European Parliament decides to tackle commodity speculation: a little bit
By Markus Henn, WEED
As reported in Newsletter No 12, the European Parliament (EP) and the EU Council of Ministers of Finance (ECOFIN) are currently each in the process of co-decision on the review of the ‘Markets in Financial Instruments Directive’ (MiFID). Over the summer months, many drafts and compromise papers were circulated and amended by informal working groups preparing the vote in parallel, both for the Parliament’s responsible committee for economic and monetary affairs (ECON), and for the ECOFIN.
After the vote in July 2012 was postponed, the EP’s ECON committee came to a common position in its vote on 26 September 2012. The EP’s Rapporteur, MEP Markus Ferber (EPP group, Germany), was keen to have a broad majority vote as there obviously was no clear majority of his party together with the other conservative group (ECR) and the liberal group (ALDE). Indeed, a broad majority vote provides the EP Rapporteur with a strong mandate and position when negotiating a compromise text with ECOFIN. An EP plenary non-final vote on MiFID II/MiFIR has been planned for 25 October 2012 (for an update of the exact voting date, consult the EP website). Such a vote should provide the EP with an even stronger position when negotiating a compromise with the Council during the so- called ‘trilogue’ process.
Civil society has targeted the MiFID process in various ways. For instance, before the ECON vote, website campaigns called on citizens to sign on to letters to the European Parliamentarians. At a public action that took place on the morning of the ECON vote on 26 September, almost 100,000 signatures were handed over to those responsible in the different political groups, including Rapporteur Ferber. All actions called for meaningful measures (position limits) to restrict speculative trading in food commodity derivatives.
Limited regulation of food speculation on commodity exchanges
Before the 2012 summer break, EP Rapporteur Ferber had apparently given up some strong amendments to limit commodity price speculation as explained in Newsletter No 12. Particularly, he seemed to have changed his opinion that position limits should be obligatory and set by law. He was publicly criticised for this change by several NGO petitions in June and July 2012. In direct exchange with NGOs, Mr Ferber stated never having abandoned his initial strong proposals to limit commodity derivatives trading by speculators, even though internal documents supported the NGO accusations.
The final ECON vote decided that position limits should be obligatory on all commodity derivatives exchanges, or other trading venues, for financial traders while others, who are hedging the risks of their physical commodity trade, receive exemptions. Other measures to control trade in commodity derivatives can be taken in addition, according to the ECON decision. Traders that are hedging a risk related to their physical commodity business, will be subject to particular position control measures. The ECON voted text now includes important details proposed by NGOs and other political groups such as setting the limits to prevent “market distorting positions” and covering cash and delivery settled contracts. A worse outcome luckily has been prevented at the last minute. Before the vote, the draft text would only have allowed to limit trading “towards the end of a contract's expiry”, a proposal made by the UK MEP Kay Swinburne (ECR), a former investment banker. This would have undermined the effective prevention of financial speculation that (also) takes place in the months before the expiry month. However, the Social Democrats (S&D group) tabled a last minute amendment to take this wording out and replace it with “over a certain period of time”. Another last minute change now demands to discriminate towards classes of traders rather than setting position limits only per single trader.
Notwithstanding the obligation to have position limits, the ECON text still implies loopholes and dangers during the design of the implementation detailed regulations. For example, the position limits do not clearly cover all trading months which would be necessary to address the trading techniques of financial speculators. Civil society organisations criticised the ECON vote for allowing different loopholes, including that position limits would only apply on net positions rather than on the amount of contracts or the open interest.
While position limits are an important tool, important other proposals to ensure that commodity derivatives markets are not flooded with investors’ money were not voted on. For instance the ECON decision did not adopt a proposal by the Social Democrats and the Left (GUE) to prohibit certain financial products related to commodity prices, such as commodity index funds. The ECON compromise text only stipulates that “Particular attention shall be given to financial instruments offering commodity index replications.”
Organized Trading Facility (OTF)
The introduction of a so-called ‘organized trading facility’ (OTF) remained controversial in the EP. The Social Democratic shadow Rapporteur, Robert Goebbels from Luxemburg, tried very hard to prevent these new trading venues that would be less transparent and regulated than exchanges but more so than current private trading platforms. While his position might be driven by lobby interests of the exchanges (‘regulated markets’) and banks (who now provide non-regulated trading platforms), it also seems to be favourable for the public as it prevents further market fragmentation and deregulation. However, in the end, a compromise solution by Rapporteur Ferber was voted on, which only excludes equities from being traded on OTFs. Also, OTFs shall only have discretion (i.e. a free decision) over “how a transaction is to be executed and how clients interact”. Nonetheless, this compromise solution would mean that commodity derivatives could be traded at these new kind of trading venues that will only be lightly regulated compared to regulated markets. This might undermine effective control and prevent more over-the-counter (OTC) derivatives to be traded on exchanges. Even though, for example, position limits shall apply to OTFs too, it will be more difficult for authorities to have oversight if different forms of trading places are active in a particular market.
Regulating the speed of high frequency trading (HFT)
HFT was a very strongly debated issue in the EP. Finally the ECON vote pushed for a pretty ambitious set of measures, here are a few of them:
- A minimum holding period in a trading venue’s system of 500 milliseconds. This should ensure that the markets do not further speed up whereby the trader with the fastest computer and software formulas to offer and cancel trades, makes the most profit.
- Higher fees for cancelled positions: large parts of offers for trading are not executed but cancelled. This is extensively used by high frequency traders and massively drives up the volume of the trading while making interested parties unsecure of how they can trade without manipulation.
While these and other additional measures are promising limitations on HFT, it is not clear if they could really change the so-called “arms race” that high frequency traders are involved in or stop the increasing number of financial parties (on the stock exchange, HFT constitutes around 60% of trading in the US and around 40% in the EU) making profits from speculative HFT transactions that are far remote from economic considerations.
What will the Council of Finance Ministers do?
As of 1 July 2012, the EU presidency shifted from Denmark to Cyprus who is supported by other member states to compensate for its lack of human resources to conduct the MiFID negotiations. The Finance Ministers are planning to vote on the ECOFIN position on MiFID II and MiFIR at their meeting of 13 November 2012.
Under the Cypriot presidency, new text proposals and new compromises for the many working group sessions have been made to prepare the vote on the MiFID review by the Ministers of Finance. By mid September 2012, the EU member states had been asked to provide comments on new additional criteria that would need to be taken into account when setting the mandatory position limits on commodity derivatives trading.
The draft Council texts suggest a very broad and thus worrisome loophole, namely the exclusion from the full scope of the Directive of “market makers in relation to commodity derivatives, emission allowances, or derivatives thereof” which goes back to the interest (and lobbying) of the energy sector.
Regarding HFT, the Council so far did not propose measures comparable to the ones voted on by the EP’s ECON Committee. The only sign of possible action by a national government on this issue is a national draft law by Germany, which included at least some measures going into the direction of the EP.
The debate about the review of MiFID will continue until the whole co-decision process has been finalised. For instance, Finance Watch will hold a conference on 10 October 2012 on MiFID in Brussels. The question is whether the EU decision-making will be influenced by the District Court of the District of Columbia which ruled on 28 September 2012 in favor of the International Swaps and Derivatives Association, a forceful financial lobby, against the CFTC’s new rule to limit speculative OTC commodity derivatives (swaps). The new CFTC rule was to have gone into effect on 12 October 2012.