Changing proposals by the world's largest derivatives exchange and its regulator to restore the Chicago wheat futures contract as an effective hedging tool have roiled the market. Traders are complaining that a proposal by a government regulatory panel to adjust wheat storage fees prompted violent swings in futures prices last week, causing some investors to lose hundreds of thousands of dollars in two days.
Then, CME Group announced on Tuesday that it plans to install new grain storage rates from September 2010 - nearly a full year later than the target date suggested by the subcommittee of the Commodity Futures Trading Commission. The CME's announcement prompted another wild swing in spreads, or relation between futures prices of various months. Traders complained that it will be hard to set fair prices for futures while the timing of the new storage rates remains uncertain. Some traders have mentioned possible lawsuits.
The CFTC subcommittee urged the storage rates to be adjusted with the CBOT December 2009 wheat contract. CFTC Chairman Gary Gensler, who is leading the Obama Administration's push for tighter regulation of derivatives contracts, has called for prompt action on the wheat contract. The CME on Tuesday announced its plan to wait and put the new "variable" storage rates into effect with the September 2010 contract.
It attributed the delay to exchange rules that do not allow major changes in futures contract deliveries with significant open interest. "It is just more talk. This is all based on CFTC approval. The CFTC has already said that it is not willing to wait that long. Until the two sides can come to an agreement, it would be best if everyone just shut up," one active wheat spread trader in the Chicago wheat pit told Reuters late on Tuesday.
"Since this change has the potential to impact pricing of calendar spreads, it is targeted for implementation for the first spread that is not currently at financial full carry," CME, parent of the Chicago Board of Trade, said in a statement. "The Exchange recommends implementation with the September 2010 contract, pending CFTC approval."
Commercial grain companies say the CBOT wheat contract has become an ineffective hedging tool because cash and futures prices have stopped converging at contract expirations. Grain hedgers have largely abandoned the CBOT contract due to a lack of convergence in CBOT wheat the last two years. Gensler in July called the situation "unacceptable" and vowed action to correct it.
"I can only assume that CME in making the statement yesterday was not only considering the open interest in the contracts but also the fact there likely have been some behind the scenes discussions with the CFTC about how they would react," said Rich Feltes, senior vice president of MF Global Research in Chicago.
"I don't see a conflict unfolding," he added. "In terms of the CFTC I would say the fact that a fix is on the table and proposed is more important than when the fix is enabled. Politically, they are showing progress, and I think that is more important than timeliness."
"DEVASTATING" Traders described the effect of the September 23 recommendation by the CFTC panel as "devastating" on the CBOT wheat market as traders were left scrambling to adjust forward positions already in the market over the next 12 months or more. "It had the exact same effect of screaming fire in a crowded theatre and then sealing the exits," the CME spread trader said.
"I have never sued anyone in my life and thought I never would. Any time 30 million dollars changes hands, spread over hundreds of people, as a result of a statement, it looks to me like a tailor-made recipe for a class action suit."
Variable rate storage tries to address a basic problem with the lack of convergence by raising the cost of storing grain and thus encouraging its move into commercial grain marketing channels. But the formulas are complicated and critics have also said the idea unfairly favours grain storage owners like members of the National Grain and Feed Association.
"It is common knowledge that the commercials have stopped using the CBOT wheat contract as a hedging tool, and many discretionary speculators describe our contract in terms that aren't fit for a family/flour publication," a top wheat analyst wrote in a national trade publication late on Tuesday. "We all await the next 'comment' from either the CFTC and/or the CME about the contract's future. Every comment so far has been like throwing gasoline on a smouldering fire."
Feltes, who has argued that the CME wheat contract needs radical changes including a cash index settlement, said it was likely that the CME's latest proposal for a delayed introduction of the storage rates would end up being adopted. "It is not as timely as the committee recommended, but the committee doesn't have to deal with potential lawsuits on changing contract specs for a large open interest," he said.
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