09.20.2011
By Terry Flanagan

Regulators Focus on Commodity Derivatives

IOSCO report lays out principles for combat market manipulation and enhance price discovery.

The International Organization of Securities Commissions (IOSCO) has published a report on principles for the regulation and supervision of commodity derivatives markets.

The report, prepared by the Task Force on Commodity Futures Markets, addresses the G20’s November 2010 request for further work on regulation and supervision of physical commodity derivatives markets.

The principles themselves are high-level standards, supported by detailed explanatory background information on how regulators can apply them in their respective jurisdictions.

They address design of physical commodity derivatives contracts; surveillance of commodity derivatives markets, including monitoring large positions; and enhancing price discovery and transparency, including allowing regulators to impose position limits and the reporting of OTC derivatives to trade repositories.

While not yet approved by IOSCO’s Technical Committee, the Task Force may also recommend development of detailed recommendations on large trader reporting requirements and market surveillance practices.

Under the SEC’s large trader reporting rule, large traders, defined as anyone whose trades equal or exceed two million shares or 20 million during any calendar day, will be required to identify themselves to the SEC and their broker-dealers will be required to monitor their transactions under a large trader reporting regime.

The rule will enable the agency to efficiently identify significant market participants and collect data on their trading activity so it can reconstruct market events, conduct investigations, and bring enforcement actions.

The CFTC has proposed anti-manipulation and anti-fraud rules issued by the CFTC under the Dodd-Frank Act.
The rules are based on a proposed interpretive order issued by the CFTC in May that provides guidance on disruptive practices enumerated under Dodd-Frank, such as violating bids and offers, demonstrating intentional or reckless disregard of the orderly execution of transactions during the closing period, or spoofing, i.e., bidding or offering with the intent to cancel before execution.

The need for regulators to have better access to information on these entities is heightened by the fact that large traders, including high-frequency traders, are playing an increasingly prominent role in the securities markets.

The principles are aimed at ensuring a globally consistent approach to the oversight of commodity derivatives markets, which will deliver effective supervision, combats market manipulation and improves price transparency.

The principles update and add to the guidance in the 1997 Tokyo Communiqué, which set benchmarks for contract design, market surveillance and information sharing for physical commodity derivatives markets.

They are primarily intended to apply to exchange-traded futures contracts, futures contracts, options, and options referenced to a physical commodity, index or price series which may settle in cash or by physical delivery, although many of the principles will also be applicable to OTC markets.

In developing these principles the Task Force have added to the areas of guidance in the Tokyo Communiqué to take account of their experiences and to respond to contemporary trends in commodity derivatives markets.
These trends include the scale, speed and cross-border nature of trading on  markets; novel forms of market abuse; investors focus on commodities as an asset class and the impact of new investor classes and futures trading on physical commodity prices; the rapidly evolving regulation of OTC derivatives markets; and regulation of market participants.

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