Remarks of Commissioner Michael V. Dunn before the National Grain Trade Council’s Mid-Year Meeting

Kansas City, MO

September 8, 2006

Thank you, I am very happy to be here today. Your comments are very kind, I just wish I knew who you had me confused with.

It reminds me of a story I once heard.

A preacher dies, and when he gets to Heaven, he gets a beautiful crown from St. Peter, who welcomes him. Walking around later he sees a New York cab driver who has an unbelievable crown, absolutely huge, encrusted with jewels and gorgeous metalwork.

He goes back to St. Peter, and says "I don't get it. I devoted my whole life to the Lord and my congregation, yet that cabdriver has a bigger and better crown? What did I do wrong?

St. Peter says, “Well, we have a new compensation system here in heaven, we reward results. Let me ask you, did your congregation always pay attention when you gave a sermon?"

The preacher paused and admitted reluctantly, “Well, once in while a few people may have fallen asleep."

St. Peter nodded, "Right. And when people rode in this guy's taxi, they not only stayed awake, but they prayed nonstop!"

Well, on the Commission, I have tried to be a voice for agriculture, I appreciate the help and advice that many of you have given me in this endeavor.

I am gratified that last month I was reconfirmed for another five-year term on the Commission. I think we have made some good headway in reinvigorating the agricultural agenda, and I am really excited to be able to keep working on it.

I would like to specially thank Jula and the National Grain Trade Council for helping make the Commission’s Ag. Advisory Committee Meeting such a success. I thought Dan Brophy brought a lot to the discussion, and I really enjoyed hearing his and all the participants’ perspectives.

As that meeting showed, there is no shortage of changes and issues facing agricultural markets. One of the exciting things happening in the agricultural sector is the move of the agricultural exchanges to electronic side-by-side trading, and I’d like to give you a little update on that.

Although, I suppose it could not really be called a rapid change, the Chicago Board of Trade, Kansas City Board of Trade, and Minneapolis Grain Exchange’s recent adoption of electronic side-by-side trading for its grain complex marks a significant milestone in the volume of grain futures traded electronically.

It certainly appears to be quite popular. Currently, electronic trading comprises about 23% of the CBOTs volume for side-by-side contracts. That is higher than what the Minneapolis and Kansas City exchanges have experienced with their side-by-side trading, and electronic volume on the CBOT looks likes it may increase further; It will be very interesting to see what happens to electronic trading volume over the next few months.

Let me turn to what is going on at the CFTC now. We have several policy issues before us at the Commission. The comment period has closed on the Commission’s call for comments regarding changes to its Commitment of Trader Reports. We received more than 4500 comments regarding the reports, far and away a record number of comments for the Commission. Currently we are reviewing the comments and we will publish the changes we are going to make to the reports later this year. We plan to have those changes take effect on January 1st 2007. Unfortunately, because we are still reviewing the comments, it would be premature to comment on the changes that we are likely to make.

We have also received many comments regarding the Commission’s proposed guidance for Self-Regulatory Organizations, and many, in particular from the agricultural community. On this issue too, because we are still receiving and reviewing comments it would be premature to comment on any specifics, but I can assure you that your comments have been heard and will be considered as the Commission moves forward.

Globalization continues to be a challenge for the Commission and the industry. With global, electronic marketplaces, regulatory concerns become ever more complex. The question at the heart of this issue is how does the Commission meet its responsibility to the public trust to ensure that contract markets operating in the U.S. are fair and transparent—wherever those markets might be nominally located.

The history of the CEA in the U.S. has shown that in determining the level of regulation that is appropriate for a given contract market, two of the key factors are the susceptibility of that market to manipulation and the nature of the investors involved. Where a contract market involves a commodity with limited physical delivery which is open to the general public, the CFTC’s public duty and regulatory interest are at their zenith.

If the cash commodity involved is primarily a domestic commodity inextricably interwoven into the domestic political, physical, and economic fabric of the United States, an additional layer of complexity is presented. The Commodity Exchange Act provides an array of authorities and responsibilities to the Commission when it comes to protecting domestic commodity markets. These authorities and responsibilities are not necessarily or readily transferable to a foreign government.

