UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 AGRICULTURAL ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Thursday, August 5, 2010

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 2 

 1 A G E N D A

 2 Introduction

 3 COMMISSIONER MICHAEL DUNN, Chairman

 Agricultural Advisory Committee (AAC)

 4 

 GARY GENSLER, Chairman

 5 Commodity Futures Trading Commission

 6 COMMISSIONER JILL E. SOMMERS

 7 COMMISSIONER SCOTT D. O'MALIA

 8 COMMISSIONER BART CHILTON

 9 ICE Futures U.S. Cotton No. 2 Contract

 10 MARSHALL HORN

 Division of Market Oversight, CFTC

 11

 TOM FARLEY

 12 ICE Futures U.S.

 13 Reactions

 14 JORDAN LEA

 Eastern Trading Company

 15

 JOHN BARRETT

 16 Cotton and Grain Farmer

 17 WOODS EASTLAND

 Staplcotn

 18

 Questions and Discussion

 19

 Wheat Convergence

 20

 Market Fundamentals and Historical Background

 21

 DAVID AMATO

 22 Division of Market Oversight, CFTC

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 3 

 1 A G E N D A

 2 NICOLE AULERICH

 Office of the Chief Economist, CFTC

 3 

 Reactions

 4 

 DAVID LEHMAN

 5 CME Group

 JEFFREY C. BORCHARDT

 6 Kansas City Board of Trade

 7 STEVEN K. CAMPBELL

 Louis Dreyfus Commodities

 8 

 Questions and Discussion

 9 

 Livestock Price Reporting

 10

 Market Fundamentals and Price Reporting

 11

 HARRY HILD

 12 Division of Market Oversight, CFTC

 13 JAY JOHNSON

 Grain Inspection, Packers and Stockyards

 14 Administration, USDA

 15 WARREN PRESTON

 Agricultural Marketing Service, USDA

 16

 Reactions

 17

 PAUL PETERSON

 18 CME Group

 19 DON CLOSE

 Texas Cattle Feeders Association

 20

 NEIL DIERKS

 21 National Pork Producers Council

 22

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 4 

 1 A G E N D A

 2 Questions and Discussion

 3 Other Business and Closing Remarks

 4 DONALD HEITMAN

 Division of Market Oversight, CFTC

 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

 www.andersonreporting.net
 5 

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

 2 CHAIRMAN DUNN: We've got a very long

 3 schedule today and I really appreciate everyone

 4 coming here. Let me welcome everyone to the

 5 CFTC's Agricultural Advisory Committee meeting.

 6 This is the thirty-fourth meeting of the advisory 

 7 committee. The CFTC considers the four advisory

 8 committees each chaired by a separate Commissioner

 9 to be a major element in the information gathering

 10 and public outreach programs of the Commission. I

 11 want to thank all of you for attending, and a

 12 special thanks for each of the presenters and

 13 reactors in today's panels. The panels are made

 14 up of experts from CFTC staff, the United States

 15 Department of Agriculture, and knowledgeable

 16 private parties from the exchanges, the trading

 17 industry and market users community.

 18 Each of the panelists has spent a

 19 considerable amount of time in preparing for

 20 today's program and I want to recognize the

 21 contribution of your time and expertise and offer

 22 my sincere thanks and appreciation for

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 6 

 1 participating today. This meeting will revisit

 2 some of the market concerns that we have discussed

 3 in the past agricultural and other Commission

 4 meetings. The issue of cotton contracts has been

 5 the subject of both industry and CFTC studies and

 6 will be discussed again today, specifically recent

 7 developments regarding the contracts delivery

 8 points, the continuing and perplexing situation of

 9 lack of converge in the wheat market is still with

 10 us and will be revised, and the last panel will

 11 discuss livestock price reporting and livestock

 12 market fundamentals.

 13 Our format today will be the same as in

 14 the past. First we'll hear from the presenters

 15 regarding what is going on in a specific market

 16 and what problems have been experienced, then

 17 we'll hear from a panel of reactors who will

 18 provide expertise from the perspective of the

 19 trading and market users and will be followed-up

 20 by a period of questions and answers by the

 21 Commission, the AAC and the audience. As an added

 22 item, Don Heitman of the CFTC staff will give an

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 7 

 1 overview of how the recent passage of the

 2 Dodd-Frank bill specifically impacts agricultural

 3 commodities. Over the next year the CFTC will be

 4 actively writing rules to implementing the

 5 Frank-Dodd bill. The Commission values the input

 6 from the public and encourages members of the 

 7 public to submit their views to the agency. To

 8 submit views on any of the 30 rule-writing areas,

 9 go to cftc.gov, click the link to OTC Derivatives

 10 Reform Law. Under the heading of Rule-Writing

 11 Process, click on See List of OTC Rule Making,

 12 find the rule-making area you're interested in and

 13 click on it. From there you will find email

 14 addresses to which you can send your comments

 15 regarding each of the rule-writing areas. If the

 16 press doesn't get anything else out of my opening

 17 statement, that last paragraph I think is of

 18 paramount importance. The Chairman and staff is

 19 working as hard as they know how and that's very

 20 hard, believe me, but we are overwhelmed with the

 21 short deadlines that we have to meet the

 22 Frank-Dodd provisions of the bill and if the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 8 

 1 Chairman has anything to say about it we will meet

 2 those deadlines and I am confident that he is

 3 going to drive the staff and the Commission to be

 4 able to do that.

 5 It is extremely good for the public to

 6 give us your input and we're already being

 7 inundated with folks from the industry and

 8 lobbyist groups, special interest groups, and

 9 trade associations, which is great. We've got to

 10 hear from them. But the best time I have found in

 11 getting your input into rule making is before pen

 12 goes to paper. It is extremely important for you

 13 to lock onto those rule-making areas and give the

 14 staff that is beginning the development of these

 15 rules, your input on what you think is important.

 16 Please, please do that.

 17 I want to thank all of you for your

 18 attendance and the staff of the CFTC in making

 19 this possible, and I will ask the Chairman if he

 20 has any opening remarks.

 21 CHAIRMAN GENSLER: Good morning. Thank

 22 you, Commissioner Dunn for chairing today's

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 9 

 1 meeting of the Agricultural Advisory Committee,

 2 for your leadership in this important area and for

 3 those remarks about the overall Dodd-Frank

 4 rule-making effort. As you say, we have a lot to

 5 do. This is a great agency, the staff is up to

 6 it, but we need the public's help. We need the

 7 public's comments. You're going to hear today

 8 about agricultural swaps and we'll hear directly

 9 from this Committee and hopefully the public will

 10 weigh in, but in all 30 years that we've put on

 11 the website I appreciate what Commissioner Dunn

 12 said because it's really important to hear from

 13 the public and their thoughts.

 14 I want to also join Commissioner Dunn in

 15 thanking my fellow Commissioners and all of the

 16 expert panelists here today. The importance of

 17 the timing of the meeting of course is it's the

 18 first public meeting since the Dodd- Frank bill

 19 passed and that legislation for the first time

 20 will bring comprehensive regulation to the

 21 derivatives marketplace, specifically, it will

 22 subject all the dealers themselves to

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 10

 1 comprehensive oversight, it will bring

 2 standardized derivatives to transparent trading

 3 venues and also to centralized clearing. This

 4 will greatly reduce risk in the marketplace and

 5 promote transparency for the public.

 6 As we move forward with regard to this,

 7 I was going to focus on the areas today that I'm

 8 keenly listening to including of course the

 9 questions of wheat convergence and the ICE cotton

 10 contract, and I'm particularly interested in the

 11 views of the Committee regarding how we write

 12 rules with regard to these agricultural swaps.

 13 Don Heitman from our staff of course will give an

 14 overview later on on this important subject.

 15 I'm interested in hearing the views of

 16 the Committee on the ICE Futures Cotton No. 2

 17 Contract. You know so much more than I do about

 18 this subject. It's important that the exchanges

 19 periodically review contract specifications and

 20 make sure that we're keeping up with the changing

 21 market environment. It's important that exchanges

 22 review delivery points so that they best reflect

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 11

 1 the changing characteristics of the physical

 2 marketplace, and of course I look forward to your

 3 thoughts.

 4 With regard to the convergence in wheat

 5 contracts, recently the Chicago Board of Trade

 6 went through some similar issues. They

 7 implemented changes with regard to variable

 8 storage rates on soft red winter wheat, but

 9 unfortunately now we see the significant problems

 10 down in Kansas City that you're going to help

 11 advise us on. It's really at the core of any

 12 futures contract that it converges. Without

 13 convergence, hedgers lose confidence in the

 14 marketplace whether that be farmers, millers,

 15 grain elevator operators, so I'm particularly

 16 interested in how this contract that is having

 17 problems now can be addressed for hard red winter

 18 wheat.

 19 I look forward to hearing from the third

 20 panel on livestock price reporting. Again I want

 21 to thank Commissioner Dunn and my fellow

 22 Commissioners as well as the full Agricultural

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 12

 1 Committee here today.

 2 CHAIRMAN DUNN: Thank you, Mister

 3 Chairman. Commissioner Sommers?

 4 COMMISSIONER SOMMERS: Good morning. I

 5 want to say thank you to Commissioner Dunn and to

 6 his staff for organizing the meeting today and for

 7 the excellent agenda items. I especially

 8 appreciate the forum that we have in the

 9 Agricultural Advisory Committee to discuss these

 10 issues that are on the agenda today. I think that

 11 bringing together both the exchanges and market

 12 participants and producers around the table to

 13 talk about the progress we've made on some of

 14 these issues, to talk about the specifics and 

 15 differing points of view on many of these issues

 16 because a number of these issues have been on our

 17 plate almost since I've been at the Commission.

 18 I've been here for 3 years, so we've been

 19 discussing these issues for a long time and I want

 20 to say how much I appreciate this forum.

 21 The progress, particularly on the

 22 recommendations that were in the CFTC's staff

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 13

 1 report on cotton trading during the week of March

 2 3, 2008, and the additional changes that have been

 3 suggested for the ICE No. 2 cotton contract, I

 4 think, will be particularly interesting. I look

 5 forward to the discussion on the CBOT wheat

 6 contract performance and the changes since the VSR

 7 has been implemented, as well as discussing the

 8 Kansas City Board of Trade's hard red winter wheat

 9 basis issues. Commissioner Dunn and I had the

 10 opportunity to be in Kansas City on July 1 and I

 11 look forward to the updates since then.

 12 Additionally, the livestock futures

 13 contracts and the pricing report are on the agenda

 14 today, and I want to say how grateful I am to USDA

 15 for being here to help us discuss those important

 16 issues.

 17 Finally, agricultural swaps have been of

 18 interest to me, with my background, and something

 19 that we have talked about as well for almost 3

 20 years. So I appreciate Don Heitman giving us an

 21 update on how Dodd-Frank will treat those issues.

 22 Thank you all, the members of the Committee and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 14

 1 the panelists that are here today, for giving us

 2 an opportunity to discuss these issues.

 3 CHAIRMAN DUNN: Thank you, Commissioner

 4 Sommers. Commissioner Chilton is going to be

 5 joining us by telephone. Commissioner Chilton,

 6 are you on the line? He has not joined us yet so

 7 I will go to Commissioner O'Malia.

 8 COMMISSIONER O'MALIA: Thank you very

 9 much. Good morning everyone. I'd like to thank

 10 Commissioner Dunn for organizing the meeting and

 11 your leadership on these issues. Growing up on a

 12 very small family farm, these issues are very

 13 interesting to me. Growing up in Michigan, cotton

 14 was never a concern of ours, but I do have a soft

 15 spot in my heart for this red wheat contract. And

 16 I appreciate everybody's willingness to

 17 participate here today to share your views with

 18 the Commission regarding the current events in the

 19 agricultural markets and hopefully some positive

 20 solutions that can bring convergence and price

 21 discovery back to these markets if there's any

 22 concern about that.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 15

 1 I'm interested to hear from the cotton

 2 market participants regarding the CFTC report on

 3 the March 8 cotton market events and the Informa

 4 study regarding delivery points. As physical

 5 markets evolve it is critical that the related

 6 futures contracts with physical delivery evolve in

 7 order to ensure that the price discovery process

 8 for hedging remains intact. I'd like to know if

 9 the cotton market has evolved both in response to

 10 the changing market events of March 2008 in the

 11 contract and whether these contract changes will

 12 address those problems. Further, I am interested

 13 in receiving a report from the CME group regarding

 14 the results related to the contract modifications

 15 in the CBOT wheat contract. I believe these

 16 modifications can inform the Commission on issues

 17 related to the lack of convergence in the Kansas

 18 City hard red wheat futures market. Finally, I'm

 19 interested to hear about the current state of

 20 price reporting in the livestock market and

 21 concerns about price transparency. We must ensure

 22 that the data underlying futures contracts is the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 16

 1 best available data so that the contract performs

 2 it's vital price discovery function.

 3 I'd like to thank staff who have worked

 4 many hours putting this together and everybody's

 5 participation here today. Thank you.

 6 CHAIRMAN DUNN: Thank you very much,

 7 Commissioners. I'd like quickly to have the

 8 members of the ag advisory committee to introduce

 9 themselves. This is probably the greatest group

 10 and I really, really appreciate not only what

 11 you're doing coming to these particular meetings,

 12 but also the advice that you give me periodically

 13 through the year. Edgar Hicks will send me issues

 14 and things that he sees out in Nebraska all the

 15 time. I really appreciate getting those types of

 16 heads-up of what's going on. It keeps me in touch

 17 with what's going on in the field, but let's start

 18 with, John, if you would start off with

 19 introductions.

 20 MR. NATZ: Kevin Katz with National

 21 Council of Farmer Cooperatives.

 22 MR. BRUNS: Matt Bruns with the National

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 17

 1 Grain and Feed Association.

 2 MR. HICKS: Edgar Hicks with the

 3 National Grange.

 4 MR. CRYAN: I'm Roger Cryan with the

 5 National Milk Producers Federation.

 6 MR. DIERKS: I'm Neil Dierks from the

 7 National Pork Producers Council.

 8 MR. LANGLEY: Reese Langley, USA Rice

 9 Federation.

 10 MR. LANCLOS: Ken Lanclos, Risk

 11 Management Agency.

 12 MR. WILLETT: Sam Willett, National Corn

 13 Growers Association.

 14 MR. DOUD: Gregg Doud, National

 15 Cattlemen's Beef Association.

 16 MS. PETERSON: Dana Peterson, National

 17 Association of Wheat Growers.

 18 MR. GAINE: Jack Gaine with Managed

 19 Funds Association.

 20 MS. COCHRAN: Christine Cochran with

 21 Commodity Markets Council.

 22 MR. ANDERSON: John Anderson, American

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 18

 1 Farm Bureau.

 2 MR. WANDS: Hayden Wands with the

 3 American Bakers Association.

 4 CHAIRMAN DUNN: Thank you all. I

 5 appreciate that. I understand we had a little

 6 technical glitch and Commissioner Chilton may be

 7 online now. Bart, are you on? The wonders of

 8 technology. We'll let him address when he gets

 9 here.

