Last summer's record oil prices led to commodities reform proposal

Obama administration officials didn't say so. But their May 13 announcement that they would seek new regulations for over-the-counter derivatives was a response to last summer's record crude oil prices.

Obama administration officials didn't say so. But their May 13 announcement that they would seek new regulations for over-the-counter derivatives was a response to last summer's record crude oil prices.

"All OTC derivatives dealers and all other firms whose activities in those markets create large exposures to counterparties should be subject to a robust and appropriate regime of prudential supervision and regulation," US Treasury Secretary Timothy F. Geithner said.

"Key elements of that robust regulatory regime must include conservative capital requirements, business conduct standards, reporting requirements, and conservative requirements relating to initial margins on counterparty credit exposures," he continued in a letter to US Senate Majority Leader Harry N Reid (D-Nev.).

Current regulations under the Commodities Exchange Act and the Commodity Futures Trading Act don't cover markets outside regulated exchanges which have grown significantly. Speculators hid their trades and positions on these so-called dark markets so they could push crude oil and other commodity prices higher despite relatively ample supplies, critics have charged for the past 18 months.

They said that crude oil trades increasingly occurred on less regulated foreign exchanges or in OTC markets until crude oil prices were $147/bbl. Speculators who never intended to actually take delivery of the product they traded then cut their positions sharply. Prices were already dropping by October when the economic downturn became a recession and energy demand fell sharply.

Four objectives

Geithner told Reid that OTC derivatives regulation should prevent activities in those markets from posing risk to the financial system; promote the markets' efficiency and transparency; prevent market manipulation, fraud, and other abuses; and ensure that OTC market derivatives are not inappropriately marketed to unsophisticated investors.

"To achieve these goals, it is critical that similar products and activities be subject to similar regulations and oversight," he maintained.

Michael Dunn, acting chairman of the US Commodity Futures Trading Commission, said that the May 13 announcement, and prior statements from members of the 111th Congress regarding substantial increases in the agency's budget, will buttress the CFTC's ability to fulfill its mission. "Today's announcement clearly articulates a comprehensive plan that will establish a regulatory framework for currently unregulated markets," he said.

In the markets that the agency regulates, he said that OTC derivatives have an impact on US futures markets' price discovery function. "By regulating these contracts and having the ability to set position limits, we will have the ability and necessary information to ensure market integrity," Dunn said.

Members of Congress who have pushed for commodities regulatory reform applauded Geithner's announcement. US Senate Agriculture Committee Chairman Thomas R. Harkin (D-Iowa) said on May 13 that the outlined proposal was a step in the right direction and a more substantial expression of commitment to regulatory reform than the previous administration's.

'Stronger regulation'

"I have long said that we need much stronger regulation in order to bring transparency and integrity to derivatives markets as a step toward rebuilding our economy. Though there are still more details that need to be address, I look forward to working with the [Obama] administration and my colleagues in Congress as we move forward on this critical issue," he said.

By imposing tough regulations on OCT markets, the United States is finally tackling what tackled its economy, according to Maria E. Cantwell (D-Wash.), a member of the Senate Finance Committee. "In public hearings and private conversations with the Obama administration, I have insisted that the Treasury Department move quickly to establish tough regulatory controls that will protect the public against speculative financial meltdowns. Treasury Secretary Geithner's pledge today to support a series of regulatory reforms which I have been advocating represents a historic and long-awaited step," she said.

"These reforms will realize the goal of regulating all forms of derivative dealers and transactions and will bring 'dark' markets to light by requiring publicly accessible trade recording and record-keeping. The administration's apparent commitment to aggregate positioning limits across all markets, once enacted into law, will protect the public from the reckless speculation that has greatly aggravated our current economic downturn," Cantwell said.

"We applaud the letter by Treasury Secretary Geithner, and we agree there must be strong, comprehensive, and consistent regulation of OTC derivatives," US Reps. Collin C. Peterson (D-Minn.), who chairs the House Agriculture Committee, and Barney Frank (D-Mass.), said in a joint statement.

They indicated that as chairman of the two House committees sharing jurisdiction on this issue, they would closely together to achieve that goal. "Increased oversight, accountability, and transparency of the financial markets are essential to restore consumer confidence in the marketplace, protect investors, and preserve the overall integrity of the financial system," they said.

Contact Nick Snow at nicks@pennwell.com

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