‘Manipulation, not speculation, is bad’

Rajalakshmi Nirmal | Updated on January 09, 2018

KEVIN C. PICCOLI, Deputy Director, Commodity Futures Trading Commission

The market regulator needs to ensure fair pricing, says CFTC Deputy Director

With SEBI taking charge of the commodity derivatives markets, a lot has changed. But still, it is a long way before we see a robust platform for farmers and other commodity producers. BusinessLine spoke with Kevin C. Piccoli, Deputy Director, Commodity Futures Trading Commission, the regulator for futures & options in commodities in the US, to understand how they deal with the challenges that commodity markets pose.

He spoke on many issues — role of regulator, why it is not uncommon for commodity contracts to be unsuccessful and how to ensure that the derivative market benefits farmers. Excerpts from the interview:

Can you give us an idea of how the global commodities market has changed in terms of participation of investors and in terms of regulation over the last few decades?

I think it has been a fascinating development over the last 2-3 decades, because if you think back, then, the commodity market was calm and almost boring to some extent. Everyone viewed the commodities market as trading places with people in their pits, showing hand signals and yelling at each other, but that market doesn’t exist anymore.

It is now a 24/7 electronic market. It is a global market and it is so inter-connected. If someone sneezes in Mumbai, you can catch the flu in New York. It is that well connected, which makes it exciting. The number of products that have come into the market in the last 10-15 years has grown immensely. I think that has helped bring attention from institutional investors of the commodity world, and new products such as ETFs that are also getting evolved in commodity activities.

But the challenge is for regulators, because it is a complex market — now you have commodity swaps, forwards, futures and physical — and all this within one fund which creates complexity. So from a regulator’s stand point, we want to make sure that the markets are fair, transparent and operating in the best interest of the public.

In India, we see the regulator banning some agri futures contracts often on grounds of speculation. How do you deal with this in the US?

I think it is a part of the market oversight process in monitoring the futures price. At CFTC, we have a number of people who monitor the market trading activity every day and when something unusual happens, they call up the trader and ask, “what’s happening, why are you now so long or why are you so short in this position or why are you traditionally long, now why are you short…” so we make sure we understand what’s happening in the market because we are not concerned about if the futures contract is profitable, whether people make money or not, we hope they do, but, that is not our business.

Our business is to make sure that the markets are fair, there is no manipulation and it is an effective risk management tool for hedgers, producers and end-users. But most commodity futures contracts are not successful. Of the 10,000 or so registered contracts with the CFTC, I think less than 2 per cent are traded over 100,000 contracts in open interest. 95 per cent have less than 10,000 contracts in open interest. So, it is not unusual for a contract to not be successful.

We hear that a lot farmers in the US hedging price risk through derivative contracts. What is your suggestion for us? How do we get our farmers to the derivative market?

In the US, we have a number of very large farmer corporations. These are large family-owned farms that go through associations such as the American Grains Association and grain co-operatives and they help by pooling the farmers together, so that gives them the power of a large corporation. So by having a co-operative or an association…they can help educate the small farmers because it is not that simple, so they can provide them that knowledge and experience.

We have advisory committees at the CFTC and at the advisory committees we invite the grains association to talk to us about what the small farmers want, so they have a voice in Washington.

Speculation is always seen as a bad thing in India, at least as far as the commodity futures market is concerned. How do you see speculation? Is it good or bad for the markets?

Our job is to make sure that the pricing is fair and there is no manipulation. But, speculators bring liquidity. Every market, every contract needs liquidity. You can help make sure that speculators do not manipulate or control the market. We get all the trade activity the next day from all the exchanges put it through our computer models and we have specially developed algorithms that go through different scenarios and it comes back to the analyst when they walk in the morning. The analysts then look at trading patterns by traders by company, by broker, by institution and see also if it is a hedged trade or a speculative trade. So, the best thing is having a lot of good people at the regulator.

SEBI is a terrific regulator. So, just monitor, anything goes wrong you take enforcement action. So, speculation by itself is not bad. Manipulation is bad, speculation is not necessarily bad.

Commodity futures traders complain about the high transaction charges, the CTT and other levies as it shrinks the margin of profit. So, do you have charges such as these in the US commodity market? If yes, how much?

Yes, in the industry we certainly do. There are transaction charges depending on the product. There is exchange fees, there is the National Futures Association which is the self-regulatory organisation for the industry, they have a charge that they put on trades, and then there is obviously a commission that the broker wants to get, so yes there can be a cost, nothing is free. It is very important to make sure that the markets are regulated and not having the proper resources to do it is going to be more harmful.

Many pose this question: what is the economic significance of a futures market in a developing country? They say it is only a market place for jobbers and speculators. What is your reply to that?

Spot market is good to tell you the price of a commodity today. But the farmer is sowing seeds in the ground to produce crops down the line. They need to know the price 3-6 months from now when they harvest the crop.

And if they are able to lock in the price today, when they plant, they don’t have the risk of a drought or of monsoon wiping away their crop. They transfer their risk to someone else and that’s what the futures market does — it is a risk management tool for them because farmers are not in the business of taking risk.

Let the brokers, investment banks, the hedge funds take the risk, that’s what they do for a living and, they get paid for it.

Published on December 03, 2017

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