Remarks of Commissioner David D. Spears
Kansas Governor=s Conference on Agriculture
March 20, 1998
It is a privilege to be here today in my home state of Kansas. I am honored to have the opportunity to speak at Governor Graves= 1998 Conference on Agriculture. All of us are well aware of the importance of agriculture to the Kansas state economy. I want to commend the Governor and Secretary Devine. I believe this conference helps in highlighting agriculture=s importance.
Just a bit about myself. I grew up on a farm in Osborne, Kansas. After earning my degree in economics at Kansas State University, I spent about 10 years with the Bank for Cooperatives here in Wichita. Afterwards, I spent about 7 years in the legislative arena working for Senator Dole.
I am the third Kansan to serve in the capacity of a CFTC Commissioner. In fact, the seat I am serving in is sometimes referred to as the ADole Seat.@
Thanks to Senator Dole, we have had a CFTC Commissioner from Kansas for the past fifteen years. From 1982-1991, Kalo Hineman from Dighton served on the Commission. I am sure many of you know Kalo. He remained true to his Kansas ties and always extended his services to the agricultural community. It is my desire to follow his lead and continue to reach out to the agricultural community at large, and also to consider the needs of the financial market place.
And of course, following Kalo=s retirement, Sheila Bair was appointed. Sheila did an excellent job following in Kalo=s example, and did an outstanding job on the Commission.
I think it is fair to say that up until the day I took office at the CFTC, my experience with regulatory agencies involved debating issues of regulation. There were times when my opinion was on the opposite side of some of those regulators, like the EPA, USDA, and the Department of Transportation, among others. Now I find myself in a role as a regulator and it has certainly taken an adjustment period.
Serving as a Commissioner at the CFTC has proven to be an interesting and rewarding experience, as well as a tremendous learning experience. Among other things, I have tried to bring to the job a little bit of the common sense you find in the coffee shops in Kansas.
At the same time, I also believe in personal responsibility. If you make a bad business decision, then you need to live with the consequences. However, the role of government agencies such as the CFTC, is to make sure that the facts are known by all parties. Market participants do look to someone to set the ground rules, establish boundaries and make sure the game is played by the rules. In other words, one of our roles is to ensure market integrity. As in a basketball game -- call the fouls and if necessary toss someone out of the game.
With that introduction, I would like to provide you with a brief overview of the CFTC.
The Commodity Futures Trading Commission regulates futures and options contracts, not equities like stocks. It was created as an independent regulatory agency in 1974 by the Commodity Exchange Act. Before 1974, the CFTC=s predecessor, the Commodity Exchange Authority, was located within the USDA. The principal purposes of the CFTC are:
$ to protect the public interest in the proper functioning of the futures markets;
$ to encourage competitiveness and efficiency; and
$ to protect market participants from abusive trade practices and fraud.
The CFTC is authorized to have five Commissioners with one serving as Chairman. It is a bipartisan commission, with no more than three being from the party of the President. Recently, the term of one Commissioner expired and consequently, I am the only sitting Republican.
The Agency has approximately 600 employees located in 6 different offices throughout the country. It is headquartered in Washington DC, with regional offices located in Chicago, New York, Los Angles, Minneapolis and Kansas City.
In addition to overseeing the market professionals, we also oversee 11 futures exchanges. Some of the exchanges you have probably heard about include the Chicago Board of Trade, the Chicago Mercantile Exchange, the New York Mercantile Exchange, and familiar to this part of the country, the Kansas City Board of Trade. The value of the underlying assets upon which the futures are traded oftentimes is in the trillions of dollars.
One interesting point is how futures have changed. As you probably know, the futures exchanges originally were developed to trade agricultural futures which have been regulated since the 1920=s. Agricultural futures were the main source of volume until the late seventies, early eighties. Today, agricultural futures contracts make up approximately 20% of traded volume while the other products like financial, metals, and energy make up nearly 80% of traded volume.
