Institute for Agriculture and Trade Policy
Theme 1: Financial regulation
Perhaps the least regulated of all financial markets are commodity exchanges, which primarily trade price risk management instruments, rather than commodities. In U.S. commodity exchanges, perhaps just 7 percent of all futures and options contracts result in a commodity delivery. Government and private sector agricultural, mineral and energy investments and planning are determined with reference to global commodity prices. When speculation becomes excessive relative to the liquidity needs of hedgers in physical commodities, the resulting price volatility can frustrate ex ante rate of return analysis and paralyze investment.
The market power of private Over the Counter (OTC) trades in commodities derivatives has created a “shadow” commodities system whose trading data are not reported to regulatory authorities. Extreme price volatility resulting partly from regulatory failure has had devastating affects on food and energy security around the world.(http://agriculture.house.gov/testimony/111/h020409/Masters.pdf) Nevertheless, for firms that can induce and profit from price volatility, commodities speculation instruments are enormously profitable, and hence the incentive for traders to circumvent regulation is very high. For example, an estimated third of all net income for Goldman Sachs in 2008, some $1.5 billion, came from commodities trades.(http://online.wsj.com/article/SB122705339535539245.html)
IATP has published a short report on commodities speculative instruments and U.S. legislation that would reduce the amount of and opportunity for excessive speculation in commodity exchanges. ( http://www.iatp.org/iatp/publications.cfm?accountID=451&refID=104414). The report also considers the possibility of multilateral rules on commodities derivatives. We have submitted invited testimony (http://www.agobservatory.org/library.cfm?refid=105090) to a U.S. congressional hearing on a later version of that legislation. (http://agriculture.house.gov/inside/Legislation/111/HR977.pdf) The Committee’s analysis of the effects of excessive speculation on the U.S. agricultural system and of U.S. commodity exchange legislation may yield some lessons for broader jurisdictions of financial regulation. Extreme price volatility induced by excessive speculation is only one factor in the commodities price spike that induced food riots and energy shortages in 2007 and the first half of 2008. Better regulation of commodities exchanges alone will not ensure more stable and remunerative commodity prices. Public management of commodities stocks and tough enforceable trade disciplines on the dumping of commodities at below cost of production are other policy tools needed to stabilize prices for investment and planning. However, improvements in supply chain management and trade policy will be readily undermined by the induced price volatility of weakly regulated commodity exchanges. Here are 4 issues for the Committee of Experts to consider.
1. OTC trades of both commodities and financial derivatives form part of the mammoth “dark pools” of private and unregulated investments. Since OTC trades strongly influence prices in public exchanges, OTC trading data should be reported completely and promptly in all jurisdictions, so regulators can act promptly when traders exceed speculative position limits. Position limits should apply equally to all market participants, lest exemptions, exclusions and waivers for favored financial institutions result in financial institutions “too big to fail.”
2. “Self -regulation has failed,” wrote Alan Greenspan, former U.S. Federal Reserve Bank Chairman. Nevertheless, finance services industry “reformers” still advocate self-regulation, e.g. allowing commodity exchanges to enforce violations of trading rules. The General Assembly should affirm the authority of governments to enforce compliance with all financial market rules, including those of commodity exchanges.
3. During the FfD discussions, the “Tobin Tax” on financial market transactions was proposed as a means for creating a development fund. A Tobin variant could applied to commodities speculation, both to reduce the sometimes minute to minute trading that drives excessive speculation and to partly finance commodity exchange regulatory authorities.
4. Commodity index funds bundle up to 24 agricultural, energy, base and precious metal commodities. Agricultural commodities, the minor part of these funds, are subject to price swings driven by energy and mineral prices, endangering food security. The Committee should consider whether, in the absence of effective regulation, the funds should be banned. Fund trading at least should be subject to “circuit breakers” whenever extreme volatility impedes food security.
Theme 2: Multilateral issues
In responding to “financial regulation", we urged the Committee of Expert to analyze commodity exchanges as financial markets urgently requiring regulation. Because of the global market reach of commodities exchanges, regulation of these financial markets entails activities of multilateral institutions. These institutions include:
International Monetary Fund
At the Annual Meetings of the IMF and World Bank in October 2008, more than one banker commented publicly on the spectacular failure of the IMF as a macro-economic and financial regulator. Several rich country members of the IMF have refused to allow an IMF audit of their own financial houses, thus impeding analysis and corrective action, including that for commodity exchanges. In 2004, U.S. authorities waived the capital reserve requirements for the biggest commodity index players (Goldman Sachs, Morgan Stanley, Lehman Brothers, etc.), freeing up billions of dollars for speculation and then allowed them to build up unsustainable debt to equity (e.g. 30:1) ratios. Since national authorities are sometimes unable or unwilling to regulate excessive speculation and other symptoms of an unsustainable macro-economic order, the General Assembly should urge the IMF to review the financial regulatory policies and enforcement capacity of all its members. If the IMF, fails to audit rich country financial policy and regulation, it should at least report on specific regulatory causes of balance of payment problems, particularly for commodity export dependent developing countries.
World Trade Organization
As national authorities try to regulate the financial services industry, financial institutions may ask authorities to review government commitments to the 1997 Financial Services Agreement of the General Agreement on Trade in Services (GATS). The proposals of the GATS Working Party on Domestic Regulations, if agreed by WTO members, likely will add to the burden of proof for governments to justify the “necessity” of regulations under the GATS.(http://www.tradeobservatory.org/library.cfm?refID=103596)The Committee of Experts should review whether proposed financial institutional reforms violate the GATS and if so, propose how the GATS may be changed to enable WTO members to ensure prudent regulation of all financial services.
UN Conference on Trade and Development (UNCTAD)
UNCTAD staff economists and consultants forewarned member governments over the lack of institutional reform following the 1997 financial services debacle in East Asia. But mandate and budget reductions marginalized UNCTAD as the global financial crisis unfolded. As extreme price volatility seized commodity markets and sent food and energy import bills to record heights, UNCTAD was hampered in using its commodities expertise to undertake a full study of commodity exchange operations and regulation worldwide. We urge the Committee to provide guidelines for a General Assembly resolution to call for such a major study. Among the possible uses of such a study would be to prepare a Model Regime for Commodities Exchange Regulation and/or a multilateral Code of Practice for commodities exchange regulation.
UN Task Force on the Global Food Crisis
The current Task Force report contains only a slight and tentative reference concerning the relation of commodities speculation to the food crisis. The Committee should consider recommending to the General Assembly that the Task Force initiate a civil society consultation to try to determine the extent to which commodities speculation affected agricultural commodity and retail food prices, taking into account the energy price factor of food production and distribution.
UN Framework Convention on Climate Change (UN Environmental Program)
The capping and trading of Green House Gas emission credits on commodity exchanges has been touted as a “market-oriented” way of meeting GHG commitments to the Kyoto Protocol. Governments are preparing for the Conference of Parties to the Framework Convention to consider whether negotiations should revise the cap and trade schemes or adopt an alternative mechanism for reducing GHG. Part of this discussion may concern how a market in “climate derivatives” (http://www.rybinski.eu/index.php?ta...) on cap and trade emissions credits may affect GHG emissions under current and reformed regulatory practice scenarios. The Committee may wish to review critiques of traditional cost and benefit analysis (http://www.progressivereform.org/ar...), particularly those regarding climate change, (e.g. http://www.nrdc.org/globalwarming/c...) in light of the financial regulatory failures that are partly due to the cost-benefit framework of regulatory economics.
IATP thanks the Commission for its work and stands ready to answer any questions it may have about our submissions to the consultation.