COMMODITY FUTURES TRADING COMMISSION 

 AGRICULTURAL ADVISORY COMMITTEE 

 PUBLIC HEARING COMMITMENTS OF TRADERS REPORTS, 

 THINLY TRADED MARKETS, AND BASIS AND CONVERGENCE 

 IN THE GRAIN MARKETS 

 Washington, D.C. 

 Tuesday, August 1, 2006 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 2 

 1 PARTICIPANTS: 

 2 Commission: 

 3 MICHAEL V. DUNN 

 4 REUBEN JEFFERY III 

 5 WALTER LUKKEN 

 6 FRED HATFIELD 

 7 Other Participants: 

 8 JOHN FENTON 

 9 DON HEITMAN 

 10 DAVID LEHMAN 

 11 DAN BROPHY 

 12 GREG ZERZAN 

 13 TOM COYLE 

 14 FRED CLARK 

 15 NANETTE EVERSON 

 16 DAVID KASS 

 17 WARREN PRESTON 

 18 STEVEN TURNER 

 19 MICHAEL HAIGH 

 20 JIM BAIR 

 21 FRED CLARK 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 3 

 1 PARTICIPANTS (CONT'D): 

 2 JACK GAINE 

 3 NEAL GILLEN 

 4 ELDON GOULD 

 5 TONY JACKSON 

 6 JULA KINNAIRD 

 7 RICK KIRCHHOFF 

 8 GARY MARTIN 

 9 LARRY MITCHELL 

 10 BEVERLY PAUL 

 11 JOHN RUTHERFORD 

 12 LARRY SHAEFFER 

 13 JENNIFER SPURGAT 

 14 RANDY STEVENSON 

 15 PETER VITALIANO 

 16 LEROY WATSON 

 17 RYAN WESTON 

 18 SAM WILLETT 

 19 GREG ZERZAN 

 20 MARK G. BAGAN 

 21 JEFF BORCHARDT 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 4 

 1 PARTICIPANTS (CONT'D): 

 2 TOM ERICKSON 

 3 TOM COYLE 

 4 SUSAN KEITH 

 5 ANDY MORTON 

 6 DALLAS TONSAGER 

 7 

 8 

 9 

 10 * * * * * 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 5 

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

 2 (9:37 a.m.) 

 3 COMMISSIONER DUNN: Good morning, ladies 

 4 and gentlemen. I am Chairman of the Agricultural 

 5 Advisory Committee, and I want to welcome you all 

 6 to Washington, D.C., at the beginning of this most 

 7 lovely and warm month. We have record triple- 

 8 digit figures with the temperature today, so I 

 9 appreciate you all getting here. It is air 

 10 conditioned in here like the old movie theaters, so 

 11 just plan on spending the day. 

 12 This is the thirty-first meeting of the 

 13 Commodity Futures Trading Commission's Agricultural Advisory 

 14 Committee. For many of you, it may be your first 

 15 advisory meeting. It is certainly my first as 

 16 Chairman, and I want to thank Chairman Jeffery and 

 17 my fellow Commissioners for selecting me for the 

 18 honor of Chairing this Committee. 

 19 For a little history, the Ag Advisory 

 20 Committee was first formed in 1985, and has been 

 21 the Commission's longest-standing advisory 

 22 committee. It was created to advise the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 6 

 1 Commission on issues affecting users of 

 2 agricultural, commodity markets, and it is a 

 3 valuable communications link between the 

 4 Commission and the agricultural community. 

 5 Given the increased complexity and 

 6 diversity of participants in agriculture markets, 

 7 the Committee is an excellent venue to exchange 

 8 information and discuss issues that affect 

 9 the operations of agricultural commodity 

 10 markets. During my tenure, with the blessing of 

 11 the U.S. Senate and our President, hopefully 

 12 beyond this particular meeting, I would like to 

 13 find a way to make this Committee as relevant as 

 14 possible for all of us. 

 15 For this meeting we originally planned 

 16 to cover two issues, potential changes to the 

 17 Commission's Commitments of Traders Reports, and 

 18 the economic markets' implications of thinly 

 19 traded price discovery markets. To this, after 

 20 many inquiries from producers, we have added a 

 21 brief discussion on the weak basis and lack of 

 22 convergence that is occurring in some of the grain 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 7 

 1 markets, particularly wheat. This marks a change 

 2 in our agenda that was published in the Federal 

 3 Register, and I wish to note that we will be 

 4 covering it as a new item of business. The 

 5 purpose will be to review the problem and engage 

 6 the Committee's interest in pursuing it further. 

 7 We are here today to get your input and 

 8 try to answer questions that you might have. Now 

 9 I would like to recognize the Chairman of the CFTC 

 10 Reuben Jeffery and my fellow Commissioners, Walt 

 11 Lukken and Fred Hatfield. 

 12 COMMISSIONER JEFFERY: Thank you, 

 13 Mike, and I assume in keeping with your 

 14 movie theater theme with the air conditioning 

 15 here, you will be serving the popcorn as well. 

 16 (Laughter) 

 17 COMMISSIONER JEFFERY: At the outset I 

 18 would like to thank Mike and his staff for 

 19 organizing this hearing, and most importantly, all 

 20 of you for taking the time to be here today, 

 21 considering particularly the elements and the fact 

 22 that it is summer, and there are any number of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 8 

 1 other things we could all be doing. 

 2 The topics today here are extremely 

 3 important to the work of the CFTC, and most 

 4 importantly, to the agricultural community. As 

 5 you are aware, the CFTC has a long-standing 

 6 commitment to vibrant, sound, and reliable 

 7 agricultural futures and options markets. 

 8 I am equally sure you recognize the profound 

 9 changes taking place, in the overall 

 10 futures markets. These include new types 

 11 of futures markets such as ethanol and South 

 12 American soybean futures, the growth of electronic 

 13 trading, including the launch of side-by-side 

 14 trading, coincidentally, today in certain major 

 15 historically agricultural product oriented 

 16 exchanges, as well as changes in technology and 

 17 government foreign policy. These changes raise 

 18 issues for both the agricultural community and the 

 19 CFTC. 

 20 Today, two principal issues are going to 

 21 be addressed: the role of the CFTC's Commitments 

 22 of Traders Report, about which we have heard from 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 9 

 1 many of you prior to this hearing 

 2 and whether or not, we should adopt 

 3 changes to that report to reflect changes in the 

 4 market; and second, the economic and policy 

 5 implications of low-volume, less liquid markets 

 6 and their effects on the price discovery function. 

 7 As we move forward to address these 

 8 issues, I am hopeful that this Committee will live 

 9 up to the advisory of its title in every way 

 10 possible. We encourage your active participation 

 11 in today's proceedings, and any follow-up comments 

 12 you might have for the record will be welcome. 

 13 The Agricultural Advisory Committee can play a key 

 14 role as a forum for maintaining an ongoing 

 15 dialogue between the agricultural community and 

 16 the Commission. 

 17 I want to thank you again for your 

 18 attendance, and I look forward to a productive and 

 19 active discussion today. Thank you again. 

 20 Commissioner Lukken? 

 21 COMMISSIONER LUKKEN: Good morning. I 

 22 just wanted to join my fellow Commissioners in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 10 

 1 welcoming everybody here today for the Ag Advisory 

 2 Committee meeting. I wanted to congratulate Mike 

 3 Dunn for assuming the role of Chairman of that 

 4 Committee. He is going to do a great job. I was 

 5 happy to serve as Vice Chairman for a bit under 

 6 Chairman Newsome, so I know the difficulties and 

 7 how important this Committee can be in determining 

 8 policy for the agricultural community as it 

 9 relates to the futures markets, and I am certain 

 10 Mike is going to do a great job in that role. 

 11 I want to give a special welcome to 

 12 those who have had to travel here, and those in 

 13 the ag community, some old friends, some new 

 14 friends, so I am looking forward to hearing the 

 15 spirited debate this afternoon and this morning. 

 16 I would say that in particular it is a 

 17 great agenda. I am particularly interested in 

 18 this morning's topic on the Commitments of Traders 

 19 Reports. This has a long history at our agency as 

 20 we will hear shortly. It is something though that 

 21 has become an important transparency item for the 

 22 marketplace itself and something that is deserving 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 11 

 1 of review, something that has not been reviewed in 

 2 a while,and we are going to take a look at it from 

 3 top to bottom to make sure that it is working as 

 4 intended. 

 5 So I look forward to the debate and 

 6 hearing the presentations this morning. With 

 7 that, I will turn it back over to the Chairman of 

 8 the Ag Advisory Committee and let him introduce 

 9 our next Commissioner. 

 10 COMMISSIONER DUNN: Just so you all 

 11 know, they are all to the left of me because of 

 12 the way the microphones work. They are not 

 13 philosophically to my left. 

 14 (Laughter) 

 15 COMMISSIONER DUNN: Fred Hatfield, who 

 16 came on board the same time I did. Fred? 

 17 COMMISSIONER HATIFLED: Thank you, 

 18 Commissioner Dunn. I want to welcome you all here 

 19 as well. I want to thank Commissioner Dunn and 

 20 his staff for organizing and putting this hearing 

 21 together. We like to call Commissioner Dunn 

 22 "Farmer Mike" here at the CFTC. He has 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 12 

 1 symbolically, I think, chosen today to have this 

 2 hearing because, as Chairman Jeffery said, today 

 3 in Chicago, Kansas City and Minneapolis we have 

 4 side-by-side electronic trading with floor 

 5 trading for the first time. 

 6 

 7 Having grown up in the Central Joaquin 

 8 Valley of California, agriculture to me sure has 

 9 gotten a lot more complicated than I recall it 

 10 growing up. When I look at today's agenda, and we 

 11 are talking about Commitments of Traders Reports, 

 12 thinly traded markets, and basis and convergence 

 13 in the grain markets, you have to have economists, 

 14 counselors, and surveillance experts to figure 

 15 that all out. But it is necessary I think not 

 16 only because of the futures markets, also because just 

 17 the sheer growth in the commodity markets. 

 18 Everything seems to be overshadowed by the 

 19 talk about energy and the financial futures markets, 

 20 but when you look at the ag commodity growth just 

 21 in the last 5 years, ag commodity growth is up 60 

 22 percent, 25 percent in the last year alone. So 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 13 

 1 the growth is phenomenal, and some of that growth 

 2 is feeding some of the issues that we are here to 

 3 talk about today. So I appreciate the fact that 

 4 we have the expertise and the backgrounds of the 

 5 people who are here to help us address these 

 6 issues. 

 7 COMMISSIONER DUNN: Thank you very much. 

 8 I would be remiss if I did not note the void we 

 9 have in the Commission. This is the first public 

 10 meeting we have had since the resignation of 

 11 Commissioner Sharon Brown-Hruska, and when I came 

 12 on and Fred came on she was the Acting Chair and 

 13 was a great mentor for me and good friend, and we 

 14 will miss her. This is the first time we are 

 15 having a meeting without her, and you guys are a 

 16 lot uglier. 

 17 A few logistics before we get to the 

 18 introduction of the members of the Advisory 

 19 Committee. Today's session is being recorded. A 

 20 transcript will be made available to our website. 

 21 The session is also being broadcast live via 

 22 teleconference and via videoconference to CFTC 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 14 

 1 Regional Offices in a listen mode only. 

 2 You will notice that we have a 

 3 roundtable session, but given the expansion of the 

 4 Advisory Committee and the size of our room, we 

 5 are having what we call a modified roundtable 

 6 format here, and I appreciate you all working with 

 7 this little handicap that we have. 

 8 When you come to the table to use the 

 9 microphones or if you are speaking from the floor 

 10 microphones, after you are recognized, I would like 

 11 you to give your name and who you represent. We 

 12 do have a court reporter here, as I have said, so it is 

 13 important that you do identify yourselves every 

 14 time before you speak. If the volume needs to be 

 15 adjusted, we have technicians who will take care 

 16 of that. Just speak directly into the microphone 

 17 and I think you will be all right. 

 18 All questions and comments must be into 

 19 the microphone. That will assist our court 

 20 reporter and those listening via telephone and 

 21 video conference. Questions and comments must be 

 22 limited to 5 minutes or less, and we may shorten 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 15 

 1 the time limit if it becomes necessary to ensure 

 2 that everyone has the opportunity to speak and be 

 3 heard. 

 4 I would like the members of the Advisory 

 5 Committee to please stand and identify themselves 

 6 as to who they are and who they represent, and I 

 7 think we will start over here. 

 8 MR. ZERZAN: I am Greg Zerzan with the 

 9 International Swaps and Derivatives Association. 

 10 MR. GAINE: Jack Gaine, President of the 

 11 Managed Funds Association. 

 12 MR. GOULD: Eldon Gould, with the Risk 

 13 Management Agency of the Department of 

 14 Agriculture. 

 15 MR. COYLE: Tom Coyle, National Grain 

 16 and Feed Association. 

 17 MR. STEVENSON: Randy Stevenson with R- 

 18 Calf USA. 

 19 MR. BAIR: Jim Bair, North American 

 20 Miller's Association. 

 21 MR. MARTIN: Good morning. Gary Martin 

 22 with the North American Export Grain Association. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 16 

 1 MR. VITALIANO: Peter Vitaliano with the 

 2 National Milk Producers Federation. 

 3 MR. WATSON: I'm Leroy Watson with the 

 4 National Grange. 

 5 MS. KINNAIRD: Jula Kinnard, National 

 6 Grain Trade Council. 

 7 MR. CLARK: Good morning. I'm Fred 

 8 Clark on behalf of the U.S. Rice Producers 

 9 Association. 

 10 MS. SPURGAT: Jennifer Spurgat with the 

 11 National Association of Wheat Growers. 

 12 MR. WESTON: Ryan Weston, American Sugar 

 13 Alliance. 

 14 MR. RUTHERFORD: John Rutherford, 

 15 International Dairy Foods Association. 

 16 COMMISSIONER DUNN: Are there other 

 17 members of the Ag Advisory Committee? 

 18 MR. KIRCHHOFF: I'm Rick Kirchhoff, with 

 19 the National Association of State Departments of 

 20 Agriculture. 

 21 MR. JACKSON: Tony Jackson, with the 

 22 Independent Bankers. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 17 

 1 MS. PAUL: I am Beverly Paul, with the 

 2 American Soybean Association. 

 3 MR. GILLEN: I am Neal Gillen, American 

 4 Cotton Shippers Association. 

 5 MR. WILLETT: Sam Willett, National Corn 

 6 Growers Association. 

 7 MR. MITCHELL: Larry Mitchell, American 

 8 Corn Growers Association. 

 9 MR. SHAEFFER: Larry Shaeffer, Renewable 

 10 Fuels Association. 

 11 COMMISSIONER DUNN: Are there any other 

 12 members? 

 13 

 14 MS. LUDLUM: Kelli Ludlum, American Farm 

 15 Bureau Federation. 

 16 COMMISSIONER DUNN: We also have a 

 17 couple of other special guests I would like to 

 18 recognize. One is someone who had been previously 

 19 a member of the Advisory Committee, the Honorable 

 20 Dallas Tonsager who is on the Board of Directors 

 21 of the Farm Credit Administration. 

 22 We have from the Hill representing the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 18 

 1 Senate Agricultural Committee, Andy Morton. Is 

 2 there anybody else from the Hill? 

 3 Fred had talked about the beginning of 

 4 some exciting things happening in Kansas City, and 

 5 we have two other special guests, the gentlemen 

 6 who are responsible for running both the Kansas 

 7 City and the Minneapolis Grain Exchanges. Jeff 

 8 and Mark, if you will stand up and identify 

 9 yourselves. 

 10 MR. BORCHARDT: I'm Jeff Borchardt, with 

 11 the Kansas City Board of Trade. 

 12 MR. BAGAN: Mark Bagan, with the 

 13 Minneapolis Grain Exchange. 

 14 COMMISSIONER DUNN: Thank you, 

 15 gentlemen, for being here today. 

 16 Our first item on the agenda is the 

 17 Commitments of Traders Reporting Program. The 

 18 weekly Commitments of Traders Reports provides 

 19 market participants, researchers, and the public 

 20 valuable snapshots of each Tuesday's open interest 

 21 of all futures and options markets in which 20 or 

 22 more traders hold positions that meet or exceed 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 19 

 1 CFTC's Large Trader Reporting Level. 

 2 On June 21st, the Commission published 

 3 in the Federal Register notice that it was 

 4 undertaking a comprehensive review of the 

 5 Commitments of Traders Program to see public 

 6 comment and review. Chairman Jeffery in my 

 7 opinion has done an outstanding job of trying to 

 8 increase transparency in how we operate at the 

 9 Commission with a number of public meetings and 

 10 comments in the Federal Register. I do not know 

 11 if he knows what he has opened, but I am told we 

 12 have received a record 4,000 comments already on 

 13 the Commitments of Traders, and we will be reading 

 14 all 4,000 of them. 

 15 (Laughter) 

 16 COMMISSIONER DUNN: This period closes 

 17 on August 21st for comment. As I noted earlier, a 

 18 transcript of today's meeting regarding 

 19 Commitments of Traders Reports will be included as 

 20 part of the document for the review of the 

 21 Commitments of Traders Reporting Program. 

 22 We will begin the discussion with a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 20 

 1 presentation of the Federal Register's release 

 2 from John Fenton and Don Heitman from the CFTC's 

 3 Division of Market Oversight. John is in charge 

 4 of our Commission's Market Surveillance Program, 

 5 and Don is one of our senior legal and policy 

 6 specialists for agricultural markets. 

 7 We will then have a series of 5-minute 

 8 views from the field in which Dave Lehman of the 

 9 Chicago Board of Trade, Dan Brophy on behalf of 

 10 the National Grain Trade Council, Greg Zerzan of 

 11 the International Swaps and Derivatives 

 12 Association, Tom Coyle on behalf of the National 

 13 Grain and Feed Association, and Fred Clark, on 

 14 behalf of U.S. Rice Producers Association. I 

 15 will not reintroduce these gentlemen when they 

 16 come forward. Their bios are in the information 

 17 that you have received. 

 18 Following that, we will open up the 

 19 floor for a modified roundtable discussion from 

 20 members of the Ag Advisory Committee, and then 

 21 open it up for public comments for the members of 

 22 the public who wish to talk on the subject matter. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 21 

 1 Is Nicole McNair here? Nicole from my office is 

 2 available for the public members who wish to speak 

 3 on this. We would really like to find out who you 

 4 are, so if you will sign up with Nicole, and we 

 5 will schedule you to speak publicly. 

 6 With that I am going to turn it over to 

 7 John and Don. 

 8 MR. FENTON: Thank you very much, 

 9 Commissioner Dunn. I will give some background of 

 10 our Large Trader Reporting Program which we use in 

 11 our market surveillance, and it is the raw 

 12 material that goes into our Commitments of Traders 

 13 Reports. Don, who is the author of the Federal 

 14 Register notice, and we have gotten a lot of 

 15 favorable comments for how well-written it was, 

 16 will go through the history of the evolution of 

 17 the Commitments Report, how it has changed over 

 18 time and how we have tried to keep it current and 

 19 as timely as possible, and useful to market users. 

 20 I will start by explaining our Market 

 21 Surveillance Program. That is in the first 

 22 instance why we get large trader reports. The 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 22 

 1 federal regulation of commodity markets started 

 2 back in the 1920s. In 1921, the Grain Futures Act 

 3 was passed, and I think it is fair to say the 

 4 primary motivation of the passage of the Grain 

 5 Futures Act was the sense that futures markets, 

 6 the grain markets, were subject to manipulation. 

 7 In fact, from available records during the 19th 

 8 and early part of the 20th centuries, there were 

 9 fairly numerous instances of manipulation. So the 

 10 Grain Futures Act was passed, and within a very 

 11 short time, I think within a year or two of the 

 12 passage of the Act, there was some form of large 

 13 trader reporting instituted. Don will go through 

 14 this, but shortly thereafter there was an attempt 

 15 by the agency to provide information on the users 

 16 of the market. 

 17 Large trader reporting was motivated by 

 18 the observation that to properly do surveillance 

 19 on a market you need to know who has the large 

 20 positions in the market and market power as a 

 21 result of large positions, so that is why we get 

 22 large trader reporting. We are looking for 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 23 

 1 concentrations of positions that could pose a 

 2 threat of squeeze or a corner, large relative to 

 3 open interest, and large relative to potential 

 4 deliverable supply. 

 5 We have market economists who are 

 6 assigned to specific markets. Their jobs are to 

 7 become experts in those markets. They get these 

 8 daily reports, and I will explain in a bit how we 

 9 get them, but they look at these reports every day 

 10 to see who has positions in the markets and how 

 11 they have changed over the previous day. They are 

 12 comparing those positions to other factors in the 

 13 market such as deliverable supply. They are 

 14 looking at price relationships which can be an 

 15 early indication that there is a problem 

 16 developing in a market, basis relationships which 

 17 we are going to talk about later today, and spread 

 18 relationships tend to become distorted when there 

 19 is evidence of a manipulation. Our economists 

 20 also follow the fundamental factors in the market 

 21 to understand what moves the market and what 

 22 factors are at play in the market. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 24 

 1 As the Commission knows, we present 

 2 usually three or four markets at weekly 

 3 surveillance meetings. They may be markets that 

 4 we are concerned about, or they may be just 

 5 markets for which there was some interesting 

 6 development during the week that we want to keep 

 7 the Commission apprised of. 

 8 If there is a problem in the market, we do a 

 9 number of things. One, we are working with the 

 10 exchange. Exchanges have a self-regulatory 

 11 responsibility to police their own markets, so 

 12 they are supposed to do surveillance. They are 

 13 very close to the market. They have great access 

 14 to expertise at the exchange, so we take full 

 15 advantage of their knowledge and work with them. 

 16 Some of the things we do when there is a 

 17 problem is we contact traders that we are 

 18 concerned about and other traders who can provide 

 19 us information to start what we call a jawboning 

 20 process which is to talk to traders to find out 

 21 what their intentions in the market are, to 

 22 express concern of the Commission if in fact we 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 25 

 1 have a concern, and just to sort of talk our way 

 2 through what could be a problem or a congested 

 3 expiration. If we are not satisfied with the 

 4 results of that process, we can issue warning 

 5 letters. It is a letter that more formally 

 6 conveys to traders the concern of the Commission 

 7 about an expiration and that they have a 

 8 responsibility to make sure that their trading 

 9 does not result in a manipulation of prices. 

 10 The Commission has broad emergency 

 11 powers. We can intervene in a market. We are 

 12 very loathe to do that. It is not by any means a 

 13 tool that we use frequently. I think in the 

 14 entire history of the Commission we have had four 

 15 emergency actions, and I think only three of the 

 16 four were related to market problems. 

 17 If at the end of an expiration we feel 

 18 like there is evidence that a trader may have 

 19 either attempted or actually manipulated the 

 20 market, we will refer that to our Division of 

 21 Enforcement and they will then proceed to 

 22 investigate it and take appropriate legal action 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 26 

 1 against the traders. 

 2 So the raw material of our Market 

 3 Surveillance Program is the Large Trader Reporting 

 4 System. Every day we get reports from the Futures 

 5 Commission Merchants, the brokers in the industry, 

 6 for all customers who have positions above reporting 

 7 levels. Reporting levels can vary from as low as 

 8 25 contracts for some of the smaller markets, to as 

 9 high as 3,000 contracts for the Eurodollar market. 

 10 Just as an instance, in the ag market, corn's 

 11 reporting level is 250. 

 12 The goal of setting the reporting level 

 13 is to get all positions that we potentially would 

 14 be concerned about during an expiration, and also 

 15 to get coverage of around 70 to 90 percent of the 

 16 total open interest in the market. That coverage 

 17 is useful to us in surveillance, but it is also 

 18 useful for information that we provide in the 

 19 Commitments of Traders Reports. 

 20 The Commission has I think leveraged 

 21 this information, the large trader reporting 

 22 information, quite successfully beyond market 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 27 

 1 surveillance. Market surveillance was the 

 2 original reason we get it. I am a little biased 

 3 here, I think it is still the number-one reason 

 4 why we get it, but we have made other uses of it. 

 5 It is now being used in our financial surveillance 

 6 in markets to protect against the financial risks 

 7 in the market. Our Division of Clearing and 

 8 Intermediary Oversight is now drilling down below 

 9 the Futures Commission merchants to look at the 

 10 customers of the Futures Commission merchants who 

 11 may potentially pose a financial threat to the 

 12 Futures Commission merchant, and ultimately to the 

 13 clearinghouse. 

 14 We also use the large trader data in 

 15 research projects that our Office of the Chief 

 16 Economist uses. A recent example was that Michael 

 17 Haigh did a study of managed money traders and 

 18 their impact and their role in energy markets, and 

 19 that has received quite a bit of attention. 

 20 Finally, the large trader information 

 21 provides the foundation for the Commitments of 

 22 Traders Reports which is why we are here today, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 28 

 1 and the intent here is to provide transparency to 

 2 show more than just the open interest in a market, 

 3 to show broadly speaking who holds that open 

 4 interest. We know that it is a report that people 

 5 find very useful. It is the largest hit that we 

 6 get on our website. We would actually like for 

 7 the commentors to provide more information on how 

 8 it actually is used and how it is useful to 

 9 people. 

 10 One thing that I actually did not list 

 11 as one of the uses, but I think it is very 

 12 important, is that it gives us the information 

 13 which we can use to talk to, for example, 

 14 congressional committees with confidence that we 

 15 are on top of the market and that we know what is 

 16 happening. And it is just as important to know 

 17 when there is not a problem, namely, in the 

 18 absence of information you might assume that there 

 19 was a problem, often times knowing who is in the 

 20 market and knowing the size of positions and the 

 21 composition gives you comfort that in fact there 

 22 is not a problem and that we can explain what is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 29 

 1 happening. Commissioner Dunn introduced Andy 

 2 Morton, and I have spoken to Andy and others on 

 3 congressional staff many times on energy and ag 

 4 issues, and I know recently Chairman Jeffery spoke 

 5 about hedge funds, and Commissioner Lukken 

 6 recently spoke about energy markets, and I think 

 7 they were able to speak with confidence partly 

 8 because of large trader information that we have. 

 9 Generally speaking, we break down the 

 10 large trader information into two groups, 

 11 commercials and noncommercials. Commercials are 

 12 traders who are engaged in business activities 

 13 that they use futures markets to hedge. It 

 14 includes the traditional commercials, producers, 

 15 farmers, farmers of corn, for example, 

 16 manufacturers, processors of agricultural and 

 17 other commodities, dealer merchants who are 

 18 intermediaries in marketing the commodity. 

 19 Then there is a relatively new category 

 20 that is really an important part of the discussion 

 21 today which is swaps and derivatives dealers. 

 22 They are engaged in OTC activities which creates 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 30 

 1 risks for them and they use the futures markets to 

 2 hedge those risks. In a world where you have two 

 3 categories, commercials and noncommercials, we 

 4 have felt they fit better in the commercial 

 5 category. But we know there are people who feel 

 6 that that has caused a problem with the commercials 

 7 category, and that is at least one of the reasons 

 8 why we are soliciting comments. 

 9 Noncommercials are speculators and 

 10 includes the managed money traders, commodity 

 11 trading advisers, commodity pool operators, hedge 

 12 funds. It includes floor traders and floor 

 13 brokers. Then just any other speculator who has a 

 14 view of prices and trades accordingly. The 

 15 difference between these two categories which 

 16 historically was considered to be important is 

 17 that commercials are offsetting risk, and 

 18 noncommercials are assuming risk in order to make 

 19 a profit, hopefully. 

 20 The way we actually get the information 

 21 we use to make these classifications is from our 

 22 Form 40 Report, which all reportable traders have 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 31 

 1 to file when they first become reportable, and 

 2 then have to refresh every 2 years. There is a 

 3 question on this report which asks the trader if 

 4 they are engaged in activity that they use futures 

 5 markets to hedge. If they indicate yes to that 

 6 question, then they are asked to identify the role 

 7 that they play in the market; are they a producer 

 8 or a manufacturer, a dealer merchant, a swap 

 9 dealer or something other than that; to tell us 

 10 what futures markets they are commercials in, what 

 11 futures markets they use to hedge, and what their 

 12 risks are. So if they are a producer of corn and 

 13 they use the corn market to hedge that risk, they 

 14 would indicate that. 

 15 Commissioner Dunn briefly described the 

 16 Commitments of Traders Reports, so I will go through 

 17 this rather quickly. It is a snapshot of the market 

 18 every Tuesday at the close of business. We 

 19 publish it for any market where there are 20 or 

 20 more traders who hold reportable positions at the 

 21 close of business. This last Friday we just did a 

 22 calculation. We did commitments reports for about 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 32 

 1 100 different markets, and I think that that is 

 2 probably typical, so every week we produce a 

 3 commitments report for 100 markets or so. It is 

 4 released at 3:30 in the afternoon. It is 

 5 available in long or short format. The short 

 6 format is just a subset of the information that is 

 7 in the long format. It is also available in 

 8 futures only and in futures and options combined 

 9 forms. In futures only obviously we are only 

 10 showing futures positions, and in futures and 

 11 options combined we show the combined positions in 

 12 a futures equivalent basis. So options positions 

 13 are adjusted and put on a futures equivalent 

 14 basis. The reportable positions are broken out 

 15 between commercials and noncommercials, and then 

 16 the residual are nonreportable traders who, being 

 17 nonreportable we really do not know anything 

 18 about. 

