Trading Forum 2013 Geneva, 12 th March 2013 Financial market regulation and commodity markets

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1 Federal Department of Finance FDF State Secretariat for International Financial Matters SIF Multilateral Affairs Trading Forum 2013 Geneva, 12 th March 2013 Financial market regulation and commodity markets Alexander Karrer, Deputy State Secretary 1. Introduction It is a great pleasure for me to participate in this year s Trading Forum here in Geneva. We welcome the opportunity to continue our dialogue with the commodity trading industry. At a time when developments at the national and international level create challenges for regulators and market participants, the importance of such a dialogue is further enhanced. Today, I will talk about financial market regulation and its relevance for commodity trading. Financial market regulation both at the international and the national level is one of the main topics we are dealing with in the State Secretariat for International Finance. Another topic that keeps us busy is company taxation, which I will briefly touch on later in my presentation But before I turn to financial market regulation, let me first make some general comments on the development and importance of the Swiss commodity trading hub. 2. Importance and strengths of the Swiss commodity hub Notwithstanding its rapid growth in recent years, commodity trading has a long tradition in Switzerland. Its history reaches back to the middle of the nineteenth century. Over time, a significant commodity trading cluster established.

2 In my view, the attractiveness of Switzerland as a location for commodity trading depends on a mix of elements. The most important factors are: an extensive cluster offering all services related to commodity trading; the availability of a highly developed and stable financial system; a stable and reliable political, economic and legal framework for companies; a sound tax environment; the availability of high skilled employees and an open and competitive job market. The development of the Swiss commodity trading sector was not the result of a specific industrial policy by the authorities but rather of a favourable general political, economic as well as legal framework for doing business. Offering such a framework is a continuously evolving task. And the Swiss government is determined to meet this challenge. According to estimates, the contribution of the commodity trading cluster in Switzerland to GDP is about 3,5% which is comparable to receipts from Swiss banks financial services abroad or even more important. For the Swiss financial sector, the provision of services related to commodity finance are a welcome complement to its traditional pillar focusing on wealth management. Hence, the commodity sector has become an integral and increasingly important part of the Swiss economy in general and of some regions in particular. Given its size, in light of a more vertical integration of some trading houses and against the background of the recent financial crises it is not surprising that the Swiss commodity sector has attracted increasing public interest recently. The public at large, and even specialists know quite little about your activities. This is why, as you may have heard, together with other federal departments we have compiled a report for the Swiss government. This report will address the importance of the commodity cluster and the related economic and political challenges. The Federal Council will consider this report in the coming 2/9

3 weeks alongside with possible actions and measures designed to ensure continued competitiveness and integrity, as well as to enhance transparency of activities related to the commodity sector in Switzerland. 3. Financial market regulatory reforms and their impact on commodity trading Let me now turn to financial market regulation and its impact on commodity trading. I will focus on four issues: company taxation, the overthe-counter (OTC) derivative market reform, the work on shadow banking, and anti money laundering legislation. Reforms and discussions in these areas have at least two things in common: First, they were not launched to address specific issues in commodity markets. Nevertheless, due to their interconnectedness with financial markets, commodity traders may be affected as well. And second, they all take place in an international context and in some areas have led to the elaboration of new international standards Company Taxation It is no secret that certain aspects of company taxation are an issue of debate particularly between Switzerland and the European Union. This debate is also relevant for commodity trading companies located in Switzerland. The European Union considers that certain tax regimes are distorting competition. Without going into details, let me just mention what we are doing to address this issue: (1) We have entered into a dialogue with the European Commission on this issue and (2) we are preparing a legislative reform of company taxation with a view to reaching three objectives: (1) ensure the competitiveness of our tax regime, (2) increase its acceptance at the international level and (3) secure the necessary financing. 3/9

4 Today Switzerland has an attractive system of company taxation, allowing in particular for rulings to be predictable and for tax levels to remain moderate, even if by no means they are the lowest in international comparison. At the federal level, in particular in our negotiations with other countries, we are working hard to maintain this favourable situation. But it is to a large extent also the responsibility of the Cantons to ensure that a competitive environment for company taxation can be maintained also under revised, internationally more compatible tax regimes and that the three objectives I just outlined can effectively be met OTC derivative market reform With regard to OTC derivatives markets, the recent financial crisis highlighted a lack of transparency that can threaten the stability of the financial system. As a reaction, international efforts undertaken by the G20 and the Financial Stability Board (FSB) resulted in a reform agenda comprising three main requirements: o First, standardised OTC derivatives shall be cleared by central counterparties. o Second, OTC contracts, if appropriate, shall be traded on electronic platforms. o Third, all OTC derivative transactions shall be reported to trade repositories. Since the Swiss OTC derivatives market is mainly a cross-border market, Switzerland needed to have more clarity on reforms in large jurisdictions before amending its legislation regarding OTC derivatives. There are still pending cross-border issues that remain to be solved at the international level. These issues include the extraterritorial scope of some provisions in major jurisdictions and the potential 4/9

