The essential role of banks for physical commodities

A new report reiterates that commodity producers, suppliers and end-users need banks to finance projects and hedge their risks.

Meetings between the European Institutions have restarted in Europe about the Markets in Financial Instruments Directive (MiFID) which aims to regulate, among other things, the functioning of commodity derivatives markets.

At the margins of these meetings, there was intense NGO activism with regard to commodities speculation and mass emailing of policy makers and influencers in Brussels inviting them to join them in a demonstration outside the European Parliament. Before this demonstration, they had gathered a petition of more than 30,000 citizens’ signatures against food speculation.

Their logic is pretty simple: increasing positions taken by financial players in commodity derivatives markets trigger commodity prices to the detriment of the poorest population which struggle to access food. Therefore financial firms should get out of the commodities markets.

However, a growing pile of research reports shows that the development of commodity derivatives markets does not in itself trigger higher prices but on the contrary helps mitigate the shocks that are really affecting physical commodity markets (such as climate shocks, disruption of the supply chain caused by political events such as civil wars etc.).

The latest report was released by the research company IHS and is entitled The role of banks in physical commodities. It states that:

“If the banks were not participating in physical commodity markets, their ability to serve clients with risk management and financing services would suffer. It is not at all clear who could replace them.”

But still, NGOs say that banks look guilty and they demand decisive actions. And surely, since this report was commissioned by an industry group, it will not make them change their mind.

Now, the question is: do we still want an argument between a prosecutor (the NGOs) and a defender (the banks)? Or is there another way forward? And shall we accept that evidence is ignored simply because it is provided by the defender?

There surely are hard facts and economic evidence which representatives of the industry (bankers, investors, and corporates), policymakers, regulators and NGOs would agree upon: for instance, that agriculture production has to double within the next thirty years in order to feed 9 billion people by 2050. Also, that about $80 billion per year needs to be invested in production infrastructures, transportation networks and storage facilities within the same period to enable such shift in agriculture production and supply.

Commodity producers, commodity suppliers, commodity end-users always reiterate that they need banks to finance their projects and to provide them with hedging financial instruments. Every market participant agrees that transparency in physical markets should be enhanced, that regulators should have the right to intervene to address disorderly markets.

The past five years, and in particular 2008 and 2009, were chaotic in both physical commodity markets and financial markets (whatever the asset class). Have we ever heard industrial firms, producers, suppliers and end-users calling for getting the banks out of these markets? No.

Is there any independent academic research suggesting that we should get banks out of these markets? No.

For four years the industry has called for a constructive dialogue, based on evidence and facts, around the best way to enable commodities production and supply to meet the ever-growing demand.

The IHS report, rather than a “defense” commissioned by Wall Street, should be seen as a call for a reasoned consideration of the full role that banks play in commodities markets.


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