Presentations by U.S. Exchange Representatives
Michael Braude, President and CEO, Kansas City Board of Trade 25
Mark Fichtel, President and CEO, New York Board of Trade 30
Kent Horsager, President and CEO, Minneapolis Grain Exchange 36
James McNulty, President and CEO, Chicago Mercantile Exchange 41
Mike Ryan, 2nd Vice President, Chicago Board of Trade 49

Legislative Update
Walt Lukken, Senate Agriculture Committee 114
Ryan Weston, House Agriculture Committee 117

Recent Innovations in Agricultural Risk Management and Marketing

CyberCrop.com - Ron Wineinger, Vice President of Marketing 129
e-markets - Scott Cavey, Vice President of Business Units 149

ICEcorp.com - Brett Johnson and Ed Keating, Vice Presidents and Co-Founders 163

P R O C E E D I N G S

WELCOMING REMARKS

COMMISSIONER SPEARS: First let me thank all of you for coming. I recognize that participating in these meetings represents a significant commitment of time, effort and expense for all concerned. On behalf of myself, my fellow commissioners and staff, please be assured that we truly appreciate your efforts.

Today's Agricultural Advisory Committee meeting takes place at a pivotal point in marketplace evolution. New markets, the trading system, new technology are bringing profound changes to financial and commodity markets around the world. Exchanges, market users, regulators and legislators are all struggling to keep pace with the rapid-fire developments.

Financial markets have been the principal focus of ongoing change and have received the lion's share of attention but ag markets are also feeling the effects. Agriculture is affected directly; for example, through the emergence of electronic trading systems for ag products. It is also affected indirectly since changes in exchange structures and systems will affect agriculture as well.

Our first agenda item today will be a presentation by Greg Kuserk of the CFTC's Division of Economic Analysis on the Commission's response to the evolving marketplace embodied in the recently published regulatory reinvention proposal intended to simplify and modernize federal regulation of futures and options markets. Please note that the comment period in this proposal remains open and a transcript of the relevant portions of today's meeting will be included in the public record.

Our second agenda item will be presentations by representatives from each of the U.S. exchanges that list agriculture products. Their presentations will include their views concerning the Commission's proposal, their response to competitive challenges, such as innovative changes to their corporate structure.

Following these two presentations we'll have a general discussion of each of the foregoing issues, the potential impact on agriculture futures contracts and markets in general.

A third agenda item today will be presentations by staff members from both the Senate and House Ag Committees concerning Congress's response to the changing marketplace, as embodied in their committees' respective versions of CFTC reauthorization legislation.

Finally, we will hear presentations on recent private sector developments on ag risk marketing and management tools. Representatives from several innovative electronic trading systems will describe new cash markets, potential futures markets, as well, in various ag commodities.

Before we get started I'd like to pause for a few introductions. I'd first like to recognize each of my fellow commissioners and ask them for individual statements if they have some.

To start with, I'd like to recognize Chairman Rainer. Chairman Rainer, as you all know, has been chairman of the agency now for approximately about a year and it's been due to his leadership and efforts that we've come as far as we have during the past year on reg reinvention.

So with that, I'll introduce Chairman Rainer.

CHAIRMAN RAINER: Thank you very much, Commissioner Spears.

I'd like to welcome everyone here today and thank you for your time. We have just an excellent group of people today and I think we're going to get a lot out of this meeting. I'm really excited about it.

I'd like to place this in a little bit of context of what's been going on with this proposal. On June 22 we published in the federal Register the proposed rules for regulatory reform. That was followed on June 27 and June 28 with two public meetings, which were comprised of five panels for a total of 23 different witnesses. We had 24 presentations. One person decided to do it twice.

That included an overview panel of five people who were generally considered very senior people in the industry who'd been around a long time. We had a panel on exchanges, a panel from the over-the-counter swaps industry, and the next day we had a panel on intermediaries, followed by a panel of clearing houses and clearing systems.

And today is an important day because it's in that context we're interested in presenting and hearing from views about how the agriculture commodities may fit into this proposal.

As you're probably aware, at the moment the proposal carves out agriculture from a couple of important elements of the plan, namely rule changes, terms and conditions of contracts, and agriculture commodities are currently in the proposal limited to the RFE status, if you know what that means, and not able to go to the DTF status, which is a lighter form of regulation for certain conditions.

And so it's in that vein that we're interested in this discussion as to what the various views might be and I'm looking forward to--I understand there will be additional--at least one additional meeting on your part to discuss these matters.

So with that, I'll turn it back to Commissioner Spears and thank him and his staff for the efforts of organizing this group. I think around the table and looking in the audience, we have a number of serious players on matters and we're very appreciative of your here. Thank you.

COMMISSIONER SPEARS: Thank you, Chairman.

I'd also like to recognize my fellow commissioners and I'll ask them if they have anything they'd like to add.

Commissioner Barbara Holum?

COMMISSIONER HOLUM: Thank you, Commissioner Spears. I would simply echo the words of the chairman and Commissioner Spears in welcoming all of you this morning and thanking you for your participation, not only today but over the past many months on this important subject and I look forward to the proceedings of this afternoon. Thank you.

COMMISSIONER SPEARS: Thank you, Barbara.

Commissioner James Newsome.

COMMISSIONER NEWSOME: Thank you, Commissioner Spears.

I, too, would like to take this opportunity to thank you for taking time away from your businesses and your organizations to be here to give us advice on agricultural issues that are currently and will be before the Commission.

I know that we have a strong agricultural roots at the Commission, not only with our history but also with the people that are serving on the Commission now. We certainly are very interested in your thoughts and what's important to you.

I think we're at a very critical time in terms of the Commission, not only our regulatory reform issue that we're going to discuss parts of today, but also with the Commodity Exchange Act reauthorization that Congress is apparently discussing. I know that many of you have been very involved in that process. It's not only important but it's been a very busy time with the Commission as we work with constituency groups such as you and with members of Congress, as well.

I know that not only myself but other members of the Commission and staff have been meeting with many of you and your organizations over the last several months to try and develop opinions and get you to provide input to us and I want to thank you for that because it's very important and very critical not only at this point but as we drafted language and have gotten to the point where we are now.

I believe certainly we're headed in a very positive direction, not only in terms of market participants but for products, as well. And I think as we go forward, to me, the key word is flexibility--flexibility to change, flexibility to embrace new technology, flexibility to participate with new market participants and with new products.

Again I appreciate all of you taking time to be here and I look forward to the discussion.

COMMISSIONER SPEARS: Thank you, Jim.

Commissioner Tom Erickson.

COMMISSIONER ERICKSON: Thank you, David.

I too would like to welcome everyone today and very much appreciate your participation in these processes and proceedings. It's very important to the Commission and I think also for our record to be able to have the ability to hear from you directly and also in greater detail in written comments. I know for a number of you we'll be hearing a full presentation really for the first time and I'm anxious to hear from you your reactions to the final proposal. Thank you very much again for coming.

COMMISSIONER SPEARS: Thank you, Tom.

At this point in time I'd like to go around the table and have each of the members of Advisory Committee and those guests who are sitting at the table, as well, introduce themselves and tell us what organization you're with.

So with that, I'll start on my immediate left.

MR. ACKERMAN: Good afternoon. I'm Ken Ackerman. I'm the administrator of the Risk Management Agency of USDA and I'm very glad to be here.

I would want to just say I congratulate the Commission. I've read the documentation from the meeting this morning and I think it's a very formidable piece of work and has a lot of insight and it challenges some very core principles--I guess I can usee that phrase--on how regulation in this field should go forward. I congratulate you on it and look forward to the discussion.

MR. MARTIN: I'm Gary Martin from the North American Export Grain Association. I'm pleased to be here and continue to look at your work as something that's very positive.

MR. KUSERK: I'm Greg Kuserk. I'm an economist with the Division of Economic Analysis at the Commodity Futures Trading Commission.

MR. HORSAGER: Kent Horsager, president and CEO of the Minneapolis Grain Exchange.

MR. FICHTEL: Mark Fichtel, president and CEO of the New York Board of Trade.

MR. BRAUDE: Mike Braude, president and CEO of the Kansas City Board of Trade.

MS. MUEDEKING: Christina Muedeking, National Pork Producers Council.

MR. WHITE: Robert White representing the National Grain.

MR. KERWIN: Rick Kerwin representing the National Grain Trade Council.

MR. KUBECKA: Bill Kubecka. I represent the National Grain Sorghum Producers Association.

MR. DODDS: Bill Dodds representing the National Grain and Feed Association.

MR. McLENDON: I'm Bob McLendon. I'm a farmer from Georgia. I'm president of the National Cotton Council.

MR. DIERLAM: I'm Bryan Dierlam representing the National Cattlemen's Beef Association.

