Agricultural Advisory Committee

Commodity Futures Trading Commission
Agricultural Advisory Committee

23rd Meeting

Wednesday, May 14, 1997
1:00 p.m.

Three Lafayette Centre
Suite 1000
1155 21st Street, N.W.
Washington, D.C. 20581



Joseph B. Dial, Chairman
Nancy Danielson, National Farmers Union
Jim Sanford, National Cotton Council of America
Glenn Moeller, National Corn Growers Association
Robert White, National Grange
Paul Hitch, National Cattlemen's Association
Robert Bold, National Association of Wheat Growers
Scott Hackett, Millers' National Federation
Trenna Grabowski, American Agri-Women
Neal Gillen, American Cotton Shippers Association
Mark Scanlan, Independent Bankers Association of America
Richard Ellinghuysen, National Farmers Organization
Kate Coler, American Bankers Association
Steve Patton, National Council of Farmer Cooperatives
Bill Dodds, National Grain and Feed Association
Jim Lindau, National Grain Trade Council
Gary Hellerich, American Soybean Association
Ken Ackerman, USDA-Risk Management Agency
Steve Oman, American Farm Bureau Federation
Dave Lyons, North American Export Grain Assn.
Todd Vanhoose, Farm Credit Council
Gary Madson, National Pork Producers Council
Dan Shaw, National Grain Sorgum Producers



Welcoming Remarks

Commissioner Joseph B. Dial
Chairman, Agricultural Advisory Committee

The CFTC "White Paper" on the Prohibition  of Agricultural Trade Options
Paul Architzel, Chief Counsel
Greg Kuserk, Industry Economist
Division of Economic Analysis

"A Day at the Commission"
Examples of Issues CFTC Deals with Day-to-Day
Susan Bovee, Associate Director, Division of Enforcement
Steve Braverman, Associate Director Rule Enforcement, Division of Trading and Markets
David Fickert, Industry Economist, Division of Economic Analysis

CFTC's "Fast Track" Contract and Rule Approval Process
Paul Architzel
David Van Wagner, Special Counsel, Contract Markets Section, Division of Trading and Markets

Approval Process to Establish New Futures Exchange
Alan Seifert, Deputy Director, Contract Markets Section, Division of Trading and Markets
Fred Linse, Chief, Agricultural Commodities Unit, Division of Economic Analysis

Report on USDA's Risk Management Education Program - Summit on September
14, 1997 in St. Louis, Missouri
Ken Ackerman, Administrator, Risk Management Agency, U.S. Department of Agriculture

Presentation by National Cotton Council of America on their Risk Management Education Program
Kevin Brinkley, Economist, National Cotton Council of America

The CFTC-Agricultural Advisory Committee Website -

Comments on the Proposed Legislation to Amend the Commodity Exchange Act
Randy Green, Staff Director, U.S. Senate Committee on Agriculture, Nutrition and Forestry
Stacy Carey, Staff Director, U.S. House of Representatives Committee on Agriculture, Subcommittee on Risk Management and Specialty Crops

Status of New Delivery Points for CBT Grain Contracts including the Wheat Contract
Dr. Craig Pirrong, Washington University at St. Louis, CBOT Grain Delivery Task Force 188

- - -


CHAIRMAN DIAL: If everyone would come in and take their seats, we would like to get started. We have a very, very full agenda with lots of interesting topics, and we want everyone to have an opportunity to express themselves and talk about these subjects to the fullest extent possible. Our Chairperson, Brooksley Born, is speaking to the National Grain Trade Council today in Arizona. She asked me to bid you welcome on her behalf and express to you her regrets that she wasn't able to be here herself in order to do that, and to also tell you what a valuable role the Agricultural Advisory Committee plays in CFTC's deliberations and considerations.

We have one of our Commissioners with us at the present time. I'd like to recognize Commissioner John Tull. John, would you stand up so folks could see you? Thank you, sir. John, of course, has a distinguished career that he put on hold to serve as a CFTC Commissioner, a distinguished career in agriculture, and has received quite a number of awards and has been recognized by several industries, as a matter of fact, for his yeoman service in agriculture.

I want to recognize and to thank my staff. This type of meeting takes a considerable amount of time and effort and coordination, and obviously we couldn't do it without them. Kimberly Harter, who most of you have occasion to visit with from time to time, is my Administrative Assistant. She is the one that puts all of this together and makes the trains run on time and sees that all of the equipment and everything is set up. John Foltz is my Special Assistant. Don Heitman is my Legal Counsel. If it wasn't for Don, I guess I'd stay in hot water all the time instead of just part of the time.

Let's begin now by quickly going around the table, and the members that are seated here at the table, if you would identify yourself and the organization that you're with, and if this is your first meeting, well, tell us that so we will know, so the folks in the audience will know, those of you who are serving your organization at this first meeting for you. So Steve, we'll start with you.

MR. OMAN: Steve Oman representing American Farm Bureau.

CHAIRMAN DIAL: Be sure and turn on your mikes and pull them as close to you as you can.

MR. OMAN: Steve Oman representing the American Farm Bureau.

MR. ACKERMAN: I am Ken Ackerman, the Administrator of the Risk Management Agency at USDA.

MR. HELLERICH: I'm Gary Hellerich, representing the American Soybean Association.

MR. LINDAU: I'm Jim Lindau sitting in for Bob Peterson for the National Grain Trade Council. Normally I'm with Minneapolis Grain Exchange.

MR. DODDS: Bill Dodds, representing the National Grain and Feed, and Kendall Keith, president of the National Grain and Feed, is with us today.

MR. PATTON: I'm Steve Patton representing National Council of Farmer Cooperatives.

MS. COLER: I'm Kate Coler with the American Bankers Association, and this is my first meeting.

MR. ELLINGHUYSEN: I am Richard Ellinghuysen representing National Farmers Organization.

MR. SCANLAN: I'm Mark Scanlan with the Independent Bankers Association.

MR. SHAW: I'm Dan Shaw with the National Grain Sorghum Producers sitting in for Bill Kubecka, who is from Texas and about two months late planning and decided he better stay down there and finish planning his crop.

MR. SANFORD: I'm Jim Sanford, representing the National Cotton Council.

MR. MOELLER: I'm Glenn Moeller. I represent the National Corn Growers Association, and this is my first meeting.

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

MR. HITCH: I'm Paul Hitch. I'm chairman of the Live Cattle Marketing Committee of National Cattlemen's Beef Association, and I represent them.

MR. BOLD: I'm Robert Bold, representing National Association of Wheat Growers.

MR. HACKETT: I'm Scott Hackett representing Millers' National Federation.

MS. GRABOWSKI: I'm Trenna Grabowski, representing American Agri-Women and our national president, Jane Pettibone, is here today.

CHAIRMAN DIAL: Delighted to have you.

MR. GILLEN: I'm Neal Gillen. I'm Executive Vice President of the American Cotton Shippers Association.

CHAIRMAN DIAL: Before we get down to business, I think it's appropriate for me to advise you that this past month, the Commission and the staff of CFTC lost a valuable staff member and a good friend when Blake Imel suffered an apparent heart attack while hiking in one of his favorite parks.

Blake held a Bachelor's Degree in Agricultural Economics from Purdue University and a doctorate in agricultural economics from the University of Wisconsin. He worked for USDA's Economic Research Service and the commission's predecessor agency, USDA's Commodity Exchange Authority, before joining the CFTC in 1974.

Over his 22 years of outstanding service with the Commission, Blake's institutional memory, experience and expertise were invaluable to all who served with him and to the futures industry we regulate. Blake lost his parents as a teenager and went to live with his Uncle Ralph and Aunt Phyllis on their farm near Frankfurt, Indiana. As Deputy and for the past two years Acting Director of the Division of Economic Analysis, Blake was an integral part of the Commission's major policy decisions concerning the futures industry and agriculture.

He never failed to reflect on how those decisions would affect Uncle Ralph. To Blake, Uncle Ralph was symbolic of this country's farmers, and Blake understood and sincerely cared about all of them. As long as there is a CFTC, Blake Imel's legacy of concern for American agriculture will endure. I would ask if you would join me in a moment of silence in the memory of and respect of our friend Blake Imel.

[Moment of silence observed.]

CHAIRMAN DIAL: Thank you very much. The first item on your agenda is the CFTC White Paper on the Prohibition of Agricultural Trade Options. In a moment, Paul Architzel, the Chief Counsel, and Greg Kuserk, Industry Economist, for the Division of Economic Analysis will make the presentation on that paper.

But before they do that, I would like to make one brief comment. One of the most outstanding and successful players in professional hockey was asked once by a reporter why he was so much better than those that he played with. And Wayne Gretzky replied, well, it's very simple. Most of these guys skate to where the puck is. I skate to where the puck is going to be. The CFTC White Paper on the Prohibition of Agricultural Trade Options is the commission's recognition that risk management in American agriculture is going to be at a different place and fill a different role in the future than the needs that it faces today.

And for that reason, we are submitting this white paper for public consideration, and at the appropriate time for comment in order that the Commission can make a prudent and judicious decision about what action it should take on the prohibition of agricultural trade options. The white paper is now up on the Internet as we speak. You can find it at CFTC's Website under "What's New". It also will be on the Agricultural Advisory Committee's Website and the Division of Economic Analysis' Website. So Kimberly, what's our Web address? It should be on that paper that you've got right there in front of you, that one.


CHAIRMAN DIAL: Okay. for the ag committee. Okay. I'll turn it over to Paul Architzel and Greg Kuserk for their presentation on the CFTC White Paper, staff white paper, on Ag Trade Options.

MR. ARCHITZEL: Commissioner Dial, members of the committee, it's a pleasure to be here today to brief you on the Division of Economic Analysis’ study entitled, "Policy Alternatives Relating to Agricultural Trade Options and other Agricultural Risk Shifting Contracts," also referred to as the staff white paper.

With me today, also from the Division of Economic Analysis, is Greg Kuserk, a senior research economist and co-author of the study. The commission has considered the issue of whether to remove the prohibition on the offer and sale of trade options on the enumerated commodities several times. It has been the subject of several meetings of the Commission's Agricultural Advisory Committee over the years and was one of the first items of business of the first Agricultural Advisory Committee under the chairmanship of Commissioner Kalo Hineman.

In fact, consideration of this issue was one of the impetuses behind formation of a permanent agricultural advisory committee. Trade options are off-exchange options offered for business-related purposes to a producer, processor, merchant or commercial user of the commodity which is the subject of the option. Currently, Commodity Futures Trading Commission Rule 32.2 prohibits the offer or sale of off-exchange options on those agricultural commodities which are enumerated in the Commodity Exchange Act.

These include, among others, wheat, cotton, rice, corn, oats, soybeans and livestock. Although prohibited for the above commodities, trade options are permitted to be offered and sold for all other commodities. There have been suggestions to the commission that the existing prohibition on the offer or sale of such off-exchange trade options on the enumerated agriculture commodities should be ended. Others support the continuation of the existing prohibition, however.

On December 19, 1995, the commission hosted a public roundtable to discuss this issue once again and to provide a forum for members of the public to provide their views. 17 members of the public participated representing a broad cross section of agricultural interests as well as academia and the futures industry. In addition, written comments were accepted and incorporated into the record. Some still expressed reservations over the wisdom of lifting the prohibition.

In general, however, based upon a perception that those engaged in agriculture today have a greater need for risk shifting instruments, roundtable participants expressed varying levels of support for relaxing the prohibition. The Commission directed the staff to study the issue and to report on its findings. I now would like to highlight for you the division's analysis and discuss briefly the division's recommendations to the Commission.

Before that, I just would like to reiterate one more time that the views and recommendations discussed today are those of the Division of Economic Analysis. They do not necessarily reflect the views of any commissioner or the commission itself at this time. In our analysis, we provided a thorough description of ag trade options including the regulatory history of it, their economic purpose, and the differences between on-exchange and off-exchange instruments, particularly the differences between forwards and futures.

Picking up at that point, we then specifically discussed the benefits and the potential risks of agricultural trade options, and that's where I'd like to start today in highlighting our analysis. With regard to the benefits of trade options, the first benefit certainly is that there is a potential variety of sources for the vending of these option instruments. Notably, at the first handler level, elevators and other first handlers of the commodity may offer these instruments if permitted.

A variety of agricultural interests have said that producers tend to trust first handlers with whom they deal in the cash market and would prefer to be able to access risk shifting instruments through the people with whom they have a business relationship in the cash market.

Secondly, trade options may be able to permit a greater precision of hedging in that they may be customized by size, location, commodity grade or other specifications. The final potential benefit is there may be some flexibility in financing offered at the first handler level to producers. This may be that the premium for the option, the actual cost of it, may not be collected until the producer brings the crop in, in which case the premium may be paid for as an adjustment to basis on the crop as opposed to having to pay for the premium up front. There are other kinds of financing flexibilities that may be offered as well.

We then went on to discuss the risks of trade options. First of all, we analyzed the potential risk of increased fraud caused by the decentralized nature of vending off-exchange instruments, in general, and trade options in this case, in particular. In the past, going back to the '70s when the commission was first formed, the commission noted that there was a widespread problem with fraud in off-exchange instruments generally, and we certainly have to be cognizant of that history.

Secondly, because of the decentralized nature of the vending of the instruments, there would be no centralized market to provide self-regulatory oversight of the vending of the instruments For an agency of our size, or any agency, that represents a problem of resources as far as being able to surveil and oversee the offering of those kinds of instruments when it's in decentralized type environment.

The lack of standardization may also lead to increased fraud. Generally, for exchange traded instruments which are standardized, people have the ability to understand them, to learn how they operate. In the case of non-standardized instruments, where each instrument may vary, there's an increased risk that people may not understand how that particular instrument works or may interact with their business.

And that is associated with the problem of the learning curve. In this case, options have not been offered off-exchange for the greater part of 50 years or more. No one has experience at this point with those kinds of instruments, and it can be expected that there will be a steep learning curve until people become acquainted with them, how to use them and how they interact with their business.

Other risks associated with trade options may include some of the following: credit risks. Credit risks may come into play because of the asymmetric credit relationship between the grantor of an option and the purchaser. One side of an option pays the premium up front typically. The other side needs to perform on it. And that leads to particular types of problems with regard to credit risk between the two.

Operational risk is also something that needs to be focused upon. There are concerns about internal controls at the first handler level in particular. During the commission's Roundtable on Agricultural Trade Options, several people indicated that the elevators that they had been involved with did not have good internal controls and didn't have the capability of assessing how these kinds of instruments would interact with their own balance sheet or with those of the customers. That's an important concern that needs to be addressed in focusing on these issues.

We've noted in the past that many of the problems we've had in or related to commodity trading or futures trading may have related to lack of good internal controls. That remains a concern. Also systemic risk is a concern, but not in the typical way we may think of it with regard to financial instruments. In this case, I think the systemic risk is characteristic of rural economies where there may only be one elevator in a town or in a region. If that elevator gets into trouble because of this instrument or some other type of trading behavior, the effects of a failure by one elevator may spread throughout the town or the regional economy. It's different from the systemic risk that we think about in terms of financial instruments with a bank going down and whether or not that will affect other banks and other people in the financial sector. Here it may be localized to a particular town or region. Nevertheless, it's something that needs to be considered and addressed.

We next discussed some of the restrictions or regulatory approaches that can address some of the potential risks that we outlined. And in this discussion, we are simply highlighting those kinds of restrictions which would be possible to address, some of the risks that we identified. First of all, there would be possible restrictions on the nature of the parties. Two kinds of restrictions are size limitations on the parties themselves or a minimum size on the size of the transactions. One of the limitations of this type of restriction is that it may restrict the benefit of having trade options to those who might most find them useful, and that is certainly something that the commission needs to consider.

Also, as far as vendors of the instruments, we could have a registration requirement either under current commission registration categories or a new category for registration. We could have simply notification to the commission that an entity is offering to vend these instruments or we could have a line of business requirement. Currently for non-agricultural commodities, the requirement is that the person being offered the option is a commercial, which means that you could have non-commercials offering the options. Another approach to consider in this aspect of agricultural trade options is requiring that both parties be commercials. I think typically that's going to follow the way we envision that initially these would be offered and would also prevent or guard against the kind of fly-by-night operations starting up where someone isn't a commercial already.

Finally, we could have an education requirement for either the vendor, the buyer or both counter parties. It's unusual to have that kind of requirement directly on users of an instrument. However, it has been done before in connection with the pilot option program that was done under the Department of Agriculture. There was an education requirement for people participating in that program. The study goes on to highlight some of the benefits of having that kind of program and some of the costs involved including the potential that such an education requirement could be used as a lure to people to attend what might be marketing seminars rather than actual educational type of seminars.

We also could place restrictions on the instruments or their use, and these restrictions could follow either being conditions of lifting the prohibition or they could be given in the form of guidance. The trade option rule itself is not completely open-ended. There are requirements in it, one of which I mentioned earlier, which is that the instrument be vended to a commercial. The second one is that the instrument, that the option, be solely for purposes related to the option buyer's business as such.

The commission really hasn't had an opportunity to discuss that requirement in much detail. This may be an appropriate time for the commission to look at that requirement, which is an existing one in the trade option rule, and how that would apply specifically in the case of agricultural trade options. Some of the issues may be, and as we discuss in the study, whether the instrument is being used to manage risk, and how that ties into the requirement that the instrument be related to the business as such. And we looked at factors such as size of the instrument compared to the underlying cash position, timing of expiration of the cash position, and other factors like that.

We also looked at the issue of option writing to generate income and how that related to this requirement. Some of the practices include writing covered calls, and that is something that the commission would need to consider if it determined that it was going to lift the prohibition, is how that practice relates to the conditions for lifting the prohibition?

Also, we looked at regulation of marketing, disclosure requirements and account information requirements. We've heard that in relation to hedge-to-arrive contracts, which I talked about in this committee last year, one of the complaints we heard was that people didn't know where they were at particular times, and that relates to getting timely information about accounts.

Other possible limitations we looked at were required cover of market risk and how the trade options would be covered, and also, as I discussed earlier, internal controls. We also looked at a number of related issues which don't concern ag trade options directly. However, they related generally to this area, and we thought it was appropriate that the commission or the division address all the issues that are currently outstanding.

The first one relates to forward contracts having option like features, and this goes back to the 1985 interpretation which is the last time or the most authoritative statement that there is regarding what's a forward contract. That interpretation was done through example, giving three examples, two of which were forward contracts, one of which was a trade option. We've heard from various people that because of changes in the cash market, it would be helpful to have additional examples laid out or additional guidance separating forward contracts from other types of instruments, and certainly in one of our recommendations we agree that that should be considered and looked at again to provide more guidance.

Secondly, we looked at the issue of the swaps definition and how that related to the prohibition on ag trade options. There has been some amount of ambiguity or confusion on the part of some people on whether or not swaps instruments are affected by the prohibition on agricultural trade options.

And finally, we looked at the issue of comparability of treatment for exchange traded markets. Again, during the roundtable, this issue was brought out that if the commission were to determine to lift the prohibition on ag trade options, what effect, what implications does that have for exchange-traded instruments?

I'd like to just summarize what our recommendations were to the commission. Again, these are the division's recommendations. The commission will have to consider whether or not they agree and want to act on them or not. The first one, the first three actually go together. Unfortunately, they are in chronological or logical sequence, not necessarily the most important one first. The first one is to deny a petition for rulemaking which is currently pending. The reason we need to do that and recommend that the commission does that is in order to then proceed on to the next two, and we recommend that the commission consider lifting the trade option prohibition subject to appropriate conditions, and to accomplish that, that the commission publish in the Federal Register an Advanced Notice of Proposed Rulemaking. That Advance Notice of Proposed Rulemaking would rely upon the division's study for its analysis, and would ask questions of the public: number one, is this a good idea to lift the prohibition; and, two, if it is, what kinds of conditions or regulatory requirements are appropriate to doing that?

The next recommendation is that the commission confirm the prohibition on agricultural trade options does not apply to the scope of the swaps exemption and that has to do with the commission's granting of hedging exemptions to certain types of companies.

And the last recommendation, as I mentioned earlier, is that the commission as resources permit, update and reissue the 1985 OGC interpretation, and that would be done through a variety of mechanisms. I'd be happy to answer any questions.

MR. GILLEN: Paul, did you consider a minimum capital requirement such as what you have with dealer options?

MR. ARCHITZEL: That goes to the issue of what kind of cover would be appropriate, and there is any number of ways of addressing that. During the roundtable, the exchanges indicated that they believed it was appropriate to have a one-for-one cover requirement, that if you issue a trade option you lay that risk off on a one-to-one basis on the exchange.

Another way of dealing with that problem would be to have some kind of capital requirements, and I think there are a variety of mechanisms. One of the things we'll be seeking public comment on is what's the best way of dealing with that issue, but certainly that is an issue that needs to be addressed.

CHAIRMAN DIAL: Please identify yourself.

MR. LINDAU: I'm Jim Lindau from the National Grain Trade Council. Where is the demand for ag trade options coming from? As you read the list of contracts that are currently covered by them, I think you did not mention soybeans, cotton. Is there a great deal of activity in those areas? I'm curious to know who really is looking for this?

