London, 13 December 2010

London's loss of influence was starkly displayed last week in three proposed new regulations affecting commodity trading published by the European Commission. On Dec 8, the European Commission sent out a consultation document on regulation of wholesale gas and electricity markets, as well as a review of the Markets in Financial Instruments Directive ( MiFID), and a recommendation for a tougher and more harmonised approach to punishing rule breakers in financial services.

All three documents presage a big expansion in EU involvement in commodity markets, which is likely to see Britain's Financial Services Authority (FSA) and its successor authorities demoted to a branch office of the European Securities and Markets Authority (ESMA) and the new Agency for the Cooperation of Energy Regulators ( ACER).

Strong lobbying by the FSA and commodity exchanges to preserve principles-based light-touch regulation of wholesale and derivatives markets seems to have had little impact; the FSA's forthcoming demise and suspicions about its no-change-needed message have undermined its credibility and influence with Commission staff and other member states.

Instead the Commission's proposals show increasing convergence with and influence by regulators from the United States.

COMITY ON COMMODITIES

On everything from position limits, to regulation of over-the- counter (OTC) derivatives, comprehensive regulation of physical and financial markets, and market abuse, the proposals show the growing impact of a trans-Atlantic approach intended to create a level playing field and minimise opportunities for regulatory arbitrage.

Commodity markets have become increasingly global over the last 20 years. Now regulation is going global as well. Behind the scenes, regulators are increasingly sharing experience, information and expertise to craft a harmonised approach.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (PL 111-203), much of it drafted by the U.S. Treasury and Commodity Futures Trading Commission (CFTC), borrowed concepts and language from existing European law. Now the Commission proposals show extensive borrowing and influence in the other direction.

According to officials, the CFTC has led a technical seminar for other regulators trying to set up their own commitment of traders (COT) reporting systems. Several exchanges and countries outside the United States are likely to begin publishing their own COT reports in 2011.

While there has been an identifiable international commodity trading community for some time operating comfortably across borders, until recently regulation remained national in outlook, and showed substantial differences in approach, as well as limited awareness of the cross-border implications.

But just as a community of competition regulators emerged in the 1990s and the 2000s sharing increasingly similar perspectives and willing to work more closely with one another -- in response to the transnational nature of large corporations and M&A activity, and earlier crises provoked by clashing laws -- something similar is now occurring in commodity regulation.

"Comity" is the basic operating principle in competition regulation and set to extend to commodity market regulation. It is the idea that countries and regulators should extend certain courtesies to one another and not act in a way which undermines the common purpose in achieving efficient, transparent and orderly markets.

Regulators share common objectives and recognise the need to avoid undermining one another's actions in an attempt to seize temporary market share.

LONDON ALL ALONE

Unfortunately, London's regulators, exchanges and lobbying firms appear increasingly marginalised within this new regulatory community. Speaking to the UK Parliament's Treasury Committee on Dec 2, London Metal Exchange Chief Executive Martin Abbott expressed "concern about the level of UK representation on ESMA, were ESMA in fact become the dominant regulatory body" for commodities.

"The problem that we have, therefore, with the concept of another layer or a different type of regulation coming from Europe is that it will necessarily come from countries that have no expertise in regulating our type of market".

"We are hopeful that the European regulators will recognise where the areas of excellence are in the European regulatory financial framework, and the area of excellence in commodity regulation is here in London," Abbott said.

But the chief executive's words belied his hopes. Recent proposals show the Commission has listened to Britain's regulators and exchanges -- and decided to ignore them. London is losing the argument.

The FSA continues to insist at every opportunity its role is not to act as a price regulator nor to combat price movements. Existing arrangements for managing large positions and ensuring markets trade in a fair and orderly manner free from abuse are working well and cannot be improved upon. Its position was set out in a position paper published in December 2009 and has not changed ("Reforming OTC Derivative Markets: A UK Perspective" especially chapter 9).

In contrast, the European Commission retains an open mind about whether speculation has resulted in excessive price rises and volatility, led to technical problems and dislocations, and whether there has been market abuse (MiFID review, page 37). It sees scope for existing safeguards to be strengthened "to ensure that consumers have confidence in the integrity ... of markets ... and that prices ... reflect a fair interplay between supply and demand" (proposed regulation on gas and electricity, page 7).

The FSA's iron insistence there is nothing wrong and therefore no cause to change has failed to convince other European regulators, and left it with little to contribute to the debate.

The FSA finds itself in the peculiar position of having strong support from the major commodity dealing banks, but being almost isolated among its fellow regulators. In theory, that was supposed to give London a huge advantage, an opportunity to win business from New York. In practice, it looks like the FSA has been outflanked by regulators from Washington and Brussels, and will be forced into line by the new ESMA and ACER.

During the first half of 2011, new commodity market regulations will be finalised by both the CFTC and the European Commission. While there is still a window of opportunity for exchanges and firms to make representations and lobby, it is rapidly closing.

Britain's authorities and exchanges face a strategic choice. Press ahead with existing arguments there is nothing to fix, and hope to win converts, but risk being even more marginalised as the final proposals are drawn up. Or accept the need for at least some change in the hope of securing some influence to shape it.

Ends --

John Kemp is a Reuters market analyst - for Commodities Now.

The views expressed are his own.