SPEECHES & TESTIMONY

Remarks of Commissioner Dan M. Berkovitz before the National Cattlemen’s Beef Association, Denver, Colorado

Improving Price Discovery for Commercial Hedging

July 31, 2019

 

Thank you for that kind introduction.  I also want to thank Darryl Blakey and the National Cattlemen’s Beef Association (NCBA) for arranging this opportunity to speak to you and to visit beef production facilities here in Colorado.

 

Coming from Washington, I have to mention some fine print.  My remarks here today are my own views and are not the views of the Commodity Futures Trading Commission (CFTC), its staff, or any other Commissioner.

 

I would like to explain my interest in being here today and then I’ll talk about some issues that this Committee has been interested in.

 

Futures and options are important hedging and price discovery tools for cattlemen and others in the beef industry.  One of the fundamental purposes of the CFTC is to ensure that trading in futures and options contracts for commodities such as cattle is fair, efficient, and effective for commercial end users.  I take this responsibility very seriously. It is the reason that our agency exists.  All of us at the CFTC must continuously work to help ensure that the futures and options markets for cattle and other commodities provide an effective means for ranchers, farmers, and other end users to manage risks and discover prices.

 

I grew up in Indiana and ever since I went away to college I’ve been going back home regularly to visit my family and friends there.  If there is one thing I have learned in the time I’ve lived in Washington, it’s that it’s important to get out of Washington to see what’s going on and listen to what people in the rest of the country are saying.  That’s why I’m here today.  I’m here to talk to you and other people who use our commodity markets and learn about what’s working and what isn’t.  Only by talking with you and seeing your operations in person can I better understand how the futures markets can best serve America’s ranchers and farmers.

 

I am in the middle of several visits to some of America’s agricultural centers.  Last week, I was in Arkansas visiting poultry feed mills and farms, rice mills, and soybean growers.  I heard about many of the challenges Arkansas farmers are facing this year, from torrential rainfalls and record flooding to trade issues.  I saw firsthand the resilience and ingenuity of our farmers facing these challenges.

 

Next week I travel to Minnesota to visit dairy co-ops, grain elevators, and processors of a range of agricultural commodities.  I’ll also sit down with farmers and agriculture businesses at an annual agriculture trade show called Farmfest.

 

These trips are part of a constant learning process.  In April, I participated in our Agricultural Advisory Committee meeting and our second Agricultural Commodity Futures Conference in Kansas City.  More recently, I sat down several times with our staff economists to review agricultural market developments in the weeks leading up to my trips.

A common theme that emerges is the importance of futures contract design and trading rules.  Price limits, contract size, product specifications, grading, delivery locations, and–most importantly for live cattle–the delivery process, all are critical features of a futures contract that determine whether it works as an efficient and effective tool for hedging.

The live and feeder cattle markets pose unique challenges for standardizing futures contracts and exchange trading.  There is a significant diversity in the production practices across the country and cattle need to be shipped live.  These features make it more difficult to determine how cattle futures contracts can be standardized in contrast to more homogeneous commodities such as grains and metals.  There have been tremendous improvements in genetics and production practices that have led to better and more consistent output, so self-regulation of livestock markets is an on-going process, but a vitally important one for your industry.

For the Live Cattle and Feeder Cattle contracts, it is critical that CME get input from cattlemen on contract terms.  Only with your input can the exchange and the CFTC better ensure that the contracts reflect the cash market and encourage fair and liquid trading with convergence. 

It is my understanding that CME has been working with NCBA, with assistance from the CFTC, to implement a number of changes to the cattle contracts over the past several years.  I was pleased to hear that CFTC staff engaged with you and CME to help facilitate market-based improvements to price limits, delivery times, grading, and other requirements for CME-approved livestock yards.  I am told that the Live Cattle Marketing Committee views CME’s expandable daily price limits for cattle contracts as having “a positive effect on the markets’ ability to trade efficiently during times of increased volatility.”[1]  I look forward to more positive collaborations between producers, exchanges, and the CFTC to improve trading and resolve legitimate concerns among market participants.

Work to improve the futures contracts continues.  I applaud your efforts in ensuring that there is an adequate supply of well-trained USDA graders for deliveries.  I understand that dynamic specifications for quality and weight are under consideration and further work to provide efficient delivery points can be explored.  To the extent the CFTC can support this effort, I encourage the NCBA to engage with us.  The CFTC’s role is not to dictate contract terms but to engage with all parties to understand where the areas of concern are and facilitate contract design that serves the livestock industry consistent with our statutory mandate from Congress.  

