Commodity Regulation to Toughen - NY Times 060308

http://www.nytimes.com/2008/06/03/business/03cftc.html?pagewanted=print

June 3, 2008
Commodity Regulation to Toughen
By DIANA B. HENRIQUES, NY Times
Regulators of the nation’s commodity markets will demand more information about investors to determine whether they are evading market limits on speculation and artificially driving up world food prices.

The regulatory agency, the Commodity Futures Trading Commission, also plans to initiate talks with bank regulators to ensure that adequate credit is available for the farm economy.

In addition, the commission intends to strengthen a program aimed at lowering the cost for farmers of hedging crop prices, which has grown more expensive with the increasing volatility in the markets, according to a draft of the proposals obtained by The New York Times. The commission is expected to announce the proposals Tuesday.

Finally, in an unusual departure from the secrecy that usually cloaks its enforcement actions, the commission will confirm that it is investigating the price spike that hit the cotton futures market in late February, a step demanded by cotton industry executives at a commission hearing on April 22.

The commodity futures markets play a key role in establishing worldwide prices for wheat, corn, soybeans and other foodstuffs, as well as energy products like crude oil and natural gas.

But in recent years, these markets have also become an attractive haven for investors seeking both profits from rising prices and protection against inflation and a withering dollar. As a result, billions of dollars have poured into the commodity futures market — from pension funds, endowments and a host of other institutional investors — through the new conduit of commodity index funds.

Billions more have come in from investment banks that are hedging the risk of complex bets, called swaps, that these same investors have made in the unregulated international swaps market, which dwarfs the regulated markets supervised by the C.F.T.C.

The commission has come under fire, most recently at a hearing on May 20 before the Senate Committee on Homeland Security and Governmental Affairs, for not doing enough to monitor the impact of these investors on markets that have such influence on family budgets nationwide.

The proposals are being presented as an initial, but not final, response to those concerns, which echoed complaints made at a C.F.T.C. hearing in April by farm industry officials. They believe this flood of new money from swaps and index funds is undermining confidence in the market’s role in setting prices and managing risk.

“The commission recognizes that — although no single solution exists — there are several steps it can take to improve oversight of the futures markets and bring greater transparency and scrutiny to the types of traders in the marketplace,” according to a draft statement introducing the plan.

Specifically, the commission will start requiring more information about index funds and, more significantly, about the clients on the other side of the unregulated swaps deals that are being hedged on the regulated futures exchanges.

The swaps market has traditionally be seen as off limits for federal commodity regulators, but the commission clearly is responding to Congressional concern that investors may be using swaps dealers to evade rules that limit the size of their speculative role in regulated markets.

Besides collecting more information about these new players, the commission is revising its monthly trading reports, starting in July, to present the expanded data in a way that will be clearer and more comprehensible to the public.

The commission is also putting the brakes on granting waivers that have exempted some commodity index funds from speculative limits, and is formally dropping proposed rule changes that would have extended a blanket exemption to all index funds.

In recent years, more than a dozen commodity index fund companies have been granted individual waivers, after successfully arguing that they were using the futures markets exclusively to hedge their obligations to the people who have invested in their index funds. But the commission now intends to “be cautious and guarded before granting additional exemptions in the area,” according to the draft proposal.

The proposal also outlines the commission’s plan to coordinate with the Farm Credit Administration and banking authorities, including the Federal Reserve Banks in Chicago and Kansas City, Mo., to help insure a reliable supply of credit to the farm economy.

Bank regulators testified at the commission hearing in April that farm-belt banks were financially sound and could handle the credit demands of farmers and grain elevators trying to meet margin calls on their hedged positions in the futures markets.

But the commissioners are apparently not satisfied that this ability to lend is being matched by a willingness to lend and are trying to head off a credit crisis that could wipe out farmers and grain elevators before they can profit from higher crop prices at harvest.

The proposals also include steps to strengthen an existing alternative to futures contracts — an over-the-counter product called agricultural trade options that farmers grain-elevator operators could use to hedge crop prices. The existing product has not gained acceptance as a hedging tool, and the commission is directing its staff to find ways to make it more useful to hedgers and more visible to regulators.

Today’s initiative comes less than a week after the commission announced steps to expand its information and oversight of energy traders in the futures markets, and confirmed that it has been investigating possible manipulation of energy futures prices for six months.