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Commodity market regulators are stepping up their efforts in surveillance and enforcement.
This trend will likely continue
to accelerate as new regulatory legislation moves forward. Regulators¶ budgets and
enforcement resources dedicated to
commodities are increasing as the political demand for market reform grows. Regardless of
the exact forms that regulatory
change take, the commodity trading community faces:
At A Glance
The Changing Landscape of
Commodity Market Regulation
‡ additional trade and position reporting requirements,
requests for data submissions, and certifications;
‡ more formal investigations, complaints, and
enforcement actions related to market manipulation
and trading abuses; and
‡ more ad-hoc regulatory reviews.
The transition of futures markets from the traditional
³floor´ open auction to electronic marketplaces has given
regulators unprecedented ability to focus on policing
for market manipulation. The traditional resource split
between monitoring floor rules, examining floor broker
activity, and dealing with trading issues is shifting in the
new, more transparent trading environment. The analytical
techniques used by the regulator¶s market oversight
divisions are becoming increasingly sophisticated and
data-driven. In electronic markets, the lag between a
trading event and when it is noticed and flagged by a
regulator is diminishing rapidly.
Commodity commercials, hedge funds, managed funds,
swap dealers, large investors, commodity pools, and other
firms engaged in commodities trading face numerous
challenges in this environment. Regulators will expect
firms to develop internal compliance and trade surveillance
programs that go beyond traditional expectations and
methods. They will expect that compliance and surveillance
programs be comprehensive, independent, and equipped
with the proper tools to detect and report suspicious
trading activity and potential market manipulation issues.
These expectations are a challenge, but also an opportunity
to add value to a firm¶s shareholders and its trading division
employees. Now, more so than ever, the long-term viability
of a commodities trading business will depend on their
compliance functions performing well.
Compliance and surveillance functions at commodity
trading firms should focus on four key areas to meet
the challenges and opportunities presented by this new
regulatory environment.
Read the Signals
Regulators are increasing the amount of detail they provide
to the public about investigations, complaints, and trading
issues regarding market manipulation. In several instances,
they have provided ³blow-by-blow´ descriptions of the
relevant peripheral circumstances, and the capability to use
modern quantitative techniques in assessing the data are
necessary to assessing a potential issue.
Open and Maintain Communications Channels
with Regulators
Maintaining a good relationship with regulators will likely
pay dividends in future regulatory inquiries and actions.
Building goodwill with the regulator requires building
trust in a company¶s compliance and surveillance program.
This goodwill can result in more flexibility, time, and
independence in a regulatory investigation. It may also lead
to better settlements (and lesser sanctions) in proceedings,
and a greater likelihood that official actions can be avoided
based on preliminary internal investigative work. To build
this goodwill, companies must demonstrate that they are
proactive in implementing adequate surveillance tools and
systems, that they have the capability for self-investigation,
and that they have the protocols for self-reporting.
NERA¶s Capabilities
NERA has extensive experience in helping commodity
businesses and trading firms fully develop competencies in
these areas. With a team of commodity market economists,
former regulators, and market practitioners, NERA is
uniquely qualified to advise commodity trading firms on
all aspects of trade compliance and surveillance. There
are many ways we can help, with service offerings that
generally fall within three broad aspects of commodity
market manipulation issues:
1. Manipulation Prevention and Detection
Procedures, Metrics, and Analytical Support
‡ Surveillance screening, metrics, and tools
‡ Trading policies and procedures
‡ Compliance/surveillance best practices
‡ Regulator relations
2. Investigations and Regulatory Response
Assistance
‡ Data request support
‡ Trade activity analysis
‡ Market-based analysis
‡ Pre-litigation advice
alleged manipulative scheme, details of the execution of the
alleged scheme, and the alleged market price outcome.
Although manipulation cases might be isolated incidents,
similar manipulation themes tend to be repeated.
Ignoring these signals, and being ill equipped to
internally monitor for the ³known´ manipulations in the
marketplace, leaves compliance teams in a precarious
situation. Regulators¶ public signaling indicates that they
expect the trading community to look into these issues
quickly and for themselves.
Develop the Right Metrics
Internal compliance and surveillance teams can, and should,
arm themselves with tools and metrics that are at least
as rigorous as those used by their regulators. Finding the
appropriate mix of risk-based, price-based, and activitybased
screeners is essential. While it is not reasonable to
focus on every market and every trader on every day, a
risk-based approach to data screening can increase the
likelihood that compliance and surveillance teams are
alerted to potential issues.
The screeners can include:
‡ Simple Price-Based Screeners
‡ Economic Model-Based Screeners
‡ Stochastic Barrier Screeners
‡ Trade Activity-Based Screeners
‡ P&L-Based Screeners
‡ Risk and Position-Based Screeners
In large, complex trading operations, implementing an
effective set of screeners may seem logistically impossible.
However, NERA has worked with firms to design screeners
that can be applied to large-scale data sets to produce
relevant output metrics across markets, product types, and
contract specifications.
Maintain Drill-Down Capabilities and Resources
Screeners, no matter how well designed, will lack the
specific context, knowledge, and circumstances required
to adequately assess potential market manipulation issues.
Screeners are a tool, not the solution, in the effort to detect
potential market manipulation. Ultimately, the ability to use
available data quickly and rigorously, the skill to examine for
3. Enforcement Action Advice/Litigation Advice,
and Testimony
‡ Education of litigation stakeholders
‡ Examination of trading behaviors
‡ Quantitative analysis of market pricing
‡ Expert reports and testimony
About NERA
NERA Economic Consulting (www.nera.com) is a global
firm of experts dedicated to applying economic, finance,
and quantitative principles to complex business and
legal challenges. For half a century, NERA¶s economists
have been creating strategies, studies, reports, expert
testimony, and policy recommendations for government
authorities and the world¶s leading law firms and
corporations. We bring academic rigor, objectivity, and
real world industry experience to bear on issues arising
from competition, regulation, public policy, strategy,
finance, and litigation.
NERA¶s clients value our ability to apply and communicate
state-of-the-art approaches clearly and convincingly,
our commitment to deliver unbiased findings, and our
reputation for quality and independence. Our clients rely
on the integrity and skills of our unparalleled team of
economists and other experts backed by the resources
and reliability of one of the world¶s largest economic
consultancies. With its main office in New York City, NERA
serves clients from more than 25 offices across North
America, Europe, and Asia Pacific.
Contacts
Dr. Robert Mackay
+1 202 466 9291
[email protected]
Dr. Sharon Brown-Hruska
+1 202 466 9222
[email protected]
Matthew Evans
+1 212 345 2945
[email protected]