 19 I am sure this is going to be very 

 20 difficult to see even if you have paper in front 

 21 of you, but this is actually the Corn Report for 

 22 last Friday. The first column shows the total 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 33 

 1 open interest in the market, and then it breaks it 

 2 out between the various reportable categories. 

 3 For the noncommercials it shows the long and 

 4 short. In this case, noncommercials held about 

 5 300,000 long contracts and 87,000 short contracts, 

 6 and that is outright exposure for those traders, 

 7 and then there is a spreading category. So if a 

 8 trader is long one month and short another month, 

 9 that is considered a spread position and reported 

 10 in the spreading category. Also, a position that 

 11 is long futures and short options or short futures 

 12 and long options is considered a spread position, 

 13 and that is shown in the spread category. 

 14 Then the commercial category breaks out 

 15 between long and short. We do not have a 

 16 spreading category here because we assume that the 

 17 positions when they are long and short may not in 

 18 fact be spreads as they are not trades that are 

 19 based on expectations of changes in the spread 

 20 relations. They may be commercial positions that 

 21 are offsetting exposures that are based on 

 22 different months, so we just report it as either 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 34 

 1 long or short. As I said before, this would 

 2 include both the traditional commercials and also 

 3 what we call the nontraditional commercials, 

 4 including swap and derivatives dealers. 

 5 Then the total is all of the traders 

 6 that are reportable, and then to the extreme right 

 7 there is a nonreporting column which is the 

 8 residual. Then we break it out into the 

 9 percentage that those positions represent, and you 

 10 can see that for the total reportable longs, they 

 11 had 88 percent of the open interest, so we are 

 12 meeting the goal of having 70 to 90 percent, and 

 13 the total short was around 81 percent. Then at 

 14 the bottom we have concentration ratios which show 

 15 what the top four traders and the top eight 

 16 traders hold as a percent of the total open 

 17 interest. 

 18 With that, I am going to turn it over to 

 19 Don who will walk us through the origin of the 

 20 Commitments Report and how it has changed over 

 21 time. 

 22 MR. HEITMAN: What I am going to do is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 35 

 1 walk everybody quickly through what is in the 

 2 Federal Register notice, requesting comments on 

 3 the COT reports. The first thing that we will do 

 4 is to go through the history. The COT reports trace 

 5 their antecedents all the way back to the Grain 

 6 Futures Act of 1922 which established the Grain 

 7 Futures Administration within USDA. Their 

 8 objectives included “to obtain for the use of 

 9 Congress and the enlightenment of the public, 

 10 authentic and comprehensive information regarding 

 11 trading in grain futures.” To the end, they 

 12 imposed reporting and record-keeping requirements 

 13 on the exchanges. Using that information, the 

 14 Grain Futures Administration starting publishing 

 15 annual statistics. The first year they published 

 16 was 1924, and the statistics showed hedging versus 

 17 speculative transactions in grain futures. When 

 18 the Commodity Exchange Act came along in 1936, it 

 19 broadened the jurisdiction and created the 

 20 Commodity Exchange Authority and added a bunch of 

 21 new commodities such as cotton, butter, eggs, and 

 22 potatoes, among others, which were included in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 36 

 1 these annual statistics. 

 2 Over the years as new agricultural 

 3 commodities were traded for future delivery, these 

 4 were added to the Commodity Exchange Act and added 

 5 to the Commitments of Traders reports -- soybeans, 

 6 soybean oil, soybean meal, frozen concentrated 

 7 orange juice, and livestock futures, among others. 

 8 Eventually, we switched over from these 

 9 annual statistics to monthly COT reports, which 

 10 were first published in 1962. The Commodity Exchange 

 11 Authority characterized that as a step forward in 

 12 the policy of providing the public with current 

 13 and basic data on futures markets operations. So 

 14 these monthly reports were compiled at the end of 

 15 the month and published on the eleventh or twelfth 

 16 day of the following month. The first one was 

 17 published on June 13, 1962. Since that date, the 

 18 reports have been continually evolving and 

 19 improving, we like to think. 

 20 In April 1975 after passage of the CFTC 

 21 Act, the Commission succeeded the Commodity 

 22 Exchange Authority and we continued monthly 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 37 

 1 Commitments of Traders reports, but added all the 

 2 new commodities brought under CFTC regulation by 

 3 the CFTC Act -- coffee, sugar, cocoa, metals, energy 

 4 products, and financial products, among others. 

 5 The frequency of the reports was 

 6 increased. In 1990, the reports went from monthly 

 7 to twice monthly; in 1992, to every 2 weeks; and 

 8 beginning in 2000, they were published weekly. The 

 9 timeliness also improved. In 1990, publication moved 

 10 to the sixth business day after the “as of” date, and 

 11 in 1992, to the third business day after the “as of date”. 

 12 And the amount of information published was also 

 13 increased. In the 1970s, we added data on numbers of 

 14 traders in each category, a crop year breakout, and 

 15 concentration ratios, and in 1992 we added options data. 

 16 The distribution was also widened. In 1993, 

 17 the reports were changed from a paid subscription- 

 18 based mailing list, to fee-based electronic 

 19 access, and in 1995, we just put it up on the 

 20 website freely available to everybody. 

 21 As the reports have evolved, the market 

 22 has also evolved, and it is the interaction between 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 38 

 1 the markets and the reports that gave rise to this 

 2 Federal Register notice. One of the issues 

 3 contributing to this was the elimination of the 

 4 Series '03 reports, which happened in 1982. This 

 5 action was intended to remove a paperwork burden on 

 6 large traders. Large traders had been required to 

 7 file Series '03 reports, for every large trader in 

 8 the market. The Commission eliminated the Series 

 9 '03 reports in 1981. The Series '03 reports had 

 10 required each reporting large trader to classify 

 11 their positions as hedging or speculation, and that 

 12 was the source of the data for the COT reports up 

 13 until 1981. 

 14 When the Commission eliminated the Series 

 15 '03 reports, they actually suspended the COT reports 

 16 for 18 months to allow computer changes, and when 

 17 they began publishing again, they based the 

 18 COT data on a different series of reports -- on the 

 19 Series '01 reports filed by FCMs (brokers) and the 

 20 Form 40 Statement of Reporting Trader that John 

 21 mentioned earlier. There is significant 

 22 difference in this new reporting mechanism, and that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 39 

 1 is that the Series '03 reports had classified trades 

 2 as “hedging” versus “speculation.” When the COT 

 3 reports resumed, reportable positions were classified 

 4 as “commercial” or “noncommercial” based on the 

 5 declaration in that Form 40 Statement. 

 6 The public perception is, I think, that 

 7 “commercial versus noncommercial” in the current 

 8 reports is report is essentially the same as 

 9 “hedging versus speculation” in the pre-1982 

 10 reports. However, the markets have evolved a lot 

 11 since 1982, so we are faced with the question: do the 

 12 commercial versus noncommercial categories of today's 

 13 COT reports appropriately classify trading practices 

 14 that were not contemplated when the hedging 

 15 versus speculation category was removed in 1982? 

 16 Another thing that contributes to this 

 17 uncertainty is the speculative limits and hedge exemption 

 18 rules. The Act and CFTC regulations require the Commission 

 19 and the exchanges to impose limits on the sizes of 

 20 speculative positions in the futures markets. Bona 

 21 fide hedges are exempt from these limits, and the test for 

 22 what is a bona fide hedge is whether a position is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 40 

 1 “economically appropriate to the reduction of risks 

 2 in the conduct and management of a commercial enterprise.” 

 3 Again, you have the “commercial” label. Both the hedge 

 4 exemption rules and the standards for classifying 

 5 commitments of traders positions refer to 

 6 “commercial” positions. 

 7 The question becomes, how do you deal 

 8 with the entry of “nontraditional commercials” into 

 9 the marketplace? John alluded to this when he 

 10 spoke about swap dealers. Since the early 1990s, 

 11 various nontraditional commercials have requested 

 12 and received hedge exemptions. The best example 

 13 is a swap dealer that enters an index-based over- 

 14 the-counter swap with a large pension fund. The 

 15 pension fund is seeking to diversify its portfolio 

 16 to include physical commodity exposure. The swap 

 17 dealer makes a swap with the pension fund for the 

 18 index, and the swap dealer now is in effect short 

 19 the index. Thus, it has a big short exposure in these 

 20 physical commodities which it seeks to hedge in 

 21 the futures market. The corn, soybeans, and wheat 

 22 positions in the swap dealer's portfolio of long 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 41 

 1 futures are granted a hedge exemption from federal 

 2 speculative limits and reported as “commercial” for 

 3 COT purposes. 

 4 The effect on the COT numbers is 

 5 significant. Pre-1991, both the long and the sort 

 6 side open interest in the Commitments of Traders 

 7 reports represented traditional hedgers -- 

 8 producers, processors, manufacturers, and 

 9 merchants. Today, a significant proportion of 

 10 long-side open interest in several major physical 

 11 commodity futures contracts is held by 

 12 nontraditional hedgers such as swap dealers. This 

 13 has raised questions as to whether the Commitments 

 14 of Traders report can reliably be used to assess 

 15 futures hedging activity by persons hedging 

 16 exposure in the underlying physical commodity 

 17 markets. 

 18 To address this issue of whether the COT 

 19 reports are accurately reflecting what is going on in 

 20 the market, the alternatives we discussed were: we 

 21 could adopt changes in the way the COT data are 

 22 presented in the reports; or we could stop 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 42 

 1 publishing the reports if data anomalies cannot be 

 2 resolved or we find the reports provide no public 

 3 benefit. We put that second option in because we felt, 

 4 in order to get the broadest possible range of comments, 

 5 we should list the broadest possible range of 

 6 options. It led to, among other things, people 

 7 calling me, because I am the Federal Register 

 8 contact person, and saying very unkind things to me 

 9 on the phone. Also, the Secretariat asked me a question 

 10 that I had never encountered before, which was “are we 

 11 required to post on the website the comments that 

 12 have profanity in them?” and I said “yes -- for 

 13 purposes of full disclosure. I think it is 

 14 extremely unlikely that any children are going to 

 15 be going through the Commitments of Traders 

 16 comments.” I would like to say to anybody who is 

 17 listening or reporting this, as it says on the slide, 

 18 “Relax, calm down and take a deep breath. We are not 

 19 going to stop publishing the COT reports.” We will 

 20 find some way to address the data anomalies. 

 21 As Commissioner Dunn said, we have 

 22 received over 4,000 comments and it did, I think, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 43 

 1 achieve the result of showing us there is a great 

 2 deal of desire on the part of the trading public 

 3 for the information that is in the COT reports. 

 4 Based on the issues I have described, we 

 5 listed a bunch of questions that we are hoping to get 

 6 answers to from the public commentors, and I am going to 

 7 turn it back over to John to go through the questions. 

 8 MR. FENTON: Before I get to that, I 

 9 just want to clarify a thing that is often times 

 10 confused. There are two types of traders in 

 11 futures markets whose trading is related to 

 12 commodity index trading. One, as we have already 

 13 mentioned, are swaps dealers who do OTC contracts 

 14 related to a commodity index and then come into the 

 15 futures markets to hedge that risk. Those traders 

 16 are included, as we have said before, in the 

 17 commercial category. However, commodity index 

 18 funds trade directly in futures markets, such as, 

 19 and I can disclose this because it is publicly known, 

 20 Deutsche Bank has an ETF that is based on the 

 21 Deutsche Bank Liquid Commodity Index and they take 

 22 positions in the underlying futures of that index. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 44 

 1 Those commodity index funds are reported as 

 2 noncommercial traders. So that in and of itself 

 3 seems like an anomalous situation where the 

 4 ultimate purpose of that trading is very similar, 

 5 and yet it reported in two separate categories in 

 6 our report. 

 7 What we would like to find out both from 

 8 commentors to the Federal Register Notice and from 

 9 the members of the Ag Advisory Committee here 

 10 today is to give us some helpful ideas on these as 

 11 well as other questions. First of all, how is the 

 12 Commitments of Traders report useful to people, 

 13 just as background to us? Is the current 

 14 classification system flawed? I am sure there are 

 15 various opinions on that. If it is flawed, what 

 16 changes should be made, and to what futures 

 17 market? That second question I think gets to the 

 18 issue of to a great extent this is all a function 

 19 of the growth of commodity index trading, and that 

 20 is a subset of all the markets. As I said, we do 

 21 Commitments of Traders Reports on a hundred 

 22 markets, and yet the underlying markets of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 45 

 1 commodity indices are 15 or 20 of the major 

 2 markets. We would like input on whether changes 

 3 should be made to all reports even though the real 

 4 interest is in a subset of those reports. Along 

 5 the same lines, would a periodic supplementary 

 6 report with finer classifications be sufficient, 

 7 rather than changing the current Commitments 

 8 Report, we could put a periodic monthly or 

 9 quarterly supplemental report that would provide 

 10 the information that gives a finer breakdown? 

 11 To the extent this issue is motivated by 

 12 commodity index trading, that trading is very 

 13 stable. There are not a lot of changes from week 

 14 to week. If we do put it out on a weekly basis, I 

 15 think people will see that there really is not a 

 16 whole lot happening from week to week, and so a 

 17 monthly report might be sufficient. 

 18 Would a finer classification put traders 

 19 at a competitive disadvantage? Would it disclose 

 20 information that could be used to the disadvantage 

 21 of traders? There are some traders whose trading 

 22 activity is based on a number of different kinds 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 46 

 1 of trading. It could be both physical hedging, 

 2 and it can be swaps hedging, and right now that is 

 3 reported to us as a single number and we currently 

 4 do not have a way of breaking that trading out 

 5 between the components. Either we would have to 

 6 figure out a way to do that or we would decide 

 7 which is the primary component and then report it 

 8 all under that primary component. 

 9 Those are some of the questions that we 

 10 hope to hear from folks today and also from 

 11 commentors to the Federal Register Notice. 

 12 COMMISSIONER DUNN: Thank you very much, 

 13 John and Don. It always amazes me that as the 

 14 staff goes through these literally thousands of 

 15 reports that come in that they are able to give us 

 16 a meaningful presentation during our surveillance 

 17 meeting. 

 18 With that, I would like to have our 

 19 folks from the field, Dave Lehman, Dan Brophy, 

 20 Greg Zerzan, Tom Coyle, and Fred Clark come 

 21 forward. 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 47 

 1 Let me take this opportunity to introduce 

 2 a couple of other people who have joined 

 3 us. I am told Honorable Tom Erickson, 

 4 former Commissioner, is here. There he 

 5 is. Also Susan Keith, from the 

 6 Senate Agriculture Committee has joined 

 7 us. 

 8 I will go in the order that we have you 

 9 on the agenda, if that is fine with everyone. 

 10 With that, Dave, we will begin with you. 

 11 MR. LEHMAN: Thank you, Commissioner 

 12 Dunn, Chairman Jeffery, Commissioners Lukken and 

 13 Hatfield, for the opportunity to appear today at 

 14 the CFTC's Ag Advisory Committee and provide 

 15 comments on the Commitments of Traders review. 

 16 The Chicago Board of Trade commends the 

 17 CFTC for its comprehensive review of the 

 18 Commitments of Traders Report and for recognizing 

 19 the significant role that index fund trading has 

 20 assumed in the agricultural markets. While the 

 21 CBOT is still developing its answers to the 

 22 questions asked in the Federal Register Notice, I 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 48 

 1 will provide preliminary answers to some of these 

 2 questions. 

 3 However, before I do that, I would like 

 4 to give a little background on the issue from the 

 5 CBOT's perspective. During the fall of 2005, a 

 6 number of market participants communicated to the 

 7 CBOT their concern that CFTC's Commitments of 

 8 Traders Report may need modification to properly 

 9 account for the increasing participation in CBOT's 

 10 agricultural futures markets by index fund 

 11 traders. While these market participants welcomed 

 12 the beneficial impact on market liquidity provided 

 13 by index fund traders, they also expressed concern 

 14 that many of these traders were being placed in 

 15 the commercial category of the Commitments Report. 

 16 As we understand it, the commercial 

 17 category of the Commitments Report historically 

 18 reflected hedging transactions connected to the 

 19 activities of producers, processors, and 

 20 merchandizers of the underlying product. As index 

 21 fund trading has increased in these markets, some 

 22 of that trading is reported under the commercial 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 49 

 1 category even though it represents a different 

 2 type of customer base than that which was 

 3 historically assumed to comprise that category. 

 4 In November 2005, CBOT and members of 

 5 the National Grade Trade Council held a conference 

 6 call with CFTC staff to discuss the feasibility of 

 7 creating a new or subcategory of the Commitments 

 8 of Traders Report that would include the positions 

 9 of nontraditional hedgers. CFTC and CBOT market 

 10 surveillance staff explained that some index funds 

 11 have received hedge exemptions from speculative 

 12 position limits in agricultural futures and are 

 13 being reported in the commercial category on the 

 14 COT report. In both cases, these hedge exemptions 

 15 do not apply to positions held in the spot or 

 16 delivery month. 

 17 In December 2005, CBOT wrote a letter to 

 18 CFTC Chairman Reuben Jeffery expressing its 

 19 support for a change in the Commitments of Traders 

 20 Report that would place the positions of index 

 21 funds and other nontraditional hedgers in a 

 22 separate category or subcategory of the existing 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 50 

 1 commercial category. The purpose of this change 

 2 would be increased transparency of the Commitments 

 3 of Traders Report in reflecting the positions of 

 4 traditional commercial hedgers and index fund 

 5 traders. 

 6 The CBOT has continued to work with the 

 7 industry in a broad cross-section including the 

 8 National Grade Trade Council and the National 

 9 Grain and Feed Association to better understand 

 10 the concerns of the industry over how 

 11 nontraditional commercials are currently being 

 12 reported in the Commitments of Traders Report. 

 13 The CBOT, as I said, intends to submit a 

 14 comment letter and is still developing its final 

 15 answers to those questions, but I will give our 

 16 preliminary answers today. Based on the feedback 

 17 we have received from market participants and on 

 18 the number of comment letters that the CFTC has 

 19 received on its website, the Commitments of 

 20 Traders Report appears to be widely used 

 21 throughout the trading community by both 

 22 commercial and speculative traders. CBOT research 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 51 

 1 staff utilized historical data from the 

 2 Commitments of Traders Report to monitor trends in 

 3 participation in our products among commercial and 

 4 noncommercial traders. 

 5 We do not believe that the Commitments 

 6 of Traders Report currently provides any category 

 7 of trader with an unfair advantage over another 

 8 category of trader. We support continued 

 9 publication of the Commitments of Traders Report. 

 10 We support a revision in the categories of traders 

 11 in the Commitments of Traders Report to include a 

 12 new category of nontraditional commercial. We 

 13 believe that the CFTC should continue the current 

 14 weekly frequency of distribution of the 

 15 Commitments of Traders Report as improvements in 

 16 computer technology have enhanced efficiency of 

 17 data-handling procedures. 

 18 Again, thank you very much for the 

 19 opportunity to appear today to speak on this 

 20 important issue on behalf of the Board of Trade. 

 21 COMMISSIONER DUNN: Thank you very much. 

 22 Dan? 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 52 

 1 MR. BROPHY: Thank you very much, 

 2 Commissioners. I was going to thank you for the 

 3 opportunity to get out of Chicago weather as well, 

 4 and actually I think I should apologize for 

 5 exporting our steam bath to Washington. 

 6 My name is Dan Brophy and I am Chairman 

 7 of the Futures Committee of the National Grain 

 8 Trade Council. The Grade Trade Council has worked 

 9 on this issue since spring 2005 with CFTC staff. 

 10 Our work includes work with the Chicago staff of 

 11 the CFTC, letters to the Commissioners dated 

 12 September 16, 2005, March 2006, and various 

 13 meetings here in Washington, as well as with 

 14 Chicago staff. We will be submitting a comment 

 15 letter in mid-August to the Commitments of Traders 

 16 issue. 

 17 In quick summary, we wish to point out 

 18 that today's Commitments of Traders Report 

 19 combines traditional grain hedgers, or appears to. 

 20 Actually, I heard some new information that I was 

 21 not aware of, but I think it is generally true 

 22 from our perspective that the report combines 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 53 

 1 traditional grain hedgers in the same commercial 

 2 category as a large and very influential and 

 3 active group of new traders that we call financial 

 4 hedgers. These are primarily index funds, but 

 5 from what we gather from trade sources, they 

 6 comprise other new instruments as well. 

 7 According to our discussions with our 

 8 trade sources, these flows of money into our 

 9 markets are just immense. One of our sources said 

 10 $7 billion was indexed in 2001, $40 billion in 

 11 2004. They estimated $100 billion currently. 

 12 These do not include estimates for customized 

 13 more narrowly based commodity index baskets or 

 14 new ETFs, both of which probably add to the total 

 15 I just mentioned. 

 16 Six to nine percent perhaps of this is 

 17 thought to include U.S. grain futures, corn and 

 18 soybeans at 3-week contracts, meal, and oil. The 

 19 flow may have slowed somewhat recently, but the 

 20 net growth will continue based on the historical 

 21 performance of these indices relative to stocks, 

 22 bonds, and other investment vehicles. Therefore, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 54 

 1 the influence of index hedging and financial 

 2 hedgers will continue to grow in the grain 

 3 markets. 

 4 They are completely legitimate hedges, 

 5 and we are the first to recognize that. We are 

 6 glad for their involvement in our markets. 

 7 However, the character of these financial hedges 

 8 is fundamentally different than the traditional 

 9 grain hedge, and this is the point of our 

 10 presentation. These positions, as has been stated 

 11 in your own questionnaire and stated today, are 

 12 typically long positions. We have not seen any 

 13 competing reverse instruments developed. I 

 14 suppose one day they will come. But they are 

 15 typically long, they are typically rolled forward, 

 16 they are not sold out. These are commodity price 

 17 developments which are completely different than 

 18 anything we have seen before because if you 

 19 normally have a flow of buying into a market, it 

 20 triggers activity in the part of traditional 

 21 hedgers, producers, merchandizers, consumers in 

 22 grain markets, et cetera, and it triggers a lot of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 55 

 1 activity, but the price movements trigger 

 2 absolutely no response from the index hedgers. 

 3 In effect now, the grain markets have 

 4 two distinctly different types of hedgers using 

 5 our markets whose activity is captured in the 

 6 commercial category in the COT report. The 

 7 traditional hedgers, again, they are instantly 

 8 responsive to price movements in the underlying 

 9 commodity, and financial hedgers whose positions 

 10 really are investment securities, these positions 

 11 are not for sale or seldom for sale, they are not 

 12 responsive to price movements in the underlying 

 13 commodity, they are not responsive to supply- 

 14 demand developments. This is a new and critical 

 15 distinction, but it is missed entirely in the current 

 16 COT reporting format. 

 17 What I want to emphasize to you today is 

 18 that in our view the index and other commodity 

 19 investment hedges have the characteristics of 

 20 securities, not commodities futures. They are 

 21 futures positions held for investment, not for 

 22 trading, not for resale, so in effect, a component 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 56 

 1 of the futures market open interest has been 

 2 securitized as investment securities and is 

 3 something we have never seen before. 

 4 The CFTC and the grain futures exchanges 

 5 have the specific data, but our members believe 

 6 that in some grain futures contracts, the index 

 7 hedges now constitute a significant share of the 

 8 open interest. The 3-day delayed release of COT 

 9 information poses in our view absolutely no threat 

 10 to the confidentiality of positions and can offer 

 11 no advantage to any group of traders over another. 

 12 As grain markets increasingly migrate off trading 

 13 floors to screen trading, and it started today, 

 14 trading will become completely anonymous, fewer 

 15 information sources will be available, and, 

 16 therefore, this will further guarantee the 

 17 confidentiality of activity in positions and also 

 18 make the COT report more valuable to the industry. 

 19 Regarding the convergence issue, we 

 20 would simply like to say that the buying power and 

 21 the staying power of the index hedgers has the 

 22 potential to exceed the influence of traditional 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 57 

 1 hedging. The nonresponsiveness to price movement 

 2 and supply-demand development such as crop size in 

 3 the physical commodity by these entities may make 

 4 the relationship of some futures contracts to the 

 5 underlying cash markets less predictable and more 

 6 volatile. This increases risks to the traditional 

 7 hedgers who rely on historical basis 

 8 relationships. We would like to note, as you all 

 9 know, that there is a multibillion-dollar domestic 

 10 and global industry including storage, handling, 

 11 processing, shipping and receiving facilities, 

 12 banking credit lines, banking relationships for 

 13 managing inventory and other price risks, exchange 

 14 traded futures contracts, all of this network and 

 15 all these enterprises have been built up over the 

 16 last 150 years around the general reliability of 

 17 the futures-to-cash-basis relationships. The 

 18 hedge of this large industry needs to be promoted 

 19 and protected. 

 20 We believe that traditional hedgers need 

 21 disclosure of financial hedger commitment of 

 22 traders data to assist them in determining the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 58 

 1 size of the nonprice responsive commercial open 

 2 interest or other open interest that, as I said, I 

 3 was not aware was not in the commercial category. 

 4 We need assistance to determine the size of this 

 5 nonprice responsive commercial and other open 

 6 interest relative to total open interest. 

 7 More accurately constructed COT data 

 8 will help traditional cash grain hedgers assess 

 9 whether hedging risks and hedging effectiveness 

 10 have changed or may change. Without this data, 

 11 there is simply no way to know as a traditional 

 12 commercial hedger if a hedging risk different from 

 13 anything ever experienced in the history of our 

 14 industry resides in the market this hedger is 

 15 using for his daily management of price risks. 

 16 Therefore, making available to the trading 

 17 community more accurate, comprehensive data will 

 18 improve market transparency and assist in 

 19 efficient price discovery function of the grain 

 20 markets which is definitely your objective, our 

 21 objective, and beneficial to the public. 

 22 We are asking the CFTC to create either 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 59 

 1 a new and separate reporting category or a 

 2 subcategory of the existing Commitments of Traders 

 3 commercial category to capture open interest data 

 4 for nontraditional financial hedges and 

 5 distinguish this new and important component of 

 6 open interest from the open interest held by 

 7 traditional grain hedgers. Thank you. 

 8 COMMISSIONER DUNN: Thank you very much. 

 9 Greg? 

 10 MR. ZERZAN: Thank you, Commissioner and 

 11 the other Commissioners. 

 12 I am Greg Zerzan and I represent the 

 13 International Swaps and Derivatives Association, 

 14 or ISDA. As you know, ISDA is the world's largest 

 15 financial-services trade association. We have 

 16 nearly 750 members in countries all around the 

 17 globe, and our members are as diverse as 

 18 multinational banks, commodity firms, 

 19 manufacturers, and consumer goods producers. 

 20 We are grateful for the opportunity to 

 21 comment, and we would like to congratulate the 

 22 Commission for your continued willingness to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 60 

 1 tackle changes and issues in the dynamic 

 2 marketplace. 

 3 The members of ISDA would have some 

 4 concerns with changes to the Commitments of 

 5 Traders Report. We will be submitting our 

 6 comments formally later, we are still in the 

 7 process of formulating them, but in general we 

 8 would note that to the extent a separate category 

 9 was created which would apply to what we believe 

 10 would potentially be a narrow subset of 

 11 participants in this industry, we are concerned 

 12 that opportunities would be created to 

 13 disadvantage these participants, opportunities 

 14 which would allow others to see their trading 

 15 positions, deduce their strategies, and trade 

 16 ahead of these participants. It is worth noting 

 17 that this would be not simply to the detriment of 

 18 this narrow community of swap dealers, but to the 

 19 detriment of their ultimate customers who include 

 20 pension funds, mutual funds, and other members of 

 21 the public. 

 22 There is no reason to single out this 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 61 

 1 narrow community, and there is a danger of 

 2 eliminating the key benefit of anonymity which is 

 3 provided by the futures markets. There is also a 

 4 danger that by separating out nontraditional 

 5 commercials from commercials, you allow the 

 6 commercials' positions to be exposed, and, 

 7 similarly, the trading strategies to be more 

 8 easily deduced. 

 9 ISDA is in support of continuing the 

 10 Commitments of Traders Report. We believe it is 

 11 useful and it has generally worked well. We feel, 

 12 however, that if it is necessary to add a new 

 13 category, that category be broad enough to include 

 14 a wider community of nontraditional commercials so 

 15 that swap dealers as a subset would not find 

 16 themselves particularly exposed. We also would 

 17 support limiting the frequency of the report as 

 18 suggested in question 10 of the Federal Register 

 19 Notice. 

 20 ISDA looks forward to continuing to work 

 21 with the Commission and members of the community 

 22 to reach a healthy resolution which does not 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 62 

 1 expose swap dealers unnecessarily, but addresses 

 2 larger concerns within the marketplace. Thank 

 3 you. 

 4 COMMISSIONER DUNN: Thank you, Greg. I 

 5 think we have on the agenda Tom Coyle next, and 

 6 Tom is sitting in this particular position because 

 7 he is using the computer to do a PowerPoint 

 8 presentation for us, and so that is the reason why 

 9 we have them in different places. Tom, if you 

 10 will, please. 

 11 MR. COYLE: Good morning, Commissioner 

 12 Dunn, and good morning other Commissioners. 

 13 My comments will focus primarily on the 

 14 need for additional transparency in reporting of 

 15 fund trading in the CFTC's weekly Commitments of 

 16 Traders Report. I appreciate the opportunity to 

 17 share of the views of the National Grain and Feed 

 18 today. We will be submitting written comments to 

 19 the Federal Register Notice shortly. 

