U.S. Commodity Futures Trading Commission
25th Agricultural Advisory Committee Meeting
Wednesday, August 12, 1998
1:05 p.m. through 4:31 p.m.
Three Lafayette Centre
1155 21st Street, N.W.
Washington, D.C. 20581
P A R T I C I P A N T S
AGRICULTURAL ADVISORY COMMITTEE MEMBERS:
DAVID D. SPEARS, Commissioner - Committee Chair
GARY HELLERICH, American Soybean Association
TODD VANHOOSE, Farm Credit Council
MARK SCANLAN, Independent Bankers Association
PAUL HITCH, National Cattlemen's Beef Association
ROD GANGWISH, National Corn Growers Association
JAMES H. SANFORD, National Cotton Council of America
RICHARD ELLINGHUYSEN, National Farmers Organization
JAY BAUMGARTNER, National Farmers Union
WILLIAM A. DODDS, National Grain and Feed Association
BILL KUBECKA, National Grain Sorghum Producers
ROBERT R. PETERSEN, National Grain Trade Council
ROBERT L. WHITE, National Grange
JIM BAIR, North American Millers’ Association
KENNETH ACKERMAN, USDA
ROBERT M. BOR, USA Rice Federation
JOHN BLANCHFIELD, American Bankers Association
NEAL P. GILLEN, American Cotton Shippers Association
STEPHEN OMAN, American Farm Bureau Federation
BROOKSLEY BORN, Chairperson, CFTC
JIM NEWSOME, Commissioner
JOHN E. TULL, JR., Commissioner
BARBARA HOLUM, Commissioner
JOHN MIELKE, Division of Economic Analysis
PAUL ARCHITZEL, Chief Counsel, Division of Economic Analysis
GREG KUSERK, Economist, Division of Economic Analysis
JOHN DAMGARD, President, Futures Industry Association
MICHAEL GREENBERGER, Director, Division of Trading and Markets
WALT LUKKEN, Senate Agriculture Committee Staff
DAVID EBERSOLE, House Agriculture Committee Staff
C O N T E N T S
David D. Spears, Commissioner, Chairman of the AAC
Status Report on the Agricultural Trade Option
Pilot Program and Discussion by Committee Members
Greg Kuserk, Economist, Division of Economic Analysis
Paul Architzel, Chief Counsel, Division of Economic Analysis
Overview and Discussion of Proposed Rules
Increasing Speculative Position Limits for Certain Agricultural Commodities and Amending
CFTC Guideline 1, Contract Market Designation Requirements
Paul Architzel, Chief Counsel, Division of Economic Analysis
The Future of Futures - a Discussion of Developments Involving Electronic and Off-Exchange Trading
John Damgard, President, Futures Industry Association
Michael Greenberger, Director, Division of Trading and Markets
Overview of the Upcoming CFTC Reauthorization
Walt Lukken, Staffperson, Senate Agriculture Committee
David Ebersole, Staffperson, House Agriculture Committee
P R O C E E D I N G S
CHAIRMAN SPEARS: We will go ahead and get started. People are still trying to make their way into the room and take their seats, but we will go ahead and get started.
My name is Dave Spears. I want to welcome you all here today to the Agricultural Advisory Committee meeting. I believe this is the 25th meeting of the Agricultural Advisory Committee, and on behalf of myself and all of the commissioners, I want to thank each of you personally for coming to this meeting.
We recognize it is a commitment on your part with both time and resources to be here, but, again, on behalf of all of us at the Commission, I really appreciate your attendance.
As most of you know, this Committee has a long tradition. This is the 25th meeting. There has been strong leadership over the years provided by former commissioners, including a fellow Kansan, Kalo Hineman who chaired this Committee, as well as Commissioner Joe Dial, who most recently chaired the Committee.
Most of you recognize that we have not met for a while, and we have a lot of issues going on within the industry. Since this is my first meeting presiding as chair, I would like to give you my perspective on what I see the role of this Committee is to this agency.
Everyone recognizes that there are a lot of changes taking place within the agricultural community and futures industry as a whole. The industry is very dynamic right now. A number of profound changes are taking place in regard to commodity markets, trading systems, technology, and, of course, government foreign policy.
What needs to take place is input from you to this Commission in regard to a number of these issues. These are crucial issues not only to agricultural, but to the CFTC. There is no question that, in my opinion, the role of this Advisory Committee is to provide advice and counsel to the Commission.
On the agenda today, we have a number of very important issues to talk about, including a number of controversial issues at times. What I would like for us to do is present the information to you as a Commission to the Committee as to bring you up to speed on a number of issues. It is also important for us to get feedback from you.
What I would like to have is an open forum of dialogue that continues from here on into the future. This Committee will serve as a forum of input and counsel to the Commission and advise on the issues important to the agricultural community as a whole.
First, let me introduce my fellow commissioners who are here today. I will start with introducing Chairperson Brooksley Born, to my right. She will make a few comments in just a minute.
Jim Newsome, our newest commissioner, is down here on the far right. As you all know, Jim was sworn in Monday of this week. This is his second full day on the Commission, and his second day in this room for a meeting. So we are very fortunate to have him.
Commissioner Tull, across the table from me, has been a commissioner for, I believe, 4 years, and has provided a strong leadership to the Commission. As well as Commissioner Barbara Holum, down here on the end.
I would also like to briefly note that I think all five commissioners being here demonstrates this agency's commitment to the agricultural community. Not often do you have all five of us in the room at the same time, and I think that demonstrates how important this community and this group is to this agency.
I would also like to acknowledge the presence of a number of the exchanges. I noted when I walked in the door that a number of representatives of the exchanges are here as well, including Jim Lindau, who is president of the Minneapolis Grain Exchange. I see representatives from the Chicago Board of Trade. Chicago Merc is here as well. So I want to thank you for being here.
I think there is certainly a role to have a dialogue between the exchanges, the Commission, and the community as well.
Just a couple of housekeeping things. I would like to note that when it is your turn to speak or you would like to speak, please let me know. I will recognize you. Also, on the microphones, it is important to push the button before you speak, and after you speak, turn it off because no more than three microphones can be on at the same time.
I also want to recognize, just real briefly, my staff, Jennifer Roe, who did a tremendous amount of work putting this meeting together. It would not have happened without her, and I want to personally thank her for doing the work that she did, as well as Mike Torrey on my staff, and Don Heitman.
With that, I think what we will try to do is maybe go around the room just briefly, introduce ourselves, and then I will have Brooksley make a couple of brief comments and we will get started on the agenda.
I have already introduced Brooksley. So why don't we start with Gary.
MR. HELLERICH: Gary Hellerich, representing the American Soybean Association.
MR. VANHOOSE: I am Todd Vanhoose with the Farm Credit Council.
MR. SCANLAN: I am Mark Scanlan with the Independent Bankers Association.
MR. HITCH: Paul Hitch, National Cattlemen's Beef Association.
COMMISSIONER NEWSOME: Jim Newsome with the Commission.
MR. GANGWISH: Rod Gangwish, representing the National Corn Growers.
MR. SANFORD: Jimmy Sanford, representing National Cotton Council.
MR. ELLINGHUYSEN: Richard Ellinghuysen with National Farmers.
MR. BAUMGARTNER: Jay Baumgartner, representing National Farmers Union.
MR. DODDS: Bill Dodds, representing the National Grain and Feed Association.
COMMISSIONER TULL: John Tull.
MR. KUBECKA: Bill Kubecka, representing National Grain Sorghum Producers.
MR. PETERSEN: Bob Petersen, National Grain Trade Council.
MR. WHITE: Robert White, representing the National Grange.
COMMISSIONER HOLUM: Barbara Holum.
MR. BAIR: Jim Bair.
MR. ACKERMAN: Ken Ackerman with USDA.
MR. BOR: Bob Bor, representing the USA Rice Federation.
MR. BLANCHFIELD: John Blanchfield, American Bankers Association.
MR. GILLEN: Neal Gillen, the American Cotton Shippers Association.
MR. OMAN: Steve Oman, American Farm Bureau Federation.
CHAIRMAN SPEARS: Thank you very much.
Before we get into the rest of the agenda and get into the primary topics, I would like to give the opportunity for Chairperson Born to make a few comments.
CHAIRPERSON BORN: Thank you very much, David.
I would like to extend a very warm welcome on behalf of the Commission as a whole and the Commission staff to all the members of the Agricultural Advisory Committee, and to thank you for being willing to serve the Commission and the public in this important capacity.
The Commission's advisory committees play an important role in providing information and advice to the Commission relating to its regulatory responsibilities. You are our window to the world of a very important segment of market participants and persons and entities that are impacted by the futures and option markets.
We greatly value your views and your willingness to share them with us. Without your help, we would be much less effective in carrying out our responsibilities to preserve market integrity, to prevent price distortion, and to protect market participants and the American public.
Again, welcome and thank you very much for being here.
CHAIRMAN SPEARS: The first item on our agenda is a status report the Agricultural Trade Option Pilot Program and discussion by the Committee members regarding that pilot program.
Before we get started, let me explain what we are going to do in this topic of discussion. I am going to have two of our staff members provide some briefing information to you. It will take about 15 to 25 minutes, and then I would like to get into an open discussion from the Committee members themselves, and again get into the situation where we are receiving input from you and your thoughts and ideas regarding the pilot program itself.
I would also like to recognize and note that Paul Architzel is going to visit in a little bit about some things going on in the pilot program, but I want to also announce that the Commission is trying to be helpful in regard to an education initiative. Our EA staff, the Economic Analysis staff, are in the process of putting together draft education brochures pertaining to the program.
They are designed to be brochures that will be user-sensitive, recognizing who the people might be that would be wanting to use the brochures for different purposes and different tools. Paul will get into that a little later on, but we are trying to help get the word out, disseminate the information, so that this program can be a useful program to the all community.
So, with that, I would like to introduce Greg who, I believe, is going to go first and make a brief presentation, and give the Committee a status of where things are in terms of the Agricultural Trade Option Pilot Program, what it is all about and how it works.
Paul Architzel will follow by making some additional comments. After he speaks we will get into the open discussion.
I might apologize. The first two speakers are going to use overheads. So the people on the far end of the room down here may have to move their chairs a little bit. So I apologize for that up front.
MR. KUSERK: I should mention that in the blue folder you received today, there is a copy of the overheads that I will be using here. So, if you cannot see them very well, you can go through them in your packet there.
It is a pleasure to be here this afternoon to address this group on the topic of ag trade options, and what I would like to do is give an overview of the structure of the pilot program that went into effect on June 15th of this year.
As most of you know, this process of lifting the prohibition on agricultural trade options has been a long and sometimes arduous one. The rules adopted by the Commission, though, represent an attempt to strike a balance between parties with widely divergent views on agricultural trade options.
These views range from continuing the ban, as it was, on agricultural trade options to other parties which favored a completely unfettered market in these options.
While this approach doesn't necessarily satisfy everyone, and it may run the risk of offending everyone, we think that we were able to address the most serious concerns of those wanting to maintain the ban, while crafting a pilot program, allowing for the controlled reintroduction of trade options to the agricultural community.
It should be noted that lifting the prohibition allows the individuals to enter into contracts which had not been available for more than 60 years; that is, a contract which a producer or other entity can walk away from delivery.
It should also be emphasized that the lifting of the ban in no way calls into question the legality of any types of cash or forward contracts that existed prior to the lifting of the ban.
What I would like to do in the next 15 minutes or so is to present a summary of the final interim rules by looking at the process of how the rules were drafted. I will begin by taking us back to 1991, which is the last time the Commission has proposed to lift the ban on agricultural trade options.
At that time, faced with stiff opposition to the proposal, the Commission chose not to act on the proposal, effectively leaving the ban in place.
By 1995, however, the over-the-counter markets in financial products was really taking off, and people in the agricultural sector began to take notice of the instruments and considered how similar instruments might be useful in agricultural.
In addition, talk of changes to the farm program and greater openness in international trade prompted the industry to seek a greater variety of risk-shifting contracts. As a result, parties that had opposed lifting the ban in 1991 had become proponents of lifting the ban in 1995.
In response to requests to look into the continuing agricultural trade option ban, the Commission held a chairman's roundtable on the prohibition of agricultural trade options in December of 1995.
This roundtable provided the impetus for the current rulemaking by gathering individuals from various interests in agriculture to voice their concerns and desires for lifting the prohibition.
What I have up here on the overhead basically shows the process from 1995 through where we are today as to what steps the Commission took to lift the prohibition.
We started with the chairman's roundtable in '95, and out of that, the Division of Economic Analysis was directed to do a study of these markets and look into what policy alternatives there might be to lifting the ban.
That report was made public in May of 1997, and soon thereafter on June 9, 1997, the Commission went out with an Advanced Notice of Proposed Rulemaking.
Following that, the Commission held public field meetings in Bloomington, Illinois, and Memphis, Tennessee, and also went out to give an information briefing at the National Cattlemen's Beef Association meetings in Reno, Nevada.
Following that, the proposed rule was put out on November 4th of 1997, followed by the final rules which were adopted on April 16th and went into effect June 15th of this year.
To give you an idea of what went on in each of these steps, in the policy paper that Economic Analysis presented, we noted a number of benefits and risks that we felt would be associated with lifting the ag option ban.
Among the benefits were the ability to customize contracts, the ability to bundle other services with option contracts, for instance, combining financing of the premiums with the options or other services that might be offered by those offering the options.
We also felt there would be a greater supply of and competition in offering these types of options, and we also felt there would be a greater variety of option vendors that producers and others in the industry would be able to choose from.
On the other side, we felt that there would be certain risks that would come along with lifting the ag option ban, and these, we noted, would be increased chances of fraud. There is an increased credit risk since you have contracts that are entered into bilaterally. You have potentially higher liquidity risk as opposed to an exchange-trading environment where you have many buyers and sellers. In the over-the-counter markets, you are somewhat limited to who you may purchase these instruments from.
We also felt there would be the increased potential for operational risk, systemic risk, and certain legal risks.
Based on the study, the Division drafted an Advanced Notice of Proposed Rulemaking that would consider the lifting of the agricultural trade option ban. Basically, in that proposed rulemaking, we proposed a regulatory structure that might be applicable to these markets.
In this regulatory structure, we noted in particular whether or not there should be limitations placed on the nature of the counter-parties. The question was how open should these markets be to non-agricultural interests, and should sophistication of the participants be a concern in deciding who would be able to enter into ag trade options.
We questioned restrictions on the instruments or their use. Again, the question was how wide open should the market be with respect to crafting different types of instruments. If you look at markets such as the swap markets, you see very sophisticated, complex instruments, and the question was how sophisticated or complex of an instrument should be allowed in this type of a market.
We asked questions regarding the regulation of marketing. In particular, we were looking at disclosure documents and what type of disclosure documents should be required in this type of market. We also looked at other possible limitations, some that dealt with credit risk, which included looking at collateral, minimum capital, cover requirements, third-party guaranties, minimum credit ratings and things like that.
