CFTC Changes On Tap

January 12, 2011 08:00 AM

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.

“One of the potential benefits is that the law brings oversight to an unregulated market,” notes Michael Adjemian, who works in the Market and Trade Economics Division of the USDA’s Economic Research Service. “They have established CFTC as the single regulator for OTC commodity swaps. But one potential cost is that the increased reporting and record keeping may be more expensive for certain swaps, especially at first as those requirements come online.”

CFTC ag swaps proceedings are in the preliminary stage. The commission is reviewing the comments provided by the agribusiness industry and evaluating the responses against the Dodd-Frank Act regulatory requirements.

Once a set of proposed rules are issued, the industry will start the lobbying process. Until that time, producers and other stakeholders are in a holding pattern, waiting to see how CFTC interprets it all.

Key Concepts

> The Dodd–Frank Wall Street Reform and Consumer Protection Act is a federal statute signed into law in July 2010. The act provides sweeping changes to financial regulation—the biggest changes enacted since the Great Depression. It affects all federal financial regulatory agencies and touches on most sectors within the financial services industry.

> The Commodity Futures Trading Commission (CFTC) is a federal agency responsible for regulating the trading of futures and options contracts in the U.S. Its mandate is to protect market users and the public from fraud, manipulation and abusive practices related to the sale of commodity and financial futures and options, and to foster open, competitive and financially sound futures and option markets.

> Over-the-counter (OTC) derivatives are contracts that are privately negotiated and traded directly between two parties. They are not traded through an exchange and account for the greatest portion of outstanding global derivatives contracts. OTC derivatives and exchange-traded derivatives together make up the global derivatives market.

Top Producer, January 2011

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