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EU cracks down on commodity speculation in new deal

Wednesday, 15 Jan 2014 | 6:11 AM ET

A deal to regulate high-frequency trading and curb commodity speculation has been clinched by the European Union (EU), as policymakers attempt to clamp down on financial market loopholes.

After two years of work on the rules, negotiators from the European Parliament and Council came to an agreement late Tuesday.

The measures will set limits on positions held in commodity derivatives, curbing speculation in the area to limit their impact on food and energy prices.

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Rules on high-frequency trading in financial instruments will also be imposed, requiring firms to have controls like "circuit breakers" in place – which stop the trading process if price volatility gets too high. Algorithms used will have to be tested and authorized by regulators.

(Read more: EU not a 'soft option' as politicians vote to combat marketabuse)

The measures – outlined in the Markets in Financial Instruments Directive, or MiFID – are part of the EU's attempts to avoid another financial crash.

Ed Parker, head of derivatives at law firm Mayer Brown, said the rules would "dramatically reshape" the way firms operating in the financial services sector would conduct their business.

"For the OTC (over-the-counter) derivatives market, there will be a seismic shift resulting in higher costs, tighter margins and reduced flexibility when hedging," he said in a statement.

"On the positive side increased transparency and investor confidence may be positive for the market. However, we won't know what the real impact will be until the regulators decide the fixed position limits, and whether any onerous approach will limit liquidity."

EU's Barnier: We Will Regulate Derivatives
Michel Barnier, European commissioner for internal market and services, highlights the need for the U.S. and E.U. to regulate their financial sectors.

Policymakers hope the new rules will plug failings in the existing legislation, identified in the recent financial crisis, and bring the regulation up-to-date with technological developments.

Algorithmic trading, for example, has been credited with causing the 2010 "flash crash," after high-frequency traders started aggressively selling. At that point, more than 60 percent of U.S. equity trades were accounted for by HFT, according to Bloomberg. The industry has become less profitable since then.

The negotiators agreed to push the organized trading of financial instruments onto regulated trading platforms, to end the so-called "dark trading" taking place away from regulated markets like stock exchanges.

The measures are expected to implemented by the end of 2016.

(Read more: Europeans struggle to set derivatives rules)

Michel Barnier, European Commissioner for Internal Market and Services, welcomed the deal – but said he would have preferred a "more ambitious" implementation period.

"These new rules will improve the way capital markets function to the benefit of the real economy," he said in a statement. "They are a key step towards establishing a safer, more open and more responsible financial system and restoring investor confidence in the wake of the financial crisis.

Arlene McCarthy, a British Member of the European Parliament from the Labour Party, said the regulation of high-frequency trading would "slow down the pace of trading, increase transparency and ensure prices reflect current market."

And with regards to the curbing of commodities speculation, she added: "For the first time, the EU will regulate commodities to tackle food speculation. High and volatile food prices have a devastating impact on poor and food dependent countries."

The rules, which will apply to investment firms and market operators, must be formally approved by European Parliament and EU-member governments before taking effect.

The British Bankers' Association, which represents the banking and financial services sectors in the U.K., said it "remained concerned about the impact of the new rules on the real economy by limiting market liquidity and hurting the competitiveness of European firms."

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