Commentaries

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The case for GDP bonds

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Around the world, governments are struggling to drum up buyers for the mountain of bonds they need to sell. And that’s especially true for big deficit, low savings countries like Britain and the United States.

The returns they are offering on conventional government bonds are low and there’s the risk of inflation eating away at their value. Perhaps it is time for a different approach.

Rather than hiring investment banks to bamboozle the public into subscribing for unwanted conventional bonds, or cramming them down the throats of the banks as part of expanded reserve requirements, governments should consider issuing bonds linked to gross domestic product.

GDP bonds are not a new idea but few governments have issued them. Those that have don’t make for a distinguished roll call, including as they do Bosnia Herzegovina, Bulgaria and Argentina, which swapped conventional bondholders into GDP bonds after its currency collapse in 2001.

CFTC review process – thinking about the eventual outcome

Several people have asked what I think will be the eventual outcome of the US Commodity Futures Trading Commission (CFTC)’s review of position limits and hedging exemptions in energy futures markets.  My guess is that the review will result in only fairly minor changes.

The most likely changes to emerge from it are probably: 

(a)  CFTC rather than exchanges will set position limits and be responsible for granting exemptions. 
(b)  Position limits will apply on an aggregate basis that will cover an entity’s positions across all exchanges and OTC.  To enforce this system, CFTC will demand data on OTC positions and on positions that are “near to” those on markets it regulates (ie Significant Price Discovery Contracts). 
(c)  Position limits on contracts close to expiry may be “hardened” to become fully binding (with few or no exemptions other than for physical hedgers intending to make or take delivery). 
(d)  Position accountability levels on contracts further away from delivery may be hardened somewhat but unlikely to become absolutely binding.  CFTC will almost certainly demand more documentation and proof to back up claims that they being held for “bona fide hedging” purposes. 
(e)  CFTC may revisit the classification of traders as commercial/non-commercial.  For firms with both hedging and trading operations, it may require the two to be separated out for reporting and regulating purposes.  The system would then regulate positions rather than entities. 

CFTC prepares to recant speculators’ influence

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johnkempcrop– John Kemp is a Reuters columnist. The views expressed are his own –

Like Archbishop Thomas Cranmer before he was burned at the stake for heresy, the U.S. Commodity Futures Trading Commission (CFTC) seems about to make a dramatic recantation.

GM dumps Chinese in Opel race, standoff looms

Two things Opel junkies need to know in today’s news.

1) General Motors has dumped Chinese state-owned carmaker BAIC’s long-shot bid to take over GM’s main European arm. That leaves a two-horse race between Canadian-Austrian car parts maker Magna and Belgium-based financial investor RHJ, loosely associated with U.S. private equity firm Ripplewood.

2) The two trustees appointed by the German authorities to a board overseeing Opel in its transition to new ownership are refusing to toe Berlin’s line that Magna’s bid is the only game in town (according to an intriguing Reuters sources story).

Kroes hits right note on EU bank aid

Neelie Kroes, the EU Competition Commissioner, is right to be taking a hard line on state aid to banks, which will distort competition if not repaid. However, she will have to fight member states like Britain and Germany, which are desperately encouraging banks to lend locally, nursing large losses on their capital injections or trying to avoid massive upheaval in their banking industries.

The reasons for her tough stance — laid out in guidelines she will unveil on Thursday, obtained by Reuters – are sensible. At their heart is the desire to maintain the imperfect European market in financial services that the Commission has done so much to foster. State aid risks distorting this market because of members’ differing ability and willingness to underwrite their banking sectors.

Polish EU vision breaks the mould

At last — a Polish vision of the future of the European Union that does not involve refighting
World War Two or dying in a ditch for outsized voting rights.

In a thoughtful report entitled “Europe can do better”, a group of eminent Poles, including two former foreign ministers and a former central banker, offer a blueprint for Poland to partner EU heavyweight Germany in advancing European integration.  Even if some of the proposals look unrealistic, Berlin would do well to grasp the outstretched hand from Warsaw and explore common ground.

Spotlight falls on London commodity regulation

– John Kemp is a Reuters columnist. The views expressed are his own – 

    By John Kemp
    LONDON, July 7 (Reuters) – As the Commodity Futures Trading Commission (CFTC) contemplates toughening position limits and oversight of U.S. commodity markets, the spotlight is shifting to the weaker regulatory regime overseen by the Financial Services Authority (FSA) in London [ID:nN07310607].
   Until now, criticism of London has centred on the so-called “London loophole”, which allowed U.S.-based commodity traders to amass positions in U.S. commodity contracts on exchanges registered in London rather than at home to avoid position limits and reporting requirements in the United States.
   Commodity traders could evade position limits and reporting on the New York Mercantile Exchange (NYMEX) light sweet oil and heating oil contracts by building up additional positions on the London-registered lookalike contracts on the Intercontinental Exchange (ICE).
   The loophole has been largely closed following a “voluntary” agreement between the CFTC, FSA and ICE last year. The FSA and ICE agreed to implement position limits on commodity contracts deliverable in the United States on the same basis as limits applied in New York. In return the CFTC agreed not to seek jurisdiction and continue to allow trading from terminals in the United States under existing “no action” letters.
   
