EU Commodity Markets Jockey For Position

Terry Flanagan

Market participants believe that proposed one-size-fits-all changes by regulators aimed at cutting down on speculation in Europe’s commodity markets will not work at all venues.

The European parliament is currently looking to introduce limits on the positions commodities traders can take as well as banning banks from giving outside brokers direct access to markets as part of a sweeping crackdown on high-frequency trading.

The European Commission proposed the draft law, known as MiFID II, last October and it is now before parliament and the 27 member states for approval, with further changes expected.

“Both exchanges and market participants require liquidity,” David Peniket, president of ICE Futures Europe, told Markets Media. “A lot of the debate is based on a general concern following the flash crash in the U.S. equity market [in May 2010, when the Dow Jones Industrial Average plunged almost 1,000 points, only to recover its losses within minutes]. However, the commodity markets, by their very nature, function differently and ICE has recently undertaken measures to manage the number of messages in the market without damaging valuable market liquidity.”

Last year, the London-based futures exchange for global energy markets implemented a new messaging policy to discourage inefficient and excessive messaging without compromising market liquidity.

“Before 2011, ICE’s messaging policy, like many other exchanges, was a simple order-to-trade ratio with published benchmarks above which high-frequency traders were assessed a fee,” said Mark Wassersug, vice-president of operations at IntercontinentalExchange, last month.

“However, this simplistic approach didn’t differentiate between orders that ‘added to liquidity’ and those that were far out of the market. Our HFT Messaging Policy directly addressed this problem by overweighting orders far away from the market relative to those orders near the best bid or offer at the time of entry.

“The ratio of orders using the weighting scale to lots traded is called the Weighted Volume Ratio (WVR). Traders exceeding our WVR benchmark incur a fee and fees increase as higher WVR thresholds are exceeded. This framework has been extremely successful in managing the high-frequency traders in our markets.”

The Federation of European Securities Exchanges (Fese), which lobbies on behalf of 46 of the region’s exchanges, says commodity markets represented by Fese already apply varying approaches tailored to their own venues to ensure orderly markets.

Fese says its members employ three such policies. The venues either use position management, which allows intervention when appropriate or necessary in particular as the settlement time of the physically settled commodities approaches, as well as adopting delivery limits, where systems limit the quantity of physical commodities that can be delivered on expiry. The third system in place is that of lending guidance, which is specific to the London Metal Exchange (LME), to deal with the LME’s daily settlement requirements.

“We agree with the Commission’s proposal as long as it acknowledges the existing diversity of methods to achieve the same objectives,” said Fese.

“It is important that the European Union should not simply opt for a regime based on ‘U.S.-style position limits’ exclusively, because this is only one of several equally valid methods aimed at supporting liquidity, preventing market abuse and supporting orderly pricing and settlement conditions but it will not be suitable for each and every market in Europe.”

French president Nicolas Sarkozy has blamed commodity derivatives speculation on driving up world food prices.

“Unfortunately, high-frequency trading is not well understood and, as a result, is often blamed, in the absence of facts and analysis, for a multitude of market problems, whether real or perceived,” said Chuck Vice, president and chief operating officer of ICE.

“HFTs are an essential source of liquidity in our markets and often provide price discovery where other traders may be reluctant to do so.”

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