Commodity derivatives reform in Europe

Presentation to the seminar on commodity market regulation: development consequences & prospects

Dr Julian OramWorld Development Movement

April 15, 2011

Drivers for reform of EU commodity derivatives markets

1. poor regulatory oversight of financial derivatives seen as contributing factor to banking crisis and ongoing economic instability in Europe

2. growing evidence of role of excessive speculation in 2007-2008 commodity price spike, and recent food and fuel price volatility

3. desire to harmonise EU regulatory measures with US financial reforms

4. response to public anger over the banks role in recent crisis and resulting public austerity

Current Supervision of Commodity Derivatives in EU

• Main European agricultural commodity exchange is the NYSE/ LIFFE, which arose out of mergers between the LIFFE/ Euronext/ NYSE.

• The commodity trading arm of NYSE Liffe operates from two main centres, London and Paris. – London Traded Agricultural Commodities: Cocoa, Feed Wheat,

Robusta Coffee, White Sugar. 16.7 million contracts traded in 2010 – Paris Traded Agricultural Commodities: Corn, Malting Barley, Milling

Wheat, and Rapeseed.

• Derivatives trading happens across European market venues, but is concentrated in City of London.

• Poorly regulated and across European markets:– Lack of regulatory coordination & oversight; no equivalent of CFTC– Large volume of trading in dark markets– Sketchy regulatory knowledge or supervision of commodity derivatives

• Futures markets relatively immature in EU compared to US markets due to historical reliance by EU farmers on CAP as primary mode of insurance in Europe…. But will likely grow in importance post 2013.

A regulatory jigsaw1. OTC Derivatives, proposed new regulation: Unit G2 (Financial Markets Infrastructure)• use of Central Counterparty Clearing (CCP) for OTC derivative contracts between financial

counterparties• eligibility for clearing defined by combined bottom-up and top-down approach;

2. Markets in Financial Instruments Directive (MiFID), revision: Unit G3 (Securities Markets)

• MiFID review seeks to strengthen pre- and post-trade market transparency and bring more derivatives onto organised trading venues.

• Considering use of position limits for commodity derivatives

3. Market Abuse Directive (MAD), revision: Unit G3 (Securities Markets) • increase market integrity and investor protection • Strengthen effective enforcement against market abuse. • improve the transparency and integrity of derivatives markets. • increase coordination among national regulators to reduce regulatory arbitrage; as well as

ensuring greater cooperation with jurisdictions outside the EU.

4. Other relevant measures; i.e. new legislation on CDS/ short-selling, Capital Requirements Directive & Alternative Investment Fund Managers Directive

What is being considered within these regulations/ directives?

• Most clearing-eligible and sufficiently liquid derivatives to be traded on regulated markets or other organised trading facilities

• Categorisation of traders by type of regulated entity and by activity

• Position reporting• Time-bound intra-day price limits to reduce short-term excessive

volatility• Position limits

– Individual– Aggregate – financial, index funds

Basic procedure for EU regulatory reform• Proposal from the Commission presented separately to the Parliament and

the Council for first readings

• If both agree, proposal can be adopted as law

• Or… Parliament and Council can propose amendments to the proposal which are then sent back to the Commission for agreement, amendment or withdrawal

• Commission then passes proposal back to the Parliament and the Council for a second reading and the procedure is repeated

• If they agree on amendments, act is deemed to be adopted

• If Parliament and Council can’t agree after the second reading a Conciliation Committee is convened

Varying perspectives across the EU• France supports improved European regulation of financial markets for commodities

derivatives, and has called for the EC to draft a specific directive for the regulation of commodity derivative markets. Italy has also been supportive, as have Hungary and Luxembourg.

• UK has generally opposed steps to significantly tighten financial participation in commodity markets at political level, also at FSA. Germany has very recently expressed opposition to measures such as position limits

• Has tended to be divisions between agriculture ministries, which are generally keen on EU action to improve both physical and financial commodity markets, vs finance Ministries which have been less quick to embrace derivatives reform– But recent informal statement from finance ministers in Budapest has indicated

strengthening support for tougher action, eg on position limits

• EU internal markets Commissioner Michel Barnier favours strong reforms: “Speculation in basic foodstuffs is a scandal when there are a billion starving people

in the world. We must ensure markets contribute to sustainable growth. I am fighting for a fairer world and I want Europe to take the lead on that.

Lobbying and Advocacy on Derivatives Reform in Europe

• Financial services industry strongly resisting reforms and spent billions of € lobbying against OTC and MiFID

• Individual banks & hedge funds, as well as most major national and international financial industry associations submitted lengthy submissions to MiFID consultation

• Major concerns over EU/ financial sector revolving doors, over-representation on advisory groups & expert committees, lack of transparency over informal lobbying

• Last year a group of 60+ MEPs were so concerned by extent of financial lobbying that they issued a call for greater counter-lobbying and set up a website called Finance Watch to provide a platform for this

• MEP corruption scandal could lead to new lobby rules

•Over 3,300 people sent a submission to the EC’s consultation on MiFID calling for more transparency and hard position limits to stop excessive speculation on food via WDM website

•Growing coalition of NGOs and others forming counter-lobby to financial services industry

2011: a crucial year for the future of commodity market reform

• CFTC ag position limits to be set• MiFID proposals should be adopted

by EP and Council of Ministers by end of the year

• French Presidency of G20 with action on commodity derivatives as a key priority

What’s at stake?