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Index traders need tighter limits, Senate investigation says

Agriculture.com Staff 02/08/2016 @ 12:56pm

For more than a year you've known about problems of convergence in the futures markets, especially wheat contracts on the Chicago Mercantile Exchange. Last year cash prices and the value of futures were far apart as contracts expired, making grain buyers already suffering from expensive margin calls even more reluctant to forward price grain.

Wednesday, the Senate's Permanent Committee on Investigations released a bipartisan report, Excessive Speculation in the Wheat Markets, that puts a big chunk of the blame on index traders. The report calls for ending waivers on trading limits that the Commodity Futures Trading Commission has granted in recent years to large index traders.

The traders sell financial instruments that are tied to commodity indexes that include wheat. Their buyers are hedge funds, pension funds and other institutions that have no intention of ever selling or owning wheat. To offset their own risk, the traders buy wheat futures contracts, among others.

In recent years this has had a dramatic effect on CBOT wheat futures contracts, the report says.

"…purchases by index traders in the largest wheat futures market, the Chicago Mercantile Exchange, grew sevenfold from about 30,0000 daily outstanding contracts in early 2004, to a peak of about 220,000 contracts in mid-2008, before dropping off at year's end to about 150,000 contracts," the report says. "The data shows that, during the period from 2006 through 208, index traders held between 35 and 50% of the outstanding wheat contracts (open long interest) on the Chicago exchange and between 20 and 30% of the outstanding wheat contracts on the smaller Kansas City Board of Trade."

Index traders have a greater presence in the Chicago exchange compared to the other two U.S. wheat exchanges and more than in other grain markets, the investigation found. And no other grain market "has experienced the same degree of breakdown in the relationship between the futures and cash markets as has occurred in the Chicago wheat market."

Normally, the CFTC limits speculators who aren’t true hedgers from holding more than 6,500 wheat futures contracts at one time. But in recent years it has waived trading limits, allowing a few swap dealers to hold as much as 53,000 wheat futures contracts. The Senate committee report recommends a phase out of those waivers and enforceing the 6,500 contract limit again.

Early reaction to the report Wednesday was favorable.

"This report confirms what National Farmers Union has been saying for some time, excessive speculation led to the commodity price bubble," National Farmers Union president, Roger Johnson, said in a statement. "Unfortunately, as speculators created this market bubble, many farmers ended up locking in higher input and feed costs. Now, following the market collapse, farmers and ranchers are struggling to pay these higher costs and rural communities, in turn, are feeling the pinch. The report makes four recommendations that NFU whole-heartedly endorses. Phasing out existing wheat waivers for index traders, taking further action, analyzing other agricultural commodities and strengthening data collection for non-agricultural commodities are good steps and should be taken under consideration by the CFTC."

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