MS. GATTIS: I'm Tara Gattis. I'm with Independent Community Bankers of America.

MR. METZ: I'm Bob Metz. I represent the American Soybean Association.

MS. THATCHER: I'm Mary Kay Thatcher with the Farm Bureau.

MR. GILLEN: I'm Neal Gillen. I'm executive vice president of the American Cotton Shippers Association.

MR. BLANCHFIELD: I'm John Blanchfield, director of agricultural banking at the American Bankers Association.

COMMISSIONER SPEARS: Thank you. Again I thank each of you for attending the meeting. I think we have a couple of additional folks who'll be joining us a few minutes late due to travel, as well as due to other meetings on the Hill. They'll be joining us around 2:00.

I'd like to take just a brief moment and recognize a couple of special guests in the audience. One guest is Dan Amstutz, who's been a long-time member of this advisory committee. Dan, thank you for coming. We appreciate it.

Second, I'd like to recognize Jonah Bowles, who is a guest who was asked to attend from the Virginia Farm Bureau. Thank you, Jonah, we appreciate your coming.

Finally, before we get started with the first agenda item, I'd like to take just a moment and thank my staff who helped to put this meeting together, especially Jennifer Roe, Alan Ott and Don Heitman. I also want to thank those people from the support staff, administrative services, for doing the room. One never recognizes the amount of effort involved in this type of meeting together until you get involved in doing it--moving tables and chairs. So thank every one for participating in getting the room together for us.

With that, let's go ahead and get started. I'd like to ask Greg Kuserk to do a brief overview of the Commission's regulatory reinvention proposal and following that we'll have a discussion and presentation by the presidents and representatives from the U.S. exchanges and then a general discussion.

So Greg?

CFTC REGULATORY REINVENTION PROPOSAL

MR. KUSERK: Thank you, Commissioner Spears.

What I'd like to do here is give you an overview of the regulatory reform that the Commission is proposing for the futures and options markets. I think many of you are familiar from other briefings we've had prior to releasing the proposed rules; many of the items are the same but there are some important differences that have come up as we put together the proposals.

The proposals were published on June 22 in the Federal Register. There were four proposals that were issued that day. The first deals with the regulatory structure of exchanges, including the approval of rules and rule amendments. The second dealt with the regulation of intermediaries. A third dealt with regulation of clearing organizations and a fourth dealt with legal certainty for over-the-counter derivative instruments.

The presentation I'd like to give you here today deals basically with the first proposal that dealt with the structure for exchanges. In the vernacular of the Commission we use the term multilateral transaction execution facilities. The reason I want to deal mainly with this area is because this is probably where folks in the agricultural markets will see the most impact on your day-to-day dealings with these markets.

The first thing I'd like to touch on are the regulatory goals that we have in these proposals. The first thing that we tried to do is to replace one-size-fits-all rules with core principles. The idea here would be to give exchanges more flexibility in trying to set up the regulatory structures that apply to their exchanges. So whereas in the past, the Commission has had more prescriptive-type rules that spelled out exactly how things had to be done on exchanges, what we've tried to do is replace these with core principles where exchanges would be left more on their own to determine how they were going to meet the principles. In addition, the Commission would publish guidelines which would give guidance to the exchanges on how they should go about meeting these core principles.

The second goal of the proposal was to develop a more flexible structure for the futures and options derivatives markets. In this regard we're proposing to have three regulatory tiers. We refer to these as recognized futures exchanges, derivatives transaction facilities and exempt multilateral transaction facilities.

The idea here would be that we'd have different tiers that would apply to different types of exchanges, depending upon the types of commodities that would be traded on the exchanges and the types of market participants that would be in these markets. The general idea is that the less susceptible a commodity might be to manipulation or the more sophisticated the parties who are participating in the markets, the lower the level of regulatory oversight by this agency would be.

Now with respect to the agricultural markets, what we get into is determining where different types of commodities might trade. If we look at the exempt MTEF level, in general, ag commodities would be excluded from being able to trade in this type of market. Specifically, the types of commodities that would trade in this type of market would be financial-type commodities, including such commodities as debt obligations, foreign currencies, interest rates, exempt securities, measures of credit quality, things like that.

In addition, commodities that are defined by occurrences or contingencies that are beyond the control of the counterparties would be eligible to trade in these markets. Such things as weather derivatives would be eligible for this type of market. In addition, there would also be cash-settled contracts that are based on economic or commercial indexes, such as measures of CPI, bankruptcy rates, commercial occupancy rates in a city--things like that would also be eligible.

In addition, exempt MTEFs, to trade on exempt MTEFs you would have to be an eligible participant and in general, this would follow the guidelines that we have in the current Part 35 of our rules, so typically large institutional traders.

When we get to the next level, which is the DTF or derivative transaction facility, basically we're looking at two different types of exchanges that would operate at this level. One would be for exchanges that are trading MTEF commodities, so basically that list I just went through with financial-type instruments and cash-settled indexes, things like that.

In addition, it would be possible on a case-by-case basis for various commodities to be traded on a DTF and on a case-by-case basis, the Commission would look at the surveillance history of the exchange; they would look at the type of commodity that's being traded and what additional regulatory undertakings the exchange would take on to trade these types of commodities.

The second type of exchange that would operate at the DTF level would be commercial-only markets. However, I'd point out that enumerated ag commodities would be excluded from this category. Enumerated ag commodities, if you're not familiar with what those are, those are things like wheat and corn and cotton and soybeans, your major type commodities. Agricultural commodities that aren't enumerated are things such as coffee, sugar, cocoa, fruits and vegetables and shrimp, for instance. So commodities like that would be eligible to trade on a commercial-only market. However, the ones that are enumerated, we've carved out and they would not be eligible to trade on this type of market.

And as far as the commercial-only, again that would be defined as the typically large institutions who are involved in the underlying commodities, also. So there would be that requirement on those exchanges, too.

When we get to the RFE level, the recognized futures exchanges, basically that's basically what you're looking at today when you see the exchanges in the U.S. They trade any type of commodity. Anyone's allowed to trade in those markets, so you have retail customers being in those markets, whereas the other ones are more restricted as to who can trade on those markets.

The other part of our proposal deals with listing of new products. As far as listing new products, the Commission already has rules in place where exchanges are able to self-certify that the contracts are not inconsistent with the Commission's rules or with the act and in that case are able to start trading those contracts immediately without receiving prior approval from the Commission.

Alternatively, the exchanges will still be able to come into if they wish and ask the Commission to approve their contracts, which would be done under our fast track approval system.

In addition, for exchanges that are operating at the RFE level, there is a requirement in the core principles that the contracts not be readily susceptible to manipulation. And as guidance for what this means, we would use our current guideline 1 as guidance to the exchanges on how a contract should be designed so that they wouldn't be subject to manipulation.

With respect to new rules and rule amendments on RFEs, again we provide alternative procedures. Exchanges would be able to self-certify that the rules or the rule amendments weren't inconsistent with the Commission's regulations or the act. Or they could come in and ask for fast track review and approval of the rules or amendments.

With respect to amendments to terms and conditions for the enumerated commodities, however, they would not be eligible for self-certification and would have to go through the current approval process that the Commission uses for these types of changes.

Now if we look at the rules, new contract rules and rule amendment approvals for DTFs, again we have alternative procedures. In this case we don't have a certification procedure; we simply require notice to the Commission of the new rules, contracts or rule amendments. And for the most part we would have to receive that notice before the rule went into effect but we wouldn't approve it and basically I think we require it a day before the rule would actually go into effect or the contract was listed for trading.

In addition, these exchanges could still come in and receive fast track approval for these contracts or rules.

Again I would note here that on the DTFs, this would not apply to the enumerated commodities again because in general, they're excluded from this level of trading.

The next slide is probably difficult for you to see but it's in your packet. It's basically just a summary of what I've just gone through. It lists the enumerated commodities as they're listed in the act and then some examples of nonenumerated commodities and then just the different procedures that you would go through in adopting new contracts or rule changes.

As far as issues for agriculture, as you look forward to commenting on these proposals, the one thing would be to consider the rule change procedures for RFEs as they apply to agriculture. The question there would be does it make sense to you to have this carve-out for the enumerated commodities with respect to the rule change procedures for RFEs or should they be included along with the other commodities that would be eligible to trade at that level?

The second thing would be to look at the DTF level and the restrictions on commercial DTFs with respect to agriculture so that if you're an enumerated commodity, even if it's a commercial-only exchange, the enumerated commodity still wouldn't be eligible to trade at that level.

There's also the question as to whether final rules versus proposed rules are going into effect at the end of the comment period.

