The Policy Hurdles Facing Commodity Markets

For the past 15 months, commodity markets have negotiated the push and pull of global economics, with increased production in the West clashing with declining demand in China.  Crude oil has seen record volatility in 2015; with corn, wheat and soybeans not far behind.

Making things more challenging for commodity market participants is that many regulations and policy decisions surrounding these markets await final decisions or have only recently been implemented in the United States. From new rules for position limits – the number of futures contracts a participant is allowed to hold – to Dodd-Frank requirements and reauthorization of the Commodity Futures Trading Commission (CFTC), many  key regulatory items have hedgers and traders looking towards Washington, even as market volatility continues.

As leader of the Commodity Markets Council, a Washington-based association that represents commodity markets and their participants, Gregg Doud is keenly aware of the issues facing his membership. At the CMC compliance meeting in Washington in September, Doud heard from members about the challenges in navigating a world where both markets and policy are in transition. We sat down with him to discuss where the key issues stand, and where CMC’s priorities lay heading in to 2016.


OpenMarkets: You recently completed your annual policy meeting in Washington. Any top issues that emerged from your membership?

Gregg Doud: There was a lot of discussion about the CFTC reauthorization legislation which deals with CFTC’s authorities and presents an opportunity to address a number of commodity end-user concerns  We had key staff from Senate Agriculture Committee  there to discuss it. The Committee’s majority and minority staffs are working very well together. There’s a lot of effort to hone in on issues that impact commercial market participants.

The House passed its reauthorization bill in June but it’s uncertain if we’ll see anything go across the Senate floor on this before the year’s end.

OM: The Basell III supplemental leverage ratio has been a big issue for commodity participants. Can you explain what that is and why it’s important?

GD: The Basel III leverage ratio is significant.  If not revised, the rule will dramatically increase the capital that a bank needs to facilitate cleared derivatives transactions which will ultimately impact end-users and the markets more broadly . CMC members don’t agree with the methodology that Basel III has come up with to do this.  We have been involved in the U.S. and Europe on the Basel subcommittee addressing this. We’ve made some progress with policymakers  in helping them understand our concerns and issues.

The question is, if we do see some changes to Basel III will they be done in a manner that is helpful to us or not?  The Basel committee is comprised  of the central bankers around the world, so they deal with issues beyond the derivatives industry. Our ability to affect change in that environment is difficult, but CMC members have made a great deal of effort to help them understand our concerns around the supplemental leverage ratio, and how it will affect end users – particularly those who use ag and energy futures to hedge real commercial risks.

OM: Now that Dodd-Frank is mostly implemented, do you have a sense of how it’s affecting participants in commodity markets?

GD: We’ve entered a compliance stage with Dodd-Frank.  To give a sense of how things have changed, last year we had about 25 people at our compliance meeting, and this year we had over 50. Compliance is an emerging topic that’s getting more attention.  There is a lot of movement among major trading firms and processing companies to find people who are highly skilled in compliance. The message at our meeting was that if you’re a company that does not have a compliance division, you better see that you do very soon.

OM: Are compliance requirements causing concern over costs?

GD: One of our members, a very large ag trading firm, testified at a Senate ag hearing this summer that their costs for compliance have doubled, and I think that is representative across the industry. The CMC has tried to help policy makers understand that ag and energy users didn’t cause the financial crisis, exchanges and clearing houses didn’t cause the financial crisis. Nevertheless,  the burden on us from a regulatory and compliance standpoint is extraordinary. These companies are spending an extraordinary number of resources to comply with new rules and regulations.

OM: Commodity position limits remains an issue. What are the concerns of CMC members?

GD: Maybe the number one issue of concern with the CFTC is the definition of bona fide hedging. There has been enormous concern for some time around this. We’ve been hedging in the futures markets for many decades. Why suddenly, after a financial crisis that had nothing to do with these industries, is there a proposal to redefine a bonafide hedge?

My impression is that CFTC Commissioners are beginning to understand where end users are coming from. The decisions of accepting or not accepting what is a bona fide hedge have to be made at the speed of commerce, and the only way you can do that is to have some sort of mechanism that lets this be done at the exchange level.  This is an issue that may emerge yet this year, and it’s something we’ll continue to be focused on.

OM: Part of your role is educating legislators and regulators on the inner workings of commodity markets. What are some of the common issues that need explaining?

GD: Without question, at the top of the list is the role of the speculator. There is a perception, particularly in energy markets, that speculation is evil.  The honest answer is that speculation is a critical component of the futures markets. If you’re a farmer trying to forward price your crop, if you’re a processor trying to buy raw materials and hedge your finished product, if you’re a supermarket and you want to manage some of that risk, you have to have someone willing to take the other side of that transaction. You have to have someone willing to provide that liquidity. That’s where the speculator is a critical piece of this.

OM: What are you looking at going into 2016?

GD: We’re going to continue to watch position limits, and the bona fide hedging piece of it, and the Basel III leverage ratio.  We’ll continue to watch developments in Europe. We have CMC Europe made up of 18 companies including the commodity  exchanges and CMC Europe is very heavily involved in the EMIR process and MiFID process which is similar to the Dodd-Frank changes that we’ve been dealing with on the U.S. side for several years.

Our great concern there is that we have two separate regulatory regimes that are like two ships passing in the night and they don’t match up very well. So instead of building out one compliance mechanism in your company you have more than one.  We have to find a way to help these match up. The CFTC is working very hard on these cross-border issues as well and we appreciate their attention and leadership on this.

We’ll discuss a lot of this at our State of the Industry conference in Miami, which begins at the end of January and includes a strong line-up of policy and industry leaders.

Evan Peterson is director of corporate marketing at CME Group and managing editor of OpenMarkets.

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