Compliance In Commodity Derivatives Markets – Commodities/Derivatives/Stock Exchanges

On June 21 and 22, lawyers, compliance professionals and
commodity traders convened in Houston to discuss current
compliance matters and the state of commodity markets, with the
focus on energy commodities as well as carbon and environmental
products. The following themes emerged from the panels with
speakers from private industry, consultancies and regulators, such
as the Commodity Futures Trading Commission (“CFTC”), the
Federal Energy Regulatory Commission (“FERC”) and the
National Futures Association (“NFA”).

1. Enforcement

In 2021 and 2022, the industry experienced a record number of enforcement actions from the CFTC and the NFA,
with record settlement amounts. Enforcement focused on fraud and
manipulation, Foreign Corrupt Practices Act (“FCPA”)-like
enforcement and misappropriation of material non-public information
in commodity markets, failure to register in appropriate capacity
and substantive regulatory violations, such as reporting.
Importantly, in addition to enforcement from traditional market
regulators, the Department of Justice (“DOJ”) has been
much more actively involved in commodity derivatives market-related
enforcement traditionally relegated to the CFTC, FERC, NFA and the
Securities and Exchange Commission (“SEC”).

2. Commodity Digital Assets

Application of financial engineering is rapidly spreading beyond
cryptocurrencies to physical commodity markets. Blockchain is
increasingly used to track commodity transactions and the
non-fungible tokens (“NFTs”), and other smart contracts
are helping end users to trade commodities and ensure a more
efficient and accurate delivery. These applications are at the
nexus of the SEC’s, CFTC’s and FERC’s jurisdictional
reach, with a significant regularity overlap. DOJ is likely to
continue being actively involved in policing these markets under its wire fraud
authorities, while market regulators clarify their regulatory
reach.

3. ESG and Environmental Commodities

Environmental, social and governance (“ESG”)
initiatives in commodity markets are at the forefront of commodity
trading strategies − with the emphasis on climate change
mitigation and the trading of environmental commodities. Both
compliance and voluntary markets in carbon mitigation are rapidly
developing under local state authorities (such as CCA and RGGI) as
well as commonly accepted voluntary industry standards and
registries (such as ACR, CAR and Verra). The CFTC recently
published a request for information (“RFI”) to
assess the scope of the markets and its likely jurisdictional
reach.

4. Market Volatility

The war in Ukraine and the unprecedented global sanctions
imposed on Russia, which together with Ukraine are the world’s
largest suppliers of many critical commodities, such as natural
gas, crude oil, agricultural commodities and fertilizers, have
severely strained commodity markets and are likely to even further
disrupt commodity and commodity derivatives markets. Market
volatility is causing drastically higher and more frequent margin
calls, which increase the costs of trading; as a result, many
commodity contracts have moved from the exchanges to the OTC
markets. These trends call for enhanced compliance supervision on
both the exchange and clearing side of the markets, and the end
user and market intermediary side.

5. Enhanced Compliance

Discussions during the FIA conference demonstrated that the
category of unregulated commodity trader no longer exists, and
there are either registered or unregistered market participants
− but all are regulated and all are subject to potential
CFTC, SEC, FERC, NFA or DOJ enforcement. This calls for greater
assessment of operational, regularity and compliance risks and a
design of more comprehensive compliance policies and procedures as
well as business continuity and disaster recovery
procedures.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.