Monday, September 7, 2015

Digging and Drilling in the Commodities Markets

Last week we updated you on the FX investigations.  This week, we learned just a little more about the supervisory interest in keeping tabs on the potential for commodities misconduct.

Early in 2014, German regulator BaFin expressed its concern that precious metals manipulation (like currency manipulation) may be worse than the LIBOR-rigging scandal.

The LIBOR rigging is essentially centered in the window around 2007 to 2009/2010 and the FX and commodities misconduct may both have lasted longer.  From a benchmark rigging angle, the regulators have generally focused on 2009 - 2012, but the class actions are much broader, now often going all the way back to 2004.  Insofar as the guilty pleas are concerned, much of that is for misconduct after 2009/2010.

On Friday, the WSJ ran a very interesting story covering the FCA's (UK regulator) concerns about the monitoring of abuse in the commodities markets.  The WSJ article points out that the FCA's review "comes after recent changes in the market, in which a number of large banks, such as Barclays PLC and Credit Suisse Group AG, left commodity markets."

The FCA was really looking into internal surveillance procedures, but it did find certain lapses in (1) firms' monitoring of internal communications and (2) in their limited interest in submitting Suspicious Transaction Reports (or STRs) when noticing suspicious movements. This extract from the FCA's report captures some of their concern.
Firms that did not fully recognise the risks of market abuse were more likely to employ inappropriate surveillance, in terms of the choice of automated or manual systems, calibration of systems and frequency of monitoring. Overall, there was little order level monitoring, making it difficult for firms to demonstrate effective monitoring for market manipulation, and we often found surveillance being done on an inadequate or poorly targeted sample basis.  
Most firms’ communications surveillance captured Instant Messenger and recorded lines, but did not monitor these on a systematic basis. We observed more effective monitoring at firms where sampling was targeted at higher risk periods (such as at contract expiry or around important announcements) and at higher risk individuals 
Many firms had inadequate STR procedures, with typically no written procedures and a lack of clarity on what constitutes an STR. The number of STR submissions within the commodities sector is low in comparison to other asset classes, which may indicate that potential suspicious transactions are not being appropriately reported. 
It will be interesting to see whether the FCA will succeed in getting the banks to self-police in the commodities space, especially given so many of the large banks are so heavily short, notably betting against silver and gold.  Courtesy of Ed Steer, here's a graphical depiction of the bank's overriding short interest in silver (via CFTC's data on futures contracts).

As you'll see, the banks really started to get short (particularly the US banks) in mid 2008, and have been heavily net short ever since. The dynamic is still true of non-US banks, but is far less pronounced.

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