Jeffrey H. Harris Collins Chair in Finance Southern Methodist U and U of Delaware In the Aftermath of the Crisis: Evolution in Financial Regulation and Policy October 10, 2010 National Association of Business Economists

Regulatory Challenges Financial Crisis—precipitated by mortgages Commodities Public (mis)Perceptions Worldwide Markets—Cooperation ◦ IOSCO, OECD, IEA, etc. Financial/Product Market Overlap ◦ SEC, EIA, FERC, Fed, etc. ◦ On Exchanges and OTC Perspective—futures markets robust 2

Dodd-Frank Title VII—OTC Derivatives ◦ Increase transparency, efficiency ◦ Mitigate counterparty risk ◦ Mitigate systemic risk Requirements ◦ Execution on swap execution facilities (SEFs) ◦ Central clearing ◦ Public reporting ◦ CFTC/SEC/Fed-defined universe

Dodd-Frank (cont.) Position limits ◦ Prevent excessive speculation ◦ Prevent manipulation ◦ Ensure market liquidity ◦ Ensure price discovery Swap dealers ◦ Capital requirements ◦ Margin requirements ◦ CFTC/SEC/Fed-defined universe

Sources of Commodity Price Changes Uncertainty/Risk Management? Animal Spirits/Excessive Speculation? Traders? ◦ OTC swaps ◦ Speculators—”Massive Passives”  Commodity Index Traders  ETFs 5

What We Know: Data Available Large Trader Data—at CFTC.gov weekly ◦ End of day positions Commercial ◦ Producer/Merchant ◦ Swap Dealers (Index Funds) Non-commercial ◦ Managed Money (Hedge Funds) ◦ Others

What We Know: Market Growth Increased participation ◦ Hedge funds ◦ Swap Dealers  Commodity Index Funds  OTC swaps ◦ Exchange Traded Funds (ETFs—metals, energy) Relatively stable mix over time 7

Economic Studies “Fundamentals, Trader Activity and Derivative Pricing” ◦ Buyuksahin, Haigh, Harris, Overdahl, and Robe Focus on Swap Dealer participation ◦ From commodity index trading in nearby futures ◦ From OTC positions in back-dated futures Cointegration of Crude Oil futures prices ◦ Result in “better” pricing for hedgers in 1-year and 2-year contracts Supports the notion that markets should encourage broad participation

“Massive Passives” Hedge Funds Commodity Index Funds* ◦ Little relation between price changes and position changes --Aulerich et al. (2010) ◦ Weak Inverse relation between price changes and position changes  In-flows (+)  Rebalancing (-) ◦ During the “roll period”  Push nearby prices down, next nearby up ◦ Rebalancing, provide liquidity OTC swaps ETFs

NYMEX WTI Crude Oil Commodity Index Values Quarterly Equivalent Contracts vs. Daily Price WTI Crude Oil Price (Nearby NYMEX Future in $/bbl)

11 UNG (United States Natural Gas Fund) Tracking Error UNG Performance Apr 18, 2007 to Sep 16, 2010: -87% ($50.77 to $6.75) NatGas Prompt Contract Performance: -46% ($7.497 to $4.062)

Dodd-Frank Challenges Rule writing/enforcement burden Square peg/round hole with OTC markets? Position limits—expand Federal role, enter politics? CFTC/SEC/Fed coordination ◦ Consumer Protection

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