MR. ARCHITZEL: I think we've heard from a variety of agricultural groups that do have interest in having this kind of instrument available. I'm not sure that it breaks down by specific commodity. Certainly, we've heard from many interests who are affected by the FAIR Act that because the FAIR Act will leave them feeling the need to hedge and manage their risks better, their market risks, and in that type of environment they may be able to use these to their benefit.

MR. LINDAU: Is there any evidence that there's great activity in those commodities where ag options are not denied? Soybeans, for example?

MR. ARCHITZEL: Soybeans is one of the enumerated commodities. An example of a non-enumerated commodity might be cocoa or dairy products, that type of thing. And I would say, no, there is not evidence of a great amount of activity that we're aware of. On the other hand, these changes in the cash market and in government support programs are sort of getting underway now so that what went on in the past may not be indicative of future needs.

MR. DODDS: Jim, I would just say in general the grain producer wants them. He'll use them much like he uses cash grain contracts. He would rather sell a cash grain contract to a local dealer than hedge his grain in Chicago.

CHAIRMAN DIAL: Any other questions? Identify yourself, please.

MR. ACKERMAN: I'm Ken Ackerman with USDA. In describing some of the regulatory restrictions that you say potentially could be put in place, I take it you're not proposing any of those potentials, but those are ones you're asking for comment on--

MR. ARCHITZEL: Right. At this time, we're just identifying potential approaches.

MR. ACKERMAN: Some of those sound like they would be creating something of a regulatory network over the elevators in terms of registration or reporting or tracking of types of transactions or controlling types of transactions. Are there precedents for that kind of regulation in other areas?

MR. ARCHITZEL: Well, I think there are a number of ways of approaching even the type of regulatory requirements we've outlined. For example, if they're self-effectuating conditions of the exemption, there wouldn't necessarily be tracking and reporting to the commission. It might only be that an elevator would have to satisfy the requirements in order to be a vendor of these type of instruments. For example, if there were an internal controls requirement, it may only be that the elevator have review by a CPA that certifies it has internal controls, and then it will be qualified to do the business. So it doesn't necessarily follow that it's creating an entirely new level of oversight.

Nevertheless, the commission certainly could determine that safety, prudence and caution suggested that more oversight would be a good thing, and I think that depends in part on the kinds of comments we get from the public.

CHAIRMAN DIAL: Other questions?

MR. GILLEN: What is your time frame on your notice of proposed regulation?

MR. ARCHITZEL: Somebody always asks that. This is a priority for the division and I believe for the commission to get this in the Federal Register. Because we've done the study, most of the analysis is already done, so I expect that the Advance Notice of Proposed Rulemaking will appear in the Federal Register in a short time period. And after that, I suppose it depends upon the nature of the comments we receive how quickly the process moves forward.

MR. GILLEN: Neal Gillen again. Are you going to give it a 60 or 90 day comment period?

MR. ARCHITZEL: I think that's up to the commission and that hasn't been determined yet. Do you have a view of that?

MR. GILLEN: A minimum of 60, I'd say.

MR. ARCHITZEL: Generally I find that when we try and move things faster, we get requests for an extension of time, but that's certainly up to the commission to determine.

CHAIRMAN DIAL: Okay. We have time for one last question. Okay. Thank you very much, Paul and Greg. You both have performed yeoman service in writing and making available this white paper. As I said in my remarks to introduce Paul and Greg and the presentation on their white paper, the commission will look forward to receiving your comments and your observations and your opinions.

We'll move now to the next item on the agenda. As the commissioners and the chairperson are out and about visiting with those who are part of the industry that we regulate and our counterparts in other government agencies and in the private sector in general, perhaps the most commonly asked question of us is, well, what's going on over at CFTC?

So we have an opportunity to speak to that, but I thought that it was appropriate that you all at least hear a snapshot, if you will, presentation about the people who carry out the daily work of the commission, who make it possible for the commissioners to comment on what's going on over at CFTC to do so. And these folks are obviously the staff, and I entitled this topic on the agenda as "A Day at the Commission." It obviously is not going to be all encompassing because the commission has so much to say grace over that none of you have the time to stay here long enough to hear what a day at the commission really consists of, but once again I have asked representatives from the Division of Enforcement, the Division of Trading and Markets, and the Division of Economic Analysis to briefly give you an idea of just some of the things that they do that make up a day at the commission, which is the work of the commission that's manifested in everything that comes out of the commission and becomes apparent in the activities of the industry that we regulate and has an impact on American agriculture.

So, first, I'm going to call on Susan Bovee, who is the associate director of the Division of the Enforcement for her presentation.

MS. BOVEE: Thank you, Commissioner Dial. I'm pleased to be here today with such an illustrious group of representatives of the agricultural industry. I don't know if anyone knew this when they asked me to speak, but my mother is a Nebraska farmer, and I'm very deeply imbedded in the entire agricultural economy of this country so I'm delighted to see so many of you here.

As Commissioner Dial said, I'm an associate director of the Enforcement Division, and that job involves heading up a team of 12 attorneys and investigators, and I'm one of four associate directors in this division. So we have approximately 55 people being led by this group of associate directors and under the jurisdiction of my superiors, a deputy and a director of this division.

And our purpose and job is to investigate and to litigate violations of our Commodity Exchange Act and the regulations under it. The Division of Enforcement gets it leads for what to investigate from a number of sources. Sometimes we read about things in the paper just as you do and get curious about them. Sometimes we receive information from one of the other divisions of this agency. Often we get calls, either from people we know or from persons who wish to remain anonymous in the public, to tell us that they think something strange is going on in this particular pit of an exchange or at this brokerage firm, and no matter where the input comes from we set about to look into those matters.

In order to make the best use of our resources, we don't just dive headlong into everything full tilt. We have a procedure in which we start into an investigation for about 20 hours and take kind of a hard, close and fast look at what we're doing to see if there is any merit in going on, if it makes sense, if it's cost effective. If it seems to be, if there is not just a whiff but a distinct odor, then we'll open an investigation and move forward in a somewhat more formal fashion.

Those investigations can either be those in which we use subpoena power, which require the approval of the commissioners themselves before we can do so, or it can be informal, in which case we don't have the ability to command people to give us documents or to come and testify, but we do have the ability to make phone calls, do research, look at documents that we have or that we can request. Either way, we proceed down the investigational road until we finally come to some understanding of what's been happening and whether or not that actually amounts to a violation of our act or regulations.

We investigate a number of different kinds of people, and by people I mean both individuals and organizations. The first bunch of them could be loosely categorized as persons who are registered with us under our act. Those are people who conduct a business that requires them to be registered. They advise commodity futures trading, they run commodity pools, they are commodities brokerage firms, they trade in the pits as floor brokers or floor traders. And so we have the ability just by looking at the registrants under our statute to get quite a wide view of the commodity futures industry. But that isn't where our ability stops. We in addition have the ability to look beyond our own registrants to those who are not registered but perhaps should be in the first instance, and even if they need not be are either conducting or facilitating some kind of violation under our act or regulations.

It's one of the ways that our commission differs from the exchanges. Exchanges generally when they set about to investigate a problem are limited to interviewing and reviewing their own membership and their membership files. They don't operate with subpoena authority and they're not able to go outside the four corners of their exchange to find out what's going on. We are able to do that and have often found, as a matter of fact, that we are able to join forces with an exchange when there is certain conduct in which both exchange members and persons off an exchange are involved because that way the people on the spot at the exchange are able to tell us a lot about what's going on. We are able then to share with them information about what we learn off exchange. So we've had some fruitful joint efforts in that area.

Beyond that, though, we have the ability to go into whole areas that exchanges really neither touch nor see. There is an enormous amount of off-exchange fraud in this country. Some of it is small potatoes possibly from your perspective. It's, you know, a handful of people who invest a handful of dollars and maybe all together it amounts to $50,000 among ten people. But these are often schemes in which people have invested their meager savings, and this is the sort of thing which although it doesn't seem to make a difference to the gross national product makes a great deal of difference to people in a small community that have been affected by a fraudulent scam run by somebody who is not registered with us.

We are entitled under our statute to investigate those matters and have had many great successes in pursuing those people, in getting funds back for those who have been wronged, and to get injunctive relief which prohibits them from ever engaging in this conduct again at the peril of being held in contempt of court if they do.

So this is the kind of conduct that doesn't even come to the attention of an exchange for the most part because by the time the transaction reaches them, the exchange would have no reason to believe it's not legitimate. The fraud occurs further upstream between an unregistered person and the customers with whom he's dealing. So I think that's a way that our division adds particular value to the system of self-regulation that exchanges engage in.

Now, we also undertake to look at various kinds of specific conduct in particular commodities, and here is where we play no favorites. We look at fraud issues across the board whether it's in agricultural commodities or otherwise, and there are many kinds of ways in which these things come up. I thought I would give you just a couple of examples of things we have done in the agricultural area fairly recently, which shows really the breadth of how we try to address the marketplace and to ensure its safety for all participants.

In one action last year, the Division of Enforcement brought a complaint against an employee of a large cattle operation who was the lead trader who was hedging the cattle operations functions and who was deceiving his employer by sharing the information about his cattle operation trades with his brother who ran a brokerage firm. His brother was registered with us, and it was only through a painstaking backtracking of telephone records, which we were able to subpoena as well as the testimony of certain persons who are out of exchange jurisdiction that enabled us to put together a paper trail that was incontrovertible. It showed absolutely that before every large position was put on by this cattle operation through the man that we sued, his brother placed trades through his own brokerage firms.

This kind of fraud is known as trading ahead, and it is illegal and it tends to undercut the safety of the marketplace and to make prices infirm and untrustworthy. It is the very heart of our surveillance job and our oversight and our investigatory purpose to root out that kind of thing and to prosecute it to its fullest. We brought charges against these brothers and achieved, I think, a very handsome settlement. And I think even more importantly than the effect on the particular defendants, we were able, I think, to send a strong message to the marketplace that these activities are watched. They are watched not only by the Division of Enforcement but by the other fine divisions of this agency whose job it is to monitor a lot of these activities.

And you can't just assume that because you're one fellow who's nowhere near Washington that your conduct won't be scrutinized, and so I think that's one way in which we help protect the agricultural marketplace. Another recent example that I'll just give a very broad-brushed description of is an instance in which we have overseen trading in a particular agricultural pit and determined by taking a close look to make some recommendations to our commission along with the Division of Trading and Markets about the way the exchange handled these particular matters. The exchange had taken disciplinary actions, had imposed some sanctions, and after reviewing what the exchange did, the Division of Trading and Markets and the Division of Enforcement together agreed that these sanctions and this action seemed less than perfect.

This matter is currently before the commissioners and with both Commissioners Dial and Tull here today, I don't want to say more about the balance of the issues here. But because this was an agricultural pit and the matters involved trading conduct in that pit and the reliability of the pricing of the commodity in that pit, we thought this was a matter of the first importance. I see Commissioner Holum back there. I'm sorry. You came in while I was speaking. This is a matter of great importance, I think, to the integrity of the agricultural marketplace, and I assume that in the fullness of time, some of what I'm talking about will become less mysterious as the matter moves through the commission.

These are just a couple of ways in which we address agricultural matters almost everyday. Obviously we're active in other commodities as well, but I think the dedication of the many attorneys in this division, and I don't mean to forget to mention that we have three other branch offices in which both attorneys and investigators also play a large role in this division in New York, Chicago and Los Angeles. I think all told with all of those offices plus our headquarters office, we are able to add considerable value to marketplace protections and to a certain amount of sense of safety and settleness that all of you can feel so that when you market or grow or sell commodities that you understand that the pricing of those commodities is reliable and will remain reliable because people are working to make sure that it will. I'm happy to answer any questions if you have any. I know I've taken up more than my time here.

CHAIRMAN DIAL: Any questions? Jim?

MR. LINDAU: One quick one. What's the average duration of an investigation of say one large enough to involve an exchange from beginning to filing a report?

MS. BOVEE: Gee, I didn't come with that statistic in my pocket.

MR. LINDAU: It doesn't have to be perfect.

MS. BOVEE: I would think especially as we deal with larger and larger entities or institutions the matters tend to slow down, often because the matters before us are very important or are matters of first impressions. So I would think above a year, possibly less than two years, is probably the likely trajectory of those kinds of matters. For somewhat smaller matters involving more garden variety types of fraud or misconduct, things can move quite quickly. We have been able to bring a case, investigate and bring a case in as little as 17 days. And in that matter achieved a preliminary injunction after 17 days against the conduct of a fellow that stole--I don't know--about $3 million from a group of persons who thought they were investing in a commodity pool and who apparently were not.

So we can move quite quickly when we have to. Obviously, the facts of these kinds of things differ enormously. Where there are large matters at stake, we try to deliberate and we try to be careful. The idea is not to rush to judgment or to stampede anybody in any particular direction. So I think as the stakes go up, the pace slows down.

CHAIRMAN DIAL: Any other questions? Thank you very much, Susan.

MS. BOVEE: Thank you.

CHAIRMAN DIAL: Appreciate it. As Steve Braverman, the Associate Director for the Rule Enforcement, Division of Trading and Markets, moves to the podium, let me recognize Commissioner Barbara Holum who came in. Barbara, thank you very much for being with us this afternoon. Steve.

MR. BRAVERMAN: Thank you, Commissioner. Well, first, let me say that it's a real pleasure to be here talking to this group about some of the day-to-day operations that go on at the CFTC. What I'm going to talk about today I think is something that you all will be interested in, especially those here that are users of the markets, and that is the very critical and fundamental statutory and regulatory obligation that the commission has, and that is to ensure that exchange surveillance programs are operating effectively and that the commission itself has a program for overseeing those self-regulatory programs.

As Commissioner Dial said, I'm an associate director in the Rule Enforcement Unit of the Division of Trading and Markets. We have approximately eight attorneys in Washington and 20 or so investigators out in our regional offices who carry out the function of oversight of exchange trading practices and exchange compliance programs. First, let me just give you a brief background on the regulatory framework within which the exchanges have to operate with regards to enforcing their rules.

First, exchanges, of course, are self-regulatory organizations. They have to implement procedures to enforce standards that are set out by the Commodity Exchange Act and the commission's regulations. Some of these standards include trading standards for floor brokers. These standards, which have been in effect for, oh, I think since 1974 or '5, the inception of the commission, prohibit floor brokers from such dual trading abuses as trading ahead of customer orders, trading against customer orders, disclosing customer orders to other members on the floor, any types of prearranged trading or accommodation trading, any kinds of wash trading or money passes in the pit.

These are some of the trading standards that are set out. There are also standards for recordkeeping requirements. These recordkeeping requirements were enhanced in May of 1990 after the CFTC/FBI sting. We at that time required additional recordkeeping to include collection of trading cards 15 minutes after each half hour bracket so that the trading cards will be taken out of the executing broker's hand in a much more expeditious fashion than it was before. We required the floor brokers to record all their trades in non-erasable ink, and there were other recordkeeping requirements that also served to deter traders from any potential trading abuses.

Thirdly, we have standards which say that the exchanges have to diversify their governance, board governance, disciplinary committee governance. We increased the representation of public directors on exchange boards of governance. And those are some of the examples of some of the standards that the exchanges have to follow. Exchanges have compliance systems and programs to enforce rules against members. These include programs to effectively monitor various sub-programs that they have in effect, and one of them would be market surveillance. They must have an effective program for enforcing their market surveillance function, market surveillance being knowing who the traders are in a particular market, knowing what the fundamental issues are reflective of supply and demand, open interest, basis relationships, inter-market spread relationships and so on.

The second part of the program must address trade practice abuses. They must have a program to identify potential trade practice abuses such as the ones I listed before. They have to have the capacity to thoroughly investigate those potential violations and if they find a reasonable basis to believe that any of their trading rules were indeed violated, they would, of course, have to have an effective disciplinary program to deter, hopefully deter other brokers from committing the same types of violations.

We look at all of these programs from an oversight perspective including an exchange's audit trail program, which is their program for quite simply reconstructing trading. Audit trails have, of course, been a very popular subject lately, and we look at each exchange's audit trail system and how accurate that system is and how effective that system is in identifying who executed what order, for who, at what time, and what commodity in order to be able to reconstruct trading and prove violations.

Our program for overseeing these different sub-programs at the exchanges consists of an integrated program of floor surveillance, computerized surveillance, and record surveillance, to conduct direct oversight of exchange trading activity on a daily basis. And what I mean by that is that each day commission staff are reviewing all trades that take place on all the exchanges using our computerized surveillance system in an attempt to identify for further investigation possible violative trading activity.

We also conduct what we refer to as rule enforcement reviews. These are audits, if you will, of each exchange periodically in which we review an entire exchange's compliance program or at times we will focus our attention on a particular issue at each of the exchanges and examine that issue at all of the exchanges which we call a horizontal rule enforcement review.

For instance, we have gone into each of the exchanges over the past couple of years and issued reports on their ability to enforce their rules concerning insertions and deletions from time and sales records. We have gone in and looked at each exchange's program for enforcing their rules for handling out-trades and errors that occurred during the day. These reports, the horizontal reports, we try to apply a best practice approach to our recommendations. We look at each exchange's program and select what we think is the best practice approach and make appropriate recommendations.

The cornerstone, I suppose, of our oversight surveillance program is our own computerized surveillance system. We refer to this as the Exchange Database System, or EDS. We receive computer tapes every month from each exchange of all the trading activity and we load those tapes on our mainframe computers in Chicago, and our investigators in the region are then able to download that information on their personal computers at their desk and manipulate that information in order to satisfy their needs.

For example, trading ahead of a customer order, we will sort the trading activity. We'll sort the trading activity by contract usually, select a period of time, and tell the computer to isolate for us any traders who received a better price for their own account within a minute of executing a customer account order that they had in their hand. And the parameters can be flexible. We say within a minute. We follow up on those exceptions and we investigate those.

Another example would be looking for patterns of noncompetitive trading and accommodation trading. We can isolate, for instance, any particular trader or traders who trade opposite each other on what seems to be a consistent basis. We can manipulate that data to point out any patterns between two traders in the same market who seem to be trading preferentially with each other which might be an indication of a noncompetitive trade or a prearranged trade if they're not going to the pit.

The system has been very successful and has resulted in many referrals to our Division of Enforcement and to the relevant exchange where the activity has taken place, and we are always continuing to update the technology on that system. EDS, I'll also mention, is used and has been used to reconstruct trading during major market events such as the March '96 wheat expiration, the July '89 soybean situation, the '87 stock market crash. We turn to the EDS system to help us reconstruct markets during those significant market events where it's so critical to get an accurate reconstruction and to determine whether or not there were any violative activity taking place during that time period. So that's been a very, very useful tool for the commission staff.

The other facet of our oversight that I mentioned before would be the Rule Enforcement Review Program. This program is actually mandated by Congress in the 1992 Futures Trading Practices Act. We are now statutorily obligated to review each exchange's compliance systems once every two years as practicable. The rule enforcement reviews are reports to the commission which evaluate an exchange's entire program or one facet of their program, and these reports serve as sort of a report card to each exchange as to how they are performing from a compliance perspective, and each one is read by other exchanges so that the effect is across all exchanges.

When we do a rule enforcement review, typically, it's very in depth. We will go out to the exchange and spend four or five days out there. We'll look at investigation files and disciplinary files. We'll look at their computerized surveillance systems which all the exchanges at this point in time use. We look at their recordkeeping reviews which can lead to substantive investigations, and we conduct our own independent tests of an exchange's one minute trade timing system for the accuracy of that system, and we also conduct our own independent tests of exchange trading documents, trading cards and order tickets, to make sure that members are in compliance with those rules.

Over the history of the rule enforcement reviews, we've made many recommendations for enhancements. The exchanges for the most part have embraced those recommendations and have implemented those recommendations. Some of the more significant results from rule enforcement reviews, in my view, have been the improved automated surveillance systems that are now used at all the exchanges. Of course, the larger ones have more sophisticated systems because they can afford them. But even the smaller ones who used to thumb through tons of paper to look for trading violations have automated their systems also as a result of recommendations made by commission staff. Increased levels of sanctions is another positive result from rule enforcement reviews.

Increased scrutiny of time and sales records to make sure that they're accurate, to make sure that if a broker wants to insert a trade or delete a trade, that that trade, in fact, took place, and we made a recommendation, in fact, in the horizontal review of that subject that all inserts and deletions have to be approved by at least two members of a pit committee or a floor committee, whereas before it was much less scrutinized and we think that that's a real positive step.

We've also made general improvements to audit trails and recordkeeping generally and at some exchanges we recommended eliminating cross trades where a broker crosses a customer's trade directly against his own account, which was a controversial matter several years ago. We've gotten some exchanges to do that, to prohibit that.

And just finishing up, I guess rule enforcement reviews assure the quality of exchange enforcement programs and they also educate exchanges as to the regulatory standards for meeting their self-regulatory obligations. And I just got the word that my time is up so I will ask for any questions?


MR. DODDS: Steve, from your perspective, what's the frequency of a broker problem? I mean is it once a month or ten a year or--

MR. BRAVERMAN: Well, from time to time we will get customer complaints directly here at the commission, which are typically complaining about a bad fill or complaining about an inaccuracy in the time of sales, insertions and deletions that don't make sense. Most of them are bad fills and the allegation is that the broker traded ahead of the customer's order and pocketed his fill. The frequency of those? They're not very frequent. The exchanges, on the other hand, also receive customer complaints. And our experience is that they're not that frequent at the exchanges either. The larger exchanges in Chicago, of course, get more complaints than others because of their activity level. But for the most part, actual customer complaints are down.