We also sought comments on internal controls, and the extent to which financial statements of trade option merchants should be audited.
Based on the comments that we received from the advanced notice, in addition to speaking with individuals at the various public meetings we held, the Division went forward with recommending a 3-year pilot program to lift the ban on agricultural trade options.
In those proposed rules, we outlined a regulatory structure that would govern these markets. Within that structure, we felt that it was necessary to restrict the type of options to physically settled options, without the ability to offset these contracts.
The reason that we considered cash settlement important was because we felt that the agricultural trade options were meant to serve a commercial purpose, which is basically merchandising and hedging. We felt the cash settlement would make contracts more conducive to speculation, and in light of the HTA, or hedged-to-arrive experience, we felt as an initial start, cash settlement would provide a means to control some of these risks.
We also looked at restrictions on eligible vendors, basically limiting vendors to individuals who are in the business of agricultural in the commercial business.
This kind of goes along with the physical settlement portion of the options in that in order to be an eligible vendor, you would necessarily have to be able to take delivery of a commodity.
We also proposed regulation on agricultural trade option merchants. In this respect, the regulation of these merchants would include registration, which when proposed would have required a merchant to register with the National Futures Association, and it would have included fingerprinting.
We also proposed a competency test. In this case, the Series III would have served the purpose of this test, but in addition, we would propose that another, more of a subset of the Series III would be developed for competency testing purposes.
The regulations also would have required mandatory ethics training, which would have had to have been performed every 3 years. In addition, agricultural trade option merchants would have to have a minimum net worth of $50,000, which they would have to maintain, and they would be required to segregate customer premiums.
There were also restrictions on the types of options and market strategies. The rules would not allow short sales of options by producers, except in a situation where a short call is sold, but in combination with the purchase of a long put option.
The regulations would have required risk and trade term disclosure, recordkeeping and reporting requirements, which trade option merchants would have been required to maintain books and records. There would have been required routine reports on a quarterly basis. These reports would have included information on the volume of options entered into, open-interest, premiums, fees, commissions, and other charges, and the numbers of options and quantity of commodity exercised under these options. Entities would also be subject to special calls.
Finally, the regulations proposed a set of written--well, it won't be finally. It was also proposed that written internal controls would be required of ag trade option merchants.
The rules also provide an exemption for sophisticated entities. Under this exemption, entities that have a minimum net worth of $10 million would have been exempted from the trade option rules and regulations.
In setting the amount at $10 million, the Commission noted that Part 35 and Part 36 of our rules place a net worth of $1 million as opposed to the $10 million in the agricultural trade option exemption.
This higher level was chosen for the Agricultural Trade Option Pilot Program because of the relatively large investment in land and equipment needed to operate farms. It was felt that the lower $1-million net worth required might not accurately reflect the sophistication of a producer to enter into complex transactions.
This is not to say that individuals in agriculture are not as sophisticated as in other markets, but I note that this was an area where options had not been available for a very long time, and because the exemption would not place a restriction on the types of instruments that could be entered into, potentially farmers could be entering into very highly engineered products.
We felt it was better to take this slowly and to potentially look at this situation later if things warrant a further look at it.
Finally, in the proposed rules, the Commission added relief for exchange-traded instruments. To this point, exchanges were not allowed to market options that involve physical delivery on the options, and what we proposed to do was to lift that ban and allow for physically settled options on exchanges.
After considering the comments that were received on the proposed rules, we went back and did some fairly significant modifications to the proposed rules, and what I would like to go through now is take you through and indicate where significant changes occurred from the proposed rules to the final rules.
As for physical settlement and the offset provisions of the rules, the Commission decided to maintain those rules as they were. This was to ensure that contracts were entered primarily into, between parties who know each other, that typically deal with each other through normal commercial channels.
The Commission also noted that options could be amended to reflect changes in cash market activity, so that if a producer's production situation changes or he decides to store commodity, things like that, we recognize that the options, although you could not get out of them, you could amend them to reflect those changes in the underlying activity.
We also indicated in the final rules that physical delivery requirement did not necessarily preclude the development of revenue-type option contracts. We felt that it would be possible to design a revenue-type contract, which might involve some type of a variable delivery requirement in it.
Under the regulation of agricultural trade option merchants, we note that under the registration requirement, the fingerprinting requirement was dropped. We felt that because parties would be restricted pretty much because of the physical settlement features of these contracts to dealing with parties they already knew, we did not think that fingerprinting was necessarily a requirement that we would need for registration.
The competency testing was also changed significantly. As opposed to requiring a test, the Commission instead decided to institute the process of an education process, where ag trade option merchants would be required to go through 6 hours of instructional requirements.
In addition, the ethics training portion of the rules were changed to include that as part of the instructional requirements.
The minimum net worth of $50,000 was left unchanged, and segregation of customer premiums, while still required, noted that the premiums could be used to purchase cover. Part of the reason for having segregated premiums was to offer some protection to the purchasers of options, and we felt that if the agricultural trade option merchant is going to go out and cover these options that they have written, then that would be a legitimate use of the premiums.
Under the risk and contract terms disclosure, we maintained general and transaction-specific disclosures. The proposal was that there is a general disclosure that would be given to the purchaser of an option or an option customer before he enters into his first option. That would not have to be provided with each option, but then in addition, there would be specific terms that deal with a particular transaction that would have to be disclosed each time. These terms include things like the premium, the amount of the commodity, the basic information that you would have in a contract.
We also shortened and eliminated redundant information from the risk disclosure documents. We have modified the rule to make clear that an exact schedule of discounts and premiums need not be specified. Instead, it can be noted that a range of premiums and discounts might apply to reflect whatever the current situation was.
In addition, the Commission eliminated monthly customer account statements, but, instead, vendors would be required to notify customers of approaching expirations.
In this case, we felt that because of the types of instruments, the types of options someone could purchase, it was not necessary to have a monthly disclosure of what those positions would be, but instead, what seemed to be more important to customers would be that they know when certain options would be coming up for expiration, so that they would be alerted to make their decision as to whether they wanted to exercise them or not.
In addition, the requirement that trade option merchants would have to respond to customer queries in writing was extended from 24 hours to 48 hours.
With respect to recordkeeping and reporting requirements, we still require that books and records be kept. However, we removed the NFA authority to inspect the books and records.
In addition, routine reports were scaled down. In the final rules, only volume, open interest, and exercise would have to be reported, while information on premium and fees would no longer have to be reported on a quarterly basis, although we noted that information might still be required if special calls were to be performed.
In addition, the rules on special calls noted that information would be limited to requests on information related to the agricultural trade option position itself, and finally, the written internal controls would still be required.
The final two items in the regulatory structure, those dealing with exemption for sophisticated entities and relief for exchange-traded instruments were left unaltered.
At this point, I would like to introduce Paul Architzel. He will come up and speak a little bit about the current status of the trade option exemption.
MR. ARCHITZEL: Well, if this seems like a lot to digest, it has been a lot and a long process in actually adopting these rules and thinking about these issues.
I think one thing that is clear from Mr. Kuserk's presentation is that the Commission undertook this process in a very thorough and considered manner, in that each of the rules that was proposed and finally adopted by the Commission was done so partly in respect to what other rules were adopted and proposed, so that they stand together as a web, and that changing one rule would affect other parts of the proposal.
What I would like to do at this point is to give a very brief discussion of the history and the next steps we will take following our adoption of the rules.
As Greg mentioned, the final rules became effective on June 15th. Prior to that time, we started receiving requests for information about the actual mechanics of registration and of compliance with the rules. In particular, the National Grain and Feed Association was very active in requesting information. We responded in part in writing to their requests. These responses were carried in their newsletter to help disseminate the actual mechanics of registration, such as who to call to get a registration form and that type of information.
We also received a number of direct inquiries from people who were interested in becoming registered. Again, their inquiries were looking at the rules and studying what their effect would be.
Part of the nature of the requests reflect the fact that we are embarking on an entirely new program. People do not have established systems at hand and are not familiar with what the rules are since it is a new program.
Subsequent to the rules becoming effective, we met several times with various groups, including the NGFA, to discuss implementation of the rules and issues relating to implementation.
So far, approximately 10 firms or organizations have contacted the National Futures Association "NFA" to request registration materials. Although, this looks like a low number, it may be deceptive since some of those contacting NFA and requesting registration forms are organizations which intend to copy those forms and make them available to their memberships. Accordingly, the 10 requests for information may, in fact, represent a far larger number of entities actually having registration materials.
At this point, no one has yet actually applied for registration or notified the NFA of its intent to become a trainer. Mr. Kuserk talked about the training that was required to become registered. Trainers will have to identify themselves. No one has come forward with that letter of intent yet.
The Commission in adopting these rules noted that it was a pilot program, that the rules were interim final rules, and that the Commission would be conducting an evaluative process during the pilot program.
As part of this, the Division contacted a number of trade sources to follow up on issues relating to implementation of the rules.
Here are some of the things that we found. First, most people, whether they are representative of producers or potential ATOMs, suggested that development of this market will be dependent upon demand developing among producers for the instruments.
People also noted a number of impediments to the development of that demand. The first, being current low prices in agriculture. They indicated to me in discussions with them that because of the low prices in agriculture, many producers feel that the markets are at their low, and they are not looking to these kinds of instruments. They do not care to lock in prices that are at the current low levels. Accordingly, there is really little demand on the producer's side for those new kinds of instruments at this time.
The second impediment is timing. Currently, producers are primarily interested in the risks they face with production and are not really thinking of marketing strategies and those types of activities at this point.
Finally, there is the question of the learning curve. We noted that impediment in all of our papers to the Commission, beginning with the white paper (over 2 years ago). That is, we are reintroducing an entirely new instrument which has not been traded for over 50 years, and people are simply not familiar with it.
In my conversations with people in the field, most producers are simply not aware that it is now possible to have agricultural trade options offered to them, and that this will take a while to filter down.
In particular, a lot of associations that I have talked to and other types of organizations are going to be offering education to their members, but they are planning for that education process to take place this winter.
So that based on that learning curve, we should see interest start to pick up during the mid-winter round of meetings.
Now, from a supply perspective, I heard a number of people express the following, impediments to ATOMs offering these instruments.
First, there was an often-expressed skepticism that producers would be willing to pay premiums up front, which is a typical way we expect that agricultural trade options would be made available.
I heard very often that we just do not think that producers would be willing to enter into an instrument where they have to pay the premium up front.
Secondly, some firms and individuals express skepticism in general concerning innovative contracts at this time, based upon their experience with HTA contracts. They expressed a reluctance to enter into new types of contracts and a feeling that they would rather stick to the tried and true.
There is a skepticism in charging into this new area, and more of a holding back, to wait and see what happens.
Some people express the thought that exchange products and current traditional-type cash contracts offer many of the benefits that they perceive being offered by agricultural trade options. In part, this may be part of the learning process, getting people familiar with what agricultural trade options can offer them. But at this time, there is a common perception that there is not a whole lot that agricultural trade options are going to offer which is in addition to those instruments which are currently available.
Also, it is a completely new program, and I found firms are still studying the issues. They are still studying technical issues about the mechanics of complying. We are expecting to get additional questions on implementation. We are happy to receive those. My phone number is published in the Federal Register notice, and you all have it in your packet. We will respond in writing to the extent that these questions are questions of general interest so that everyone will have the benefit of having our answers. Certainly, we look forward to having technical questions sent to us if those are stumbling blocks to people’s participation.
In addition, some potential ATOMs said, "Yes, we are ready to offer the instruments, and we will offer them, but we are not going to be the first." I heard that from several people. Again, there was reluctance to charge into this area. In part, it may be a reaction to the past situation with HTAs.
A number of people did tell me that it is not worth the trouble of complying with the regulations, and this was tied into the perception that there is not a whole lot of demand for this. Part of the thinking goes that only about 10 percent of farmers will go to the Board of Trade or another exchange to trade futures, and we do not expect that the number to be far higher for this type of contract.
Therefore, the total volume of business that is possible to us offering this is not going to be very great. It is not a question of this regulation being tweaked or that regulation being tweaked. It is just not worth the effort based upon the expected limited volume of business.
Some people said the regulations were too complex and require too much paperwork. Again, in certain instances, I think in talking to them, part of the situation or problem was one of perception. There had been a lot of discussion during the Advanced Notice of Proposed Rulemaking and the proposed rulemaking. The final rules, what is actually required, have not yet filtered down and been factored in. For example, as Mr. Kuserk explained, we pared back on some of the requirements that people objected to, like the fingerprinting requirement as part of the registration procedure. It was not clear that people actually focused on the changes that had been made from the proposed rule to the interim final rules. So, again, part of that may be educational.
Now, on the other hand, people did tell me that they are offering instruments pursuant to the $10-million exemption level. Their expectation was that as people became more familiar with what was being offered, that that familiarity and comfort level would filter down, and that the business being done would filter to lower levels which would require registration. Thus, we may start to see registrations occur as people become more comfortable with the instruments they were offering under the exemptive relief.
As Commissioner Spears indicated, there are some next steps that we are considering. First, because the learning curve seems to be major impediment, both on the demand side and the supply side, the Commission will undertake an education initiative.
What we plan is to offer brochures which are targeted to four groups. The first will be targeted towards producers. That brochure will simply outline what an agricultural trade option is and what it can do for producers. It will be written in very clear, simple terms.
I know many people have discussed whether the disclosure document is too complex. We will certainly try and produce this brochure in a very clear, simple manner, and we hope to get your input on that to make sure that it is clearly written, and is not it is too complex.
Secondly, we will produce a brochure for potential ATOMs. This will be in the form of questions and answers. It will be geared towards technical questions, of how to register, where to call, what needs to be done to register.
Again, we would welcome your input in this, what questions you have. I try and keep track of what questions I get by phone, but if there are questions that you have that are suitable for this kind of publication, we would welcome you telling us what those questions are, so that we can get that information out to the public.
Thirdly, we would expect that we would produce a brochure for agricultural extension agents. This would be written on a level more appropriate to the kind of role that they have in agriculture, which is to give advice. It would take into account the fact that they are already familiar with some of these items.
The last one we expect to do is for rural bankers. We feel that the financial part of the transaction is an important one. For this program to be used, we need to address questions about whether farmers will pay a premium up front. From that perspective, we think getting rural bakers familiar with it and involved is one of the keys to making the pilot program work.
We hope to move on this quickly, and we really hope to have your involvement in the drafting of these brochures. As we draft documents, we will be sharing them with those of you on the Committee and others for comment, so that we can get the best possible document.
Our intention is to make this information available on the Internet, to save our own printing costs. The brochures would be freely downloaded by you and all of your organizations to, in turn, distribute to those people to whom they are targeted.
