Agricultural Advisory Committee

United States of America
Commodity Futures Trading Commission
Agricultural Advisory Committee
26th Meeting

Wednesday, April 21, 1999

Three Lafayette Centre
1155 21st Street, N.W.
Washington, D.C. 20581

The meeting convened, pursuant to notice, at 1:05 p.m.




CARL ANDERSON, Texas A&M University

PAUL ARCHITZEL, Commodity Futures Trading Commission

BILL BIEDERMAN, Allendale, Inc.

STACY CAREY, House Agriculture Committee Staff

DR. PETER GRIFFIN, American Feed Industry Association

KENDELL KEITH, National Grain & Feed Association

WALT LUKKEN, Senate Agriculture Committee Staff

PHILIP OLSSON, American Feed Industry Association

BEV PAUL, Senator Bob Kerrey Staff

MIKE SEYFERT, Senator Pat Roberts Staff

SCOTT STEWART, National Introducing Brokers Association





- - -



I. Welcoming Remarks, David D. Spears 3

II. Panel Discussion - Risk Management 10

Strategies for Producers of Agriculture Commodities

III. Risk Management/Crop Insurance Legislative Review 62

IV. Panel Discussion - Agricultural Trade Options Pilot Program 113

V. Meeting Adjourned 170



COMMISSIONER SPEARS: Good afternoon. My name is David Spears and I want to welcome you here to the 26th meeting of the CFTC's Agricultural Advisory Committee. First, allow me to state the commission's sincere thanks to the committee members and organizations that they represent for being here. We are all well aware of your commitment of time and resources, and we certainly appreciate your efforts to be here.

As you have noted on the agenda today, the meeting is primarily focused on risk management tools and issues. The CFTC is determined to work with the agricultural industry to help educate farmers on how to better manage their risk. Today we'll here a variety of views on effective risk management tools already available and other innovative programs.

Before opening today's program, I'd like to recognize my fellow commissioners and allow them to make a couple of brief comments. To start with, I'd like to recognize Chairperson Brooksley Born. Thank you for being here, Brooksley.

CHAIRPERSON BORN: Thank you very much, David, and I would just like to extend the welcome of the commission to all of you here. Our Advisory Committees are critically important to the commission's operations. You are the way that we learn about the industries affected by our regulations and get practical feedback and advice. The fact that you are all willing to contribute your time and expertise to helping the commission be the best regulator that it could be really means a lot of us, and I would like to personally extend my deepest gratitude.

COMMISSIONER SPEARS: I would also like to introduce Commissioner Barbara Holum.

MS. HOLUM: Thank you, David. I, too, would like to welcome everyone for coming and participating, and you have all already given a lot of input into this Ag Options Pilot Program, and I know a lot of us in this room have been very concerned over the last year about the program, and I'm pleased that Commissioner Spears and this Advisory Committee are taking the lead to put together a program that works well for all of us. Thank you.

COMMISSIONER SPEARS: Thank you, Barbara. And finally, our newest commissioner on the commission, Commissioner Jim Newsome.

MR. NEWSOME: Thank you, Mr. Chairman.

I appreciate the opportunity to make some comments. I'd like to thank everyone for taking time out of busy schedules to be here to provide assistance to us as we address ag trade options. Certainly, in my mind, from an agricultural standpoint, nothing is more important than addressing the risk management issues that we all face given low commodity prices, the phase-out of the price support program. So this is extremely important to me in the background that I come from. I believe that the more risk management tools that we can provide to industry, the more opportunities that we make. The more competition in this area, I think the better--I think all of us will be better off. Certainly, I think the agricultural sector will be.

I just want to reiterate that I am committed to working with you to make this program a reality. I'm committed to making necessary changes to the program to make it beneficial and I'm committed to doing that now. So I look forward to your comments, and I look forward to working with you.


I want to thank each of the commissioners for being here. I know their schedules are full, yet recognize the importance of this group. I certainly appreciate your time and your efforts.

I also want to recognize a special guest in the audience, former Commissioner Joe Dial. He is the former head of this committee, and I thank you, Joe, for being here. I know Joe continues to have a lot of interest in this area and provides leadership on these issues across the country.

I'd like to continue on around the table and have the individual committee members to quickly introduce themselves and the organization they represent. So with that, I might start with you, if you would introduce yourself. There are still people arriving, and they will be here a little bit late, but if you would introduce yourself.

And then, a housekeeping issue, if you would speak into the microphone. When you're done speaking, push the button and turn it off. I think only two or three microphones can be on at any point in time. So if you would just remember to turn your microphone off as you finish speaking. Thank you.

MR. WILSON: I'm Lemmy Wilson from Newport, Tennessee, and I represent NCBA.

MR. HELLERICH: I'm Gary Hellerich from Valparaiso, Nebraska, and I represent the American Soybean Association.

MR. OMAN: Steve Oman from Findlay, Ohio, and I represent the American Farm Bureau.

MR. BOLD: Robert Bold, Lewistown, Montana, and I represent the National Association of Wheat Growers.

MS. KEITH: Susan Keith. I'm on staff at the National Corn Growers Association. I'm at the table today because it did not rain in eastern Iowa last night or Glen Miller would be here.

MR. QUANDT: Larry Quandt, Mason, Illinois. I represent the National Farmers Union.

MR. DODDS: Bill Dodds from Toledo, Ohio. I represent the National Grain and Feed Association.

MR. NELSON: Chuck Nelson. I'm representing the National Grain Trade Council. I'm with Bundy Corporation here in Washington.

MR. OLSON: Ron Olson from Minneapolis, Minnesota, representing North American Millers' Association.

MR. FEDERICO: Len Federico, representing the U.S. Rice Producers Group. I'm with Louis Dreyfuss Corporation in Wilton, Connecticut.

MR. BIEDERMAN: I'm Bill Biederman. I'm with Allendale. I'm not a member. I'm just a speaker here today.

MR. ANDERSON: I'm Carl Anderson from Texas A&M University.

MR. AMSTUTZ: I'm Dan Amstutz from Washington, representing the North American Export Grain Association.

MR. WHITE: I'm Robert White from the Kenton, Ohio, and I represent the National Grange.

COMMISSIONER SPEARS: On my left is Paul Architzel who is also on the CFTC staff and will be part of the program later on.

As most of you can tell by the agenda, we have broken the program into three different parts. The initial session of the meeting will be a panel discussion on risk management strategies for producers of agricultural commodities. We have asked a couple of individuals to make presentations to help provide some food for thought for discussion. As my fellow commissioners have said, this commission fully recognizes the value of this type of advisory committee. We certainly want to encourage an open dialogue and discussion among committee members. In order for our commission to be effective, we need to have industry input -- your input is essential. I encourage any comments or questions to the speakers on the first panel.

The second panel will be primarily made up of congressional staff giving us committee updates of what's going on on the Hill in legislation and issues, as well as a presentation on proposals by the American Feed industry and how that may impact regulatory and legislative issues. Then, finally, we're going to have a discussion on the commission's Agricultural Trade Options Pilot Program. There will be a couple presentations to generate some food for thought. We will then get into an open dialogue about scenarios or possible changes to the pilot program.


COMMISSIONER SPEARS: I'd like to recognize the first panel members. We first have Bill Biederman who recently testified before the Senate Ag Committee on this topic. Bill will discuss his organization's risk management program. Bill is the vice president and director of research and co-founder of Allendale, Inc. His organization is based in Illinois and provides research and consulting services on agricultural issues to major food companies, the U.S. Department of Agriculture, the U.S. Department of State, and foreign governments among others.

Also joining Bill today on the first panel is Dr. Carl Anderson from Texas A&M. Mr. Anderson will speak about risk management programs designed by his team at Texas A&M. He has an extensive background in price risk management and price discovery processes. His research projects have focused primarily on developing new hedging strategies.

I want to thank both of these gentlemen for traveling to be with us here today. Each member's materials have been included in the committee member's packet, which include Mr. Biederman's speech and Mr. Anderson's slides along with several pamphlets published by Texas A&M. We look forward to hearing more.

Mr. Biederman, I believe you're first on the agenda. Will you go ahead and proceed with your presentation?

MR. BIEDERMAN: Good afternoon and thank you, Chairman Spears and the entire Ag Committee, for giving me this opportunity to present today. My name is Bill Biederman, vice president, director, and co-owner of Allendale, Inc. Allendale is, as Chairman Spears said, a research and brokerage firm located in McHenry, Illinois. We are a guaranteed introducing broker with R.J. O'Brien. We have approximately 2,000 clients throughout the U.S. and Canada.

Allendale provides a daily research product, the Allendale Advisory Report, which is subscribed to by producers throughout the breadbasket of the U.S. Our average producer farms approximately 1,500 acres and has 89,000 bushels of unfarmed storage. Allendale nor myself nor any associate or related partner have received payment or compensation or is contracted to receive payment or compensation with regard to statements or opinions expressed today.

Mr. Chairman, I would like to just get right to the point, and therefore I'm not going to read through my statement. The 1996 Farm Act is expansionary and is likely the most bearish policy ever adopted. In addition to being bearish, it strips the market-based income support from the producer by eliminating the target price and deficiency system, thus we knew the producer had to either manage risk or face financial losses as the market reacted to the increasing supply.

But the '96 Farm Act is not all producer negative. The Farm Act opened the door for new risk management products like revenue assurance and other regulated products that, when combined, can help the producer manage risk even better than old farm program; thus Allendale put together a risk management program based on the premise that, number one, no one knows where the market is going and therefore we do not base the program on trying to sell at the high.

Secondly, no one knows their cost per bushel, but everyone knows their cost per acre, and therefore we base our marketing on dollars per acre rather than dollars per bushel.

Third, we make the program easy to understand. In other words, we made it similar to the old farm program. In 1998, Allendale, Inc. announced a complete risk management package called Allendale Risk Management Program or ARM. Corporate alliances were established with Rain & Hail, one of the nation's largest crop insurers, and Amcore Bank, the third largest lender in Illinois. This year, Allendale has expanded and improved the ARM program to include American Agri-Insurance, the third largest insurer, and we have opened the door to other banks.

The ARM program combines revenue insurance with marketing. Through the ARM, we bring the insurance professional, the banker, the broker, and the elevator operator to the producer's table to establish a management team focused on the same goal, to lock in a profit based on normal yields. Let me demonstrate how this program now works. For the last 20-some years, we have been marketing grain on the farm in the following manner: The red line that you can see on the graph represents the target price. In fact, this represents the target price in the county that I was farming in, and the way we would market grain is when the price would exceed this target price, we would just continue to sell into that so that we would end up with an average price represented by the black line.

In this case, it was 283. We knew that when the market would go down, there would be a deficiency payment, the target price minus average farmer price, and we knew that we could take that deficiency payment and add it on to the average price we sold at. When we would do so, it would raise the price we sold from 283 up to 313. This was called farming for the farm program, and this has been done over the last 20 years by every farmer in America, whether he was conscious or not conscious of it.

What we did with the new tools that are available to us is the exact same thing. We no longer have the target price by the government, but now we have target prices established through private enterprise through the different assurance programs. We can set up a target price, but as you'll note, it's no longer in dollars per bushel. It's in dollars per acre, and there are some big advantages to this.

So we establish a target price, let's say, of $261 based on the different CRC products that are available. Then we do our marketing on dollars per acre above this. So let's say in this case we end up with a average of $287 an acre revenue. In the fall, there would be one of four or two of four deficiency payments that we can now collect. These deficiencies, however, are not from the government. They're from private enterprise. Those deficiency payments are then added onto the price we sold at, and instead of $287, we end up with a net gross income of $347. So we end up having the same marketing plan, the same marketing program, as we've had from the last 20 years. It's something we're very familiar with and something that we can trust.

These tools are, however, better than the old farm program for the following reasons: First of all, there are no payment limitations. Secondly, it pays on every acre. Third, the components of the program are fully regulated, thus we've eliminated the risk associated with unregulated cash contracts. And fourth, the ARM program is being used by many banks to collateralize operating and margin loans.

Now I'm going to turn to the ARM program itself and show you two client examples of how the program worked in 1998. The program is split up into four quadrants. And I know you can all see this. I'll blow it up in just a minute, but I wanted you to see that we have an input section here, an analysis section just to right of it. Down on the left-hand side, we have a settlement sheet, and on the right side, it's bank analysis. So now I'll blow this up, now that you can see the overall image. I'm going to skip over to the right so that you can see the graph, as I know what all the inputs are, and I'm going to point out to you that this program does respond to each and every farm, as you can see the graph respond accordingly.

The lines that you see in the graph, the dome-shaped line represents farm income under the new farm policy. Under a free market policy, farm income is optimal when we have a decent yield at a decent price. In other words, if we go way to the left, and we lower yields dramatically like we did a few years ago in 1995 and '96, it doesn't matter how high prices go. If we don't have bushels to sell, income declines dramatically.

If we go way to the extreme right, and we have 500 bushels per acre like we all did this year, and the markets go down, we end up with reduced income. It's not as reduced because bushels are always better, but it does decline. So optimal income occurs in a free market environment when we have a decent yield with a decent price. The income curve under the ARM program is the exact opposite. When we have a normal yield, our income is going to be less in the arm program than if we were not in the arm program. The reason is because there's costs to the insurance. There's costs to options. There's costs to forward contracting in futures. When we absorb those costs, we still have a profitable income, but it's less than if we did not have to go through those expenses.

But what it does do is, when we go way to the left, and we lower yielding dramatically, theoretically prices should respond by rising. So we can collect up to two deficiencies. First of all, if yields are down dramatically, we'll collect on our insurance policies. That will get added on to our target price which is represented by the green line. Additionally, if prices do rally, we have tools built into the system that will take advantage of that rally. So that would be the second deficiency, and as we add those deficiencies to our target levels, the further to the left we go and the more extreme we get, the higher the income on the farm.

If we go to the right side like we did this last year, we have more bushels than we planned. More bushels means that every bushel is worth something, and that means that we're going to exceed our budget. Those additional bushels are looked at as a deficiency payment, and the farther we go to the right, the more we have to add on to our target price; and if the market goes down, that inventory has been hedged, and there's been a value assigned to it. So the lower the market goes, it is more money we have the add to our target.

The red line represents the cost of farming per acre. This particular client is from west central Illinois. He has 148 bushel APH. He has a 20 under basis in the fall and a 5 over basis in the spring. He has on-farm storage and pays nine percent on his money. Last year we employed a 75 percent CRC policy. We can employ other policies like multi-peril and things like that, but it does change revenue curves dramatically. The cost of the insurance was $22 an acre. We were able to collateralize operating loans and guarantee the banks $255 per acre, no matter what the problem.

This individual ended up with an actual yield on $185 bushel per acre, and the fall price was established at $2.19 for CRC. Under that scenario, this individual made $451 per acre net gross income. Well, let me define net gross income for you. Net gross income is gross income less the cost of the options employed, insurance, storage, interest, and commissions.

We had another client in west--excuse me--eastern Indiana who last year got caught in that green snap from the strong winds that went through. Let me show you, without changing the inputs above--he actually did better than what I'm going to show you--but he only had a 40 bushel yield.

So let's put in a 40 bushel yield. Prices are still at 219. In this case, he only had 40 bushel to deliver when we had forwards sold at about 111 bushels. On those 40 bushels, he only had a $123 income, and on the 71 bushels, since he sold higher than where the market was in the fall, he collected an extra $70 of income from that. The options that we purchased were worthless because they were calls and the market had gone down last year. The insurance we bought for $22 now paid $227. After storage, interest, and commission fees, he made $356 per acre.

On top of that, all of these gentlemen collect transition payments, deficiency payments, and disaster payments. The total gross income under this scenario was well over $500, according to their bankers, per acre which is tremendous in last year's environment.

And I can see most people, when I talk to them about this program, they understand how this works in a down market, but what would have happened if we would have hedged low and the market would have gone up? Let's put in $3.50 just to show you that example. This is a typical situation that I have experienced more than once using cash contracts. We're involved in them, and now we only have 40 bushel to deliver, 71 bushel that were committed on that we can't get out of.

In this case, you would lose $46 on those 71 bushel that you can't deliver on because the market went up from where we sold, but because we have options, they're now worth $66. The insurance recalculates at the higher price, $248, and we ended up netting $348 for net gross income. The total income would have been over $500 in this case.

In any case, whether the market was at $2.19 or $3.15, this individual from eastern Iowa would have made about $350 in net gross income under this program. So the program works whether the market is up or down, and the program works whether yields are good or bad.

I want to point out that these tools are better than the old farm program because, number one, there's no payment limitation; number two, it pays on every acre; and three, they're fully regulated.

Concerns have been expressed that the insurance industry is reducing the need for the futures and options. As of today, I can tell you that the effect is actually the opposite. Now, for the first time in agricultural history, the producer can use the futures and options in a manner that will not force him or her out of the market when margin calls occur. Due to the bushels guaranteed in the new assurance programs, we can hedge 100 percent of the insured yield without collateral risk to the bank. As a result, we can provide the banking industry with a collateralization model that allows them to make all margin calls without threatening the operating line of credit. This is a major milestone in the use of the exchange.

Things that can be done to improve the program: After working with the producers from all over, I think what we can do in Washington is help the America farmer and level the playing field without completely changing the farm bill. First of all, I believe we need to further improve the APH formula. The success and profitability of a farm is higher dependant on the APH formula. Narrowing the spread from actual yield to APH would be helpful.

