GENEVA Tougher global regulations on derivatives and capital requirements might put small oil traders out of business in the next few years and increase the dominance of just a few major houses, something the regulators might ultimately regret.
"The big fear at the moment is that regulators may achieve the opposite of what the regulations are meant to achieve. You might end up with less competition," said Folker Trepte, a partner at PwC, who advises commodities traders.
Trepte says that when clients ask him how regulations will change the trading landscape in the next years, he has a pretty gloomy answer - if you are a small firm, you may not survive.
"Some small and mid-sized traders will decide to leave the market as costs will become too high. Sometimes you have two traders and may need more people in the back office. It may be just too expensive," Trepte told a room full of traders at an industry conference Global Energy in Geneva this week.
Commodities traders have been adjusting to tightening regulations on financial markets since the middle of last decade and will have to continue doing so until 2015 as new rules on derivative trading and capital requirements come into force.
Regulators in the United States and the European Union say new rules are needed to cap speculative froth, prevent important institutions from collapsing and eliminate manipulation, which pushes up energy or food prices.
The adjustments will cost a lot.
"The regulations as well as financing issues could have the biggest toll on smaller and mid-sized companies and traders," Christophe Salmon, chief financial officer for Europe, Middle East and Africa at Trafigura, one of the world's biggest traders, said on the sidelines of Global Energy.
So far, regulations have had the biggest impact on commodities trading at large banks due to a crackdown on proprietary trading and the planned Dodd-Frank regulation, which would limit positions banks can take in derivatives.
Under Basel regulations, requirements to set aside capital for trading at banks nearly tripled this year.
Although commodity traders are exempted from capital requirements until 2015, it looks more and more likely the rules for traders could be quite similar to banks.
"I see many commodities businesses in the EU and the U.S. restructuring quite dramatically. There will be consolidation and it is better to realize now that you will be too small in the new world and try to find a solution," said Robert Finney, partner at law firm Holman Fenwick Willan.
Trepte says that although it will take up to two years to get more clarity on the final outline of regulations, it is possible that in Europe traders may need a banking license.
The idea seems strange to most players.
"Trafigura is an international commodities trading and logistics company - not a bank. So I don't understand why we would need a banking license," said Salmon from Trafigura.
With all its financial might Trafigura could afford a license but it could be a step too far for small traders.
By 2015, traders might also be required to put aside big sums under stricter capital requirements which for a big player could amount to over a billion of dollars.
Europe is also considering introducing a clearing threshold of 3 billion euros for commodity derivative contracts.
"It will be for a gross amount and if you are a big company you may come very close to it,' said Trepte.
Some traders are already trying to adjust by splitting activities into regulated and unregulated units with the unregulated having most trades and regulated units clearing a much smaller proportion of trades, he adds.
Some are considering moving operations to Dubai or Singapore to benefit from lighter rules and as Switzerland comes under increased pressure to move closer to EU legislation.
All of that might ultimately create severe dislocations for several years, warned Finney from Holman Fenwick Willan: "It will become more difficult for non-EU parties to deal with the ones in the European Union."
Gary Morsches, managing director at CME Group, one of the world's largest exchanges, agreed that regulation might ultimately lead to some unintended consequences.
"The worst thing which can take place is when people decide not to hedge and trade with 'naked' positions as they cannot take the regulation risk," he said. (Additional reporting by Emma Farge, Editing by William Hardy)