Also, we expect that we will continue to be asked and solicited for guidance on implementation, and we welcome those requests. There may be wrinkles in the actual implementation of certain rules. I will give you one example.
The registration rules incorporate registration rules which are generally applicable to all futures professionals. The reason we did this is quite simple in that we were trying to make the rules simple and less complex. Rather than rewriting the entire rule book, we referred to other rules.
Well, as it turns out, most futures divisions of companies are separately incorporated. So some of the registration requirements look very reasonable because the futures division may be a small division of a company.
As it turns out, I am hearing that some requirements, which simply refer to other registration rules may have a different impact on cash grain companies, which may not be separately incorporated divisions of a large company. Instead these companies may operate as a unitary company.
If there are mechanical problems like that and mechanical obstacles in the rules, the best thing to do is first call and find out what is the understanding of the rule. The next thing is to discuss with the staff whether that type of problem is susceptible to a staff interpretation of the rule, an interpretative letter, or perhaps in appropriate circumstances a staff no-action. These will tend to be interpretations of how the rule is to be applied.
On larger questions of policy, the Commission indicated that this is a pilot program. The Commission intends to look at the rules as the pilot program develops, and to try and see what the problems are and to respond to them and see how the program is developing.
In this regard, the Commission has provided many opportunities for public comment. As Mr. Kuserk noted, the rules that we have were an attempt to try and accommodate many diverse views on what is the appropriate way to structure rules for this market.
Again, the Commission will be looking at this. If people or individuals or groups would like the Commission to look at certain rules or if they have suggestions on certain rules, our general rules provide a mechanism for that to be done, and that is a petition for rulemaking. An individual or an entity can petition the Commission to take another look at a particular rule, and we will go through that procedure.
Again, the Commission will do this on its own as a matter of having a pilot program, but it will also be responsive to people making specific suggestions.
That is where we are and brings you up to date. I will turn the meeting back to Commissioner Spears.
CHAIRMAN SPEARS: Thank you, Paul and Greg.
What I would like to do now is get into an open dialogue discussion regarding the agricultural trade option pilot program.
I want to stress what Greg and Paul both said, that this is a pilot program, and all of the commissioners are committed to making it a workable, viable program for the agricultural community.
In my letter to you last week, I posed a couple of questions that could be utilized to create discussion – food-for-thought questions that we could talk about today. Since then, a number of you have written to me and have talked to me about points of view that you have regarding this issue.
So, instead of going through those questions, what I would like to do is just open up the meeting to an open dialogue.
We are a little behind schedule. I wanted to have a little more time for discussion. I think what we are going to try and do is run into the next program a little bit in order to allow for sufficient time to talk about this program because of its importance to the Commission. I think it is extremely important.
So, with that, I would like to recognize anyone who would like to give their viewpoints regarding this program.
As Paul mentioned, we are also trying to get the word out to producers and to other entities as to what the program is all about, and I think education is a key part of that.
I will turn the floor open to anyone who would like to visit about the program.
MR. DODDS: My grandfather always told me never to be last. I am not sure I want to be first.
There is a statement at your table here, anyway, from the National Grain and Feed. Maybe what I will do is you can turn back to Appendix 1. I will refer to that, and I have a few comments to make. Then I will catch up with you.
Let me first say, Chairperson Born, Commissioners, fellow Committee members, and guests, we commend Commissioner Spears for recognizing the importance of allocating this time on this very important subject to discuss agricultural trade options.
Agricultural trade options can become an important risk management tool for agriculture, and their introduction comes at a critical time for both farmers and agribusinesses.
The FAIR Act of 1996 shifts a large portion of risk management onto the private sector. The private sector can respond to these challenges, and agriculture can prosper with less regulation only if Government provides an environment that gives commercial businesses adequate marketing flexibility and keeps regulatory burdens at reasonable levels.
Effective June 15th, qualifying firms could become or begin signing up as an agriculture or trade options exchange. According to the National Futures Association, to my knowledge, none have signed up yet.
The agricultural trade options regulations are rather ominous, and attached to this paper is a single page from a June 4, 1998, National Grain and Feed Association newsletter which compares the regulations of agricultural trade options with non-ag trade options, swaps, regulated exchange futures and options, and see Appendix I. That is what I made a reference to earlier.
It is obvious, looking at this chart, agricultural trade options are more highly regulated than either non-agricultural trade options, swaps, and in some respects are even more regulated than the futures and options traded on regulated exchanges.
Excessive regulation costs are not the only cause of reluctance for potential agricultural trade options, merchants' applications. The CFTC regulations, by stipulating specific rigid terms that must be included in the agricultural trade option contract, inhibit flexibility, the contract development, and create unnecessary risk for contract writers.
Most important, the CFTC regulations, by prohibiting cash settlement, have taken away a substantial proportion of the value and benefits of agricultural trade options.
The potential value of a variable agricultural trade option program could be described in many ways. Some of the difficulty in specific monetary value is because agricultural trade options have not been offered, and no one is certain as to what forms agricultural trade options may develop.
Given this caveat, our association anticipates that wide use of agricultural trade options would result in walk-away rights being attached to many existing cash-forward contracts, had a viable agricultural trade option rule been in place in 1997 and 1998.
An example of a walk-away contract, plains area wheat producers typically, from my perspective and those friends of mine in the area, are reluctant to forward contract wheat, even in a minimum price contract due to production uncertainties. In 1998, this reluctance to adequately forward price or place a floor under market prices has been extremely costly, some say exceeding 75 cents per bushel over the recent months.
If only 25 percent of this production had been forwarded contracted with agricultural trade options, many dollars would have been saved, and I have seen numbers as high as $140 million in farmers' pockets.
Making the Agricultural Trade Option Pilot Program work. Based upon the responses of potential agricultural trade options to the current rule, it appears likely that unless changes are made to reduce the regulatory burden and/or enhance the value of the agricultural trade options contracts that are permitted, participation will be very limited. We would encourage the CFTC to begin actively considering changes to the program that would make the program more attractive.
Possible improvements to the existing pilot program might include: exempt from regulations commercial agricultural trade option contracts that do not include products--this would treat agricultural trade options on an equivalent basis to all other trade option contracts--two, exempt from regulation any parties to an agricultural trade option that have a minimum net worth of $1 million; and, three, permit cash settlement to make the program substantially more valuable to the participants.
In response to the questions prepared by Commissioner Spears, what plans has your organization made to advocate its members concerning the introduction of these instruments, the National Grain and Feed Association has, through newsletter articles to its members, and through programs offered at annual conventions and Country Elevator Council meeting, have been actively educating its members on possible commercial uses of agricultural trade options and instruments on how to become an ATMO. See Appendix 2, and that is in that packet that we handed out.
The National Grain and Feed is developing an educational program through funding by the Risk Management Agency to instruct growers how to effectively use combination strategies for risk management.
To what degree have banks become aware of the potential uses of these instruments? National Grain and Feed is unaware of any banks that have actively pursued agricultural trade option opportunities.
Three, please be ready to share concrete examples of contracts or types of transactions for use by your members. National Grain and Feed is aware that revenue contracts that require delivery if exercised can be offered under this program. However, we do not expect such revenue contracts to become widely used. Unless basis risks for such contracts can be hedged by contracting with producers across several State regions, it would appear difficult to offer such contracts on an attractive basis.
Innovative marketing and risk management programs of which you may be aware that are evolving to help farmers deal with market risks. As noted in response to Question No. 1 above, the National Grain and Feed Association is developing an educational program for grain farmers that will incorporate combinations of strategies using both cash-forward contracts and crop insurance.
Item 2, initiatives being used or considered that would apply advanced in computer and telecommunications technology to agricultural marketing and risk management, the CBOT's Project A is an example.
The last thing I will mention, if you will turn back in that packet, to the item called Focus, and behind that, there is agricultural trade options questions and answers section--and I misled you. There is a spot in there, page 3 under the Focus section. There are some examples in there, "Show me a few examples of agricultural trade options." Those, you should read, and I think you would get a quicker understanding of how producers might use them.
Thank you very much.
CHAIRMAN SPEARS: Thank you, Bill.
As Bill mentioned, we included in your packet the statement of the National Grain and Feed Association. The NGFA asked me to include it as part of the information that they presented to me this morning. I thought it would be beneficial for you to have to read later on, and Bill summarized it in his comments.
I also would like to recognize anybody else who would like to discuss this issue.
MR. ACKERMAN: Thank you, David.
I just would comment very briefly, just overall on this. I appreciate the good presentation by Paul and Greg.
One clarification. Bill Dodds mentioned the grant recently awarded to the National Grain and Feed on education by the Risk Management Agency. I would just note that we should share the credit. This grant came from the Risk Management Education Project, in which the Commodities Future Trading Commission has been a very active partner.
So, in a way, this is a joint initiative among our agencies, and I am glad to share the credit on this. We think it is a very important grant and a very important initiative.
Generally, I think it is important when you look at agricultural trade options to put this into context with what is going on in the country right now.
There is a major national debate occurring today on the adequacy of the foreign safety net, both in terms of productions provided by Government, as well as tools made available by the private sector.
To the extent initiatives like agricultural trade options can help in that debate and help in the current concerns about the safety net, they are very important and very useful.
This year, the debate is being driven by three major factors. In a way, we have three major farm crises going on at the same time. On one level, we are seeing very low prices, as has been pointed out, for wheat and corn and soybeans and many other major commodities, which is causing very high concern among farmers about how to hedge price risk, and not only how to hedge price risk in an intra-year way, but also how to hedge price risk in a multi-year way, how to deal with cycles, sometimes multi-year cycles of low prices and what kind of tools can be developed to do that.
Second, we are seeing a bad production year this year. I think as everyone knows, there is a drought going on in Texas, Oklahoma, and major parts of the Southeast, at the same time as we have had El Nino in California causing very wet weather. So many farmers are dealing with poor production years at the same time we are dealing with the year of low prices.
Finally, we have a fully separate farm problem, a regional problem, where certain parts of the country have seen bad weather cycles, multi-year cycles. We are hearing this primarily from the Northern Plains, where the area in the Dakotas and Minnesota over the past 5 years have had to deal with the 1993 flood of the half-millennium, further floods in 1995, in 1996 the worst winter in several hundred years, the very visible floods in 1997, and major outbreaks of wheat scab, all in the same area, all in the short period of time, which has created even additional problems, beyond low prices and this year's disaster.
All of this has pushed forward major concerns about how to improve the farm safety net, and we are seeing on the crop insurance side a series of new initiatives, of new products, of new pilot programs, of new ideas from the private sector coming forward.
Just yesterday, the FCIC board of directors met and approved about half-a-dozen pilot programs, including five new crops, plus several pilot programs on APH, which is the yield coverage.
In September, we are going to have another meeting dealing with revenue insurance products developed by the private sector.
So, clearly, when you look at ag trade options, they very much have a role to play. Clearly, there is the potential market for it.
Bill Dodds mentioned the example of farmers who had failed to forward contract grain in the Northern Plains. We are seeing this year that prices of soybeans are now sinking below $5. Many farmers, 6 months ago, had a very good opportunity to lock in prices and did not take advantage of it. So the need for this type of product and also for education are highly important.
The one thing I would encourage, both the ATOMs, the agricultural trade option merchants, as well as the exchanges in developing new products within the relief provided by this regulation, we view this clearly as a teachable moment, a moment in which farmers would be very open to new products.
This would be a very good time on both sides, both the ATOMs and the exchanges, to be talking to farmers and getting a sense from farmers on how they think these products can fit within their overall market plans, their overall farm strategies, their overall risk management plans, their overall financing plans because, for these to be commercially successful, the key ultimately may be how they can fit into context of a farmer's overall view.
One other thing I will mention briefly, and Commissioner Spears mentioned this briefly, is about the education program. I would simply like to say from our part, we have been very actively working with CFTC on risk management education. To the extent we can use our forums to help all of you around the table in doing outreach on this project, that is something we would be very glad to do.
For people in the futures industry, I would note that we have a risk management education conference in Chicago on August 26th and August 27th, which may be an appropriate point to raise some of these issues.
CHAIRMAN SPEARS: Thank you, Ken.
As Ken mentioned, we have participated in some of his programs. They are holding regional risk management education conferences around the country, and I have attended a couple of those, as well as other commissioners, like Commissioner Tull. They are very beneficial programs, and I think this is an opportunity for all of us to get the word out regarding some of these programs.
So thank you, Ken, for the opportunity to participate in those programs.
MR. DAMGARD: I was struck by Ken's remarks about sharing the credit. I just want to opine that maybe there would be more credit to share if we would get away with the delivery requirement.
I agree with Mr. Dodds that some of the firms that would be most anxious to jump into this field are the financial services firms who already have a relationship with many of the producers, but by virtue of the prohibition on cash settlement are unable to register.
I do not know if I should direct that to you, Ken, but I am so used to it since 1992 that I just do not know who else to talk to.
CHAIRMAN SPEARS: Neal?
MR. GILLEN: Yes. I would like to echo John and voice the support of the cotton trade for Bill Dodds' statement, and also for the very perceptive remarks of Ken Ackerman, who has always been in the vanguard of new developments ever since his days up on the Hill.
There is no interest whatsoever in the cotton trade for ag trade options given the draconian requirements of the pilot program. I think that it is all summed up in Greg Kuserk's observation of the Catch 22 that the ban on cash settlement was imposed in order to contain the risk, and the limitation on vendors was imposed in order to require delivery.
There has to be a reconsideration of these requirements. There is an interest. We have been approached. Some of our members have been approached by the banking community who are interested in giving long-term financing to viable commercial producers, and in the cotton industry, that pretty much sums up every type of producer. Of course, you have to be viably commercial in order to get financing, but there was consideration given to long-term financing to make available to farmers fixed-price contacts outwards of 5 years, just like Ken was talking about.
This is what we will be open to, if we have more flexibility in the regulations. So I would ask everyone who is a member of the Commission, who had their druthers early on about these instruments, that the proof is in the pudding. There are no applications. There is no interest at this time.
You can talk about fingerprinting and all sorts of paperwork. That is not the concern. The concern is the Catch 22 that you just cannot play this game, and that is what it is, simply put. The door is shut.
CHAIRMAN SPEARS: Paul, go ahead.
MR. ARCHITZEL: Again, I would like to reemphasize that in considering these rules and proposing the rules and then finally adopting the rules, the Commission looked at all of the risks attendant with the new program. The concerns that were expressed, not just by the Commission, but by many commenters, was the fear that you would get people offering instruments who were not in agricultural commercial channels, which a cash settlement provision would make possible.
That is to say, it would be possible for someone to set up a firm to offer these to farmers located in some distant part of the country and use WATTS lines to offer these and to develop a very speculative instrument.
On the other hand, when we started this process, the rationale we heard for why these instruments were a good idea was that people were saying producers really trust the local elevator or whoever their first handler is and they wanted to deal with them because they are the ones who produces usually deal with in merchandising their crop.
