Wednesday, November 23, 2022

Behnam hails smoothly functioning derivatives markets amid global turmoil

By John Filar Atwood

In a challenging year that has seen Russia’s invasion of Ukraine, significant supply chain disruptions, and global monetary and fiscal policy shifts, the U.S. derivatives markets have functioned as designed, according to CFTC Chair Rostin Behnam. In remarks at the U.S. Treasury market conference, he stated that the entire market system, including clearinghouses and clearing members, functioned well this year and derivative markets did not transmit significant stress to the broader financial system.

Behnam based his comments on recent data on the Treasury futures and commodity markets, which the agency staff has been studying carefully. He noted that highly elevated volatility does usually result in increases in observed bid-ask spreads and resting depth, which can increase transaction costs. Still, participants were able to trade in significant volumes this year and adjust their risk positions effectively, providing reliable price discovery for the global commodity trade, he stated.

Backdrop. He acknowledged that commodity and financial markets have been extremely volatile this year, with pressures coming from onset of, and extended recovery from, the pandemic and the war in Ukraine. He cautioned that with the war still going markets may shift suddenly in extreme ways. The war has led to substantial uncertainty in the global markets for energy, agriculture, and metals, he said, often leading to unanticipated movements in commodity prices because of changing market sentiment.

Adding to the stress is shifting monetary policy including the tightening by the U.S. Federal Reserve and other principal economies around the world aimed at slowing inflation, Behnam said. Price movements in commodities markets are further affected by exchange rates, with the U.S. dollar recently rising to a 20-year high against many other major currencies, putting additional upward pressure on price increases, he noted. On top of that, supply-side decisions such as OPEC’s move to decrease production by two million barrels per day have contributed to commodities price pressure and uncertainty, he added.

CFTC actions. Behnam said that amid all of the volatility, the CFTC is working to ensure that commodity markets continue to fairly and transparently serve their intended price discovery and risk management functions. The staff is carefully examining specific aspects of the markets, such as whether managed money traders have an undue impact on the direction of prices. He noted that preliminary analysis across a range of asset classes shows that managed money trading often lags price changes, and these traders are more likely to provide liquidity to other traders than take liquidity.

Position limits rule. Behnam noted that properly functioning derivatives markets need liquidity providers to better absorb price spikes. As seen with the implementation of the position limits final rule in March 2021, he said, when there is sufficient liquidity in the markets they continue to perform their price discovery functions by being an accurate reflection of supply and demand. During times of significant volatility like we are in now, he added, participants in the agribusiness and energy sectors look to U.S. markets for the risk management and price discovery.

He pointed out that the position limits rule has provided the CFTC with additional tools to ensure the proper functioning of the commodity markets by expanding federal position limits to include 16 additional agricultural, energy, and metals futures contracts of particular importance to the U.S. economy. A secondary effect is that it has strengthened the relationships between the Commission and exchanges regarding position oversight and accountability, he said.

According to Behnam, the position limits rule also supports risk management by, among other things, expanding the bona fide hedge exemptions for commercial end users but not for financial firms. The rule clarifies that commercial end users may now qualify for hedge exemptions for unfixed price transactions, he stated, which are common in the agricultural and energy industries. End users emphasized to the CFTC that these are important for effective risk management, he said.

He noted that Congress enacted the position limits regime to ensure the derivatives markets function as intended and meet both price discovery and risk management purposes. He said that the CFTC will remain vigilant in ensuring that this regime and other CFTC rules are achieving the goals that Congress mandated.