Secondly, work on a basis product that would establish benchmarks. For instance, there would be a risk management tool that is based on freight rate, that is it would limit the adversity that basis has on a local area.

Third, create a short-term set-aside program to temper LDP exposure of the bearish impact of the expansionary policy and keep this within the context of freedom to farm. The idea could be of a one-year CRP program where producers could voluntarily bid acres into the program. Fourth, continue to subsidize the insurance premiums 30 percent. When Congress approved the 30 percent premium subsidy, we saw an immediate response and producers today are employing a higher level of insurance than earlier anticipated.

Fifth, continue to raise the percent coverage of the APH to 85 percent in all states. Nearly every client we interviewed who qualified for the 85 percent coverage was able to substantially increase income versus the 75 percent program.

And sixth, continue to protect the public from unregulated contracts by monitoring and enforcing the rules that require full registration of parties offering contracts and derivatives.

In conclusion, the 1996 Farm Act is accomplishing exactly what it was intended to do. Producers are being forced to become more efficient and are using regulated risk management tools like the insurance, futures and options, to manage risk. As stated by John Hansen, director of the financial services for Farm Credit Service of America, he said, and I quote, By using safe regulated marketing strategies with the federally subsidized crop insurance, we can guarantee the farmer revenue per acre. I'm very aware of the comments we've received from our clients that it was--and it was referring to the arm program--very well received, end of quote.

But the key to the producer's success is a level playing field and the ability to afford these tools. The more effective APH program, a limit of only basis adversity, a minor set aside program, and continued premium subsidies for CRC, as well as a move toward greater percent coverage, will allow producers to manage risk with the confidence that the tools they are using have the integrity of a regulated product provided by the CFTC and the FCIC. It is this type of contract they desire and seek. It is this kind of product that will allow them to remain in business for years to come.

We realize that the CFTC cannot address all these issues I bring before you today, but we do look to you to clearly communicate to those in Congress that the products offered on the regulated exchanges and offered through regulated insurance vendors are providing complete risk management products and in fact are providing more risk protection for the producer than old farm bill.

We also look to you as our financial regulator to provide public assurance and confidence that the contracts offered within the industry have the integrity and financial backing. Just as the banks count on the FDIC; equities markets, the SEC; and the insurance industry, the FCIC; we count on you, the CFTC to maintain a fair, legal, and orderly market.

As Congress continues to address the issues of risk management, I urge them to strengthen the CFTC's role in monitoring derivative market activity. As long as we offer the producer regulated tools, those who are managing their risks will thrive in the years to come.

Thank you very much.


I think we will probably hold off on questions until after Dr. Anderson gets a chance to make his presentation, and then I'd like to have the committee pose any questions to the two of you at that time together.

While Dr. Anderson is getting ready, I'd like to go ahead and recognize three members who is just arrived after the introductions to our meeting. I'll start with, on my left, Bill Kubecka, with the National Grain Sorghum Producers Association, Ken Ackerman at the end of the table with Risk Management Agency, and then Todd Vanhoose with Farm Credit up here on my right. So thank you for coming, gentlemen; and Dr. Anderson, whenever you're ready, you may begin.

DR. ANDERSON: Thank you very much, Chairman and Commissioner Spears. It's indeed a pleasure and a privilege for me to have the invitation to visit with you and discuss risk management as we are handling our educational programs from Texas A&M University.

We have two unique programs that I want to highlight today, and I'm going to skip a lot details because any time you get into intensive--

CHAIRPERSON BORN: Can you use a microphone? I think it has to be--

DR. ANDERSON: Is this okay? All right. Thank you. I'll try--if anyone can't hear, please raise you hand, and I'll talk a little louder.

The risk management--I want to give you a little background, a little history as to where we're coming from. The Texas Risk Management Educational Program which I have been involved in since the beginning of time, I want to go back and say a little bit about my futures trading. I've had a lot of experience working with the exchanges and working with my futures trading commissions and with individuals over the years, and I want to compliment you for the work you do and the regulatory emphasis you place on a complicated issue, but it's very important today.

I go back--I, of course, worked with the Federal Reserve Bank of Dallas for some time, and at that time of the stage of growth in Texas, we were putting in the cattle feeding industry in the panhandle a great risk on our agricultural lenders, and there was a lot of concern on the part of the federal reserve system that if they bring that risk and dump it into the panhandle of Texas we might have some banks that could not handle the risk.

So how were we going to do this? I did the surveys, and the interesting thing was that as the lenders moved in, they were very cautious in putting up a little bit of collateral or a lot of collateral against a little bit of the borrowing capacity, borrowing about 30 cents on the dollar when cattle and feed is going kind of slow. We learned how to do hedging effectively on cattle and feed, and that lending went up to about 80 cents on the dollar, a very key factor to expanding the cattle feeding industry in Texas, a great experience for me.

Then as we move along, we come along with these options in 1984. I worked then more in cotton with the New York Cotton Exchange. We went into Memphis, Tennessee, went with Joe O'Neil, president of the New York Cotton Exchange, and we started the options training.

And then another good thing that happened from USDA was a pilot program in the late 1980s. We had counties in Texas that were picked for the options program, and this is where we really started our intensive training. As in crops, as you well know in Texas we have a lot of yield variability, and straight futures hedging was a very risky business, or in other words, you could hedge a very small portion of your control because you're not sure if you're going to make 25 percent of your expected yield; and so that was not working well.

Well, with options, the whole picture has changed. We then came along and worked with the options programs. We started teaching two-day intensive programs. We learned very quickly that the detail for producers involved in understanding and implementing the use of futures and options was overwhelming. People that had not been thinking about this sort of way of hedging had a hard time. So our two-day programs really didn't get us very far.

We then started marketing clubs. We found out that these people would meet once or twice a month. Then we could move on. So with that, we did a little training and soon our better people said, well, this is basics, A-B-C. We want something more advanced, and so that's where I start today.

This is our advanced training program for our Texas risk management. We started what we call a master market program. As far as I know, in ag education, this is--how can you get people who are mostly producers in agricultural to attend an eight-day, 64-hour intensive training program? That's what our master market program is dealing with, and of course, as you well know, with farm policy changing, price risk is great, the educational resources are then putting a lot of pressure on us, and here we're then saying how are we going to get this master market program started? How are you going to--because we figure you take eight days, at least 64 hours to get producers just warmed up to understanding what Bill is talking about. So they could realize and evaluate what Bill is talking about. They need to know about the market.

So with this, we did our programming with our master market concept and educational programs that deal with master marketing clubs, and what's unique here is master volunteers. We require the people who attend this 64-hour training to go out and start a marketing club or become a part of a marketing club. So it multiplies itself in chain reaction, and this we have found to be very successful.

We put our program together. We're believers in that we must have the advice of the grass roots folks. So we use advisory committees just as you are here with the Commodity Futures Trading Commission. We use these to put our programs together. We also use peers, our own associates, to help us evaluate our program. The first thing we came up on was how are you going to pay for this. Our first obstacle was it costs money to put on a workshop. If you're going to have a first-class workshop, and you're going to get the best teachers in the United States, you're going to most likely have to do a little bit of hiring some consultants; and our program, we try to make it at least 50 percent non-Texas-based educators.

So we have a registration fee, $250 per individual. We get grants. We seek grants. We have some grants. Our main grants come from, like, Texas Farm Bureau, Texas Corn Growers, Texas Wheat Producers, and from other agribusiness, and of course, then we have just the basic extension funding behind the resource of that, our budget. Our expected results, highly trained marketers, improved educational materials, professional development, and a marketing club multiplier. We have approximately 50 marketing clubs actively ongoing in Texas as we roll along and new marketing clubs develop and old marketing clubs kind of graduate.

So it's an ongoing result, but here is what we're most proud of: We started this program in eight days over six weeks, two days and then skipped two weeks and then two days and let a little time go, let the people talk to each other. In two and a half years, we go back to this original marketing club group in Amarillo, Texas, mostly grain and livestock folks, and ask them what do you think, and here are the results: 82 percent indicated an improved bottom line. The range was between six and almost $100,000 per operation. In averaging this out, it's about $33,000 per year added income by the added training these folks received in learning how to do a better job of using the marketing and using the marketing strategies and the tools.

The objective here is to develop a marketing strategy, a marketing plan for this individual operation. That is what's all involved. In eight days you start out with putting people in groups. You go find and tell me what's your cost of production per acre, and I want it per yield. I understand that we've got a problem with yield and we're going to do crop insurance on that, but I like to have a five-year average. I want to know if it costs--you know, if it costs 75 cents to grow cotton, and I can promise them 55 cents, we've got a big problem, and that's what's happening right now, and we have to try to work with that.

So we then come up at the end of the program, individuals have to tell us their marketing program. They are actively involved in this training session. So we've had six of these workshops. We will allow only 60 people. We just finished one up in Amarillo, Texas. We had 90 people wanting to get into that, 60 limitation at $250 each. So we're having a little bit of a problem serving our clientele fully.

So part of our Texas regional marketing program includes the marketing clubs. Another thing I've done and worked with is we're going across the south now with the marketing club. I teleconference with these clubs. If they want to meet at 7:30 in the morning, and they want to talk about the markets, I'll certainly talk with them; but I thought, well, why don't we get some real top experts. We want to use the industry involved.

So now we have, in working with J.C. Bradford & Company of Memphis, Tennessee, we have an 800 number so once a month, two days or so after the supply and demand forms come out, we bring out about 80 locations from Texas to Florida, to South Carolina, North Carolina where farmers can sit down. They will listen to, for 50 minutes, some outstanding grain person evaluate the grain outlook, someone do the same thing for soybeans, and the same thing for cotton and for rice.

Now all of this is just take your time. Most places have a banker or lender who will buy the coffee and the donuts, and they sit down, and they drink coffee, and they listen to these professionals talk about the cotton outlook or the grain outlook, corn or wheat, and then they will build their strategy. We talk about strategy. Included in our program is standardized performance handling. Those farmers do not know a whole lot about their business from a standpoint of accounting for management. Yes, you have records for income tax, but you and I know that that's only a start for really managing. So we have a package. We have software. We call it BudPro. You can work yourself down into getting the cost per acre, put in any kind of yields you want to, and you come up with the cost of production.

In addition, we have a curriculum guide. We're putting together a thick notebook, four pages, you teach a subject, what's a put option, call option, futures, short, long hedge. Each one of those is a teaching plan. They've got complete teaching plans. They're on our web address if any of you want to look, a thick notebook. I don't want to overpower you with a lot of detail, but that is sort of the follow-through that we've found.

Now we now have producers say we need more. So where we are today is individual old farm and ranch analysis. A software package that not only evaluates individual farms based on that farmer's record of yields and prices over the past so that we can look at the financial impact of alternative strategies of reducing risk, bringing in whether we use straight futures, whether we use options or we use a combination, and how we fit it crop insurance to work with this. And so we get a organizational structure of these farms.

Now this is a tax--this is where resources are really taxed. It's only through the fortune that we had one of our representatives in Texas attend our first master market program. So with his seeing what you can do through education to help people help themselves, he's been a very strong advocate, and he's gotten enough funding for us to hire some young men that can sit down across the table from a farmer or rancher and go through this software package. It's complex. It builds in, though, the organizational structure of that farm based on where it is today.

That evaluation then works with the land resource base, with the equipment base, and we're looking at leasing now versus owning equipment. It's very clear, in particular in cotton, a new six-row cotton spindle picker will run somewhere around $325,000. So then leasing may work. Marketing alternatives, crop and revenue insurance is brought out, the debt, whether we need to reduce debt, increase debt, how's the financial situation, and what we have then is a strategic plan running out for five or ten years. Most farm analysis will do zip. Here's the bottom line today. Because this has historical data, it will then carry out for five years, and even out to ten. Much as the food and agricultural factory program does for the nation in the evaluation for the outlook for crops, we do that same sort of thing on the individual farm. But this is a one-on-one basis, starting farmers out with their records. We're finding it challenging but very rewarding. And so that's where we are today. The package is here. Our plans are, as we develop these softwares, we'll make them a little more user friendly. They will be put on the internet so that farmers can call up on the internet and work with their future in that manner.

So I want to thank you for your time, and this is the end of my presentation. Thank you.

COMMISSIONER SPEARS: Thank you, Dr. Anderson. Again, as committee members recognize, the purpose of this part of the program was designed to educate the members of the committee on various tools, programs out there that are being presented to farmers and ranchers as they go about their risk management activities.

My lawyer tells me I have to say this. So for the record, and I'll read this per his instructions, but Bill, Mr. Biederman, you mentioned appealing to Congress concerning risk management issues. "I'd like to state for the record that the AAC is intending to advise the commission, and only the commission, and any appeals to Congress are outside the scope of the AAC's charter." I thank you for your comment, but my lawyer told me I had to say that. We cannot in any way be part of lobbying Congress on any issues. You can lobby, but we cannot.

I'd like now to open, for a few minutes, the table for discussion or comments or questions to the two speakers. Again, Bill and Carl, thank you for being here. I might start by asking Bill a question, and then I have one for you too, Carl in a minute.

But, in general, Bill, what has been the first reaction of the majority of the farmers that you have approached about your program, and were they familiar with those types of tools or different risk management tools available to them such as hedging, options, those type of things, and how much time do you have to spend educating participants in your program about those type of various tools, and what are some of the challenges you face there?

MR. BIEDERMAN: The reaction was overwhelming. We actually turned some customers away because we didn't anticipate the demand as large as it was. So I think there is huge market there for the industry to work with. Our process, we might be overextreme, but we required everybody to go through a marketing meeting, and we held several meetings a week around the country. We did this mostly in conjunction with another insurance company or with a bank or both.

As far as their knowledge, I found a wide variance from crowd to crowd of their knowledge of the tools, but we found an incredible willingness to use the program to its full extent. We had several people sign account papers before we even--they sign account papers before they do any analysis at all on their farm, and several had no experience at all. They're in the program. They're 100 percent committed, and I will tell you that the comments that I've heard just this last week is that this is great because I don't have to try to outguess the market. So they feel real good about it.

I hope that answered your question.

COMMISSIONER SPEARS: If anybody else has any questions, feel free to jump in.

I might just ask, Dr. Anderson, in your opinion, what is the biggest obstacle confronting farmers as they go about trying to undertake your program and the type of programs Mr. Biederman has offered?

DR. ANDERSON: I think that's a good question, and I don't know that I've really figured it out yet. Farmers are very reluctant to get into a lot of detail, and I find--and we find in programs that we're now offering it's the most educated folk that are coming out. Most of them have some college experience, and half of them have a college degree. So the biggest obstacle, I think, just the lack of farmers putting forth enough interest to move into learning or finding someone to work with them that they can trust. There is a little bit of the problem of finding trustworthy folks to work on the risk management side, and then I would say, secondly, probably if you're dealing with, say, a put option, it could be the up-front cost involved until they learn how to manage the options with other strategies.

COMMISSIONER SPEARS: Are there any questions from other committee members?

Mr. Wilson.

MR. WILSON: Dr. Anderson, on the Amarillo two-and-a-half-year evaluation, $33,000 average improvement, do you have a handle on what percentage of that was grains versus livestock?

DR. ANDERSON: I don't really have a percent, but being in Amarillo, we know that it's definitely between the grain and the livestock side, but we didn't look at the breakout, sir.

MR. BOLD: Bill, I would say your program is real interesting. In fact, we even had lunch discussing a parallelism to the program that you already have in place; and we're from wheat country, and to the best of our knowledge, the ARM program that you offer is not available in that commodity or that part of the world yet; is that correct?

MR. BIEDERMAN: No, sir, it's actually available. We just haven't had the time to go out into that part of the country.

MR. BOLD: So when will you?

MR. BIEDERMAN: Well, probably this fall because it is a fall crop. So we have to go out during the late summer. But we do have it written for corn, beans, hard red wheat, soft red wheat, durum.

MR. BOLD: So you feel by this summer or this fall you'll be in the hard red wheat country and probably the hard red spring country?

MR. BIEDERMAN: That's what our hopes are, sir.


MR. ACKERMAN: A quick question for Bill. By the way, I enjoyed both of your presentations. I had the opportunity to attend a marketing club meeting in Seneca, Kansas a couple of weeks ago put on by Kansas State University, and it was a very interesting session and very useful meeting for the farmers involved. There were about 30 farmers in the local area who had been meeting for about eight or nine weeks and comparing notes and got quite a lot out of it.

My question for Bill is this: Your presentation is very interesting and presents a very interesting way of how to mix insurance and futures and options into a structured pattern, and your discussion about what can be done to improve things, one of the things you mention is APH, actual production history. This has been a very controversial area within the crop insurance world as something that needs to be addressed. You said generally we should find ways to further improve the formula. I just wondered if you had any thoughts on how you would go about it.

MR. BIEDERMAN: Actually, I think that would take a long time to discuss, and I don't think we have the time for that, but you know, the basic gist of what I'm trying to say there is that when there's a farm who can produce 150 or 170 bushel per acre, and the insurance APH is at 110, you have why by the insurance. By the time I take 75 percent of 110, like one farmer said, I can go out and throw the seeds in the ground and produce that kind of a crop.

So it really doesn't provide a service. So in specific locations around the country, that's an issue, a very big issue.


MR. HELLERICH: Okay. I have a question concerning your data here you presented. I believe you had an average price up there of 283 in your computations that you used for this past year. Now as we look ahead for '99 and 2000, that 283 is substantially above what in reality is actually out there. Now are you proposing to use this program when you're in a guaranteed loss situation?

