investor's guide to commodities - PRI Signatory Extranet - Principles ...

More documents

Recommendations

Info

12 The Responsible Investor’s Guide to Commodities4INVESTMENTSIN COMMODITYDERIVATIVES4.1 The issues at stakeInvesting in commodity derivatives is the main way in which institutionalinvestors seek exposure to commodities. Investments are implemented bymeans of futures, OTC contracts, index tracking funds, swaps on indices, hedgefunds and other active strategies.Financial investors usually sell back (“settle”) their derivative contractsbefore expiry to other counterparties and therefore avoid holding the physicalcommodity. Over the long-term, they therefore have no effect on absoluteproduction levels and related ESG issues. Over shorter timeframes, though,they can create price signals in the futures market that impact producer decisionsand influence prices in the spot market. Increased volatility in commodityprices can make it difficult for society to adapt and, in the case of foodcommodities, can lead to food crises and social unrest. Excessive speculationon futures markets can also potentially disrupt futures markets role as a pricediscovery and risk hedging tool for farmers and producers. When looking atcommodity derivative investments we are therefore dealing with systemic risksof a more indirect nature, compared to other types of investments with moredirect ESG impacts.The G20 has put commodity price volatility at the top of its agenda andmany international bodies and national regulators are dealing with the issue.A heated debate about the potential influence of financial investors on commodityprices is under way with highly divergent opinions being expressed.Academic research on the issue is often inconclusive, in part because it relieson past data that cannot capture the rapidly changing situation with regard tothe nature and scale of investments. In Appendix 2 we summarise findings ofrecent “meta” publications on this issue to complement the literature alreadyreviewed in our interim report.“… what little distortion speculators maycause is soundly trumped by the servicethey provide. In particular, they supplyliquidity and price information that makesfutures markets more efficient”—The Economist, 13 November 2010
13Based on our discussions and interviewswith investors and on the literature reviewed,we have identified the following mechanismsthat can lead to investors impacting pricelevels and volatility:• In many futures markets, financial investorshave become the leading players (comparedto commercial investors)• Financial investors increasingly decide toinvest based on factors that are unrelatedto fundamentals, such as herding arounda price trend (which might initially bejustified by changes in fundamentals butthen becomes self-reinforcing) or wantinga certain exposure for portfolio diversificationreasons (which, if manifested in anindex strategy, leads to obligatory “rolling”of futures contracts to maintain exposure,without regard to fundamentals)• By piling into commodities markets at suchscale, and in a manner that is largely insensitiveto fundamental drivers, financialinvestors have in fact eroded their originalcommodities investment case of uncorrelatedreturns. Partly as a result of this,more sophisticated investors have begun toseek commodity exposure through investmentsin real assets such as farms, minesor forests.• The advent of highly liquid exchangetradedfunds makes it relatively easy formomentum-driven investors to move largeamounts of money in or out of commoditymarkets• All of this can lead to increased volatility infutures markets, and as a consequence alsoin spot markets 7• Some observers also point to the fact that astructurally higher volatility will also leadto higher physical commodity price levels.This is explained by the following relationship:increased volatility in futures marketsleads to increased margin requirements,making it more expensive for farmers tohedge their production risks. This cost iseventually passed on to the end consumers.4.2 Recommendations forinstitutional investorsThe main responsibility for dealing withthese issues clearly rests with regulators.US and European regulators have alreadyintroduced a range of measures aimed atincreasing transparency and limiting excessivespeculation (these include measuresto increase transparency of both regulatedand “over-the-counter” markets, centralclearing requirements, regulation of significantparticipants, position limits, etc.).Investors nevertheless have an importantrole to play. Based on our discussionsand engagement with investors, a seriesof voluntary measures that investors canimplement with the goal of avoiding negativeimpacts and actively contributing towell-functioning markets were identified.These include:■■Defining reasonable performance targetsfor active managers to avoid themhaving to chase momentum and takeexcessive risk■■Using multiple investment channels,avoiding that single investment managersor funds attain a dominating positionin the market with a higher risk ofcontributing to volatility■■When investing passively, implementingprocedures aimed at rebalancing portfolioallocations for different commodities(e.g. when prices exceed levels justifiedby fundamentals). This has the effectthat the investor is a seller of futureswhen prices go up excessively (and viceversa)which tends to stabilise prices.■■Insisting on hedge fund managers beingtransparent about their positions andstrategies■■Not allowing managers to hold positionsinto delivery period or taking deliveryso as not to affect the price-buildingmechanism■■Setting limits on investment in smaller,more illiquid commodity markets wherelack of market sophistication / liquiditycoverage could lead to investors havinga big influence on prices■■Engaging with commodity futuresexchanges, investment managers, indexproviders, etc. with the goal of improvinggovernance and transparency ofcommodity and OTC markets■■Contributing to the policy debate moreproactively and transparently, in view ofbalancing short-term interests with theneed for ensuring the long-term sustainabilityof derivatives markets and investors’access to them.7. Given today’s size of futures markets and the observed contangoeffect, price discovery is usually happening in the futures market“Investorsthat believemarkets arebroken shouldlobby for betterregulation,in particularbettertransparency”—Head of Commodities of apension fund interviewed inthe course of the project
Page 1 and 2: THE RESPONSIBLEINVESTOR’SGUIDE TO
Page 3 and 4: ForewordGlobal competition over sca
Page 5 and 6: 5Appendix 1. Overview of key enviro
Page 7 and 8: 7HEADLINES OF MAIN RECOMMENDED BEST
Page 9 and 10: 9FINANCIAL INVESTMENTS IN COMMODITI
Page 11: 11Possibility tomitigate ESGrisks b
Page 15 and 16: 155INVESTMENTSIN PHYSICALCOMMODITIE
Page 17 and 18: 176INVESTMENTSIN REAL ASSETS6.1 The
Page 19 and 20: 197DEBTOR EQUITYINVESTMENTSIN COMPA
Page 21 and 22: 218SPECIAL FOCUS:INVESTMENTSIN AGRI
Page 23 and 24: 23“One of the main things in food
Page 25 and 26: 25“There is no inherent ethical d
Page 27 and 28: 27APPENDIX 1.OVERVIEW OF KEY ENVIRO
Page 29 and 30: 29appears to have been to throw the
Page 31 and 32: 31GOALS OF THE CONFERENCE:• To hi
Page 33 and 34: 33SET THE DIRECTION• Establish an
Page 35 and 36: 35• The opening plenary previewed
Page 37 and 38: 37encing prices levels and volatili
Page 39 and 40: 39PRICE IMPACT: DEFINITION OF RESPO
Page 41 and 42: 41“You really do have to wonder w
Page 43 and 44: 43PARTICIPANT LISTParticipant Name
Page 45 and 46: 45APPENDIX 4.THE PRINCIPLES FOR RES
Page 47 and 48: 47Annexes to the Principles for Res
Page 49 and 50: 49APPENDIX 5.PROJECT TIMELINE2010Ba
Page 52: Published by the UN Global Compact

investor's guide to commodities - PRI Signatory Extranet - Principles ...

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?