MR. PATTON: Steve, early in your remarks, you mentioned standards of board governance. I was wondering if you could expand that for me so I could understand that a little better?

MR. BRAVERMAN: The Futures Trading Practices Act of 1992, I believe, required exchange governing boards to be more diverse in their membership, and as part of that, boards now have more public director representation and diversity across floor membership so that there is equality among representation of the FCM community, the floor broker community, and the local community. So it's a much more balanced yet diverse governing situation.

CHAIRMAN DIAL: One last question.

MS. DANIELSON: Steve, on the number of complaints, you said it was down. Would it be one a month or I mean just any kind of range on that?

MR. BRAVERMAN: Well, I don't have any numbers precisely. But, you know, I think I would attribute it to the activity in the stock market, if I may. The levels of trading in some futures markets has flattened out and there is less volatility, and when there is less volatility, then there's less reason for customers to complain about bad fills, which is typically what they complain about. And I think that's an offshoot of a lot of money going into the stock market, not that there's not a lot of equity in the commodity markets, but when you get a market like the Eurodollars, which has been fairly flat of late, at least until interest rates were raised last month, you're taking the volatility out of the market, and you're going to have less customer complaints.

MS. DANIELSON: I'm just trying to get an idea on volume because you read about cases every once in awhile, but I don't know if those are really the exceptions?

MR. BRAVERMAN: I really couldn't give you a number. I mean from my experience, in a typical year a large exchange could get a couple of dozen given no anomalous market events, and a smaller exchange could get half of that or less.

MS. DANIELSON: Thank you.

CHAIRMAN DIAL: Okay. Steve, thank you very much--

MR. BRAVERMAN: Thank you.

CHAIRMAN DIAL: --for that excellent presentation. We'll move now to a presentation by David Fickert, who is the Industry Economist, Division of Economic Analysis, and David has flown over from our Chicago office to make this presentation on EA, as we call it, surveillance activities.

MR. FICKERT: Thank you, Commissioner Dial. The Division of Economic Analysis consists of Market Analysis Division, Research Division, and Market Surveillance Division. I'm from the Market Surveillance Division. Market surveillance has regional offices in Chicago, as Commissioner Dial mentioned where I'm from, New York, Kansas City, and our headquarters staff here in Washington.

Today I'd like to give you an overview of some of the day-to-day tasks and some of the issues that are relevant for Market Surveillance. Market Surveillance's primary mission is to detect and prevent futures market disturbances and to help ensure futures contracts trade and liquidate in orderly manner. As the title would indicate, Economic Analysis is there to look at the economics of the marketplace and the participants in that market. To do this, we collect two primary types of data.

We collect public data, which is obviously available to anyone. That data would include market news, reports, supply and demand numbers, cash prices, and all the data that's associated with futures trading: prices, volume, open interest, deliveries and all that goes along with that. The CFTC Market Surveillance staff also collects confidential data. This data would include exchange clearing member positions, individual large trader positions. Within large trader positions, that would include the actual futures position, background data on the trader, their location, what businesses they're involved in, and in some cases for hedgers we also collect cash position data.

This would be--and the confidential data--in addition, these two, the clearing member data and the large trader data, are collected on a daily basis. That's the clearing member and large trader data are collected daily from the FCM community.

Additionally, Market Surveillance collects private data as needed for different market events. Individuals are contacted and we will collect data including intentions to deliver or intentions for their trading position, cash position data, purchases, sales commitments, and other data to get some understanding of what's happening economically in the market with regard to the expiring futures contracts, all futures contracts, but specifically the expiring futures contracts.

Additionally, we're in constant contact with exchange staff and our counterparts in market surveillance at the exchanges to gather additional information. I've brought some examples that we can take a look at of some of the day-to-day things that we're doing in Market Surveillance. I'd like to use March corn expiration for our examples. Some of this data has been changed obviously for confidentiality reasons, but a lot of it, public information, we're using the actual data here.

This chart represents open interest. It's comparison of what we like to look at, some of the factors we like to look at, to judge what is going on in the marketplace. Just to give you quickly the general structure of this chart, this line represents the 1997 data, this line is '96, and then the previous years, the high-low range for that data, and what we're doing is counting down days till expiration.

1997 in this case you can see the open interest was above previous years, and we do this across all expirations taking a look at to see what kind of a decline, what kind of liquidation we get in the open interest, one of the measures to see how the market is performing. In this case, as I mentioned, 1997 is above 1996 and above what we've seen in the past years' ranges, possibly something that we would want to take a closer look at and determine why do we have this situation.

More public data that we're looking at: corn basis comparison. This happens to be for the second week of March. We compare at multiple locations, the delivery points: Chicago, Toledo, St. Louis, also basis values for Ohio Train, Evansville, Decatur, Illinois and other points, to take a look at what cash prices are with relationship to the current futures situation. In this case, again we're looking at the March expiration here--it happens to be basis for May though--to get some understanding where we are currently across multiple locations, the star representing '97, where we've been in the past, and where those locations, the values of those locations relative to one another.

All of the factors that we look at, both the public and private data, we're trying to piece together what's going on in the market. This is a representation of the March-May spread. In this instance, 1997 was an inverted market. Also, 1996 was an inverted market, but normally we're looking at a market that is in a carry. So this is another factor that we would put in, try to piece together a puzzle to determine what's going on from some of the public data that we have available.

And this is the last piece of public data that we have, I'm sorry, today. It's corn stocks in deliverable Board of Trade warehouses. 1997 is right down here. Obviously, as you can see, just by looking at the graph, 1997 falling so far outside of the previous year and of past years, another factor that you put in including in what you're doing and trying to evaluate the overall market situation and where from an economic point of view there might be concerns. This is the total deliverable supply that's available to be delivered quickly on a contract and this case on the March contract. Supplies could move into deliverable positions, but this is what we're facing at the time. And so when we're looking at what is going to happen as the market expires, we have to take into account the potential deliverable supply.

The other source of information we have is confidential data. The primary source of confidential data we have is our large trader reporting data. This chart represents reporting traders on one single day and their make-up in the marketplace alongside. Significant portion is made up by merchandisers, processors, floor merchandisers, floor traders and brokers, non-reportable positions--people who are below the CFTC reporting level, who we have no information on--the long side positions. Equally we have the short side positions. In this particular case, on the short side we had much greater number of non-reportable traders so less information, but again we still had merchandisers, processors, some of the other people who make up the positions in the market.

We know their positions because they're reporting every single day their position to the CFTC if they're over the reporting level. We have background data on them so we can determine who they are and put them into a particular class as we analyze the market.

The surveillance data is summarized for the commission senior staff and for the commissioners in surveillance briefings on Friday using a surveillance report. This is a more detailed data on the large trader data. We have the largest clearing positions broken down by what they have in their own accounts and what they have in customer accounts. The largest long positions, the largest short positions, ranked by size, and a little bit of the permanent records or what would be public data, exchange type data. We'll review this information looking at how large someone's position is. If ABC Grain has a position--this is in million bushels, by the way--for corn, 23 million bushels, their percent of the open interest is 32 percent of the open interest. As we will look at concentration and market participants and try to gather more information on those people, find out what their intentions are, find out why they're holding this position, what their hedge is against, with again the idea of trying to understand what's happening in the market to try to make sure we have a good idea of what's going on if things seem out of the ordinary. If we've heard a complaint, if it just seems to be an abnormal situation, we will take a look and try to contact these traders, usually via phone call, and find out what their perspective is on their market.

Steve Braverman mentioned the surveillance system. He was talking about the Exchange Database System which is a system that monitors what's happening in the trading pit and who's trading with who. We monitor position data and who owns the position. It's a little bit different than the type of data that they're looking at in the Trading and Markets Division. We have the ownership of the position. They also can look at that data, but we're looking specifically at who owns the position and what the relevance is to the economic part of the market as opposed to possibly more the mechanical part of the market of actually the trading.

The CFTC tries not to become a factor, but if we see concentrations that are very large or we have concerns because some of the fundamental factors seem to be outside their normal ranges or at an unusual level, the CFTC may have to become a factor. We normally start with phone calls, contacting traders, asking them what they intend to do. Potentially we could send warning letters after a verbal warning. Finally, after a formal warning, the commission potentially could have an emergency action, but obviously that's no one's intention.

Additionally, as I mentioned, we're in constant contact with the exchanges. The exchange has their own procedures. They have their business conduct committee, which reviews positions, finds out what traders are doing in the market, and if they feel they need, they will take steps to encourage participants to liquidate or roll positions or whatever the case may be to liquidate in an orderly manner.

Market surveillance goal is not to become a factor in the market but to continuously collect the information on the market and its participants so if need be the commission has what it needs if they need to become involved in a market expiration. Take any questions.

CHAIRMAN DIAL: Any questions?

MR. HELLERICH: Yes, Gary Hellerich from ASA. These investigations and so forth, you discover things that are not in order or out or order and so forth, you turn that over then to Division of Enforcement then to continue on with that or how is that process handled?

MR. FICKERT: Potentially something could be turned over to the Division of Enforcement. Our primary goal is to work before the contract ever gets to expiration, to be involved if need be before the contract expires to try to make sure it expires in an orderly fashion. If something were to be a major event and warrant a situation, then Enforcement would become involved in it. Steve Braverman or I'm sorry--they alluded to the March '96 wheat. That was something that eventually became an enforcement issue. But our goal is to make sure we're constantly on top of what's happening in the marketplace, contacting traders, contacting exchange, monitoring positions every single day to see what's happening in the market, and if need be encouraging people to act in an orderly fashion as the contracts expire.

MR. HELLERICH: Okay. Then what you're telling me then in that March expiring May contract in wheat there, you were on top of that then as far as it came toward expiration time?

MR. FICKERT: We have been following the March wheat contract right up to expiration, yes.

MR. HELLERICH: Okay. There is a lot of concerns about that out in the country, you know. Hey, why wasn't somebody watching this thing? Why did it get way out of hand? And so it's helpful to be able to come back and say, well, these things were being monitored and so forth.

MR. FICKERT: It was being monitored. Without specifically commenting obviously on any of it, it was being followed by the Market Surveillance staff, both at the Board of Trade and at the CFTC.

CHAIRMAN DIAL: Any other questions? Okay. Well, thank you very much, David. We'll move now to a presentation on CFTC's Fast Track Contract and Rule Approval Process, and I'll ask Paul Architzel to return to the podium and present Division of Economic Analysis part on the Fast Track Contract and Rule Approval Process.

MR. ARCHITZEL: David was just talking about contract expiration and our concern about price manipulation and orderly trading. One of our primary jobs here is to oversee the futures markets to minimize their susceptibility to such price manipulations or distortions. We think that one of the best ways of doing that is good contract design. If a contract is well designed, generally it becomes harder to manipulate the contract.

Following from that, we also think that preapproval of contracts is important, the reason being that after a contract starts to trade, it becomes more difficult to change its terms and conditions since they're listed so far out. Any time we would like to see a change made, it may not take effect for a year or more, so that in essence we're stuck living with having to do close surveillance of that contract while it trades out and new terms come in. So we think it's very important to look at contracts before they start to trade.

On the other hand, we also know that the ability to innovate and introduce new contracts is really important to the exchanges and their ability to compete. And we're pretty sensitive to that. Over the years, we've made great efforts to try and cut our review time of new contracts, preapproval time, while they're being reviewed, and we've been very successful with that. This chart shows the period from 1983 to the present, and it shows that our average review time has gone from over a year to down to about 90 days for the average contract.

Last year we approved about 90 contracts futures and options, which gives you an idea of the volume we're looking at in our designation process. In addition to new contracts, we're also looking at amendments to terms and conditions of existing contracts, and these are also important to look at because they may affect commercials in the market, they may affect the pricing on the contract, or they may affect delivery points, for example, which has a direct bearing on commercial interests using the contract.

Now, what we've done and to be even more responsive to the exchanges in this process, is to promulgate new fast track rules, and what these rules do is cut our review time even further, and this summarizes where our time periods currently are. We either will review new rules in ten days if they're very routine and fall into certain categories or 45 days if they're not routine-type contract terms.

With regard to new contracts, certain types of new contracts like cash settled contracts not on agricultural commodities can be reviewed in ten days. All other contracts will be reviewed in 45 days. Those are all contracts which are physically delivered as well as cash settled agricultural contracts. Now under this fast track review, if it's a 45 day period, we have an opportunity for public comment, which we think is very important. We may have contacted some of your members or you for trade interviews or we may have a public comment period in the Federal Register in which you will have an opportunity to write in views on your contract. We think it's important to be able to find out from the trade, from commercials, and out in the trade what their views of certain proposals by the exchanges are in order to review them better.

The other part of the fast track procedures are that these time periods give us an opportunity to work with the exchange toward fixing a contract that has a problem that may be fixed and getting it approved and trading. So we're trying to provide an efficient system where we're not wasting our time writing a lot of letters or doing a lot of paperwork or legal requirements or procedures to get the contracts out of here and trading, and we think that certainly our procedures do that.

The goal of our fast track rules are to compress the time for commission review of new contracts and amendments to contract terms and conditions, to provide certainty to the exchanges when our review will be finished so that they can go ahead and plan on their marketing and launching their new contracts. However, one of our goals is also to preserve the preapproval review that I spoke about, to ensure that the contract design is built into the contracts from the beginning, and also to steer clear of inefficient and costly corrections that would have to occur later if we didn't have the preapproval process.

We also built into this system a little bit of flexibility which we think is important based on our experience over the years. We have a 30 day period that we can extend, the basic ten or 45 day periods, and that would be for complex or novel contracts or specific rule proposals. Some contracts are more complex than others. The first time you may have a cash-settled contract, for example, it takes longer to review it. There are more people who have interests that need to be spoken to, and there may be more legal issues that need to be resolved. There is some flexibility that's required, and we've built in a certain amount of that flexibility into the system.

Finally, our other goal was to maintain an opportunity for public comment either through the Federal Register at a comment period or through conducting trade interviews on our own. We think that that's an important aspect of our current procedures that needs to be maintained.

One of the ways we've gone about cutting our time periods is to provide for more electronic use and processing. This overhead transparency is the page from our Website. It can be accessed through "What's Pending" and under this, the first page are all fast track contracts and also rule proposals will go up later. We're currently in the process of getting this set up. By using this, anyone of you will be able to access our Website, see what's pending. You will be able to access directly the terms and conditions of the proposed contract and then using a return signal from the program, you will be able to send in your comments directly to us by return e-mail.

In this way, we'll be able to compress the time we take for public comment periods, give you all an opportunity to comment and make it easier for us to process the paperwork part of it, which leaves us more time to do our analysis. So that our pre-trading analysis of contracts will continue at about the same depth and intensity, and yet we can make the whole process run a lot faster by providing for an electronic handling of this.

We have asked the exchanges to provide their submissions electronically, and the first, this page is up and running now on our Internet and Website, and we are making use of it. So far we haven't gotten any comments in on it yet, but we've only gotten one or two contracts in at this point using the fast track procedures. Are there any questions I can answer?

MR. ACKERMAN: Paul, what is the general volume of new contract proposals that you're receiving these days?

MR. ARCHITZEL: Well, we did 90 last year. For this year, the calendar year, we're up to 41. So I would say that the exchanges continue to develop new contracts at a fairly rapid pace, and we are keeping pace with them now despite the fact that we have fewer staff than we did ten years ago. We certainly have greater expertise and more efficient systems to deal with that load.

CHAIRMAN DIAL: How many comment letters have come in on the proposal for changing the delivery terms to the CBT corn and beans?

MR. ARCHITZEL: At this point, we have about 370 in house and it looks like the flow is still coming in. None of those have come in electronically. They're all on paper, which is an amazing burden considering we need four or five copies in our division alone for people to look at. So the time spent in xeroxing that number of comments is quite a burden. Hopefully, this new system will ease that, and we'll be able to process things quicker.

CHAIRMAN DIAL: Any other questions? Okay. We'll move on then. Thank you very much, Paul. We'll move on to a presentation by David Van Wagner, Special Counsel, Contract Markets Section, Division of Trading and Markets, who is going to talk about fast track and the rule approval process.

MR. VAN WAGNER: Good afternoon. In addition to the fast track review procedures for rules that relate to contract terms and conditions, as mentioned by Mr. Architzel, the commission recently adopted a similar rulemaking to streamline the process for the review of exchange rules that do not relate to contract terms and conditions. This body of rules covers a wide variety of subject matters ranging from straightforward rules such as exchange administrative matters and exchange membership requirements to more sophisticated rules such as automated trading systems, margining systems and market maker procedures.

The types of rules covered by these provision's also demand a wide variety of regulatory responses from the commission. Some require commission approval under a section of the act or the commission's regulations. Some require approval because the submitting exchange requested that treatment, and some may be put into place without approval but upon the prior review of the commission. The commission deals with a large volume of these non-term and condition rule proposals. We handle about 300 of these submissions per year, and each submission might actually contain a number of rules within it. This average of about 300 submissions a year has continued for the past three fiscal years.

Under the new fast track rule review procedures, all non-term and condition rule changes are either deemed approved or permitted to go into effect without approval ten days after they're received by the commission unless the commission finds that the submission either raises novel or complex issues or is of major economic significance. In these circumstances, the commission will retain proposal for additional review of either 45 days or 75 days in those instances where it decides to publish the submission for comment in the Federal Register.

At the end of this extended 45 or 75 day review period, the commission again will either deem the proposal approved or allow it to go into effect without approval unless, of course, we initiate disapproval proceedings for the submission. Prior to the adoption of these fast track rule review procedures, there were two review tracks for non-term and condition rule changes. Rule changes which didn't require approval were disposed of within ten days of receipt. Those that did demand approval were disposed of within 180 days.

So these new fast track procedures will have little if any effect on those rules which do not require approval, but it will significantly reduce the amount of time that we will have to look at those which do require approval, cutting it down from 180 days to as little as ten and at most 75 days. The commission's new fast track procedures should help the exchanges to implement their rule changes in a prompt and timely manner and it's also responsive to the exchanges' needs to act in a fast moving competitive environment.

The fast track procedures, however, retain the requirement that all rules be subject to prior review. With prior review, the commission is able to assess the impact of these rule changes on persons who might not have been involved in exchange's formulation of the rules such as non-member market participants and the general public. In addition, prior review ensures that the commission is able to solicit either informally or formally the views of market users, other regulators and other interested parties with respect to a rule proposal. These parties often provide us with insights and help as to the possible impact of rule proposals. I'd be happy to answer any questions you might have about this.

MR. LINDAU: Did you say how many of these requests you receive in a year?

MR. VAN WAGNER: Well, right now we probably average about 300 rules submissions. They might contain a variety of rules within them, but 300 of these non-term and condition rule submissions.

MR. LINDAU: And of that number, how many are rejected?

MR. VAN WAGNER: Most of them are not. Well, actually very few are actually disapproved. There are a handful which, upon the urging of staff, the exchanges might withdraw. There is a significant number of them which are modified after interaction with Commission staff here. It's definitely an iterative process between us and the exchanges when they come in with things.

MR. GILLEN: I'd like to ask you about one of the contract rule change proposals in your handful. That is a rule change that was proposed by the New York Cotton Exchange, I believe, in 1993 or 1994 to render ineligible from the certified stocks cotton that was pledged to the CCC loan as collateral. The commission placed a tremendous burden on the exchange. It submitted a list of vague questions for the exchange to answer to which they did, and somehow this proposal is still pending. I don't think it's on any type of track. It's been derailed, and I just wonder how the commission staff or the commission can place itself in a position to be determining what an economic purpose is?

MR. VAN WAGNER: I have to admit I'm not particularly familiar with that submission. Sometimes the give and take can be laborious, but--

CHAIRMAN DIAL: Fred Linse with the Division of Economic Analysis.

MR. LINSE: Mr. Gillen, as you may recall, that particular proposal was submitted for commission approval, I believe, on two occasions. The division after reviewing the proposal, which included contacting people in the industry and reviewing public comments submitted in response to the Commission’s Federal Register notice on the proposal (many of which were of negative nature), we determined there was serious policy questions about the potential impact of this proposal on the deliverable supply of the commodity available for delivery on the futures contract. Accordingly we remitted the proposal to the exchange for further justification.

The current status of the proposal is that it is back with the exchange. The exchange may respond to the Commission’s request for further justification if they so choose.

MR. GILLEN: Am I to interpret your answer to say that the commission is predisposed to disapprove the rule change?

MR. LINSE: We haven't made any determination to disapprove the proposal, but we did feel there appeared to be serious policy concerns. We are still expecting the exchange to provide more justification for the proposal that would alleviate these concerns, if the exchange decideds to resubmit the proposal.

MR. GILLEN: I'll just finish and raise a question. Are these policy concerns or political concerns?

MR. LINSE: No, these are policy concerns.

CHAIRMAN DIAL: Any other questions?

MR. VAN WAGNER: Thanks very much.