At the same time, volume has also significantly increased. In the last year, the volume of trading at the United States exchanges climbed to record heights. For the 1997 year, volume at the 11 biggest US exchanges increased about 14% over 1996.
On the surface, these gains tell me that business is good. But it is my responsibility as a regulator to ask myself -- Could the gains have been better? I think that is one of my roles because, as we all know, too much regulation of the market place hurts economic growth. As a regulatory agency, it is important that we oversee the futures markets to make sure that they operate in an open and competitive manner, but at the same time, there needs to be a balance. It is precisely that balance that I work towards -- a balance which permits participants to compete and to succeed on a level field without undue regulation, and which also permits the public to remain protected from fraud and abuse.
I would like to focus for a moment on a term that could have a significant affect on the agricultural community. That term is systemic risk. As we all know, agriculture is global, what happens in Asia or South America impacts the US and Kansas.
We have all witnessed the explosive growth of foreign stock and futures exchanges and the emergence of many new markets around the globe. These developments have increased the interdependency among the US financial markets and the financial markets of the world. There is no question that the events within the borders of a single nation influence the events in other nations.
In this type of global environment all of the domestic markets are tied into a single worldwide market network. For example, the October 27, 1997 554 point drop on the New York Stock Exchange was proceeded by days of market turmoil in Asia. You might ask, what do regulators do in these situations when there are irregular market gyrations? We watch, and we watch closely.
Taking you back to the October 19, 1987 market drop, the so called ABlack Monday,@ when the Dow Jones Industrial Average dropped 508 points, or 22.6 percent, the biggest one day percentage loss in history, a working group was formed to respond to similar situations in the future.
The group consists of the heads of 4 government agencies that oversee the financial markets of the United States. The current members of the group include Treasury Secretary Robert Rubin, Federal Reserve Chairman Alan Greenspan, Securities and Exchange Commission Chairman Arthur Levitt and the CFTC Chairperson Brooksley Born.
The working group meets regularly to discuss options, to review crisis scenarios and to monitor systemic risk. As we all know, the government=s reaction to a crumbling stock or futures market would have a critical impact on investor confidence around the world.
We are also keeping a close eye on the effects that this Asian situation is having on the demand for all types of commodities, including agricultural commodities, such as corn, soybeans, and other grains, as well as on the livestock industry. It is important for us in the US to bare in mind the risk that we may encounter due to both global and national events.
In addition to monitoring systemic risk, managing risk also is something that is important to a stable market place. As we all know, the use of futures contracts are one of the ways in which people manage risk. So, I would like to talk a bit about risk management because I think it is relevant to many in this room.
With passage of the 1996 Farm Bill, farmers and ranchers, more than any time before, are looking at risk management opportunities. We have not seen US agriculture rely this much on the market for almost 70 years. This shift in the government=s farm policy has created a new era for agriculture.
The producer=s success will depend on the producer=s ability to develop a written marketing program that includes the prudent use of risk management tools.
As we move forward into this new era, producers must build their own financial safety net. This will occur as growers learn how to secure guaranteed revenue by transferring production and price risks to other parties.
There are several different methodologies farmers can use to manage their business risks. One has been in use for some time and focuses on predicting the weather and trying to guess the direction of agricultural commodity prices. The purpose of this is price enhancement.
A second risk management methodology is one described as the Asafety net@ approach. Its development has accelerated at a rapid pace since the passage of the 1996 Farm Bill. The USDA and the private sector are actively engaged in developing Asafety net@ risk management tools.
Risk management tools fall into two somewhat different categories of contracts: 1) Revenue Insurance and 2) Revenue Assurance.
Revenue Insurance is a contract written by an insurance company. (Crop Revenue Coverage and Income Protection)
Revenue Assurance is not written by an insurance company, it is evolving as we speak and it will probably be used primarily by agribusiness companies. A revenue assurance contract between the producer and an agribusiness company would work as follows: the company wants to maintain or initiate a long-term business relationship with the grower. The company wants to supply the seed, fertilizer, chemical, fuel and financing to the farmer--and manage his/her production and price risks by guaranteeing revenue per acre. There are a number of reasons why the company wants to provide this safety net for the producer, but at the same time the company may also want to transfer the risks it takes on in the process.
