"CFTC Responds to a New Era in Agriculture and the New Age of Information Technology"
Remarks before the
National Grain and Feed Association's
Commodity Exchange Committee
November 7, 1996
Joseph B. Dial
Commodity Futures Trading Commission
I appreciate the opportunity to speak to you today. Meeting with this group is always a stimulating experience. Once again allow me to commend all of you who gave of your valuable time to produce the 1996 NGFA White Paper on Hybrid Cash Grain Contracts: Assessing, Managing and Controlling Risk.
That document offers your members a lot of useful information on prudent internal controls and risk assessment. For those who doubt the importance of these best management practices, I respectfully remind them of the billions of dollars lost by Barings Bank, Metalgellschaft, and Sumitomo because they were lax in creating or applying proper internal controls.
For several years now, the Commission has spent a great deal of time encouraging the disciplined use of internal controls by all businesses that rely on derivatives to transfer risk. Therefore, we applaud the work done by NGFA and other industry groups to promote the use of internal controls and risk assessment tools.
Today I want to talk about three subjects. The first is agricultural risk management education. The second is what the Commission is doing in the area of information technology. The third and final one is the delivery points issue.
Agricultural Risk Management Education
The first and most logical question to ask when this subject comes up is, "why, all of a sudden, is there so much emphasis on education in agricultural risk management?" The answer is simple, we are entering a new era of global agriculture and this is no longer just your father's farm.
As you all know, the FAIR Act lifted production controls and is gradually reducing price supports for the basic agricultural commodities. Furthermore, Congressional ratification of GATT and NAFTA has set the stage for incremental removal of protectionist tariffs and non-tariff trade barriers. These paradigm shifts in government policy have increased the probability of greater volatility in feed and food grain prices than has existed in the past. Just as we saw record high prices in 1996, we may well see historically low prices in the future.
Granted, farm product prices that go from mountaintop highs to Dead Sea lows are nothing new to agriculture. However, for the past 60 years the government has tried to level out these price swings and protect producers. That taxpayer- financed safety net is being phased out. As a result, farmers should learn how to secure revenue by using private sector risk management tools as soon as possible.
I believe that few, if any, farmers will have profitable operations in the 21st century unless they do learn how to manage their production and price risks. The three out of four producers who today earn more off the farm than they do from their crops and livestock may get by without managing risk. But the 20 percent of farmers who grow 80 percent of the total agricultural commodities harvested in the U.S. will not.
Nonetheless, both groups will need to focus on securing revenue rather than chasing prices. To do this, they will have to overcome both past behavioral patterns and the attitudinal barrier many farmers have against transferring yield and price risks. This is no easy task, but it can be done -- and education is the way to do it.
The most recent initiative in the area of agricultural risk management education is being developed in response to Section 192 of the FAIR Act. As you may recall, Congress directed the Secretary of Agriculture, in consultation with CFTC, to "provide such education in management of the financial risks inherent in the production and marketing of agricultural commodities as the Secretary considers appropriate." The Commission is working closely with USDA as that agency seeks to comply with Section 192.
When this educational program comes on line, it will augment the present broad array of agricultural risk management educational programs already offered by many private and public sector institutions. There are ample opportunities for farmers to learn how to shift their business risks.
However, as with all educational programs, there is one other critical element that cannot be left out. By way of analogy think of it this way. The world's greatest chef can prepare an entree that is a gourmet's dream, but if the restaurant patron has no appetite, then all that effort and expertise is for naught. So it is with any attempt to educate farmers on how to transfer their business risks. The program won't be worth the paper it is written on if producers have no appetite for the training experience.
If our educational programs are going to succeed, there must be a clearly articulated credible message that explains to farmers, in their language -- not obscure economic terminology -- why it is in their own best interests to learn how to manage yield and price risks. This message must be delivered in a positive tone and repeated time and time again, even if it is not politically popular.
Fulfilling this educational role is crucial and the agricultural community is best suited to carry it out. Farmers' organizations, agricultural trade associations and the ag media have the organizational and communications infrastructure for delivering this message most effectively. Spreading the risk management gospel must become a top priority for these groups.
In a speech I made to the "Risk Management Issues Conference," sponsored by American Farm Bureau Federation (AFBF) in Chicago in September, I said the following:
American Farm Bureau Federation should take the lead in bringing about a combined united effort by the whole agricultural community to write a vision statement on risk management. This would become an industry wide message that would be supported by a commitment of funds from each organization and association to be used in promoting the practice of prudent risk management in American agriculture.
The economic benefits that would accrue to the members of all agricultural organizations as the result of such an exercise should be obvious to everyone. I know NGFA is not only aware of the importance of this issue, but to your credit, you are doing something about it. Therefore, I urge you to expand your work in this area and take a leadership role in getting the whole agricultural community to join together in promoting the practice of prudent risk management in American agriculture.
As farmers become better risk managers, they will come to depend more and more on recent advances in computer and communications technology. This is simply another reflection of a communications revolution that is affecting every facet of modern life. Spectacular growth in the use of personal computers, data systems, the Internet, and proprietary on-line services, is revolutionizing the financial services industry, including that segment devoted to agricultural risk management. Producer hedgers, private investors and industry professionals alike are: enjoying real-time access to trade data and market news; experimenting with new ways to gather, store and communicate information; and performing increasingly complex analyses of trade and market data.
