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Home > Blogs > Ian Fraser > Debate on commodities speculation turns ugly

Debate on commodities speculation turns ugly

Finance Blogger: Ian Fraser Ian Fraser

A row is building in Europe about whether commodities speculation is good or bad for the economy.

In the blue corner the Nice-based Edhec-Risk Institute, which is closely aligned to the  asset management sector and is responsible for a number of indices of risk and investment performance. In the red corner is Finance Watch, a Brussels-based lobby group which aims to ensure the voice of ‘end investors’ is heard in the corridors of Brussels when legislation covering finance is being developed

The report that Edhec-Risk is particularly eager to knock back is “Investing not Betting”, published by Finance Watch in April in response to the EU’s MiFID2 (Markets in Financial Instruments Directive 2) consultation.

The 'Investing not Betting' paper alleges that financial markets have lost sight of their fundamental purpose and that these failures are eroding MiFID's core objective – which is to support economic growth by supplementing bank lending with more market-based financing. The 'Investing not Betting' paper argues that markets need regulatory "incentives" to ensure that, instead of solely focused on short-term profit maximization, they are also capable of delivering other benefits including efficient allocation of resources, the avoidance of spurious asset-price bubbles, and greater financial stability.

In 'Investing not Betting' Finance Watch makes it pretty clear that it sees unconstrained betting on commodities prices via derivatives as detrimental to the wider economy and society. It says:

“A market dominated by speculation quickly becomes divorced from economic activity, burdening society with a poor allocation of resources ….  aggressive speculative behaviour takes away liquidity from other market participants ... Excessive commodity speculation raises prices artificially and damages the market for real buyers and sellers. Financial products linked to commodities are proven to raise commodity prices to artificially high levels, harming consumers everywhere and the poorest most of all. They also hamper the normal functioning of commodity derivative markets so that natural buyers and sellers of commodities cannot hedge their exposures as effectively.

But Edhec-Risk Institute is having nothing of this. In a paper titled “Who Sank the Boat?”, the Nice-based institute seeks to rubbish Finance Watch’s claims, one by one. Edhec-Risk research associate Hilary Till writes:

“Modern commodity futures markets are the result of 160 years of trial-and-error efforts. One result has been the creation of an effective price discovery process, which in turn assists in the coordination of individual efforts globally in dynamically matching current production decisions with future consumption needs in commodities.

“Before performing surgery on these institutions, we suggest that Finance Watch’s supporters tread carefully and not adopt “speculative” regulatory proposals whose ultimate effects are unknown. We recommend that EU policymakers instead consider studying market practices globally and then adopt what is demonstrably best practice, rather than invent new untested regulations.”

Edhec-Risk accepts Finance Watch’s concerns about food and oil price spikes are "fully justified", but doubts whether restricting speculation would do anything to prevent them. It argues that the Brussels-based lobby group's proposals "fall somewhere in the continuum of being a placebo to actually being harmful to the goals to which they aspire."

Noël Amenc, director of the Edhec-Risk Institute is opposed to the “scapegoating” bankers and financial speculators for the crisis. Writing on the institute’s website in May 2012, Amenc said there is “no evidence that speculation is a cause of high levels of volatility in commodity prices.” He added that the only academic work to support that view was “has not been the object of any serious publication and corresponds more to a report of convenience with predetermined conclusions than a genuine scientific enquiry.” He added:

“Derivatives markets require speculators in order to be liquid and efficient, and derivatives ultimately help towards better management of the risk of commodity price variations. Derivatives are not the problem but are part of the solution. The answer to food price volatility is not to prosecute or block markets, but to use them better …”

So quite a divergence of views here. Maybe I am biassed but there's also something vaguely specious, and defensive of vested interests, about the institute's riposte, especially when one considers what Hernando de Soto said about the global derivatives market in Staying in the Dark about Derivatives Will Bring Economic Collapse.

For the record, Finance Watch's seven proposals for reining in what it considers to be unwarranted speculation in commodities markets are spelt out in on pages 38-47 of the "Investing not Betting" paper (PDF of full document). They are are as follows:

(1) Implement a European consolidated regulatory position reporting system, including positions resulting from OTC and regulated trading of commodities and commodity derivatives.

(2) Define hedging positions - objectively reducing risk directly relating to commercial activities - as opposed to speculative positions.

