My Lords, I am very pleased to speak to this group of amendments this afternoon, having sadly been unable to make Second Reading. I declare my interest as a co-chair of Peers for the Planet. I also declare my relative ignorance of this topic, as I am not steeped in the details of financial services. I very much approach this issue from a layperson’s perspective, guided by common sense. Much of my efforts here are to apply parliamentary scrutiny to this very complex issue and to seek reassurances from the Minister.
As we debated in the previous group, it is vital that we have proper scrutiny of proposed changes to laws and regulations governing financial markets. Potentially poorly regulated markets could have significant negative real-world consequences, as we have seen in the past. Complexity is now endemic in this sector and can catch regulators, and indeed parliamentarians and Ministers, out. Derivative markets are particularly complex and require especially careful scrutiny.
My Amendments 21 to 25 and 41 concern the proposed future regulation of trading in commodities and their derivatives. Many noble Lords will be aware of this, but to give some background, derivatives are used in the financial markets and the wider economy to hedge exposure to commodity prices in the future. However, this opens up the opportunity to speculate and seek profit from volatility. Roughly two-thirds of commodity trading relates to commodities in the energy and food markets. Therefore, unchecked speculation and poor regulation in these markets can have very real-world consequences. Some types of commodity derivative investment are of course socially desirable. For example, soft commodity or energy producers seeking to insure themselves against future risks arising from such things as weather and an unstable climate are making a necessary hedge to keep products economic. However, there are dangerous aspects of this as they relate to food and energy, which affect people’s lives and the affordability of living.
Momentum-based trading strategies can exacerbate steep price rises and the cornering of markets, by which I mean taking large positions that are disproportionate
to your genuine participation in the market, which could force unnatural or artificial scarcity into the market and raise prices. More generally, increasing volumes of capital being tied up in future derivatives removes money from the real economy today, where it could be delivering much greater real-world impacts.
There is overwhelming evidence that unchecked speculation produces price bubbles. I do not intend to go into this in detail, but in relation to oil, a 2021 piece in Resources Policy looked back at a whole host of research dating back to 2009 in highly cited journals. So firm is the consensus that there is now a whole body of techniques dedicated to measuring and modelling bubbles. We are well past the point of discussion of whether there is a risk; it is now about how we manage it and its impacts.
The co-author of last October’s UN Conference on Trade and Development—UNCTAD—trade review said that a ratio of around 70% real hedging and 30% speculation might be seen as “healthy”. However, he added that what we see in the market today indicates that the ratio has been reversed: 70% speculation and 30% real hedging. The same report warned of a policy-induced global recession. The report said that insufficient attention has been paid to the “betting frenzies” on future markets in the current crisis and called on Governments to tighten rules on speculation. However, with this legislation we seem to be doing the opposite.
EU legislation on commodity derivatives was introduced, and it was not simply pointless bureaucracy. There was clear evidence in the run-up to and during the financial crash of 2008 that food and energy prices were being driven upwards not by shortages but by fevered speculation, so action was taken. Investment banks were seen to be profiting by around $16 billion a year from commodity trading. Thanks to these new approaches, we have seen that profit-making fall by around three-quarters, according to analysis from the research firm Coalition. So there was a reason for the EU regulations that we are seeking to modify as we translate to post-Brexit financial regulation.
The general point is that we should be seeking to allow the socially beneficial, but not allowing bubbles to be created in this market. We should not be making it easier to do that but keeping a careful eye and tracking trends, while requiring clear data and better disclosure. You could argue that the EU perhaps overreached or did not get it exactly right, and that we should seek to take our own approach, but I have some questions about the Government’s proposals in the Bill.
It appears to me, and I seek reassurance from the Minister on this, that Schedule 2 is handing the power of setting appropriate position limits and controls—and the maximum position any firm can take on trading on a commodity—to financial exchanges, or certainly taking the power to do so. But are those exchanges not incentivised commercially to maximise liquidity and volumes of trade, so does this not create something of a conflict if they are also setting their own limits?
These new arrangements would see the FCA retaining backstop powers to give directions, but only in certain fairly narrowly defined circumstances. It can request
information and intervene, but the drafting suggests that the exchanges would be free to set their own limits. Is this the case and, if so, how does the Minister expect them to handle this potential conflict between their commercial interests and a more cautious approach to the prevention of harmful speculative bubbles?
There is also the question of what will be regulated in future. The current rules cover both over-the-counter trades and exchange trades but, as I understand it, this new approach is about simply deciding not to continue to seek oversight of over-the-counter trades. From what I have been able to read, this seems to be based on the fact that those consulted said it was too difficult to do. That does not seem a good enough reason to remove the oversight of OTC trades and focus simply on exchange trades.
There is also the point about exchanges having less oversight of systemic risks building up in the global market. Whereas the FCA engages via the IOSCO, the International Organization of Securities Commissions, and the FSB—
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