Crossing the Line

Question:
What do the EC Commissioner for Internal Market and Services, finance ministers in Brazil, France, Germany, Italy, Japan, Russia, South Africa, Switzerland and the UK, and regulators and central bankers in Australia, Hong Kong and Singapore have in common?

Answer:
They have all written to the US CFTC to express their concerns about cross-border derivatives regulations.

Why are they concerned?  As the finance ministers recently wrote:

“We are already starting to see evidence of fragmentation in this vitally important financial market, as a result of lack of regulatory coordination. We are concerned that, without clear direction from global policymakers and regulators, derivatives markets will recede into localised and less efficient structures, impairing the ability of business across the globe to manage risk. This will in turn dampen liquidity, investment and growth.”

To anyone who has watched this issue unfold over the past two or three years, such concerns are no surprise.  It is, though, a bit of surprise to see how The New York Times describes the situation.  Witness this page one headline from the Wednesday, May 1 paper: “Banks Resist Strict Controls of Foreign Bets”

There are (at least) three things wrong with these seven words:

1)      There’s nary a mention of the concerns of some of the world’s leading policymakers in the headline.

2)      No one is resisting strict controls.  The issue, as the finance ministers point out, is that “We share a common commitment with respect to OTC derivatives reform, and are implementing rules across very different markets with different characteristics and different risk profiles, to support this global initiative… An approach in which jurisdictions require that their own domestic regulatory rules be applied to their firms’ derivatives transactions taking place in broadly equivalent regulatory regimes abroad is not sustainable. Market places where firms from all our respective jurisdictions can come together and do business will not be able to function under such burdensome regulatory conditions.”

3)      Bets?  Even better, foreign bets?  How and why are derivatives transactions characterized as bets?  Is capping your interest rate exposure a bet?  Is hedging your currency exposure a bet?  Is protecting your credit exposure a bet?

We’re an international organization, and especially sensitive to these sorts of things, but even so, doesn’t this seem a touch xenophobic?  If the letter mentioned above had been co-signed by a US Treasury Secretary and sent to his EC counterpart, would it have been described in the same way?

But wait, there’s more.

Further down in the article, there’s this description of the “bitter international campaign” being waged by Wall Street and the world’s top finance ministers (as if they are working in concert):

“The effort…is just one front in the battle still being waged nearly three years after Congress passed the Dodd-Frank law, which revamped financial regulations in the United States in hopes of curtailing risky trading practices blamed for the global financial crisis in 2008.”

We’re the first to admit that the financial system needed strengthening (and we have made good progress doing so), but let’s not forget what the financial crisis was all about.  It was, first and foremost, about bad real estate decisions and bad mortgages. That was true in the US just as it was true in the UK, Ireland, Portugal, Spain and other hard-hit nations.

Unfortunately, The Times’ treatment of the important issue of cross-border derivatives regulation really crosses the line.

Speculating on Position Limits

Amidst the clamor over high gas prices in the US, the editorial pages of The Wall Street Journal and The New York Times both weighed in today on the issue of those prices and whether they are being influenced by speculation.

The Journal’s editorial commented on a briefing held by the Administration in Washington on Tuesday and stated:

“Nowhere in his remarks did the President claim that speculation is doing any harm. He did not cite any negative impact on the oil market. He did not say that speculators are manipulating oil prices, nor did he describe in even the vaguest terms the individuals or institutions that might be involved. He didn’t cite any research. Mr. Obama didn’t even, well, speculate about whether oil prices would be higher or lower if not for unnamed actors who may or may not be affecting the markets.”

The Times, not surprisingly, had a different take. It stated that: “Research…indicate[s] that …excessive speculation, mainly by Wall Street index-fund traders, is needlessly driving up prices…”

What is “excessive” speculation? And what exactly does the Times have a problem with: your garden-variety speculation or excessive speculation?

No matter. The Times editorial goes on to say:

 “…it is important that the administration’s working group on oil and gas price fraud — formed a year ago by Attorney General Eric Holder Jr. — finally weighs in on the question of how, and how much, manipulators and speculators are pushing up prices. The group’s silence raises questions about how serious the White House really is about addressing this issue.”

We all agree that illegal market manipulation is wrong and needs to be policed and prevented. But could it be that the reason for the delay is that there is insufficient evidence to support the idea that speculation is distorting commodity markets?

The editorials go on to discuss the lawsuit that ISDA (along with SIFMA) filed against the CFTC’s position limits rule. (The lawsuit is currently pending in the US District Court for the District of Columbia.) These rules are intended to curb speculation.

The Journal writes that: “…the commission now must defend in court a rule it enacted last fall to curb speculation… the regulator has to find a way to carry the argument without the evidence to support it.”

It notes then-Commissioner Michael Dunn’s statements when the position limits rule was passed:

“ ‘No one has proven that the looming specter of excessive speculation in the futures markets we regulate even exists,’ said then-Commissioner Michael Dunn before the CFTC voted on the new rule last October… Mr. Dunn, a Democrat, provided the swing vote in favor of new limits on the size of trading positions only because he believed the Dodd-Frank law left him no choice.

“But even though he voted for the rule, Mr. Dunn said that ‘position limits may actually lead to higher prices for the commodities we consume on a daily basis.’ Less liquidity makes it more difficult for market participants to hedge their risks, which could raise costs for everyone.”

The Times says this:

“The Dodd-Frank financial reform law directs the Commodity Futures Trading Commission to implement new ‘position limit’ rules, which would curb speculation by limiting the share of the market that traders can control at any given time. Unfortunately, the rules recently proposed by the C.F.T.C. are weak, watered down by disagreements between the Democratic and Republican appointees on the commission. The new rules have already been challenged in court by industry groups that represent banks and derivatives dealers.”

Just to be clear, the basis of our lawsuit was two-fold. First, we believe the position limits rule may be harmful to commodities markets, and to end-users, by reducing liquidity and increasing price volatility. As we stated then: “The evidence is overwhelming that position limits are, at best, unnecessary and may, at worst, negatively impact commodity markets and users. Numerous studies have been conducted by government agencies and others into commodity price volatility and little, if any, support exists for the idea that speculation causes that volatility or that position limits curb speculation.”

We also believe the CFTC’s decision-making process in enacting the rule was procedurally flawed. The rule was adopted without making findings as to the necessity and appropriateness of the position limits, as required by statute. Furthermore, the CFTC failed to conduct any meaningful cost-benefit analysis and lacked a reasoned basis for its rule.

To summarize, there are several questions here: Does speculation distort commodity prices? Will position limits help curb speculation? Did the CFTC properly follow the law in enacting its position limits rule? We believe the answer to each question is no, and that the prevailing evidence supports our position.