The other thing to consider is that as these new rules go into effect, we will gain additional experience with how these exchanges operate and at that point I think we will continue to review the effect on agriculture and where agriculture might fit into this scheme.

As far as the process, the rules were proposed on June 22 and the comment period ends on August 7, 2000, so roughly three weeks, I think.

As far as getting the rules, I think some are out on the table out there. You can also find them at our website. If you look under Federal Register notices on the web page you'll be able to find these rules there. So thank you.

COMMISSIONER SPEARS: Thank you, Greg.

I'd like just to recognize that we've had three new members join the group since the meeting started. First I want to welcome Jim Bair from North American Millers Association, Wayne Hammond, National Wheat Growers Association, and then Todd Vanhoose from the Farm Credit Council. Thank you guys for coming.

Because the first two agenda items are so closely tied together, I would suggest that we proceed directly now to the presentations by the exchange representatives, then have a general discussion that would include everyone's perspectives regarding how agriculture fits into the new regulatory reinvention proposal.

There's no question in my mind that farmers and futures exchanges need each other. Farmers depend on exchanges for price discovery and hedging while the exchanges rely upon agriculture for a very important customer base.

I want to say a special thanks to those exchange representatives who are able to be here today. We've been joined by Mike Ryan, second vice president of the Chicago Board of Trade. Thank you for coming, Mike.

What we're going to do now is hear a brief presentation from each of the exchange representatives. I felt it was important for this advisory committee to have the opportunity to interface with these representatives from the U.S. exchanges that deal with agriculture products and to hear first-hand some of the challenges that they're going through at their exchanges as they evolve and develop and deal with the new corporate structure issues, as well as technology and foreign competition.

So first I'd like to start with Mike Braude. Mike is the president and CEO of the Kansas City Board of Trade and is the dean, I think, of all the futures exchange presidents. As most of you know, Mike's been at the Kansas City Board of Trade roughly 17 years. He has led that exchange through tremendous prosperity and growth and Mike will be retiring, I think, effective August 1?

MR. BRAUDE: November 1.

COMMISSIONER SPEARS: November 1. So with that, I'd like to introduce Mike and thank you for being here.

PRESENTATIONS BY U.S. EXCHANGE REPRESENTATIVES

MR. BRAUDE: Thank you very much, Commissioner Spears. Obviously we appreciate being here.

Let me say first of all that the Kansas City Board of Trade views the CFTC's regulatory reinvention proposal with somewhat mixed emotions. At this time we certainly see definite pros to it and some cons to it but let me hasten to say that I think you're dealing with those cons and in the present form, I don't think they're that serious.

On the pro side, we definitely believe that it makes U.S. exchanges better able to react to threats from both the over-the-counter markets and foreign competition.

Second, we feel that it gives U.S. exchanges more flexibility in creating markets for different types of users. We believe that U.S. markets will be able to react more quickly and easily.

The potential cons we see, and again I think you are addressing them, is that it would be possible that it would create untried and untested market competitors to establish exchanges and, in the same sense, it would be possible that it could cause market fragmentation and reduce existing market liquidity.

Specifically regarding agricultural commodities, we feel at this time futures in enumerated ag commodities, specifically in our case wheat, absolutely should only be allowed to trade on a regulated futures exchange. We feel this is necessary to ensure the liquidity, the oversight necessary for a healthy agricultural economy. We feel that freedom to farm makes these protections even more important, given the ongoing educational process required to get farmers up to speed with prudent risk management.

Commissioner Spears also asked me to say a few words about where we in Kansas City stand regarding electronic trading. For the past two years we have been working toward formulating an electronic trading strategy. Up to now we feel that we've truly been best served by waiting to see how the industry developed. We continue to stay informed about trends and initiatives that are under way within the industry and we've researched various concepts and options available. We're in the final stages of formulating a plan for the best and most cost-effective system that will allow us the opportunity to effectively compete in the electronic marketplace.

We understand that whatever system we implement must be open, allowing for the ease of connectivity by all FCMs and independent software vendors or ISVs. Because there are a large number of ISV firms that have written user interfaces, we plan to focus primarily on our core competency, which has always been and will continue to be providing an efficient, well regulated market.

To do this, we feel like we need to utilize a system that can be easily interfaced by the FCM and IVS communities with the least amount of programming and cost while still maintaining a level of functionality that, at a minimum, meets our customers' needs. Doing so, the ISVs and firms build or buy the user interface that best meets their needs and we're free to improve existing products, develop new products, increase performance and the functionality of our system.

With regard to acquiring electronic systems, we have three basic business models for acquiring an electronic trading platform. First, we could build a system ourselves basically from scratch. The second alternative is to pay a service provider and either list our contracts on their system or run it locally. Either situation, we're liable for fees, either at a fixed rate or on a per-transaction basis.

The third alternative would be to exchange services with someone who has the technology by providing what we have, clearing and regulatory functions on their behalf, in exchange for the use of their technology.

Each of these strategies has pros and cons and we're evaluating alternatives in all three of these areas to determine what is the best alternative for the Kansas City Board of Trade and its members.

With respect to demutualization, I would point out to you that in a sense, we've been the only exchange that's been demutualized for 40 years. We are a for-profit corporation. In fact, we paid a dividend the last three years. We are not a publicly held for-profit corporation and to go that step, which we're not at the present time contemplating, would require change in our by-laws.

Commissioner Spears, we thank you for the opportunity to appear. On a personal note, this, after 17 years, as you mentioned, this will probably be my last time at the CFTC. I've always appreciated the great cooperation that I've received from you and the chairman and all your fellow commissioners. I'm confident that Bob Peterson, who most of you know, will enjoy an equally constructive relationship with this committee and with the Commission. Thank you.

COMMISSIONER SPEARS: Thank you, Mike. You'll be missed.

I'd next like to turn to Mark Fichtel, president and CEO of the New York Board of Trade. That's the parent company of the Coffee, Sugar and Cocoa Exchange or Cotton Exchange.

Prior to his appointment, I think in March?

MR. FICHTEL: March 30.

COMMISSIONER SPEARS: March 30, he served as senior executive vice president, Office of the Chairman, American Stock Exchange. So Mark, I'd ask you to share where you are at your exchange and some of the challenges you face.

MR. FICHTEL: Thank you, Commissioner Spears, and I'd like to thank the other commissioners for this additional opportunity to do a reprise of the last performance a few weeks ago. I am going to add some additional comments per Commissioner Spears' request.

The NYBOT, as we indicated last time, supports the CFTC's proposed regulatory framework and we believe that it provides greatly needed regulatory relief for exchanges without sacrificing market integrity, transparency and oversight. It shows a shift in the thinking of the CFTC that we think is to be welcomed.

Exchanges need regulatory relief so that we can adapt to a changing and increasingly competitive marketplace. Flexibility is going to allow us to minimize our costs and maintain our attractiveness to investors who provide the liquidity necessary for efficient markets.

Now currently, CFTC rules and staff reviews tend to be descriptive. For example, they describe what systems must be used and how an exchange's rules should be worded. The new framework, the CFTC would set performance standards or core principles, 15 in the RFE, seven in the DTFs, and give an exchange greater flexibility to develop the necessary rules and procedures and systems to comply with those standards, and this strikes, we think, a good balance between self-regulatory responsibilities and federal regulatory responsibilities.

The New York Board of Trade, however, does have some recommendations to improve the proposed regulatory framework, which will be provided in detail with written comments which we will be submitting to the CFTC. Today I would like to focus on two issues with regard to the proposal that are important to our exchange's agricultural markets--coffee, sugar, cocoa, cotton and orange juice.

First is the eligibility for DTF status. We welcome the opportunity to be able to convert existing markets or to create new markets under the DTF regulatory regime. Again this scheme will give us greater flexibility for our markets to contain costs and to develop innovative approaches to meet the needs of the market users.

We're also pleased that the CFTC is willing to consider on a case-by-case basis granting DTF status to the nonenumerated agricultural commodities, such as our world sugar contract, on the basis of surveillance history and other characteristics of relevant contracts.

However, as Greg noted earlier, the proposal would not allow agricultural commodities enumerated in Section 1(a)(3) of the act to trade on a DTF. We believe that each agricultural commodity should be allowed, on a case-by-case basis, to decide whether it would like to seek DTF status. This would allow the CFTC to determine, based on the circumstances of the particular agricultural market, whether DTF status is appropriate. Without this flexibility, we are concerned that the opportunity that might be possible for these various agricultural markets would be lost.

The second thing I'd like to address is the contract rule review for enumerated agricultural markets. We would like to recommend that terms and conditions for contracts based on agricultural products enumerated in Section 1(a)(3) of the act not be subject to prior CFTC approval. If an exchange meets certain market surveillance, trade monitoring and other criteria, such an exchange should be able to list new contracts and to amend existing contracts without CFTC approval.

