UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 AGRICULTURAL ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Thursday, October 29, 2009

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 1 A G E N D A

 2 Introduction:

 3 COMMISSIONER MICHAEL V. DUNN

 Chairman, Agricultural Advisory Committee

 4

 CHAIRMAN GARY GENSLER

 5 CFTC

 6 Market Fundamentals and Historical Overview

 7 DAVID KASS

 8 CHRISTA LACKENMAYR

 Division of Market Oversight, CFTC

 9

 Report, Proposal and Reactions

 10

 ANDREI KIRILENKO

 11 Office of the Chief Economist, CFTC

 12 DAVID LEHMAN

 CME Group

 13

 MATT BRUNS

 14 National Grain and Feed Association

 15 CHAD BURLET

 Burlet Trading

 16

 JOSHUA KIRLEY

 17 Vice Chairman, Wheat Futures Pit Committee

 18

 19 * * * * *

 20

 21

 22

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 1 P R O C E E D I N G S

 2 (9:10 a.m.)

 3 COMMISSIONER DUNN: Good morning, ladies

 4 and gentlemen, and welcome to the 33rd meeting of

 5 the Agricultural Advisory Committee. And as we

 6 begin to get started, what I would like to do is

 7 begin by adding introduction of the members of the

 8 AAC, so I will ask you to go around the table,

 9 identify who you are and who you are representing.

 10 And Bob, if I could start with you.

 11 MR. DINNEEN: Hi. I'm Bob Dinneen with

 12 the Renewable Fuels Association.

 13 MR. BAIR: Jim Bair, North American

 14 Millers Association.

 15 MR. COPPOCK: Daren Coppock, National

 16 Association of Wheat Growers.

 17 MR. CRYON: Roger Cryon, National Milk

 18 Producers Federation.

 19 MR. BRUNS: Matt Bruns, National Grain

 20 and Feed.

 21 MR. PEPPLER: Kent Peppler, National

 22 Farmers Union.

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 1 MR. NATZ: Kavin Natz, National Council

 2 of Farmer Cooperatives.

 3 MR. WILLETT: Sam Willett, National Corn

 4 Growers Association, and I'm joined this morning

 5 by Gary Niemeyer, a member of the Board of

 6 Directors for National Corn Growers Association.

 7 MR. BURLET: I'm Chad Burlet, Burlet

 8 Trading, but I am not a member of the AAC.

 9 COMMISSIONER DUNN: But you are a

 10 panelist today.

 11 MR. LEHMAN: Good morning. Dave Lehman,

 12 CME Group.

 13 MR. WORTHEY: Good morning. I'm Mark

 14 Worthey. I'm an employee of Flowers Foods,

 15 representing American Bakers Association today.

 16 MR. BLANCHFIELD: John Blanchfield,

 17 American Bankers Association.

 18 MR. GILLEN: Neal Gillen, American

 19 Cotton Shippers Association.

 20 MS. PAUL: I'm Beverly Paul, with the

 21 American Soybean Association.

 22 MR. BOONE: Robbie Boone, Farm Credit

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 1 Council.

 2 MS. JOHANNES: Mary Johannes,

 3 International Swaps and Derivatives Association.

 4 COMMISSIONER DUNN: Well, thank you very

 5 much. I wish to welcome you all to the

 6 Agricultural Advisory Committee, to the Commodity

 7 Futures Trading Commission. As I said, this is

 8 the 33rd meeting of this Advisory Committee.

 9 The subject of today's meeting is

 10 convergence in the wheat futures contract and the

 11 proposal to implement variable storage rates on

 12 this contract. On April 22nd of 2008, the CFTC

 13 held an agricultural forum to address concerns

 14 about the volatility of the agricultural markets

 15 in the fall of 2007.

 16 At that forum, I asked who was

 17 responsible for fixing the problems that were

 18 identified. I stated, "I don't think there's a

 19 silver bullet or a single solution for what ails

 20 the marketplace. And certainly the solutions that

 21 come up cannot be implemented overnight, but I

 22 firmly believe that the market participants are

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 1 the best qualified to come up with solutions that

 2 will ensure that we have a viable, fair

 3 agricultural futures market that will provide a

 4 fair price discovery and for risk mitigation."

 5 This morning you will see a chronology

 6 of how the market participants have worked to

 7 address wheat convergence concerns. As I

 8 predicted, solutions did not come overnight.

 9 However, there has been a continued

 10 commitment by the industry to work together to

 11 seek resolution of the convergence concerns in the

 12 Chicago wheat futures contract. I commend all of

 13 those dedicated folks that have been working on

 14 this effort.

 15 Today we will meet to discuss a variable

 16 storage rate proposal that mostly everyone agrees

 17 is the next step in this multi-year effort to

 18 solve the convergence issue. As with everything,

 19 including the variable storage rate proposal, the

 20 devil is in the details, and the implementation of

 21 this proposal has been a point of contention

 22 between the exchange that owns the contract and

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 1 some of the users who rely on it.

 2 I look forward to hearing from both

 3 sides on this debate today. I am hopeful that the

 4 discussion will help guide the AAC -- the Ag

 5 Advisory Committee -- and the Commission as it

 6 moves forward to resolve the convergence problem.

 7 As you all are aware, the CFTC has this

 8 latest proposal out for comment in the Federal

 9 Register. This is a material change to the

 10 contract and, as such, requires a vote of the

 11 Commission. The intent today is not to vote on

 12 that but to hear from the subcommittee on its

 13 recommendations and hear the response to that by

 14 the Agricultural Advisory Committee.

 15 The transcript of this meeting will

 16 become part of the comment record of the proposal,

 17 and I encourage everyone to submit their views on

 18 this subject as soon as possible. I want to thank

 19 all of the AAC members and the presenters for

 20 their time, effort, and advice in these matters.

 21 I particularly would like to thank

 22 everyone who volunteered and was chosen to serve

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 1 on the AAC Subcommittee on Convergence which will

 2 present its report and recommendations today. The

 3 subcommittee's report should be viewed as a

 4 precursor to Commission action, but it will be

 5 used as an important source of information on the

 6 convergence issue.

 7 My commitment is to listen to you with

 8 an open mind to your thoughts on everything we

 9 discuss today, and again I want to thank all of

 10 you for your participation. I will turn it over

 11 to the Chairman of the Commission for his opening

 12 remarks.

 13 CHAIRMAN GENSLER: Good morning. Thank

 14 you, Commissioner Dunn, for chairing today's

 15 meeting of the Agricultural Advisory Committee.

 16 I also want to welcome Commissioner

 17 Scott O'Malia to the CFTC. I note the importance

 18 of having a full Commission, all five of us, in

 19 place at this critical time in our nation's

 20 history and as we try to recover from the worst

 21 financial crisis in 80 years.

 22 I also want to thank the President for

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 1 nominating and the Senate for confirming not only

 2 Commissioner O'Malia, but now Commissioner Sommers

 3 and Commissioner Chilton. We now have our full

 4 Commission, and I think the next one of us up

 5 might even be Commissioner Dunn in 2011, so we've

 6 got a while that we are all together, the five of

 7 us, which is just terrific.

 8 I also want to join with Commissioner

 9 Dunn in welcoming this full committee and its

 10 members, and wish to thank you for the advice and

 11 contributions that you've given in the past, and

 12 certainly on this critical issue that we're facing

 13 today.

 14 The agricultural futures markets remain

 15 at the forefront of our regulatory agenda. The

 16 markets provide critical price discovery function

 17 for many sectors throughout our economy, and not

 18 only affect the growers and farmers and merchants,

 19 but every American as they go to the food store

 20 and sit down for dinner at night. The Commission

 21 and the staff make policing these markets against

 22 fraud, manipulation and other abuses a top

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 1 priority.

 2 Now, as I sit here today, and I hope I

 3 am able to join you for the full meeting -- I know

 4 there were some bets on how long I was going to

 5 last here -- there are three things that I would

 6 like to just listen to. One, of course, is this

 7 wheat convergence issue that is the main topic.

 8 But also I would like to hear from

 9 people their thoughts on this critical thing we're

 10 doing right now with Congress to bring reform to

 11 the over-the-counter derivatives marketplace, how

 12 it affects the products and markets that you know

 13 most about in agriculture, but just as you have

 14 been watching this great debate go on, it would be

 15 terrific to hear your thoughts.

 16 Secondly, as you know, we are seriously

 17 considering imposing position limits in the energy

 18 markets which, along with the exchanges we

 19 actually had in place through just eight years

 20 ago, 2001. It would be terrific, as we do have

 21 position limits in the agricultural market, to

 22 hear what works, what doesn't work, and just

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 1 observations in the agricultural markets as we

 2 consider this in the energy markets.

 3 And then of course third, as we look to

 4 your advice in this wheat convergence issue,

 5 that's the main topic and the meat of the meeting,

 6 but it would be terrific to hear your thoughts on

 7 some of these other things as well. More

 8 particularly, convergence in the wheat market, the

 9 Commission has been very concerned about the lack

 10 of convergence in soft red winter wheat, the

 11 contract that we're chatting about.

 12 At the height of the poor convergence

 13 last year, you all know the figures better than I,

 14 if I mistakenly remember them, but in the Toledo

 15 cash market I think it was always hovering between

 16 $1.30, $1.15, and it even popped out to a $2.00

 17 problem at some point. It has recently been

 18 brought in, in July and September, in the.60 to.75

 19 range, but it is still, at least in my mind set,

 20 not satisfactory. At the core of these markets it

 21 has to be far tighter than that, and more

 22 predictable.

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 1 In April the Chairman of the

 2 Agricultural Advisory Committee, Commissioner

 3 Dunn, brought together stakeholders affected by

 4 the lack of convergence, formed a subcommittee,

 5 which I applaud him for. And over the last

 6 several months members of that committee have been

 7 working to identify causes of the poor

 8 convergence, provide recommendations to the full

 9 committee, and I look forward to hearing them

 10 today.

 11 But, if I might, particularly I would

 12 like to understand from your point of view what

 13 continue to be the causes of the lack of

 14 convergence. For instance, is it the design of

 15 the contract? If so, what issues? Two, is it

 16 just the nature of the market's in full carry and

 17 it's been in full carry for such a time? Or, as

 18 many people have observed, is it the role of index

 19 investors and the significant portion of the

 20 market that's held by index investing?

 21 To the extent it is contract design, of

 22 course, there's a recommendation in front of us

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 1 from the Chicago Mercantile Exchange with regard

 2 to variable storage rate, and it would be helpful

 3 to understand whether that will address whatever

 4 contract design problems there are. Or are there

 5 other contract design issues? It would be helpful

 6 to know.

 7 To the extent that you are supportive of

 8 this variable storage rate, of course the timing

 9 of its implementation is so critical, and I know

 10 that's in front of you, and all the work that

 11 Commissioner Dunn has done. So I thank you again,

 12 chairman of this committee, Commissioner Dunn, for

 13 hosting this meeting.

 14 COMMISSIONER DUNN: Thank you, Mr.

 15 Chairman. We will now turn to Commissioner

 16 Sommers.

 17 COMMISSIONER SOMMERS: Thank you. Good

 18 morning, and thank you all for being here to

 19 discuss the important issues in front of the

 20 Agricultural Advisory Committee.

 21 I want to particularly thank

 22 Commissioner Dunn for his leadership on all of

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 1 these issues, and those of you who have

 2 participated in the Subcommittee on Convergence.

 3 I appreciate your service to the Commission, and I

 4 look forward to your report and recommendation

 5 today.

 6 I also appreciate the Chicago Board of

 7 Trade's proactive efforts to try to find a

 8 solution to this problem, and our Commission staff

 9 who have worked very hard to help us better

 10 understand this complex issue. Over many months

 11 we have devoted significant time and effort to

 12 examining poor convergence between cash and

 13 futures prices in certain agricultural futures

 14 markets, particularly the CBOT soft red winter

 15 wheat contract.

 16 The CBOT's recent rule changes that

 17 provided for seasonal storage rate, added delivery

 18 locations and other changes have narrowed the

 19 basis, but the contract continues to exhibit a

 20 lack of convergence problem, particularly when the

 21 futures market is near or exceeds full carry.

 22 This issue is core to our mission at CFTC, and I

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 1 want to make sure that it is accurately

 2 discovering prices and is providing an opportunity

 3 for producers and commercial entities to hedge

 4 price risk.

 5 Many market participants have expressed

 6 concern about the continued usefulness of this

 7 contract, which is troublesome.

 8 I think we must attempt to restore the

 9 confidence that our markets operate efficiently

 10 and effectively, and to strengthen market

 11 integrity. Public confidence in the markets is

 12 crucial.

 13 I am hopeful that through the dialogue

 14 today, we can come to an agreement on appropriate

 15 next steps that will allow us to finally move

 16 towards resolution. I appreciate all of your

 17 input over the past several months, as well as the

 18 time and effort you all have devoted to finding

 19 these workable solutions, and I look forward to

 20 hearing the discussion today.

 21 COMMISSIONER DUNN: Thank you,

 22 Commissioner Sommers. Commissioner Chilton?

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 1 COMMISSIONER CHILTON: Thank you, Mr.

 2 Chairman, and I thank the Chairman of the

 3 Commission for his tireless work on all these

 4 issues, and congratulate Commissioner O'Malia in

 5 particular but also Commissioner Sommers.

 6 I don't know if people remember back in

 7 the nineties there was this catch phrase, "Not."

 8 You know, you would make some declarative

 9 statement and then you would say, "Not." "Nice

 10 tie. Not."

 11 I want to echo what Commissioner Dunn

 12 and the Chairman were saying. This meeting is not

 13 about taking an action on the wheat contract.

 14 We're not going to take a vote here today.

 15 It's only to get your input. And the

 16 reason we want it in particular is because of this

 17 convergence issue. That has been adequately

 18 explained. But I am concerned that we had some

 19 market-moving event the last time the subcommittee

 20 met on the conference call, and so I just want to

 21 make sure that people understand what we are not

 22 doing here today.

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 1 I do appreciate, Dave, CME coming

 2 forward with a proposal, and I want to make sure

 3 that folks understand the lay of the land. When

 4 they provide a proposal to us, we have 45 days in

 5 which to act. In order to disprove what they have

 6 proposed on their contract, we actually have to

 7 show that it's a violation of the Commodity

 8 Exchange Act. that it violates the law. If we

 9 can't show that, we don't have a legal basis for

 10 disproving it. That 45 days, by the way, is up on

 11 November 13th, I believe. November 13th.

 12 We can proactively, as the chairman of

 13 the committee said, approve it. We could also, by

 14 default, just do nothing, and it would take

 15 effect. So the other option in our little state

 16 of play here is that CME, if they believed that

 17 perhaps, given market circumstances, they might be

 18 able to do this in a more expeditious fashion --

 19 because I think a lot of people agree with the

 20 general constructs of what they have outlined,

 21 although we will find out more today, but there

 22 are some issues on the date, too -- and so it's

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 1 possible that they could withdraw what they have

 2 before us and say that maybe it would be in May or

 3 maybe it would be in June, but that's CME's call.

 4 So I look forward to hearing people's

 5 discussion, look forward to hearing Dave's

 6 presentation, also.

 7 The other topic I wanted to mention

 8 that's related, while this issue may be dealt with

 9 -- and maybe the market will take care of it. I

 10 mean, maybe this will all be resolved before we

 11 would get to sort of the remedy, just by market

 12 forces. But I notice in our commitment of traders

 13 report that we released, the three-year totals,

 14 that there is a heavy proportion of index traders

 15 that are -- you know, these are what I have called

 16 "massive passives."

 17 These "massive passives" are large, they

 18 are long, they are price-insensitive. They're not

 19 really trading in the market much. Not in wheat,

 20 but in some of the other contracts that are fairly

 21 small and illiquid, like cotton, and there are

 22 some others, you know, having this large group of

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 1 "massive passives" who don't trade, I get

 2 concerned that maybe that would exacerbate a

 3 circumstance like we're having today. I'm not

 4 saying it is. I'm saying it's something that me,

 5 personally, that I'm thinking about, and so I

 6 think in the future we need to be aware of that

 7 dynamic and try to come to grips with what, if

 8 anything, we should do.

 9 And then the last thing is, I didn't

 10 want this meeting to go by without saying that it

 11 was about a year and a half ago when we sat here

 12 and we heard from this committee about the cotton

 13 contract, the end of February, the beginning of

 14 March 2008. We've had an investigation going. We

 15 announced it in June.

 16 Earlier this month we received a letter

 17 from Senator Chambliss and eleven others, Senator

 18 Lincoln and nine other Senators, and they have

 19 urged us to ensure that we provide as much

 20 information as possible. And I can tell people

 21 that our enforcement folks have worked very hard

 22 on that report, that investigation, and that I'm

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 1 really hopeful that we'll get that out soon, and

 2 that we will give as much information, more in

 3 general than we do on these sorts of enforcement

 4 actions, in the future.

 5 So I look forward to hearing what you're

 6 going to say and asking questions. I'd tell you I

 7 have five other points but then I'd have to say,

 8 "Not." So thank you, Mr. Chairman.

 9 COMMISSIONER DUNN: Thank you,

 10 Commissioner Chilton. It gives me a great deal of

 11 pleasure to say this.

 12 Commissioner O'Malia?

 13 COMMISSIONER O'MALIA: Thank you. Good

 14 morning, Mr. Chairman. Thank you for the warm

 15 welcome. I greatly appreciate being here and

 16 having the nomination through. Congratulations to

 17 Commissioners Chilton and Sommers, as well, for

 18 their swearing in.

 19 Commissioner Dunn, I appreciate you

 20 chairing this hearing to take testimony on the

 21 corrective measures identified to remedy

 22 fundamental problems with the wheat contract. It

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 1 is so refreshing, in my second week, to take a

 2 nice easy issue that is so cut-and-dried.

 3 But I am fully aware of the importance

 4 this product has on world food prices and the

 5 commercial implications to farmers, storage

 6 operators, and shippers, as well as those with

 7 significant investment in futures contracts.

 8 Although I am in my second week, I am

 9 impressed with the body of work that the committee

 10 has produced on the fundamental flaws of this

 11 contract, and I compliment Commissioner Dunn as

 12 well as the Commission staff and the subcommittee

 13 participants who have worked very hard to develop

 14 a range of options for us to consider. I am very

 15 interested to hear the testimony of our expert

 16 witnesses, and I greatly appreciate everyone's

 17 participation here today. Thank you.

 18 COMMISSIONER DUNN: Thank you very much,

 19 Commissioner O'Malia.

 20 Let me give a little outline of what's

 21 going to take place for the remainder of the

 22 meeting. We have two members of the first panel

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 1 on to give us the market fundamentals and a

 2 historic overview, and after they have made their

 3 presentation, then it's incumbent upon the Ag

 4 Advisory Committee to have any questions that you

 5 might have of them, of what went on, what

 6 transpired, what the history is and what the

 7 market fundamentals are. So they will make a

 8 presentation and the AAC will be able to question

 9 them on that.

 10 Then the second panel, we will have a

 11 report of the recommendation from the AAC

 12 subcommittee, and then we will have a presentation

 13 of CME Group's proposal to implement a variable

 14 storage rate on that.

 15 And then we are going to kind of take a

 16 break, so that everybody can kind of digest what

 17 they had heard so far, and then we're going to

 18 come back and we have a couple of reactors.

 19 Matt Bruns and Chad Burlet are going to

 20 talk about their reactions to what they had heard

 21 on this.

 22 And then I will open it up for any other

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 1 public comments that they have on the proposals

 2 that are there, and then go back to the Ag

 3 Advisory Committee. It is your show, your

 4 opportunity to get the questions in that you need

 5 in helping you decide what area we might want to

 6 recommend.