 20 I thought since there had not been a 

 21 meeting in some time that we would give an 

 22 overview of NGFA and why we are here and why this 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 63 

 1 issue is important. The National Grain and Feed 

 2 Association has 900 members and over 6,000 

 3 facilities. Our members handle grain, process 

 4 grain, and include millers and now includes 

 5 ethanol producers as well. Our members work with 

 6 farmers to provide marketing strategies, and to 

 7 accomplish that and to provide effective hedging, 

 8 we need to have as much market data timely and 

 9 accurate as possible. 

 10 The Commitments of Traders Report has 

 11 been a useful tool to provide insight on 

 12 Commission participants. Speculators and hedgers 

 13 have different economic interests for being in 

 14 the market. Gauging the interests of these groups 

 15 provide insight to value and to risk. 

 16 Historically, it was fairly easy to identify the 

 17 difference between a speculator and a hedger, 

 18 because a hedger was traditionally a grain handler 

 19 that was handling the physical commodity. Today 

 20 that is not possible from the current reports. 

 21 The NGFA has supported the increasing 

 22 position limits at the Chicago Board of Trade for 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 64 

 1 years. We view that as positive for the industry, 

 2 improves the foundation of the exchanges, and it 

 3 enhances trade transparency particularly because 

 4 it does allow swaps trades to show up in the 

 5 Commitments of Traders Report. In April 2005 we 

 6 again supported the significant increase in 

 7 position limits, but at this time there was a 

 8 genuine concern that this kind of trading could 

 9 overwhelm the amount of actual hedging of physical 

 10 commodities, so we made two requests at the time. 

 11 One was that there would be more information and 

 12 more details in the reports, and more transparency 

 13 about who was trading the markets. Secondly, to 

 14 the Board of Trade to make sure that the delivery 

 15 process and the convergence was protected. 

 16 For an idea of the increase in position 

 17 limits, the corn limit has been increased by 340 

 18 percent since 1999, soybeans 150 percent, and soft 

 19 red wheat up over 100 percent, which are pretty 

 20 significant increases. These increases in limits 

 21 have achieved their goal which was to bring on 

 22 more participation. What is particularly 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 65 

 1 interesting and I think important to this 

 2 discussion is the fact that it not only brought 

 3 more participation, but it brought in new users 

 4 and the new users who have different economic 

 5 interest in the market, and it specifically 

 6 increased the amount of various fund types. I 

 7 don't even want to categorize them as one because 

 8 there are so many different kinds of funds, and it 

 9 is expected that we will continue to see growth in 

 10 that, even more enhanced by the electronic 

 11 trading. 

 12 In the same time frame, the Chicago 

 13 Board of Trade volume is up over 80 percent as the 

 14 charts show, and probably significant to the 

 15 discussion later about wheat and the basis levels 

 16 and some of the imbalances, let's say, is that the 

 17 white open interest volume is up 150 percent. In 

 18 fact, at one point in 2006, the open interest in 

 19 wheat was actually larger than the production of 

 20 soft red wheat. If you look historically, that 

 21 typically does not exceed 40 percent, and is 

 22 seldom over 30 percent. That is a key issue for 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 66 

 1 some of the balances or imbalances that we are 

 2 seeing in cash and futures. Soybeans have seen a 

 3 similar growth, not quite as dramatic as we have 

 4 seen in corn and in wheat. 

 5 The key issue for our participation 

 6 today is that National Grain and Feed strongly 

 7 believes that the report is more important today 

 8 than it has been in the past particularly because 

 9 the landscape has changed. We have new user 

 10 groups. If you look back on the reason for having 

 11 the report to begin with, it was to provide that 

 12 kind of information on who was using the market 

 13 and why. Everyone will have their reasons to 

 14 analyze the data, but at least the data was there. 

 15 It is our view that the increased open interest 

 16 and the new user groups have actually reduced the 

 17 utility of the report. The report needs to have 

 18 more detail to affect proper analysis and market 

 19 efficiency. We applaud the success of the 

 20 regulated exchanges and we welcome the growing 

 21 participation of the various funds. This 

 22 represents a robust market. At the same time, we 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 67 

 1 believe that the growth increases the need for 

 2 more detail. 

 3 Commenting on the issue brought up 

 4 earlier, and I will make it brief and add comments 

 5 later particularly as it relates to wheat, is the 

 6 fact the futures prices have been elevated by a 

 7 new and significant buyer and, as Mr. Brophy had 

 8 identified, tends to be one-sided. There are a 

 9 number of things that impact the wheat market this 

 10 year, the fact that you have crop problems in hard 

 11 wheat and you have crop problems in spring wheat 

 12 this summer, and we have not seen that in soft 

 13 wheat. So as you see, the prices relative to 

 14 these other issues, the soft wheat which is the 

 15 most liquid market, actually, has tended to 

 16 follow. Identifying exactly why that volume is up 

 17 or what impact it is having is difficult because 

 18 the report does not differentiate between who is 

 19 buying in the market. 

 20 The other key issue is transportation 

 21 costs. I can put in perspective that 

 22 historically, wheat from Chicago to New Orleans 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 68 

 1 would probably cost 25 cents a bushel, and today 

 2 it is 85 cents a bushel. It is hard to say is it 

 3 futures, is it transportation, is it new 

 4 participants? Again, having more and better 

 5 information about who is participating in the 

 6 market may aid in that discussion, and I will 

 7 answer any questions. 

 8 COMMISSIONER DUNN: Thank you, Tom. 

 9 Fred? 

 10 MR. CLARK: Thank you, Commissioner Dunn 

 11 and Chairman Jeffery, Commissioner Lukken and 

 12 Commissioner Hatfield. 

 13 I am pleased to be here this morning on 

 14 behalf of the U.S. Rice Producers Association. It 

 15 is a trade association comprised primarily of 

 16 producer organizations in Mississippi, Missouri, 

 17 Texas, California, and Arkansas. I am pleased to 

 18 offer what I would call our brief initial thoughts 

 19 on the Commitments of Traders Reports and its 

 20 important to individual producers and those who 

 21 may do futures trading or marketing on their 

 22 behalf. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 69 

 1 The COT reports are a great asset to all 

 2 users of agricultural markets, futures and options 

 3 markets in particular. As indicated in your 

 4 Federal Register release, the reports are one of 

 5 the most visited areas of CFTC's website. We 

 6 believe that this activity is indicative of the 

 7 importance of the reports to all market users. 

 8 The reports are especially important to 

 9 individual farmers or agricultural producers, and 

 10 the easy availability of the information is one of 

 11 the great levelers, we believe, of the market 

 12 playing field between large and small market 

 13 players. This is critical for individual farmers 

 14 like rice farmers who do not have the time or the 

 15 resources to follow futures markets and even the 

 16 cash markets to the same extent that many 

 17 commercial users or speculative traders might. 

 18 Obviously, for these and other reasons we would 

 19 oppose the elimination of the Commitments of 

 20 Traders Reports. 

 21 First of all, I want to say thanks so 

 22 much for having this hearing today because I know 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 70 

 1 I have learned a lot already about the context in 

 2 which you are considering these changes, so this 

 3 has been very helpful and is appreciated. 

 4 Generally speaking, I think producers 

 5 feel as if those who actually deal in commodities 

 6 in some way, in other words, those who actually 

 7 produce them, market them, buy them, handle them, 

 8 process them, sell them into the market, should be 

 9 as a class somehow readily identifiable in the 

 10 Commitments of Traders Reports. I know this is 

 11 what we are talking about here this morning, but 

 12 that is the goal, I think, because other 

 13 participants in the markets can skew those results 

 14 or cloud what is really happening in the market. 

 15 So determining the positions and activities of 

 16 what producers consider to be true hedgers or true 

 17 commercials is a key in many respects to their 

 18 ability to carry out their marketing plans and to 

 19 operate profitably. 

 20 Producers tell us that they use the 

 21 information from the reports to determine their 

 22 own position relative to the market. For example, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 71 

 1 the higher that they believe the aggregate short 

 2 position to be in the market, they would normally 

 3 conclude that means there has been more selling 

 4 perhaps done by sellers relative to buyers, and 

 5 the opposite, of course, would be the same case. 

 6 To the extent that information is clouded by 

 7 information in the report that is not indicative 

 8 of actual physical market participants, that makes 

 9 that job more difficult for them. 

 10 As important as all this data is, I 

 11 think it is also critical for producers to be able 

 12 to readily see the change in all these market 

 13 factors over time. So almost as important as what 

 14 is reported is how often it is reported and that 

 15 it is reported in a consistent way so they can see 

 16 market movements, because that is critical to 

 17 them. Like all other traders in these markets, 

 18 farmers and others in agriculture, of course, have 

 19 what could probably be characterized as an 

 20 insatiable desire for market information, and we 

 21 understand that sort of human inclination. 

 22 Having said that, we think one critical 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 72 

 1 difference is that individual producers are 

 2 probably at a pronounced informational 

 3 disadvantage compared to major market traders and 

 4 commercials in the markets. So to the extent the 

 5 Commitments of Traders Reports can help to level 

 6 that playing field, I think that is why producers 

 7 think the reports are so important. 

 8 It is also important that producers be 

 9 able to readily separate actual commercial market 

 10 users or hedgers in their minds from other 

 11 participants such as hedge funds, swap dealers, or 

 12 pure speculators. As was alluded to I think in 

 13 our Federal Register release, the market behavior 

 14 of each of these participants varies as has been 

 15 discussed here a little bit today already, so the 

 16 more information that producers have that can 

 17 allow them to glean who is doing what to whom and 

 18 why, to put it colloquially, the better off they 

 19 will be and the more likely they will be able to 

 20 separate out what they believe to be what I call 

 21 real cash market effects and help them market 

 22 their commodities against what they believe the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 73 

 1 real cash market to be. Each regarding each of 

 2 these factors is important to be able to 

 3 determine, of course, which factors are driving 

 4 the changes I mentioned earlier, the changes in 

 5 the market, and which ones may not be. 

 6 In addition to that what is important to 

 7 producers is the basis in the futures relative to 

 8 the cash, and that is important as well. Again, 

 9 the basis may be clouded to some extent by 

 10 nontraditional commercials in the market. 

 11 In a brief response to some of the other 

 12 questions you raised in our Federal Register 

 13 Notice, we do not believe that the Commitments of 

 14 Traders Reports provide any particular segment of 

 15 traders with any unfair advantage. In fact, we 

 16 believe the existence of the reports acts as 

 17 evidence of the need to make market information 

 18 readily available to producers on a timely basis. 

 19 Because the reports are publicly available to 

 20 everyone who is concerned, we would argue that any 

 21 unfair informational advantages will be reduced as 

 22 the reports are published more frequently and with 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 74 

 1 more information. Thus, we would urge that the 

 2 reports be published more often and as close to a 

 3 real-time basis as possible. 

 4 We intend to comment in writing on these 

 5 and the other questions you raise in the Federal 

 6 Register Notice soon, but I would sum up some of 

 7 the views of our producers as follows. One, the 

 8 Commitments of Traders Reports are one of the 

 9 Commission's most useful tools in assisting 

 10 producers to design and execute marketing plans. 

 11 Two, of course, we oppose the elimination of the 

 12 reports. Three, we believe the reports should be 

 13 published as frequently as possible with as much 

 14 readily accessible information and detail as 

 15 possible. Four, daily reporting should be the 

 16 goal to which the Commission should currently 

 17 aspire in this regard. And five, the reports 

 18 should be biased towards providing more market 

 19 information and transparency whenever that is 

 20 possible and practical. Thank you again or having 

 21 this meeting today and for the opportunity to talk 

 22 with you. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 75 

 1 COMMISSIONER DUNN: Thank you all of the 

 2 panel members. The way we will proceed here is we 

 3 will allow the Commissioners to ask the panelists 

 4 any questions they may have, and then I 

 5 would open it up to the panelists to ask each 

 6 other any questions that they may have. Then the 

 7 Advisory Committee members if they want to ask the 

 8 panel a question, please come forward and do that. 

 9 Then we will open it up for any public members who 

 10 are here today who would like to make a comment or 

 11 ask a question. Also, Don and John will be 

 12 available for questions as well. 

 13 First of all, I am delighted to hear a 

 14 consensus that we ought to keep the Commitments of 

 15 Traders Reports, and I think that bodes well for 

 16 what the Commission has been doing in the past. 

 17 It is a little frightening to let everyone know 

 18 how we are watching you, and then suddenly find 

 19 out that you are all watching us to see how we 

 20 are watching you, and that I think is something 

 21 that as a Commissioner I need to keep in mind. 

 22 Dan, I am paraphrasing you on this, and, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 76 

 1 Greg, I would like to get your reaction to this. 

 2 You said that these open interests become 

 3 securitized when the swap dealers and others get 

 4 those, and then they are nonprice responsive. It 

 5 seems like that could cut both ways, but, Greg, I 

 6 would like to get your reaction to that. 

 7 MR. ZERZAN: Thank you, Commissioner. 

 8 Before I would react, I would like to maybe hear a 

 9 little bit more about what exactly Dan meant by 

 10 that. 

 11 COMMISSIONER DUNN: Would you amplify, 

 12 Dan? 

 13 MR. BROPHY: Yes. These are based on 

 14 committee discussions, my discussions with my 

 15 sources in the industry and other committee 

 16 members, discussions with their sources in the 

 17 industry, and admittedly, we are at something of a 

 18 disadvantage because we do not have the data the 

 19 Commission has, but what is happening is that 

 20 these index instruments are becoming Wall Street 

 21 instruments, or have become Wall Street 

 22 instruments. They are sold to the public as 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 77 

 1 investment instruments. They are not for resale. 

 2 They are not something that Tom's company 

 3 purchases or Cargill or ADM purchases to hedge an 

 4 export sale or a sale to a domestic miller, for 

 5 instance, and then resells when Tom's company or 

 6 an exporter or domestic trader buys the grain from 

 7 a farmer. Those are transactional futures 

 8 instruments. 

 9 These have become investment 

 10 instruments, and Greg's group of companies, ISDA, 

 11 I am sure has more technical knowledge about this 

 12 than I do, but there is simply no question that 

 13 there is a huge component of the open interest in 

 14 at least one commodity, perhaps two that I am 

 15 positive about, that is not for sale. I 

 16 understand some of these swaps or some of the 

 17 index funds have run into tax problems with the 

 18 IRS, I do not understand all those details, but 

 19 they have gotten around the problem that was 

 20 presented by the IRS's challenge to them when they 

 21 were actually buying futures and warehousing those 

 22 futures to back up their sales of the investment 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 78 

 1 instrument. They have developed much more 

 2 sophisticated swaps that solved the tax problem, 

 3 but the element of open interest continues to 

 4 exist that is not for sale. 

 5 I hope I am being clear about it, but I 

 6 just do not think there is any question that some 

 7 significant portion of open interest in some 

 8 markets has become a security not for resale. We 

 9 are not saying that is a bad thing, but we are 

 10 saying, going back to my comment about the 

 11 multibillion-dollar hedging industry and 

 12 merchandizing, milling, processing, handling, 

 13 exporting, domestic trading industry, all the bank 

 14 relationships, banking, credit relationships for 

 15 hedging, credit lines, all of those are built 

 16 around the general reliability, there is no 

 17 guarantee, but the general reliability of the cash 

 18 futures relationship, i.e., basis predictability 

 19 in hedging effectiveness. 

 20 So as a large and perhaps growing 

 21 component of open interest in the grain markets 

 22 becomes nonprice responsive and not for sale, that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 79 

 1 affects the hedging risk that the traditional 

 2 hedger is looking at. Again, we are not saying 

 3 that this is a bad thing, but the only way to get 

 4 a sense of the size of that risk so the 

 5 traditional hedger can assess whether or not he 

 6 wants to participate or widen his basis parameters 

 7 is to have some idea of the component of that 

 8 relative to total open interest. 

 9 My suspicion is in corn there is a 

 10 sizable index fund and financial hedge open 

 11 interest, but that market is so much bigger than 

 12 wheat that it has not had the effect that I think 

 13 it is now having in wheat. Let me give you an 

 14 example, and Tom Coyle brought up some of this. 

 15 The open interest in wheat is one-third the size 

 16 of the open interest in corn in futures in Chicago 

 17 soft trade wheat. The size of the soft trade 

 18 wheat crop this year is 3 percent of the corn 

 19 crop, so it is a major new component that is a 

 20 change, the likes of which the industry has never 

 21 seen before. We are not opposed to it. We simply 

 22 want some idea of what it is relative to total 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 80 

 1 interest, and that would make the Commitments of 

 2 Traders Report much more useful. 

 3 If I may, I do not see any risk of 

 4 revealing anybody's position, CFTC would know this 

 5 better than we do, but historically I do not think 

 6 there have been any problems along these lines, 

 7 and when the markets were much smaller and there 

 8 was no financial hedge interest involved, the 

 9 commercial open interest was thought to be 

 10 traditional hedgers and there were no problems 

 11 with that. I hope that answers. 

 12 MR. ZERZAN: I think Dan is restating 

 13 the issue that the Commission is tackling, which 

 14 is to say there are reflected in the commercial 

 15 category persons who are not in all cases taking 

 16 and dealing in the cash markets. Certainly, we 

 17 are sympathetic to the idea that this may create 

 18 issues for some cash market participants. 

 19 However, our concern is how you break out the 

 20 depiction of the so-called nontraditional 

 21 commercials, because certainly in some markets we 

 22 have indications that there are a very small group 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 81 

 1 of persons who would fit within this 

 2 nontraditional category. And if you are 

 3 maintaining an index with published targeted 

 4 levels of investment in different types of 

 5 commodities and then you break out this same group 

 6 and do a narrow subset which is able to be seen by 

 7 the public in real time in Fred's world, then you 

 8 have the very real opportunity for other persons 

 9 to view this information to know where these 

 10 people are in the markets and where they need to 

 11 be, and, therefore to trade ahead, which, 

 12 obviously nobody wants that. 

 13 So I think it is not really that there 

 14 is a disagreement. I think the issue is how do we 

 15 ensure that we protect nontraditionals and their 

 16 end customers, being pension funds and mutual 

 17 funds and other members of the retail public, to 

 18 ensure that they are not disadvantaged and the 

 19 markets as a whole are not disadvantaged by a 

 20 level of exposure which allows other parties to 

 21 take advantage of new information which heretofore 

 22 did not exist. I think that is really the long 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 82 

 1 and the short of it. 

 2 COMMISSIONER JEFFERY: I have one 

 3 question for you, Greg. You talked about 

 4 the swap dealer category and maybe expanding 

 5 it. How would you break it up? Because one of 

 6 the nice things about the simple categorizations 

 7 we have is that while they may cover a lot that is not 

 8 necessarily obvious in each of the two categories, 

 9 it is real simple -- you are in one bucket or 

 10 the other. So once you go beyond that and try to 

 11 slice and parse this down more finely, are there 

 12 any specific categories you would suggest that we 

 13 consider? 

 14 MR. ZERZAN: Mister Chairman, as I am 

 15 sure you frequently encounter, I have come to you 

 16 with a suggestion that lacks any real specificity, 

 17 hoping that you in your wisdom would be able to 

 18 figure out what I mean. 

 19 (Laughter) 

 20 MR. ZERZAN: Frankly, as we wrestle with 

 21 our submission, this is one of the things that we 

 22 are trying to figure out, how you would parse this 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 83 

 1 in a way that provided some information that was 

 2 useful to the market but did not disadvantage the 

 3 narrow subset people who are swap dealers. 

 4 I think part of the problem is, in some 

 5 of these markets we are talking about perhaps four 

 6 people who would fall into the category of swap 

 7 dealer or nontraditional, and frankly, I could not 

 8 tell you off the top of my head what other groups 

 9 we would want to add to that, but I think we 

 10 probably need to work creatively to figure out how 

 11 we could make it a broader list than just in that 

 12 instance those four entities. 

 13 COMMISSIONER JEFFERY: We are open to 

 14 all suggestions. 

 15 COMMISSIONER LUKKEN: As a general 

 16 statement, I would say that the addition of the 

 17 nontraditional swap dealers and others who are 

 18 coming into these markets, in my view, are a good 

 19 thing, and we are trying to aggregate as much 

 20 information into the marketplace as we can. If 

 21 you don't believe me, go visit one some day and go 

 22 up and see the weathermen, the economists and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 84 

 1 everybody who is going over all this information 

 2 to try to bring this to the marketplace to their 

 3 economic advantage, just as any processor or 

 4 farmer might want to do himself. So as a general 

 5 rule, I would say this is all a good thing. 

 6 However, we have to balance the idea of 

 7 transparency, as Dan had stated in his statement, 

 8 with this idea of protecting confidentiality. 

 9 One thing I worry about in the 

 10 electronic age is if we get this wrong, these swap 

 11 dealers will vote with their feet and they will go 

 12 somewhere else and we will not have any of those 

 13 because none of it will be transparent. So we do not 

 14 want that. But we are trying to find some balance 

 15 in the middle where we are able to provide some 

 16 additional transparency with some confidentiality 

 17 so that we are not giving away proprietary 

 18 information. That is the key and that is the 

 19 sort of information that we are going to want from 

 20 Greg, even though he does not want to give it up 

 21 today, and others who might have thoughts about 

 22 these issues, too. How can we provide some 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 85 

 1 cover for these folks so that we are not giving 

 2 away trading positions? 

 3 One thing I would like the panel to 

 4 comment on is where the interests diverge between 

 5 the nontraditional and the traditionals. As I 

 6 think about this -- if they are long in the markets, 

 7 both want the markets to go up, both are hedging 

 8 interests, some have proprietary trading desks, 

 9 but some people who are producing also do 

 10 proprietary trading as well. So for policy 

 11 reasons, try to tell us why this information would 

 12 be useful. What are you going to gather if a swap 

 13 dealer's positions are one versus the traditional 

 14 commercials? What sort of information does that 

 15 reflect to you to change trading strategies? To 

 16 me, they are perfectly aligned. And if they are 

 17 perfectly aligned, why are we further breaking 

 18 them up? But I am sort of dumb in this area, so 

 19 please enlighten me. 

 20 MR. COYLE: I would go back and give you 

 21 an example of the past, and I will give you the 

 22 current situation. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 86 

 1 Let's assume that you are a farmer 

 2 trying to decide whether or not you want to lock 

 3 in a percentage of your price, you really do not 

 4 have a sense of whether there is good demand or 

 5 not. Everything is in arrears. You do not see 

 6 the sales for a week or whatever. You see your 

 7 crops, but you are trying to gauge whether or not 

 8 there is real consumer demand. So you see a 

 9 Commitments of Traders Report that shows the 

 10 commercials and you believe the commercials to be 

 11 Cargill, ADM, buying futures, you see the long 

 12 side of that going up, so you draw the conclusion 

 13 that there is good demand, it is confirmed again 

 14 by an export sales report, you do not see the 

 15 domestic sales which would be hedged that way, and 

 16 so you make a decision that maybe the demand is 

 17 better than you were expecting that you be a bit 

 18 more patient in establishing your sales program. 

 19 And remember, you are just weighing that against 

 20 the other risks you have, that if you sell ahead 

 21 and you have a crop problem, now you have sold too 

 22 much of your crop, so you need that information. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 87 

 1 Today you simply cannot make that judgment because 

 2 the information is not available, and today the 

 3 open interest is going up and up. Typically, that 

 4 is the sign of a bullish market, that is a good 

 5 thing. The farmer is happy about that. But may 

 6 not quite recognize that that is not consumer 

 7 demand led. Therefore, as the price goes up, you 

 8 do a hedge to arrive contract and you sell next 

 9 year's wheat at $4.50 a bushel and you are just 

 10 planning out your vacation for next year, but you 

 11 do not lock in the basis levels because you assume 

 12 that that is an indication that basis levels 

 13 should be strong as well. But when you get there, 

 14 you realize that demand has not grown, which you 

 15 probably should have known because export sales 

 16 did not show any sales, and you get there and the 

 17 basis is 60 under. You say I did not sell $4.50 a 

 18 bushel like in my normal basis of 20 under, the 

 19 basis is 60 under partly because of 

 20 transportation, and partly because the futures 

 21 market is doing more of the work than you would 

 22 normally expect, and now you have that exposure. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 88 

 1 Compound that by the number of farmers in a whole 

 2 industry group, I'll tell you what, our members 

 3 are the opposite, the hedge to arrive problem. 

 4 People say now we are saying we ought to put risk 

 5 disclosure on our contracts, and when you do a 

 6 hedge to arrive, your risk isn't the futures, your 

 7 risk is the basis, and when you did a White Paper 

 8 in 1996 that said basis is not as much of a risk, 

 9 the landscape has changed. So that would be an 

 10 example for a farmer. 

 11 Let's give another example where your 

 12 crops are really having a problem and you really 

 13 are bullish. You really should not be selling, 

 14 but you are seeing the markets weaken. Maybe it 

 15 is weakening because at some point in time these 

 16 long only index funds say it has been a 3-year 

 17 horizon, my investment portfolio plan is to be 3 

 18 years, and now I am getting out, and the market is 

 19 actually weakening while the crop is burning up. 

 20 The farmer says, I must the wrong, the crops must 

 21 be better somewhere else, mine are terrible, and 

 22 so I had better go ahead and sell some of my crop 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 89 

 1 now. Then when that phase ends and then the 

 2 markets skyrocket, the farmer missed that. 

 3 Everyone is going to have to make 

 4 judgments on the information. The fact is, today 

 5 they do not have the information. And we 

 6 certainly appreciate the fact that you would not 

 7 want to be able to identify a specific grain 

 8 company in the report, and you would not want to 

 9 be able to identify a specific swaps dealer 

 10 either, and the assumption is that the current 

 11 rules of 20 participants would be enough to 

 12 protect that, but there may be other ways to do 

 13 that. Today, like you, Dan, I was a little bit 

 14 surprised to realize that actually the index funds 

 15 were in the noncommercial and the swaps were in 

 16 the commercial. I thought it was the opposite. 

 17 But if you put both of them in this new category, 

 18 and swaps dealers do not just provide contracts 

 19 for long-term investors, somebody like Perdue 

 20 Farms or some other commercial may say I want some 

 21 creative hedge, I want an average price for 2 

 22 years out because I am worried about ethanol and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 90 

 1 price of corn, so you buy the same thing from a 

 2 swaps dealer, and maybe putting them all in one 

 3 category covers that exposure, but the detailed 

 4 information is important. 

 5 COMMISSIONER HATFIELD: I am struck by 

 6 your testimony, Tom, about the growth in the wheat 

 7 market saying at one point that earlier this year 

 8 I believe that wheat futures were 105 percent of 

 9 U.S. wheat crop, and normally from 1994 to 2004, 

 10 it would be about 40 percent. Greg has indicated 

 11 that his group of swap dealers are a very narrow 

 12 subset, it may be a small group of people but it 

 13 may be a large impact. So if any of the panelists 

 14 have any further comments on the size of these 

 15 subsets, whether it is swap dealers or what-not in 

 16 these commodities, either collectively or 

 17 individually, I would be interested in the impact 

 18 that they make. Does anybody want to take a crack 

 19 at that? 

 20 MR. COYLE: We have made some 

 21 assumptions about the impact because we have seen 

 22 the basis levels weaken, and, again, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 91 

 1 transportation changes as well, but we do not 

 2 really know anything on the grain side about who 

 3 the dealers are and how big they are, so I will 

 4 pass it to someone else. 

 5 MR. CLARK: I would reiterate the same 

 6 thing, we do not know. And again, we do not have 

 7 any problem with these folks being in the market. 

 8 We think it is a good thing. It provides some 

 9 liquidity in some respects, but we do not know how 

 10 big their positions are. 

 11 COMMISSIONER HATFIELD: Greg, do you 

 12 know, and will you tell us? 

 13 MR. ZERZAN: As I said, in some markets 

 14 we have indications that it is a very, very small 

 15 group of participants. I think in general one of 

 16 the things about the futures markets is that they 

 17 afford a level of anonymity which is in general a 

 18 good thing and that people support. So I do not 

 19 think it is always possible to know. 

 20 But I think as Commissioner Lukken 

 21 pointed out, in some respects it is irrelevant 

 22 because someone who is long in corn is hoping the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 92 

 1 price goes up, and it does not matter if he is 

 2 actually going to be selling corn at the market or 

 3 if he is holding that position on behalf of 

 4 investors. So there is an alignment of interests 

 5 which in some ways negates the concern that I 

 6 think is a side issue here, because I do not think 

 7 the concern really is that the character of the 

 8 market participant somehow bodes for a negative 

 9 future market direction. I think it is that the 

 10 character of the market participant might affect 

 11 an end user's ability or a producer's ability to 

 12 judge that subset of the market which is actually 

 13 interested in the cash commodity. So I think 

 14 there are some markets where this is a very small 

 15 number, there are some markets where it is 

 16 probably larger, and there are some markets where 

 17 you simply could not tell. 

 18 COMMISSIONER HATFIELD: Let me ask you 

 19 this also, Greg. In Tom's written testimony he 

 20 mentions that they say we believe that the 

 21 Commission's current rules restricting reporting 

 22 aggregate positions of market segments containing 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 93 

 1 less than 20 reportable participants is more than 

 2 adequate protection. Do you agree with that? 