By such action, the CFTC would not lose oversight authority. Among other things, it has power under Section 8(a)(7) of the act to alter or supplement any exchange rule to the extent found necessary or appropriate.

When designing or modifying a contract, our exchange's goal has been and will continue to be to develop a product that is consistent with cash marketing practices and one that can be used effectively by a wide range of market users and these are absolutely necessary ingredients for success of the exchange. We can consult with potential market users and conduct extensive market research before we attempt to implement any change and we would continue to do so. We look at cash market practices, the interests and needs of market users, pricing patterns, deliverable quantity and historical information on production and consumption.

All new product initiatives must receive the approval of our board of directors, who are comprised of experienced world leaders in trading commodities, as well as public directors. But even more importantly, they must first receive the approval of our contract committees, which are made up of specialists in the area.

Just a brief word on electronics. I came to the New York Board of Trade specifically to bring technology to the process. We hope to have an electronic order entry and trade reporting system floorwide by the end of this year or beginning of next year. We already have an alliance with E-speed, the Cantor Financial Futures Exchange, if and when we decide to trade any or all of our products purely on a screen.

With regard to demutualization, I'm going to emphasize that these are my thoughts, since we have not brought them to the board yet. I want everybody to understand these are not the New York Board of Trade's comments.

That's a second reason that I came to the New York Board of Trade. I firmly believe that all exchanges, and I applaud you, by the way, for already being there. In this environment, all current exchanges will have to be demutualized and they will have to be for-profit. They'll have to have a corporate structure. I've watched amazing folks at two of our current competitors and all of our new competitors are in that structure. I think that any exchange that operates under the old structures is going to be at a severe competitive disadvantage.

However, I think even more importantly for the agricultural commodities that we trade, their shift in strategy will be positive. I believe that we will always have to focus on keeping all the participants in our markets happy. That includes trades, FCMs, specs and locals and if we lose the loyalty of any of those, we're going to hurt the business.

Secondly, we must have an attractive and stable business in terms of those who are participating in order to protect investors.

Third, as part of this demutualization effort, we would always maintain our contract committees. This is a fundamental integral part of the way we operate.

Fourthly, the CFTC will still be there, regardless of whether we demutualize or not. And whether or not some of these changes that are proposed go through, if a producer group feels that they are disadvantaged, they can always appeal and no market is going to tell its regulator that it's not going to listen to the regulator's concerns that have been brought to the fore.

And finally, an era of choice is upon us. Any commodity that feels that it is not being treated fairly by its market might have hesitated a few years ago to move its markets. I suspect that that's going to be a lot less of an impediment as we go forward. And that's another reason why there should be less fear about looser regulation. Thank you very much.

COMMISSIONER SPEARS: Thank you very much.

I'd like to introduce next Kent Horsager. Kent is the president and CEO of the Minneapolis Grain Exchange. If Mike was the dean, Kent is the newest member. I think you've been there 30 days. Welcome and we're interested in hearing your comments, as well.

MR. HORSAGER: Thank you very much, Commissioner Spears. It is a pleasure to be here with this group and representing the Minneapolis Grain Exchange today.

First of all, let me say that the Minneapolis Grain Exchange is pleased that the Commission has recognized that the rapidly changing technologies, evolving market reality and economic competition require a new regulatory framework. A new regulatory process is necessary in this trading environment. Therefore, in general we're extremely supportive of the Commission's proposed rules.

The MGE applauds the effort put forth by the Commission to streamline the regulatory process. The proposal provides for three separate tiers. The exchange concludes that it will at least initially receive limited benefits because our current product line is primarily commodities which are agriculture-based in the enumerated list. The exchange therefore will have no opportunity to avail themselves, again initially, at least, of any flexibility to choose another regulatory tier other than of the recognized futures exchanges.

The current proposal will likely then incent platform and product innovation in other marketplaces, across other regulatory tiers, and this is to choose regulatory changes. Thus, the concern would be that it's arbitrarily depriving the agricultural industry of the benefits of progress and developments which are being made in the area of trade and risk management tools being offered.

In this light, I have five specific points of interest that I think the core principle posture may not be as apparent. First of all, the exchange believes that it is in the best interest of the agriculture community and the exchanges to permit the enumerated agricultural commodities listed in the Commodity Exchange Act should be traded on a recognized derivatives transaction facility; that is, DTF.

The exchange believes that the four primary objectives of the CEA--ensuring market and price integrity, protecting the market against manipulation, protecting financial integrity and protecting the customers from abusive trading or sales practices--can be adequately met and it would indeed be in the interest of the exchange operating under any format to meet that.

Secondly, the exchange would not be in favor of any proposal to permit only commercial or institutional traders to trade the enumerated contracts or commodities on a DTF. Restricting noninstitutional traders of these commodities to an RFE while permitting institutions to operate in the environment of the DTF would create two playing fields and two potential pricing mechanisms.

Third, the noninstitutional traders may represent a small percentage of some of the commodities being traded by an RFE but nonetheless they can trade through futures commission merchants or FCMs. Even though some of the FCMs have adjusted capital that is less than $20 million, they're still extremely valuable and contribute greatly to effective marketplaces.

The proposed adjusted net capital requirement should probably be eliminated or reduced since the minimum requirement does not automatically improve financial integrity of a DTF market. Furthermore, there are much more effective ways to measure financial integrity in the marketplace than adjusted net capital and it seems arbitrary and possibly inefficient.

Fourthly, the exchange is pleased to see that the futures exchanges would continue to be able to launch new contracts by certification. This is a process that the exchange employed just recently when we introduced our cottonseed contract within the last two months. However, the exchange is concerned about the proposed process for changing contract terms and terms and conditions of enumerated commodities.

The proposed rules, as is currently the situation, require agricultural group commodity rule changes to be submitted for review and approval. The exchange respectfully requests that the Commission alter the proposed rules to permit changes to the terms and conditions of agricultural commodities by certification. Permitting certification on rule changes and conditions of agricultural commodities would, in fact, benefit the agriculture community as well as other industries by being able to respond to market users in the conditions that they face.

It seems also illogical that an RFE can launch a new contract by utilizing certification essentially overnight and yet take 45 days or longer to receive the appropriate approvals.

And then fifthly, the exchange noted that the proposal requires products trading under the RFE, DTF or MTEF market to be separated in terms of physical environment and locations. The exchange just hopes that the CFTC will utilize a very practical approach when interpreting this requirement.

And then lastly, I was asked to comment a little bit on our demutualization or organizational structure and with respect to that, the exchange's mission is to provide price discovery in risk transfer services. It is committed to being a customer-centric and user-friendly exchange as we go forward. Therefore, the board has considered this. However, at this time it has no plans to demutualize or reorganize. Thank you.

COMMISSIONER SPEARS: Thank you, Kent.

I'd next like to recognize and welcome Jim McNulty. Jim is the president and CEO of the Chicago Mercantile Exchange. Jim, thank you for being here.

MR. McNULTY: Thank you, Commissioner Spears. I'm delighted to be with you here today and to give testimony on the CFTC regulatory reinvention, CME's demutualization plan and how these developments are likely to affect our agricultural markets at the CME.

First I would like to express my gratitude to Chairman Rainer, Commissioner Spears, other commissioners and the staff for the incredible amount of work that went into working through all of the complex issues in the CEA reauthorization. I think that this work helps us assure that our futures markets will remain relevant on a global basis for the foreseeable future. This work and these changes we see as crucial to our future and it is greatly appreciated.

Innovation is key. It's key to the CME's success and it's also key, we think, to the ag members' success. Our clients expect the CME to innovate in order to provide the highest levels of liquidity, transparency and credit-worthy clearing and settlement of your products, and all of this at a reasonable cost.

102 years ago we were the Butter and Egg Board. Sixty years ago we began livestock trading. And next week we will launch e-mini electronic trading on lean logs. In the near future we think that farmers will be able to hedge from the field using web technology in our Globex electronic trading system. This is how far and how fast we think technology will bring us.

We see three major drivers in terms of innovation. The three drivers are globalization, technology and deregulation. They're all linked. If you think about where technology has taken us, it took 65 years for 30 percent of the U.S. population to use airlines and to drive cars. It took 45 years for 30 percent of the U.S. population to use electricity. It took 20 years for 30 percent of the U.S. population to use computers and it has only taken seven years for 30 percent of the U.S. population to do transactions on the Internet.

Internet technology is changing the pace of the way people do business in a rate that is almost unimaginable and unthinkable by major corporations. That will affect everybody in this room going forward.

