Tuesday, October 07, 2014

Senators Ask CFTC to Scrutinize FBOT Approvals on Aluminum Futures

Senators Sherrod Brown (D-OH), Tammy Baldwin (D-WI), and Elizabeth Warren (D-MA) urged the CFTC to conduct a thorough review of the London Metal Exchange (LME), the largest exchange for aluminum futures, before approval of the LME’s application as a foreign board of trade (FBOT). The Senators pointed to concerns with ongoing irregularities in the trading of aluminum contracts and warehousing practices as need for further action. In a letter to CFTC Chair Tim Massad, they cautioned that if the CFTC is unable to work with the LME and the U.K. Financial Conduct Authority to come to a resolution that fully addresses the delivery issues facing end users, Congress may be forced to legislate in this area.

In that event, the CFTC should refrain from approving LME’s application for registration as an FBOT until Congress has had the opportunity to address distortions in aluminum futures trading and delivery by taking appropriate legislative action through the CFTC reauthorization process. Legislation is currently pending in Congress that would reauthorize the CFTC for five more years. It would also be useful for the CFTC to suggest any legislative changes to the Commodity Exchange Act that might improve the CFTC’s authority and oversight concerning the LME and other FBOTs.

The FBOT registration process, as allowed by the Dodd-Frank Act and defined by the CFTC regulations, provides an opportunity for meaningful market oversight that protects U.S. end-users and consumers. The Senators said that it is critical that the CFTC use this opportunity to examine the LME’s practices and to work with the Financial Conduct Authority and the LME to ensure that the LME meets the standards the CFTC set forth in its FBOT registration rule.

The Senators have deep concern with the ongoing irregularities in trading of aluminum contracts and the warehousing and physical delivery of aluminum to end users. They asked the CFTC to also immediately use its oversight tools to thoroughly examine aluminum markets used by U.S. participants and to allow sufficient time for Congress to make any necessary legislative fixes through the reauthorization of the Commodity Exchange Act before authorizing foreign boards of trade through the CFTC’s FBOT registration process.

More specifically, the legislators have serious concerns that aluminum contracts’ storage and delivery provisions, as overseen by the LME, are vulnerable to manipulation and have resulted in an inefficient physical delivery settlement process which raises costs for consumers and erodes confidence in the LME. They identified problematic LME rules, including insufficient warehouse load-out rules and practices for LME aluminum contracts that have resulted in end-users waiting in queues for as many as 683 days to take delivery of aluminum, despite high levels of production and large amounts of aluminum waiting in storage for delivery. In addition, there are inadequate rules requiring the institution of “Chinese walls” between warehouse companies and trading operations to prevent conflicts of interest between commercial investments and other financial activities.

Rules preventing warehouse owners from storing their own metals in their warehouses, but allowing the parent company of a warehouse owner to store metals in a warehouse owned by one of its subsidiaries, are also problematic, as are overly restrictive LME rules prohibiting only unreasonable incentive payments, which the Senators called a vague term that is open to abuse. Even while the LME itself has acknowledged that warehouse competition is conducted on the basis of high incentive payments, and such payments are significantly linked to the existence of aluminum queues, it has taken no steps to address this structure.