 7 I am going to be working from a

 8 consensus of what we hear from the various

 9 members. We're not going to have a vote per se,

 10 but what we are going to be doing as Commissioners

 11 is to listen to the tone and tenor of what the Ag

 12 Advisory Committee have to say in their statements

 13 and in their questions in this arena.

 14 So let's start off, then, with that

 15 first panel, and we have two members of the CFTC

 16 staff: Dave Kass, who is with the Division of

 17 Market Oversight in Chicago.

 18 When I first became Chairman of the Ag

 19 Advisory Committee back in August of 2006, we had

 20 our first meeting, and prior to that meeting Dave

 21 called me and he said, "Commissioner, I've just

 22 had a meeting with a group of the Illinois Farm

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 1 Bureau wheat producers, and they have a real

 2 concern about convergence. Let me show you some

 3 things." So as an ad hoc to that first meeting,

 4 we invited Dave to come in to talk about

 5 convergence, and he is our man with the history on

 6 this.

 7 The second panelist that we have on

 8 there is Christa Lockenmayr, who is a member of

 9 the Division of Market Oversight, and she is going

 10 to give us a background of what has taken place, a

 11 historical overview. She has got a chronology

 12 that she has put in there, that I think you will

 13 all find very, very interesting.

 14 So, Dave, if you will, please.

 15 MR. KASS: Good morning, and thank you.

 16 Christa and I are going to essentially present

 17 sort of a factual underlayment.

 18 Hopefully, no opinions will sneak in.

 19 If one or two does, it will be of course my

 20 opinions, not necessarily those of the Commission.

 21 But I'm going to talk a little bit about

 22 just sort of the history of basis and convergence

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 1 in the wheat contract.

 2 This first graphic -- and as an

 3 economist, of course you lose your license if you

 4 don't present a whole lot of graphics and tables

 5 and charts, so I'll be doing that -- this just

 6 shows absolute prices of wheat going back to

 7 January '04, so the better part of six years. And

 8 the red represents the difference with the cash

 9 price at Toledo, the Toledo bid, so where you see

 10 lots of red, that shows weakness, that the cash

 11 price was below the futures price.

 12 And interesting to note, at prices more

 13 or less above oh, let's say, $9.00 or so, which of

 14 course were historically high prices that we

 15 reached predominantly last spring, we had awfully

 16 good convergence, very little where you see red

 17 with cash prices well below the futures prices.

 18 But also when you had prices from, say, $7.00 to

 19 $9.00, which historically would be very, very high

 20 wheat prices, there were also periods of time that

 21 you had bad convergence, or a weak basis, rather.

 22 This doesn't necessarily show convergence, because

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 1 convergence is a very specialized basis at or

 2 around the time of futures expiration. This is

 3 basis over a longer period of time.

 4 Now, this isolates on just the basis,

 5 goes back further in time, actually. This goes

 6 all the way back to January of 1996, and shows the

 7 Toledo truck basis, the major delivery point on

 8 the wheat futures contract, on the soft red

 9 contract.

 10 And again you can see that this is not,

 11 although the problem got exaggerated, it's not by

 12 any means a recent problem. We had, all the way

 13 back in this area here, in the late nineties, we

 14 had what would have been considered a very, very

 15 weak basis historically.

 16 Then we had -- the yellow parameter here

 17 represents plus or minus.10 of the nearby futures

 18 price, so that would be considered a more or less

 19 reasonable convergence period, so that's what the

 20 yellow represents.

 21 And you can see that the history of this

 22 -- and of course basis, weak basis, sometimes you

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 1 get weak basis for lots of reasons, and basis is

 2 related to a lot of things, not just what's going

 3 on with the futures expiration but what's going on

 4 in the fundamental market, things like barge rates

 5 and lots of other things. But this is just the

 6 history of it.

 7 Obviously we had that meeting in August

 8 2006 that Commissioner Dunn related to, and at

 9 that time we saw very, very high basis in that,

 10 leading up to that meeting, and it was presented

 11 at that meeting as a terrible problem with wheat

 12 basis and poor convergence. But then of course

 13 that was -- we saw improvement, actually, for a

 14 period of time, and we got down to where we got

 15 some reasonably good convergence in late '07 and

 16 into '08, but then we all know what happened

 17 subsequently to that.

 18 This is kind of the current situation

 19 for wheat basis at selected locations, just to

 20 kind of set this up. The boxes that range from

 21 top to bottom of each of these little rectangles

 22 represents the historical range in basis at these

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 1 points. And this is all for the fourth week of

 2 October, and you can see then where we were

 3 historically.

 4 The red triangle represents the median

 5 of that, and then you've got a green box and a

 6 blue diamond. The blue diamond represents where

 7 we were a year ago in basis, in 2008, fourth week

 8 of October. And then the green box represents

 9 where we are pretty much current, at least as of

 10 last week, in terms of basis.

 11 And you can see, for example, at Toledo,

 12 which again is the one historically people look at

 13 in terms of basis and convergence for this

 14 contract, because it has been the major delivery

 15 point. Last year at this time we were about $1.50

 16 below futures. This year we're in the area of

 17 about.90. But of course the median period of time

 18 is closer to the.15 to.20 range, so even though.90

 19 or so represents a substantial improvement on

 20 where we were a year ago, when you consider the

 21 median was in the area of.15 to.20, we've still

 22 got a long way to go.

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 1 Moreover, at this point in time in

 2 October, we're not talking so much about

 3 convergence at this point in time, because

 4 convergence applies as you approach the delivery

 5 month.

 6 And of course first notice day on the

 7 next futures contract is November 30th, so we've

 8 got about five weeks prior to first notice day, so

 9 you really wouldn't expect tight convergence at

 10 this point in time.

 11 This is just a summary, and I'm not

 12 going to go through this whole thing, but it's

 13 sort of what are the classic market forces in

 14 periods of time when you have a negative basis?

 15 This is only for a period of time where futures

 16 price exceeds the cash price as you approach the

 17 delivery month.

 18 Then you have sort of the classic

 19 situation that would apply. Holders of long

 20 futures products obviously would want to not get

 21 delivery and pay an expensive futures price for

 22 something they could get more cheaply in the cash;

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 1 or if they were getting it and then had to

 2 liquidate that cash, they would obviously suffer a

 3 loss because they would be liquidating at the much

 4 lower cash price. So they would tend to sell

 5 futures.

 6 If you needed the product and you were

 7 long futures, you would certainly want to get rid

 8 of your futures and buy it in the cash market.

 9 Traders with delivery capacity can obviously

 10 profit in this situation from selling futures for

 11 delivery, buying the cash, perhaps, and then

 12 issuing delivery notices and profit from that

 13 difference. So all of these things help

 14 convergence, all these acts by players in the

 15 market during sort of a classic.

 16 What happens if market is at full carry

 17 is quite different, at least for the first group,

 18 the long futures that really don't need product.

 19 They no longer have the threat of delivery because

 20 they're looking more at full carry. They can earn

 21 a positive return on invested dollars by taking

 22 delivery now and carrying it into the deferred

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 1 contract, whether the next deferred or some

 2 further out, so they don't need to sell their

 3 futures contracts. They may buy futures, they may

 4 not, but in any event they're not helping

 5 convergence at this point in time.

 6 The middle group there, the long futures

 7 that need product, they'll act pretty much the

 8 same. Again, they're going to sell their futures

 9 and buy it cheaper in the cash market, to the

 10 extent they need the cash.

 11 The other group that's affected

 12 tremendously by a full carry are those with

 13 delivery capacity, the delivery facilities. You

 14 might think they would be more than willing to

 15 make delivery at wide basis, where we were seeing

 16 $1.00, $1.50 basis at times in delivery period,

 17 but they would be reluctant many times to make

 18 delivery because anything they deliver out on the

 19 street, if it's going to be carried month after

 20 month after month, it's going to tie up their

 21 facility.

 22 Most of the delivery facilities are not

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 1 pure warehousemen; they are merchandisers. They

 2 want and need their facility for throughput, so

 3 their ability to sell futures and buy cash or

 4 deliver cash they already own can be very limited.

 5 They would do it up to a certain point

 6 of comfort, but once they reach that comfort level

 7 they're not going to do it anymore.

 8 And if these things are carried over

 9 month after month after month, they may have

 10 reached their comfort level.

 11 So increasing delivery capacity, which

 12 of course we saw this past summer, may not have

 13 much effect on delivery capacity in the short run

 14 in a full carry market, for that very reason.

 15 They may deliver a small amount up to their

 16 comfort level, but once that amount is sticky in

 17 terms of staying in their facility, that's it.

 18 You're not going to see a lot more capacity coming

 19 out of that.

 20 So that's the problems and sort of the

 21 disconnect that you'll find in a full carry market

 22 situation. There's a lot of other nuances to

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 1 that, but that's just a quick overview.

 2 This, now, up to this point I've been

 3 talking about sort of basis over time. Now we're

 4 going to talk more about the convergence, which is

 5 the specialized basis at or around the delivery

 6 period. The blue bars here represent basis on

 7 first notice day of futures contracts going back

 8 through March '98, so quite a long period of time.

 9 And this is the scale on the right-hand

 10 side, so you can see the zero line which would be

 11 cash equals futures, and then you see it falling

 12 below that at points. I have a little trouble

 13 picking this thing out. There it is.

 14 And obviously, again, you see this

 15 dramatic basis here, looking at the blue, where we

 16 got down on first notice day, even, basis

 17 approaching $2.00. It was well over, looks like

 18 about $1.90 at its worst point in September of

 19 '08. And going back historically, you can see

 20 there were other periods, even as early as back in

 21 the late nineties and into 2000, where we had what

 22 at the time looked like pretty poor basis

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 1 relationships. It only looks not as bad now.

 2 I'm going to be showing this same

 3 graphic, this blue part, in a later slide, so it's

 4 important to note what this is and what it

 5 represents. One thing it does represent, during

 6 this period back here we were seeing, you know,

 7 month-to-month, future-to-future, improvement in

 8 basis.

 9 But of course if you thought, "Gee, the

 10 problem is over," then all of a sudden you had bad

 11 basis. But then again in late '06 we ha, again, a

 12 month-to-month improvement in basis, and one might

 13 have thought, "Well, if we weren't out of the

 14 woods back in 2000, we're out of the woods now.

 15 The problem is fixed." And, of course, "not," as

 16 the Commissioner said.

 17 And you'll see now recently basis has

 18 improved again, month-to-month, from September '08

 19 through this past September of '09. Is that

 20 finally on the right track and we're going to get

 21 there eventually? Well, history would say maybe

 22 not.

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 1 The red lines, by the way, represent the

 2 numbers of deliveries just on first notice day, so

 3 these would be initial deliveries, and you can see

 4 clearly where you have weak basis, you do tend to

 5 get heavy deliveries, of course. But apparently

 6 not heavy enough, because here recently you can

 7 see in the last half dozen or so futures

 8 contracts, all the way here on the right, we had

 9 the heaviest deliveries we've ever seen and yet we

 10 still had poor convergence, so heavy deliveries

 11 doesn't even necessarily get you there.

 12 That one outlier there, May of '09, the

 13 very largest one, was coincident also with a Board

 14 of Trade rule change where they restricted the

 15 number of receipts that could be carried over, so

 16 that was an unusually heavy delivery period

 17 because by the end of that month noncommercials

 18 could no longer carry as many as they had in the

 19 past, so that's one of the reasons that one is

 20 particularly heavy.

 21 Now let's look at spread. I mentioned

 22 in full carry and spread. Let's look at spread.

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 1 This goes back to March -- this, by the way, I'll

 2 give full credit, this slide and the next one, to

 3 the University of Illinois that has been doing a

 4 lot of work on this as well -- this now represents

 5 the spread on the first delivery day between the

 6 nearby future, the expiring future, and the next

 7 deferred future.

 8 The red line just sort of arbitrarily

 9 represents 80 percent or more of full carry, and

 10 you can see then going back, more often than not

 11 we are above the full carry situation.

 12 CHAIRMAN GENSLER: Could I just

 13 interrupt? Just one quick question on this full

 14 carry chart.

 15 Is this full carry as the CME proposal

 16 is LIBOR plus 200 basis points, or is this some

 17 other measure of full carry, if you could, Mr.

 18 Kass?

 19 MR. KASS: I believe they used LIBOR,

 20 and of course it's 80 percent, and I think the

 21 Board of Trade's proposals represent 85.

 22 Actually, given current interest rates so low, I'm

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 1 not sure that the interest rates might move this a

 2 little bit, but it's not going to make enough to

 3 throw you out of a full carry into a non-carry,

 4 depending on what the interest rate --

 5 CHAIRMAN GENSLER: Would it not make a

 6 big difference if you add 200 basis points or not?

 7 Because that does really address what full carry

 8 is.

 9 MR. KASS: Well, I think I'll let the

 10 Board of Trade --

 11 CHAIRMAN GENSLER: No, no. I was just

 12 asking what the arithmetic of this chart is.

 13 MR. KASS: The arithmetic on this is

 14 LIBOR.

 15 CHAIRMAN GENSLER: Thank you.

 16 MR. KASS: And the higher the interest

 17 rate, of course, the more it would take you to get

 18 to full carry.

 19 So this just shows, demonstrates, that

 20 we have been at or above 80 percent of full carry

 21 pretty much throughout history. There are a few

 22 here and there where we weren't.

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 1 And, finally, my final graphic shows

 2 that Toledo wheat basis which I showed you before,

 3 the little bars falling below the zero line, so

 4 that's the same, and in overlays now using the

 5 right-hand scale, at what percent we were of full

 6 carry during these periods of time. So the red

 7 represents the percent of full carry, and the

 8 line, there's essentially a line drawn at the 80

 9 percent. It's the zero line for basis, but it's

 10 the 80 percent line for purposes of what is full

 11 carry. And again you see a pretty good

 12 correspondence between when you had periods above

 13 80 percent of full carry tend to be associated

 14 with the times where we had the worst convergence,

 15 and periods where we fell well below 80 percent of

 16 full carry, those downward peaks or I guess

 17 valleys on the red line, typically you had much

 18 better convergence when you weren't at full carry.

 19 It's not perfect. There's a period of time you

 20 see back in about the, between the Sep '03 - May

 21 '04, where we were actually above 80 percent of

 22 full carry, looking at the red line, but we had

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 1 very good convergence.

 2 So, like most economic relationships, it

 3 looks like it sort of generally applies but it's

 4 not a perfect relationship, and we seldom get

 5 those sorts of things. So there's a lot of

 6 confluence of events that go into these, but carry

 7 does seem, particularly when you get above 80

 8 percent, does seem to have a good relationship

 9 here with the lack of convergence.

 10 So, with that, I will turn it over to

 11 Christa.

 12 MR. LEHMAN: Commissioner Dunn, could I

 13 just ask a clarifying question of Dave?

 14 COMMISSIONER DUNN: Sure.

 15 MR. LEHMAN: Dave, the basis data that

 16 you presented, is that from USDA?

 17 MR. KASS: The basis? I think it's a

 18 private source, Hollander and --

 19 MR. LEHMAN: Oh, from Hollander and

 20 Feuerhaken?

 21 MR. KASS: Yes.

 22 MR. LEHMAN: Okay. And those are bids,

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 1 correct?

 2 MR. KASS: Right.

 3 MR. LEHMAN: So they're not prices which

 4 --

 5 MR. KASS: They're elevator bids at the

 6 location.

 7 MR. LEHMAN: A public bid but not a

 8 transaction price?

 9 MR. KASS: Yes.

 10 Mr. LEHMAN: Thank you.

 11 MS. LACKENMAYR: Good morning. Thank

 12 you very much. I'd like to just set this up with

 13 a brief history of the convergence issue in the

 14 wheat contract, specifically relating to two sets

 15 of contract changes and the lead up to those up

 16 until the present point.

 17 First of all, in this chart -- it starts

 18 in 2007 -- in blue you'll see the delivery months

 19 below, and then the bar represents where the basis

 20 was at that point. You can see the peak period is

 21 in December, and it's been gradually improving

 22 since then.

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 1 I believe Commissioner Dunn discussed

 2 the Special Agricultural Forum that led off this

 3 issue in his first meeting in 2006, and then that

 4 was followed by another Agricultural Advisory

 5 Committee meeting, which you know.

 6 And in August of that year the CBOT sort

 7 of unveiled their first set of changes to the

 8 industry, followed quickly by the submission of

 9 the changes and their approval in December.

 10 Those changes were basically to expand

 11 the delivery territory, to reduce the vomitoxin

 12 levels, and also to institute the seasonal storage

 13 rate.

 14 And then, as Dave mentioned, the second

 15 set of changes was to put a limit on the number of

 16 certificates that can be held for noncommercial

 17 purposes. And you also see that the University of

 18 Illinois has done some exceptional research on

 19 this topic, and that we have had other government

 20 institutions involved. The Permanent Subcommittee

 21 on Investigations issued a wheat convergence

 22 report, and our chairman testified at that

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 1 hearing, and then also there were research reports

 2 by the USDA.

 3 At the time when the proposals were

 4 submitted, the CBOT advised us that the proposed

 5 new delivery territories would foster convergence

 6 by expanding deliverable supplies, meaning that an

 7 increase in capacity would lead to an increase in

 8 supplies, and that the higher storage charges

 9 would improve convergence by allowing spreads to

 10 widen and the nearby contract to fall relative to

 11 cash values.

 12 So the alternative to that would be that

 13 the deferred price would go up, and we haven't

 14 been able to really see that the nearby has

 15 dropped or that the deferred has increased. And

 16 also that a reduction in the amount of vomitoxin

 17 would enhance convergence, as it would reflect

 18 milling quality grade.

 19 So you see for the first change -- I

 20 believe the slides in your packet may be a little

 21 bit different than what I have but the information

 22 is essentially the same -- you'll see from when

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 1 the changes were instituted to essentially the

 2 present, there has been a huge increase in

 3 capacity, over a 115 percent increase. The unused

 4 capacity there is not empty. Essentially it's

 5 capacity that the regular facilities can use to

 6 issue shipping certificates.

 7 You also see that there is a

 8 considerable number of new players, some

 9 cooperatives that are able to deliver, and then in

 10 the table in the bottom left you'll see that

 11 despite the increase in capacity, the registered

 12 receipts level has actually gone down, so it

 13 hasn't been exactly as anticipated.

 14 You will also see here from this map

 15 that the new delivery territory is essentially

 16 coincident with a vomitoxin outbreak along the

 17 Ohio River here in the northeast of the map, and

 18 essentially along the Mississippi River, so that

 19 may have resulted in wheat that was not of

 20 deliverable grade when the new changes were

 21 instituted.

 22 And then this brings us back to the

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 1 basis chart. We haven't seen the improvement. We

 2 have seen an improvement, but not the one to

 3 convergence that we were hoping for. And so at

 4 the time when we approved, when the Commission

 5 approved the changes, there was some concern among

 6 staff and in the industry that they would not

 7 achieve convergence.

 8 And so what we did was refer the matter

 9 to the Subcommittee on Convergence and suggested

 10 some topics for them to look at, which is modified

 11 compelled load out; restrictions on

 12 cash-and-carry, which is essentially the contract

 13 change in January that limited the number of

 14 shipping certificates that could be held; further

 15 increases in storage rates; cash settlement; and

 16 also restrictions on hedge exemptions. And at the

 17 time we also noted that the CBOT was very

 18 cooperative in discussing new changes, and that's

 19 where this dynamic storage rate came from.

 20 COMMISSIONER DUNN: Thank you very much,

 21 Christa. I would now like to open it up for

 22 questions, and usually we allow the Commissioners

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 1 to ask first, but since this is the AAC meeting,

 2 we're going to let the AAC members question first

 3 and then the Commissioners on any follow-ups that

 4 they might have. So if you have a question or a

 5 comment about the presentation of the first panel,

 6 please just raise your hand and we'll call on you.