 10 Our first panel today is going to be on

 11 the cotton contract and it's one that we've heard

 12 a lot about since March 2008 when we had a great

 13 deal of upheaval in that contract and a great

 14 upheaval in the industry itself. We're going to

 15 hear from Marshall Horn from CFTC and Tom Farley

 16 from ICE on studies that have been done by both

 17 the CFTC and ICE, and then we're going to have

 18 reactions from Jordan Lea, John Barrett and Woods

 19 Eastland who represent various sectors of the

 20 cotton industry.

 21 Before I do that I need to read

 22 something to you. We have received an appeal from

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 19

 1 the Port of Corpus Christi that has filed an

 2 appeal with the Commission concerning certain

 3 procedures followed by the Intercontinental

 4 Exchange in dealing with the port's petition to be

 5 designed as a delivery point. The purpose of this

 6 meeting is not to address the current appeal. I

 7 therefore ask all of you not to discuss the

 8 specific procedures followed by ICE in dealing

 9 with the port's petition. Nevertheless, to avoid

 10 any possible appearance that the Commission's

 11 decision on the pending appeal could be based in

 12 part on material outside the appeal's record, I

 13 intend to ask the Commission to incorporate the

 14 pertinent parts of the record of this meeting into

 15 the record of the appeal process.

 16 COMMISSIONER CHILTON: Mister Chairman?

 17 CHAIRMAN DUNN: Commissioner Chilton,

 18 please.

 19 COMMISSIONER CHILTON: Thanks, Mister

 20 Chairman. I'm sorry, like yesterday, Mike, I was

 21 on but couldn't do the audio, so I apologize for

 22 that and won't be long.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 20

 1 These markets have changed dramatically

 2 and I think it's a good thing that we look at it.

 3 They've changed over the years with technology and

 4 with traders. It's not like they changed

 5 overnight and took some BP magic beans, but

 6 they're changed and this is something that we need

 7 to be looking at. In particular the Chairman

 8 mentioned a couple of years. I'm particularly

 9 interested in our new authority with regard to

 10 position limits to make sure they're fair and

 11 calibrated in a real way that makes sense for

 12 markets. I'm also interested in our disruptive

 13 trading practice authority. For too long I think

 14 these markets have been subject to commodity

 15 roller coaster rides and we make sure that that's

 16 not happening, that they remain legitimate hedging

 17 tools not just for participants and not just for

 18 our economy but for consumers. So I look forward

 19 to hearing what everybody has to say and I thank

 20 you for your indulgence with the technology and

 21 thank you all for participating. Thanks, Mister

 22 Chairman.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 21

 1 CHAIRMAN DUNN: Thank you, Commissioner

 2 Chilton, and we'll try to make sure that we give

 3 you ample opportunity to have your input.

 4 CHAIRMAN GENSLER: I was going to say

 5 that as Commissioner Chilton mentioned about

 6 position limit authority on agricultural position

 7 limits, this Commission is supposed to do that in

 8 270 days which really means it's 255 days from

 9 now. So most of the rules are a year, but

 10 agricultural position limits is 270 and oil and

 11 metal are actually 180 days.

 12 CHAIRMAN DUNN: Thank you. I would like

 13 to recognize Dawn Stump who is here from the

 14 Senate Agricultural Committee. Thank you very

 15 much for attending this. With that, Marshall, if

 16 you will lead us off with your presentation.

 17 MR. HORN: Thank you very much,

 18 Commissioner. I'd like to do a brief overview,

 19 there will be more detail of course from other

 20 participants, to indicate what I'm going to cover,

 21 the current market situation in the cotton market

 22 at this time, a very brief discussion of the March

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 22

 1 2008 situation in cotton, the recommendations from

 2 the CFTC staff report regarding that time period

 3 and that volatility, the issue of price limits and

 4 the very current issue, very topical issue of

 5 delivery points on the cotton contract.

 6 Starting with the current cotton market

 7 factors and using some USDA numbers, since May,

 8 the nearby cotton future which is the 1st of July

 9 then the October ranging between about 73 cents

 10 and 84 cents per pound. The new crop

 11 statistically started August 1 looks like it could

 12 be a very large crop. More acreage was planted

 13 and growing conditions are very, very good. The

 14 USDA estimates new crop at about 18.3 million

 15 bales which is about one-and-a- half times as

 16 large as the 2009-2010 crop that we just finished

 17 of 12.2 million bales. Although we have a large

 18 crop expected, demand appears to be strong and

 19 that is keeping prices at a fairly high level. We

 20 expect usage of the crop both domestically to

 21 increase from last year, domestic consumption is

 22 going to stay about the same according to USDA,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 23

 1 while exports which are the heart of the

 2 consumption of cotton are expected to increase to

 3 14.3 million bales, up 2 million from last year,

 4 and season- ending stocks for next July are

 5 projected to be up to 3.5 million bales versus 2.9

 6 this time.

 7 Currently the October contract is

 8 trading to at a premium to the December contract

 9 and this is unusual historically. The October

 10 contract however is thinly traded. It is a new

 11 crop contract and tends to represent the earliest

 12 harvested cotton in the U.S. which is south Texas.

 13 Part of the reason for the inversion of October

 14 over December is that certificated stocks for the

 15 ICE exchange have declined tremendously. On June

 16 2 they were about 1 million 80 thousand bales, a

 17 relatively high number historically, now the slide

 18 says 44,000, but the last number I saw was 41,000,

 19 so they've almost been decimated. A lot of that

 20 is due to the strong demand for U.S. cotton and

 21 China in particular, the largest consumer of

 22 cotton for its mills has been a very active buyer

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 24

 1 recently of U.S. Cotton and has very strong

 2 demand for its textile products. What we here

 3 from trade and from everyone really is that most 

 4 of the remaining cotton stocks are already sold.

 5 Continuing, the December contract is a

 6 true new crop contract and it's a very liquid

 7 contract, much more so than the October, and

 8 recently it's been trading at a premium to March

 9 which suggests some tightness, a premium of about

 10 2 cents lately. We expect a big crop and the

 11 inversions do suggest that the marketplace views

 12 available cotton stocks at this time as tight, but

 13 then there will be a large crop.

 14 The next topic is the March 2008 cotton

 15 situation. I have five points to mention. It was

 16 a time period of extreme price volatility. There

 17 were very large margin calls to cotton merchants

 18 and other traders in the market. It was a time of

 19 extreme volatility in many commodity markets and

 20 many agricultural markets including crops that

 21 compete with cotton for acreage. It was also the

 22 first time that floor trading was no longer

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net 
 25

 1 permitted for cotton futures when it went to all

 2 electronic on the futures side and options still

 3 traded on the floor as well as electronically. At

 4 that time the futures price movements were

 5 restricted by price limits and it frequently hit

 6 the limit either up or down, whereas margins were

 7 determined based on synthetic prices derived from

 8 options which were free to move without limits and

 9 that relates back to the second point about the

 10 very large margin calls to cotton merchants and

 11 others.

 12 The CFTC staff investigated the

 13 situation in March 2008 and published a staff

 14 report in January I believe 2010 this year. One

 15 of the main things that was looked for given the

 16 tremendous volatility was possible price

 17 manipulation. It was looked at for several

 18 possible scenarios of how there might have been

 19 manipulation and the investigation turned up no

 20 evidence of manipulation. The staff report had

 21 several recommendations even though manipulation

 22 was not a factor. First, that ICE U.S. Analyze

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 26

 1 in light of historic price volatility the expected

 2 frequency with which current price limits will

 3 restrict trading; that ICE U.S. evaluate whether

 4 in conditions of rapidly rising prices and extreme

 5 price volatility the newly expanded price limits

 6 will allow the cotton market to operate

 7 efficiently and facilitate price discovery and

 8 risk management functions. There had been an

 9 increase and a change in the rules for price

 10 limits for cotton futures but we asked that the

 11 experience with the new limits be evaluated. That

 12 ICE U.S. notify the Commission of whether it

 13 intends to implement the dormant Rule 10.09(b) and

 14 subject cotton options to price limits. If so,

 15 ICE U.S. Should provide the Commission with an

 16 update on the status of the technology upgrades

 17 that are needed to implement that dormant rule.

 18 As a result and in reaction to the

 19 report and the recommendations, ICE Futures

 20 submitted a proposal for Commission approval for a

 21 price limit on cotton options on May 21, 2010.

 22 The Commission staff and the Division of Market

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 27

 1 Oversight requested additional information and

 2 clarification and this proposal is being reviewed

 3 by the CFTC.

 4 I'd like to turn to the question of

 5 delivery points and I'll point out very much that

 6 it's a very important issue and it was not part of

 7 the staff report on what happened in March 2008.

 8 Currently there are five delivery points for the

 9 cotton contract. These delivery points have

 10 remained the same for many decades. They are

 11 Galveston and Houston, Texas, New Orleans,

 12 Louisiana, Memphis, Tennessee, and

 13 Greenville/Spartanburg, South Carolina. Memphis

 14 tends to be the most active and has the most

 15 deliveries and most deliverable stock, and

 16 Galveston is often in second place, Houston and

 17 Greenville somewhat less, not having a lot of

 18 cotton sometimes and having a decent amount other

 19 times, New Orleans very occasionally. Over the

 20 years the production of cotton has shifted from

 21 one state to another so it's not what it was

 22 decades ago.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 28

 1 In regard to delivery points, ICE

 2 commissioned the consulting firm Informa Economics

 3 to, "Analyze the adequacy of the five existing

 4 cotton futures delivery points and determine

 5 whether there are other locations that would serve

 6 as commercially relevant delivery points." On

 7 July 16, ICE announced the recommendations of the

 8 subcommittee studying the delivery points. They

 9 did not agree with everything that Informa said.

 10 They unanimously recommended that to the cotton

 11 committee that that committee should recommend to

 12 the board of directors which is the determining

 13 body of course to add a new delivery point for

 14 cotton at Dallas/Fort Worth, Texas, and eliminate

 15 New Orleans. Just a couple of days ago the board

 16 of directors of ICE Futures adopted that

 17 recommendation and then will go to the CFTC for

 18 approval.

 19 CHAIRMAN DUNN: Marshall, just a couple

 20 of quick things for clarification on your

 21 presentation. Stocks here of 44,000 bales. How

 22 is that historically?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 29

 1 MR. HORN: It's the lowest in years. I

 2 don't know how years back, but it's a very, very

 3 low level. It's 440 contracts. Actually, I think

 4 it went down to 410 or something like that the

 5 other day. It's going down every day.

 6 CHAIRMAN DUNN: For the proposal for

 7 Commission approval on the price limit on cotton

 8 options and given the fact that we're trying to

 9 implement the Dodd-Frank bill, do you have a

 10 timeline or a timeframe on when you might see

 11 something come in to the Commission for that

 12 approval?

 13 MR. HORN: That's really handled by

 14 other parts of the Commission of Market Oversight.

 15 I'm in surveillance and that's product review.

 16 However, it's a fairly complicated proposal in

 17 terms of how it works, and as I indicated, we did

 18 ask for clarification. I know it does have a

 19 timeframe on it and it's not anything like 200

 20 days. It's a lot sooner than that, but I don't

 21 know the exact deadline at this point.

 22 CHAIRMAN DUNN: The same question then

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 30

 1 for the delivery point changes that ICE has

 2 currently made. That does have to go to the

 3 Commission for approval? First of all I wanted to

 4 make sure that's correct.

 5 MR. HORN: Yes, sir, it is.

 6 CHAIRMAN DUNN: Do we have an estimate

 7 or a timeline of when that might happen?

 8 MR. HORN: I don't know. It will be

 9 studied very closely I'm sure.

 10 CHAIRMAN DUNN: Thank you very much.

 11 COMMISSIONER CHILTON: Mister Chairman?

 12 CHAIRMAN DUNN: Yes?

 13 COMMISSIONER CHILTON: I wanted to ask

 14 Marshall a question because of how he had said it.

 15 He said that they were waiting on stuff from ICE

 16 and it's my understanding that they submitted

 17 something on May 21 and that the division asked

 18 for more information and that over a month ago.

 19 So I think it's in our court and I hope we move

 20 forward like I think all of us do to get this

 21 done. I know we've got a heavy workload and this

 22 one that would be nice as Chairman Gensler said to

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 31

 1 clear the decks before we get on to the work in

 2 the Wall Street Reform Act. Is that correct,

 3 Marshall?

 4 MR. HORN: Yes, it is. It's on a

 5 calendar to be addressed within a certain

 6 timeframe. I'm not sure of the exact timeframe.

 7 It's a fairly short timeframe.

 8 COMMISSIONER CHILTON: Thank you.

 9 CHAIRMAN GENSLER: I guess, Marshall,

 10 what we're all saying is we're going to put this

 11 on that list that we were working with the

 12 division directors on, the non-Dodd- Frank list,

 13 that I think it's the shared view that you're

 14 hearing from all three of us that we want to move

 15 it along.

 16 CHAIRMAN DUNN: Just to give you some

 17 insight here or some insider information from the

 18 Commission, the Chairman has what he has called

 19 the Clean Plate Club and he is pushing the

 20 division directors to clear the plates so that we

 21 can go full steam ahead on the Frank-Dodd bill and

 22 there are things in there that I've been asking to

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 32

 1 address since the day I came on the Commission

 2 that are finally being addressed and I am very,

 3 very grateful for that Clean Plate Club.

 4 CHAIRMAN GENSLER: Thank you,

 5 Commissioner Dunn. I'm grateful to all of my

 6 fellow Commissioners because we have not only the

 7 30 teams set up on the 30 Dodd-Frank, but we have

 8 nearly that many, it's less than 30, on the Clean

 9 Plate List as well, and Marshall just realized

 10 he's now on it too. Thanks. I'm sure it's an

 11 honor, and thank you for your volunteerism.

 12 CHAIRMAN DUNN: Thank you. ICE has also

 13 been very busy in this arena and we're fortunate

 14 to have Mr. Tom Farley with us. Tom, if you could

 15 walk us through some of the Informa stuff and the

 16 actions that have been taken by ICE.

 17 MR. FARLEY: Sure. Thanks. If I may, a

 18 quick clarification on something Marshall said.

