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NGFA asks CFTC for help in reshaping wheat contract

10/06/2008 @ 9:12am

The National Grain and Feed Association (NGFA) recently called the CME Group's proposed changes to its CBOT wheat futures contract a "good first step," but said additional actions are needed "on an expedited basis" to restore the contract's utility as a pricing and risk-management tool for commercial hedgers.

In a statement to the Commodity Futures Trading Commission (CFTC), the NGFA said the CBOT wheat futures contract's performance has deteriorated, its integrity and functionality has declined, and "it may be at risk of failure if current trends continue."

The NGFA continued to express a "sense of urgency" in urging that a more comprehensive approach be taken to enhance the convergence - or narrowing - between futures and cash market prices for the CBOT wheat futures contract during the delivery period. While not opposing the CFTC's proposed changes - which it said "could help enhance convergence somewhat" - the NGFA said they should be viewed as "interim improvements," and that additional changes were needed to "reestablish the relationship between cash and futures to achieve convergence."

The NGFA said one such additional action to enhance convergence may be to create "demand certificates" that would allow the maker of delivery to compel load out of the underlying commodity -in this case, wheat - to satisfy futures contract obligations. "We are not recommending the adoption of demand certificates today," the NGFA said, noting that additional analysis was needed on how such demand certificates should be structured and implemented. But the NGFA said its own task force, established in September, is meeting to further refine the demand-certificate concept, with recommendations expected to be submitted to the CME Group and CFTC within 30 days.

The NGFA's statement was submitted in response to the CFTC's request for comments on the CME Group's proposed changes to its wheat futures contract. The NGFA said it did not oppose the CME Group proposals, which involve establishing seasonal storage rates at grain elevators designated as delivery locations for CBOT wheat futures contracts; expanding the number of grain elevator delivery locations for CBOT wheat at market-based differentials; and setting tighter limits on deoxynivalenol (vomitoxin) in wheat eligible for delivery to satisfy outstanding futures contracts. The NGFA said it may be appropriate to analyze whether to apply similar seasonal storage rates to other CBOT grains and oilseed futures contracts at some point in the future.

But ultimately, the NGFA said, the growing influence of investment capital in CBOT futures markets - compared to commercial participants that use futures to offset price risk in the underlying commodity - may well necessitate the creation of a new futures contract structure at the CME Group. In that regard, the NGFA again called on the CME Group to expedite research on designing new alternatives to the current CBOT wheat futures contract, such as a new world wheat index contract, a U.S. wheat index contract comprised of all wheat classes, or some other index product. Such an index contract could be used by investment funds wanting to buy wheat futures contracts as part of an investment portfolio, potentially operating side-by-side with the current CBOT wheat contract used by traditional hedgers.

"Currently, the CBOT wheat futures contract is trying to meet the needs of separate and distinct groups of market participants - which have very different needs - within one contract structure and one regulatory scheme," the NGFA said. "We do not believe this structure is working."

The NGFA cited the "disproportionate" participation of investment capital as the "primary factor" in the declining performance of the CBOT wheat futures contract. The NGFA noted that "Index" investors, as defined in the CFTC's Commitments of Traders report, now control about 60 percent of CBOT wheat futures contract open interest (futures contract positions that are not liquidated by an offsetting transaction or fulfilled by delivery) - a share that represents about 1.5 times the size of the entire U.S. soft wheat crop. "The disproportionate participation of investment capital relative to total participation (in CBOT wheat futures) has been the primary factor leading to deterioration in (the contract's) performance," the NGFA said, noting that commercial participation in the CBOT wheat futures contract has declined as a result.

The NGFA on numerous occasions over the past year has cited the infusion into agricultural commodity futures markets of large amounts of investment capital that typically takes "long-only" positions unrelated to supply/demand fundamentals as a major contributor to futures price volatility and market disruption. Those taking "long" futures market positions purchase futures or options contracts, but do not offset those purchases with a cash market position in the underlying commodity.

The NGFA's statement to the CFTC also noted that wheat futures contracts offered by the Kansas City Board of Trade and Minneapolis Grain Exchange have not experienced the same problems with convergence that have plagued the CBOT wheat futures contract, in large part because of much smaller participation by investment capital relative to traditional commercial users.

The National Grain and Feed Association (NGFA) recently called the CME Group's proposed changes to its CBOT wheat futures contract a "good first step," but said additional actions are needed "on an expedited basis" to restore the contract's utility as a pricing and risk-management tool for commercial hedgers.