France launches campaign to tame commodities derivatives

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France launched a major attempt to tame the powerful world of commodity derivatives trading on Tuesday, urging the European Union to come up urgently with common rules.

Three French ministers also warned that they will make this a priority at a G20 meeting in November, arguing that their aim is to prevent trading in financial instruments from distorting prices for underlying raw materials such as oil and farm products.

They said in a document on derivatives trading sent to EU Internal Market and Services Commissioner Michel Barnier: "It is essential that Europe commit fully to regulation of these markets and that it do so now."

They said in a letter: "We feel it is desirable that a European initiative first define common principles for the regulation of derivatives of all raw materials and assimilated products."

This could take the form of "legislation defining regulation of trading of commodity derivatives and assimilated products."

In an accompanying argument, they laid out concerns that trading in derivatives could cause sharp distortion and volatility in the prices of raw materials such as food and oil.

Barnier said he "shares fully" French concerns, telling AFP he believes that commodity derivatives trading needs to be controlled "at a European level and a world level".

A former French foreign and agriculture minister, Barnier said he will make next month a series of proposals to member states and the European parliament to tackle the "sometimes brutal" evolution of prices in commodities markets.

France is a leading exporter of agricultural products and has a big international food-processing sector. It is also a big importer of oil and gas.

The ministers, Christine Lagarde for finance, Jean-Louis Borloo for energy and Bruno Le Maire for agriculture, stressed that "France takes the deployment of a framework for effective regulation of all financial markets very seriously, and will make this a priority during its presidency of the G20 (Group of 20 countries) starting in November."

And they noted that France had recently called for "improvements to European regulation of trade in commodity derivatives and assimilated goods", at the European level.

The ministers listed specifically such instruments based on oil, gas, metals, agricultural produce and carbon quotas.

By way of example, they said that the amount of trade carried out in instruments for the future delivery of oil amounted to 35 times the volume of contracts for the physical delivery of oil.

"As things now stand, a percentage of raw materials derivatives (commercial futures contracts) as well as major participants in these markets (notably commodity traders) are simply not covered by European financial regulation."

Action to ensure "transparency" and on the way prices are formed on the markets is needed, and more should be known about how agricultural markets and related derivatives markets affected each other.

But they acknowledged that commodity derivatives, designed originally as hedging instruments, "also play a key role in price discovery and in shaping expectations of price formation for raw materials."

But a rise in volatility in 2007-2008 "fuelled fears that this same volatility would spill over from financial markets to physical markets -- that commodity markets would no longer be governed only by fundamentals, but also by trends on derivatives markets."

A big rise in the price of agricultural products, if disconnected from "physical realities", would "unfairly penalise both producers and consumers."

They stressed: "The fact is that this fear of volatility spreading from financial to physical markets demands close attention if market participants' confidence in the usefulness of commodity derivatives is to be restored."

Derivatives are virtual financial instruments based on underlying physical goods and play a vital role in financial markets, for example in enabling companies and traders to hedge or insure against risk.

But when big flows of money take positions on such markets the price of the underlying physical product can become highly volatile.

© 2010 AFP

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