 19 It might be a distinction without a meaningful

 20 difference, but my understanding is that adding a

 21 new delivery location does not require approval as

 22 long as it's being added for a contract month that

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 33

 1 does not have any open interest. I defer to

 2 others in this room including Audrey Hirschfeld

 3 and those of you on the dais about CEA and CFMA,

 4 but that's my layman's understanding which I think

 5 is a little bit different than the way I heard it

 6 described.

 7 CHAIRMAN DUNN: Thank you. We'll try to

 8 get that resolved and get back to you on it as

 9 soon as possible with the General Counsel's

 10 office.

 11 MR. FARLEY: Thank you Commissioners

 12 O'Malia, Sommers and Chilton, Chairman Gensler,

 13 and thanks especially to Committee Chairman Dunn

 14 for allowing me to be here today. Thanks for your

 15 leadership, Commissioner Dunn, Chairman Dunn I

 16 should say, in putting together this public

 17 hearing on issues of importance to cotton as well

 18 as obviously wheat and other markets.

 19 I'll say a few words about ICE's cotton

 20 no. 2 futures contract generally, specifically on

 21 delivery points, and while not in my prepared

 22 notes, I'll also add a few words about the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 34

 1 recommendations to address Commissioner Sommers's

 2 and Commissioner O'Malia's opening remarks, and

 3 I'll add that at the end just so that you have our

 4 perspective on the implementation of those

 5 recommendations.

 6 For almost 140 years, our exchange first

 7 as in 1870 the New York Cotton Exchange and then

 8 the New York Board of Trade and now ICE Futures

 9 U.S. has traded cotton futures and options. Over

 10 the last several decades our cotton no. 2 contract

 11 has become not just the benchmark for U.S. cotton

 12 but really the benchmark for global cotton. By

 13 way of context just briefly a few statistics, in

 14 2009 we traded just about 5.3 million contracts 

 15 which is $150 billion of value or 5 times global

 16 production of cotton of 30 billion and about 15

 17 times world exports. During the last 25 years

 18 we've had five delivery locations and they've been

 19 static, Houston and Galveston in Texas, New

 20 Orleans, Louisiana, Greenville, South Carolina and

 21 Memphis, Tennessee. During that 25 years we've

 22 had many petitions to either expand an existing

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 35

 1 delivery location, one of those five, or do add

 2 new delivery locations and in each of those

 3 instances the answer has been no after careful

 4 consideration. Just by way of background on how

 5 those types of decisions are made at the exchange

 6 and a little bit of background on our governance,

 7 the board of directors of ICE Futures U.S. has

 8 sole governance and sole decision- making

 9 authority over all rules including cotton contract

 10 delivery locations. Just to tell you a little bit

 11 about our board, we have nine members. Our

 12 Chairman Fred Hatfield is sitting here in the

 13 audience today, a former CFTC Commissioner. Fred

 14 like five others is a public director under the

 15 CFTC guidelines. Fred and the five others would

 16 qualify as independent directors under the New

 17 York Stock Exchange public company listing

 18 requirements. The other three board members at

 19 ICE include two executive officers of ICE Inc. and

 20 me as the President and Chief Operating Officer of

 21 ICE Futures U.S. One final note, none of us are

 22 cotton market professionals and so we don't have

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 36

 1 conflicts of interest in that regard.

 2 At ICE we agree with something Chairman

 3 Gensler said in his remarks which is it pays to

 4 every once in a while to take a step back and look

 5 at contract terms of all your contracts and make

 6 sure you're keeping up with market conventions.

 7 I'm paraphrasing your words, Chairman Gensler.

 8 It's not exactly what you said, but that's the

 9 idea.

 10 In 2009 the exchange commissioned

 11 Informa Economics to study our current delivery

 12 points. Informa is a leader in broad-based

 13 agricultural research and they completed their

 14 report in April of this year. It was a very

 15 thorough, very thoughtful report and included

 16 multiple sets of data on cotton, cotton production

 17 statistics, consumption statistics, market and

 18 expert statistics, and it also included a series

 19 of recommendations that Informa made about what we

 20 should do with our current slate of delivery

 21 locations, whether we should change those, modify

 22 those, add new ones, et cetera. That full report

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 37

 1 is available on our website.

 2 After that report was published, we drew

 3 a subcommittee from our full contract committee

 4 and charged them with studying this issue. We

 5 charged them with making recommendations on any

 6 necessary changes to the current locations. Their

 7 decisions were to be based not only on the Informa

 8 report but also on their collective and individual

 9 wisdom, experience, expertise in the cotton market

 10 and any other available information including but

 11 not limited to information contained in the

 12 applications from the port of Corpus Christi and

 13 Dallas, Texas to become delivery locations on the

 14 cotton market.

 15 If I can take a step back, our full

 16 cotton committee that I referred to comprises 21 

 17 industry professionals, producers in the form of

 18 farmer cooperatives, merchants, futures commission

 19 merchants, so it's a broad spectrum of customers

 20 domestic and international. In order to make sure

 21 the subcommittee was balanced because these are

 22 customers and they have a view and they have a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 38

 1 vested interest, we took a wide cross- section in

 2 constructing that subcommittee. The subcommittee

 3 included two farmer co-ops, a Texas farmer co- op,

 4 and Memphis Eastern farmer co-op, it included two

 5 domestic-based global merchants, one

 6 international-based global merchant and me as a

 7 representative of exchange management. In

 8 carrying out its mission, the subcommittee first

 9 sought to clear up what they believed to be

 10 misperceptions in the marketplace and agreed on

 11 two facts or guiding principles that they thought

 12 were important to establish. The first was that

 13 the current cotton contract terms are sufficient

 14 to ensure convergence. There is no issue with

 15 convergence in our contract. The second item was

 16 that the events of the first quarter of 2008 would

 17 not have in any way been changed by a modification

 18 to delivery points whether subtracting existing,

 19 expanding existing or adding new delivery points.

 20 It was fundamentally not a delivery point issue

 21 that arose.

 22 Having established those two facts and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100 

 Alexandria, VA 22314

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

 www.andersonreporting.net
 39

 1 having established that a lack of convergence of

 2 the Q-1 2008 cotton episode are not reasons to

 3 make changes to delivery locations, the

 4 subcommittee then set about to say what are the

 5 circumstances under which you would change

 6 delivery points and specifically what are the

 7 criteria that you will apply to a prospective

 8 delivery location to determine whether or not it

 9 merits inclusion, and they established three

 10 criteria. The first was the trade flows in and

 11 out of that location. The second was the cost to

 12 move cotton in and out of that location. And the

 13 third was the extent to which that location is

 14 balanced between producers on the one hand and

 15 users on the other hand.

 16 In addition, even if a prospective

 17 delivery location meets those criteria, you need

 18 to dig a level deeper and understand all the

 19 factors in the mix for that location, and let me

 20 give you an example of what I mean. It's possible

 21 that a location could meet those criteria but it

 22 could be so geographically close to an existing

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 40

 1 delivery location that it could be essentially

 2 economically comparable. For instance, committee

 3 members cited the Port of Corpus Christi as

 4 potentially one such example. It's approximately

 5 200 miles from Houston, it's approximately 200

 6 miles from Galveston, it's equidistant to the West

 7 Texas growing region, equidistant when compared to

 8 Houston and Galveston. Ultimately using this

 9 criteria, the subcommittee proposed adding

 10 Dallas-Fort Worth as a delivery location and

 11 subtracting New Orleans, and that was the sum

 12 total of the recommended changes.

 13 Other potential new delivery points

 14 including Corpus Christi as I mentioned, are

 15 Lubbock, Texas, or west coast delivery locations,

 16 those were all contemplated as well and there were

 17 reasons that the subcommittee chose not to 

 18 recommend them. In the case of Corpus Christi one

 19 thing I heard cited was it's not a significant

 20 center of trade flows. In the case of Lubbock,

 21 one thing I heard cited was that it may advantage

 22 producers but unduly disadvantage end users and in

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 41

 1 the west coast location it was the opposite, it

 2 could potentially advantage end users but unduly

 3 disadvantage farmers or producers who would have

 4 to pay a great deal of money to get cotton in

 5 position to deliver against a west coast delivery

 6 location.

 7 Ultimately after considering the

 8 recommendations of the Informa report, the

 9 subcommittee, the cotton contract committee, and

 10 the applications from Dallas and the Port of

 11 Corpus Christi, the board of ICE Futures U.S.

 12 Unanimously resolved earlier this week which is

 13 the reason by the way we didn't submit a written

 14 record, this is breaking news and we've been

 15 working diligently on this write-up to the date of

 16 this hearing, that New Orleans should be deleted

 17 as a delivery location and Dallas-Fort Worth

 18 should be added. The board also determined that

 19 these changes will be implemented commencing with

 20 the December 2013 futures contract which ties back

 21 to the clarification that I mentioned at the

 22 outset of my comments.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 42

 1 In reaching the decision to New Orleans,

 2 the board of directors noted that New Orleans is

 3 no longer a meaningful port for cotton or storage

 4 location I should say for cotton. In determining

 5 to add Dallas-Fort Worth as a delivery point, it

 6 was noted by the board that over the last several

 7 seasons there has been a significant volume of

 8 cotton moving into and out of the location, that

 9 costs to move cotton into and out of the location

 10 whether by truck, rail or otherwise are

 11 competitive, and finally that there is a balance

 12 between the producer community, particularly that

 13 Texas producer community as well as the end user

 14 community. The board has not reached a decision

 15 on Corpus Christi. There was a little bit of bad

 16 information about that that we saw earlier this

 17 week. The board has not made a decision about

 18 Corpus Christi and we continue to study the

 19 matter.

 20 I'll add a few comments to directly

 21 respond to Commissioners Sommers and O'Malia. As

 22 Marshall pointed out, the report that the CFTC

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 43

 1 issued about the 2008 volatility, we agreed with

 2 the conclusions of that report. There was no

 3 manipulation which was something that we believed

 4 all along and stated publicly and, further, there

 5 was no speculative buying. When I say no I mean

 6 there may have been some very de minimis

 7 speculative buying during that volatile period of

 8 February 29, March 3 and March 4, but there was

 9 essentially no speculative buying during that

 10 period and that volatility was the consequence of

 11 a tightening credit environment and heavy buying

 12 by the trade community. The recommendations that

 13 came out of that report we agreed with

 14 wholeheartedly and we've implemented all three of

 15 them. The third recommendation required that we

 16 notify the Commission of what we intended to do

 17 and we did that in May as we described. The first

 18 two recommendations had to do with studying to

 19 make sure the limits that we set were appropriate.

 20 We studied on our own, we worked with our

 21 customers and we all mutually agreed that the

 22 limits we put in place are reasonable and in fact

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 44

 1 that has been borne out in the marketplace as we

 2 have not hit limits frequently at all since we

 3 implemented those, I don't have the exact

 4 statistics, and so I did want to respond directly

 5 to the recommendations in that regard.

 6 Thank you again for your time and

 7 attention. I'll be happy to answer any questions

 8 that you or members of the committee have.

 9 CHAIRMAN DUNN: Thank you, Mr. Farley.

 10 Quickly, the Division of Market Oversight has sent

 11 me a note saying, If there is no open interest in

 12 the contract, there would not, I repeat, not need

 13 to be Commodity Futures Trading Commission

 14 approval for delivery location change. So your

 15 contention is correct if there is no open interest

 16 on there. Mr. Farley, there has been brought to

 17 me a lot of concern from the cotton committee and

 18 advisory committee what authorities they have

 19 within the contract. I know when ICE took over

 20 the exchange it was done with the caveat that they

 21 would retain those authorities but subsequent to

 22 that there was a governance rule by Commission.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 45

 1 Could you tell me the impact that that has had on

 2 that committee?

 3 MR. FARLEY: Sure, Commissioner. The

 4 cotton committee has no governance or

 5 decision-making authority at ICE Futures U.S.

 6 That said, I do view them as a trusted adviser. I

 7 don't want to embarrass anybody. Sitting to my

 8 left is one of the members is Woods Eastland.

 9 Suffice it to say Woods a little bit more about

 10 cotton than I do. So when there's a

 11 cotton-specific issue, Woods is the type of

 12 person, and I use Woods by name again not to

 13 embarrass, him, but there are several Woods on

 14 that committee. To my right is Jordan Lea, also

 15 similarly well versed in cotton. So we go to that

 16 committee because they're a valuable source of

 17 information and again we view them as a trusted

 18 adviser, and with respect to cotton, they know

 19 more than any of us at the exchange and we make a

 20 habit out of listening to our customers. But that

 21 committee has absolutely no decision-making

 22 authority or governance at the exchange. As an

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 46

 1 artifact of the acquisition by ICE in 2007, there 

 2 was some decision-making authority at that

 3 committee level but that's been eliminated and is

 4 no longer a factor.

 5 CHAIRMAN DUNN: Thank you. Other

 6 Commissioners? If not, if we could get the

 7 reactor panel, please, and if we would start as we

 8 have you listed. Jordan Lea first.

 9 MR. LEA: Thank you, Commissioner Dunn

 10 and members of the Commission. I'm Jordan Lea of

 11 the Eastern Trading Company in Greenville, South

 12 Carolina. I appear today in my capacity as

 13 President of the American Cotton Shippers

 14 Association known as ACSA whose members market

 15 approximately 75 percent of the cotton produced in

 16 the United States and are the primary commercial

 17 users of the ICE no. 2 upland cotton futures and

 18 option contracts.

 19 At the outset I wish to inform the

 20 Commission that ACSA endorses the recommendations

 21 of the subcommittee of the cotton committee of the

 22 Intercontinental Change or the ICE to delete New

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 47

 1 Orleans and to add Dallas-Fort Worth as delivery

 2 points on the ICE no, 2 upland cotton contract. I

 3 want to stress however that the adequacy of

 4 delivery points is not an issue for the commercial

 5 users of the contract. As the attached 1997 study

 6 in my remarks conducted for ACSA by Dr. Anne Peck

 7 and the 2009 memorandum prepared by Neil Galland,

 8 ACSA's former executive vice president and general

 9 counsel indicate, the ICE no. 2 contract is

 10 functioning well. There is full convergence,

 11 adequate storage capacity and most importantly, it

 12 provides accurate price discovery for producers

 13 and adequate hedging for its commercial users.

