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NGFA RECOMMENDS ACTIONS TO ENHANCE PERFORMANCE OF GRAIN, OILSEED FUTURES MARKETS WASHINGTON – In the aftermath of the April 22 public meeting conducted by the Commodity Futures Trading Commission (CFTC), the National Grain and Feed Association (NGFA) today issued a series of recommendations that it urged be implemented in an effort to enhance the performance of grain and oilseed futures contracts important to commercial hedgers. The NGFA said it was essential that action be taken now to address the disruption in grain and oilseed futures markets and avert the potential for severe financial stress within the grain, feed and grain processing sector that relies upon prudent hedging activities to offset price risk inherent in cash markets. “One of the bedrock fundamentals on which hedging strategies are based is the existence of consistent and reliable convergence between cash and futures prices” during the delivery period, the NGFA said in a statement submitted to the CFTC. “Today, that previously reliable relationship has deteriorated to the point that many commercial grain hedgers are questioning the effectiveness of using exchange-traded futures…and some elevators have been forced to restrict or eliminate deferred-purchase bids to producers.” The NGFA’s official comments during the CFTC public meeting were presented by NGFA Chairman Tom Coyle, general manager, Chicago & Illinois River Marketing LLC, Chicago, Ill. When entering into cash grain contracts with producers for future delivery, grain elevators and other commercial buyers typically sell an offsetting futures contract to protect against price movements that may occur before the grain is delivered. The futures exchanges require elevators and other futures market participants to pay a fee – known as a margin requirement – to maintain the futures contract until it is repurchased, with the hedge lifted at the time the physical grain is sold. The increased volatility in futures market prices has resulted in increased margin requirements on grain elevators and other commercial hedgers to maintain outstanding futures contracts. That, in turn, has increased dramatically the amount of money needed by grain elevators, feed mills and grain processors to finance margin requirements on outstanding futures contracts. The NGFA cited a confluence of factors – some of which are occurring simultaneously – that have contributed to changes in basis levels between cash and futures prices. The NGFA said these factors include increased and more volatile transportation and fuel costs; growing worldwide demand for grains and oilseeds; extremely tight carryover stocks of corn, wheat and other grains; and increased demand for storage created by the growth in biofuels, which has increased storage costs. But a major factor contributing to “weaker” basis, the NGFA said, is the infusion in agricultural commodity futures markets of large amounts of capital from passively managed index and pension funds that take long-only positions unrelated to supply/demand fundamentals, which the association said has contributed to futures price volatility and is “causing disruption” in markets. “These passively managed, long-only contracts are not responsive to short-term economics and are not for sale for extended periods of time,” the NGFA said. “This results in elevated prices not reflective of demand, promotes increased speculative interest in the market, and leads to increased price volatility and pressure on banking resources to fund margin requirements.” Persons taking a “long” futures market positions have bought futures or options contracts, but have not offset that with a cash market position. “Additional futures price increases resulting from supply/demand shocks, bad weather or ever-larger amounts of investment capital from these funds could lead to severe financial stress,” the NGFA said. “Even today, some elevators lack the capital to finance additional hedges” because of ever-increasing margin requirements to maintain those hedge positions. To address these issues and to provide time for agricultural futures markets to adjust, the NGFA urged that the following actions be taken: Update Storage Rates: To enhance convergence between futures and cash prices, the CME Group should immediately resurvey grain elevators to determine if increased storage rates (premium charges) should be implemented for grain warehouses that are regular for delivery for Chicago Board of Trade futures contracts. At the NGFA’s recommendation, the CME Group earlier this year sought CFTC approval to increase the monthly storage rates for corn and soybean futures contracts from 4.5 cents per bushel to approximately 5 cents per bushel – the same increase that previously had been implemented for wheat futures contracts. If warranted by the results of the survey, the NGFA said it would urge the CME Group and CFTC to implement the updated storage rates as soon as possible.
