Commodities market participants discussed the resiliency of the derivatives industry during the COVID-19 pandemic, as well as lessons learned that will shape the future of commodity markets, during a wide-ranging discussion that took place as part of IDX-V on June 25.
Panelists agreed that commodity markets functioned normally despite high volume and the unprecedented challenge of working remotely amid the pandemic. "Simply to say there was volatility, that's to be expected during crises of any nature," said Guy Wolf, global head of market analytics at Marex Spectron. "The question is, does it reveal structural flaws?"
While generally expressing a view that the system remained resilient, however, participants did highlight a few areas of stress in commodity markets that they would like to see addressed and noted key lessons learned that could inform the industry’s response to the next crisis.
Paul Willis, a technical specialist in commodities at the U.K.'s Financial Conduct Authority, gave the regulatory perspective at IDX-V. He noted that one of the key lessons learned in the COVD-19 pandemic was not just about how an entity like the FCA can move quickly to offer relief, but also when a regulator should stand behind the status quo. Willis gave the example of asking firms to withhold normal data or reporting, and how the act could actually increase operational complexity and risk by forcing firms to change their workflow at an already challenging time.
"Some of the things we could have done, and indeed some of the things we were actually asked to do by the industry itself, we decided not to do because we looked at the risk picture on a holistic basis and felt it was actually better to try and keep things in a stable state," Willis said.
Guy Wolf of Marex Spectron also noted that while "most experienced commodity market participants are aware that prices can go negative," particularly in energy or power markets, some were still taken off guard by the negative pricing of oil futures earlier this year. While not a widespread challenge, he did note surprise that some electronic trading platforms weren't even capable of displaying negative pricing and exhibited a "lack of understanding" of how physically delivered commodity contracts behave. That "came with a real cost" for the industry as a whole, and makes it incumbent upon market participants to be better educated about products in the future to prevent similar challenges.
Looking beyond oil, it's also important for the industry to take a deeper look at all physically delivered contracts in light of logistical complications created by the pandemic and related economic shutdowns.
Steffen Riediger, director of European power derivatives at the European Energy Exchange, noted that alternative delivery mechanisms are a big topic of conversation in the wake of COVID-19 and will surely be a focus of the industry going forward. He noted that conversation will not just involve oil or gold, which saw prominent logistical challenges with storage and delivery during the crisis, but "even more so when it comes to the power spot business" as electricity is "critical infrastructure" for the real economy.
"Delivery mechanisms and stability of the delivery chain is an essential element of an energy exchange and the clearinghouse behind it," Riediger said.
As for the evolution of new products in the commodity arena, Paul Dawson, head of regulatory affairs at RWE Supply & Trading, noted that European economic recovery efforts have "wound the clock forward" on sustainability efforts. "What previously looked like a longer-term green deal has now turned into a big green recovery package in the short-term," he said.
This move will accelerate product development that had already been underway in commodities markets, however Dawson noted that uncertainty around whether a proposed U.K. emissions scheme will function as a standalone entity for pricing carbon or be fully integrated with European efforts continues to create uncertainty for related derivatives products.
Panelists also briefly discussed possible changes to position limits and the ancillary activities exemption under the pending MiFID II review. Panelists agreed that changes to the position limits are urgently required. On the ancillary activities exemption, Paul Willis of the FCA admitted that the existing "MiFID II regime is a blanket regime" and it makes "a lot more sense" to apply some kind of qualitative analysis that allows commercial users to participate in commodity markets effectively.
By way of example, he pointed to decades old efforts as part of the Financial Services Act of 1986 that allowed for the regulation of commodity market participants alongside exemptions "to ensure that those firms that trade in commodity markets for commercial purposes did not inadvertently get swept up into regulation" via a "much more nuanced regime."