 14 I appear today in response to the

 15 Commission's request to provide ACSA's critique of

 16 the Informa study and not the recommendations of

 17 the previously mentioned ICE subcommittee. Let me

 18 begin by stating that ACSA agrees with the

 19 recommendations of the Informa study that Memphis

 20 be maintained as a delivery point. We do though

 21 respectfully disagree with other recommendations 

 22 for the reasons discussed herein.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 48

 1 In brief, Informa would add a new

 2 location in Texas and discontinue New Orleans,

 3 Galveston and Houston as well as consider dropping

 4 Greenville. It would consider adding Lubbock

 5 because it is a primary production area but not

 6 Dallas because it is not in a producing area and

 7 may not have sufficient warehouse capacity. We

 8 contend that the contract is functioning properly

 9 by providing convergence with the spot and the

 10 futures price and the delivery period resulting in

 11 accurate price discovery and hedging for

 12 commercials. Given that fact, one must ask the

 13 question as Professor Anne Peck did in her

 14 analysis of delivery points on the no. 2 contract,

 15 whether a contract change will have affects on the

 16 market and if so whether those effects will

 17 improve the functioning of the market. Not only

 18 did the Informa study not address this critical

 19 question, it presumes that a principal purpose of

 20 a futures contract is to provide producers with

 21 delivery points at the farm gate. Simply put, it

 22 suggests that the ICE no. 2 contract would better

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 49

 1 serve producers by being a cash or a delivery

 2 contract which is contrary to the purposes of a

 3 futures contract and is the formula for failure of

 4 this extremely useful risk-management tool.

 5 Another assumption of the Informa study

 6 is that a change in delivery point could increase

 7 income to producers. The net price to a producer

 8 is determined not by the futures price at the

 9 delivery but by the market price. The fact is

 10 that the price received by West Texas or really

 11 any producer is the world price in the export

 12 marketplace and not the literal futures price.

 13 Therefore, to place a delivery point in the heart

 14 of the largest production area in the world as the

 15 Informa study recommends would be detrimental to

 16 both producers and to the contract in general.

 17 This suggestion also ignores the established fact

 18 that the U.S. and the international cotton

 19 industries have been well served by the location

 20 of delivery points in either consuming, export or

 21 central marketing locations for the last number of

 22 decades as previously mentioned. As Dr. Peck

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314
 Phone (703) 519-7180 Fax (703) 519-7190

 www.andersonreporting.net
 50

 1 said, the central purpose of a futures market

 2 insofar as it differs from other markets is to

 3 give reflection today to the value of a commodity

 4 today and at specified future dates. That is, its

 5 central purpose is price discovery and price

 6 discovery alone. Many of the features unique to

 7 futures markets such as their standardized

 8 contract terms were designed specifically to

 9 promote efficient price discovery. Peck notes,

 10 and I can tell you from personal experience, that

 11 the uniformity of contract terms rarely mirrors

 12 the actual physical transaction between

 13 commercials.

 14 In the current pattern of expert flow,

 15 Informa's data is inaccurate in that it misstates

 16 that volume actually shifted from specific ports

 17 given that the data was not properly gathered.

 18 More importantly, Informa overlooked the evolution

 19 underway in the export patterns of shipments -- by

 20 the size of new ships coming online which are

 21 restricted to deep-water ports. The new

 22 generation of ships, the Pan Max container vessels

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 51

 1 as we call them designed to transit the widened

 2 Panama Canal starting in 2014 are already in

 3 service and currently calling on Charleston which

 4 increases the importance of Greenville as a

 5 delivery point. I would add that in discrediting

 6 Greenville's viability as a delivery point, the

 7 Informa study primarily focused on the use of the

 8 contract solely from a seller or a deliverer's

 9 bias or point of view as opposed to that of a

 10 receiver or ultimate user, and we've already heard

 11 Tom speak to the need to balance the needs of each

 12 party. When you combine the total production in

 13 the Southeast along with the total consumption of

 14 the U.S. Textile industry, a delivery point in

 15 the Southeast is more important than adding one in

 16 West Texas based on concentration and volume

 17 alone. Further, the diversion of cotton traffic

 18 from the West Coast ports will increase

 19 considerably when the co-joined ports of Houston

 20 and Galveston begin operation of their new

 21 container port in time for the opening of the

 22 widened Panama Canal. More Texas cotton will then

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 52

 1 move through the new Houston- Galveston container

 2 port because of the lower cost to move cotton to

 3 shipside and the decreased time of delivering

 4 cotton to Southeast Asia and the Far East, our

 5 primary customers.

 6 The development will also enhance the

 7 establishment of a delivery point in Dallas-Fort

 8 Worth. Corpus Christi however in our opinion is

 9 lacking as a delivery point for a number of

 10 reasons, one of those reasons being that the

 11 container vessels mentioned, the Pan Max vessels,

 12 will not be able to transit beneath the Harbor

 13 Bridge to gain entry to the port and the Texas

 14 Department of Transportation lacks the $800

 15 million necessary to raise the level of the Harbor

 16 Bridge to allow such vessels to enter that port.

 17 We would also concede that New Orleans' days as a

 18 cotton port have passed. Currently there are no

 19 warehouses licensed to store certificated cotton

 20 in New Orleans. Therefore we believe its deletion

 21 is justified.

 22 Lastly, the Informa report relies

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

 Phone (703) 519-7180 Fax (703) 519-7190
 www.andersonreporting.net
 53

 1 heavily on changes in crop production patterns for

 2 its delivery point recommendations. The fact of

 3 the matter is that crop patterns continually

 4 change and have changed since the high prices that

 5 impelled the switch to corn and other grains and

 6 oil seed production. The latest USDA crop report

 7 shows that this year production will increase as

 8 Marshall mentioned by 50 percent from 12.2 million

 9 bales to 18.3 million bales. Therefore, the

 10 importance of delivery points is not diminished,

 11 particularly Memphis which has always been the

 12 primary transportation and marketing center for

 13 the U.S. cotton industry.

 14 In conclusion I'd like to stress a few

 15 following points. The events of March 2008 were

 16 -- related to the adequacy of delivery points on

 17 the ICE no. 2 contract and I would rubber stamp

 18 and agree with everything Tom said in reference to

 19 those except maybe for my knowledge about cotton.

 20 I'd like to think I know a lot. The level of

 21 trading on the ICE no. 2 contract reflects total

 22 confidence in the current configuration of

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 54

 1 delivery points. This fact alone argues for the

 2 validity of the current delivery points which both

 3 the commercials and the speculative traders deem

 4 to be an adequate balance wherein neither buyer

 5 nor seller are penalized or discouraged from using

 6 the contract. That believe by the primary users

 7 of the contract provides the essential liquidity

 8 necessary to provide cotton producers with

 9 adequate price discovery. The users of the

 10 contract require stability in its terms and

 11 conditions. Though ACSA believes that the current

 12 delivery structure is adequate, we have agreed to

 13 the deletion of New Orleans and the addition of

 14 Dallas-Fort Worth. ACSA's membership believes

 15 that the users of the ICE no. 2 contract are best

 16 served when the contract's terms are consistent.

 17 Therefore we would urge that once established, the

 18 proposed changes in the delivery structure and all

 19 other terms and conditions of the contract be

 20 maintained. Thank you.

 21 CHAIRMAN DUNN: Thank you very much.

 22 Let's turn to someone who does have an up-close

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 55

 1 and personal relationship with cotton, Mr. 

 2 Barrett?

 3 MR. BARRETT: Thank you very much,

 4 Commissioner Dunn. Thank you for having me,

 5 Commissioners. My name is John Barrett. I live

 6 in San Patricio County which is near a place we've

 7 heard a lot about this morning called Corpus

 8 Christi, Texas. I've been a cotton and grain

 9 farmer for more than 35 years and I really

 10 appreciate the opportunity to talk to you this

 11 morning about what keeps me in business which is

 12 the cotton market and the cotton contract.

 13 I've got four main points that I'm going

 14 to try to make in my slide presentation. They are

 15 these. The first point is that the cotton

 16 contract as worked by the New York no. 2 contract

 17 is not working for me as a farmer. In other

 18 words, it is dysfunctional for farmers. It's fine

 19 for merchants, but it doesn't work for farmers.

 20 The second point is that Corpus Christi would be a

 21 wonderful delivery point for reasons that I will

 22 get into. The third point, we just heard that

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 56

 1 Corpus Christi had an $800 million bridge problem

 2 and we're going to show you some information about

 3 that. Then the fourth point I want to make is

 4 that if it makes sense to exchange, New Orleans

 5 for Dallas, that we think that it would make sense

 6 to exchange Galveston or Houston for Corpus

 7 Christi.

 8 Because of the events of 2008, there is

 9 very little forward contracting in South Texas.

 10 In times past, the majority of the South Texas

 11 crop would be forward contracted at a price off of

 12 the New York contract, but that has been severely

 13 restricted because of losses incurred by the

 14 merchant community. A second important reason why

 15 the contract is dysfunction for farmers is the

 16 widened basis between the cash market and the

 17 futures market has caused the price of options to

 18 become unaffordable for a farmer and we cannot use

 19 the New York market to hedge any longer. Because

 20 of the events of 2008, farmers were unable to use

 21 the futures contract to arbitrage the wide

 22 difference between the cash price and the futures

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 57

 1 price because I could not get access to an

 2 approved delivery point warehouse. I've tried to

 3 move cotton during February 2008. I tried

 4 tenderable cotton into the Galveston warehouse

 5 facility that at that time was owned by W.B.

 6 Donovan Company and I was told that they were full

 7 of their own company cotton and they had no room

 8 for my cotton. At the same time, the warehouse

 9 that's owned by me as a farmer in Corpus Christi,

 10 Texas had plenty of space and if it would have

 11 been a delivery point, there are a number of

 12 farmers who could have certificated cotton and use

 13 that cotton to arbitrage the positions of the

 14 merchants who were trying to get out of the

 15 contract.

 16 There has been some talk here at the

 17 table about the fact that the contract converges

 18 with the cash price at expiration and that's true.

 19 It generally does except for some transportation

 20 differences. The problems I have as a farmer and

 21 given the fact that I just mentioned that forward

 22 contracting has almost become a thing of the past

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 58

 1 is that during the year when I invest my money in

 2 the crop, the ground, the seeds, the chemicals,

 3 the fertilizer, all of the things that we have to

 4 spend a lot of money on, that there will be times

 5 when the basis between the cash price and the

 6 futures price is this wide. But when I get to the

 7 point at the end of the contract when I actually

 8 have cotton, the basis might be this wide and I've

 9 lost the opportunity at whatever point in the year

 10 that I wanted to attempt to lock in that spread, I

 11 didn't have an opportunity to do so.

 12 This talks about my second point as to

 13 why Corpus Christi would be an excellent delivery

 14 point. Corpus Christi as opposed to the other

 15 delivery points has a large amount of warehouse

 16 storage space that is owned by producers instead

 17 of merchants. Corpus Christi has 550,000 bales of

 18 storage space by farmers. In addition, Corpus

 19 Christi is in the center of a substantial

 20 production area that stretches from the Rio Grande

 21 Valley almost to Houston. The addition of a

 22 delivery point in Corpus Christi would allow

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 59

 1 farmers to arbitrage themselves against the

 2 contract without having to rely on the merchant

 3 community. In addition, Corpus Christi is the

 4 only port on the Gulf of Mexico that has a Corps

 5 of Engineers approved 52-foot ship channel. We

 6 have an additional ship channel that goes to the

 7 La Quinta facility which I'm going to talk more

 8 about in a minute that is not only permitted by

 9 the Corps of Engineers but is currently under

 10 construction.

 11 This slide is a list of the reasons that

 12 current shipping trends make Corpus Christi

 13 particularly attractive, and I started to say when

 14 I asked for the wrong slide that these first three

 15 reasons are very similar to the points that Mr.

 16 Lea before me just made. But the final point on

 17 here is the one that I really talk about. The La

 18 Quinta Trade Gateway is a project that the Port of

 19 Corpus Christi has been working on for several

 20 years. It's coming to fruition. I mentioned that

 21 the dredges are out there working right now. Four

 22 years ago that company that myself and my fellow

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 60

 1 farmers own, Gulf Compress, invested $13-1/2

 2 million building a cotton warehouse at this future

 3 container port. It is going to be a hub of

 4 commerce looking into the future. The ICE

 5 contract has been looking into the situation back

 6 as it was in the 1920s and we're asking ICE to

 7 look into the future after the Panama Canal is

 8 actually widened.

 9 I didn't want to get into a geography

 10 lesson when I came up here, but I found out I was

 11 going to have to. ACSA has said that we have a

 12 bridge problem. Up at the front of the room the

 13 Commissioner of the Port of Corpus Christi

 14 Authority, Francis Grandy is standing and he's

 15 more of an expert in this than I am, but if you

 16 look at the right-hand slide of the graphic or in

 17 the audience the one that's up on the screen

 18 you'll see the town of Port Aramsas. That is on

 19 the Gulf of Mexico and that's where the big ships

 20 come in. Then if you'll follow a blue line kind

 21 of to the southwest that's labeled Corpus Christi

 22 Ship Channel, you'll see that blue line goes to

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 61

 1 the west to Corpus Christi which is where the

 2 bridge is. Right where that blue crosses Highway

 3 181 there's a bridge and the bridge is too short

 4 for some ships. But if you'll back up on that

 5 blue line back toward Port Aramsas you can see

 6 where it forks off kind of to the northwest and it

 7 goes to the pink location here called Project

 8 Site. That's La Quinta. That's where we want to

 9 do our cotton business and there is no bridge.

 10 I heard something earlier today that I

 11 didn't really understand, that you couldn't have

 12 delivery points too close together because they'd

 13 be equivalent. But we've got delivery points in

 14 Houston and Galveston and as you can see they're

 15 awfully close together. Neither one of them has

 16 much warehouse capacity and they have very little

 17 nearby cotton production. Informa, ICE's

 18 consultant, recommended deleting both of them, but

 19 we don't go that far.

 20 Our recommendation is that we make an

 21 exchange of either Houston or Galveston for Corpus

 22 Christi. Corpus Christi has more warehouse

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 62

 1 capacity than Houston and Galveston combined.

 2 Corpus Christi's capacity is readily accessible by

 3 farmers and people in my situation wouldn't face

 4 the one that I had in 2008 when there wasn't any

 5 room at the inn at Southern Compress. Then unlike

 6 Houston and Galveston, Corpus Christi has

 7 significant nearby cotton production. Gentlemen

 8 and Commissioners, I appreciate your time and I

 9 appreciate the ability to appear before you today. 

 10 Thank you.

 11 CHAIRMAN DUNN: Thank you very much, Mr.

 12 Barrett. Mr. Eastland, if you would, please.

 13 MR. EASTLAND: Thank you, Commissioner

 14 Dunn. My name is Woods Eastland. I'm the

 15 President and Chief Executive Officer of Staple

 16 Cotton Cooperative Association which is a

 17 farmer-owned cotton marketing cooperative. We

 18 market cotton essentially that is raised east of

 19 the State of Texas. Probably the most relevant

 20 thing is our position in both the cash market and

 21 the futures market is the exact same position as a

 22 producers because we work for producers and market

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 63

 1 their cotton for them and that in the cash market

 2 we are already net long to basis and in the

 3 futures market we are always net short futures

 4 which would be the same as the aggregated position

 5 of all the cotton producers in the United States.