Therefore, the requirement that you deal with the person who is next in line in the merchandising chain if you are a producer, makes sense. It controls for other risks and other problems that if you simply said we are going to allow a cash settlement, you would have to deal with through other regulatory mechanisms.
I think it is all well and good to focus on this one aspect of the rules, but other aspects of the rules are built on the fact that physical delivery is required if the contract is exercised.
If you change that aspect of it, I think you really have to seriously look at all of the other protections or other rules that are not in place, and whether you should put rules in place to control for that type of problem.
This issue is not something that the Commission invented. These were concerns expressed by many people who commented to us. The reason that the Commission had such a long and involved process is because there was concern that these instruments be allowed at all, and that the ban be lifted at all.
So I think, in that sense, you have to look at the totality of what the Commission has done, and these regulations sort of stand together because we have made adjustments in some areas because physical delivery is required.
CHAIRMAN SPEARS: Rod?
MR. GANGWISH: Just a couple of brief comments, but an aside first.
I would like to thank the commissioners for sitting at the table today. Although I am a fill-in today, I think my first meeting was the 9th meeting of the CFTC meeting, and I met some of you there at that meeting. So some of you have been here longer than I was, but in all that time, commissioners would attend and come, but never sat at the table, and I appreciate the importance that you feel that you are placing on this advisory committee.
I am a farmer from Nebraska, and there are other farmers around the room. We appreciate that attention.
I would just like to second several of the comments, Bill and Neal and Ken as well, that have been made. I would like to say that I really feel that regardless of some of the comments that were shared for reasons for either not offering or not participating in trade options, we are approaching a low, I hope, in markets, not only the grain markets, but in livestock markets as well.
It is at the highs and at the lows of those markets that I feel that farmers need new marketing alternatives the most.
I was at the hearing that was held on ag trade options and testified that day, and I think--although I do not remember the exact words, I said something like we need to relax the regulations, and also I think I remember saying that the best marketing alternatives for farmers have yet to be written, and I believe that, but I suspect--and I think that regardless of the reasons that were quoted or said or presented here, I really suspect that the reason that we do not have ag trade options offered today, at least the first one is that we have not relaxed those regulations enough.
The word "sophistication" crops up a couple of times in today's presentations as well, and that kind of knocks me up the side of the head. I am a survivor, and I am in agriculture today because I understand and I am able to determine what I can and cannot do and what I should and should not do. I make mistakes, and so does everybody, but the farmers and producers in today's agriculture are able and will be able to determine what is good or what is not good for them.
Yes, there will be some mistakes, and we will have some growing pains along the way, but I already get the phone calls from the 800 number in Florida that wants me to buy gold options or platinum or whatever else it is. So I am not concerned about things like that.
CHAIRMAN SPEARS: Gary, I think you asked to be recognized.
MR. HELLERICH: Yes, thank you.
Approximately 3 weeks ago, the National Board of Directors of the American Soybean Association met, and this was a common comment that I hear from fellow directors. It was at the country level, the elevator managers, the grain merchandisers, they feel that proposed options program is much too difficult for them to work with. There are too many requirements, and it is just not user-friendly.
So I wanted to pass that onto you, David.
CHAIRMAN SPEARS: Anyone else?
MR. WHITE: I would also like to add to all the comments the situation of the educational part.
In many instances, I have come to this meeting and felt that the cart was in front of the horse; that we were being presented things that many farmers did not understand, and that we did not follow up on the educational part, and that that misunderstanding grows with time. Those things are shunned, and, thus, those things do not function and other things enter into the situation that make them not very functional.
So I think probably the most important thing is the education factor. That should be number one, and then the other things can come into play after everyone understands what the circumstances are. I think that is where we really become successful with programs.
CHAIRMAN SPEARS: Bill?
MR. KUBECKA: Yes, David. I would like to make a comment personally, myself, as a producer, and that is that I do have some options on the table right now, and if these were not going through a broker's house and with our drought that we have in Texas now, I would be a double loser. So it is important from the aspect of natural disasters that we have this ability to have cash settlements. I just want to share that with the commissioners and with those that may not be directly on the farm, but I have firsthand experience at it. I have to have that ability.
CHAIRMAN SPEARS: Paul?
MR. HITCH: Speaking as both a producer and as the chairman of the live cattle market of NCBA, I feel like I ought to say something.
MR. HITCH: The thought occurred to me, you know, A, you have had this thing open for a couple of months and have not had any takers. You might have perfected a hemorrhoid transplant. There is a world of potential donors, but there is no available recipients out there.
MR. HITCH: From regards to the cattle market--well, it does take two to make one of these things work, you know. You have got to have two players.
I think with regards to the cattle market, what you have is a limit. The obviously people to be writing these options are the packers, and what they have got going now works pretty well for them. They do not feel any particular pressure to involve themselves in the option deal, and they want a reliable supply. They do not want an optional supply.
I think as far as cattle sellers are concerned, speaking as a fat cattle seller, I would really be interested in negotiating one of these things.
As far as I know, nobody is set up to write the other side of the deal. As I look at it as them, I turn around and say, "Well, why don't I do it as a buyer of feeder cattle?" I presume that I could also set up and offer options on feeder cattle, and I look at the requirements that are involved in doing that. I wonder, is anybody going to pay me, are there enough sellers of feeder cattle out there that are willing to pay me the option premium up front. I am dubious, but there could be, particularly if you had larger ranching organizations. They might be willing to enter into some kind of a thing, but the requirements to playing the game look to me to be fairly onerous.
Maybe it is just not worth a candle. I guess we would prefer to go broke doing the things we have already been doing, rather than explore an optional way to go broke.
I might mention two other things. First of all, we talked about the farm safety net, and cattlemen, for whatever reason, have operated without a net forward, sometimes to their displeasure.
Secondly, I wonder why the hell I am here because I am in cattle, pigs, corn, and wheat, and all of them are losing money. Usually, you can find something in that bag of tricks to please you. I am clearly as a producer interested in other means of risk management, and I commend you for having developed this, and I am really quite distressed that it has not caught on, but, certainly, within the cattle community, it has not.
CHAIRMAN SPEARS: Thank you, Paul.
I want to personally thank all the producers and ranchers who have come today. We have a lot of people here on the table, and it is especially gratifying to have those from the farm and from the feed lots here to express their viewpoints. It means a lot to us.
Anybody else like to comment on this subject?
MR. OMAN: Yes. Steve Oman, American Farm Bureau Federation.
I guess talking as a producer and a producer from an area where the HTA thing is--people are stilling spinning from it and we do not have the reactions, a lot of people have not really been to court and know where we are going with that in our area, but I think a lot of these things, when they look at them, to a lot of producers, it is in the same category to them, and they are just scared. There again, it comes back to the education process.
I think a lot of farmers are really--you know, the comment was made about 10 percent of the farmers participate in the futures market, and I think something like this after the fiasco went through the country with the HTA thing, I mean, there has got to be a major educational process because they are going to be looked at as the same thing.
CHAIRMAN SPEARS: Thank you, Steve, and I think we all at the Commission recognize and appreciate the fact that there needs to be a tremendous amount of education done, and we look forward to working with all of the producer groups and industry representatives in that regard.
Richard, you will be the last commenter on this issue, and then we are going to go to another topic real quickly and then take a short break.
MR. ELLINGHUYSEN: Thank you.
I think that the Commission has done a good job in putting forward something that a lot of debate has gone on for a long time about, and I think that when you look at most procurement systems and offerings of risk management products, as this has been structured, from an elevator context or a grain livestock procurement, dairy procurement, what have you, you are looking at ways by which you can move product in, do it consistently over time, and offer a valuable service.
We are looking at a time period now with so much commodity around us. Why would someone want to create a vehicle to help do that? I mean, there really is not a real good reason.
I think some of the things that were talked about earlier in the presentation, about some of the reasons why we are not seeing things develop, are valid reasons. I think the fact that markets are low, a lot of volume around us and so forth.
So I am not really excited about seeing something relaxed a great deal, particularly at this time, and shop the market to see what players might jump in. Clearly, we would get more players with speculation, but at the same time, I think what Paul said earlier also has to be brought to bear.
A number of the requirements that were initially proposed were dropped way back, and now we are looking at something that if we were to open up this type of flexibility, I think we would need to relook at what that means from a regulatory standpoint.
I do not like to be the one that says this at this point because I understand and I recognize the need for our producers to have flexible means by which they manage their risk, but, again, we do have the other options on the exchange today which they can cash in and walk away from. So it is not like there is nothing there.
We do need, yes, to develop longer term-type programs, and I think we are on that way. We would like to have them all yesterday, but I think, again, the process we are in is a good one, and I commend the Commission for the work you have done.
I do not take anything away from the comments that were made earlier by any of the people here because we need to be in this thing. We need to be working again toward creating new and good products.
CHAIRMAN SPEARS: With that, I am going to bring to a close this topic of discussion, and we look forward to working with all of you in regard to this.
As we move forward as far as reviewing the pilot program, we want to continue to receive your comments in regard to what we need to be doing to make the pilot program more viable and workable.
I have asked Paul to go over the next topic very quickly because we are behind schedule. So I have asked him to condense that 20-minute presentation to about 3 to 5 minutes. He said he can do it in five, and I trust that he can.
Then, depending on the time, we may take a short break. I may ask you just to come back to the table with your refreshments, and we will continue on the agenda so we can get done by 5 o'clock.
So, with that, Paul?
MR. ARCHITZEL: Thank you, Commissioner. This is a test to see how short a lawyer can make a brief.
This is a report on two proposed rules that are currently open for comment. The Commission proposed these on July 17th, when they were published in the Federal Register. The comment period is over on September 15th for both. My phone number is listed in the Federal Register release. You have copies of those in your packages. If there are any questions and there is not time for them now, please call me and I will be happy to speak with you.
The first one is a revision to speculative position limits. There are four parts to that proposed rule. I am only going to talk about the first, which is uniquely applicable to agriculture.
What the first part does is it proposes to raise Federal speculative position limits. The second part applies to codifying exemptions from exchange limits, and those are for non-agricultural commodities. The third part would propose expanding the existing exemption for entities that use independent account controllers to additional types of entities that use such kinds of systems, and the third one has to do with aggregating various accounts.
Now, on Federal speculative position limits, the Commission has had speculative position limits going back to 1936 on the core domestic agricultural commodities. The last time the Commission dealt with this was in 1993, at which time the Commission proposed to increase substantially speculative position limits.
The increases were based on two criteria, one being the overall positions of large traders in the market and how they were distributed in the market, and the second being on open interest in the markets and the fact that open interest had grown over time.
When the Commission proposed this it was very controversial with agricultural groups. One of the reasons I believe it was controversial was because they had not been changed since 1936, and it was the first time that they were being proposed to be raised and increased.
In response to those concerns, the Commission determined to introduce interim final rules and to increase the limits halfway to what they proposed, and to do that in two stages. This would give the Commission an opportunity to study the effects of the increases and, of course, to amend the rules or not to go any further with the increases if it were appropriate.
This chart indicates the current levels, which is the phase two level, and the final proposed level, which we initially proposed back in 1993 and which we are re-proposing now.
As you can see, the phase two level was about halfway to what they were before and what we are proposing now.
The Commission is proposing at this time to raise speculative position limits on a number of bases. One is that in April 1995, the Division of Economic Analysis did a study of the limits that had been raised until that point, and what it found was that raising the limits did not have an effect on market performance. Any changes in market performance reflected market fundamentals not raising the speculative position limits. This result is what one would expect to hope to find.
Secondly, we very recently reviewed trader positions and open interest and found that trader positions had grown over the last several years. People were holding larger positions or at least a subset of people were holding larger positions. Also, open interest in the markets had grown. I think this tells the entire story for why it is appropriate to be raising speculative position limits now.
What we really need to look at are these two columns, the percent of market growth and the percent of the increase in speculative position limits that we are proposing.
I think what you can see is that in the intervening years, the markets have grown in open interest substantially more than what the percentage by which we are proposing to increase the speculative position limits. Thus, it seems that it is the right time to go ahead and propose these increases.
The actual table of the proposed increases is in the Federal Register release, and if there are any questions or comments, I would be happy to respond before I go to the next rulemaking.
CHAIRMAN SPEARS: I might just add, Paul, it is hard for some of us to see the chart you put up there because of the distance. Those charts are probably available after the meeting if anybody wants to see them.
MR. ARCHITZEL: We will make them available after the meeting. We will have them on the outside table.
The next rulemaking involves Guideline No. 1, which is not directly applicable to you. It is applicable to the exchanges. The reason that it is important is that it establishes the process the exchanges go through in order to become a designated contract market. So that, exchanges in making new contracts have to apply to us, and we will review the contracts and approve them.
The first thing to ask is why does the Commodity Exchange Act require this? I think it is an important aspect of our regulatory structure in this country.
We review the terms and conditions of contracts before they start trading to see whether the contract is potentially subject to manipulation. Of course, you cannot necessarily tell that in advance. However, if the contract terms are misaligned to the cash market, you can certainly determine that and say there is a probability that this contract may be more susceptible than others to manipulation because of that misalignment of contract terms.
These types of deficiencies are best addressed before the contract starts to trade and people have open positions because contracts trade substantially a long time out. If you have to make adjustments and there are open positions in the contracts, it becomes much more difficult to change contract terms.
Thirdly, public comment is oftentimes important to consideration of certain contracts. If it is a new commodity, if it is something that we do not have a lot of experience with, or a new industry which is subject to other regulation, public comment is often helpful and will turn up problems that the exchange had not considered or raise concerns that need to be vetted.
Finally, it gives an opportunity for other regulators that may have an interest to have a chance to look at the contract before it starts to trade.
The Commission as part of its overall program for regulatory reform, adopted fast-track procedures for approving new contracts. Basically, what this does is it establishes a fast track for reviewing contracts under which the Commission will review and approve contracts in either 10 or 45 days, depending on what type of contract it is.
Those rules are already in place. Of a total of 59 contracts approved since they started, 27 have been approved under the 45-day review period, and 18 under the 10-day review period. Nine were submitted by the exchanges at their own discretion under regular procedures, and five because they were equity index products were not eligible for fast track.
So, basically, what we have done as part of our regulatory reform is we have speeded up the entire process.
The proposal for Guideline No. 1 is to finish that project by making the entire process more streamlined.
What we are proposing, is to streamline Guideline No. 1, the format by which exchanges apply to the Commission for contract approval. What we are doing is we are streamlining the format to make it more like a checklist so that the exchanges do not have to write a narrative. We are also making the requirements much more concrete and much more clear.
Rather than having general guidance to the exchanges on what it takes to be approved, we are offering concrete terms as much as possible. This is what the final will look like. It is going to be a one-page application. I am not sure that it all fits on the overhead screen.
