London, 22 July 2010

Accusations of excessive speculation in London's cocoa market have come at the worst possible time for the NYSE Liffe exchange, and could lead to the introduction of tougher rules, lawyers and analysts said. London's commodity markets are under pressure to tighten regulation as the United States pushes forward with plans to tame speculative activity that was blamed by some for pushing food and energy prices to record highs in 2008.

The issue surfaced in cocoa when 16 European industry players wrote to Liffe threatening to move to the rival U.S. IntercontinentalExchange, complaining of the amount of speculation and lack of transparency in the London market. David Hufton, head of oil brokers PVM, said in a note to clients on Wednesday the cocoa market spat had shone an unwelcome spotlight back on commodities in London.

"In a world with its regulatory racing shoes firmly in place it is suicidal to provide market sceptics with such ammunition. "The whole debate about the morality of allowing speculation in strategic resources, especially food, is unfortunately back."

The physical delivery of almost all of London's graded cocoa stocks on the expiry of the July futures contract last week -- the equivalent of almost 7 percent of world production -- has attracted widespread press coverage. There have been suggestions this cocoa went to just one or two parties. Liffe said in a letter earlier this month that it saw no evidence of abusive trading behaviour on the July cocoa contract.

Liffe cocoa prices touched 32-year highs last week, and many have argued the rise was driven in part by a long term decline in output from the world's biggest producing region, West Africa, rather than by speculation.

Changing Political Climate

Michael Lewis, head of commodity research at Deutsche Bank in London said there was a long history of attempts to corner commodities that have never attracted much attention in the past, but now the political climate had changed.

"This kind of thing has been going on for at least 90 years, but there will inevitably be more focus on the market as there are already ongoing attempts to curb excessive speculative activity," Lewis said. Liffe told Reuters it will launch a weekly report of trader positions later this year after consultation with its members.

A spokesman at Liffe said it would mirror those provided by the Commodities Futures Trading Commission (CFTC) in the United States, but said they were still working on the details. The New York ICE Exchange already provides a weekly position report. So far the exchange has not moved to impose limits on the number of contracts that any one investor can hold.

Liffe's letter to the cocoa protest group said that "Whilst there was some support from market participants for the introduction of position limits, there were also many views expressed against the introduction of such a policy." Lawyer Jonathan Herbst, a partner at Norton Rose in London, said the cocoa market dispute increased the likelihood European law will fall into line with the United States. The European Union's executive Commission is working on a bill governing over-the-counter derivatives.

"There is clearly a chance we will end up with position limits through the European Commission's OTC derivatives bill. There could be a copycat element where the European Parliament says in the U.S. they have mandatory position limits and we should do the same. "If it becomes European law it will trump whatever the (British) Financial Services Authority or exchanges might want."

FSA to Act?

The FSA, the UK regulator, declined to comment when asked if it was working with Liffe on future regulatory plans, but in a paper in late 2009 the FSA argued against the need for hard position limits in derivative markets. "We do not believe that limiting one class of market participant by imposing specific limits is a desirable or warranted response." However, in recent months the FSA has been attempting to portray itself as a tougher regulator of commodities than previously perceived, landing a series of high profile market abuse cases.

Speculation by UK newspapers that Armajaro, a British commodities and hedge fund firm, was the main recipient of the July cocoa stocks has stoked debate over transparency at Liffe.

The company was the subject of similar speculation in 2002 when newspapers reported it took a large delivery of cocoa beans and was investigated by the FSA. The FSA did not take any action against Armajaro at the time. Both the authority and Armajaro have so far declined to comment.

Trade sources said Armajaro's commodity focused hedge funds have around $500 million in assets under management and have earned investors around 17 percent between January and June.

European trade and industry sources told Reuters on Monday that Switzerland's Barry Callebaut , the world's largest chocolate maker, was the end user of about 100,000 tonnes of cocoa that will be delivered against the July contract.

Ends --

By David Sheppard, Reuters - for Commodities Now.