Industry bodies urge caution over commodities rules

BRUSSELS – New rules for commodity derivatives businesses under the European Union's Capital Requirements Directive (CRD) and the Markets in Financial Instruments Directive (Mifid) must not become "inappropriate regulation", three major industry associations said in late June.

The associations penned the response for the European Commission, which had called for advice in 2006 on the introduction of new capital requirements and a new licensing regime that would be standard throughout the EU for firms that trade commodity derivatives. At the moment, some countries have some form of licensing and/or capital requirements, while others do not. Both the US and the UK have a fairly "light touch" regulatory regime for commodities businesses. Current EU rules include temporary exemptions for commodity firms that deal in commodity derivatives, but this exemption was set to change under the CRD and Mifid.

International Swaps and Derivatives Association (Isda) executives were optimistic about the potential outcome of EC thinking on any new commodity derivatives regulation. "We genuinely believe the commission has an open mind and is playing with a straight bat," says Isda's Brussels regulatory affairs liaison, Roger Cogan.

Isda penned the response along with the Futures and Options Association and the European Federation of Energy Traders.

Emmanuelle Sebton, head of risk management at Isda, says commodity derivatives firms should not be required to hold capital in a Basel II Pillar I-style arrangement, because the firms are not "systemic in the same way that financial services firms are". She argues that Pillar II and Pillar III rules should apply, so that firms are subject to review by home country regulators and must produce some risk disclosures for the public. Isda argues that requiring firms to hold capital could dent liquidity, and the lack of liquidity in the marketplace could increase levels of both credit and market risk.

However, a report by the Committee of European Banking Supervisors (CEBS) published in mid-June argues that the risks arising from commodities markets and other markets are the same, and that in the absence of risk mitigation, significant counterparty risk arises. The report also argues that while systemic risks exist, they vary widely across the various commodity markets and underlying products.

Cogan also argues that Mifid licensing rules should not apply as most counterparties to commodity derivative transactions are professional, and so the same focus on the protection of retail clients is not needed. The associations are arguing that the exemption in Mifid for commodity businesses remains.

CEBS is holding a hearing on the commodities business issue in early July, and the European Commission is planning its own hearing in the autumn. The EC is expected to produce a consultation document in the middle of 2008, with proposals – if any – coming at the end of 2008. The Committee of European Securities Regulators is also reviewing the subject of commodity derivatives.