CFTC Should Include Agricultural Markets

The National Grain and Feed Association believes it would be a "critical mistake" for the Commodity Futures Trading Commission to exclude agricultural markets from its proposed new regulatory framework that is designed to provide a reduced level of regulation of futures markets. The views were expressed Wednesday before the CFTC Agricultural Advisory Committee by NGFA President Kendell W. Keith.

"We commend the CFTC on this market-responsive regulatory initiative that gives the regulated community the right to make choices on the preferred levels of regulation from a business perspective," Keith said. But he said that granting regulatory relief to "virtually the entire futures and options industry," except for agricultural commodities such as grains, oilseeds, grain byproducts and livestock, could undermine the use of futures and options as risk-management tools in agriculture.

The NGFA is an association of about 1,000 grain, feed, processing and grain-related firms comprising 5,000 facilities that handle more than two-thirds of all U.S. grains and oilseeds.

Under the CFTC's proposal, issued on June 22, futures exchanges would be permitted to choose between the degree of regulation that is prudent for their markets, depending upon the product being traded and the sophistication of the customer. Specifically, exchanges would be authorized to established so-called "derivatives transaction facilities" to serve commercial clients under a lesser degree of regulation under CFTC oversight. But the CFTC regulatory reform proposal excludes enumerated agricultural commodities.

The CFTC's proposal emanated from recommendations issued in November 1999 by President Clinton's Working Group on Financial Markets which examined the regulation of over-the-counter derivatives markets. The working group, which consisted of Federal Reserve Board Chairman Alan Greenspan, Treasury Secretary Lawrence Summers, Securities and Exchange Commission Chairman Arthur Levitt and CFTC Chairman William Rainer, recommended changes to existing regulations to permit exchange-traded financial products to compete more effectively, as well as clarification to remove the legal uncertainty overhanging financial over-the-counter markets.

"Because (the President's Working Group) focused on financial markets, it made no specific recommendations on agricultural contracts," Keith noted. "However, the same market forces creating new competition for regulated financial markets are present in agricultural markets, and we believe they should be addressed simultaneously."

The NGFA said it plans to urge the CFTC to change its proposed regulations to grant futures exchanges the flexibility to also have agricultural contracts regulated as derivative transaction facilities. "We believe that with proper exchange self-regulation and CFTC oversight, agricultural markets can properly handle this new level of responsibility and the benefits would be broad," Keith said. He noted that futures market customers are protected most by the controls and financial strength of the exchanges and their clearing corporations.

Keith cautioned that excluding agricultural commodities from the CFTC's new regulatory approach could pose the following risks:

–Institutional investors, such as investment funds, likely would avoid agricultural futures markets if transaction costs remain at current levels while costs in financial and other futures markets decline because of the new regulatory framework. These investors are critically important to providing liquidity in agricultural futures markets, particularly in the deferred months (beyond one year) where a decline in liquidity could reduce the price bids and undermine the viability of multi-year agricultural futures contracts.

--Participation in regulated agricultural futures markets could decline as commercial commodity interests seek lower-cost alternatives to hedge products, including electronic exchanges, private contracting, agricultural swaps or vertical integration through joint ownership, joint ventures or contracting.

--Price transparency, which is an important protection for farmers and commercial firms in agriculture, could be threatened by a long-term decline in trading in central, open futures markets.

The NGFA also recommended that Congress and the CFTC consider ways to provide greater legal certainty concerning the regulatory treatment of off-exchange traded agricultural cash-forward contracts, noting that the President's Working Group had made a similar recommendation to clarify the regulatory status of over-the-counter financial instruments. The NGFA also noted that forward cash contracts that require delivery of the underlying commodity have been exempt from CFTC regulation under existing law and CFTC interpretation. However, uncertainty has arisen over the regulatory status of some cash-forward contracts that provide for more marketing flexibility.

It is "imperative" that such uncertainty be resolved, the NGFA, given the predominance and growing importance of cash contracting as the principal form of price risk management by producers. "Such legal uncertainty creates litigation risk for commercial companies and reduces the offering of risk-management tools available to farmers and others," the NGFA said. "This is a serious impediment to new product development."