By Susan Thomas
LONDON (Reuters) - Commodities trade houses will come under increased scrutiny by Britain's Financial Conduct Authority (FCA) as those firms play an increasingly critical role in the global economy.
The FCA will also keep a close eye on oil majors and the gas and power utilities because of the significant role they play in commodity derivative markets, FCA Director of Markets David Lawton said in a report published on Thursday.
The report comes as new rules came into force in Europe this month to shine more light on the $700 trillion derivatives markets designed to prevent a repeat of the financial crisis that was triggered by those complex products.
In response to the crisis, politicians and regulators around the world called for action to make risks easier to spot in this opaque part of global financial markets, including in commodities markets.
While trading firms are largely not subject to financial services regulation, Lawton said, they are significant participants in regulated markets.
"The rise in proportion of activity on London markets by unregulated, overseas entities poses a challenge to our market supervision, alongside risks to market standards and integrity," Lawton said.
Some regulators and market participants have argued that trading firms pose systemic risks, but this is difficult to assess due to relatively limited published financial information on these firms either to the market or to regulators.
"One way we are responding is to develop a dialogue with the trading firms over which we do have a direct regulatory remit, particularly in relation to market conduct and financial crime risks, and we welcome their constructive response to this initiative," he said.
Lawton said the structure of the energy markets meant oil majors and gas and power utilities tend to be direct market participants.
"Given their consequent impact on market integrity, we therefore need to maintain an active dialogue with them," he said.
Lawton noted that commodity markets straddle the boundary between regulated financial activity and physical commodity activity that is outside financial services regulation, posting risks to the price formation process.
He singled out the role of warehouses, where these are part of the delivery and settlement process for exchange contracts, and the role of physical commodity benchmarks.
Earlier this month, the FCA said it would keep a close watch on commodities warehousing to ensure that reforms in storage policies by the London Metal Exchange and NYSE Liffe are carried out effectively.
Rents charged by warehouse firms to store metals such as aluminium - and the often glacial rate at which stocks are delivered out of sheds to LME clients while charges continue being levied - have aroused complaints and lawsuits.
Coffee and cocoa markets copied some of these controversial business models, but both the LME and NYSE Liffe are now making changes to warehousing practices in the markets they oversee.
"We have been fully engaged with the LME's consultation process and will seek to ensure that the impact on market integrity/orderliness has been fully addressed," Lawton said.
"The interest in these issues is generating momentum internationally, and so a coordinated regulatory response may be desirable."
(Editing by William Hardy)