 7 No questions or comments? Pretty much

 8 history, and everyone says that's correct? Very

 9 well, then. Let's go into the second panel, if we

 10 will, and we have Andrei Kirilenko, who is with

 11 the Office of the Chief Economist, who was the

 12 staff person for the subcommittee for the Advisory

 13 Committee, and he will go through an overview of

 14 what they looked at and their proposal. And then

 15 we will have Mr. David Lehman from the CME Group

 16 talk about what the actual proposal was from the

 17 CME Group.

 18 And please keep in mind that in essence

 19 everybody is agreeing on what the next step ought

 20 to be. It's the timing aspect of it. So, Andrei,

 21 if you will, please.

 22 MR. KIRILENKO: Mr. Chairman, Chairman

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 1 Dunn, Commissioners, members of the committee, I

 2 would like to organize my remarks not around

 3 charts necessarily but around sort of the

 4 principles and the philosophy that we had to go in

 5 and try to address this issue.

 6 Once it became clear over time that this

 7 issue of convergence is beyond day-to-day

 8 surveillance and not necessarily entirely the

 9 matter of enforcement, we moved and tried to

 10 understand this issue, researched this issue and

 11 tried to understand this issue better, collect a

 12 body of knowledge so that we could then work with

 13 the industry and the exchange on solving it.

 14 So to lay out the basic principles that

 15 we have in mind, what are the key issues? The

 16 contract, this contract, is the property of the

 17 exchange. That's a fact. However, a persistent

 18 lack of convergence inhibits this contract's

 19 ability to deliver on its key public attributes.

 20 And so there is a consensus that over

 21 time developed in the industry that the problem is

 22 imbedded somewhere in the aspects of the design of

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 1 this contract. That has to do with where it's

 2 delivered, how are deliveries scheduled, what are

 3 the rates associated with the delivery or

 4 nondelivery.

 5 And we also know that there are some

 6 incentives that are sort of aligned on the two

 7 sides of the contract. Some participants benefit

 8 from a lack of convergence and others lose.

 9 So there is, in principle, an

 10 inefficiency that has to be addressed.

 11 However, those who know how to solve

 12 these technical contract design issues are often

 13 the beneficiaries of the design, so there was a

 14 feeling that the regulatory intervention,

 15 regulation or at least study, is justified.

 16 So we first look at how we have dealt

 17 with issues of this sort in the past, and there is

 18 a history of involvement of both the precursor of

 19 the CFTC and the CFTC itself with both the wheat

 20 contract and the grains contract. You see that

 21 this is not a new issue. This issue goes back to

 22 a long time ago, even before the CFTC was formed.

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 1 I could give you a quote from 1926. The

 2 FTC at the time suggested to Congress that "the

 3 Chicago Board of Trade be requested to permit

 4 delivery of grain on futures contracts at other

 5 important markets." So there was that whole

 6 report underlying that.

 7 In March 1979 the CFTC stepped in and

 8 ordered the termination of trading in the expiring

 9 March wheat futures contract at Chicago, and

 10 that's a pretty significant action.

 11 And among some of the reasons for the

 12 termination was a perceived distortion of price

 13 relationship.

 14 In December 1996 the Commission issued a

 15 notification to the Chicago Board of Trade that

 16 the delivery terms on the corn and soybean futures

 17 contracts did not satisfy the objectives of the

 18 Act, and this action resulted in the creation of

 19 the Illinois Waterway delivery system for corn and

 20 soybeans, which many industry participants feel

 21 works very well for these two contracts.

 22 So the initial involvement in the most

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 1 current episode of convergence and contract design

 2 was to study the issue, to bring together

 3 industry, academics, regulators, together, and we

 4 held a number of roundtables, conferences on the

 5 issues. And numerous proposals emerged to solve

 6 the convergence in grins and oilseeds, and wheat

 7 in particular.

 8 Three major types of proposals: One is

 9 to address the structural issues, in particular in

 10 the wheat contract, and the structural issue here

 11 is that the production of wheat has moved west to

 12 Minnesota and North Dakota, but the delivery areas

 13 remained along the Chicago, Illinois waterway

 14 area.

 15 Another set of proposals is to address

 16 the carry, to limit the -- to move away from full

 17 carry, effectively, to limit speculative ownership

 18 of certificates, to limit market participation of

 19 index funds, to increase storage rates, to do

 20 something that would make carry more expensive,

 21 basically.

 22 And the third one is to address the

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 1 decoupling of cash and futures markets in some

 2 more drastic way, to just basically separate the

 3 two markets, that is, through compelled load out,

 4 modified compelled load out, or cash settlement.

 5 So that was the initial involvement, and

 6 then the subsequent involvement, as these

 7 problems, we noticed from the charts that they

 8 sort of were not being solved, the CFTC formed the

 9 Subcommittee on Convergence as a subcommittee of

 10 this Agricultural Advisory Committee. Eighteen

 11 members of the subcommittee were selected from 36

 12 candidates who submitted their -- the candidates.

 13 And sort of the principle that we're following in

 14 working on this issue is to introduce greater

 15 transparency and to induce collaboration, to

 16 elicit collaboration among those who are in the

 17 market, dealing with this contract -- the

 18 exchange, the regulators, and others.

 19 So the work of the subcommittee was

 20 done, the formation and the work was done in a

 21 full transparent fashion.

 22 All the meetings were announced. The

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 1 public was able to listen in to all of the

 2 meetings, and the subcommittee discussed ways to

 3 address contract design issues among the ones that

 4 I showed you before. Basically, there were five

 5 different types of options: To introduce new par

 6 delivery area for wheat; to increase storage

 7 rates; to put penalties on ownership of

 8 certificates; to compel the load out; and to look

 9 into a cash settlement of this contract.

 10 The full report of the subcommittee is

 11 in your binders. The main recommendation that

 12 emerged in the last conference call in September

 13 2009 is that the subcommittee recommended to the

 14 CFTC's Agricultural Advisory Committee that the

 15 CME Group adopts a variable storage rate mechanism

 16 for the CBOT wheat contract starting with the

 17 December '09 contract. At that point, Dave

 18 Lehman, representative of the CME Group on the

 19 subcommittee, objected to this recommendation.

 20 The rest of the report, the underlying,

 21 the background, the summary, and who is on the

 22 subcommittee, is, as I said, in your binders. The

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 1 subcommittee during that conference call also

 2 decided that it will remain as an ad hoc body to

 3 monitor progress with this, with the wheat

 4 contract and other agricultural contracts, and to

 5 see how it could be of further assistance.

 6 Thank you.

 7 COMMISSIONER DUNN: Thank you, Andrei.

 8 David?

 9 MR. LEHMAN: Thank you, Commissioner

 10 Dunn. Thanks for bringing the Ag Advisory

 11 Committee together, the experts in the industry,

 12 to discuss this issue. I think we're finally

 13 there, and there's no "Not" after that statement

 14 because I think the variable storage rate is a

 15 very innovative concept. It's one that addresses

 16 the fundamental cause that the research has shown

 17 behind the lack of convergence, and that is

 18 spreads reaching full carry and not being able to

 19 expand further because of the fixed storage rate.

 20 I just wanted to clarify. Andrei's last

 21 comment was that he noted that I did not support

 22 the subcommittee recommendation, and that's not

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 1 correct. As I think everyone that's involved with

 2 the subcommittee knows, the variable storage rate

 3 proposal came from CME Group. We developed it in

 4 the fall of 2008 and presented that to the

 5 subcommittee. What I objected to was the

 6 implementation date, the December implementation

 7 date.

 8 So what I want to do today is go through

 9 what the variable storage rate proposal is, and we

 10 submitted this to CFTC, as Commissioner Dunn

 11 noted, in late September, September 29th, to be

 12 exact. It's under a 45-day review. And what the

 13 proposal or what the mechanism essentially does is

 14 introduce a transparent, market-driven formula

 15 that would allow storage rates to expand at every

 16 expiration or following every expiration.

 17 So today we have a seasonal storage rate

 18 in place that expands twice a year, or expands

 19 once a year and then retracts. It expands in

 20 July, stays in effect through mid-December when

 21 the storage demand is greatest and storage costs

 22 are higher, and then it reverts back to 5 cents

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 1 per bushel per month in December.

 2 The variable rate is a mechanism that

 3 will allow the rate to increase by that same

 4 amount, by 3 cents per bushel per month, at each

 5 expiration, if the spread as a percentage of

 6 financial full carry is 85 percent or greater. If

 7 the spread, conversely, is 50 percent of full

 8 carry or less, the storage rate would decrease by

 9 the same amount, by 3 cents per bushel per month.

 10 So the two variables in the calculation

 11 are full carry, and that's what this first chart

 12 or slide shows, and that's a straightforward

 13 calculation. We do use the 3-month LIBOR rate

 14 plus 200 basis points --

 15 CHAIRMAN GENSLER: Yes. I just, for the

 16 record, think that that's more than full carry,

 17 but we could ask the committee.

 18 How many of you finance at LIBOR plus

 19 200? I'd be interested, as we go around the

 20 table, how many of you finance at LIBOR plus 200,

 21 how many finance at something else.

 22 MR. LEHMAN: Yes, right now it's 2.28

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 1 percent. So if you have a cost of money that's

 2 less than 2.28 percent, then your full carry

 3 calculation would be a little different. Not

 4 everyone in the market has the same cost of funds.

 5 We know that for a fact. Different entities have

 6 capital available at different rates. We did a

 7 survey, a broad survey of the marketplace on this

 8 particular question, and the survey responses were

 9 very strongly in favor that 200 basis points over

 10 LIBOR is an appropriate cost of capital.

 11 The next variable in the calculation is

 12 just a number of days, and that is typically

 13 either 60 or 61 or 62 in a two-month spread, or 90

 14 or 91 or 92 in a three-month spread. And then,

 15 obviously, the futures price of the nearby

 16 contract and the daily storage premium are the

 17 other variables in the calculation.

 18 So how we implement this is, the spread

 19 is calculated every day beginning on the 18th

 20 calendar day of the month prior to the delivery

 21 month, and then it's compared to this full carry

 22 calculation, that period from the 18th calendar

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 1 day through option expiration day, so that's

 2 roughly 35-40 days. We do the calculation and

 3 calculate the average.

 4 And if over that 35 or 40-day period the

 5 average is percent of full carry of greater, then

 6 on the 18th calendar day of the delivery month,

 7 after deliveries have taken place, we increase the

 8 storage rate by 3 cents per month. That then

 9 stays in effect until the next calculation period.

 10 We start calculating for the following delivery

 11 month right away, on the next calendar day, do the

 12 same calculation through option expiration day

 13 prior to the next futures month expiration,

 14 average it, and have the same announcement.

 15 And we'll publish this on our web site

 16 every day. It will be transparent for the market

 17 to observe what our calculation is. If someone

 18 has a different rate of interest and their

 19 calculation is a little different, they'll be able

 20 to see what we're publishing, anyway.

 21 And so this will be a running mechanism

 22 that continues throughout the crop year. If, as I

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 1 said, that calculation results in a ratio that's

 2 50 percent or less of full carry, the storage rate

 3 will come down by 3 cents per bushel per month.

 4 But it will never fall below 5 cents per

 5 bushel per month or the 16.5/100ths of a cent per

 6 bushel per day. That will be a floor.

 7 So in our view it's a very

 8 market-oriented way to allow the spreads to

 9 expand, and as the spreads expand and are better

 10 able to represent the cost of carry in the cash

 11 market, we expect the front end of the futures

 12 curve to come down and meet the cash market.

 13 As I said, the components of the

 14 calculation, 3-month LIBOR plus 200. Market

 15 feedback confirmed that as an accurate,

 16 transparent measure of the cost of capital.

 17 Current spreads actually confirm that. If you

 18 look at where the spreads are today, using that

 19 interest rate, we're at 95 to 97 percent of full

 20 carry in the nearby spreads.

 21 The trigger level of 85 percent, there

 22 has been some discussion of that, and some have

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 1 used 80 percent as the level to trigger an

 2 increase in storage rate. We think 85 percent is

 3 the right trigger level. It's a level that makes

 4 it a little harder to achieve an expansion in

 5 storage rates, and there is an economic incentive

 6 in this mechanism for firms who are carrying wheat

 7 to try to achieve a higher storage rate by getting

 8 those spreads out beyond the trigger level, so we

 9 don't want to set the trigger level too low and

 10 make that too easy.

 11 We want convergence. We all agree on

 12 the objective. We just want to make sure that the

 13 mechanism doesn't introduce too much flexibility,

 14 I guess, or volatility into what storage rates and

 15 carrying charges are.

 16 Likewise, the 50 percent trigger for

 17 lowering storage rates was uniformly supported by

 18 the marketplace in our survey, and again we think

 19 it's an appropriate number at which to lower

 20 storage rates, and does make it a kind of

 21 difficult target for those who want lower storage

 22 rates. If they're trading in spreads to try to

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 1 achieve that, it's something that won't be all

 2 that easy to achieve.

 3 This is just a history, and I know

 4 Christa and Dave went over kind of the chronology

 5 of the changes in the wheat contract. This is a

 6 chronology of the storage rates in the wheat

 7 contract.

 8 Jan 2000 through July of '08, they were

 9 15/100ths of a cent per bushel per day or 4.5

 10 cents per month. In July of '08 we made an

 11 increase to 16.5/100ths or 5 cents per bushel per

 12 month, so roughly a 25 percent increase in storage

 13 rates at that time.

 14 We still observed problems with

 15 convergence, so we quickly, after the July '08

 16 change, convened an industry group, two industry

 17 meetings actually in Chicago to look at what the

 18 next changes in the wheat contract should be to

 19 address the basis convergence issue. At that time

 20 we agreed on the seasonal storage rate which

 21 increases from 5 to 8 cents per month during that

 22 July through December period, and the additional

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 1 delivery points on the Ohio River, Mississippi,

 2 and northwest Ohio.

 3 So September 2010 going forward, we hope

 4 that we have a variable storage rate in place, and

 5 as I said, this is what's currently pending CFTC

 6 approval.

 7 We wanted to look at why the CME Group

 8 believes in implementing this change in September

 9 of 2010. All of the previous changes that Christa

 10 discussed and the changes that I just discussed

 11 have generally been agreed to around this time of

 12 year or maybe even a little earlier and then

 13 implemented beginning with the next crop year.

 14 And in wheat the new crop begins in July

 15 of -- on the calendar it's a winter grain, so July

 16 through June is the crop year in terms of the

 17 futures market, and that has been our practice in

 18 terms of implementing the new delivery locations.

 19 They were effective this July. The

 20 seasonal storage rate, same time. In July of

 21 2008, as I said, we implemented the higher storage

 22 rate and shipping certificates.

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 1 So that has been our practice, is to

 2 obviously not affect open interest, and not affect

 3 the value of positions that are already held in

 4 the market. So I've listed what the open interest

 5 here is. This was as of, I believe, the 23rd of

 6 October, 185,000 contracts in December, and you

 7 can see across the board in the first four months,

 8 anyway, out through July, where there's 45,000

 9 contracts in open interest.

 10 So if we were to implement the variable

 11 storage rate in December, which the subcommittee

 12 proposed and which I objected to in the

 13 subcommittee report, that would impact all of this

 14 open interest that you see on this slide, this

 15 roughly over 250,000 contracts of open interest.

 16 So the Dec-Mar spread is a 3-month

 17 spread. That could widen out by 9 cents per

 18 bushel at 3 cents in each month, so we would see

 19 that spread potentially going from 19 cents to 27

 20 cents. The Mar-May spread could widen out as much

 21 as 12 cents per bushel.

 22 Now of course we're just saying

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 1 everything else equal, we increase the storage

 2 rate by 3 cents per month, this is what the

 3 spreads would do. And of course we can't predict

 4 what other changes might be going on in the

 5 market, but this is the best we can do in terms of

 6 trying to quantify this issue today, so if you--

 7 COMMISSIONER DUNN: Wait. We've got a

 8 question.

 9 CHAIRMAN GENSLER: I just didn't

 10 understand the arithmetic. Why would, if you go

 11 back a slide --

 12 MR. LEHMAN: Yes?

 13 CHAIRMAN GENSLER: -- why would

 14 March-May go out 12 cents and May-July go out 19

 15 cents? I mean, just pure arithmetic, why?

 16 MR. LEHMAN: Sure. Because these

 17 actually build on -- these are assuming full carry

 18 and they are cumulative, so if we increase the

 19 storage rate in December to 8 cents per bushel per

 20 month, and then in March we increase it to 11, and

 21 in May we increase it to 14, that's -- these build

 22 on each other, Mr. Chairman, so that's how the

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 1 variable --

 2 CHAIRMAN GENSLER: I see. But if it for

 3 instance was just put in place in March, then it

 4 would be two more months to the March-May. Is

 5 that --

 6 MR. LEHMAN: If it was implemented in

 7 March, in March we'll have a 5-cent storage rate

 8 because the seasonal would have expired at that

 9 point, so we would increase the March-May by 3.

 10 The May-July would be 3 on top of that, if we're

 11 still at full carry, so March-May would go up to

 12 8. May-July would go up to -- and so this is all

 13 what would happen if we implemented in December.

 14 I'll get to the March --

 15 CHAIRMAN GENSLER: Yes. Maybe it's a

 16 later chart. It would be helpful to know if it's

 17 March, because --

 18 MR. LEHMAN: Yes. I'll get to that in a

 19 later chart.

 20 COMMISSIONER DUNN: But again, Dave,

 21 just clarification here, it's based upon the

 22 assumption of full carry.

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 1 There's no impact to the rule.

 2 MR. LEHMAN: That's right. It's based

 3 on the assumption that these spreads are at full

 4 carry, and the VSR is triggered based on the

 5 formula that we've proposed to CFTC.

 6 So if each of these spreads still remain

 7 at 85 percent of full carry, they trigger another

 8 increase as we go through time.

 9 CHAIRMAN GENSLER: And isn't it correct

 10 that this past year you actually implemented

 11 changes on the July contract and they were open

 12 interest, so last September and December there

 13 were recommendations and they were implemented on

 14 contracts that were open? Is that correct?

 15 MR. LEHMAN: Yes, and the September

 16 implementation would be on open interest, too, and

 17 the requirement for that is that the Commission

 18 must approve that.

 19 CHAIRMAN GENSLER: So it's not a pure,

 20 black-and-white thing that you never implement

 21 something on open interest?

 22 MR. LEHMAN: No. The black-and-white

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 1 for us, Mr. Chairman, is that we go to the next

 2 crop year. And because the old crop, new crop

 3 dynamics, the fundamentals between crop years are

 4 usually quite different and there's a lot of

 5 variability from one crop year to the next,

 6 therefore going out to a new crop month gives us

 7 the most comfort, and the market has been

 8 comfortable with that as well.

 9 CHAIRMAN GENSLER: But that's with

 10 respect to crop years. Just to make sure we

 11 clarify, it's not related to the open interest,

 12 then. Because you have, the CME has put in place

 13 changes even when there's open interest

 14 outstanding.

 15 MR. LEHMAN: Yes, but that's subject to

 16 Commission approval.

 17 So doing the math, and this is again a

 18 static analysis of what the financial impact would

 19 be of implementing the variable storage rate in

 20 December of this year, which is what the

 21 subcommittee recommended, would have a potential

 22 worst case scenario of $384 million impact on the

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 1 marketplace. Implementing in March --

 2 COMMISSIONER DUNN: Dave, again a point

 3 of clarification. That impact is on swap dealers.

 4 Is that --

 5 MR. LEHMAN: No. This is an impact on

 6 the entire open interest in the marketplace.

 7 COMMISSIONER DUNN: Okay. Did you try

 8 to calculate the cost of the inefficiency in the

 9 marketplace on producers, grain handlers,

 10 processors, and end users?