MR. BIEDERMAN: No, sir, we're not. In fact, if we run the budgets for a particular farm and it doesn't meet or exceed costs to that there is a profit potential built in, we don't advise it. We just tell them not to do anything. But I can show that you that everybody in the program this year is locked in at a profit.

MR. HELLERICH: Yes, that might be at this year, but I'm talking about this coming year and the year after.

MR. BIEDERMAN: Yes, that's what I'm referring to, 1999, Year 2000. With a 240 price, we've got that built in. This particular example was for last year because we've closed it out. We know where we're out. This coming year, we do have examples of--in fact, there's four examples in your presentation out there of people who are looking at the 1999, Year 2000 crop year.

MR. HELLERICH: Okay. I guess I wasn't aware of where the market was in sufficient time to capture a $2.40 market. Because we're at--in Nebraska, we are typically running at a 20-25, 30-35 cent basis.

MR. BIEDERMAN: Right, and we do have--

MR. HELLERICH: And it makes it very difficult to come up with a profit at this type of a situation.

MR. BIEDERMAN: That's correct, and we take basis into account also, sir.


MS. KEITH: Bill, I had a question about the graph that you showed. When was your X axis on that chart? It's the one that showed the income with ARM and without, that one.

MR. BIEDERMAN: The X axis was the revenue if you're not with ARM. So, in other words, you would be on this curve here. In this particular example, you'd make about $340 an acre if you're not with the ARM program and you have an average yield, average price. If you have an average yield, average price, and you're in the ARM program after you've consumed the costs of the program, you'd make about $300 an acre net gross income.

MS. KEITH: What's your other axis then?

MR. BIEDERMAN: This would be revenue if you're in the ARM program. So, in other words, you would go to match it with this, or you would go across to match it if you're in the ARM program.

MS. KEITH: I see.

MR. BIEDERMAN: But if you would like, Gary, I can show you that this particular farm here with a 240 price has a--this is using today's marketplace with 240 futures. We're looking at a collateral guarantee of $248 an acre, and if he has a normal crop of about 150 bushels--oops. I did that wrong--and if we have $1.90 price in the fall, he's going to make $338 net gross income. That's after taking out the cost of the insurance and options and everything else.

So you know, it's not a barn burner this year, but it is profitable. That's why people are doing it.

MR. HELLERICH: Okay. They will do it with that particular set of circumstances there. Soybeans are in a similar situation. We have in Nebraska, South Dakota, southern Minnesota, western Iowa, we carry some large basis in there, and these prices don't work for this year and, you know, it's--to explain to this group that here's a program that works, it maybe works in that situation, but let's don't apply it to all areas of the country.

MR. BIEDERMAN: Well, Gary, the other comeback to that is show me a risk management plan that does show a profit at this price in every location. There isn't one, whether it's regulated or non-regulated. This is the best program out there, and it is regulated, and it works in many places, and in fact in the soybeans--I don't want to start arguing with people, but when we use the CRC-plus product where the futures are at, we actually are showing a profit for a lot of customers around the country.


MR. BOLD: Yes, Bill, how do you go about assuring or guaranteeing that basis line that you've got there around the country, because that's the real variable, and what do you do to lock that in or to take price risk management quotient out of that?

MR. BIEDERMAN: The only two variables that are left at harvest time are the spreads and basis, are the only two variables that are not locked in, or sometimes they are locked in if they reach our objective. We do have some customers in Colorado who have already locked in their 15 under basis, and they're done for the year. So it depends on, you know, as you know, spreads and basis going into the fall.


MR. QUANDT: Yes. Bill, even under this scenario, though, if we stayed in this trend and the prices trend lower yet, this scenario will not be an adequate--at some point will cease to be an adequate risk management tool. In other words, we may still need to look at policy changes.

MR. BIEDERMAN: Sir, I think there's an economic problem whenever prices get below 240 across the country. There is not a risk management program out there that you could come up with that would work, but at this price level, it's still works, and it's being employed successfully.


MR. DODDS: Thanks, Carl and Bill. I would just like to speak to the process that Bill described, because this is the process of tomorrow as we look at farm marketing. I mean, Bill's got a product. Others have products. We're moving towards, you know, dollars per acre and all the tools that are becoming available that's allowing us to do this in the industry, and it's coming fast.

COMMISSIONER SPEARS: Yes, I want to be understood that be no means are we endorsing Bill's product as a commission, but the idea was to, again, educate the members of the committee of the different type of programs out there.

Just quickly, both of you, I would be interested in your thoughts as to coming into the age of computers and technology. How are you finding the farmers that you work with, both in, Dr. Anderson, as far as your program and then, Bill, your program, what are their computer skills? Do most of them have PCs already? Are they buying PCs, or how are you seeing this world of internet and that technology playing into your programs? Dr. Anderson first and then Bill.

DR. ANDERSON: We're finding that the skills of using the computers has really improved tremendously in the last several years, and the farmers that we're dealing in our educational program that I just discussed, the majority of them, of course, are the top echelon of producers. They do have computers, and another thing that our educational program does, we have a basic program in how to use your computers as well.

So I think we're coming along very rapidly with producers who do have the computers in their business offices, and they have the skill to use them, and the internet is really, I think, may just open up a whole new avenue new. That's why we're thinking and all of our programs I discussed are on our internet site or will be in the just a short while.

MR. BIEDERMAN: My wife and I had the privilege to attend the Farm Bureau annual conference down in New Mexico, and it was a wonderful meeting, and we were talking to a real special group of people that were there, but they surveyed the crowd, and it was well over 70 percent were using computers and were on line, and I've continued to ask that to crowds when I go out and speak, and it's well over 70 percent, easily over 70 percent that not only have the computers but are on-line.


MR. HELLERICH: As you visit with these people who are in these marketing sessions and so forth in developing these plans, they are having to dedicate a certain amount of time to these things. Now, I have found a lot of times being asked by people what do you do, or how do you answer if I need to dedicate time to this and how do I replace the time that I did prior to this time? In other words, the fellow or the individual or the lady or whoever it is has not been sitting around doing nothing, and now we have an additional workload here, as you mentioned eight sessions during a four-week time period and so forth. What adjustments have you seen in your clientele, both through the extension and through the private sector? What changes have occurred in the structure of how these people do business?

DR. ANDERSON: That's a very good question. One of the things we have to do is provide these in-depth programs, generally in January and February when other farm activities are not really demanding as much. The thing that I do, and we find our very best producers, I think the ones that are the most progressive in taking the 45 minutes or so to attend a marketing club, we simply argue with them that they'll make more money or try to convince them that they'll be making more money devoting that 45 minutes to thinking and planning than they can doing some other activity, and then we try to show them the dollars and cents; and one thing I emphasize, it's not an investment like going out and buying a new machine or investing in seed or chemicals. It's investing time, and we just need to get a better balance between the management of our time in the way of marketing and strategic plans for risk strategies as well as the production of the other activities.

COMMISSIONER SPEARS: Bob White, you asked to be recognized.

MR. WHITE: What is interesting to me is as a farmer, I've sat through three different presentations by three different professors with three different ideas on how to manage my risk, and that's kind of discerning and, you know, I'm sure that the gentlemen would agree that maybe there is not one single way that is best, that a farmer not only has to listen to four presentations and then decide what will work for him.

So it all boils down to the fact that a farmer still has the decide in his circumstance what will work for him. So that makes it even more difficult for a farmer in an area with different yields and different circumstances to come to the fact of how do I actually manage my risk, you know; and you know, the presentation is very interesting, but yet it still boils down that that individual that's successful in marketing is the same individual that's probably successful in growing the commodity. And I just wanted to make that point.


Dr. Anderson, I'd just be interested, just real quickly, I know that your university is very much involved in this as you've presented your program. As Ken Ackerman mentioned earlier, other universities across the country are involved in these type of programs. He mentioned Kansas State University, from my home state, and I've also attended and Ken has several--Ken attended one. I attended two of their--they call them risk management clubs. You call them marketing clubs. They call them risk management clubs. Can you just--do you know off the top of your head how many other universities are involved in those type of educational programs, and then I'd like to ask Ken Ackerman if he would just take just a second and kind of--you know, what we're talking about is risk management education, and I serve on the USDA Risk Management Education Committee with Ken, and maybe Ken can just kind of outline, just real quickly, some of his thoughts as far as what's going on across the country on risk management education. So Dr. Anderson first and then Ken, if you would comment.

DR. ANDERSON: I'm not aware of any particular number that says how many risk management or marketing clubs we have, and that's a good point. I call them marketing clubs, but that's not really any necessity. It could be marketing. It could be risk management or some other name. We're just trying to find a handle. We think that there are, I would say, maybe a third of the states in the nation have some form, but what the problem is is that it hasn't really been given the appropriate resources that are necessary. It takes a lot of concentration.

In Texas we're very fortunate to have a fairly sizable staff, and we have regional economists across the state, and they're the leaders for setting up the marketing clubs, and then that's why we're leaning on the producers as well to help us. We will not sponsor a marketing club ourselves from the university. It takes a local leader to make it successful, and so we lean heavily on our local leaders, and I think we have a number of states that have good programs and ours, though, is unique, and I don't know of any that have a 64-hour start-up program.

COMMISSIONER SPEARS: Ken, if you would go ahead and just kind of update us on your activity at the Risk Management Agency.

MR. ACKERMAN: Thank you, David.

We've been trying to maintain a very active program on risk management education, though with very limited resources. We issued a RFP for proposals last year out of which we funded 17 proposals from around the country. Commissioner Spears was involved in that process. We think it was a very good process. It included funding for the risk management clubs in Kansas. I believe we have one project in Texas and others around the country. We think it's been a very good program, although this year because of funding constraints, we've had to limit it.

I will tell you that as part of our legislative--or package of legislative proposals for the risk management safety net for coming years, we have proposed a substantial increase in financial investment nationwide to risk management education. This will require legislation. It's now before Congress. As Commissioner Spears mentioned before, we are not allowed to talk about lobbying, but just to know, the proposals have been put before Congress, and they are part of the risk management package, the crop insurance package.

I would emphasize also, as Dr. Anderson mentioned, our main experience is that the most effective programs are those that rely on local opinion leaders to get the message across and those that involve partnering with the private sector, with academics and with commodity organizations, grower organizations represented in this room, in order to get the message across. So we hope the level of activity will pick up in the future once we get a better funding source for it.

COMMISSIONER SPEARS: Thank you, Ken. Bill.

MR. DODDS: Ken, can I ask a question? Is your department, or I would guess it's your department, forming a new risk management committee, or is there one in place?

MR. ACKERMAN: No. Or excuse me. The committee that Commissioner Spears referred to is on the risk management education. It's a four-member steering committee overseeing that program, including the CFTC, the Risk Management Agency, the Extension Organization, and the USDA's Operation of Outreach. We are also setting up a crop insurance advisory committee separate from that.

We've recently put out a Federal Register notice and are taking names, I think through the end of April. That's a new advisory committee that we'll being setting up over the next few months.


MR. HELLERICH: Thank you, David. I have a question of the panel there. We are talking here in terms of corn and soybeans and wheat. We haven't addressed alternatives, alternative crops. It might be pink corn or it might be a soybean that has a characteristic that perhaps becomes in demand by the worldwide trade for some reason or another. Now, how do we address the situation where we move into an area of production, a producer moves into an area of production where there's no methods out there to underwrite the exposure that he has while he's developing this crop? In other words, what we have in place basically programs everybody to stay in those shoes. There's no apparent method of rewarding entrepreneurship. So can you address that matter or speak to it a little bit, please?

DR. ANDERSON: I'll give you a quick response. I've had a little bit of experience in looking at niche markets and also looking at new crops, and of course I come from the marketing side, and what we almost always have to do there if we get into this thing commercially, whatever crop it's going to be, we're going to have to find--it's a contractual arrangement, is what it amounts to, kind of like the vegetable industry.

An example would be colored cotton. It came on as being, you know, really we won't have to dye it. It will be natural environmentally and all, and it's a great idea, but it has some draw backs, and it didn't take us but one year to get warehouse that's full of colored cotton that we couldn't market. So we learned very quickly. Those folks learned very quickly that you better have a forward contract, contractual arrangement, and we just have to bypass all of the other marketing systems, has been my experience.

COMMISSIONER SPEARS: I believe Dan, you asked to be recognized.

MR. AMSTUTZ: I just have a few comments, and first let me say I've enjoyed these presentations too, and I am enthusiastic about the development of new tools for risk management, which I think are important, but my comments really are going to camp on what Gary has said and what my Ohio friend here has said, Robert White, and part of this, I guess, is a bias, but I think you cannot eliminate this process of assessing the risk in order to manage it intelligently. We're living in an era of volatility in prices, not only in farm commodities but in others as well, and we have frequent examples these days, unfortunately, of so-called professionals in the financial instrument areas that are experts at using hedging strategies, and they've lost billions of dollars, one partnership I'm thinking of particularly; and if you ask yourself the question of where did they go wrong, and the answer has to be that they did not assess the risk or did not attempt to assess the risk.

And so I don't think in managing risks, I don't think you can avoid that, and sometimes it's more profitable not to do the business. Sometimes it's more profitable not to plant the seed. Sometimes it's more profitable not to take the position, and I think you have to recognize that this is a part of the process of dealing in an era of price volatility which I presume will continue.


MR. OMAN: Yes, this is for Bill. In your scenario on the crop insurance side, the CRC side, would county posted prices have a lot of to do to improve that situation? That was a disappointment I think I've seen in the CRC program, was the fact that if we get dealt with county posted prices like we have at two FSA offices, there's no reason that harvest dates receipts couldn't be used for the same thing for crop insurance, and I just wondered if that's been looked at or thought about.

MR. BIEDERMAN: That's a good point. It could be used if they wanted to work it in there, but the way they have it set up, it doesn't. So there's a gap for basis that you have to account for, and so that we've worked that in, and I think anybody who comes up with a competitive product will, but the posted county price does come into play in, of course, calculating LDPs and loan deficiencies, and that, of course, if there is one, would be added on to the revenue which you saw.

COMMISSIONER SPEARS: Bill? I think we're going to make this the last question, and then we'll take a break.

MR. KUBECKA: One quick question to both you gentlemen, especially you, Bill. I represent Sorghum. Sorghum is grown in more of the--marginal crop. You know, where does this leave us? You know, our margins are so thin, and a lot of times they just don't work. All we're doing is adding to our costs. I looked at your graph there where they intersect, and you move up that profit line, and what do you have then?

MR. BIEDERMAN: I'm surprised nobody has asked about cattle and hogs too. To answer your question, Bill, I think that we have to realize that the agricultural sector is going through a huge transition time here, hence transition payments. Now, we're only the second year into it. I think that because of the success of this program and other programs that are competitive to it, we're going to see a huge amount of effort put towards creating new regulated contracts that can help industries like yours and the cattle--I know there's already a push in the cattle and the hogs to do it, and once we get those products put into place, we'll have a very well--great product that provides a lot of protection and security.

COMMISSIONER SPEARS: Dr. Anderson, did you have a response to his question?

DR. ANDERSON: I'll just agree with Bill that we've got a situation where a lot of commodities, the price today is below the cost of production and far below the cost of production, and it puts in a very delicate situation. It's one that I expect it would happen to us just as soon as we had two or three years of production, and I don't think we really had a backup plan to deal with having bumper crops or good crops for several years and get these low prices. I think it's something that we need to address as a agriculture industry.

COMMISSIONER SPEARS: With that, I'm going to go ahead and take the prerogative of the chair and call for about a ten to fifteen minute break. Let's get back together again about 2:35. There are coffee, soft drinks, and cookies out here. I know both Bill and Carl will be around just for a few minutes, just for a little while.

Bill, do you have something you wanted to say real quick?

MR. BIEDERMAN: Yes, because I do have to leave right this minute, but I would like to point out I here some confusion and some conflicts within the discussions here today. I'd like to point out that I don't think we should confuse risk management products and alternatives with where the economics of the market is, because that's a policy question on supply, acreage controls. That's for Congress to discuss and, you know, if they want the price to get back up to the profitable level, they're going to have to have more set-aside and things like that or pray for a drought. But the risk management tools that we have, they're really great, and they're being accepted well in the country.

COMMISSIONER SPEARS: I thank both of you for coming here today.



COMMISSIONER SPEARS: We're going to start on the second part of our program. This session is designed to update the committee members on risk management and crop insurance legislative review. We've asked representatives from the House Ag Committee, Senate Ag Committee, and also from a couple of Senators' offices, Senator Roberts and Senator Kerrey, to present. They will update us on what activities are going on in both the Senate and House Ag Committees and various legislative proposals on the Hill, including risk management and crop insurance legislative initiatives.

Following that, I've asked Phil Olsson and Dr. Peter Griffin from the American Feed Industry Association to make a presentation on their livestock revenue insurance program. It's received a lot of attention this past spring. That program has been a focus in various producer groups and the Administration. I thought it would be beneficial for the committee to hear about it; and at the end of their presentation, because it does raise some legislative, regulatory issues, I'm going to ask Paul Architzel from our staff to make brief comments and responses to some of the program issues.

But to start with, we're very fortunate to have representatives from the Hill here. We have Stacy Carey from the House Ag Committee, Walt Lukken and Marcia Askwitz from Senator Lugar's office, the Senate Ag Committee; and then, in a few minutes, we're going to here from Bev Paul and Michael Seyfert from the Senate, Senator Kerrey's office and Senator Roberts' office.

