The NGFA this week urged the CME Group and Commodity Futures Trading Commission (CFTC) to prepare now to act quickly to adopt additional steps if existing changes already adopted by the exchange fall short in enhancing the performance of the CBOT wheat futures contract.
During testimony presented at a Senate subcommittee hearing, Chairman Tom Coyle, general manager, Chicago & Illinois River Marketing LLC, Chicago, Ill., presented the NGFA’s view that the influx of investment capital in recent years has overwhelmed the wheat contract and has been the significant factor causing a lack of convergence in the contract. Coyle testified about the impacts of the lack of convergence on grain hedgers and producers. Coyle said the NGFA’s preference would be to achieve enhanced contract performance for hedgers with minimal intervention, but that some restrictions could be needed if contract changes fail to achieve desired results quickly.
The hearing was conducted by the Senate Homeland Security and Governmental Affairs Committee’s Permanent Subcommittee on Investigations concerning its 247-page study that attributed the lack of performance in the CBOT wheat futures contract to speculative market activity by index traders. Others testifying at the hearing included CFTC Chairman Gary Gensler; representatives of the American Bakers Association, Consumer Federation of America and Goldman Sachs; and Charles Carey, vice chairman of the CME Group. A press release focusing on NGFA’s testimony is available by clicking here. Opening statements of senators and prepared testimony of the witnesses, in addition to an archived webcast of the hearing and the subcommittee report, can be accessed by clicking here.
The following paraphrasing of the key aspects of the question-and-answer section of the hearing will give NGFA E-Alert readers a flavor for the substance and tone of the hearing:
Questions Posed to CFTC Chairman Gary Gensler:
Sen. Carl Levin, D-Mich., subcommittee chairman: Will the CFTC be looking at whether index trading constitutes excessive speculation?
Gensler: The CFTC will look at potential application of speculative trading limits across all classes of speculative investment.
Levin: Has the participation of Commodity Index Traders been the cause of a lack of convergence in the CBOT wheat contract?
Gensler: We believe Commodity Index Traders are a contributing factor to lack of convergence.
Sen. Tom Coburn, R-Okla., subcommittee ranking member: How aggressive should Congress be in legislating a solution to the performance problems of the wheat contract – potentially phasing out hedge exemptions granted to Commodity Index Traders? Or should we rely on CFTC to use its authority to remedy the problem?
Gensler: The CFTC and Congress should work as partners to ensure proper functioning of futures markets. We believe it is within the Commission’s current authority to revoke no-action relief from speculative position limits previously given to two index funds. We think the Commission is within its current authority to implement speculative position limits for energy commodities. Phasing out existing hedge exemptions for wheat market participants might be less clear, might require a rulemaking or legislation.
Sen. Susan Collins, R-Maine: I would be concerned if index funds were not held to speculative position limits in the same way as other speculators. I would advocate that CFTC directly set position limits for energy commodities, rather than allowing exchanges to determine limits.
Gensler: I tend to agree. There is strong logic to applying speculative limits consistently across contracts that involve physical commodities.
Collins: Are you concerned that commodity index traders might just set up additional entities to circumvent position limits?
Gensler: The commission would look to the controlling entity behind market participants to enforce position limits.
Questions Posed to Industry Panel:
Levin: How quickly does the wheat contract need to re-establish convergence?
Tom Coyle: We would like to see convergence re-established within the current crop year. The next change to the contract, if needed, could be rolled out between the September and December expirations to encourage a return to convergence.
Levin: Would you agree that a dramatic increase in investment by index funds contributed to the lack of convergence in the wheat contract?
Coyle: No. The funds didn’t contribute to lack of convergence. They caused the lack of convergence.
Levin: To what would you attribute lack of convergence in the CBOT wheat contract?
Steven Strongin (Goldman Sachs): We believe contract design issues are the cause of lack of convergence. In particular, we think the increased value of storage is not reflected in the CBOT’s storage rates.
Levin: Mr. Coyle, would you agree?
Coyle: It is true that the value of storage has increased, but we do not believe that is the cause of convergence problems. We believe the large investments by Commodity Index Traders have created the convergence problem.
Levin: Who is hurt by lack of convergence?
Coyle: First, the elevator is harmed because its basis risk has increased dramatically which makes it difficult to manage hedges. The farmer is also hurt as some of the elevator’s risk is passed back to him in the form of lower basis. Because they didn’t have access to enough capital, some elevators were forced to stop bidding for farmers’ grain more than about 6-8 months out.
Levin: Do you support position limits on commodity index traders?
Strongin: We support position limits on the customers of index funds.
Levin: Mr. Coyle, you make the point in your testimony that large volumes of index fund investment actually drains liquidity from the CBOT wheat futures contract. Would you explain that?
Coyle: Index funds typically are long-only, with positions held for long periods of time, and non-responsive to price. They now hold 56% of open interest in the wheat contract, with spread trades excluded. That means more than half the open interest is not for sale at any price for extended periods of time, which removes liquidity from the contract.
Coburn: Can you foresee a time when index trading is not allowed on the Chicago Board of Trade?
Coyle: We would much prefer to see contract performance enhanced through changes in the contract, rather than through restrictions on participation. But if contract changes aren’t enough and performance doesn’t improve quickly, some limitations might be needed. There could be a downside to limits on participating in the futures market. Under current rules, any individual can own 8% of the soft red wheat crop. Altogether, Commodity Index Traders own 196% of the annual crop. If funds want to own the commodity and are limited in owning futures, they could make an investment in physical bushels. Imagine the situation if funds held 196% of the crop in physical bushels over the long term.
Levin: When would you expect to make additional changes to the wheat contract, if needed, to help restore convergence?
Charles Carey, vice chairman, CME Group: We would hope to see improvement within a couple of delivery cycles. We could propose changes after the December or March contract expiration.
Coburn: What are the factors in lack of convergence?
Carey: The wheat contract correlates more to world prices than to Chicago or Toledo prices, so that’s a contract design issue. Other factors are index trading, low wheat stocks worldwide, acreage competition for ethanol feedstocks, and the fear of not getting comparable returns elsewhere.
Coburn: Do you plan to address these factors in the CBOT’s response to the situation?
Carey: We will take action to address these factors and improve the wheat contract’s performance.