 3 MR. ZERZAN: I think it is dependent. I 

 4 think it depends on the size of the overall 

 5 market. The reality of it is, as Commissioner 

 6 Lukken noted, there is a real danger that you will 

 7 either, number one, exposing the positions both of 

 8 the nontraditional and the traditional 

 9 commercials. Secondly, you have the danger that 

 10 you will force persons who prize anonymity and 

 11 their ability to be sure that people will not 

 12 trade ahead to move to over-the-counter positions 

 13 and out of the exchanges. To draw a flat-line 

 14 number 20 is I think probably not justifiable in 

 15 terms of the broad variety of markets about which 

 16 we are talking. 

 17 COMMISSIONER DUNN: As promised, now we 

 18 will let the panelists each other questions, if 

 19 you have any. 

 20 MR. BROPHY: May I respond to some other 

 21 comment from a minute ago? 

 22 COMMISSIONER DUNN: Sure. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 94 

 1 MR. BROPHY: The index fund managers who 

 2 I have spoken to, one directly and one second 

 3 hand, made it very clear to me they do not care if 

 4 the market goes up or down. They happen to be 

 5 long, but it does not make any difference. Their 

 6 index fund investment is a security that has been 

 7 sold to a public that wants commodity portfolio 

 8 price exposure, and they recognize that sometimes 

 9 that exposure will be profitable at the end of the 

 10 month or at the quarter of the year, and other 

 11 times it will not. But the one fellow's comment 

 12 to me again and again was, You do not understand, 

 13 they are not going to sell anything. And after a 

 14 while, I did understand. 

 15 The second thing that I would like to 

 16 say is that Greg has a concern about positions 

 17 being revealed and front running and so forth, but 

 18 actually my understanding of this is, and I have 

 19 even seen some of the public announcements, that 

 20 most funds publicly disclose the percentage of a 

 21 given commodity that is in their fund. Sometimes 

 22 they actually publicly disclose when they are 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 95 

 1 going to buy, the GSCI is publicly disclosed when 

 2 the roll takes place. There are firms that 

 3 trade around that speculatively. I just do not 

 4 see any risk of front running that is at all 

 5 significant, and I do not see any concerns with 

 6 positions being revealed because, as I said 

 7 before, all these years the commercials' positions 

 8 and in fact the large reporting speculators' 

 9 positions which were assumed I think correctly to 

 10 be the trend trading funds, those were all 

 11 reported when these categories were pretty clean 

 12 and nobody had any problem with it. 

 13 The other thing which will be in our 

 14 comment letter is that I do not see any utility at 

 15 all of the attempt to reconstruct somebody else's 

 16 positions. I think a number of years ago the 

 17 Commission was involved in a debate about whether 

 18 there was such a thing as insider information in 

 19 commodities trading, and I have learned from 

 20 experience that there is no such thing. The 

 21 markets are very volatile for a number of factors 

 22 at any one moment, and I just do not see where 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 96 

 1 anybody has any advantage over somebody else in a 

 2 given moment knowing something. 

 3 COMMISSIONER LUKKEN: May I ask for a 

 4 point of clarification, because there seems to be 

 5 some confusion on whether these long-only 

 6 commodity funds are categorized as noncommercials 

 7 or commercials. I think of Goldman Sachs where 

 8 they are a dealer and also have a fund. So I am 

 9 trying to figure out exactly which direction are 

 10 they. And am I the only one confused on this? 

 11 MR. FENTON: Most of what we see in the 

 12 futures market related to commodity index 

 13 trading, at least what we have identified, are 

 14 swap dealers categorized as commercial. So the 

 15 vast majority of commodity index positions in the 

 16 futures markets have been included in the 

 17 commercial long category. 

 18 A much smaller amount where the trading 

 19 is directly in the futures market by commodity 

 20 index funds is classified as noncommercial, that 

 21 would end up in the long category there, but that 

 22 is quite small in comparison to the other. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 97 

 1 COMMISSIONER LUKKEN: But are the people 

 2 on the commercial side hedging something, 

 3 typically? Or are they just a dumb long fund that 

 4 is just in for long? 

 5 MR. FENTON: The person in the futures 

 6 market, the swap dealer, is hedging something. 

 7 They are hedging the risk of their OTC position. 

 8 COMMISSIONER LUKKEN: Over-the-counter 

 9 position. 

 10 MR. FENTON: So from their point of view 

 11 it is a hedge, but it is not a hedge of physical 

 12 exposure in the underlying corn market, for 

 13 example. 

 14 COMMISSIONER LUKKEN: But these long- 

 15 only, trend-following funds, they are on the 

 16 noncommercial side, versus the swap dealer hedging 

 17 folks who are on the commercial side? 

 18 MR. FENTON: Right. 

 19 COMMISSIONER LUKKEN: Thank you. 

 20 COMMISSIONER DUNN: John, does it in 

 21 fact end up as Dan said, they are nonprice 

 22 responsive open interest then? 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 98 

 1 MR. FENTON: I think that has been our 

 2 experience. The pattern over time has been in 

 3 terms of the total participation, it has been a 

 4 gently upwardly sloping line, so it has grown. It 

 5 does not have any of the in and out kind of 

 6 characteristics that some of the either technical 

 7 trading or speculative trading has, so it does 

 8 appear to mostly be insensitive to price. 

 9 COMMISSIONER DUNN: Does that, in 

 10 your opinion then, have an impact on the 

 11 price discovery in the marketplace? 

 12 MR. FENTON: In my opinion it does. 

 13 

 14 MR. COYLE: Commissioner, we had our 

 15 convention last March. I chaired a panel 

 16 discussion and we had one of what you would call a 

 17 traditional hedge fund, a trading fund, a manager 

 18 of an ETF, and also one of these index funds. The 

 19 message was very clear that the money that was 

 20 going in their accounts had a horizon of 3 plus 

 21 years, and if at the time the markets were 

 22 breaking and the comment was as the market breaks, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 99 

 1 our money is going out, more people are investing 

 2 and they are not looking at getting out, because 

 3 of the time horizon. At some point you have to 

 4 assume that you are going to get to that level of 

 5 investment dollars that are in those funds, and 

 6 then the investments will be--but today people are 

 7 trying to get cash into that what they call space 

 8 in their investment portfolio, and whether or not 

 9 they are close to it or not, most people I talk to 

 10 say not even close, but at some point they will 

 11 get balanced and they just are not balanced today. 

 12 MR. ZERZAN: I think it is important to 

 13 recognize that to the extent a swap dealer is 

 14 serving as an intermediary, the swap dealer is 

 15 hedged, and you are right, if he is doing his 

 16 business correctly, he is really not concerned 

 17 with the moment of the prices. But the important 

 18 thing to remember is the underlying parties who 

 19 are counting on him, the index funds and the 

 20 investors in those funds, the pension funds, the 

 21 mutual funds, et cetera, they are very price 

 22 sensitive and they are very concerned about where 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 100 

 1 the price is going, and they reflect supply and 

 2 demand. So to say that there are participants in 

 3 this market who are just riding the wave and they 

 4 do not care one way or another, so, therefore, it 

 5 affects price discovery, I think is to completely 

 6 discount the reason they are in this market in the 

 7 first place, which is that there are people who want 

 8 commodity exposure but they do not want to ride 

 9 commodity exposure down, they do not want to be 

 10 reflecting declining demand, they want in fact to 

 11 participate in the price movements in the market. 

 12 So there is a reflection through the swap dealers, 

 13 and it is not to say that you have this large 

 14 group of individuals in there who are simply 

 15 distorting supply and demand, they are in fact 

 16 reflective of the underlying supply and demand. 

 17 COMMISSIONER DUNN: Are there members of 

 18 the Ag Advisory Committee who would like to ask 

 19 any questions or make any comments? Again, would 

 20 you come up to the microphone and state your name, 

 21 please? 

 22 MR. STEVENSON: Randy Stevenson with R- 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 101 

 1 Calf USA. This is my first meeting, and I have 

 2 noticed one of the basic principles here 

 3 is 3,500 years old, and that is transparency 

 4 in the marketplace. Back then, all 

 5 transactions were at the city gate in 

 6 the light of day, so I would encourage you to 

 7 impose as much realistic transparency to it 

 8 because it is the ultimate self-regulating 

 9 enforcer. 

 10 The other question that comes to mind 

 11 when you are weighing some of the swaps versus the 

 12 commercials, my question would be, when the 

 13 futures were established, who was it designed to 

 14 benefit initially, and does it still? Is that 

 15 part of the mission? Thank you. 

 16 COMMISSIONER DUNN: Thank you, Randy. 

 17 Are there any other members? 

 18 MR. GAINE: Good morning Commissioner 

 19 Dunn and other members of the Commission. 

 20 COMMISSIONER DUNN: Jack, please 

 21 identify yourself. 

 22 MR. GAINE: I am Jack Gaines, President 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 102 

 1 of the Managed Funds Association. August 1, 1977, 

 2 I became General Counsel to the CFTC and I just 

 3 want to comment favorably on the change in tone 

 4 here, where back then in the 1970s and 1980s, the 

 5 word speculator, the word fund, the words managed 

 6 money, were not necessarily the most popular 

 7 expressions among this group, and I have really 

 8 enjoyed the discussion this morning where all of 

 9 these activities are discussed and no one says 

 10 there is too much speculation, there is this, 

 11 that, and the other thing, and I think we are down 

 12 to some issues that are raised here that we are 

 13 going to follow this very, very closely, and I 

 14 think drawing some of the distinctions between 

 15 some of these motivations of traders, for example, 

 16 someone suggested somebody is in there and price 

 17 neutral. As a lawyer and in my economics training 

 18 that I received here, that is what a hedger is 

 19 supposed to be. In the perfect hedge, he should 

 20 be neutral to price movement up or down. Of 

 21 course, with basis and other changes, that 

 22 probably is not exactly true, but being price 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 103 

 1 neutral, that is, putting position on it seems to 

 2 me without regard to whether it goes up or down 

 3 may not be all bad. 

 4 But I just wanted to comment that it is 

 5 a great area that you are looking at and we will 

 6 follow it very closely. We do not have any 

 7 answers, but I find this very illuminating this 

 8 morning. Thanks. 

 9 COMMISSIONER DUNN: Are there any other 

 10 members or public who would like to make a comment 

 11 or ask questions? 

 12 If not, let me thank the panelists. 

 13 This has been fantastic, and it really has for me 

 14 been a tremendous source of information. Thank 

 15 you very much. 

 16 This actually puts us about 10 or 15 

 17 minutes ahead of schedule, so what we will do now 

 18 is break for lunch, and we will come back here 

 19 then for the afternoon session at 1 o'clock. 

 20 (Whereupon, at 11:34 a.m., a 

 21 luncheon recess was taken.) 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 

 104 

 1 A F T E R N O O N S E S S I O N 

 2 (1:06 p.m.) 

 3 COMMISSIONER DUNN: Ladies and gentlemen, 

 4 could we please get seated, so we can get right into 

 5 the afternoon session? 

 6 I thought this morning's session was 

 7 just great, and I really, really thank the 

 8 panelists that we had on. They did a fabulous 

 9 job, and now it is a challenge to the folks who 

 10 are up here now. I hope you all had a good lunch. 

 11 We are going to turn to the 

 12 Thinly-Traded Market Price Discovery for this 

 13 afternoon's session. While this subject of thinly 

 14 traded markets is one that our economists worry 

 15 about daily, I am told we have not previously 

 16 discussed this at the Agricultural Advisory 

 17 Committee, and so I think it is time for us to 

 18 raise this subject. The purpose of today's 

 19 session is to explore this issue to better 

 20 understand what market users see along with 

 21 potential problems CFTC staff worry about. We are 

 22 particularly interested in learning more about the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 105 

 1 potential concerns of market users in this area 

 2 and fostering discussion between market 

 3 participants and regulators of the various parts 

 4 of the price discovery chain. 

 5 In coming up with this particular topic, 

 6 I talked with Dr. Ken Clayton who is the Deputy 

 7 Administrator for Ag Marketing Service. We met at 

 8 the Ag Outlook Conference, and we started talking 

 9 about what is the relationship on price discovery 

 10 between what goes on at the CFTC and what Ag 

 11 Marketing Service does. So we kind of hatched the 

 12 idea of having this particular session. 

 13 We will begin with an "Overview of the 

 14 CFTC Authority over Cash, Futures, and Options 

 15 Markets." Nanette Everson, our General Counsel, 

 16 will make that presentation. 

 17 Then we will have an overview of 

 18 "Thinly-Traded Markets in Dairy, Pork, and Beef" 

 19 by Dave Kass, our Industry Economist in the 

 20 Chicago office. 

 21 The "Role of Price Discovery Markets in 

 22 USDA Programs," will be presented by Warren 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 106 

 1 Preston, Chief Economist, Livestock and Seed at 

 2 USDA Ag Marketing Service. Warren and I knew each 

 3 other in a past life when he was at Packers and 

 4 Stockyards. I hope I remember what agency he is 

 5 with now. 

 6 Then we are going to have Michael Haigh 

 7 talk about "Price Discovery, Cost of Carry, and 

 8 Trader Interactions in Commodity Markets." 

 9 Michael is an Associate Chief Economist here. 

 10 We will have "Economic Issues in 

 11 Thinly-Traded Price Discovery Markets" by Steve 

 12 Turner who is the chair of the Department of 

 13 Agricultural Economics at Mississippi State. 

 14 Thank you very much for traveling up here, Steve, 

 15 to participate. 

 16 It then calls for us to go to a break, 

 17 but instead of going to the break because we only 

 18 have one panelist on the "View from the Field", 

 19 Gregg Doud, I am going to ask Gregg Doud to come 

 20 up and do his "View from the Field" while the 

 21 panelists are still here, and I think it will 

 22 generate a better discussion. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 107 

 1 With that, I would like to begin with 

 2 Nanette. 

 3 MS. EVERSON: Thank you very much, 

 4 Commissioner. I know you are all excited after 

 5 lunch in the 100 degree heat to listen to a 

 6 lecture on the law. So I will be speaking for an 

 7 hour and a half. No, just kidding. 

 8 I am very honored to be here and want to 

 9 thank Commissioner Dunn for all the hard work in 

 10 terms of setting up this Agricultural Advisory 

 11 Committee. It is a very important undertaking 

 12 where we seek the viewpoints of scholarly people 

 13 and thoughtful people in terms of input in our 

 14 decision-making process, and it is a great honor 

 15 to be here. 

 16 I would like to just make three points. 

 17 The first one is that -- is this working okay? 

 18 MR. DUNN: It is working okay, and they 

 19 will control it back there. So if you just get in 

 20 a comfortable position and talk, they will pick it 

 21 up. 

 22 MS. EVERSON: Okay, got it. The first 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 108 

 1 one is that our historical roots in the 

 2 agricultural commodities area are enduring and 

 3 significant, and they are very important to our 

 4 legal authorities, and that is something you will 

 5 see throughout the Act, and I will talk about 

 6 that. The second one is that we have authority, 

 7 not regulatory authority, but we have statutory 

 8 authority over cash markets where there are 

 9 underlying agricultural commodities, and this is 

 10 very significant. It is focused primarily on 

 11 manipulation. I will be talking about those 

 12 statutory texts. The third one is that we are at 

 13 essentially the zenith of our authority in terms 

 14 of our full range of tools when we are talking 

 15 about agricultural commodities, futures, and 

 16 options on agricultural commodities that are 

 17 traded on designated contract markets. 

 18 Looking at the first point, the 

 19 historical significance of our roots in the 

 20 agricultural field, this is a very important 

 21 constituency for us, and I think you can see it 

 22 primarily in an interesting statistic. Only about 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 109 

 1 7 percent, by volume of the contracts that trade on 

 2 designated contract markets are agricultural. 

 3 Nevertheless, a very large percentage of our 

 4 surveillance resources that we allocate go to 

 5 surveilling the agricultural commodities. So this 

 6 is a very significant area. It derives from the 

 7 fact that we have the underlying physical, and 

 8 this is subject to potential manipulation. 

 9 I always learn a great deal when I hear 

 10 John Fenton give his views and his testimony, and 

 11 I think he really honed in on this, looking at the 

 12 1922 original Grain Futures Act, where he said 

 13 that the evil that Congress sought to really 

 14 address in that statute was manipulation and that 

 15 there was evidence of that. So this is something 

 16 that is extremely significant to us. 

 17 I noted that this morning the 

 18 Commissioners were right on the money, and they 

 19 knew that today was the first day of trading at 

 20 the Chicago Board of Trade in terms of the side by 

 21 side pit and electronic trading and also for 

 22 Kansas City for its hard red wheat. You can tell 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 110 

 1 I am not a farmer, I am sure. What that shows you 

 2 is that no matter how fancy things get and how 

 3 things evolve and change in this very rapidly 

 4 changing market, we are still focused on the 

 5 fundamentals here which are looking for manipulation 

 6 and to go after it whenever we find it. 

 7 Another example of the historical roots 

 8 is something very significant which is that we 

 9 have independent litigating authority, and that is 

 10 really no small thing. In Section 6(c) of our 

 11 Act, we can go directly into Federal District 

 12 Court and commence an action. The reason for 

 13 that, without getting the permission of the 

 14 Attorney General, is that we need to nimble, we 

 15 need to be able to move quickly in these physical 

 16 markets, and we don't have to bypass but we may 

 17 bypass. We don't have to go through the Attorney 

 18 General which is an elaborate process. Very few 

 19 agencies have this level of independent litigating 

 20 authority, and it derives from 1974 when we were 

 21 very much focused on the agricultural commodities. 

 22 So this is very important in terms of our 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 111 

 1 historical background. The bottom line is that 

 2 this birth, shall we say, in this field has really 

 3 given us the muscular authorities that we have, 

 4 and it continues to be very significant to us. 

 5 The second point is we have no 

 6 regulatory authority over physical commodity 

 7 markets, but we do have very significant statutory 

 8 authority. Again, we are going after manipulation 

 9 here. What is interesting is you will see there 

 10 are four texts. There is 6(c), 6(d), 9(a)(2), and 

 11 4(b). All of these have these key phrases in those 

 12 texts. What they talk about is our power 

 13 concerning “commodities in interstate commerce or 

 14 for future delivery,” and that "or", of course, 

 15 sets up the contrast that we can focus on 

 16 “commodities in interstate commerce.” Again, you 

 17 see sort of historical roots, like if you look at 

 18 9(a)(2), one of the specific texts that they talk 

 19 about is false reporting concerning crop 

 20 information. So this is very important. We have 

 21 manipulation, attempted manipulation; we have 

 22 corners, attempted corners. We look in kind of a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 112 

 1 mini squeeze situation for an impact on a 

 2 regulated futures market. We are not talking, of 

 3 course, about going into the forwards market. 

 4 That is clearly excluded from our definition of a 

 5 futures contract, but this is significant. 

 6 Again, you can see this in the 

 7 allocation of our resources. I am advised that we 

 8 have more full time employees or full time 

 9 employee equivalents for surveilling the 

 10 agricultural markets than the other markets, 

 11 although energy recently has given us a good run 

 12 for the money. 

 13 The third point I want to make is that 

 14 regarding options, futures and options on futures 

 15 where the underlying is agricultural commodities, 

 16 we have the full zenith of our regulatory and 

 17 statutory authority. So we use all of our levers 

 18 and all of our bells and whistles. We do it to 

 19 regulate the exchanges that trade the products, 

 20 the traders who trade the products, the clearing 

 21 organizations that clear the products, and those 

 22 who solicit and offer the products. So we use all 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 113 

 1 of our tools legally in terms of these important 

 2 markets. 

 3 Just to close, whenever I get lost, 

 4 which one is wont to do in the Byzantine 

 5 complexities of the statute, I like to go back to 

 6 Section 3 which is our Purposes and Findings, and 

 7 I think that really kind of always puts us right 

 8 back on focus in terms of what we are looking for. 

 9 The Purposes, I think, were extremely well crafted 

 10 by Congress, and they remain our guiding themes: to 

 11 detect and deter price manipulation, to ensure 

 12 financial integrity of transactions, protect 

 13 market participants from fraud, and also after the 

 14 CFMA, to promote responsible and creative 

 15 innovation. We focus on these in the commodity 

 16 markets in terms of our legal authorities, and we 

 17 will continue to do so. 

 18 Thank you. 

 19 MR. DUNN: Thank you very much, 

 20 Nanette. We will now go to Dave Kass. You are 

 21 going to see the presenters kind of gravitate down 

 22 to this end. They have to do that, or did they 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 114 

 1 give them -- oh, they did. Okay, maybe they won't 

 2 have to. 

 3 Dave, if you would, please. 

 4 MR. KASS: Thank you. I should preface 

 5 my remarks that most of this will be factual. If 

 6 an opinion or two happens to leak out of my own, 

 7 it is my own and not necessarily the opinion of 

 8 the Commission. 

 9 Also, to kind of echo what Nanette 

 10 said, actually I have been here more than a few 

 11 years. I go back to when 100 percent of regulated 

 12 futures trading was agricultural futures trading, 

 13 and it is about 8 to 9 percent now. As a member 

 14 and a longstanding member of the surveillance 

 15 activity, I can tell you that a disproportionate 

 16 amount of Commission resources goes to the 

 17 agriculturals compared to some of the financials. 

 18 Something like Euro dollars, which is probably one 

 19 of the largest markets traded in the United 

 20 States, doesn't get near the sort of concern and 

 21 use of resources that something much smaller does 

 22 in the agricultural community. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 115 

 1 I am going to present basically three 

 2 market categories. They illustrate different 

 3 issues about thin markets and how the thinness of 

 4 markets has caused us surveillance issues and 

 5 things that are done to address it. It certainly 

 6 is not meant to indicate that these three markets 

 7 are the thinnest of the markets we regulate by any 

 8 means. They happen to be Chicago Mercantile 

 9 Exchange markets, but for one, I am from the 

 10 Chicago office. So it was going to probably be 

 11 Chicago markets anyway. Those are the ones I am 

 12 most familiar with. It just happens to be those 

 13 markets. The Chicago Board of Trade and all the 

 14 other organized exchanges have their share of thin 

 15 markets, but these, I think, will illustrate a few 

 16 points about thinness and some of the issues it 

 17 causes. 

 18 Let us go forward. First of all, what 

 19 is the requirement to even trade a market in the 

 20 United States under our rules for a designated 

 21 contract market? Again, as Nanette said, that is 

 22 the one where we have zenith of our powers. If 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 116 

 1 you are on a designated contract market, you come 

 2 under the full brunt of our regulatory powers and 

 3 authorities. 

 4 I apologize, you have sort of 

 5 micro-copies of these in your package. If I can 

 6 find where this pointer is, did it come off the 

 7 screen altogether? Oh, there it is. 

 8 Basically, there is a core principle now 

 9 and has been since the CFMA, the Commodities 

 10 Futures Modernization Act, of the year 2000, and 

 11 it basically says you can have a contract where 

 12 they are not readily susceptible to manipulation. 

 13 That is the broad language. Then we have guidance 

 14 on that. As you all know, even in the 

 15 agricultural community, there are two major types 

 16 of markets: The physical delivery where you 

 17 actually deliver something, whether it is a 

 18 foreign currency, a treasury note, or load of live 

 19 cattle, and you actually deliver a product, and 

 20 there is a change of title; versus a cash-settled 

 21 market where you settle on the last day, and it is 

 22 another mark-to-market, and you settle on the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 117 

 1 basis of some index. 

 2 We have guidance depending on which of 

 3 those broad classes you fall into as to what we 

 4 mean by not susceptible to manipulation. 

 5 Basically it is, in the case of a physical 

 6 delivery, your primary concern is deliverable 

 7 supply, of course, and that the deliverable supply 

 8 is then something that will not be conducive to 

 9 price manipulation or distortion, and that the 

 10 deliverable supply can reasonably be expected to 

 11 be available to the shorts. If it is not 

 12 available to a significant number of shorts, what 

 13 good is it? So it is available to the shorts and 

 14 saleable by the long. Any long trader who would 

 15 happen to get this would have outlets for it, 

 16 reasonable outlets for it. That is the basic 

 17 guidance on physical delivery. 

 18 Then cash settled says that it should be 

 19 settled at a price -- and this is key -- 

 20 reflecting the underlying cash market, again not 

 21 subject to manipulation or distortion, and that it 

 22 is based on a series that is reliable, acceptable, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 118 

 1 and publicly available, and timely. So these are 

 2 the conditions. I will leave it to the folks who 

 3 come after and to the industry reps here today if 

 4 they have suggestions in terms of to what extent, 

 5 either for the physical delivery markets or for 

 6 the cash settles, if they have an opinion about 

 7 whether they are meeting these core requirements. 

 8 Let us start then with the CME dairy 

 9 markets. They have a spot butter market that used 

 10 to trade three days a week. It now trades all 

 11 five days, but it trades for about 15 minutes or 

 12 so in the late morning in an open outcry, pure 

 13 auction market. Spot cheese similarly trades 

 14 right before or after the spot butter market. 

 15 Actually, this was already an agenda topic, but I 

 16 am sure many of you are aware that just a few 

 17 weeks ago, several Senators including Senator 

 18 Feingold have asked GAO to investigate these 

 19 markets to see whether they are susceptible to 

 20 manipulation or not. So we will see what, if 

 21 anything, come of that, but we have been looking 

 22 at these markets for quite some time. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 119 

 1 Also on the dairy side, well, there are 

 2 actually a couple milk futures. There is the 

 3 Class III which is settled on the USDA price. So 

 4 that is a cash-settled. There are two butter 

 5 futures contract. There is a physical delivery 

 6 contract of 40,000 pounds and then more recently, 

 7 they have side by side traded a half-size but it 

 8 is cash- settled. So this is a case where the 

 9 exchange decided, based on industry comment, to 

 10 offer another product and kind of see which one 

 11 would best serve the industry, which would be used 

 12 and take off. The younger of the two, the cash- 

 13 settled, looks like it is sort of winning the 

 14 volume battle as we go forward. 

 15 Let me talk a little bit about the spot 

 16 market, particularly since that is the one that is 

 17 the smaller of the markets and it has come under 

 18 this recent attention, but it has gotten quite a 

 19 bit of attention over quite a few years. It was 

 20 traded up in Green Bay in the National Cheese 

 21 Exchange, and then it was moved ultimately to the 

 22 Chicago Mercantile Exchange. This chart that you 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 120 

 1 see is comparing the annual volume done on those 

 2 markets, the spot markets again. These are not 

 3 futures. These are actual physical trades of 

 4 butter and cheese, what percent of total annual 

 5 production, the annual trades on these markets do. 

 6 You can see butter recently over in this 

 7 period here is running about, it looks like, 5 to 

 8 6 percent of total annual production of butter is 

 9 traded on that market, again on an annual basis. 

 10 Cheese is much, much smaller. It is 

 11 cheddar cheese that is traded. If you took it as 

 12 a percentage of total cheddar cheese produced in 

 13 this country, you are seeing about, let us say, 

 14 1.5 percent these last few years. If you took it 

 15 as total cheese because it is the only cheese 

 16 traded and, we understand from the industry folks, 

 17 it only represents less than 1 percent of all 

 18 cheese produced in the country. Yet, our 

 19 understanding is that this cheese market, which is 

 20 the one that is usually focused on, people use it 

 21 as a formula or base to price something like 80 to 

 22 90 percent of all the cheese that is traded in the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 121 

 1 United States. Clearly, it represents, let us 

 2 say, a half a percent or so of total cheese 

 3 production, and yet it is used to price a lot of 

 4 stuff that moves through the dairy industry. Of 

 5 course, that then works its way back into various 

 6 dairy prices that the USDA puts out, and it is 

 7 used ultimately to go back and price milk. 

 8 This little inserted table up here shows 

 9 the average daily volume of these. So this is the 

 10 volume. The lines are the volume in terms of 

 11 production equivalent or what percent of 

 12 production. You can spot butter -- again the 

 13 numbers are probably are hard to read, so I will 

 14 just go ahead and tell you -- was averaging about 

 15 10 loads a day, and that was pretty much when it 

 16 was doing three days a week. Now that it is doing 

 17 five days, I think actually the average per day is 

 18 down, maybe because they took the three days and 

 19 expanded it into five, so you are doing less per 

 20 day. But spot cheese is quite low in 2005 at only 

 21 about four contracts a day. So that means some 

 22 days, obviously, there is zero volume, zero, one, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 122 

 1 two, something like that, and other days, there 

 2 might be ten or fifteen on average. We are 

 3 talking a very, very small number of loads. 

 4 In fact, this data is through 2005. We 

 5 have half of this year in. If you projected that 

 6 out for the full year, if we did the same, doubled 

 7 the volume during this first half for the rest of 

 8 the year, we are only operating at about a quarter 

 9 of what you are seeing there in terms of the 

 10 total. So far this year in cheese, we have traded 

 11 120 cash loads, so call it 240 for the year. In 

 12 the last two years, we did about 1,000 loads. For 

 13 the full year, we are projecting we may come in at 

 14 about a fourth of what we have done the last two 

 15 years. Butter is not quite as bad as that, but we 

 16 are projecting based on the half year, a little 

 17 under 500 loads perhaps this year. Last year, it 

 18 was 1,500 --so about a third -- and two years ago, 

 19 it was about 2,000. If anything, based on the 

 20 first six months, these markets are getting even 

 21 thinner, these spot markets. 

 22 We do have information. We did analyze 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 123 

 1 some data. Even though there is very little 

 2 trading done and one might have issues with that 

 3 in terms of defining this as thin, based again on 

 4 conversations I have had personally with people in 

 5 the industry and others and analysis of the 

 6 participants, we do see a large share of the 

 7 industry that takes time out of their day for that 

 8 little 15-minute window each day. Business comes 

 9 to a stop, and they have a major trader 

 10 participate or at least on the phone with these 

 11 brokers, ready to participate. It is the old you 

 12 think the price is too low in the case of some or 

 13 too high in the case of others, depending on which 

 14 side of the user or producer you are, but if you 

 15 don't like it and you think it is too low, you are 

 16 free to buy it, or if you think it is too high, 

 17 you are free to sell it. There is a lot of 

 18 potential for participation in this market. 

