February 21

CFTC and Dodd Frank Regulations Making it Hard for Traders to Profit

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CFTC and Dodd Frank regulations making it hard for traders to profit from markets – increasing regulation affecting cleared derivative and OTC FX markets

The Commodity Futures Trading Commission (CFTC) is pulling rules our of the closet that seek to protect market participants. Time and time again since its enactment back in 1936, the CFTC has come up with rules and regulations that are aimed to curb uncertainty in the commodities markets that arise as a result of speculative buying and selling of commodity based swaps. The latest sets of rules are aimed at controlling various activities in the market as explained below. This is hitting the OTC FX markets the hardest. While many exchange and liquidity pools had forced energy traders to comply with a $10 million requirement to start trading OTC contracts in Power, Nat Gas and Petroleum products in the past, it has not been until recently that the OTC FX market has been forced into such requirements. As a matter of fact, many prime brokers and FCMs officially kicked out OTC FX traders that had active and good-standing  accounts on October 1, 2012. This ousting of many successful FX traders has left a liquidity void in many FX dark pools and ECNs. Many of the traders had been individuals with no affiliation or smaller prop-shops and hedge funds that refused to comply with ECN requirements or simply did not meet the capital requirements.

CFTC chairman Gary Gensler has recently pointed out that the rules are meant to make sure that the markets do not become very concentrated with speculators; the rules detailing the position limits are said to be protective in the sense that they prevent the market from over speculation that could result in unreasonable fluctuation of market prices. For this reason, the CFTC seeks to have well regulated markets by setting limits to positions so as to have the prices based on only fundamentals.

However, the main problem with the new regulations is its actual impact on the market. To begin with, commodities trading is a global business and hence, competition is coming from all corners of the world and not just the U.S. There are now extreme regulatory measures on the U.S based commodities traders. Position limits prevent the traders from hedging activities which is a disadvantage to them and a long-term disadvantage to the market and the economy as well. This is because, the inability to take various positions on the commodities markets whether oil, or FX means that your ability to hedge your losses as well as profit from certain positions is controlled by an external force. The eventual result is that the investors may end up losing a lot of money or missing out on very good opportunities to profit.

The long term impact of the CFTC rules on the market is that several investors may opt out to go to less regulated markets in other countries hence depriving of the economy some potential outputs. In addition to this, a mass exodus of the investors to other markets will result into a very illiquid U.S commodities market and therefore taking the country back to the past. An illiquid market means a market that is becoming more and more opaque which contradicts CFTC goal of a transparent market place. This simply means that it will be even more difficult to determine the probable prices of a certain commodity future.

With a very illiquid commodities markets, the impact is well felt in the foreign exchange markets. This is because, FX is in itself a form of a commodity; different currencies movements are determined based on both fundamental and technical analysis. The unpredictability of the commodities markets coupled with a mass exodus of investors means that the base currency remains unstable therefore impacting on the foreign exchange trading. If the CFTC’s goal is to provide a stable market where all parties are free to participate they should look carefully at the end result mega-regulation which is pointing towards the largest entities trading in markets that price out traders with both capital requirements, red tape and leading edge infrastructure costs in order to fairly compete with price discovery, liquidity and quality of execution.


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