PALM BEACH, Florida (Reuters) - Traders in physical commodity markets from grains to oil to sugar and gas are worried that a U.S. government push to regulate opaque over-the-counter trading will disrupt their business.
At issue is scrutiny by the Commodity Futures Trading Commission on trading by cash merchants of contracts for things like grain barges or oil tank cars, as “paper” commodities.
The CFTC is in the process of rule-making for last year’s landmark Dodd-Frank financial reform law. The law mandated greater market transparency, among many changes.
“The industry is not asking for a wholesale repeal. We are just asking that we get it right the first time around,” said Christine Cochran, president of Commodity Markets Council, an industry group holding its winter meetings here.
“There are serious business issues. People could be entering into contracts that they entered into in good faith that could become illegal for an indefinite period of time, and that just freezes business,” she said.
“How do you move that barge of beans or move that oil through the pipeline? It’s real. In Washington, it’s a lot of talk about financials. But it has impact to the physical markets,” she said.
Cochran and other commodity executives were particularly concerned about established private paper trades of commodities of things like grain warehouse receipts or grain barge shipments being re-defined as “swaps,” which are 1-to-1 over the counter financial contracts CFTC is scrutinizing in all markets with the eye of tighter reporting requirements.
“I’ll take it at a face value that the regulators are trying to do the right thing and make the markets more transparent and get information across all market sectors,” said Rich Feltes, vice president for commodities research at RJ O‘Brien, a big brokerage house.
“But the short term fear is how is this all going to actually shake out,” he said, warning about a “rushed” agenda. “The most frightening part was the folks writing regulation don’t have a lot of experience in OTC instruments.”
“That is the concern: there are certain rule makings that are the cart before the horse,” said Thomas Erickson, vice president for government and industry affairs for Bunge North America and former CFTC commissioner.
He said commodity traders for a start want CFTC to tell them one thing: “This is what we mean by a swap.”
One grain merchandiser explained that the problem is lack of CFTC definition now that could bite traders later.
“The rule says if you have the physical intent to deliver then it’s not a swap. But what happens is everybody has physical intent that you’re going to sell a barge and deliver it -- you buy and sell all these barges,” the trader said.
In reality, though, barge paper privately changes hands many times, as ownership risk is switched based on prices in a similar dynamic seen in futures markets.
“It was in your book, I bought one and sold one -- you settle the equity based on the price,” the trader said.
“The barge actually delivers from point A to point B only the notional value. The only invoicing of the barge goes to the guy who ultimately bought it and ultimately sold it.”
So what if CFTC decides that paper traders do not have real “physical intent” to deliver?
“They are going to turn that into a swap. If it’s a swap it’s subject to tremendous regulation. We don’t even know what the regulation will be,” the trader said, saying if such cash market deals “end up as qualifying as swaps it’s going to be a huge disruption. That’s the question.”
Corporate buyers of large amounts of commodities also see CFTC scrutiny as disruptive for OTC commodity swaps -- tailored deals for more precise timing, pricing and delivery than, say, a futures contract which delivers only in January or May.
“For a company like ours...tapping over the counter market is a valuable tool in this kind of a market environment,” an executive at the meeting who asked for anonymity told Reuters.
“As prices go up, our working capital gets restrained and we have enormous hedging needs. They are massive. So we will go to that financial firm and structure over-the-counter relationships so they effectively step into our shoes. Then we have certainty of cost of our hedge. I don’t think the commission hears that,” the executive said of the CFTC.
Reporting by Christine Stebbins; Editing by David Gregorio