Having spent over three years above or close to $100 a barrel, sliding crude oil prices have been the talk of the town in commodity markets in 2015. So it was perhaps only a matter of time before some market participants and regulators began to question the impact of financial trading on oil prices. Whether prices are up or down, it seems that complaints about speculation are one of the few things you can truly count on, along with death and taxes.
On both sides of the Atlantic, efforts are underway to address these worries by imposing position limits on commodity derivatives. In the US, the Commodity Futures Trading Commission (CFTC) is forging ahead with proposals for position limits that "prevent excessive speculation", in line with the 2010 Dodd-Frank Act. In the European Union, a 2014 update of financial markets legislation named Mifid II incorporates a system of position limits, whose aim is to "prevent market abuse" and "support orderly pricing and settlement".
These are noble ambitions. But will the rules work? That depends first on whether you believe excess speculation is creating market disorder, and second, whether the rules would prevent that disorder from occurring. Although there is no doubt that firms with outsized positions will be forced to rein them in, the answer to both questions is probably no.
This puts regulators in a difficult position, which grows still more uncomfortable when you consider the massive amount of hassle required to set, implement and monitor compliance with the limits. The CFTC's proposals are hardly a model of good governance – in fact, they are a rehash of measures rejected by a US federal court in 2012 – but the current poster child for needless complexity is Mifid II.
The collateral damage is likely to be the refiners, airlines, manufacturers and other firms that use commodity derivatives for legitimate risk management purposes. In both jurisdictions, such firms are supposed to be exempt from position limits. But an attitude of 'guilty until proven exempt' will scare off many hedgers that simply can't afford the administrative burden of compliance. This burden multiplies when companies have to deal with different sets of conflicting rules.
Complaints about speculation are one of the few things you can truly count on, along with death and taxes
It's time for a rethink. Global markets require global rules. This fact was recognised in a January 22 comment letter to the CFTC from the Futures Industry Association, which proposed that the EU and US properly co-ordinated the implementation of position limits. I would go further: they should simplify and harmonise the rules too. Not only would this prevent regulatory arbitrage, it would make the regime clearer and more manageable for companies that rely on commodity derivatives.
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