ANALYSIS - Singapore keeps faith in self-regulating oil market

A motorist prepares to put fuel into her car at a petrol station in Melbourne in this July 2008 file photo. As regulators in the world's top oil trading hubs move to tighten rules and boost transparency in opaque markets, Singapore may gain importance and liquidity as it stands by its pledge to let industry regulate itself.

SINGAPORE (Reuters) - As regulators in the world's top oil trading hubs move to tighten rules and boost transparency in opaque markets, Singapore may gain importance and liquidity as it stands by its pledge to let industry regulate itself.

U.S. President Barack Obama's administration moved on Wednesday to exert more control on over-the-counter (OTC) derivatives markets, proposing measures that could deter some of the oil sector's more lucrative trading practices, such as taking bigger or strategic positions in less liquid markets.

But neither those plans nor a tepid call by Asian and Middle East energy officials for more oversight are likely to shake Singapore's trust in free markets.

Coupled with newly planned oil futures contracts and more OTC swaps clearing mechanisms, the lure of a more lightly regulated physical market could heighten the city-state's draw for investment banks, traders and oil companies who are betting that commodity trade will remain a bright spot, recession or no.

"To the extent that Singapore authorities seek to encourage liquidity by maintaining open access to the market and supporting clearing mechanisms, we believe this to be a positive step in enhancing the country's position as a commodity trading hub," said a senior trader with European oil trading firm Trafigura.

Singapore officials say they see little use in following the United States in imposing sterner rules to check speculation and volatility, measures meant in part to assuage fears over investment funds' sway on prices when oil spiked last summer.

"In today's economic climate, there is a tendency to over-regulate market behaviour to gain short-term stability," said Chong Lit Cheong, Chief Executive of International Enterprise (IE), the state agency that manages the oil and commodities markets in Singapore.

"However, this may not be desirable in the mid- to long term," he told Reuters via email last month.

To an extent this approach reflects an acknowledgement that it would be hard to control a market in which much of the actual trade takes place well beyond Singapore's borders, although most major industry players base their trading teams here.

The latest measures by U.S. federal regulators include subjecting all OTC derivatives dealers -- whose trades are not made via an exchange -- to "a robust regime of prudential supervision and regulation", including conservative capital, reporting and margin requirements.

While the growth of clearing houses that all but eliminate counterparty risk in OTC trades is viewed as a positive by most in the oil industry, many traders fret that related efforts to boost supervision and tightening up position limits could backfire by curtailing liquidity.

"We believe such actions to restrict trade weaken true price discovery," said the trader from Trafigura, refuting views that limiting the size of positions each company can take, or excluding firms that mainly deal in derivatives, would curb speculation and enhance price legitimacy.

CRACKED DOWN BEFORE

The trend is not entirely new: U.S. authorities cracked down on power and gas trade after the California and Enron crises, and on oil trade following sporadic leveraged trading plays in which companies would effectively corner the market in benchmark crude.

While trading practices tamed significantly as regulators began scrutinising these practices, trade in Singapore has continued much as usual, with regular but not high-profile binges or trade strategies that might raise eyebrows in the West.

Reflecting the relatively more moderate views in Asia, Asian consumers nations and Middle East oil producers mustered only a mildly worded call for "further harmonised actions such as (the) introduction of position limits" at their biennial meeting in April, despite speculation being a topic of much debate.

Not that Singapore traders are free from trade limits after last autumn's credit crisis drove large volumes of previously bilateral OTC swaps trade onto clearing houses, which IE's Chong said are now processing up to 80-90 percent of all OTC oil swap trades, up from just a small fraction a year ago.

"A lot of counterparties are not willing to trade on bilaterals in view of the worldwide credit problems," said a trader with a Japanese trading house.

New York Mercantile Exchange's ClearPort and AsiaClear, both of which take centralised credit risk with the clearing house rather than individual counterparties, impose position limits.

Activity in Singapore-based OTC contracts on ClearPort surged fourfold from a year ago to over 6,000 contracts a day in March, down from a high of more than 8,000 in February.

If a proposed SGX fuel oil contract takes off later this year, that could raise its share of the clearing business by traders who want to net out positions.

For graphic of Singapore clearing volumes on ClearPort click here

EXCHANGE ENCOURAGEMENT

Greater liquidity with a viable futures contract would help address lingering concerns about oil prices themselves as some regulators take a greater interest in the process of establishing benchmark prices in opaque physical markets.

"Exchanges and clearing houses provide a relatively better regulated environment for mitigating counterparty credit risks. A liquid exchange is also a more transparent pricing mechanism," Chong said.

In its review of market rules, a task force led by the CFTC and UK's Financial Services Authority concluded regulators must also be able to get more information on OTC and physical markets.

The task force under the ambit of the International Organization of Securities Commissions, said it was not even clear the local regulator in some jurisdictions had the authority to demand this information, prompting it to consider bringing oil price agencies Platts and Argus within the regulatory framework.

Shrugging this off, Chong said Platts and Argus are driven by self-interest to ensure integrity of their methodologies and the trading sector will pressure those who try to manipulate prices.

"These have served markets relatively well and we do not see a need to regulate price assessors in Singapore at the moment."

(Additional reporting by Chua Baizhen)