 6 I also recently served as chairman of the

 7 subcommittee of the cotton committee of ICE

 8 Futures that was charged with reviewing the

 9 Informa study and determining whether or not

 10 recommendations should be made as to adding and/or

 11 deleting delivery points. The Commission is aware

 12 of the recommendation that we did make. In

 13 reaching that recommendation it was the sense of

 14 the committee that six points should be noted.

 15 They're in my comments. Without detailing all six

 16 I just wanted to mention that it was unanimous

 17 among the committee members and you had there two

 18 cooperative managements from two separate

 19 cooperatives one being a large West Texas

 20 Cooperative, two merchants as Tom said, two

 21 international merchants headquartered in the U.S.,

 22 one international merchant headquartered overseas.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 64

 1 It was unanimous that the current terms, and that

 2 was the current as they existed while we were

 3 meeting, were sufficient to ensure convergence at

 4 expiration. And second that the price volatility

 5 that we saw in March 2008 was not related in any

 6 way or caused by an insufficient number or an

 7 inappropriate distribution of delivery points.

 8 I might want to add that as chairman the

 9 subcommittee did not issue a detailed subcommittee

 10 report to the committee which detailed our

 11 reasoning process. I think the reason for that is

 12 we all reached the same conclusion, but of the six

 13 members of the committee, I don't know if there

 14 were six different routes that were gone through

 15 to get to that conclusion, but I know there was

 16 more than one so we didn't want to read it like a

 17 U.S. Supreme Court opinion with dissents. So we

 18 just issued our recommendations and the six points

 19 that were the sense of the committee. We did have

 20 a very open and very frank discussion. We had all

 21 of the submissions, and I'm not sure from, Mr.

 22 Chairman, your opening statement what I should

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 65

 1 talk about or not talk about regarding Corpus

 2 Christi, but we did have the benefit of the Corpus

 3 Christi submission which we reviewed as well as

 4 submissions from other areas and talked about some

 5 delivery points such as the West Coast that the

 6 exchange as far as I know had not been petitioned

 7 about by outsiders, and we did reach a unanimous

 8 recommendation.

 9 I could say from the standpoint of the

 10 reasoning process that I went through as one

 11 committee member, and if somebody on the staff has

 12 the Informa report, sometime in the future if you

 13 would look at page 30, I reached an opposite

 14 conclusion than Informa did even looking at

 15 Informa's own data. If you were to draw circles

 16 around Greenville, South Carolina, Memphis,

 17 Tennessee and the Dallas-Fort Worth area of about

 18 a 300-mile radius, that's important because of the

 19 data that Informa presented as far as freight

 20 costs are concerned. If you would draw those

 21 circles you would see that the major production

 22 regions of the United States would like within

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 66

 1 that 300-mile diameter of those three points. The

 2 major production areas of upland cotton in the

 3 United States would lie within the 300 miles of

 4 that area of any of those which would give the

 5 freight costs to deliver to a producer or somebody

 6 like a co-op representing producers relative

 7 equivalence all the way from the production areas

 8 of northeast North Carolina to the production

 9 areas of West Texas, that is if Dallas- Fort Worth

 10 were included. That's the reason why I argued for

 11 Dallas-Fort Worth and I think that going forward

 12 that concept is a very important concept for the

 13 management not just of the cotton contract but the

 14 management of all of the agricultural contracts

 15 where you have a very widely dispersed

 16 geographical production area. The idea of where

 17 the major production part of that is and where

 18 it's not I realize would always be a thorny issue,

 19 but I that it's important for the management of

 20 the exchanges as these production areas shift to

 21 realize that there is a responsibility they have

 22 incumbent to the producers to give producers in

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 67

 1 different areas to have a delivery point where

 2 their relative freight costs to get their cotton

 3 to the delivery point would be somewhat the same

 4 from production area to production area and I

 5 think that cotton has met that.

 6 Let me go on to the second point that

 7 I'd like to cover here and that has to do with the

 8 responsibility that you have now under the new

 9 financial regulation bill. I'm probably not the

 10 only person in this room that hasn't tried to read

 11 those 2,000-and-some-odd pages or however long it

 12 is, but let me say this. I think the debacle that

 13 occurred in the cotton market in March 2008, a

 14 contributing factor to that were large speculative

 15 positions, the large positions, which entities

 16 that formerly had been defined as speculators were

 17 permitted to take because their positions became

 18 redefined as hedge positions and I'm talking

 19 specifically about index funds and I'm talking

 20 specifically about the positions of swap dealers.

 21 I think that was a contributing factor. I think

 22 it's important as you define a hedger that a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 68

 1 hedger needs to be defined in its traditional

 2 sense. Let me digress a minute to say I've been

 3 office for 24 years. I was the CEO of Staple

 4 Cotton before the innovations of proliferation of

 5 index funds and of swaps through swap dealers

 6 occurred and we had a cotton futures market that

 7 worked perfectly well without them as far as price

 8 discovery and convergence is concerned. Since

 9 then we've had a cotton market that has worked

 10 fairly well without them. Unfortunately there are

 11 certain times in which it hasn't worked.

 12 The point I wanted to make is this. I

 13 think the definition of hedgers should be limited

 14 to someone who in their normal course of business

 15 takes title to the physical commodity and this is

 16 when you're talking about agricultural

 17 commodities, small markets, take title to the

 18 physical commodity either as a producer, a

 19 distributor or consumer. If you follow that

 20 definition and then you look at the activities of

 21 an index fund, an index fund has a contract with

 22 its investors. That contract is a speculative

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 69

 1 vehicle. If the index fund then is allowed to

 2 take the opposite position to its contract or take

 3 a position in the contract market based on its

 4 contract and is allowed a hedge exemption in doing

 5 that, the position in the contract market is the

 6 derived position. The primary position is the

 7 contract with its investors. Yet in allowing its

 8 derived position to be considered a hedge, what

 9 you're allowing is that the derived position as a

 10 hedge and it's derived from a speculative

 11 position. That makes no sense to me. How can you

 12 say that a derived position in futures and options

 13 is a hedge when the primary position is a

 14 speculative position?

 15 Look also at swap dealers. First of

 16 all, one of the ways in which they are used by

 17 speculators is to exceed their spec limits. When

 18 a speculator reaches his limit that he is allowed

 19 to have in options or futures, if he wants to

 20 exceed that and has enough confidence in his

 21 position, one way in which he can do it is to

 22 enter into swap contracts. When he enters into

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 70

 1 swap contracts he is expanding or extending his

 2 speculative position. However, the swap dealer

 3 then is allowed to take the opposition position in

 4 the contract market to his people with the

 5 speculator on the other side and that's treated as

 6 a hedge. That has the exact same effect on the

 7 price level of the market either futures or

 8 options as if the speculator himself had been

 9 allowed to exceed his limit in that contract

 10 market and take additional positions. Again you

 11 have the situation where the derived position

 12 which is the position that the swap dealer takes

 13 in either options or futures in a contract market

 14 is derived from a speculative position which is

 15 the contract he has with a speculator in the cash

 16 swap market. Again I would say to me just trying

 17 to think about what makes walking-around sense, it

 18 makes no sense to allow a speculative position in

 19 a cash market to be hedged and treated as a true

 20 hedge position in a contract market. So those

 21 were some things that I would hope that you and

 22 the staff would consider as you are looking at

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 71

 1 defining these definitions and setting limits

 2 going forward. Thank you very much.

 3 CHAIRMAN GENSLER: If I could ask a

 4 question, and I like your walking-around sense

 5 actually. Congress incorporated a lot of that in

 6 saying that for the first time this Commission

 7 will be allowed to set aggregate position limits

 8 on agricultural commodities and what's called

 9 exempt commodities like oil and natural gas and

 10 metals, gold and silver. Looking at the swaps

 11 market and looking at the futures market and

 12 that's what we'll be working on, we have 270 days

 13 on the agricultural one. That's not my question

 14 but I was giving you that confidence. My question

 15 was later we'll hear from Don Heitman of our staff

 16 about agricultural swaps and explicitly in the

 17 statute it says that agricultural swaps can't be

 18 done in the same way that all the other swaps can

 19 be done unless we write a rule to allow it. So

 20 Congress set up a whole regulatory structure that

 21 at least I was very much for as you know, but on

 22 agricultural swaps they're going to defer a bit

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 72

 1 and leave it to us. So I'd be very interested in

 2 do you think that there is a role for cotton swaps

 3 specifically in the marketplace? The second

 4 question that you'll want to think about it maybe

 5 you'll think about it for weeks and let us know,

 6 if there is a role for them, should it be

 7 regulated just like all other swaps or is there

 8 something special and unique, some additional

 9 regulation that's needed. Those two separate

 10 questions I know you might not be ready for, but

 11 it would be helpful to know.

 12 MR. EASTLAND: I think certainly there

 13 is a role for them. Somebody else may have a lot

 14 more intelligent solution or suggestion than I've

 15 got, but one possibility to consider would be that

 16 by regulation your swap dealer has got to know the

 17 counterparty's position that he's contracting

 18 with, whether he's contracting with a spec

 19 position or with a hedge position. If it's a

 20 hedge position then he should be able to lay that

 21 off in a contract market unlimited because it's a

 22 true hedge. If it's a spec position then I think

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 73

 1 it would be reasonable if he were asked to

 2 aggregate all of his spec positions he might be on

 3 the long side of some swaps and the short side of

 4 the others; aggregate some of that spec position

 5 and then the amount of that that he could take the

 6 position of in the contract market would be

 7 limited to one spec limit or I would assume in

 8 this process you would probably some sort of a

 9 special limit for swap funds. But I think the

 10 aggregate position of the swap dealer where his

 11 counterparties are specs, there should be a limit

 12 on the number of futures and options contracts

 13 that he would be allowed to participate in in the

 14 contract market.

 15 CHAIRMAN DUNN: Thank you, Mr. Eastland.

 16 I think it really is important as I said at the

 17 onset that we get as much input as we can as we go

 18 through this frenzy of rule making and I would

 19 encourage everyone here on the early panels to

 20 please stick around for Mr. Heitman's presentation

 21 because it will give you an insight of where we're

 22 going and how we're going to get there.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 74

 1 What I'm going to do is ask a question

 2 and then let fellow Commissioners ask any question

 3 and then we'll open it for the Ag Advisory

 4 Committee to ask any questions. We always allow a

 5 point of personal privilege for the Chairman.

 6 CHAIRMAN GENSLER: Thank you.

 7 CHAIRMAN DUNN: If you could simply and

 8 succinctly tell us why it is important or not

 9 important for producers to have a delivery point

 10 close to their operation. I think that's the crux

 11 of what I had heard Mr. Barrett talk about. Then

 12 if Mr. Barrett would amplify and others would

 13 comment because I heard him say that he could not

 14 lock in the spread on his cotton and I'm a little

 15 confused. Is that you could not access the

 16 futures market or you could not lock in the spread

 17 using a delivery?

 18 MR. BARRETT: Right, Commissioner.

 19 First of all, I'm not arguing for a delivery point

 20 close by my farm. I'm wanting one that producers

 21 that is readily accessible to producers.

 22 CHAIRMAN DUNN: Is that storage per se

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 75

 1 because that's what you had indicated?

 2 MR. BARRETT: Yes. The storage is not

 3 necessarily readily accessible if it's owned by a

 4 merchant and the merchant doesn't choose to make

 5 the storage to me as a producer.

 6 The question you asked about the margins

 7 or using the contract to hedge is basically a

 8 situation where I put out fertilizer in December

 9 and I'm selling cotton on the December contract

 10 and the December contract in terms of the roller

 11 coaster that Chairman Gensler was talking about

 12 earlier goes up and down and sometimes it goes way

 13 up. Sometimes the cash market doesn't follow it

 14 and I want to be able to lock in that price. I

 15 would have the opportunity since the merchants are

 16 not forward contracting to the degree that they

 17 used to and I can't use them to lock in a call

 18 contract, I would have the ability if I could

 19 reliably be able to deliver my cotton to go on the

 20 futures contract and sell the futures and then

 21 have my cotton to deliver against the contract at

 22 the time I chose to lock in the futures price.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 76

 1 CHAIRMAN DUNN: Another panelists? Mr.

 2 Eastland?

 3 MR. EASTLAND: If I could, because like

 4 I say, I work for 4,000 cotton producers and I'm

 5 also a cotton producer myself, certainly there are

 6 times in which every cotton producer wishes that

 7 his own preferred warehouse, the one that he might

 8 own an interest in or his gin does or wherever he

 9 delivers cotton were a delivery point warehouse.

 10 Fortunately also because if it weren't this way

 11 the contract wouldn't be working properly, those

 12 instances are pretty far between I think at least

 13 in my experience in what I've seen. I do then go

 14 back and urge the approach I took on this

 15 committee which I think is a very reasonable

 16 approach about just making sure that relative

 17 freight is available; that relative freight costs

 18 are somewhat similar. There are producer-owned

 19 warehouses I know in the Memphis territory

 20 delivery point. I don't know about

 21 Houston-Galveston. I do know this, that during

 22 the period after the debacle of March 2008 when

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 77

 1 you got forward into the July contract and then

 2 into the December contract, as far as getting

 3 additional warehouses approved at the already

 4 existing delivery points, there was not any

 5 application that I know of that was turned down by

 6 the exchange because the standards they use,

 7 really all they want to sure of is that the cotton

 8 going to be safely stored and is in a facility

 9 that you can get it insured and is in a facility

 10 that is approved by USDA and those are pretty low

 11 hurdles to jump over. I know Mr. Barrett with his

 12 own crop unless he's just a huge, huge producer,

 13 it wouldn't make sense for him to go out and rent

 14 warehouse space in Houston, Galveston or Memphis

 15 for his own. I guess only the very largest

 16 producers could do that. But there has been no

 17 problem with expanding the volume of approved

 18 space and delivery points and then after 2008

 19 we've seen it shrink back down again.

 20 MR. LEA: My comments will be relatively

 21 brief, but I do think the risk in putting a

 22 delivery point at the farm gate, and we've seen it

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 78

 1 in other commodities, you disassociate the spot

 2 market or you actually co-join the spot market and

 3 the futures price where the contract becomes the

 4 spot market. In other words, as opposed to the

 5 ability to forward contract cotton and gain access

 6 to cotton through traditional marketing methods,

 7 merchants or even cooperatives are faced with or

 8 forced to take delivery of the contract to

 9 actually create and source inventory and that

 10 would be primary objection to adding delivery

 11 points right there at the point of production in

 12 excess or even really at all.

 13 CHAIRMAN DUNN: Mr. Farley, what is the

 14 total delivery point storage capacity for the

 15 contract?

