The world's largest commodity exchange is taking forceful steps to calm volatility in commodities trading in an attempt to avoid a repeat of the extreme price fluctuations of 2008.
CME Group Inc. has increased margin requirements for energy trading on the CME-owned New York Mercantile Exchange, raising some by 25 per cent. It was the third margin increase this year by the CME for trading in oil, which had been on a wild ride lately. The price of oil dropped 15 per cent last week, the sharpest decrease in more than two years, and then jumped 5.5 per cent on Monday, the biggest one-day jump in three months.
The Chicago-based CME's decision on oil late Monday came just days after the exchange took aim at silver trading, which had become even more feverish. Silver hit record highs last week, coming close to $50 (U.S.) an ounce and jumping roughly twofold in six months. The CME pushed through a series of margin hikes late last week, pushing them up by 84 per cent.
So far the moves have been working. The price of silver fell nearly 30 per cent immediately after the new margin requirements, although it has been moving back up and closed Tuesday at $38.48 an ounce. Oil fell about 2 per cent Tuesday morning to $101 a barrel, but moved back up again and closed at $103.88.
"Most of those huge declines had nothing to do with fundamentals but everything to do with leverage," said Jim O'Shaughnessy of O'Shaughnessy Asset Management in Stamford, Conn.
Commodity trading is generally far more leveraged than trading in equities, something regulators and politicians have complained about for years. While margins in stock trading are typically 50 per cent of the value of the underlying equity, they can be as low as 5 per cent for commodities trading.
The CME has two types of margins, which are technically called "performance bonds." The "initial" bond is the amount required to open a trading account and the "maintenance" bond is a sum that must be maintained on deposit at all times. For example, if the initial bond for a contract is $1,000 and the maintenance margin is $750, whenever trading in the contract brings the account below $750, the exchange can issue a margin call to bring it back to $1,000.
On Monday, the CME increased the initial margins for the benchmark West Texas intermediate oil contract to $8,438 from $6,750. Maintenance margins jumped to $6,250 from $5,000. Considering that each contract contains 1,000 barrels of oil, the margin amounts are still less than 10 per cent of the value of the contract, hardly enough to affect large institutions that tend to dominate commodities trading.
Indeed, by the end of trading Tuesday, the impact of the new margin rules was already fading.
"The market shook off the margin rate hikes and once again is concentrating on the economic recovery," said Carl Larry, director of energy derivatives and research at Blue Ocean Brokerage LLC in New York. "People are thinking that $100 is the new $80 and a bottom."
The CME could still increase margins further. It has increased margins for other commodities, including corn, several times to help ease volatility. But energy markets are far larger and the margins would have to go much higher to have an impact, analysts say. For example, the initial bond for oil would have to be at least $12,500 to equal the new margin requirements for silver.
Kim Taylor, president of CME clearing, said the exchange is not trying to influence prices through margin rules.
"Margins are set as part of the neutral risk management services we provide," Ms. Taylor said in a blog post explaining the decision to increase margins for silver trading. "They aren't a means to move a market one way or another, or to encourage or discourage participation from one kind of market participant or another."
Many more restrictions on commodities trading are expected, mainly at the behest of politicians eager to rein in speculators. The Commodity Futures Trading Commission, which regulates U.S. commodity markets, has proposed a series of regulatory changes that are expected to take effect next year. The proposed changes will further increase margin rules and limit the positions hedge funds and other speculators can take in commodity markets.
With files from Bloomberg News
Paul Waldie