John Kemp is a Reuters market analyst. The views expressed are his own.
Aug 8 (Reuters) – “See no evil, hear no evil, speak no evil” might well have been the motto for Britain’s commodity market regulators in recent years.
In too many instances, light-touch self-regulation by the exchanges, overseen by the Financial Services Authority (FSA), now reincarnated as the Financial Conduct Authority (FCA), has degenerated into ineffective or no regulation.
But the cosy relationship among brokers, exchanges and official regulators in London is being blown apart by more aggressive oversight from the United States.
On July 23, the Senate Banking Committee put a spotlight on the physical trading operations of the major commodity-dealing banks with a hearing on whether they should be allowed to control power plants, warehouses and oil refineries. Prodded by the committee and U.S. banking regulators, JPMorgan has indicated it will reduce its presence in physical trading.
Under attack from U.S. lawmakers and aluminium customers about the lengthy queues at its London Metal Exchange (LME)-registered warehousing operations in Detroit, Michigan, Goldman Sachs has offered to swap any aluminium in the queue for immediately available aluminium, though only for end-users.
The U.S. Commodity Futures Trading Commission (CFTC) last month ordered Wall Street banks and other traders to retain documents, emails and instant messages related to incentives or premiums given to metal producers in exchange for storing metal, as well as load out rates and delivery procedures.
Do-not-destroy notices such as this probably presage a wide-ranging probe into how the warehousing system operates and whether it has artificially inflated location premiums.
On July 31, Reuters reported Britain’s FCA has not ruled out its own investigation. “The FCA has been, and continues to be, closely engaged on warehousing issues with the exchange and the various initiatives it has put in place over recent years,” an FCA spokesman said on July 29.
The U.S. Department of Justice has also launched a preliminary investigation into aspects of warehousing and metals markets, sources familiar with the matter said.
Now Goldman and the LME have been named co-defendants in a class action lawsuit filed in the U.S. District Court for the Eastern District of Michigan, which covers Detroit. The lawsuit, brought by Superior Extrusion, an end-user, alleges “anticompetitive and monopolistic behaviour in the warehousing market in connection with aluminium prices”.
The LME and Goldman Sachs have responded by saying the lawsuit is “without merit” and promised to contest it vigorously.
More follow-on lawsuits have subsequently been filed in Florida and Louisiana.
OIL BENCHMARKS
Criticism is not restricted to metals. Persistent concerns have been expressed about the construction and accuracy of oil-pricing benchmarks such as Brent, which is also based in London, though traded worldwide.
Much of the adverse comment has stemmed from concerns about the methods used by price-reporting agencies (PRAs) to calculate daily benchmarks. Concerns have been expressed that Brent and other oil-price benchmarks are open to the same sort of manipulation as Libor and interbank lending rates.
But behind the arguments about calculation methodology are deeper concerns about the composition and competitiveness of the benchmarks themselves. Falling output of crudes deliverable against the Brent contract has left it looking increasingly unrepresentative and vulnerable to squeezes.
PRAs and regulators have drawn up a voluntary code of conduct and formal principles respectively to deal with some of the methodological issues. And the physical basis for Brent prices is being reformulated to address concerns about declining liquidity. Nonetheless, change has been slow.
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