 16 MR. FARLEY: I don't know the exact

 17 number, Commissioner, but it's about 2 million

 18 bales. One interesting way of looking at it is if

 19 you compare the total aggregate crop versus the

 20 total aggregate storage and then you look across

 21 markets to get a feel for how much storage is

 22 available relative to other markets, cotton far

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 79

 1 and away has the most space, far and away by a

 2 factor of I'm guessing now but maybe 5 times wheat

 3 and beans and corn for instance.

 4 CHAIRMAN DUNN: During whatever passes

 5 for normal times I guess I could say this, what is

 6 usually the percentage of storage capacity that's

 7 being used in the contract?

 8 MR. FARLEY: There have been very few

 9 normal times since early 2008. In early 2008 --

 10 you might be able to help me here, but it went

 11 from in the couple hundred thousand up close to

 12 that storage capacity, I think 1.8 million bales

 13 was our high point, and we're back down now as

 14 Marshall said to 41,000. So to give you a normal

 15 time, it's difficult to do. If you look at cert

 16 stock going back prior to 2008 it's typical to

 17 have something in the 1- to 400,000 bale range.

 18 MR. LEA: Yes, I would agree with what

 19 Tom said. After March 2008 as a response or in

 20 reaction to the volatility and to meet people's

 21 desire to deliver, we used almost 2 million bales

 22 of capacity, but at one point there was 3.3

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 80

 1 million bales of capacity available, and in

 2 Greenville, South Carolina, my community alone,

 3 there was over a million bales of available

 4 capacity only about 70 percent of which was

 5 utilized, but to my knowledge, no individual point

 6 actually ran out of capacity. Like I've said,

 7 some were very close and were almost full. We had

 8 over 3 million bales of capacity even after 2008

 9 and only ultimately used almost 50 percent of it.

 10 CHAIRMAN DUNN: Mr. Barrett, but you did

 11 have trouble getting certified deliveries. Is

 12 that correct?

 13 MR. BARRETT: Yes, sir. The warehouse

 14 I'm talking about is Southern Compress. It's

 15 located in Galveston, Texas. It used to be owned

 16 by W.B. Donovan Company and I tried to get cotton

 17 in there and the manager told me it was full.

 18 This would be in February 2008.

 19 CHAIRMAN DUNN: Thank you all.

 20 Commissioner Sommers? Commissioner Chilton, do

 21 you have any questions?

 22 COMMISSIONER CHILTON: I have a quick

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 81

 1 one for Mr. Eastland and Mr. Farley. These

 2 markets up until 2008 seemed to be comparably

 3 stable and the traders were fairly consistently

 4 commercial traders. There were speculators of

 5 course as there are in any market. We need

 6 speculators. There's nothing wrong with

 7 speculators. We can't have an orderly functioning

 8 market without that. But that said, in recent

 9 years there have been these new speculators.

 10 That's what I talked about the beginning, that

 11 there are new dynamics in these markets and that

 12 they've shifted their focus to cotton and beans,

 13 et cetera, seeking to diversify their investment

 14 portfolios. These new speculators have the

 15 possibility of financially overwhelming the

 16 markets compared to the typical hedgers and they

 17 have this distinctive passive fairly insensitive

 18 long-only trading strategy. I call them massive

 19 passives. They've come to represent a significant

 20 portion of some markets. When the agency looked

 21 at the 2008 debacle, these massive passives or

 22 traders like them in index funds accounted for 38

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 82

 1 to 41 percent of the open interest. I'm not

 2 suggesting that they singlehandedly created a

 3 price spike, I just think it's something new we

 4 have to look at, that when they are that large

 5 people want to say it's liquidity, but if they're

 6 not trading because they're price insensitive, it

 7 seems to me it's dead liquidity. My question for

 8 Mr. Eastland and Mr. Farely is with this new

 9 authority that we have in the Wall Street Reform

 10 Act are there things that we need to look at

 11 specifically with regard to this class of traders?

 12 And I don't know the answer. I'm just raising the

 13 question. Thanks, Mister Chairman.

 14 CHAIRMAN DUNN: Thank you, Commissioner

 15 Chilton.

 16 MR. FARLEY: Thanks, Mister Commissioner

 17 Chilton. You picked the right two guys because I

 18 think Woods and I have in the past and may today

 19 have a healthy debate about this issue so you'll

 20 get perspective from both sides.

 21 Just a couple of points on index funds.

 22 I think in general they're a very, very good

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 83

 1 thing. Number one, they encourage inventory

 2 accumulation which can dampen price volatility in

 3 times of minimal supply or extreme demand and I

 4 think as consumers, as Americans, as global

 5 citizens, that's a very, very good thing because

 6 it's going to limit price spikes in extreme

 7 circumstances. The second thing about index funds

 8 that I think are really a great thing is that

 9 commodities markets by and large are full of

 10 people who want to go short the futures contracts

 11 because the consumers are you and me. We wear a

 12 cotton shirt and we're not going to go out and

 13 hedge that cotton shirt, and so for many, many

 14 years, over a century in this country, you had a

 15 lot of people who wanted to hedge short futures

 16 and now you add people who wanted to buy long

 17 futures and therefore you saw open interest grow

 18 and you saw more longer-dated futures hedging, it

 19 enabled farmers to risk manage more of their

 20 crops, et cetera, and so I see that as a very good

 21 thing.

 22 The third thing I'll say on index funds

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 84

 1 is you refer to them as massive passives which I

 2 like. It's catchy. But I'll point out we just

 3 got finished talking about our cert stock, our

 4 open interest is also down dramatically. So you

 5 tell me if there are massive passives why is it

 6 that the open interest deviates and it tends to

 7 deviate that when prices go up open interest

 8 begins decreasing. I would submit to you it's

 9 because that these massive passives aren't so

 10 passive and they are in fact price responsive.

 11 All that said, I agree with several of

 12 the comments that Woods made about position

 13 monitoring and I think that it's great that the

 14 CFTC now has the ability to look out into OTC

 15 markets as well as futures markets and make sure

 16 that people are not using long-only index funds as

 17 a mechanism for evading position limits and that's

 18 not something that I or anyone at ICE would

 19 support certainly.

 20 COMMISSIONER CHILTON: If I may respond

 21 quickly, remember Robert Palmer said "you're

 22 immune to the stuff"? I'm not suggesting they're

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 85

 1 immune to the stuff when it gets crazy, but when

 2 we had $147 oil, sure they changed their position

 3 then. So there is some extreme position where

 4 they change, but as a general strategy, they say

 5 this in their prospectus that they're going to go

 6 long, they're going to -- these prices. Right?

 7 MR. FARLEY: Sorry, Commissioner

 8 Chilton. What was the question?

 9 COMMISSIONER CHILTON: The question is

 10 the index funds and ETFs when they get into these

 11 markets, they state to their clients they're going

 12 to try to go long and mirror the long-term price

 13 of whatever the commodity is. It doesn't mean

 14 that they are totally price insensitive, they're

 15 not immune to huge price spikes, so when oil gets

 16 up to $140, yes, then they may sell because it

 17 would be crazy not to. But when you look at

 18 cotton and you look at the prices, it wasn't

 19 enough for these index traders to get back into

 20 the market. The prices weren't volatile enough

 21 for them. So they don't respond to normal market

 22 moves. Am I making myself clear?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 86

 1 MR. FARLEY: I understand. I'm claiming

 2 that they are price sensitive and you're saying

 3 they're not entirely price insensitive, so I think

 4 there's a spread in our views but maybe we're not

 5 as far apart as I originally though.

 6 I'll just comment that if you're going

 7 back to Q1 cotton, that was just an entirely

 8 extraordinary circumstance. I don't know how to

 9 think about index funds during that 3-day period.

 10 They were neither buying nor selling in massive

 11 amounts and it was the only time that I know of

 12 where you had almost a short covering of an entire

 13 industry. So we tend to and I think others in the

 14 industry tend to look at the factors and

 15 circumstances during those 3 days surrounding that

 16 massive short covering.

 17 CHAIRMAN DUNN: Mr. Eastland?

 18 MR. EASTLAND: Commissioner Chilton, I

 19 largely agree completely with your statement. I

 20 would say this as far as index funds. As far as

 21 2008, and of course I've read the report of ICE, I

 22 think you've got to look at it over a minimum of a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 87

 1 60-day period from essentially 1 February through

 2 31 March, but we're beating a dead horse if we

 3 talk about that anymore.

 4 As I say, I go back to my definition of

 5 who a hedger is and the reason I take this is the

 6 true hedges that are available in any of these

 7 markets is limited, a true hedge being someone

 8 taking a position in options and futures which is

 9 opposite their position in the cash market for the

 10 physical commodity. Those true hedges in an

 11 agricultural crop are limited to the supply which

 12 was the beginning stock and the size of the crop

 13 produced that year less what's been consumed. So

 14 it's just the remaining supply at any one time and

 15 historically that remaining supply especially in

 16 cotton because 95 percent of the cotton in the

 17 world is produced in the Northern Hemisphere so

 18 the supply varies very directly from the end of

 19 harvest to essentially the major harvest over in

 20 January until it bottoms out again until harvest

 21 starts again maybe in August; the supply

 22 continually gets smaller.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 88

 1 I think in these markets the Commission

 2 should be extremely interested in keeping some

 3 rough balance between hedges and specs as far as

 4 their open interest in futures and in options.

 5 That's the reason why I say I think in order to do

 6 that, the way to do that is to define a hedger as

 7 someone who in the normal course of their business

 8 takes title to the physical commodity as either a

 9 producer, a distributor or a consumer and they 

 10 would have hedge exemptions. I don't think index

 11 funds fit that definition and I think swap dealers

 12 fit that definition only to the degree to which

 13 their counterparty is a true hedger. Therefore,

 14 there should be spec limits placed on the

 15 positions of the index funds because they are

 16 speculators in our markets and also on the

 17 position of the spec side of swap dealers.

 18 COMMISSIONER CHILTON: Thank you.

 19 CHAIRMAN DUNN: Thank you very much.

 20 Commissioner O'Malia?

 21 COMMISSIONER O'MALIA: I'd like to

 22 address one of the reforms proposed as to the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 89

 1 March 2008 episode as Mr. Farley called it. I'd

 2 like to get the panelists' input as to whether

 3 they fully support the request to establish a

 4 trading halt on the futures options contract which

 5 I believe 2 times the market price. Can I just

 6 get everybody's input on that?

 7 MR. LEA: I'll start. Yes, we do

 8 support that. I'm not sure how successful, they

 9 called it a cooling off period in equity markets.

 10 I'm not sure they've been enormously successful

 11 but I think they generally are and I think they

 12 would be at least a substantially positive in at

 13 least the cotton market if not all commodity

 14 markets for everybody to sort of regroup to see if

 15 cooler heads might prevail if we can get a grasp

 16 on what market condition might be creating the

 17 volatility. I think if we'd had something like

 18 that in March 2008, possibly some of that might

 19 have been avoided so I do think it's a step in the

 20 right direction. Of course if it's not

 21 appropriate and if it doesn't work as well as we

 22 think, I think you don't have to scrap all of it

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 90

 1 but try something like a similar effort. But I

 2 think it's definitely a step in the right

 3 direction from my personal opinion.

 4 MR. FARLEY: I agree with Jordan.

 5 MR. BARRETT: I believe that the

 6 synthetic closes circumvented the normal daily

 7 limits and I believe that's what made a lot of

 8 people go broke in March 2008 and I think it needs

 9 to be fixed.

 10 MR. EASTLAND: I agree with the

 11 proposal.

 12 CHAIRMAN DUNN: Mister Chairman, did you

 13 have another follow-up?

 14 CHAIRMAN GENSLER: There are five of you

 15 I guess on the panel. You could even just raise

 16 hands if it would be more efficient. Who thinks

 17 that there should be a delivery point in Dallas?

 18 That's three. And who doesn't?

 19 CHAIRMAN DUNN: Marshall?

 20 CHAIRMAN GENSLER: Sorry, Marshall. I

 21 think it's Mr. Lea, you said something in your

 22 comments about it's not good to have the futures

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 91

 1 contract be the spot market. I didn't quite

 2 follow that and I'm thinking about this in wheat

 3 and other markets as well. To me one of the

 4 fundamental things in our marketplace is to make

 5 sure and assure there's convergence. I think you

 6 were saying something a little different but I was

 7 confused because you might be saying you didn't

 8 want convergence and that was confusing to me.

 9 MR. LEA: Yes, sir. I fully support and

 10 want convergence and I think that the cotton

 11 market with the exception of the episode that Tom

 12 mentioned, generally speaking I've been in the

 13 cotton business for over 20 years now and we've

 14 always seen a convergent market largely because of

 15 the success of the no. 2 contract. But my comment

 16 wasn't, and you've mentioned wheat, I've got a

 17 paper where the former chairman of Pillsbury

 18 mentions that the delivery process needs to

 19 represent a relative inconvenience. Otherwise, if

 20 delivery is too convenient for the producer or

 21 even the consumer, then the futures market becomes

 22 the spot market. In other words, cotton is not

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 92

 1 traded on a spot market outside of the futures

 2 market and that's what I was suggesting, that by

 3 not putting delivery points at farm gates we will

 4 successfully be able to avoid turning the contract

 5 into a spot market.

 6 We certainly want to do everything we

 7 can to keep convergence like we've had in my

 8 experience with the cotton market, but what I

 9 don't want to do, I but 100 percent of my cotton

 10 currently on the spot market or in the spot

 11 market. I rarely take delivery, I have, and I

 12 have delivered in the past, but what I want to

 13 avoid is I've seen instances in other commodities

 14 where you can't build inventory without taking

 15 delivery and Eastern Trading specifically, maybe 

 16 I'm not representing the opinion of ACSA --

 17 CHAIRMAN GENSLER: To clarify, you do

 18 think convergence is a good thing?

 19 MR. LEA: Yes, sir.

 20 CHAIRMAN GENSLER: You want some as you

 21 said relative inconvenience. But I also take it

 22 that you think it's important to be able to

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 93

 1 deliver against a contract.

 2 MR. LEA: Absolutely.

 3 CHAIRMAN GENSLER: I think some of the

 4 problem in the Kansas City situation is those

 5 delivery elevators really aren't taking delivery

 6 and there are a lot of farmers that I met with

 7 when I went out to Kansas City who said you can't

 8 do 5,000 bushels, that delivery elevators aren't

 9 taking delivery, so relative inconvenience or lots

 10 of inconvenience; small inconvenience.

 11 MR. LEA: I would agree with you. Small

 12 inconvenience.

 13 CHAIRMAN GENSLER: Thank you.

 14 COMMISSIONER O'MALIA: We were just

 15 discussing trying to figure out what the contract

 16 terms are. Does the cotton contract have a hard

 17 position limit or does it flow with open interest?

