The Frank-Dodd Financial Reform Bill could cause a slight decline in “hardcore’ energy futures and derivatives contracts, which might mean slightly less volatility in fuel markets, says Jerry Gidel of North American Risk Management Services in Livingston, Texas.
Gidel and other risk management experts told New Diesel Magazine (www.new-diesel.com) in telephone conversations late last week that hedgers and risk managers in the biofuels industries need to be aware of the new regulations in the new financial reform legislation and what alterations they need to make in how they execute and report deals to avoid penalties and other new pitfalls.
The Wall Street reform package set to take effect designs to change the way big banks play the commodities markets. One of the things JP Morgan Chase, Goldman Sachs and others investment banks do is use their own capital to make bets on the market, instead of using those funds to provide debt. The Commodity Futures Trading Commission has argued this to be a reason for tight credit lines in recent years.
The best thing about financial reform is that it can get the “over the counter part of derivatives trading out of the shadows and into reality,” Gidel says. “Maybe it will lessen the amount of these credit default swaps and other off-the-record B.S.”
This bill is meant to increase the transparency in the over-the-counter (OTC) markets.
“The number of participants and the size of their positions in over-the-counter markets has not been known or disclosed,” says Will Babler of Galena, Illinois’, First Capitol Risk Management. “The new bill limits bank proprietary trading and seeks to improve transparency. The regulations attempt to reduce market distortion and over-concentration of risk.”
Some negative aspects of the the new regulations could be a loss of liquidity in futures markets, meaning it could be harder to buy or sell, says Scott Irwin, professor of agricultural economics at the University of Illinois. Irwin has been studying the role of speculators in commodity markets for several years, and says that while there are many “unknowns” in regard to financial reform, the new legislation is unlikely to have a major impact on agricultural and fuel markets.
“If the new rules are too burdensome it could drive some dealers and speculators out of the market, which means that spreads could get wider and hedging costs could go up,” Babler says.There has been an influx of money into the commodity markets. There will be other firms that continue speculative activity in commodity futures, even if the big banks bow out. Investment banks, however, have been leveraging agricultural markets as a way to diversify their investments so they are not going to totally back away.
“That expertise will go elsewhere if the Goldman Sachs of the world close their prop shops,” Gidel tells New Diesel Magazine. “It’s not going to just disappear.”
“I think these new regulations are going to have very little impact on the market,” Irwin says. “But the jury is still out; it’s still very unclear how it will change the scope of trading and we are going to have to see what happens in the final rule.”