 11 MR. LEHMAN: We did not make that

 12 calculation, but as the charts that Dave and

 13 Christa showed, the basis from September of 2008

 14 until September of 2009 in Toledo, anyway,

 15 strengthened from about $2.00 under to roughly.60

 16 under. So I would theorize, and some of the

 17 commercial traders who are here could confirm it

 18 better than I, that that's a pretty good pick-up

 19 for the short hedger.

 20 So the short hedger has a basis position

 21 there of long cash. They sell futures, and when

 22 the basis strengthens, that benefits the short

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 1 hedger. Now, if the basis weakens -- so it's all

 2 timing. It's when you put your futures position

 3 on and how the basis moves during the time you

 4 hold your futures position. But if you were

 5 buying grain at harvest, buying wheat at harvest

 6 last September at $2.00 under and you sold it in

 7 May or June of this year at $1.00 under, you gain

 8 $1.00 on the basis as a short hedger.

 9 So, you know, I would let -- obviously

 10 anyone else who might have a comment on

 11 inefficiencies by producers, they can certainly --

 12 COMMISSIONER DUNN: I kind of

 13 circumvented what I set up as ground rules, saying

 14 we would wait until after the presentation, but I

 15 would like those that are producers, grain

 16 handlers, processors and end users to think about

 17 that and during the round of questioning or

 18 comment period, get your input on that.

 19 MR. LEHMAN: Very good. So, moving on

 20 to the March, if we implemented this in March of

 21 2010, obviously we miss the big hump of open

 22 interest that's in December. There's 182,000

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 1 contracts, open interest, in December. In March

 2 would get us beyond that, but March is still --

 3 the March-May spread was 97 percent of full carry

 4 when I calculated it the other day. So that means

 5 if we implement this in March, that spread could

 6 go out by 3 cents per bushel. The May-July spread

 7 could expand as well. And so when you calculate

 8 the feedback effects of implementing in March on

 9 the open interest in each contract month, you come

 10 up with a total of $46 million that would be

 11 transferred as a result of the exchange

 12 implementing a change on existing open interest

 13 that affects pricing of the contract.

 14 CHAIRMAN GENSLER: Dave, just

 15 arithmetic. Again, this assumes that it stays all

 16 in full carry. These fancy Latin words, "ceteris

 17 paribus" means all out --

 18 MR. LEHMAN: Yes, everything else being

 19 equal.

 20 CHAIRMAN GENSLER: -- which also means

 21 like that's not the real world. Okay.

 22 MR. LEHMAN: It's the best we can do

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 1 with the data we have.

 2 CHAIRMAN GENSLER: Well, all right.

 3 COMMISSIONER DUNN: Mr. Chairman, I

 4 thought after our last hearing you weren't going

 5 to use Latin.

 6 CHAIRMAN GENSLER: It's others that put

 7 them in reports. I don't know.

 8 MR. LEHMAN: My economist threw that in,

 9 so I'll have to go back and have him stick to

 10 English in the future.

 11 If we implement in May 2010, now we're

 12 getting -- you know, we have less open interest

 13 that potentially is impacted.

 14 The May-July spread, though, is at full

 15 carry, so that spread would be impacted, and so we

 16 see that spread widening out from 10.25 to 16

 17 cents, and the financial impacts then are shown on

 18 this slide, of what we estimate at $8 million.

 19 If we implement in July of this year,

 20 the July-Sep is trading inside full carry, so

 21 that, potentially implementing variable storage

 22 rate in July may not affect that spread at all.

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 1 And, as I said, the July futures contract is the

 2 first month in the crop year for wheat.

 3 The reason we didn't propose July is

 4 that on July 18th, the day that the July -- the

 5 day the storage rate would be increased under the

 6 variable trigger, we already increase the storage

 7 rate by 3 cents, by the same amount, under the

 8 seasonal rate that's in place today. So there is

 9 significant open interest in July.

 10 It's possible, under the variable

 11 storage rate, that as the market dynamics are

 12 changing, the variable rate might not be triggered

 13 in July. The July-Sep spread might trade under 85

 14 percent of full carry, and we would then not have

 15 an increase to 8 cents on July 18th.

 16 However, if we leave the seasonal

 17 storage rate in place that's there today, we will

 18 increase to 8 cents on July 18th, and then we move

 19 to September and the variable storage rate would

 20 then replace the seasonal rate in September. It

 21 would work on top of the 8 cents that's already in

 22 place because of the July seasonal going into

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 1 effect.

 2 So that's the play on July. I mean,

 3 it's a little complicated, and I apologize for

 4 that. It seems like July would be a good

 5 alternative, but it does have the other side of

 6 the equation, of the rate perhaps not being

 7 triggered by a variable mechanism in July when

 8 it's already going to increase due to the seasonal

 9 rate. So there really is no estimated financial

 10 impact of a July or September implementation,

 11 although the caveat on the July is that it could

 12 be impacted the other way.

 13 COMMISSIONER CHILTON: But, Dave, you

 14 seemed to indicate that May wouldn't have a

 15 material change in the contract.

 16 Is that correct, too?

 17 MR. LEHMAN: Well, our estimate is an $8

 18 million effect, and that's across the open

 19 interest that's in May and July that would be

 20 impacted. So as you move through the months of

 21 the old crop contracts, you have less open

 22 interest that would be impacted, and you don't

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 1 have this building and cumulative effect that we

 2 assumed as we went from December through --

 3 COMMISSIONER CHILTON: But again, that's

 4 the best guesstimate that you can give right now,

 5 and so it's a time certain length enough that your

 6 presumptions, the calculations you're making could

 7 significantly change.

 8 MR. LEHMAN: Yes.

 9 COMMISSIONER CHILTON: I mean, it's a

 10 pretty long way away. So it's $8 million. I'm

 11 not saying $8 million is a de minimis amount.

 12 It's definitely not if you're a farmer or an

 13 elevator or somebody dealing with this. But it

 14 could change significantly between now and then,

 15 right?

 16 MR. LEHMAN: It sure could. That's

 17 right, Commissioner, and as I'm sure many of the

 18 producers and merchandisers in the room can

 19 attest, we've got a very challenging weather

 20 situation in the Midwest right now. Wet weather

 21 is delaying planting of the winter wheat crop. I

 22 have been reading estimates we may have 1 to 2

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 1 million acres less winter wheat planted this year

 2 because of the wet weather. A lot of winter wheat

 3 is planted double crop with soybeans, and the

 4 soybean harvest is just delayed because of the wet

 5 weather, so we may have a very different

 6 fundamental situation by May or July of next year.

 7 COMMISSIONER O'MALIA: Dave, Professor

 8 Irwin has kind of drawn a bright line at the 80

 9 percent level of full carry.

 10 Have you run these numbers against that

 11 calculation?

 12 MR. LEHMAN: This chart, Scott,

 13 Commissioner O'Malia, that I just put up now,

 14 looks at the spreads as a percent of full carry

 15 going back to March of 2007. So what we see in

 16 this chart is that out of these 14 -- I believe

 17 there are 14 -- expirations, an 85 percent trigger

 18 would have been hit nine times. We wouldn't have

 19 triggered the lower storage rate at all during

 20 these 14 expirations, and in five of these

 21 expirations there would be no change, meaning we

 22 fell between 85 and 50.

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 1 Only one of these expirations fell

 2 between 85 and 80. So in March of '07, as you can

 3 see, there was an 82 percent calculation. And

 4 again, this is based on what we saw in history,

 5 and it doesn't take into effect if you triggered

 6 higher storage, then what would the following

 7 spread trade at?

 8 I mean, the following spread is going to

 9 be different if you triggered higher storage, but

 10 we didn't -- you know, we had no way to observe

 11 that from the data.

 12 So we just said from the data that we

 13 have, if we look back through time and back-test

 14 this a little bit, there's only one case where it

 15 fell between 80 and 85. So that's kind of a

 16 non-event, it looks like, from the data, but to be

 17 conservative -- you know, our primary goal is to

 18 really do no damage, do no harm in the market.

 19 We thought choosing 85 was a cautious way to

 20 proceed on this.

 21 There is an Appendix in the hand-out,

 22 and if there's anything that anyone has seen in

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 1 that that they would like me to comment on, I

 2 would be happy to. This just gives really kind of

 3 a recap of a lot of data that Christa and Dave

 4 already presented, shows the actual basis

 5 convergence at expiration for the last year and a

 6 half or so, but I don't plan to cover this unless

 7 anyone would like me to comment on anything in

 8 that appendix.

 9 COMMISSIONER DUNN: Thank you very much.

 10 We will now take a 10-minute break. It might

 11 stretch into 15. And after that break the

 12 panelists are going to be joined by Mr. Bruns and

 13 Mr. Burlet, who are going to give their reaction

 14 to the presentations we have heard so far. Then

 15 I'll open up for any other public comment that

 16 they may have on this proposal, and then open it

 17 up for questions by the AAC. So if we can get

 18 back here in 10 to 15 minutes, we're in good

 19 shape.

 20 (Recess)

 21 COMMISSIONER DUNN: Ladies and

 22 gentlemen, I think we'll go ahead and continue.

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 1 We did a good job earlier this morning of staying

 2 on schedule. So if we could have Mr. Bruns and

 3 Mr. Burlet join the panel, and also Josh Kirley,

 4 who has also asked to make a presentation. And so

 5 I will go through with Mr. Burlet and then Mr.

 6 Bruns and then Mr. Kirley, and then we'll open it

 7 up for any other public comments that we might

 8 have. So if we could begin, please.

 9 MR. BRUNS: Commissioner Dunn and other

 10 Commissioners, we appreciate this opportunity to

 11 appear before you today, and we thank you for

 12 calling this meeting of the Agricultural Advisory

 13 Committee to focus on the solutions for the

 14 Chicago Board of Trade's wheat contract's lack of

 15 convergence. And I thank you for the opportunity

 16 to present the National Grain and Feed's views on

 17 this today.

 18 I am Matt Bruns, Vice President for

 19 Exports for Archer Daniels Midland Company in

 20 Decatur, Illinois. In that function I manage

 21 ADM's risk management on a daily basis. I also

 22 serve as Vice Chairman of the NGFA's Risk

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 1 Management Committee as well as NGFA's

 2 representative to the Agricultural Advisory

 3 Committee.

 4 As you know, the NGFA and its member

 5 companies have worked for many months for

 6 solutions to the lack of convergence on the CBOT

 7 wheat contract. Less convergence and less

 8 predictability in the futures and cash prices has

 9 resulted in a less useful hedging tool for our

 10 member companies, who are the first purchasers

 11 from producers, and who hedge their price and

 12 inventory risk on regulated exchanges.

 13 The NGFA's member firms play a

 14 critically important role in helping producers

 15 market their crops by offering a variety of cash

 16 forward contracts. Unfortunately, some of the

 17 availability of these cash forward contracts has

 18 been constrained in the last couple years due to

 19 spikes in the future prices which have caused

 20 large margin requirements on most end users and

 21 commercials, as well as CBOT's wheat contract's

 22 unpredictability in basis levels.

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 1 Over the past two years we have worked

 2 closely with the CME Group for solutions that

 3 could reestablish convergence.

 4 We support the contract changes made to

 5 date by the CME Group, and we agree that

 6 additional action is necessary in order to

 7 reestablish a reliable relationship between cash

 8 and futures values.

 9 With respect to the current proposal by

 10 the CME to implement a variable storage rate on

 11 the contract, we are in complete agreement that

 12 this contract amendment is the next logical step.

 13 We believe that, over a period of time, the

 14 variable storage rate will reestablish

 15 convergence.

 16 That is an important point. The

 17 variable storage rate will take some time to work.

 18 We believe that it eventually will result in

 19 convergence, but it will be a process as the

 20 storage rate ratchets up over time. For that

 21 reason, we have recommended strongly that it be

 22 implemented as soon as possible, ideally on the

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 1 December 2009 contract, so it can begin the

 2 process of working immediately.

 3 Our industry has struggled with this for

 4 more than two years on the wheat contract, with

 5 the lack of convergence.

 6 Waiting until September of 2010 to

 7 implement this change proposed by the CME could

 8 result in another couple years before the change

 9 would have its full effect. Our member firms and

 10 their farmer customers who rely on a properly

 11 functioning futures market to manage their risk

 12 cannot afford to wait another couple years.

 13 A second compelling reason to implement

 14 the VSR right away is, if we don't, the storage

 15 rate will actually move in the wrong direction.

 16 Under the current seasonal storage rate

 17 implemented earlier this year, the rate is

 18 scheduled to move down from 8 cents per bushel per

 19 month to 5 cents per bushel per month in December.

 20 Clearly, this would be a move in the

 21 wrong direction. Even if the VSR is implemented

 22 this December, it will simply have the effect of

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 1 keeping the storage rate at the current level, but

 2 at least better than letting the rate tick down

 3 and allowing further delays in implementing the

 4 VSR's effects.

 5 Currently, right now in Toledo the cash

 6 basis bid is around.95 under, so you can see to

 7 get to convergence we have about.95 from today's

 8 values. Now. that's the bid, and Mr. Lehman,

 9 there's a long ways between the bid and what's

 10 actually trading, but that's where we are today.

 11 So we just view that as one reason to implement it

 12 sooner rather than later.

 13 It's also important to note that the

 14 Agricultural Advisory Committee's own Subcommittee

 15 on Convergence has recommended the VSR be

 16 implemented in December of 2009. We have

 17 appreciated being part of this subcommittee's

 18 discussions, and we hope that the Commission will

 19 place a high priority on implementing its expert

 20 recommendations.

 21 In the interest of balance, we do

 22 recognize that implementing the VSR in December

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 1 will have some impacts on market participants.

 2 However, we believe that those impacts would be

 3 relatively small compared to the consequences for

 4 commercial grain hedgers and producers of

 5 essentially putting off the solution for another

 6 couple years.

 7 And below we've got an examination of

 8 the open interest which was probably one or two

 9 days away from Dave Lehman's example that he used

 10 on OI. Generally we agree with the CME group that

 11 significant changes should not be implemented on

 12 contract months with high levels of open interest.

 13 However, the numbers show that open interest drops

 14 dramatically after December 2009, and by May 2010

 15 is not significantly higher than September 2010.

 16 A second factor that supports quick

 17 implementation is the fact that spreads are not at

 18 full carry on the July through September 2010

 19 contract, a condition that the CME Group has

 20 indicated in the past would make them more

 21 comfortable on making changes with open interest.

 22 We urge the CME and the Commission to take these

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 1 factors into account when determining the final

 2 implementation date.

 3 Another reason for early implementation

 4 is old crop versus new crop, which for a fact in

 5 July when you start harvest, you have more supply

 6 on the market than you do demand because of the

 7 harvest bushels that are upon us. Thus, any

 8 material changes on a contract will be slower to

 9 see starting in July because of the new crop

 10 supply, whereas if you implemented in this old

 11 crop, old crop months, you would see the changes

 12 more quickly in the basis levels and this VSR

 13 would work more quickly, in our opinion.

 14 With this exceptional and urgent

 15 situation, we submit that the Commission and the

 16 CME Group need to weigh the potential impacts on

 17 the market participants with open positions, some

 18 who may already assume that the VSR is coming,

 19 versus the harm that could be inflicted on the

 20 wide swath of commercial grain hedgers if

 21 convergence is deferred for another couple of

 22 years.

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 1 We believe strongly that the broader

 2 public good of implementing the VSR quickly

 3 outweighs the concerns about potential negative

 4 impacts. If December 2009 implementation cannot

 5 be met, we urge the implementation be no later

 6 than the March 2010 contract.

 7 We would view this quick implementation

 8 as a one-time, extraordinary action, made

 9 necessary by the specific circumstances

 10 surrounding the CBOT's wheat contract. If the VSR

 11 would be considered in the future for corn and

 12 soybeans, we would anticipate a more traditional

 13 approach to amending those contracts.

 14 In order to ensure that the VSR more

 15 robustly and quickly encourages convergence, the

 16 NGFA also recommends that the trigger rate where

 17 higher storage rates be implemented is 80 percent,

 18 instead of the 85 percent that the CME has

 19 proposed. We view this as a small and subtle

 20 change in order to more quickly achieve our goal

 21 of convergence. In conclusion, the NGFA has

 22 worked diligently with the CME and the CFTC on

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 1 this important issue, and we continue to support

 2 efforts to bring balance and viability to this

 3 contract. We stand ready to continue with that

 4 support, and we will provide technical and

 5 practical assistance in bringing conclusion to

 6 this matter as soon as possible. Thank you.

 7 COMMISSIONER DUNN: Thank you very much,

 8 Mr. Burlet. Mr. Bruns?

 9 MR. BURLET: Mr. Chairman,

 10 Commissioners, thank you very much for this

 11 opportunity to speak today. My name is Chad

 12 Burlet. I am President of Burlet Trading, and

 13 over the course of my career I have had the good

 14 fortune of being able to view this issue and

 15 similar issues from four very different

 16 perspectives.

 17 From my time with Cargill, I can

 18 appreciate the view of a company that is often a

 19 maker of delivery and is owner of a considerable

 20 amount of storage space, so I clearly understand

 21 why they would encourage or the National would

 22 encourage a quicker implementation. Through my

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 1 time with Goldman Sachs, I can appreciate the role

 2 that the over-the-counter market has in this

 3 process, as well as a firm that very often

 4 participated as a taker of delivery.

 5 Also during that time I served four

 6 years on the Board of Directors at the old Chicago

 7 Board of Trade, and I can appreciate the

 8 exchange's responsibility in this process. And

 9 now as a professional trader I sit in somewhat

 10 more of a neutral corner and can observe the

 11 process hopefully a little bit more objectively.

 12 Clearly the key issue today is the

 13 question of timing. I would like to respectfully

 14 disagree with the suggestion that this needs to be

 15 rushed into because it will take time to work. I

 16 can assure you that once the decision is made by

 17 you Commissioners, the market will price it within

 18 a day, and the market will begin to react.

 19 The irony is that the previous change,

 20 which was a massive expansion of delivery

 21 territory, actually does take time to work because

 22 of the physical aspect of adding space, adding

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 1 transportation, building business relationships,

 2 and positioning one's facility to participate in

 3 the process. I think the chart that Mr. Kass put

 4 up demonstrating a significant improvement from

 5 2008 to 2009 is an indication that that change is

 6 beginning to work.

 7 One of the principles that's being

 8 considered today I think is a principle that

 9 transcends the futures business and really relates

 10 to all businesses in general, and that is the

 11 sanctity of a contract. And our legal system has

 12 frowned upon changing legal contracts after they

 13 have been entered into, and I don't think the

 14 current situation reaches the threshold of

 15 ignoring the sanctity of the existing contracts.

 16 I would also submit that I think David's

 17 estimates of the dollars involved are decidedly

 18 understated, as they only consider the impact on

 19 the open interest at the exchange. The impact

 20 would be far greater and would far exceed those

 21 holding futures positions. The over-the-counter

 22 market would clearly be impacted, and the cash

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 1 market is going to be impacted.

 2 So what's being considered with a change

 3 within the crop year is a massive wealth transfer,

 4 and puts the Commission in the inappropriate

 5 position of choosing winners and losers.

 6 And I can't say whether the beneficiary

 7 or the harmed party would be the hedged or the

 8 unhedged farmer, whether it would be the hedged or

 9 the unhedged miller, but clearly a massive wealth

 10 transfer would occur, and I think the law of

 11 unintended consequences would certainly rear its

 12 ugly head.

 13 So, in closing, I would encourage the

 14 Commission to follow the recommendation of the CME

 15 to wait for new crop for implementation. I think

 16 rushing to make the change in the next couple of

 17 months would do the contract far more harm than

 18 good.

 19 Thank you.

 20 COMMISSIONER DUNN: Thank you very much,

 21 Chad, and I apologize for calling you "Mr. Bruns."

 22 MR. BURLET: That's actually a nice

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 1 compliment.

