Fast and Furious? High-Frequency Trading and the Right to Food
By Jesse Coleman and Kaitlin Cordes
October 10, 2016
As food systems become increasingly globalized, and commodity markets more complex, policymakers face the ever more difficult task of identifying and addressing multiple risks to food security. One risk that has largely escaped attention in global food policy discussions is the potential for high-frequency trading to exacerbate commodity market volatility, with corresponding negative impacts on the world’s hungry. Although arcane trading practices are not usually raised in the context of the right to food, it is increasingly urgent for governments and other stakeholders to pay more attention to the potential risks arising from these types of sophisticated trading strategies, and to consider whether more steps should be taken to buffer the most vulnerable from the shocks of food price swings that such strategies could engender.
High-frequency trading and commodity markets
High-frequency trading (HFT) is fully computerized trading, and depends on privileged access to market information gained through speed advantages. HFT firms fork up millions of dollars for direct data feeds and prime placement (or “co-location”) in data centers that house stock exchange computer servers. These speed advantages enable high-frequency traders (HFTs) to leap-frog other investors, using algorithms to move in and out of positions at high speeds, and eventually exhorting prices for orders that – but for faster access to market information – might have been matched at more favorable prices. Essentially, HFTs have an informational edge that allows them to receive and act upon new information more quickly than other market participants, and ultimately to “pick off” orders sitting on trading venues before other investors can react.
HFT strategies have both their supporters and critics, but for those who work on food security, the most concerning aspect of HFT is its potential to create or exacerbate market volatility. Algorithmic trading strategies make short-term directional bets, and are often agnostic to whether they are trading IBM stock or soybean futures. Such strategies tend to be most profitable during periods of increased volatility, and thrive in environments that are complex and opaque.
Given that HFT strategies are used in commodity trading and can exacerbate volatility in a market, careful consideration of their potential impacts on food prices is necessary. The role of HFT is an important nuance in the broader “financialization” of commodities argument—which suggests that food prices are being increasingly driven by speculative financial strategies, rather than by the realities of buying and selling food—and one that has been missing from most food policy debates.
One of the few studies to specifically consider HFT and food commodities comes from the United Nations Conference on Trade and Development, which in 2012 compared short-term intraday price movements for five commodities (including four food commodities) with movements in the U.S. equities market. The study found that, prior to 2008, there was little or no correlation between the short-term price movements of the commodities and equities examined … until the collapse of Lehman Brothers in September 2008, after which such correlations changed and became strongly positive.
The study’s authors noted that common explanations of commodity price fluctuations did not explain the sudden linkages between equity and commodity price movements. Rather, the authors proposed that two structural changes in financial markets had fundamentally altered the nature of commodities trading. First, financial actors seeking to diversify portfolios and hedge risk had begun, following the financial crisis of 2007-08, to invest more heavily in financial products derived from commodity futures. Second, the emergence of full electronic (or computerized) trading in many commodity markets during the course of 2006 had opened the door to HFT. Indeed, this milestone marked the beginning of an increase in the volume of “ticks” (or price movements) for the five commodities studied.
Further research is needed to clarify the extent to which these factors hold implications for real food prices. The role of HFT (versus commodity speculation more generally) has been largely ignored by those working on food policy issues, and the argument thus remains unexplored. Yet some anecdotal evidence of HFT triggering anomalous price movements in commodity markets has already emerged: in March 2011, for example, cocoa futures fell 12 per cent in less than one minute; similarly, as sugar prices began to fall in late 2010, “sell” orders were automatically triggered, causing prices to crash by 11 per cent in one day. These violent price movements – which may themselves be occurring more frequently than in the past – deserve closer scrutiny than they have received to date.
What are the potential implications of HFT for the right to food?
Governments have legal obligations to respect, protect, and fulfill the right to food. This right is enshrined in multiple binding international and regional human rights instruments, and some argue that the “minimum core component” of the right to food may have already achieved customary status (making it binding on governments even if they have not signed or ratified a treaty that protects it). Right-to-food obligations arguably also apply extraterritorially.
Despite these protections, some 795 million people were “undernourished” in 2015. This means that, for a period of at least one year, 795 million people were unable to acquire a sufficient level of food to meet dietary energy requirements.
With respect to HFT, the main question is whether the volatility that it may create or exacerbate in commodity markets can ultimately affect individuals’ right to food, defined as “physical and economic access at all times to adequate food or means for its procurement.” While further research is needed to assess the specific implications of HFT for food price volatility, we are concerned that the characteristics of HFT strategies could impede the realization of the right to food by introducing greater volatility in commodity markets and significantly affecting real food prices, with detrimental impacts on peoples’ access to food.
Indeed, HFT in food commodities is unique because of its potential connection to the sustenance of those living close to, or below, the poverty line. High and volatile food prices can hit those with low incomes (who spend a majority of their income on food) the hardest, both by undermining their capacity to purchase food, and by reducing the quality of food consumed. The global food crises of 2007-08 and 2010-11 pushed an additional 80 million and 44 million people into hunger respectively, bringing increased poverty, instability, and conflict to vulnerable regions across the world.
Apart from net-food purchasers, smallholder farmers in low-income countries who rely on agriculture as their primary source of income can also be negatively affected by food price swings. Where volatile prices at the global level create or exacerbate volatility at the local level, the perceived risks associated with volatility may dissuade production (also affecting net-food purchasers to the extent that this lowers real supply for local markets). Moreover, price fluctuations can create poverty traps, whereby farmers respond to price shocks with temporary coping mechanisms (such as asset sales) that then lead to permanent effects.
Searching for answers … and solutions
Governments seeking to uphold their right-to-food obligations need further research to assess the implications of HFT, both for real food prices and for peoples’ ability to access sufficient food. Depending on those research outcomes, governments may need support in finding effective solutions, which could range from changes in financial regulations to stabilization policies that insulate vulnerable people from food price shocks. This is also aligned with Goal 2 of the Sustainable Development Goals, which seeks to eradicate extreme hunger by 2030, and commits governments to adopting “measures to ensure the proper functioning of food commodity markets… in order to help limit extreme food price volatility.”
Policymakers and other stakeholders attending the Committee on World Food Security plenary this week have long lists of priorities for achieving sustainable food systems and improved food security, goals that are critical for realizing the right to food. It is doubtful that exploring the complexities of HFT is on many of those lists. Yet managing food price volatility is critical for achieving the Committee’s goals—and requires further exploration of the implications of HFT.
Kaitlin Cordes is Head of Land, Agriculture & Human Rights and Jesse Coleman is a Legal Researcher at the Columbia Center on Sustainable Investment, a joint center of the Earth Institute and Columbia Law School. Further details regarding CCSI’s work on human rights and development can be found here.
This blog was originally posted on RightingFinance.org and LandPortal.org.