CHAIRMAN DIAL: Thank you very much, David. We'll move now to the final item on the agenda before we take our break, which is the Approval Process to Establish a New Futures Exchange. Alan Seifert, the Deputy Director of the Contract Markets Section, Division of Trading and Markets, will make a presentation for T&M, and then Fred Linse will return to finish with the presentation, the part by Economic Analysis.

MR. SEIFERT: Good afternoon. We will now move on from specific rules and designations to, as Commissioner Dial indicated, a discussion of the designation process for an entirely new exchange. The self-regulatory core of a new exchange is found in its proposed rules. Those rules have various different characters. One category of rules is dictated by the various standards that you've heard various speakers talk about that are found throughout the Commodity Exchange Act and the commission's regulations. And those standards run the gamut from governance, financial minimum standards, disciplinary program standards and so on.

The second category of rules, which Fred Linse will talk about, are those rules which address terms and conditions of contracts that are to be traded on the exchange themselves. The third category of rules are those rules which while not required to be put in place by any specific provision of the act or the commission's regulations are rules which are not inconsistent with those provisions and the exchange elects to put into place subject to commission review.

In addition to reviewing all of those rules, which in the instance of a new exchange amount to a substantial number, the commission staff will also look at the other aspects of the self-regulatory program of the exchange. Those aspects include the human resources that will be directed toward the various functions that have to be performed by a self-regulatory organization, the significant operational programs that have to be in place. These are most notably, provision for the clearing and matching of trades on schedules and with collection of funds that meet the appropriate regulatory standards, and, of course, as has been mentioned here before, the programs that the exchange will have in place to assure that there is compliance with its rules including effective surveillance programs to address the different areas that have been discussed heretofore.

Once an exchange has all these rules in place, they've been reviewed by the commission, the commission has either approved them or allowed them to go into effect, then the exchange has a legal obligation to enforce those rules, and then we move on past the actual designation process. Insofar as an exchange intends to provide for trading through an electronic means, then part of the commission's assessment of the proposed exchange's readiness to become an exchange is to determine whether the electronic means selected by the exchange will be adequate for them to serve their intended purposes.

The commission in 1990 adopted a set of international standards that were sponsored by an organization some of you may know whose acronym is IOSCO. Those standards are the guiding light for the commission's technical staff in looking at electronic trading systems. There are ten standards. I'll just mention a few. They go most notably to issues such as access to the system. A big concern is the extent to which someone might gain unauthorized access, the extent to which people at a computer might be able to enter trades when they were not the authorized party to do so.

What we identify as the “algorithm” is of fundamental importance the system. It is basically the provisions that determine who gets matched against whom under what terms in the actual operation of the market. Obviously, the fairness that that algorithm provides for or fails to provide for is fundamental to the existence of that prospective exchange.

That's an overview of the exchange designation process. I'm now going to address a specific proposed exchange that's before the commission. There has been some press on this so I'm sure that some of you have heard about this exchange. It's dubbed Futurecom. It is intended to be the first futures exchange that will operate via the Internet. Initially it's to provide for cash settled live cattle futures and option contracts. Members will be provided access through a password and user ID to what have been identified as secure Futurecom servers that will be provided by Futurecom. Orders will be entered on standard electronic data entry forms. Matching will take place anonymously in accordance with very simple price time priority algorithm provisions.

Users will be able to receive real time quotes and account information throughout the operation of the trading day. Trading hours are proposed to be 8 a.m. to noon Central Standard Time. This proposed exchange is one that raises some novel and complex issues. It is the first of potentially a large number of Internet exchanges. If the commentary of some of the people in the industry is to be taken seriously, there are a number of other entities and individuals waiting in the wings to pursue this type of exchange operation. So since it is the first time that the commission is looking at this, since the Internet is to some extent a moving target, this will be something that will be scrutinized carefully by the commission staff and the commission.

The initial submission came in in January of this year. There was a Federal Register release requesting comment that was published the last day of January. Process-wise, we are in the early stages of consideration of this exchange. The exchange just this week sent in a substantially revised rule book that is something that we will be looking at in the immediate future. We have begun, in consultation with the computer staff at the CFTC, our technical review of the exchange systems that will be employed in the operation of Futurecom.

At this point, the commission staff have open questions regarding how this exchange will operate. We don't have necessarily all the information that we will need to have in order to evaluate this exchange, but the process is underway. After we review the most recent submission, then at an appropriate time, we will make more information available to the public. Clearly there already have been and will be significant additions to what is before the commission in the record of Futurecom that will need to be made available to interested parties, and we will do so.

In sum and finally, the issues that we probably will be spending most of our time on in dealing with Futurecom will address the clearing mechanism and procedures, the compliance and surveillance programs of the exchange, and more generally just getting enough information that assures us as to the ability of the exchange to fulfil its self-regulatory duties. As I have mentioned, we'll be looking at access and security issues related to the fact that the way that people will be gaining access to this market will be through the Internet. Those are my remarks. I'd be glad to answer any questions.

MR. HITCH: Paul Hitch. Is there a two-step process or is it all tied up in one? And the question is you have an exchange, you have a contract; is the approval process considering both the establishment of the exchange and the approval of the contract or is that--I mean I can consider if there are two, you could get an exchange approved and a contract denied, and you've got an exchange with nothing to trade on it.

MR. SEIFERT: Well, that wouldn't really be a very successful venture, and therefore the answer is that, yes, the commission staff's review of both goes forward simultaneously. Fred Linse, who will be before you in a moment, will talk about his simultaneous review of the contract. So, yes, we review the entire package at the same time.

MR. ACKERMAN: Alan, there have been other computerized trading systems before. Could you talk a little bit about what makes doing it on the Internet different? Is it simply a matter of security or are there other factors?

MR. SEIFERT: Well, I as you know am a lawyer, and so I'm not necessarily going to identify every technical issue, but there certainly is the fundamental difference that people are not going to be using telephones or other, heretofore conventional means of communication. They're going to be communicating through getting on-line through some Internet vendor. There will be issues of getting through and of looking at the adequacy of encryption. There will be various issues that go to the operation of the Internet generally, but then there are also related technical issues regarding the hardware that will be selected by Futurecom that we will be looking at very carefully because there are all kinds of issues about vulnerability and so forth whenever you have hardware. That aspect is more common to previous electronic trading systems.

MR. ACKERMAN: Do I understand you right that someone could have access, say, by getting on the Internet through America On Line or a system like that? And at that point, there are questions of whether the intermediate access provider becomes somehow a party to actions on the exchange or am I misunderstanding you?

MR. SEIFERT: They will have to have access--

MR. ACKERMAN: I guess not a very good question.


MR. SEIFERT: They will have to access via the Internet Futurecom secure servers. And so there should not be, as it has been presented to us, an open question about the security of the system. But exactly how this will operate is something that we're, as I stated, in the beginning stages of evaluating along with our technical staff.

MR. LINDAU: I've read the application, but I can't remember if it identifies itself as a for-profit or not-for-profit operation?

MR. SEIFERT: This will be, I believe this will be a limited partnership for-profit organization is my recollection.

CHAIRMAN DIAL: Any other questions? Okay.

MR. HITCH: Any estimate on time scale of when the thing might be approved or denied or resolved?

MR. SEIFERT: At this point, I can only tell you that this is something that we are actively engaged in and it would be premature for me to give expected completion date.

MR. ACKERMAN: Alan, are there similar models in the securities world of trading systems on the Internet that people have experimented with or is this concept novel throughout the financial industry?

MR. SEIFERT: To my knowledge, there are systems on the Internet that provide people with access to trade through their broker dealer, and that might be analogous and that might be very similar, but to actually have an exchange, it's the only one that I'm aware of, but that's not necessarily the gospel. I can't speak for the latest developments on the security side.

CHAIRMAN DIAL: Okay. Alan, thank you very much. Fred Linse, Agricultural Commodities Unit, Division of Economic Analysis.

MR. LINSE: I'm going to briefly describe the division's review process for proposed new futures contracts, such as the live cattle futures contract that is being proposed by Futurecom. As Alan indicated, the Commission’s review process for new exchanges consists of two phases. Alan’s division is focusing on the general rules and the trading aspects, and my division are focusing on the proposed terms and conditions of the futures and options contracts.

The division’s review proposed new contracts is performed by economists. The primary focus of division’s review is to assess the susceptibility of proposed futures contracts to price manipulation and distortion. For physical delivery contracts, such as the Chicago Mercantile Exchanges live cattle futures contract, we're primarily interested in assuring there is adequate levels of economically deliverable supplies available for the futures contract. Accordingly, we assess the quantities of the commodities available at the proposed delivery points that meet the contract's quality requirements. We also look at the concentration in the ownership and control of the delivery facilities.

For cash settled futures contracts, such as the Futurecom proposal, we evaluate the susceptibility of the proposed cash settlement price to price manipulation and the extent to which it reflects the cash market. We also look at the cash price series that underlies the cash settlement price to assess whether it’s a reliable and acceptable indicator of the cash market value of the commodity. In addition, we determine whether the underlying cash price series is publically available and whether it’s available on a timely basis.

As part of our review process, I did want to mention that we obtain information from a lot of different sources. Typically, we contact people in the cash market to obtain the information that bear on these particular matters. If necessary, we also contact other government agencies. Finally and also very importantly, we publish these proposals in the Federal Register for public comment. In doing so, we seek the input of members of the public, such as yourself, on proposals with the hope that we will obtain information that will be useful in our work. In fact, we have over the years obtained useful information through this comment process.

So with that, I will conclude my remarks. Again, in our review of the Futurecom proposal we are evaluating the susceptibility of the proposed cash settlement price to price manipulation and distortion using the standards that I mentioned. If there are any questions, I’d be happy to answer them.

MR. HITCH: Have you gotten lots of comments?

MR. LINSE: If I'm not mistaken, we have received about 20 comments on the Futurecom proposal to date.

CHAIRMAN DIAL: Any other questions? Okay. Well, thank you very much, Fred. We'll take a break now, and then we'll come back about 3:20.

[A short break was taken.]

CHAIRMAN DIAL: The second half of the meeting this afternoon is going to begin with a report on USDA's Risk Management Education Program with particular reference to the summit on September 14, 1997 in St. Louis, Missouri. Ken Ackerman, the Administrator of the Risk Management Agency of USDA, is going to make a presentation, and as you all are aware, Ken is USDA's representative on the Agricultural Advisory Committee. So Ken, it's all yours.

MR. ACKERMAN: Thank you. I will be very brief on this because I know there are a lot of other items on the agenda. As I think all of you know, last month on April 10, we announced kind of jointly, USDA and the CFTC, the formal approval of the Risk Management Education Program. That announcement coincided with a presentation and hearing before the House Agriculture Subcommittee on Risk Management and Specialty Crops at which I testified along with Chairman Brooksley Born of the CFTC and Bob Coopman of CSREES where we announced the formal kicking off of the Risk Management Education Program. Also at that hearing were a number of the stakeholders in the Risk Management Education Program including many groups represented around this table from both the insurance industry, the futures industry, and many of the grower organizations as well as the grain trade.

That hearing I would emphasize got quite a lot of attention in the media. It was covered by C-SPAN. It was covered by Channel Earth, which is the new all agriculture network that has recently been set up and is operating on Direct TV.

The major elements that were announced last month with the formal education program included the creation of a steering committee whose membership consists of the three agencies that I've mentioned, the Risk Management Agency, and CSREES from USDA, as well as the Commodity Futures Trading Commission. We have put together a working group that represents not only the government agencies but also the private sector stakeholders that has been meeting very energetically and putting in a lot of hours since that time to get the program up and running. We also announced that we would be making a financial commitment to this effort.

Our budget for fiscal 1998 contains $5 million that are earmarked to cover a number of projects in the education program, primarily in setting up a delivery system to get education out to the field. The formal kickoff of the education program will be at the meeting in September. We are looking to put together a two-day meeting. The planning is now underway by the working group. The first day will be a set of public events to emphasize the importance of risk management education. The speakers will be high officials in government, both the executive and legislative branches. We expect to have quite a bit of participation from the various industries, futures, insurance, grain trade, with various grower organizations in both the grains crops as well as livestock and dairy all participating in it.

The second day will be a substantive set of train-the-trainers sessions on topics ranging from marketing, production, finance, legal liability, human resources, and the actual substance of risk management. Those sessions would be replicated at the local level and would become the basis for getting information out directly to farmers. The education effort, the face-to-face education effort to farmers would be carried out, we would anticipate primarily by local opinion leaders including local business people, again, agents, elevators, brokers, as well as the local farm organizations and extension agents.

So as not to bury the lead, the two most important things you need to know about the kickoff are the date, which is September 16 and 17. I believe that's a Tuesday and Wednesday. It will be in a major midwestern city to be determined. Apparently it's down to Kansas City or St. Louis, possibly Chicago, depending on how the accommodations work out. I think all of the groups here represented in the room today would have an interest in being involved in it.

The second main thing to know, this is Bill Murphy sitting over here. Bill is our lead person at the Risk Management Agency in pulling together this operation so if you haven't been actively engaged in it so far, please make a point to talk to Bill before you go. With that, I'll take any questions if there are, and if not, I'll turn it back over to--yes, sir.

MR. PETERSON: You mentioned dairy, and it just jogged my memory. What if anything is new with the Dairy Options Pilot Program?

MR. ACKERMAN: The Dairy Options Pilot Program is being actively reviewed by USDA. They are looking at both the funding issues and legal issues as well as the program itself. There have been no determinations made on it yet, but it's under active review. We've heard quite a lot of interest on it from the industry and from interested parties. It's something that we're focusing on. Any other questions? Thank you very much.

CHAIRMAN DIAL: Thank you, Ken. We'll move now to a presentation by Kevin Brinkley who is an economist for the National Cotton Council of America. He's going to make a presentation on their Risk Management Education Program. Kevin.

MR. BRINKLEY: Thanks, Commissioner. We appreciate the time to be here on your schedule today, and I know we're in a hurry. We, as a result, as many of you have heard, as a result of the new farm legislation that we're working under nowadays--we started operating under the new environment, and one of the advantages we have as an organization that is made up of several different interest groups is we have a lot of feedback, and some of the feedback that we began to hear even as we saw how the bill is going to take shape was that, you know, fine, you're going to give us this new marketing environment, teach us what to do with it. And so over the last really two years, we began developing risk management initiatives, we call them, and we've taken three different areas so far. We'll be expanding this as we learn how to cope with this new environment.

One of those areas is we've tackled a subject called risk decomposition, and we've taken geographical areas of the United States and we've analyzed those based on USDA statistics by crop districts, and what we come up with is the risk factors that are faced by producers, whether it's due to acreage shifts or prices or yields, and that can be helpful to a producer to know whether he ought to be more interested in crop insurance or maybe he ought to be more interested in commodities markets.

Another area that we've done, and this again was where feedback was so helpful from some of our cooperating associations, is we've gone into the area of risk management education, and our good friends over at the American Cotton Shippers Association were helpful in getting us steered in the direction of a risk management video, and I brought one here to leave behind with Commissioner Dial, but we're very proud of this project. We took and went out and found some of the best marketing experts we could find in cotton, and we got them on videotape doing step by step instructions about how to effectively manage risk in the cotton markets, and so I'm sure we'll probably do more of these type projects, but this is our first one called Price Risk Management: The Basics, and we're very pleased with that product.

A companion product that we've developed along with that is a workbook, and again this goes step by step through what they need to do, and it's geared toward anything from beginning level marketers all the way up through intermediate, and this will also be available to our members.

Well, the third area that we got into is the Cotton Risk Management Network, and one of the things that we discovered when we got into this process about educating our members is that they didn't really have the information at their disposal, and with the Internet developing the way it is, we decided, well, hey, why not transmit the information to them electronically. And so we did that. We got some sponsors from a couple of foundation members that we have, the Seneca Ag Products and the New York Cotton Exchange, and they sponsored us to build this network, and what it is is a piece of software that we will give to producers and other members of our association to educate them about risk management, prices primarily. We'll also have several other features that I'll cover in this little short demo that we'll do here today.

This is the start screen, and probably this is where they'll come everyday to begin, and they'll update, and the data that you see in here is updated at the end of the day. This is not an intraday. It's not meant to be a trading system. It's for education. And so we update this data. They will be able to get this sometime either late in the evening or early the next morning. But we got three areas here. You saw the bottom. We've got it segregated in three distinct areas: market data, market intelligence, and market scenarios.

So if we come over to the market data section, you see six buttons appear over here on the left, and those are futures, options, cotton program variables, U.S. market, and world market, and then we have a little interactive section where they can combine various prices. So if I come over to the futures button, we'll see appear here on screen another area, and we've got four different commodities here. We've got cotton and we've got the major competing crop. So if I go back over here to the cotton button, and they'll have over here at their disposal a list of the active and historical contracts. We've given them about five years worth of data here.

They can isolate their date ranges, and they can examine this data for patterns. Well, that's all very nice, but most people have a hard time probably identifying with numbers so we added some analytical tools in here. We put some charting facilities in here, and you have here a standard line chart for the close of the market. We've also given them some of the tools that you're used to seeing, candlestick charts, and high-low close charts, and volume and open interest.

And so we've got this available also for the corn contract, for soybeans and wheat, same types of information, same type of interface, and so we feel like this will help these producers with the 100 percent planning flexibility that they have. This will help them be able to make those decisions because we're interested primarily in their profitability.

Go back to the market data section. One of the areas that our guys are getting used to more and more is futures options contracts. We put cotton options in here. And you see this very simple screen really. Down the left hand side you have dates, trading dates, and then across the top we've listed strike prices, and again we have a selection box up there. We've got several contracts available here, but I've just pulled up a July '97 put, and you got the strike price and the premiums listed in the table below, and again to help them keep track of the trends in these different strike prices.

If I go back over here, we've got--cotton, of course, has a lot of interaction with government programs, less than it used to, but we're still involved in this market, and we have over here our marketing loan rate, our course count adjustment for some of our growths. We have transportation, our adjusted world price, and certificate values, which are very useful to all those involved in the market. So we give these out again on a weekly basis as they're announced by the Secretary of Agriculture.

Well, another area that we have is U.S. markets, and I apologize for my short-circuit here. Here you see spot markets, and USDA collects spot prices from seven regional markets around the U.S., and you see here the dates down the left-hand side and across the top you'll see some abbreviations, SJV, DSW. Those are the regions. And we've given them the ability again to isolate date ranges. We've got graphics abilities here, and they can look at two different growths of cotton, more of a base grade of cotton and then a nicer middling grade. If they want to see what the abbreviations are if they're not used to it, they can hit that little button and it will pop up some definitions there for them to look at.

I won't take the time to go into it, but we've also got this for U.S. mill deliver prices which comes out on a weekly basis. Getting back over here to our market data section, one of the areas that our producers especially are not used to looking at is the world market, and what we've done here is provide them with a way to judge what is the average world price of cotton and what are our competitors doing in the international markets. And this has been very helpful to examine this data because we export typically about 45 to 40 percent maybe of our cotton every year, and export figures definitely play into our prices there. So you can see that they've got the A index, which is the average of the lowest five world prices, and if you scroll down through here, we've got our competitors, and here you see a Memphis quote and a California-Arizona quote, and again we can see where we can fit into the world picture. And we also have that for the next crop year as it's reported.

Now head back over the market data section one last time, and if you look over here on the left, you see a button called "Interactive," and this is the button that allows us to combine different price series, and for them to do their own analysis about spreads between these different prices. Here I've just pulled up the current A, which is the world price, a spot price that's comparable to that world price, and a futures contract, a December futures contract, which you might want to compare to that, and so if you hit that "Calculate" button, it brings those all together, but where this probably makes the most sense is if we go back over here to the graphics section, and here we see some pretty steady relationships between these prices, but at times during the year, these prices begin to take on different relationships, and some of them even invert at different times, and it gives producers signals about where the market is headed from there, and so this is a section that we really think is going to be useful, and we're even going to enhance in the future.

I'm going to jump to another area, market intelligence, and here I've got a couple of tools at my disposal, and they're really simple tools. One of the things that we've found was those involved in the markets out there really have a hard time probably keeping up with all the different events that go on that affect a market. You know we get calls up there at the office, hey, the market was limit down today; what happened? Well, you know, USDA came out with some kind of a bearish report or something like that. So what we try to do is put a calendar up there, and it has some abbreviations up there that may not make a lot of sense on first glance, but what we've done is try to fit those abbreviations in the box, and you see like back here on Monday, the 12th, we had a WASDE report, and if you click over there, you actually see down here in the box a description of what was happening on that particular day.

And what we hope to do over a period of time is get people used to here is the cycle of events, and if there is something special, look over here on this calendar and get ready because these things are relevant to what might happen in the market.

I've got another tool at my disposal here, and this one is actually one that we're more responsible for the input in here, but we've got a section for narrative reports, and what we've done here is provide a forum for outlook reports from industry economists. We have gotten a section for strategy reports from market analysts. Anything that might have an impact on the way a producer thinks about a market or the information that he can get about export movements or anything like that, we're going to try to put those things up here as often as we can to help them understand what's going on out there. So we think this will be very helpful as well as we get input from across the industry to help them.

