The agricultural commodities sector has been the subject of controversial discussions for some time now. Deutsche Bank set up a working group to analyze the role financial investors play on the commodity futures markets already in 2011. In March of last year, the Bank decided to temporarily halt the launch of new staples-based exchange-traded products.
After evaluating numerous studies on the matter, the working group established that there is little empirical evidence to support the notion that the growth of agricultural-based financial products has caused price increases or volatility. At the same time, it confirmed that agricultural commodity-based futures markets offer substantial benefits to farmers and processors.
Thus, Deutsche Bank's Management Board decided to continue to offer financial instruments based on agricultural staples. The following Q&As provide more details on this decision as well as a summary of the working group's findings:
1. To what extent is Deutsche Bank involved in transactions in the agricultural sector?
- The agricultural sector is a key component of the global economy. In developing countries alone, more than USD 80 billion need to be invested every year in order to increase productivity levels to meet the increasing demand for food in the coming decades.
- We support these investment needs. We offer a variety of funds so our clients are able to invest in the entire value chain in agriculture, including in innovations and technology. These investments can take the form of shares or direct investments or, as in the case of the Africa Agriculture and Trade Investment Fund (AATIF), financing that the fund provides directly to farmers and processors or indirectly via local banking systems.
- Of course, we also offer credit facilities and financing for farm operators, trading companies and food processors. Our clients operate around the world.
- And last but not least, we also provide our clients with hedging services for agricultural commodities as well as exchange-traded funds (ETFs).
2. Why is Deutsche Bank continuing to offer its clients staples-based financial products?
- We have carefully reviewed the causes of rising and volatile food prices. The vast majority of studies agree that the fundamental cause of rising food prices is sharply rising demand that is not yet matched by supply. Demand is surging because of population and income growth in developing countries while production is limited by water scarcity, climate change, lack of infrastructure and harvest waste.
- The review of numerous studies revealed that there is no convincing evidence that the growth of agricultural-based financial products has led to either higher or more volatile prices.
- At the same time, commodity derivative markets offer farmers and processors a number of benefits. Firstly, these markets allow producers and processors to hedge against fluctuating prices. Second, they provide strong price signals that enable farmers to better judge and plan supply within the constraints of the growing season. Finally, they give farmers the certainty they need to make long-term investments in infrastructure and farming technologies. Financial investors inject liquidity into these markets.
- After a period of intensive consultation and reflection, we have lifted our temporary halt on launching new exchange-traded products based on agricultural staples. And in the future, when new products are launched, our approval process will make sure that the investment strategies which underpin our investor products do not facilitate price spikes.
3. Are financial investors responsible for increased food prices that lead to so many people suffering from hunger?
- Food demand is substantially outpacing the limited supply: as a result commodity prices are rising. Without significant investments in agriculture, rising prices will become a permanent fixture.
- The world is expected to have nine billion people to feed. Furthermore, most of the population growth is expected in developing countries, in which the middle class is growing rapidly. As a result of shifting consumption trends, this growth pattern has a significant impact on the demand for meat. Meat generally requires two to five times more grain to produce the same calorific value of the grain itself.
- At the same time, food supply is challenged in much of the developing world because of constraints on production and distribution, such as outdated farming techniques, severe weather events, the impact of climate change and an weak storage and distribution infrastructure.
- Agricultural production could be raised substantially by adopting improved farming technologies. If farmers were to generate more revenue from their crops, they could buy the tools to increase output still further and help satisfy demand.
- The price of a commodity in isolation is meaningless; it is affordability that is important. Poverty makes food less affordable and leads to hunger. Increasing the supply of food to meet demand should help push down prices and reduce poverty.
4. What role do speculators play? Is there a risk of excessive speculation?
- Speculators are indispensable for the functioning of commodities markets. They are the investors, market-makers and traders who provide the liquidity that the producers and processing industry need to insure themselves.
- The role of speculation in the commodities markets has been extensively examined and there is no conclusive evidence nor consensus that it is excessive or is adversely impacting prices.
- The greater the number of participants in the market and the broader the range, the more likely the market is to generate optimal liquidity, efficiency and transparency and to produce prices that most accurately reflect fundamentals.
- Farmers need a proper and robust price signal in order to make investment decisions, such as implementing more advanced farming methods to boost production. And farmers need futures markets to insure against the risk of changing prices within the growing season.
5. Are commodity prices disconnected from supply and demand?
- Pricing on all markets, agricultural markets included, is a search process during which prices may temporarily overreact.
- It is also clear that an increase in financial investments in the derivatives markets can only result in price spikes on the spot markets if the demand for the physical commodity rises.
- In actual fact, evidence suggests that financial investors have not created additional demand. This largely reflects the fact that agricultural commodity-based index funds or exchange-traded funds (ETFs) are not backed by physical commodities.
6. But is it not true that speculating on commodities drives up the price in local markets?
- First, prices are determined by fundamental factors such as consumer demand and demand of the processing industries on the one hand and, on the other, by crop harvests (actual and anticipated) and existing stocks. Price discrepancies at the local level are mostly the result of trading barriers and other distortions.
- Unlike for corn and wheat, there is no liquid market in rice futures. And yet rice prices have been just as volatile as corn and wheat prices with the difference being that producers and processors are unable to insure themselves against these fluctuations.
7. Do we need more regulation in these derivative markets? Should we ban financial investments in commodities markets?
- The G20 has articulated a five-point Action Plan on Food Price Volatility and Agriculture which aims to address many of the structural deficiencies in the sector. It also promotes appropriate regulatory reform to limit market abuse and increase transparency. We firmly support these proposals.
- Functioning markets require a solid regulatory framework. This is as true for derivative markets as for any other. Greater transparency will ensure market integrity.
- We do have concerns, however, about proposals to introduce position limits in the European Union under the Markets in Financial Instruments Directive (MiFID). Such measures would restrict a bank's ability to execute customized trades tailored to the needs of its clients.
- In the US, rules on position limits introduced by the Commodity Futures Trading Commission (CFTC) have been vacated by the court because the CFTC did not provide evidence that these rules are necessary for limiting "excessive speculation". The CFTC has appealed the decision.