For instance, the duty to ensure that prices for commodities in interstate commerce in the United States are not manipulated is not readily or, perhaps, practicably transferred to a foreign authority, no matter how competent that authority might be.

I do not know what the answer is, but the Commission has requested comments on the subject, and I look forward to discussing the issue further with my colleagues, including what the next steps might be.

The big issue for us in Congress is reauthorization. As you know, the Commission is still awaiting completion of its reauthorization bill. A reauthorization bill has passed the House and we are still waiting on the Senate to take up the bill that passed out of the Senate Agriculture Committee. Major amendments likely to be considered address regulation of over-the-counter energy products and the retail sale of foreign-exchange or Forex contracts.

Given the critical nature of energy as a commodity, recent high prices and scandals affecting the energy sector have brought renewed attention to energy markets. Due to the complexity of these markets, there are no easy answers. I think our central mission should be to make sure that energy markets are as transparent and resistant to manipulation and fraud as possible.

One of the biggest questions the public has is why are energy prices so high? Well, we all know it is a tough question to answer definitively why the price of a market is what it is. Breaking down the fundamentals of a market is as much art as science. One person’s market fundamentals may be another’s speculative excess.

One of the purposes of having a market is, of course, price discovery. Barring some kind of squeeze, corner, or other manipulation, it probably is not possible to say whether a price is too high. You or I might have an opinion on that, but there really is no other objective price to compare too.

While I think it would be valuable for the Commission to formally study what, if any, effect the large influx of speculative money has had on trends in commodity markets, it would be quite difficult, if not impossible, to define at what point an influx of open interest, for instance from index funds, created conditions that led to “unreasonable fluctuations” or “unwarranted changes” in price. The Commission is not in a position to pick among different economic uses of a particular futures contract and decide which are to be discouraged or encouraged.

I think the key thing is to make sure there is sufficient openness and transparency so the Commission or someone can make sure a market is functioning fairly and efficiently. The Commission does that for energy markets traded on a designated contract market. Through our commitment of trader reports we can even pass some of that information back to the public.

However, a large portion of energy trading occurs in the over-the-counter market, mostly beyond the scrutiny of any federal agency. The Commission’s enforcement actions continue to uncover repeated examples of people and companies trying to game the energy markets, often in the belief that no one is watching, or that if someone is, there is nothing that can be done to them.

Most of the energy cases we file affect narrow segments of the industry, and each one individually probably does not have a large impact on consumers overall. However, each of these cases calls into question the integrity of the energy markets they involve, and as Enron showed, there can be large consequences for consumers in the biggest cases. At the end of the day, the Federal Government simply needs to get a decent handle on exactly what the extent of the problem may be. Unfortunately that task too easily falls through the cracks in the regulatory framework for energy.

I think it is a good idea for Congress to consider whether the integrity and transparency of energy commodity markets face any challenges. Certainly those markets have changed a great deal since deregulation began in the 1990s. Because the CFTC is barred from regulating the OTC energy markets, it cannot collect large trader data from unregulated energy markets, or conducting regular surveillance of them. It is virtually impossible to know, therefore, the extent of fraud and manipulation that may be occurring in the over-the-counter markets.

The nature of the OTC markets is such that it would not be feasible or useful to require surveillance of the entire OTC market. However, I think it is important that Congress consider whether there should be increased surveillance of key OTC markets that fulfill a price discovery function. It is these markets where we have seen most of our energy-related enforcement cases arise from, and that are most likely to affect consumers when there are problems.