I’d like to touch on a couple of issues for which the CFTC plays a more direct role.  First, clearing services are becoming more concentrated.  CFTC data shows that the number of registered FCMs that actively clear futures and options for customers has fallen from 90 in 2007, before the financial crisis, to about 55 firms today.  Many of the former FCMs were the smaller firms that tended to service commercial hedgers. 

Futures and options customer clearing is also concentrated in FCMs affiliated with the largest banks in the country.  The ten largest FCMs—all but one of which are affiliated with large banks—hold about 75 percent of all required customer margin.[2]  Concentration of clearing services is even greater in the swaps markets where five large bank FCMs clear 80 percent of the notional amount of swaps. 

The changes in the make-up of FCMs mean fewer available FCMs and larger FCMs.  The larger FCMs have substantial fixed costs and so prefer large traders who trade in volume and generate more fees.  Commercial hedgers generally trade only when hedging or covering and so engage in fewer trades than speculators and high frequency traders.  This adds up to fewer clearing services options for commercial hedgers.

A second concern is systemic risk.  Due to the current capital requirements, bank FCMs have limited ability to take on additional clearing clients.  In this capital-constrained environment, the sudden loss of a single large FCM could be disruptive to markets if its clients’ positions cannot be ported smoothly to other FCMs and the positions are liquidated in bulk.[3]

The on-going availability of clearing services for the agricultural sector and systemic risk go to the heart of your ability to access the markets efficiently and effectively.  These are concerns I think we all share.

There are no simple fixes to reverse this trend.  A number of factors have contributed, including low interest rates, cross-border competition, capital demands, and the cost of new technology.  I have supported revisions to bank capital requirements so that capital does not have to be set aside to cover customer margin funds.  This change will increase clearing capacity at bank FCMs.  Hopefully, more banks will expand clearing services as this change gets implemented.  However, changing capital requirements alone will not solve the clearing capacity problem so I think this is an issue we must continue to address.  Many of the factors that have contributed to this problem are outside the control of the CFTC, but we must do what we can to increase the capacity and diversity of clearing services.

Turning to the issue of confidence in the markets, your Committee included a number of resolutions in NCBA’s 2019 Policy Book regarding transparency, monitoring markets for manipulative behavior, preventing spoofing, quote stuffing, and layering, and generally “foster[ing] an environment that builds confidence in the ability of the hedging community to effectively manage forward price risk . . .”[4]  I support these goals.  While CME is the front line market monitor and data provider, the CFTC plays a significant role in market surveillance and provides a strong deterrent against wrongful conduct through our enforcement actions.

The CFTC’s aggressive enforcement activities against spoofing demonstrate our commitment to policing trading in these markets.  The CFTC has litigated or settled 27 spoofing cases since receiving spoofing enforcement authority in 2011 and more spoofing cases are progressing as I speak. In my prior position as General Counsel at the CFTC I was part of the CFTC team that worked with the Congress to develop the prohibition on spoofing.  It is particularly gratifying for me to see that this provision has been very useful in prosecuting abusive trading in our markets.

In conclusion, I want to emphasize my commitment to making sure the futures markets serve ranchers, farmers, and other commercial firms that use these markets to manage risk.  I support and will encourage engagement by the CFTC with cattlemen, beef processors, CME, and other market participants to help improve hedging and price discovery for commercial operators.

Thank you for taking the time to listen and I look forward to talking with you more in the future.

Thank you.

 

[1] National Cattlemen’s Beef Association, 2019 Policy Book (Updated: January 2019), at 97.

[2] CFTC data available at https://www.cftc.gov/MarketReports/financialfcmdata/index.htm.  The sole non-bank is ADM Investor Services Inc.

[3] The Financial Stability Board has warned that “concentration in clearing service provision could amplify the consequences of the failure or withdrawal of a major provider.  In particular, concerns have been expressed about the ability to port client positions and collateral in this situation.”  Financial Stability Board, Incentives to centrally clear over-the-counter (OTC) derivatives: A post-implementation evaluation of the effects of the G20 financial regulatory reforms—final report at 3 (Nov. 19, 2018), http://www.fsb.org/wp-content/uploads/R191118-1-1.pdf.

[4] National Cattlemen’s Beef Association, 2019 Policy Book (Updated: January 2019), at 99.