It also leads us to globalization. In talking with the major players in the futures industry around the world, it's very clear now that they expect that the front ends of the futures industry will essentially be merged, not necessarily because exchanges merge but because you'll be able to see every price from every exchange around the world electronically on ISVs and various platforms. So that will greatly contribute to globalization.

And finally, deregulation. We're beginning to find a level of deregulation around the world that's creating much more even playing fields and we think this will also increase the amount of business and liquidity on the exchanges.

So how is the CME responding to this rapidly changing environment? One of the most important things we thought we could do was to go into the demutualization process. That program began over a year ago and June 7 of this year we had a vote which was 98.3 percent in favor of demutualization. I might add that in the 102 years of CME history, that was the most unanimous vote we had ever had. In fact, one of the gentlemen sitting at this table called me and said the only time he had seen that was in Cuba and wondered how that took place.

Why would we demutualize? I think number one, we needed to shift the emphasis of the exchange from members to customers, to shareholders, and to other stakeholders. Couldn't be so single-line driven. It had to be broadly driven.

We had to streamline our decision-making process. I think the day I arrived five plus months ago, we had 214 committees. We need to streamline them.

We also have a board of 38 people. Now to put that in perspective, Daimler-Chrysler that has probably 100 times as many people employed as the CME only has a board of 18 people. So we need great streamlining of our processes.

And we also think it provides us with an interesting currency and the ability to access capital markets by going through this demutualization. And it unbundles equity from our members.

That led us, of course, to a business plan and the business plan really had two major focuses. One was intense customer focus and the other was shareholder value. What does intense customer focus mean? And I think that some of the people in this room could find it interesting. It means that we need to go out to our end users to understand their business, to understand their needs, and then to make sure that we regulate our markets with the goal of fairness and transparency and cost-efficiency. This is one of the thing that we are absolutely dedicated to. It also means having the right kind of access, the right kind of rules and the right kind of technology to be a first-class modern exchange.

Second, shareholder value. As we demutualize, it'll be extremely important for us to have a return on invested capital that is greater than our cost of capital. In other words, we need to give our shareholders a fair risk-adjusted return. It gives us a great metric system because now we know that we're focussed on our end users and we're also focussed on getting the right returns for our shareholders and it helps us make better judgments about how to go out and meet our clients and the public.

That led us to a plan, because we also need to create growth opportunities. The plan is based on retail, institutional, and B2B environments. If you look at how many people were trading stocks electronically in 1995, there were approximately 400,000 to 500,000 people trading stocks electronically. Today there are 15 million people trading stocks electronically.

And if you look at the futures industry, in 1995 there were about 400,000 to 500,000 retail customers; today there's probably a similar number. It probably hasn't increased too much. We think that's partly because we haven't had exactly the right environment or the right platform.

What does the retail client want? They want a "wizywig" environment--a what-you-see-is-what-you-get environment where they can look at a price on a screen, hit a mouse button, click on that price and within one second get a ping back and then, within another second, find out that they've executed. This is what all exchanges will be doing within the next five years, in my opinion.

Finally, in the institutional arena, what institutions want is much better capital efficiency and they want to make sure that they can keep their costs down. That's something that we can do through rules and also constantly upgrading the capabilities of our clearinghouse on the technology side.

And finally, B2B, which I think is very interesting to the agricultural community. We think that the B2B markets over the next four years could grow to approximately $5 trillion a year in volume. We think that there will be approximately 4,000 markets or what people will call exchanges that open up over the next four years.

All 4,000 of these exchanges are not going to survive. The business plan or the value proposition of these exchanges is that number one, they will bring content, meaning publishing content, which will be very good for creating community. And then from that community they hope to create commerce. Commerce will only be created if you have the right kind of clearing, settlement and credit processes in place. That's what our exchanges already have in place, the exchanges sitting at this table.

So I would contend that one of the things that we can do to help the growth of business is encourage content development and encourage community development, which we already do and will do, I hope, a better job of consistently going forward and then help commerce by helping people with solving some of these clearing and credit problems.

In conclusion, the demutualization at the CME is a catalyst and this catalyst allows us to rebalance the focus of the exchange, which shifts in favor of our end users and users of our ag products. The shareholder value orientation will drive us to create greater efficiencies and product innovation and we expect to attract new types of clients in the electronic world where we intend to make you, the agricultural backbone of this country, beneficiaries. Thank you very much.

COMMISSIONER SPEARS: Thank you very much, Jim.

Next I'd like to introduce Mike Ryan. Mike is the second vice chairman of the Chicago Board of Trade. Mike is an independent trader and a member of the exchange since 1980. He served on the exchange's executive committee and a number of other leadership positions, as well. Mike, welcome.

MR. RYAN: Thank you.

Good afternoon. My name is Mike Ryan. I serve as the second vice chairman on the board of directors. I'm on its executive committee and I'm also chairman of the Strategy Committee. I'd like to thank Commissioner Spears and the CFTC's Agricultural Advisory Committee for the opportunity to appear today to discuss the effects of the CFTC's regulatory framework and CBOT's restructuring initiatives on the CBOT's agricultural markets.

As most of you probably know, CBOT's core agricultural products are futures and options on wheat, corn, oats, soybeans, soybean meal, soybean oil and rough rice. These products account for approximately 25 percent of our transaction volume. The remainder derive from the financial and stock-indexed products.

CBOT's agricultural futures options contracts are utilized by a very diverse group of users, including many who do not participate directly in the markets but use the price discovery information provided by these products for business planning and NBOTC products.

For example, many producers can now hedge directly using exchange-traded futures and options but prefer to forward contract with their local elevator. These forward cash contracts are typically priced basis CBOT futures. CBOT's agricultural futures contracts are also used by the U.S. Department of Agriculture's Risk Management Agency to determine payment levels for crop revenue insurance products. However, few crop insurance companies participate significantly in these markets.

The primary participants in the CBOT agricultural futures and options market include a broad range of U.S. and foreign commercial firms involved in grain merchandising, processing, grain and livestock production and food processing and manufacturing. Important sources of liquidity in the agricultural markets include CBOT members and institutional investors, such as commodity funds and pools.

While in the past, CBOT has had few competitors for its agricultural products, information technology, globalization, the growth of foreign exchanges have combined to create an intensively competitive environment for the entire futures industry. As a result of these competitive pressures, CBOT has engaged in a number of initiatives designed to improve market efficiency and lower costs, including enhancement of electronic order routing, CBOT's open outcry markets, implementation of the Eurex Alliance Electronic System, and restructuring.

In order to enhance liquidity in CBOT's agricultural futures and options markets, CBOT staff constantly monitors contract performance and reaches out to market users to determine how effectively we are meeting risk management and price discovery needs.

Since September of 1999, CBOT has reviewed contract terms from every agricultural contract and implemented changes for all of them except soybean meal. Exchanges which range from redesigned delivery systems for corn and soybeans, enhancing quality, specifications for rough rice futures, were developed in close cooperation with representatives of the producer and other agricultural trade associations.

The same combination of performance monitoring and customer input is used by the CBOT to develop its current proposal to increase the maximum daily price fluctuation limits for the CBOT's agricultural products. Exchanges initiated to enhance worldwide product distribution will provide market users with more continuity and price discovery, improve market access during volatile markets. They were developed based on input from members of the CBOT's agricultural advisory committee, major agricultural clearing firms and the CBOT membership.

While a slight majority of our AAC favored either eliminating or increasing daily limits by 50 percent, some producer groups and members of the National Grain and Feed Association felt current limits should be maintained. Therefore, the CBOT's proposed increase in price limits is a compromise between market participants who prefer no limits and those who believe that daily price limits provide a cooling-off function in volatile markets.

On behalf of the CBOT, I would like to commend the commissioners and staff for their efforts in developing a new regulatory framework. I believe this proposal creates an environment in which the U.S. futures industry may compete effectively in the global derivatives marketplace. Replacing detailed regulations with the core principles that give exchanges the flexibility to decide and design how to meet their regulatory obligations will allow exchanges to better meet the needs of the diverse customer base.

Competition among providers of risk management and price discovery services in the agricultural markets is increasing as a result of advances in information technology, globalization of markets and the regulatory disparity between traditional exchanges and OTC and foreign markets. In short, users of risk management, price discovery services provided by traditional exchanges are demanding increased transparency, greater access and lower costs.

The impact of information technology on the commodity markets is currently most pronounced in the cash markets where on-line exchanges, such as Iceberg, e-markets, Brewster and CyberCrop, to name a few, are attempting to link buyers and sellers of agricultural products and inputs directly. Enhancements in information technology are also lowering the barriers to entry into traditional exchange markets, as evidenced by recently approved contract markets for live cattle, large freight, and a wide array of financial products.