 19 Let us move on to another commodity 

 20 altogether, and that is feeder cattle futures. 

 21 This represents a little bit different situation. 

 22 It is one of the first, if not the first, to do 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 124 

 1 cash-settled. Back in 1986, it converted from a 

 2 physical delivery because of some chronic problems 

 3 with feeder cattle live deliveries and went to 

 4 cash-settled. Initially, when it first started as 

 5 cash-settled, it was settled to a Cattle-Fax 

 6 price that represented a 200-pound weight range, 

 7 600 to 800 pounds, and it represented 27 states. 

 8 Essentially, every state that did feeder cattle 

 9 business was represented in the index. Well, 

 10 through a series of changes when it converted to a 

 11 USDA-settled price in January of 1993, they 

 12 reduced the range by half. It was only 700 to 799 

 13 pounds, so it cut that down quite a bit, and it 

 14 reduced it to 12 states because, quite frankly, 

 15 with having all those states and areas, they were 

 16 getting lousy correlations for cash value. It 

 17 couldn't be used as a very good hedge because by 

 18 being such an expansive contract, it really wasn't 

 19 serving the industry well. 

 20 Now it has evolved further. Now it has 

 21 expanded from that original 600 to 800 back to 700 

 22 to 799. Then it went to 700 to 849 in year 2000. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 125 

 1 It added another 50 pounds. Then just recently in 

 2 August, 2005, it went to its current which you see 

 3 on the graphic. Again we are back to a 200-pound 

 4 range, although it is slightly different. It is a 

 5 little heavier now, 650 to 849. So that shows 

 6 kind of an evolution of trying to address this 

 7 issue. 

 8 Otherwise, it is a seven-day moving 

 9 average. One of the reasons for that is obviously 

 10 the more days you involve, you can include more 

 11 market feeder cattle. Most auction places only 

 12 auction once certain times of year, maybe twice a 

 13 week. With seven days, you are going to capture 

 14 most of those auctions. So it designed around the 

 15 characteristics of that market. You can see the 

 16 speculative limit then is 300 contracts. 

 17 Looking then at how this turns out, this 

 18 graphic -- you can see it is very seasonal -- 

 19 shows the number of feeder cattle that are 

 20 included in the index. The seven-day average 

 21 index is published everyday by the exchange based 

 22 on USDA data, and you can see a very pronounced 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 126 

 1 seasonal issue. In January, it peaks and falls, 

 2 and finally, October and November are sort of the 

 3 valleys, as just the season when cattle are being 

 4 marketed. You can see this in numbers. This 

 5 table just goes back to the year 2000, and you can 

 6 see highlighted in red are months where are 

 7 average, there were fewer than 20,000 -- I am 

 8 sorry. 

 9 This is the futures months. They traded 

 10 January, March, and April, and they settle on a 

 11 seven-day moving average. These are the number of 

 12 head actually included when January settled in the 

 13 year 2000, how many feeder cattle were in the 

 14 index used to settle the contracts. You can see 

 15 in that case, it was 37,000, and we have had as 

 16 many as 44,000 in the index. The red are those 

 17 that are below 20,000. There is no particular 

 18 significance to 20,000 except when the MERC made 

 19 their change in 1993 looking forward, that was the 

 20 big change from the Cattle-Fax and the 27 states 

 21 down to the 12 states, they said that we believe 

 22 this change is likely to have well over 20,000 on 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 127 

 1 any settlement index. Well, in the years since 

 2 that happened, they are not all included here, but 

 3 you can see here in the 1993 -- I am having 

 4 trouble picking this up. 

 5 The last line is what the average was. 

 6 You can see in the early months, we certainly get 

 7 more than 20,000, but in some of the later 

 8 seasonal months, we get well under. The average 

 9 for the years 2000 to 2006 for November was only 

 10 10,000, actually slightly less than 10,000. 

 11 The encouraging thing is -- let me find 

 12 out. Oh, there we are. It is pretty close to 

 13 where I wanted it to be. It is kind of hard to 

 14 find. 

 15 If you look at August, 2005 -- that is 

 16 when one of these big changes occurred -- and you 

 17 compare these numbers here to the ones above them 

 18 before this most recent change, in every case, 

 19 they are quite a bit larger. So that is 

 20 encouraging that these changes that took place in 

 21 August, 2005, are much larger than their 

 22 corresponding months or the average. At least it 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 128 

 1 looks like that was a change in the right 

 2 direction with this expansion that added another 

 3 50 pounds and some grades and stuff. 

 4 We like to think of it, in market 

 5 surveillance, as not just necessarily in terms of 

 6 the number of head -- this number then is again 

 7 these six years or better part of six years up 

 8 through May of this year -- but of how many head 

 9 are in the contract. I remember we saw something 

 10 like 10,000 at its lowest. Convert that to 

 11 contract units, the number of head in a futures 

 12 contract, and you come up with the equivalents 

 13 here of how many futures contracts are in the 

 14 index. In January, for example, we had 563 

 15 contracts typically in the settlement of that 

 16 contract, equivalent number of head of cattle. In 

 17 October, you can see it is down to 236. In 

 18 November, it was 151 on average. 

 19 Now the red numbers in this case are 

 20 compared to the speculative position limit which 

 21 in the spot month, it is 300 contracts. The 

 22 significance of that, from a surveillance 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 129 

 1 perspective, is somebody holding a spec limit 

 2 sized position of 300 contracts would hold a 

 3 position equivalent to more cattle than are actually 

 4 used to settle the contract. You can see that in 

 5 September, October, and November futures on 

 6 average. The second line of data is the minimum 

 7 we have ever seen over this period of time, and 

 8 you can see sometimes it is way under 300 

 9 contracts. In fact, November, you can see at a 

 10 minimum, the smallest contract we had in November 

 11 actually only had 95 equivalents. 

 12 This one is kind of interesting because 

 13 I believe that 191, we did bring charges of 

 14 manipulation in that October, 2003 case. That is 

 15 a case that is pending in Federal court right now. 

 16 That is the saga of the feeder cattle 

 17 and some ways we look at thin markets there. 

 18 Let me conclude with the lean hog 

 19 futures market which is also cash-settled and has 

 20 its own kind of interesting comparisons. This is 

 21 a 40,000-pound lean hog carcasses, and this is a 

 22 two-day moving average. You can see some of the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 130 

 1 things. Again, this is settled to a USDA price. 

 2 The USDA puts out actually several 

 3 different prices. One is producer-sold 

 4 negotiated. This is a producer of hogs, going to 

 5 the local packer and saying: Here is my load or 

 6 truckloads. I am going to deliver them in the 

 7 next 14 days. What will you give me for them? He 

 8 gets their best price, and it is a pure spot 

 9 market, what is the best price, arms-length trade. 

 10 The USDA also publishes -- included in 

 11 the index -- something called the Swine or Pork 

 12 Market Formula. This is that same or another 

 13 producer bringing his hogs to market, but it is 

 14 formula-priced. There was some formula agreed to, 

 15 and it is priced on something that could be the 

 16 negotiated price that day. They say, ours are 

 17 better hogs, so we are going to get a dollar more 

 18 or something like that, or it could be one of the 

 19 other pork products price or something like that. 

 20 The point is it is a formula price, and it is not 

 21 negotiated that day. It is based on a negotiated 

 22 differential to some swine or pork market price 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 131 

 1 put out. 

 2 This is some data. This is USDA data, 

 3 but it actually put together by a professor at the 

 4 University of Missouri-Columbia, showing the 

 5 trends. Now these two, remember, are the two that 

 6 are used to settle the lean hogs future contract, 

 7 and you don't have to know a whole lot about 

 8 statistics and stuff to see a clear declining 

 9 trend in the numbers of negotiated hogs that are 

 10 just out there. This is the total hogs traded in 

 11 the United States picked up by USDA, and you can 

 12 see of all the hogs marketed, we went from 13-14 

 13 percent back in the 2002-2003, and now we are down 

 14 to about 11 or 10 percent. Obviously, if this 

 15 trend continues to get less and less negotiated 

 16 hogs -- remember, this is the one that is pure 

 17 spot, that is negotiated right there, hand to 

 18 mouth, and the one that is most competitive in my 

 19 opinion. I guess one of my opinions is sneaking 

 20 out, sorry about that. The other included in this 

 21 index is the swine and pork market formula. You 

 22 can see also a decline there as well. Between the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 132 

 1 two components, we are seeing declines. This 

 2 means the number of hogs included in this index is 

 3 going to get less and less, particularly if this 

 4 trend continues. 

 5 If those are declining, what is 

 6 increasing? That is mostly these packer-sold or 

 7 packer-owned which means a packer owned the hogs 

 8 to begin with and either used them themselves or 

 9 sold them to another packer. Obviously, the 

 10 preponderance of that is the packers are using 

 11 their own hogs. 

 12 This just illustrates the same point 

 13 graphically. This top line is the producer-sold 

 14 negotiated, and you can see, particularly 

 15 recently, a clear sort of, in my view, down trend 

 16 in those. More recently, just this year in fact, 

 17 in the spring, the packer-sold went up quite a 

 18 bit. I think that was due to, in the State of 

 19 Iowa, they have some restrictions on packer 

 20 ownership of hogs, and there were some 

 21 reinterpretations between affiliates and that sort 

 22 of thing. There was some reclassification of hogs 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 133 

 1 in that case, and clearly, the reclassification 

 2 went toward including more packer-sold, and those 

 3 are not included in the index. 

 4 Then this is just another way of looking 

 5 at the same thing. This is the negotiated sales 

 6 as a percent of total sales that are included in 

 7 the index. These are not of the U.S. total now. 

 8 Those are included in the index at expiration, and 

 9 these are the various expiration months going back 

 10 a few years. You can see it has sort of flatlined 

 11 here. It doesn't seem to be declining much, 

 12 although it is clearly less now than it was. 

 13 Then again, doing the same sort of 

 14 analysis that we did for feeder cattle, looking at 

 15 it in terms of futures contract equivalents, you 

 16 can see, based on this analysis that this line 

 17 represents, for those who can't read it off the 

 18 chart, 1,650 hogs included in that two-day moving 

 19 average. Now the spot month spec limit is 950. 

 20 In feeder cattle, of course, we saw sometimes and 

 21 quite often, less than the spec limit. Of course, 

 22 950 would be down here off the chart somewhere. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 134 

 1 The lowest ones now in terms of contract 

 2 equivalent have been the last four expirations. 

 3 This represents April, May, June, and July 

 4 expiration. The four most recent expirations 

 5 represent the lowest point. So from a 

 6 surveillance point, again that would be a concern. 

 7 It is about 1.5 times the spec limit, so it is not 

 8 so bad that way. But again if this were a trend 

 9 and start to get less and less of these negotiated 

 10 hogs and that sort of thing, that would become a 

 11 further concern. 

 12 Finally, let me end on this. For your 

 13 consideration, these are some of the ways -- I 

 14 think some of the feeder cattle rule changes 

 15 illustrate this -- to minimize distortion because, 

 16 remember, that is one of the criteria for a 

 17 market. It has to be not susceptible to either 

 18 manipulation or distortion which is a little 

 19 broader term. You can clearly minimize, one, by 

 20 increasing the product underlying the futures, 

 21 physical delivery versus cash-settled. Of course, 

 22 physical delivery, the more delivery points you 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 135 

 1 add or the quality of whatever it is, whether we 

 2 are talking grains or hogs or treasury notes, 

 3 anything you add to delivery is going to make 

 4 changes to the way that contract is priced. If 

 5 there is one maxim in this industry where you have 

 6 a choice to make a physical delivery, you are 

 7 going to deliver whatever is cheapest. You would 

 8 be nuts not to. If you add points at very 

 9 undesirable locations or grades that are less 

 10 desirable and you don't appropriately discount it 

 11 or whatnot, the futures are going to price your 

 12 least common denominator, your cheapest to 

 13 deliver. So you have those issues. 

 14 Cash-settled, we saw feeder cattle. 

 15 They started with 200-pound range in 27 states. 

 16 They started huge, and over the years, at least 

 17 decreased the number of states to 12. Adding more 

 18 states and stuff doesn't necessarily -- there are 

 19 tradeoffs in terms of basis pricing. 

 20 The second item then is, of course, you 

 21 can somehow control, if you are faced with a thin 

 22 market, by decreasing the speculative limits, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 136 

 1 particularly in the spot month and perhaps have 

 2 different limits for different months. You saw 

 3 clear differentiation in feeder cattle in some 

 4 months versus others in terms of supply, so that 

 5 would be a consideration. Talk about thin 

 6 markets. For frozen pork bellies, the spec limit 

 7 gets down to 10 contracts for this August future 

 8 in the spot months. There is where the Exchange 

 9 has obviously used a very tiny spec limit. It is 

 10 down below our reporting level of 25 contracts. 

 11 In any event, from surveillance, we have 

 12 to do a lot of this. We have to verify the 

 13 transactions, take a look at it. If we know who 

 14 the traders are in the cash, see if they have 

 15 futures positions and it looks like they are doing 

 16 something. That would be our concern if they are 

 17 salting the cash index or putting out bids or 

 18 offers or something in order to affect a futures 

 19 position because they can have a lot of futures 

 20 and may not take much cash, so that any loss they 

 21 might take on a cash trade, they can more than 

 22 make up for by having very large futures. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 137 

 1 Of course, this other category is any 

 2 other which I will leave to others to come up with 

 3 ideas. 

 4 Again, these are thin markets. These 

 5 are not necessarily the thinnest. They just sort 

 6 of illustrate, I think, some of the issues that 

 7 are our surveillance staff has to deal with and 

 8 the creative ways, I think, in which the Exchanges 

 9 have tried to address this. 

 10 That concludes my remarks. 

 11 MR. DUNN: Thank you, Dave. Warren, 

 12 will you give us a little overview of the price 

 13 discovery role in USDA's markets? I hope that is 

 14 working for you there. 

 15 MR. PRESTON: Thank you, Commissioner 

 16 Dunn, and thank you for inviting AMS to 

 17 participate. 

 18 I will wait for the presentation to come 

 19 up. Let me just preface my remarks by stating 

 20 that I am in the Livestock and Seed Program, so my 

 21 comments are geared toward the livestock industry, 

 22 but I do mention some others. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 138 

 1 We had the advantage of having Dr. 

 2 Turner in town, and we had him give sort of an 

 3 enhanced of his presentation yesterday. I will 

 4 just note that there was a lot of interest. We 

 5 put out the word to what is kind of a loose- knit 

 6 USDA economist group, and we had economists there 

 7 from AMS, from ERS, from Grade Inspection Packers 

 8 and Stockyards, from the Farm Service Agency, Risk 

 9 Management Agency, and the Cooperative State 

 10 Research, Education and Extension Service. This 

 11 issue of thin markets is one that seems to be 

 12 generating a lot of interest. 

 13 Let me just give you a little background 

 14 on AMS Market News. This year, actually, we 

 15 celebrated our 90th year of publishing Market News 

 16 information. Currently, we put out over 600 

 17 daily, monthly, and annual Federal and state and 

 18 international reports. I know that those hit 

 19 numbers aren't always a good indicator of usage, 

 20 but we are getting about 50 million hits annually 

 21 on the web site, so somebody is looking at it. 

 22 We have 125 Federal employees in our 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 139 

 1 Market News branches -- 80 reporters, and then the 

 2 remainder is support staff. We have state 

 3 reporters who work under our direction, and that 

 4 is an area that I may touch on a little bit that 

 5 is getting tougher and tougher for us as states 

 6 have been cutting back their budgets and they are 

 7 not supporting these positions as vigorously. One 

 8 of the reasons we have to go from 27 states 

 9 reported in an index to 12 states is that we don't 

 10 have staff there and we just don't have enough 

 11 market activity to justify having a Federal staff 

 12 member in that state to pick up markets there. 

 13 Our basic economic theory is publicly 

 14 provided market information increases market 

 15 transparency. It is almost a tautology. It 

 16 reduces search costs, and that means that 

 17 participants in the market don't have to go out 

 18 and expend their own resources to discover what 

 19 prices are and what market conditions are. They 

 20 can look at the market information that is 

 21 provided publicly. It has that public good aspect 

 22 that once the information is collected, the cost 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 140 

 1 of disseminating it to one additional user is 

 2 virtually zero. Anyone who has an internet 

 3 connection these days can access our Market News 

 4 information. That market information increases 

 5 market efficiency in the technical efficiency 

 6 sense that you can have better resource allocation 

 7 -- allocate your resources to production and 

 8 marketing activities as opposed to price discovery 

 9 activities. 

 10 The theory is pretty simple. Economists 

 11 typically posit that there is a demand schedule 

 12 and a supply schedule. In a competitive market, 

 13 the point where those two schedules intersect is 

 14 where you end up with the equilibrium price and 

 15 equilibrium quantity. But nobody can observe the 

 16 demand schedule; nobody can observe the supply 

 17 schedule. We can estimate those kind of things. 

 18 What can we observe? Well, what we get 

 19 in practice is we get a bunch of transactions -- 

 20 that is represented by the graph on the right -- 

 21 that will be traded at some price, and there will 

 22 be some quantity associated with each one of those 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 141 

 1 transactions. We can aggregate those up and 

 2 average them together and come up with a market 

 3 average price. If we have enough of them, we can 

 4 say something also about the market quantity that 

 5 is clearing. We can also add in some information 

 6 about the quality and the quality characteristics 

 7 and the timing of the transactions and something 

 8 about the price ranges. It is a very difficult 

 9 process to go from that economic theory to getting 

 10 that information in practice. 

 11 What has happened for Market News and 

 12 AMS is that, while technological changes reduce 

 13 the cost to us of disseminating market 

 14 information, actually what is going on is the 

 15 changing industry structure and organization of 

 16 the agricultural and food industries has increased 

 17 the difficulty of collecting and assembling the 

 18 information. Back 90 years ago, we could go into 

 19 a terminal market, and all the traders were there. 

 20 All we needed to do was put a reporter in there, 

 21 have that reporter collect all that information at 

 22 one point, and then they could post it up. They 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 142 

 1 would have chalkboards at the different Market 

 2 News offices, and they could just get the calls in 

 3 and the teletype in, and each market would report 

 4 in what was going on. In that way, the industry 

 5 had an excellent sense of what was happening 

 6 nationally. Well, with the increased 

 7 consolidation and, as David just pointed out, with 

 8 the movement away from negotiated cash market 

 9 trades and more formula pricing and more contracts 

 10 in direct trade between two parties, it is not 

 11 quite as easy for us to just put a Market News 

 12 reporter out in every feed lot business office and 

 13 collect those prices. So now we have that burden 

 14 of trying to get that information together and 

 15 assemble it into market intelligence or at least 

 16 market information that is useful to the industry. 

 17 This is a type of graph that I am sure 

 18 you have all seen. This is based on Packers and 

 19 Stockyards programs' information. The Four Firm 

 20 Concentration Ratio in Meat Packing from 1980 have 

 21 increased quite dramatically for steers and 

 22 heifers, increasing from about 30 percent up to 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 143 

 1 about 80 percent; boxed beef, even a little bit 

 2 higher; And hogs, not quite as much but 

 3 increasing from about 30 percent to about 60 

 4 percent. The problem that this raises is two- 

 5 fold. One is that typically with fewer and larger 

 6 traders, you just have fewer trades to report. 

 7 The trades tend to be larger, and it kind of goes 

 8 along with the whole consolidation and growth, not 

 9 just on the packing side but also on the 

 10 production side, fewer and larger farms, so that 

 11 each transaction tends to be larger. Then the 

 12 other is we run into confidentiality issues. When 

 13 you start putting out a market price and you only 

 14 have two or three or four players, then the 

 15 question is are you starting to reveal information 

 16 about prices being paid or being received by an 

 17 individual player in the market and then what 

 18 implications does that have for competition. 

 19 Some of the changes that we have had in 

 20 the industry: We have fewer and larger farms, 

 21 handlers, and processors, so that results in fewer 

 22 and larger transactions and confidentiality 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 144 

 1 issues. We have private party negotiation rather 

 2 than open market trade, and that makes it more 

 3 difficult to assemble market data. We have 

 4 increased use of marketing agreements, contracts, 

 5 and formula pricing, so that means we have fewer 

 6 negotiated transactions to report. Also increased 

 7 product differentiation makes it more difficult to 

 8 aggregate the data for homogeneous products. As 

 9 David referred to, going from a 50-pound weight 

 10 range to a 200-pound weight range also means that 

 11 you have a bigger mix of qualities in those 

 12 transactions. 

 13 Just to illustrate each of these points, 

 14 this is an illustration, also from Packers and 

 15 Stockyards programs' data, of purchases of 

 16 livestock at public markets since 1980, and you 

 17 can see that they have declined quite a bit. They 

 18 were already relatively low, down in the 20 to 25 

 19 percent range for hogs, cattle, sheep, and lambs, 

 20 but for all three of those classes of livestock, 

 21 they have declined to the point where hogs is well 

 22 below 5 percent, probably in about the 2 percent 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 145 

 1 range, as the trade has moved to direct trade and 

 2 contractual trade as opposed to going through 

 3 markets. 

 4 One of the other changes I talked about 

 5 in the organization of the industry is increased 

 6 use of contracts. I would include marketing 

 7 agreements and contracts both in this. The scale 

 8 in terms of the years in this chart is a little 

 9 bit misleading. It goes back to 1950, but it 

 10 doesn't go each individual year. What I wanted to 

 11 show was broilers which, in 1950, virtually 

 12 everything was cash traded. There were no 

 13 contracts. By the mid-1950s, that industry was 

 14 basically fully integrated, and there was no more 

 15 cash market trade to speak up in broilers, and it 

 16 has stayed that way, up at 90 percent contract 

 17 production, ever since. 

 18 Some of the other commodities: Wheat 

 19 has stayed fairly small. That doesn't seem to be 

 20 changing a lot. Corn and soybeans are just around 

 21 10 percent with just a small blip in 2003 which is 

 22 the latest data that I have. We took this from an 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 146 

 1 ERS report. Cattle varies a little bit and hit up 

 2 over 30 percent in 1999 and right now back up 

 3 close to 30 percent. Cotton was increasing but 

 4 seems to be leveled off around 50 percent. Then 

 5 pork has increased quite a bit since the mid-1970s 

 6 from virtually no contract production to now up 

 7 around 60 percent. So this leaves fewer 

 8 negotiated trades to report. 

 9 Product differentiation, I put this 

 10 slide in for two purposes. One is just an 

 11 unabashed plug for some of the programs that we do 

 12 in AMS. We now have 44 USDA-certified beef 

 13 programs, and these are specifications that go 

 14 beyond the USDA grades like choice, select, prime 

 15 but have additional specifications required. The 

 16 issue here is then, when we are reporting boxed 

 17 beef trade, it gets more difficult to assemble 

 18 that information into homogeneous categories 

 19 because now choice beef is not just choice beef. 

 20 If you are looking at, for example, certified 

 21 Angus beef, we are talking about the upper 

 22 two-thirds of the category of choice beef plus 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 147 

 1 other requirements. Then that product moves out 

 2 of that choice beef category. We either put it in 

 3 and have more noise in that category, or we take 

 4 it out and then we end up with fewer transactions 

 5 to report in that category. We see this happening 

 6 in all of the livestock products, more and more 

 7 product differentiation. It seems to be happening 

 8 in the grains as well. 

 9 In terms of a little bit of economic 

 10 ideas here -- I think you are going to hear these 

 11 again from Steve Turner -- what is a thin market? 

 12 We have talked a little bit about it, and we kind 

 13 of have this vague idea of what a thin market is, 

 14 but conceptually, what are we talking about? 

 15 Hayenga, back in the late 1970s, said that a thin 

 16 market was one with few negotiated transactions 

 17 per time period. One of the key words here is 

 18 negotiated. I think it really does fit in with 

 19 the ideas that David talked about before. When 

 20 you are looking at formulas and contracts, it is a 

 21 little bit different than negotiated because I 

 22 think people are interested in looking at the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 148 

 1 intersection of supply and demand as that 

 2 commodity market unfolds in this given point in 

 3 time, so that we can fix some information set that 

 4 is available to everybody. When you start 

 5 including contracts and you start including 

 6 formula prices, that is fine, but what you have to 

 7 realize you are doing is you are also including 

 8 information that happened when that formula was 

 9 negotiated three months ago or three years ago or 

 10 even possibly 30 years ago. When that formula was 

 11 first put together, that was the information set 

 12 that was put together at that point in time. 

 13 You can really see this vividly on our 

 14 swine reports. We have a prior day purchase 

 15 number that we put out, and we have a prior day 

 16 slaughter number -- the average price paid for the 

 17 hogs that were slaughtered yesterday and the 

 18 average price paid for the hogs that were bought 

 19 yesterday -- and those prices are not the same. 

 20 One reason for that is that the ones that were 

 21 bought were bought over a period of time, some 

 22 reflecting formulas and different kinds of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 149 

 1 contracts, and you kind of have this 

 2 conglomeration of all different kinds of 

 3 information sets. 

 4 Another concept then for a thin market 

 5 is the number of transactions relative to total 

 6 volume needed to estimate the true, yet unknown, 

 7 price at a given level of precision. This was 

 8 Bill Tomek's concept, and it is basically a 

 9 statistical sampling concept of a thin market. 

 10 The basic idea is that we have some sort of a 

 11 distribution of a price that is unknown, and what 

 12 we want to do is to estimate what that price is. 

 13 That is a fine concept if the ideas of statistical 

 14 sampling theory apply and you have that kind of 

 15 randomization, so that if you pull in more volume, 

 16 it is being pulled in through some sort of random 

 17 sampling. But the problem is market news 

 18 reporting is not a random statistical sampling 

 19 process. NASS reports are because they do 

 20 actually use sampling theory and they actually 

 21 send out statistically valid samples, but when we 

 22 are trying to report daily prices or twice daily 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 150 

 1 price, we can't do statistical sampling. 

 2 And so, what happens is that the 

 3 reported prices that we put out are going to be 

 4 influenced by the volume of trades; they are going 

 5 to be influenced by the timing of trades within a 

 6 day; and they are going to be influenced by the 

 7 location of those trades. Just increasing the 

 8 number of trades reported alone doesn't 

 9 necessarily bring you closer to that true, but 

 10 unknown, price at this point in time. That is 

 11 something that we need to be very careful about, 

 12 and I think it fits very well with the idea of the 

 13 increased surveillance of the transaction activity 

 14 because we actually have an issue in the CME index 

 15 where we have had reporting, kind of a select 

 16 reporting from somebody who was not participating 

 17 previously and then reporting in that market. The 

 18 natural inclination is well, more information is 

 19 better than less, but that information was maybe 

 20 in one of the tails at the upper end or the lower 

 21 end of that distribution, and it influences the 

 22 reported average price. So we need to be very 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 151 

 1 careful about applying this concept. 

 2 This is a little bit of a play on words: 

 3 Public price reporting can't be done for peanuts. 

 4 Basically, the illustration I am giving is 

 5 actually peanuts, and what I mean is that it does 

 6 take resources to be able to do the price 

 7 reporting when you have these thin market 

 8 situations. In the case of peanuts, there are few 

 9 negotiated transactions at the producer/first 

 10 handler level. Most of the crop is forward priced 

 11 or there are contracts and marketing agreement 

 12 entered into early in the season. When it comes 

 13 time that the crop is being harvested, there is 

 14 very little negotiated trade to be reported, and 

 15 the transactions that do occur are diffused over 

 16 time. There are few players. There really are 

 17 two major purchasers of in-the-shell peanuts and 

 18 then another fringe that makes up a very small 

 19 portion of the remainder of that. A lot of these 

 20 contracts contain non-disclosure agreements, so 

 21 even if we did get the contract prices or even if 

 22 somebody is willing to report it, they are not 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 152 

 1 permitted through the contract to report it. 

 2 The problem that we have in terms of 

 3 USDA programs is that these producer prices 

 4 underpin program payments. The Farm Service 

 5 Agency has difficulty in coming up with the 

 6 national average price for peanuts because we 

 7 cannot find the prices to report, but they have to 

 8 create a price. Then the other point is that 

 9 futures markets depend on having a cash market 

 10 price. 

 11 The point of this slide is current price 

 12 discovery really is necessary for futures market 

 13 operation. If I look at the graph here which is 

 14 just looking at prices over time, if I start at a 

 15 known point here, I can engage in risk management 

 16 strategies in the futures market and through 

 17 futures and options to mitigate my risk as I am 

 18 going forward. But we have had cases where we do 

 19 not have good solid cash market information. 

 20 Industry has said, well, let us put a futures 

 21 market in place. You can't kind of take that 

 22 information set in the future and bring it back if 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 153 

 1 I don't know where I am starting from. It is kind 

 2 of like if I am building a house on quicksand, if 

 3 I don't have a foundation to start with, where I 

 4 am right now, I really have difficulty knowing 

 5 where I should be in the future, given carrying 

 6 costs, interest rates, and storage costs, and 

 7 things like that. How do I know where I need to 

 8 position myself in the future if I don't know what 

 9 is happening right now. 

