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Regulation guides growth opportunities in commodity markets

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The over-the-counter commodity derivatives market has been shrinking since June 2008, falling by 78 per cent in terms of notional outstandings, a report by Celent says.

Exchange-traded derivatives declined in 2007, but have grown 123 per cent since then.

The importance of commodities as an alternative asset class has been highlighted by increased investment in exchange-traded derivatives over the last two years. Regulation has played an important role in the market’s direction.

"Tighter regulation of the commodity derivatives markets has led to higher investment in physical commodities, turning the spotlight on the latter market," says Anshuman Jaswal, Celent senior analyst and author of the report. "Not only are the banks moving into this field, but commodities trading companies are moving in the opposite direction and increasingly setting up asset management and derivatives trading units."

There has been a rise in central counterparty clearing for OTC derivatives. There is a move away from bilateral clearing driven by market conditions and strong regulatory pressures. The share of centrally cleared transactions in overall OTC energy commissions in the IntercontinentalExchange was almost 95 per cent in 2009, up from 79 per cent in 2007.

OTC central counterparty clearing facilities have increased, and their product coverage in the commodities sector has also risen. The expected rise in share of clearing of OTC derivatives has led to a spate of introductions of such facilities by leading exchanges across all asset classes. Various leading exchanges such as CME, ICE, and NYSE Liffe have clearing for OTC commodities derivatives.

Exchange-traded derivatives are growing rapidly.  An important factor in this growth has been the rise in volumes in Asia, while those in North America and Europe have stagnated. During 2007-2009, exchange-traded derivatives have risen from USD6.7trn to USD14.8trn, a rise of 123 per cent, while OTC derivatives have declined from USD8.5trn to USD2.9trn, falling 65 per cent. The financial crisis and the ensuing regulatory pressures to move derivatives trading to exchanges wherever possible seem to be having an effect, says Celent.

Asia has consolidated its market share in exchange-traded derivatives business. Asia now accounts for almost two-thirds of the derivatives volume in the global market. The tremendous growth shown by Chinese and Indian commodity exchanges is a major factor in this development.

Physical commodities market is becoming an attractive avenue for investment. Investment banks such as JP Morgan, Goldman Sachs, Morgan Stanley, and UBS are part of a strong trend for commodity derivatives dealers to move into acquisition of physical assets. The physical assets of JP Morgan have gone up almost three times from USD3.6bn in 2008 to USD10bn in 2009; for Goldman Sachs, the rise is sevenfold, up to USD3.7bn in December 2009 from USD0.5bn in November 2008. Morgan Stanley has seen its physical assets more than double from USD2.1bn in 2008 to USD5.3bn in 2009. Finally, the physical commodities assets of UBS rose from USD9bn in 2008 to USD16.2bn in 2009.

Greater regulatory control, post-crisis, has spurred interest in physical commodities. The strengthening of regulation by CFTC and other leading global regulators with regard to position limits in the derivatives markets has led the banks and asset managers to explore other avenues for increasing their profitability. Low interest rates maintained by leading central banks have also been a factor.

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