While the CFTC's regulatory reform proposal will enable traditional exchanges to better meet these competitive challenges, reduced costs and regulation will also benefit these new competitors. The regulatory framework will benefit users of risk management and price discovery services directly by allowing service providers to reduce costs and stimulate innovation. New product listings are likely to proliferate in response to the lower regulatory costs, the lower cost structures of electronic trading.

New products specifications may also be influenced by the proposed regulatory structure as providers look for innovative ways to provide users with the tools they demand in the most cost-effective manner.

On June 28 of this year, the Board of Trade membership overwhelmingly voted in favor of implementation of the initial step of the exchange's strategy to restructure as a for-profit, demutualized organization with about 91 percent of the membership voting in favor. This initial step will allow the CBOT to reincorporate as a Delaware nonstock, not-for-profit corporation which will serve to facilitate the CBOT's future restructuring efforts.

The improved restructuring plan has the following features: allocation of shares of stock representing both trading rights and equity member ownership in for-profit CBOT to the members; option of a streamlined management governance structure of the CBOT with a smaller board of directors and a more efficient decision-making process that would enhance CBOT's ability to respond to the rapidly evolving marketplace; reorganizing the CBOT's electronic trading business as a for-profit company focussed on electronic trading; allocating shares in the electronic trading company to the members; unlocking value in the current membership interests of CBOT, through a potential initial public offering of the stock of the electronic trading company; attracting capital for the electronic trading company and potentially for the for-profit CBOT; and lastly, executing a three-year non-compete cooperative agreement with the electronic trading company, during which time for-profit CBOT could not operate in an electronic trading system within its corporate structure, except for a small order retail execution-type system.

The structure of the exchange is essential for many reasons. Without it, the CBOT may not be able to preserve a viable open outcry exchange capable of competing in the future and, at the same time, capture the growth of electronic trading. Restructuring enables the CBOT to adopt a business model that will allow it to make the decisive moves required to address competitive challenges, built advantageous strategies alliances, lower costs, and serve the customers.

Detailed business plans for the restructured CBOT companies will be developed by the boards of directors and management of the two companies. However, the strategic focus of the two separate companies provides a broad picture of their business objectives and how the agricultural markets may be affected.

With the open outcry company, the focus is expected to be on attaining and enhancing liquidity by investing in supporting technology, capturing and efficiently executing trades while considering changes to trading rules and other measures aimed at retaining and enhancing order flow.

The main reason for becoming a for-profit corporation is to allow the CBOT to be governed by a more modern and developed body of corporate law in Delaware than that provided by the CBOT's current special charter. Restructuring also will allow for a more streamlined corporate governance system that allocates authority from the membership to the board of directors. The reorganized electronic trading company would continue the CBOT's endeavor to build a market leadership position by providing a superior electronic trading platform, initially capitalizing on the CBOT brand and Eurex alliance and providing greater access to a continually expanding global trading community.

These clients will not be required to own seats or any other type of membership interest in order to utilize direly the electronic trading platform. The focus of the electronic trading company will be on creating a cost-competitive trade execution capability and will invest aggressively in technology to maintain and enhance its competitive advantage. This could include new business and revenue sources in the area, such as business-to-business e-commerce and commodity trading, direct retail access, enhancing its capability to other exchanges and geographies.

In summary, I believe the combination of the CFTC's proposed regulatory framework and CBOT's restructuring initiative will allow the exchange to enhance the world's most liquid, accessible and reliable marketplace for a wide array of financial and agricultural products and services. Exchanges will also stimulate innovation and product development and lead to the creation of new trading mechanisms.

The proposed regulatory framework, combined with the conversion of exchange governance structures, will allow risk management products and price discovery services to be provided at a lower cost, directly benefitting users of the services.

Again thank you for the opportunity to appear before your committee today. I'd be happy to answer any questions.

COMMISSIONER SPEARS: Thank you, Mike.

First, I want to thank each of you for coming and attending the meeting and making your presentations. I think this is the first time that I know of that we've had the senior leadership of each of the exchanges in ag products at the Agricultural Advisory Committee meeting and I appreciate your attendance and presentations and look forward to your comments during the discussion period, as well.

I think it's evident to the membership of the Advisory Committee that the U.S. exchanges are going through massive change, not only through their corporate structure, as well as their leadership. I didn't realize till a minute ago that each exchange will either have a new president and CEO either currently in place or will soon be in place within the next short time period. So that's quite a remarkable change.

What I'd like to do next is have a discussion period where we can have a free flow of information and thoughts and views and concerns among the Advisory Committee members where they'll have the opportunity to present some of those thoughts and questions not only to the Commission but it's a unique opportunity for the presidents and leadership of the exchanges to also hear from this Advisory Committee.

So I'm hopeful that not only can they engage in a dialogue, as well as with the commissioners, but you, as well.

As Greg pointed out early on, there are a couple of key issues that are very important to the Commission that we need input on in developing the final rules on the reg reinvention proposal. As Greg highlighted in his comments, the question is how do we treat agricultural contracts as we go through this transition process? Should ag contracts be treated differently than the other contracts?

Also, as noted earlier in the discussion, the new rule proposal has a carve-out so that the enumerated ag commodities can only trade on an RFE platform and would be subject to the current criteria for rule changes, approval for rule changes on terms and conditions of contracts.

A second question that we're very much interested in input from this committee now and as you develop your final comments for the comment period would be should ag commodities trade on a DTF level? Should there be the opportunity and flexibility to go from the RFE to DTF level?

And then how that should deal with, as well, as far as rule changes and terms and conditions on rule changes as far as notification, certification on a DTF level, as opposed to the RFE.

So I'd like at this point in time during the meeting to have a discussion as long as necessary and we'll take a break before we go to the third part of the agenda. I'd like to have an opportunity to open it up for discussion among members of the Advisory Committee--their thoughts, their views, their questions, their concerns with regard to the above issue.

I've also been asked by two members or two groups on the Advisory Committee to make a short statement of their position, so I'll recognize those members if they'd like to submit them, as well. So at this point in time the Commission is open for comments and questions.

Neal, go ahead.

MR. GILLEN: Thank you.

Commissioner Spears, Chairman Rainer, Commissioner Erickson and members of the Advisory Committee, I thank you for the opportunity to present these views as the Congress and the Commission move in unison in the final stages of the process of deregulating commodity markets. While I am of the view that it is the proper direction to take, I share the observation and concerns of many that what is happening may not be fully understood by important participants in the process. Underlying these concerns is the future role of the Commission and the fact that agriculture is not participating in the deregulatory process.

In 1974 the American Cotton Shippers Association was among a handful of advocates, including the National Grain and Feed Association and the National Farmers Union, who urged the Congress to remove the regulation of the agricultural futures contracts from the Department of Agriculture through the establishment of an independent regulatory agency with authority to regulate all commodity contract markets.

Until that time, the regulatory authority over commodity futures trading was vested in a USDA agency, the Commodity Exchange Administration, and limited to the contract markets trading in agricultural commodities. The unregulated commodities--gold, silver and other precious metals--were self-regulated by the contract markets on which they were traded.

In 1973, Senator Robert J. Dole recommended that the regulatory jurisdiction of the CEA be extended to include trading in all contracts for future delivery, noting that the public desired and required this protection. Further, he observed that should a problem occur in a nonregulated futures market that it would reflect badly on all other futures markets.

America had just ended a regretful period of government price controls, inflationary pressures were unleashed on the marketplace and commodity prices were rising to new plateaus driven by significant increases in the price of oil and other energy products vital to maintaining our productive resources, particularly agriculture.

Further, financial, stock indexes, options or other derivative instruments did not exist. It was around this time that the world's financial powers, the signatories to the Bretton-Woods Agreement, abandoned the concept of fixed currency rates in effect since 1945 and agreed to let market forces determine the value of the various world currencies. Overnight, a significant opportunity emerged for the development of contract markets and off-exchange markets for the trading of the various currencies. By the early 1980s, trading in stock index futures began and soon after, Congress lifted the ban on the trade of agricultural options.

The success of these markets is well documented. Trading volume has expanded well beyond expectations and the contract markets and this agency have kept pace with this exponential expansion through effective self-regulation and prudential oversight.

This important fact is overlooked. The regulation of these markets has been effective, not overly intrusive, and accomplished with minimal resources. Simply stated, the CFTC's regulatory role has provided the trading public the necessary confidence to utilize the markets and has materially assisted in the phenomenal expansion of the U.S. futures industry.

As the Congress and the Commission move from an era of effective regulation to a new era of deregulation or self-regulation, the question comes to mind: are the appropriate safeguards in place to maintain the public's confidence in the financial and futures markets?