I am personally interested in the further development of risk management tools and have been afforded the opportunity to represent the CFTC by serving on the USDA=s Risk Management Steering Committee. The committee has many different functions, one being to develop programs that educate farmers on how to effectively manage their risk. In fact, the steering committee is currently in the process of accepting proposals for risk management education efforts.
In addition to the CFTC=s involvement in the steering committee, the Agency is interested in other risk management opportunities. The Commission has an advisory committee for agriculture, appropriately called the Agricultural Advisory Committee (AAAC@). The AAC is composed of 25 member organizations which represent the ag industry nationwide. As of January, I was asked to serve as chair of the AAC.
One of the issues of importance before the Commission and agriculture as a whole is the use of agricultural trade options as a risk management tool. The use of ag trade options have been banned since 1936.
Let me just explain what trade options are generally.
Trade options are unregulated private contracts negotiated between a buyer and a seller. For example, between a grain elevator and the farmer. In other words, the contracts are not traded in the pits of the exchanges but instead are a private contract between two parties. In their simplest form ag trade options are similar to forward contracts that farmers use today with one key difference -- with a forward contract, a farmer is required to make delivery, whereas with an ag trade option, he has the option.
Such trade options are permitted in metals, energy and financial products, with certain restrictions, but remain prohibited for agriculture. Dropping the ban would allow buyers and sellers in the agricultural business to enter into option contracts.
For example, a grain farmer could sign an option contract to sell soybeans at harvest time to an elevator. By locking in an agreed upon price in advance, the farmer would protect himself against price declines later. The elevator also could protect itself against having to pay a higher price for the commodity.
Also, because the specific terms of the option contracts would be privately negotiated between the parties, the producers would have an input in writing the terms regarding price, delivery date, quantity and even quality. This would permit more precise matching of hedges to the actual market needs and price risks of the individual parties.
The Aoption@ part of the contract requires the farmer to pay a fee or premium. Again, that premium permits the farmer to bail out of the agreement if he finds a better price elsewhere at the time when the option is supposed to be exercised.
A proposal by the CFTC to lift the ban on Agricultural Trade Options went out for public comment on November 4, 1997 and the comment period closed on December 4, 1997. In that time period, and for awhile after the close of the comment period, we received 448 comments.
The CFTC=s proposal to permit off-exchange trade options between commercial users on agricultural commodities is a good starting point. But the proposal is a bit long from my regulatory perspective.
It is contained in a 16 page federal register release, tiny print, three columns per page. The way I see it, that makes it rather complex and I am working hard towards transforming it into a final, shorter and workable proposal. As I said, I am committed to regulatory reform without undue regulatory burdens.
With a few adjustments, it is my hope that ag trade options will be a true risk management asset to the agricultural community, including the grain exchanges, grain companies, the producers and related businesses. It will permit the grain processors and producers alike to improve their risk management tools because it will provide them with greater flexibility to individually tailor contracts to meet their personal needs.
I also think, although some people may differ with my view on this point, that permitting agricultural trade options will increase the use of exchange traded futures and options. Everybody wants to manage their risk, and the processors are no different. So, it is my view that the processors will increase their use of exchange traded futures and options in order to hedge their positions in the cash markets. In other words, I think it is good for business all around.
President Eisenhower once said that farming looks mighty easy when your plow is a pencil and you=re a thousand miles from a cornfield. I spend most of my time in Washington -- but enjoy the times when I can be home on the farm, attending a meeting similar to today=s or visiting with people like yourselves. As they say, the heartland.
I look forward to any comments you may have today and please remember that my door at the CFTC is always open to you. Thank you Governor. Thank you Allie. I appreciate the opportunity to be here today.