Commodity Traders Face Higher Costs Under New European Rules

  • Regulator sets two tests to determine level of speculation
  • Rules to place commodities firms on even footing with banks

Commodity traders and consumers are set for higher costs as the industry will for the first time be subject to similar regulations as stock and bond markets under European Union proposals to prevent market abuse.

Companies where speculative activity makes up more than 10 percent of their total commodity derivatives trading will need to get a financial license, comply with new disclosure rules and set aside additional capital to back trades, the European Securities and Markets Authority proposed Monday. ESMA also relaxed some previously proposed limits on the total open positions a trading firm can hold in a market.

The update of the region’s Markets in Financial Instruments Directive, designed to help prevent another financial crisis, will reshape commodities industries, including the $940 billion power and natural gas markets. The rules impose costs that may prompt some companies to scale back their trading, leading to less-liquid markets and higher consumer bills, according to utility executives and energy watchdogs who commented on previous draft proposals. ESMA says the recast will prevent abuses.

“This is certainly burdensome from a compliance perspective,” said Craig Pirrong, a finance professor at the University of Houston who prepared a paper on the new rules for metals trader Trafigura Beheer BV. “To those who have only a hammer, everything looks like a nail.”

Two Tests

On top of the so-called “main business” criteria, firms will also be assessed under a “market share” test to determine if their speculative trading in commodity derivatives is high relative to overall trading in an EU market. The exemption thresholds, which don’t include hedging transactions, range from 3 percent for oil products and natural gas up to 20 percent for carbon dioxide emission allowances.

“It all comes down to whether firms are able to identify enough of their trading activity as hedges to fall beneath the thresholds,” Pirrong said.

The proposed position limits would range from 5 percent to 35 percent with special criteria for new and illiquid contracts, according to ESMA. Previously the authority had proposed a range from 10 percent to 40 percent.

“There is an element, indeed, of a cost increase for non-financials” such as utilities, oil companies and gas producers, Steven Maijoor, chairman of the authority, said Monday on a call with reporters. The changes will create a more level playing field for commodities companies and banks, he said.

The plan’s additional costs are unnecessary because energy is already regulated, said Energy U.K., an industry group in London representing 80 suppliers of power and gas. The extra expense will ultimately be borne by consumers, damaging the region’s competitiveness, it said.

“There is also a knock-on impact on smaller players, as market liquidity is likely to be hit as firms try to exit the market and transaction costs will increase, including wider bid-offer spreads,” Hannah Fensome, the group’s spokeswoman, said in an e-mailed response to questions. 

The European Commission has three months to decide whether to endorse the proposals before final approval by the European Parliament and the bloc’s Council.

ESMA posed almost 250 questions as part of its consultation since December on the rules, divided into nine categories, according to data compiled by Bloomberg. It received a total of 6,753 comments

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