(Kitco News) - Uncertainty regarding the outcome of regulations for financial markets is one the main risks for commodities markets in 2011, Barclays Capital said in a research note Thursday.

Ever since the food and oil spikes of 2008, regulation of the commodities market has been a focus but greater oversight has become an objective for all financial markets in order to increase transparency and reduce systemic risks to the global financial system, the bank said.

The U.S. Dodd-Frank Act is the most advanced regulation so far and covers a wide range of issues, but for the commodity markets specifically the law makes requirements that the Commodity Futures Trading Commission and the Securities Exchange Commission establish rules for the over-the-counter derivative markets by 2011.

“The scale of the task is huge,” Barclays said, noting that the CFTC estimates it may need to write as many as 60 new regulations and as of the second half of last year alone it had almost 500 meetings.

Further, the timelines are aggressive and the CFTC cannot keep up, which is unsurprising, they say. For instance they noted that the January target for position limits for exempt commodities has been missed as the comment period is not scheduled to be complete until the end of March and implementation is not expected until 2012.

Definitions are just one basic problem, such as trying to define what types of firms and activities these regulations should apply to, Barclays said. There is also little clarity regarding products and trading platforms.

Transaction costs are likely to rise as the expanded role of the CFTC requires more funding, new reporting rules will require greater investment in compliance staff and technology and there are likely to be greater margin and capital requirements, the firm said.

Position limits are under consideration by the CFTC, but those are still under debate, even at the agency, Barclays said, pointing out comments by CFTC Commission Michael Dunn: “To date, CFTC staff has been unable to find any reliable economic analysis to support either the contention that excessive speculation is affecting the markets we regulate or that position limits will prevent excessive speculation […] with such a lack of concrete evidence my fear is that at best, position limits are a cure for a disease that does not exist or at worst, a placebo for one that does.”

The uncertainty regarding regulation may be pushing some risk management to non-U.S. markets, Barclays said, noting that the position of swap dealers has fallen sharply since mid-2010. Swap dealers, which can include end-users, would be most affected by position limits, the firm said. Currently the CFTC defines the term swap dealer broadly: any entity that holds itself out as a swap dealer, makes a market in swaps or regularly enters into swaps as an ordinary course of its business.

Finally, Barclays said given how much investment in commodity supplies will be needed over the next 10-15 years, “market participants need two things: confidence in long-term pricing signals provided by the back end of commodity futures curves and depth in those futures markets enabling them to effectively manage their price exposure. Both of these vital functions appear to be at risk from the current rules and regulations being written in U.S. commodities futures markets as a result of Dodd-Frank.”

 

By Debbie Carlson; dcarlson@kitco.com

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