Remarks of

Joseph B. Dial, Commissioner
Commodity Futures Trading Commission

Before the Board of Directors
National Council of Farmer Cooperatives

June 11, 1997

Hyatt Regency Hotel
Washington, D.C.


I appreciate this opportunity to address the Board of the National Council of Farmer Cooperatives. My appearance here today represents one more chapter in the long history of communication and cooperation between the Commodity Futures Trading Commission and the NCFC -- as shown, for example, by NCFC's active participation on the CFTC's Agricultural Advisory Committee, which I have the honor of chairing. This is a most appropriate time for me to appear before you because the Commission is currently dealing with a number of significant issues of particular interest to NCFC and its members. I will give you a brief rundown on the current status of three major issues -- legislative matters, grain delivery points, and agricultural trade options -- and I will then conclude my remarks with a few thoughts on the new era that agriculture is now entering and the implications of this new era for NCFC and its members.

Legislative Matters

Starting with legislation -- from the perspective of the American farmer, the most profound legislative change in recent memory is the Federal Agricultural Improvement and Reform Act, which took effect in the spring of 1996. I will discuss in the conclusion of my remarks the new era for American agriculture, ushered in by the FAIR Act. I mention it here only to give an added perspective to some equally profound amendments that have been proposed for the Commodity Exchange Act -- the CFTC's authorizing legislation. Both the House and Senate versions of these currently pending CEA amendments include provisions exempting so- called professional markets from nearly all of the provisions of the Act. I find it ironic that just when the FAIR Act is making farmers responsible for managing their own price and production risks, these "promarket" provisions would seek to dismantle most of the regulatory safeguards governing futures trading -- one of producers' most important risk management tools.

CFTC Chairperson, Brooksley Born, has articulated the Commission's concerns about the promarket provisions very effectively in a number of recent speeches, and I would like to share with you some of the points she hammered home. The proposed deregulation, which could cover up to 90 percent of exchange trading volume, would greatly restrict federal power to protect the public and the markets against manipulation, fraud and financial instability. The power to bring fraud and manipulation cases after the fact, which the CFTC would retain under both bills, could be an illusion of protection at best. With no Commission surveillance of the promarkets, and with the rules governing speculative limits, large trader reporting and exchange recordkeeping eliminated, the CFTC would lack the data to analyze market problems. In effect, we would be a police force charged with enforcing the traffic laws with no radar and no patrol cars, pedaling a bicycle in pursuit of those who violated the 100 mph "promarket' speed limits. For example, under the "promarket" arrangement, rules intended to protect market participants from trade practice abuses, such as the rules governing exchange audit trails, competitive trading and open pricing, would be swept away. Commodity professionals trading exclusively on the promarkets would no longer be subject to registration, criminal background checks, fitness requirements or sales practice standards. Financial integrity safeguards, such as segregation of customer funds, net capital requirements, financial reporting, and margining of accounts, could be abolished. In sum, the bills could eliminate 70 years of government protection of futures market integrity just when farmers need that protection the most.

The Senate bill, which appears to be farther along in the legislative process, differs from the House version in exempting certain domestic agricultural commodities from the promarket provisions. Again, however, the protection retained for agriculture under this Senate carve-out could be purely illusory. The Commission has serious concerns about the danger of financial "spillover effects" where an unregulated market trades side-by- side with a regulated one, especially if funds in both markets are handled by the same clearinghouse. In addition, the unregulated promarkets might siphon off speculative trading from the regulated agricultural markets -- reducing their liquidity and their usefulness for hedging and price basing. These same concerns have been raised by Secretary of Agriculture Dan Glickman, and by a coalition of agricultural groups that testified before the House subcommittee in April.

The current status of the proposed Commodity Exchange Act amendments is something of a moving target. However, I can share with you several encouraging signs. The Congressional sponsors have stated that neither the promarket provision, nor the other sections that the Commission finds problematical, are set in stone. More importantly, active negotiations are underway among various interested parties aimed at forging reasonable compromises. I cannot predict whether those negotiations will succeed. I can, however, assure you that the CFTC approaches them with an open mind. We remain committed to a balanced approach -- reasonable reforms that will allow US futures markets to meet the competitive challenge of offshore and over-the- counter markets, but will do so without sacrificing legal standards that have assured the market and financial integrity of US futures trading for over 70 years.

