Time is Not Now for MiFID to
Embrace Commodities
By Jeremy Wilcox
COMMODITY MARKET PRACTITION- growth in the carbon allowance market – has brought the market
ERS, and particularly those in the ener- under MiFID scrutiny.
gy sector, may well consider themselves Not surprisingly the commodity sector is up in arms, arguing that it
to be victims of their own success. The does not fall under the scope of the Investment Services Directive,
commodity sector was not initially cov- (which MifID will replace) so why should it be subject to MiFID?
ered by the new Markets in Financial Commodity, and particularly energy markets, have been flirting
Instruments Directive (MiFID), which with tougher regulation for some time. There are many energy com-
was designed for financial instruments panies running sizeable commodity funds that are not currently cov-
and institutions. However, the trading ered by financial regulation, yet the scale of these businesses has
growth in the commodity sector – and prompted calls for these firms to be reined-in. And this, it would
in particular the near exponential seem, is what is happening with commodity traders who trade in
energy derivatives to be covered by MiFID.
In June, the Commodity Derivatives Working Group (CDWG – a
The central argument put forward by the commodity sector
coalition of industry associations) warned that any new public
against its inclusion in MiFID is that the collapse of a commodity
policy on commodity derivatives must not stifle competition and
fund or trading house would not have the same systemic implication
liquidity in the industry. as that of a banking failure. As Anthony Belchambers, Chief
The CDWG, which comprises the International Swaps and Executive of the Futures and Options Association, explains: “There is
Derivatives Association (ISDA), the Futures and Options
no level of systemic risk in the commodity sector and the underlying
Association (FOA) as well as the European Federation of Energy
business of commodities is unregulated trading while the financial
Traders (EFET), was responding to a consultative document by
market is a highly regulated business.” In other words, it is like com-
the European Commission on regulation for commodity firms
paring apples and oranges.
that trade in commodity derivatives. MiFID and the Capital
Requirements Directive (CRD) include temporary exemptions for
these firms, pending the current review.
... regulation has to be risk-based
“Banks and commodity firms agree that regulators must and proportionate
proceed cautiously to ensure a suitable, proportionate regime for
participants at this critical stage of the commodity derivatives
The resistance of commodity firms to their inclusion in MiFID is by
market’s development. The net effect will be more efficient price
no means an attempt to avoid regulation and oversight – far from it.
formation and lower levels of financial risk,” according to Robert
As Belchambers explains, regulation has to be risk-based and propor-
Pickel, Executive Director and Chief Executive Officer, ISDA.
tionate. And the risks faced by the energy sector are relatively
“Public policy makers need to maintain the appropriate
regulatory landscape to enable commodity firms to participate in
insignificant when compared to those faced in the financial markets.
the trading of commodity derivatives. These firms should not be
Addressing the financial and commodity markets, Belchambers
forced out of, or prevented from entering these markets, because
says there has to be a level playing field. Using the football analogy,
of over-prescriptive regulation – thus damaging liquidity,” says he says: “In football the pitch has to be reasonably level and all the
Peter Styles, Electricity Committee Chairman, EFET. players operate by the same rules; but the players from different
The CDWG found that there is little risk-based foundation for
teams wear different uniforms. In other words the uniforms are tai-
subjecting commodity firms to prudential regulation based on
lored to that team of players.”
minimum capital standards, under Pillar I of the CRD (aimed at
Perhaps part of the problem for the energy sector is that it has
limiting the default probability of highly systemic financial
institutions).
always been in the slipstream of the financial sector. The derivative
Commodity firms use a variety of often sophisticated risk
instruments developed to advance financial markets (such as swaps)
control mechanisms. The CDWG argues that prudential
have been largely applied to the energy market with some tailoring.
regulation of commodity firms should be based on the
In some respects the energy market has been wearing the second-
supervisory review of such internal risk management systems, as hand clothes of the financial markets – never having had clothes
well as public disclosure of key risk indicators (in line with the
specifically tailored for it.
approach of Pillars II and III of the CRD).
The energy sector’s close following of the financial markets has
The CDWG also advocates that own-account trading by
largely been enforced by the increasing numbers of financial market
commodity firms with professional counterparties need not be
participants, joining first the energy sector and now the fast-growing
licensed under MiFID.
The CDWG also believes that financial regulators should not
carbon sector. The strong influence of financials in the energy mar-
try to regulate the underlying physical markets, which could
ket has been the main driver of trading growth in the past decade
complicate the ongoing liberalisation of the energy markets.
and as these financial players introduce more complex and volatile
derivative instruments to further extract value from the sector – as
82 SEPTEMBER 2007 COMMODITIES NOW
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