5 inconsistencies between these provisions. They also include concerns regarding access to central counterparties and information in trade repositories abroad. That said, the Federal Council is committed to implement this multilaterally agreed reform. The Federal Department of Finance is currently preparing draft legislation for consultation by this summer. Our aim is threefold: to strengthen financial stability, to safeguard the competitiveness of the Swiss financial centre, and, by introducing a reporting requirement for transactions, to increase transparency. While commodity derivatives are a tiny fraction of OTC derivatives worldwide, they will also be affected by this reform. At the same time, since commodities are very diverse, there will always be a need for specifically tailored OTC derivatives to meet flexible hedging needs of physical commodity traders. Various market segments are just not liquid enough to allow for standardization. This is well acknowledged also by regulators in Switzerland. Hence, in the implementation of the above mentioned reform, the hedging needs of physical traders will be taken into consideration when determining the scope of clearing requirements. Another target the Federal Council mentioned is to ensure, where necessary, consistency with EU legislation. This should avoid conflicting rules and facilitate market access of Swiss financial market participants Shadow Banking Another reform that might affect commodity trading is the current international work on the regulation of the so called shadow banking sector. Shadow banks are institutions that provide bank-like services but are not regulated as banks. Typical examples for shadow banks 5/9

6 are money market funds. Hence there is a concern that activities may shift from the regulated banking sector to unregulated sectors, thereby creating a new source for financial risks. The Financial Stability Board is currently developing new international standards to regulate shadow banks. Now, you may wonder whether commodity trading has anything to do with shadow banking. That is exactly one of the questions that have been investigated within the Financial Stability Board. In particular, the Financial Stability Board analyzed the structure and business model of the commodity trading sector. For the time being, no relevant shadow banking risks arising from the activities of physical commodity traders have been identified. Thus, in the current work of the FSB, commodity traders are not considered to be part of the shadow banking system. Nor are they considered to be systemically important financial institutions. However, this may be only the case for as long as physical commodity traders do not provide bank-like services or integrate banks Anti Money laundering Let me now turn to the third topic: provisions against money laundering. Financial integrity may be threatened in particular by corruption and the laundering of proceeds of criminal activity. The threat of companies being abused for criminal purposes extends all sectors of economic activity, including commodity trading. What can be done to address these challenges? Again, on a global level, governments and international bodies have a role in establishing global standards as well as in ensuring that they are implemented. On a national level, it is the responsibility of governments to translate the standards into national law. The Federal Council attaches great 6/9

7 importance to preserving the integrity of the Swiss financial centre and therefore fully supports the standards set by the Financial Action Task Force (FATF). In Switzerland, persons who on a professional basis physically trade in commodities for the account of others are considered as financial intermediaries. They are thus subject to the Swiss Legislation on Combating Money Laundering. In addition, the Swiss Criminal Code provision on money laundering obviously applies to any person active in Switzerland, whether a professional or not. Switzerland s anti-money laundering regulations generally are consistent with the FATF standards. Nevertheless, certain adjustments are needed in order for the revised FATF recommendations to be effectively implemented in Switzerland. Therefore, the Federal Council launched a draft consultation at the end of February to further strengthen the mechanisms to combat money laundering and terrorism financing. Certain of these changes also apply to commodity traders when they act as financial intermediaries. A recurring issue is whether physical commodity trading on own account should also be subject to the legislation on combating money laundering. This question was examined as well during the preparation of the draft consultation. However, the Federal Council refrained from doing so. Indeed, there are compelling reasons not to consider such a requirement. First of all, up to now there is no evidence that physical commodity trading on own account is misused for money laundering. Second, financial intermediation in the commodity sector is subject to the legislation on combating money laundering. Thus, the corresponding checks by a bank are activated as soon as potentially criminally 7/9

8 obtained money is used in payment transactions. Moreover, the money laundering supervision of commodity trading on own account is not convincing from a conceptual point of view: as the trader is trading on own account, he would have to check the background of his own transactions. This task, however, would raise an obvious conflict of interest with reporting requirements as provided by the anti-money laundering law Other ongoing discussions Before concluding my remarks, let me just mention two additional aspects that specifically address commodity markets: First, the IOSCO, a standard setter of security market regulators, has issued principles on the regulation and supervision of commodity derivatives markets in 2011, including measures for intervening in markets such as position limits. Swiss legislation is already in conformity with some of these principles. Once the OTC derivatives reform mentioned before is implemented, we expect the Swiss framework to be largely in line with the remainder of them. Second, the discussion in the G20 on transparency in commodity markets is ongoing. Since this year, Switzerland has been invited by the Russian presidency to participate in G20 working groups, we can closely follow these developments. Currently, however, the focus is not on financial regulation, but on transparency on production, consumption and stocks in physical commodity markets. Typical examples of this work are JODI Oil or newly JODI Gas. Switzerland is fully supportive of this work. 4. Closing remarks Let me conclude with two general remarks. 8/9

9 First, as mentioned at the beginning, Switzerland strives to maintain a stable and reliable economic and legal framework, which is to the benefit of all sectors. This will make sure that Switzerland remains an attractive location for doing business, including commodity trading, which provides a substantial contribution to our economy. At the same time, as I have highlighted in the context of financial regulation, Switzerland is generally committed to implement multilaterally agreed standards and reforms. This holds for other areas as well. Second, as you have noticed, a recurrent theme of the financial sector reforms mentioned was transparency. Transparency in financial markets is important to improve financial stability and the integrity of markets. But transparency of physical commodity markets is also important. And the relevance of transparency obviously expands to other fields as well, including financial flows of commodity firms and the sustainable and socially responsible production of raw materials. Switzerland supports transparency, be it in financial markets or other fields. Companies have to be aware that the public expects a transparent as well as socially and ecologically responsible behaviour by economic actors, not only here in Switzerland, but also in their businesses worldwide. This is why not only governments, but also companies have to take an active part in these efforts. More transparency should also be in the interest of your industry. Being transparent about how the industry does business is an opportunity to increase confidence and to secure continued support for the role commodity trading plays in contributing to sustainable growth not only in trading hubs such as Switzerland, but at a global scale. 9/9