But to start with, I will defer to the seniority and the 15 years experience of Stacy Carey to update this committee on activities on the House side. Then I'll defer to Walt to update us on the Senate side. So Stacy, if you would go ahead and start, I'd appreciate it.

MS. CAREY: It's a pleasure to be here with you today. It's not often that we hear that people are thankful to have Hill staff around. So it is an honor to be here, and we always enjoy the opportunity to come down to the Commission and particularly to chat with the Ag Advisory Committee. This is a very important body and, over the years, we've been dealing with issues relative to the Commission and such. It has been a very good source of discussion and information.

So the topic today is risk management and crop insurance, and by way of background, I work on the House Agriculture Committee, specifically for the Subcommittee on Risk Management Research in specialty crops, and as a part of that jurisdiction is included commodity futures trading, crop insurance, specific tobacco, peanut, sugar programs, biotechnology research issues.

We have a wide range of jurisdiction which we enjoy particularly with risk management. That is such a buzz word now days, and it means many different things to many different people, that it has allowed the committee and particularly Chairman Ewing and the members of the subcommittee to explore issues, many different issues in many different areas.

So two of our main issues that we will be paying a lot of attention to this year are crop insurance improvement--we are no longer saying crop insurance reform because we have reformed the heck out of that program for years and years and years as Ken can attest to. We're calling it improvement, short-term improvements.

The other issues that I'll just briefly touch upon, by way of time frame, is CFTC reauthorization because that has risk management implications as well, but particular risk management, like I said, it means many different things to many different people. It's an issue discussed very widely amongst many groups, but crop insurance is the one avenue now, one program that many of our members look to as sort of the domestic safety net for our agricultural sector, and I think the large belief of the chairman and many of the members is that they want to assure that there is a viable, working program in place.

And I think it's safe to assume after our many hearings that the program is so large and covers so many regions and areas and commodities of this country that we are sort of moving to the concept that it's not really feasible to actually fix this program once and for all because it's a constantly evolving program. Issues, many issues, change and are brought up over time, and I think although there's probably some criticism about Congress going, beginning with 1994 reform and the disaster bill and constantly going back to this program. I would argue that that's a good sign that government is being responsive to the program and trying to address the needs that are out there because it is not a monolithic program by any stretch of the imagination.

So we have been fortunate enough this year on the House side, and I know the Senate got a place marker to obtain $6 billion in new spending for crop insurance improvement. On the House side, that funding is parsed out over five years. There's no funding in the first year, but it will average out to $1.5 billion in years two, three, four, and five.

So we are tasked with the enormous burden of trying to pull together legislation to make what we're calling, again, short-term improvements to the program; and I say short-term because both Chairman Combest and Ranking Minority Member Stenholm have also talked about long-term improvements to the program, if you will, but that focuses more on an overhaul of the program, and I think their thoughts are geared toward almost a complete restructuring.

I know Mr. Combest has said that he wants to keep the long-term effort more of an insurance-type of reform, but he's really thinking long-term overhaul, more of an agricultural trust fund, for lack of a better term, type of approach, and I think he sees the long-term approach more as a funding cycle where any new money that would be obtained for agriculture would be put into this fund, paid out to producers in bad years. Reserves would build up in good years.

That's a very simplistic sort of description of what I think--or what he's expressed in various speeches about the long term. He says it needs a lot of work, and I think in the time right after we get through the short-term focus, that he will begin and Mr. Stenholm will begin to looking at long-term focus.

But for the immediate purpose on the short-term legislation, the subcommittee will be looking to mark up a bill by early June. So we are in the process and have been in the process over the April break of meeting with industry folks to get input as to what their priorities are for this legislation, what do you think should be the priority for improvement, what is problematic for you, and we're really in the mode right now of getting input and receiving input so that we can sort of put together a framework for this bill.

We will look to have drafting start--we'll probably do an initial framework of a bill by the end of this month, within the next couple of weeks. So this is really on a fast track, and I should just say if there's anybody that we've missed that has an interest in this program, please don't hesitate to give us a call, because, you know, we will start drafting very shortly.

But there are a number of issues involved with the program, and I think the philosophy of the subcommittee and many of the members is the role of government is to make available as much risk management tools as possible to the producers so that they can choose and make those decisions for themselves about which tools will help them manage their risk in the manner that they feel will achieve the best results, whether it's production risk, financial risk, operating risk marketing risk. We don't really view our role as directing a certain agenda or certain product out there, but rather because of the diversity of our farming operations in this country, there should be as much diversity in the products available to them, whether that is ag trade options, using the option; dairy options pilot program, expanding that per se for your regular catastrophic, you know, crop insurance; multi-peril coverage for fruits and vegetables. There's just such a wide array of diversity that we believe our role is to facilitate these products, the availability of these products to agriculture producers.

So I won't ramble on for much more. I just sort of wanted to give you a framework of where we're going on crop insurance, and I will just mention briefly CFTC reauthorization. It's Chairman Ewing's wish to try to get legislation pulled together this year earlier rather than later, and so we will shortly be working on that effort as well and obviously want input from everybody in this room here today.

So with that, I will turn it over to my esteemed colleagues in the Senate. It's nice to have the House go first for once.

MR. LUKKEN: Thanks, Stacy.

I appreciate being invited. It's always nice to come down to the Commission. Unlike the House, risk management is not lodged in one staffer. So we split the issue, and unfortunately Andy Morton, our chief economist at the committee who handles crop issues, was not able to come down and join us, although he wanted to. We had a hearing this morning--Ken was there testifying--and he had some follow up to that. So he's not able to come down and visit with you, but he has briefed me. So hopefully I can give some insights on what's happening in the senate on crop insurance. We began overviewing the crop insurance program, I guess the beginning of March. The Senator, as he often does with these large issues, starts out by posing a set of questions that go to the fundamental public policies of why we do these programs, why we should pay for them, what is the benefit for the society, agriculture in general. And so he did that. He released a dozen questions at the beginning of March. We held a couple of hearings, March 10th and March 17th, on the current program.

Today, of course, we had a hearing where Inspector General came out with a report that was critical to have current program, and that was something we reviewed today with Ken testifying on that.

The budget resolution that Stacy mentioned which sets out spending limits for Congress has given us $6 billion to spend on improving the program. So any sort of improvements and alternatives that we look at, of course are going to have to be overlayed over that $6 billion figure.

So with that, next week, I wanted to mention that we are having a crop insurance roundtable in the Senate which I invite you all to attend and participate in. Roundtable is sort of Senator Lugar's favorite thing now to get sort of an informal group of folks together, experts in the field to discuss these issues and the important topics of the day, and instead of a hearing format which is a little more rigid in structure, I think he enjoys the give and take of the roundtable format. So that's what's going to happen a week from today.

I think he sees the three different policy alternatives in this area to be, one, adding more subsidies to the current structure as one of them. You know, that's difficult given the $6 billion figure that we've been given, and also I think the Senator has some concerns given that economists have testified that, you know, this current program is inelastic, and we have sort of weigh that whether additional money is going to increase participation, if so, at what level. The other alternative is to add subsidies but also give some fundamental structural changes to the program. So that's something we'll look at.

And on the other side of the spectrum, some folks have talked about replacing the system entirely and just doing an ad hoc disaster assistance bill every year. So the reason they cite this is that participation levels can be increased every year. We do disaster assistance bills. Why do we do the program if it's always going to happen every year? So I throw those out there, not that he's advocating any of them, but those, I think, are the three things, the spectrum of different alternatives that everybody is looking at.

After this roundtable a week from today, I think, as Andy described it, we go into our legislative phase where we'll seriously be considering what legislation and what direction we'll be heading, putting pen to paper as far as legislation. So I encourage you, with that, to come next week and see the fireworks.

And as far as my issues, the Commodity Exchange Act issue, I mean, as Stacy mentioned, there's always risk portions to that. Again, we released a set of questions in, I guess it was December, a set of 48 questions and some of those dealing with agricultural issues and ag trade options, and we've been receiving those from folks from the industry and will publish that at our hearing shortly.

We held a roundtable in February that discussed ag trade options. We had some agricultural folks there, a farmer, Bob Kohlmeier from World Perspectives was there as well, and I think coming out of that, the Senator had a feel--well, he felt that there are three or four distinct issues that he felt that he could get into at additional hearings and be able to further that agenda, and one of them being agricultural trade options. So we're scheduling a hearing for the beginning of May on agricultural trade options to review the current program, what improvements can be made.

We're also go to try to look at the educational efforts surrounding the program, whether--you know, what is the demand for these types of tools; if so, what is the best way to put them in the hands of farmers and educate them, and so, you know, after we have this hearing, we'll look at different ways that we can improve the program, whether it's through regulation or whether it's through introducing legislation on our part. Those are the options we're going to have to look at.

So with that, I'll cease fire, and if there's any questions--like I said, I don't handle the crop insurance issue. So I'm not going to be able to answer anything specific, but I'll defer to Stacy, my expert next to me.

COMMISSIONER SPEARS: Are there any questions for Stacy or Walt before we move on? Gary.

MR. HELLERICH: Yes, thank you, David. I'm not clear on this list of 48 questions that you have proposed or put out or whatever. Could you explain that a little more?

MR. LUKKEN: Sure. When we had a hearing in December on over-the-counter derivatives, we decided, and like I said, this is something that--this is the way that the Senator in his very logical mind approaches problems, is that he sort of surrounds it by asking questions, you know, what are the public policy reasons for subsidizing crop insurance, or what are the reasons that we do these laws this way, and we try to--we do this just to get people to sort of step back from the issue a little bit and think about, you know, the original reason that we are even involved in this issue; and a lot of people, they get to the rub, you know, whether we do this or don't do this.

A lot of times we have to step back and say, you know, why should we be involved in this business at all, and I think that's part of the exercise, but they're not--you know, he does not mean them as rhetorical. They're meant to be answered, and we've encouraged folks to answer them on our web site and at all the hearings we have been having, but the 48 questions you refer to were directed towards the Commodities Exchange Act. Crop insurance, we released a set of 12, I think in March, but the 48 are on our web site if anybody is interested in looking through those, and I can give you that afterwards if you're interested.


MR. WHITE: I address this to Stacy, just maybe a comment that she may wish to comment on. The situation where disaster relief versus crop insurance, and we've been told off and on through the past few years that you buy crop insurance, we're not going to do any disaster relief, and so you've formulated a program through the Farm Service Agency that you will pay so much for crop insurance, and so farmers did that. Then there became a--along came a disaster, and so they passed money to pay farmers for disaster, and my only comment is that this program that you're going to build where you have this fund and this fund will build in good times, farmers for some reason--I guess maybe I'm guilty too--say if it's good times, why buy the insurance? So the fund doesn't build. Then a disaster comes along, and you don't have a fund.

I guess maybe there's not an answer for that, but I'd be interested in hearing how you're going to build this fund in good times. Is there an answer that you have?

MS. CAREY: I think that's still in formulation, because I think the whole concept of, first of all, the terminology in Agricultural Trust Fund will not work the way that Mr. Combest has sort of laid it out, because federal trust funds, you know, if you're in a deficit year, no money goes anywhere, even to agricultural producers.

So there's an issue with the accounting, if you will, but his thought, I think sort of really culminated after the disaster bill, and his thinking was we just spend $6 billion in one year. Was there a better use of that money in a more long-term cohesive effort, and if there is, is there a way to build that into a program that, you know, whether it's building up, again, reserves in good years, whether it's the producer premium gets socked away and builds up and accrues interest and what have you, so that you've got a pot of funding there for when there's a disaster year and payments need to be made out.

There's a lot of work that needs to be, you know, sort of flushed out in details, and a lot of discussion needs to occur on this issue. But I think that's sort of his general thought.

MR. WHITE: A follow-up comment, was there ever a fund established in Washington that grew to a certain size and was left alone for that purpose?

MS. CAREY: No. A very good point, and we are all acutely aware of that. There's the Federal Highway Trust Fund, Social Security. Yes, that's a point that we're well aware of. Thank you.

COMMISSIONER SPEARS: In the interest of time, I'd like to go ahead and call up Mike Seyfert and Bev Paul from Senator Roberts' office and Senator Kerrey's office to kind of outline the Kerrey-Roberts Bill, and then we'll have time to ask--go ahead, Stacy and Walt. You guys can stay there if you want to, to take questions in a minute, additional questions, but I wanted to make sure that both Mike and Bev had time to talk about the Kerrey-Roberts Bill, and I want to leave adequate time within this session for the proposal of the American Feed Institute.

I'm not sure, Mike or Bev, which one of you two are going to go first.

Mike, welcome, and I thank both of you for being here as well.

MR. SEYFERT: Well, lucky all of us. Three o'clock in the afternoon when most people are thinking about a nap, and you get to listen to us talk about crop insurance. I usually tell people, as most of you know, Bev has quite a bit of experience in the crop insurance program. So I'm kind of like the graduate student usually who is followed up then by the professor who will clean up all my mistakes.

Most of you, a lot of you in this room, I think have a pretty good idea of the Roberts-Kerrey legislation and how it was developed and what it does. So we thought we'd just summarize that real quick. I'll go through mainly how we developed it in the producer sections, and then Bev will talk more about the administrative provisions and the product development encouragement provisions and that that we have in there.

Basically, I think most of you know Senator Roberts and Senator Kerrey have been talking for several years about some form of crop insurance legislation, even prior to Bev and my arrivals on the staff, back when it was Brian Edwards and Theresa Gruber, and they've discussed it several times, but I think last year in the situation we got in with the disaster legislation and everything else really convinced Senator Roberts and Senator Kerrey that it was time to seriously consider looking at doing some legislation.

And so in November, Senator Roberts and Senator Kerrey requested from most of the major farm groups, commodity groups, and groups with an interest in town here to come to us with their top priorities for addressing needs in the crop insurance program. We had expected to hear from quite a few of those groups. I don't know that we expected to hear from as many of them as we did. We heard either in written comments or in direct meetings that Bev and I had or that our bosses had from other 20 of those groups, and what we consistently heard from most of the groups was that the program needed to provide policies which were affordable for producers and which gave them the coverage that they needed for the amount of money that they were putting in, that the program didn't address the needs of beginning farmers or producers who are trying to rotate crops under the new farm legislation, and that there were also obviously a lot of problems, as we've heard in the last few years from the northern plains, problems with producers suffering multi-year losses.

We also heard quite a bit about the possibility of livestock coverage and also the need for product development and just some regulatory changes. We took all of those comments together, spent several months going through them and in May introduced a bill, Senator Roberts and Senator Kerrey along with 12 other members of the Senate, the Crop Insurance for the 21st Century Act. Basically, what it does, in a nutshell, to address the need of subsidy or of coverage that we heard from producers. The current subsidy formula is inverted from the way it currently is, as most of you know, the highest level subsidies at the lowest level of coverage. It will change that to a 55 percent level of coverage at 75/100 or 55 percent subsidy at 75/100, 50 percent below that, and at 50/100 or below; 65-100 coverage, the subsidy will be 45 percent.

Also, the subsidy will be available for revenue policies, the same as it for MPCI and other policies that are out there. As most of you know, the revenue portion of a lot of the revenue products that are out there now do not receive the same level of subsidy. That would change under our legislation, and that's in response to comments that we heard from a large number of the commodity and the farm groups. We require the establishment of an APH credit program of some type for beginning farmers, those who have been farming for two years or less and producers that are rotating crops for farming new land.

As you know there has been a yield structure in place, and it's been tested with RMA. The comments we heard from people was that that didn't do enough, and so basically what our legislation does is instruct the board to develop--to work to develop some form of new system to address the needs of producers.

An important part of our legislation, we think, is trying to address multi-year losses. Basically, what we have done is said that if a producer has suffered a, quote, disaster for three out of the last five years which had resulted in a total development of a 25 percent or more in their APH, they'll be allowed to exclude the lowest year from their APH calculations so that they can get--hopefully increase the coverage and get rid of the problems that we're hearing from a lot of the producers of not--of losing their coverage levels when they have multi-year losses. They would be able to build that back up, and once it reached 25--that 25 percent was regained, the exclusion would be gone. There would be no cap on how quickly that would come back, and our hope is also that eventually products will be approved by the board which will be seen as addressing this problem and that the board would certify that, indeed, products have been developed to address multi-year losses, and this provision would sunset.

A couple of just short other sections in there is the authorization of disappearing deductible contracts to be authorized, something we heard from groups. Basically what that does, assume you have 75/100 coverage. A company could offer, for example, another contract which says for a loss above 50 percent, every 10 percent above 50 percent, your deductible will be reduced by 5 percent so basically you could have 100 percent loss and 100 percent coverage.

We've heard a lot of problems with rating systems, rating problems, particularly in the south. We have a pilot in there to hopefully address some studies, create some studies to develop a system which would be in place to address that.

And then we just removed the current exclusion for livestock that's in the current law. Basically, all we did is remove it at this time, something we had heard from several farm groups and also members that that was something we needed to look at. At the time we wrote the legislation, nobody had any sawed proposals on the table, and so we placed the waiver in there and have basically said let's see what we can come up with and then we'll like at it from that point. We do know just a simple waiver as it currently is will be very, very expensive, and that's why hopefully something more solid and concrete will come out of the discussions we've been having with the groups.

I think that summarizes that portion of our bill. I'll let Bev talk. We also have a summary of our bill, which we'll pass around, and also a side-by-side that the CRS has put together of the issues that are being discussed, current law, what our bill would do and also what the proposal which has been discussed by Ken and RMA would do in comparison.

