EXPLAINER: Price surge prompts regulators to peer into commodity hinterland

A surge in food and energy prices has pushed inflation to the highest levels in decades, piling financial strain on households and political pressure on regulators.

In the case of some commodities, regulators say they do not have information on who holds the large positions that can inflate prices beyond levels implied by supply and demand.

While contracts such as oil or metal futures traded on exchanges are transparent and tracked, regulators have far less insight into related hedging contracts transacted privately or over-the-counter (OTC), often in different countries and involving chains of brokers.

Commodities markets are complicated by physical stocks of metals, oil and other commodities such as grains used in spot market deals. Data on this hinterland is patchy.

Financial watchdogs say they need more information on the consequences for banks and brokers in the face of increased margin calls on commodities contracts that mean clients need higher levels of credit to meet them.

Regulators draw a parallel with the collapse last year of Archegos after banks stopped finance to the private investment firm.

Who’s involved so far

The Financial Stability Board (FSB), which coordinates financial rules for the Group of 20 Economies (G20), has begun scrutinising commodity markets over the coming months to identify “vulnerabilities” that may need addressing.

The Bank of England is taking a “deep dive” into how transparency in commodities can be improved.

Can we expect a raft of new rules

Not really.

Commodities have always been more volatile than other asset classes such as stocks and bonds, regulators say.

And given that commodity markets overall have not collapsed or required bailouts from taxpayers that would justify a radical overhaul, it will be a case of making what’s in place work as intended.

After the global financial crisis in 2008, trade repositories were set up to record on and off exchange transactions in all types of derivatives, including those linked to commodities, but not all contracts are included.

As the chaos on the LME nickel market showed, teasing out a timely aggregate global snapshot of risks from data held in many different repositories is not possible – and physical markets are not included.

As a start, the LME has changed its rules to require members to report their off-exchange positions weekly.

But there will be little global appetite for more fundamental changes, such as designating commodity companies as of “systemic” importance and therefore required to hold capital buffers in the same way banks do.

The focus of reviews will be on links between commodity firms and the wider financial system and what could destabilise the financial system.

What role does speculation in commodities by hedge funds play? Are rules needed for commodity traders that are largely unregulated in many countries? Should large commodity players demonstrate to regulators their resilience to market shocks?

The debate over margins in cleared and uncleared commodity derivatives is expected to be especially divisive. The LME had to nearly double its default fund after the nickel debacle and some ask whether a greater safety cushion is generally needed.

Others say higher margins could dry up liquidity in markets and create different problems.

The LME decision to tear up contracts following its problems with nickel has also prompted a debate on when exchanges should be allowed to do that.

Any regulatory tweaks will only be effective if implemented jointly by the world’s main financial centres, which could take years.

(By Huw Jones and Pratima Desai; Editing by Barbara Lewis)