Commodity trading houses under fire

Commodity trading houses are secretive, largely unregulated, pay relatively little tax and, until recently, have made big profits. Not surprisingly, they have come under increasing scrutiny with the Financial Times headlining a major investigation on Monday ahead of its global commodities summit which was marked by an anti-industry protest. NGOs argue that their speculative activities increase volatility, creating more uncertainty for farmers, and force up prices for consumers. They also reinforce asymmetries in north-south relations. For a special issue of Food Ethics on this subject go here: Food Ethics

Leading commodity houses such as Cargill are reacting by saying they need to be more transparent about their activities. But there is a tension there, because it is having an information edge in relation to supply and demand patterns that enables a commodity house to trader profitably. Their defenders would argue that they enable the market to work more efficiently by clearing the market and helping price adjustments. They link regions of surplus and deficit around the world.

Commodity houses cover a number of sectors of the economy including minerals, metal and oil, as well as agriculture. According to the FT, the net income of the largest trading houses since 2003 surpasses that of the combination of mighty Wall Street banks Goldman Sachs, JP Morgan Chase and Morgan Stanley, or that of an industrial giant such as General Electric. They made more money than Toyota, Volkswagen, Ford Motor, BMW and Renault put together. However, times are now more difficult, particularly since the recent drop in commodity prices. Aggregate profit growth has stalled.

When I have attended specialist agriculture conferences, someone from Cargill is often there, but they generally keep a low profile. Probably their own data is better than that being presented. William Wallace founded Cargill in 1865 as an Iowa grain elevator, but it now operates in 65 countries, employing 140,000 people. The company is privately held by about 80 of Wallace's descendants, although staff have a 17 per cent stake. It is by far the world's largest trader of agricultural commodities, a turning point being when it bought rival Continental in 1998. It has the biggest market share in key raw materials such as sugar, corn and wheat, putting it in a position to be a price maker rather than a price taker.

Cargill's name is well known, but there are also less known companies in niche markets. For example, the Hamburg-based family-owned Neumann Kaffee Gruppe is behind the beans that go into one in seven cups of coffee worldwide. Swiss-based trading house Ecom Agroindustrial mills more coffee beans than any other company. According to the World Bank, its clients include Starbucks and Nestlé. Company turnover in 2011 was in excess of $4 billion.

The sector is largely unregulated. Switzerland, the main hub of these companies, has admitted that 'Physical commodities traders are, in principle, not subject to any oversight.' The tax burden is low. According to the FT, they pay less tax than oil or mining groups or Wall Street banks.

But the growing level of scrutiny is ringing alarm bells. Cargill has warned that trading houses must embrace ethical and transparent business practices or risk getting into hot water with regulators.

Financiers spring to defence of ETPs

The controversy over exchange traded products (ETPs) and their effect on food prices continues with some financial providers say they will not withdraw them. In a report issued this April, Finance Watch, a Brussels-based public interest advocacy group argued that excessive commodity speculation raises prices artificially and damages the market for real buyers and sellers. Read more here: Commodities

Others take the opposite view. They point out that the size of the financial market in commodities is tiny in comparison with the physical market and it is the physical market that sets price - the tail does not wag the dog. Nevertheless, the financial market could still have a disproportionate effect in uncertain conditions.

Against that Guy Wolf from commodities broker Marex Spectron commented, 'The futures market is a forum for buyers and sellers to hedge their exposure that benefits both parties and in fact we need more speculation to help absorb volatility.' Indeed, even a report called Farming Money from Friends of the Earth Europe (FoEE) admits that speculators can bridge the gap between buyers and sellers and provide liquidity in the market.

Twenty-five groups including FoEE are urging member states to use this autumn's review of Mifid (the Markets in Financial Instruments Directive) to curb speculation in food and other commodity derivative markets. They are advocating strict position limits and banning financial entities from speculating in commodity markets. Read more here: Speculation

The largest providers of ETPs have made it clear that they have no plans to withdraw these instruments after a number of operators said that they would. Volksbanken of Austria announced that it was withdrawing investment products linked to agricultural commodities and Germany's Commerzbank removed agricultural products from its Comstage commodity exchange traded fund in July. In March Deutsche Bank, the second largest provider of ETPs in Europe, said it would refrain from launching any new ones based on basic foodstuffs.

However, ETF Securities, the largest provider of commodity traded ETPs in Europe and iShares, the world's biggest ETP manager, said they had no plans to scrap their offerings. Their defenders argue that investment in agricultural commodity ETPs do not result in hoarding because they invest in futures unlike physical gold ETPs which hold bullion in a vault.

Globalization of agriculture inevitably led to its involvement in more sophisticated financial instruments which some would describe as socially harmful. Others see them as an efficient market clearing mechanism. Much depends on how influential they are in the market. At present they are not dominant and an outright ban would be an over reaction.

Banks withdraw food commodity funds

There has been considerable discussion about whether speculation drives food commodity prices up, although no definitive answer. My hunch would be that it tends to make them more volatile which creates difficulties for both producers and consumers.

Now a number of European banks are withdrawing vehicles that make it relatively easy for investors to speculate on food prices: Speculation

The decision represents a victory for campaigning groups such as Food Watch, Oxfam and the World Development Movement. The banks were concerned about reputational damage, no doubt enhanced by upward pressure on prices following the drought in the United States.