1. 1
Market
Manipulation
in
Commodity
Futures
Markets
Introduction
Manipulation
in
commodity
futures
markets
has
been
a
prevalent
feature
throughout
history.
Many
high
profile
cases
of
manipulation
such
as
the
Jay
Gould
and
James
Fisk’s
manipulation
of
gold
markets
in
1869,
ranging
to
the
Hunt
brothers
manipulation
of
the
silver
market
in
the
1970’s,
highlight
the
difficulty
in
over
a
century
that
regulators
have
had
in
monitoring
and
controlling
markets,
due
to
their
complexity
and
lack
of
transparency.
The
establishment
of
the
CFTC
in
1974
was
an
attempt
to
regulate
the
futures
industry,
however
as
of
2013
the
CFTC
had
successful
won
only
1
case
in
37
years,
leading
to
accusations
of
the
manipulation
in
commodity
futures
markets
as
an
‘unprosecutable
crime’.
This
essay
covers
the
potential
for
manipulation,
implications
of
such
activities
and
the
ability
of
regulators
to
combat
this
behaviour.
Potential
for
market
manipulation
in
commodity
futures
markets
Commodity
futures
are
particularly
susceptible
to
manipulation
due
to
their
relationship
with
their
physical
underlying
asset
which
has
finite
supply,
and
sizeable
storage
and
transportation
costs.
Manipulation
is
‘the
elimination
of
effective
price
competition
in
a
market
for
cash
commodities
and
for
future
contracts
through
the
domination
of
supply
and
demand
and
exercise
that
domination
to
intentionally
produce
artificially
high
or
low
prices’
(Rosa
,
et
al.,
2013).
The
two
distinct
categories
that
encompass
different
market
manipulation
strategies
are
market
power
and
fraud
based
manipulation.
Market
power
manipulation
is
the
more
prevalent
mechanism
due
to
its
ease
of
concealment
into
regular
market
behaviour.
Market
power
manipulators
exploit
the
imperfect
liquidity
in
the
commodity
futures
market
and
the
underlying
commodity
cash
market.
Cornering
the
market
and
a
squeeze
are
two
similar
and
historically
common
forms
of
market
power
manipulation.
In
cornering
the
market
a
manipulator
takes
a
large
long
position
in
future
contracts
as
well
a
sizeable
quantity
of
their
underlying
commodity.
As
the
contract
approach
maturity
the
manipulator
is
entitled
to
a
larger
quantity
of
the
commodity
than
is
available
to
the
delivery
market1
causing
delivery
impairment
and
resulting
in
the
contract
counterparty
being
pressured
into
either
bringing
additional
supplies
to
market
at
large
cost
or
buying
back
their
futures
position
at
an
inflated
price.
The
manipulator
simply
ensures
they
close
their
contact
at
this
inflated
price
and
make
a
profit.
A
squeeze
is
similar,
except
the
manipulator
identifies
and
takes
advantage
of
a
natural
shortage
in
the
commodity
market
to
increase
the
price
of
their
futures
position.
Squeezes
and
corners
theoretically
seem
simply
to
construct,
but
in
real
world
scenarios
they
may
require
continuous
additions
of
capital,
long
term
outlook
and
high
levels
of
risk.
Another
method
of
manipulation
which
warrants
mention,
yet
is
difficult
to
categorise
is
uneconomic
trading,
which
involve
abuse
of
derivative
trading
and
pricing
to
result
in
favourable
price
fluctuations
upon
leveraged
position,
on
market
or
OTC.
All
these
methods
described
however
1
This
insufficient
liquidity
in
the
delivery
market
in
the
case
of
a
corner
is
due
to
the
purchase
of
the
underlying
commodity
of
the
futures
contract,
however
large
deployment
of
capital
for
the
purchase
is
not
necessary
if
the
manipulator
can
focus
upon
a
particular
commodity
hub,
rather
than
an
entire
market.
By
doing
this
the
manipulator
may
exploit
economic
frictions
in
the
transportation/
transaction
costs
of
the
commodity
between
geographical
hub
locations.

2. 2
essentially
work
upon
the
same
market
mechanism
of
taking
advantage
of
illiquidity
and
contribute
to
an
artificial
price.
Fraud
based
manipulation,
whilst
not
unique
to
commodity
derivative
markets
are
still
used
by
manipulators
to
derive
profit.