 2 COMMISSIONER DUNN: And I apologize to

 3 you, as well, Matt.

 4 Josh Kirley had asked if he could make a

 5 presentation, and now is the time for any of the

 6 public that wants to have any input into this that

 7 were not on the original schedule. So with that,

 8 Josh, if you would, please.

 9 MR. KIRLEY: Thank you very much, Mr.

 10 Chairman, Commissioners. I will do my best to be

 11 brief.

 12 As you said, my name is Joshua Kirley.

 13 I am the Vice Chairman of the Wheat Futures Pit

 14 Committee and a high-volume liquidity provider for

 15 all spreads in the CBOT wheat futures contract.

 16 Let me say firstly and clearly, given my

 17 direct experience in trading these spread

 18 contracts every day, both in the pit and on the

 19 screen, I feel very strongly that this current VSR

 20 proposal is a well-intentioned but one-sided and

 21 misguided solution to a serious problem.

 22 Implemented at any date, variable storage rates

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 1 will decimate liquidity, encourage market

 2 manipulation, confuse and destabilize an already

 3 skittish marketplace, and discourage people from

 4 trading futures past the first month, particularly

 5 if they are a long hedger.

 6 But the reason I flew in from Chicago to

 7 be here today is a far more pressing issue: That

 8 is the possibility of early implementation of

 9 variable storage rates. I can say with a fair

 10 amount of certainty that early implementation will

 11 cause irreparable damage to the integrity and

 12 functionality of this wheat contract. It would be

 13 similar to yelling "Fire" in a crowded theater and

 14 then sealing the exits.

 15 To realize how one-sided and significant

 16 a change this would be, you must first understand

 17 how important full carry is to a spread trader.

 18 In a market with so many variables, it is the

 19 closest thing we have to an absolute. Full carry

 20 is the cornerstone of the spread trade.

 21 Full carry allows traders like myself to

 22 manage risk. Like futures themselves, there is

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 1 beauty in its simplicity. It is a stabilizing

 2 force, providing definitive parameters often

 3 acting as brakes to a runaway train. While there

 4 are no perfect analogies between commodity spreads

 5 and outright equities, the closest thing that

 6 exists is comparing full carry in spreads to a

 7 stock price of zero. That is, when a person buys

 8 a stock, they know their downside risk. They

 9 cannot trade below zero. Having that certainty

 10 contributes to a liquid market.

 11 Liquidity providers like myself are

 12 willing to bull spread inside a full carry because

 13 it is a trade with clear-cut, measurable risk

 14 parameters. Much like the person who invests in a

 15 stock, they do so knowing the risk and only

 16 risking what he or she can afford to lose.

 17 The very fact that you have people who

 18 are willing to take that calculated risk provides

 19 a service to the market.

 20 When everyone feels the need to sell,

 21 that wall, be it full carry in a future spread or

 22 zero in a stock price, it creates a pool of

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 1 willing bidders.

 2 In a stock, those bidders provide an

 3 orderly exit to people who are long and wrong. In

 4 a grain spread, those bidders facilitate the role

 5 of a position for the long hedger.

 6 Without that fixed value, long hedgers

 7 could lose up to $2 or $3 a year on their long

 8 position even if the price of wheat itself does

 9 not go down a single penny.

 10 What you are proposing through early or

 11 immediate implementation of this VSR would be akin

 12 to interceding in a publicly traded stock and

 13 telling the shareholders that zero is no longer

 14 the end of the line. Imagine the person that

 15 bought 1,000 shares for $5 apiece. They did so

 16 knowing the maximum risk of that trade was $5,000.

 17 Now, what if an outside agency were to step in and

 18 decree that now this particular stock can trade as

 19 low as negative $5?

 20 Only with immediate implementation of

 21 variable storage rates it gets worse than that,

 22 because that negative $5 mark is now a variable,

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 1 and the closer the stock price gets to it, the

 2 further away it moves from you. That's why I said

 3 earlier by this formula, it rewards bullying. The

 4 more you can move a market in one way, the more

 5 potential it has to continue moving in that

 6 direction.

 7 Once that person is finally able to

 8 offset that loss, a loss far greater than what was

 9 possible according to the rules at the time they

 10 purchased the stock, even if they are still

 11 solvent, they're never going to buy that stock

 12 again. They will probably never invest in any

 13 stocks offered on that exchange.

 14 Even if VSR will lead to convergence,

 15 and I side with a number of academics who believe

 16 it won't, what good is convergence if there is no

 17 liquidity left in the marketplace?

 18 After all, you cannot execute a trade if

 19 there is no one to take the other side of it. How

 20 can it be a market improvement if it blatantly

 21 serves one segment of the trading population to

 22 the clear detriment of the other?

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 1 Or, in another sports analogy, how can

 2 you allow the players of one team to change the

 3 rules of a sport during the fourth quarter of a

 4 game? And, to quote a Reuters reporter, immediate

 5 implementation of the VSR would be like moving the

 6 goal posts after the football has already been

 7 kicked.

 8 Earlier Dave Lehman here stated that $7

 9 million would be lost if this proposal is

 10 fast-tracked into a market that does not have the

 11 time to prepare for it or the energy to absorb the

 12 policy change. It is the people who are on the

 13 right side of that $7 million that are trying to

 14 press you into doing just that. The others, even

 15 if they are still solvent after it's over, the

 16 traders who were just burnt by having the rug

 17 pulled out from under them are not going to stick

 18 around to get fooled again.

 19 Making this degree of wholesale change

 20 to an active contract with more than half of the

 21 open interest, especially to a spread that is

 22 already trading at full carry, would profane the

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 1 integrity of the contract, violating the trust

 2 that us market participants have placed in this

 3 body and our exchange. In the wheat contract, our

 4 liquidity pool has already dwindled by more than

 5 50 percent, with the remaining few market makers

 6 only willing or able to take less than half of the

 7 size they once did. If this VSR is forced through

 8 in the short term, that liquidity pool will run

 9 dry.

 10 Earlier, in making the case for

 11 immediate implementation, Mr. Bruns stated that we

 12 must act now because it could be two years before

 13 we see the desired results. All I ask is that

 14 they extend that same patience and courtesy for

 15 changes that have already been made by our

 16 exchange.

 17 Markets are not like a sports car, where

 18 you turn the wheel and there's an immediate and

 19 precise and immediate reaction. It's more like

 20 driving a big boat. If you've ever done that for

 21 the first time, you turn it and you think nothing

 22 happened and you turn it back, and you're not sure

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 1 which turn is causing the changes.

 2 Well, in the wheat market we've had six

 3 minor and one major changes in the last year.

 4 We've changed the trading hours, we've changed the

 5 algorithms, we've changed the seasonal storage

 6 rate, we've changed the settlement procedures.

 7 It's just too many changes in too short a time for

 8 the market to absorb. It's over-baked. We need

 9 to let this market breathe and find out what

 10 effect these changes are going to have.

 11 In my opinion, the changes already made

 12 by the CME have made and continue to show promise.

 13 The CME's seasonal storage rates are already

 14 working. Convergence has improved for 12

 15 consecutive months. Just because the existing

 16 plan does not provide for limitless profits for

 17 grain elevators and short hedgers is no excuse to

 18 destroy the remaining integrity and liquidity to

 19 the contract.

 20 I know I went on longer than I wanted

 21 to, so if I could just say one last thing, I wrote

 22 a long letter, as you can guess, to the CFTC web

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 1 site. I encourage you all to read it. And,

 2 finally, I would like to thank you all very much

 3 for letting me come here and speak today. At no

 4 point in this process have you heard from the

 5 liquidity providers, the people that actually make

 6 the trades in the pit and on the screen, and I

 7 appreciate your giving myself and us the chance to

 8 be involved in this process. Than you very much.

 9 COMMISSIONER DUNN: Thank you very much,

 10 Josh. We genuinely appreciate your coming here

 11 today and expressing your point of view. That is

 12 what this Commission and this Advisory Committee

 13 is all about, hearing all sides of the issues.

 14 Is there anyone else from the public

 15 that would like to make a comment or a statement

 16 at this time?

 17 (No response)

 18 COMMISSIONER DUNN: If not, then I will

 19 turn this over to the Advisory Committee for their

 20 questions that they have, and feel free to call on

 21 any of the panelists that you have heard to date.

 22 Please identify yourself.

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 1 MR. COPPOCK: Thank you, Mr. Chairman.

 2 Daren Coppock with the National Association of

 3 Wheat Growers. I have a question for the last

 4 speaker.

 5 I believe you opened your statement by

 6 saying that this variable storage rate concept was

 7 a well-intentioned but wrong approach to solve a

 8 serious problem. What I'd like to know from you

 9 is, in your view, what is the problem, and what

 10 would you propose to fix it?

 11 MR. KIRLEY: To be totally honest, I

 12 have no idea. There are a lot of great or

 13 macro-economic factors in place here that I don't

 14 understand. What I do understand is the actual

 15 physical trading. I know what happens. For

 16 example, in my opinion, variable storage rate has

 17 already been introduced and the market rejected

 18 it.

 19 On August 24th the NGFA issued a

 20 statement that said this committee was leaning

 21 towards immediate implementation of variable

 22 storage rates. The next day there was no

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 1 liquidity in the market. There was about a 3-cent

 2 pocket where everyone cancelled bids and offers.

 3 $15 million changed hands. People -- it basically

 4 destroyed liquidity and order. I don't know what

 5 the solution is, but this isn't it. This just

 6 will not work in a real, practical sense.

 7 MR. COPPOCK: Let me re-ask my first

 8 question, then: What's the problem?

 9 MR. KIRLEY: A lack of convergence, and

 10 I think a lack of convergence is not so much the

 11 problem as a symptom of the real problem, which is

 12 a lack of liquidity. That is, there are a lot

 13 less participants willing to take a lot less risk.

 14 COMMISSIONER DUNN: Yes?

 15 MR. WILLETT: Does additional volume

 16 necessarily mean additional liquidity in the

 17 marketplace?

 18 MR. KIRLEY: Additional volume within,

 19 say, two or three ticks above whatever the trading

 20 price is. When I'm speaking of volume, I'm

 21 speaking of not trading volume but actual bid and

 22 offer volume. I'm saying on August 23rd if you

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 1 had 1,000 Dec-May or March-May contracts, you

 2 could have gotten out of that position within one

 3 or two ticks. The next day, after this was not

 4 green-lighted but it looked like it might happen,

 5 it would take you 50 or 60 or 70 ticks to get out

 6 of 200 contracts. What I mean by "volume," I mean

 7 the size of the bids and offers. They were there

 8 before and they're not there now.

 9 VOICE: I think you meant September,

 10 right, Josh?

 11 MR. KIRLEY: Yes, I'm sorry. Yes,

 12 September. Sorry.

 13 COMMISSIONER DUNN: Gary?

 14 MR. NIEMEYER: Gary Niemeyer with the

 15 National Corn Growers. I am a farmer, and first

 16 of all I'd like to say that I'm really not a

 17 person who relishes regulations. I just want the

 18 markets to perform in a reasonable and expected

 19 fashion, minus the volatility that is normally

 20 associated with commodity markets.

 21 And in some of the questions, you know,

 22 there is not going to be a good time to implement

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 1 any of these, ever. I mean, quite honestly, if

 2 you really are interested in new crop, you could

 3 start with corn and soybeans right now, but

 4 obviously wheat is the larger problem.

 5 And you say that it would have a

 6 financial problem. If I'm not mistaken, you

 7 almost trade three years worth of products

 8 currently on the board, so again, there is no good

 9 time. But I would hope that we could resolve

 10 somehow something that makes it possible for me to

 11 be able to sell my grain and to get financed from

 12 a banker and expect a reasonable convergence at a

 13 certain point in time.

 14 I think delaying this much longer is

 15 just not going to resolve the problem. It's

 16 probably going to take a year for it, even with

 17 the variable rate, to see how it works. And I'm

 18 sure that there has already been a lot of

 19 leaked-out information for the last several

 20 months. I read it every night on my commodity

 21 reports, about regulations that are coming down,

 22 so I don't think it's unexpected.

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 1 COMMISSIONER DUNN: Just to follow up,

 2 Gary, I had asked for producers to try to come up

 3 with some type of back-of-the-envelope guess of

 4 what is the lack of convergence costing you now.

 5 MR. NIEMEYER: Well, I'll answer that

 6 question. I think when I was here the last time,

 7 we had a meeting, it was in April a year ago or

 8 something of the sort, and I was just really

 9 getting into it. But at the time, in the middle

 10 of the summer I decided to purchase fertilizer

 11 because it looked like the price was going up

 12 dramatically, and I wanted to sell my crop and I

 13 couldn't do it. There were no elevators. I could

 14 do it if I had a multimillion-dollar financial

 15 backing that I could go borrow money to trade

 16 commodities with.

 17 Those input costs continued to climb all

 18 the way through September, so I did make a smooth

 19 move by prepurchasing, but I couldn't sell my

 20 grain. And I tried several times to sell

 21 December, this year's crop that we're currently

 22 harvesting, for $6.51. I do follow charts. And I

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 1 couldn't get the job done at multiple elevators.

 2 Again, I could have gone and borrowed maybe

 3 $250,000 or $300,000 to cover a position as large

 4 as the amount of corn.

 5 I don't know how to answer directly, but

 6 I also got to thinking about the concerns and the

 7 situation where we're in right now. If we would

 8 have had this kind of fall last fall, I can't even

 9 begin to tell you what the markets would have

 10 done.

 11 I can't anticipate that. There is a

 12 certain amount of volatility you're never going to

 13 get away from in this market, and it's price risk

 14 management. But the ability for me not to sell

 15 through my elevator, which I've sold through for

 16 40 years I've been farming, the next year's crop

 17 or a portion of it just to cover my cost, was not

 18 available.

 19 COMMISSIONER DUNN: Thank you.

 20 MR. DOUD: Greg Doud with the National

 21 Cattleman's Beef Association. I have a question

 22 for Mr. Lehman, and would like the other panelists

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 1 to react to it as well.

 2 I'm curious as to why you didn't go to a

 3 cash settled contract, and instead chose this

 4 variable storage rate. And I'm curious to know

 5 from the other panelists whether this would

 6 resolve some of these issues or not.

 7 MR. LEHMAN: Cash settlement, as you

 8 have read the report from the Convergence

 9 Subcommittee, was one of the alternatives that

 10 that subcommittee discussed and reviewed. It's

 11 something that the exchange has looked at for

 12 quite some time, much, much longer than the

 13 Convergence Subcommittee has been in effect, and

 14 we do use it in some of our livestock markets.

 15 We have cash settlement for lean hogs.

 16 We have it for the feeder cattle contract as well.

 17 The industry, the grain industry, as we

 18 discussed it with them, really felt that they

 19 weren't comfortable with the reliability of cash

 20 prices that are available, since they are only

 21 bids. As I wanted to confirm with Mr. Kass

 22 earlier in terms of his basis charts, these are

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 1 public bids that -- in his case apparently they

 2 were from a private source, but typically what's

 3 available, what we would have to use if we were to

 4 try to construct a cash index, would be public

 5 bids that USDA collects from grain elevators,

 6 ethanol producers, processors.

 7 And those bids are what -- you know,

 8 what that entity wants to be published for that

 9 location, and not necessarily what price they

 10 would pay for grain if they were buying grain, and

 11 certainly they don't represent the price at which

 12 they could sell grain because there's a margin.

 13 So several issues over reliability of data, over

 14 concentration of who the firms are that would be

 15 providing that data, have really made this a

 16 non-starter for the marketplace that we talk to

 17 when we're working on contract design changes. So

 18 that's my perspective.

 19 COMMISSIONER DUNN: Mr. Lehman, are you

 20 then advocating mandatory price reporting for

 21 grains?

 22 MR. LEHMAN: No, I'm not.

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 1 COMMISSIONER DUNN: Just wanted to be

 2 sure.

 3 MR. BURLET: To elaborate on what Mr.

 4 Lehman said, I'll use soybeans for an example.

 5 The soybean market, with a processor, when you

 6 have a $1.00 or $1.50 crush margin, you know, the

 7 bids and payables can vary between.30 and.50 a

 8 bushel as far as what they're posting compared to

 9 what they're paying, just because of the amount of

 10 margin that the processor is making.

 11 So there's a big push in soybeans, for

 12 example, compared to the other grains, so soybeans

 13 would be a problem as far as a cash settled

 14 contract, getting accurate information on what

 15 bids are out there.

 16 MR. CRYON: I'm Roger Cryon with the

 17 National Milk Producers Federation. Our members

 18 don't necessarily buy or sell wheat, but we are

 19 interested in effective grain futures markets

 20 generally.

 21 Last year there was an academic

 22 roundtable to discuss this issue, and I thought

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 1 the Chief Economist's office did a very nice job

 2 describing what I thought at the end of that

 3 meeting was a consensus, that the underlying issue

 4 was that these wheat futures with the fixed

 5 storage rates effectively had an option for

 6 storage attached to it, and that when the actual

 7 market value of storage diverged from that fixed

 8 rate, it created a premium on the contract that

 9 caused divergence from the cash market.

 10 I haven't really heard that discussed in

 11 quite that sense, that the solution then, the

 12 theoretical solution is to find a way to set the

 13 storage rates so that they reflect the market

 14 value of storage when the time comes to take

 15 delivery of one of these contracts. And actually,

 16 in fact, when I first read this proposal, that's

 17 what I ought I was reading. I guess I didn't read

 18 it closely enough.

 19 I thought I was reading a proposal to

 20 actually set the storage rate for the current

 21 month's contract at a function of the spread from

 22 that month to the next month, which seemed to make

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 1 a lot of sense to me. But what I think I see in

 2 this proposal, with the 3 cents that has the

 3 potential to kind of continually ratchet up the

 4 storage rate 3 cents at a time without necessarily

 5 ever bringing it back down, is a kind of implicit

 6 forced load-out.

 7 That's one solution. You know, that's a

 8 solution that's a little bit of a gross

 9 instrument, but it is one solution.

 10 But I think it's worth recognizing that

 11 under certain circumstances the result of this

 12 proposal is to essentially put into effect a

 13 forced load-out. I just think that it ought to be

 14 made clear, as this is being discussed, that

 15 that's effectively what is being proposed.

 16 MR. LEHMAN: Just as a point of

 17 clarification, the variable storage rate mechanism

 18 does let the storage rate come back down under the

 19 formula that we have defined. If the spread

 20 trades below 50 percent of full carry, then it

 21 comes down at the same rate that it went up, by 3

 22 cents per month. There is a minimum that we

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 1 specified at 5 cents per bushel per month.

 2 And just another point: These rates

 3 that would ratchet up potentially by 3 cents at

 4 each expiration or following each expiration are

 5 maximum storage rates, and that has always been

 6 the case in our contracts. The storage rate

 7 that's specified is the maximum, so that an

 8 individual warehouseman could negotiate a

 9 different rate with someone if they choose.

 10 And I think the difference in how,

 11 Roger, you're perceiving the optionality issue

 12 that the academic roundtable reviewed -- and I

 13 think that's an appropriate theoretical analysis

 14 of how these contracts really work, is they do

 15 have a storage option in them, and the fixed

 16 storage rate caps the premium on that option. So

 17 by having a mechanism to allow the storage rate to

 18 expand, we remove that, you know, that barrier, if

 19 you will, on the premium of the option.

 20 And I think the only difference we have

 21 is on when it would apply. It sounds like you're

 22 suggesting that it should apply on the current

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 1 delivery month, so that you would actually be

 2 paying that rate if you take delivery in the

 3 current month, and our thinking is that that's

 4 probably unfair to the marketplace, to make a

 5 change that close.

 6 So it would be changing it -- five days,

 7 essentially, before you entered deliveries, you

 8 would be changing the economics of whether you

 9 took delivery and carried that instrument or not.

