This EDHEC-Risk position paper specifically responds to a recent report by Finance Watch on regulatory proposals for commodity derivatives markets in Europe. It describes an alternative narrative for what caused the recent commodity price spikes and then notes what implications this narrative has for addressing Finance Watch’s regulatory proposals.
We agree with Finance Watch’s concerns regarding food and oil price spikes. Our main concern is that the public interest group’s specific proposals may actually be placebos (or worse) that distract from properly addressing the fundamental factors responsible for these price spikes.
The paper reviews both the theory and empirical evidence regarding how commodity futures markets work, including the role of the speculator. It also discusses how difficult it is to apportion causality for commodity price spikes when inventories-relative-to-consumption become sufficiently low.
It concludes by noting that modern commodity futures markets are the result of 160 years of trial-and-error efforts. Before performing surgery on these institutions, we suggest that Finance Watch’s supporters tread carefully and not adopt “speculative” regulatory proposals whose ultimate effects are unknown. It further recommends that European Union policymakers instead consider studying market practices globally and then adopt what is demonstrably best practice, rather than invent new untested regulations.