Mumbai: Soaring prices of a range of commodities — food, energy, metals — have generated a lot of heated debate around the world. Governments are keen to rein in galloping prices and their inability to do so is causing disaffection among the people. The desirability of stubbornly pursuing policies of neo-liberalism is being questioned, especially because the market economy has failed to ensure growth with equity.
In India, too, commodity futures trading has attracted political and commercial attention. The one-point agenda of those in favour of such trading seems to be to expand the number of market participants, augment flow of funds into the market and raise trading volumes. In other words, nothing else really matters.
Greater role
If realised, it is certain to bring tremendous gains to one community — the brokers; and it will also help improve the valuation of some commodity exchanges. Promoters of exchanges are keen to quickly raise the valuations and exit by selling their share. Some have already done so; and others are waiting.
No wonder, commodity traders, the exchanges and even the market regulator are all pushing for greater role for banks, mutual funds and foreign institutional investors in the commodity futures market with the argument that such a move alone will improve liquidity and help discover correct prices.
Belief is now gaining ground that far from bringing any real benefit to primary producers and consumers, allowing those with no genuine interest in the underlying can actually distort the market and thwart the process of genuine price discovery.
Operational weaknesses
Recent developments in the US — the champion of free trade — have further reinforced the view that the role of institutional investors needs to be limited. Indeed, the internal working of the market regulator Commodity Futures Trading Commission (CFTC) is under review and the agency’s operational weaknesses are being identified for rectification.
According to reports, Senator Joseph Lieberman (I-Conn), chairman of the Senate Homeland Security and Government Affairs Committee, said at a hearing recently that he will consider drafting an outline of legislation that would limit the role of institutional investors in commodity markets. He seeks to close what he calls a loophole that allows large investors to circumvent commodity positing limits.
This unbridled growth raises justifiable concerns that speculative demand — divorced from market realities — is driving food and energy price inflation, and causing a lot of human suffering, Lieberman said.
Swap Agreement
The so-called swaps loophole exempts investment banks from reporting requirements and limits on trading positions that are required of other investors. The loophole allows pension funds to enter into a swap agreement with an investment bank, which can then trade unlimited numbers of the contracts in futures markets.
Lieberman said at the end of the hearing, he has concluded that index speculators are responsible for a significant part of commodity price increases that are really hurting a lot of individuals [and] a lot of businesses, and we ought to see if we can do something about that. Lieberman said he will convene another panel of witnesses to examine how to close the swaps loophole, among other ideas for reform, some of which are included in the Consumer First Energy Act of 2008 proposed on May 7 by a group of Senate Democrats.
The excess volatility in recent months in the agricultural commodity futures markets has prompted the CFTC to take several new initiatives in the near future including and importantly improving the oversight of large financial participants such as the hedge funds.
The lack of convergence of the spot market prices with the futures market prices is another area of deep concern. In the absence of such convergence, both producers and consumers are at a loss to know what the real price for the commodity should be.
Domain knowledge
Clearly, even in the US, questions are being raised about the functioning of the market, and systems and practices followed are being questioned. One can well imagine how rudimentary Indian markets are and how poorly they are regulated. In the absence of adequate domain knowledge, the regulatory authority runs the risk of falling prey to glib presentations about the health of the market from those whose only aim is to push trading volumes higher.
Meanwhile, CFTC chief economist has denied that institutional investors were responsible for rising commodity prices, or that excessive speculation exists in those markets. Fundamental factors of demand and supply drive the market up, according to him. However, others have pointed out that even though fundamental factors are important, they cannot explain the phenomenal price rises in recent years.
Urgent need
Opposition to large inflow of funds into a market that was originally meant essentially for commodity producers, consumers and traders to benefit from — in terms of price discovery and price risk management — has once again brought to the fore the urgent need to review the policies relating to this market.
Futures trading has ceased to be genuine hedging mechanism and has become an avenue for investment of funds. With commodities emerging as an asset class, the original intention of starting this market stands defeated.
