ORAL STATEMENT OF JOHN E. TULL, JR.
COMMODITY FUTURES TRADING COMMISSION
COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY
UNITED STATES SENATE
MAY 15, 1996
Good morning, Mr. Chairman and members of the Committee. With me today are Mr. John Mielke, Director of the CFTC's Surveillance Section, and Ms. Andrea Corcoran, Director of our Division of Trading and Markets.
Mr. Chairman, I commend you for calling today's hearing on volatility in U.S. grain markets. It is a timely and important subject.
This morning I would like to describe how the CFTC has intensified its surveillance of grain and soybean markets in the last year. I will then describe the events that led to the price spike of over $2 per bushel in the final minutes of trading of the Chicago Board of Trade's March 1996 wheat futures contract on its expiration date, March 20. Finally, I will discuss a staff policy statement that we are issuing today on a type of contract, sometimes called a "hedge-to-arrive" contract, that some farmers have entered into with grain elevators.
The Commission's routine surveillance of expiring futures contracts is based on an intensive analysis of daily large trader activity data and other pertinent information that our surveillance staff gathers from a variety of sources. We focus on large trader positions in relation to deliverable supplies and open interest, futures prices in relation to the cash market, and the latest information on supply and demand conditions. These data are augmented by trader interviews, information sharing with surveillance staff of all the grain exchanges, and our staff's seasoned judgment regarding the likelihood that traders with market power, or those who lack the capacity to make delivery, will behave responsibly, and that final futures prices at expiration will reflect the underlying cash market.
When predictions of critically low supply began to appear last fall, the CFTC market surveillance staff began intensifying its monitoring of the grain and soybean markets. The staff conducted a series of interviews late last year with various cash grain firms and advised those merchants that the CFTC or the CBT could request detailed documentation of their cash positions and their commitments underlying any large positions carried into the delivery month. The staff also increased its contacts with holders of large futures positions and the operators of the elevators to which grain may be delivered under CBT contracts. In addition, in February, the CFTC's Chicago surveillance staff developed a coordinated surveillance plan for grain markets with their counterparts at the CBT. This plan remains in effect.
As described in my written testimony, the CFTC intensified its surveillance of the CBT March wheat future at the beginning of the expiration month. On its expiration day, March 20, trading in this market was orderly for the first few hours. CFTC surveillance staff entered the pit around 11:45 a.m. to observe the close of trading. Under CBT rules, on the last day of trading in an expiring futures contract, a bell is rung at noon signalling the beginning of the close of the expiring future. Normally, trading in the expiring contract is permitted for only one minute following the noon bell, with the close of trading indicated by a second bell.
After the noon bell, three floor brokers holding customer buy orders began to bid the market from $5.35 to about $6.50 before a floor trader, who had no position in the market, offered to sell and go short March wheat at $7.00 at 12:02:12 p.m. Two floor brokers quickly bought a total of 155,000 bushels for their customers at that price. The next trades were recorded as taking place at 12:02:50 p.m. at $7.50, at which price the same floor trader and one other floor trader sold a total of 150,000 bushels opposite the remaining buy orders. A total of 61 contracts, representing 305,000 bushels, traded at those extraordinarily high prices.
Under CBT rules, after the regular close of the market, another two minute session can be held. This session is called the "Modified Closing Call" and is generally used to provide local traders with an opportunity to close out their positions and floor brokers with a means to complete orders that were unfilled at the close. Trading during the Modified Closing Call can take place only within a narrow price range determined by the pit committee specifically for that session. The Wheat Pit Committee determined that the price range for the March wheat future during the Modified Closing Call would be $5.30 to $5.32. In that session, the two floor traders who sold the 61 contracts at $7.00 and $7.50 offset those positions, that is, bought 61 futures contracts, at $5.32 opposite a sell order entered by the largest long in the market. At the end of the trading day, the Board of Trade Clearing Corporation set the clearing settlement price for the trading day, which is the price for marking such trades to market, at $6.40, the midpoint of the range of trades during the regular close.
The Commission was briefed by its staff immediately after this highly unusual episode. Several questions remain to be answered. First, why did trading during the regular close not cease at 12:01 p.m., as dictated by CBT rules? Second, why did the Pit Committee set the trading range for the Modified Closing Call session at $5.30 to $5.32, when the settlement price for the regular close was $6.40, the midpoint of the trading range? Third, in a market as large as the CBT wheat market, why was no one willing to sell any contracts until the price had been bid from $5.35 to $7.00?
I want to assure you on behalf of all of the Commissioners that these events will be promptly and thoroughly investigated and resolved in a fair manner. All of these questions and others are being explored in the CBT's investigation and the CFTC's independent investigation. When markets are volatile, it becomes especially important to maintain market integrity and customer confidence. Therefore, it is imperative that the CFTC and the Exchange promptly ascertain whether any rules were violated, and if so, take appropriate action.
The CBT staff has conducted an expeditious investigation. The Exchange's Business Conduct Committee has issued preliminary charges against a number of members and member firms regarding their participation in the March wheat expiration. Under Exchange rules, these charges are confidential pending their resolution by the Exchange.
CFTC staff have requested additional information from the Exchange and have sent a letter requesting that the Exchange review its rules and procedures governing trading during the close and the Modified Closing Call session. In addition to its own investigation, the Commission will review the CBT findings and, if necessary, take action on its own.
The March wheat expiration has served as a wake-up call to the entire grain industry. May grain liquidations are proceeding smoothly, with open interest and large trader positions in these markets declining at a rapid pace. Nevertheless, we will continue our intense surveillance of all grain and soybean futures as long as these markets remain volatile.
Finally, I want to mention the impact of volatile grain markets on certain contracts, sometimes called "hedge-to-arrive" or "flex-hedge," that some producers and country elevators have entered into. While these contracts differ considerably in their terms and conditions, a common characteristic is that they allow the producer to defer delivery of the commodity by rolling forward the month or price specified in the contract. Under some of these contracts for the current crop year, some producers have committed to deliver grain this fall and in subsequent years, and now must roll forward the reference month prices at considerable loss under current market conditions. Some elevators that have established related futures positions also may be experiencing financial stress.
In response to this situation, the Commission's staff is issuing today a statement of policy to provide certainty to producers and elevators who may wish to use cash payments to unwind, terminate, or restructure these "hedge-to-arrive"-type agreements. This staff release also provides guidance on prudent risk reduction practices for producers and elevators in the future.
In conclusion, Mr. Chairman, I believe that grain and soybean markets will continue to be volatile through the summer, and the Commission will be especially vigilant to ensure that futures markets are operating properly and rules are strictly enforced. I appreciate this opportunity to discuss the current grain market situation with the Committee, and would be happy to answer any questions you may have.