3 Trading Venues

This chapter examines trading venues. The communiqué of the G20 finance ministers and central bank governors of 15 April 2011 states that participants in commodity derivatives markets should be subject to appropriate regulation and supervision. Therefore, certain exemptions from Directive 2004/39/EC (MiFID) are to be modified. These amendments particularly affect clearing houses, trade repositories, and trading venues, and reflect the increased risk and technological development since the last financial crisis. In Europe, MiFID II both defines the types of commodity derivatives that are regulated and the types of activity undertaken in relation to them that requires authorization. It also defines the types of trading venues that create the European trading landscape. As of January 2018, there are three types of trading venues in Europe: regulated markets, multilateral trading facilities, and organized trading facilities. While there are some important distinctions between them, it will be noted that many of the same requirements apply to each of them.

5 Market Abuse

This chapter assesses market abuse. Market abuse offences, in all of their possible forms, frustrate the concept of market efficiency by allowing undue advantage to the individuals performing the abusive actions, thus jeopardizing the development of fair and orderly markets. In turn, this is likely to harm confidence by undermining investors' beliefs that the market is fair, leading them to withdraw their investments. In Europe, the first European-wide legislative package was initiated with the adoption of the Market Abuse Directive in 2003 (Directive 2003/6/EC), with the aim of providing a broad framework that would address market manipulation and insider dealing practices in the EU. However, in the aftermath of the Financial Crisis in 2008, a review of the regime was required as a number of deficiencies were found. In 2011 and in order to address these issues, the European Commission adopted the proposal for the Regulation on insider dealing and market manipulation (MAR) as well as the Directive on Criminal Sanctions for Insider Dealing and Market Manipulation (CSMAD).

7 Illicit Behaviour

This concluding chapter explores regulations on illicit behaviour, including violations of embargo sanctions, bribery of government officials, and money laundering. Embargoes and financial related sanctions against ‘rogue’ countries are economic in nature and are designed to coerce such countries into conformance to international norms. Sanctions may be applied to particular economic sectors, or a country's economy may be entirely embargoed, sometimes with humanitarian exceptions. Moreover, sanctions may be applied to import and exports of commodities, but are also often applied to prevent access to banking and other financial services. Meanwhile, the US prohibits the bribery of foreign government officials in order to obtain business through the Foreign Corrupt Practices Act of 1977. The US has also led the world in combatting money laundering, which typically involves the deposit of proceeds from illicit activities into what appear to be legitimate banking or brokerage accounts. The Securities and Exchange Commission and the Commodities and Futures Trading Commission impose anti-money laundering requirements on the broker-dealers and futures commission merchants they regulate. Those requirements include supervisory programmes designed to prevent and detect use of firm accounts for money laundering.

1 Introduction

This introductory chapter provides a background and an overview of commodities trading. The trade of commodities is the earliest and most basic form of commerce. A central tenet in economics theory, the act of trade or ‘exchange’ of a commodity occurs at the intersection of supply and demand and also where the price or exchange rate is determined. Since commodity prices change based on myriad factors, the volatility of commodities prices is the raison d'etre of why derivatives developed. Derivative markets perform two essential functions: price discovery and hedging. Price discovery is important because it allows market participants to value their financial assets without actually having to sell those items. Hedging is also important because it allows a market participant to offset risks from exposure to financial instruments in its portfolio or that it anticipates buying in the future. The chapter then looks at the rationale for the regulation of trading in commodities-related financial instruments as well as the impact of Brexit on the regulation of commodities trading in Europe.

2 Commodity Trading Houses

This chapter discusses commodity trading houses, which refer to companies that buy and sell physical commodities and commodity derivatives for their own account and/ or on behalf of their customers. Commodity trading houses may be very specialist and deal in a few commodities only or they may have a wide-ranging business covering many different types of commodity. Moreover, commodity trading houses may form part of a wider group, where other parts of the group are in the business of producing commodities, whether that is by extracting them from the ground as a natural resource or manufacturing a usable product from one or more such resources. The commodity trading house may effectively be the marketing entity within the group. Sometimes that marketing entity will also enter into derivatives. The chapter then considers the reasons why commodity trading houses might trade commodity derivatives and the different ways in which such trading can be undertaken. It also studies the regulatory regime applicable to commodity trading houses and the reasons why such companies may fall within the scope of financial services regulation in some countries.

4 Trading Regulations

This chapter focuses on trading regulations. Derivative trading in financial instruments on organized exchanges consists largely of the following instruments: futures, options, options on futures, and swaps. Those transactions are differentiated from ‘cash’ transactions and ‘forward’ contracts. Forward and cash contracts are traded in over-the-counter (OTC) markets, which are generally subject to the day-to-day oversight of a government financial services regulator. Nevertheless, OTC cash and forward transactions may not entirely be free of governmental restrictions. For example, in the US, the anti-manipulation prohibitions in the Commodity Exchange of 1936 (CEA) may be applied to trading in cash and forward contracts where they are effected in order to create artificial prices. Particular OTC derivative transactions involving retail customers in foreign currency are also subject to regulation by US authorities, including the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC), and banking regulators. The purpose of those regulations is to protect unsophisticated retail customers from fraudulent business conduct and dealer failures. Meanwhile, the trading in OTC derivatives in the EU and the European Economic Area (EEA) is regulated under the European Market Infrastructure Regulation (EMIR) as amended by EMIR Refit.

6 Benchmark

This chapter addresses benchmarks. A benchmark is essentially a standard or point of reference against which things may be compared. Benchmarks are referenced in many contracts including commodity derivatives. They can be determined in a number of different ways, from calculation of factual data such as information about transactions executed through to exercise of expert judgement. In recent years, there has been a focus on the need to ensure that benchmarks accurately reflect the market they claim to measure, are transparent about how they are determined, and that they are not influenced by potential conflicts of interest. This action started at international level, with the G20 leaders declaring in 2011 to prepare recommendations to improve the functioning and oversight of the oil price reporting agencies (PRAs). PRAs are publishers and information providers who report prices transacted in physical and some derivatives markets, and give an informed assessment of price levels at distinct points in time. The International Organization of Securities Commissions (IOSCO) subsequently published a set of Principles for Financial Benchmarks (IOSCO Principles) in light of investigations and enforcement actions regarding attempted manipulation of major interest rate benchmarks.