A rapid deregulation of commodity and financial markets coupled with swift technological advancement (e.g., computerised trading based on algorithms) and financial innovation (e.g., commodity index funds) have facilitated the entry of big financial players into both physical commodity markets and commodity derivatives markets (such as futures, options and swaps) in the major exchanges of the world (but not in India, where banks are prohibited from trading). The growing integration of financial and physical commodity markets over the last decade is popularly referred to as “financialization of commodities.
The key financial players (non-commercial participants) in the commodity futures markets are very diverse and include investment banks, merchant banks, swap dealers, insurance companies, hedge funds, mutual funds, private equity funds, pension funds and other large institutional investors. Table 3 gives the list of top 12 most active banks in commodity derivatives trading in 2011.
Why are financial players interested in commodity derivatives?
Financial players view commodities as a separate asset class or as part of a real assets allocation. The traditional asset classes include equities, bonds and other fixed income securities, property and cash.
Financial players add commodity derivatives to their investment portfolio, the pool of money they invest, as part of a strategy to diversify their portfolio.
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