 18 MR. FARLEY: It's a hard position limit.

 19 COMMISSIONER O'MALIA: Let me ask the

 20 panelists if they have an opinion on whether they

 21 prefer hard or something that floats with open

 22 interest in light of potential involvement from

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 94

 1 the massive passives.

 2 MR. FARLEY: Can I make one distinction,

 3 Commissioner? Cotton is distinct from sugar or

 4 other commodities such as oil in that it's not

 5 just a delivery month position limit, it's all

 6 month hard position limit with no people

 7 accountability.

 8 MR. LEA: My opinion would be a hard

 9 limit. Going back to the massive passive Woods

 10 mentioned, we like the hard limits and we'd like

 11 to see illustrated who owns those positions, that

 12 in our opinion massive passives are illiquid. We

 13 want the speculative activity because we want the

 14 open interest. It makes my job as a hedger

 15 easier. But I also want to know how much of the

 16 market is potentially liquid in periods of extreme

 17 volatility. I've never thought about your

 18 question and I think it's a very good question,

 19 but right now I'd say we prefer hard limits.

 20 MR. BARRETT: I agree with him.

 21 MR. EASTLAND: I also agree. We have a

 22 hard hedge exemption and we feel like we need that

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 95

 1 in order to plan our business. If it were

 2 floating then it would be dependent on what

 3 everybody else is doing and the size of the open

 4 interest which would not work for us. And since

 5 we have a hard one and like that, we certainly

 6 want the specs to have a hard one also.

 7 COMMISSIONER O'MALIA: It was your

 8 comments that made me ask the question due to the

 9 bona fide hedging that you had raised and the

 10 criteria for that, does it make sense if we're

 11 able to look through the dealer to the position,

 12 does it matter whether it's a hard position or

 13 based on an open interest?

 14 CHAIRMAN GENSLER: I was going to ask,

 15 Commissioner O'Malia, when you're saying hard

 16 versus floating, in January we put out a proposed

 17 rule that had something that reset. It was a hard

 18 limit but it reset once a year based on the size

 19 of the market, so you could say it was a little

 20 bit hard and floating. Which one were you

 21 referring to?

 22 COMMISSIONER O'MALIA: I'm referring to

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 96

 1 what's going on in the ag markets today and if you

 2 have an opinion about that. Obviously we're going

 3 to have to revisit that and I was thinking a

 4 little bit about our position on the proposal and

 5 getting everybody's opinion on what we're going to

 6 be addressing as a result of what bona fide

 7 hedging is and how we establish position limits

 8 and what the priorities should be.

 9 CHAIRMAN GENSLER: In that context I

 10 think what we heard from the panelists was a hard

 11 limit is good in cotton at least is what you said,

 12 but if were reset whether it's a once a year, once

 13 every 2 years or something so it's relative to the

 14 market and you know specifically the hard limit

 15 maybe went up because the size of the market

 16 changed or sometimes went down, whether that would

 17 be acceptable in the sense that it would be known

 18 in advance but it might adjust once every year or

 19 2 years.

 20 COMMISSIONER CHILTON: Mister Chairman,

 21 I think the difference might be in what

 22 Commissioner O'Malia is saying is our proposal on

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 97

 1 energy was 10 percent, so if it's 10 percent of

 2 open interest, it fluctuates with the size of open

 3 interest. If it's a certain number of contracts

 4 then it's a static number. I have a lot easier

 5 time talking about percentages because if you go

 6 out and you say to somebody should a trader be

 7 able to have 30 or 40 percent of a market, they

 8 can give you a quick answer. If you give them a

 9 hard number, you really have to be familiar with

 10 the individual market. And so while I like the

 11 ease of a percentage like we had in our energy

 12 proposal, I'm not sure that that makes sense

 13 because it constantly would be fluctuating. Even

 14 with your annual reevaluation of it, if it's 10

 15 percent of the market, that depends on how many

 16 traders are in the market. Is that what you were

 17 asking, Commissioner O'Malia?

 18 COMMISSIONER O'MALIA: Yes, a little

 19 bit. I was obviously responding to Mr. Eastland's

 20 comments in light of the legislation that's going

 21 to essentially allow us to look through the dealer

 22 and look into who has the bona fide hedging, we'll

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 98

 1 have the fidelity and the granularity of those.

 2 Understanding who's in that market, does anybody

 3 have an opinion? I'm trying to understand

 4 everybody's thoughts on this and I think it would

 5 be a good topic for this committee here to discuss

 6 and get everybody's opinion on this. I think that

 7 obviously we're going to be dealing with it in how

 8 many days, Mister Chairman?

 9 CHAIRMAN GENSLER: 255 in this one, and

 10 then we have to put a proposed rule out well

 11 before that. So any advice you have, I like

 12 Chairman Dunn's words, what we put out in January

 13 was really a hybrid. It was fixed for a year and

 14 then it readjusted and then it was fixed and

 15 readjusted and it allowed us not to have to

 16 readjust it but let it readjust formulaically.

 17 CHAIRMAN DUNN: Future panelists be

 18 prepared. Commissioner O'Malia will be asking

 19 that question again.

 20 Let me turn it open to the Ag Advisory

 21 Committee. Do you have any questions or the

 22 panelists or the reactors? Mr. Hicks?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 99

 1 MR. HICKS: The part where it says,

 2 December represents the new crops which should be

 3 big. It appears that new markets right now use

 4 available cotton stocks is tight. But it mentions

 5 that there's a 2-cent premium December and March

 6 but you have this big crop coming on. So

 7 theoretically if you have a big crop you have

 8 carrying charges.

 9 MR. HORN: There are two parts to price

 10 determination. One is supply and we're going to

 11 have a good supply, and one is demand and we have

 12 considerable demand at this point.

 13 MR. HICKS: The other point is what is

 14 the relationship between the open interest in

 15 December and open interest in March?

 16 MR. HORN: December has the bulk of the

 17 open interest. I believe it's over 100,000

 18 contracts. March has a very sizable open

 19 interest, I'm guessing in the neighborhood of

 20 40,000 contracts. October has about 1,000, very,

 21 very small.

 22 MR. HICKS: My concern is, one of the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 100

 1 questions I have, again I'm speaking on more of my

 2 interest in grain, but this catches my interest,

 3 what impact do the funds have in terms of trading

 4 the spreads between December and March? Do the

 5 index funds get involved in any of that at all,

 6 the price relationships?

 7 MR. HORN: Index funds in my experience

 8 tend to stay mostly concentrated in the most

 9 active month, most of the index funds, and roll

 10 over on a set schedule, and some firms do it very

 11 mechanically and some firms do it with more

 12 discretion based on their possibility impact on

 13 the market and based on opportunities to roll over

 14 either ahead of the big roll or in a better way

 15 than doing it mechanically so that they tend to be

 16 1-month traders.

 17 MR. HICKS: I think the issue of

 18 convergence is one that's also tied to the

 19 confidence and price relationships in cash and

 20 futures and futures from one month to -- the

 21 relationship between Chicago, Kansas City,

 22 Minneapolis. I'll give you an example. When I

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 101

 1 worked at Cargill we were pretty successful and

 2 our division was pretty successful at trading

 3 wheat. Matter of fact, we were so good at it I

 4 thought I could do it on my own. I quit my job,

 5 bought my seat in Chicago. I bought my seat on

 6 the smaller exchange in Chicago which at that time

 7 was the Mid-America and became a spread trader. I

 8 look at this now as if I had to do that over

 9 again, I still would be at Cargill because of the

 10 financial ability that they have. I look at the

 11 guys when I was a clerk in Chicago and I look at

 12 the guys I admired who were spread traders. We

 13 have very few spread traders in Chicago now. We

 14 have no intra- market traders and we have no

 15 inter-market traders because of that exposure.

 16 It's my contention that this weakens; that this

 17 lack of confidence of traders like myself who will

 18 not trade that spread caused the elevators to

 19 widen their basis because there are no spread

 20 traders that will lay that risk off who will take

 21 that assumption like we were talking about this

 22 spread between December and March in cotton. I'm

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 102

 1 speaking as a grain trader and not as a cotton

 2 trader.

 3 CHAIRMAN DUNN: This is probably a good

 4 segue into our next panel.

 5 MR. HICKS: The other point I want to

 6 make is an observation on cotton. I lived in

 7 Louisiana so I was a cotton trader and the first

 8 markets that I traded were cotton and my interest

 9 was more of an interest in Civil War issues.

 10 That's how I started trading. I couldn't help but

 11 think about Darwin S. Fenner who was a member of

 12 the New Orleans Cotton Exchange, and when the 

 13 recommendation was made to eliminate New Orleans I

 14 was thinking if Darwin Fenner were here he would

 15 turn over in his grave. But it also makes you

 16 wonder if we have these issues now, the magnitude

 17 of the decisions that the Commission has to make

 18 because it's going to be a confidence issue in

 19 that exchange if people who are farmers like Mr.

 20 Barrett, if he has a lack of confidence, then as a

 21 trader then I'm going to have a lack of confidence

 22 too. It's just an observation.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 103

 1 CHAIRMAN DUNN: Thanks for putting a

 2 little more heat on us.

 3 MR. HICKS: It's an issue that listening

 4 to the discussion on cotton makes we realize the

 5 challenges we have in trying dealing with the

 6 issue of wheat.

 7 CHAIRMAN DUNN: A good observation. Are

 8 there any other comments? If not, let me finish

 9 up with probably the big question to Mr. Farley.

 10 With the changes that you've made, are you

 11 relatively confident that we won't see a repeat of

 12 what happened in March 2008?

 13 MR. FARLEY: Yes, I'm confident you

 14 won't see a repeat of what happened in March 2008.

 15 We've referred to it publicly as a perfect storm

 16 where you had this confluence of factors that were

 17 really unique. It seems like in the history of

 18 risk management in this country, each crisis is

 19 slightly different so I'm not confident we won't

 20 have the next crisis. Those sorts of things

 21 happen. But, no, I think the industry, and I want

 22 to thank the industry, has really helped us put in

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 104

 1 place mechanisms and controls that give us all a

 2 great deal of confidence that what happened in

 3 March 2008 won't happen again, although I'd be

 4 interested in hearing what the others' views are

 5 and whether or not they agree.

 6 MR. EASTLAND: I would say,

 7 Commissioner, the significant change was letting

 8 futures have their own daily limits and not have

 9 them being margined to options that had to limit.

 10 That was the most significant change. As long as

 11 that's changed there, the next crisis will just be

 12 a little different. That's all.

 13 CHAIRMAN DUNN: Thank you.

 14 MR. LEA: I would agree with them. I

 15 hope that Tom is right. At my company we've

 16 obviously tried to amend the way we do things and

 17 even if another 2008 comes along, we're more

 18 prepared. The margining to the futures close, as

 19 long as we can maintain that, then I think shame

 20 on you if you do wind up in a similar situation as

 21 March 2008, shame you the trader, not shame on

 22 anybody else in here.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 105

 1 CHAIRMAN DUNN: Let me thank this panel.

 2 This was really, really good. We went way over

 3 our limit, but it really got some great discussion

 4 here amongst the Commissioners and I really

 5 appreciate what you've done here today as far as

 6 plant a lot of seeds for us to reap at a later

 7 date.

 8 (Recess)

 9 CHAIRMAN DUNN: Next we have wheat

 10 convergence with David Amato, Nicole Aulerich,

 11 David Lehman, Jeff Borchardt and Steve Campbell.

 12 Are the panelists ready?

 13 MS. AULERICH: Yes.

 14 CHAIRMAN DUNN: All right. Just as soon

 15 as I get two other Commissioners in here, we'll

 16 get started, and here comes one now.

 17 Ladies and gentlemen, if we can get

 18 started with our next panel, and we'd like to

 19 start off with Dave Amato from the Division of

 20 Market Oversight.

 21 David, if you will, please.

 22 MR. AMATO: Thank you for the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 106

 1 opportunity to speak today. My presentation is

 2 going to be sort of a generic overview of Kansas

 3 City and the Chicago market, and then my

 4 colleague, Nicole, is going to kind of drill down.

 5 So this will just be the generic overview.

 6 The first slide takes a look at Open

 7 Interest at Chicago and Kansas City. This is all

 8 futures and option combined Open Interest, AFOC

 9 Open Interest. The blue line is Chicago and the

 10 green line is Kansas City. And you can see, over

 11 this 10-year time period we've had a tremendous

 12 increase in Open Interest. At Kansas City the

 13 Open Interest today is about three times greater

 14 than it was in the year 2000. It went from about

 15 300 million bushels to about a billion bushels

 16 over this time period, and as most of you know,

 17 the production tends to be in the 750-to-900

 18 million bush range for Hard Red Winter wheat on a

 19 year-to- year level.

 20 Chicago also has seen tremendous growth

 21 over this 10-year time period, going from about

 22 800 million bushels in the year 2000 to over three

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 107

 1 billion bushels currently. That's almost a four

 2 times increase since the year 2000. The U.S.

 3 production for Soft Red, which is traded on the

 4 Chicago Board of Trade, is in the range of, say,

 5 280-to-400 million bushels per year. So despite

 6 the Soft Red Winter crop being much smaller which

 7 trades on the Chicago Board of Trade, that's the

 8 contract that has the large Open Interest.

 9 So we have a contract at Chicago and

 10 Kansas City that's been expanding, but we have had

 11 at times performance issues, and that main

 12 performance issue has been the weak convergence

 13 which we've talked about quite often.

 14 So the next slide deals with some of the

 15 side effects that we see when we have poor

 16 convergence, the first one being price discovery

 17 is weakened. When you have a consistent weak

 18 basis, and we're seeing futures 80, 90, sometimes

 19 in Toledo in the past and Chicago it was $1.50

 20 over the cash market. Clearly, there's a

 21 disconnect between what we're seeing in the cash

 22 market and what we're seeing in the futures

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 108

 1 market. So the idea that people can look to the

 2 futures for price discovery, obviously there's a

 3 disconnect there.

 4 Hedge effectiveness, if you're a

 5 producer and you're used to having your basis be

 6 30, 40 cents under and now you're having a very

 7 volatile basis, a basis that's now $1.50, maybe,

 8 under in Kansas City, obviously that reduces your

 9 hedge effectiveness ability.

 10 Third point, crop insurance programs.

 11 The USDA crop insurance programs when they're

 12 trying to calculate potential revenue that a

 13 farmer can receive in a year, they use the futures

 14 price. So if that futures price is potentially

 15 overstated, if there's a disconnect between the

 16 cash and the futures and futures appears to be

 17 overpriced, it's overstating what the potential

 18 revenue that a farmer would be receiving, and

 19 therefore it sort of disrupts the insurance

 20 program, and the farmer won't be getting the

 21 protection that he actually should be getting

 22 because his real price is far under what the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 109

 1 futures price is showing.

