Tighter U.S. commodity trading laws may be boon to foreign exchanges

Tighter U.S. commodities regulations could hurt American derivatives exchanges as market participants would likely head for budding rivals on foreign shores, analysts said.

“Like any other businesses, exchanges and markets are competitive. With electronic trading, they are competitive around the globe, so participants will look for the most efficient and least expensive place to trade,” said David Resler, chief economist at Nomura Securities International Inc. in New York.

Two Dubai energy markets are about to launch futures listings that will compete against flagship energy contracts traded in New York and London. The Dubai debuts coincide with a flurry of activity on Capitol Hill to pass legislation that would curb what some lawmakers perceive as speculative forces — possibly a factor pushing the barrel of crude to a new all-time high of $135.09 on May 22.The Dubai Gold & Commodities Exchange just launched cash-settled contracts on the world’s two crude oil benchmarks, West Texas Intermediate Light Sweet Crude — the flagship contract of the New York Mercantile Exchange — and Brent Crude Oil. Nymex trades the WTI for both physical delivery and financial settlement while its Brent contract is cash-settled. For its first day of trading, the DGCX traded 2,833 contracts, or less than 1% of the 326,598 WTI contracts for July delivery traded on Nymex on May 27.

On June 2, the Dubai Mercantile Exchange will launch its own financially-settled Brent contract, which is traded on over-the-counter and regulated markets owned by IntercontinentalExchange Inc., Atlanta, for either physical delivery or financial settlement. The DME is also expected to launch a WTI contract later this year.

The DGCX was founded in 2005 by government-owned Dubai Multi Commodities Centre in partnership with Financial Technologies (India) Ltd. and the Multi Commodity Exchange Ltd, both in Mumbai. NYSE Euronext took a 5% stake in MCX in February.

The DME, which made its debut last year with Oman crude futures contracts, is a joint venture between Tatweer, part of government-owned Dubai Holding, the New York Mercantile Exchange and private equity group Oman Investment Fund, Muscat.On May 7, Democratic senators presented the proposed Consumer-First Energy Act of 2008, which includes provisions similar to the House’s Renewable Energy and Energy Conservation Tax Act of 2008, which was passed 236-182 on Feb. 27.

The Senate bill would prevent U.S.-based oil traders from routing transactions through offshore markets to evade position limits. It would also require the Commodities Futures Trading Commission to substantially raise margins for oil trading.

“There is a need for market oversight, but no country can decide to set onerous regulations and not expect that these regulations will likely drive business away,” Mr. Resler also said, noting the negative impact that the 2002 Sarbanes-Oxley Act had on U.S. capital markets. One unintended effect of the Sarbanes-Oxley legislation was to push companies to go public or raise capital in foreign markets to avoid enhance scrutiny.

Commodity prices have soared over the past year due to rising global demand, a surge that has spurred food riots in the poorest countries and grumbling at the pump in the wealthiest ones.

On May 20, Sen. Joseph Lieberman (I-Conn.) chaired a Senate Homeland Security Committee hearing on the impact of speculation by institutional investors and hedge funds on commodity prices.

“My own conclusion is that index speculators are responsible for a big part of the commodity price increases,” Mr. Lieberman said at the hearing. Among the legislative measures envisioned by the committee: barring institutional investors from investing in commodity markets via index funds and swaps.

The legislation would likely apply to foreign institutional money as well, which would put the U.S. exchanges at a competitive disadvantage and lead to large liquidity shifts around the world. For instance, sovereign wealth funds — many of which are based in the oil-rich Persian Gulf area — could decide to trade contracts on Dubai’s new energy markets, instead of Nymex.

“It’s certainly reasonable that, in an electronic age where foreign exchanges can have terminals or connections to U.S. traders, that one consequence of adding restrictions to U.S.-regulated trading would be a shift to foreign alternatives, or unregulated OTC alternatives,” analyst Edward Ditmire at Fox-Pitt Kelton Cochran Caronia Waller LLC, New York, said.

Jamie Parisi, chief financial officer of CME Group Inc., Chicago, told a conference hosted by investment bank Fox-Pitt Kelton in New York on May 21 that the CME is looking at sovereign wealth funds as an area of growth. As the world’s largest futures exchange, the CME, which is trying to acquire Nymex, could help the fast-growing sovereign funds take large positions with minimal market impact, Mr. Parisi explained.

Because Nymex has a stake in the DME and clears DME contracts, it is relatively better positioned than its competitors regarding global oil trading.

While lawmakers consider measures to force commodity prices down, the jury is still out on whether the surge in oil prices results from fundamentals or speculative pressures.

According to an industry source, the measures, if passed, would trigger an exodus from U.S. futures markets because oil traders would take their business elsewhere — and not only for oil trading but for their entire futures portfolios due to margin offsets.

“It would be a disaster for the stock price of U.S. futures exchanges,” the source said.

The Senate bill also seeks to allow the U.S. Attorney General to bring an enforcement action against any country colluding to set the price of oil or natural gas too high.

Under the “stand-up to OPEC” part of the proposed legislation as posted on the Senate website, “nations concerned with maintaining good diplomatic relations with the U.S. will likely be reluctant to blatantly act in a way that is counter to U.S. law.”

The Organization of Petroleum Exporting Countries includes countries such as Algeria, Angola, Iran, Libya, Nigeria and Venezuela.

Most Wall Street firms have raised their oil price forecasts this month, based on fundamentals — rising demand and declining supply. Analysts at Goldman Sachs Group Inc. are at the high end of the predictions with $200 a barrel before the end of the year.

The Paris-based International Energy Agency is currently reassessing reserves for the world’s top 400 oil fields and will release its findings in November. According to news reports, the IEA is revising its assessments lower.

Oil investor T. Boone Pickens recently predicted that crude oil prices would hit $150 a barrel this year because supply will not exceed 85 million barrels a day while global daily demand runs at 87 million barrels.

CFTC Chief Economist Jeffrey Harris testified in Congress this week “there is little economic evidence to demonstrate that prices are being systematically driven by speculators.” Instead, Mr. Harris described increase demand, lower supply due to geopolitical disruptions as the “perfect storm” pushing prices up.

The CFTC’ has already just received extended oversight powers for OTC trading.

Market forces rather legislative action may take care of high energy prices, said Robert Brusca, chief economist at New York consultancy FAO Economics.

“If oil prices stay this high, we will have a global recession and demand for oil will drop sharply, taking prices lower,” Mr. Brusca said.

Contact Isabelle Clary at [email protected]