 10 One of the solutions that Congress 

 11 proposed to some thin market price issues is 

 12 livestock mandatory reporting. That was enacted 

 13 in 1999. The first reports that we put out were 

 14 in April of 2001. The Act expired for the first 

 15 time on September 30th of 2004. It was extended 

 16 until September 30th of 2005, and now we are 

 17 operating that program on a voluntary basis, so we 

 18 call it our voluntary mandatory reporting. The 

 19 purpose of livestock mandatory reporting is to 

 20 improve market transparency. One of the big 

 21 changes that it created was it enabled us to 

 22 report those non-cash transactions, those kind of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 154 

 1 formula pricing arrangements, forward contracts, 

 2 marketing agreements, and packer feeding that we 

 3 just didn't have information on before. 

 4 The challenge that we have with that is 

 5 it is not a cure-all, and we do have difficulties. 

 6 Probably the primary one, particularly when we 

 7 first rolled this out, actually there are two of 

 8 these. One is timeliness. There was a concern 

 9 that the reporting was not coming out as timely. 

 10 Basically, we have all the major packers reporting 

 11 to us and within an hour, we need to assemble all 

 12 that information into a Market News report. We 

 13 have to clean up all the data, and of course, 

 14 there typically will be errors in there, and we 

 15 don't want to put out just meaningless noise. So 

 16 that is an issue for us. Also, if trade breaks at 

 17 a particular point in time, we really don't have a 

 18 way to get that information out easily through 

 19 mandatory alone. 

 20 Confidentiality was a big issue. We had 

 21 to change our confidentiality rules because the 

 22 law does say that we cannot release proprietary 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 155 

 1 information. Of course, reporting burden is a 

 2 concern that the packers have. It probably is the 

 3 most efficient place to collect the information 

 4 since there are relatively fewer packers and there 

 5 are fewer reporting entities. Then compliance is 

 6 an ongoing issue. 

 7 One of the hypotheses, at least that I 

 8 have, or I guess I will raise the question, is 

 9 whether livestock mandatory reporting stabilized 

 10 the trend away from cash market transactions, at 

 11 least in steers and heifers. Now on this graph, 

 12 the dark blue portion is the negotiated cash 

 13 trades; the light blue is negotiated grid. That 

 14 is basically a formula. A grid is a formula, but 

 15 the base is negotiated. The dark yellow is 

 16 formula, and then the light yellow is the contract 

 17 purchases. This goes back to 2002, the fourth 

 18 quarter, up through 2004. What we are seeing is 

 19 that trend away from the negotiated cash trade 

 20 kind of stabilized. Now that may have been partly 

 21 due to what was going on with cattle prices at 

 22 that time, but it also may be due to the fact that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 156 

 1 we increased the transparency on what was going on 

 2 with these formulas and contracts, and maybe 

 3 people found out that there weren't some of these 

 4 unknown sweetheart deals that were out there, and 

 5 they thought maybe the negotiated market wasn't 

 6 such a bad place to trade after all. 

 7 I do need to caution you on this. That 

 8 negotiated grid is something that initially we had 

 9 included in the formula purchases and we 

 10 reinterpreted that. So we need to be a little bit 

 11 careful about how we interpret that. 

 12 This is something that also the previous 

 13 discussion touched on. The negotiated market is 

 14 really the place where prices are set, even though 

 15 we have all the formula trading going on. Part of 

 16 the Livestock Mandatory Reporting Act was a swine 

 17 contract library that the Grain Inspection Packers 

 18 and Stockyards Administration runs. They haven't 

 19 been able to keep that up to date since the Act 

 20 expired, but the most recent data they have 

 21 shows the contract terms. Ten of the 

 22 contracts that they reported on used a plant 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 157 

 1 price, an internal plant price, as the base, and 

 2 111 of those contracts used an AMS Market News 

 3 price. So it is still that negotiated trade is 

 4 far and away the driver of pricing, whether it is 

 5 formula forward contract or negotiated itself. 

 6 Looking ahead, where are we going from 

 7 here? In AMS, we clearly see the continuing 

 8 changes in the organization of the supply chain 

 9 are going to shift the locus of price discovery in 

 10 agricultural commodity markets. We are going to 

 11 have declining volumes of negotiated trades that 

 12 are going to continue to challenge our traditional 

 13 market reporting institutions. We are going to do 

 14 our best to develop Market News programs that aid 

 15 price discovery and improve market efficiency. As 

 16 I said, it is a public good, and it is very easy 

 17 for support for the program to kind of get lost 

 18 amid the noise. We really, surprisingly, need to 

 19 increase our resources in some ways to continue to 

 20 collect and assemble this kind of information, 

 21 even though we can disseminate very cheaply. 

 22 That concludes my remarks. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 158 

 1 MR. DUNN: Thank you, Warren. 

 2 We heard from CFTC and from USDA, and now 

 3 Dr. Turner who is the Chair of the 

 4 Department of Agriculture and Economics at 

 5 Mississippi State University, who tells me that he 

 6 would really rather be doing this than being an 

 7 administrator, is going to try to bring this all 

 8 together for us. 

 9 DR. TURNER: Thank you, Commissioner 

 10 Dunn. Again, I am going to present a framework. 

 11 Thin markets have been defined pretty well, so I 

 12 am going to zip through that. I will try to get 

 13 us back on schedule here a little bit. 

 14 What are thin markets? Again, markets 

 15 with little trading volume, little liquidity, and 

 16 we are concerned about anybody exerting undue 

 17 influence on the market. In the simplest context, 

 18 a thin market is one in which relatively few 

 19 transactions establish prices. There are some 

 20 real concerns about that. 

 21 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 159 

 1 One caveat -- I like that word, so I 

 2 like to use it a lot -- just because you might 

 3 have something called a thin market, every 

 4 transaction is not equivalent with respect to the 

 5 information that it has. So you could have thin 

 6 markets, but the information that is coming 

 7 out of them could be valid and reflective of a 

 8 true market. I don't know what the probability of 

 9 that is, but the probability is greater than zero. 

 10 It is a lot less than zero, but again let us just 

 11 remember that. The point is that price discovery 

 12 mechanisms or market institutions might influence 

 13 behavior and price results. This is the theme of 

 14 my discussion: These matter. 

 15 Now again, I am going to zip through 

 16 this because most of us have had Econ 101. 

 17 Here in our country and in our economic 

 18 system, we know this. We kind of believe that 

 19 whatever it is, there is a schedule, a demand 

 20 schedule, a supply schedule. The key reminder is 

 21 this is a snapshot at a particular point in time 

 22 for a particular location for a particular 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 160 

 1 commodity or good. This is a snapshot. We all 

 2 know that life is a movie; it is not a snapshot. 

 3 So we take lots of snapshots, and we put them 

 4 together, and that is the movie, and, in 

 5 economics, we call that a time series. 

 6 That is going to be important. 

 7 The other thing is price discovery is a 

 8 communication process, and we can put up barriers 

 9 to communication or we can enhance communication. 

 10 Basically, all price discovery is, is a way to get 

 11 at those supply and demand schedules. It is the 

 12 actual operational mechanism whereby buyers and 

 13 sellers arrive at a specific price. 

 14 I am going to talk about an experiment 

 15 that I was a part of. I want to put this up 

 16 there. You can't see it very well, but do you see 

 17 these little dots? Do you see the demand and the 

 18 supply schedule and see these little dots? Those 

 19 little dots are actual exchanges. So the little 

 20 dots are price discovery. 

 21 All the buyers had, in this experiment, 

 22 was their reservation price as. In other words, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 161 

 1 if I bought something, what could I resell it for? 

 2 If I sold it, what could I get it bought for? In 

 3 other words, they had reservation prices, but they 

 4 only knew theirs for those particular three units 

 5 they had. They went into this privately 

 6 negotiated market and found another trader who 

 7 took the opposite side and they made a trade. You 

 8 notice that we have a series of trades. Then we 

 9 go through time, and we get it where it converges 

 10 to equilibrium price. 

 11 This is not unusual in experimental 

 12 economics; this happens quite a bit. By the way, 

 13 experimental economics is well known and well 

 14 established. Again, this is an English auction, 

 15 but the same kind of thing is happening, and I 

 16 will come back to the private negotiation and the 

 17 English auction and discuss that a little further. 

 18 Price discovery mechanisms -- you call 

 19 them markets, you call them whatever you want to 

 20 call them -- are the link between what we say is 

 21 theory and this price discovery process. The 

 22 important thing to remember here is there are 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 162 

 1 institutions, structural arrangements, and 

 2 communication tools that are conductive to this 

 3 price discovery mechanism. I can't overemphasize 

 4 how much we take this for granted. This is a 

 5 great place to say that because we have 100 years 

 6 or 160 years or however long that we have been 

 7 trading futures contracts, and we come to expect 

 8 that, that there are market institutions. If you 

 9 travel in other places in the world that are 

 10 trying to develop those kinds of institutional 

 11 arrangements, you are made aware that a lot of the 

 12 things we take for granted are not around in some 

 13 places. 

 14 The bottom line is, though, how do you 

 15 measure market performance? Usually it is done in 

 16 several of these fashions. I am going to 

 17 concentrate on pricing efficiency, but again you 

 18 can look at price patterns, you can look at the 

 19 volume that is traded, distribution aspects, 

 20 market efficiency, pricing efficiency. There are 

 21 basically five measures that are commonly talked 

 22 about. Three of those measures have to do with 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 163 

 1 price bias, and two of those measures have to do 

 2 with price risk. The reason this is important is 

 3 because when we evaluate a market, especially a 

 4 thin market, one of the things we want to look at 

 5 are these measures and are those markets 

 6 achieving, let us say. Are they biased? Are they 

 7 riskier? 

 8 The first one is the rate at which an 

 9 expected price series approaches an asymptote. 

 10 Again, you saw that in some of the slides, and I 

 11 might go back to them. The difference between the 

 12 asymptote and the competitive price equilibrium, 

 13 again, a market reaches an asymptote. Is that 

 14 asymptote where the competitive price equilibrium 

 15 would be? Then the third one with respect to 

 16 price bias is the difference between the overall 

 17 price mean and the competitive equilibrium. That 

 18 is going to be important. That is one that I 

 19 looked at specifically in the experiment that I 

 20 did. 

 21 Price risk has to do with the rate of 

 22 change in price variability around the expected 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 164 

 1 series. Then the last measurement would be the 

 2 overall variability around the mean price. 

 3 One of the ways that we can test some of 

 4 these things and get at market design and how a 

 5 market operates is we can use experiments. Most 

 6 of you are aware of Vernon Smith, a Nobel Prize 

 7 winner. He won that Nobel Prize by 

 8 being the father of experimental economics. He 

 9 would probably say, well, I am not really the 

 10 father, but I will take the prize anyway. This is 

 11 a supplementary way of observing phenomena or 

 12 verifying predictions made by theories with 

 13 empirical content. 

 14 The nice thing about experiments is you 

 15 can control things. You can create a thin market 

 16 and then see what happens. It is very difficult, 

 17 as Warren and David have mentioned, and it is 

 18 getting more difficult to collect the data 

 19 empirically in the markets. So can we do this in 

 20 some other ways? 

 21 There are more than two but two of the 

 22 biggest results of experimental economics are that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 165 

 1 institutions matter. The market environment or 

 2 price discovery mechanism plays a fundamental role 

 3 in determining outcomes. We can design a market 

 4 that will give someone an advantage, or we can 

 5 design a market that will not give someone an 

 6 advantage. I was asked yesterday over at the Ag 

 7 Marketing Service, well, just tell me about that. 

 8 My response was you give me the contract, and I 

 9 will do it. It is being done, but we are in the 

 10 very embryonic stages of market design. Michael 

 11 and I were talking about this earlier. It is 

 12 still amazing to me that it is 2006 and we still 

 13 don't have programs in market engineering and 

 14 market design. Maybe there are a few, but there 

 15 are not many. 

 16 The second fundamental result of 

 17 experimental economics is that the treatment of 

 18 information matters and having information 

 19 matters. If you withhold information, certain 

 20 things occur within that market. That market 

 21 behaves in a different way. So information and 

 22 transparency will matter. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 166 

 1 I am moving along here, so I will try to 

 2 stay on schedule. In three minutes, you will be 

 3 on. 

 4 What are the consequences of thin 

 5 markets? Well, you know, I am not too bright, so 

 6 I will just start from zero and go to one. None 

 7 to severe could be the consequence of a thin 

 8 market. There could be no consequence and it 

 9 wouldn't matter, or it could be that the 

 10 consequence of a thin market is very, very severe. 

 11 I am going to present two examples, one of each. 

 12 This is going to depend on, again, the 

 13 price discovery mechanism, information use, and 

 14 reporting. This gets back to what Warren was 

 15 saying. If there is no reporting or the reports 

 16 are not there, that could have a big impact. 

 17 How reliant are other markets on this 

 18 thin market? This is where National Cheese is 

 19 going to come into play. 

 20 None: We did a study and we published 

 21 it back in 1995. Basically, we did an experiment 

 22 where we tried to create a thin market and see 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 167 

 1 what the price ramifications would be. We 

 2 designed this thin market within a laboratory 

 3 setting. If you are interested, I brought some 

 4 papers. They are online, if you just go to that 

 5 site. The Journal of Agriculture and Applied 

 6 Economics is an online journal, at least that year 

 7 is, ad you can get a copy of that and see the 

 8 details. I am not going to cover the details of 

 9 the experiment. 

 10 What basically we did is we compared 

 11 price bias and variation from a thick private 

 12 negotiated market to a thin auction market. The 

 13 key there, when I look back on it, we are not 

 14 exactly comparing apples and apples or oranges and 

 15 oranges. The result we found was there was no 

 16 systematic price bias in either market. The thin 

 17 market, at least the way we designed it, and the 

 18 thick private negotiated market, there was no 

 19 price bias with respect to how we defined it, and 

 20 I mentioned that earlier. 

 21 As far as the price variation, we found 

 22 that to be lower in the thin auction market, and I 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 168 

 1 attributed that to the market mechanism we used 

 2 there. We used an English auction, and an English 

 3 auction is much like a livestock auction where a 

 4 good is put up for sale and the highest price gets 

 5 the good. Again, those were my results in a 

 6 fairly limited study, a fairly confined study. 

 7 One of the things that can be done and I wanted to 

 8 imply here is that we can design experiments to 

 9 test certain things, certain hypotheses. 

 10 Severe: Thin markets can have severe 

 11 consequences. This is a very good article, by the 

 12 way. You might want to read it. It is in the 

 13 Review of Industrial Organization by Willard 

 14 Mueller, Bruce Marion and Sial. It has to do with 

 15 the National Cheese Exchange, and that was 

 16 mentioned earlier. This study examined and 

 17 analyzed the motivation and trading behavior of 

 18 the National Cheese Exchange from 1988 to 1993. 

 19 Actually, they had data, and they looked at it 

 20 from 1980 to 1993, but up until about 1986-1987, 

 21 government price was above market price, so it 

 22 wasn't really a big deal. When market price went 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 169 

 1 above government price, this kicked in. It became 

 2 a big deal. 

 3 The National Cheese Exchange was used to 

 4 formula price 90 to 95 percent of bulk cheese 

 5 sales. David touched on that with respect to the 

 6 MERC. It is a different market but similar. It 

 7 represented only two-tenths of a percent of all 

 8 sales, so very, very little trading. I might add 

 9 that two-tenths of a percent was total sales of 

 10 volume of cheese. If we look at transactions, it 

 11 was even less. I don't know. I don't want to 

 12 speculate there. 

 13 Results indicated that the dominant 

 14 seller who was a buyer in the cash market had 

 15 exerted downward price pressure while buyers had 

 16 no impact on price. Let me repeat that. There 

 17 was a buyer in the cash market. Buyers like what? 

 18 Low prices. So this buyer went in the market and 

 19 sold and became pretty much an exclusive seller 

 20 and would do that for price advantage. 

 21 When we talk about what are the 

 22 ramifications, we look at resource allocation 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 170 

 1 here. This was quoted in the article: "For every 

 2 cent per pound reduction in the National Cheese 

 3 Exchange price" -- I only mention Kraft because it 

 4 was in the paper -- "Kraft's raw material 

 5 procurement cost by over $10 million annually." 

 6 You can imagine what the ramifications of this 

 7 were when it was published, both with Kraft and 

 8 with the other players in that market. 

 9 How did this occur? Well, prices on the 

 10 National Cheese Exchange were typically 90 percent 

 11 based on unfilled bids and uncovered offers. So 

 12 there weren't actually transactions. On one 

 13 occasion, prices changed over a 25 consecutive 

 14 weeks' period without a single trade. Of the 313 

 15 trading session of 1988 to 1993, no barrels were 

 16 traded in 53 percent of the sessions and no blocks 

 17 in 62 percent of the sessions. 

 18 In conclusion, formula pricing off thin 

 19 markets can be a major allocative problem. I have 

 20 kind of brought to you the most severe case that I 

 21 have seen. I want to also mention, back to my 

 22 caveat, a thin market can be an efficient market, 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 171 

 1 I believe -- that is my hypothesis -- if the 

 2 institutions, structural arrangements, and 

 3 communication tools are conductive to trading that 

 4 reflects current market conditions and situations. 

 5 Thank you. 

 6 MR. DUNN: Thank you. Michael? 

 7 MR. HAIGH: Commissioner Dunn, fellow 

 8 Commissioners, I am going to fully hedge my 

 9 exposure here by pointing out my disclaimer in 

 10 just saying right out, these are my opinions. 

 11 I am going to talk about four things 

 12 today: Thin markets, cost of carry, price 

 13 discovery, and trader interactions in agricultural 

 14 futures markets. That sounds like a lot of 

 15 information, but hopefully you will see that the 

 16 four things that I am going to be talking about 

 17 are closely connected together. 

 18 As everybody in this room is fully 

 19 aware, the futures markets serve two purposes 

 20 primarily, price discovery and risk transfer. 

 21 Researchers have conjectured that thin markets 

 22 affect both of these things. However, there is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 172 

 1 mixed evidence as to whether a thinly-traded 

 2 market actually provides a good price discovery 

 3 mechanism or risk management opportunities. Most 

 4 people who study these two things study them 

 5 independently and not jointly, and usually when 

 6 they find that a market has potential for price 

 7 discovery, they infer that it has good risk 

 8 management possibilities. There are problems with 

 9 that, and I will get through that later. 

 10 The crux of price discovery rests in the 

 11 notion of cost of carry or the carrying costs, as 

 12 it is known, of carrying a good forward in time -- 

 13 the more stable the cost of carry, the most stable 

 14 the pricing relationship between the underlying 

 15 commodity price and the futures price. Types of 

 16 carrying costs might include storage costs, 

 17 insurance, transportation, financing, or the 

 18 so-called convenience yield. In a world where 

 19 there are no arbitrage opportunities remaining, 

 20 we should find is the futures price should be 

 21 roughly equal to the spot price once you have 

 22 taken into account the cost of carrying it forward 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 173 

 1 in time. If that relationship breaks down, there 

 2 are arbitrage opportunities. 

 3 Unfortunately, we don't live in a 

 4 textbook economics world, and we do have 

 5 imperfections in the cost of carry models. For 

 6 instance, the relationship between cash and 

 7 futures markets may not be as tight if we have 

 8 transactions costs, unequal borrowing and lending 

 9 rates, margins and restrictions on short-selling, 

 10 limitations to storage, or low supplies of the 

 11 commodity, making arbitrate difficult. 

 12 I just returned from Asia and wanted to 

 13 tell you a quick story about something that 

 14 surprised me in South Korea. The development of 

 15 the Kospi 200 futures contract, which is the 

 16 contract that is linked to the 200 stock index, 

 17 had a miserable time when it first started 

 18 trading. Short- selling was just not allowed. If 

 19 short-selling is not allowed, arbitrage will break 

 20 down, making this relationship incredibly messy. 

 21 The reason I am telling you this is that this is 

 22 an extreme example in the imperfection in the cost 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 174 

 1 of carry relationship, and it has implications for 

 2 price discovery and risk management. 

 3 Other imperfections in cost of carry are 

 4 limitations to storage. Arbitrage conditions have 

 5 to be ultra-dependent on storage. Some things 

 6 just can't be stored, and that restricts the 

 7 possibility of being able to create a futures 

 8 contract. Non-storable commodities are things 

 9 like live cattle and hogs. Even though there is 

 10 an inventory of livestock related to the animals 

 11 on feed, no fixed storable supply exists, unlike 

 12 grains, for instance. This affects the cost of 

 13 carry relationship. 

 14 An example of a commodity that has a 

 15 very strong cost of carry relationship that ties 

 16 the underlying spot market to the futures market 

 17 is precious metals, for instance, where arbitrage 

 18 strategies are very effective, short-selling is 

 19 very possible, and there is a large supply of the 

 20 underlying asset which means that the futures and 

 21 the spot prices are very closely connected. 

 22 This chart I have here, reflects a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 175 

 1 couple of the elements that affect the cost of 

 2 carry relationship on each of the axes -- supplies 

 3 across the top, and storability going north/south. 

 4 If you think of it in two ways, in the 

 5 top right hand corner, where we have plenty of 

 6 supplies and the ability to store, we find a 

 7 market like precious metals. That market is 

 8 usually at full carry, meaning the spot and 

 9 futures markets are very tightly linked through 

 10 predictable relationships. As you find 

 11 imperfections in the cost of carry relationship -- 

 12 low storability, low supplies -- we see departures 

 13 in the cost of carry relationship, for instance, 

 14 livestock or orange juice. Everything else in the 

 15 middle, you sometimes see departures. 

 16 Turning our attention now to studies of 

 17 effective risk management and price discovery in 

 18 so-called thin markets, there have been a number 

 19 of attempts, academic studies that have looked at 

 20 the cheddar cheese futures contract. There have 

 21 been a couple of studies that have looked at that, 

 22 one study by Fortenberry and Zapata on the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 176 

 1 fertilizer futures market, shrimp futures, ocean 

 2 freight futures, and a recent study on Brazilian 

 3 coffee, live cattle, and sugar futures. I will 

 4 give you a rundown essentially of what these 

 5 studies have found in just a second. 

 6 Before I do that, I just wanted to show 

 7 you the longevity of these thinly-traded 

 8 contracts. Now bear in mind, as far as I know, 

 9 all of these were open outcry, so their lifetime, 

 10 as you can see in that second to last column, 

 11 varies -- 5.67 years for the black tiger shrimp, 7 

 12 years for the white shrimp. The far right hand 

 13 column gives the highest volume year in terms of 

 14 the number of contracts. By all accounts, these 

 15 are very, very thinly-traded markets. Compare 

 16 these markets to, say, the lean hog contract at 

 17 CME which has a volume, I believe, in 2005, of 

 18 about four million contracts. So when we talk 

 19 about lean hogs being thin, these markets are 

 20 really thin. 

 21 Researchers usually find a positive 

 22 relationship between price discovery and effective 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 177 

 1 risk management. The closer the markets are 

 2 linked -- by that, I mean the cash and the futures 

 3 markets -- the more effective the risk management 

 4 opportunities. For example, in the shrimp study, 

 5 there was found to be no relationship between the 

 6 cash and the futures market which, in turn, led to 

 7 very poor risk transfer. For the cheese market, 

 8 it was found in the early days of training, there 

 9 was no relationship between cash and futures, but 

 10 as time went by, the relationship strengthened and 

 11 risk management possibilities opened up. In the 

 12 fertilizer markets, they found a very strong 

 13 relationship between cash and futures in the very 

 14 beginning. 

 15 For ocean freight, this is an unusual 

 16 one because even though volume decreased over 

 17 time, price discovery actually improved, which you 

 18 may think would lead to better risk management 

 19 possibilities. I am very familiar with this study 

 20 because I actually did this one, but what people 

 21 often neglect to say is that even though price 

 22 discovery improves in the market, meaning the cash 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 178 

 1 and futures become tighter linked, you might think 

 2 that there are better risk management 

 3 possibilities. Less volume means a wider bid or 

 4 spread, essentially. This market had such a wide 

 5 bid or spread, that you could have steered one of 

 6 the big ships through it in this case. The 

 7 markets were better for price discovery but 

 8 certainly not for managing risk. 

 9 For Brazilian contracts, which is the 

 10 most recent study, a tight link was found between 

 11 cash and futures, but effective hedging was only 

 12 found in some of the markets that they had studied 

 13 there. 

 14 So, hopefully, what we have established 

 15 so far is that price discovery is different in 

 16 different markets, depending on the underlying 

 17 characteristic of the market, and in some markets, 

 18 there is not a tight link. If the cost of carry 

 19 relationship does not hold, price discovery fails 

 20 and researchers generally find that risk 

 21 management opportunities will diminish. 

 22 What I want to show you now are some 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 179 

 1 graphs of commercials and non-commercials -- here, I 

 2 call them hedgers and speculators -- in different 

 3 markets. 

 4 Why I am showing you this is that 

 5 despite the differences between the markets that I 

 6 am going to show you, fundamentally, we still 

 7 observe the same types of trading patterns. The 

 8 first graph that I am showing you here -- I really 

 9 like these graphs because this is about as close 

 10 to textbook economics as you get -- is the 

 11 relationship between the non-commercial and the 

 12 commercial traders over a period of time in the 

 13 Commitment of Trader categories. So this 

 14 information is released to the general public. 

 15 Here, you can see that this is a very 

 16 tight relationship between the trading activity 

 17 for a financial product. 

 18 Here, we have the S & P Index. It is 

 19 not quite as tight, but most of the periods of 

 20 time, you see the opposite positions by the 

 21 commercials and non-commercials. 

 22 Let us move to the corn futures contract 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 180 

 1 which, if you remember that matrix of storability 

 2 versus supply, it was sort of in the middle in 

 3 terms of the full carry sometimes holds, sometimes 

 4 it doesn't. Despite the fact that it doesn't 

 5 always hold, we still see the same sort of strong 

 6 relationship between the commercials and non- 

 7 commercials in that market. So these are 

 8 commercial and non-commercial traders. 

 9 As John Fenton pointed out earlier on 

 10 today, we are able to look at specific types of 

 11 traders, and one particular type that people seem 

 12 to be interested in are the managed money traders 

 13 which are collectively the Commodity Pool 

 14 Operators, Commodity Trading Advisors, and 

 15 Associated Persons, and then anybody else who 

 16 manages money. 

 17 What I want to show you here is not an 

 18 output from someone's heart report but a link 

 19 between managed money traders and the largest 

 20 commercial traders which are the livestock 

 21 feeders. You can see here an incredibly tight 

 22 relationship. It looks like they are spiking at 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 181 

 1 exactly the same period of time. The reason why 

 2 we see these spikes is because both of these 

 3 traders are getting out of their contracts at the 

 4 same time and are not particularly interested in 

 5 taking delivery. 

 6 In conclusion, what I want you to 

 7 take away from here is that researchers usually 

 8 find a positive relationship between price 

 9 discovery and risk management -- the closer the 

 10 markets are linked, the more effective the risk 

 11 management opportunities. 

 12 Between price discovery and cost of 

 13 carry, even if a market is heavily traded, 

 14 relatively, the price discovery function may not 

 15 be perfect due to the characteristics of the 

 16 market's storability, storage, et cetera. Despite 

 17 the difference in volume and despite differences 

 18 in price discovery in the futures market, the 

 19 strong relationship between hedgers and 

 20 speculators or commercials and non-commercials 

 21 still holds. 

 22 Given the seriousness of this topic and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 182 

 1 its importance, I am going to focus on the right 

 2 hand side of this PowerPoint slide and say thank 

 3 you very much and open up for questions. 

 4 MR. DUNN: Thank you very much, Michael. 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 183 

 1 

 2 

 3 COMMISSIONER DUNN: From what you were 

 4 saying, Dr. Turner, about changes in the structure of 

 5 the market, what is the impact of e-trading going 

 6 to have on thinly traded markets? 

 7 DR. TURNER: Theoretically, they should 

 8 hang around longer. If an exchange is in the 

 9 business of successful contacts, previously, if a 

 10 contract had no volume they would discontinue the 

 11 contract. The cost of carrying contracts now 

 12 would be low with etrading, and unless you are 

 13 concerned about reputation or something else, or 

 14 branding, you could keep it on longer as far as in 

 15 the cost world. 

 16 COMMISSIONER LUKKEN: I have a related 

 17 question. I was struck by this morning's 

 18 conversation in which we were talking about too 

 19 much liquidity in certain markets and the type of 

 20 liquidity that was being brought, and then this 

 21 afternoon where we do not have enough liquidity. 

 22 It made me think also today, being the initiation 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 184 

 1 of electronic trading in ag products, and related 

 2 to Mike's question, how do we encourage some of 

 3 that managed money liquidity that is brought 

 4 into these marketplaces to come into these 

 5 illiquid markets? I think of the ICE/NYMEX 

 6 situation that is going on now. When ICE started 

 7 listing this contract, a huge amount of demand 

 8 appeared out of nowhere. It was not stolen away 

 9 from NYMEX, it came from out of the blue, and I 

 10 wonder if there is pent-up demand out there either 

 11 because of electronic or failure to have somebody 

 12 on the floor of the exchange that these contracts 

 13 might be able to get some demand from electronic 

 14 trading or other means that encourage managed 

 15 money to come to these illiquid markets. I am not 

 16 sure if anybody has views on that. 

 17 MR. HAIGH: I would imagine that a lot 

 18 of this managed money is attracted to volatility 

 19 for the first part, but also there has to be some 

 20 liquidity there in the first instance for them to 

 21 get going, so which comes first, the chicken or 

 22 the egg, and there has to be growth in the market 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 185 

 1 before it is attracted there. 

