commodities helped to lower prices in recent years. More recently, exogenous shocks such as the Arab Spring, Hurricane Sandy, and structural changes on the supply side, such as fracking, are contributing factors to a difficult market.”
In Stableford’s opinion, “the only commodity funds that should be considered as investment vehicles are the bullion funds for precious metals. Investors increasingly regard gold, silver and to a lesser extent platinum as hard money currencies, with the attraction of being no one else’s liability.” In contrast, Stableford views wheat and rice as “staples grown to feed people so there should not be speculation.” He warns that “with high rice prices you get revolutions!”
The changing regulatory environment Stableford reflects how, “In reaction to the 2011 bubble, the US CFTC, emboldened by Dodd-Frank, sought to curb speculation in commodities, but the preamble was initially shot down by the US District Court of Appeals.”
After those early teething troubles, he stresses that current re-proposed legislation has ballooned into something far more comprehensive – covering 28 commodity contracts versus the original eight.
Stableford is sanguine about new CFTC rules capping traders’ position sizes. “The rule limits, established to date, will pose no threat to the vast majority of speculators who help to provide genuine liquidity in futures-traded commodity markets. Similarly, they will not impede normal hedging activities by the producers and commercial consumers of commodities,” he argues.
Of course non-financial traders are in any case exempt from clearing in the US, as are bona fide hedging transactions. But even in the EU, where even smaller non-financial traders must clear and report trades, Stableford is confident that they will be able to do so. “Technology is working and growing geometrically,” he says, with “Advent Data Services which acts as a backbone so even smaller players will be able to access the infrastructure they need.”
Stableford seems to be an ardent advocate of the rule limits, and foresees that they will be profoundly benign for markets. “They should help to prevent a fashion for commodity trackers from distorting the markets and contributing to damaging commodity price inflation.” Stableford explains how some exchanges are “like clubs where people are looking to game the system the whole time as is the nature of markets.” The rules limits, Stableford contends, are designed to stop people continuing to buy in an upward market.
Commodities subject to proposed position size limits
The 28 core referenced futures contracts are: Chicago Board of Trade Corn, Oats, Rough Rice, Soybeans, Soybean Meal, Soybean Oil and Wheat; Chicago Mercantile Exchange Feeder Cattle, Lean Hogs, Live Cattle and Class III Milk; Commodity Exchange, Inc. Gold, Silver and Copper; ICE Futures US Cocoa, Coffee C, FCOJ-A, Cotton No. 2, Sugar No. 11 and Sugar No. 16; Kansas City Board of Trade Hard Winter Wheat; Minneapolis Grain Exchange Hard Red Spring Wheat; and New York Mercantile Exchange Palladium, Platinum, Light Sweet Crude Oil, New York Harbor ULSD, RBOB Gasoline and Henry Hub Natural Gas.
“The rules are a good effort and they should also make life more difficult for algorithmic, high- frequency and black-box trading,” he argues. “The logic is that traders are being told, ‘This is your ammunition for a day, month or contract’,” and that limits scope to manipulate markets. Stableford expects the rules “should prevent high-frequency traders from front running and causing even greater volatility to the detriment of commercial hedgers.”
There is limited potential in Stableford’s view for funds to side-step the rules through OTC (over the counter) or physical trading as he thinks this activity will also eventually get reported to the regulators, via counterparties’ reporting obligations. For instance, futures, options and swaps referenced to a futures price are deemed to be “economically equivalent” to the future itself and so are not exempt from rule limits or reporting requirements.
Even so, Stableford admits that it can be difficult for regulators to obtain a holistic global view of positioning, but he thinks the situation is improving. “Regarding cross-country positions this data is somewhat vague at the moment, but consolidation within the market landscape has lent a degree of transparency with NYMEX owning LME as well as many US depositories,” he points out. He adds that “Commitment of Traders Reports are published weekly by leading exchanges, such as IPE, ICE, SME, allowing regulators and central banks greater transparency during interim periods within the regulatory time-frames of reporting requirements.”
It is also unclear whether regulators can see the big picture through the lens of exchanges, when some physical trading activity may be hidden from view. Ever the cynic, Stableford says: “On the physical side, the wily investment banks came up with a subtler and even more profitable scheme. Fortunately, The New York Times has done a very good job of exposing it.” It seems that some banks are playing musical chairs with inventories to
obscure their holdings, and Stableford concedes that “Sophisticated investors, some hedge funds, and certainly sovereign wealth funds will have similar facilities, which may cloud true positions from regulators.”
Advent in a brave new world “Clearly regulation is a complex and fluid subject,” admits Stableford, who asserts that “Fortunately, Advent products are at the forefront of meeting the present and future reporting requirements of our clients in this changing regulatory environment.” Advent is helping clients report to all kinds of regulatory bodies worldwide including the FTC, FCA, EU committees, the EU transparency directive, Euroclear, and the SEC.
More than 300 hedge funds use Advent software, which has received awards from The Hedge Fund Journal including ‘Best IT Provider’ and ‘Leading Provider of Fund Accounting and General Ledger Systems’. Stableford says clients are using Advent’s “peerless accounting software which offers true derivative exposure,” meaning it will calculate the overall notional exposures and risk-factor sensitivities across a huge portfolio.
The software aggregates all of this “across multiple locations and instruments,” which is particularly helpful for global hedge funds using a multitude of prime brokers, counterparties, and trading venues and funds exposed to a spectrum of exotic instruments. In turn, “shock modeling capabilities” help with stress and sensitivity tests for scenarios including rate rises, and volatility spikes. Users can stress-test variables in isolation or in varying combinations.
Moreover, financing and margining capabilities allow for stress-testing of spread, haircut and margin hikes – and are synchronised with collateral management requirements in relation to central clearing. All in all, it sounds like Advent is taking the bull by the horns when it comes to the brave new world of more intrusively regulated markets. THFJ
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