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Q&A: CME Group ag manager Tim Andriesen

Q: What is your role?

A: I’m responsible for the business part of the CME. In the clearinghouse, risk is managed between the counterparties and trades. And the front-end of that is the actual trading. Within the CME Group’s business lines, I’m responsible for the agricultural business line. THis involves understanding what the products are, what products we should offer, old products and making sure they remain pertinent, and managing this part of the business line.

Q: Is your background in Agriculture?

A: No. I grew up in eastcentral Illinois (Rantoul), in some of the best corn/bean ground in Champaign County, Illinois. Graduated from southern Illinois University and when I was looking for a job, I fell into the grain business. I spent 16 years trading cash grain with processors, coops, working with farmers. I then moved over to the financial world and was involved in the banking side trading over-the-counter products in both the U.S. and Australia. Four years ago, I joined the CME Group.

Q: What’s the history of futures contracts? Do they start as futures and become option products?

A: Options market makers have to hedge their risk. The primary risk is price risk. And to do that effectively, they need a futures market to lay that risk off into. So, it’s really difficult to have an options product without a futures contract. At the CME Group, we have deep and liquid futures markets. Because of that we can offer many different options contracts: Not just the standard options, but the short-dated new-crop options, weekly options, options on spreads for different months.

Q: Why are the short-dated new-crop options contracts so hot right now with farmers?

A: It fits a particular need for the producer. I’ve always been an advocate of producers using options. I love the idea that I can lock in a floor price or participate if the (corn, soybean, wheat) price goes up. If you think about producers, they are always optimistic thinking the price is going to go up. But, the realists say, “I gotta have some price protection.” The challenge with options is that you pay a premium for the option contract. And, depending upon the volatility of the market for how long that option exists, that really drives the premium that you pay. However, with short-dated new-crop options, they are options on the December futures, November soybean futures, and July wheat futures contracts only. So, instead of buying an option contract from the time it is listed until it expires in November, for soybeans, a farmer can opt for a short-dated contract. Another example, if a farmer is worried about the crop getting in. He/she only needs to buy an option that will expire in June vs. having to buy a full-dated option that wouldn’t expire until November. If the crop gets planted, but the farmer wants more price protection for a few more months, he/she then can buy another short-dated option for a few months out. THese contracts are popular because it gives the producer more control of what he/she is spending in options premium and more flexibility to what he wants to do with marketing crops.

Q: How do you come up with agricultural trading products?

A: Usually it’s a phone call. Somebody calls us up with an idea. We’ll listen to the idea. If it makes sense, we will vet it with more people in the marketplace, whether it’s producers, commercials or market-makers (people that are going to provide liquidity), and that is very important. You want to have participation from producers and end-users, but you also have to have liquidity in the middle. The new product has to be something that we think has good demand across the marketplace. Once we do that, we put together what the framework of the new contract might look like, show it to a few more user groups and then start a launch.

Q: How do you fit a contract that will be proper size for farmers to use vs. commercials?

A: Right now, full-sized contracts for the major grains are 5,000 bushels, and mini-contracts are 1,000 bushels. A mini-contract is the size of an exceedingly loaded semi-tractor trailer. The goal is to find the right balance of a contract size that makes sense with the commercial market and where we think there will be more of a commercial trade around a product, we’ll have a bigger contract. In the case of trying to attract producers, we will have a smaller contract.

Q: How well do you think the failures of MFGlobal and Peregrine Financial Group were handled for the farmers and other that hedged through them?

A: It was disturbing for us, because it was an event that was unprecedented in the history of the Exchange. It took time to get to the point where people were getting a significant amount of their money back, about 99% of it right now. So, the payback process has worked. Our goal was to try to make sure that the payback happened and happened as quickly as possible. Hence, we put together $550 million worth of guarantees to the bankruptcy trustee. If he overpaid, the CME Group would be there to back up that overpayment. What’s more important is looking at the changes that have been made, going forward. We have a better understanding of the money moving around, on behalf of the FCM. Rules have been put in place to where more transparency helps show where money is invested. And there are controls in place, in the event that the FCM wants to move money out of the segregated account pool.

Q: The consensus is that once the CME Group figured out how to trade options on the electronic platform, the actual trading floor would not be needed. What is your perspective on that line of thinking?

A: People have been predicting the demise of the floor for a long time. But, if you go down on our trading floor, you’ll find standing room only for the options pits. Certainly, there is an increasing amount of trade electronically. And what we see is when anyone wants to do any trade with any complexity, whether it’s with new products or any combination trades, the floor is still meeting a significant need for customers. I will tell you that the short-dated new-crop options are trading almost exclusively on the floor. So, we feel it is still a really important marketplace for us. The liquidity and service the floor traders provide is very very important.

Q: Local cash prices have diverged more and more instead of converged with futures prices. What is the CME Group doing to address this issue?

A: Convergence is about the futures and cash markets at the delivery location. If you look at the last several years, there is a strong track record that convergence has been occurring. Unless you have delivery everywhere, you can’t look at what the price of corn is in Grand Island, Nebraska, and say that it should converge with the (Chicago) futures price. It’s simply not going to because there are transportation costs and logistics costs for getting corn from Grand Island to the Illinois River. Convergence is important for us because convergence assures the processor or user can take delivery and use the grain, or the tributary locations can deliver those grains. But, in terms of convergence and looking beyond that geographic constraint, if you have to remember that there are other factors that really impact that.

Q: Hog futures have a cash settlement system. Wouldn’t the CME Group be better served to go to a cash settlement against a national cash average price of corn, similar to the Cash Index for hog futures?

A: The challenge for markets that are set to an Index is to have a cash index. So, you need to have a cash price at a given location that is not manipulatable and that everyone believes. That is a bit of a challenge. There probably isn’t one location in the United States where you have that today. Even the most liquid markets are driven by one or two market participants. So, everyone likes the idea of saying that if we cash settle we won’t have these issues. But the reality is that you have a different set of issues when you cash settle things. In the case of some markets, you have government mandatory price reporting. So, you are pretty sure that you are capturing a lot of different prices, from a lot of locations, from a lot of different market participants. In those cases, they are good prices because the government is auditing those locations to make sure they are good prices. The other thing I would point out is that when you have a delivery market, people can deliver and take part in the process. It is very transparent to look at the economics. So, our view is that physically delivered contracts, creating convergence, are still probably the best approach.

Q:

A: 20 years ago, delivery locations were only available in Chicago and Toledo, Ohio. There was no delivery beyond those markets. Now, delivery points have expanded to the Illinois River. If you think about what can be pulled into the Illinois River, that is a significantly greater delivery area than what there was 20 years ago. Our goal is to make sure that our contract is a benchmark risk management product that reflects prices domestically and globally. But, in terms of doing that, there is no way that we can take all of the basis risk out of the market. If you look at the ag markets, they are very predictable in terms of basis. People understand this idea of basis. If you look at other commodity markets, people don’t understand the concept of basis.

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