In 2008, it was sub-prime mortgages. In March of 2020 it was money-market funds. And now, regulators fear, a crisis is brewing in commodity markets.
“Every crisis has a dimension, where we look at something that maybe we should have been looking at a lot harder before the crisis,” Ashley Alder, chair of the International Organization of Securities Commissions, said on 26 April at the City Week 2022 conference in London. The IOSCO is an association of organisations that regulate securities and futures markets. “This time around we have commodities.”
The war in Ukraine rocked commodities markets, and regulators want a closer look at what they say is a murkier and less regulated asset class.
“The relationship that regulators have with key actors in this area is often non-existent, and if it exists it is not particularly tight,” said Alder. “The spot market is extremely opaque, the futures market, there are a number of issues, there is the question of margin pressure on end users such as producers and buyers.”
Alder made reference to the March nickel squeeze on the London Metal Exchange as an example of market volatility causing financial stability risk.
On 8 March, the LME cancelled $4bn worth of nickel trades and suspended trading in the metal for more than a week. Chinese stainless steel producer Tsingshan was the main instigator of a short squeeze holding 150,000 tonnes of short positions, more than was available in LME warehouses. The LME told Financial News that it was unaware of how heavily shorted Tsingshan’s nickel positions were, as many of its short positions were conducted not on the exchange but using over-the-counter contracts.
“There’s a whole question of the relationship between futures markets, which are exchange-traded, and over-the-counter markets, which are far less regulated. A lot goes on in the OTC market, which is not transparent,” said Alder.
The cancellation of trades has shaken the confidence of market participants. Open interest in nickel has declined and some firms are reviewing their relationship with the exchange.
The LME’s conduct during the nickel saga is being probed by the Financial Conduct Authority, Prudential Regulation Authority and the Bank of England.
In separate remarks FCA chair Nikhil Rathi said that the FCA’s work with the Bank of England and others “made sure we could effectively monitor volatile commodity markets as we both saw with LME and LME Clear”.
Verena Ross, chair of the European Securities and Markets Authority, on the same panel as Alder, said regulators must remain vigilant.
“Market volatility could strike further short squeezes,” said Ross, adding that since the war began Esma has increased its monitoring of credit rating agencies, volatility asset classes and CCP clearing of those assets.
Both Russia and Ukraine are major exporters of numerous commodities, most notably oil and wheat. Futures contracts in both commodities have surged with oil up more than 30% since January, while wheat is up 40%.
A concern that both regulators raised is that commodities trading is much more connected with the real economy, impacting both growth and inflation.
“This is an area I am watching very carefully, and trying to learn lessons of the immediate effects of some of the issues that plagued the commodity markets in the first few weeks. It is unlikely that this is the last volatile spike in commodity markets,” said Ross.
“This is not going to go away. This will continue to be a big factor going forward that will impact GDP and inflation.”
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