Well, we've got one last area to cover here, and this one is called market scenarios, and here I've got a couple tools to look at. One is the World Price Model. Now there's an organization actually based here in town called International Cotton Advisory Committee, and they're an organization made up of several governments that grow cotton, and what they've done is they've developed a price forecasting model for an entire season. Now our season in cotton runs from August to July. And what they've done is they've developed an econometric model that will say we think the price will be 79 cents over the next season or they're actually able to go two seasons out.

And so what we've done is we've developed an interface that shows their data against actual data. So the user of this system can come in here and look at their prediction, and that would be that green line there, and actually we're looking at the '93 crop year. Let me get something a little more current up here. This is the current crop year, and we see here that we've got that prediction in the green line, and actually prices for this entire crop year are running a little below their average, but if I were to go back and map out what their performance has been over the past few years, it's been actually very accurate.

But we think the power of this comes in for the user is the user can say all right, well, that's ICAC's guesstimate. I actually think that China is going to import a million bales less than what ICAC says. And so I change their estimate and hit "Calculate," and you can see that if China drops out of the market by a million bales, look what it did to the price. It lowered it, and therefore they can get an idea about the things that influence the world cotton market prices and they can be aware of those things as they're happening on a day-to-day basis, and hopefully teach them to anticipate some of the future movements of price. And again this is not to predict or project a price at any one point in time, but to help them understand the things that influence such prices.

I've got one last thing to look at here, and that's the farm returns model, and again this one is geared primarily at producers. But anybody could really use this to see the impact of prices and cost on acreage shifts. So what we have here is we have at the top of the screen a cotton price and up to three alternative crop prices. And so if I want to go in there and put in my expectations--I'll just change this to something more like soybeans. I could go in here and put in my acreage numbers, and this would be for different fields on a particular farm, and I've got three fields here, 200, 300 and 400 acres. I can go in and put in my cost structure and per acre for cotton and that competing crop, and I can also put it in in fixed costs, and the thing that you can also play with in here is yields.

And so you could go in and vary those yields as many times as you want, and what you can do once you have those in there is hit this "Cash Basis" button, and this returns to you the returns per acre in dollars or in total for your enterprise, and you can see here that on field one that alternative crop, say soybeans, was a better choice, and, in fact, on all three of those fields soybeans was a better choice for this guy.

But what you can do is play what-if with this model. You go in here and you change the prices, recalculate as many times as you want, and we think this will be especially helpful to those that are evaluating financing out there in the country. Bankers are getting more and more concerned about these issues, and this will give them yet another tool to carry in there and say, look, I've evaluated all these alternatives; how can we accomplish a profitable year?

That's really all of our areas. Let me back up and show you one more thing. I do have that also in a percentage return basis as well as cash. That's really it in a nutshell of what we developed. We do have some things that we want to do in the future. This is kind of a crawl-before-you-walk product here. We've got some things like an ag risk program that some of you may have seen that from Ohio State. We're talking to them currently, but that computes probability distributions for expected yields, prices, things like that. We want to do a T-Account Wizard to help them step through that process little by little and also something to manage their portfolio. Enterprise Budget Builder is another big one when you get back to the question of financing. It's something that will allow them to do a detailed analysis of that and break down acreage acre by acre, and then probably the last thing that we want to accomplish is maybe a trading simulation area in here where somebody who is not experienced in trading commodities markets can go in and actually play the game for awhile without actually putting any real money into it because there are several out there who have never even touched this stuff, and they need to get their feet wet gently.

So those are some things that we want to do. We're looking evaluating the partnerships. We've got some partnerships with like I said cooperators right now, but we're evaluating that with other parties as well as we move into this. Commissioner, I'll be glad to answer any questions at this time.

CHAIRMAN DIAL: Any questions for Kevin? Yes.

MR. MURPHY: I've see this program several times. It's an excellent program. Have you been approached by any of the other major commodities to do a similar one for them?

MR. BRINKLEY: Well, we have, but--

MR. HEITMAN: Could you repeat the question because the reporter can't pick up anything from the audience?

MR. BRINKLEY: Sure. The question was have we been approached by other commodity organizations, and the answer to that is, yes, we've talked about it with them lightly. We haven't actually gotten into any serious discussions. We didn't want to do that until we got this one fully up and running, and we're--by the way, I didn't mention we're planning on deploying this on May 28 of this year. But we are evaluating that, and, of course, we're interested in talking to other folks about ways of partnering up with them to make this a more efficient process. Other questions? Yes.

MR. GILLEN: Neal Gillen. Kevin, you might mention/talk about costs of this particular software to members of the National Cotton Council.

MR. BRINKLEY: That's one of the best parts. I can't believe I forgot to mention it. Because of those sponsors that we got, we were able to give this out to our membership at no cost. It is a service of being a member of our organization, and the only thing they have to do is be connected to the Internet, which is getting more and more commonplace. So if they're a member, they'll have this service at their disposal.

CHAIRMAN DIAL: Any other questions?

MR. HELLERICH: Yes. Gary Hellerich here. What is the cost to non-members?

MR. BRINKLEY: They can't afford it. We're not making it available at this point to non-members of the organization. We do a lot of things at the National Cotton Council that you can get the benefit of it whether you're a member or not, but this is one of those kind of gold-level membership benefits that at this point anyway we're not making available to non-members. Yes.

MR. VANHOOSE: Todd Vanhoose with the Farm Credit Council. Have you worked with any of the lender community on trying to come to grips with the things that a farmer can take out of this kind of a program? Can he take that to his lender and is that what his lender is looking for?

MR. BRINKLEY: Well, we again took some very I don't want to call them baby steps because we feel like there's some important tools here, but as we move through the next stages of this, one of the things we're looking at doing is forming I'll call it a task force or a council or something for feedback to evaluate this program and say what shall we do with it in the future, and in that task force we want to include people who are clued in on the lending industry and what's important to that, and how can we make a program like this spit out the results that help a producer and his lender communicate.

MR. VANHOOSE: Well, I mean I see this as a good first step. It's the best program of its kind that I've seen and we've been looking around at them, and this used to be the kind of things that lenders could help a farmer do, but it's getting to be cost prohibitive for us to do that, play that role. So this kind of thing is tremendous, and we'd be happy to work with you to try to make sure we can take what comes out of it and process a loan very quickly.

MR. BRINKLEY: Sure, and we would welcome the help, yeah.

CHAIRMAN DIAL: Any other questions?

MR. BRINKLEY: Thank you.

CHAIRMAN DIAL: Kevin, thank you very much. About three years ago, in one of the speeches I made, I made reference to the future of agriculture and the fact that I thought that the day was coming when those that were involved in production agriculture would no longer be referred to as farmers, but they would become business specialists in production agriculture, and I think that that is going to be the fact as evidenced by this type of sophisticated yet very practical tool that those that are going to manage their risks in the future are going to have to have access to and take advantage of.

Speaking of the technology that's available to farmers, because of the interest on the part of so many of the agricultural groups and producers in the agricultural sector with regard to the Internet, we decided that we would develop a CFTC Agricultural Advisory Committee Home Page, and what you see here in front of you now is the cover page, the beginning of that home page. There is an audio message on this home page. I'm not sure that we can play it here, but we're going to give it a try.

[Audio welcome message played.]

CHAIRMAN DIAL: We then have a listing of the member organizations. As you can see, there is the column that gives the name of the organization, the individual who represents that organization, but not that individual's phone number or address unless they are also the Washington representative, and in that event we do have the transit information including the phone number and fax number.

There is a cite that you can go to for meetings. These will give previous meeting listing including the agenda of that meeting, the press release and the official transcript, and upcoming meeting lists, the date and the time of the next meeting with agenda items.

Next is CFTC Ag Issues. This is a listing of Website links to ag related issues before the CFTC. It lists ag related Federal Register notices, speeches, congressional testimonies, commitment or trader's reports, press releases and other areas on the main CFTC home page that would be of interest to agriculture.

Related links, this is a listing of other Internet Websites that you might find useful, their listings to the exchanges and other regulatory agencies, to departments within the executive branch, the Senate and House Websites with links to the agricultural committees, land grant institution Websites, magazine and news publications and various other agriculture Websites of interest. And then finally the bulletin board. As I mentioned in the welcoming address, this can be used to post comments on current ag issues. You can post your comments to me, and I'll respond within a couple of days time, and you may also respond to each other's questions and comments.

This is a valuable tool designed with you in mind. I hope the whole ag community will use it and help us make it even better. There is a sheet in your packet that gives the Web address for this particular Website.

We'll move now to the item on our agenda that provides for comments on the proposed legislation to amend the Commodity Exchange Act. I would like to call first on Mr. Randy Green, who is the Staff Director for the Senate Committee on Agriculture, Nutrition and Forestry. Randy works for the committee's chairman, Senator Richard Lugar of Indiana. This is Randy's second tour of duty with the committee. From 1989 through 1991, he was a staff member specializing in commodity support programs and the federal budget. In January 1992, he was named Deputy Under Secretary of Agriculture for International Affairs and Commodity Programs, and subsequently served as Acting Under Secretary of Agriculture.

As the U.S. Department of Agriculture's principal policy official for commodity programs and trade, he oversaw agencies including the Foreign Agricultural Service and the Agricultural Stabilization and Conservation Service. Prior to joining the agricultural committee staff in 1989, Randy was director of the Wheat Export Trade Education Committee which monitors and analyzes trade policy for U.S. wheat producers. From 1984 to 1987, he was Manager of Government Relations for the American Soybean Association. He was Chief Legislative Assistant for Agriculture to Representative Charles Stenholm of Texas from 1982 to 1984, and most importantly of all Randy was born in Gorman, Texas. He's a 1982 graduate of Texas A&M University in College Station with a degree in agricultural journalism. Randy, welcome, and thank you for being here.

MR. GREEN: Thanks very much, Commissioner. Ladies and gentlemen, it's a great honor to be here and to be invited to visit with you on this important topic. I find myself at a high tech podium where instead of the normal place to spread out my notes I have a keyboard. So if I wander back and forth while I'm talking, I'll try and still do it within earshot of the microphone.

I've been invited to talk about S. 257, a Senate bill entitled the Commodity Exchange Act Amendments of 1997. S. 257 was introduced earlier this year, and it's presently sponsored by Senators Lugar, Harkin, Leahy, McConnell, Roberts, Moseley-Braun and Durbin. Several provisions of the bill are controversial and I plan to deal mostly with those. I note in passing, there are a number of provisions that aren't, but presumably you're more interested in the former category.

Among the controversial provisions are revisions to the so-called Treasury Amendment which excludes certain financial products from the Commodity Exchange Act as well as a provision to give new legal certainty to swaps that are based on equities including stock indices, and neither of these sections has a particularly direct impact on agriculture so I will not dwell on them now but will be glad to answer questions about them if you like at the appropriate time.

Neither will I dwell overmuch on the sections of the bill that aim to streamline the process of approving new contracts and rules, though these would apply to agricultural as well as to other contracts. I will simply say, and then be ready to address further points and questions, that both of these share the characteristics that they try to reverse the current presumption in law against new products until an exchange shows why they should trade and creating instead a presumption that new commercial products ought to be allowed to trade unless there is a reason in the law or in the regulations or in the case of new contracts in the public interest why they should not trade. This reversal of the presumption is, of course, the key part of these sections, and although other facets of these proposals including public comment have perhaps drawn more attention, I think the key part is the reversal in this current presumption.

Now, a section of the bill which has excited great controversy, the so-called pro-market provision. The underlying concept behind this section is relatively easy to state. Professional institutional and large scale market participants do not in the view of the bill require as much federal oversight or protection as do individual investors. Since regulation imposes costs on both markets and their participants, it may be possible to relax regulation prudently in markets that are not open to the general public. Moreover, since financial market participants especially have a variety of over-the-counter alternatives available today, an insistence on maintaining regulations designed for an earlier era may run the risk of harming the competitive position both of organized exchanges and of the firms that participate in them.

Under S. 257, professional markets could not be automatically established for agricultural products. Current law is maintained in this respect in that any exemptions from the Commodity Exchange Act would need to be preapproved by the CFTC. Now despite this exclusion, some agricultural groups have voiced concern that establishing professional markets for, for example, financial products could cause speculative capital to migrate from the more regulated agricultural pits to the less regulated pro-markets.

And while respecting this view and wanting to take it into account, I question whether one ultimately finds it convincing for two basic reasons. First, it seems likely to me that speculative liquidity in agricultural markets will be determined overwhelmingly more by the supply-demand fundamentals that influence price volatility and only marginally, if that, by any difference in regulatory treatment. Second, and relatedly, it is much more plausible that speculative capital would migrate from a market in one like product to another less regulated market in more or less the same product. Here again the bill's presumption against pro-market in agricultural products would seem to address this concern adequately, at least in our view.

I would be interested in more discussion of that during the question period. Some have also asked why the rationale for not including agricultural products in the pro-market, and I think there are several reasons that one could adduce. The agricultural markets, unlike most of the financial and currency markets, are, I think it would be generally agreed, central and critical to price discovery, and therefore may justify a somewhat heavier regulatory hand. Generally speaking, professional markets like swaps markets are open only to appropriate persons which tends to mean large-scale persons, and therefore in markets where one wants to encourage direct participation by individuals including farmers such as the agricultural markets, again it's not clear that the model adequately fits.

And finally there may be issues that arise where products are traded for physical delivery that do not arise in markets such as the financials where this is not really a consideration. Well, as I say, this is probably the most controversial part of the bill. I do find it at least worthy of note that some have opposed professional markets because of allegedly insufficient regulation but at the same time express great interest in agricultural trade options which if legalized would not be required to trade on an exchange. It might be substantially less regulated than exchange traded products.

I simply ask the question without knowing the answer whether there are unique dangers inherent in an organized exchange environment which would become of lesser or no concern once the trading is done off-exchange? Interest is great in agricultural trade options--properly so. It may offer tremendous benefits to producers, a decision ultimately the commission will make, but the contrast at least I think is interesting.

This is not to say, of course, that exchange and off-exchange products have to be treated the same, by the way. Clearly, given the history of swaps, they do not. It does, as I say, however, raise certain questions. Senator Lugar has said repeatedly that he wants to be flexible and address the CFTC's legitimate concerns as we move forward with the bill, and indeed I'm not sure that the various parties are as far apart as it sometimes appears.

Chairperson Born has stated that there can be a lesser degree of regulation for professional market participants. She said, and I quote, "I could imagine legislation that would appropriately outline the terms at a lowered level of regulation for professional markets." I hasten to add in fairness to her that she does not consider S. 257 as presently constituted to be that legislation.


MR. GREEN: In recent weeks, it seems to me that all of the interested parties have shown a feeling of cooperation that is going to be necessary in order to arrive at something like a consensus or as near to it as possible. So I remain quite optimistic that we will be able to enact legislation that adjusts the Commodity Exchange Act to changing market realities but does not do violence to the act's goals of safeguarding it with market integrity and market participants. Now, there is a brief overview for you. I would be glad to either answer questions now, Mr. Chairman, or depending on your preferred agenda defer to Stacy and then perhaps answer questions together.

CHAIRMAN DIAL: Well, I know that you have a tight schedule, and you said that you had to get back as soon as possible so why don't we go ahead and take questions for Randy now.

MR. HITCH: What's the push for this? In other words, what problem is this act or bill rather intended to address?

MR. GREEN: I think it is intended to address several problems because it has several features and maybe opportunities as well. It does seem to me that there is a long-term question about the ability of U.S. exchanges efficiently and satisfactorily to compete with and in changing financial markets. And that a part of the competitive challenges that exchanges may face though by no means all can be attributed to regulatory costs. If those costs can be reduced in a prudent way, why then the opportunities will be greater to keep this trading in the United States, which I think all of us would agree we want to do.

That there is no crisis, and assuredly there is not, does not demonstrate that there is no problem, and it seems to me that if one looks at volume and a number of exchange-traded products, especially financials, one is not sanguine about what the future may hold. In other areas of the bill, the goals are different. The problems being addressed are different. I mentioned the case of equity swaps, and there the problem is simply a lack of legal certainty under the current regulatory environment. The bill seeks to provide that.

In the case of contract designation, the problem that the bill seeks to address is simply a process which may sometimes take longer than is necessary and may be more cumbersome than is necessary. The effort is to be able to bring the act up to date with current realities, with current markets, and this is not to say by any means the act has failed. It's been in many ways a single success. But it was written and updated at a time when markets, especially financial markets, were quite a bit different than they are now. It's not clear that it's kept pace with those realities. Yes, sir.

MR. ACKERMAN: Randy, I have two questions. You had talked about why agriculture commodities would be treated differently from financials because the price discovery function is different and physical delivery can raise issues that financials do not face. How do you square including the other physical delivery commodities or how do you distinguish between the agricultural commodities and commodities like silver, for instance, which over the years has had a regulatory record as being appropriate for a pro-market?

MR. GREEN: Well, I mentioned one distinction which exists, namely that one may be more concerned in the agricultural markets to encourage participation by individuals who may not meet the appropriate person determination that one would be likely to come up with for a professional market. This may be less a factor in the metals market. The appropriate person determination in the bill is essentially the same as that which now exists for the swap market so that although some farmers would meet it, most would not, and again one doesn't want to discourage that participation.

Moreover, Congress has historically found and I think with some good reasons that across the board, not only in futures markets, the justification for government intervention in agriculture is probably higher than that in most other industries. Some of that has to do with the fact that it's our food supply. Some of it has to do with the desire that Congress has historically had to support the incomes of farmers and the prices that they receive, but there is certainly a history of drawing those distinctions. But you raise a legitimate question. I don't deny its legitimacy at all. I simply say that there are some distinctions, although in the case you cite, the distinction of physical delivery obviously does not apply.

MR. ACKERMAN: One other if I may?

MR. GREEN: Sure.

MR. ACKERMAN: The last time the Congress legislated in this area was the 1992 legislation, and the 1992 legislation contained a number of regulatory tightenings based on the sting operation, for lack of a better term, by the FBI and CFTC on four trading pits. As I recall, three out of the four trading pits involved at the time were financials and currencies. Those would not be subject to the pro-market. How do you square those to initiatives of the committee?

MR. GREEN: Well, it's part of what needs to be talked about as we move forward and my aim today is probably not to sort of stake out extreme positions in either direction but to indicate that our hope as always is for a consensus. I would note that the sting operation, as I recall, was initiated by the FBI and the bill does not abolish the FBI. Moreover, the bill certainly retains even in the pro-market context certain authorities to police against fraud, against manipulation, and against other potential abuses and retains the emergency powers of the commission. Further, I think one anticipates more discussion of exactly how a pro-market ought to look as we go forward.

MR. HELLERICH: Mr. Green, Gary Hellerich from ASA. I have a little hesitation in accepting your statement that concerning you didn't feel that there would be a problem with generating market in the ag sector versus the pro-market area. It looks like to me that people will be emphasizing the pro-market area. There won't be much interest over here in the ag market area. You know your costs are lower and so forth, and there won't be as much regulation and so forth. I don't understand. I guess explain your point of view a little more.

MR. GREEN: Well, I guess it gets back to the point I made that I think among the challenges the futures industry faces, regulatory costs are one but by no means the only one. It happens to be one of the few that Congress can do something about. But I would not by any means represent--I don't think anyone would, and I don't think you have--that the only reason people trade in one contract versus another is regulatory costs. You know if one thought that, I suppose there would be a case for the bill being even more in one direction than it is.

What I say is not that regulatory costs have no impact, but that ultimately people who constitute speculative liquidity are probably going to base their decisions where to trade, in what pits to trade, overwhelmingly on whether they can make money in those pits as speculators. And I suspect, though again I'm very open to a dialogue about it, that that is going to have a great deal more to do with the supply-demand fundamentals in the particular commodity at a given point in time.

Certainly, the change in volume in the agricultural contracts in 1996 would at least tend to support that point of view, and I had made the additional point that it seems to me you can make more of a case that one would engage in sort of regulatory arbitrage where there are like products. This may be another good reason for not putting agricultural products in the pro-market.

Now your point may also be that exchanges themselves would emphasize the professional markets as a sort of business practice, perhaps to the detriment of the more regulated markets. Once again, though, I have to think that the exchange's interest is going to be to emphasize those markets in which there is interest in trading, and clearly that is the case in respect to the agricultural markets. Yes, sir?

MR. LINDAU: Just by way of emphasis, I'd like to point out that there are at least two exchanges in the United States that are only ag contract oriented, and we surely aren't going to emphasize any other avenue of trading.

MR. GREEN: Yes, sir.

MR. HITCH: Even though agriculture was exempted from this pro-market thing, as I understand it in the bill, the comment period was significantly shortened on changes to the ag contracts down to ten days. And I wondered what was the purpose for that. It's very little time to get together and study something and make a cogent comment on it.

MR. GREEN: Well, it's a good question. A ten-day period is actually ten business day period that is two weeks in which upon receipt by the CFTC of, let's say, a new contract, although some of this will apply to rules as well of a new contract, the CFTC would need to determine whether the contract appeared to violate a provision of the law, a provision of the regulations or the public interest, and these are basically the tests that they look at now. If that appeared to be the case, there would then be further 15 business day period by the end of which there would need to be a disapproval proceeding initiated by publication in the Federal Register, but obviously it would not be completed for some time hence after that.

