighten regulatory grip on commodity futures

G. Chandrashekhar Mumbai | Updated on March 14, 2011


Global commodity markets are buffeted by a plethora of factors, including geopolitical tensions, currency gyrations, supply constraints, fears of demand slowdown and weather aberrations. All these combine to create an exceptional picture of uncertainty and of course price volatility. Every signal, or even absence of a signal, is interpreted in terms of commodity price risks.

However, the latest is that regulatory uncertainty under the lead of the US has become the focus of investor attention.

Of course, regulatory risks to the commodity market - tighter rules and stricter oversight - started with the extraordinary spike in crude oil and food prices in early 2008. For instance in the US, the Commodity Futures Trading Commission, commodity futures market regulator, imposed position limits with the aim of reducing speculation in commodities and lowering prices.

But now, the ambit has been expanded. The latest regulatory exercise is part of broader objective across all financial markets - equities, bonds, housing, commodities and so on. The objective is to increase transparency and reduce systemic risk to the global financial system.

Dodd-frank act

The regulatory risks have now heightened following signing into law of the Dodd-Frank Act in the US, which seeks to bring about sweeping changes in the US financial markets covering asset classes, including commodities.

According to experts, while it covers an extremely wide range of issues from establishing new agencies to monitor systemic risks to creating national underwriting standards for home loans, the key areas for financial markets are the requirements that the commodity markets regulator and Securities and Exchange Commsission (SEC) establish rules for regulating over-the-counter derivatives markets by July 2011. Market participants apprehend that the regulator may not be able to stick to the timelines, and that there could be delays leaving the markets uncertain.

There is reason to believe the US regulators are now examining ways necessary to regulate swap dealers and reduce risks in the system. It also seeks to improve transparency, improve derivatives pricing, and reduce systemic risk by creating standardised derivatives that can be centrally cleared.

While a number of independent research studies have reportedly found little relationship between investor activity ? some call it a euphemism for speculation ? and commodity price changes, public opinion and political thinking seem to be turning against rabid financialisation of the commodity futures market.

Late last year, experts from as many as 75 countries affiliated to the United Nations Food and Agriculture Organisation after deliberations concluded that rather than global market fundamentals, speculative behaviour, among other factors, caused price spikes. Among the root causes of volatility, the meeting identified ?growing linkage with outside markets, in particular the growing impact of ?financialisation' on futures markets?.

Modi panel

Closer home, recently, a panel headed by the Gujarat Chief Minister, Mr Narendra Modi, has categorically recommended suspension of futures trading in commodities that are critical for food security.

It is unclear what stand the Government would eventually take. If the Centre comes to a logical conclusion that commodity futures markets are harmless and advance stakeholder interest, then why continue with the ban on certain commodities. On the other hand, if such trading does not advance primary producer or consumer interest, why continue to support it?

The current policy towards commodity futures trading in our country is flawed and shows the policymakers in poor light. Policy implementation cannot be selective and arbitrary. The logical nexus between policy and objective sought to be achieved should be well established.

Published on March 14, 2011

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