Betting on hunger

Banks are earning huge profits from betting on food prices in unregulated financial markets. This creates instability and pushes up global food prices, making poor families around the world go hungry and forcing millions into deeper poverty. It’s time to stop bankers from gambling on hunger.

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WDM food speculation campaign: Questions and answers

This document answers all your in depth questions about food speculation.

Glossary of financial jargon

Baffled by 'derivatives'? Do you know your 'over the counter' from your 'hedge'? Food speculation is an issue that can get quite technical but here's our jargon busting glossary which will help steer you around the murky waters of financial markets.

Clearing exchange

A clearing exchange acts as the intermediary between the buyer and seller of a derivatives contract. So instead of the buyer and seller interacting directly, the clearning exchange becomes the buyer to each seller, and the seller to each buyer, of a contract. The clearing entity makes the payments to each side of the deal,
covering the buyer and seller from the risk of the other side defaulting. This in turn provides financial stability by insuring both parties against default.

In contrast, derivative contracts which are sold directly between two parties (see over-thecounter derivatives below) can be defaulted on as either side may not deliver either the goods or the money. It was non-payment of derivatives
contracts (not traded through clearing exchanges) which contributed to the 2007/08 financial crisis.

In return for being protected from default, buyers and sellers pay a fee to clearing
exchanges. This protects traders from default by the other party and creates a small cost for each trade which takes place. This cost is small for real users of commodity derivatives like farmers. In fact, most farmers choose to use centralised
clearing rather than over-the-counter trading, because their whole reason for using futures contracts in the first place is to protect themselves from risk. However the fee represents a deterrent for financial speculators to buy and sell contracts exclusively as a moneymaking venture.

Commodity

A commodity is a type of good which is the same no matter who produces it. There is no difference in quality. Because a commodity is the same, it can be easily traded at one global price. For example, a tonne of copper is the same whether it comes from Chile or Zambia.

In contrast, televisions are not commodities as they can be differentiated by features, branding, size etc and therefore different models of televisions command different prices.

For most commodities there are markets where they are traded on the day and derivative markets where contracts are traded for future delivery of the product. In these markets, a single price is quoted for the commodity. The three main  categories of commodities are food, metals and energy (primarily oil and gas).

Commodity index fund A commodity index fund is a way for institutional
investors such as pension funds, insurance companies and mutual funds to put money into commodities. Commodity index funds put money into a range of commodities in fixed proportions by buying futures contracts and other derivatives
in them. Those using commodity index funds see commodities as a way to diversify where their money is held. They tend to put money in and pull money out due to factors unrelated to supply and demand of individual commodities and look instead to indicators such as stock and property market signals. This can play havoc with
commodity prices as it divorces their value from the actual demand and supply of the commodity itself.

Derivative

A derivative is a financial contract which does not involve the trade of any real product. It is ultimately based on the trade in something real, so its value is ‘derived’ from a real trade. A future is one form of a derivative contract. Derivatives
got more complex through the 1990s and 2000s as financial markets became increasing unregulated.

Futures contract

A futures contract is a contract between two parties to buy or sell an asset of standardised quantity and quality at a specific future date at a price agreed today.
WDM food speculation campaign

Hedge

A hedge is when someone seeks to reduce their risk to price fluctuations. It can be done in many ways. For instance, a farmer can use futures contracts to hedge against large falls in the price of the crop they are selling. They forego the
benefit of any increase, but protect themselves from a fall.

Hedging is also used by financial traders to diversify risk. Putting money into commodities is seen by many financial traders as a hedge.

Commodities can be seen to move in line with inflation, or in opposite directions to shares. Therefore, a trader can protect themselves against inflation, or a fall in share prices, by putting some of their money into commodities.

Hedge fund

Hedge funds are financial funds that put money into a wide variety of markets. They tend to have the fewest regulations applying to them of any financial institutions. They put money into all kinds of markets, including shares, government debt and commodity derivatives. Whilst they are called ‘hedge funds’ they do not hedge.

They tend to do the opposite. They put money into the riskiest activities as an attempt to get the highest returns. Methods they particularly use are borrowing lots of money to then trade with, short-selling and putting money into
derivatives. Hedge funds tend to be used by a small number of wealthy investors.

Over-the-counter derivative

An over-the-counter derivative is a derivative traded privately between two financial traders; at least one of them will usually be a bank. The bank creates the derivative in a specific way for its client. Because it is created in private, the
rest of the market does not clearly see what is being traded at what price. Also, over-thecounter derivatives can easily be defaulted on, unlike those which go through clearing.