 2 COMMISSIONER LUKKEN: And you think it 

 3 is up to the exchanges to provide dealers in the 

 4 marketplace to get that seed growth going and try 

 5 and encourage folks to come in? 

 6 MR. HAIGH: We certainly observe that. 

 7 When a new market is developed, they provide 

 8 incentives for market makers, so that is one 

 9 approach I would expect. 

 10 MR. KASS: Actually, the Chicago 

 11 Mercantile Exchange had its second annual dairy 

 12 forum a week ago today, and the spot butter and 

 13 cheese were the focus of the full day, butter in 

 14 the morning and cheese in the afternoon. One 

 15 question arose is whether they should put the spot 

 16 markets up electronically, and the consensus was 

 17 no, that it is counterintuitive. It is cheap for 

 18 the exchange to do that, but the rationale was now 

 19 there is public information out there of what 

 20 brokers are executing the trades. Everybody knows 

 21 there are probably 15 brokers standing around and 

 22 they can make guesstimates about who their clients 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 186 

 1 are based on past practices and they know trades 

 2 have been executed on behalf of certain physical 

 3 clients. If you put it up electronically, you 

 4 lose some information, and they thought that made 

 5 more transparency if you have the physical market 

 6 traded in the pit where you could see the broker 

 7 as opposed to electronically where you would not 

 8 necessarily see that. 

 9 Of course, then the counterargument was, 

 10 perhaps if there were more anonymity, so these are 

 11 some of the tradeoffs. An interesting sort of 

 12 debate, but that was a matter of debate at these 

 13 meetings. 

 14 COMMISSIONER LUKKEN: Are there 

 15 funds out there that want to be anonymous, as Greg 

 16 brought up this morning? 

 17 COMMISSIONER DUNN: Fred? 

 18 COMMISSIONER HATFIELD: Yes, I was 

 19 wondering if some of you could put this into 

 20 historical perspective for us. It seems like 

 21 there have been thinly traded markets around for 

 22 almost as long as there have been markets, and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 187 

 1 Dave talked about fewer and fewer negotiated 

 2 trades, and I think Dr. Turner said that it was 

 3 harder to gather the data. Can you guys maybe 

 4 take a crack at where are we on this? Is it 

 5 something that is just going to be more and more 

 6 of an issue? Have we been able maybe from a 

 7 surveillance perspective to keep up with this? I 

 8 would like to get your take on it maybe in an 

 9 historical perspective, if that makes any sense. 

 10 MR. KASS: I think Dr. Turner makes a 

 11 good point. It is very cheap. It used to be you 

 12 had to allocate pit space and you have a certain 

 13 number of bodies there and desks and things like 

 14 that, so if a market was not going to trade a 

 15 certain amount of minimum volume that you were 

 16 going to capture some money back, there are 

 17 representatives here from the exchanges, obviously 

 18 this is what they know, that it is a revenue 

 19 issue. 

 20 Now with electronic trading, there is a 

 21 proliferation and that it is very cheap to list 

 22 another contract. Merc is talking about relisting 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 188 

 1 a dry whey contract. That is obviously not 

 2 a huge market, but it is very cheap to list it, 

 3 and they would list it probably electronically. 

 4 In answer to your question, Commissioner, I would 

 5 think if anything we probably are going to see 

 6 with etrading, my opinion is that you might see 

 7 more thin markets because, as Dr. Turner said, you 

 8 can keep them on board longer and foster them. 

 9 Obviously, the hope is that they would generate 

 10 more and more volume, but you can stick with them 

 11 longer. 

 12 DR. TURNER: My standard reply is that 

 13 is an empirical issue. 

 14 (Laughter) 

 15 DR. TURNER: This issue, it is 

 16 interesting, back in the late 1970s it became a 

 17 very analyzed topic. Then from about 1980 

 18 something it just dropped off the kind of research 

 19 map, and it is interesting now that in 2006 it has 

 20 boomeranged back. We are in a lot different 

 21 environment than we were in 1978-1979, but those 

 22 of you who are old enough remember what was 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 189 

 1 happening back in 1978-1979, the economy was not 

 2 the greatest back the. 

 3 The electronics now are much more 

 4 advanced than they have been and cost is a crucial 

 5 factor. There is also institutional resistance, 

 6 and I call it market lethargy. I was an egg 

 7 producer, my father was, and we priced, formula 

 8 priced off earner an Urner Barry quote, and we 

 9 knew that the Urner Barry quote could be subject 

 10 to whatever, but it was so simple to formula 

 11 price. And we knew that if were formula pricing, 

 12 other people were formula pricing, so we just got 

 13 used to it. 

 14 So I think there is that inertia, too, 

 15 so until there is something that prompts change, 

 16 and the National Cheese Exchange is a great 

 17 example. That went on for quite a long time. So 

 18 that is my take on it. 

 19 COMMISSIONER DUNN: For Warren and 

 20 David, do you see a need for a role for greater 

 21 collaboration between USDA and CFTC, between the 

 22 spot cash market and futures markets? 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 190 

 1 MR. PRESTON: I think it is clearly an 

 2 issue, particularly for these kind of cash-settled 

 3 contracts, and we do work with CFTC and the 

 4 exchanges in trying to establish to what markets 

 5 should we report and how should we go about 

 6 assembling that information and provide that as a 

 7 public service. It is an issue that we do need to 

 8 work together to make sure that we fully 

 9 understand what is going into these different 

 10 price series, what are the quality differences, 

 11 what kinds of things are happening. 

 12 While electronic trading, in 

 13 response to Commissioner Hatfield's question, is 

 14 becoming easier, it seems like from our 

 15 perspective we are still seeing fewer and fewer 

 16 negotiated cash market trades. I do not know that 

 17 those are going to take place on exchanges, but 

 18 that seems to be the best place to get that 

 19 information as far as having the 

 20 information sets of all the market participants 

 21 and what is happening right now and you pull it 

 22 all together, it seems to me that current 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 191 

 1 negotiated market still is a desirable price 

 2 series to have. This is my own personal opinion. 

 3 I do not see the industry gravitating toward 

 4 more negotiated cash market trade, it is going to 

 5 be more formula-based, and the question for us is 

 6 where can we aid the price discovery process. 

 7 Is it going to take place at the wholesale level, 

 8 is it going to take at the farm first handler 

 9 level, is it going to be at the retail level and 

 10 formulas will be derived off of retail reported 

 11 prices? That is where we are looking. So I see 

 12 the negotiated trades continuing to get fewer and 

 13 fewer. 

 14 MR. KASS: I think your question about 

 15 cooperation between not just AMS but others, USDA, 

 16 I would say that within the last 3 years because 

 17 of that October Feeder Cattle which was a case we 

 18 brought in a cash-settled contract which derived 

 19 from the USDA price, since then we have done a lot 

 20 more work with USDA particularly in these 

 21 livestock areas. Our learning curve is just leaps 

 22 and bounds of where it was prior to that October 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 192 

 1 2003 situation across the board, and we have had 

 2 excellent cooperation in terms of them telling us 

 3 about their surveillance activities in cash and 

 4 our surveillance activities, but with these trends 

 5 of fewer and fewer negotiated trades, unless other 

 6 things change, it requires more and more vigilance 

 7 on both parts and more cooperation between the 

 8 two, and we have been pretty happy with the 

 9 cooperation. 

 10 COMMISSIONER DUNN: I am going to use 

 11 the Chairman's prerogative here because we did get 

 12 behind. We were scheduled for a break, but I see 

 13 people have been on the honor system taking their 

 14 own as they needed them. I would like 

 15 to ask Gregg Doud to come forward to do his 

 16 presentation on what they see from the field. I 

 17 know Dr. Turner has to go catch an airplane pretty 

 18 quickly, so if Gregg can go, we will 

 19 push through and have a rolling break. 

 20 MR. DOUD: Thank you, Commissioner Dunn. 

 21 I apologize, I just got home from Kansas at about 

 22 1 o'clock this morning after a bunch of airplane 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 193 

 1 trips, it finally got me. I have a pretty bad 

 2 cold, so I am going to make my comments pretty 

 3 short and try to get through them here. 

 4 I really appreciate all the dialogue 

 5 that as taken place today. There are a couple of 

 6 things I would like to point out from the 

 7 conversations that we have had in the cattle 

 8 industry. Number one, these markets have changed. 

 9 I well remember where I looked at these markets 

 10 every day from the time that I was with the 

 11 Kansas Farm Bureau in the late 1980s. In 

 12 those days we did not have index funds, 

 13 we were barely learning about fund managers, 

 14 and the nontraditional hedger was not a term 

 15 we were familiar with. But we are today, and 

 16 I think the point I would like to make is our 

 17 reports need to change with changing times. 

 18 In the private-sector it has 

 19 changed dramatically, and one of things we 

 20 have a lot of difficulty with today is 

 21 separating out is who is a hedger and 

 22 who is a speculator. In particular, I 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 194 

 1 would like to raise the discussion of the index 

 2 funds. I am just a farm boy from Kansas, but for 

 3 the life of me, I cannot figure out how those guys 

 4 are hedging anything. Those guys are making a 

 5 play on inflation, and to me that is a speculative 

 6 play, but that is probably a discussion for 

 7 another day. 

 8 The only thing that concerns me from 

 9 time to time is, and I have talked with the CFTC 

 10 and your staff about this, we get caught in this 

 11 trap of “this is the way we have always done it.” 

 12 I think that would be the one caution I would give 

 13 you today as we work through this. With all the 

 14 changes that we have seen, we have gotten more 

 15 volatility in basis, and we are very concerned, 

 16 particularly in the Feeder Cattle Index of 

 17 decreasing the Merc's ability or our ability to 

 18 use the CME feeder cattle as a risk management 

 19 tool. 

 20 Just 3 weeks ago one of your staff 

 21 people from Chicago, Bill Konkitis, joined Dan 

 22 Basse of Ag Resource in Chicago to give a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 195 

 1 presentation at our Summer Conference. Actually, 

 2 it was two presentations and a kind of round-table 

 3 format there. There were pretty interesting 

 4 observations coming out of that. Number one is we 

 5 had some of the biggest risk managers in the 

 6 cattle business sitting in on those sessions. And 

 7 I say sessions, it was the same session that they 

 8 sat in twice to give you a feel for how 

 9 important they thought this issue of the funds was 

 10 in their everyday risk management process. 

 11 They were actually interested in some of 

 12 the Bill's comments, and mostly the comment about 

 13 the fact that the CFTC is aware of everything that 

 14 is going on and they are on top of it. I think 

 15 that was a very important point that you folks 

 16 need to make: that we have the data, we are on 

 17 top of this, everything is on the up and up. I 

 18 think the reaction of most of the folks in the 

 19 room was, Why can't they share some of this data? 

 20 Why can't there be some sort of give and take and 

 21 continuing dialogue just like we had with Bill 

 22 today, it was outstanding, and in a way put 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 196 

 1 everybody on a level footing to understand what 

 2 is occurring in this business today. I think that 

 3 was a very, very important item that even Bill 

 4 took away from the discussion. 

 5 Lastly, I would like to make a couple 

 6 comments about the Feeder Cattle Index. We are 

 7 going to add calves to that in March of next year. 

 8 We have had a great dialogue here. Early this 

 9 year, letters went back and forth between the CME and 

 10 a group of NCBA folks that are working at looking at 

 11 the Feeder Index trying to ultimately make it a better 

 12 risk management tool. You have seen the numbers as 

 13 far as the seasonality of what we are running into 

 14 there. I think there is a tremendous amount of 

 15 effort going on now with the CME, with USDA, and 

 16 with us, to try to sit down and go through this 

 17 data as best as possible and figure out how we can 

 18 make a better risk management tool, whether 

 19 it is adding an auction barn here or there or 

 20 adding more direct trade or adding more value 

 21 enhanced trade: without diminishing the value of the 

 22 risk management tool. And I think everybody is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 197 

 1 very aware of the changes that have been made, how 

 2 well it has worked. How do we tweak this thing 

 3 just a little bit to make it better without going 

 4 back to having 27 states involved and something 

 5 that is unwieldy and you cannot deal with? 

 6 I guess the key word here is change. I 

 7 do a lot of speaking and recently was up in Canada 

 8 talking to a group of farmers that farm 29,000 acres 

 9 in two different countries. They did not know what 

 10 the Golden Rule was, and I was shocked that these 

 11 guys are massive users of risk management tools in 

 12 this country and elsewhere, and there are key 

 13 parts of this environment, and maybe there is part 

 14 of this reporting process as well that we can use to 

 15 help folks understand the forks in the creeks that are 

 16 hauling water to cattle in 102 degree heat and 

 17 they listen to the radio and they see what is 

 18 going on with their crops and they do not see the 

 19 market reacting the way they think it should, they 

 20 need help in understanding why that is. 

 21 In that context I guess my last point 

 22 would be we have seen a lot of this involvement in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 198 

 1 my opinion based on an inflation hedge in recent 

 2 years based on what is going on in energy and 

 3 other places. Markets go up and markets go down, 

 4 and if we do not have the ability to inoculate the 

 5 guy at the fork at the creek on what is going on 

 6 in this industry, when the cattle cycle does 

 7 turn one of these days and this thing heads 

 8 in the other direction, they are going to 

 9 begin to ask a lot of questions that they are 

 10 not necessarily interested in asking today. And 

 11 if we do not inoculate these folks just like we 

 12 did 3 weeks ago at our meeting in helping them 

 13 understand some of the new realities in this 

 14 marketplace, we are not necessarily doing our job, 

 15 at least my job in my role with my trade 

 16 association and elsewhere. 

 17 COMMISSIONER DUNN: Thank you, Gregg. 

 18 The key point I am taking away from your 

 19 presentation is that we are in a dynamic 

 20 industry and it is changing and we have got to be 

 21 prepared to change along with it, all of us. 

 22 This is the point where I will open it 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 199 

 1 up for the panelists and for Gregg to ask any of 

 2 them questions, or they can ask each other 

 3 questions. 

 4 We will now open it up to the members of 

 5 the Advisory Committee. Does anyone on the 

 6 Advisory Committee have any comments or questions? 

 7 Again, please state your name. 

 8 MR. STEVENSON: Randy Stevenson, R-Calf 

 9 USA, and mostly directed to the Professor over 

 10 here. As the cash markets diminish, and I notice 

 11 several of you pointing out the intersection of 

 12 supply and demand, in the formula markets a lot of 

 13 that supply is tied up or committed, so you have 

 14 the variability that is condensed into that remaining 

 15 supply. Does that show up with as increased 

 16 variability and increased risk there in 

 17 the remaining cash market, do we see that transfer 

 18 over into the futures market, and possibly what 

 19 can we do about it? 

 20 MR. HAIGH: I will take a theoretical 

 21 answer to that any reduction in the supply of 

 22 a commodity is going to relax the strong 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 200 

 1 relationship between cash and the futures market, 

 2 and that is sort of the gist of what I was going 

 3 through there, you will get a reduction in the 

 4 full carry making it harder to effectively price 

 5 and also to manage risk. So I would say the 

 6 answer in short is, yes, it would affect the 

 7 relationship the less the supply of the commodity. 

 8 DR. TURNER: I would concur with that. 

 9 Again, as far as the volatility issue, my initial 

 10 hypothesis would be, yes, that the potential would 

 11 be there for more volatility, but, again, I would 

 12 like to see some empirical analysis of it. 

 13 COMMISSIONER DUNN: What kind of impact 

 14 does that have on USDA and CFTC then as we try to 

 15 do surveillance and monitoring? 

 16 MR. PRESTON: I guess I take a little 

 17 different tack on it in terms of the theoretical 

 18 impact because also when you take away that 

 19 supply, you are also taking away the demand side, 

 20 because if that you have supply tied up, then the 

 21 demand curve moves down as well. 

 22 Theoretically, you do not need a lot of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 201 

 1 information to discover prices, it is the marginal 

 2 trades. That is the issue that we are 

 3 grappling with, is the negotiated market 

 4 reflecting those marginal trades when somebody 

 5 runs short of supply or somebody is long on supply 

 6 and they get into that negotiated market, either 

 7 if they have too much product, they will have to 

 8 put it on the market, if they do not have enough 

 9 product, to buy it. Is it an effective mechanism 

 10 to discover prices, or is it that we are ending up 

 11 with the residual market? It is really a 

 12 different product and a different characteristics 

 13 set that we are really looking at? That is 

 14 really the issue, I think, that is of concern to 

 15 us, is it the market indicator in a case that 

 16 is still helping us discover prices, the cash 

 17 market, the negotiated market, or is it ending up 

 18 being a residual market for those suppliers who 

 19 are not already engaged in formulas and what-not? 

 20 I do think we need to be careful that 

 21 formulas do not necessarily mean that that supply 

 22 is tied up. That just means that there is already 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 202 

 1 an agreed to pricing mechanism, and that does not 

 2 necessarily that it is tied up. And that is one 

 3 of the reasons we moved that negotiated grid into 

 4 a negotiated category. We had it in formula 

 5 because it is a formula price, but the base itself 

 6 is negotiated. In my view, everything is 

 7 negotiated, it is just when it was negotiated. 

 8 Was it negotiated today or was it negotiated some 

 9 time prior? And either side is typically free to 

 10 move away from that contract or that agreement at 

 11 least within some limits. 

 12 MR. KASS: I think a smaller number of 

 13 negotiated trades, if it is good information, it 

 14 is good information, but from my point of view in 

 15 surveillance, we are always concerned about market 

 16 power. When you get a smaller number of trades, 

 17 it increases the likelihood somebody at least 

 18 might try to do the math, could I exercise enough 

 19 market power in the physical market particularly 

 20 for cash and a certain is involved and how does it 

 21 compare to the gain I might get in futures, we do 

 22 not want people even doing that math. That is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 203 

 1 dangerous. So the smaller the market, the more 

 2 people might pencil it out and see if that is 

 3 something that they could do. So from a 

 4 surveillance point of view, obviously that raises 

 5 very deep concerns for us. 

 6 MR. COYLE: I don't know much about 

 7 these smaller markets, but just an observation. 

 8 If I am hearing it right, there are markets that 

 9 are thinly traded and it appears that there 

 10 is more of this direct trade maybe because 

 11 of more consolidation in industries or 

 12 various industry groups. And while it would 

 13 appear then that you would not have that much 

 14 information about these either formula trades or 

 15 these negotiated trades or settlements, it would 

 16 seem to me as more and more of that grows, again, 

 17 this is just an observation, you would want to 

 18 learn more and more about exactly how those prices 

 19 are made because that may then adjust how you want 

 20 to look at your pricing mechanisms. 

 21 MR. DOUD: I would also make a comment. 

 22 Theoretically, if you are beginning to see that 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 204 

 1 happen, your basis would get more volatile as 

 2 well. One of the key questions then is, if you 

 3 have a problem in a thinly traded market or not, 

 4 are you getting convergence at the end, and at 

 5 least so far we are. So you cannot really measure 

 6 what is going on out over time, but we still seem 

 7 to be getting pretty convergence in all this. 

 8 COMMISSIONER DUNN: Not to fast, Gregg, 

 9 we have yet another session. 

 10 (Laughter) 

 11 COMMISSIONER DUNN: Are there other 

 12 comments from the members? 

 13 MR. VITALIANO: I have a question for 

 14 you, David Kass. I think by these structural 

 15 measures, thin markets are here to stay and they 

 16 are probably going to become more and more of the 

 17 total percentage of production that is traded in 

 18 open negotiation. That is just the way the 

 19 markets are going. So, I think in terms of 

 20 surveillance, more and more emphasis has to be 

 21 placed on what Steve Turner talked about, are 

 22 these markets performing from the point of view of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 205 

 1 pricing efficiency? In the Commission's 

 2 surveillance work, how much of your attention and 

 3 activities are devoted toward elaborating and 

 4 looking, analyzing direct price performance, 

 5 however you might be able to do that, to see 

 6 whether those markets are indeed performing 

 7 despite their obvious structural imperfections, or 

 8 even by looking at some what I might call creative 

 9 structural measures? I think you mentioned a good 

 10 one rather anecdotally in the CME cheese trading, 

 11 a small percentage of production is traded, but if 

 12 you look at how the industry reacts to those 

 13 market, in a sense there seems to be a lot of 

 14 potential volume that makes that market perhaps 

 15 more contestable than the pure trading volume 

 16 numbers would suggest. Could you tell us a little 

 17 bit more about how you are looking at developing 

 18 surveillance tools in a world in which thin 

 19 markets are pretty much a given? 

 20 MR. KASS: Actually, in the next session 

 21 I am going to throw up some slides that show 

 22 exactly where we have identified some issues. If 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 206 

 1 we see a lack of convergence, futures and cash 

 2 coming together, clearly, in a cash settled market 

 3 they are going to converge, so that is not an 

 4 issue. It is settled to the settlement price, so 

 5 there you have to look beneath the surface quite a 

 6 bit more to see what went into that cash index to 

 7 make sure that was not influenced. 

 8 But I can tell you firsthand, for 

 9 example, just over the last or year an a half, I 

 10 have had a number of conversations with milk 

 11 producers up in the Northeast who either email or 

 12 write into the Commission, and we do our own 

 13 independent analysis, but we hear a lot from 

 14 producers, whether you're talking dairy, you're 

 15 talking grain -- all throughout the industry they 

 16 are not hesitant to let us know when they seen an 

 17 anomaly and want an explanation. Hopefully, if we 

 18 are doing our jobs we can explain it on the fly 

 19 because we have done the research, we have seen 

 20 the same anomaly. Occasionally, they will point 

 21 out an aspect that maybe we had not considered and 

 22 we will go back and take a look at it and get back 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 207 

 1 to them. But I have answered a number where 

 2 people are usually pretty impressed that a federal 

 3 agency—―and obviously we are a relatively small 

 4 agency—―that they will get a personal phone call 

 5 back, often it is me because I cover a lot of 

 6 markets, and we will sit on the phone with them 

 7 and hear what they have to say, they will hear our 

 8 explanation. They may still be unhappy with the 

 9 low price of milk or wheat or whatever it is, but 

 10 I think they come away usually understanding how 

 11 we do surveillance and our concerns and how we 

 12 look at these markets. So some of it is triggered 

 13 internally, some of it is triggered by I am sure 

 14 by some of your members, for example, who I have 

 15 had conversations with. 

 16 COMMISSIONER DUNN: Do we have other 

 17 members of the Advisory Committee? 

 18 MR. HAIGH: I might add something to 

 19 something you had brought up earlier, Commissioner 

 20 Lukken, about attracting managed money into thinly 

 21 traded markets. This is more of a statement than 

 22 a question, but I have heard anecdotally that some 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 208 

 1 potential participants have said that they are not 

 2 willing to enter these kinds of markets at this 

 3 point for fear of unintentionally showing power. 

 4 So it really is a situation where they have to 

 5 have enough liquidity to be able to do what they 

 6 need to do in these markets before they are even 

 7 going to come into them. I have heard this on a 

 8 couple of different occasions why they will not 

 9 use the futures markets. 

 10 COMMISSIONER DUNN: John Bunting had 

 11 indicated that he would like to speak. 

 12 MR. BUNTING: I am John Bunting. I am a 

 13 dairy farmer in Delaware County, New York, and 

 14 have really appreciated the opportunity to be here 

 15 today and have learned quite a few things that you 

 16 don't tend to think beyond dairy and milk and so 

 17 forth. But I thought it was very interesting that 

 18 Dr. Turner brought in the Willard Mueller/Bruce 

 19 Marion study. There was a legal case on that 

 20 which fell into trouble in the courts because milk 

 21 pricing and all the things surrounding milk are 

 22 essentially so complex, they are like religion in 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 209 

 1 the Middle Ages. 

 2 So the attorney, Tom Dobson, tried to 

 3 explain to the court every nuance of milk pricing. 

 4 The judge did not get it, and Kraft in defense 

 5 said how can we set the price of milk? The 

 6 government sets the price of milk, and they used 

 7 case law, and the judge said, yes, I can 

 8 understand that so they did not win. 

 9 Let's go back. We have seen several 

 10 things here in which we see the intersection of 

 11 supply and demand, and in dairy I don't think that 

 12 you can honestly get that demand equation with as 

 13 much precision as you can the supply level because 

 14 we track very closely the production of milk in 

 15 this country. 

 16 If you go back to the days of parity 

 17 where the Secretary had the opportunity to readily 

 18 adjust the parity level, you see a fairly strong, 

 19 not extremely strong, correlation between the 

 20 production of milk in this country and the price 

 21 of milk in this country, and as you move on 

 22 further and further, there becomes less of a 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 210 

 1 relationship. If you look at a 5-year period from 

 2 2000 through 2004, the relationship of price to 

 3 milk production is -.09, in other words, there is 

 4 none. Then if you look at where milk is being 

 5 produced in this country and you take the same 

 6 time period, what you find is that 30 states did 

 7 not produce more milk, that only four states in 

 8 that 5-year period produced more milk. When you 

 9 look at the driving force behind that, what you 

 10 see is that it is California real estate money and 

 11 IRS Tax Code 1031 that is really driving the 

 12 supply of milk in this country because the dairy 

 13 farmer can sell his farm in Riverside or San 

 14 Bernardino County for $400,000 or $500,000 an acre 

 15 and 1031 lets them keep all of that providing he 

 16 becomes a yet larger dairy farmer. 

 17 So the four states, California, Texas, 

 18 New Mexico, and Idaho, all have significant 

 19 increase in milk production, and yet with all of 

 20 what has happened since 1996, the United States 

 21 has been a net importer of dairy products. We do 

 22 not produce a surplus of dairy products. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 211 

 1 So you have to look at this price 

 2 mechanism which everybody does, and as Mr. Kass 

 3 said, farmers call him and complain about it. But 

 4 in fact, the suggestion is that we set up milk 

 5 pricing based on futures, and while I think most 

 6 people who have delved into milk know that milk is 

 7 one of the thin markets in which the cash market 

 8 determines the futures prices. So then if you go 

 9 back, and you do not have to go back very far, to 

 10 late 2004 or 2005, and I think those who are 

 11 familiar with the milk market know that there was 

 12 one trader who went in and bought futures and then 

 13 went into cash market and ran them up, and the 

 14 rumor is that he built an $8 million house and had 

 15 $20 million left over, that is a matter pretty 

 16 much of who did it and is of record, whether he 

 17 made $28 million, I do not know. 

 18 Then you go back to the Mueller/Marion 

 19 report, and what they suggested there was that 

 20 Kraft was interested in increasing their profit 

 21 because of their relationship with Philip Morris. 

 22 At the beginning of October of last year, the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 212 

 1 price of cheese on the Cheese Exchange began to 

 2 drop and to fall, and I had been told that this 

 3 was going to be happening by way of some brokers 

 4 in late September, and sure enough, it happen. I 

 5 thought Kraft is just going in to lower their cost 

 6 for their February, March, April buying period. 

 7 But then more recently I began to look 

 8 at it, and it is strictly a theory, and as Bruce 

 9 Marion would say, they have the motivation and 

 10 they have the opportunity to do it. At this 

 11 point, Altria is going to spin off Kraft, and if 

 12 you look at the difference in the share value of 

 13 Kraft from the beginning of October to the present 

 14 time and you realize that there are 1.66 billion 

 15 shares of Kraft stock that Altria owns 88 percent 

 16 of, the difference in that share price which was 

 17 very tightly tracked over the time they have had 

 18 it to farm milk prices is something like $3.5 

 19 billion. 

 20 So I would suggest that there is 

 21 continuing opportunity for manipulation within the 

 22 market and that we really should change some of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 213 

 1 that, and this is not strictly a CFTC question, 

 2 but we should not put 100 percent of farm milk 

 3 pricing in the hands of a few powerful people. 

 4 What we need to do is give them their due, which 

 5 might be 30 percent of the value of farm milk 

 6 pricing. That would make your job a lot easier, 

 7 the policing of it, the volatility would 

 8 disappear, and the oversight would be a simpler 

 9 problem. So that is just my suggestion, and 

 10 thanks for your time. 

 11 COMMISSIONER DUNN: Thank you, John. As 

 12 John points out, a lot of that also has to do with 

 13 the USDA and the milk marketing orders and 

 14 producers. We will have an opportunity in the 

 15 upcoming Farm Bill to address those particular 

 16 issues. Another person who had asked to address 

 17 the group is Kathy Ozer, and I see Kathy just came 

 18 in. 

 19 MS. OZER: I am Kathy Ozer, and I am the 

 20 Executive Director of the National Family Farm 

 21 Coalition, and many of the issues that John 

 22 Bunting just raised are issues that our coalition 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 214 

 1 has been very concerned about. We have an active 

 2 Dairy Subcommittee that represents dairy farmers 

 3 who work on their farms but are very concerned 

 4 about what is happening in Chicago at the CME. We 

 5 have been involved in meetings with them. A 

 6 couple of us came and spoke with Mike Dunn last 

 7 year and with staff and really see the role and 

 8 the importance of there being real oversight and a 

 9 real involvement and engagement in this process. 

 10 I think what we saw almost 2 weeks ago 

 11 with the Senate Agriculture Committee doing their 

 12 oversight hearing on dairy is that there is a real 

 13 need for both legislative change, but also 

 14 regulatory oversight at whatever levels that 

 15 currently exist in law, but also support for 

 16 changes so that we will have a system that truly 

 17 works for farmers and for consumers. 