Another issue that will be addressed in reauthorization is fixing the so-called Zelener loophole. That loophole follows from a case, CFTC v. Zelener, in which the 7th Circuit Court of Appeals found the CFTC had no jurisdiction over retail forex contracts known as “rolling spots”. These contracts, on their face, are written as spot contracts. However, in practice, delivery never occurs, and they are rolled over into a new contract as they expire. The logic of the 7th Circuit has been adopted by courts in Ohio and Florida (the 6th and 11th Circuits respectively), and will very likely spread to others. There is nothing about the “rolling spot” contract that limits itself to foreign exchange. These contracts could very easily be used in other commodities. The current language of both the House and Senate reauthorization bills would only fix the Zelener problem for Forex.

Given the ingenuity of criminals committing commodities fraud that I have seen during my tenure, I think it is better to close doors that might lead to trouble as soon as possible, rather than waiting to see who comes in. As the Zelener loophole becomes adopted by more and more courts, I become more and more worried about closing that loophole only for forex. I think it paints a bullseye for where criminals will go next.

Both of these issues will be discussed during reauthorization, and I think the debate will be helpful in making sure we maintain a balance between fostering innovation and competition in the industry, and making sure that the public is protected, as best we can, against fraud and deceit.

I’d like to turn now to future plans for the Agriculture Advisory Committee. There are a lot of exciting issues to dig into. The globalization of commodity markets could clearly have an impact upon agricultural commodity markets. If, for instance, the liquidity for one of our major grain exchanges were to shift to an overseas market, what would the consequences of that be? Are there changes that need to be made to ensure that U.S. exchanges are on a level regulatory playing field with foreign exchanges?

These are all questions that I would like to address within the context of the Agricultural Advisory Committee.

Other issues that I would like to cover in upcoming meetings are reviewing the impact speculative limits increase of last year, hedge to arrive contracts, and agricultural trade options. I would also like to look at some emerging markets that could have impacts for the agricultural world such as the ethanol and carbon markets.

Lastly, I would like to consider whether the Commission needs to update its regulations for granting hedge exemptions for non-traditional hedgers. Recently, I have objected to the granting of no-action relief to two firms seeking relief from the Commission’s speculative position limits. While I do not necessarily disagree with granting such relief, I believe those types of policy decisions should be made by the Commission through a public process to amend its rules, not ad-hoc staff letters to the industry.

I have concerns about the use of no-action process generally, but, in addition, the area of speculative position limits in agricultural commodities is one of keen interest for the users of agricultural markets. In 2005, the Commission considered revising or doing away with speculative position limits for agricultural commodities. In the face of concern from agricultural producers, the Commission ultimately decided to retain the limits, but did implement significant increases. I hope that we can undertake a similar process for redefining bona fide hedging as well.

As always, I welcome any thoughts all of you might have for topics for future meetings. My goal is to make the Ag. Advisory Committee as relevant as possible to its members.

I would like to mention one last issue. Recently, some of the grain markets have been experiencing an abnormally weak.basis and lack of convergence at expiry—particularly the soft red wheat market. We discussed this briefly at the August meeting of the Agricultural Advisory Committee.

There are several factors that play into the current situation, for instance, the high cost of transportation, and large supplies coupled with weak demand. However, we are increasingly concerned that there may be a problem with the contract specifications themselves. We should get convergence (cash and futures coming together) at expiration regardless of the market fundamentals when the contracts are functioning well.

From what we have observed the CBOT grain markets are not experiencing convergence when we have large supplies and full carry markets. According to our staff, in order to get convergence, changes will probably need to be made to the contract specifications. Things being considered are changing the storage rates and the delivery differentials down the river. The CBOT sent out a survey about 10 days ago to the Commercial traders to get feedback on storage rates that I am sure many of you have already seen.

The high cost of transportation is certainly not helping matters. Right now, barge and rail rates are very high. Not only are fuel prices at record levels, but low water levels have reduced barge loadings, and there is increasing competition for rail cars.

Commission staff has been in regular contact with staff at the CBOT to address this situation and we are confident that the CBOT is taking appropriate steps to define the problem and work on a solution.

Thank you again for letting me come here today. I have really enjoyed working with Jula and NGTC over the years, and look forward to continuing that relationship. I would be happy to take questions.

Last Updated: April 2, 2010