Remarks of Commissioner James E. Newsome before the Mississippi Agricultural Economics Association, Mississippi State University
June 24, 1999
Thank you for the opportunity to be here with you today. I would like to thank Dr. Marty Fuller for inviting me to this conference, and all of the people who organized and planned today's activities.
I firmly believe that this kind of dialog is beneficial for all who attend, myself included, because it fosters relationships between farmers, agribusinesses (including lenders and insurers), university officials, and government representatives. As many in agriculture are currently experiencing hardship, we must work together to ensure the long-term stability of an industry that serves as Mississippi's economic leader.
Many of you already know who I am and where I come from, but let me give a little background about myself for those of you I have not yet had the opportunity to meet. I, along with my three brothers, grew up on my family's cattle operation in Florida. For the last ten years, I worked as the Executive Vice President of the Mississippi Cattlemen's Association and Beef Council, and consequently, I tend to look at things from the producer's point of view. I am proud of my agricultural background, and of the values and work ethic it has provided.
The Commodity Futures Trading Commission functions as an independent government agency created in 1974 to protect market participants against fraud and manipulation and ensure safe and fair markets.
In the interest of time, I'll try to make my comments brief regarding risk management.
Risk Management Concept in Agriculture
All producers must protect themselves against downside price risk, given the Freedom to Farm Act, increased market volatility, and most recently, exceptionally low commodity prices. However, most producers do not use the futures market (only about 10 percent according to one study)
There are several reasons why producers are not aggressively marketing their crops. Probably the main reason is that they haven't had to. Our farm policy prior to 1996 was geared more toward supply management, with guaranteed government payments for base acres of production.
This policy created a price floor for program commodities, which led to many producers placing more emphasis on areas of their farming operation other than marketing. However, today's market-oriented approach to farm policy has created an incentive for producers to adopt some type of marketing strategy to ensure downside price protection.
Other reasons why farmers and ranchers have not instantly adopted existing risk management tools range from a lack of trust of the commodity exchanges to the new and untested instruments to a general lack of marketing tool awareness.
While there have been some instances in years past where fraud and manipulation of commodity markets has occurred, I believe that utilizing today's technological advancements and learning from past experiences, the exchanges have made significant enhancements to their market systems. The exchanges and the CFTC have also improved their coordination, which has led to better surveillance activities.
Many producers who have utilized exchanges in carrying out their marketing function have benefited from this type of risk management. However, for the above-mentioned reasons, some will probably never market their crop using that medium.
Agricultural Trade Options (ATOs)
Given these dynamics, I believe that we must find a way to create products that are attractive to the agricultural sector, both producers and agribusinesses, while ensuring the preservation of market integrity. The CFTC made an attempt to do this in April of last year with the introduction of the Agricultural Trade Options pilot program.
An agricultural trade option is an agreement giving the agricultural producer the right to deliver his or her commodity in the future for a set price. The producer is not obligated to deliver and may simply choose to "walk away" from the option contract. In return for this right, the producer pays a fee, usually called the option premium. Agricultural trade options would not be traded on a commodity futures exchange, but directly between commercial parties.
There has been a long history of on-again, off-again options trading, both on- and off-exchange. Since 1974, there has been a gradual lessening of the regulatory prohibitions on trading commodity options, the last of which has been the lifting of the off-exchange agricultural trade options ban.
The difference in the ATO program and exchange-traded options is where the deal is done. With ATOs, "traded between commercial parties" could mean that a farmer hedges their crop with the purchase of trade options from a local grain elevator or other local entity, who would be the Ag Trade Options Merchant (ATOM), or seller of the option.
While I was not a Commissioner at CFTC during the creation of the pilot program, I do support the general concept. However, most agribusinesses (who would be the primary sellers of options) have complained that the program rules are too burdensome in nature, making the program more trouble than it's worth. In fact, since it's creation over one year ago, there have been no applications to become ATOMs, which effectively has made the program useless.
A cattleman involved in analyzing this program probably summed it up best last August. He said since we [CFTC] had the pilot program open for a few months and had yet to have anyone register, that we "might have perfected a hemorrhoid transplant. There is a world of potential donors, but there are no willing recipients out there."
Since arriving at the Commission last year, I have met with industry participants around the country, and there appears to be several common areas of concern regarding the program: overburdening paperwork requirements, the exemption level, the lack of cash settlement ability, and registration issues. We are working to fix the program and we hopefully will have some beneficial changes out very soon.
The program must be attractive, not only to farmers and ranchers, but also to local elevators and other agribusiness firms. In order to achieve such a goal, the process must be industry-driven. Industry knows best what it needs and what will actually work.
I believe the more risk-management tools available to industry and the higher the level of competition, the better the products will ultimately be. If ATOs are not the answer, then we need to work together to determine what will be attractive in the dynamic agriculture environment of both today, as well as tomorrow.
Dr. Coble talked about the different risk management products available or becoming available in agriculture, and the roles that private and public institutions will play in development, as well as the initial and long-term offering of these products.
While I cannot predict what will be available long-term or what will fit each individual producer's marketing needs, I will say that risk management is evolving rapidly and producers need to familiarize themselves with these new products and decide which ones accomplish their desired marketing goals and be willing to switch strategies if newer and better products become available.
Thanks again for the invitation to be with you today. Please feel free to contact me in Washington if you ever have any questions or comments about anything that the CFTC is doing. I will be happy to answer any questions at this time.