Market innovation keyed the phenomenal growth of the U.S. economy and its related markets in the last decade, but tied to this growth is a combination of governance that kept it on track at a controlling rate of acceleration. The agencies participating in this effective governance--the Federal Reserve, Treasury, the SEC and the CFTC--have concluded the markets have come of age and it is time to relax the, albeit limited, restraints.

The report of the President's Working Group could be the most influential document in the history of U.S. financial markets. Given the leadership of the Working Group, its far-reaching recommendations are being followed with little dissention or dispute. I do not challenge the conclusion of the report or its recommendations. I simply raise the question: why is there an inconsistency in the regulation of the agricultural and nonagricultural commodities?

We understand the need for transparency, the essentiality of price discovery, and the concern that commodities with a finite supply could be manipulated. Every market participant shares these concerns--the producer, merchant, cooperative, processor, and speculative interests. If the contract markets afford adequate participation to the representatives of these interests in the development of rules and regulations and the governance of that market, then the self-regulation of the futures and options trading in this agricultural market should be permitted.

Simply stated, we understand the markets, we are entitled to a meaningful role in market development and governance, and we do not wish to be prohibited from benefitting from any innovative trade practices available to the nonagricultural commodities.

What is the stake of cotton? Permit me to quote from Mr. Robert McLendon's testimony this morning to the House Committee on Agriculture. "The industry and its suppliers, together with the cotton product manufacturing, account for one job of every 13 in the United States. Annual cotton production is valued at more than $5 billion at the farm gate. In addition to the fiber, cottonseed products are used for livestock feed and cottonseed oil is used for food products ranging from margarine to salad dressing.

While cotton's farm gate value is significant, a more meaningful measure of cotton value in the U.S. economy is its retail value. Taken collectively, the business revenue generated by cotton and its products in the U.S. economy is estimated to be in excess of $50 billion annually.

Cotton stands alone, above all other crops, in its creation of jobs and its contribution to the U.S. economy.

The agricultural spot and forward markets are open networks ubiquitous with accurate price data and other information vital to all who function within them. This open network of producers, merchants, cooperatives and processors utilizes transparent market information to serve one another by producing a product, adding value to it, offsetting price risks, protecting the product's value, shipping it for processing or manufacturing, and then creating a product or products which stimulates additional production.

The participants in these networks moving farm products from the field to the consumer adhere to the highest standards by sharing the norms or values of fairness, truth and reciprocity beyond those necessary for ordinary market transactions. That is why the Congress, in 1921, included the forward contract exemption in the Commodity Exchange Act.

The agricultural segment of American business is perhaps the most complex and yet the most efficient and productive in our economy. Americans spend approximately one-fourth of their disposable personal income on food and fiber, the lowest percentage in the world because of the productivity of our nation's farmers and the efficiency of our processing and distribution system. Our efficient and self-sustaining system equals the efficiency of the financial markets, yet it is trapped within a legislative and regulatory framework that precludes its use of the product innovation allowed the nonagricultural commodities.

Why do the Commission and the Congress trust the financial markets to move toward self-regulation yet deny the same privilege to agriculture? The answer lies in the recent failure of the implementation of the pilot program for agricultural trade options. It is assumed that innovation is either too risky for agriculture or agriculture lacks the sophistication to innovate. These assumptions are not only unfounded but they are prejudicial to the interests of agriculture.

Since 1985 when the Commission's Office of General Counsel issued an Interpretative Statement on the forward contract exemption, the trading of agricultural product has been constrained from innovation and limited to merchandizing transactions in a physical commodity in which delivery is delayed or deferred for commercial convenience or necessity.

In the 15 years since the issuance of this opinion, the production, harvesting and distribution practices have undergone considerable improvement through technological change. Except for the advent and significant use of exchange-traded options contracts, there has been little change in the risk management instruments made available to the producers of agricultural commodities. It is patently unfair and unreasonable to continue a policy that denies agricultural producers the innovations in risk management instruments made available to other industrial producers.

Much has transpired in the 79 years since Congress enacted the forward contract exemption. The law of contracts and the court interpretations are uniform throughout the various states, the reputable agricultural buyers are known to the producers, trade rules and practices are well established, arbitration and other legal remedies are readily available to resolve disputes, and accurate spot and futures price information is available on a continuing basis.

Therefore, if ready buyers and sellers agree to terms they are financially capable of undertaking, they should not be restrained from entering into such contracts. Denying producers and merchants the flexibility to enter into such contracts is denying them the right to maximize their opportunities to minimize their risks and maximize the price potential of the market.

By labeling transactions as non-sanctioned trading instruments we are denying agricultural producers the right to innovative risk management alternatives. In doing so, we are failing to consider, in the words of the Commission's 1985 Interpretative Statement, and I quote, "the economic reality of the transaction." The reality is that delivery will be required or not required depending on the specifics of the contract to which the parties, possessing the legal and financial capacity to engage in such transactions, have entered into of their own volition solely for purposes related to their business. This is the standard utilized by the Commission for all commodities other than agricultural commodities.

In its desire to protect agricultural producers, the Commission is instead penalizing producers in denying them the potential of beneficial marketing innovations. Before the Commission and the Congress finish their work on the deregulation of the markets they should reconsider the decision to continue treating agriculture as a market meriting constructive regulations and instead provide U.S. agriculture the same opportunities it allows other segments of our thriving economy. Thank you.

COMMISSIONER SPEARS: Thank you, Neal. We appreciate your comments, Neal. The Commission, as you know, has labored diligently in trying to receive as much input from the agriculture community as possible on these issues as we developed the proposed rules.

As Commissioner Newsome mentioned earlier on, each of us have met with numerous representatives around this table, as well as members of the group. This topic was a discussion at the last Agricultural Advisory Committee meeting we had and that's why I think this process is so important today, is that we can hear the views and comments. As we've discovered, there hasn't always been total agreement on those views but I think it's important that we hear from all the parties as to what their thoughts might be on that.

With that, Bill, I'll turn the comments to you.

MR. DODDS: Commissioner Spears, the National Grain and Feed Association in its structure has a risk management committee and they met as late as yesterday with 15 members from the grain industry. I was unable to attend. I would ask that you permit Kendell Keith, president of the National Grain and Feed, to maybe make a few comments relative to what was discussed on this subject at our meeting yesterday.

COMMISSIONER SPEARS: I appreciate that, Bill.

I might just note for the housekeeping rules that it's important that as we finish speaking into the microphones, turn off the microphone. The system is quirky in that if more than three microphones are on at one point in time, the system shuts down.

So with that, Kendell, I'd welcome your comments.

MR. KEITH: Thank you. I'll try to be brief in the interest of allowing more time for discussion.

We, too, agree that the CFTC deserves commendation for this proposal. We think the concept is sound. It provides regulated markets the choice on how regulated they want to be, based on market need.

At the same time, we see this proposal as incomplete from agriculture's perspective from two standpoints. One, ag markets do have new competition from many sources and we think they need regulatory relief to be able to compete. Secondly, there is a strong need for greater legal certainty for off-exchange forward agricultural contracts, much like the over-the-counter contracts in other markets.

As to the first point, we plan to support permitting exchanges the flexibility to move the agricultural contracts into the less regulated category of DTFs. We believe that with proper exchange self-regulation and good oversight by a well qualified CFTC, that these markets can properly handle this level of new responsibility and there will be broad benefits to the market.

At the same time, we're going to ask the CFTC to restrict the flexibility to a certain extent so as to not permit exchanges to bifurcate markets on the basis of types of traders. That's a concern we've had since the pro-market exemption and that's going to be part of our recommendation to the agency.

We think there are some risks in not moving forward in deregulation. Maintaining status quo for futures markets is going to keep transaction costs high. We think the institutional investors are going to look elsewhere for places to invest portfolio money. We think we will reduce the liquidity, especially in the out-months, and potentially affect, impede multi-year contracts.

We think high transaction fees are going to encourage commercial hedgers to look for alternatives. In particular, as electronic exchanges develop, there's going to be a myriad of alternatives that are easy to use, low-cost, and we think that there's a risk that we will move and migrate off organized exchanges and a long-term threat at least to price transparency in the marketplace. We don't think that's good for anyone concerned here.

Concerning the second issue I talked about, mentioned briefly on cash forward contracts, we do have a written statement where I go into more detail on that but we are quite concerned that the agricultural marketplace be given reasonable freedom to develop contracts to serve farmer needs. We think the environment out there today is certainly not ideal for doing that and a lot of this is driven by the lack of legal clarity.

Cash contracts in our industry are still the number one price risk management tool out there today. We think with the changes in the marketplace, the need to serve end-use customers better and more diverse end-use customers--we're going to see more integration, more contracting take place, so it's very important in our view that we decide and more clearly state what is permitted in cash contracting, what is subject to CFTC jurisdiction and also what is not.

