NCFC LIVESTOCK MARKETING COMMITTEE MEETING

NATIONAL COUNCIL OF FARMER COOPERATIVES

JANUARY 22, 1996

SHERATON WASHINGTON HOTEL

JOSEPH B. DIAL

COMMISSIONER

COMMODITY FUTURES TRADING COMMISSION

Introductory Remarks

When I became a CFTC Commissioner in 1991, I brought to Washington a lifetime of experience in farming, ranching, agribusiness, banking and international trade, as well as an active involvement in environmental issues. As a cattleman I ran commercial cows and calves, steers on grass, and cattle in the feedlot. Registered cattle were also an important part of my ranching activities. This real world experience has been a great asset to me in fulfilling the duties of my office.

Risk Shifting and Profitability

In the four years I have been a Commissioner, my work has put me squarely in the middle of every facet of using derivatives to shift risk. (Both futures and options, as well as certain over-the-counter instruments, derive their value from an underlying asset, thus the name derivative.)

Every day, I see examples of domestic and international companies, involved in financial, energy, and metals businesses, using derivatives-based risk shifting strategies to improve their profitability. I see similar examples of agricultural processors, merchandisers, and exporters using prudent hedging to manage their business risks.

On the other hand, only a relatively small number of agricultural producers devote that kind of attention to assessing their business risks and even fewer of them do anything to manage yield and/or price risks. This traditional behavior by farmers and livestock producers will change, as we move ever closer to a 21st century type of agricultural business owner/operator, who strives to be profitable in a fiercely competitive world market.

The forces driving this change will be: (1) less funding for federal commodity price support programs; (2) more private sector tools enabling producers to initiate their own financial safety net through revenue insurance or revenue assurance; (3) bankers willing to loan money at the most attractive interest rate to producers who manage their risk, while showing little or no inclination to finance those who don't; and (4) a marked reduction in existing trade barriers that hamper the movement of agricultural products in the global market.

Congress Establishes the Commodity Futures

Trading Commission

Because risk shifting and price discovery in exchange-traded futures/options play such a crucial role in sound business management, Congress decided in 1974 that there should be an independent federal regulator for the futures markets. Today, the CFTC has jurisdiction over 10 exchanges where trading volume averages over two million contracts per day. The agency has supervisory responsibility over some 63,000 registered firms and individuals, who provide services to hedgers and speculators in the U.S. and around the world. There are 60 CFTC staffers devoted to daily surveillance of the 185 active futures and option contracts listed on U.S. exchanges.

The CFTC's Chairman and four Commissioners are nominated by the President and confirmed by the Senate to serve five year terms. These five full-time, salaried Senior Executive Service appointees manage an agency with about 540 employees and an annual budget for this fiscal year of $49 million dollars.

How the Agricultural Community Communicates

with the CFTC

The views and insights of the agricultural community are of major importance to the CFTC. So much so, that in 1985 my predecessor, the Honorable Kalo Hineman, a Kansas farmer and rancher, set up the CFTC's Agricultural Advisory Committee (AAC). For the last four years I have had the honor of serving as Chairman of this committee.

The AAC consists of 24 members, representing the full spectrum of agricultural organizations and trade associations, from producers to processors to exporters to agricultural lenders. Cattlemen are very ably represented by Eddie Nichols, a Nebraska cattle feeder, who was selected by the National Cattlemen's Association (NCA). The NCFC is represented by Richard Johnson of CountryMark Cooperative. However, any of you -- as individuals or as members of the National Live Stock Producers Association -- are welcome to attend these public meetings.

The twice yearly meetings of the AAC are an important opportunity for producers to ask questions and offer suggestions or constructive criticism about futures markets or the CFTC. For those of you who attend NCA's mid-year and annual meetings, you can hear an update on market issues when I speak to the Marketing Committee. Likewise, I speak to a variety of other agricultural groups, consisting of anywhere from three to 3,000 or more farmers and ranchers. My door -- and my phone line -- are always open. Feel free to call me any time the cattle market is going up.

CFTC's Response to Cash Market Changes

When the market goes down, my phone rings off the wall, but that's okay because the exchange of factual information between the agency and the industry benefits both of us. Let me give you a couple of examples of the CFTC's response to cash market declines in fed cattle. In May of 1994, when cattlemen became concerned about the drop in fed cattle prices, NCA asked us to review packers' positions in the live cattle futures market. At the same time, NCA wrote Congress asking it to look into this drastic economic change for the industry. Because the CFTC responded so quickly to NCA's request, we sent Congress a report on this matter literally the day after receiving their letter directing us to study it. That is bound to be a record for a government agency.