And at that point, there would be opportunities for public comment. I've said that one of the points a number of people have made, Senators, on their perception of a need for more public comment. I think people involved in the bill are very interested in discussing that. But what I've described to you is the provision in the bill as it now stands.

It does seem to me that this is an area where substantial improvements have been made by the CFTC, and I commend them for it in the time that it takes to approve new products. Once again this can become a competitive issue because, of course, anybody in the world can trade any product and sometimes he who gets to the market first does best. But the very success of the commission in some ways makes me less nervous about the bill's provisions than others are simply because it seems to me the commission already in the vast majority of cases is performing under terms that comport fairly well with what's in the bill. Nonetheless, as I say, clearly an issue that we want to talk with people more about.

CHAIRMAN DIAL: Other questions? Gary.

MR. HELLERICH: Yes, I have a question then concerning, you know, I represent soybean producers out here in the country. And I am very much concerned about deregulation of these exchange markets, and particularly I'm entering into an era here where we have greater risk, price risk management, and so forth, and here we have a situation here where the senator is saying, well, we need to drop some of this regulation, get rid of it, and, you know, I look at it and say, gee, Scott, you know, they'll deregulate this and then pretty soon, oh, my, they'll be over here in the ag sector, they'll deregulate that. This doesn't look good at all, and a lot of--it's not very much of a confidence builder in regulation of these markets, and the true purpose of these markets is the convergence of futures and cash price, and they aren't putting a lot of confidence in that, and I just, you know, this is what we're seeing out here in the country from my particular locality.

MR. GREEN: It's a very valid point of view. I would, as you might expect, put it a little differently--because I hear what you're saying. But it does seem to me there's another way to look at it, which is that if one shares the view that there might be some long-term competitive challenges that face on-exchange futures trading in the United States, and I think it's hard to look at the over-the-counter derivatives markets, overseas exchanges and other factors without at least having some notion that that might be the case, why then it becomes in our interest, I think, to address the competitive environment in which those exchanges and FCMs and other market participants, everybody, operates because if in the long-term futures trading is not viable for financials, let's say, it isn't necessarily going to be viable for agriculturals either. There are outstanding exchanges that trade only agricultural products, but on a total industry basis, the vast majority of futures trading today is not agricultural.

And so I can almost turn the argument around and say that while I'd agree with you that maybe the heightened price risk is one additional reason not to apply a professional market exemption necessarily to agriculture and all I can talk about really is the bill, Senate bill, as it's written, and that's what it says, why it can be in agriculture's interest for regulatory costs elsewhere to be relaxed if that has the effect of reducing costs and make agricultural contract trading viable long-term. Now I've not convinced you but that's at least my point of view. I can only tell you what I sincerely think.

CHAIRMAN DIAL: One more question. We have time for one more question. Yes, sir. Steve Patton.

MR. PATTON: Thank you, Commissioner. Randy, maybe more of a comment than a question. But for those of us who have a high degree of confidence in both the CFTC and the sponsors of the bill, can we be confident in the fact that there is some communication between the agency and the staff and bill sponsors? I think there is a good many people believe that some modification is necessary, but can we at least have confidence in the fact that there is some communication back and forth in order to hammer out the proposal or hammer out the bill?

MR. GREEN: Yes. We communicate all the time. Don't always agree, but I had certainly intended earlier, and I hope I did, to compliment both the commission and other participants in the overall debate for what I take to be a spirit of flexibility in wanting to arrive as close to a consensus as possible. I have appreciated the ability to have contact with commissioners, with commission staff. We've tried to be open to their comments as well and those of other regulators, those of other market participants. There are some genuine philosophic differences in the way different parties involved in the debate approach the bill, and I don't seek at all to sugarcoat that, but I do believe that people want to arrive at as close as possible to a common view that balances the concerns of different parties. Have to do that, you know, without giving up basic principles, and Senator Lugar would feel that way and so would the CFTC.

But it's been my purpose, I think, to not try to sort of heighten rhetoric but rather to say that we want to work together. I think all of us do, and that's about all I can say about that, but that effort continues.

CHAIRMAN DIAL: Dave Miller, you had a question?

MR. MILLER: One of the concerns that is raised about the whole pro-market concept is the cross-effect into agriculture whether it's clearinghouses, the role of those type of effects, and we've seen on international markets, the Barings Bank type of bond trading scenario where it, in fact, brought down multiple institutions and really caused some havoc on an unregulated market. And so those type of cases exist out there for concern. And one of the questions, I guess, that I would have is what role do you see as or does the Senator see for a regulatory agency within pro-markets to not necessarily deal with the day-to-day things that work right, but to deal with those instances when things are not as they should be and have occurred in markets both in the U.S. and internationally within the last decade and some which have gotten very much press?

MR. GREEN: Well, you've capsulized in a pretty eloquent way what I think is probably one of the key challenges in working out the way the bill ought to ultimately work because, as you say, it isn't the everyday occurrences that must and perhaps even ought to be subject to constant scrutiny and oversight but the problems. The bill addresses that in a certain way through anti-fraud, anti-manipulation emergency authorities and so forth. I've said already I think different participants in the debate will advance other ideas, and we want to look at those.

I would observe that if one tries to divine a common thread in a number of the financial imbroglios of the last five to ten years, I'm not certain that the degree or kind of regulation is the common thread which emerges but rather perhaps a lack of internal corporate controls that allows some of these things to happen, and it does seem to me there's been notable progress made, in some instances not on exchanges, but in over-the-counter markets, through the work of the Group of 30 and other institutions in trying to encourage corporate practices that make these sorts of things much more difficult to happen.

I don't represent that as the total solution. Please don't misunderstand. But it does seem to me one looks at Sumitomo, one looks at Barings, Daiwa, at some of the other episodes, the common thread is perhaps more the lack of internal controls and firm accountability than anything else.

CHAIRMAN DIAL: Neal Gillen, and that will be the last question.

MR. GILLEN: Randy, I feel I must at least comment and ask you a question given that you referred to me in your remarks.

MR. GREEN: I did?

MR. GILLEN: Well, most of the people around this table favor tough regulation, most if not all, and most of the ag groups, trade and producer, support trade options for the reason being that producers want more risk management alternatives, more flexibility. We're very transparent and open about those discussions. There was a full symposia here in December 1995 where this was fully discussed.

MR. GREEN: It was a good discussion, too. I wasn't there but I read the transcript.

MR. GILLEN: Well, to your knowledge or to Senator Lugar's knowledge, has any proposal come forth, tangible proposal, as just how pro-market would be used? Give us an example of a contract. For example, could one shut down the regulated wheat contract and open up a pro-market wheat contract or run them in tandem? What type of examples do you have or have been proposed? The literature doesn't contain any examples. I think it's the unknown factor that concerns a lot of people, particularly people, a number of people on your committee that raise the same question. So I was wondering if you could opine on that subject?

MR. GREEN: It's a very good question. You asked two. The answer to the first question is no, under the terms of the Senate bill, one could not shut down the regulated wheat contract and start another one because the enumerated agricultural commodities are not the subject of an automatic pro-market. Now, as is the case today under current law, if the commission decided to allow that, it could. We leave that power with them. But one would guess they would be unlikely to exercise it.

The answer to the second question is more complex. The bill, I think, is trying to create an environment where people can develop products that are likely to be innovative in markets that are likely to trade in different ways. They may be electronic though they need not be. They may involve differing contract sizes though they need not. They may involve products that are not the subject of current contracts. There are currencies, for example, in which certain types of businesses might logically want to hedge but which don't now trade on exchange.

The key aspect would seem to be flexibility, the ability of the exchange to design these contracts in innovative ways. Now much of the debate will center on how explicitly to answer your question in the statute, and a number of participants in the debate will want to see it answered with substantially more detail than is the case in the bill as introduced, and I acknowledge that. But the bill doesn't really determine what contracts exactly are going to be offered. It says some that can't be, notably agriculture but also important limitations on stock index products.

So though it's not an absolutely satisfactory answer to your question, I think the real aim is to let people creatively develop these things, and you probably are not going to know in advance exactly what products will take off. Again, the debate is going to be how many bells and whistles do you actually put into the statute that may give you additional comfort. The bill as presently constituted has few. Others want more.

CHAIRMAN DIAL: Okay. Thank you very much, Randy.

MR. GREEN: Thank you, Commissioner. Thank you, ladies and gentlemen. Appreciate it.

CHAIRMAN DIAL: Stacy Carey with Congressman Ewing's office is going to give us some information about the congressman's bill. But first let me introduce Stacy while she is making her way up here. Stacy Carey began working in Washington, D.C. in 1984 for her hometown congressman, former Representative Tom Lewis of North Palm Beach, Florida. She currently assists Congressman Tom Ewing of Illinois in his capacity as chairman of the Subcommittee on Risk Management and Specialty Crops. She has worked on the House Agriculture Committee during the past five years and previously worked in Cargill's Washington, D.C. office on behalf of the company's cocoa, malt, and rice divisions.

Stacy currently serves as Staff Director for the Risk Management and Specialty Crops Subcommittee, which exercises jurisdiction over the Commodity Futures Trading Commission, crop insurance, and risk management issues. The subcommittee also has jurisdiction over marketing and trade issues, tobacco, peanuts, sugar, fruit, vegetable and nursery crops.

Stacy worked extensively on the NAFTA agricultural negotiations, the Crop Insurance Reform Act of 1994, the 1995 reauthorization of the Commodity Futures Trading Commission, reform of the Perishable Agricultural Commodities Act, and most recently the 1996 farm bill. Stacy, welcome.

MS. CAREY: Thank you. I appreciate having the opportunity to come and speak with you all in a more formal manner. I know that some of us have been meeting in a more informal manner over the course of the months on this issue, but on behalf of Chairman Ewing and the subcommittee, I first would like to thank those of you here and the ag groups that participated in our three days of hearings recently. For those that testified and those that submitted testimony, we appreciate your input and your comments, and overall I guess I should just start and maybe go back a little bit and talk. Randy did a good job of sort of encapsulating the summary of the Senate bill, which is very similar, many of the provisions are very similar to our House bill that was introduced by Chairman Ewing in September last year and then reintroduced again in January.

There are a couple of minor and some major differences in the bill I'll mention very quickly. On the largest issue in terms of pro-market, as many of you know, the ag bill carves out agricultural products from a pro-market. We keep it in. The Senate bill also codifies the swaps and hybrid instruments exemption. We don't touch those provisions in our bill. The Senate bill includes provisions on delivery points for foreign futures contracts. That provision is not in our bill. And another provision that is a little bit different is how we treat the findings section. We include a pretty comprehensive definition of hedging in our findings bill. The Senate bill amends Section 3 to just strike fluctuations through price. So those are just a little bit of the major and minor differences between our two bills.

But, again, just by way of context, and a lot of this was discussed at the hearing by way of history, question has been asked why are we going through this debate now? And I think a lot of the issues that are included in 467, and I will keep my comments to our bill now, Chairman Ewing introduced it as a discussion document, but many of these issues were brought up and discussed in the context of the CFTC reauthorization in 1995, which as many of you know is, and maybe some commission staff can confirm it, probably one of the most expedited reauthorization processes in the commission's history because it was a simply one-line reauthorization to extend the commission through the year 2000.

And we did that basically to allow the commission to operate from a very strong base of support, but recognize that a lot of these issues that we were talking about in '95 and even prior to that were pretty major issues to the industry, and we sort of reserve the right to bring them up and discuss them in the future, which is what both the House and the Senate started last session in order to begin the discussion purposes and sort of get the ball rolling because I think a lot of the thought is, and Chairman Ewing particularly feels this way, there is a responsibility for members of Congress to legislate good policy, and a lot of the feeling was is that you tend to get a better product when you're considering these issues outside of the hammer of a reauthorization.

You take the time, you talk about the issues, you have the debates, you have the discussions, and hopefully you tend to end up with a better product in the end. Many of you that are involved in the process, congressional process, know that when policy and politics mixes, it's sometimes pretty; oftentimes, it's not. So we, and Chairman Ewing in particular, are taking great pains to make sure that we have a very thorough and very thoughtful debate on these issues, and to that end I might mention that the ag groups and all of you represented here today are very, very important part of that process, particularly in context to the House Agriculture Committee.

A lot of the thinking that is reflected here is similar to thinking that's reflected by many of our members. So to that extent and even more, your comments and thoughts are very important to us as we go through the process, and the three days of hearings, to get members to sit through three days of hearings is a little bit difficult to do, but we thought that they were a success because what we were able to do was gather more information on the record and further discussion on some of the many issues, some of which are very controversial, in order to get a good base of information by which to make some good rational decisions.

Where we are now, many of us on the Hill, there have been discussions occurring in many segments of the industry. We're keeping a very close ear to the ground on how those are proceeding. I might also make the point, too, that that process is a very, very important process because when individuals or entities that are involved in these issues very directly can get together and figure out a better way or the best way to proceed, you get a better package. You get a better policy package in the end than if it is left to Congress to sort of pick and choose and figure out sides and throw this all together.

So to that extent, I'd like to, you know, reiterate Chairman Ewing's focus on the ability for entities to keep working at these issues and try to come to consensus on a lot of the issues that have been out there and have been discussed for a period of time now since last fall.

Early on in some of our discussions, too, with the ag groups, and you may have some additional thoughts to offer, and I might just also mention that the producer groups have done a very, very good job of meeting with folks to try to figure out the exchanges, CFTC, and try to understand and gauge what issues are involved here. And early on, Randy and I spoke with some of you, and the question was put forward, and I even had a press question on this, I guess I should say, what does this have to do with producers? What is the hook here for producers? What provisions relate to the producing and the agricultural community?

And the answer that I gave on an informal basis was that there was no Section 101 or there is no specific provision in here that relates to producers other than preserving the overall integrity of the futures market, assuring price discovery, and looking at the sort of macro views and goals, rather than we had had a discussion document that dealt with many issues that deal with the issues of the regulator and the regulatee. And that is where the discussion has sort of focused.

For the ag community, it would be similar to a bill, a farm bill per se of issues that the producer groups have with USDA. You could look at a farm bill to a certain extent and say that's more of a bailiwick for the ag groups. But, you know, that is a little bit of the focus and a little bit of what we're looking at here. I'm sort of diverging because Randy has brought up some good comments and such. And I'll mention, too, one of the issues on pro-market, the question has been asked quite often what will a pro-market look like?

What will it be? What contracts will be traded? And in this information gathering stage, those are very, very accurate and appropriate questions. And I think the answer is, and as we work through this, and I think as entities work through this, one of the things that comes to mind that may resonate a little bit, and I may be off-base, I may be not, I'm sure I'll get some questions on it, but has to do, one of the suggestions or comments that I made was in terms of our subcommittee. Take the sugar program, for instance, or a cotton program. Nobody knows year to hear what the yields will be, what harvested acres will be. Nobody really knows, has insight into what the actual market will be. USDA makes it projections every year, but the issue is, particularly from the producing groups, that there is an assurance, enough of an assurance, and we went through this in the farm bill, that there's enough of a safety net there to assure that there will be minimum standards met and minimum safety net provided for producers.

Extrapolate that to a certain extent to a pro-market. Nobody--well, there are some issues that will needs to be discussed and more information out there, but I don't think anybody can really say what exactly a pro-market looks, what contracts will be traded when, at what volume, and such, but the goal here, and I think the goal of Chairman Ewing and the goal in putting forth the discussion documents is to allow that competition to occur in the OTC markets, but while requiring enough of a safety net there through the Commodity Future Trading Commission and the regulator to assure that the market integrity will be preserved, and that we will, in fact, enough of a safety net there for public interest and such for the futures market.

I'm sure that analogy is going to get me in a little bit of trouble, but it's one that I offered that came to my mind in sort of trying to figure out the competitive nature and how do you reach this balance, and it was a balance that was very much focused on in our hearings in terms of providing the competition and the flexibility while maintaining that safety net.

I think that was a very key message for our hearings. We're hopeful that that was a message that was received and taken seriously by those who are most involved in the process, and we're hopeful that we'll be able to move forward and find some consensus on the issues as we go ahead. So with that, I will take any questions. Yes.

CHAIRMAN DIAL: Please identify yourself.

MS. DANIELSON: Nancy Danielson, National Farmers Union. Stacy, on the Senate side where they brought up the issue of why agriculture wasn't included in the pro-market exemption, I think part of the answer was because it wasn't really necessary to be competitive with foreign markets as it was with some other commodities that were traded. What was Chairman Ewing's thought in including agriculture in the pro-market exemption?

MS. CAREY: His thought basically on that issue was that in putting out a discussion document, including the agricultural products in that needs discussion, and part of what we're trying to sort through, and you guys may have some thoughts on this, too, I think the focus will be is establishing and talking about a pro-market and assuring that that safety net is there. I think the question becomes does the agricultural community want to be out? I mean I think the first question is to establish is there an ability to create a pro-market with certain standards, certain amount of safety net, and if that can be achieved, the question I think to the ag groups, if there is a comfort level there, is there also an opportunity there?

And I think that's more of an opinion and more of the thought process behind it. I think Chairman Ewing's thought was to put it in to get the discussion moving and to quite frankly hear back from you guys what the preference is. Is it a positive? Is it a negative? You know that's sort of the purpose of a discussion document is to look at both sides of the issue. I think if we probably kept it out and we had a House and Senate bill that were similar, we probably wouldn't, you know, be having this discussion as extensively as we're having it today,

MS. DANIELSON: Just one follow-up. Have you heard from any agriculture groups that are supporting having the pro-market exemption for agriculture so far?

MS. CAREY: No. No, we haven't. As far as particular folks or particular commodity groups that would want to be in it, no. I would expect, and you guys probably know better, but that's a reflection of the comfort level with pro-market to begin with. And that's where I think probably the better, you know, some of the eventual focus will be in talking about the terms of a pro-market, what it means, what it doesn't mean. If that dialogue is developed, I think the question should be and rightfully should be does ag want to be a part of this opportunity here or not? Yes.


MR. GILLEN: You mentioned safety net. To the agriculture community, the integrity of the futures markets is the real basic safety net. And Ken Ackerman mentioned before that it was in 1992 that the Congress was particularly concerned about the integrity of the markets and took action to bolster the integrity of the markets. I didn't particularly agree with all of those actions because, you know, things happen, and they'll continue to happen. But where the agriculture community is concerned, where the financial community is concerned, where the brokerage community is concerned, is the fact that we feel that the CFTC has a lot of experience in enforcement and keeping the markets acting appropriately, and when they sound concerned, we listen as does everyone else in the financial, the economic community. This is not an ag issue, and it's somewhat patronizing to the ag community that they be considered not to have knowledge outside the scope of their own contracts because everything is interrelated, and, you know, we didn't get the real opportunity to discuss these at the hearings because the hearings were cut short for housekeeping over there on the floor, and I realize you're the messenger and you don't vote on the committee, but this is a very, very serious issue and in my 30 years of dealing with commodity futures regulation, I have never seen a question give rise to so much concern from the people who are very, very sophisticated about markets down to the people who have no sophistication about markets, don't trust markets, don't trust the people who trade the markets, and as we go into the new era of risk management, we have to be going the opposite direction.

We have to be building and fortifying the integrity of what are very, very well managed markets by the exchanges. I don't have any criticism of the exchanges, but that's all I have to say.

MS. CAREY: You bring up a couple of issues, Neal, and I think they are quite relevant to some of the discussion that we're dealing with, particularly in this issue, that is often there in a number of issues, and that is perception. And that is lack of trust, mistrust, and we have taken great pains and will continue to do so to assure that there is proper dialogue and information on the issues so that we don't get into a misperception type of situation, that we're actually looking at the issues and actually figuring out what is right, what is not right. That is why we're heavily relying and will continue to do so on the expertise of both the Commodity Futures Trading Commission, the exchanges, and the ag community.

I hope that, and I hope that none of my comments have lent or members' comments or a discussion document have lent to the perception that the ag community is being patronized because that is not the case whatsoever. As Chairman Ewing has said and as I have said here this morning, the input in the belief of the ag community is vital to our committee. That is why we're here today. That is why our door is continually open to talk. I'm sure we will have more dialogue as to what is appropriate, what is not appropriate. And that's why this juncture of discussion is so vitally important right now, and that is why a discussion document and this type of debate is so vitally important because these issues need to be thought through and need to be dealt with, you know, very carefully.

An issue that came up at our hearings that I think is very important and very relevant to the ag side of it is this whole liquidity issue and the concern about a pro-market and all the interest in a pro-market draining the liquidity from the traditional ag markets. And that issue, I think, needs to be delved into to a certain extent. We had varying testimony during our hearing. We had the fed comment that, you know, these markets, an unregulated or less regulated market could operate efficiently side by side. We had some express concerns about that issue that I just characterized there, and I think it warrants additional views and thoughts because, you know, one of the issues, probably one of the issues to explore is if you look at the exchanges now and their make-up now, the MERC or the Board of Trade and the division between the traditional ag markets and the financial instruments, when a new financial contract--and I'm throwing this out; I don't know the answer to the question; I'm not the person to really talk about this because I don't have the expertise, but it's just an individual thought that comes to mind--in that when a new financial contract is introduced and it's a very popular contract, does everybody scurry, do hedgers and speculators scurry to trade in those financial markets at the detriment of the current ag markets now?

