In case you missed it earlier on Thursday…
IOSCO (the umbrella securities regulators’ body) has published a report asking for comments on regulating a rather key cog in the physical market for oil. ‘Functioning and Oversight of Oil Price Reporting Agencies’ may sound a bit dry, but we think it could really ruffle some feathers in oil trading if the report’s ideas gain traction.
Physical traders report their daily bids, offers and transactions to “PRAs” (as IOSCO calls ‘em) such as Platts or Argus. These have their own pricing methodologies and benchmarks, etc. All this price discovery feeds through into the ‘paper’ market for pricing OTC derivatives, swaps and so on. The most famous example is Platts’ 30- to 45-minute ‘windows’ for capturing submissions at the end of the trading day, probably. The ‘window’ sits within a much bigger assessment process where Platts editors sort through trader submissions and verify transactions. It’s all designed to avoid manipulation. Not always successfully though.
But the IOSCO paper has taken level aim at pricing transparency here…
There is a risk that a PRA’s benchmark price can be manipulated by the submission of false prices or by over or understating the volume transacted. It is very important, as described above, that the processes employed by PRAs mitigate this risk. As mentioned, a further risk is the potential for market participants to selectively report transactions in an attempt to manipulate prices, i.e. to submit only those prices that will have an impact on PRA benchmarks in a particular direction. This practice may potentially influence the physical benchmark price and, by extension, the PRA benchmark price referenced in oil derivatives contracts.
PRAs do not contractually require the market participants that participate in their price formation processes to submit all of their transactions. It is of key importance therefore that PRAs’ processes take account of the potential for selective reporting by participants in order to influence prices and identify where submitted prices are trending away from what they assess to be real market value.
This raises the issue of the number of transactions which underlie PRA-assessed benchmark prices. Stakeholders have commented to IOSCO that the number of completed transactions reported to a PRA for inclusion in its benchmark price assessment is low in many cases. Specifically, the number of transactions in certain benchmark assessments can often be less than five and not infrequently there are no prices submitted to a particular PRA on which it can base its assessment. In such cases, PRAs have alternative procedures for making an assessment. For example, where there are no deals done the reporters must use their own judgment to interpolate, extrapolate and arrive at price assessments that the trading community would deem objectively reasonable. In such circumstances the PRA’s view of the real market price may be easily distorted by selective reporting.
It’s interesting — IOSCO is making deep inroads into how the market functions here, going beyond PRAs to traders. We’re tempted to agree with Reuters columnist John Kemp, writing earlier on Thursday:
IOSCO appears to be on the brink of recommending wholesale reforms that would subject PRAs to the same sort of regulation that is currently imposed on brokers and dealers in the financial markets. From there it would be only a small step to extend the same approach to other physical market participants.
It is a big shift that deserves proper debate – not something which should happen incidentally via reform of the PRAs.
Related link:
Brent’s got its problems too – FT Alphaville (2010)
Regulators review oil pricing agencies – FT