Grain Delivery Points

Let me turn now to the issue of grain delivery points. In December of 1996, when the Commission initiated its currently pending action in this area, problems with the delivery terms of the CBOT corn and soybean contracts had been building for a long time. These problems included: (1) a general decline in the role of terminal markets in the cash market for grain; (2) a continuing shift of commodity flows away from exchange delivery points, especially the par delivery point in Chicago; and (3) a continuing decline in cash market activity at the contract delivery points -- again, particularly Chicago. Several comprehensive studies completed in 1991, including one by the CBOT, supported these general conclusions. The last straw was added in 1995 when several Chicago delivery warehouses closed, reducing storage capacity there from 52 million to less than 15 million bushels.

The CBOT responded by appointing a special Task Force to propose amendments to the delivery terms of the corn and soybean contracts. After more than a year of deliberations, the Task Force proposed contractual amendments to the Board, which approved them in a modified form. However, even this watered- down version was voted down by the CBOT membership.

At that point, the Commission had no choice but to invoke Section 5a(a)(10) of the Commodity Exchange Act. Under that provision, on December 19, 1996, the Commission formally notified the exchange of its findings, that the delivery terms of the corn and soybean contracts no longer accomplished the statutory objectives of permitting delivery at such delivery points and differentials as would tend to prevent or diminish price manipulation, market congestion or the abnormal movement of the commodities in interstate commerce. This notification triggered a 75-day deadline, built into the statute, for action by the exchange. On the March 4 deadline, the exchange informed the Commission of a "working alternative" response, which would drop the existing Toledo and St. Louis alternate delivery points and initiate a delivery system based on shipping certificates on the Northern Illinois River. This proposal was subsequently approved by the exchange membership and formally submitted to the Commission.

The Commission published the exchange proposal for comment on March 14th and subsequently extended the comment period twice. That period now will expire on June 16th. To describe the CBOT proposal as controversial would be an understatement. To date, the total number of comments received is over 550, including many from coop elevators in areas near, and not so near, to the Toledo delivery point. This number represents the most responses ever received to a CFTC request for comment. To further supplement the record, the Commission has also scheduled a public meeting, to be held tomorrow, June 12th, to receive oral and written presentations from exchange representatives, commercial users of the contracts and other interested parties.

Based on its review and analysis of the extensive record compiled on this issue, the Commission will then determine whether the exchange proposal meets the statutory standards, or whether the Commission will be forced to assert its statutory authority to impose some different delivery rule. I cannot predict what the final decision will be. I can, however, assure you that the Commission's decision will not be based on political considerations, or on the comparative economic effect that any delivery alternative might have on any particular geographical area. The Commission's decision will be based solely on the statutory factors -- a system that permits delivery at delivery points and differentials that will tend to prevent or diminish price manipulation, market congestion or the abnormal movement of commodities in interstate commerce.

Agricultural Trade Options

A third major issue on the Commission's current agenda is agricultural trade options. A trade option is an off-exchange commodity option offered to a commercial person or entity for purposes solely related to that commercial's business. An option buyer has the right, but not the obligation, to make or take delivery of the commodity. Trade options have many potential benefits. The most obvious is that they offer producers the ability to lock in downside price protection without cutting off upside price potential. If the price goes down, the option is exercised and the producer will cover the cost of production, or some other level of price protection that he or she has selected. If the price goes up, the producer can forfeit the premium, abandon the option, and sell the commodity in the open market.

Trade options can offer benefits to farmers and cooperative elevators alike. Unlike exchange-traded options, these off- exchange instruments can be customized to meet the specific needs of each producer's operations, giving elevators more flexibility in offering risk management opportunities to farmers -- and the chance to generate additional income from option premiums. Also, a trade option is more likely to be accepted by the farmer for the very reason that it is being offered by the local elevator -- a firm he knows and trusts.

Agricultural trade options have a long and convoluted history -- too long and convoluted for me to describe in any detail in these brief remarks. Suffice it to say that, for the present, trade options in the basic agricultural commodities remain subject to a ban dating back to the 1930s. In recent years, however, several ongoing developments have raised questions about the continued wisdom of such a ban. These developments have included: (1) the success of off-exchange trade options in non-agricultural commodities; (2) the success of exchange-traded options in both agricultural and non-agricultural commodities; and (3) farmers' need for the widest possible variety of risk management tools in today's highly competitive agricultural markets.

By 1994, I had become convinced that the Commission needed to take another look at giving people in agriculture the same opportunities as those in the metals, energy and financial fields -- the chance to add trade options to their arsenal of risk management tools. In December 1995, the Commission hosted a public roundtable discussion of agricultural trade options. The 17 participants represented a broad cross section of agriculture, as well as academia and the futures industry. While some still expressed reservations, there was general support for relaxing the ag trade options ban, based on an increased need in modern agriculture for a variety of risk shifting tools. The Commission directed its staff to study the issue and report on its findings.

