There has been quite a bit of commentary recently about the Dodd-Frank Financial Regulatory Act. There are provisions that are important to you as an agricultural producer and marketer.
Our agricultural futures markets are regulated markets. That means that they meet the requirements of the Commodity Exchange Act [the Act] as administered by the Commodity Futures Trading Commission (CFTC). The federal purpose in approving and regulating these markets is to augment the flow of the physical commodity in interstate commerce. It has always been recognized that to augment that flow there needs to be a balance between the volume of hedge positions and speculative positions in a regulated futures market. These two concepts are clearly enumerated in the Act.
The classic method to determine if speculation is excessive is by comparing the price relationship between the cash market price and the futures market. Do they converge during delivery, and between delivery periods do they stay within a historically normal relationship? If yes, things are OK. If not, they are out of balance.
Some limits must be placed on the size of speculative positions because the volume of true hedges that can be placed at any one time is limited by the volume of the physical supply, which declines incrementally after harvest.
The volume of speculative positions is naturally limited only by the willingness of speculators to commit their money to the market. Thus, the exchanges and the CFTC had historically placed limits on the size of positions that a speculator could hold in a regulated futures market, and had strictly adhered to traditional definitions of a speculator. This was in order to maintain the balance between hedgers and speculators.
In the last few years, this balance has been upset by actions of the exchanges’ management and by the CFTC. Most exchanges now are for- profit businesses, and thus increasing volume, which increases revenue, has become more important to them than maintaining the balance. Thus, they have sought to increase speculative limits and have defined trades that traditionally were considered speculative as hedges, and thus without limits. The CFTC has approved these changes.
The two main redefinitions were swap dealers and index funds. A swap dealer is someone who enters into an off-exchange contract with a counter party for a fee, which in some cases is a mirror image of the futures contract. Speculators use swaps to increase their position once they have reached the spec limit allowed by the exchange. However, if the swap dealer executes a futures or option contract counter to his position in the swap contract with a speculator, the exchange management and the CFTC call him a hedger, with thus no spec limit. This trading has the same effect on the futures or options price as if the speculator had exceeded his position himself in the futures or options market.
Producers are affected by all this because it affects the basis they are offered on forward crop contracts. The less confidence that the merchants have that the cash and futures markets will trade in their traditional price relationships, the less quantity they are willing to purchase on a forward crop contract at a reasonable basis, and the less quantity they are willing to purchase and carry in inventory at a reasonable basis. You have skin in the game.
Dodd-Frank tries to correct this by legislatively defining a hedger as someone who takes title to the physical commodity in the normal course of their business, but it grants to the CFTC the power to grant exemptions to this. The size of the exemptions granted, and to whom, will determine if the necessary balance between hedgers and speculators is re-established.
– Woods Eastland, Greenwood, Miss.
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