By Jon H. Harsch
© Copyright Agri-Pulse Communications, Inc.
ARLINGTON, VA. – USDA's 2011 Agricultural Outlook Forum opened Thursday morning with bullish forecasts for the U.S. farm economy coupled with warnings of increased price volatility and therefore increased risk throughout the supply chain. Next, a panel of commodity market experts explained how new markets have developed to manage the increased risk.
IHS Global Insight Chief Economist Nariman Behravesh opened the discussion by predicting that “most commodity prices can be expected to rise by at least 10% in 2011” but that this surge will be a continuing “roller-coaster ride.”
Infinium Capital Management Founder & CEO Charles Whitman gave a history of risk management going back to ancient Greece, noting that “in the 1800s, the volatility of pricing in agricultural products led to the invention of futures contracts.” Today, he says his brokerage firm is part of a highly complex, highly effective and increasingly transparent electronic trading system which now includes derivatives and which enables businesses “to hedge away the risks and focus on their core competencies.”
Whitman said the increasingly sophisticated global electronic trading system “is bringing transparency, is bringing access to many more markets and many more products, with access to them 24 hours a day. It's bringing increased volume and increased liquidity. It's bringing tighter spreads between the bid and the offer. It's bringing faster contract adoption.” Recalling his own pre-electronic-trading days, he said “when the Chicago Board of Trade wanted to launch a new contract, it physically had to carve out space on the floor, it had to build a pit.” He said now the process is quick and easy and “market makers like myself can price and provide liquidity equally as quickly.” He said electronic trading provides instant reporting and risk management so that “you know instantly whether you are filled or not, you know the price,” making it possible to “instantaneously manage your risk.”
To show how quickly electronic trading has evolved, Whitman pointed out that while there were only nine CME ag contracts in 2007 with over 50% electronic volume, that number jumped to 30 contracts last year. For the same period, the total number of CME ag contracts grew only from 37 in 2007 to 63 last year. Adding to the changed situation, the contracts now are traded globally by 28 ag exchanges in the U.S., Asia, Africa, Australia, Canada, China, India, Latin America and Europe. The result, he says is that it's now much easier to hedge specific risks. He predicts that “the futures market will be exciting for those who embrace the electronic trading of ag markets.” He adds that “Companies will be able to hedge in new ways” with “cheaper cost of hedging and lower execution costs” and with the added benefit of dampening price volatility “and helping to keep overall food prices lower.”
Commodity Markets Council President Christine Cochran said one key to how well markets will work in dealing with increased volatility and risk will be the new trading rules being hammered out currently by the Commodity Futures Trading Commission (CFTC) to implement the Dodd-Frank financial reform law which Congress passed last year. She noted particularly that for the first time, the CFTC will set capital and margin requirements for the previously unregulated swaps market.
Whitman warned that CFTC will have a challenge handling its massive new responsibilities since it's already “overwhelmed, understaffed and underbudgeted.” He said he remains hopeful, saying the purpose of Dodd-Frank “is to try to level the playing field, to give people greater access and to have more security in clearing and margin.” But he says the bill's ultimate success will depend on both getting adequate funding and staff to enforce new provisions and also making the right calls on defining swaps and setting margin requirements.
Those warnings were echoed across town at a Commodities Futures Trading Commission (CFTC) rule-making meeting Thursday. CFTC Commissioner Michael Dunn said the CFTC “is under serious strain at its current funding level. We lack the staff and technological resources necessary to implement Dodd-Frank and continue to fulfill our pre-Dodd-Frank duties under the Commodity Exchange Act.”
Dunn warned that “without additional funding, the strain will only become worse in July, when much of Dodd-Frank goes into effect. At that point, in addition to our traditional oversight of the futures industry, we will also be regulating the swaps market – a market that has been estimated to be nine times larger than the futures market.” Noting that the just-passed House budget bill “would cut the Commission’s already tight budget by nearly a third,” Dunn said “With a further cut in our budget, the Commission will have to abandon its principle based regulatory regime and adopt a prescriptive or even a restrictive regime. I am fearful this would have a negative impact on both the futures and swaps industries in the United States. There would essentially be no cop on the beat.”
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