We followed up that initial review with an in-depth analysis of intra-day trading in the CME Live Cattle pit. Commissioners and staff then went on the road to present this information to cattle feeders in five states.

Then, in March of 1995, NCA asked us to look into trading in cattle futures by commodity pool operators (CPOs), commonly referred to as commodity funds, or just "the Funds." In about two weeks we provided this information to NCA, Cattle-Fax, and state cattle feeder associations.

The above mentioned reviews, in 1994 and 1995, suggest that there were no undue concentrations of positions or trading, for the purpose of influencing prices, on the part of a "few large companies."

CFTC Surveillance

Before presenting the overheads that will provide a "word picture" of the 1993, 1994, and 1995 cash and futures cattle markets, let me brief you on how the CFTC conducts surveillance of the futures markets.

Our surveillance staff collects, analyzes and compares daily data concerning overall supply and demand conditions in the cash market, cash and futures prices and price relationships, and the sizes of hedgers' and speculators' positions in the futures markets. We are most concerned about contracts that are expiring, because that is when a contract is vulnerable to abuse of the delivery process.

If our routine reviews detect a situation that might cause distortion, congestion, or some other market problem, we will take the following steps:

* Contact significant participants in the market in question.

* Request more background information regarding their cash and futures markets positions and trading intentions in the expiring contract.

* Warn the parties that we expect them to conduct their trading in a responsible manner.

Depending on the traders' responses, additional steps could range from formal warning letters to emergency market intervention (a power the CFTC has used only four times in its 20 year history).

The key to identifying potentially disruptive futures positions is our large-trader reporting system. Each day, staff economists examine on-line computer listings of large trader positions to identify any positions that could pose a threat to the orderly liquidation of expiring futures contracts. This information is obtained from FCMs, clearing members, and foreign brokers.

Whenever an account attains a "reportable position," the FCM must file a form identifying the account and, thereafter, must file daily reports, for as long as the account remains reportable. In addition, once a position becomes reportable, the trader must file a more detailed identification report (a Form 40) to further identify accounts and reveal any relationships that may exist with other accounts or traders.

Keep in mind that CFTC surveillance goes on every business day. We are persistent in our efforts to maintain a level playing field for both longs and shorts with futures positions.

Straight Talk and Tough Enforcement

Also, we are dogged in our determination to pursue and punish those who violate the Commodity Exchange Act, or CFTC regulations. Let me give you an example of a recent enforcement action involving live cattle futures.

In 1993, we filed and settled an administrative complaint against a firm and several persons connected with it. Our investigation revealed that they filed false reports and forms in order to conceal a regular practice of exceeding speculative position limits, and unauthorized trading. The Commission fined the firm and the individuals involved a total of $2.22 million dollars.

Overheads

Now, as mentioned earlier, the following overheads will cover the movement of cash and futures prices, and data on the positions of funds, packers, and feeders in the live cattle futures market.

* In 1993, 1994, and 1995, the April and June futures and cash markets moved within the historical range for basis in their respective spot months.

* From July 12, 1994 through June 13, 1995 less than one percent of the reportable speculative traders had positions equal to or slightly above the former (August 1993) All Futures Combined speculative position limit of 4,500. For this same time frame, 90 percent of reportable speculators held net positions of 500 contracts or less over this 11 month period.

* Packers came into the March 7 through June 13, 1995, period net short and were net buyers of over 9,000 futures-equivalent contracts, largely to reduce short hedges. Funds entered this period with relatively large net long positions, representing over 22 percent of long open interest. Funds were net sellers throughout the period of March 7 through May 9, while cash and future prices were declining.

* During March, this fund selling mostly was to liquidate long positions that were losing value as prices were falling. Funds collectively became net short around April 4, but then bought over 10,000 contracts to reduce those short positions from April 11 through June 13.

* As a group, cattle feeders, who could manage their inventory risks by carrying short futures-equivalent positions, collectively held the largest aggregate positions of the three groups examined, and usually held relatively equal long and short positions over the course of this period. Feeders' aggregated position shifted back and forth between net short and net long. They were net buyers of futures and options on 8 weeks and net sellers on 6 weeks. Overall they were net sellers of about 5,800 contracts.

* None of this data suggest any undue concentrations of positions or trading for the purpose of influencing prices on the part of a "few large companies."