Manipulation of Commodity Futures Markets: Analysis of Regulatory Recommendations

B058498

Futures and Options

Peter Moles

27th February 2017

Word Count: 1434

In the light of your understanding of how commodity futures work and the academic literature on manipulation, review the effectiveness of the proposed regulatory recommendations proposed in the academic literature and how these would affect the operation of the commodity futures markets.

I. Introduction

Manipulation in commodity futures markets has been widely condemned for many decades, and authorities have been attempting to repress it for a similar period (Perdue, 1987). Legislators have persistently failed to precisely define “manipulation”, due to the term’s ambiguity and far-reaching implications, as well as failing to recognise and describe the distinct types (Pirrong, 2010). Empirical evidence suggests that this, combined with a lack of preventative regulation and prosecutorial action, has resulted in the exploitation of the commodity futures market, at the expense of the less informed trader and other stakeholders in the market. The following report discusses the regulatory remedies suggested in the academic literature – with strong focus on Markkham’s (1991) recommendations – and their impact on economic efficiency and the operation of the commodity futures market.

II. Defining and Separating “Manipulation”

According to Markkham (1991), instead of defining the term “manipulation”, US Congress instituted a prohibition on manipulation “so vague and broad” in order to cover a variety of conducts that could be concocted by a trader attempting to influence prices. More recent evidence, however, stipulates the need for more specificity surrounding the definition and that a clear distinction is made between types of manipulation – most notably, market power and fraud-based (Pirrong, 2010). It is apparent from the academic literature that historically having a broad, comprehensive definition has not resulted in meaningful progress towards a reduction in manipulation; therefore, Pirrong’s (2010) recommendation is justified.

Due to the distinct nature of the main two types of manipulation (market power and fraud-based), it would be economically “dangerous” to refer to both inclusively under one term, as the mechanisms by which they distort price differ and they “have different effects on prices and quantities” (Pirrong, 2010). Markkham (1991), as part of his recommendations, enforces this point and suggests augmenting and reallocating resources within the Commodity Futures Trading Commission (CFTC) to target these types of manipulation separately. This would be more economically efficient and would result in more convictions and, consequently, fewer cases of misconduct. Separation of resources would reduce the investigative scope and could allow the CFTC to focus specifically on certain cases of misconduct.