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CFTC Changes On Tap

January 12, 2011
By: Guest Editor, Top Producer

Some of the potential regulatory changes being tossed around by the Commodity Futures Trading Commission (CFTC) could affect producers. Stakeholders in the agribusiness industry will also have to deal with the changes, so they’re submitting comment letters to ensure their voices are heard. The changes, which stem from the Dodd-Frank Act, deal with risk management tools as well as the cost and complexity of traditional hedging.

The increased reporting burden and the move to clear over-the-counter (OTC) derivatives through regulated exchanges could affect grain hedgers, which would have a trickle-down effect on producers.

“The vast majority of hedging in the agricultural commodities space is done on exchanges already, so the impact is likely to be quite modest,” says Paul Forrester, partner at law firm Mayer Brown.

Co-ops Need Swaps. There is a small but significant portion of agribusinesses that use OTC swaps in their risk management or to back up products they offer to farmers. OTC swaps are essential for elevators to offset risk on price guarantees offered to producers for future deliveries. Local co-ops enter into swap agreements with their cooperative. Cooperatives use OTC swaps to customize hedges in order to better manage exposure and volatility, according to Charles Conner, president and CEO of the National Council of Farmer Cooperatives.

OTC Swaps diagram

“In addition, swaps give cooperatives the ability to offer customized products to producers to help them better manage their risk and returns,” Conner says.

One rulemaking that will likely have a spillover effect on producers is the requirement that the CFTC set speculative position limits for all commodities. Traditional ag commodities have had spec limits in place for many years.

“Under the current spec limits the process works pretty well and we think producers and agribusiness companies have had a fair amount of input on the issue,” says Todd Kemp, director of marketing and treasurer of the National Grain and Feed Association.

However, CFTC may change the spec limits and establish an aggregate position limit that would include both OTC and exchange traded products. “We are concerned about whether that is the appropriate approach, particularly for enumerated ag commodities,” Kemp says. “We don’t know where that would be set and whether that would open the door for more speculative investment money coming into the ag market.”

This could affect the convergence of cash and futures values—which happened in 2008 when the rise in nontraditional investors in the ag commodities market caused spikes in futures prices and increased risks for grain hedgers and purchasers.

The broader impact of diverging spot and futures pricing is that it may curtail the marketing opportunities grain hedgers are able to offer back to producers and impact the margin they are operating under, which would impact producer bids.

Swap Definitions. Another big concern is swap definitions. Under the Dodd-Frank Act, the term “swap” encompasses a range of products that are generally not considered swaps (such as price guarantees provided by elevators to producers for future deliveries), which could curtail the ability of market participants to enter into such arrangements. Plus, increased regulatory scrutiny and reporting required under Dodd-Frank will increase the cost and complexity of certain swaps.

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FEATURED IN: Top Producer - January 2011

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