Are Trading Houses Too Big To Fail?


Are trading houses too big to fail? It seems to be a central question coming out of the Financial Times Global Commodities Summit. The natural follow-up question is how much, or what kind, of regulation does the futures market need?
CFTC Commissioner Scott O'Malia gave the keynote speech, leading off with concerns that the Dodd-Frank financial reform legislation has complicated the too big to fail question, especially as it pertains to non-bank swap dealers. Banks that fall into the too big to fail category get the competitive advantage associated with the backstop of the federal government, but it's not clear if large merchant firms -- like the Glencores and Cargills of world -- get that same advantage.
"While it is my belief that trading firms are not TBTF, I also believe that the Commission's ability to analyze derivatives data will allow the Commission to monitor the impacts of large trading houses on physical and financial markets. Additionally, this will allow the Commission to determine whether certain trading strategies pose a significant systematic threat to our markets and economy," he said, according to a copy of his speech.
"In other words, the foundation of the Commission's capacity to perform its market surveillance function will depend on how successful the Commission is in utilizing data."
Cargill's Chief Executive Greg Page said commodity trading firms are facing new scrutiny over their influence on food and fuel prices and are being unfairly lumped in with financial misbehavior, according to an article in the Financial Times (link at bottom).
"The term 'trading' has become wrapped up and confused in the public perception with speculation, with hoarding, with market fixing, monopolies, cartels and bad practices," Page said. "There is increasingly little differentiation in the perception between trading and the worst excesses of the financial sector -- the massive points of difference being misunderstood or in many cases ignored. We should not be afraid to point out those differences."
Page presented the industry with a choice: "We can either earn and embrace the governance and regulation we want and need, or ignore our ethical, behavioral and societal obligations, and then accept the governance that others may impose upon us."
In other words, the commodity sector should learn from the banking sector's mistakes. It should get out ahead of regulation, behave responsibly and ethically and proactively craft its own fate.
That opportunity will come this summer with the reauthorization of the Commodity Exchange Act, and many advocates of enhanced customer protections are already starting to prepare their lists of what they'd like changed. CFTC has virtually no regulatory authority over high-frequency traders, and many foresee bringing them into the fold.
The commodity sector should take a little advice from CFTC Commissioner Bart Chilton, who argued that it's important to keep financial regulations simple in a speech to the St. Louis Federal Reserve Bank.
"All too often, over the past three years, regulators have unnecessarily "complexified" a proposal," he said. "To my mind, there need be no disconnect between finding a result that ensures a healthy business atmosphere and at the same time safeguards a fair, open, competitive marketplace for consumers. We can do this, in a respectable, reasonable and responsible way, but not if we needlessly continue the cycle of increasing complexity in attempting to develop our solutions."

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