 10 So we choose to implement it after deliveries in

 11 the nearby month, and so it has a little bit of a

 12 lag, but I think that's a little fairer way to do

 13 it.

 14 MR. CRYON: Can I respond? I think --

 15 I'm obviously not taking a position on this, but

 16 the way I read it, what I imagined was a

 17 reasonable approach was that you would apply the

 18 -- because the objective is essentially to set the

 19 storage rate as close to the market value of

 20 storage as possible, that you would have that

 21 apply to the current contract, and then the next

 22 contract would start over again. Instead of

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 1 having a continual escalator/de-escalator, that it

 2 would be refigured every month based on how the

 3 carry relates to the spread. And that's a

 4 theoretical observation. It's not a position.

 5 MR. COPPOCK: If I can, let me jump back

 6 in with a few comments. I apologize. I'm going

 7 to have to leave shortly for another commitment.

 8 But from the Wheat Growers' perspective, let me

 9 just offer a few brief comments on how we look at

 10 what's being proposed.

 11 Fundamentally, lack of convergence is an

 12 impairment to the functioning of the market, and

 13 so it results in higher, more volatile basis. It

 14 creates a situation where producers can't hedge

 15 their risk, where our commercial customers can't

 16 hedge their risk, either, and it impacts the

 17 ability of grain merchandisers, to whom we sell

 18 our crops, to be able to offer the kinds of

 19 services that Gary was talking about earlier,

 20 whether it's cash forward contracts or other

 21 things. Our marketing options get shrunk when the

 22 futures market is not performing adequately.

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 1 So there has to be a strong link between

 2 futures and cash markets and strong convergence.

 3 Otherwise, trying to play in that market is like

 4 playing fantasy football. We might as well trade

 5 the contract in Las Vegas if it doesn't have any

 6 more relation to the cash market than what it has

 7 shown in the recent years.

 8 This proposal may work to improve

 9 convergence. It may not work. The consensus

 10 within our organization is that it's worth a try,

 11 and it's worth a try sooner rather than later.

 12 I know the open interest issue is a

 13 valid concern. None of us, I think, want to cut

 14 across commercial contracts in any circumstance if

 15 we can at all avoid it.

 16 But also keep in mind that the longer we

 17 allow the market to continue not functioning also

 18 relates to harm, as Commissioner Dunn has alluded

 19 to, and that there are farmers and commercial

 20 players in the market who are impacted by that.

 21 And so the sooner we can get a solution

 22 in place, the better. It's not a perfect one.

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 1 It's a bit of a blunt instrument.

 2 But there are no perfect solutions.

 3 Some have noted that it's going to be a major

 4 wealth transfer from one sector to another, and

 5 that may be true, but I think it will help

 6 convergence and we think it's worth a try.

 7 It's also important to remember this is

 8 part of the solution. Lots of other changes have

 9 been made: the vomitoxin specs, new delivery

 10 points on the contract. All of those things

 11 together hopefully will lead us toward more

 12 convergence down the road.

 13 One of the signals from the market that

 14 we have watched and the somebody asked earlier for

 15 other comments, not necessarily related directly

 16 to this proposal, but one of the things that

 17 really caught my eye was, at one point the Chicago

 18 market had something like three times the amount

 19 of open interest as the actual production of the

 20 underlying commodity, which signals that there is

 21 some huge disconnect between the cash and the

 22 futures.

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 1 Now, I know there's lots of reasons why

 2 that can happen. Part of it is that production

 3 variability in soft white winter bounces around

 4 from one year to the next. People that raise soft

 5 white wheat from the Northwest tend to hedge it in

 6 Chicago because there's no white wheat contract.

 7 Lots of global players will hedge their wheat risk

 8 in Chicago. And so there's lots of reasons why

 9 they might not exactly line up, but three times

 10 the actual commodity production seems a bit high.

 11 The last thing I would say is that we

 12 would like to see CFTC and CME proceed, but

 13 proceed with caution. And I think a concern that

 14 probably all of us share around the table is,

 15 let's make sure that the cure isn't worse than the

 16 disease.

 17 COMMISSIONER DUNN: Thank you, Daren.

 18 Jim?

 19 MR. BAIR: I'm sorry, Josh. I didn't

 20 catch your last name.

 21 MR. KIRLEY: Kirley, K-I-R-L-E-Y.

 22 MR. BAIR: Would it be possible for the

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 1 Commission to make his statement available to the

 2 committee? Electronically, preferably, but I

 3 would like to have that if I could. Thank you.

 4 COMMISSIONER DUNN: When we get a

 5 transcript of this, we can get it out, but I can't

 6 give you an absolute period of time that we're

 7 going to get that done.

 8 MR. KIRLEY: I can e-mail it to you

 9 right now, if you want.

 10 COMMISSIONER DUNN: Others? Gary?

 11 MR. NIEMEYER: Yes. Mr. Lehman, I want

 12 you to understand, we really don't want to destroy

 13 the market. We want to make it work. That's our

 14 whole purpose. And the gentleman from Beef

 15 brought up the last thing I was going to bring up

 16 today: Why don't you develop a new, side-by-side

 17 index trade of cash settlement or something? That

 18 would not upset this gentleman, would not upset

 19 this gentleman, would not upset this gentleman.

 20 And maybe that is the means, by achieving

 21 convergence for me and keeping the market viable.

 22 I mean, that was just my general observation.

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 1 MR. LEHMAN: I work in research and

 2 product development. That's my responsibility at

 3 CME Group. And we're always looking at new

 4 products. We already have a cash settled wheat

 5 calendar swap that was launched in April of this

 6 year.

 7 We have a cash settled corn calendar

 8 swap as well, and a soybean calendar swap, so we

 9 have cash settled instruments that are available.

 10 In fact, they're available for you to trade

 11 directly with a counter-party rather than trading

 12 it on our centralized order book platform.

 13 Now, maybe you would prefer to have it

 14 traded in the central order book, and we are

 15 looking at potentially an index product that would

 16 be based on some prices that we think are maybe

 17 more reliable than the cash prices that are

 18 available.

 19 There's always a concern, when you

 20 launch kind of a look-alike contract, that it

 21 would impact the liquidity of the existing

 22 contract. If you just transfer some liquidity

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 1 from one contract to another, then you may end up

 2 with two contracts that are less liquid and are

 3 less efficient, really, for the marketplace.

 4 So, you know, it's not clear necessarily

 5 that adding an additional wheat contract -- and in

 6 fact, talking to the marketplace, they don't

 7 really want to see an additional wheat contract.

 8 There are three already. There's a Chicago

 9 contract, a Minneapolis contract, a Kansas City

 10 contract, and the market actually seems pretty

 11 comfortable with having those three existing

 12 contracts.

 13 But we do have a cash-settled wheat

 14 swap, calendar swap, that's available, that really

 15 looks just like a futures contract, that might be

 16 a good idea for us to get out and meet with the

 17 corn growers and make sure they're aware of that

 18 product.

 19 And we have it in corn and soybeans as

 20 well.

 21 MR. BURLET: Mr. Chairman, just to

 22 follow up on what Matt and Dave said when the

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 1 question of a cash index was first raised, as many

 2 people in this room probably know, the nature of

 3 the cash wheat market is decidedly different than

 4 corn or soybeans. In the latter two you have

 5 liquid, clearly identifiable markets virtually

 6 year-round at multiple locations.

 7 The nature of the wheat market, as was

 8 stated, the difference between posted bids and

 9 where one could buy a reasonable quantity of

 10 quality wheat, that spread is tremendously wide,

 11 for reasons I think that are well understood.

 12 So that, for wheat, poses a huge

 13 challenge. Then the second comment I wanted to

 14 make, just as a follow-up, I know you shared the

 15 frustration of not getting a new crop corn bid

 16 from your local elevator. I don't think VSR in

 17 wheat will change the modus operandi of your local

 18 elevator on corn. I think the changes that are in

 19 place and that are coming with the physical side

 20 of the contract that were changed, are going to be

 21 more effective over the long term than is VSR.

 22 MR. WESTERN: Thank you, Commissioner.

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 1 Obviously there has been a lot of thought put in

 2 on this on both sides. Convergence is always a

 3 serious issue, and I just want to kind of follow

 4 up on something Mr. Burlet was commenting on.

 5 Obviously things have been tried. I'm all for

 6 seeing what can make this work.

 7 In sugar in particular, we have domestic

 8 contracts, we have world contracts, and for us in

 9 particular, just in the case that there's

 10 precedents or as people are thinking forward,

 11 there's usually a big difference for us crop year

 12 to crop year, and you can really see that between

 13 August and November.

 14 So I just kind of wanted to state that,

 15 so as we're looking forward any future changes,

 16 right now luckily everything is working fairly

 17 smoothly in our markets. It's generally kind of a

 18 small market, compared to a lot of the rest of you

 19 around the table, but I did want to make sure I

 20 commented on that, on the crop year issue.

 21 COMMISSIONER DUNN: Thank you.

 22 MR. WORTHEY: I am Mark Worthey,

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 1 representing the American Bakers Association. The

 2 company I work with is a baker, an end user of the

 3 raw agricultural product. And from the American

 4 Bakers Association, I would say that we are a

 5 reluctant supporter of the VSR, and I say

 6 reluctant because as it will act to expand the

 7 spreads between -- in the deferred, that creates,

 8 as an end user, for us a higher cost for acquiring

 9 those materials in that deferred time.

 10 Relationships that we have with

 11 customers are not, and pricing agreements that we

 12 have, are not determined on spot market. They are

 13 planned in advance, and as a producer we have to

 14 take positions that are significantly further out

 15 into the market than just dealing with a spot

 16 contract, so that is a negative as far as a

 17 commercial baker would be concerned.

 18 From a timing standpoint I will agree

 19 with several people that have spoken already, that

 20 doing this in a December contract would represent

 21 a very disruptive event in the marketplace. I

 22 believe the intent of any action that is to take

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 1 place is to avoid disruption rather than to create

 2 disruption. We had comments concerning the

 3 contract sanctity which we would certainly agree

 4 with, and changing the terms of a contract once

 5 the contract is actively being traded does not

 6 seem to be an appropriate action for the

 7 Commission to take.

 8 And I would be remiss, while I have the

 9 microphone, if I failed to mention, as

 10 Commissioner Chilton had in his opening comments,

 11 that there hasn't been any reference as a solution

 12 to the convergence problem dealing with the index

 13 funds.

 14 Index funds currently are holding a

 15 position size which is 212 percent of the current

 16 wheat crop. As a comparison, soybeans are holding

 17 23 percent and corn, 13 percent.

 18 So, again, the reluctance to support the

 19 VSR is that it is making a step toward the

 20 problem, but again it seems to be not addressing

 21 the -- that it is addressing a symptom rather than

 22 what appears to be the root cause for the

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 1 convergence problem that the market is

 2 experiencing.

 3 COMMISSIONER DUNN: Thank you, Mark.

 4 MR. WILLETT: Sam Willett, National Corn

 5 Growers Association. My question is for Mr.

 6 Burlet, and that is, could you elaborate on the

 7 impact of this change by timing on the

 8 over-the-counter market?

 9 MR. BURLET: Well, the over-the-counter

 10 market is very diverse and there are an almost

 11 countless number of different products that are

 12 out there. Many are indexed to the exchange

 13 settled price, so my comment relative to the size

 14 of the financial impact that David showed in his

 15 presentation is that there are a great number of

 16 contracts that are tied to those prices that are

 17 not represented in the open interest numbers that

 18 he showed. That's why I felt his estimate of the

 19 financial impact was low, or at a minimum

 20 conservative.

 21 MR. KIRLEY: If I could respond quickly

 22 to what I believe Gary Niemeyer said earlier -- do

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 1 I have that right -- first in terms of an index

 2 contract, I think that would be a very good

 3 solution in terms of a less violent, more

 4 consistent with the free market approach. I think

 5 if you had two side-by-side contracts, whichever

 6 one was the stronger, more viable, more useful one

 7 would survive, and the other one would fall away.

 8 Secondly, in terms of making a change to

 9 a contract with open interest, I know that's

 10 unavoidable, but I think we should make it to a

 11 contract that represents 3 or 4 percent of the

 12 open interest, not that represents 70 or 80.

 13 You're talking about a difference between a couple

 14 hundred thousand dollar loss versus $70 million.

 15 And to what you just said, I think that

 16 these commodity funds and hedge funds have had a

 17 negative impact on our markets in terms of their

 18 usability, but finding an approach that punishes

 19 them, we have to also be careful not to punish the

 20 long hedger.

 21 And, finally, in terms of just this

 22 committee, I think it's important that in terms of

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 1 giving advance warning, we not over-politicize the

 2 wheat contract. Every time one of these meetings

 3 finishes, or there is a rumor that goes around the

 4 floor, or there is a press release by the NGFA or

 5 the CME or whoever, invariably the next day

 6 there's pockets -- I mean, spreads don't trade.

 7 They gap, they re-price themselves, and that's not

 8 trading. I mean, hundreds of thousands of dollars

 9 change hands without a single trade happening.

 10 You know, it used to be markets moved on

 11 crop reports or fundamental factors or technical

 12 factors. Now they move on, you know, the

 13 decisions of this committee and rumors on what

 14 they're going to decide. We've got to be careful

 15 to let the free market decide the spread prices,

 16 and not the government or the decision of people

 17 in this room.

 18 COMMISSIONER DUNN: Jim?

 19 MR. BAIR: Jim Bair, North American

 20 Millers Association. We're not perhaps as

 21 convinced as others that the VSR will have the

 22 intended effect, but we have no counter-proposal

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 1 so we're willing to not oppose it, and we wish us

 2 all good luck that it may have the effect that

 3 people hope that it will.

 4 We also might like to see an earlier

 5 adoption of the reduced vomitoxin limits in the

 6 contract. We think that's long overdue, and

 7 putting that off for another two years, we think

 8 that deserves some consideration to be accelerated

 9 there.

 10 But listening to all the comments that

 11 have been made so far, I think it might be a

 12 reasonable compromise to have the VSR become

 13 effective perhaps with on of the spring 2010

 14 contracts. Either the March or May contract might

 15 be a reasonable compromise to close this

 16 discussion.

 17 But I also wanted to say I think this

 18 has been one of the most positive and constructive

 19 Ag Advisory Committee meetings that the Commission

 20 has held in a number of years, certainly in my

 21 memory, and I think this roundtable format has

 22 worked particularly well, and I just want to

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 1 congratulate you for a successful meeting.

 2 COMMISSIONER DUNN: Thank you. Any

 3 other comments? Chuck, from the CMC?

 4 MR. LAMBERT: Thank you, Chairman. I'm

 5 from Commodity Markets Council, and we understand

 6 and share the concerns about the need for

 7 convergence, but we also philosophically have the

 8 idea that a policy change should not be an

 9 additional source of uncertainty in the markets,

 10 and that we affect as little of open interest as

 11 possible.

 12 In my former life we had policy that

 13 said we would not accept contract changes until

 14 the next new contract to be offered. So I don't

 15 think we have the luxury of waiting that long, but

 16 given that conditions are taking us in the right

 17 direction and narrowing the basis, we think

 18 September is a reasonable compromise. It does get

 19 you out into the new crop year, and it affects as

 20 little open interest as possible.

 21 COMMISSIONER DUNN: Any other comments?

 22 All right. I will now turn to the Commission and

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 1 let them ask their questions. And then, since

 2 this is the advisory group, we have heard from

 3 some of you what your advice is on this matter,

 4 but for any of the others that would like to give

 5 us their advice on it after the Commissioners ask

 6 their questions, I'll be open for that advice.

 7 Mr. Chairman, I'll start with you.

 8 CHAIRMAN GENSLER: Thank you,

 9 Commissioner Dunn. I have a question I guess for

 10 each of the panelists, but I'll express it a

 11 little bit as a concern, as to whether the

 12 variable storage rate really is going to work. I

 13 do know that, I think it was Mr. Lehman who said

 14 we are finally there, so I'm wondering whether

 15 there is a real "there" there.

 16 But my concern is whether we are really

 17 addressing the fundamental issue about this

 18 contract, and I noted Mr. Kirley said that he

 19 wasn't really for variable storage at all, didn't

 20 think it gets us there, so I guess he would say

 21 we're probably not finally there. But I might be,

 22 you know, a little closer to Mr. Kirley and

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 1 worried as to whether this is really going to

 2 work, whether it's in March or September.

 3 And why not some of the other

 4 recommendations? We've talked a little about the

 5 cash settle contract, but to me sometimes it feels

 6 like this is a contract designed for decades ago.

 7 Some of the production has moved elsewhere, and

 8 obviously distribution is down in the Gulf rather

 9 than in the Great Lakes dominantly.

 10 MR. LEHMAN: I will comment, Mr.

 11 Chairman, if I might. You know, the changes in

 12 the underlying cash market certainly are that

 13 production has moved farther south, but western

 14 production that was mentioned earlier, in North

 15 Dakota and Minnesota, is not soft red winter

 16 wheat. That's spring wheat in that region.

 17 So the CME contract, I think when it

 18 comes down to it, it is a fundamental contract

 19 design issue. It's really acting as a world

 20 benchmark for the wheat market. As I think Mr.

 21 Coppock mentioned, it's used to hedge white wheat

 22 because there is no white wheat contract, or it's

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 1 used to hedge even hard wheat produced here in the

 2 U.S. at times because of its liquidity, and it's

 3 used to hedge wheats from all over the world, but

 4 yet it has a very narrow delivery quality and

 5 grade that's a small part of the total wheat crop.

 6 The question is, how do you construct a

 7 global delivery mechanism, if you will, that would

 8 better match up with the price discovery function

 9 of this contract? And I've been at CBOT for quite

 10 some time, and we've had a number of groups

 11 convene to try to figure that out. With the kind

 12 of frictions in international trade, with

 13 subsidies in some countries, whether it's through

 14 a single desk selling function such as the

 15 Australian Wheat Board or the Canadian Wheat

 16 Board, or problems in Argentina with the

 17 government putting restrictions on exports, or

 18 wherever, all of those things really have led us

 19 to think that it's not a feasible instrument to

 20 try to create a physical delivery contract.

 21 Now, cash settlement I think deserves

 22 more research, and that's one of the

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 1 subcommittee's recommendations, is to continue to

 2 look at that. Another idea was to move delivery

 3 to the Gulf, the primary delivery point there, and

 4 we did vet that pretty thoroughly with not only

 5 the convergence group, but the CME Group staff

 6 talked with the marketplace independently.

 7 And the concern there is that about 60

 8 percent of the U.S. wheat use is used

 9 domestically, and if your pricing basis is at the

 10 export location, you're really restriction what a

 11 taker of delivery can do with wheat that has

 12 stopped at the Gulf. They have to go into the

 13 export market, and with the predominant use of

 14 wheat being domestic, that doesn't seem to work

 15 very well for a hedger, you know, that's a miller

 16 in the domestic market.

 17 And also it's a pretty concentrated

 18 market at the Gulf. It's a high volume throughput

 19 market, obviously. There really isn't an

 20 intention to store wheat there. It's to move it

 21 through that location.

 22 CHAIRMAN GENSLER: But doesn't the oil

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 1 product work in Cushing? I mean, WTI is all at

 2 one point, and obviously it's only a small

 3 percentage of oil that actually goes through

 4 Cushing, but there's convergence in that product.

 5 There's a form of forced load-out there, too.

 6 MR. LEHMAN: Yes, there is. Right,

 7 there's no storage rate in that contract. It's a

 8 flow. I mean, that's the kind of fundamental

 9 structural difference between the energy markets

 10 and the grain markets, is that energy products are

 11 continuously produced and they are flowing from

 12 production to consumption at a pretty constant

 13 rate.

