F.A.O. said in a policy brief published June 22 the worldwide rise in food prices two years ago “might have been amplified by speculators in organized futures markets. However, limiting or banning speculative trading might do more harm than good.”
Although futures speculation appeared to have affected prices in the short-term only, efforts to reduce such speculation might have unintended, longer-term consequences, the paper said. Any limitations could “divert speculators from trading and thus lower the liquidity in the markets available for hedging purposes.”
Futures contracts involve the formal obligation to sell or buy a given amount of a commodity at a specified time and price. They provide farmers and traders with an important defense or “hedge” against price risks.
But only 2% of futures contracts actually end in the delivery of the physical commodity as they are generally traded before their expiration date. As a result, such contracts or obligations are attracting increasing numbers of financial speculators and investors, especially as they can provide attractive returns when equities and bonds may become unappealing.
Large commodity funds now hold about 25% to 35% of all agriculture futures contracts and, with other investors, have become an important source of liquidity to the market. But if prices rise too sharply, mechanisms to intervene in future markets might divert speculators from trading and thus make less money available for important hedging purposes.
“Proposals to create an international fund to react to price hikes might therefore not be an optimal solution,” the F.A.O. cautioned. “What is more, such a fund would require exorbitant resources to counteract speculation effectively.”
Regulatory measures should instead aim primarily at enhancing confidence in the good functioning of the market. The brief explained one way this could be achieved was by increasing transparency and the amount of available information on futures trading. Another would be to closely investigate any instances of suspicious behavior by traders, as already practiced by the U.S. futures trading supervisory body.
“Commodity futures have become an integral part of the food market, and they perform an important role for many market participants. Adequate regulation should improve, not ban, speculative trading in order to foster market performance,” the brief concluded.