Streamlining Commodity Trading Series:

It’s Time to Re-Design Price Reporting for Physical OTC Commodity Markets

This is part of a series of blog posts that make up the “Streamlining Commodity Trading Series”. Our goal with this series of posts is to delve into the processes that make up the commodity trading life cycle from the beginning to end and highlight practices that have a positive impact on market and transactional efficiency.

In the realm of physical commodity markets, such as energy and environmental trading, the physical Over-the-Counter (OTC) landscape presents unique challenges. Unlike traditional exchange-based markets, physical OTC markets thrive on direct transactions between participants or through broker representatives, offering flexibility but often lacking in transparency. This opacity can introduce uncertainties and risks into the market, yet these markets are core to the entire derivatives complex that is often stacked on top of them.

For decades the market response to this challenge has been assessments conducted by Price Reporting Agencies (PRA’s) through the collection of data from direct market participants. The problem is that the collection of this data can occur in many, often manual, ways and can be subject to validity concerns from duplication to incompleteness all the way to fraud. These validity concerns can result in significant susceptibility to manipulation or at least the perception of such manipulation amongst wary market participants and external stakeholders.

The most significant response to address this problem came in October 2012 when the Board of IOSCO (the International Organization of Securities Commissions) published its final report on IOSCO PRA Principles, which set out principles intended to enhance the reliability of oil price assessments that are referenced in derivative contracts subject to regulation by IOSCO members. Those principles have since been adopted by most PRA’s in physical OTC commodity markets.

While the IOSCO principles improve the process of price reporting, they do not address all of the risks and challenges in collecting and validating market data from the OTC market. The markets have gained a false sense of security from blanket IOSCO compliance statements in PRA reports while the process of data collection and validation is often still highly susceptible to error and manipulation. Evidence of this can be found in the recurring disconnects and lack of convergence between financial and physical markets that we see across much of the commodity complex today.

Why do we still look to price reporting that is conducted via opaque assessments and delivered to the market after a protracted period of analysis? Online tools designed to collect closing markers and trade prices from market participants have been available for decades now – tools that not only reduce risk but also propel the market towards real-time efficiency and reliability.

Is it time to re-imagine how we collect, validate and report market data from OTC markets?

The Distinct Challenges of Physical OTC Commodity Markets

Physical OTC commodity markets operate under a distinctive set of dynamics. Transactions in these markets usually encompass vital resources and regulatory implications, necessitating accurate and transparent pricing. Yet, the decentralized nature of OTC trading can hinder price discovery and lead to information asymmetry, making risk management a complex endeavour. PRA’s through attrition and concentration are often entrenched with monopolies on market data collection and distribution for the specific commodity or a geographic region. There is little incentive for them to overhaul the traditional methods of collecting data nor do market participants have the to centralize such an activity themselves (for competitive reasons). That creates inertia that stifles progress in this area.

Can Online Data Collection and Reporting Help?

Online tools focused on gathering closing markers and trade prices from participants in physical commodity markets bring a series of transformative possibilities:

Transparency for Better Decision-Making: Online data collection tools establish a transparent environment by aggregating and disseminating market data. Participants gain valuable insights into market trends, helping them make informed decisions based on accurate information.

Empowering Price Discovery: Online data collection tools provide a central repository of prices and trends, serving as a reference point for negotiations, price determinations, risk management and compliance evaluations.

Validating Data: It is extremely important to ensure that reported prices are real, complete and correspond to the precise market that they are represented as. Online data collection improves the audit trail for OTC market data and can be used by compliance personnel to ensure accuracy through manual or automated systems. The low latency of data collected in an automated, online manner allows for crowd-validation through challenges to those prices that facilitate better certainty in the data.

Mitigating Risk: In commodity markets uncertainties can lead to significant financial repercussions, and access to reliable closing prices aids participants in evaluating and managing risk. Well-informed decisions can be made with immediate access to data, reducing exposure to unforeseen and potentially adverse market fluctuations.

Boosting Market Confidence: When participants can rely on consistent, unbiased pricing data, trust in the market's fairness and integrity grows. This confidence can attract more players to the market, enhancing liquidity, investment and provide greater certainty around capital investment decisions.

Profitability: The availability of historical market data through online tools empowers traders and analysts to conduct and automate comprehensive market analysis. Patterns and trends can be identified, leading to refined trading strategies and higher profit potential.

Addressing Information Imbalance: Online tools level the playing field, ensuring that all participants access the same information at the same time. This mitigates information imbalance and levels the negotiation field, fostering fair trade practices.

Process Automation and Technology Innovation: Digital solutions to the data collection and reporting (data input and output) function can open up the ability to integrate market signals in real time into not only ETRMs for the purpose of measuring and managing risk, but also into your analytics and modeling in order to facilitate a much more responsive view of these markets on the trading floor. As new technologies are implemented this flow of data will also support pattern/trend recognition and algorithmic response.

Moving to a Digital Future

The world of physical OTC commodity trading is always transforming, yet price reporting practices have remained largely unchanged for decades. Online price collection tools wield the potential to revolutionize these markets by introducing transparency, accuracy, and risk reduction. These tools provide the bedrock for informed decisions, accurate pricing, and strategic risk management. As the market gains confidence and efficiency, it invites a more diverse participant pool, setting the stage for a thriving market ecosystem. By embracing technology and transparency, physical commodity markets can usher in a new era of sustainability, growth, and prosperity.

Neutral Markets we can build and operate these tools and offer new pricing models that allow for better industry participation and lower costs. Our leadership team has a long history of designing and operating price reporting and market data services, and we are very well-versed in the best practices and potential pitfalls in solving market data problems.

Thanks for reading and please contact us today for more information!