Jan 31, 2011

Betting on food

Are we adding up to the number of hungry people around the world?
By Irfan Mufti

Over the recent months, soaring food prices fuelled by financial speculation have contributed to protests in countries like Pakistan, Mozambique, Tunisia, Bangladesh and Algeria. Millions of people are being pushed further into hunger as food becomes unaffordable. Making food markets work for the world’s poor is more urgent than ever. How?

Experts have already warned that the cost of food will soar by 50 percent over the next few decades as the world becomes a victim to famine, mass migrations and riots. The increase will be triggered by the exploding world population, rising cost of fuel and increased competition for water. Spiraling food prices will push hundreds of millions of people into hunger, trigger mass migration and spark civil unrest.

In Pakistan, the prices of basics such as wheat, bread, vegetables, rice and milk will spiral to inflation-busting record within the next few years. The recent report issued by Food and Agriculture Organization (FAO) sets up to predict future crises, calling for ‘urgent actions’ to prevent food shortages. Even a modest rise in food prices could push 100m people into hunger, warns FAO.

Global food prices are already at a record high. Last month, the price of cereals, sugar and meat soared on the world’s markets after a series of crop failures caused by bad weather. Foresight predicted that the world’s population would rise from 6.9bn today to around 9bn by the middle of the century. As the world gets more crowded and wealthy, demand for food, water, and energy will soar.

At the same time, climate change will increase the risk of droughts, floods and crop failures, creating a ‘perfect storm’ of food shortages and above-inflation rises in prices.

A recent report by the Oxford University states: “There is a very large risk of a quite substantial increase in prices over the next 30 or 40 years. We are going to have to produce considerably more food. So, inescapably, we have to produce more food from the same amount of land without wrecking the environment.” The report, written by 40 scientists in 35 countries, calls for a ‘green revolution’ to boost production using traditional, organic crops designed to be resistant to drought or salt water and better training for farmers in developing countries.

Several experts are also saying that the food system is failing. Firstly, it is unsustainable, with resources being used faster than they can be naturally replenished. Secondly a billion people are going hungry with another billion people suffering from hidden hunger, while a billion people are over-consuming.

The situation is worsened while food market is also operating unethically, thus shifting the flow towards financial gains using food as financial commodity and not as basic human need. Financial speculators and bankers are manipulating the market and increasing their gains causing unnatural price hike for consumers. The European Commission is drafting new financial regulations and has launched a public consultation on their proposals. Investment banks, like Goldman Sachs, are lobbying hard to weaken these proposals so that they can continue to profit from betting on food prices.

It’s vital that the voice of ordinary people is heard so that that strong and effective regulations can be introduced needed to prevent millions facing further hunger and deepening poverty.

Peoples’ organisations and representatives have already shown concern about the impact of food speculation on consumers in the developing world. Speculation by financial actors in commodity derivative markets is causing excessive volatility and inflating prices for physical commodities such as food. These markets exist for price discovery and risk management in the physical market, however, they are being distorted by speculators and bankers seeking to profit from rising prices and momentum traders increasing volatility.

This has a devastating effect in global food markets as was seen in the 2007-08 food crises when a further 115 million people went hungry. Food prices reached a record high in December 2010 and without effective regulation to improve transparency and reduce speculation in commodity derivative markets the risks of another food crisis on the same scale are increasing.

Governments and multilateral forums and market regulatory authorities have to seriously consider the proposal for the review of ‘Markets in Financial Instruments Directive’ (MiFID) which would go a long way to ensuring these markets work effectively for producers and consumers and to reducing the negative impacts of speculation. MiFID is the EU directive which regulates financial markets, including proposals for regulating food speculation in derivative markets.

Food derivatives are financial contracts based on the price of food. They were initially designed to give farmers more certainty over the prices they receive for their crops in the future. However, these contracts are now being traded by financial speculators who are not interested in buying or selling actual food, but are making money by betting on rising food prices. This betting pushes up the price of actual food making it unaffordable for people around the world and pushes people deeper into poverty and hunger.

The two key regulatory changes are urgently needed. Firstly, many food derivatives are traded directly between two parties with no requirement for information about the deal to be made publicly available (this is known as ‘over-the-counter’ or OTC). This means that no information, such as the price is available and there is no way to see what effect this has on the wider market. All food derivatives should be traded on exchanges, in the same way shares are, to allow everyone to see what is happening. This should help to make sure that the price -of food derivatives reflects what’s happening in the real world. Secondly, food derivative markets aren’t working properly as they are overwhelmed by the huge number of financial speculators. There should be effective position limits to reduce the influence these speculators can have on food prices.

Some other measures that need to be taken include: reforms and effective regulation in food-trading markets. It should be a requirement that all commodity derivatives should be traded on an exchange (or equally regulated facility). This will improve transparency promoting price discovery, prevent dealers profiting from information asymmetry in ‘over-the-counter’ (OTC) deals and ensuring such deals trading do not distort the prices of exchange traded derivatives. It is important that all food commodity derivatives should be moved off OTC due to the risk of distortion to underlying food markets.

Similarly, it is vital that regulation reflects the difference between derivatives of financial and commodity assets, and the risk of distorting the underlying market. Food is not a financial asset like any other and regulation must reflect the potential for devastating impacts on people’s lives through speculation. All commodity derivative trading venues should make position limit information available to regulators and the public for the purposes of market transparency.

Efforts to categorise traders in multiple ways, accurately reflecting their role in the market is also important. This categorisation should reflect whether they are commercial or non-commercial participants, the investment vehicle as well as the type of regulated entity. Regulators should be given the power to adopt hard position and prevent speculation limits for all types of derivative contracts.

The review process at the EU must consider the impact of this regulation on the people, especially in the developing world, not just its impact on the financial services industry. Many financial institutions make significant profits at the expense of affordable food, due to current under-regulated markets. These institutions will be lobbying hard in their own interest to water down these regulations, however, loosening these regulations will only serve to boost profits for a handful of firms while damaging markets, failing to reduce market risk and damaging the lives of people around the world.

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