War on Commodities: US Regulators Approve Derivative Trading Curbs

The relentless politicization of the marketplace continues, with intensifying fixation on commodity trading curbs

From Bloomberg,

The top U.S. derivatives regulators voted 3 to 2 today to curb trading in oil, wheat, gold and other commodities after a boom in raw-materials speculation, record- high prices and years of debate and delay.

The rule has been among the most controversial provisions of the Dodd-Frank financial overhaul, enacted last year, which gave the Commodity Futures Trading Commission the authority to limit trading in over-the-counter commodity swaps as well as exchange-traded futures. The rule will limit the number of contracts a single firm can hold.

“Our duty is to protect both market participants and the American public from fraud, manipulation and other abuses,” Chairman Gary Gensler said at the commission’s meeting in Washington in support of the rule. “Position limits have served since the Commodity Exchange Act passed in 1936 as a tool to curb or prevent excessive speculation that may burden interstate commerce.”

The rule limits traders to 25 percent of deliverable supply in the month nearest to delivery. The spot-month limits apply separately to physically settled and cash-settled contracts. Deliverable supply will be determined by the CFTC in conjunction with the exchanges.

Gas Contracts

Cash-settled natural gas contracts will be subject to a different regime. Traders will be permitted to hold contracts equal to five times deliverable supply in Henry Hub swaps, derivatives that settle in cash instead of the delivery of the underlying commodity. Henry Hub is a natural gas delivery point in Erath, Louisiana, and the benchmark for U.S. futures.

Outside the spot month, the caps limit traders to 10 percent of the first 25,000 contracts of open interest and 2.5 percent thereafter.

“You want speculation or you don’t have any markets,” said Commissioner Bart Chilton in an interview today on Bloomberg TV. “There’s nothing wrong with speculators. It’s when it begins to get excessive. We’ve seen where you can have 30, 35, 40 percent plus in some markets with just one trader holding onto that concentration. That can impact markets.”

The commission estimates that the limits will affect 85 energy traders, 12 metals traders and 84 traders of certain agricultural contracts. The caps will go into effect 60 days after the agency defines the term “swap.” The agency declined to estimate when that will be. Limits outside the spot month are likely to go into effect in late 2012.

Affected Contracts

The limits will apply to 28 physical commodity futures and their financially equivalent swaps including contracts for corn, wheat, soybeans, oats, cotton, oil, heating oil, gasoline, cocoa, milk, sugar, silver, palladium and platinum.

The rule calls for traders to aggregate their positions, a change that may affect large firms with multiple strategies. It also would tighten an exemption allowing so-called bona fide hedgers to exceed the caps.

The new ruling is certainly not about protecting the public from fraud, which has always been used as excuse for interference.

The flurry of various interventions in the commodity spectrum has been directed at controlling prices with the ultimate goal of containing consumer price inflation. This opens the doors to further interventions in the marketplace and the economy which most likely will be channeled through monetary policies.

This has been part of the signaling channel policies designed to manage inflation expectations or to camouflage the untoward effects of current policies.

Again this will likely impact the commodity markets on the short term.

The markets will always find a way to go around or skirt regulations. Price controls or edicts won’t stop the laws of economics, especially from venting on the negative consequences from arbitrary regulations. Price controls only skew the economic balance of these commodities which leads to even more volatility.

The sad thing is that it has been the nature of politics not to penalize authorities or hold them accountable for any failure of their actions. On the other hand, policy failures translates to even more interventions.