COLUMN/AGRIBUSINESS: Challenges and opportunities for regulating commodities

As it is -- ambiguity, uncertainty, and lack of clarity regarding policy and regulations around commodities trading impacts the efforts to harness the potential and prospects in commodity markets; this fact applies across, at the local, regional and global levels. The possibility of integrating and harmonising the legal/regulatory framework and embedded institutions could unlock the potential and empower the commodity trading ecosystem to grow and mature in a manner similar to that of securities markets.

In the case here, integration and harmonisation of legal/regulatory frameworks around storage, warehousing, marketing, trading, pricing and other supporting infrastructure around this space could be a matter of necessity. And so, the legal/regulatory environment relating to warehouse and warehousing receipts systems; the mercantile exchange, cooperative unions/societies, agricultural produce marketing boards, capital markets and securities, etc will have to harmonised to enhance the coordination for efficiencies.

Commodity markets are critical -- studies point out high correlation of commodity prices with domestic economic growth, inflation and the pace of exports in developing countries. To bring this perspective into context – let us consider our case: as data indicates – we are a commodity dependent country, agriculture is still one of the most important economic sectors contributing about 25 per cent of the national GDP and over 75 per cent of the rural household income.

The sector provides almost 95 per cent of the national food requirement and livelihood to more than 70 per cent of the population. The sector contributes about 30 per cent of total exports and almost 65 per cent of the raw material requirements for industries. These, and others, are clear indications that the sector has a strong influence in the national economy.

However, for the realisation of expected sectoral growth level of not less than 8 per cent (it has been at about 7 per cent according to recent data), it is important to ensure that formal commodity marketing and trading systems are effective and efficiently working, capable of guaranteeing social and economic benefits to producers, traders and consumers.

As it stands, the current commodity marketing and trading system is yet to attain such desired outcome. The marketing and trading systems and their embedded institutions are fragmented, uncoordinated and unpredictable. There are sentiments that for most agricultural produce, farmers are receiving the low end of the bargain while consumers’ prices are high with no relationship to the transaction costs.

Likewise, the regulatory systems, marketing institutions and enforcement mechanism are somehow inefficient to the expense of farmers and sometimes consumers.

The development of organised commodity market(s), exchange platforms and related market infrastructure and ecosystem has of recent assumed significant interventions in the financial development policy of many countries. As stock markets assumed importance as instruments to enhance allocative efficiency of financial resources, commodity trading /exchanges emerge as a powerful instrument in managing price risk management, so vital for sustained economic growth.

The regulatory agenda

This being the case, what should be the regulatory agenda of commodities regulations? We underscore that we are at an early stage, but as we strive to become sophisticated, let’s consider where the global regulatory agenda is as far as commodity trading is concern. These are some global trends: (a) Paper trading value for commodity far outstrips physical trading; (b) There is prevalence of a complex range of trading strategies and technologies; (c) Trading houses are emerging as major players, in some counties, replacing banks; (d) There is financialisaton of commodity trading with more of fund management, investment products and diverse categories of investors participating in trading.

Other global trends include: (e) Consolidation of the commodity exchange industry that extends to other market segments; (f) the growing power of commodity producers; (g) growing linkages between commodities markets across the world and a wide range of investment and trading products; (h) volatility in commodities markets quite often turning into issues of public unrest leading to ad hoc policy interventions and measures; (i) and the issue of managing the interests of various stakeholders engaged in the value chain of commodities trading, and so on.

Influencing factors

These trends and developments could surely have a bearing on the regulatory framework that needs to be built up, going forward, our commodity trading system will have to make way for a complex market structure with more players, products, instruments and innovations that could call for a proactive and agile regulatory framework.

At present, the scope of merchantile exchange is quite narrow and limited to just few envisaged products. Some brokers have been identified, trained and licenced, but as it has been the case for our stock exchange -- the strategic and operational roles of banks, market makers, liquidity providers and institutional investors as far as trading in commodities exchange is concerned is yet to be clearly determined, this could limit appetite and liquidity in the exchange.

Historically, at the global level, the development of regulation of commodities trading has evolved under price stabilisation and liquidity enhancement instruments; (b) transparency and reporting; (c) regulation of Over the Counter (OTC) trading and dealing activities; (d) banning certain trading strategies and actors; and (e) strengthening regulatory and supervisory authorities and international cooperation.

The background for an integrated framework for commodities regulation at the global level was initiated by the G20, followed by several other global and regional regulatory initiatives that, among others, include: the Dodd Frank Act, IOSCO (Principles for the Regulation and Supervision of Commodity Derivatives Markets), Markets in Financial Instruments Directive (MiFID), European Markets Infrastructure Regulation (EMIR), Markets in Financial Instruments Regulation (MiFIR), and Market Abuse Regulation (MAR). By the way MiFID II has further strengthened the scope of monitoring trading activities.

Regulatory issues

In conclusion, with respect to regulation enhancement and better coordination, the key issues to consider include: (a) bringing commodity firms, venues and products under the merchantile exchange regulatory scope; (b) greater regulatory oversight by transaction reporting for commodity trading; and (c) commodity benchmarks used in financial contracts to be brought under regulation.