Derivatives supervision helps in fight for right to food

The International Organisation of Securities Commissions (IOSCO) released principles for regulation and supervision of commodity derivatives markets last week. Effective supervision of these markets is necessary to avoid even the prospect that derivatives contribute to speculative price bubbles in commodities, which can increase the number of people driven into hunger.

According to the Food and Agriculture Organisation (FAO) of the United Nations, a further 40 million people were pushed into hunger in 2008, primarily due to higher food prices. The total number of undernourished people in the world that year was 963 million.

Not only have food prices been high, they have been volatile.

According to the FAO, by mid-2008 international food prices had skyrocketed to their highest level in 30 years.

Food prices rose above that peak in December last year; then in March this year the FAO food price index dropped for the first time, after eight months of continual price spikes. The FAO predicts that food prices will likely remain volatile.

While there is no doubt the rise in food prices involves a lot of moving parts – including market fundamentals such as the supply and demand for food commodities and transportation and storage costs – there is evidence to show a speculative bubble caused by commodities derivatives also played a role.

In a September 2010 briefing note, Olivier De Schutter, UN special rapporteur on the right to food, said a number of signs indicated that a significant proportion of the price spike was due to the emergence of a speculative bubble.

“Prices for a number of commodities fluctuated too widely within such limited time frames for such price behaviour to have been a result of movements in supply and demand: wheat prices for instance rose by 46 per cent between January 10 and February 26, 2008, fell back almost completely by May 19, increased again by 21 per cent until early June, and began falling again from August,” he said.

Food price volatility has also been the focus of a report coordinated by the FAO and OECD, in response to a request in November from the G20 on how to better mitigate and manage the risks associated with the price volatility of food and other agricultural commodities.

The report recognises the disagreement about the role of financial speculation as a driver of agricultural commodity price increases and volatility. But it does say that “increased participation by non-commercial actors such as index funds, swap dealers and money managers in financial markets probably acted to amplify short-term price swings and could have contributed to the formation of price bubbles in some situations”.

The inter-agency report says for agricultural commodity derivatives markets to function well, appropriate regulation needs to be in place across all relevant futures exchanges and markets.

The UN’s rapporteur, De Schutter, also advises that reforming the global financial system should be seen as part of the agenda to achieve food security, particularly within poor net food-importing countries.

In the US, the Dodd-Frank Act sets out a new section, which, among other things, requires the Commodities Futures Trading Commission to establish limits on the number of agricultural commodities that can be held by any one trader. But the EU has been less prescriptive.

Now these reports, combined with the IOSCO, provide some real, practical, evidence-based guidance for policy makers and regulators.

In his briefing note, Food Commodities Speculation and Food Price Crises: Regulation to reduce the risks of price volatility, De Schutter outlined steps to prevent improper speculation in the commodities derivatives market. They include:

  • Regulators distinguishing between traders hedging against genuine commercial risks and non-traditional, market momentum-based speculators interested simply in making gains on price changes.
  • Regulators should recognise there are fundamental conceptual differences between commodity derivatives and financial derivatives. They should not be treated as belonging to the same category of instruments.
  • Once the distinction is made, access to commodities derivatives markets could be restricted to traders and specialist brokers.

The principles that IOSCO released also address the G20’s request for further work on regulation and supervision of physical commodity derivatives markets, and aim to ensure a globally-consistent approach to the oversight of commodity derivatives markets to deliver effective supervision, combat market manipulation and improve price transparency.

The principles update and add to the guidance in the 1997 Tokyo Communiqué and respond to contemporary trends in commodity derivatives markets.

These trends include: the scale, speed and cross-border nature of trading on markets; novel forms of market abuse; investors’ focus on commodities as an asset class and the impact of new investor classes and futures trading on physical commodity prices; the rapidly evolving regulation of OTC derivatives markets; and regulation of market participants.

The principles address the following areas:

  • Design of physical commodity derivatives contracts – focused on establishing design concepts for futures contracts.
  • Surveillance of commodity derivatives markets – including the basic framework for surveillance, powers needed to access information for both on-exchange, OTC, and cash market transactions, emphasising the importance of monitoring large positions.
  • Disorderly markets – sets out the powers needed by market authorities to intervene in the markets to address disorderly conditions.
  • Enforcement and information sharing – addresses the basic framework for a successful enforcement program, including required powers.
  • Enhancing price discovery and transparency – how to improve this to the public and regulators through the publication of open interest according to certain categories of traders; the establishment of formalised systems to allow regulators to impose position limits; and the promotion of the reporting of OTC derivatives to trade repositories.
© Copyright: Whole articles from this website and newsletter cannot be reproduced without permission from the editor. If you wish to publish introductions to any article please ensure that it links to original content site, and that it shows clear attribution to, plus author name and date. Failure to abide by this request will be considered a breach of copyright and legal action will be taken.

  • Filter:
  • News

    Intelligence on up to the minute items from around the globe

  • Investor Profile

    Behind the scenes summary of large institutional investors’ investment strategy and future plans

  • In Conversation

    Candid conversation with the leading investment experts

  • Analysis

    An in-depth examination of the latest investment trends and ideas

  • Insider

    An editorial perspective on what affects the people and processes in this industry

  • Research

    Cutting edge academic and practitioner insight

Beyond divestment

While divestment is a useful tool to communicate concerns of climate risk to stakeholders, it ... [more]

Investors need to rethink operating model

A neat little story of investment flows, asset allocation changes, and relationship and service demands ... [more]

The power of technology: forward looking risk tools

The finance industry is slow in its willingness to innovate around technology, and is behind ... [more]

Focusing on the long term: a guide

Investors say they  like to, and want to, focus on the long term, but they ... [more]

The volatility effect: lower risk without lower return

Efficient markets theory has been challenged by the finding that relatively simple investment strategies are ... [more]

Why consultants can’t pick winners

A research paper that concludes that the funds recommended to institutional investors by investment consultant ... [more]

What would Keynes do?

What would Keynes’ do? Delegates at a London investment think-tank discussed this question with Cambridge ... [more]

Hedge funds: sheep in wolves’ clothing

Hedge funds are sheep in wolves’ clothing, they are claiming their returns to be alpha, ... [more]

London investment think-tank

Investment professionals from pension funds, endowments and family offices in the UK and Europe were ... [more]