 14 Grain is produced annually. It has to

 15 be stored, then, until the next crop is available,

 16 and so this carrying charge structure that Josh

 17 really I think expressed pretty articulately, that

 18 the market has come to depend on to provide

 19 signals of should I keep it in storage or should I

 20 move it into the cash market, would be gone with

 21 --

 22 CHAIRMAN GENSLER: But this just seems,

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 1 while it's not unique to wheat, it seems so

 2 pronounced in wheat compared to corn and soy.

 3 MR. LEHMAN: Yes. I think the

 4 difference in kind of scale of the wheat market

 5 versus corn and beans -- corn and bean futures are

 6 world benchmarks as well. The cash market grades

 7 that are deliverable on those contracts are world

 8 benchmarks. U.S. No. 2 soybeans, China will buy

 9 those all day long, and they certainly do. And

 10 U.S. No. 2 yellow corn is the benchmark livestock

 11 field in the world, and we have customers

 12 worldwide who use that commodity.

 13 Soft red winter wheat, wheat is a

 14 different commodity. It has three major classes

 15 -- hard spring wheat, hard winter wheat, and soft

 16 winter wheat -- and then a variety of different

 17 qualities within those classes, based on protein

 18 content, based on vomitoxin --

 19 CHAIRMAN GENSLER: And I understand soft

 20 red winter wheat is, what, maybe 20 percent of

 21 U.S. production, and maybe single digit, you know,

 22 2 or 3 percent of worldwide production.

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 1 MR. LEHMAN: It's a small --

 2 CHAIRMAN GENSLER: I mean, it's a sturdy

 3 crop but we've got the entire world trying to

 4 trade on top of it. You add the index investors

 5 that have over 50, roughly 50 percent of the open

 6 interest, and that's a lot to put on this sturdy

 7 crop.

 8 MR. LEHMAN: It is, and you know, I

 9 guess we're a victim of our success. We've built

 10 this liquidity in this market, and Daren expressed

 11 a concern --

 12 CHAIRMAN GENSLER: Actually, Mr. Kirley

 13 would say there's not the liquidity in the market.

 14 MR. LEHMAN: Well, different

 15 perspectives are always -- that's what makes the

 16 market. But having three times the soft red

 17 winter crop in open interest would tell you, well,

 18 there's a lot of liquidity in the market.

 19 CHAIRMAN GENSLER: No, actually, that

 20 would just say there's a lot of interest, not

 21 necessarily liquidity. Mr. Kirley, is that what

 22 you would say?

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 1 MR. KIRLEY: To answer your first point,

 2 I think my major fault with the variable storage

 3 rate is the formula itself.

 4 It is confusing, it is complicated, and

 5 it is off-putting. You know, if we were that

 6 bright, we would be options traders.

 7 A lot of us don't understand this. I've

 8 been studying the thing for two months and I still

 9 don't quite get it. You know, if someone came up

 10 to me six months ago and said, "Josh, what's full

 11 carry for DFDs?" I'd say, "It's 91.5 cents.

 12 That's it." If they ask me that question in six

 13 months, I'll give them a formula of variables

 14 predicted on three variables and I still can't

 15 narrow it down within $2.00. I mean, it is

 16 confusing.

 17 CHAIRMAN GENSLER: May I just turn to

 18 other panelists? And then I'll turn to other

 19 Commissioners and hand back the mike. But those

 20 who have asked for this to be earlier -- no, you

 21 haven't asked for it to be earlier, Chad.

 22 MR. BURLET: I was going to answer your

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 1 first question: Is it going to work?

 2 CHAIRMAN GENSLER: Yes. All right,

 3 Chad. Is it going to work?

 4 MR. BURLET: I think the most important

 5 change in terms of making convergence occur is the

 6 change that went in a few months ago, which was

 7 the massive expansion of delivery space, delivery

 8 territory, tripling of the amount of delivery

 9 capacity. As I stated in my comments, I think

 10 that's already starting to have an impact.

 11 What the VSR will do is make that more

 12 effective. It will make that more attractive, and

 13 things will happen more quickly. Space is being

 14 built. Companies are making decisions to

 15 configure themselves to participate in the

 16 delivery process.

 17 And the VSR complements that existing

 18 change that went in in July.

 19 CHAIRMAN GENSLER: I hope you're right,

 20 but you had said earlier -- I was listening

 21 intently -- you said that markets don't need a

 22 long time to adjust. They adjust within a short

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 1 period of time. So why hasn't that all been

 2 priced into the market? Why hasn't convergence

 3 collapsed in anticipation of all that you've just

 4 said is such good and well-intended --

 5 MR. BURLET: Actually, I differentiated.

 6 Where this change, the VSR will be priced within a

 7 day, the previous change takes time because of the

 8 physical aspects that are involved.

 9 Companies are forming relationships to

 10 back delivery space, to enable them to --

 11 CHAIRMAN GENSLER: Let me go to my next

 12 question, but I would note that Commissioner Dunn

 13 has already said it's not "if," it's only "when."

 14 So you would think that it would have already been

 15 priced into the market, this change, possibly.

 16 MR. BURLET: What we're talking about is

 17 the physical side of it in terms of more

 18 participation. Christa's chart where she showed

 19 unused capacity and reduced participation, I think

 20 that's the physical side of the market.

 21 CHAIRMAN GENSLER: Let me just ask, and

 22 this is not just for the panelists but anybody on

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 1 the Advisory Committee, those who are recommending

 2 that it's earlier, whether it's December, March,

 3 May, earlier, that's not what the CME has

 4 proposed. So I'm asking whether you think it's

 5 necessary or appropriate, either for the

 6 protection of persons producing, handling,

 7 processing or consuming the commodity -- I'm

 8 reading straight out of our statute, by the way --

 9 but I just want to know whether you think it's

 10 necessary or appropriate for the protection of

 11 persons producing, handling, processing or

 12 consuming any commodity traded in the futures

 13 delivery, or do you think it's necessary or

 14 appropriate for the protection of traders who are

 15 on the markets, those who are dealing on the

 16 markets? And there's an important reason I ask

 17 this question, for anybody who wants it.

 18 MR. BRUNS: Well, from the National

 19 Grain and Feeds perspective, our reasoning is to

 20 protect the producer and the persons, the people

 21 that are using this commodity on a daily basis,

 22 the first definition, which you just explained to

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 1 us.

 2 CHAIRMAN GENSLER: Anybody else want to

 3 address -- I mean, there are some people in the

 4 room recommending it earlier, and I'm trying to

 5 understand if that's your basis or it's some other

 6 basis.

 7 MR. NIEMEYER: I think our basis would

 8 be that we would echo what the National Grain and

 9 Feed Association wants to do, because we grow

 10 corn, and there may be different possibilities to

 11 rectify different markets differently.

 12 MS. LUDLUM: Mr. Chairman, from the

 13 American Farm Bureau's perspective, we have

 14 requested implementation sooner rather than later.

 15 I don't know if -- there is a problem in the wheat

 16 markets -- I don't know if it is serious enough

 17 that it would justify the CFTC using its statutory

 18 powers to do something on its own, you know, above

 19 and beyond what CME has already submitted in its

 20 proposals, which just require the CFTC to sort of

 21 meet a lower threshold in terms of determining

 22 whether to allow that to go into effect.

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 1 We don't have the solution to the

 2 convergence problem, and I would just sort of echo

 3 some of the things that Mr. Coppock said from

 4 their Wheat Growers' perspective, many of whom are

 5 our members as well. The market is not performing

 6 effectively right now. We would like to see a

 7 remedy to that. I don't know whether the VFR is

 8 the right solution. It seems like the best

 9 solution at this point, but I don't know if it

 10 rises to the level of CFTC action compared to a

 11 market proposal.

 12 CHAIRMAN GENSLER: Thank you. That was

 13 very well -- I think you understood where I was

 14 reading from, 8(a)(7).

 15 And I turn back to Commissioner Dunn.

 16 COMMISSIONER DUNN: Thank you, Mr.

 17 Chairman. Commissioner Sommers?

 18 COMMISSIONER SOMMERS: I have a couple

 19 of questions just following up on some of the

 20 things that the Chairman was talking about, for

 21 Dave.

 22 When you consider a world wheat contract

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 1 that potentially is cash settled, can you explain

 2 to me what the structure of that contract would

 3 look like, that would take all different varieties

 4 of wheat that could be delivered -- not delivered,

 5 because it would be cash settled, but you would be

 6 hedging all different kinds of wheat into that

 7 contract.

 8 MR. LEHMAN: One of the ideas that we

 9 have discussed, and it came up in the April

 10 roundtable last year, I believe, we talked about

 11 just creating an index from the Chicago-Kansas

 12 City-Minneapolis contracts, and using the futures

 13 prices from those contracts to create what would

 14 be a proxy for a world wheat contract. It

 15 wouldn't really be a world wheat contract because

 16 we wouldn't have prices from Argentina or from

 17 Australia or from Europe or the Black Sea embedded

 18 in that contract, but it would represent the three

 19 primary classes of wheat that are produced and

 20 consumed in the market.

 21 So that's probably one of the most

 22 realistic approaches. Now, we haven't had

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 1 business discussions with Kansas City or

 2 Minneapolis to determine if they're willing to

 3 enter into that kind of an agreement, and as I

 4 said, the industry doesn't really want that. They

 5 see it as adding a fourth contract to a market

 6 that is already kind of crowded with three

 7 separate contracts and most likely just

 8 diminishing the liquidity or open interest,

 9 whatever you want to refer to it as, in these

 10 existing markets. And I think that is a real

 11 concern for the Minneapolis contract and the

 12 Kansas City contract, where their open interest is

 13 much, much smaller than Chicago.

 14 We've also looked internationally, and

 15 there is a consultancy that has developed some

 16 world wheat indexes, and we're in discussions with

 17 them over obtaining their intellectual property to

 18 see if there's something there that might work as

 19 a world wheat contract. It would likely be -- I

 20 think it's settlement prices for different futures

 21 contracts around the world in one version, and of

 22 course these contracts are not very liquid. Paris

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 1 wheat. There is a wheat contract in -- well,

 2 there are a number of wheat contracts around the

 3 world, but they are all relatively illiquid, so it

 4 would most likely have to use cash prices if it's

 5 going to be truly a global contract.

 6 So those are some of the ideas we've

 7 been working on.

 8 COMMISSIONER SOMMERS: My other question

 9 also follows up on where the Chairman was going, I

 10 think. Is there anyone around the table besides

 11 Mr. Kirley that would say that they think the VSR

 12 does not work, that it's not somewhere the

 13 Commission should be considering? And if not, are

 14 there any other potential solutions that we have

 15 not talked about today besides some of these other

 16 potential contracts?

 17 Thank you.

 18 COMMISSIONER DUNN: Thank you. I'm

 19 going to kind of stall here for a minute until

 20 Commissioner O'Malia gets back.

 21 But we haven't really heard from some of

 22 the folks on this right-hand side of the panel,

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 1 and John and Mary, we've heard some things,

 2 concerns about CITs and other interest in there.

 3 Do you have anything to contribute in

 4 this arena?

 5 MR. GAINE: Yes. In my 32 years

 6 involved with that statute, Mr. Chairman, that you

 7 were reading, I think the Commission has shown a

 8 tremendous restraint and judgment in its

 9 reluctance to interfere with an ongoing contract.

 10 I remember one meeting, one member of

 11 the Commission moved to add a delivery point to

 12 cotton, and that was roundly defeated, 1 to 4, by

 13 the vote. In the March '79 wheat which is

 14 referenced in the report here, we closed down the

 15 market after a lot of anguish and nail-biting,

 16 etcetera, to interfere with ongoing markets.

 17 In the silver market back in '79 and

 18 '80, either we did directly or we spoke to our

 19 friends at COMEX and the Board of Trade on the

 20 silver contract. They put in liquidation only,

 21 and there were petitions to close out all the

 22 contracts, which would have had enormous economic

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 1 disruption because the distant months were way out

 2 of line with the nearby prices.

 3 My comments, I don't have an answer

 4 whether -- having grown up, Mr. Chairman, on

 5 Brookville Road about three blocks from where you

 6 used to live, my knowledge of soybeans and wheat

 7 and winter wheat and soft and hard is probably

 8 very inside-the-beltwayish, that is to say, very

 9 close to zero. But I think the process is

 10 important, that the Commission -- and the sanctity

 11 of the contract was raised as well -- and I think

 12 the Commission is being deliberate here.

 13 Anytime you alter the contract -- and I

 14 represent, pardon the expression, speculators.

 15 Okay? I think we add a lot of good to these

 16 markets. We add liquidity. We help in the price

 17 discovery process. But we need predictability.

 18 We have no interest in divorcing cash prices from

 19 futures prices.

 20 We like fundamental supply and demand to

 21 operate. We'll take our research and do what we

 22 -- I guess what our members feel, which way

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 1 everything is going. We have no interest in

 2 volatility.

 3 So it really is one of process. I think

 4 people have raised -- I mean, cash settlement, did

 5 I see something? Did Minneapolis have a proposal

 6 a year ago or so, a couple of years ago, on some

 7 cash grain, cash wheat --

 8 COMMISSIONER DUNN: Layne, would you

 9 like to respond?

 10 MR. GAINE: Wasn't that kicking around?

 11 COMMISSIONER DUNN: Layne, could you get

 12 to a microphone?

 13 MR. CARLSON: I was going to say the

 14 Minneapolis Grain Exchange does have five cash

 15 settled contracts, corn, soybeans, and the three

 16 different wheats. Because of what we've seen --

 17 the industry has had problems with convergence and

 18 we've seen what's going on. We've had some

 19 explosive growth in our soft winter wheat index.

 20 Right now we have open interest of over 2,000

 21 contracts and trades every day. Again, looking at

 22 it from a cash basis, what the makeup is, is

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 1 prices from around domestic United States. About

 2 500 elevators or so are reporting each day, and

 3 that's what is used to sell the contract.

 4 COMMISSIONER DUNN: Dave, did you have a

 5 point on that? Dave Lehman. Did I see your light

 6 on earlier?

 7 MR. LEHMAN: No, I was just clarifying

 8 that yes, Minneapolis does have cash settled

 9 contracts and they are national average cash

 10 prices, so there actually is a way that you could

 11 trade our contract, our physical delivery

 12 contract, as a spread against that national

 13 average contract, and have a position in the

 14 average basis. And we think that at some point

 15 that may develop, but I think the market still has

 16 a concern over, are the cash prices that are going

 17 into that index really representative of where

 18 values are in that market?

 19 COMMISSIONER DUNN: Thank you.

 20 MR. GAINE: Again, as part of the

 21 process, cash settlement down the road might be

 22 something to think -- you will regret you asked me

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 1 to speak. Do I have until 1 o'clock?

 2 No, it's processes, really, and

 3 everybody has raised it. I don't have a clue,

 4 quite frankly, about the storage rates, the

 5 quantity, the quality. I do have a concern of

 6 interfering with ongoing arrangements that are

 7 already in place. So thanks.

 8 COMMISSIONER DUNN: Thank you, John.

 9 I'm well aware of your ability to filibuster.

 10 Mary, did you have any comments?

 11 MS. JOHANNES: No. This is my first

 12 meeting, and I really appreciate the opportunity.

 13 I'll refrain right now.

 14 Thank you.

 15 COMMISSIONER DUNN: Let me turn to our

 16 folks that are providing credit to this area, and

 17 ask Robbie and John if they have any concerns as

 18 far as the providers of credit for producers and

 19 many of the elevators out there.

 20 MR. BLANCHFIELD: The American Bankers

 21 Association doesn't have a position on this

 22 particular question. I would just point out,

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 1 though, that banks provide credit to both sides of

 2 the trade, and that's what they do.

 3 MR. BOONE: I'll agree with John. We

 4 are fairly agnostic to the issue, and like Mary,

 5 this is my first meeting, so I'm listening and

 6 learning for the most part today.

 7 COMMISSIONER DUNN: We will note that

 8 the Farm Credit system and the American Bankers

 9 have agreed here. That is a first.

 10 Neal, you had a comment?

 11 MR. GILLEN: I don't have a dog in this

 12 particular fight. I will have a couple of issues

 13 to bring up under new business. I have followed

 14 it, was at the economic roundtable that Andrei so

 15 effectively ran last December, and have monitored

 16 the conference calls. And I think we had Joe

 17 Nicosia on the subcommittee, and I think the

 18 subcommittee really put their heads together and

 19 came up with some sound recommendations.

 20 But I want to turn the tables and ask

 21 Chairman Gensler a question on this particular

 22 issue. I have a question for the chairman.

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 1 Hypothetically, let's say you had the full support

 2 of the Commission, and a determination was made

 3 that you would use your emergency powers. How

 4 would you go about resolving the issue of

 5 convergence?

 6 CHAIRMAN GENSLER: I'm benefited that

 7 you said it was a hypothetical, and I don't think

 8 it's appropriate for the chairman of a regulatory

 9 commission to address themselves to hypotheticals,

 10 so you gave me an easy out, Neal.

 11 I do think, and I will express just my

 12 own concern, that this is going to take a long

 13 time to figure out, that we're not at the right

 14 place yet. Sixty or 70 cents lack of convergence

 15 just doesn't feel right to this Chair. It's not

 16 right for farmers or grain elevator operators or

 17 anybody along the line that wants to hedge in

 18 these marketplaces. That the fixes, so to speak,

 19 to date haven't fully worked. Maybe it, as was

 20 said by Chad, it needs more time. Maybe, as Mr.

 21 Kirley said, we should give it more time. But I

 22 think that they haven't worked yet and that's not

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 1 satisfactory.

 2 There is a proposal on the table. I

 3 hope that it's correct, that we're finally there,

 4 but there seems to be even a debate on that, so we

 5 could find ourselves one year from now back in the

 6 same room, looking at another incremental, small

 7 change. And I'm wondering, you know, what's the

 8 real -- and I'm not an expert here. I'm relying

 9 much more on Commissioner Dunn and this committee.

 10 What is the fix that we're going to be

 11 faced with a year from now when we're debating

 12 what's going to happen in 2011 at that time, when

 13 this variable storage rate thing only modestly

 14 helps? But I'm hoping that it's more than that.

 15 COMMISSIONER DUNN: Thank you, Mr.

 16 Chairman. Commissioner O'Malia?

 17 COMMISSIONER O'MALIA: Well, the

 18 Chairman just about took my question. If we are

 19 here in a year, and this variable storage rate is

 20 implemented and the spreads widen to full carry

 21 and reflect in the new storage rates, what happens

 22 next?

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 1 The other question is, how does this

 2 cash-and-carry trade end? Somebody mentioned

 3 there was a shortage of wheat being planted. What

 4 happens in a year if the crop doesn't come in?

 5 I'll open that up to anybody.

 6 MR. LEHMAN: I'll respond to that, but I

 7 think probably Matt with the commercial grain

 8 companies is probably in a better position to

 9 actually make that comment than I am.

 10 But if the crop is short, if we do have

 11 the acreage reduction that we're hearing from the

 12 market analysts because of the trouble planting

 13 the winter crop this fall, that will act to

 14 tighten spreads. The variable storage rate

 15 mechanism won't be needed, and that's the beauty,

 16 in my eyes -- and I admit I'm biased, but I think

 17 that's what is beneficial to everyone here about

 18 the variable storage rate. It's only going to

 19 expand storage rates and expand carrying charges

 20 when the market calls for it, so it is

 21 market-driven. There is no up-side cap on the

 22 amount of increases. They can increase by 3 cents

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 1 every expiration. We have five expirations per

 2 year, and it will continue to build if need be.

 3 So with a short crop -- I mean, this is

 4 really kind of Plan B. Plan A was the new

 5 delivery locations and the seasonal rate. Plan B

 6 was the variable rate, and so I guess now we're

 7 trying to come up with a Plan C, and I don't know

 8 what that is at this point.