Ultimately, we hope to make this available online so that exchanges could fill it out online. We have replaced a lot of the narrative that would be required with a chart or checklist, which only needs to be required if the rule is a unique rule, if it is new to the contract.
If it is a clone rule of a contract that has already been approved, all the exchange needs to do is to list the number of the already approved rule, so that they do not have to go through any explanation. They just fill in that column. We know it is an approved rule, and that is the end of what the exchange has to do.
This will save the exchange costs in applying to us, and it will save us costs in reviewing what the exchange does. We are operating with far fewer staff now than we used to have in this function, and it will be more efficient for us and more efficient for the exchanges.
Once this is complete and the application format is adopted, the Commission will have completely overhauled and streamlined the application process for new contracts from the application stage to the review stage to the approval stage, and in doing that, it will have cut costs to the exchanges in applying for new contracts, and our costs as well in reviewing those applications.
We would have done that as a benefit without sacrificing any of the important customer and market protections under the Commodity Exchange Act.
I do not know if that is 5 minutes, but it is close.
CHAIRMAN SPEARS: Thank you, Paul.
Are there any questions for Paul regarding those issues?
MR. GILLEN: Yes. I have a question for Paul.
Paul, given the current contretemps between the Chicago and the New York exchanges about the alleged pilfering of their contracts and electronic trading of them, if Chicago is to come online with electronic trading of cotton, sugar, coffee, and cocoa, what are the Commission's policy guidelines for the registration of such contracts?
MR. ARCHITZEL: Well, you have got two things. Number one, we would be looking at Guideline No. 1, which deals with the terms and conditions of the contract. Number two, you would be looking at Guideline No. 2, which deals with the rule enforcement program of the exchange, and both have to be satisfied for new contracts. Those requirements are the same, whoever comes to us.
If it is a brand-new trading platform, like a new exchange, obviously there is going to have to be review of the platform as well as the contract. So all of that will need to be looked at, and that will be true for whatever exchange applies to us for whatever contract.
MR. GILLEN: Let's just say that the statements that I read in yesterday's Wall Street Journal are not posturing and are a given. What is the time process that is involved here?
MR. ARCHITZEL: Well, I think there are two parts to that. One is the contracts, and one is the platform. I can speak to the contract term part, and that will be that they will be applying for a contract designation, and it will go under normal procedures, and they will be eligible for fast-track approval.
However, if we are talking about an innovative or different trading platform, that will have to be analyzed as well. That difference or uniqueness for the trading platform or difference may make the contract not susceptible within this fast-track framework.
MR. GILLEN: The fast track is like a 30-day period, is it not?
MR. ARCHITZEL: It is either 10 or 45, but it really applies for contracts that are not novel or unique. It applies for the situation where I am an exchange, I have a contract, I come up with an innovative contract which fits within everything that is already approved, and the Commission is trying to say, "Good, go forth. We do not want to hold you up."
If it is a new, novel or complex contract, it is not going to fit within this fast-track framework.
MR. GILLEN: I would just say to the Commission, I hope if we go to electronic trading on cotton that the industry will have more than 30 to 45 days to review it and analyze it before we come to you with our concerns, if any.
MR. ARCHITZEL: I think the Commission is very careful, and any time it has new and important issues to consult with the public, that is one of the things that the review process and the Commodity Exchange Act provide for, and it is one of the things we wanted to safeguard in doing the fast track rules. It is one of the things we have provided for, that the public will have an opportunity to comment on important new contracts.
CHAIRMAN SPEARS: Jim, do you want to be recognized?
MR. BAIR: Yes. I wanted to say that I agree with Neal's comments.
Later, under the Other Business portion of today's agenda, I may have some comments about the proposal as stated today on the vomitoxin specification in the Chicago wheat contract.
U.S. flour millers are the single largest user of U.S. wheat, and we have some real strong concerns about that. We think that that will really undermine or even destroy the deliverability component of the wheat contract, and while we always appreciate efficiency in Government, it gives me some concern that that would be on a fast-track procedure. I think it needs more deliberation than a 10- or 45-day review period.
CHAIRMAN SPEARS: You mentioned that we plan to discuss that issue under the topic of Other Business later on.
MR. ACKERMAN: Just two quick questions, and this may betray my ignorance of having been away from the field for a few years.
Two quick things. How do you treat physical delivery contracts differently than cash delivery contracts under this proposal?
MR. ARCHITZEL: Well, if it is a cash settlement contract, it is eligible for the 10-day treatment, and generally, there are fewer issues we need to deal with so that we are able to do our analysis more quickly, and that would be the main difference.
MR. ACKERMAN: Thank you.
Secondly, what is the status of the economic purpose test under this new provision?
MR. ARCHITZEL: That is a good question. That comes up time and again, and since we re-did Guideline No. 1 back in the 1980's, we have not required exchanges to justify the economic purpose of commodity futures contracts, although the lore is we do--we have not required that since the 1980's. It is only be request, and the Commission has never requested an exchange to demonstrate that, to my knowledge.
CHAIRMAN SPEARS: With that, I am going to go ahead and bring--Jim, do you have a question
MR. SANFORD: Yes. I am sorry to pull on your schedule. I appreciate your job, but I need to rise the same concern that Neal Gillen has expressed concerning the Chicago Board.
We are very interested in a deliberative response, if this issue is approached. We want to make sure the public has the appropriate time to respond. We are very interested in maintaining the integrity of our cotton market, and we think the New York futures exchanges has done that for us.
CHAIRMAN SPEARS: With that, I am going to go ahead and bring the subject to a close. Let's take a short break. Let's be back at our seats by 3 o'clock, please, so we can go ahead and get on the next subject.
CHAIRMAN SPEARS: Let's go ahead and get started, please.
We are going to go ahead and get started. The next topic on the agenda is called "The Future of Futures - a Discussion of Developments Involving Electronic and Off-Exchange Trading."
As we all recognize, a number of changes are taking place within the futures industry. Electronic trading is one of them, as well as other issues that are before the agency and before the industry as a whole and the agricultural community.
For this next topic, I have asked John Damgard, who is president of FIA, to give an overall view of what is going on within the futures industry. I then asked Michael Greenberger to respond to what role the CFTC has and how it is reacting to those dynamic changes. After they speak, I would like to get into an open discussion and have you tell us what the needs of your organization are as we move into the next century as regards to the futures industry, what are the needs of your membership and your organizations, respectfully.
So, with that, I would like to introduce John Damgard. John is going to give an overview, and we will go from there.
MR. DAMGARD: Thanks very much, David, for asking me to come today. I know that I am talking to a lot of people that are probably pretty sophisticated in their knowledge of futures. So I will make this as informal as possible, and I will try to run through it pretty quickly. I would encourage anybody to interrupt me or ask any questions that they might have.
The state of futures right now, oddly, is quite good, if you measure it from the standpoint of what is going on domestically. Our volume is up about 15 percent in the United States this year over last year, and world volume is up about 11 percent. So that suggests non-U.S. volume is only up 8 percent.
Notwithstanding the earlier remarks of low producer prices in the ag complex, more and more people are learning how to use futures and options as risk management vehicles, and that business is going to continue to grow. The question is really whether or not it is going to grow on exchange or whether it is going to grow off exchange or whether it is going to grow in the United States or whether it is going to grow outside the United States, depending on a variety of question, whether or not management decisions in the United States on behalf of the established exchanges are made in a fashion that drives the business overseas, whether or not the regulatory regime in the United States becomes too onerous because one thing about the dealer market, it is very portable and very mobile. Lots of innovation is taking place right now in the OTC markets, and to the extent that they find they can do that business more effectively outside the United States, that is exactly where it is going to go.
The great big firms that are involved in the global business have presences all over the world, and every financial center, as far as they are concerned, these are 24-hour markets. The exchanges and the time zones that allow the people who are awake at that particular moment to access the market are the ones that are going to do the business.
They pass the book from time zone to time zone. It goes from New York or Chicago to Tokyo or Sidney or Singapore and then on to Frankfurt, London, or Paris, and then back to New York. So our markets are going all the time.
It is interesting that the origins of futures markets, as many of you know, is actually in the agricultural arena, and ag markets have continued to grow. When the CFTC was created in 1974, nobody had any way of contemplating the kinds of products upon which futures contracts are based today.
Virtually, all futures contracts were then based on agricultural commodities, and now we are down to the point where it is probably 15 percent. I am sure I have got that statistic around here, but I am not going to refer to it because it takes too much time.
Today, the largest exchange continues to be the Chicago Board of Trade with 19 percent of the volume, followed by the life exchange in London, followed in third place by the Chicago Mercantile Exchange, followed by the Chicago Board Options Exchange in fourth place, and in fifth place is the DTB, the Deutsche Termini Bosch in Germany.
The Deutsche Termini Bosch is the exchange that has decided to go electronic, and what they have when you visit their exchange instead of pits, where people are milling around is a thermostatically controlled room with a computer in it, and they have recently listed the number-one contract in London. Over a period of about 4 or 5 months, we saw the business move out of London to Germany, and it was basically a result of cost.
It is much cheaper to use an electronic market, and from time to time, you will see that firms have to decide whether in a busy market, when a lot of market-makers on the floor make the spreads much smaller, the best deal comes from the open outcry market.
In quieter markets, where you are not supporting that kind of a structure, it appears now that the electronic markets are the cheaper markets, and I think that the business community has very little loyalty and very little conscience with respect to where they do their business.
So, notwithstanding the fact that business is way up in the exchange-traded futures market, seat prices in Chicago are down 48 percent of the Chicago Board of Trade this year and 66 percent down at the CME. So what does that say? That says in Chicago and in most of the designated futures exchanges, we have confusion and we have fear.
In the dealer market right now, we have innovation and we have portability and we have some advantages that relate to the fact that they can design their products in a way that escapes the full regulatory burden that faces the exchanges.
There are industries such as the maritime industry who have actually been chased out of the United States by excessive regulation. I do not know a lot about it, but I would say there are probably still some barges and things going up and down the river that have to meet the standards imposed by the Federal regulator, but it seems to me that world shipping, you do not see a whole lot of U.S.-flagged vessels moving U.S. grain.
There is no benefit to our industry in seeing some sort of a race to the bottom. So regulation since 1974 has, one would argue, benefitted this industry because it has given market users a high degree of confidence that they are going to get a fair deal.
On the other hand, the markets are changing so fast and there are so many new questions facing the leaders of our industry with respect to whether or not it is in their best interest to be electronic or open outcry, that there is much less room for error and mistake.
I think that most of you have read in the last few weeks it is the Chicago Board of Trade whose signature contract has been the U.S. 30-year Treasury bond. Maybe it is half their business or 60 percent of their volume. Celeste can probably tell us exactly.
That contract is currently being threatened by an application before the CFTC right now on behalf of the cotton exchange, and a cash broker in New York who applied for designation before the CFTC as an electronic market.
There was a very interesting hearing here yesterday, which many of you attended, where essentially the cotton people said let us get up with our contract and let the customer decide which is best, and the Board of Trade and, as a matter of fact, the American Stock Exchange, who I think intends to get into the electronic side of trading Government securities as well, objected to it on the basis of a number of points that I think the Commission is going to have to weigh pretty heavily.
Notwithstanding that, conventional wisdom says that sooner or later, there will be electronic markets, and the Board of Trade has made a very difficult political decision in order to run their Project A electronic system, which previously just operated when the pits were not open. They are going to run that out during the daytime side by side, along side the open pit.
MR. WHITE: One question. When these situations evolve that outside of our borders, leniency on rules, force--
MR. DAMGARD: Attract.
MR. WHITE: --or attract, our boards to change their rules to lenience, and something happens outside of our border that causes the market to go awry. What is your opinion on that type of situation where we are losing that opportunity to regulate because of loss of business? Is there some concern about that?
MR. DAMGARD: I think that our markets have evolved into institutional markets.
Someone mentioned that most farmers are not directly accessing the Board of Trade, but, rather, forward contracting with their elevator, and their elevator operator is the one that is on a day-to-day basis taking positions on the Board of Trade that protects his agreement with the farmer, whatever it may be.
So I think in many foreign markets, what has happened is their regulatory scheme, quite honestly--they come to the United States and they study hard our regulatory scheme. The CFTC runs programs in Chicago for foreign governments who come and study just exactly how we regulate, but that does not prevent things like Barings Bank in London going right down the drain. It was not a regulator problem. It was a problem where senior management simply did not understand that there was a young kid over there who was--they sent auditors over there, and the auditors came back and were equally fooled. It was a generational problem, and that was a very serious problem. And that exchange suffered the consequences of loss of credibility.
It is coming back now. We have seen the same thing in Hong Kong where the futures market in Hong Kong actually shut down in 1987, and everybody that was on the long side lost money, and everybody on the short side did not get paid because the long guys were sitting on the board.
So there is nothing I think that we can do other than jawbone or enter into treaties with some of these foreign markets, but there are organizations. I compliment the chairperson for chairing meetings twice a year, maybe more, with international regulators who are attempting to seek some parity in terms of making sure markets work.
We did an awful lot of work in the aftermath of Barings. So there are international markets that have signed up to certain standards, and it seems to me that there is a burden on customers to know when they are dealing in the New Zealand wool market that that New Zealand wool market might not have the same rules with respect to customer-segregated funds and the same rules and regulations that have worked pretty well here.
I do not know if that answers your question, but there is a lot of buyer beware in this business, and I think the same thing would apply to anybody that gets into the business of offering ag trade options.
I mean, my point earlier just said the firms that have had a long history in designing risk management vehicles, and I use Merrill Lynch, but it could be any number of Chicago- or New York-based financial services firms, are prevented from getting into the business to offer these instruments to farmers because they do not have delivery points.
I do not know that they will see this business as attractive enough to go out and buy country elevators, just to be able to get into the business. Yet, it seems to me--and I am not an expert on it, but somebody with a $50,000 net worth--I mean, you could have a snake oil magician with a car that is presumably paid for, you know, qualifying to offer farmers' products.
Now, I know that there is many, many more requirements besides just the $50,000 net worth, but most people have a fair amount of respect for Merrill Lynch, and if they enter into a contract with Merrill Lynch, Merrill Lynch is going to be on the other side of that contract paying off. They are not a bucket shop.
To the extent that nobody has yet signed up for the program, it seems to me the losers are the farmers. That is why I was kidding Ken a little bit about sharing the credit. Let's get some credit to share.
I do not know if that answered your question or not.
The off-exchange business is quite concerned about being regulated in the same way as the on-exchange business, and rather than go into the whole legislative history of what has happened since 1992, I will just say that until 1992, the exchanges had what amounted to almost a monopoly. If you wanted to do risk management business, you came to a designated exchange because the law says all futures contracts shall be traded on a designated board of trade.
In 1992, it was the banks that came in and said we have a very big business offshore, and we are doing it onshore as well called swaps, and the swap business is potentially illegal unless you tell the CFTC that they cannot regulate swaps.
