Mondays always get me down

A decent weekend. Not much going on…

And then, on Monday morning, bam! Breaking news from The Wall Street Journal: “Big U.S. Banks Make Swaps A Foreign Affair”. The story basically posits that US banks are using their overseas affiliates to write some swaps with non-US counterparties without a parent company guarantee. This means that the transactions would not fall under the purview of US regulators.

Sounds troubling.

But as the infomercials say: Wait! There’s more!

A lot more.

First, the transactions would in fact fall under the purview of regulators in the jurisdictions in which they are done.

Second, on the major systemic risk issues (clearing, trade reporting, margining), there is likely to be little to no substantive difference between major jurisdictions.

So this clearly is not a case of regulatory arbitrage. It’s really about the fact that some customers do not want or have the capacity to understand and comply with regulations in two different jurisdictions. These non-US customers prefer doing business with non-US firms. They don’t want to trade on SEFs. So the US firms are structuring their businesses to meet this demand.

Most people know all of this, as the Journal article acknowledges.

So what’s really the issue? Apparently, it’s the fact there are some differences between jurisdictions in the timing and substance of trade execution rules. So some see the shift to trading overseas as a way for firms to avoid trading on SEFs, which they view as a bad thing, because:

“For US regulators, the new rules aim to bring swaps trading into the open and protect the US financial system from firms amassing huge derivatives positions in non-US markets.”

But that’s not the role of SEFs – that’s what clearing and trade reporting are all about. And as we noted, on these issues there’s not much if any difference between jurisdictions.

One final thought: the article begins with a chart that purports to show concentration in the derivatives markets. The data in question, however, is for the US only and includes only US banks. As we have written, the derivatives markets are truly global, and a look at our report here shows a more accurate picture.

Misperceptions like this… that’s why we’re hangin’ around, with nothing to do but frown….

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.