   BORROWING FROM EQUITIES
   But closing the London loophole is unlikely to be enough to silence criticism about the standards applying in London commodity markets. The problem is not the FSA’s (voluminous) regulations but the growing gap between what’s written on paper and what happens in practice. It has left everyone (regulators, market participants and customers) unsure about what is allowed and what is not.
   It stems from competing visions about the appropriate role for regulation in commodity markets. Historically, these markets were assumed to be dominated by knowledgeable “professionals” who could be expected to look after themselves, rather than “retail” investors. So a light touch regime which prevented obvious abuses (such as fraud) was all that was required.
   As the level of participation by retail investors and less knowledgeable customers (such as pension funds) has increased, expectations about the level of regulation have risen. Increasingly, rules developed for equity markets have been applied (in slightly modified form) to commodities — with an emphasis on treating customers fairly, preventing insider trading and prohibiting “market abuse”.
   In most cases though, the rules contain a carve out allowing behaviour to deviate from published norms as long as it is in line with “accepted market practices”. The clash between historically accepted practices and what the rules now theoretically say has become an enormous source of confusion about what is and is not permitted.
   
   ACCEPTED MARKET PRACTICE?
   To take one example: the execution of large orders on or close to the close of the market and the declaration of a settlement or daily valuation. Established equity market practice puts a special onus on clients, brokers and traders to ensure large or unusual orders executed at this time do not cause, or appear to cause, manipulation or price distortions. Trading in the run up to the close is especially sensitive and subject to heightened scrutiny. Actions which appear designed to “support” closing prices are clearly forbidden.
   But the situation is far less clear cut in commodity markets. Many clients want to achieve closing prices since these are used to mark positions to market and to settle hedging programmes. So much trading is concentrated in a relatively narrow “window” ahead of the close and declaration of daily valuations. The large amount of liquidity concentrated in this short period attracts further trading from those needing to execute large orders.
   With this late trading activity there is a widespread temptation and open market talk about attempts to “support” or “hammer” the close. But does this constitute market abuse? It clearly contravenes the written regulations. But equally clearly it is in line with accepted market practice. So it falls into a grey area. It seems to depend upon the (unobservable) intentions of the market participant.
   Equally contentious is the question of how to deal with large long positions which dominate the market nearby or over certain sections of the forward curve also remains contentious. Such positions would clearly be considered abusive in equities, and the U.S. Treasury has warned bond market participants it will hold them to a high standard of behaviour if they do the same in U.S. government securities. But the position in commodities is more equivocal and the source of perennial controversy [ID:nL7149027].
   The FSA requires commodity brokers to submit “suspicious transaction reports” (STRs) where they suspect their clients or others are engaging in activity that could amount to market abuse. But in an update sent to regulated firms in September 2008, the FSA noted it had received only a “handful” of STRs related to commodities out of 700 across all markets, and said it would have expected a greater number. Firms have come under pressure to increase the number of STRs.
   The lack of STRs highlights industry uncertainty about what constitutes the level of “reasonable suspicion” needed to trigger a report; what are accepted practices; and how to define misuse of information cases compared with other markets.
   
   TWO-TIER REGULATION PROBLEM
   Uncertainty is compounded by the FSA’s decision to devolve frontline market regulation to the exchanges themselves, retaining only a supervisory and second-tier function for itself. While exchange operators have tried to separate their business function (which involves maximising volumes) from their regulatory one (policing market behaviour), there is an inevitable tension.
   More importantly, it has left the FSA with a dearth of expertise on commodity matters. Commodities are a very small part of the regulator’s remit. The institution has failed to build up the specialist personnel, knowledge and market contacts it needs to be able to take its own independent view and cross-check the information it is receiving from the exchanges and their members.
   In an ideal world, the business and regulatory functions would be separated. Exchanges would run themselves as pure commercial enterprises, with regulation transferred to the FSA. The FSA itself would clarify its fundamental approach – either reverting to the traditional light-touch system and abandoning the pretence of equity-like regulation, or making the new regulatory system real by taking a tougher line on previously accepted market practices.
   In reality, this sort of change is too ambitious; it runs counter to too many vested interests. But a useful start would be for the FSA to increase its own expertise in this area, strengthen its market contacts and conduct more direct surveillance and supervision, while making clearer what “market practices” remain acceptable and which ones are consigned to history.
   (Edited by David Evans)

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