So, in 1992, Congress said, "Okay, CFTC, you cannot regulate swaps." Any other instruments that meet the following conditions, also, you can in your wisdom determine whether or not they should be subject to all or part of the CEA.
So, for a while, we saw sort of an explosion of new off-exchange contracts that did in some ways directly compete with exchange-traded products.
The exchanges for the first time were faced with a very competitive threat, and some exchanges saw the creation of more risk as a good thing because the dealers who were offering these instruments needed to go someplace to lay off their risk.
If you look at the Euro dollar contract on the Chicago Mercantile Exchange, it was a short-term interest rate contract. You look at the growth of the swaps industry, the correlation is almost exact.
So the Merc was the first to realize, I think, that their best customers who bring all the business to the exchanges, the FCMs, were firms that were also engaged in customized risk management instruments that would not fit so well in an exchange in the first place.
My view is we are going to see an awful lot of growth in the customized over-the-counter market, and there will continue to be arguments about just exactly how this should be regulated, and the fact that the dealers have a lot of flexibility in terms of where they do this business means that this Commission and other financial regulators around town are going to have to look long and hard at the rules they put in place for fear of running that business outside the United States.
In the meantime, I think the exchanges need to do a lot more in terms of creating efficiencies for the market, and lots of what is going on in Chicago right now, the most encouraging thing to the dealers is that they have agreed to combine their clearing facilities. That is the difference between an OTC product and a futures contract.
A futures contract, you have no counter-party risk. In an OTC instrument, you have to make sure. You have to take into consideration the credit risk of the person on the other side of that contract, and that is one of the reasons I think how ag trade options were discredited in the very first place. There were people walking away from their obligations.
I think I have used my time.
CHAIRMAN SPEARS: Thank you, John.
I would like to have Michael Greenberger, who is director of the Division of Trading and Markets, give you a brief overview of what the Commission is doing as to be responsive to some of the changes that John laid out.
MR. GREENBERGER: Thank you, Commissioner Spears.
First of all, I would like to say how honored I am to be asked to represent the Division of Trading and Markets at this meeting, but I will also say, since we are not discussing anything that is firm and fixed, that any views that I am articulating now are my own and cannot be attributed or should not be attributed to the Commission or the Commission staff.
From my perspective, serving as the director of the Division of Trading and Markets, I think a lot of what John says about the field and what is happening in the field is very apt. I think especially the thing that ought to be focused on is the great concern about, and a lot of our attention being placed on, issues concerning electronic trading.
I think that that does raise an issue that should be of interest to the agricultural community because I think that the developments that are taking place, and we are not in the business and I am not in the business of seeing where this is all going to head, but I do think that it is creating a lot of competitive spirit within the industry and the options available to people who want to manage their risks are going to become manifold.
I think that, aside from an interest in agricultural trade options, there may be after options available to the agricultural community for managing risk that could be very attractive.
Principally--and the thing I would like to focus on is we have got three issues, one of which I think directly concerns the agricultural community, and two which deal with electronic trading and maybe do not directly concern it now, but I think will, and I think we are beginning to see that happening.
One, we have before us an application by a company called FutureCom to establish trading in live cattle futures over the Internet. This is the first such application of its kind to the Commission. It has been before the Commission for sometime, but I must say that we have, since the end of March, I think, begun to move very rapidly in our consideration of it.
We have gathered a lot of data. We have put the application out for public comment. We are still examining the comments and data before us, and no decision has been reached on this application, even on a tentative basis by the division, but I do think that it suggests the possibilities that you may see options for trading, trading that might be done from one's living room or home office or bedroom, and being able to engage in the management of risk.
I would want to emphasize also when I talk about these developments that, again, it is the Commission's job--or I view my own job as protecting markets and protecting market's users, and I am not in the business of predicting where the markets are going to go or how the markets are going to develop. I do say, when I talk about these developments, that I am impressed by the fact that the exchanges, the Chicago exchanges and the New York exchanges, are not sitting still on this issue. While there may be a debate about whether to move from open outcry to electronic trading, even on the issue of traditional open outcry, I had the privilege of sitting at a table in Chicago last week where people were discussing the electronic developments that can enhance the open outcry system.
So I think all across the board, whether you are talking about traditional open outcry or whether you are talking about electronic trading, this industry is looking to the future and very, very much plugged in to seeing how technology can be used to make the markets more efficient and more inexpensive for its users.
Aside from the FutureCom application, there has been mention also of the issue of the Cantor Fitzgerald/New York Cotton Exchange proposal to create an electronic contract market to trade Treasury futures.
Unlike the Internet, in that situation you are using a closed system that would not be accessible to everybody, but only the members of that proposed exchange and membership would be somewhat more difficult to obtain
than it would on an Internet-based trading system. In any event, it raises a lot of the same issues raised by Internet trading.
I think the Commission is very much looking at how this technology works. I think, again, no decisions have been reached, and as John has mentioned, it has obviously been a controversial issue, but it has been of tremendous use, I think, to our division, to our Office of Information Resource Management, and to all the staff at the Commission to confront these issues. We are learning about them, and I think we are putting ourselves in a position where we can give cookie-cutter guidance to the field on how they should proceed.
It may have taken us a little longer to deal with the Internet or a little longer to deal with the closed electronic system proposed by Cantor Fitzgerald and the New York Cotton Exchange, but we have gotten a lot of experience. I am very confident that we are going to be able to keep up with regulatory developments and be very much attuned to the kinds of things that are going on in the field.
The third development, I think, that is of interest as well, and while there always is a lot of talk about us losing business to overseas markets, I think we can be heartened by the fact that all of the major foreign exchanges very much want to do business in the United States and are lining up at our door to be able to do so.
We have in 1996 permitted the DTB to allow terminals to be placed in their members' offices in the United States, and that, I think, quite candidly, and the market has shown that that has proven to be a very successful venture. I think especially in the last 6 months, it has become clear that it has been a successful venture.
Other exchanges have wanted to come in. I think the commissioners in their wisdom have decided that the DTB process was through a division no-action letter, and the commissioners are very much in favor of having a more transparent and public system that gives notice to, in this case, the entire world about to do business in the US.
The system we are going to set up would be less than registration of a contract market. There will be regulatory controls. We have put out a concept release last month on this issue, and there is a 60-day comment period.
I can tell you from my own experience, every major foreign exchange is interested in being put in the position of being able to put their terminals in the United States. Again, I think that shows that there is going to be a lot of competition here.
Now, one would naturally think that the fact that foreign terminals are coming into the United States, your first instinct may be that that is going to be very threatening to our exchanges. However, our exchanges have been very aggressive in trying to get their terminals in foreign countries as well. They see foreign terminal registration here as an obvious path to further growth on their part abroad.
The CBT has Project A. CME has Globex. NYMEX has NYMEX Access. All of those exchanges are interested in marketing and trying to get into other countries.
I will say that one of the things we are very much looking at is foreign exchanges, and what we have suggested in the concept released, although have reached certainly no final decision on it, but that if foreign exchanges want to come into the United States, that we really want to see what the regulatory structure of the home state is in terms of welcoming our exchanges abroad.
Speaking personally--and I think this has been confirmed in personal discussions I have had--I think looking at things from that perspective is not only going to make the United States more accessible to foreign exchanges, but it is going to make the home state foreign countries much more hospitable to our exchanges coming in.
In the final analysis, what this bodes is a global worldwide system. The options for the user of the market are going to be phenomenal. I think that, as John says, more people are learning how to use the futures market as a risk management device. I see it as a growth market. I personally do not think that either existing institutions should be threatened or entrants into the field should be afraid. I think there is going to be more business for everybody to handle.
Again, standing back, our principal objective and concern is to make sure that the users of this market, the United States users of this market, are protected. In terms of foreign terminals, we want to make sure that if something should go awry that the United States user of the foreign exchange will have access to remedies, including the waiving of jurisdiction on the part of the foreign terminals in the United States.
The final overriding theme is technological integrity. We have to be absolutely sure that both the electronic trading that goes on by the domestic exchanges in the United States, the electronic trading that goes on over the Internet, the electronic trading that goes on over closed facilities, the electronic trading that goes on over foreign exchanges here, as is true of open outcry trading, that it has technological integrity, that the markets can be protected, and that the market users are protected. I think the Commission has been very diligent and concerned about being sure that the markets are protected and the market users are protected.
Thank you, David.
CHAIRMAN SPEARS: Thank you, Michael.
I would like to devote a little bit of a time where we can have the opportunity for any of you to react to comments by John or Mike. Also, relate any issues or concerns or thoughts you might have regarding the futures of the futures industry.
MR. ACKERMAN: I have question. This one is either for Michael or John or even Chairman Born, if you care to jump in on this.
I have the opportunity of having been involved closely with the futures industry up through the early nineties and then to step away from it somewhat for the last few years.
When you look for me at the industry now versus where it stood, say, in 1992, the biggest visible change is the development of electronic trading on a very large scale, and the potential for that trend to increase very sharply over the next year, 2 years, or 3 years.
As you see major exchanges, both overseas and in this country, look to taking large trading pits and converting them to electronic trading, it is a very, very large difference.
I guess the question I have is whether the regulatory structure is designed to address that, and the way that I am raising the question is this.
Traditionally, when you look at the kinds of issues that have dominated futures regulation--for instance, there have been a lot of debates between the CFTC and the industry about audit trail. In the future, the whole question of audit trail may be replaced by debates on computer security or debates on network access or questions about software development.
Traditionally, regulatory agencies have been very heavy on lawyers, economists, accountants looking at regulatory rules and financial arrangements and oversight systems. In the future, the questions may much more involve technology and does a computer system work the way it should and what are the impacts, for instance--one of the proposals that was mentioned was a computerized exchange on the Internet.
Well, we all know that there have been situations that have come up where portions of the Internet have shut down for periods of time. It is a very well-publicized situation with American Online, I believe last summer.
I guess my question is, are regulatory agencies like the CFTC or the SEC or NFA or others equipped or equipping themselves to deal with these technology issues, or viewing them as, in fact, the regulatory issues of the future?
I do not know if I am expressing the question right.
MR. DAMGARD: I will yield to the Chairperson in 2 seconds, but I agree with you, Ken.
I think that what we are looking at now is less room for the intermediary, and right now, a buyer and seller meet each other at an exchange, and they meet at that exchange via the broker that represents them.
So you have two clearing brokers and sometimes an introducing broker making their way from buyer to seller.
And if buyer and seller can meet each other without the benefit of an intermediary via the Internet, then it seems to me regulators have to take a whole new fresh look at how to regulate because right now they regulate by putting the burden on the intermediary, whether it is the exchange, which is always complaining about over-regulation, or whether it is the intermediary who is burdened with all sorts of financial requirements and recordkeeping that they always feel is--and it seems to me there will have to be a whole new way in which to regulate if, in fact, we see not only the Internet replace current trading mechanisms, but private Internets as well. And what do you do about financial integrity? Who sees that the person, particularly in a futures contract, that is on one side of the deal, where the payment is to be made 6 months down the line? Is there margin payment? Who holds the margin? How is the financial integrity guaranteed?
CHAIRMAN SPEARS: I will let Chairperson Born respond, but keep in mind, she is an attorney.
CHAIRPERSON BORN: Let me just say that so far, I do not think that the Commission sees any major problems with our regulatory system in terms of applying it to electronic exchanges or other technological developments.
We have three existing electronic trading systems that we have approved in the past, NYMEX Access, Globex, and Project A. We are not running into statutory problems in our consideration of the two proposals we have got on the table.
Luckily, the statute is very flexible and talks in terms of principles like open and competitive trading, fair access to the markets, integrity of the system in terms of protections against price distortion, manipulation, fraud.
Audit trails remain relevant. You could have an electronic exchange that did not keep the data or provide for the data necessary to determine whether people were trading ahead of their customers and other problems like that.
In the long run, if the markets evolve further and intermediation, for example, becomes passe, then we may need to address the regulatory scheme, I think, and see whether amendments are necessary.
Luckily in 1992, Congress gave us the power to exempt a number of transactions, and the persons engaged in those transactions from some or all of the statutory scheme, with terms and conditions that the Commission finds are appropriate in the public interest, which is ability. It gives the Commission the ability to fashion quite flexible regulatory schemes based on the kind of market we are dealing with.
I think that should carry us forward at least for the foreseeable future, but we have seen such rapid change here, we may not be foreseeing everything that is going to happen.
MR. GREENBERGER: If I could just add to that more from the staff level perspective, I agree with everything the Chairperson has said.
MR. GREENBERGER: But I would say that I want to emphasize that we must remember that we did deal with Globex, Project A, and NYMEX Access, as the Chairperson said. We have in the United States today alternative electronic trading systems that have been reviewed.
The point I wanted to make, especially from the staff perspective, I am tremendously impressed--and I would encourage people if they want to test me out on that to come visit the Division of Trading and Markets and our Office of Information Resources Management – by the sophistication and skill of the staff who can sit down and discuss algorithms that are being used, the software that is being used, the technology that is being used.
I am very pleased to be able to say that I was able to recruit to T&M Bob Wasserman, who is not only an accountant and a lawyer, but a computer programmer. We have a lot of skill in this Commission, and I feel very, very comfortable that we have had an excellent exercise in dealing with the Internet, in dealing with closed electronic systems, in dealing with Project A.
I expect that if we do approve a system where foreign terminals will come in, we will be asked in the early part of 1999 to review the electronic systems of many of the foreign exchanges, and I feel very, very comfortable about the ability of the Commission staff to deal with that in the most sophisticated way.
If anybody doubts that, I encourage you to come visit us at Trading and Markets. We would be happy to show our stuff to you.
CHAIRMAN SPEARS: I might ask Paul Hitch from the National Cattlemen's Association to comment. Electronic trading is an issue that the NCBA has been interested. It is a topic at your meetings. Would you want to comment?
MR. HITCH: First of all, NCBA has always had a history of let the market decide. So it goes way back through NCBA and NCA and American National Cattlemen. So you have got to kind of know something of the history of the organization, but it has never been wildly enthusiastic about a lot of Government regulations.
Obviously, I mentioned earlier we also have no safety net. So there is no price support program for cattle, and we have been opposed to that sort of thing.
So our inclination is to say rather than deciding in advance that FutureCom or some other electronically traded cattle bill would work or would not, we are of the opinion to let the cattle industry work it out. Go ahead and put it out there, and if the trades and, in this case, the cattlemen find it a useful vehicle for hedging or managing their risk, then they will adopt that.
If they do not, the thing will die not by virtue of regulatory fiat, but, rather, by virtue of the fact that the people simply did not support that market.
There is some enthusiasm within the cattle community for a cash-settled contract due to some dissatisfaction with the convergence that has taken place--or, rather, failed to take place over the last 2 or 3 years with the currently traded live cattle contract on the Mercantile Exchange.
