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UN wants tougher regs for commodities

Monday 6 June 2011 - by Andrew Hickley

The United Nations has recommended that international supervisors introduce new regulations for commodities exchanges in order to reduce "financialisation" in these markets which harms the real economy.

Position limits should be applied to these exchanges while transparency measures must be improved, a report from the UN's Conference on Trade and Development finds.

It also highlights a financial transaction tax as a solution to "generally slow down" the activities of speculators in commodity markets.

The study warns that market participants are creating bubbles in the markets by following the positions taken by their rivals, a process described as "international herding".

"Acting against the majority, even if justified by fundamentals, may result in large losses, often of borrowed money. It may therefore be rational for market participants to ignore their own information and follow the trend," the UN agency says.

"This is what many financial players do by default, basing their trading decisions purely on the behaviour of price series (algorithmic trading), which can lead to a commodity price bubble."

It warns this seriously distorts the price mechanism process, blaming the practice for having facilitated a 20 per cent of the price of crude oil before prices dropped earlier this year.

Based on both empirical research and a series of interviews with market participants, the report makes four recommendations.

It suggests that governments and central banks could intervene in markets to deflate price bubbles, particularly in currency and bond markets. Authorities could step in as a market maker, given that they have enough clout to shock the market when it overshoots, it says.

The report also calls for banks that conduct proprietary trading to be banned from hedging transactions for their clients because of conflicts of interest.

In addition, it demands that transparency requirements in physical commodity markets are increased in order to both reduce uncertainties in the market and allow participants to better assess fundamental supply and demand relationships.

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