Written evidence submitted by the World
Development Movement
EXECUTIVE SUMMARY
The financial reform consultation does not provide
a clear mandate or mission for the regulation of commodity derivatives.
The underregulation of these products has contributed to excessive
volatility in commodity prices for end-users, hurting domestic
commercial and consumer interests as well as undermining international
development goals. WDM recommends charging the new Consumer Protection
and Markets Authority with regulating commodity derivatives trades
in order to reduce excessive speculation, price volatility and
counterparty risk.
1. The World Development Movement (WDM)
is a UK campaigning organisation which tackles the root causes
of poverty. WDM is a democratic membership organisation with 15,000
supporters and 60 local groups. We lobby governments and companies
to change policies that keep people poor.
2. WDM shares the Treasury's aim of promoting
"confidence in stability, integrity and efficiency of financial
markets". However, in this regard we have been surprised
and dismayed by the considerable gap within the Treasury report
around the legislative and regulatory standards governing derivatives
trading in general, and the trade in commodity futures derivatives
in particular.
3. The consultation document briefly mentions
that Over-The- Counter (OTC) financial markets, exchanges and
other trading platforms will be regulated by the Consumer Protection
and Markets Authority (CPMA) and that investment banks will be
monitored by the Prudential Regulation Authority (PRA). However,
the regulation of commodity derivatives is not specifically addressed
within the remits of the proposed agencies. This means there is
no improvement upon the current situation in which the FSA, which
is nominally responsible, does "not have dedicated rules
for commodities and commodity derivatives markets. Rather, its
regulation of commodities markets is derived from several different
regimes and its overall approach combines these."i
4. The regulation of commodities derivatives
must be addressed specifically as these markets have clear and
immediate impacts on spot markets, and therefore on both direct
consumer and commercial buyer prices in the UK. Recent food inflation
and rising input costs for food manufacturers, hauliers, and aviation
companies—driven in part by financial speculation on commodity
derivatives—is damaging for the entire UK economy, especially
at a time of fragile growth.
5. As an organisation primarily concerned
with international poverty issues, we are in particular concerned
that commodity trading must be regulated to reduce volatility
in food prices and ensure that the patterns of the global food
prices in 2007-08 are not repeated. According to the World Bank,
the 2007-08 food price spike resulted in the number of people
in extreme poverty increasing by 20 million. ii
6. Research by the World Bankiii, the UN
Special Rapporteur on the Right to Foodiv, UN Conference on Trade,
Aid and Developmentv, and the World Development Movementvi demonstrate
the central role of financial investors in the 2007-08 world food
crisis. As outlined by these reports, it is evident that the increase
in food prices in 2007-08 was due to the financialisation of commodity
markets. For example, the World Bank stated that:
"commodity related activity on the financial
side can induce higher price variability in the sense of exacerbating
the length and the amplitude of price cycles, as they most likely
did during the "perfect storm' of 2007-08." vii
According to an analysis for WDM by Prof Jayati
Ghosh, Chair of the Centre for Economic Studies and Planning,
Jawaharlal University:
"it is clear that the recent volatility
in world trade prices of important food items simply cannot be
explained by real demand and supply factors ... FAO data show
very clearly that there was scarcely any change in global supply
and utilisation over this period [January 2007-September 2010]."viii
7. A wave of recent reforms and discussion
in the US and EU have reshaped the future of the regulation of
commodities. The Dodd-Frank Wall Street Reform and Consumer Protection
Act in the US specifically focuses on regulating agricultural
commodities and position limits. However, effective implementation
of the Act is dependent upon countries like our own similarly
reforming regulation so as not to create a system of arbitrage
in which American money uses Europe as an underregulated offshore
haven.
8. The European Commission will be addressing
the regulation of commodity speculation during the 2011 review
of the Markets in Financial Instruments Directive. Specifically,
OTC regulation will be addressed shortly in the proposal for a
Regulation on OTC Derivatives, Central Counterparties and Trade
Repositories. It is essential that the UK government support strong
measures through reforms to these regulatory instruments in order
to create greater transparency and efficiency in these markets,
and so that effective limits can be applied to prevent financial
institutions from distorting the price of essential commodities
such as food grains or oil.
9. RECOMMENDATIONS
In order to curb systemic risk and ensure an
efficient market flow and efficient price formations, we recommend
that the CPMA be given clear responsibility for regulating both
OTC and exchange-traded commodity derivatives, with the regulatory
objectives of:
— Reducing counterparty risk, for
example through improved transparency and channelling of a vast
majority of over-the-counter deals through clearing on an exchange.
— Reducing price volatility, through
increased margin requirements for purely speculative derivatives
transactions.
— Reducing excessive speculation,
for example, through the introduction of strict position limits
on the amount of contracts that can be held by financial services
for speculative purposes (as introduced in the US Dodd-Frank Act).
4 November 2010
REFERENCESi FSA
Markets Infrastructure Department (2007), Growth in Commodity
Investment: Risks and challenges for commodity market participants.
www.fsa.gov.uk/pubs/other/commodity_invest.pdf
ii World Bank (2009).Global Economic Prospects.
Commodities at the Crossroads, p96.
iii Baffes & Haniotis, The World Bank (2010).
Placing the 2006/08 Commodity Price Boom into Perspective. http://www-wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/2010/07/21/000158349_20100721110120/Rendered/PDF/WPS5371.pdf
iv Olivier De Schutter (2010). Food Commodities
Speculation and Food Price Crisis.
http://www.srfood.org/images/stories/pdf/otherdocuments/20102309_briefing_note_02_en_ok.pdf.
v UNCTAD (2009). Trade and development report
2009. Chapter II: The financialization of commodity markets.
vi World Development Movement (2010). The Great
Hunger Lottery.
http://www.wdm.org.uk/food-speculation/great-hunger-lottery.
vii Baffes & Haniotis, The World Bank, ibid.
viii Ghosh, J. (2010). Commodity Speculation
and the Food Crisis. (Available from WDM).
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