The Dodd Frank OTC FX derivatives exemption only looks like a “win” for traders.Upon closer examination, the exemption might be a defeat. And one of the reasons commodities got slammed this week.
Many on Wall Street seem to consider the exemption of FX swaps and forwards (derivatives) a major defeat because of what the Dodd Frank regulation didn’t exempt: all other OTC derivatives, namely energy derivatives, but also interest rate swaps.
Just because the media reported the exemption as a win doesn’t make it so.
Add that announcement to this past week’s SEC/CFTC pronouncements on commodity future position limits, and you can see why large players like gas companies, which uses derivatives to hedge the price of oil, might have begun to reduce their positions in anticipation of potential position limits.
A quant at a major European bank tells us that those 2 things, plus additional margining requirements and the recent announcement that the Attornery General, Eric Holder, was going to begin investigating “speculators” who were artificially driving up commodity prices [here’s one reason why THAT investigation really began and here’s another], all set-up for a major reversion in commodity prices.
So to sum up, these 4 things might be some of the reasons for the commodities dump last week:
- Commodities future position limits concern (The CFTC proposed position limits in January. It then delayed the ruling for up to a year. The market expects it will adopt the limits soon.)
- Obama’s/Holder’s recent announcement of an investigation of speculators in the oil market and Goldman’s call
- Margining requirements concern (Sure enough, a former regulator announced on Friday that he was interested in margin increases in commodities.)
- The exemption of FX derivatives –but not interest rate or energy derivatives– from OTC regulation. (Explained below.)
The straw that broke the camel’s back was in last Friday’s announcement of the FX derivatives exemption, in which the Treasury writes:
The Secretary’s authority to issue a determination is limited to foreign exchange swaps and forwards and does not extend to other foreign exchange derivatives. Foreign exchange options, currency swaps, and NDFs may not be exempted from the CEA’s definition of “swap” because they do not satisfy the statutory definitions of a foreign exchange swap or forward.
The announcement seems to make it clear that interest rate and energy derivatives will not be exempt. What that told large players like gas companies is that they will have to keep a lot more capital now, because those trades will have to take place on an exchange in the future.
In order to increase capital in preparation for margin increases, players sold what was up (commodities).
If you have anything else to add, please let us know.