The benefit to primary producers and large consumers has become suspect. A serious rethink on functioning of the market and making it genuinely work for the stakeholders has assumed great urgency.
In India, too, commodity futures trading has attracted political and commercial attention. The one-point agenda of those in favour of such trading seems to be to expand the number of market participants, augment flow of funds into the market and raise trading volumes. In other words, nothing else really matters.
Greater role
If realised, it is certain to bring tremendous gains to one community — the brokers; and it will also help improve the valuation of some commodity exchanges. Promoters of exchanges are keen to quickly raise the valuations and exit by selling their share. Some have already done so; and others are waiting.
No wonder, commodity traders, the exchanges and even the market regulator are all pushing for greater role for banks, mutual funds and foreign institutional investors in the commodity futures market with the argument that such a move alone will improve liquidity and help discover correct prices.
Belief is now gaining ground that far from bringing any real benefit to primary producers and consumers, allowing those with no genuine interest in the underlying can actually distort the market and thwart the process of genuine price discovery.
Operational weaknesses
Recent developments in the US — the champion of free trade — have further reinforced the view that the role of institutional investors needs to be limited. Indeed, the internal working of the market regulator Commodity Futures Trading Commission (CFTC) is under review and the agency’s operational weaknesses are being identified for rectification.
According to reports, Senator Joseph Lieberman (I-Conn), chairman of the Senate Homeland Security and Government Affairs Committee, said at a hearing recently that he will consider drafting an outline of legislation that would limit the role of institutional investors in commodity markets. He seeks to close what he calls a loophole that allows large investors to circumvent commodity positing limits.
This unbridled growth raises justifiable concerns that speculative demand — divorced from market realities — is driving food and energy price inflation, and causing a lot of human suffering, Lieberman said.
Swap Agreement
The so-called swaps loophole exempts investment banks from reporting requirements and limits on trading positions that are required of other investors. The loophole allows pension funds to enter into a swap agreement with an investment bank, which can then trade unlimited numbers of the contracts in futures markets.
Lieberman said at the end of the hearing, he has concluded that index speculators are responsible for a significant part of commodity price increases that are really hurting a lot of individuals [and] a lot of businesses, and we ought to see if we can do something about that. Lieberman said he will convene another panel of witnesses to examine how to close the swaps loophole, among other ideas for reform, some of which are included in the Consumer First Energy Act of 2008 proposed on May 7 by a group of Senate Democrats.
The excess volatility in recent months in the agricultural commodity futures markets has prompted the CFTC to take several new initiatives in the near future including and importantly improving the oversight of large financial participants such as the hedge funds.
The lack of convergence of the spot market prices with the futures market prices is another area of deep concern. In the absence of such convergence, both producers and consumers are at a loss to know what the real price for the commodity should be.
Domain knowledge
Clearly, even in the US, questions are being raised about the functioning of the market, and systems and practices followed are being questioned. One can well imagine how rudimentary Indian markets are and how poorly they are regulated. In the absence of adequate domain knowledge, the regulatory authority runs the risk of falling prey to glib presentations about the health of the market from those whose only aim is to push trading volumes higher.
Meanwhile, CFTC chief economist has denied that institutional investors were responsible for rising commodity prices, or that excessive speculation exists in those markets. Fundamental factors of demand and supply drive the market up, according to him. However, others have pointed out that even though fundamental factors are important, they cannot explain the phenomenal price rises in recent years.
Urgent need
Opposition to large inflow of funds into a market that was originally meant essentially for commodity producers, consumers and traders to benefit from — in terms of price discovery and price risk management — has once again brought to the fore the urgent need to review the policies relating to this market.
Futures trading has ceased to be genuine hedging mechanism and has become an avenue for investment of funds. With commodities emerging as an asset class, the original intention of starting this market stands defeated.
The benefit to primary producers and large consumers has become suspect. A serious rethink on functioning of the market and making it genuinely work for the stakeholders has assumed great urgency.
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