Regulators too must embrace this revolution -- and not just by passively responding as they try to keep pace with each new trend. Regulators must become active participants. We must discover how the communications revolution can make regulation better, cheaper more efficient -- and we must respond to the enforcement challenge posed by those who would use technology to provide new window dressing for the same old frauds and scams.
The CFTC has undertaken a number of initiatives in this area. Without going into detail, let me quickly list four of them.
(1) In October of 1995, the Commission launched its Internet Website Home Page. We have since steadily expanded the nature and variety of information available and are currently generating over 3,000 "hits" per day.
(2) In August of 1996, the Commission's Division of Enforcement set up its own interactive home page. This gives Internet users both direct access to a comprehensive listing of individuals and firms that have experienced enforcement problems, and the opportunity to communicate directly with our enforcement staff concerning suspected wrongdoing. The leads generated by this service, along with our staff's direct surveillance of the Internet, have resulted in a number of Internet-related investigations and enforcement actions.
(3) On October 15, the Division of Enforcement initiated a new and very creative use of the Internet. In effect, our enforcement folks hung out a "wanted poster" on the CFTC's Internet web page. We are seeking a man named Donald B. Chancey, a defendant in a CFTC injunctive action who disappeared after allegedly embezzling some $3 million from at least 19 investors in an unregistered commodity pool. In addition to the usual actions we would take to locate such an individual, we also posted on the Internet: (1) a picture of Chancey; (2) information about the fraud case against him; and (3) a form people can use to E-mail us any information they might have about Chancey or his whereabouts. I applaud this ingenious attempt to apply modern technology to a law enforcement practice that dates back to the old west and beyond.
(4) Also in August, the Commission's Division of Trading and Markets published an Interpretation, along with proposed rule amendments, concerning the use of electronic media by commodity pool operators (CPOs) and commodity trading advisors (CTAs). The intent is to find ways whereby CPOs, CTAs and their associated persons can use electronic media both for meeting disclosure and reporting obligations to their customers and for filing required documents with the Commission.
The Commission supports technological advances not only in its own operations, but within the futures industry as well. For example, in February and March of this year, we invited the leadership of the four largest U.S. exchanges, as well as representatives of market users, to brief us on their current situations and future plans on the technology front. Then in October, we convened an "Exchange Order and Trade Automation Roundtable" in Chicago. The Roundtable brought together panels of market users, financial market experts, exchange officials and academics to discuss exchange automation issues, including the practicability of further automating order delivery and trade transmission systems. Exchange automation is a "win-win" situation for all concerned. Exchanges benefit from lower costs and greater efficiency, making them more competitive. Regulators, and the customers we are charged with protecting, benefit from a better audit trail.
Let me conclude by turning to an issue that should be both familiar and troubling to all of you -- delivery points on the Chicago Board of Trade. The Commission has long been concerned about the continued adequacy of Chicago as the primary delivery point for the CBOT's grain and soybean futures contracts. These concerns have been based on an increasingly decentralized marketing pattern for these commodities, and a corresponding erosion of Chicago's status as a delivery market. The pattern is the same for most other terminal markets.
Recent events have added a note of even greater urgency to these long-standing concerns. In the fall of 1995, three of the six regular delivery warehouses in the Chicago delivery area closed their doors, reducing rated delivery capacity from 53.9 to 22.8 million bushels. There is every indication that the Countrymark (Gateway) elevator may soon follow suit, taking another 8.1 million bushels off the table. This would leave a delivery capacity of only 14.7 million bushels in the Chicago area -- a reduction of nearly 75 percent.
The CFTC and CBOT surveillance staffs responded to this situation -- and to the general increase in grain market volatility over this past summer -- with intensified market surveillance. Our coordinated surveillance plan, which remains in effect, has included:
increased contacts with large traders, collecting cash market position data from commercial traders with large delivery month positions, routinely assessing the intentions and delivery capacity of market participants in the delivery month, coordinating and sharing market information received, and reviewing the financial capacity of market participants.
So far, this intensified market surveillance plan has worked. We have seen some minor blips -- like the problem at the tail end of the 1996 March wheat liquidation -- but no major crisis. However, we cannot count on this system to keep working indefinitely. You simply cannot stay on "red alert" forever. Sooner or later, somebody is going to have a go at trying to squeeze a market with only 14.7 million bushels of deliverable supply. It is abundantly clear that something must be done to address the underlying problem.
The CBOT has made an effort to do just that. Unfortunately, that effort failed. The exchange appointed a special task force to develop recommendations for revising the grain and soybean contract delivery provisions. On September 17, 1996, the Board approved the task force recommendations, with one significant exception. The most far-reaching reform -- a recommendation to add East-Central Illinois as a delivery area -- was voted down at the Board level. Then on October 17th, the exchange membership vetoed even the watered down version of delivery reforms by nearly a two-to- one margin.
Where does that leave us? With a big problem and no solution in sight. I sincerely hope that the exchange and the industry can get together -- and right soon -- to address this problem in a meaningful way. In the absence of meaningful action from that direction, the Commission might be required to act. I would note that, under Section 5a(10) of the Act, upon finding that an exchange's delivery rules do not meet the statutory standards, the Commission is required to notify the exchange and give it 75 days to make appropriate changes. If the necessary changes are not forthcoming, the Commission, after giving the exchange an opportunity to be heard, can implement the needed rule changes itself.