(3) Define and implement ex-ante individual limits on speculative positions on commodity derivatives markets (resulting from a transaction executed OTC or on a regulated venue), as a percentage of the total market – e.g. 2.5%, as a means to have at least 40 market participants, limiting the risk of market abuse.

(4) Define and implement ex-ante market limits on speculative positions on commodity derivatives markets (resulting from a transaction executed OTC or on a regulated venue), as a percentage of the total market – e.g. 30% as a means to protect the hedging function and the quality of the price formation mechanism of these markets from the detrimental effect of excessive speculation.

(5) Limits (individual and market) must apply for all months of the contract (not just the spot month) and to both cash- and physically-settled contracts.

(6) Position management arrangements have failed to prevent market abuse and do not have the purpose of limiting speculation. They are thus an inadequate alternative to position limits. However, used along side limits, it may provide regulators with an additional tool with which to oversee the markets.

(7) Prohibit all financial products offering commodity index replication.


As I said  in Fear and loathing in London as Barnier taps consumer power on April 4, Finance Watch has been welcomed by the EU internal market commissioner Michel Barnier, especially given that the European Commission is widely considered to have been "captured" by neoliberal finance sector lobbyists when Irishman Charlie McCreevy was in charge.

More on commodities market speculation, derivatives and hedge funds:




Tags: agri-commodities , asset bubbles , asset price bubbles , betting , capital allocation , Charlie McCreevy , commodities , derivatives , EDHEC Risk Institute , European Commission , European Union , Finance Watch , financial crisis , financial stability , food price volatility , food prices , hedge funds , Hilary Till , investment , Michel Barnier , MiFID , Noël Amenc , oil price , OTC derivatives , soft commodities
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  1. hchow says:
    Sat Jun 30 00:01:00 BST 2012

    I would like to respond to a couple of the quotes from Edhec-Risk in this article: “...we suggest that Finance Watch’s supporters tread carefully and not adopt “speculative” regulatory proposals whose ultimate effects are unknown. We recommend that EU policymakers instead consider studying market practices globally and then adopt what is demonstrably best practice, rather than invent new untested regulations." Far from being 'new and untested', position limits (points 3 and 4 on Financewatch's list of proposals)– which would cap the amount of contracts that traders in commodity derivative markets can hold –were used to effectively regulate the commodity derivative markets in the US for most of the twentieth century. Their removal in the 1990s coincided with the start of the growth in excessive financial speculation as well as food price volatility. Position limits are the norm in commodity markets across the world and are currently being reintroduced in the US through Dodd-Frank. Not only has position limits been historically proven but they also commonly practiced. Indeed failure to adopt equivalent regulation in Europe would risk international regulatory arbitrage. “Derivatives markets require speculators in order to be liquid and efficient, and derivatives ultimately help towards better management of the risk of commodity price variations. Derivatives are not the problem but are part of the solution. The answer to food price volatility is not to prosecute or block markets, but to use them better …” A certain level of liquidity is necessary in the commodity derivative markets to ensure that there is always someone willing to take the other side of a contract of those who are genuinely hedging commercial risk. However, the markets are now experiencing levels of liquidity far beyond what is necessary to facilitate commercial hedging. Financial speculators now dominate the market, holding over 60 per cent of some markets compared to just 12 per cent 15 years ago. Excessive levels of liquidity are actually disrupting and distorting the market, leaving prices to fluctuate away from fundaments, thereby undermining their ability to fulfil their basic intended functions of hedging and price discovery. This article begins by asking whether commodity speculation is good or bad for the economy. I've already argued that a level of speculation is required to meet the needs of genuine hedgers however we have seen excessive levels of speculation since deregulation from the 1990s onwards. Excessive speculation on food does not benefit consumers or producers and instead impacts the poorest, the hardest and destabilises the wider economy through introducing inflationary pressures. In fact the only advantages of excessive speculation accrue to the banks who profit from it. There is a general consensus in the evidence that speculation affects food prices and in the EU, policy makers have to follow the precautionary principle: where activities lead to morally unacceptable harm, which is plausible but uncertain, action should be taken to avoid or diminish that harm. After all, we are talking about food here – a basic need of every person and not something that should gambled on just to line the pockets of a few.

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