Uncontrolled speculation on agricultural commodities does not seem to have diminished since 2008. Nonetheless, governments and NGOs are increasingly more aware of the ravages caused by all-out liberalization dominated by erratic changes in world agricultural prices. Accordingly, in late July 2013, France finally adopted a law for the regulation and separation of banking activities. This law prohibits banks from speculating on agricultural commodity derivatives in order combat market speculation.
But victory against market manipulation and abuse is far from assured, particularly with regards Asian and Anglo-Saxon banks and trading companies. If speculation continues, fuelled by excess liquidity in relation to what is required in return for physical sales for which we want to guarantee prices, as recently pointed out by momagri Chief Economist Bertrand Munier1
, it is not a case of “the good guys on one side and the bad guys on the other." "Firstly there is ‘useful’ speculation: natural speculation that should not exceed three to four times the global harvest. Then there is ‘excessive’ speculation."
We recommend reading the article by C2A edited by Coordination Sud2
, of which we have published the extracts below. The author addresses the specificity of the agricultural sector and the development of pure speculative behaviour, uncorrelated to economic and strategic market fundamentals, and warns of the dangers of deregulated markets in a globalized world.
Though initiatives have been taken with regards regulation, particularly those of the CFTC, comprehensive financial reform is urgent if we want to establish transparent agricultural markets and adopt efficient control mechanisms.
momagri editorial Board
In theory, financial markets should secure the functioning of food markets
To speculate is to bet on the future development of a financial market in the aim of making profits, particularly on financial markets (futures). Trading does not generally lead to the transaction of physical goods but consists of the purchase and sale of “papers.” Therefore they conflict with physical markets, where physical goods are exchanged for money. You can speculate on financial, monetary and merchant assets, but also on derivatives.
Initially, the market for agricultural derivatives was supposed to play a positive role on food markets whose prices are structurally volatile. Indeed, agriculture is unpredictable as it is particularly vulnerable to climate and production variations.
In addition, the demand for food is inelastic: other products cannot substitute food. In this context, financial markets theoretically play a critical role in the trade of agricultural commodities.
- They should allow market participants to cover the risks inherent to agriculture. This way they allow both contracting parties to anticipate their future costs and revenues by guaranteeing the price of agricultural commodities at a fixed date at a predetermined price.
In reality, the extreme financialisation of agricultural markets exacerbates global food insecurity
- They should also facilitate price definition. Indeed, the prices of commodity futures contracts represent a reference price for the physical trade and serve as guidance when negotiating the sale or purchase prices.
- They should also facilitate markets. Naturally, agricultural markets are subject to wide price fluctuations because the purchase and sale of agricultural products are "wholesale" and take place during harvest, so just once, or a few times a year. Because they occur throughout the year, the purchase and sale of derivatives on agricultural commodities streamline the liquidity in financial markets and physical agricultural markets.
Today, agricultural and food markets are being dramatically financialised, and financial markets no longer play the role of securing physical markets.
Investment in agricultural derivatives has exploded since the early 2000s, because it lets financial operators diversify their investment portfolio and minimize risk. Many institutional investors now therefore include derivatives in raw materials in their equity portfolios, while the major investment banks routinely advise their clients to invest 5-10% of their portfolio in commodities.
The importance of financial operators in the agricultural derivatives market is becoming much greater. On the Commodity Exchange in Chicago, financial speculators now occupy 65% of the market, compared to only 12% in 1996. In the end, less than 3% of futures contracts on commodities actually result in the delivery of a commodity. The remaining 97% are resold by speculators before their expiration date. Consequently, speculative activities do not have any connection with the physical markets. This financialisation and excessive speculation accentuate the volatility of agricultural prices:
- Financial markets no longer serve their function for price formation. Financiers are insensitive to changes in supply and demand of food items in the physical markets. Their positions are independent of the characteristics of physical markets and the reality of stocks, and add to the actual demand.
This means that high prices can therefore be formed in a situation of abundant food, which leads to situations of food insecurity in the South, along with profits for speculators.
- Financial markets are no longer used to provide cover for agriculture’s inherent risks. The higher the prices, the more the collateral and acquisition costs of a future increase: the amount increased by 300% between 2006 and 2008. In developing countries, small farmers are forced to borrow to cover agricultural risks, making them more vulnerable to price volatility.
Who benefits from the financialisation of agricultural markets?
This extreme financialisation of agricultural markets benefits financial operators and large commodity traders who speculate on both physical markets and futures markets. By participating in raising food prices, they make food inaccessible to the poorest and accumulate profits. In 2009, Goldman Sachs earned $5 billion through trade in agricultural products. In 2011, Barclays Capital obtained $550 million and JP Morgan expected to earn $1.2 billion.
French banks also have fared well by speculating. In November 2012, the main French banks managed at least 18 funds that speculate in raw materials, almost all of which were index funds.
Their total value is €2,583 million. This figure is relatively low when compared with the total value of index funds managed by German banks for example, which amounted to €11,385 million, but this trend is worrying. Indeed, the vast majority of these funds were created after the food crisis of 2008, with the clear objective of increasing speculation on commodities, and making even more profit on agricultural markets.
As for the agricultural commodity multinationals - the top four are Archer Daniels Midland, Bunge, Cargill and Louis Dreyfus - they take advantage of this situation because they are exempt from position limits on financial markets because of their position as “commercial actor” in the physical markets. This position in the physical markets also gives them access to information that most financial players do not have.
Their speculative activities are skyrocketing; traders also openly admit they derive financial benefit from this additional information. They have created investment funds for speculators: in 2010 Cargill’s Black River Asset Management managed $4.5 billion of financial assets, and Louis Dreyfus Commodities Alpha Fund managed $2 billion of financial assets, with a return on investment of 17.3%.
How can agricultural markets be effectively regulated?
Position limits are a particularly effective tool for regulating derivatives markets. They impose a cap on financial players for the number of contracts on a given raw material at a given time, and are used to regulate the derivatives markets in most major countries around the world (Japan, China, Australia, Africa South, etc.). In the United States, they were used during most of the twentieth century. Their removal in the 1990s coincided with the hyper financialisation process of derivatives markets and caused major price distortions in agricultural markets. They were reintroduced in 2010 when President Obama approved the “Dodd-Frank Wall Street Reform and Consumer Protection Act.”
In Europe, the reform of the Markets in Financial Instruments Directive (MIFID) is being negotiated and should allow the introduction of position limits for speculative activities in derivatives markets for commodities. The debate is complicated by the position of some Member States such as the UK. However, France has made a significant step forward, which will likely strengthen its negotiating position in Brussels.
Beginning 2013, three elements were added by parliamentarians to the initial banking reform plan proposed by the government:
- From 1st July 2015, the Financial Markets Authority (FMA) will impose position limits on financial instruments for any underlying agricultural commodity a person is allowed to hold.
- From the formal adoption of the legislation, any person holding financial instruments for an underlying agricultural commodity will communicate daily details of its positions to the FMA.
- The Financial Markets Authority, meanwhile, will publish a weekly report presenting the aggregated positions of the various categories of persons holding financial instruments for underlying agricultural commodity positions.
The regulation of physical markets which enables southern countries to protect their agricultural markets is also necessary to support family farmers and peasant farmers, the only way of ensuring food security for current and future generations.
2 Retrouvez l’intégralité de l’article en suivant ce lien http://www.coordinationsud.org/wp-content/uploads/Les-Notes-de-la-C2A-N%C2%B013-financiarisation1.pdf