Why You Should Read About The Embedded Volatility Optionality Debate -- expanded

Writing this makes me feel like I should add a subtitle ‘or why we are never invited to dinner parties’, because the subject seems so wonky and almost alien to most observers, but what the debate represents is a metaphor for or a snapshot of the state of the regulatory debate.

The CFTC (who else? They are the lingering menace in compliance departments’ nightmares) has promulgated rules involving supply contracts for commodities to interpret whether or not these contracts contain swaps and options. The extreme interpretations of these actions range from gross regulatory overreach to kudos for identifying a potential area of extreme risk exposure.

The problem is not what is on the surface but the details we do not know.  Why do/did financial institutions stockpile commodities and positions in commodities in entities that were or were not transparent in their corporate organizations? In any market with highly sophisticated (read computer based) trading and hence price setting should there not be some skepticism? But should Federal agencies really care about inventories and deliveries of corn?

The lobbyist line up (billable time, for sure), and the complexity of the discussion builds. The fights are behind the scenes and mired in the wonkish details. By watching this isolated battle progress, we get a view of the framework of many battles for the foreseeable future. However, this one is too complex for Jon Stewart, so we will have to read the articles ourselves.

For those of you who have ignored the news flow since 2007 (I am jealous) there was a global financial crisis which lingers to this day.  Most would agree that at the root of the crisis was excessive risk by risk takers, often using other people's money and with very little regulatory oversight.  Fast forward to today, where the same institutions who established and still continue a strategy of regulatory capture are terrified (justifiably IMHOP) of the trend towards regulatory overreach at all levels from all agencies resulting in turning their jobs into compliance factories. The antagonists du jour are the CFTC pitted against the legions of lobbyist whose mission in life is to write the most detailed rules I have ever seen and then imbed these rules into the process.  The commodity suppliers (read corn harvester in Iowa) is forced into regulatory oversight due to the detailed language in the supply contract with the grain elevator.  I said it was wonkish.