In a context of increased volatility of agricultural commodity prices and financialization of agricultural markets, the G20 nations, at the November 2010 Seoul Summit, asked the International Organization of Securities Commissions (IOSCO) to research how to implement the specific regulation and supervision of commodity derivatives markets. On September 15, IOSCO thus published a report entitled “Principles for the Regulation and Supervision of Commodity Derivatives Markets”1
, which recognizes the relevance of certain regulation instruments, such as position limits, while insisting on the need for a global approach rather than one limited some countries. While the G20 Summit held on November 3 and 4, in Cannes emphasized the necessity to improve the regulation of commodity derivatives markets, and when the United States and Europe are adopting measures to this effect, the article covering the IOSCO report, published by the Economic Analysis and Forecast Division of the French Ministry of Agriculture2
, is particularly informative.
Momagri Editorial Board
Firstly, the report acknowledges the events that occurred since the Tokyo Communiqué, especially regarding the development and increased complexity of over-the-counter (OTC) transactions, and the rise of trading based on algorithms (i.e. resorting to automats that place trading orders based on specific programs), and high frequency trading in particular. These developments were at the heart of other IOSCO studies and the subject of reports that are not specific to agricultural commodities. Yet, in its September 15 report, IOSCO calls upon the authorities to acquire real-time supervision systems that are adapted to the new trading techniques (see below), and to obtain the means to monitor useful information on OTC positions. Following-up on the conclusions of the G20 Pittsburg Summit on the same issue, the organization promotes the registration of OTC transactions on central trade repositories.
The principles to be upheld when designing derivative products are then fully reported. First, they must be valuable to potential users who want to protect themselves against price volatility. With this in mind, derivatives should be designed to facilitate a close correlation with underlying physical markets. In this respect, the report lists very precise recommendations regarding the specifications and technical clauses of derivatives contracts, in order to prevent disengagement between derivatives prices and underlying derivatives prices (what is called the “basic risks”).
The report subsequently devotes a large section to the provisions to be adopted to allow regulatory authorities to conduct effective market surveillance. This surveillance should go beyond the transactions made on regulated markets and OTC transactions. Authorities should then be able to monitor useful information related to physical markets, and to have the required capacities and means to process and analyze such information. The speed with which orders are placed and fluctuating prices now demand real-time surveillance, which could be achieved through automated systems. Players controlling or holding significant positions (large positions) that are liable to generate price distortions should be carefully identified and monitored.
The report focuses next the sensitive issue of the powers of intervention by the competent authorities to prevent market disorders and manipulations. Among such powers, the report states that regulators should have the powers to order operators to alter positions, as well as to place ex-ante restrictions on the size of a position a market participant can take, as it is the case for agricultural commodities in the U.S. since 1936. Among the other instruments put forward by the report, one notes the possible implementation of instruments to curtail trading––such as “circuit breakers”. These already exist in quite a number of markets, where transactions are suspended when prices are experiencing strong variations over a short time.
Another chapter covers the constraints and sanctions to address real or attempted abusive trading practices. Without going into details, IOSCO recognizes that the concept of inside information, which is easily identified in securities markets, must be adapted to the specific nature of commodities. Above all, IOSCO acknowledges the need to explicitly sanction cross-market manipulation. These transactions involve holding simultaneously important trading positions on physical and on derivatives markets, thus triggering artificial price variations that benefit the manipulating trader.
Lastly, the document emphasizes the necessity to regularly publish the positions held by key groups of market operators, whether commercial or non-commercial participants, a requirement already proposed by the US Commodity Futures Trading Commission (CFTC), through its Commitment of Traders.
The G20 Agricultural Plan of Action has praised IOSCO members for their research on the regulation of commodity derivatives markets. The work now represents a key element of positioning strategy for the G20 Finance Ministers and Central Bank Governors Meeting on October 14 and 15, as well as the Cannes Summit in November.
It is now up to IOSCO members to adapt these principles to their own legislation. In this respect, we note that the report endorses the earlier US resolutions, through the Dodd-Frank Act. Regarding Europe, where the European Commission should soon indicate its propositions to revise the directives “abusive market trading” (2003/6/CE) and MIFID (2004/39/CE), the IOSCO report could also be mobilized to advance European regulation in commodity derivatives markets. Such strengthening will definitely impact physical market operations, especially regarding transparency and access to information.
1 The report is available on the IOSCO website at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD358.pdf
2 Please visit http://agriculture.gouv.fr/Veille-no47-septembre-2011-Le for the article published by the French Ministry of Agriculture.