My guess is no, but I don't know. I mean I think that's some of the information that we need to bring out, and in terms of a pro-market--and this was interesting discussion at the hearing-- too, in the competitive issue, whether it's competition abroad or some of the regulatory, I think we're dealing or we're talking about different types of competitive issues.

We're talking about regulatory issues, the regulator-regulatee, and I think that there is some common ground there to address some of the issues that have been of utmost concern, but we're also talking about the ability for exchanges to compete in the OTC market. And is that appropriate? Is that acceptable? What is the safety net that needs to be included to allow that competition to exist? And then, you know, you've got the issue of foreign competition as well to a certain extent.

So there are a number of different elements in competition that need to be looked at. You know that's what the debate is about. And that's what a lot of the issues are about and why the door remains open because I think we've got a lot more work to do and a lot more information to get on the table before moving to some consensus here.

CHAIRMAN DIAL: Are there any other questions? Ken Ackerman.

MR. ACKERMAN: Stacy, it's nice to be on this side of the table from you for a change.

MS. CAREY: You deserve it, Ken.

MR. ACKERMAN: A comment and a question. Others at USDA have commented on the bill itself so I won't comment on that, but I do compliment both you and the Senate side for what you mentioned at the very beginning, that is separating this issue from the actual reauthorization of the CFTC. I was involved the last time that a major controversial issue was paired with the CFTC reauthorization, and doing it that way did place not only the CFTC but the whole futures community at a disadvantage, I thought, and to have an issue like this where there is a disagreement between the commission and many in the industry, to do it in a year that's separate from a reauthorization, I think is something that helps protect all sides while the issue is worked through.

Also, and I had mentioned before the concerns of 1992. Neal mentioned that as well. I think everyone recognizes obviously the world has kept turning since 1992 on a lot of fronts. The exchanges and the CFTC have both made very gratifying progress on resolving a number of the regulatory concerns that were raised at that time. The fact that the record of U.S. futures exchanges as a regulatory matter has been very high, very good, over the past several years, such to the extent that there have been problems, most that have been eye-catching have been either overseas or have been off-exchange. Also the competitive issue that Randy Green mentioned before is one that was struggled over quite hard in 1992. It was a difficult issue and continues to be.

Obviously, the regulatory concerns, as I mentioned, are things that others have laid out from USDA. The question I had is more kind of how you envision this bill working because I've heard it described different ways. The way Randy described it in response to a question earlier and the way you've described it is a little different than what I had heard otherwise. So let me just ask you. In the areas that the bill would cover or the House bill does not exclude agriculture, do you envision the pro-market provision as a way of providing for some limited universe of new products to come forward in a much more flexible environment or is it the intention or is it envisioned that the major existing products, the major existing exchange markets, would change and change themselves, either limit their participation base, whatever, to come under the new system? I don't know if I'm making a clear distinction on that, but how do you envision this working?

MS. CAREY: Well, you're asking me to envision a pro-market, and I don't have that crystal ball, thank you very much. I don't think I'd want it. But I think in just general terms, part of what needs to be looked at is the relationship between flexibility or new products that would come under a pro-market and its relation to the traditional products. I think that's sort of what you were intimating, and when the pro-market provisions were put in the bill, nobody had any grand design of how things would actually, you know, what sort of world we would be in, you know, in a year or two or what have you. But I think it's a very valid point because I think part of the main concern is to give flexibility to tap into some of the OTC market and allow the exchanges to tap into that, and I think the question just comes back to is what is the relationship in those new products on the traditional markets and how that would develop and are there liquidity issues involved and that type of situation?

So to answer your question, I guess, you know, on one front, it was to provide flexibility for new products, and on the second front, you know, a need to figure out what that relationship would be.


MR. LINDAU: A couple of comments and not really a question. Certainly, the advent of new contracts, wherever they've been, whatever they've looked like, has increased the activity in the futures markets. It simply hasn't drawn away from what's there. One new contract doesn't steal from another to its disadvantage. This is simply not a zero sum game. You can see that by the competition that's grown overseas, the increased value of the U.S. memberships, the large rooms that the exchanges are building for more traders. So the increase in activity results from new opportunities.

The second point is that nobody, and I mean nobody in this business, benefits from a weakened Chicago Board of Trade or a weakened Chicago Mercantile Exchange that's based on their inability to compete. So the need to examine the competitive issues is paramount is this. The form that it takes ultimately is important, but the discussion has to take place about competition because none of us is stronger as those exchanges are weakened. And finally I would urge you not to lose sight of the very important regulatory costs and efficiencies that are embodied in the rest of the bill as we spend a lot of time talking about pro-markets. Those are very important to all of the exchanges as well.

CHAIRMAN DIAL: There's time for one more question because we still need to deal with the delivery issues. Richard.

MR. ELLINGHUYSEN: This is perhaps more of a comment than a question also, and I think it's perhaps more one of perspective. I'm with National Farmers and I represent producers. And we've come through the last several years where we have a NAFTA trade agreement, a GATT trade agreement, and we're anticipating more volatile markets. And we have a new farm bill in effect today, which is removing our safety net, if you will, and in light of that, we're shifting more, as this body has discussed in the past, to the need for more risk management activities and education and so on. And we had a good presentation on that this morning. A lot of that is going to involve futures activities, futures related activity.

And now at this point in time, we're looking at, in effect, deregulating potentially a significant part of that and putting it into a pro-market type environment which no one can predict what exactly will happen, and so from an independent producer standpoint, it's not real comforting. We're shifting to an era with a lot of volatility and uncertainty, and now the vehicle we're looking at, learning about, taking much more protective mechanisms from, may become less regulated, and so from a perspective standpoint, and you referred to this as opportunity, and whether or not the ag community will want to participate in this opportunity, some ag producers are wondering how much more opportunity they can afford right now.


MR. ELLINGHUYSEN: To put it in the perspective of producers.

MS. CAREY: And that is a very important perspective because I think the era that we're involved in, particularly in the last five to ten years, in terms of risk management--Ken knows about this, Commissioner Dial knows about this--it is giving producers the flexibility, an additional opportunity to manage their risk. I wish government could predict exactly what happens all of the time, but we are not in a position to do that. But the risk management side of it, and part of what I was going to say, part of the concept that has been developing is the ability for producers to tap in and use the futures markets.

I mean that has been the concept that has been developing for a number of years. Joe has been involved in that. Ken has been involved in the producer risk management side of it, you know, in terms of crop insurance, a very important tool for producers. So it is an opportunity. Our markets are changing. I understand the perspective, and a lot of the change that we have gone through recently is probably linked to that to a certain extent. But in terms of the futures market, you know, I might offer an example. Take the National Cheese Exchange, for instance. We conducted hearings on that whole issue and that correlation of the relationship of the National Cheese Exchange to the dairy industry and the ag community in terms of that.

There was a very negative reaction to the NCE, and every time prices went down, it was that nasty National Cheese Exchange's fault, but--I forget that I'm on the public record here--but at any rate, we've had that contract now trading on the MERC on an exchange that provides a transparency, that provides a liquidity. The openness of that contract trading now--I'm sort of diverging a little bit--but that illustrates a point of the connection here from the producer community to why we need to assure a competitive exchange system, but a competitive exchange system that will preserve market integrity, public interest, and this again is the balance that the members are searching for, and why your input is so important into that, because these are the issues that we need to make sure that we balance and weigh, you know, as we search to come to solutions for this legislation. So I know Joe is going to cut off questions now, but our door is open. We're the House Ag Committee, and we encourage any thoughts that you all might have as we move through this process, please share them with us. All the testimony that was submitted is being reviewed and will be looked at in context of, you know, next steps for the House Ag Committee.

So to the extent that others have ideas that weren't a part of the written record or weren't written testimony submitted, please do give us a call and set up a meeting. I know Chairman Ewing would be interested in meeting with folks that have views on this. Thank you very much for having me.

CHAIRMAN DIAL: Thank you, Stacy, very much. Appreciate it. Our final agenda item is the Status of New Delivery Points for the CBT Grain Contracts including the Wheat Contract. I'm going to call on Dr. Craig Pirrong to give the CBT's point of view. Dr. Pirrong is Assistant Professor of Finance at the Olin School of Business at Washington University and has a great deal of knowledge and experience in these types of issues.

MR. PIRRONG: While I'm getting wired in here, I'd just like to say I appreciate having the opportunity to speak today to speak about the Chicago Board of Trade corn and soybean futures contracts, in particular, and the status of those, and as somebody who has been following the delivery issue for a number of years and has made modest contributions to the debate on delivery issues regarding corn and soybeans over the years, I can say affirmatively that the proposals of the Grain Delivery Task Force, which were overwhelmingly approved by the membership of the Board of Trade, are positive changes and very positive changes indeed for the year 2000 and beyond.

And the changes have received considerable amount of comment in the months since the Grain Delivery Task Force on which I served initially circulated its proposal, and I've read all this comment, followed it very carefully, and with great appreciation for all the time and effort that people have spent in making those comments. And after reading the comments, both pro and con, I'm even more convinced that the Grain Delivery Task Force and the exchange chose the right solution, and I want to try to give you a little bit of the rationale for that today.

The first thing I'd like to note is the following. The members of the Grain Delivery Task Force didn't come into the process of evaluating the corn and soybean futures contracts with preconceived notions of what place should be deliverable, at what differentials and things of that nature. We wanted to come in with a clean slate insofar as where to locate delivery point. We didn't come up with an idea of where to locate the delivery points. Instead we came in with a set of criteria, which we believe are widely agreed upon criteria to use, in order to formulate ideas for designing the new contracts, and the criteria that we came up with were these.

Most of them are pretty standard. We want to provide convergence between cash prices and futures prices. We wanted to make sure that the futures prices are transparent and also the cash market in which delivery occurs is transparent as well. We wanted the system to be simple and easily understood. We wanted to price the marginal unit. We didn't want to determine some sort of average price. We wanted to price a marginal unit because that facilitates arbitrage to make sure that convergence works well.

We also wanted a contract that operated in the natural flow of grain in order to diminish the potential for price manipulation. We wanted to make sure that the delivery mechanism could tap into a substantial flow of both corn and soybeans. And finally, given that one of the main things an exchange brings to the table is financial security to those that trade the contract, we wanted to make sure that we designed a contract that was operationally dependable and financially sound.

Now on the basis of those criteria and after evaluating a wide variety of alternatives that were proposed both within the committee and by commenters outside the committee, after engaging in extensive consultation with the CFTC and with anybody and everybody that wanted to offer an opinion on the issue, we came up with the following contract terms. First of all, we're going to have delivery on the northern Illinois River, specifically between Chicago-Burns Harbor and Pekin. All locations along the river are deliverable at par. One of the most crucial innovations of the contract is that we're going to use shipping receipts as opposed to warehouse receipts.

This was essential to allow us to tap into a flow of grain as opposed to a stock of grain in a particular terminal market. We also initiated a 30-day load-out requirement. This is to give, first of all, sufficient delivery capacity so as to prevent and diminish price manipulation, and also to give the taker of delivery some certainty over the timing during which he was actually going to be able to receive and load out grain.

In order to maintain a balance between those that are making delivery and those that are taking delivery, we also gave the takers of delivery precedence for load-out during the normal eight-hour business day but allowed operators of regular delivery facilities to use their house for their own purpose without any restriction outside of that eight hour day.

Now, what are the virtues of the system? Well, the first virtue and the one that is probably of most direct concern to the CFTC and the regulatory authorities is that this is going to have the effect of diminishing price manipulation and the prospects for price manipulation. All right. Everybody here is probably familiar with the fact that terminal markets in general and Chicago and Toledo in particular have been declining as major grain centers for years.

This decline has made contracts based on delivery in those locations increasingly susceptible to the prospect of being squeezed and manipulated. So instead of basing a delivery system on a terminal market and particularly a declining terminal market system, we moved the delivery system into one of the largest, if not the largest, single flow of grain in the United States, the northern Illinois River system. All right.

And essentially what that does is do two things. First of all, it increases the physical capacity for delivery. If you look and compare warehouse space with the load-out capacity on regulatory terms for the northern Illinois delivery system that we've come up with, physical capacity for delivery increases by about 60 percent over and above what Chicago and Toledo could offer prior to the closure of several major warehouses in Chicago.

More importantly, though, because this delivery system is located within the flow of grain, sort of the amount of corn and soybeans that this delivery system can tap into is significantly larger than the amount of corn and soybeans that Chicago and Toledo could ever tap into. Right now, the Illinois Waterway Delivery System that we propose essentially has flows of grain that are about five times the flow of corn that goes into Chicago and Toledo.

All right. The flow of soybeans to the Illinois Waterway Delivery System is a little more than two times the amount that flows through Chicago and Toledo. What's more the tributary regions of the Illinois Waterway Delivery System are larger than for either of the terminal markets that were the linchpins of the previous delivery system and so in the event of extraordinary demands for deliveries, the northern Illinois River system can tap into that far more effectively than could a terminal market system because terminal markets tend to fill up once a year, whereas the waterway system is in the flow of grain throughout the year.

So the bottom line is that the capacity issue should now be moot. All right. This system has the capacity to deliver sufficient quantities of corn and soybeans to dramatically diminish the possibility for price manipulation. All right. Now we were able to do this while retaining a single delivery point concept, and we think that this is very important for a variety of reasons. First of all, single delivery point is simple, it's easily understood. This facilitates arbitrage and basis trading. It also improves the transparency in price discovery to some degree because participants in the market know what cash market relationships they have to examine in order to determine the appropriate basis relationships.

Moreover, multiple delivery systems can create imbalances between longs and shorts, the makers and takers of delivery. A single point concept is not so imbalanced in favor of the shorts, the deliverers. Also, many of the virtues that have been asserted for multiple delivery point systems, I think upon scrutiny don't hold up. All right. In particular, just because you potentially would like grain from a particular location and that location happens to be a delivery point doesn't mean that you're going to be able to guarantee that you're going to get deliveries there when you want them, and particularly since the short has the option of where to make delivery, typically you're going to get grain where you don't want it, not grain where you do want it.

Another aspect of this system has to do with geographic balance. With the decline of Chicago and the de facto evolution of Toledo as the par delivery point, the effective point of convergence for Chicago Board of Trade contracts had moved east to the eastern edge almost of the Eastern Corn Belt. Well, it's been a long-term secular trend that corn and soybean production has been migrating in the exact opposite direction, to the west. All right. We wanted to create a delivery system that put the point of price convergence more towards the center of gravity of the grain trade in the United States, and by locating it in the Illinois Waterway System, we put the point of price convergence in the Western Corn Belt, in the center of gravity of the grain trade of the United States.

But it's important to know we didn't locate it in western Ohio or in Minnesota or someplace like that. Instead we located it on the eastern edge of the Western Corn Belt. Again, centrally located in order to provide balance between eastern and western hedgers.

Contracts also maintain a balance between domestic and export users. Now the primary mode of execution for these contracts, for delivery execution, is certainly going to be through barge although one can execute via vessel or rail if one receives delivery in Chicago. But that shouldn't lead one to believe that this is a contract for exporters only and that the domestic users of the contracts are out of luck. Nothing could be further from the truth.

First of all, we always have to remember that the purpose of our futures contract is not to provide a merchandising tool. Instead, the purposes of a futures contract are to provide a transparent price that you can use for price discovery and to provide a hedging mechanism. And statistical analysis demonstrates that prices on the upper Illinois River are highly correlated not only with prices and export markets but also in prices in major domestic markets in the United States. All right. So hedging effectiveness of anything will improve for a majority of hedgers in the marketplace, and that's a benefit that will be felt most greatly by the hedgers that are in the Western Corn Belt.

Some other concerns that have been raised relate to concentration. It is true that there are four large firms that supply the bulk of delivery capacity on the northern Illinois River. All right. But when talking about concentration, you have to ask concentrated compared to what? The entire grain industry in the United States, as I'm sure everybody is aware, has become increasingly more consolidated over time. And any alternative that one could choose is inherently going to have some degree of concentration because that's the way the industry is evolving.

Compared to realistic alternatives, the Illinois Waterway Delivery System is actually relatively unconcentrated. In particular in comparison to Chicago, in comparison to Toledo, in comparison to Chicago and Toledo, the upper Illinois River Delivery System is less concentrated. Some people have also raised concerns about concentration in the barge freight industry. A couple things to know. First of all, that very large fraction of the barge capacity in the United States is independently owned. That is owned by parties that do not operate regular or facilities that would be regular under the Chicago Board of Trade proposal. And also again you have to make comparisons. Concentrated relative to what? Illinois Waterway System, the barge market is definitely less concentrated than the rail market. It's less concentrated that the laker market. So when comparing to realistic alternatives, transportation is not more concentrated on our proposal either.

What about transparency? Well, the northern Illinois River is not a perfectly transparent market, but again no market is perfectly transparent, and again we have to make comparisons with viable alternatives. And by any realistic comparison, prices on the Illinois River are going to be more transparent than prices in terminal markets are today or prices in any other possible market you can consider locating a delivery point. This is a major source of cash market activity with considerable amount of price reporting information.

Again, if you're looking at transparency of the transportation pricing, the barge market is significantly more transparent than the laker market or the rail market particularly in the east, and so relative to realistic alternatives, the Illinois Waterway Delivery System offers superior transparency.

So to sort of give an overview of the virtues of the proposal, I think we have to keep one thing in mind. The best word to describe the proposal introduced by the Grain Delivery Task Force of the Board of Trade and approved by a two to one margin by its membership is balance. The contract provides balance between the makers and takers of delivery, between longs and shorts. The contract also provides balance between eastern hedgers and western hedgers. We can never make everybody perfectly happy. There are tradeoffs involved in designing a delivery contract and when talking about the interest of eastern hedgers versus western hedgers, by locating the delivery mechanism in the eastern part of the Western Corn Belt, we provide balance between eastern and western hedgers.

The system also provides balance between export and domestic markets. So in conclusion, the Chicago Board of Trade contracts represent a dramatic, and I emphasize the word "dramatic," improvement on the existing system. And to be honest, again, as somebody who has followed this debate for a number of years and anybody else who I think has followed this debate for a number of years would acknowledge that this change is so dramatic that it would have been almost unthought of, unheard of, even two, three, four, five years ago.

The contract will reduce the prospects for price manipulation, they'll improve hedging performance for a variety of users in the market, arguably the majority of users in the market, and the important thing to note is that changes to the proposal could offset the delicate balance that was a crucial part of these contracts, and with those remarks, I'm open to any questions.


MR. DODDS: Bill Dodds with the National Grain and Feed Association. I was part of the prior committee at the Board of Trade on this proposal, and I've got 35 years in this what I call cash grain business, and the largest file in my office is the latest file on CBOT delivery. And it's a cabinet, it's not a file. I have two publications in that file that Dr. Pirrong wrote, and when I found out he's going to be on the agenda, I snatched one page of one of those files and brought it with me, and I just want to read it.

Under "Conclusion," it says there is one clear-cut result, specifically, a river based delivery system is inadvisable because of the periodic episodes of extreme low correlation between Mississippi and the Illinois River prices and prices in major production consumption and production locations. This implies that an interior river-based contract will frequently perform poorly as a hedging and pricing discovery tool. And this was dated September 1996.

I have two questions. One, what's changed your mind? And two, which publication should I read?

MR. PIRRONG: Well, first of all, it helps when you quote selectively and don't really put things in context. The proposal that you referred to in there was a proposal for delivery on the middle Mississippi River. Okay. It was not a northern Illinois River delivery system. So in referring to that river system, it is inappropriate to conclude that I am making the same statement about a northern Illinois River Delivery System.

Okay. Second of all, during the process of the formulation of the delivery plan to the Chicago Board of Trade, this is one issue that I investigated. And it's one issue that had an important effect on the way that we designed the contract. In particular, what I did was I looked at the possibility of having a northern Illinois River only or a contract that was more based toward the southern end of the Illinois River.

All right. And what I found was that if you look at prices at the northern end of the Illinois River, they do not--I repeat do not--and I will be pleased to provide you with the statistical documentation for this, exhibit the same episodes of periodic poor price correlation that was found for the middle Mississippi contract which you read about in your remarks.

In contrast, the southern Illinois River, say between Peoria and St. Louis, did exhibit these same sorts of anomalous behavior that you describe and which I wrote about in my report in reference to a middle Mississippi delivery range. So this was a very important consideration for us in determining how far down the river we should go.

All right. And this was explicitly why we chose to terminate the delivery range of Peoria-Pekin as opposed to going all the way down and including St. Louis for precisely the reason that we didn't want to subject hedgers using these contracts to the kinds of difficulties that I wrote about in the report and which you just quoted. So I'm perfectly confident that there is a clear consistency between what I wrote about in September and what I've said this afternoon. And like I say, I'm ready, willing and able at any time to show you the data.


MS. DANIELSON: Nancy Danielson, National Farmers Union. Just two things. First of all, Mr. Robert White from the National Grange had to run to catch his plane just right as you were starting your presentation, and the last thing he said as he had to go out the door was whatever you do, don't let him close Toledo. So I wanted to have his comment on the record. The producers at the National Farmers Union would agree with that comment.