 18 We appreciate the opportunity for this 

 19 meeting being held today and that there is an 

 20 opportunity for public participation of family 

 21 farm and rural advocacy groups in that process. I 

 22 am not going to go over all the issues that John 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 215 

 1 just did, but just reinforce the importance of 

 2 this process and hopefully over this next year an 

 3 opportunity for there to be further discussions 

 4 about what is happening at this point as opposed 

 5 to some of the historical perspectives of what has 

 6 happened in the past, and I appreciate the work 

 7 that is being done to explore this issue more 

 8 publicly. Thank you. 

 9 COMMISSIONER DUNN: Thank you, Kathy. 

 10 Commissioners, do you have any wrap-up for this 

 11 group that you might have? 

 12 Let me thank you all. I feel like I 

 13 have gone through Economics 101, 201, 301, and 

 14 401. I might have even gotten to a 5 level, but I 

 15 really appreciate it. You have done an excellent 

 16 job in exploring an issue that has a great deal of 

 17 concern as you have heard from our public 

 18 participants today, and I appreciate it very much. 

 19 That is a good segue for us to get into 

 20 another issue that we have heard a great deal 

 21 about. All of you can leave except for Dave Kass. 

 22 (Laughter) 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 216 

 1 COMMISSIONER DUNN: As Dave said, he is 

 2 always open to talk to folks, and in that 

 3 particular capacity he has had opportunity to meet 

 4 with a group from the Illinois Farm Bureau who 

 5 came in to talk to him with concerns about a weak 

 6 basis and the convergence on the basis. Dave has 

 7 prepared, just for informational purposes for the 

 8 Advisory Group and for the Commission, some of what 

 9 is happening here which is something that we need to 

 10 probably be aware of and keep our eyes on. Dave, 

 11 if you will, please. 

 12 MR. KASS: Thank you, Commissioner. I 

 13 will preface with if an opinion happens to leak 

 14 out, it is my opinion, and not necessarily that of 

 15 the Commission. 

 16 This group that the Commissioner refers 

 17 to, they came in and arranged for about an hour 

 18 and a half and we had figured what we could do in 

 19 about 45 minutes and leave 45 minutes for 

 20 discussion and that sort of thing. It ended up 

 21 that they were there for about 3-1/2 hours 

 22 including through lunch, and I think we got some 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 217 

 1 pizza for them and this and that, and they kept at 

 2 it. They started out with the 25 cent tour of our 

 3 surveillance system and ended up with the $5 tour, 

 4 and they kept asking questions. I made two or 

 5 three trips back to my office to get additional 

 6 materials and slides to show that, yes, there was 

 7 more beneath even what we had started, but we did 

 8 not think initially we were going to have enough 

 9 time to present it. 

 10 Let's go forward. This is sort of equal 

 11 time. My earlier presentation was mostly Chicago 

 12 Mercantile Exchange products just by happenstance. 

 13 This happens to be Chicago Board of Trade, but it 

 14 is an issue that has been raised quite seriously 

 15 very recently, there has been a lot said about it, 

 16 and it is of concern and I do not think we have 

 17 quite all the answers yet. 

 18 This first graphic shows for the most 

 19 recent future that went off the board, for corn is 

 20 the red, soybeans is the green, and wheat is the 

 21 blue, where we ended up in the last 30 days of 

 22 trading. So here is your thirtieth day, twenty- 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 218 

 1 ninth, all the way down to the last trading day in 

 2 the July futures contract, what the cash basis was 

 3 over that 30 business day period. You can see 

 4 that zero isn't even on here, so we obviously did 

 5 not get anywhere close to a zero basis. We do not 

 6 usually quite get to zero, there are reasons for that, 

 7 but usually several cents one way or the other 

 8 would be considered pretty reasonable. 

 9 You can see in the case of corn, for 

 10 example, we were pretty stable at around a basis 

 11 of cash 25 cents under futures, soybeans a bit 

 12 worse at 35 cents under, and here is wheat is, and 

 13 this is based on cash in Toledo where the biggest 

 14 delivery facilities are, essentially off the map 

 15 at 65, and I think it ended up near the end at 

 16 around looks like 57 cents. Clearly, not a model 

 17 of convergence. 

 18 So we set off to try to figure out what 

 19 is going on here. One thing we looked at then for 

 20 each of these markets was how the basis compared. 

 21 Let me just give you a description of this 

 22 graphic. The zero line represents cash zero 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 219 

 1 basis. This bar represents the range of basis we 

 2 have seen, and this is over a period of 1996 

 3 through 2004, the range of basis we saw. This is 

 4 for the fourth week of July, so this would be like 

 5 just last week. This is current data, but going 

 6 back in history all the way back to 1996, so this 

 7 would be the range of bases we have seen in the 

 8 fourth week of July going that far back. 

 9 The red X, it is a little hard to see, 

 10 but here is one, for example, represents the 

 11 median over that time period. The blue box, and 

 12 you can see these blue boxes here, and this is 

 13 going to be the same for the next three charts, 

 14 represents where the basis was a year ago, so that 

 15 is the 2005 basis. Finally, and sometimes, 

 16 unfortunately, it overlaps and you cannot quite 

 17 see it, but there is kind of a yellow-green star, 

 18 and I will show you where they are. This one is 

 19 down here, and that is this year, so that is what 

 20 the basis was just last week. And the green star 

 21 is up here, and it is a little hard to see. 

 22 These are at various major trading 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 220 

 1 points, Chicago, Toledo, Ohio, which is 

 2 undoubtedly interior Ohio, St. Louis, obviously on 

 3 the river, Decatur, upper Illinois River which is 

 4 of course the delivery point on this, and the bean 

 5 contract, and of course a big setter or value 

 6 across the grain complex, and that is the Gulf. 

 7 Note for example this difference here, and you can 

 8 see this year's basis at about 30 under at the 

 9 upper Illinois River. Meanwhile, the basis at the 

 10 Gulf last week looks like about 45 over. That is 

 11 a 75-cent difference, and as I go forward, I think 

 12 you will see the reason for that. But 

 13 nonetheless, each of this year's basis is just at 

 14 the low or near low end, and certainly well below 

 15 the median, in virtually every case except for at 

 16 the Gulf. 

 17 Since I just described all that for 

 18 corn, you should figure this out. This is 

 19 soybeans, the same concept, a few different 

 20 locations, perhaps. No, I guess it is the same. So 

 21 it's the same deal, it is the basis last week over 

 22 a long period of time, the median, last year's 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 221 

 1 basis, and this year's basis, and here in soybeans 

 2 you see it quite a bit weaker. You have at least 

 3 these three that are well below. At St. Louis, 

 4 Decatur, and note for example, soybeans, well 

 5 below this year's basis, quite a bit below. Last 

 6 year and well outside the range you did not see 

 7 quite as bad as that in corn. And again, at the 

 8 Gulf of Mexico you are seeing, for example, now 

 9 upper Illinois River versus the Gulf of Mexico, 

 10 that spread is about 80 cents. So you go from 

 11 about 30 under upriver here near Chicago, to 50 

 12 over, so you get an 80-cent difference. Remember 

 13 that, and you will see that again as we go 

 14 forward. 

 15 Now let's look at one that has already 

 16 been described here as probably the worst-case 

 17 example, and this is wheat. Again, the same deal, 

 18 wheat at various locations historically, and then 

 19 what the median is and this year. Chicago, clearly 

 20 below what we had seen. But with Toledo, we had 

 21 to redraw the scale on this thing. Normally, you 

 22 would see the median at Toledo for this time of 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 222 

 1 year looks like about 7 cents under. It is a 

 2 little hard to see up here. I'm sorry, Toledo 

 3 would be about 16 under. It's right here. The 

 4 median last year was right on top of that. So it 

 5 looked pretty good last year. We were right on 

 6 top of the median. This year all of a sudden 

 7 instead of being something like 16 cents under, 

 8 even worst-case scenario over this whole period 

 9 going back to 1996, we were at about let's call it 

 10 about 44 under, here you can essentially double 

 11 that and we are just like off the reservation in 

 12 terms of how weak this wheat basis is. 

 13 This other one is kind of an odd point. 

 14 You didn't see it on the other one, this 

 15 Blytheville, Arkansas, that is a point down near 

 16 the Missouri/Arkansas border, and we illustrated 

 17 that because Missouri and Arkansas congressional 

 18 folks inquired about this and what is going on 

 19 here, and you see there is also a very, very weak 

 20 basis historically. 

 21 One thing about wheat, though, look at a 

 22 year ago. We went from, at St. Louis, for 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 223 

 1 example, right on the bottom this year, but look 

 2 where we were last year. We were right at the top 

 3 of this historical range. In fact, if you look at 

 4 the blue boxes, generally last year we were in 

 5 pretty good shape. We were at the medians, and at 

 6 least in these two cases at the Gulf and St. Louis 

 7 well above the medians. So what has happened in 

 8 the interim? 

 9 One observation I would like to make is 

 10 that in wheat we saw, was it Dave Lehman or Tom 

 11 Coyle presented some volume figures, and wheat 

 12 volume and open interest is just remarkably higher, 

 13 tremendous growth in the amount of volume and open 

 14 interest. But a lot has been said about commodity 

 15 index funds and it is easy to attribute perhaps 

 16 high prices, which is of course high relative to 

 17 cash, to commodity index funds. And there have 

 18 been vague terms used about the participation of 

 19 commodity index funds, and, frankly, it is 

 20 probably illegal for me to give you the numbers, 

 21 and we do have the numbers in terms of 

 22 participation, but I can tell you last year when 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 224 

 1 we had a very, very strong basis, the percentage 

 2 held by commodity index funds was greater than it 

 3 is this year. That is counterintuitive if you 

 4 want to jump to the easy conclusion that it is 

 5 commodity index funds causing the problem, they 

 6 had a higher percentage of open wheat contracts a 

 7 year ago than they did this year, so that is not a 

 8 simple answer to this situation we are facing. 

 9 What is some of the rationale here? 

 10 Look at U.S. diesel prices. Virtually everything 

 11 that moves in commerce is diesel-truck, rail, 

 12 barge, whatever. This is last year's diesel 

 13 prices, and, again, this is similar to what you 

 14 saw except the median is this red line. This is 

 15 the range of diesel prices from 1994 to 2004, an 

 16 11-year range, and look at last year. At the time 

 17 it looked incredible, but now look at this year. 

 18 What seemed to be incredible last year, people 

 19 wished they had those prices this year, we are near 

 20 $3 a gallon, and these are monthly prices. When 

 21 you consider the top of the range was $1.75 prior 

 22 to last year and the median was down here at about 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 225 

 1 $1.20, that explains a lot about the cost of 

 2 moving stuff from interior points to collection, 

 3 and then finally to export points. 

 4 More specifically, this is the same type 

 5 of chart for barge rates. This is the Illinois 

 6 River, and the reason for that of course is that 

 7 is where you deliver in this case corn along the 

 8 upper Illinois River. This is barge rates up 

 9 through July of last year, this is end of month, 

 10 so this spike here, I think we all know what 

 11 caused that, I will just say K, that is Katrina, 

 12 caused that huge spike in barge rates, we saw it 

 13 continue up, and it looked like it was starting to 

 14 come down, as we got into the months past Katrina 

 15 things started to get in better order, and coming 

 16 into this year in January, the green, it spiked up 

 17 again and these are essentially record levels for 

 18 barge rates for this time of year. You can see 

 19 seasonally you get your highest barge rates later 

 20 in the fall. But right now this is what we are 

 21 looking at as barge rates. 

 22 Remember those differences between corn 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 226 

 1 and beans? I think one was 80 cents or so. Look 

 2 at the cost to move it from the upper Illinois 

 3 River down to the Gulf, and this is not magic and 

 4 not by coincidence, it is about 75 cents. This is 

 5 corn, and they are a little bit different 

 6 depending on which commodity you happen to be 

 7 moving. This is not by coincidence that the barge 

 8 rate is going to be the difference in the basis 

 9 between collecting something at the Illinois River 

 10 and at the Gulf. 

 11 So these are the issues. Clearly, in 

 12 corn and beans, I think we have a pretty good 

 13 handle on some of that stuff. We are at full 

 14 carry, so you have a little disconnect. Longs can 

 15 take delivery all day long because they can hedge 

 16 it and carry it forward if they get delivery and 

 17 make a return. Shorts, on the other hand can 

 18 deliver, but they are not having to bid in the 

 19 cash market in order to deliver because you are 

 20 delivering certificates and it is a promise to 

 21 deliver. If you get called on a shipping 

 22 certificate, of course you have to make delivery. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 227 

 1 But with the economics of freight, it is unlikely 

 2 it is going to get called. So you do not have a 

 3 free hand to make delivery, there are certain 

 4 requirements, that would explain some of the 

 5 disconnect clearly between the corn and soybeans 

 6 basis because longs are looking at one thing and 

 7 shorts are looking at the other. 

 8 Wheat is a little different because that 

 9 is a physical delivery market and there are some 

 10 issues, and I think Tom Coyle talked about some of 

 11 that when he talked about this issue in this 

 12 morning's session. 

 13 I am just raising this as an issue. 

 14 This is what I think the Commission is faced with. 

 15 What is causing this wide basis and lack of 

 16 convergence? Clearly, from the Commission's 

 17 perspective we would like to know is this a one- 

 18 time phenomena or is it likely to persist. If it 

 19 is a short-term or one-time special circumstance, 

 20 how long is this likely to last, and can and 

 21 should anything be done to help the situation? If 

 22 the market is going to cure itself, obviously, it 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 228 

 1 might be a mistake to do something. 

 2 If, on the other hand, this problem is 

 3 likely to persist in one or more of these markets, 

 4 what can or should be done to address it longer- 

 5 term knowing, for example, that if you say let's 

 6 change the contract, a change in a term or 

 7 condition of an ongoing grain contract could very 

 8 well take 2 years to implement if you change it 

 9 today because you cannot generally change it for 

 10 contracts with existing open interest. 

 11 Then, obviously, as important I think 

 12 for the Commission is beyond providing this forum 

 13 for discussion which is of value in and of itself, 

 14 what role should the Commission play in order to 

 15 facilitate a solution if one is in fact necessary? 

 16 I will throw those questions out there for 

 17 anybody. There are some folks here who deal with 

 18 this every day, these bases, convergence, and I 

 19 will leave it to the Commissioner to decide where 

 20 we want to go from here. 

 21 COMMISSIONER DUNN: Let's ask the 

 22 Advisory Committee for any comments or questions. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 229 

 1 Tom, I see you are already. 

 2 MR. COYLE: I can help you at bit with 

 3 some of the numbers. I would point out just a few 

 4 things so you can see the differences. Go back to 

 5 the one you just had. You can see the big basis 

 6 difference clearly on that. This is corn. 

 7 What I want you to notice here first of 

 8 all, and this will identify the difference between 

 9 corn, beans, and wheat, is that wheat is an odd 

 10 situation this year. You will see here the basis 

 11 here in Illinois and you see the basis in New 

 12 Orleans up here, you will actually notice that the 

 13 basis level in New Orleans has gone up quite a bit 

 14 this year, and the basis level in the interior has 

 15 gone down quite a bit. In this case, you can see 

 16 the transportation values as having an impact on 

 17 the basis in New Orleans as well as in the 

 18 interior. It is important if you go to the same 

 19 chart for wheat, a couple of things you will note. 

 20 MR. KASS: We do not show the upper 

 21 Illinois River here, but we show Chicago. 

 22 MR. COYLE: You can show Chicago where 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 230 

 1 we would load grain today. This is actually our 

 2 bid today, but if we were buying grain today from 

 3 a farmer at that basis and load it out in a barge, 

 4 it would lose 40 cents a bushel. And that goes to 

 5 your comments, Mike, on the chart that you showed 

 6 and some of your assumptions about an effective 

 7 market and whether or not storage is an issue. 

 8 But what I wanted to point out here is 

 9 the fact that you actually have a lower basis in 

 10 New Orleans in wheat this year despite the fact 

 11 that barge trade is significantly higher, and that 

 12 is a reflection on the fact that there is not 

 13 demand at the export point for the wheat. 

 14 Typically what happens if freight goes up is the 

 15 first thing that has to happen is the export basis 

 16 has to go up and the end consumer has to pay it. 

 17 Some of it will work its way back down to the 

 18 interior. When that does not happen, it tells you 

 19 that there are other supplies of wheat around the 

 20 world that are more competitive, and so the 

 21 consumer will not be able to buy grain from the 

 22 Gulf. That is an important issue. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 231 

 1 Then you want to ask yourself the next 

 2 question, Why does that happen? I will make some 

 3 observations and I just wanted to add from that, 

 4 that this year's scenario is much different than 

 5 anything else we have ever had. We have record 

 6 carry-outs in all commodities, corn, beans, and 

 7 wheat, so one of the reasons why you have this 

 8 dislocation, or I would say disconnect that you see 

 9 right now in corn and beans, is the fact that you 

 10 have a big carry-out, you have high transportation 

 11 values, and commercial storage is full. 

 12 In the case of wheat, you have a 

 13 different situation and that gets to Mike's point 

 14 earlier about storage. At some point elevators 

 15 will operate effectively. Today we are loading 

 16 out soybeans below delivery values, and buying 

 17 wheat significantly cheaper, but at some point you 

 18 cannot fill your elevator with wheat because then 

 19 you cannot handle corn or soybeans. I will give 

 20 you an example this week of an elevator in 

 21 Milwaukee where we are full of soybeans and wheat, 

 22 it is wheat harvest, and we have corn boats all 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 232 

 1 week. The plant manager says, Tom, stop. We 

 2 cannot take wheat anymore. And that is the reason 

 3 why you see probably the basis in Toledo so low on 

 4 wheat. So it does get to be a storage issue and 

 5 it is unusual. 

 6 Typically, what happens then is the 

 7 price gets low enough to stop the farmer from 

 8 selling wheat, the farmers typically sell wheat 

 9 out of the field, they do not store it. They use 

 10 a half a bin for wheat because they use it for 

 11 corn and beans later, but at 90 cents a bushel in 

 12 Toledo a farmer may decide I am going to store 

 13 wheat on the farm or I am going to do something 

 14 else, and you will find unconventional storage 

 15 capacity. We are bringing a boat from Duluth that 

 16 has not had grain in it in 22 years, and we are 

 17 going to store wheat for a year. This will not 

 18 happen very often. This is unusual. 

 19 In any case, I just wanted to highlight 

 20 why that is. It really ends up being a storage 

 21 issue. You made the comment which surprised me 

 22 about the make-up of the market and whether it is 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 233 

 1 funds or whatever. You might ask yourself the 

 2 next question, what was the futures price a year 

 3 ago on wheat and what is it this year? I think 

 4 what you might identify is that the price of wheat 

 5 is significantly higher. And because the wheat 

 6 price is significantly higher, the basis has had 

 7 to go down because it is not driven by 

 8 consumption. Part of the reason why the wheat 

 9 price is so high is because you had a drought in 

 10 hard wheat, and now you have a drought in spring 

 11 wheat. We have ideal conditions in soft wheat, 

 12 record yields, and farmers took advantage of the 

 13 price that they saw last year to put in more 

 14 acres. So we really have a situation right now 

 15 where there is a lot of wheat that wants to move, 

 16 and it has to find a home. Over time these things 

 17 work out, and you may have a systemic issue in the 

 18 issue that we have said earlier, part of it is 

 19 related to the price, and the price is related to 

 20 the fact that you have some long activity in the 

 21 market where people do not sell out that long 

 22 because the price realizes a dollar a bushel 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 234 

 1 because they are not looking at the basis. 

 2 COMMISSIONER DUNN: Thank you. Are 

 3 there any other comments or questions? 

 4 MR. GOULD: My name is Eldon Gould. I 

 5 am currently the Administrator of the Risk 

 6 Management Agency of the Department of 

 7 Agriculture, but until last November I was a real 

 8 live working farmer from northern Illinois, and so 

 9 I have witnessed all of this first-hand, the basis 

 10 problem that started a year ago with the capital 

 11 K, Katrina, and as a producer you hope this thing 

 12 was going to come and go pretty quickly, but 

 13 obviously it did not, it has persisted, so I would 

 14 say roughly in northern Illinois we typically 

 15 would deliver on the upper Illinois River and the 

 16 basis has stayed twice as wide as it normally 

 17 would. 

 18 And then 2 weeks ago this past weekend I 

 19 was back in Illinois and we were in the midst of 

 20 wheat harvest at the time, soft red winter wheat 

 21 with that basis there where you had to realign the 

 22 chart to make it fit on there. At that time the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 235 

 1 basis was exactly 90 cents, so most farmers in the 

 2 area that I am aware of put that wheat into 

 3 storage because of the temperatures that weekend 

 4 were very similar to what it is here in Washington 

 5 today, and those of you who have stored grain know 

 6 that grain that is at 90 or 100 degrees does not 

 7 store very well, so we let the elevator take the 

 8 risk and that is what happened. 

 9 As was mentioned, that grain now has to 

 10 move out of storage from the elevator before 

 11 soybean harvest starts which in our part of the 

 12 world is toward the end of September. 

 13 I do not have anything to add except 

 14 from the producer's perspective the frustration of 

 15 it all, and the fact that I guess the real 

 16 question is, is this a 1-year problem or are we 

 17 changing paradigms with the problem with the river 

 18 system of fewer barges and low water? In Illinois 

 19 there have been a number of rail loaders go in 

 20 that are shipping grain to the Southwest, and of 

 21 course the number of ethanol plants. So it is 

 22 kind of interesting dynamics in the grain trade. 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 236 

 1 COMMISSIONER DUNN: Thank you, Eldon. 

 2 Would anyone else like to comment or have 

 3 questions? 

 4 MR. BROPHY: I am Dan Brophy with the 

 5 National Grain Trade Council. 

 6 I agree with what Tom said. He brought 

 7 up some good points about the unique situation 

 8 that we are facing in the wheat market this year. 

 9 I would say that the statistics that Dave pointed 

 10 out are something the likes of which I have never 

 11 seen, and I think I reference that without saying 

 12 that my remarks were in relation to wheat. I 

 13 reference that in my remarks to you gentlemen 

 14 earlier today. 

 15 I have not seen anything like this. 

 16 Dave Lehman has an explanation, Tom has an 

 17 explanation, they are both closer to all the data 

 18 in the cash market than I am, but I think the 

 19 point that can be drawn from this is that the 

 20 industry needs some confidence that it does not 

 21 have now. I think the first step toward restoring 

 22 confidence in the general predictability of basis 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 237 

 1 relationships is for the hedger, in particular, 

 2 the short hedger, to have some idea of the 

 3 magnitude of the index or financial hedge nonprice 

 4 responsive long that is in the market at the 

 5 moment. So I think if there actually is a 

 6 contract problem as some people have said today 

 7 there might be, it is too early to know, but the 

 8 only thing that we can do is let time play out and 

 9 get accurate data. 

 10 I hope that you will assist in the 

 11 reconstruction of the Commitments of Traders 

 12 Report to restore its former utility to the 

 13 industry. Thank you. 

 14 COMMISSIONER DUNN: Are there any other 

 15 comments from our general audience? If not, I 

 16 would like to ask the Commissioners for a wrap-up. 

 17 Fred, we will start with you. 

 18 COMMISSIONER HATFIELD: Thank you, Mike. 

 19 Commission Dunn, I would like to thank you and 

 20 your staff very much for what I think was an 

 21 excellent get-together today. I thought all three 

 22 of the discussions were extremely educational, and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 238 

 1 you know you have had a good conference when two 

 2 people who I consider to be experts say that they 

 3 learned something. I heard that twice today, and 

 4 that is when I think you know that you have done a 

 5 good job. 

 6 I want to thank all of our guests for 

 7 being here. I also would like to say I am 

 8 impressed every day, but it is nice to be able to 

 9 say this in public, that we have a phenomenal 

 10 staff at the CFTC. These people do the work day 

 11 in and day out, they are very smart people, and I 

 12 am glad to work with them. 

 13 Dave Kass reminds me of John Madden with 

 14 that pen. He is the John Madden of the CFTC. 

 15 (Laughter) 

 16 COMMISSIONER HATFIELD: I want to thank 

 17 everybody very much. It was great. Thank you, 

 18 Mike. 

 19 COMMISSIONER LUKKEN: I want to 

 20 congratulate Mike, too, for putting on a great 

 21 program with his staff. They were working late 

 22 last night, putting together pamphlets and 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 239 

 1 programs, so they did an excellent job of 

 2 organizing this. 

 3 I would also like to take the 

 4 opportunity to pat our staff on the back. 

 5 Something that Gregg Doud brought up, part of 

 6 today's program was to educate what we do here and 

 7 to try to bring confidence, as Dan had mentioned, 

 8 to the people who utilize our markets that we are 

 9 sufficiently overseeing this marketplace. And I 

 10 think after you have heard John Fenton, Dave Kass 

 11 and Michael Haigh and others speak today from our 

 12 staff, you get the feeling that we are on top of 

 13 these markets, and we certainly are. We see this 

 14 every day on a real-time basis. The Commission is 

 15 briefed every Friday on these things. So it is 

 16 important to know that you have confidence in us 

 17 and that we are doing the public's mission. 

 18 I would like to again thank Chairman 

 19 Dunn for putting this together, and the Chairman 

 20 of the CFTC also for allowing us to do this. 

 21 COMMISSIONER JEFFERY: I can only 

 22 underscore Walt and Fred's comments. I will not 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 240 

 1 repeat them. Again, I thank all of you for being 

 2 here and the feedback we received today 

 3 is extraordinarily helpful as we take 

 4 particularly the Commitments of Traders Report to 

 5 the next level and consolidate and assess all the 

 6 feedback we have received today and any follow-on 

 7 comments you or your colleagues want to send in to 

 8 us, and try to adapt the report to all of the 

 9 changes that we are also aware of and were 

 10 discussed today so that we can make it something 

 11 that continues to have relevance to all of you and 

 12 the community at large in their day-to-day trading 

 13 and producing activities. 

 14 Again, as to the staff at the CFTC, it 

 15 is one of the great blessings of having the 

 16 opportunity to work here as an outsider, and we 

 17 have an extraordinary group of professionals -- many 

 18 of whom who have been at the agency if not since 

 19 inception, since the inception of their careers, 

 20 who have put heart and soul into the work of the 

 21 Commission. I think you have seen it today, and 

 22 you see it day in and day out. You do not see it 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 241 

 1 most of the time, but you know it is there and you 

 2 should be comforted at the quality and the caliber 

 3 of the work that they do. This kind of session, I 

 4 think, is not only informative to all of us, but it 

 5 is also motivational to those of us who work here, 

 6 and particularly the staff, in that it is real 

 7 contact with the outside world, it is real 

 8 visibility on the significance and import of the 

 9 work that they so ably carry out throughout the 

 10 various branches of the CFTC around the country. 

 11 Again, thank you all, and we look 

 12 forward to continue to work together and 

 13 continuing this important dialogue. 

 14 COMMISSIONER DUNN: Thank you, Mister 

 15 Chairman. I echo all the thanks that my 

 16 colleagues have mentioned. But I would also 

 17 really like to thank the Advisory Committee, the 

 18 folks on the Hill, all of the people that we went 

 19 out to to ask about what should be on the agenda 

 20 for this particular Advisory Committee. You 

 21 obviously gave us good direction and pointed us in 

 22 the right direction of where to go based upon the 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 242 

 1 participation and liveliness of the debates and 

 2 the conversations that we have had. 

 3 I would be remiss if I did not hold out 

 4 my particular staff that has worked so hard. 

 5 First, Eric Juzenas. Eric, if you will stand up. 

 6 Eric did all of the background, all of the leg 

 7 work in contacting the folks. Jason Gizzarelli 

 8 assisted him when he was not out delivering his 

 9 first born. And the person who really has done a 

 10 tremendous amount of work, Nicole McNair. Nicole, 

 11 if you will stand up. I came in Sunday, there was 

 12 no air conditioning in the building, Nicole, bless 

 13 her heart, had thrust her husband Joseph into 

 14 coming and working with us, and they were putting 

 15 together all of the material that we got together 

 16 for today, and I want to thank all of you for 

 17 that. And then the group that put everything 

 18 together, the CFTC staff, Mister Chairman, you can 

 19 be very, very proud of the support staff we have 

 20 here, and I am not going to begin mentioning names 

 21 for fear I would miss someone. 

 22 But finally, as to our professional 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190 
 243 

 1 staff, it is nice to be able to showcase them, 

 2 what Dave Kass has said, and John, Don and others, 

 3 they are willing to listen to you, listen to the 

 4 public when they give a call. It is tremendous. 

 5 It is not what people think of when they think 

 6 about federal service. They do an outstanding 

 7 job, and I appreciate it. And my final thanks, 

 8 again, to the Advisory Committee and all of you 

 9 who have agreed to serve. We will be getting back 

 10 to you to find out what further directions and 

 11 other issues that you would like to have, when and 

 12 where we might have our next meeting. We were 

 13 thinking about trying to take it to the field, 

 14 maybe get out to Chicago, New York, Kansas City, 

 15 or Minneapolis to actually visit some of the 

 16 exchanges to give some of you a firsthand look who 

 17 have not been on the floor of those. It is a 

 18 little logistics problem for all of us, but I 

 19 would like to hear from you on what you would like 

 20 to do. It is your Advisory Committee to the 

 21 Commission. Thank you all. 

 22 (Whereupon, at 3:48 p.m., the PROCEEDINGS were adjourned) 

 

 * * * * * 

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100 

 Alexandria, VA 22314 

 Phone (703) 519-7180 Fax (703) 519-7190