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Note: A Merry-Go-Round of Metal and Manipulation: Toward a New Framework for Commodity Exchange Self-Regulation

By Samuel D. Posnick. Full text here.

The 2013 revelation of Goldman Sachs’ unsavory aluminum warehousing practices led to public uproar and political backlash. In November 2014, Congress released a damning report detailing Wall Street’s involvement in numerous commodities markets and finding rampant manipulation. As a result, the Federal Reserve is reexamining its regulation of financial holding companies (FHCs) and their commercial activities—a formal Notice of Proposed Rulemaking on the subject is expected later this year. Among this flurry of regulatory activity, however, two crucial issues have been overlooked. First, FHCs are not the only perpetrators of commodity market manipulation. Large commodities traders, among others, retain the ability to corner markets. Second, commodities exchanges themselves have gone through a restructuring process that increases the likelihood of conflicts of interest and unfair dealing.

This Note takes up the latter issue by exploring the current framework of exchange self-regulation and argues that it inadequately protects the public interest. An economic analysis reveals that exchanges to do not fully internalize the costs of manipulation. Further, exchange demutualization has exacerbated the problem. Thus, commodities exchanges are not properly incentivized to deter manipulation, a result that was substantiated by the Congressional report. This Note proposes a new self-regulatory approach to commodity exchange rule promulgation. It looks to the accounting industry, which has successfully retained autonomy in producing public-oriented financial accounting standards via the Financial Accounting Standards Board (FASB). Because of the similarities between the stakeholders in financial accounting standards and those in commodity exchange rules, a new self-regulatory entity structured similar to the FASB would better ensure commodity market  competitiveness, efficiency, and integrity.