EU Wants More Commodity Trading Scrutiny After War Exposed Risks

(Bloomberg) — For decades, Europe’s commodity traders have avoided being regulated on par with other financial firms. A new proposal currently working its way through the European Union legislative system could change that.

As part of a package updating its landmark MiFID II regulations on financial markets, the European Parliament has proposed to review its “ancillary activities exemption,” according to position documents seen by Bloomberg. The proposal is part of early discussions and could still change.

The loophole allows industrial companies like utilities and food processors — but also commodity trading houses — to take derivative positions without the scrutiny facing investment firms. Designed to reduce the burden of managing price risk, it also means that traders aren’t subject to rules on setting aside capital or limiting positions the same way banks and hedge funds are. 

The risks of that approach have been put under the spotlight over the past year as Russia’s war in Ukraine triggered liquidity squeezes among commodity trading houses, raising concern about potential knock-on effects for wider financial markets and prompting governments to intervene to backstop the likes of Fortum Oyj, Axpo and Equinor ASA.

Trading companies have become strategic suppliers of energy to Europe while enjoying their most profitable period ever thanks to disruptions wrought by the global pandemic, war and a historic lack of investment in supply. Even at industrial companies, traders in hedging departments are claiming bonuses in the double-digit millions. 

At the same time, spiking prices meant a dramatic increase in funding requirements for the companies that move oil, metals and crops around the world, with central banks and the International Monetary Fund signaling that greater oversight might be necessary to prevent vulnerabilities from rippling through the banking system.

One potential outcome of the EU’s review is that additional criteria could be set for companies to qualify for a regulatory exemption. It may also conclude that existing measures — such as assessing the level of derivatives trading as a proportion of a company’s total business — are sufficient.

The review will be discussed in a “trilogue stage” between the Parliament and the Council, before concrete policy is tabled to become law. Whether passed or not, the proposal could fuel debate about commodity traders, producers and consumers building speculative derivatives positions that go well beyond the hedging activities they need to minimize risk on physical trades, and the potential impact on prices.