The UK’s Financial Services Authority published a paper, which examines the recent growth in investment in commodity markets, concluding that markets have changed significantly, creating new issues which need to be understood.

The paper notes that the recent growth in commodity markets with record prices, high volatility, and the high returns to be gained have attracted a wave of new investors and firms into what was previously viewed as a specialist market. These new entrants include hedge funds, pension funds, high net worth individuals and even a small number of retail investors. The level of funds being invested is expected to grow and, unlike previous cycles, to remain, the FSA says.

The FSA reports that it has identified various risks and challenges as a result of this growth, including: increased difficulties in recruiting appropriately skilled and experienced compliance staff; large volume increases pose challenges to trading system infrastructure especially following the switch by many exchanges to electronic trading; firms are facing increased volatility in some markets which raises risk of failure; new participants may not share the same level of knowledge or understanding as traditional participants, and they may also introduce new trading techniques which traditional operators including exchanges need to be aware of; and firms need to ensure they have adequate systems and controls in place to prevent abuse taking place.

Although direct investment by retail investors in commodity markets is limited at present, financial firms are responding to growing consumer interest by developing products which will allow individuals to gain an element of exposure to commodity markets, the FSA says. “These changes combined with a shortage of financial services professionals who understand the market could result in consumers buying products they don’t fully understand. Indirect exposure of retail investors is also increasing through pension fund investment,” it adds.

“The recent growth in the level of investment in commodity markets, the development of new products and a changing user base has combined to create a greatly changed environment in the commodities markets over the last few years. This has given rise to a number of risks and challenges for both established and newly arrived participants,” said Hector Sants, FSA managing director, Wholesale Business.

“The risks we have identified should not come as a surprise to those active in the market but serve to focus attention on the areas we consider to be of most impact and importance. Firms and exchanges need to consider how they have addressed these risks and continue to mitigate against them in the
future.”