COMMISSIONER SPEARS: Thank you, Mike. Now you referred to the Roberts-Kerrey Bill. I'll let Bev talk about the Kerrey-Roberts Bill.

MS. PAUL: That's right. Thank you, David. Well, that's exactly right. It depends on who you're talking to.

I noticed a lot of smiles in the room when Mike started talking about the price tag on that livestock exclusion. So I'll leave that there except to say that that would spend way more than the $6 billion all by itself. So that will probably see some changes.

In addition to the producer-specific parts of this bill, we spent a considerable amount of time and effort trying to come up with some creative ways to help bolster from the public-private part of this program. Our bosses, I think both feel as though through the crop insurance program we've got one of the more visible public-private cooperation efforts in the ag sector, and so we have a lot at stake in trying to make that work and trying to make that work better. And so we have a complete section of our bill devoted to trying to make some changes to make that partnership work better than it is currently working today.

So I'll just talk about those for just a moment. To start with, when we were drafting the bill, we discovered something in the statute that I think goes against what many of us think common sensically [sic] is the way this program runs, and that is that the Risk Management Agency is at the top of the hierarchy, and then you have the Federal Crop Insurance Corporation Board of Directors reporting to the agency, and common sensically [sic], I think we would also imagine that the Board of Directors would be at the top of the hierarchy with the agency reporting to them.

So one of the most substantive things we do in this bill in terms of legislative language is we turned that around. We make the Board of Directors at the top of the hierarchy and the agency report to them, and that would actually be a great change in the way that the agency currently functions.

Additionally, our bill establishes what we call an Office of Private Sector Partnership within the USDA. The Office of Private Sector Partnership would report directly to the FCIC Board of Directors. RMA would report to the FCIC Board of Directors, and FCIC would report to the FCIC Board of Directors. So the agencies would be on a more equal footing.

The Office of Private Sector Partnership, as we envision it, would have four main functions. The first would be to serve as the liaison to the Board of Directors, again setting up for of a formalized process for that liaison with the board. The second is that the Office of Private Sector Partnership would review and make recommendations to the board for approval on both the privately developed policies and the publicly developed policies. We heard an awful lot of concern that we would eliminate the government's ability to develop new products and many, many people were nervous about the concern to have private sector to develop products for some of the newer or less lucrative crops, and we wanted to be responsive to that.

So we didn't remove the RMA's ability to develop new products. What we do ask through the Office of Private Sector Partnership is that the review and approval process for those products be equal to the review and approval process for the privately developed products, and so that is a function that would be within this new office. Thirdly, the Office of Private Sector Partnership would approve reinsurance contracts for new or specialty crops. We have heard an awful lot of complaints about new crops or less major crops not having the same insurance options as the more major corn, rice, soybean-types of crops, and we wanted to be responsive to that. However, instead of trying to make those crops--instead of trying to make better coverage available to those crops, most people are talking about making the CAT program or making the NAP program more generous. We wanted to take a little broader view and think about how to bring some of those newer crops along so that they've got the same kind of insurance options that people who grow corn or cotton or wheat have, and so that was our goal behind trying to make better reinsurance available for some of these more minor crops, so that more experience could be gathered, and hopefully we can make more and more insurance options available for those crops as well.

And finally, through the Office of Private Sector Partnership, we would move the reinsurance functions of the agency into that office. Finally, and I think I mentioned to develop new policies, but in our estimation, then the mission of the Risk Management Agency would be set out as being the regulator and being the agency in charge of compliance, again with some limited product development capacity still within the agency.

So the money parts of the bill aside, which are obviously the subsidy numbers, we have spent time trying to make the government part of the program work better, and through this office we are hoping that that will be a result.

COMMISSIONER SPEARS: Thank you, Mike, and thank you, Bev.

Just quickly, do we have any questions? I know, Susan, you had a question earlier you wanted to ask, but then we'll get into a discussion regarding the American Feed Proposal.

MS. KEITH: Just a question about subsidy and the revenue, the price side of the revenue products. It's available to producers this year through the additional subsidy for the crop insurance, the $400 million part of the disaster money last fall. Has Chairman Lugar softened any on the subsidy on the price side of the crop insurance products?

COMMISSIONER SPEARS: Andy is not here; right?

MR. LUKKEN: Right. I'm sorry. I don't know the substance of--no. If you want to contact me afterwards, I can probably find the answer to that.

MS. KEITH: Thanks.

MR. LUKKEN: We'll find the person who does know the answer to that question.

COMMISSIONER SPEARS: Okay. With that, I want to thank all of you for being here.

Marcia, do you have something that you wanted to say?


COMMISSIONER SPEARS: Okay. I want to thank all of you for being here. I know there's very busy schedules on the Hill, and it takes time to come down here, downtown, to have this, but it's very beneficial to us here at the agency and to this committee. So I want to thank you.

You're invited to stay for the rest of the meeting if you want to. We're going to have a discussion regarding the life stock insurance proposal and then some discussions about potential regulatory and legislative issues regarding that proposal and then ag trade options. So thank you again for coming.

CHAIRMAN SPEARS: Next, as I said, we're going to have Phil Olsson and Dr. Peter Griffin from the American Feed Industry Association who will present that association's livestock insurance proposal; and following that, as I said earlier, I'm going to ask Paul Architzel, in about five to ten minutes, his comments to very quickly summarize some of the key issues regarding that that impact this agency and legislative issues as well.

So with that, Phil, I'm not sure if you or Peter are going to go first. So I'll just defer to whichever one of you two gentlemen are going to lead with the program.

MR. OLSSON: Do I need this on? Does this work now?

I'm Phil Olsson and I'm counsel to the American Feed Industry Association. It's president, Dave Bosman, is either getting off an airplane at Dulles or going through customs right now. So he didn't feel that he could be reliably present this afternoon.

American Feed has been in the insurance business for 12 years now, since it formed a risk retention group to handle the product liability risk of its members in 1986, and that has led to some interest in other insurance areas and most recently to an interest in livestock revenue protection.

What I'd like to do is to describe the proposal that AFIA has. I will be interested in the staff's comments, although I did not realize that we were going to have an adversarial proceeding or I would have asked the commissioners to sit up at the bench; but in any event, I hope that--I may ask the opportunity for rebuttal.

COMMISSIONER SPEARS: By no means is this meant to be an adversarial proceeding. I just know that, through discussions, that it has raised some regulatory issues, and we just thought it was important for the opportunity to talk about those, and certainly we'll have time to have a dialogue.

MR. OLSSON: And I think it is an excellent opportunity to have a dialogue, and I'm pleased by that.

What AFIA is proposing is an opportunity to provide price protection for livestock producers by indemnifying them up to a predetermined price level. The insurance policies would run out for four to eight months depending on the class of livestock. The price level would be set when the producer purchases the product, and it would be a policy that would, frankly, be based on the futures policies and the options prices that were prevailing on the Chicago Mercantile Exchange at that time. So there would be a major element that is regulated by this commission and the pricing of the product.

Now, the payoff for the product would be on an agricultural marketing service cash index, and there are various indexes, and these are indeed used in determining closing price on the futures instruments. It would settle only at the closing date. There would not be the opportunity for someone to buy and sell it, an insurance policy as if it were a futures contract or an options contract. But the insurance company would back up its sale of these price protection policies with the purchase of futures instruments, and so there would be the purchase of futures options that would offset the risks that were being undertaken by the insurance company, and those instruments would be used to secure reinsurance which would be obtained from the Federal Crop Insurance Corporation.

There would be several roles for RMA and FCIC in all of this, and those would include reinsurance. They would include a buying down of the premium which is similar to what is done with present crop insurance, and they would include an administrative subsidy similar to what is done with present crop insurance.

Now, the key question, I guess, that many people ask, and certainly we've been asked it here, is now is this insurance or is this an agricultural trade option, and I think we can answer confidently that it is insurance; and why is it insurance? Insurance is a contract whereby one party, the insured, transfers a preexisting risk of financial loss to another party, the insurer, for a consideration which is a premium, and the insurer promises to pay the insured should the loss occur. What we're talking about here is livestock producers who would have a preexisting risk of financial loss. These contracts, these insurance policies, would not be available to speculative purchasers, and that would be the basic nature of the transaction and the only nature of the transaction.

Now, does this have the nature of an agricultural trade option? We think that it does not because an agricultural trade option is very substantially concerned with counterparty risk and with the management of counterparty risk, and here the counterparty risk would be substantially offset by reinsurance. Again, this is the traditional insurance mechanism.

So it is our view, as we look at this, that it is insurance. It's not an agricultural trade option, and it really doesn't fit within the definition of an option in 6 USC, Section II which speaks of things that are traditionally known as an option. This is not a product that somebody has been traditionally offering as an option out there in the country for a while.

And, you know, we've done some focus groups and some surveys out in the country, and one of things that's interesting is farmers understand this product. When American Feed goes out and describes it as insurance, they understand what people are talking about. It is a readily understood risk management tool.

Now, I noted that in the earlier panel there was a lot of talk about risk management education. I dare say that if this were recast or somehow offered as an agricultural trade option, it would require a great deal of risk management education to get a producer, a livestock producer back up to the point where he already is when you come in and say this is insurance that is insurance against a certain price risk.

So I think that we believe that it is and can be an excellent insurance tool. We believe that if it is properly managed, and one always hopes one can properly manage something, that the ability to secure the risk with futures instruments would make it a relatively low-cost program for USDA. It would be unlike your typical crop insurance where there is not only the subsidy of the premium, but there is the reinsurance risk of catastrophic loss. We're not talking about catastrophic loss here. We're talking about price risk, and that price risk can be offset.

Now, this is a product that should be carefully regulated, and I think the key perspective we have in its regulation is that whatever regulation it has, whether it's regulated by the CFTC or the RMA or some new agent, God forbid--and I was at USDA when the commodity exchange authority gave up, and there was a new agency here, and thank God there's a new agency here for that--but whenever it's regulated, it should be regulated one agency at one point.

So we see that the purchase of puts and futures instruments would be clearly regulated by the CFTC, that that part is clearly a CFTC responsibility and should be regulated there. Once those are used as security for a product with the Federal Crop Insurance Corporation, the Risk Management Agency, then the regulatory responsibility at that point should shift, and the single regulatory authority should be at the Risk Management Agency and then beyond that into the marketing, the regulatory authority which exists with all crop insurance which is the state-by- state insurance commissioners.

So we think that it is a product has the potential to alleviate some major problems in the livestock sector. We believe that it can be and should be effectively regulated on a single layer basis, and we think that with the use of futures instruments to secure FCIC reinsurance it can be a product which has a reasonable cost to the government and perhaps even less than the CBO estimates that has been talked about.

So that's what we have.

MR. GRIFFIN: I would just really add only or reiterate what Phil has said here. If we take a step back and really ask ourself what are the large questions that are going on here, first of all, what we're trying to do is get a product here that more closely addresses what the producers' needs are, and producers are marketing their livestock continuously by and large throughout the year, not at the seven days of the year or such that the futures contract would expire.

This is one of the main reasons why we would move off of a cash index, as reported by the Agricultural Marketing Service, and what we do have as well as a market base solution, as I would call it, for addressing these needs, and one of the reasons I see it that RMA is a good regulatory agency here is that they have as a mission to help producers and help them in their risk management tools, more so than I think any other agencies.

So just adding on to what Phil said, I think that credit risk is well covered by having a reinsurance agreement with RMA beyond what we are able to cover with the futures and options products. So that's it from my side.

COMMISSIONER SPEARS: Phil and Peter, I want to thank you guys for your presentation. As I've commented, you guys have been very willing to educate this agency as to your program. That's been very beneficial. In that regard, I thought it was beneficial for this committee to hear--the committee members to hear about your proposal as well, and I know in our discussions with you, our staff have raised some points as far as from their viewpoint some regulatory issues.

So this is by no means meant to be an adversary-type of discussion, but I thought it was just important for our committee members to hear what some of the viewpoints of our staff and certainly have a little dialogue about that.

I asked Paul, in a few minutes, to outline some of those points for the benefit of the committee members, and then we'll have a discussion. I think we're going to have to turn the mikes off so that only three mikes can be on at the same time or one mike can be on at the same time.

MR. ARCHITZEL: Okay. Thank you. The staff of the division of economic analysis has looked very carefully and reviewed the instrument, and in our estimation, it looks to us as though this instrument is an off-exchange commodity option, and that finding for us raises several regulatory issues that need to be addressed.

First of all, we would start from a definition of what an option contract is and more specifically a put option. A put option is a contract that gives the purchaser, for the payment of a premium, the right to sell a specified quantity of a commodity at a specified price, which is the strike price, within a specific time period. Put options protect the purchaser of the option from downside price movements and leave him the ability to profit on upside movements in the price. They are used to hedge against marketwide price declines in a commodity.

Options can take a number of forms. They can either be settled by physical delivery, if exercised, or they can be cash settled. They can provide for payment, if they're exercised, at a single point in time, or some options permit exercise at any time during the life of the option. Alternatively, options can provide for a payment of an average price which is calculated over a period of time, and that's known as an Asian option.

Going on to the next transparency. The commissioner asked me to be brief, and please feel free to stop if there are any questions as I go through this.

Looking at the instrument and comparing it to the definition, we find option characteristics. First of all, the instrument covers and transfers a generalized price risk, and we find that that's characteristic of an option. The option pays off depending upon the marketwide price level which is in effect at the time that the option is exercised and doesn't cover a specific loss to an individual which grows out of some kind of harm or injury to an insured interest.

Secondly, it's hedged are with exchange-traded options, and it's covered by--by being covered largely with exchange-traded commodity options. You can see that the nature of instrument is very similar to that which we expect ag trade options to exhibit. Which is, it is intended to be a retail oriented means of providing option protection which is then able to--the agricultural trade option merchant is then able to lay off that risk on an exchange-traded market. Accordingly, this functions identically to what we would expect OTC ag trade options to operate as, and we'll be discussing that later in the meeting.

Going on to the next slide, the other characteristics of the instrument are quite admirable -- restrictions on coverage, restrictions on the ability to speculate.

Those kinds of restrictions don't define the instrument. Similar restrictions can be found as part of the agricultural trade option program, for example. Those are marketing restrictions. Those are regulatory restrictions, but they're not defining the nature of the instrument. Similarly, who sells the instrument, whether it's sold through a network of insurance sales agents or through CFTC registrants, doesn't define the nature of the instrument.

Now, our finding that this looks to us as though it's a commodity option raises a number of regulatory issues that need to be grappled with before going forward with any kind of instrument. First of all, it raises the possibility of legal confusion over the definition of insurance and option contracts. Both types of instruments, insurance and futures and options, deal with risk. They shift risk. However, until now, there's been a fairly clean demarcation between those two types of instruments.

Futures and options are used to hedge general price risk. Insurance products are used to hedge or to guard against risks arising from damage or other types of injury to the insured interest. The existing distinction, if it's clouded, in the case of this instrument, that clouding could be used in all other types of commodity products, futures and options, that are offered currently. It would provide a road map to offer current futures and options products through insurance instruments for every futures contract, for every commodity option contract. That needs to be considered very carefully.

Secondly, it may lead to confusion regarding regulatory jurisdiction. The CFTC, beginning with its founding, provides for a national standard and national regulation of futures and options contracts. In contrast, insurance regulation operates through the system of state regulation.

Now, this isn't necessarily bad, however the confusion where of an instrument, is to be regulated can raise problems for those people who are trying to operate and offer instruments. For example where someone who registers as an agricultural trade option merchant to offer those instruments that look exactly like this kind of insurance product, a state insurance regulator might question the offer of the agricultural trade option. That may present problems for those people trying to operate under those regulations. Secondly, it introduces potentially different regulatory schemes for very similar instruments. For example, many states currently don't permit futures and options to be used by insurance companies as part of their investments and for other purposes. Here, however, you have what clearly acts as a commodity option being offered in an insurance environment as a retail product, and that certainly needs to be considered.

In addition, states may have various requirements as far as disclosure, sales, and safekeeping of customer funds that differ from the commission's and for very identical instruments. In this case, it may lead to confusion about what regulatory requirements should apply. This also may lead to marketplace confusion.

Once ATOMs begin offering, agricultural trade options, which certainly will happen at some point, individuals may be confronted with identical instruments which are described and explained to them in differing terms. For example, the commission's disclosure document talks about the risk of entering into an option, and we feel that that's a necessary type of disclosure. Is an insurance policy that operates in the same manner less risky? Should it have the same kind of disclosure or not?

Secondly, when we have an instrument being described, it's possible that there will be two sets of terminology used for exactly the same scenario, and this may lead to further confusion. Rather than providing an enhanced risk management ability for people, it may just lead them to be even more confused.

Finally, there have to be questions raised about the management of the hedging on the instrument. Those are practical issues that we really don't need to get into now, but we would just note that we would question whether there is sufficient liquidity for absorbing potentially large volumes of positions all coming from one side of the market and from a single source, and if not, how is it to be developed. Or if the risk can't be offset in the market, then what happens?

Finally, we have to note that there's some legal risk involved, because even if the agencies agree that the instruments should go forward, private parties may be in the position where they may seek judicial remedies and clarification if there's none that comes from a legislative mechanism.

So basically these are the regulatory issues that we see that need to be addressed in this situation.

COMMISSIONER SPEARS: Okay. Are there any questions on behalf of the members to either Paul or to Phil regarding the proposal?