The question I have for you, those producers, particularly the ones in the Ohio area, are very concerned that closing Toledo will cost them a lot of money. From your expertise, do you have any response for them?

MR. PIRRONG: Well, what I would say is that people that make that argument are putting themselves between an economic rock and a legal hard place. Let me explain what I mean by that. Essentially, if Toledo is a valid vibrant cash market that as a delivery point does not exert an artificial influence on prices, then elimination of Toledo as a delivery point will have no effect on the wealth, livelihood, prosperity of farmers in Ohio or anywhere else in the country.

Conversely, if Toledo as a delivery point attracts unduly large quantities of grain and causes prices in the markets tributary to Toledo to be higher than they would otherwise be if Toledo were not a delivery point, then the Commodity Exchange Act makes it clear that Toledo is not an appropriate delivery point. The Commodity Exchange Act explicitly states that the intent of the act is to prevent or diminish price manipulation and to prevent or diminish abnormal flows of commodities in interstate commerce.

And so if Toledo is a vibrant cash market that is not having a distorting effect on prices because it is a delivery point, then farmers have nothing to fear. Conversely, if Toledo is causing abnormalities in price and commodity flows because it is a delivery point, then the Commodity Exchange Act makes it very clear that it is not an appropriate delivery point.

MS. DANIELSON: Which do you believe to be the case?

MR. PIRRONG: I believe the former is the case. In effect, you go back and look at the data from say the 1980s when Chicago really hadn't declined that much and the Toledo differentials seldom made it an economic place to deliver. There are several years where Toledo had either no deliveries of corn and soybeans or very modest deliveries of corn and soybeans, but yet during those years, Toledo was a vibrant cash market that was attracting receipts and making shipments of corn and soybeans in amounts comparable to the amounts that it was making in years where it was a source of deliveries.

MS. DANIELSON: So based on what you're saying, if Toledo is closed, their price won't change one penny?

MR. PIRRONG: Like I say, I don't believe it will. And if it does, that means that it's not an appropriate delivery point.

MS. DANIELSON: Thank you.

MR. LYONS: Yes. Dave Lyons. I'm presenting NAEGA here. I'm really curious about the--you talk about the price volatility being much less on the upper river than on the lower river. Can you explain, you know, tell me a little bit about why you think that is?

MR. PIRRONG: Yeah. I think that intuition is as follows. Essentially, the closer you are to an export market, the more and more the influence of the export market on prices at that location. All right. So the further you go down the Illinois, the further you go down the Mississippi, the less competitive domestic uses for corn and soybeans from those areas become, and they essentially are exclusively tributary to the export market.

In contrast, the upper Illinois River has to compete extensively for grain with domestic uses, domestic crushers and corn processors in Illinois, movement of corn and soybeans into other domestic markets, and so it is less dependent or is more competitive with domestic uses than lower down on the river, and that means that it's less susceptible to disruptions in the export market or disruptions in the barge market, and again, the data speak very loudly about this.

I mean you look at plots of correlation over time, and the Chicago-northern Illinois River correlation with say central Iowa or western Iowa or Kansas City or the Gulf market or whatever is relatively stable over time. Or either on the middle Miss or on the lower Illinois River, say St. Louis and the lower Illinois River, those correlations are much less stable. On average, they are about the same, but the correlation on the upper river is far more stable, which means that it's going to offer a more stable, a more predictable hedge for market participants because by being located further upstream. It's more insulated from disruptions and shocks in the export market.


PARTICIPANT: When somebody issues delivery intention and they issue a shipping certificate, does it specify the elevator that it goes with or does the long get to pick?

MR. PIRRONG: Yes, it does.

MR. HEITMAN: Could you repeat the question?

MR. PIRRONG: Yes. The question was does the shipping receipt that a taker receives upon delivery specify the elevator at which delivery will occur? One of the proposals that was originally advanced before the committee was that an operator of several facilities--basically the shipping receipt will identify the location of the elevator that delivery will be made out. So the long doesn't have an option, let's say, if he gets a receipt from ADM or Cargill to say, well, I want it that Cargill house or I want it at that ADM house. Instead the shipping receipt will specify that you're going to receive it at the ADM house in Laken.

MR. OMAN: Steve Oman, American Farm Bureau. As a producer in northwest Ohio and the bulk of our production probably going to the southeastern poultry market, my feeling from what I have read, and I guess I don't quite understand what you just said about the price in Toledo, but with basis levels, I mean I could see a three to five cent basis deterioration because of this, because of that market not being able to take access, and I guess I question, you know, we're in a day and age where we've been asked to go to the marketplace, the last farm bill put us there, we got more risk management to do, and I guess it bothers me when as a producer I can see, you know, five cents coming out of, you know, basically a $10,000 reduction in income because of a move to eliminate our function in the marketplace.

MR. PIRRONG: Well, first of all, again, if Toledo is operating as it should as a delivery point, that is it is reflecting cash market conditions and not driving cash market conditions, then its elimination as a delivery point will not have any effect on your price values, your flat price at which you're going to be selling grain. Okay. If we take your assertion that it will cause a three to five cent reduction in the flat price of say corn in northwestern Ohio, again that has very troubling implications because again what's the role of the delivery system?

The delivery system is intended to ensure that futures prices reflect cash market values and reflect fundamental supply and demand factors and do not reflect artificialities induced by the delivery design. So again I mean from my perspective I really don't think that you're going to have the kind of decline in flat price levels that you fear. If corn and soybeans should flow to Toledo, and if those should flow via Toledo to eastern processing markets, the fact whether it is or whether it is not a delivery point shouldn't have any influence on those fundamental factors. The grain should move based on fundamentals, not based on what's a delivery point and what isn't.

CHAIRMAN DIAL: Steve Patton.

MR. PATTON: Dr. Pirrong, like most people, I guess, that have given this issue a considerable amount of thought, I'm concerned about the integrity of the contract and what happens to it, particularly in light of a good bit of the change that we've talked about here today with Ken Ackerman and all of us who are concerned about the farmer and the changes in risk transfer that we're asking the farmer now to manage.

Some of the things that I'm perplexed about in the northern Illinois River Delivery System, it seems to me that we're rushing head long into something that is untried and unproven at the expense of that system which we have been using that, in my opinion, by and large has been very successful. How we can consider moving toward a contract that enables a deliverer to deliver essentially its elevating capacity, essentially his loading leg, for 30 days, within the bowels of the contracts, stops trading in the first half of the contract, that is 15 days, with delivery only at 17 days rather than to the end of the month? It appears to me that we've developed some very wide chasms between, for example, September 17 and December 1.

It appears to me that we've written an export contract that we totally disenfranchised the southeastern, in my geography, in the southeastern feeder. We haven't done anything for the western belt markets, in my view. That is we've had years, and we've all known that we've had years we've had tremendous oversupplies, grain essentially stored in the middle of streets in the town squares, and the carrying charge in Dec-March corn of two cents, it doesn't appear to me that this issue deals with that whatsoever.

In fact, it appears to me that it's quite likely that now should we embrace this system that it's very likely that we have that both in the eastern belt and in the western belt. So I'm probably filled with more questions than maybe time allows to answer, but I think that this is something that requires a great deal more study and hope that and have attempted to appeal to the commission that we do that, do give this issue more study, and I think that we have rather than to radically change the delivery system--undoubtedly there is some modification necessary--but I think that we're rushing into something that we simply don't know what we'll have 12 months after we get it started.

MR. PIRRONG: There are a lot of questions implicit in there, and I'll try to the best of my ability to recall them address them. First of all, in terms of launching head long, you know, I can't speak for the exchange, but the alternatives after December 19, 1996 were rather limited in terms of what to do, and, in fact, the CFTC made it clear in its action that it took on December 19 that it expected substantial changes to the delivery system in order to achieve compliance with the Commodity Exchange Act.

Second of all, any change would be a leap into the unknown. We have had essentially the same delivery mechanism for corn and soybean futures contracts, soybeans since they were introduced in the '50s, you know, corn going back to when Hector was a pup in 1867 or something like that. That is we had a delivery mechanism based on terminal markets and delivery in store. It's clear that that kind of delivery system is no longer viable, and any delivery system is going to represent a substantial change with that that has existed up until this time.

Insofar as some of the other issues that you raise, you know, again the main means of executing receipts under this system will be for export, but again especially since on the upper end of the Illinois River, those facilities have to compete with domestic processors, domestic users, in order to retain that grain, price on the upper Illinois River is going to reflect the whole nexus of demand and supply factors throughout the country. And as a result, it's going to provide an excellent hedge for users in the east and in the west. It's not going to provide as good hedge for users in the east as a Toledo based contract would alone, but it's going to provide a heck of a lot better hedge for the far larger number of hedgers in the west than it would a Toledo-based contract.

Insofar as the delivery timing stuff is concerned, I just want to make a couple points about that. The timing calendar established in the terms of the contract addresses a very major issue with the existing contracts. That is you could get delivery at one particular point in time, but you didn't know when the heck you were going to be able to load it out. By establishing a very tight time table for when grain can be loaded out on these shipping receipts, you give a lot less uncertainty to the taker of delivery as to when delivery is going to occur, when he's going to be able to get the grain and when he's going to be able to sell it, and that reduces the risk that that participant takes from taking delivery.

What's more I think that by essentially tightening the period of time during which grain can be loaded out, that, in fact, you're going to have better understanding of what spread relationships should be, not worse understanding of what spread relationships would be. So, again, in terms of some of the major points that you raise, I would disagree most strongly, and I'd also state that these were the result of extensive deliberation, study and consultation.

CHAIRMAN DIAL: Jimmy Sanford.

MR. SANFORD: Jimmy Sanford, National Cotton Council. Ultimately, who has the authority to make this decision? CBOT or the CFTC?

MR. PIRRONG: I'm not going to answer that one. Maybe Kevin McClear from the Board of Trade in the back would like to pitch in on that one.

MR. McCLEAR: Our submission is formally pending before the CFTC, and they'll review it.

CHAIRMAN DIAL: Paul Architzel, you want to step up here and respond to that question for us, please?

MR. ARCHITZEL: When the commission took action in December, it did so under Section 5(a)(10) of the act, which required the CBT to take a look at this issue and to make changes to the contract. If we find they're not appropriate, we have authority under appropriate procedures to require that a contract be supplemented or amended.

MR. ACKERMAN: Can I ask a question? Is it at all a option in this discussion to--as I understand it, the concerns are primarily coming from producers in Ohio who feel that moving the delivery point westward creates added costs to deliver. Is it at all an option to have the delivery points on the upper Illinois River plus Toledo or does that create a multi-point delivery system with price aberrations resulting?

MR. PIRRONG: That does effectively create a multiple delivery point system, and again this was something that received a considerable amount of debate and comment within the task force during our deliberations, and it was the strong sense of the committee that the virtues of a single delivery point contract far overwhelmed the benefits that inclusion of Toledo could provide.

And particularly, I had one thing that I should emphasize. It is certainly the case that allowing delivery in Toledo would tend to improve hedging performance for hedgers in markets tributary to Toledo. But some of the other arguments that have been raised in favor of Toledo really don't stand up. In particular, one argument that was frequently made to us is, well, if I'm a feeder in the southeast and I want to take delivery, if Toledo is not a delivery mechanism, I can't get my corn that way.

Two points are: first of all, in the context of a multiple delivery system, if demand is tight in the southeast or if supplies are tight in the southeast relative to demand and supply elsewhere, standing on delivery in Toledo isn't going to get you corn in Toledo because that's probably going to be the rich market, not the cheap market. So it's not going to be a reliable back-up source of corn or soybeans for a domestic user.

Second of all, if the corn and soybeans are falling into Toledo because it is a good and active cash market, and participants in the southeast need to access the grain stored in Toledo, they can do that through cash market channels which offers several advantages to them. I'll give you one example that doesn't necessarily get a lot of comment but is important. If you get delivery, you don't know what warehouse you're going to get delivery in until you actually get the receipt, and it could be in a warehouse that doesn't have a direct rail connection with the rail operator serving your facility. All right. And so you might either have to pay substantial switching charges and run the risk of substantial delays in receiving shipment, whereas if you get the grain through cash market transaction, you can acquire that grain in a way that's going to allow you to transport it most efficiently.

So, again, I have a really hard time seeing that the elimination of Toledo as a delivery point is going to do any harm to those people that rely upon Toledo as a source of grain.


MR. HELLERICH: My question concerns, for instance, if we have a year when the Illinois River is flooding or if we have a year when a drought is occurring, and we got low water tables, we can't move anything with barges and so forth, the river is closed, what are we going to do?

MR. PIRRONG: Well, again, first of all, we should make a contrast that the lakes are closed four months a year, and we know that, and we can count on that, and we can mark that down on our calendar for the next couple hundred years. If you look at the Illinois River, the closures that have been observed have been short and brief duration and have not disrupted the flow of corn and soybeans for considerable periods of time. So, again, when you make comparisons between real world alternatives, it doesn't appear that the upper Illinois River is unduly susceptible to closure.


MR. OMAN: Steve Oman. A question I have on the Illinois River, are all the delivery points, are they capable of railing out plus the river?

MR. PIRRONG: Under the terms of the contract, the only place where the taker has an option to request rail load-out is the Chicago facilities, Chicago at Burns Harbor facilities. Some of the other delivery facilities do have the ability to load-out rail, but they're not contractually obligated to do so under the Board of Trade proposal. However, it is possible that if a taker receives delivery at that location, that he can make and negotiate arrangements with the facility operator in order to get rail load-out at mutually beneficial times.

MR. OMAN: Okay. Under that light then, wouldn't that put an undue strain on domestic users?

MR. PIRRONG: Please define what you mean by "undue strain."

MR. OMAN: Well, if you took delivery, and you have to have it railed out and you can't get a railed out facility on the river, domestically, I mean I think you'd be at a disadvantage?

MR. PIRRONG: Yeah, but again we can't have a futures contract that is all things to all people, and what's more we have to remember that the objective of futures contract is not to serve as a primary source of cash grain. The function of a futures contract is to provide a pricing and hedging mechanism, and what the delivery function or what the delivery mechanism does to facilitate that is to ensure convergence between the cash price in a viable cash market that's highly correlated with prices in other cash markets and the futures price.

And evaluated under those criteria, which are widely recognized to be the main determinant that you should use when evaluating a delivery point, this system works very well. Let's consider an alternative. If we have a delivery point, a system that includes Toledo, if I want to export via barge in the Gulf and I get delivery in Toledo, I can't do that either. So in this respect, you can't make everybody happy. Just one other remark in this regard. Another important thing to do is one thing the delivery process does very poorly when you have multiple delivery points is coordinate the delivery of grain with the use of grain.

When you have multiple delivery points, you don't have any mechanism to make sure that the guy that wants grain in Point X gets it in Point X and not in Point Y. And that's just a fundamental feature of multiple delivery systems, and although in theory you might say, hey, it's better for an eastern user if he can get delivery in Toledo, if he's not getting it when it's economically viable to get it there, I don't see what the benefit is.


MR. PATTON: Just in response to that comment, Dr. Pirrong, but I can, and it's a known, the calculation, the difference between X and Y. Speaking to multiple delivery points, and I'm sorry to be so vocal, but we could probably sit here longer than any of us want to sit here and talk about this.

MR. PIRRONG: Well, I'm standing.

MR. PATTON: On the issue of multiple delivery points, the meal contract today, we have the opportunity to stop a meal in Marks, Mississippi, or Fostoria, Ohio or Decatur, Illinois or a number of places around the country. And again we can calculate it. We can actually make the calculation to our physical utilization at a particular processing plant, whether we stop meal in Marks, Mississippi, or whether we stop meal in Fostoria, Ohio. One thing that we won't be able to do is we won't be able to correlate northern Illinois River points to House of Rayford Farms--wherever the heck he is--in South Carolina, because we won't have the opportunity to make that calculation because it won't work for us.

Now, your point about you won't be able to be all things to all people, I certainly understand and I agree with. It's not lost on this committee, I'm sure, or anybody here that our domestic consumption of corn and beans far outweighs anything that we'll ever export. I don't think it's also wasted on anyone here that the increase in growth in the volume of business has been in domestic value-added meat export part of our balance sheet, which is also very likely to continue, which again this doesn't provide an opportunity for access from that market.

So, again, I'll just only reiterate that to me, it appears to me relatively or very rather short-sighted that we don't consider something different. The inclusion of Toledo, I think, is a good idea. I have a vested interest in Toledo. I'm an operator of a Toledo facility, but I'm very committed to the in-store warehouse receipt issue and providing access to all participants. And I do agree with you that delivery should not be a surrogate for a cash grain trader. No question.

But it appears to me that this view is very myopic, that we have certain risks that we just can't manage the issue of whether--and I'll tell you that some of my colleagues that I had hoped to bring with me today are in court versus the issues on the flood of '93. So that's a real live issue that we're all aware of.

MR. PIRRONG: Well, again, first of all, I appreciate your honesty. Second of all, let me reiterate a few points. I think because the main mode of execution for shipping receipts is going to be for barge export, I have to state categorically that does not imply that this contract will not serve as an effective hedging and price basing vehicle for domestic users. Again, I mean we have a cash market, gray market, in the United States that's highly integrated. Demand and supply factors in export markets and domestic markets all contribute to the making of prices whether it be in Ohio or Nebraska.

I personally executed a substantial amount of empirical statistical research regarding price correlations and the Chicago upper Illinois River provides excellent price correlations for domestic markets throughout the United States. The last thing that I'd like to respond to is your statement that you'd like to stay with a warehouse receipt market. To be honest with you, I don't think in the existing state of the grain industry in the United States that it's possible to design a contract that is not unduly susceptible to price manipulation, that is dependent exclusively on delivery and store in terminal markets.

The decline in terminal markets is well known, well understood, and it's been recognized essentially that in order to provide additional delivery capacity, in order to prevent a diminished price manipulation, that it's imperative to move the delivery system into the flow of grain. The way the industry has evolved, the only way to move something into the flow of grain right now is through shipping receipts. Again, we have to make considerations between choices that are available to us and we have to take the evolution in the marketplace over the past ten, 20, 30 years, as something we work with and not something that we can change. And given that, I think it's fairly clear that the shipping receipt alternative was the best available.

CHAIRMAN DIAL: One more question? Anybody? Dave Miller.

MR. MILLER: Has there been work or to what degree have you quantified to what degree Toledo detracts from the Illinois river system? I mean are they completely incompatible or is it a slightly marginal reduction on the system as a whole but yet gains definite benefits to a significant sector of the industry? And has that been quantified? You know we talk, I think everyone here agrees we can't go to an in-store delivery based system totally. I don't think anybody here is talking that.

The question is the addition of Toledo within store with the shipping the Illinois River, how does that deteriorate the system, and if so to what degree?

MR. PIRRONG: Well, first of all, I think we have to recognize in the context when you're mixing shipping receipts and warehouse receipts, that really exacerbates the differences between delivery points and makes the multiple delivery point, the differences between the delivery points even more acute, and it makes it more difficult to coordinate who gets delivery, where they want to get delivery. In terms of basis trading, price basing, et cetera, to the extent that there is certainty as to where delivery is going to take place, and you have a good understanding of the basis relationships between the price at your location and the price at the delivery point, it's easier for you to do the basis trading, more economical to do the basis trading, but it's also very difficult to quantify what the benefit of that is.

In terms of hedging effectiveness, again, we face a fundamental tradeoff. If we go towards the direction of adding Toledo, that helps one group of hedgers, harms another. And essentially what we have to do is weigh given that fundamental choice, a choice that can't be finessed, which direction we have to go? It's a binary choice, this way or that way. And we decided to go with the system that was more oriented toward the western market where the predominance in production and processing takes place.

MR. MILLER: I guess the question, though, is have we quantified how much it hurts by adding Toledo? I keep hearing that it's going to hurt this other group and deteriorate their system, but is there any quantification?

MR. PIRRONG: Let's put it this way. Yeah, I've looked at the correlations, and basically it would be about a one or two percentage point decline in hedging effectiveness by including Toledo for hedgers based in the west.

MR. MILLER: And how much of an increase in the effectiveness for the east?

MR. PIRRONG: A similar increase in effectiveness for people in the east, and that's where the crux of the issue is. Essentially in terms of the degree of hedging effectiveness change, it's like a two percent shift from west to east. But when we have 80 percent production west in corn and 20 percent production east in corn, it's pretty clear that the net effect of that shift is detrimental.

MR. MILLER: Except we don't have 80-20 consumption of corn.

MR. PIRRONG: Well, but if you look in terms of processing, processing of corn is still 70, 72 percent, something like that in the Western Corn Belt as well. So you're right in terms of consumption, there is a net flow from the west to the east, but I'm still fairly confident that it's not a 50-50 balance even, let alone a 55-45 balance in favor of the east.

CHAIRMAN DIAL: Thank you very much, Dr. Pirrong.

MR. PIRRONG: Thank you.

CHAIRMAN DIAL: And thank you all for being so patient, for taking time from your busy schedules and paying your own way to attend the Agricultural Advisory Committee. If you would, please, leave your name badges here on the table, and we'll pick them up. That way we can recycle them and have them for you next time. I hope you all have a safe trip home, and once again thank you very much.

[Whereupon, at 5:55 p.m., the meeting was adjourned.]