This
is
in
part
because
the
financial
investments
for
fraud
are
negligible
in
comparison
to
the
capital
required
to
be
deployed
in
market
power
manipulation
to
cause
a
price
distortion.
The
introduction
of
false
information
into
the
market
by
methods
such
as
‘wash
trades’
and
‘pump
and
dump’
schemes
allow
manipulators
to
falsely
convey
the
illusion
of
private
information
to
the
market
and
take
advantage
of
resulting
price
movements.
Market
rigging
by
professionals
through
methods
such
is
front
running
by
trading
on
confidential
information
is
also
common
in
derivative
markets
and
contributes
price
distortions.
Implications
of
market
manipulation
in
commodity
futures
markets
Commodity
futures
markets
primary
purpose
is
to
facilitate
hedging
and
price
discovery,
which
offer
risk
management
and
reliable
information,
respectively
to
market
participants.
However,
manipulation
can
decrease
the
effectiveness
of
these
primary
functions.
Price
distortions
from
equilibrium
reduce
market
participation
due
to
mistrust
of
the
market
mechanism,
decreasing
the
effectiveness
of
the
market
as
an
intermediary
and
leading
to
a
loss
of
market
depth.
Furthermore,
misinformation
in
the
derivative
market
can
uneconomically
affect
the
flow
of
the
underlying
commodity
between
delivery
hubs
in
response
to
pricing
disparities.
Decreased
liquidity
and
a
decrease
in
market
confidence
contribute
to
further
adverse
effects
such
as
increases
in
volatility
and
spreads,
and
market
participants
may
be
unconsciously
trading
at
a
loss
due
to
relying
upon
false
information
relayed
to
the
market
by
the
manipulator.
Furthermore
collapses
of
unauthorised
attempted
manipulation
by
rogue
traders,
can
lead
to
catastrophic
losses
for
institutions
exemplified
in
the
case
of
the
$2.6
billion
loss
by
Sumitono
Corporation
in
1996
(Carpenter
and
Tanglewood,
2011)
on
futures
contracts
after
regulator
attention
exposed
a
corner
and
world
copper
prices
fell.
Ledgerwood
(2011)
suggests
that
‘the
effects
of
the
manipulation
may
spill
into
other
markets
and
disrupt
asset
values
over
time
and
other
parties
may
be
damaged’,
to
the
detriment
of
the
entire
market
not
just
the
commodity
targeted
by
the
manipulation.
Ability
of
regulators
to
combat
market
manipulation
in
commodities
markets
The
CFTC
has
historically
struggled
to
successfully
prosecute
market
manipulation,
particularly
in
market
power
manipulation
due
to
difficulties
in
detection
and
construction
of
cases.
With
incredibly
high
volumes
of
trading,
making
the
distinction
between
manipulative
intent
and
normal
market
activity
of
speculative
and
hedging
can
be
difficult
amongst
the
noise
of
the
market.
Furthermore
multi-­‐national
corporations
with
numerous
complex
hedging
and
speculative
positions
and
strategies,
are
able
to
able
to
offer
the
explanation
of
cross-­‐hedging
when
accused
of
manipulative
conduct.
Further
complexity
is
introduced
in
the
ability
of
detection,
when
the
potential
targets
of
manipulative
conduct
can
be
OTC
trades
where
the
CFTC
lacks
sufficient
supervisory
jurisdiction.

3. 3
When
screening
for
manipulation,
increasing
price
spreads
between
delivery
months
and
delivery
hubs
can
indicate
that
a
squeeze
or
corner
is
taking
place
and
that
it
should
be
an
area
of
investigation
by
the
regulator.
Nevertheless
the
lack
of
effective
screening
methods
for
the
detection
of
market
manipulation
results
in
retrospective
reliance
by
regulators
rather
than
the
preferable
pre-­‐emptive
action.
Regulators
are
therefore
inclined
to
investigate
companies
that
have
either
performed
extraordinarily
or
catastrophically.
The
difficulties
in
defining
what
constitutes
manipulation,
by
the
CFTC
particularly
market
power
manipulation,
further
exemplifies
the
complexities
in
successful
prosecution.
Inconsistent
conflicting
definitions
of
manipulation
between
the
CTFC
and
CEA
has
led
to
misguided
prosecution
attempts
and
the
evasion
of
conviction
due
to
loopholes
and
the
inability
of
courts
to
clearly
interpret
the
statues
language
and
identify
and
punish
manipulative
conduct.
