As is the case with most of the key players on your business team, the wrong choice when hiring a commodity broker can lead to serious losses. It is all too easy to fall out of hedging and into speculating under the influence of a broker who is looking after his own business, not yours. On the flip side, the right broker can be just as valuable a member of your team as your accountant or crop consultant.
"Your first step should be to define the role your broker will play,” says Jim Kendrick, University of Nebraska ag economics professor emeritus. "If you are already informed about the markets and confident about trading futures and options, you can benefit from Internet-based trading or a discount broker,” he says. "If, on the other hand, you are not comfortable with the terminology or technology involved in placing orders and are looking for a broker who will keep an eye on your positions for you or who will supply outlook and analysis, you may wish to hire one who specializes in ag contracts and is backed up by a full-service firm that has a good research arm.”
In finding a broker, word of mouth is a great place to start. Ask neighbors you respect who they work with. Bankers also may be familiar with brokers their customers use, and they are often the first to know if problems arise.
Even farmers you connect with at out-of-town meetings may be a good source of referrals; in today's wired world, your broker doesn't have to be in your town. Knowing that a broker is working with farmers who are happy with his or her service is a big step in the right direction.
Another way to find a broker who knows farmers and how they think is to use one who is part of an ag marketing advisory service, says Carl German, Extension grain marketing specialist at the University of Delaware. "There may be trade-offs, such as possibly higher costs—you may have to subscribe to the advisory service and may have slightly higher commissions if it is a small firm that clears through a larger firm,” he says. "The broker may also be very tied into the advice the company is giving, and you may feel some pressure to follow the firm's advice. That can be good or bad, depending on your capability or need for outside discipline.”
A third approach is to choose a brokerage company first. "The Chicago Mercantile Exchange has an online directory of hundreds of brokerage firms,” Kendrick says. "The National Futures Association has a search function that lets you look up firms or individuals to see whether there are any regulatory actions against them.
"In general, firms that are members of the exchange and have brokers on the trading floor must provide evidence of financial solvency,” he adds. "Those without members have to execute trades through a member firm. A lot of research about companies can be done online, but don't be afraid to ask a firm for its financial records. It is also fine to ask for customers to contact as references.”
The most important step is interviewing the individual you are considering, Kendrick says. "Get a feel for how often he thinks a hedger will be in and out of the market, whether he understands risk management versus speculating and whether he speaks your language or hard-to-follow jargon,” he suggests. "You want a partner in risk management, not a salesman who wants you to ‘trust me' or try ‘almost guaranteed' strategies.”
Kendrick recommends that you develop an example hedge before talking and see whether prospective brokers' answers match your own.
Finally, ask how long they have been in the business, what training they have and where they got it and how many clients they service.
Communication is the No. 1 factor in achieving a successful relationship with your broker, says Bryan Doherty, a broker with the Stewart-Peterson Group. "You both need clear expectations. You need to be able to identify your needs and goals and communicate them to your broker.
"Your broker needs to be able to communicate the different alternatives available to you to achieve those goals. That includes how they work, their risk and cost,” he says.
"Your broker's role should be to help you develop a successful pricing strategy no matter what prices do, not attempt to outguess the market.”
Minimum commissions are set by the exchange, but commissions can substantially vary among firms and sometimes are negotiable. Some firms charge a fee to open or maintain an account. Ask what the firm's policy is on mistakes, whether phone conversations are taped, how trades are confirmed and how often financial statements are sent out or whether you access your account information electronically.
Be Fair to Your Broker
Keep in mind that a broker's expertise should be in taking and filling orders. Although he may have a research department behind him, no one has a crystal ball. "Also keep in mind that hedgers don't trade in and out a lot, so they don't generate a lot of commission for the broker,” says Nebraska economist Jim Kendrick. "Don't tie up the phone with a lot of calls that don't have to do with placing an order.”
Top Producer, Spring 2010