This week IOSCO, the global association of national securities regulators, announced (click here) the publication of their targeted report reviewing the implementation of their Principles for the Regulation and Supervision of Commodity Derivatives Markets following a recent survey.
The 19-page final report can be found here. For context, IOSCO publish and maintain a set of principles whose objective it is to ensure that commodity derivatives markets serve their fundamental functions of facilitating price discovery and hedging, while remaining free from manipulation and abusive practices. IOSCO periodically refresh these principles, the last occasion being in January 2023. The prevailing principles may be found here.
The report published this week was “targeted” as it covered only five of the Principles – specifically Principles 9, 12, 14, 15, and 16. These were selected as they are seen key to addressing excessive commodity market volatility, over-the-counter (OTC) derivatives transparency and the orderly functioning of commodity derivatives markets. IOSCO believes that the proper implementation of the selected Principles will help to mitigate the impact of external factors which may disrupt commodity markets, as has recently been experienced.
The Chair of the IOSCO Committee on Derivatives commented:
The need to enhance the resilience of the commodities market remains a priority for regulators globally. The recommendations included in this report can help IOSCO members to implement the Principles and enhance the resilience of their markets.
The report concludes that the majority of respondents to IOSCO’s survey were broadly compliant with the selected Principles. However, both regulators and exchanges identified significant challenges in implementing certain elements of the Principles within OTC markets. The key findings and recommendations of the report are summarised below:
Principle 9: OTC Transparency:
- Most regulators have access to the reporting of OTC commodity derivatives to trade repositories;
- The information reported to trade repositories however is not available for exchanges to monitor their markets.
Principle 12: Authority to Obtain Information:
- While some exchanges reported effective systems for identifying risks in exchange-traded derivatives, several others do not have the authority to obtain OTC position data;
- Where the exchanges have access to some data, through member submission (using their rulebook, the local regulatory framework or both), it comes with limitations, which inhibits their ability to identify and act on risks that may spill over from related markets to their own;
- Where the exchanges have access, the OTC position data is different from the separate data set reported to the trade repositories, and is typically obtained on an ad hoc basis or post-event when concerns arise or where specific triggers are breached;
- The above is further complicated by other challenges, such as data anonymity, cross-border issues, and variations in the types of financial instruments that are captured by the relevant local regulatory frameworks (particularly for physically settled commodity forwards).
Principle 14: Large Positions:
- Most exchanges are able to identify large positions and have processes for identifying positions under common ownership;
- Several exchanges have the ability to aggregate customer positions on other exchanges within the same group of entities;
- The majority expressed however that the identification and aggregation of positions across different exchanges extends only to exchange-traded positions, and not to OTC positions;
- Most responding regulators have access to large position reports, at least on an ad hoc basis, however only a few regulators receive the large position reports directly.
Principle 15: Intervention Powers in the Market and Principle 16: Unexpected Disruptions in the Market:
- A majority of regulators indicated that they possess varying degrees of authority to intervene in market operations in exceptional circumstances, though it was not clear whether these powers include OTC markets;
- Most exchanges considered that they have effective arrangements to intervene in commodity derivatives markets to prevent or address disorderly markets and ensure their markets' efficiency;
- Some exchanges raised issues in relation to intervening in OTC markets.
We summarise IOSCO’s key recommendations below. For those wishing to understand these recommendations in further detail, please consult the report directly starting on page 16 (as numbered):
- Principle 9: OTC Transparency - IOSCO members should promote international consistency and cooperation in regulating commodity derivatives markets.
- Principle 12: Authority to Obtain Information and Principle 14: Large Positions - IOSCO members should ensure that both exchanges and regulators can respectively access and consolidate relevant on-exchange and OTC data in order to identify large positions.
- Principle 15: Intervention Powers in the Market and Principle 16: Unexpected Disruptions in the Market - IOSCO members should balance risk management and price discovery when applying market control measures. IOSCO members should also enhance the mechanisms in place for open communication (both between exchanges and regulators, and among regulators) during times of crises.
RegTrail Insights
In addition to implementing the above recommendations, IOSCO plans to undertake further work based on the results of this review dealing with the ability of exchanges and certain regulators to collect and aggregate information about OTC positions. While IOSCO’s recommendations are high level, their main audience for such reports are national regulators. Their recommendations have a clear and discernible impact on the direction of travel of many of these regulators. As such, keeping abreast of such reporting and recommendations can provide compliance with a valuable “heads-up” on potential future focus areas of financial regulators.