(Pirrong,
2010)
The
reliance
upon
precedent
further
confuses
courts
as
individual
cases
exhibit
varying
strategies,
perhaps
unrelated
to
the
preceding
case.
Without
legitimate
physical
evidence
of
intent
(emails,
phone
calls,
conversations)
the
CFTC
find
it
nearly
impossible
to
prove
legitimate
intent
based
on
trade
activity.
Another
method
applied
by
the
regulators
is
the
inclusion
of
position
limits,
which
limit
market
participant’s
ability
to
possess
a
monopolistic
and
manipulative
position.
However
the
presence
of
this
position
limit
can
remove
legitimate
trading
and
hedging
in
the
market
participation,
reducing
the
markets
liquidity.
There
is
concern
that
increased
regulation
and
accidental
prosecution
of
legitimate
traders
could
further
lead
to
decrease
in
market
participation,
“the
courts
and
federal
agencies
do
not
want
to
adapt
a
standard
that
inhibits
aggressive
price
competition
in
the
commodity
future
market”
(Pirrong,
2010).
The
trade-­‐off
between
increased
regulatory
intervention
and
consequent
decrease
in
market
manipulation
would
however
result
in
controllable
consequences
in
terms
of
market
impact,
rather
than
market
impact
inflicted
by
manipulators.
Finally
the
CFTC
civil
penalties
through
fines
and
settlements,
resulting
in
the
forfeiture
of
profits
from
manipulative
conduct
do
little
to
dis-­‐incentivise
the
behaviour.
The
threat
of
criminal
prosecution
and
penalties
however,
are
likely
to
have
a
more
significant
impact
upon
the
behaviour.
Conclusion
Commodity
futures
markets
are
particularly
susceptible
to
manipulation,
specifically
market
power
manipulation
due
to
their
ability
to
be
concealed
within
normal
market
noise.
This
results
in
the
erosion
of
confidence
in
the
market
mechanisms,
loss
of
market
depth,
and
the
potential
for
catastrophic
losses
to
the
detriment
of
the
industry.
Regulators
lack
of
success
in
detection,
prevention
and
prosecution
without
further
contributing
to
market
interference
has
led
to
the
accusation
of
the
manipulation
as
an
“unprosecutable
crime”.
However
an
increase
recently
in
financial
market
scrutiny,
resulting
from
GFC
fallout,
along
with
the
passing
of
Dodd-­‐Frank
Act
increasing
and
more
specifically
defining
the
powers
of
the
CFTC,
are
the
right
steps
towards
fixing
a
broken
system.

4. 4
REFERENCES
Carpenter,
P.
&
Tanglewood,
S.,
2011.
A
framework
for
analyzing
market
manipulation,
s.l.:
Georgetown
University
-­‐
Public
Policy
Institute
(GPPI).
Cinquegrana,
P.,
2008.
The
Need
for
Transparency
in
Commodity
and
Commodity
Derivatives
Markets,
s.l.:
ECMI-­‐CEPS.
Ledgerwood,
S.,
2011.
Triggers
and
Targets:
The
Anatomy
of
Market
Manipulation,
s.l.:
The
Brattle
Group.
Markham,
J.
W.,
1991.
Manipulation
of
Commodity
Futures
Prices
–.
Yale
Journal
on
Regulation,
8(281),
pp.
281-­‐389.
Merrick,
J.
J.,
Yadav,
P.
Y.
&
Naik,
N.
Y.,
2002.
Market
Quality
and
Trader
Behavior
in
a
Manipulated
Market:
Anatomy
of
a
Squeeze,
s.l.:
London
Business
School.
Pirrong,
C.,
2010.
Energy
Market
Manipulation:
Definition,
Diagnosis
and
Deterrence.
Energy
Lae
Journal,
31(1),
pp.
1-­‐20.
Rosa
,
A.-­‐M.
M.,
Rauterberg
,
G.
V.
&
Verstein
,
A.,
2013.
Revolution
in
Manipulation
Law:
The
New
CFTC
Rules
and
the
Urgent
Need
for
Economic
and
Empirical
Analyses.
University
of
Pennsylvania
Journal
of
Business
Law,
Volume
15,
pp.
357-­‐418.