The staff study culminated in a "white paper," published last month, entitled "Policy Alternatives Relating to Agricultural Trade Options and Other Agricultural Risk-Shifting Contracts." The white paper recommends that the Commission consider lifting the agricultural trade option ban, subject to appropriate conditions. The first step in that process is already underway. Monday's Federal Register included an Advanced Notice of Proposed Rulemaking requesting comment on lifting the ban and the appropriate conditions for doing so. The Notice includes a list of some 30 questions and is subject to a 45-day comment period. I would urge all interested parties to submit their comments on time so that the Commission's deliberations can proceed on schedule. The Commission is also planning two field hearings on this issue, to be held in Bloomington, Illinois on July 10th, and in Memphis, Tennessee on July 16th. The hearings will be formally announced within the next few days. It is my hope that the Commission's final action on ag trade options will be completed by this coming October. If the ban is lifted then those who want to use ag trade options for the 1998 crop year will have an opportunity to do so.

The New Era for Agriculture

As I noted at the outset, I will conclude these remarks with some observations concerning the implications a new era for agriculture may have for the NCFC and its members.

We find ourselves in a new era for agriculture because of major changes in public farm policy, not only in the US, but in many countries around the globe. Over the past several months, I have had an opportunity to get a feeling for agricultural policy changes in other parts of the world. In April of this year, I gave the keynote lecture at a "Forum on Risk Management" in Japan. The next day, I met with government officials in Tokyo to discuss the role private sector risk management tools will have under a different Japanese farm policy. While I was in Sydney, in December of 1996, I visited with senior management of several of the largest agribusiness companies in Australia. There too, we discussed the adjustments their organizations are making as a result of changes in farm policy there and abroad. In October of last year, I chaired a conference in London on "Risk Management in European Agriculture." For two days, conferees from nine countries heard presentations about how changes in governmental farm policy will affect the agricultural community in the European Union.

These experiences reinforce my belief that -- just as the fall of Communism encouraged both developed and developing nations to move toward a free market philosophy, so too has the fall of price supports and production controls pushed producers in many lands to make the transition to farming for the market and not the government. In my opinion, we have not seen global agriculture rely this much on the market for almost 70 years.

I believe the success of this grand experiment depends primarily, although not exclusively, on a producer's ability to develop a written marketing program that includes the prudent use of derivative instruments. In order to master this particular task, farmers will have to become business specialists in production agriculture. The reward for improving their business management skills and enhancing their computer literacy through continuing education will be the creation of their own financial safety net. This will occur as growers learn how to secure guaranteed revenue by transferring production and price risks to other parties.

On the other hand, those farmers who don't want to expend the time, energy and money to become business specialists in production agriculture, may have the option of becoming contract growers under one of several arrangements available in some sections of the country today. I understand that, as early as 1998 farmers may have an opportunity to participate in one of several innovative agribusiness pilot programs being considered by those companies who are willing to take on the producers' yield and price risks. Under this arrangement the farmer would agree to use the company's seed, fertilizer, chemicals, fuel and financing in return for a guaranteed revenue per acre.

Growers who don't like the idea of becoming a contract farmer, even with a secure revenue stream, may opt for participating in a business model sometimes referred to as "virtual integration." Please note, I said "virtual" not "vertical." By way of explanation let me first give you Webster's definition of the word virtual, "being such practically, or in effect, although not in actual fact or name."

Virtual integration is an arrangement between a supplier and a purchaser that requires a harmonization of every facet of their respective businesses with the single goal of delivering exactly what their customer wants. It is different from vertical integration in that the two businesses remain separate while coexisting as equals, but with no room for adversarial friction. Together the parties make decisions on R & D, manufacturing standards, product quality, shipping, accounting, marketing, and sales. Their electronic information systems are compatible and are an integral part of information sharing by and between the companies.

One of the best known examples of virtual integration is the Walmart/Procter & Gamble arrangement. These two Fortune 500 companies are partners in the practical implementation of mutual goals, yet they are not partners in actual fact or name. This model works and it has proven to be highly effective in eliminating or greatly reducing inefficiencies in many businesses. I personally think virtual integration can and will be adapted to work for the agricultural sector as we move into the 21st century. It will of course require today's farmer to become tomorrow's business specialist in production agriculture. Nonetheless, as it all comes together, American agriculture's competitive position in the world market will be greatly enhanced.