Senate report calls for tighter limits on index trader activity in wheat markets

by Jay Sjerven
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WASHINGTON — Senator Carl Levin of Michigan and Senator Tom Coburn of Oklahoma, chairman and acting ranking minority member, respectively, of the investigations subcommittee of the Senate Committee on Homeland Security and Governmental Affairs, on June 24 released a 247-page report that concluded that commodity index traders made such large purchases on the Chicago wheat futures market that they pushed up futures prices, disrupted the normal relationship between futures prices and cash prices for wheat, and caused farmers, grain elevators, grain processors, consumers and others to experience significant unwarranted costs and prices risks. The report, titled "Excessive Speculation in the Wheat Market," urged tight limits on index trader activity in the wheat market.

"It is another case of speculative money overwhelming a market and federal regulators failing to take the steps needed to protect the market," Mr. Levin said. "In fact, the Commodity Futures Trading Commission has allowed some index traders to exceed normal trading limits for wheat. It is time for the C.F.T.C. to change course, rein in commodity index traders, and clamp down on excessive speculation that is disrupting commodity prices."

A one-year subcommittee investigation examined millions of trading records from the Chicago Mercantile Exchange, the Kansas City Exchange, the Minneapolis Grain Exchange, the C.F.T.C. and others to track and analyze wheat prices. The subcommittee report said data showed commodity index traders injected billions of dollars into the wheat futures market over the last six years. Commodity index traders increased their holdings from a total of about 30,000 wheatcontracts in 2004 to 220,000 contracts in 2008. The sevenfold increase enlarged the market share of commodity index trading so in each year since 2006, commodity index traders held between 35% and 50% of all outstanding wheat futures contracts in Chicago.

By purchasing so many futures contracts, commodity index traders pushed up futures prices, created an unprecedented, large, and persistent gap between futures and cash wheat prices in the Chicago market, and impeded the two prices from converging at contract expiration, the subcommittee said. The subcommittee found the average gap between futures and cash prices on the expiration of futures contracts on the Chicago exchange grew from about 13c per bu in 2005, to 34c cents in 2006, to 60c in 2007 and to $1.53 in 2008, a tenfold increase in four years.

Characterizing the price changs as "unwarranted," the committee said the result was an undue burden on wheat farmers, grain elevators, grain merchants, grain processors, consumers, and others by making it difficult to use the futures market to protect against price changes and by generating significant unanticipated costs. The subcommittee report said those costs included higher margin calls due to higher futures prices, failed hedges and disruption of normal pricing patterns and relationships. The investigation found a major reason for each of these problems was index trading that constituted excessive speculation in wheat futures.

Also in the report, the subcommittee said the Commodity Exchange Act requires the C.F.T.C. to prevent excessive speculation by imposing position limits on commodity traders. But in the wheat market, instead of restricting traders to no more than 6,500 wheat contracts at a time, its standard position limit for wheat, the C.F.T.C. issued waivers allowing some commodity index traders to hold up to 10,000, 26,000, even 53,000 contracts at a time, the subcommittee found.

To stop what it called excessive speculation, the Levin-Coburn report recommended the C.F.T.C. phase out existing position limit waivers granted index traders through exemptions or no-action letters and instead apply the standard 6,500 wheat contract position limit to all commodity index traders in the wheat market. The subcommittee report indicated if that action fails to "cure" the pricing problems on the Chicago exchange, the C.F.T.C. should lower position limits further, such as to the 5,000 contract limit that applied to wheat traders until 2005.

The report said the C.F.T.C. should undertake an analysis of other agricultural commodities to determine whether commodity index traders have increased futures prices compared with cash prices or caused price convergence problems, and whether position limit waivers for index traders should be phased out in those markets as well to eliminate excessive speculation.

The subcommittee will hold a hearing in July on the report and its findings and recommendations.

Gary Gensler, the new chairman of the C.F.T.C., said in response to the release of the subcommittee report, "Chairman Levin’s thorough report is a significant contribution in understanding the potential effects of index trading in the wheat market and other commodity futures markets. As the commission continues our own analysis and appropriate regulatory responses, Chairman Levin’s recommendations will be given the utmost attention and careful consideration."

The CME Group, which owns the Chicago Board of Trade, said it disagreed with the findings and recommendations of the subcommittee report, which, it said, were based on anecdotal information and not sound empirical and economic analysis.

"The subcommittee report is contradicted by four separate studies conducted by the C.F.T.C., the Government Accountability Office, Informa Economics, Inc., and CME Group, all of which concluded there is no causality between market participation of index funds and non-commercial traders and wheat price levels or cash market convergence at expiration," the CME Group said.

The CME Group said those studies concluded fundamental supply and demand factors related to crop failures, strong economic growth in many importing nations, acreage switching caused by demand for biofuels and currency volatility were responsible for recent periods of increased volatility and prices swings in commodity markets.

"CME Group, along with the C.F.T.C. and broader industry participants, have developed a number of steps to address convergence issues in the wheat contract, including implementing seasonal storage rates, additional delivery territories and reduced vomitoxin levels," the CME Group said. "These changes, which are being implemented beginning with the July 2009 contract, are expected to improve convergence between cash and futures prices."

The National Grain and Feed Association said the subcommittee’s report "provides an insightful appraisal of the declining performance of the C.B.O.T. wheat futures contract. The report reflects a view that has been expressed by the N.G.F.A. for several years: The C.B.O.T. market for wheat has fundamental problems and is not providing the kind of pricing and hedging performance needed to market grain efficiently and to provide forward-pricing contracts to producers that reflect the market."

The N.G.F.A. said it was reviewing the report but it concurred with the report’s finding that the influx of capital from new players in the marketplace has contributed to the lack of convergence and placed financial stress on grain hedgers, particularly during periods of market volatility.

"The N.G.F.A. believes that phasing out existing hedge exemptions and so-called ‘no-action’ relief from speculative position limits for index funds and other investment capital is warranted and could enhance C.B.O.T. wheat futures contract performance," the N.G.F.A. said.

Robb MacKie, president and chief executive officer of the American Bakers Association, said, "We are pleased to see that the committee’s report strongly supports A.B.A.’s longstanding position on this key issue for the baking industry. This report is key to giving C.F.T.C. more reason to make the necessary changes to commodity contracts purchased by index speculators. A.B.A. strongly supports the findings of this report, and we will continue our multi-faceted approach to address this issue."

This article can also be found in the digital edition of Milling and Baking News, June 30, 2009, starting on Page 1. Click here to search that archive.

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