 9 As I mentioned in response to

 10 Commissioner Sommers' question, we're looking hard

 11 at other product ideas, and I think those might be

 12 Plan C: The cleared-only products that we've

 13 already listed. We have another set of those

 14 pending in draft form at Commission staff. We

 15 will continue to work with the industry to look

 16 for other new product ideas, such as perhaps the

 17 index of the three major contracts, and will

 18 continue to work with all of you to make sure

 19 we're providing the best risk management and

 20 hedging tool that we can.

 21 COMMISSIONER DUNN: Well, at this point

 22 the Advisory Committee advised, and I think we've

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 1 heard from almost all of you. I don't know that

 2 we've heard from Kent from NFU. Do you have any

 3 recommendations?

 4 MR. PEPPLER: Well, I'd like to say this

 5 is my first meeting, and I'm subbing in for South

 6 Dakota State President Doug Somke. So I'm not

 7 only the JV squad, I'm the redshirt freshman.

 8 The only thing I can really ascertain

 9 from this meeting -- and I think it has been a

 10 good meeting, I agree with what other people said

 11 -- the only thing that I can ascertain is that I'm

 12 sure glad I don't have you guys' jobs. I think

 13 you have a very difficult job.

 14 I think we agree with the Farm Bureau

 15 that the markets are not working, and in our

 16 position at Nationals we don't think they've

 17 worked for quite a while. And we do have some

 18 fundamental changes that we would like to see

 19 made, but I don't think today is the day to bring

 20 it up and I'm certainly not the person to

 21 articulate it.

 22 I would just like to remind the

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 1 Commission that historically farmers tend to be

 2 the one that pay the ultimate price. Ag producers

 3 tend to be the one that pays the ultimate price

 4 when we do see changes in the commodity markets.

 5 You spoke about the silver mess in the late '70s

 6 and the early '80s.

 7 I'm still paying for that one because

 8 the Hunt Brothers owned a sugar company that they

 9 bankrupted to cover their position there.

 10 So we are the last ones. We are at the

 11 bottom of the totem pole, and I would just like to

 12 remind the Commission that agriculture producers

 13 today are facing declining commodity prices. We

 14 are facing ever-increasing input costs. And our

 15 banks do a great job but credit is tight.

 16 We're seeing a severe attrition in rural

 17 America right now. Mr. Niemeyer said this is

 18 around his 40th crop. This year was around my

 19 30th crop. And I hate to say it, but we kind of

 20 represent the norm of producers out there. So

 21 we're an aging group, and the reason that we're an

 22 aging group is because of profitability. So at

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 1 the end of the day I would just ask that you put

 2 agriculture production's profitability at the top

 3 of your list. Thank you.

 4 COMMISSIONER DUNN: Thank you. Bob,

 5 anything from the Renewable Fuels?

 6 MR. DINNEEN: Thank you, Commissioner.

 7 Our companies don't really have a dog in this

 8 fight, either, other than we share an interest in

 9 making sure all commodity markets are working

 10 properly, and this is clearly one that is not.

 11 T seems to me that the solution that has

 12 been identified has a fair amount of support, and

 13 I would see benefit in making sure that's

 14 implemented as quickly as possible, to try to get

 15 as much convergence as quickly as possible. But,

 16 again, this is not something that our association

 17 has taken a specific position on, and we're not

 18 directly impacted by the wheat markets.

 19 COMMISSIONER DUNN: Are there any other

 20 words of wisdom or advice from any of the members

 21 of the Advisory Committee for the Commission?

 22 (No response)

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 1 COMMISSIONER DUNN: If not, let's turn

 2 to the final piece on the agenda, and that is

 3 other new business. Mr. Gillen, I believe you

 4 have something you want to discuss.

 5 MR. GILLEN: Yes, Mr. Chairman. I had

 6 two issues. One is a rather short statement. It

 7 pertains to the cotton investigation. In March

 8 2008, the Commission directed the Division of

 9 Enforcement to undertake an investigation of the

 10 speculative activity in the February-March 2008

 11 ICE No. 2 futures and options contracts which

 12 culminated in the financial ruin and decimation of

 13 approximately one-third of the U.S. cotton

 14 industry's marketing infrastructure, leaving many

 15 U.S. producers with unfulfilled contracts. It

 16 also had similar effects on the foreign cotton

 17 trade.

 18 The U.S. cotton industry cooperated

 19 fully in the investigation, providing all

 20 materials and documents requested by DOE, and by

 21 making people available for questioning. DOE

 22 completed its report some three months ago and

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 1 submitted it to Chairman Gensler, who I understand

 2 has now circulated it to the other Commission

 3 members.

 4 The cotton industry and key members of

 5 the Congress have requested the immediate release

 6 of this important report.

 7 Injured parties and their legal counsel

 8 have a right to review this report and to

 9 determine whether the DOE investigation has

 10 identified specific parties and specific conduct

 11 that would give rise to civil causes of action.

 12 The cotton industry urges the Commission

 13 to issue the DOE report today. Thank you.

 14 My other statement is on position

 15 limits. I wish to remind the Commission and the

 16 members of this committee of the importance of

 17 imposing position limits in order to restrain the

 18 rampant and excessive speculation that has

 19 distorted the agricultural markets in recent

 20 years. I would note that most agricultural

 21 commodities have trading limits.

 22 Cotton is one commodity that has, but

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 1 our contract is managed by the Intercontinental

 2 Exchange, and they desire to eliminate trading

 3 limits.

 4 The commercial interests in the cotton

 5 industry have been financially decimated as a

 6 result of such speculation, resulting in the

 7 elimination, as I said in my previous statement,

 8 of one-third of its merchandising infrastructure.

 9 The potential for speculation in our markets is

 10 such that many producers and small and

 11 medium-sized merchants are wary of using the

 12 cotton contract as a risk management tool. There

 13 is a lack of confidence in the market, not only in

 14 the U.S. but elsewhere in the world for similar

 15 reasons. But cotton is not alone, as other

 16 agricultural contracts have experienced

 17 speculative run-ups in prices.

 18 The results are well-known: An

 19 increased cost of doing business, given the larger

 20 margins caused by the widening basis, a cost that

 21 the banking industry is unwilling to finance.

 22 I need not dwell on the horror stories

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 1 of the past two years in our markets. We all know

 2 what happened, and we know why. What we need is

 3 prompt action by the Commission.

 4 As the Chairman just said a few minutes

 5 ago, the U.S. Congress authorized contract market

 6 designations in the agricultural and

 7 non-agricultural commodities for the purpose of

 8 trading in futures contracts primarily to hedge

 9 against price risk, discover prices through

 10 vigorous competition, and to facilitate commercial

 11 transactions.

 12 The contract markets were established

 13 primarily for the commercial interests --

 14 producers, cooperatives, merchants, processors,

 15 and end users -- while the speculative ventures

 16 were judged to be a secondary concern of the

 17 Congress. Though the Congress recognized that

 18 futures contracts offered an investment

 19 opportunity, it was made clear that such a role

 20 was subordinate to the interests of the commercial

 21 users of the contract markets.

 22 Unfortunately, for too long it has been

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 1 the policy of the Commission and the exchanges to

 2 facilitate expanded trading through expanded

 3 limits, while the commercial interests have had

 4 little or not influence in how the exchanges set

 5 limits.

 6 Over the years, the Commission has

 7 acquiesced to the exchanges' requests for

 8 increases in limits with little regard for the

 9 concerns of the commercial trade.

 10 I applaud Chairman Gensler for his

 11 leadership on this issue, for the new direction he

 12 is taking the Commission, for his willingness to

 13 take the reins and come to grips with setting

 14 position limits.

 15 I would add that there is no need for

 16 reluctance in taking such action, lacking an

 17 authorization by the Congress to also establish

 18 such limits on the OTC instruments, or because of

 19 inaction by foreign regulators. Such reluctance

 20 is aided and abetted by the fear argument that we

 21 may have heard for too many years -- fears that

 22 have never materialized, and there is little

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 1 reason to believe that they will now, given the

 2 willingness of the governments of competing

 3 foreign markets to take appropriate action along

 4 with the U.S. Congress, which I expect will soon

 5 close the remaining regulatory loopholes.

 6 In recent weeks the Commission has had

 7 an ongoing dialogue with the futures industry in

 8 response to the perceived fear that

 9 Commission-prescribed limits would drive the

 10 speculative business to foreign markets. I

 11 respectfully suggest that we should not be

 12 concerned with such a development. Were the

 13 excess speculation to leave our shores --

 14 speculation that has adversely impacted our

 15 markets -- we should welcome such a development,

 16 since this is speculative money we do not need or

 17 desire to have in the contract market.

 18 I urge the Commission to act promptly on

 19 position limits, to act promptly to protect those

 20 who the Congress directed it to protect, the

 21 commercial users who rely on these contracts for

 22 price discovery and to hedge price risk. Thank

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 1 you.

 2 COMMISSIONER DUNN: Thank you, Neal, and

 3 you segued nicely into the two issues the Chairman

 4 of the Commission has indicated he would like to

 5 speak about here, the position limits and OTC.

 6 And I am going to turn that over to him on the

 7 cotton investigation as well, so if you would like

 8 to respond, Mr. Chairman.

 9 CHAIRMAN GENSLER: Well, on the two

 10 issues it was really just to hear from you all, I

 11 mean, and Neal just commented on the need for

 12 reform in over-the-counter derivatives and

 13 anything that we as a Commission are doing in

 14 support of Congress to bring broad reform to that

 15 marketplace.

 16 As you may be familiar, that is to

 17 regulate the dealers themselves, explicitly, for

 18 what they do, making sure we lower risk through

 19 capital and margin, we enhance the integrity of

 20 this business and bring to it, even though it's an

 21 institutional market, bring some business conduct

 22 standards about fraud and manipulation to these

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 1 markets that have not had them to date; and also

 2 bring transparency through recordkeeping and

 3 reporting, first to the regulators, which we don't

 4 have right now, but then ultimately to the public

 5 by requiring those transactions that are standard

 6 enough to be brought to a listed exchange or

 7 trading platform to be brought to those listed

 8 platforms and exchanges.

 9 It was historic, in the last couple of

 10 weeks, both Chairman Peterson and Chairman Frank

 11 have moved bills through their committees.

 12 They're looking to reconcile, try to bring

 13 something to the floor of the House. Of course

 14 there is the Senate and there's a long process yet

 15 still in front of us, but just to hear comments

 16 would be terrific, as well as on position limits.

 17 I'm intrigued that Neal knows more maybe

 18 than I do. I didn't even know when things come to

 19 the ninth floor, but I'll have to check with your

 20 calendar as to when things come to the ninth floor

 21 of this building and when things go out of my

 22 office to other Commissioners in the future on the

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 1 cotton report. You seem plugged in enough that

 2 maybe you know exactly when it will be out of the

 3 building, as well.

 4 MR. GILLEN: Well, John has been around,

 5 John Gaine said he has been around for 35 years.

 6 I've been dealing with the Commission before its

 7 birth. But people do talk, Mr. Chairman, and the

 8 industry would like to see this report. We would

 9 like to have seen it yesterday.

 10 If the Commission is considering

 11 criminal action, if there are prospects for

 12 prosecution, then we withdraw our request if that

 13 is the case. But if that is not the case, we

 14 would like to see the report so we can proceed if

 15 there is reason to do so.

 16 CHAIRMAN GENSLER: I understand the

 17 request, and we also got a letter from 11

 18 Senators, all of whom we work closely with and

 19 have deep regard and respect for, but I don't have

 20 anything today to announce on the specific report

 21 that you referred to. Our Division of Enforcement

 22 has, as you said, taken a very close look, as well

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 1 as other divisions, the Division of Market

 2 Oversight and so forth in this building, and have

 3 been talking about and sharing with each of the

 4 Commissioners' offices their thoughts.

 5 MR. GILLEN: Well, when can we expect

 6 some announcement?

 7 CHAIRMAN GENSLER: I think I stand by

 8 what I just said.

 9 COMMISSIONER DUNN: Are there any other

 10 comments or advice on the other two issues that

 11 the Chairman of the Commission had asked about, on

 12 position limits and over-the-counter?

 13 MR. CRYON: I'm Roger Cryon with

 14 National Milk Producers Federation. I certainly

 15 agree in principle with what Neal said about

 16 position limits, particularly speculative position

 17 limits, in that they can temper the impact that

 18 these actors have on the volatility of the market.

 19 And as you indicated, interest isn't necessarily

 20 liquidity, and that's something I have agreed with

 21 in the past.

 22 But I also think it's very important to

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 1 make sure that the folks that the Act was written

 2 for, the producers and the users and the

 3 consumers, do have access to all the hedging

 4 opportunities that they need, that hedge

 5 exemptions are given as freely as necessary, and I

 6 believe they ought to have some margin of error.

 7 I hear cases of folks applying for hedge

 8 exemptions, they get a hedge exemption based on

 9 their actual potential volume, and then they don't

 10 have any margin of error, whereas a speculator can

 11 go and they can use their full position limit to

 12 speculate, but if a hedger goes just 5 percent

 13 above their hedge exemption, then they are in

 14 violation. That doesn't seem necessarily fair in

 15 all cases, but that's a small issue.

 16 With regard to what the Congress is

 17 considering, I think the same principle is

 18 important in considering the exemption for swaps

 19 from clearing. We have cases, for example, where

 20 farmers on one end of the country are swapping

 21 price risk with processing plants on the other end

 22 of the country. I don't see that those all

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 1 necessarily need to go through clearing.

 2 And I guess I would add finally, as kind

 3 of a side note, that in my reading of the

 4 legislation, the version I saw -- I guess I saw

 5 the House committee version, and I think they all

 6 do this -- they push a lot of things into clearing

 7 through exchanges and derivative clearing

 8 organizations under the assumption that that's a

 9 fail-safe. And I hope it's recognized that these

 10 exchanges and derivative clearing organizations

 11 will in effect become institutions that are too

 12 big to fail and will have to be backed up, if we

 13 put all our eggs in that basket in terms of

 14 guaranteeing the solidity of these contracts.

 15 CHAIRMAN GENSLER: All very good points.

 16 With regard to the over-the-counter derivatives,

 17 the approach the Administration, what this

 18 Commission has recommended, I know Commissioner

 19 O'Malia wasn't here then but the four of us had

 20 recommended at the time, in terms of regulating

 21 the dealers on both standard and customized

 22 products, allowing for all the hedging for the

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 1 associations and the companies that might be

 2 around this table, whether it's interest rate risk

 3 or all the way into the commodities markets.

 4 So tailored, as you mentioned, a

 5 tailored risk that might be a basis risk between

 6 two locations would be allowed, and it might not

 7 come into a clearinghouse. But if a clearinghouse

 8 is able to accept something for clearing because

 9 it has the features that they can manage that risk

 10 in a clearinghouse, then the presumption would be

 11 that the large financial institutions would have

 12 to move those into the clearinghouse.

 13 Why do we feel this is a public policy

 14 basis? Right now the risk is in society. It is

 15 in the markets. It's with the large financial

 16 shops. Let us not forget, AIR failed last year,

 17 and AIR was a central counter-party. It wasn't

 18 regulated a central counter-party, but it sure in

 19 heck was. And it failed, and $180 billion of our

 20 money -- that's $600 for each of you around the

 21 table, by the way -- went into AIR. But more than

 22 the $600 was the ramifications for the entire

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 1 economy.

 2 So we're trying to move as much of that

 3 off of the books of the large financial shops and

 4 into regulated clearinghouses. They would have to

 5 have discipline, mark to market procedures, and

 6 posting of collateral just as the CME has or ICE

 7 has in the futures marketplace now. And we think

 8 that actually lowers risk, and those

 9 clearinghouses wouldn't be in the leasing

 10 business. They wouldn't be in the proprietary

 11 trading business. This is what they would do.

 12 And in terms of transparency, we think

 13 that transparency, again only on those

 14 transactions that can actually be listed -- there

 15 will be a lot that's not -- but let's say even if

 16 half the market is able to be listed, that's a

 17 real benefit, because then all of you can price

 18 your transactions off of what you see coming

 19 through the transparent trading platforms.

 20 If you do a standard transaction, just

 21 as you right now could see the pricing of a

 22 futures contract, you could see the pricing of

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 1 some swap contract. Even if you're doing a

 2 tailored product, you could see the pricing in

 3 relationship to the standard product. So we think

 4 the transparency initiative is a huge plus for

 5 everyone around this table. We think the clearing

 6 initiative lowers the risk of the financial

 7 system, and of course Congress is working through

 8 how end users such as yourself might interface

 9 with that.

 10 MR. CRYON: I would agree that it

 11 reduces risk. I don't object to the idea of

 12 expanded use of clearinghouses and derivative

 13 clearing organizations. I just haven't heard the

 14 discussion about it that suggests that there is

 15 recognition that it doesn't take care of all the

 16 risks, that it really is a way of kind of

 17 centralizing things. So it is a way you can

 18 centralize things and kind of regulate them more

 19 effectively, but few comments I have heard seem to

 20 suggest that that's just going to solve everything

 21 automatically.

 22 CHAIRMAN GENSLER: No, no. It's not a

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 1 panacea, and there were a lot of other reasons the

 2 crisis came, but it's a way to separate it out as

 3 much as possible from the large financial

 4 institutions, make the large financial

 5 institutions less interconnected. But then the

 6 SEC and the CFTC and so forth have to really

 7 regulate and oversee these clearinghouses, as we

 8 do with the current clearinghouses.

 9 MR. DOUD: Mr. Chairman, Greg Doud with

 10 the Cattlemen. We very much appreciate your

 11 comments on this topic. The Cattlemen's position

 12 has been for a long time that we don't see

 13 position limits as a means to an end or, in the

 14 vernacular you were using today, if we are "there"

 15 by using position limits.

 16 We, however, would strongly agree with

 17 you, and the Cattlemen have been long advocates on

 18 this committee, Commissioner Dunn, about

 19 transparency, and the fact that we do have some

 20 ambiguity in the swaps market, and as it relates

 21 to exactly what are these position limits and the

 22 areas today where they are actually regulated.

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 1 Anything we can do to shine light on that, to

 2 provide greater transparency in that area, is

 3 hugely important to us in our business.

 4 CHAIRMAN GENSLER: Thank you. Other

 5 comments?

 6 COMMISSIONER DUNN: Any final comments

 7 from any of the Commissioners?

 8 If not, let me thank all of you, those

 9 of you that participated on the task force, and

 10 obviously the members of the Ag Advisory

 11 Committee. This has for me been a great process,

 12 and it has been open and transparent. And I

 13 understand that sometimes the market gets jittery

 14 when people talk about things, but our goal here

 15 is to do it in an open and transparent matter so

 16 that everybody is hearing the same thing at the

 17 same time.

 18 We on the Commission value the input of

 19 all the advisory groups that we have, but the

 20 Agricultural Advisory group, since it's the oldest

 21 advisory group, has a special place in my heart.

 22 And I want to thank you for the excellent job, and

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 1 giving up your time to come in and assist the

 2 Commission as we weigh the proposals that are in

 3 front of us. Thank you.

 4 (Whereupon, at 12:08 p.m., the

 5 PROCEEDINGS were adjourned.)

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 I, Carleton J. Anderson, III do hereby

 3 certify that the forgoing electronic file when

 4 originally transmitted was reduced to text at my

 5 direction; that said transcript is a true record

 6 of the proceedings therein referenced; that I am

 7 neither counsel for, related to, nor employed by

 8 any of the parties to the action in which these

 9 proceedings were taken; and, furthermore, that I

 10 am neither a relative or employee of any attorney

 11 or counsel employed by the parties hereto, nor

 12 financially or otherwise interested in the outcome

 13 of this action.

 14 /s/Carleton J. Anderson, III

 15

 16

 17 Notary Public in and for the

 18 Commonwealth of Virginia

 19 Commission No. 351998

 20 Expires: November 30, 2012

 21

 22

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