We have developed a cash-settled contract, released the bare bones of one, and have taken it to the Mercantile Exchange, as well as a couple of other exchanges. Those exchanges have declined to trade a cash-settled contract for various reasons that I do not really want to go into here, but at any rate, they said no.
So we are looking at FutureCom. FutureCom would be cash-settled. So it would kind of have two facets to it.
Number one, electronic trading, which could be done, I guess, 24 hours a day, 7 days a week from anyplace with Internet access, and it would also be a test of cash settlement, which we have not yet had on live cattle.
Now, the feeder cattle contract is cash-settled. The live cattle contract is still currently settled by delivery. So I think that there are quite a few cattlemen out there that are interested in electronic trading. Certainly, they are interested in the efficiencies because it would cost less money to trade electronically than it currently does to trade on the Mercantile Exchange.
Also, they are intrigued with the cash-settled contract. They want to see how the convergence will work.
In a way, it is kind of like a new restaurant opens up in my hometown. Hell, everybody goes and tries it once, and if they like it, they go back.
So I would anticipate if the CFTC approves this that there will be a flurry, perhaps a mini-flurry. Everybody knows how to order a hamburger. The cattle community, I do not envision as being supremely Internet-familiar. It is going to require somewhat of a generational change to some extent.
I would say this. I am very much of a klutz with computers, but my children speak it like a second language. I am 55 and they are 25 and 27. So you are going to have, to some extent, move some of me out and some more of them in to make it a viable deal.
I think that electronic trading would become a useful device in the cattle community.
CHAIRMAN SPEARS: Bob Petersen?
MR. PETERSEN: Thank you.
The discussion of Cantor Fitzgerald--I had the privilege, along with several others, of sitting here yesterday and hearing the good arguments on both sides of the issue.
I just wanted to say that we, the National Grain Trade Council, have some real concerns not about the electronic aspect, but about the idea of a company that owns and controls, and exchange for price discovery takes place.
I noticed the comment letter from Senator Roberts which brings this a little bit closer, I think, the people sitting around this table. He says, "I am concerned about establishing a precedent, one that could easily be applied next to an agricultural futures exchange controlled by a single company."
So I am wondering if somebody would like to comment about the precedent we see in Cantor Fitzgerald towards the agricultural sector.
CHAIRMAN SPEARS: Michael?
MR. GREENBERGER: Well, all I really think I can say about that is that is obviously a live issue in Cantor Fitzgerald. It is being taken under consideration. I am certain that when the Commission addresses the approval or disapproval, that issue will be thoroughly addressed. All the commissioners are briefed on it, and I think it would be inappropriate to discuss that issue that is so integrally related to that application, but I would assure you that that is something that is being focused on. It is being considered, and any answer that will be given on it will be thoroughly explained and justified.
MR. DAMGARD: I would just say that I think online trading totally changes what is the definition of an exchange and what is qualified to be a member of an exchange.
I mean, it is all well and good for DTB to say we only allow our members to trade, but what qualifies you to be a member? Carrying a Visa card? So the CFTC has a lot of things that they need to look at in this upcoming proposal on what sort of requirements should there be for foreign terminals allowed in the United States and where is the reciprocity abroad.
Everybody is watching with great curiosity the application from the cattle industry, the FuturesCom application, as well as Cantor Fitzgerald because I suspect that depending on how those contracts are treated by the CFTC or how those applications are treated by the CFTC, there are a lot of other groups standing by reading to either perfect on them or improve on them, I should say, and it reminds me of the Kansas City Board of Trade's application to trade futures on a stock index.
Kansas City came in, applied for and finally received permission after spending an enormous amount of money getting a futures contract approved, cash-settled, on the Value Line index, and the minute Kansas City got permission to do it, the Merc and the Board of Trade followed them.
Now, the Board of Trade had sort of a falling-out with Dow. So S&P and the Merc got sort of a head start, and then following that, the New York Futures Exchange started trading the NYFE.
My sense is the same thing is going to happen, and this is going to happen. We are not going to have a lot of time. I think it is going to happen much more quickly than it is in terms of taking a lot of time. I think we are all looking at a time when these markets are changing more quickly than anybody realizes.
One of the most successful futures markets in Europe is called OM, Options Mart out of Sweden, privately owned, franchised to four or five different countries, trades very successfully for-profit for its stockholders, and that isn't exactly what we think of here as an exchange.
So we are going to have to look long and hard at the definition.
CHAIRMAN SPEARS: Any other commenters or questions?
CHAIRMAN SPEARS: Well, if not, I want to thank John and Mike for their time and providing some food for thought.
Again, the purpose of this topic was to give this Committee an update of what is going on within the industry as a whole, and then have the opportunity to hear your input.
As always, the Commission stands open to listen to any of your viewpoints at any point in time, not necessarily at advisory committee meetings, but all the commissioners' doors are open. The phone lines are open to receiving comments from this Committee.
With that, I would like to go to the next topic of discussion, and that is an overview of the upcoming CFTC reauthorization.
As most of you are aware, the CFTC has to be reauthorized every number of years, like 4 to 5 years, and I think the date our current authorization runs through is--
CHAIRPERSON: September 30 of 2000.
CHAIRMAN SPEARS: --September 30 of 2000.
The reauthorization of the CFTC is going to be an issue before Congress, and other issues are going to be before Congress over the course of the next year or two.
So what I have asked is representatives from the Senate Agriculture Committee staff and the House Agriculture Committee staff to be present to brief this Committee as to what they see coming up in regards to reauthorization and the timetables that Congress will be considering these things.
I am not sure who is going to go first. The House always defers to the Senate. So I guess Walk Lukken is going to go first from Senator Lugar's staff.
MR. LUKKEN: Thank you very much.
I would like to thank Commissioner Spears and the rest of the commissioners for allowing us to come up here and brief you on what is going to happen during next year.
Some faces today are familiar. Others are not so familiar. So I encourage you, anybody who does not know me or has not met me, to come over and visit the Hill during August. It is a pretty lonely place during August.
MR. LUKKEN: As far as reauthorization, we are at the very beginning stages of figuring out what our outline is going to be and how we are going to approach this.
We have not even really set out a timetable on this.
As the commissioner said, we really do not need to reauthorize until the end of the year 2000, although recent events, especially concerning jurisdictional concerns, over-the-counter derivatives, has probably pushed up that timetable somewhat.
Senator Lugar has indicated that it is likely that we will begin a series of comprehensive hearings beginning early in the spring of 1999. Chairman Lugar, normally when he tackles broad policy issues such as this, will take a very analytical approach, just as we approach the farm bill by asking a set of broad policy questions.
We will likely do the same thing regarding the Commodities Exchange Act. They are questions such as how are the markets working, how have they changed since the last time we reauthorized the CEA, what is the appropriate degree of regulation for this market, and what are the basic public policy interests at stake.
In the end, I can say fairly that this will encompass more than just purely reauthorizing the CEA.
Likely subjects that will be discussed during these hearings will include some of the usual suspects, the Treasury amendment, exemptive authorities, some of the issues brought up today, electronic trading, ag trade options, how is that pilot program working, how can we improve on that to give farmers an effective risk management policy.
As far as the beginning of next year, we are very much in an information-gathering stage. We are excited that the Commission now is at full strength and that we can work with them to open up dialogue between them and to get information about the different subject matters that we will be tackling.
Also, the industry, I encourage you all to stay in touch with us so that we know what the concerns and the interests are when we have to tackle these broad policy concerns in the spring.
So, with that broad overview of what we are likely to tackle, I will turn it over to Dave, and then we can open it up for questions afterwards.
MR. EBERSOLE: I will be even briefer. The Senate, as usual, takes most of the time.
MR. EBERSOLE: I think this is probably one time as we enter a reauthorization that the House and Senate, at least at the staff level, and the committees be fairly looking at all of the familiar issues and looking at them in the same way. So I think that is going to be helpful.
I will be brief. You all know the issues, many of you much better than I do, and I do not have a timeline to offer you.
I would say that I am not certain that--and I am not speaking for Mr. Ewing, the subcommittee chairman, but I am not certain that he will immediately call any comprehensive hearings.
We have had several. I think that we probably need to get together in formal ways and try to see if we can come to some kind of consensus of where the regulatory programs at the Commission should be headed and then go from there.
In that regard, I think that Mr. Ewing really should go back and look at the bill he introduced in 1997, the first session, the Congress, H.R. 467, which I think has some items that need to be at least reexamined. Cost benefit analysis comes to mind immediately. I think that he probably will do that.
As far as the general question of OTC financial derivatives, I am not sure how we are going to deal with these things. If the Commission at some point says that swaps are futures, I am not sure that the Congress will be in a mood to deal with that.
So it is going to be very difficult to know where we are going to go, how our committees even is going to be composed in the next Congress.
Obviously, the Treasury amendment may be some general relief under Section 4(c) of the Act. It may be something we would want to look at.
Obviously, as Mr. Lukken says, we need to look at the ag contracts generally, to see if there is any way that the ag community can come to some kind of an agreement as to how much regulation is needed, and I think there are members of our committee who believe that we should have some deregulation of the exchange community, but that is going to be difficult to accomplish if we do not get some idea from the aggies out there exactly where we should go.
With that, I think I will stop.
CHAIRMAN SPEARS: As Walt and Dave both pointed out, there are a number of issues before the committees, including the issues that do not directly impact agriculture, but have, I think, an indirect impact. We have some time here that if any of you would like to voice any opinions or explore any of those issues, we have a little bit of time on the program to do so.
I know with my past experience over on the Hill, the viewpoints of the members around this Committee, the agricultural community carries a lot of weight with the Agriculture Committees in both the House and Senate, and I think they value your input, as they both have asked for. They have asked for your input, and what you tell them is going to go a long ways as far as how they look at the reauthorization process and the futures industry as a whole.
So I will open it up to any Committee members who want to comment or ask any questions.
MR. GILLEN: Just your personal opinions, how will the members of the committee react to the suggestion that the CFTC be merged into one central regulatory agency for financial instruments?
MR. EBERSOLE: That is always a good question.
Well, on the House side, we have a different set of opportunities, and certainly lots of challenges between three different committees.
I would look for Chairman Leach to introduce a merger bill in the next Congress.
My general impression is that our members will oppose that. If they take some other attitude, I would be very surprised.
MR. LUKKEN: As far as the Senate side, I am unaware of anybody at least on the Ag Committee who looks favorably on the merger. Of course, the Senator does not look favorably on it as well. So I cannot really speak to anybody outside the Committee.
CHAIRMAN SPEARS: Anybody else have any comments or questions? Again, you have the opportunity here.
MR. HELLERICH: Yes. I believe at this time, I would like to say that the Soybeans Growers Organization is in favor of reauthorization. We feel that the CFTC is very important in providing for a regulatory agency to oversee the trading, the risk management, the transfer of risk to people and firms outside of agriculture by firms engaged in agriculture production.
We are, of course, very much concerns that this is done in a manner that is of sound principles, and that the producers of commodities of soybeans in particular in the country can rely on the integrity of the trading system, of the risk transfer mechanism to be sound and secure.
CHAIRMAN SPEARS: Anybody else want an opportunity to express anything?
CHAIRMAN SPEARS: If not, I want to thank both Dave and Walt for coming down and making those comments. I am sure all of you recognize that these two individuals will be key players from a staff standpoint as we go through the next 2 years in addressing a number of the issues before the futures industry and before Congress. I want to, again, thank them for coming. Thank you.
With that, we are going to move on to the last topic which is Other Business. You will have the opportunity bring anything before this Committee--I know that beforehand, Jim had mentioned earlier in the Committee meeting that he had an issue that he wanted to talk about, vomitoxin.
So, with that, what I would like to do is defer to Jim to discuss that issue, and then I think we have staff available within and around the room that can address any questions that you might have. So we will go from there.
MR. BAIR: Thank you, Commissioner Spears.
Since there is a wide variety of interests around the table, different grains and oil seeds and livestock and cotton and other interests, I would take about a minute to give a little background on the issue, if I may, and then spend another minute sharing the milling industry's concern.
Our concern leads out of a proposal out of the Chicago Board of Trade, a much larger proposal to review the entire CBT wheat contract.
One component of that review involves a proposal to establish for the first time a contract specification for a limit on a substance called dioxane valinol. We refer to as DON, for obvious reasons.
This is a micro toxin that is produced by a fungus. It has been around since the 1800's, but because of minimum tillage practices and so forth, it is becoming more prevalent.
The Food and Drug Administration has a guideline of one part per million of this substance on wheat flour or flour-containing products. In order to get one part per million, you have to start with raw wheat, that is, depending on the year, two to three parts per million.
In the milling process, because this substance tends to adhere mostly to the bran, which is on the outside of the wheat kernel, in the milling processes, you are separating the flour on the inside from the bran on the outside. You can reduce the amount of DON in the finished product in the milling process.
Indeed, the proposal, which is dated today from the CFTC staff recommending that this be put on a fast track, a proposal of five parts per million, right in here, it says that "since wheat millers can reduce vomitoxin in finished products from that found in raw wheat," and, yes, that is absolutely true, as I mentioned, from two or three parts per million, down to about one part per million, not from five parts per million. That is impossible.
We have several years of experience with that. The industry that I represent processes more than 900 million bushels of U.S. wheat every year. So we think we have got a pretty good handle on the technical and operational challenges involved in handling DON and wheat.
Elsewhere in the proposal, it states that, "The proposed level of 5 PPM falls within the range of maximum levels accepted by buyers in recent crop years." My response to that is: What buyers?
I would like CFTC staff or anybody to tell me what buyers they have talked to that would accept five parts per million.
For the U.S. industry, which each and every year buys 40 percent of the U.S. wheat crop, I am unaware of anyone who would accept wheat that contained DON at those levels.
In fact, I spoke with a major miller this morning who supplies the raw ingredients to breakfast cereal manufacturers. For things like bran flakes or most cereal products, that is primarily a wholewheat product. So it would be similar to wholewheat bread or bran muffins and so forth.
If you recall, I earlier said this micro toxin tends to stay with the bran. So, if you are making a bran muffin or a breakfast cereal or something, you have got to start out with well below one part per million of wheat. For those buyers, they use a purchasing specification of zero or .5 parts per million.
So we have some real concerns about this proposal. In fact, for the last 18 months, we had been involved in a collaborative process--we thought collaborative--with the CBOT, and, indeed, had submitted comments, as had other associations represented in this room, and had even been told by CBOT staff that their own task force recommendation of traders and their members, their recommendation was three parts per million.
How their own task force recommendation got changed from three to the CFTC proposal of five, I am not sure, and perhaps that is a question better directed to other people, but we have real serious concerns because, in our opinion, what this would do would be to establish essentially a feed-wheat contract.
We do not think you need a feed-wheat contract because you already got a feed-wheat contract, and it is called yellow corn.
