New financial regulations may affect wheat

by Morton Sosland
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While most companies in grain-based foods have experienced little or no direct impact from financial regulations being implemented by the federal government, missing that bullet does not mean that all vulnerabilities have been avoided. Indeed, if there’s anything that may be positively said about the many provisions of the statute that became law last summer, it is the lack of certainty about what such sweeping changes may mean. This applies even to wheat futures and cash wheat trading that seem comfortably excluded. The act, bearing the name Dodd–Frank Wall Street Reform and Consumer Protection Act, as well as The Financial Reform Act of 2010, was enacted by the Democratically-controlled Congress in response to the financial failures besieging the country. The main aim was to pass legislation that would prevent repetition of the bank failures and financial chaos.

For grain-based foods the most obvious point of concern is sweeping changes the law makes in regulating and reporting derivatives trading. While futures contracts may be derivatives, the new law makes clear that the derivatives it covers are in swaps. The latter, with inherent questions about the soundness of counter-parties, were viewed as at the center of the recent financial collapse. Imposing rules and regulations that supposedly would prevent such a catastrophe from happening again became one of the main goals of the Dodd-Frank act.

Swaps became the focus of attention because these instruments trade without revealing exactly what the various parties promise to do. So-called over-the-counter trading, by-passing regulated exchanges, is the mode by which swaps are accomplished. The “mystery,” due to their lack of supervision or disclosure of details, made these contracts handy target. In the case of grains, the volume being done in swaps is not known, but the assumption is that it is less than rules in oil and other energy products. Indeed, oil swaps, according to some recent studies, are many times the volume of oil futures trading on regulated exchanges. With that huge volume beyond reporting, oil’s early focus was a certainty.

The likelihood that grain-based foods will avoid the reporting rules and clampdown imposed on other markets is due to excellent relations with Congress and the Commodity Futures Trading Commission. It is the C.F.T.C., along with the Securities Exchange Commission, that has the responsibility for making rules that respond to Dodd-Frank. Strict timing is a part of the act, subject only to budgetary restraints. The latter are a possibility, depending on how the Republican-controlled House wants to influence the implementation of these mandates.

While all the many rules are being written and new powers undertaken, grain-based foods would be advised to watch what is happening outside of the United States. It is true that wheat trading is not an immediate target. Yet, different attitudes rule in many foreign countries where price volatility is often perceived as being caused by unregulated trading. Many countries, themselves the beneficiaries of oil price strength, prefer focusing on wheat, corn and soybean trading, whether as a cash commodity, in futures and, yes, also in swaps.

Leading this charge is the International Organization of Securities Commissions (called IOSCO). It has created a Task Force on Commodity Futures Markets, which recently said: “Price discovery in the financial commodity markets should be improved by promoting greater transparency across futures, over-the-counter derivative and cash commodity markets.” The task force expresses concern that “physical markets are typically beyond the jurisdiction” of national regulators. The result, it warns, is “asymmetry of information which can hinder the process of price discovery.”

Declaring that successful reform requires international collaboration, rather than purely national steps, it warns that failure to gain global action “could inadvertently act as an incentive for counterparties to transact in a lesser regulated jurisdiction.” It is only recently that IOSCO has convened several meetings meant to pursue reforms that reach all market, not just for energy but for all commodities. As praiseworthy as the transparency goal may be, stepped-up regulation of markets that have operated well without it makes no sense.

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