“We believe the market situation has changed, and that neither the current nor the pending storage rates reflect the true value of commercial space,” the NGFA said. “Additional action to increase storage rates is needed to enhance convergence.” Higher storage rates would enhance convergence by widening the price spread between one futures contract expiration period and the next, and allowing more “carry” – that is, the cost of storing grains and oilseeds (which includes storage, insurance, financing and other costs) – to be reflected in futures prices. Moratorium on All Hedge Exemptions for Long-Only Investment Capital: Implement a moratorium on all hedge exemptions granted by the CFTC to long-only, passively managed investment capital entering agricultural futures markets. This would have the effect of reducing the influx of new funds into agricultural futures markets that are not tied to supply/demand fundamentals. For the two investment funds for which the CFTC already has approved a hedge exemption, the NGFA recommended against any further expansion beyond already-approved levels. Further, the NGFA recommended that all passively managed, long-only investment capital in agricultural futures markets be invested on a dollar-for-dollar unleveraged basis, and be subjected to full margin requirements. In a related action, the NGFA in February had submitted a statement to the CFTC opposing “at this time” an agency-proposed “risk-management exemption” on the size of speculative positions that index and pension fund traders can hold or control in agricultural futures or options contracts. Reexamine, Revise CFTC Commitment of Traders Report: Reexamine and potentially revise the CFTC’s commitments of traders report to more accurately reflect the extent to which long-only investment capital is involved in agricultural futures markets. The NGFA in 2005 and 2006 had urged the CFTC to amend this weekly report to establish an “index” category to assist commercial hedgers in basing their risk-management strategies on supply/demand fundamentals, rather than speculative investment capital. The agency subsequently created such an “index” category in the report in early 2007. While the addition of this “index” category significantly enhanced the CFTC report, the NGFA said there are indications that as more market participants are involved in more than one category, the report may need to be amended to provide greater detail on the involvement of long-only investment capital. The NGFA also recommended that the CFTC “fully and clearly define futures market activity reported in each existing category of the commitments of traders report to provide additional clarity for market participants.” Ease Restrictions on Agricultural Trade Options: Ease overly restrictive rules that have prevented the use of agricultural trade options. Agricultural trade options involve a contract between two parties that provides for the payment of a fee to secure the right, but not the obligation, to make or take delivery of the commodity specified in the contract. The fee charged for a trade option is designed to compensate the buyer for the risk of non-delivery, as well as other costs associated with the transaction. The seller of the trade option can offset market risk by using exchange-traded futures or options, cash market strategies or other financial protections. When issuing its final regulations authorizing agricultural trade options in 1999, the CFTC implemented a host of regulatory restrictions and financial requirements that far outweighed the benefits of offering such contracts. These included exceedingly high net worth requirements applicable to both parties to such transactions, as well as extensive reporting rules. “In today’s marketplace, we believe access to a workable agricultural trade options program could give producers additional marketing opportunities, spur new-product innovation and help ease financial liquidity concerns,” the NGFA said. “Agricultural trade options also could help ease financial liquidity concerns of elevators by attracting new capital into agricultural markets without burdensome margining requirements.”
Explore Exchange-Traded Ag Commodity Swaps: The NGFA also said that, in principle, it was supportive of allowing agricultural commodity swaps to be cleared on-exchange. Swaps are private, usually one-to-one counter-party transactions tailored to the needs of the buyer and seller. They often feature a built-in agreement allowing the buyer to repurchase the commodity at some future date, with the seller handling the risk financing of the hedge for a fee. The NGFA said granting futures exchanges the regulatory flexibility to offer such swaps “could be a catalyst for the development of new risk-management products” beneficial to commercial hedgers. The NGFA’s membership encompasses all sectors of the industry, including country, terminal and export elevators; feed mills; cash grain and feed merchants; end users of grain and grain products, including processors, flour millers, and livestock and poultry integrators; commodity futures brokers and commission merchants; and allied industries, such as railroads, barge lines, banks, grain exchanges, insurance companies, computer software firms, and engineering and design/construct companies. In addition, the NGFA consists of 35 affiliated state and regional U.S. grain and feed associations, as well as two international affiliated associations. The NGFA also has strategic alliances with the Grain Elevator and Processing Society and Pet Food Institute, and is co-located and jointly operates with the North American Export Grain Association.
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