Wheat, with minor exceptions, is not a feed grain. It is a food grain, and I do not think that it is in anybody's best interest to--what will appear to FDA to be intentionally ignoring their best advice regarding how to manufacture wheat-based foods that are wholesome and healthy for the American consumer, and that is the way that this would be perceived.
We think that doing that seriously undermines the deliverability component of the contract, and for classic hedging users of that contract, it will make it much less valuable as a hedging tool. For that reason, we have very serious concerns.
We have a concern with the process, and we have a concern with the proposal itself for the reasons I stated.
I would be happy to answer any questions, if I could, Dave.
CHAIRMAN SPEARS: Thank you, Jim.
I know you have asked a couple of questions to our staff, and I have asked John Mielke from the Division of Economic Analysis to be in the position to respond to what the current process is and respond to those questions.
MR. MIELKE: I just want to clarify one thing. There is no CFTC standard.
The Commission asked the Chicago Board of Trade some time ago to review its entire wheat contract. It was in the context of the closing of Chicago Grain Elevators.
As part of that review, the Commission staff, the Division of Economic Analysis, suggested that the Board of Trade consider a standard in this area in their contract because today's contract has no standard, and to my knowledge, neither do the wheat contracts on the Minneapolis Grain Exchange or the Kansas City Board of Trade.
So our interest is making sure that the wheat delivered on the contract is merchantable.
In that context, the Chicago Board of Trade's staff and its committees considered various alternatives, and they just recently on July 31st submitted a proposed rule us, which would have a five-parts-per-million standard.
We are just beginning our review of that. It is not a number that we in any way suggested. That is where the process stands right now; we are seeking to review it, and as part of that review, we normally talk to people in the industry.
Preliminarily, the people that our staff has talked to gave us a whole range of views, anywhere from there should not be a standard to there should be a standard as low as two parts per million maximum. So there is a range of views out there, and we note that the USDA uses five parts per million as a standard for non-recourse loans, and that was noted, but no decision has been made yet with respect the proposal. It has just been received, and the review has just begun.
CHAIRMAN SPEARS: Bob?
MR. PETERSEN: Just a point for Jim. I cannot let an opportunity like this go by. Jim and I have engaged in many good grain quality debates over the years.
Jim, I think it would be fair to say that most of your members who were buying wheat have a standard contract term in there as far as the amount permissible, the permissible vomitoxin level of anything they will buy, true?
MR. BAIR: Of course, they have to if they are interested in meeting FDA's standards for wholesomeness.
This is not a question about cash market, however. This is a question of the futures market, and to achieve convergence of those two, the futures market contract should bear some relevance to what is going on in the cash market.
Now, you and Mr. Dodds and other people around the room are certainly better able to discuss that than I am, but our members feel that what has happened now, maybe not this year because there has not been a vomitoxin problem in the soft-wheat crop this year, but in years where there have been, you had irregular price relationships between the cash and the futures markets, and there was not that convergence. Therefore, the viability of the contract suffered.
MR. PETERSEN: But delivery stocks as a practical matter would form a very small percentage of the milling supply of wheat.
MR. BAIR: That is true, but if that were the only basis for making revisions to the contract, then why have any specifications at all--I mean, they did not have any deliverability considerations.
If it is true, of course, that very little wheat is, in fact, delivered, it is the potential for the deliverability which provides the classic hedger the opportunity and the interest in using the contract as a tool.
MR. PETERSEN: It probably points up the classic dilemma in contract design and in trying to make a contract that fits all the different circumstances of all the different users.
CHAIRMAN SPEARS: Ken?
MR. ACKERMAN: Just a question for clarification. The current contract, as I understand from this document, has no specification, correct?
So what does that mean in terms if one were to deliver wheat with five parts per million or 10 parts per million today? What would happen under the current contract?
MR. MIELKE: Under the current contract, USDA grade standards apply. USDA grade standards say nothing about vomitoxin. That is an FDA advisory.
So deliveries of high vomitoxin wheat would be permitted under today's contract if they meet all other USDA grade standards.
MR. ACKERMAN: Would there be any price adjustment?
MR. MIELKE: Presumably, there would if the commodity was not merchantable because of high vomitoxin levels.
There have been some years recently where that has been a concern. I think the market worked through those remarkably well, but it is now something that the Board of Trade is considering dealing with by rule, so they will have a better handle on it presumably in the future.
MR. BAIR: Two years ago, for example, when we last had a vomitoxin outbreak in the Eastern United States in the winter crop, the wheat that is reflected by the CBT wheat contract, there were people who did, indeed, exactly what you referenced, Ken, and took delivery and learned very painful lessons about that.
If there were a year where there were extremely high levels out there, granted, a 5 PPM contract specification might be of some value, but in the year that that FDA guideline was written, that was not the case. It was primarily wheat that was in the 2-, 3-, 4-, 5 parts per million. If you set up a 5 PPM limit on the contract then, that is like playing limbo with the bar set at 6 feet. That is not much of a challenge, and everything passes through.
Wheat which is intended for human consumption would not in that situation make wholesome flour that meets FDA guidelines. So there is precedent that is very clear and painful to some people to exactly what you referenced.
CHAIRMAN SPEARS: So the bottom line is, I believe, John, that we have received a contract application from the Chicago Board of Trade. We are in the process of reviewing that, and part of the review process is a public comment period. That is where we are at in the process.
So I think it is open to people giving the Commission their comments on the issue. Thank you, Jim.
MR. BAIR: I certainly understand, and I appreciate the opportunity to have a few minutes here. I understand that it is an issue with the CBT and not the CFTC, per se, but since you are charged with ensuring the viability of the contract, and this was dated today, I thought this would be the most appropriate time to chat about it.
CHAIRMAN SPEARS: Thank you, Jim.
MR. DODDS: Being one of the bigger players of the Chicago Board of Trade, the wheat delivery mechanism, I would just say from my experience that having a contract with no limits is drastically different than having a contract with a five-parts-per-million limit.
I think as I view what the milling industry has consumed from our facility, it is a dramatic improvement in the quality standards of the wheat.
As it relates to what happens, it is no secret that all levels of vomitoxins show up depending on the weather conditions when the wheat flowers.
Two years ago, we had rains during the flowering stages of wheat. So we had vomitoxin levels that averaged probably 10 percent on the delivery market.
Through blending and through apparently different products that millers produce, they are able to do some blending.
It is interesting that with no export market that that wheat is about gone, and the milling industry consumed that wheat.
I was at Jim's annual meeting a couple of years ago on this subject, and I think because of the vomitoxin levels 2 years ago in the wheat contract, it rose to the top. I know it is a severe problem for them when we have those kind of years.
I think this is a rather dramatic change, and it should improve the quality of the vomitoxin in the delivery marketplace rather dramatically.
I would say from a cash perspective, I will admit there is a rather dark line at four in the milling industry, but we have no problem selling wheat at four parts vom to anybody in the milling industry, other than those products where they do not want it. I can give you evidence that apparently because of their blending capabilities, contracts read as high as seven parts per million.
CHAIRMAN SPEARS: Thank you, Bill.
Are there any other topics of discussion that a member of this Committee would like to bring forward to this Committee for discussion or for review?
We are now at the time for other business, and I would be interested in hearing anyone's viewpoints in regard to issues that need to be discussed today or issues you would like to see on the table at future advisory committee meetings.
As you know, these are ongoing committee meetings, and there are topics that this group would like to see discussed in the future. So I open the floor just for a few minutes to any commenters that would like to comment in regard to those issues.
MR. GILLEN: I think we should pursue the issue of electronic trading. I think we can continue on the discussions of Mr. Damgard and Mr. Greenberger as it impacts on the ag community. I think we should be looking at the future.
CHAIRMAN SPEARS: Thank you, Neal.
MR. WHITE: One that concerns me is I think in several areas of our livestock and commodity situations, grain and so forth, I wonder if--I would like to receive some other comments from some of the other board members, but I get concerned about transparency of our market.
I wonder if--in our area, we have got a lot of contract feeders. Those contract feeders do not know what their production is selling for. They are paid a price. I wonder what effect that has on the other markets, the other market for that commodity, that unknown selling price for contract livestock? How does that affect those that are not involved, and can that deteriorate an independent producer from competing? How does it affect in the market where that consumer buys that product?
We hear consumers and farmers alike say, "Well, hogs are 35, but the price in the store has not dropped for a year," things like that.
I wonder about if there is not something that--that there is some concern out there, and I feel milk is another situation. How is it that the news puts out that butter fat--we are low on butter fat, we are importing butter, and dairy farmers are receiving the lowest price for milk in some areas?
It seems to me that some of our markets are not very transparent or something when those types of situations occur. I would be interested in maybe some of the other board members' comments about what I have said, whether I am off base or they feel that that is something that we should be concerned about.
CHAIRMAN SPEARS: Paul?
MR. HITCH: The man with the red light.
There has been a lot of concern in the cattle feeding industry about price discovery. An increasing number of the live cattle are being delivered on some kind of a formula basis in which the price is either determined at a later date--or when determined, not made available to the marketers of cattle at all.
I did not think it was properly the province of the CFTC to concern itself with what was going on with the cash side of the trade. So I do not know that it is necessarily an issue for the CFTC to be involved in.
Obviously, some of these things get rather blurred. I mean, some of the contracts key to perhaps the futures price, there is all kinds of contracts being traded on out there. So price discovery or price transparency is very much an issue with cattlemen. As well, it is also tied into market concentration on the part of the packers.
There is a concern about packers unwinding futures positions and perhaps impacting negatively on the cash cattle market. That might be something the CFTC could look into.
As far as how cash prices are determined, for the most part, it is outside the purview of the CFTC. It is very much an issue with cattlemen. I do not know it is necessarily an issue with this regulatory body.
Of course, everybody is concerned about price discovery, when you finally discover the damn thing and it is 59 cents. Nobody was concerned about price discovery when you discovered it was 80 cents.
CHAIRMAN SPEARS: Thank you, Paul, for those insightful comments.
MR. OMAN: Just the one comment, and it kind of followed up on what Neal had to say about the electronic and Internet marketing.
I know accessibility, at least to that Project A market, in a lot of situations, it is kind of hard to handle. At least your local elevators, the access at least to us does not seem to be there.
So I guess access to producers through the Internet would probably solve a lot of that if we had it, and I do not know if it is available yet today or could be or what the thing there is, but I think that is one issue that I definitely think needs to be looked into.
Just a little comment on what Bob said, I do not know if it is so much--I do not think there is anything CFTC can do on market, but I guess I am not a pork producer, but I have a lot of friends that are in the business. I keep hearing the word "market access" from the independent producer. What he is talking about is a contract feeder.
I think that is the issue. I question if it is at this table, but I think it is a market issue that definitely the livestock industry has to look at.
CHAIRMAN SPEARS: Bill?
MR. DODDS: After hearing John and Michael talk a little bit about exchanges versus over-the-counter, has the Commission--it seems to me the exchanges would submit something in the way of ideas relative to deregulation that would cut their cost. Are they doing that, or aren't they doing that?
CHAIRMAN SPEARS: There has been an ongoing discussion between the exchanges, the industry and the Commission for several years now regarding deregulation.
I know the Commission continues the process of trying to streamline our regulatory requirements and make the overall process less burdensome to the exchanges and industry as a whole.
Dialogue continues to exist, and it will continue into the next year or two as part of the reauthorization.
CHAIRPERSON BORN: Well, let me just--this is a wonderful opportunity just to invite, again, the exchanges or any of the people sitting around the table who have thoughts or ideas as to ways that regulatory burdens can be reduced without hurting the public policy interest that we are supposed to protect.
We would welcome those. We have received wish lists from a number of organizations in the futures industry. The FIA, the NFA, the MFA have all given us wish lists, and we have gotten some ideas from the exchanges as well.
We have been involved since February '97 in a pretty extensive regulatory evaluation and reform effort, and have adopted and proposed a lot of rule changes that the Commission hopes will streamline things, but we certainly are open to any new ideas or suggestions.
MR. GREENBERGER: I would just like to, again, second that.
We have a massive number of rules out now that are designed to streamline exchange trading. They come from wish lists that have been given to us, as Brooksley said. I know I can speak for the Division of Trading and Markets and I am sure the Division of Economic Analysis that we are very aggressively seeking out ways to make the markets function more smoothly without sacrificing protection of the market or market users, and any ideas that anybody has, we are willing to sit and discuss.
We have had a lot of meetings this year with a lot of different groups, and we are quite anxious to make use of regulatory reform to improve the situation for end users.
CHAIRMAN SPEARS: As we wrap up, I would like the opportunity for any of the commissioners--John or Jim, do you have anything you would like to say at this point in time?
COMMISSIONER NEWSOME: As a newcomer to the Commission, all I would like to say, Commissioner Spears, is I welcome the opportunity to serve on this Commission. I look forward to building positive relationships with those who sit around this table.
Certainly, agriculture is very near and dear to my heart. As we try to develop tools to manage risk, to improve competition in our livestock markets and in our ag markets, I certainly sit available to have discussion or listen to any ideas or opinions that any of you might have.
CHAIRMAN SPEARS: Thank you.
COMMISSIONER TULL: I would just say, as I have said before, I hope that I am a good listener, and that I have listened to everything that each of you have had to say.
This commissioner values each of your opinions, and I will certainly give them all of my thought and consideration in any of the issues that have been brought up.
Thank you, Dave. Thanks for asking me, Dave.
CHAIRPERSON BORN: I just want to thank everybody for attending and for being open and thoughtful and candid in your remarks.
I think this is of just enormous value to the Commission to hear your views. You are our focus on reality.
You have to remember, we sit here in Washington and try to read as much as we can, get petitions from various members of the industry, but we are not out there in the trenches like you all are. You can really make a very significant contribution to the quality of our exercise of our regulatory authorities, and we all appreciate it very deeply.
CHAIRMAN SPEARS: Thank you, Brooksley.
I would just like to add my 2 cents. I want to thank each of you for coming.
Again, it is my hope that this Committee will truly be an advisory committee to this Commission, and, again, please do not just hold your comments to these Commission meetings. As I said before, all of us have an open door. This group is extremely important to us, which very evident by the fact that all of the commissioners stayed for 3-1/2 hours and sat through this meeting. That shows their commitment to this group, and I want to thank each of you for coming again.
As I mentioned earlier, there are a number of handouts that are in your folder that we did not go over. I did include, on behalf of the request of former Commissioner Joe Dial, a speech that Joe gave recently in Illinois. He asked that I share it with this group. A number of you have asked for that from him. So I made that available to you.
Also, out on the table are copies of slides that Paul went over regarding the spec limits and also those things that he discussed regarding Guideline 1 and ag trade options that I personally could not see, but they have been made available for you.
So, unless there are any other comments or questions, we are going to go ahead and adjourn this meeting a half hour early.
[Whereupon, at 4:31 p.m., the meeting was adjourned.]