Pension fund

Pension funds are institutional investors that take pension savings from individuals and governments. They seek to make a return with which to fund the buying of pensions for those paying into the fund. Pension funds are one of the largest institutional investors in financial markets, because they account for a large
proportion of individuals’ savings.

Position limits

Position limits place a limit on the amount of derivatives which can be traded in a particular market. They were created by US regulators in the 1930s to prevent excessive speculation on food commodities, whilst still enabling farmers
to use derivatives to hedge their risk.

Through the 1990s and 2000s, regulations in the US were weakened, allowing many speculators to be exempt from position limits that apply to them, particularly commodity index funds.

Short-selling

Short-selling is the practice of selling items on a financial market that have been borrowed from a third party with the intention of buying identical items back at a later date to return to the lender.

Traders normally undertake short-selling as a way to profit from falling prices.
For example, a hedge fund makes £10 by selling 10 shares for £1 each. These shares do not belong to the hedge fund but have been borrowed from an actual shareholder. A month later, the shares have dropped to 50p each and the hedge fund buys the 10 shares back for £5 and then returns the shares to their owner. In
this way, the hedge fund pockets the difference and makes a profit of £5.

Large amounts of short selling, for example of shares, leads to a large supply of shares on the market. This in itself can cause the price to fall. Short selling has been a major feature of the recent financial crisis, particularly in currencies,
shares and most recently in government debt in countries such as Greece.

However, it has not yet been as big a feature of commodity markets
where the main speculators (index funds) have been making money from rising prices.

Speculation

Speculation has many different meanings and uses, some of them contradictory. When we refer to speculation, we refer to financial actors putting money into food derivatives to make money, without any intention of buying or selling real food. This speculation on food contrasts with farmers who buy commodity derivatives to protect themselves from the risk of big changes in price. For farmers, buying food
derivatives is effectively insurance.

Barclays PLC and agricultural commodity derivatives report

This report, written by Brett Scott on behalf of WDM, is an overview of Barclays' involvement in commodity derivatives markets, with particular reference to its involvement in agricultural commodity derivatives (food speculation). 

Derivatives come in three main types: Futures/forwards, options and swaps. In practice, a lot of the dealing on investment bank trading floors will be in ‘over-the-counter’ (OTC) derivatives, which includes forwards, swaps and bespoke options. Futures are slightly different, in that they are traded on regulated exchanges. All these derivative types can be based on different ‘underlying assets’ - e.g. derivatives based on shares, bonds and currencies, economic indicators, and a lot of other things. By far the largest global derivative market is the interest rate derivatives market, followed by currency derivatives, credit derivatives, commodity derivatives, and equity derivatives.

Barclays Capital commodities division is a commodity derivatives business, facilitating derivative markets in energy commodities (e.g. oil, oil distillates, natural gas, coal), industrial metals, precious metals, carbon emissions, and agricultural commodities. There are roughly 350 employees. Barclays describes the business as follows:

Barclays Capital’s Commodities division has expanded rapidly in recent years to meet growing customer demand. Our Commodities Traders build ‘trading books’ specialising in goods from energy products to agricultural assets, all over the world.

Broken markets - How financial market regulation can help prevent another global food crisis

Broken Markets seeks to counter the arguments put forward by those sceptical of the influence of financial speculation on rising food prices. It shows how financial speculation has boomed, turning commodity derivatives into just another asset class for investors, distorting and undermining the effective functioning of agricultural markets.

It shows how these changes in the financial markets translate into changes in the price of food, and the devastating impact this has had on the world’s poorest people. It concludes by recommending urgent action to introduce new rules to limit the influence of financial speculators and bring transparency and stability to these out of control markets. 

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The Great Hunger Lottery - How banking speculation causes food crises

In The Great Hunger Lottery, the World Development Movement has compiled extensive evidence establishing the role of food commodity derivatives in destabilising and driving up food prices around the world. This in turn, has led to food prices becoming unaffordable for low-income families around the world, particularly in developing countries highly reliant on food imports.

Nowhere was this more clearly seen than during the astonishing surge in staple food prices over the course of 2007-2008, when millions went hungry and food riots swept major cities around the world. The great hunger lottery shows how this alarming episode was fueled by the behaviour of financial speculators, and describes the terrible immediate impacts on vulnerable families around the world, as well as the long term damage to the fight against global poverty.

In the report we describe how the current situation came to pass, the risks of another speculation induced food crisis, and what specifically can be done by policymakers here in the UK as well as in the US and EU to tackle the problem.

Download the report