MR. WILSON: Yes, my question is this: If I understand it correctly, futures instruments would be your reinsurance. What is the benefit to a livestock producer not to just go ahead and use what's already in place?

MR. OLSSON: The livestock producers can and should use what's already in place, but we believe that there aren't enough livestock producers who are doing that, both for reasons of the product friendliness of doing it, of the accessibility of doing it, and also--and this comes back to the typical crop insurance issue--the pricing of it, that, frankly, there would be a crop insurance subsidy on the premium. The premium would be bought down here.


MR. OMAN: Yes. Mr. Olsson, would you like to respond to some of the comments of Paul's and what his opinion was?

MR. OLSSON: Yes, if I could use the--if I could have five minutes and use the sheets, I'd just run through them. I've never seen those before, and I've never seen such detailed comments before, and I really would appreciate the opportunity to do that.

COMMISSIONER SPEARS: Well, could you just do it in a couple of minutes?

MR. OLSSON: Yes. We'll do it very quickly. Let's start with number one. Yes, let's start with the definitions.

COMMISSIONER SPEARS: We have about three minutes, Phil.

MR. OLSSON: I understand, but I mean, in all fairness, we really appreciate being invited here. We were also invited to a program to provide information that did not suggest that--I haven't seen any other presentation followed by the views of the commission staff in this detail.


MR. OLSSON: So if I can take a few minutes.

COMMISSIONER SPEARS: That's more than fair.

MR. OLSSON: First, in looking at this put option contract definition, I guess I would just come back that I have only looked at the statutory definition in the law. I don't know. You know, this is a CFTC definition. So it must be authoritative. Having come from Massachusetts where I raised cranberries, I'm partial to the Massachusetts definition, but I'm not sure I would have used it when I litigated on behalf of cattlemen in Texas. But I think we can find definitions anywhere, so I'm not sure that these definitions are dispositive.

Let's go on to the next one, Don. I think that options, yes, do protect against and transfer price risk. We think that insurance can insure against price risk. We think that the definition of insurance is more that it addresses a preexisting risk, and we think that's particularly important.

The other characteristics of the instruments that have been pointed here are exceptions, and we'd get into details, and we'd run over our time limits, but I think that--I mean, there are important things here. If we want to get livestock insurance out there, we need to have insurance agencies selling it. But let's go ahead. Legal confusion over the definition of insurance contracts. I'm glad that Walt is still here because, frankly, this program can't go forward until there is crop insurance legislation, and that legislation has to not only address the fact that livestock protection is authorized under the law, but it also has to address what can be used to secure that protection, and it should address the single regulatory level. If the single regulatory level is all at the CFTC, that's fine. That's fine, but it just--it should be a clear regulatory jurisdiction.

So we agree on points one and three. As to three and four, introducing different regulatory schemes for similar instruments and marketplace confusion, my understanding is the agricultural trade options have not sufficiently saturated the market at this point that they would create any confusion with the livestock insurance product; and as to the management of hedging, I believe that I pointed out that we would prefer--that is something that should be regulated by the CFTC.

And the final point, legal risk, we agree with. Without legislative clarification, there may be a risk of armageddon, because there's nothing worse than private litigation, and I say that even as a lawyer. I agree with it.

So I think that in many ways we are not as far apart. It's a matter of definition. I would hope that what we've tried to address in our proposal is the functional aspects of how this risk protection can be provided, and I would hope that we could do it all together, and I actually appreciate these comments, because they stimulate us. We've got to think what we don't think out ahead will mess up afterwards.

So I thank you, Paul, and I thank you, Commissioner.

COMMISSIONER SPEARS: Thank you, Phil. And now Peter, do you want to add anything to Phil's comments?


COMMISSIONER SPEARS: Okay. Certainly, this is intended to help stimulate discussion, like you said, Phil, and that we can go down the future addressing some of these issues with you as you develop your proposal and look forward to working with you in that regard.

Are there any other questions from the committee members for Phil regarding the proposal? Susan.

MS. KEITH: I have just one, and it seems to me that the real crux of it is the subsidy, and it seems that is if there were another way to capture the subsidy, you could get merchants out there selling this product whether you call them ATOMs and do it within the structure of the ag trade options or you do it as an insurance product, which I think does have some regulatory problems; and I think if you would look creatively at how you might look at a subsidy, there might be a lot of ways to do it and I'll even suggest one, that if we approach the tax code and look at it instead of simply a deduction but as a tax credit for a portion of the cost of an ag trade option, the premium for an ag trade option might be one way to capture the subsidy without trying to craft a purely priced product to fit within the structure of crop losses which are weather related.

MR. ARCHITZEL: I think there is another possibility of having the subsidy, and that would be something like the Dairy Options Pilot Program which is a direct subsidy for purchase of the options, and that's another model that could be used.

COMMISSIONER SPEARS: Phil, do you want to respond to Susan?

MR. OLSSON: Yes. I would simply say that there are a lot of people who are brighter than I am who are working on trying to make ag trade options work, and I wish them well on that, and we have benefitted from the dairy option model, and looking at that, we've come up with a model that may not be perfect. It may never fly, but it interrelates, and it would involve products under the jurisdiction of this commission, and we just--we're probably--our thinking is probably now in a channel where I'm not sure we can back up and get on that ag trade option creativity team, but I respect that there are a lot of good people doing it.

I would like to say, Commissioner, that I really appreciate that the commission has been very open to us, and we've had several meetings with you, and we've had the good insights of the commission and the good insights of the staff, and if I appeared slightly surprised that there was an added world champion on the program this afternoon, this is dwarfed by my appreciation for the opportunity to be here today.

COMMISSIONER SPEARS: We certainly appreciate you being here, Phil, and look forward to working with you. Your comment regarding the utilization and saturation of the ag trade option program point is well taken about the use of that program, which brings us to our next topic of discussion.


COMMISSIONER SPEARS: As I mentioned, our last agenda item is a panel discussion concerning the commission's ag trade option pilot program. As you already know, the pilot program has not been a stunning success. Regulations have widely been criticized. Not even a single firm, as has been mentioned, has been developed and registered as an ATOM. However, I have spent a considerable amount of time discussing this program with my fellow commissioners and Chairperson Born. I believe all commissioners are willing to address changes or consider changes to bring this program to life.

To that end, we are anxious to hear views on problems with the current rules and changes that could make the pilot program more effective and more user friendly. That task is exactly what this committee is all about and what this committee was designed to do. We are looking forward to an open dialogue this afternoon to discuss the pilot program.

I'm going to start off by asking Paul to briefly summarize the history of the pilot program. Then I've asked Kendell Keith of the National Grain and Feed Association, who has been on this committee since its inception. Most of you know Kendell as a leading voice in urging reform on the ATO program.

Following Kendell, I've asked Scott Stewart, who is representing the International Introducing Brokers Association, to present his organization's views regarding ATOs and the appropriate regulatory role of CFTC. Following their presentations I would like to have the opportunity to identify several of the key issues and get an open dialogue with the committee members regarding those issues.

With that, I'd like to have Paul first take a couple minutes to summarize where we are, where we've been. Paul.

MR. ARCHITZEL: Thank you, Commissioner Spears and members of the Advisory Committee. I think this is the first time I've ever been asked to go before Kendell, so I'll enjoy it.

Anyway, agricultural trade options, as you probably already know, are off-exchange options which are offered by a person having a reasonable basis to believe that the option is being offered to a commercial entity, where the option is entered into for purposes related to its business as such.

Until the Commission's interim final rules establishing a pilot program became effective on June 16, 1998, trade options on the agricultural commodities listed in the Commodity Exchange Act were prohibited. The Commission has been working on this issue for quite some time. It has given a great deal of attention and thought to the issue, and there has been an unprecedented level of public participation in the process. There has been a range of opinion from interested members of the public at each step of the way.

Just let me review for a minute. For example, 82 commenters responded to the commission's advance notice of proposed rule making. Opinion was split evenly between those who opposed the prohibition--ending the prohibition on agricultural trade options and those who favored ending it. In the fall of 1997, the commission published proposed rules to establish a pilot program to permit the offer and sale of agricultural trade options subject to regulations. Over 400 people commented. Commenters remained divided, some opposing lifting the prohibition altogether and others expressing a range of support of each of the various proposed rules.

The commission adopted final rules last April, making a number of modifications in the rules in response to comments. The commission, in adopting the interim final rules, noted that this was a pilot program and that the commission would consider rule amendments during the existence of the pilot program.

The commission has indicated that it remains open to consideration of suggested changes that represent an industry consensus on rule changes that are advisable. To assist in the discussion of what changes should be made to the rules and in helping the development of such a consensus, we've listed possible changes to the rules that various persons or entities have suggested over the previous months and have highlighted the issues that they raise in order better to focus and guide the discussion which will follow the presentations.

COMMISSIONER SPEARS: Kendell, will you go ahead and make your presentation, please?

MR. KEITH: Sure. I appreciate the opportunity, once again, to talk about the agricultural trade options. It's been a three-year project thus far, and we hope it reaches closure soon. I've used a handout here, a four page, that I had intended to do as overheads, but in the interest of time, I'm just going to speak from here. I'm going to get this done in five minutes so we can have a dialogue.

On page 1, I think the main point about ag trade options, people wonder what are we talking about. We're really talking about a more flexible contract. We're talking about a contract where delivery is optional.

MS. BORN: Could I just interrupt? I'm not sure that I know which document you're talking to.

MR. KEITH: I'm sorry. It's a four-page one that just came around.

MS. BORN: Are there two separate documents, a CFTC document and Kendell's document?

MR. KEITH: It's four pages.

MS. BORN: And what does the first line say?

MR. KEITH: It says "agricultural trade options".

MS. BORN: No, under that.

MR. KEITH: "Provides for more flexible cash contracts."

MS. BORN: Okay. I've got the right one. Thank you very much.

MR. KEITH: Okay. Yes. In essence, it means that delivery is optional. There are a lot of different ways that that flexibility can be used in cash contracts today and in important ways. First, the most obvious one is the forward fixed price contract with a walk-away provision. We think it's important from the standpoint that farmers are reluctant to book grain before they produce it, and they need to start earlier in the market year to market grain. Especially grain contracts with a walk-away option may be even more important for the future because there's more basis risk involved in those types of contracts, inherent because you lay the risk off in the futures exchange as a cash commodity buyer. You have more basis risk to manage.

Let me ask you to skip to that point, a contract that offers an average price over a preestablished time frame. These types of products are being offered today as insurance products, and there's no reason why it shouldn't be offered, in our view, as an agricultural trade option.

The fifth point down there, and then I'm going to go on to the next slide, what we call a commercial basis option contract. This is a situation where an elevator might sell forward a quantity of grain or oil seeds to a processor and be more willing to do it in a further advanced format if he knew that he could cover himself. In some cases today you don't know if you're going to get rail freight. You don't know if you're going to get the grain delivered on time because of the weather considerations, and to have an option, are they willing to forward contract more grain hopefully at better prices. Just a few examples of the way trade options could be used.

The second sheet in this series, the business environment for agricultural trade options, I've taken some of this data from a recent GAO study that came out just a few days ago actually. The estimated number of commercial farmers with cash sales above $100,000, roughly 300,000 to 500,000 today. The GAO study said that 77 percent of these people that are using--that are receiving transition payments are using crop insurance. Seventy-two percent are using forward contracts, and forty-two percent are using hedging. If you go up to the $500,000 in sales, which a lot of commercial producers are getting to quickly today, 82 percent are using cash forwards and 58 percent are using hedging. I would suggest to you that the sophistication of the farmer today is growing rapidly and their marketing savvy is growing, and the time has come to consider other alternatives.

The third point on this slide, the ATO options, we would expect mostly cash commodity buyers to be the early ATO offerers. It's just an assumption on our part. We can't be certain, but we see it as an adjunct to the cash contracting business today.

The last point on this slide is that as an adjunct to cash contracts, if farmers purchase agricultural trade options, they are net risk reducing compared to the current environment today. I would challenge anyone here at the table to show me how they expand the risk to the farm compared to the current environment of cash contracting. We don't think they do.

The third slide, ATOs, why they're needed, the second point--I'm just going to skip to the ones I think are most important. The second point there is to address the key issue impeding advanced marketing by farmers. They don't sell grain before it's produced. Okay? We think that's a critical issue to deal with. In some cases, you can deal partially with that with crop insurance. You can do it partially with selling on the board through options, but you can't cover your basis risk that way. You can't cover all your production risk that way. And so it's an important part of the mix. The third point is that we think that ATOs can serve the need for more complete risk management tools out there today. We see ATO being able to wrap production risk management tools with futures risk management tools, basis risk management, as well as logistical risk. We don't see any of the product that's out there today covering all of those risks that the farmer faces. The last sheet on the handout talks about what regulatory changes we think are needed to make an agricultural trade option program work, and just to set the stage, we observed non-agricultural options are unregulated today, and that there is a $1 million exemption on net worth or people engaged in swaps transactions outside the agricultural arena.

We would recommend we have cash settlement. We recommend an exemption at the $1 million level for writers, the same as for swaps. We would ask that ATO writers notify CFTC if they intend to write trade options. Currently, it's written that they register with NFA, and we've got a number of problems with that I can go into if you like.

We believe that risk disclosure should be required on ATO contracts. We think that ATO contracts should be treated mostly like commercial contracts, which we think they are. We should allow the industry to adopt voluntary guidelines and permit the ATO contracting parties to agree to use courts or arbitrations, a forum of their choice to resolve disputes, just like we have in cash contracts today.

We would recommend that we rely on existing state regulations of warehouses, other regulation of commodity buyers, to handle most of the regulatory burden, and we would urge that we get involved seriously in a voluntary education program for both writers and purchasers.

Lastly, but not least, let's keep in mind that this is a pilot program. Let's get something going if we can, because otherwise it won't be any kind of a program; but as a pilot the commission always reserves the right to kill the program if it doesn't work or if it gets out of control in the commission's judgment.

So with that said, I'll close.

COMMISSIONER SPEARS: Kendell, thank you for your brevity, and I know you'll have some points you'll want to make during the open dialogue, and I look forward to all the committee members having an opportunity to address some of these key issues.

Scott, do you want to go ahead with your presentation, please?

MR. STEWART: Thank you very much.

My name is Scott Stewart. I'm here to represent the National Introducing Brokers Association. It's an association of introducing brokers that are primarily scattered across the midwestern United States. Most of them work with farmers and help them with their marketing. I am personally an introducing broker and have been in the futures industry for about 20 years now.

Our business primarily works with farmers. We're also a publisher of farm market advisory information. We also publish the Ag Ed Network which is an educational product that goes to about 2,000 high schools across the country.

We're obviously here today to talk about trade options, and to be honest with you, I'll probably be the most outspoken person here today. So be forewarned.

We're here to talk about trade options because trade options aren't being used. To a great degree, the pilot program has been unsuccessful because not one merchant has signed up to use it, and the goal, obviously, of many in this room is to try to figure out what can be done to fix that and get trade options used.

My opinion is that trade options are not being used due to regulation, and they won't be used as long as there's any regulations involved. The grain trade does not want to be regulated. They do not want trade options to be regulated in any way, shape, or form. They do not want to let the CFTC or the NFA into their facilities to oversee what they're doing.

The problem is that trade options are going to ultimately, I believe in the long run, and NIBA believes, and I think a lot of people in this room will agree, can lead to great massive amounts of concentration in the grain industry. Large grain companies are the primary force behind the push to get grain trade options approved. There's just a few large firms that are behind this.

Many of the individual elevators out there are afraid of trade options and they do not want them. Several of the large grain companies have stated goals to get to the point where they have a large enough percentage of business and types of business and a variety of business that they do not have to use exchange traded products, that they can just basically match up all the orders in house and not have to go to a regulated exchange to trade. And so part of their goal in using trade options and pushing for approval of trade options is to get more tools in place where they have more grain originated and they have more power over that grain to use that to control the markets and ultimately to increase their market share. With trade options, they'll basically gain this type of control, very much like for those of you that are in the livestock industry.

We see in the cattle markets now where the packers are able to basically pull ahead contract cattle when they want them. When they don't want them, they back away. The cash bids fall apart for a few days. Then they step back up and bid again down the road. So ultimately what will happen is the grain trade begins to get more and more power through the use of tying up more and more of this grain. They'll be in a position to widen out basis levels, put out less competitive bids, and ultimately farmers are going to be the loser in the end.

Small private elevators will not be able to compete and ultimately are going to either fail or close. Many small private elevators, basically as you know, as many of you in here are producers, are managed by one professional, and they have a lot of inexperienced unprofessional staff. That elevator is ill-equipped to try to provide these kinds of tools. They don't have the recordkeeping. They don't have the tracking of the risk management or any of the software necessary to provide this type of tool. For them to be able to provide it, they're going to either be forced to sell out to a bigger elevator chain or to contract with that chain in some way, shape, or form to put the tools in place to manage this type of tool.

When you think about the futures industry as it is today, the futures commission merchants have massive amounts of computer power and staff to match up trades on a daily basis, and all they're doing is matching up a simple buy order with a simple sell order on Dec corn or a buy of a Dec corn put against a similar position, and it takes a massive amount of effort to reconcile all those positions at the end of every day.

The grain trade and the local elevator is going to be put in the same position to try to do that with not only the futures and the options transactions but all of the variety of cash transactions that can also be dreamed up. It can be a task that ultimately breaks the small elevator's back, and I personally believe that National Grain and Feed's position--and not to directly attack you, but I believe that they're one of the biggest promoters of this and have been from the start--is to--it really represents the large elevators.

