A prominent article in the Wall Street Journal describes how one type of Commodity Trading Advisors (CTAs) are wielding outsized influence in the oil futures markets as both a bullish and bearish force. As usual for the paper, it’s worth reading. Yet, the article is incomplete in one important way: not all CTAs are speculators.
WSJ writes “[a] Commodity trading adviser, or CTA, is industry jargon for a hedge fund that uses computer algorithms to divine and follow price trends.”
Nope.
That’s just one kind. You can see it right there in the CTA name. It’s got both “trading” and “advisor.”
The National Futures Association clearly draws a distinction between two broad types. From the NFA website, CTAs can be described as:
Both types generally have to register with the NFA and are regulated by the Commodity Futures Trading Commission (CFTC).
Did you know you could mitigate your commodity risk through hedging? Ask us how.
Key in the distinction between the two CTA types is how much (if any) discretion the CTA makes on behalf of customer portfolios. If on a CTA’s whim, it can sling millions or billions of dollars in and out of financial derivatives, the group of trading-CTAs can clearly affect both price and liquidity. And the effect is larger when the majority of trading-CTAs start thinking alike, as WSJ rightly points out.
However, if a CTA is only advising and recommending trading strategies for the purposes of mitigating commercial risk, then the effect is much different.
“Hedging” and “Hedge Funds” are dramatically different things. The naming is simply unfortunate.
AEGIS arranges cash-flow hedges (broadly known as swaps) on behalf of its customers. These hedges are designed to eliminate commodity price risk and are wholly, 100%, without exception, executed on behalf of customers at a price and volume they specify. AEGIS customers are trading for the purpose of risk-mitigation.
AEGIS customers have pre-existing exposure to commodity markets. In hedging, the amount and tenor of trades they conduct are almost always limited by the amount and tenor of those pre-existing exposures.
For example, an oil producer would not usually hedge (financially trade) more oil than it expects to produce.
A petroleum consumer would not hedge more diesel than the amount they expect to physically consume.
Hedging volume is naturally limited by the amount of physical purchases and sales in the markets.
In contrast, hedge funds have few pre-defined limits to how much or what type of trade they execute. Buy on Monday? Fine. Sell on Tuesday? Also OK. Change your mind on Wednesday? No problem.
Core to the hedge fund value proposition is trying to predict the future state of prices – and trading based on that belief to generate returns for investors. Hedge funds, as WSJ rightly points out, are trading for the purpose of speculation.
The CFTC recently clarified that advisor-type CTAs must execute the swaps they arrange for their customers on Swap Execution Facilities (SEFs). While AEGIS does not speak for the CFTC, it is not hard to understand why a regulator would want to have these trades subject to rulebooks, surveillance, and central oversight. Trading in the shadows just introduces too much systemic risk.
AEGIS was the first CTA to complete the SEF registration process (though its regulated subsidiary, AEGIS SEF). The AEGIS SEF is primarily a request-for-quote system where bids for hedging contracts are solicited from pre-approved counterparties – usually banks or merchant traders. Each trade is executed, surveilled, stored, reported, and subject to review by regulators – like any modern marketplace.
If you are an investor in or operate a hedge fund, perhaps. But if you are using a CTA (commonly referred to as a Hedge Advisor) to help you mitigate your commercial risk, the answer is no. Hedge Advisors are not compensated to and have no reason to agitate your markets.
When you hear about CTAs, just know the two archetypes – trader or advisor – serve two almost opposite purposes.
References
NFA |
Bonus from Bloomberg |
WSJ |
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AEGIS SEF |
THIS ARTICLE IS NOT REQUIRED TO BE AND HAS NOT BEEN, FILED WITH THE COMMODITY FUTURES TRADING COMMISSION (“CFTC”). THE CFTC DOES NOT PASS UPON THE ADEQUACY OR ACCURACY OF THIS COMMODITY TRADING ADVISOR DISCLOSURE. CONSEQUENTLY, THE CFTC HAS NOT REVIEWED OR APPROVED THIS ARTICLE.