One of the experts who testified in an earlier hearing that the CFTC held--I think it was Tom Russo--made a comment that we overuse labels in risk management and I think I agree with that. Labels that we all commonly use, such as options, futures, derivatives, trade options, swaps, cash contracts or any other term can be misleading simply because there are no pure or complete definitions of these terms.

The point that he made was that we need to focus less on labels and more on features and functionality, what the marketplace needs.

In that regard, what are the contract features most important to agriculture? In our view, the farmer needs flexibility today to deal with changing circumstances. Just a couple of examples, and I offer some more in the written comments.

The farmer cash contracts his crop but a hailstorm destroys it before combining. Should the marketplace be given the freedom to establish a value on that failure to deliver prior to the event or are we forever left with the situation where liquidated damages are only allowed to be computed at the time of scheduled delivery?

Another example: is it okay for the elevator to charge an administrative fee in the event that contracts are mutually renegotiated or is this at risk of being labeled an option premium at some stage?

I see a few smiles around the table. I think you understand that there is some legal uncertainty regarding these contract terms. But they are contract terms that are very useful in the cash marketplace.

We think farmers need increasing flexibility, in short, and to provide that flexibility, the cash market buyers need better clarity on what is considered acceptable legally. In our written remarks we do present a proposed legislative solution that would help on legal clarity. It's not the final answer--there may be better ways to deal with it--but we would also urge the CFTC to start working with commercial agriculture interests to achieve more clarity.

Most importantly, we think the CFTC needs to focus less on technical legal considerations or labels and more on the commercial needs of producers and merchandisers and users. Thank you.

COMMISSIONER SPEARS: Thank you, Kendell, and you're certainly welcome to submit your full written statement for the record of the meting, as well. We look forward to any additional comments you might have as far as a comment letter to the Commission within the proposed comment period.

Now I'd like to open it up to additional comments or questions from other members of the Advisory Committee. I know that during various discussions we've had I think a number of the producer groups have also had thoughts about that so I'd welcome, in addition to the agribusiness folks, but also producer groups to comment as to their thoughts or views with regard to the proposal.

Bryan?

MR. DIERLAM: Thank you, Commissioner.

Lemmy Wilson couldn't be here today so I appreciate you allowing me to sit at the table in his place.

I guess I do have a couple of kind of comments and questions, both some directed to the leadership from the exchanges, as well as the Commission staff, any commissioners that can answer the question.

The first one deals with the issue--I'll preface all of this by saying that the National Cattlemen's Beef Association in general is more supportive of less regulation and not more, so any questions that I ask are asked more in the interest of how do we explain some of these things to our membership, as opposed to any opposition, if you will, to anything in the rule, notwithstanding whatever comments we submit.

On the issue of the derivatives, ag commodities moving to the DTF level, there's language in the House bill that passed the House--excuse me--passed the House Ag Committee--that we are supportive of that lays out a framework, if you will, for how agricultural enumerated ag commodities on a registered futures exchange, recognized futures exchange, could move to that DTF level and we are supportive of that.

One of the gentlemen from the exchanges indicated that there was some current concern about market fragmentation and loss of liquidity and we understand that loss of liquidity isn't good for anyone, but neither is an inflexible contract that loses liquidity because it is no longer useful for risk management.

We believe that ag commodities, if they meet the requirements as laid out both in the law and the regulation, should be allowed to move to that level if they meet the requirements and the contract participants meet the requirements that are laid out in the reg. So we are supportive of that.

Another issue is on the--this ties back to the over-the-counter issue. I'll direct this question to the Commission staff.

Will enumerated ag commodities be allowed to be traded under the Part 35 swaps exemption if the contract participants meet all the requirements laid out in the regulation?

MR. KUSERK: I think the current rules allow enumerated commodities to trade as swaps under Part 35, so that would continue--they'd be able to continue to trade that way, yes.

MR. DIERLAM: Just for confirmation, the third point I'd like to direct to the members of the exchanges. This is more about how do we explain this to our members?

On a couple of occasions when we look specifically at the live cattle contract, for a number of years we have proposed a number of changes to that contract which we believe would improve the ability of producers to manage their risk and would improve producer confidence in the market, but due to opposition and other concerns from the members of the exchange, we've been unable to get that done.

At the same time, there's another issue that all facets of the industry have been opposed to and that's on the speculative limits issue. Dozens of letters were submitted when that proposal was sent up here to the Commission earlier this year.

So by prefacing that we do support less regulation and not more, we've got to be able to explain to our members how, on the one hand, will less regulation be good for the industry when, as far as the flexibility to make rule changes with just a self-certification, right now, under the existing process, we've had a difficult time getting the changes we'd like to see made; however, changes that we're opposed to seem to be forced at us.

So the concern is how do we explain to the membership and why should they support this proposal when all they've seen in the past is rule changes being pushed at us that we're opposed to? Under the current system, we have a way to comment, we have a way to discus these things and a way to have an impartial arbiter, if you will, on these rule changes.

So what would be the feedback from the gentlemen representing the exchanges on how we can explain to our membership how this deregulation specifically related to rule changes will benefit them?

COMMISSIONER SPEARS: Thank you, Bryan.

I see that Kent's moved the microphone over in front of Jim since Chicago Merc has the live cattle contract. So Jim, would you feel comfortable in commenting and responding to his questions?

MR. McNULTY: Sure. I don't think I can get to the level of detail that you would like to hear. I'm in my position now for five months and there are still some things that I haven't gotten to yet.

Clearly what we see is there are a number of stakeholders involved. You would be one of the stakeholders. There are clearinghouses. There are members. There are liquidity providers of different sorts that are involved.

I think getting the right contracts is one of the best things that an exchange can do for the success of the contract, to have the right liquidity and to provide the right risk management solutions.

Clearly with the shareholder value focus and with an intense customer focus approach to life, we should be very interested in getting the right contract specifications. And where we know we're in disagreement with any one group, we should be able to explain what the issues are. And I can pledge to you that that is of interest to me and that we will be able to do that for you and your members.

I can't always say that one stakeholder will win the day, though, because I don't think that would be fair to the other stakeholders.

MR. DIERLAM: The exchanges are facing a new era of competition, electronic trading, exchanges from overseas and outside the country at the same time that the beef industry has changed tremendously since the industry and the futures industry was first regulated.

As the industry has changed, so has price discovery; so has the method in which we market cattle, which in the end, is going to necessitate a change in the manner in which those cattle, those livestock are hedged, which will either be a change of the current contracts or an offering of new types of contracts, and those contrasts are either going to be offered by yourselves or someone who chooses to compete with you.

How do you foresee yourselves making the decisions under this regulatory framework to where you've got a contract that's your bread and butter but it's less and less capable of managing the risks of the industry for which it was designed, entailing a switch to another type of contract that for the folks who are entrenched and have been at the exchanges for a long time see that as competing with their bread and butter, but yet that contract is no longer meeting the needs of the customers.

How will that transition from an old contract that doesn't work anymore and people are using it less and less, how are you going to offer that contract even if you see it as competing with your existing business?

MR. McNULTY: Maybe I can answer that one, as well, at least from the point of view of the CME.

As a for-profit company going forward, it will be extremely important to me not to have a lot of Edsels on our electronic system or any other kind of trading system. I think we need to meet our end users' requirements and we have lots of different kinds of end users, as you know.

But we think one thing is clear, that meeting the end user requirements means you'll have to have an electronic version of the contract and an open outcry version of the contract and our end users will choose which one is the most efficient way for them to hedge or to express their investment opinion.

I think I mentioned earlier that next week we will launch an electronic contract, our first agricultural electronic contract, which will be the e-mini, lean hog contract. It's a 10,000 pound lean hog contract and people will be able to trade that electronically starting at the end of next week.

It gives you a what-you-see-is-what-you-get interface, very similar to the high growth contracts that we've had in the S&P 500 and the NASDQ 100, where this year we have 117 percent increase in volume because our clients are expressing exactly what kind of interface they want.

So we will meet those types of demands and our ears are open, so if you have things that you want to express along those lines, please feel free.

MR. DIERLAM: We have had a good number of meetings with the Live Cattle Committee, so we appreciate all the discussion.

COMMISSIONER SPEARS: Thank you.

Mike?

MR. BRAUDE: Thank you.

Let me point out in clarification that when I was talking about meeting the liquidity and risk management needs of the market, I was specifically referring to our bread and butter, wheat. We've had five straight record y

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Additional Information

Commodity Futures Trading Commission Agricultural Advisory Committee 28th Meeting Wednesday, July 19, 2000 1:35 p.m.

Commodity Futures Trading Commission
Agricultural Advisory Committee
28th Meeting
Wednesday, July 19, 2000
1:35 p.m.