Sasha Breger Bush, Guest Blogger
Back in 2003, Yale economist Robert Shiller noted in his book The New Financial Order, “We need to democratize finance and bring the advantages enjoyed by the clients of Wall Street to the customers of Wal-Mart” (1). More recently, Shiller’s 2012 article in The New York Times connects suggestions to “democratize finance” to the Occupy Wall Street Movement: “Finance is substantially about controlling risk. If risk management is suitably democratized, and if its sophisticated tools are better dispersed throughout society, it could help reduce social inequality.” Among Shiller’s proposals, in the older book and more the recent article, are for income insurance based on occupational derivatives and financial innovations to manage old age risks, thereby reducing pressures on welfare based entitlements like Social Security. Efforts to democratize finance in the advanced industrial economies are mirrored in development policy circles, where officials from the World Bank and UNCTAD, among other agencies, have been recommending for many years now that certain kinds of derivatives markets (largely for commodities and the weather) be re-tooled to better meet the needs of the agrarian poor.
On the surface, such efforts appear to be rather successful. As I detail in my recent book, derivative exchanges have proliferated across the developing world over the past several decades, with 23 of the top 50 derivatives exchanges (by volume) located in the global South in 2010. This same year, the most rapidly growing derivatives exchanges in the world were located in Asia and Latin America. Between 2003-06, commodity derivative contract volume outside of the OECD well surpassed that within. And, in 2009, China’s Securities Regulatory Commission announced that China had become the largest commodity derivatives market in the world, contributing over 40% of global volume. On the micro level, commodity and weather derivative contracts are being transformed into retail products, designed for use by smaller and poorer actors who have traditionally been excluded from global derivatives trading—e.g. retail crop insurance based in weather derivatives markets (“weather-index insurance”), agricultural producer bonds with built-in price insurance (like Brazil’s rural product bonds), and other mechanisms for passing on the risk management services of derivatives to those unable to participate directly in the markets. What could be more democratic?
This proliferation of risk management products designed to meet the needs of poor farmers and peasants across the global periphery unfortunately conceals massive concentrations of wealth and power at the core of the derivatives world. The growing array of risk management choices available to average folk provides a kind of democratic cover for an industry that is daily becoming more centralized and monopolistic. The commodity chain for derivatives products is comprised of at least four stages: trading, brokerage, clearing and exchange. While trading and brokerage are performed by a relatively broad array of actors, clearing and exchange are more exclusive functions performed by very large financial firms operating in a rather uncompetitive market setting (monopolistic competition perhaps best describes the arrangement, where differentiated but somewhat fungible products are sold across a handful of exchanges globally).
Take for instance the case of coffee futures and options markets, the case detailed in my book. Robusta coffee futures are traded on only three exchanges globally—LIFFE in London, TGE in Tokyo and NMCE in India. Robusta options are available only on LIFFE. Arabica coffee futures are sold on ICE in the US, TGE in Tokyo and BM&F in Brazil. Only ICE and the BM&F offer Arabica options. What is more, the exchanges in India and Brazil accept only local origin coffees to fulfill contracts, meaning that they exclude traders of coffees from elsewhere. The TGE also accepts coffees from limited origins, Arabica from a handful of Latin American producing states and Robusta from a handful of SE Asian producing states.
Further, of these few exchanges, ICE completely dominates the marketplace—in 2009, almost 70% of all coffee derivative contracts and almost 90% of all future coffee volumes traded worldwide were traded on ICE. LIFFE, while the 4th place contender for overall global coffee contract volumes in 2009, facilitated the exchange of 40% of all Robusta coffee futures in 2009 and almost 83% of future Robusta coffee volumes that same year (LIFFE trades fewer Robusta contracts than the NMCE, but a lot more volume due to the large lot size specified in its contracts). It is also important to note that each of these exchanges designates only one associated clearinghouse. In other words, clearing is just as concentrated as exchange in these markets.
Growing concentration in commodity and other derivatives markets has a variety of negative, and decidedly undemocratic consequences. Firms operating in uncompetitive market places influence prices, product offerings and product specifications. Large, highly-liquid and well-established exchanges may make it difficult for new exchanges to start-up and compete (the literature on “network markets” suggest that high levels of market liquidity on existing exchanges in many cases comprises a barrier to entry for new firms). Growing concentration in finance also undermines financial market stability and resilience to crisis, as we’ve learned in the context of the recent crisis. And, financiers and financial institutions empowered in the marketplace are additionally empowered in the political sphere.
Thus, you can imagine my concern when I read recently that ICE is in the process of acquiring the NYSE Euronext financial conglomerate. NYSE Euronext owns LIFFE, and this is one of the major reasons that ICE is interested in the deal. Reuters reports that this merger between two of the world’s largest derivatives exchanges would allow the newly merged ICE-LIFFE to better compete with its “arch rival”, the CME Group. Quoting financial analyst Richard Perrott, Forbes reports: “Putting ICE and Liffe together would create a major London-based derivatives exchange, specializing in interest rates, commodities and credit. Liffe would shift to using ICE’s existing clearing services, removing the need for NYSE Euronext to pursue its own [central counterparty clearing house] build-out”.
While actors in the global coffee sector may be able to choose from an increasingly large variety of products, the products are being offered by a shrinking number of firms. Indeed, it would appear that product innovation and a broadening range of product choice at the retail level has very little to do with democracy at all.
Sasha Breger Bush is a lecturer at the Josef Korbel School of International Studies at the University of Denver. Her research interests include global finance, derivatives and social policy, and food and farming. Her recent book, Derivatives and Development, was published July 2012 by Palgrave Macmillan.
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