During the--before the pilot program was proposed, many, many small elevators that we deal with and their customers told us directly that they did not want this, they didn't understand it, they were afraid of it, and they didn't want to have to provide these tools. They were already originating the local grain in their area. They had a good relationship with the farmers, and they didn't want to have to take on this added responsibility. They weren't in a position to do so.

The public interest ultimately won't be served by trade options. Testing and audits are necessary to protect the public. And I know that we're sitting here talking about what can we do to make the trade option pilot program work. The only thing you can do to get people to use them is deregulate them. When you deregulate them, you're opening up the door for all sorts of problems. Oversight is necessary to maintain the integrity of the marketplace.

HTAs are a good example of what can happen without oversight. Farmers were misled. They failed. Elevators mismanaged the risk and failed. The bank of co-ops lost millions and millions of dollars on it. There are lawsuits. There were suicides and billions of dollars were lost and some in the grain trade say that a lot of learned by that example, and I hope that it was, but without regulation and oversight to ensure that that example isn't repeated again, trade options can be a disaster in a less regulated marketplace.

The lack of price discovery in transparency is another concern. These options, if you read the CFTC's own brochure talk about them being off-exchange traded products. In the end, if they become heavily used and heavily traded off exchange, where does the farmer find out what a fair price is? Where does the rest of the world come for a central market price? We need to have exchange traded products to maintain the price discovery and transparency.

Another concern that I know the regulation has tried to address, but I see that there are some very big holes, and in the process of trying to open this up for even more freedom for use, you're probably going to open those holes up even bigger. The CFTC and the NFA have spent decades trying ultimately to get the bad guys out of the futures industry. They're oftentimes characterized by the south Florida firms.

With trade options, there is the very great potential that these options could ultimately be used by those type of operators to skirt and avoid being registered with the NFA. I know that the proposal states that they need to ultimately result with the intention of delivery and all these other things, but as Kendell Keith has pointed out, one of the greatest opportunities and benefits of the trade option scheme is to allow people to walk away. Well, when you allow people the walk away, then all of a sudden then the guy in south Florida can trade these things and never have the CFTC show up on his doorstep again. I have one very high ranking exchange official that pointed out that possibly the specialist firms and the exchanges could do the same. That's scary.

Personally, from my standpoint, I'm registered as IB. The NFA comes and audits me every three years. They look at every order ticket for time stamps and a million other things. We're scared to death that we're going to get in trouble, and we do everything we can to have a clean audit. If the trade options are put through in the form that they're being proposed, I foresee the potential where I can just write out a check for 50 grand, throw it in the bank and potentially never have to be registered again with the CFTC. All I have to do is send them a polite letter.

So I know that that is a concern, is not the intent of the CFTC regulation, but I believe that it can be gotten around. We could probably argue that point for weeks. So it's possibly best if I move on.

The goal with trade options and many of the farmer-producer groups are promoting this, one of the goals of trade options is ultimately to try to provide farmers with more tools. Then the question is do they really need more tools. So I believe the Board of Trade, the Merc options that are currently available, and the forward contracting alternatives that are currently available through elevators and the insurance alternatives provide the tool that is are necessary. We don't need to open up ourselves to this mass deregulated environment in the goal to give people more tools.

Producers have not used the tools that are available because they haven't had to. They have depended on the farm program and the government for their payments. They have not had a motivation to learn how to use marketing tools. Just within the last year have we started to see a change in that. Bill Biederman's presentation earlier with their ARM program, a large number of the people signing up in that program have never used futures or options before and had an account. We have a similar type of program where we're promoting the use of forward contracts, buying puts and buying calls, for kind of a total risk management package that could be combined with crop insurance, and we're finding a great many of the people signing up for that program are also producers that have never used futures or options before. They're really coming into their own now.

I think that by providing even more tools with possibly a million different names at an elevator is just going the confuse them further, and you have to worry about who at that elevator is going to be selling these products. If that person isn't licensed, doesn't have to take a Series 3 exam, doesn't have to learn that they need to provide a balanced risk disclosure, if they aren't auditing to be sure that the promotional material is balanced and everything that the typical participant in the futures industry is required to do, there is no guarantee any of it is going to get done. You can say you should do it. You can say we want to do it, but if you force them and if you don't audit, they won't do it. It will just slip away, and it will ultimately be totally deregulated.

Many say the market will ultimately take care of itself. The bottom line is private business is greedy and private businesses are poor risk managers. HDAs are a good example of that. The Savings & Loan Crisis is a good example of that, the problems at Drexel Burnham and most recently long-term capital. Long-term capital had Nobel prize winning economists managing their risk, and they still collapsed practically.

So I don't think we can take the grain terrain's word that it will all take care of itself. Past history has proven it doesn't. Ultimately what happens in the regulatory environment, we go through a cycle where there is fraud. We move towards regulation. Then there's too much regulation. We ultimately fight and go towards getting deregulation, which we're obviously here today for. Fraud comes back in, and then we're back at needing regulation, and Congress steps back in. It's a vicious cycle.

HTAs were very, very costly. Trade options will likely be even more costly. Concentration in the grain industry is going to happen no matter what, but HTAs are very likely just going to accelerate that, and what we might be able to delay for 10 or 20 or 30 years would happen in a matter of a few years if we give them the power to be able to do this.

Ultimately what the grain trade is looking for in pushing for trade options is they're looking for the ability to trade futures and options in an unregulated environment, in and out any time, anywhere they want to with no oversight and no regulation. Now, if that has worked, then why did we ever make the rules in the first place for the futures industry? It hasn't worked. I won't work, and we shouldn't change the rules on trade options to allow it to take place.

Thank you very much.

COMMISSIONER SPEARS: Thank you, Scott. Certainly those were outspoken--

MR. STEWART: I have never been shy.


comments, and certainly I know that you represent a viewpoint, and you did it very well.

As the committee knows, the commission is trying to review potential changes to the pilot program that would make it more user friendly and more available, yet keep in a proper balance of regulation and safeguards to protect the end user, the public.

And so what I'd like to do at this point in time is to have Paul talk about and identify some of the key issues. We also received late yesterday, and I apologize for not putting it in your packets, a letter from a number of the producer groups.

What we've done as a commission is ask the industry -- the grain industry, the producer groups -- to come to us with some type of consensus proposal. We've met with various participants and individuals, and I know that number of the groups have signed a letter. They're represented in this room today.

We've had discussions with those producers group, with Kendell and the National Grain and Feed Association and we are trying to come to terms as to what might be a reasonable set of regulations for the pilot program so that the program will be used.

In that regard, I'd like to recognize Jim Miller for a minute. Jim can explain and make you aware of this letter my staff is passing around. Then what I want to do is get in an open dialogue about the four or five key issues that Kendell has identified in his presentation and that I believe have also been identified to a certain degree in the producers' letter. We can talk about those issues as we go forward.

So Jim.

MR. MILLER: Thank you, Commissioner Spears, and I'm not going to go through and read the letter that a number of groups have signed, but I would like to comment that, because we were trying to get this letter to the commission in advance of this meeting, we weren't able to get clearance from a number of other groups that have now indicated that they're joining with the signatories to the letter that you have. Those groups include the American Farm Bureau Federal, the National Association of Wheat Growers, and the National Grain Sorghum Producers.

I think we're getting ready to be involved in what's likely to be a very interesting debate that many around this table probably would view as to extremes. I would suggest that we're suggesting a middle ground as a way to advance the ag trade options pilot program, get something that is workable so that we can test it in the marketplace to see whether it is, in fact, something that producers can use to their advantage, something that enhances market opportunities for producers as well as for the merchandising sector.

I should also note that we've been involved with this process with ag trade options for what seems like decades, even though it's only been I guess a couple of years according to Paul, and many of the groups came at this from significantly different perspectives; and over the last several months, working closely together, we have reached some agreement on the items that are identified in the letter as a way to continue to have an adequate level of regulation within the ag trade options market to provide protection for the farmers and to provide CFTC the ability to gather data to truly test the pilot program while at the same time hopefully creating some new tools as risk management opportunities for producers.

And with that, Dave, thank you very much.

COMMISSIONER SPEARS: With that, I'll turn it over to Paul and Paul, I think you can kind of identify four or five of the key issues, using overheads, and then as we talk about each issue, Paul lays out what the issue is, we can then entertain a dialogue about that particular issue.

MR. ARCHITZEL: Thank you. I don't know that we've identified all of the issues, but it seems to me that we identified the key ones that we've heard from various sources.

The first one is should registration be required of ATOMs and of the sales forces. Under the pilot program rule that currently is in effect, registration is more streamlined than for other types of futures registrants. For example, there are no fingerprints required, no proficiency test is required.

A possible alternative that's been suggested is that rather than have registration, there would be some type of notification to the commission of the individual doing this type of business. The issues that it raises, the regulatory issues, is that registration status carries with it certain features. These are: number one, the statutory right to use CFTC reparation proceedings by the customer; number two, there are existing CFTC rules for approving, disapproving, and barring registration; and three, it provides for a minimum level of probity and competence of the registrants. If we were to move from a registration regime to some other type of regime, those issues would need to be considered.

COMMISSIONER SPEARS: Kendell, is there any discussion or comments regarding the registration issue from members of the committee? Kendell, did you have something that you wanted to--

MR. KEITH: Well, I think our key issue is how registration is linked to reparations in the CFTC governing statute today. If there were some way to de-link that such that firms can at least manage their exposure to litigation risk, is the issue from our standpoint.


MR. STEWART: I think ultimately the registration issue is very, very important because the CFTC needs to know who is using these, how they're using them, and that's the real link to oversight. Ultimately, I think the grain trade wants to have a minimum of regulation, and by minimizing the registration, that's the first step towards it.

Plus, they want to--basically they don't want any connection to the CFTC's oversight, and by being registered, ultimately, you know, they do fall underneath the rules of the CFTC then, and they'll try to do everything they can to basically get this and on their own terms. So I think it's very important that we maintain a high level of regulation.

MR. KEITH: I just want to comment that I don't think it's fair to say that we're asking for no regulation. I think it's pretty clear in black and white in the papers that we presented that that's not what we're asking for.

COMMISSIONER SPEARS: Does any of the producer groups have any thoughts on this particular issue?

MR. MILLER: The current rules, we think, do prohibit merchants from registering, and we believe that there is a way to create a simplified process that still allows CFTC to have an adequate level of oversight without requiring that the merchants register through the NFA, and that would be some simplified procedure registering directly with the CFTC, create that kind of data base. It would be more than a simply notification but less than the requirement that is are in place today.

MR. ARCHITZEL: Actually, I think that gets to our second issue, which is separate from whether or not registration be required, and that would be who should conduct the registration process.

Currently our rules provide that the NFA processes registration applications. The issues for us and for the public is that there is an administrative efficiency that results in having NFA administer all of the registration procedures for all commission registrants. There is a cost to the CFTC of direct administration, obviously; and the final point would be what benefit is there from having CFTC rather than the NFA process the applications? These are the issues that we think need to be considered in determining whether or not the process should be directly with the CFTC rather than with NFA processing the applications.


MR. DODDS: I would just comment that's just based on what the registration requirements might be. It might be relatively inexpensive or it might be very expensive depending on the test you have to pass.


MR. ACKERMAN: This is for Jim Miller. The simplified form version that you just mentioned, is that something that could be equally handled by NFA or CFTC?

MR. MILLER: Possibly it could, but again, when you look at NFA as registering commercial merchants, we view ATOMs as somewhat different than that and the cost of registering with the NFA, as I understand it, can be rather significant. Again, if we're going to reduce the registration requirements while maintaining that system, it appears that it's something that could be handled by CFTC, but if not, then there should be an expedited procedure going through NFA that reduces those requirements in a similar fashion and hopefully at a reduced cost.


MR. WHITE: How does the CFTC feel about not having registration of this option at hand?

MR. ARCHITZEL: I think at this point the commission has put forward what it views as a sensible regulatory scheme and is looking for consensus by the industry on what changes make sense and are appropriate and would then consider them.

In the case of registration, for example, reparation proceedings are part and parcel of the registration status. That's a right that goes to the customer dealing with the ATOM. If that's not important to producers to have that ability to use the commission's reparations procedures, then I suppose it becomes less important that there be registration.

The other parts of the registration benefits, minimal level of probity and competence of registrants and using our existing rules, if we use our existing rules, that's an administrative ease for us. We don't have to write another rule book on how to process notifications. We know--we have rules existing for how to process registrations and how we go about denying registration. So that's a question of administrative ease, and from the staff level, it's always better to use existing rules rather than have to write new rules; and from the point of view of assuring probity and competence of registrants, the staff felt that that was a responsible regulatory approach.

If the industry agrees that it's not necessary to have that assurance, then that's something I guess the commission would consider, whether or not on weighing the cost and the benefits of its regulations if that's something that it should do away with. From a staff perspective, I think it's an important safeguard for public.

MS. KEITH: How is a trade option, though, different than when you have a commercial interest by both parties? Doesn't that really set up a different kind of relationship that has different requirements and should have different requirements in that regard?

MR. ARCHITZEL: Yes, I think it does, and I think the staff tried very diligently to address those in the regulations we have now. For example, between the proposed rule and the final rule, the commission determined not to require fingerprinting on the premise that, because of the commercial relationship, there would be some preexisting knowledge of the parties for each other.

So going through the process, the commission pared down the registration requirement from what's required of other futures professionals to what would be required of ATOMs. So we did try to take into account that type of relationship.

MS. KEITH: But what would be the--Scott said earlier that there were no use of trade options. I believe that's incorrect. I believe that there's no use of agricultural trade options. And could you just briefly discuss how the agricultural trade options are being considered by the commission compared to trade options for other futures products?

MR. ARCHITZEL: Well, I think one of the differences is that because of the statute, agricultural trade options --off-exchange options in those listed agricultural commodities -- were prohibited for an extended period of time, and options on other types of commodities or even other types of agricultural commodities that aren't the ones that are listed in the act, were permitted. So that you have the reintroduction, if you will, of new types of instruments, possibly, where there's been a complete cessation of any type of experience.

So that's a major difference from non-agricultural commodities where there always have been the potential for having off-exchange options, and there's some experience with it among commercials.

The other question that needs to be grappled with and analyzed, and the staff did this in its white paper three years ago now, that there may be somewhat of a difference in the level of the types of trade options that are offered in other commodities from the types of market audience that you may be looking at with agricultural trade options.

COMMISSIONER SPEARS: I'm sorry. Gary had a question.

MR. HELLERICH: Yes, David. I would like to comment, particularly from the standpoint of an individual producer. I know the Soybean Association is one of the signing groups of this letter, but from the standpoint on an individual producer, I would prefer to see the oversight being carried out by the CFTC, but basically keep it simple, keep the oversight responsibilities and requirements and so forth as simple as you possibly can and it will be accepted out in the country.

MR. ARCHITZEL: I think the next issue that we've identified as being one that people were giving a lot of thought to is issue number three, and that is should physical delivery be required. The current rule is that if exercised, options must be physically delivered, although early option termination is permitted if by doing so you roll into a forward contract.

The possible alternative which has been discussed is permitting cash settlement as a means of, one, either final contract settlement or, two, for early termination, and we think we ought to think about those separately because they involve separate issues. The potential benefit for cash settlement in the final settlement only would be that it would permit greater flexibility, and it would permit producers to deliver from one location to another. So there would be some greater flexibility involved.

The second point would be permitting early termination, and that potentially provides a means to recoup the time value on the option when delivery is not going to occur. An example where that would happen would be if you purchase an option and then the crop is destroyed. There's some time value left on the option, and you're going to walk away from the option anyway, you're going to let it expire, but you'd like to recoup some of the time value of the option.

In this case, a cash settlement using an early termination, would allow you to recoup some of that time value. The risk in cash settlement is that it increases the potential use of the options for speculation or at least introduces its potential for speculative use. Tying the options to a physical delivery quite clearly tied the flexibility of the option and make it much more useful as a hedging vehicle.

COMMISSIONER SPEARS: Any thoughts on the physically issue and cash settlement? Ken?

MR. ACKERMAN: Just as a general--this is a question for Kendell Keith. On your paper, you list on the first page the examples of where you would want to see more flexible cash contracts. There are four of them: forward price, fixed price, walk-away options--specialty grain walk-away option-- and then the bottom two on the page, flexible delivery contracts, cancel wheat to go to feed market and then switching commodities.

Am I wrong or basically do going forward with those four items require a change on this point? In other words, is the current requirement for physical delivery, is that, in fact, the bar from going ahead with those four items, the first two on the list and the bottom two on the list?

MR. KEITH: I think it's the bar for all of them, I believe.

MR. ACKERMAN: For all of them?

MR. KEITH: I believe, yes. Yes. For revenue contracts, and we think the CRC is a fine product from a crop insurance standpoint, but one restriction is that you've got to buy it before March 15th, and the marketplace could offer a trade option that would be offered later than that, similar to the CRC product, probably not priced quite as well today, but in any event, it would give the farmer an option after March 15th, and it would be cash settled, assuming it's a revenue contract, not necessarily requiring delivery.

COMMISSIONER SPEARS: I'll come to you in a minute, Scott, by Jim asked to be recognized.

MR. MILLER: On the cash settlement issue, a number of the groups that signed this letter provided a rather lengthy explanation of what we viewed as the needs for a cash settlement provision at the time the interim final rules are being considered, and I think those conditions still exist today; but in addition, as we look forward to what would evolve out of ag trade options, probably after the pilot program period and looking at a way to increase the number of participants in an ag trade options market, we likely would need some form of cash settlement if we wanted to bring other parties that do, in fact, have a commercial interest in agricultural but do not have the ability to produce, deliver, or accept delivery of a commodity, looking at things such as financial institutions; and in those cases obviously some sort of cash settlement provision is going to be necessary.

However, in the interim, recognizing that this is a pilot program, we still believe that cash settlement is advisable because of some rather unique situations that occur in agriculture that don't occur in other commodities that may have trade options in existence already, and we would even be willing to accept some limitations on the use of cash settlement. We certainly do not want to use agricultural trade options as a way to get producers in the position where they're speculating.

COMMISSIONER SPEARS: Thank you, Jim. Scott, do you have a comment?

MR. STEWART: Yes, just briefly, and I may be actually arguing for the other side on this point, but I'm not sure if cash settlement is going to make--or I mean requiring delivery will make a lot of difference one way or another because the producer can basically convert his trade option into a forward contract and then instantaneously buy his way out of the forward contract the way that many producers did in the pilot options programs in the grains.

So ultimately, even if you did require some form of a forward contract as a substitute to get out of the trade option, they can get in and out of these things instantaneously no matter how you write the rules. So I'm not sure if it matters which way you write it.


MR. OMAN: The only comment I'll have as a producer on this, if I was going to use them, even in the pilot program, the way things change every day as a producer, we never know, I would definitely want to cash buy out. I think you've got to be able to settle with cash because you don't know. What I do on May 1st may be entirely different by July 1st, and my whole operation could change, and for a risk management on behalf of producer, you're going to have to have it, I think.


MR. OLSON: I'll add a statement too just from the milling side. We buy a lot of grain from milling, and you contract a certain quality, and exactly what Stephen was talking about, if the farmer doesn't raise that quality, we reject it and he can't deliver it. We don't want it. We don't want any of his grain. So with other trade options you've got a common product that's homogeneous and there's no quality deterioration.

So when you throw the quality factor on grain on top of it, you'll get the cash settlements. I think it's exactly like Scott said. The industry will figure out how to get out of them. So you might as well just allow it, because it just makes it more convenient and simple because it occurs all the time anyway.

COMMISSIONER SPEARS: Chuck, you asked to be recognized.

MR. NELSON: Yes. Speaking on behalf of the National Grain Trade Council, here's what we would say: "The exercise of the agricultural trade option should not require delivery. Even though it is likely that making physical delivery or allowing the option to expire will happen in the vast majority of options traded, there are some instances that will arise where both the buyer and seller would benefit by a negotiated or cash settlement to the option. Two reasons for permitting such steps are changing consumption patterns and arbitrage."

COMMISSIONER SPEARS: Other points or questions on this particular issue?

[No response]

COMMISSIONER SPEARS: If not, then we'll go ahead and have Paul go to the next one.

MR. ARCHITZEL: The next one is should producers be able to write calls. Currently under the pilot program rule there is no call writing by producers permitted unless it's part of a fence or a window option.

Possible alternatives which have been mentioned in the last few months have been to permit producers to write covered calls. The issues that this raises is that the writer of a covered call receives the premium income but assumes greater, unlimited risk on the option. The purchaser, the ATOM faces increased default or credit risk if the producer has not truly covered the call and prices go higher.

Therefore it becomes a monitoring problem by the ATOM to see whether or not that option actually is covered, and that monitoring problem may become more acute if cash settlement is permitted, and then it becomes a question of monitoring financial ability to perform as to simply ability for the cover to be in the form of delivering on the option if it's called for.

COMMISSIONER SPEARS: Thoughts or comments or questions on this particular issue? This gets to the heart of the type of strategies that the farmer/producer can comment. Bill?

MR. DODDS: I think I'll ask Kendell a comment maybe from the risk management committee because I know this probably got the most discussion. Intuitively we would say yes, because it fits in with what we call maximum price contracts, but that's just one application. Kendell?

MR. KEITH: Well, there's a contract called a mini-max contract in the market today that allows a minimum price to be set and a maximum price for the farmer that requires delivery. Unless writing the covered calls is allowed, you could not do that in an options-type contract or delivery optional contract, unless I'm mistaken, Paul, and so that would be I guess a limitation. It is the most--is it the worst thing that could happen to keep that from happening? Probably not, but it is a restriction on the program, and probably some producers would take advantage of it if they had it.

MR. ARCHITZEL: Actually the current rules do make an exception for the fenced mini-max-type contract, and those are permitted as long as both sides of the option are even and it's not proportionally greater.

MR. KEITH: It's be so long since I've read those. You're correct, yes.


MR. OMAN: There again, the only comment I'd have as a producer, if I was using them, I would want to be able to write calls against them.

COMMISSIONER SPEARS: Any other comments before we move on to the next point?

[No response]


MR. ARCHITZEL: Okay. We're now at the fifth issue or fifth topic, and that's what should the exemption level be. The exemption level currently establishes $10 million worth of net worth. At that level, if both parties have that level, and they're both commercial, they're exempt from the rules other than from an anti-fraud rule.

A possible alternative which has been suggested is that that be reduced to some other dollar amount. The issue raised is that the pilot program offers a number of important customer and financial protections, protecting both the customer and the seller. The exemption is based upon the idea that some participants may have sufficient net worth to rely solely upon their own advisors.

In essence, the issue is when is that level of resources reached.

COMMISSIONER SPEARS: Thoughts or comments on this particular issue? Jim.

MR. MILLER: Well, we've gone round and round with this exemption issue, and in the end it's still our belief that if we can simplify the other rules and make this program attractive to merchants that maybe there should be no one that's exempt under the pilot program to ensure, first of all, that all trade options merchants are treated equitably, otherwise you're going to have one line where you have a group of merchants who are exempt from regulation and another group of merchants who would be required to comply with regulations, which raises an equity issue that we would prefer to ease the burden of compliance, make sure everyone is potentially able to comply and at the same time ensure that CFTC has the ability to continue to collect data and provide oversight to the program as a way to determine what the future of ag trade options should be down the road.


MR. OMAN: The only comment, again, I guess is as a producer out in the country, as a pilot program, if you want producers to use it, you're going to have to do that because most producers are going to deal with country elevators who are not going be in that position unless you do it.

MR. KEITH: The one argument on having an exemption level in addition to reducing some of the other regulatory burdens of the program is that if the commission really is interested in having a program, you can't really be assured that you're going find the right answer by just tinkering with the other regulations. If you do offer an exemption level that's realistic and some people can't meet, you will know for certain that you will get some participation in the program. Okay?


MR. HELLERICH: Yes, again, from the standpoint of an individual producer, I think that the exemption level has to be equal for everybody across. We can't select and choose who we're going to exempt and who we're not going to exempt. I think equality is very important.

COMMISSIONER SPEARS: If no one else wants to be recognized on this particular point, we'll go forward to the next topic/issue.

MR. ARCHITZEL: This is the last of the topics that I think have raised the most discussion, and that's should there be a different risk disclosure. Currently under the pilot program rules, there are two types of disclosure required. One is a general disclosure which is provided to the customer initially, and the second is a specific risk disclosure which is provided with each transaction.

Some of the information in the specific risk transaction disclosure includes a breakdown of the cost of the option. Possible alternatives that have been mentioned have been to provide more disclosure in the general disclosure which is given to the customer initially and either not provide a specific risk disclosure for each transaction or to provide less information at that time.

The issues that are raised is that by providing more information up front and less with each specific transaction or none with the specific transaction, it would reduce the administrative burden on the ATOM when entering into a series of transactions with an established customer; and on the flip side, it would obviously provide the customer with less specific disclosure about each of his transactions, and those are the competing interests that have to be balanced in changing the regulation as it exists now.

COMMISSIONER SPEARS: Any thoughts or comments on this one? Scott.

MR. STEWART: I think one of the greatest risks that the farm community faces is basically having trade options sold to them by possibly inexperienced unprofessionals or people who are not required to really disclose all of the risks involved. To a great extent, that's what happened in some instances in the hedge-to-arrive situation. The farmers really didn't understand how they would work and what would happen when the market moves. Now, you know, we aren't in a position, and I don't believe the government should protect everybody against every harm out there, but in the futures industry, you know, we're very, very--there are stringent regulations where we have to present a balanced presentation in our sales practices and in our literature, and without oversight and audits and registration and the other things that are required of us in the futures industry, I guess I feel like you're really setting the stage for producers to get involved in things that they don't understand again, and so I think the disclosure part of it is a extremely important, and I don't think so blanket disclosure is going to work.

I think they need to have extensive disclosure of every type of instrument that they're using, how they're using it, why they're using it, and it's got to be required, and there has to be some sort of audit trail or something to ensure that that is being done, otherwise we'll see the same kind of mistakes happen again that we saw with hedge-to-arrive contracts.

MS. KEITH: If I may, I've really got to address this question of hedge-to-arrives. If all the elevators that bought hedge-to-arrive contracts on corn had, instead, offered an ag trade option, it wouldn't have been a problem. They are such incredibly different products, and, in fact, the ag trade option offers the upside potential, and that was the problem with the hedge-to-arrive, is that the producers were not able to capture the rising prices; and so to compare those two, it really is only relevant in terms of the degree of regulation, and I don't think we're talking about going to a regulatory framework.

Producers obviously have to understand what they're purchasing, and that was a big part of the problems with the hedge-to-arrive, is the lack of understanding; but disclosure rules don't ensure understanding, and if a disclosure merely results in additional paperwork that is ignored by the parties, it does no good.

So a keen understanding at the outset of a relationship between the parties is going to be much more useful than a disclosure requirement that results in a piece of paper that is delivered with each transaction which is not read and not understood and barely acknowledged.

MR. OMAN: There again, a comment as a producer, in Ohio, we sign a--once a year we sign a delayed price agreement with the elevators we do business with that way, once a year, and all I'll say is as a producer, I want a disclosure statement, but I only need it once a year unless something changes in that contract. I don't want one every time I do a transaction with an elevator.

MR. WHITE: In comment to hedge-to-arrives and that this is a different contract, had farmers been knowledgeable about hedge-to-arrives, I think that they would have been smart enough to offset that loss. So I would like to say that what he has said is very, very much right, that many farmers do not understand these things, and that could be caught in this the same as they could be caught in hedge-to-arrive. I really believe that.

MS. KEITH: At what risk?

MR. WHITE: At what risk?

MS. KEITH: Yes. If you buy a premium for an option to sell your grain at a price, and that's what you buy, what is the risk to the producer?

MR. WHITE: I'm talking about some of the other things, the opportunity to purchase a call.

MS. KEITH: But if we just talk to the trade option, what risk does the producer have?

MR. WHITE: Well, if the person advising the farmer gets them involved in some of the other issues, then you can be back where you were with HTAs.


MR. STEWART: Just to make one other comment, I guess I want to toot my horn a little bit, because I'm sort of the outspoken person here, and you're probably wondering about my credibility. Over a year in advance to the hedge-to-arrive fiasco, the National Introducing Brokers Association sent a letter to the CFTC to then Chairman Mary Shapiro, and my name was at the bottom of that letter, and we warned the CFTC of what was going to happen with hedge-to-arrive contracts if a bull market developed; and if you go back and you look at that letter line by line, we described every gory detail of what was going to happen.

And I know that I'm the one most outspoken person here, and you're sitting there thinking that maybe I'm a bit of a radical, but the same kinds of things that I'm outlining today that will happen with trade options, we are working with producers on a day-to-day basis. We're working with the futures markets, and we have an ability to foresee the future in a sense of how these things can be worked.

The cause of trade options is a nobel one to give farmers more tools, but sometimes you have to worry about that you may be given what you ask for, and there's some real consequences to that, and that's, I think, something we need to look at very carefully.

For those of you who doubt some of my comments, I encourage you to read in detail my paper that's included in your handouts. It's pretty lengthy. Thank you.


MR. OMAN: A comment, again as a producer on the hedge-to-arrive situation, I happen to come from an area where there was a lot of hedge-to-arrives. The problem was the multi-year hedge-to-arrives. They were--farmers were basically just selling more than they could produce over numerous years, which would have nothing to do with what we're talking about, in my opinion, in these trade options. I mean, it's a different animal, and it was traded different.

I guess I could look at it as basically maybe they were trading in Chicago, like maybe Scott is saying, down there, but they should not be looked upon as what happened here. As a producer, I just disagree with that.


MR. WHITE: I would agree that this minimizes some risk, but at the same time I guess I still give some concern to some things that I see there that would be possibilities. That was my comment, the reason I made that comment.


MR. MILLER: Just speaking personally and not on behalf of any organization, it seems to me that if we can develop the regulations and provide the disclosure that, first of all, I think should discourage producers from speculating, but certainly identify it is difference between getting into a speculative position and being in a hedge position. Then we can truly look at what is the risk associated with an ag trade option and the risks that the producer has, assuming that he's not in a speculative position is the premium.

That's all he's out. If he didn't get into an ag trade option, he's subject to the price risk. So all he's out is the premium. It seems to me that we should have regulations, really, that match the kind of risks that the consumer is going to face, the consumer being the producer in this case; and fine, we need to have some disclosure, but we need to make it practical. We can't protect everyone from everything. Maybe Scott can write the disclosure for us.

MR. OMAN: Just real quick, I, as a producer, would second what he said. He summed it up pretty well for us.


I'm going to ask Paul just to touch briefly--there's a couple more pages on the handout. I'm not going to ask him to go over in detail but just describe to you what it is, and then if you have any comments or thought on that, you can get back to us later on.

MR. ARCHITZEL: I think on the last two pages of the handout we've listed a number of areas that changes have been suggested, and I think those changes raise fewer issues, and those include, for example, providing for oral contracting, and while it's questionable, how much oral contracting you would do if you need to get your premium up front, nevertheless it is consistent with state law that you permit oral contracting with subsequent verification.

Also, reducing reporting by ATOMs to the CFTC, I think that the commission has indicated a willingness to look at that issue and to work on reducing the frequency of the reports there.

Also, permitting oral notification to customers has been raised by some groups as being burdensome on smaller elevators, and certainly that could be worked around as well.

Finally, the segregation requirement currently requires that 100 percent of customer funds be segregated, and that may be able to be adjusted to result in the ability of the ATOM to use customer funds to cover their risk and yet to retain a small fraction of the funds as their commissions without having to set up a separate segregation account. Those all seem to be reasonable adjustments to the staff that we feel could be made, and it seems that those are refinements to the current rule that would reduce the burdens.

COMMISSIONER SPEARS: Chuck and then Kendell.

MR. NELSON: Commissioner, I did address one point for the National Grain Trade Council, but we have a one page summary here of a couple of other points, and maybe I could ask Alan to pass it out if that would be all right.

COMMISSIONER SPEARS: That would be great.

MR. NELSON: Thank you.


MR. KEITH: One thing I didn't mention and I just want to comment on it because of the issue being to not lower the exemption level on the net worth requirements. We're looking for ways to make things happen and to create products that really can be useful to the farmer, and if there is not a reduction in that $10 million level, we would urge the commission to consider commercial exemption for parties above the farm level, because we see the opportunities for secondary markets, wholesale markets, to develop for certain types of products, in particular revenue-type products that could be marketed by companies that want to get into that line of the business, and that could be marketed on a wholesale basis through country elevators to farmers but would not be available otherwise.

And if we don't do something with that exemption level or do something to get the commercial exemption out there, then those types of products will not come to market, in our view, and those are maybe the most important types of contracts, other than the walk-away on a cash forward that are out there, and we think that's where we will get creativity in the market.

COMMISSIONER SPEARS: With that, I think we've exhausted--oh, excuse me. Bill.

MR. DODDS: David, I would just like to commend you on the process of getting through this last handout. I thought it was very organized and it worked. But in addition to that, I would just say there is a handout that we handed out.

We talked a lot about the need of education today and the National Grain and Feed Foundation through the sponsorship of the USDA conducted three seminars to date where we've had about 500 people attend, and please utilize this if you wish.

COMMISSIONER SPEARS: What I intend to do on this part of the program is to take the comments from the participants and the individuals and the members, as well as the various comments we received from Kendell and his group and Scott and his group, and then the letter from the producer groups. What we then need to do is sit down as a commission with staff and work towards a type of consensus document that staff can bring to the commission.

I know staff has their work cut out for them in trying to incorporate the various comments. Hopefully at some point in the time, if there is a majority of the commission that can reach a consensus on some viewpoint as to a proposal, then I'm sure at that point we would move forward with it as a commission action.


CHAIRMAN SPEARS: Before I close the meeting, I want to recognize again and thank Brooksley, the chairperson, for sitting through an entire meeting. She outlasted the other two commissioners, and I certainly appreciate her willingness to sit here and do that.

Brooksley, do you have any closing comments?

MS. BORN: Well, just to thank all the participants for their very thoughtful views. I've certainly found this a very educational meeting, and I think with this kind of input to the commission, we can certainly do a better job than we would do without you and, again, let me thank you all for your time and expertise and thoughtfulness.

COMMISSIONER SPEARS: Well, certainly I want to thank and recognize each of you for coming. I know, like I said early in the program, a number of you traveled a distance to be here. The afternoon grew long, and we're at the five o'clock hour.

So unless there's any other comments or viewpoints you want to express by any other members, I'll just go ahead and adjourn the meeting. Again, thank you and I appreciate you being here.

[Whereupon, at 5:00 p.m., the meeting was adjourned.]