 2 We've talked to several Ag banks that

 3 have talked about -- or Ag-lending credit crunch

 4 due to this volatile basis -- and, finally, the

 5 forward contracting we've talked to elevators that

 6 had sort of reduced their forward contracting

 7 based on some of the volatility in the bases and

 8 the weak bases.

 9 The third graphic would be no review of

 10 sort of the supply and demand. This is the U.S.

 11 Wheat Ending Stocks as a percent of annual use.

 12 The blue bars are the Hard Red Winter on Kansas

 13 City; the red bars are the Soft Red Winter which

 14 is traded on the Chicago Board of Trade. If we

 15 just kind of highlight the last two years,

 16 2009-'10 and 2010-'11, 2010-'11 being a prediction

 17 by the USDA. Just to give you a quick primer, the

 18 bigger the numbers the more ample supplies. So

 19 you can see the last two years for both Kansas

 20 City and Chicago. We've seen a tremendous amount

 21 of what is considered the ending stocks to use

 22 ratio.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 110

 1 If we look at 2009, the Hard Red Winter

 2 stocks use to ratio was about 48 percent, and for

 3 Soft Red Winter it was about 66 percent. And then

 4 now this year we see that Kansas City is expected

 5 to be just about the same area, maybe slightly a

 6 little bit more. Obviously, this is a long-term

 7 projection, and the Soft Red has come down

 8 substantially from the 66 percent ratio down to

 9 about 44 percent, but still if you look on this

 10 graph that 44 percent would be a very, very high

 11 number. So even though it's come down, we still

 12 have relatively ample stocks being projected.

 13 Now, this number came out earlier in the

 14 month. With what we're seeing in Russia, maybe

 15 that's going to change rather quickly, but at

 16 least when these data was published, it was

 17 looking at fairly ample stocks for both Kansas

 18 City and Chicago.

 19 If you can take one thing away from the

 20 briefing, I think this would be the graph that I'd

 21 like you to sort of remember. This is basically

 22 looking at the July Expiration that just happened

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 111

 1 back about, well, two or three weeks ago, and it's

 2 looking at a moment in time, so it's trying to

 3 compare the July Expirations that we've seen for

 4 over the last 10 years or so.

 5 The green dot there is 2010, the blue

 6 triangle is 2009, the bars that you see is a

 7 high-low range for 2008 to 2000, and the red is

 8 the median over that same time period. The

 9 portion on the left that's highlighted, that's the

 10 Hard Red Winter at Kansas City, and the portion on

 11 the right is the Chicago Board of Trade contract.

 12 And the thing to focus on is the green dots.

 13 Obviously for the Kansas City section, you can see

 14 for this expiration that we just had, we see a

 15 very, very poor convergence. Kansas City went off

 16 the board -- these are truck bids just to keep

 17 everything consistent -- and it went off the board

 18 in the 70-cent range. You see, Selina,

 19 Hutchinson, and Wichita all within that 100-cent

 20 or under range.

 21 Meanwhile on the Chicago side, you can

 22 see where we were last year, which would be the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 112

 1 blue triangles on the low side of the range,

 2 however, this year the 2010 in green, you can see

 3 where a very, very good convergence pretty much

 4 right on that zero line for the three main points.

 5 So, you know, I'll let maybe Dave or

 6 Steve comment on, you know, the causes of this,

 7 but the one thing that we can say with certainty

 8 is that the Chicago Board of Trade has instituted

 9 the variable storage rate which I'm sure Dave will

 10 highlight and Nicole will talk about as well. We

 11 do have the difference, if you remember the graph

 12 that we showed on ending stocks where we show the

 13 ending stocks decreasing a bit, being a little bit

 14 tighter for Soft Red, so that's another factor

 15 into this equation as well.

 16 But Chicago has definitely seen an

 17 improvement over the last year. I believe there's 

 18 been load-outs in the March-May and July

 19 Expiration, which would imply that at least at

 20 certain locations on the Chicago Board of Trade

 21 contract that there is convergence happening. So

 22 that is obviously very good news.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 113

 1 The last two graphics deal with

 2 positions, and it's sort of a controversial topic,

 3 and I know it was covered in the cotton

 4 conversation. And what this graph is trying to

 5 show, it's a little busy so, hopefully, I can make

 6 it a little clear. It's actually two graphs on

 7 one sheet here. And what we're trying to show is

 8 the Chicago Board of Trade Commodity Index

 9 Traders. I'll refer to them as CITs, and this

 10 would be looking at their all-futures and options

 11 combined positions and their percent of Open

 12 Interest. And on the bottom of the graphic here,

 13 we have the nearby price and the basis.

 14 So just to kind of further give you a

 15 little bit of idea of what the graph is showing,

 16 the blue line is the CIT positions in net

 17 contracts, and that refers to the Y- axis on the

 18 left in blue, and the more yellowish line is the

 19 CIT percentage of AFOCO Open Interest. That's

 20 also a net percent, and that's the axis on the

 21 right side in percentage.

 22 And again, on the bottom the green is

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 114

 1 the CBOT Nearby Wheat Price, and that bleed that

 2 you see coming off of the wheat price in red,

 3 that's the basis under the future, cash basis

 4 under the future.

 5 We've heard many, many people sort of

 6 target the declining X-traders as one of the main

 7 culprits in causing this disconnect between cash

 8 and futures as the conversation that we heard

 9 previously, people talking about a massive passive

 10 traders that just have gigantic positions, and no

 11 matter what the price does they don't necessarily

 12 change their position very much.

 13 Looking at this data, it's -- we don't

 14 really see the smoking gun. If I wanted to

 15 highlight a section, if we take a look at the 2008

 16 period, you can see a very, very weak basis. You

 17 see that red bleeding off of the green line, and

 18 you see very, very poor convergence in that

 19 section, but then if we go up and look at what the

 20 CIT actual positions were doing, for a good period

 21 of that time, they were drastically reducing their

 22 percentage of the Open Interest and drastically

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 115

 1 reducing their actual net contracts.

 2 So the idea that it's a cause and effect

 3 at least in that one year on this graphic, you

 4 don't see that. And then again, if we highlight

 5 another section, the 2010 period, you can see as

 6 that green line basically makes the red line

 7 disappear, you're not seeing a weak basis anymore,

 8 and the CITs in terms of net contracts have

 9 basically close to record positions. They're

 10 percentages on the high side as well, so it's a

 11 mixed bag. We're not seeing exactly that sort of

 12 cause and effect that some people have postulated

 13 in the media and maybe this requires further

 14 study.

 15 I think it's pretty obvious that someone

 16 being this large, traders being this big, they're

 17 going to have some impact on prices, but in this

 18 rudimentary type of analysis we're not seeing it

 19 at least in the Chicago market. And I'll get into

 20 the Kansas City market here now in a second.

 21 If we look at the Kansas City market,

 22 it's the exact same setup in terms of the graphic,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 116

 1 the positions on the top and the basis bleed on

 2 the bottom. Now, here one could say that there is

 3 this cause and effect possibility. We see that

 4 currently in Kansas City positions have over the

 5 last year or so have increased a lot on a net

 6 contract basis. Percentage, though has remained

 7 relatively the same over the last couple years,

 8 anywhere from the low 30s to the mid-20s; but

 9 definitely you can see that starting in about 2009

 10 we started to have this weak basis start to occur.

 11 So that part people would say, oh,

 12 there's your smoking gun; however, you know, if we

 13 look at other sections of the graph, namely the

 14 '06 period and, say, the '08 period, there are at

 15 times where we had very large net contracts in a

 16 relatively high position, and the basis was

 17 working, you know, wonderfully. So I think that,

 18 if I may make just an opinion, it would appear

 19 that the market fundamentals have the main impact

 20 on whether we have convergence or not. Obviously,

 21 like I said earlier on the slide previous, people

 22 that have positions of this size are going to have

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 117

 1 an impact, but I think overall the market

 2 fundamentals overpower the size of these

 3 positions.

 4 And that concludes the presentation. If

 5 there's any questions, I'll be happy to try to

 6 answer them.

 7 CHAIRMAN DUNN: Thank you, David. I

 8 think in order to expedite things, I'm going to

 9 let all of the panelists go forward before we do

 10 any Q and As. And with that, Nicole, if you could

 11 give us your presentation.

 12 MS. AULERICH: Thank you for having me

 13 here today. I'm going to continue talking about

 14 the Hard Red Winter Wheat futures contract, and

 15 specifically about the convergence problems that

 16 Dave just addressed.

 17 So first, what's at the root of

 18 convergence? Well, the future market links to the

 19 warehouse receipt market, and the warehouse

 20 receipt market links to the cash market. And

 21 between the warehouse receipt market and the cash

 22 market is where we're seeing a linkage breakdown.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 118

 1 So first, let's focus on the futures market and

 2 the cash market.

 3 Now, we don't expect the futures markets

 4 to exactly replicate the cash market. There's

 5 frictions in the marketplace, so we have storage,

 6 transportation, different market dynamics, buyers

 7 and sellers. But what we do expect on the futures

 8 market to reflect a supply/demand, and the quality

 9 fundamentals up underlying crop. So for the

 10 warehouse receipt that lies between the cash and

 11 the futures market this is the instrument that's

 12 delivered by the seller to the buyer at

 13 expiration. So you're not getting delivered a

 14 rail car or a truck filled with wheat but rather

 15 this warehouse receipt that's giving you the right

 16 to this grain.

 17 Now, you can hold this receipt for as

 18 long as you want as long as you pay the storage

 19 cost of 4.5 cents per month. So this warehouse

 20 receipt is the linkage mechanism between the cash

 21 and the futures market. It's the right but not

 22 the obligation to load out the grain.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 119

 1 So incentives are right now that we're

 2 seeing in the marketplace is for the warehouse

 3 receipt to be held and not loaded out. So

 4 basically what happens is you're holding onto it

 5 and not exchanging it for the underlying wheat.

 6 So the question is, why is this

 7 happening? What are the incentives for you to

 8 hold onto the warehouse receipt? So I'm going to

 9 walk you through a brief example here. So let's

 10 say you are along the March futures contract, and

 11 you take delivery of the warehouse receipt. You

 12 can buy that warehouse receipt, then, at $4.96.

 13 At the same time you're going to sell the May

 14 futures contract short, 'cause you can deliver

 15 this warehouse receipt on the next futures

 16 contract as long as you pay the storage cost of

 17 nine cents for those two months, giving you a

 18 two-cents profit over your original investment.

 19 Four dollars and ninety-six cents will give you

 20 about a 2.5 percent return, annualized return.

 21 Well, this low interest rate environment, this is

 22 pretty attractive.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100 

 Alexandria, VA 22314

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

 www.andersonreporting.net
 120

 1 Now, this strategy is not just a

 2 one-time thing. You can repeat the strategy, so

 3 let's say at the end of March the spreads are

 4 attractive. You can close out your March, your

 5 May futures contract and roll it forward and

 6 salvage a July futures contract. Now you have

 7 more storage fees to incur for four months, but

 8 you come out with a profit of five cents over your

 9 original investment which was still $4.96, giving

 10 you about a three percent return.

 11 So again, the strategy is to hold onto

 12 the warehouse receipt and not exchange it for the

 13 wheat and the cash market. So it's not linking

 14 the cash and the futures market.

 15 So this optionality feature of the

 16 warehouse receipt creates a wedge between the cash

 17 and the futures market. The futures market starts

 18 to value the warehouse receipt, and the cash

 19 market is solely valuing the underlying cash

 20 commodity. So the larger, the optionality

 21 feature, the larger the value of the optionality

 22 feature of the warehouse receipt, the larger the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 121

 1 wedge you're going to see.

 2 Now the question is, can we see this in

 3 the data? Yes, we can. So on the vertical axis

 4 here, we have the number of warehouse receipts,

 5 and on the horizontal is the expirations of the

 6 futures contract. So our blue line, or our blue

 7 bar is the number of warehouse receipts issued at

 8 each expiration, and the red is the number

 9 outstanding. So the difference, the red being

 10 over the blue, is the amount of warehouse receipts

 11 held over from expiration to expiration. So at

 12 the end, towards the right, you can see an '09-'10

 13 prof year. There was a large amount of warehouse

 14 receipts being carried over from expiration to

 15 expiration and not being redeemed for the wheat,

 16 so not connecting the cash and the futures market.

 17 So this is consistent with the

 18 incentives of the return that we just talked

 19 about. Now --

 20 CHAIRMAN DUNN: Nicole, just a

 21 clarification.

 22 MS. AULERICH: Yes.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 122

 1 CHAIRMAN DUNN: This is on what contract

 2 now? This is on the --

 3 MS. AULERICH: This is the Hard Red

 4 Wheat.

 5 CHAIRMAN DUNN: Hard Red.

 6 MS. AULERICH: Yes, from Kansas City.

 7 Now, all parties are acting in their best

 8 interests. The warehouses aren't issuing receipts

 9 because they know the grain isn't going to move

 10 anywhere, so they don't want it filling up their

 11 warehouse and then possibly disrupting their

 12 merchandising business.

 13 Likewise, the warehouse receipt holders

 14 aren't loading out the grain because it's in their

 15 best interest to hold them. and earn this return

 16 in the futures market. So the question is, how do

 17 we remove this wedge?

 18 Well, left alone, the market

 19 fundamentals will eventually change, so either

 20 we'll have higher interest rates, the spreads will

 21 eventually tighten due to a tighter crop, or

 22 additional near-term demand, or this strategy can

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 123

 1 be made less profitable. You can make higher

 2 costs through seasonal storage rate or the

 3 variable storage rate. Or you can limit the terms

 4 of the warehouse receipt. You can make it expire,

 5 devalue over time, make it nontransferable, or you

 6 can add additional delivery options.

 7 This concludes my brief example of the

 8 warehouse receipt in convergence connection, and I

 9 can answer questions now or later.

 10 CHAIRMAN DUNN: Thank you, Nicole. I

 11 appreciate that.

 12 I'd like now to go to David Lehman from

 13 the CME Group to talk about the experience that

 14 we've had with the Chicago Soft Red Wheat.

 15 MR. LEHMAN: Thank you, Chairman Dunn

 16 and Commissioners Sommers and O'Malia. It's a

 17 pleasure to be here today. I'll try to speed

 18 through this a little bit because I know we're

 19 short on time.

 20 What slide 2 shows is a little

 21 background of the issue. We began seeing

 22 convergence inconsistency in '06 and it lasted

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 124

 1 through '09. We've made a number of contract

 2 changes, implemented shipping certificates as a

 3 delivery instrument instead of a warehouse

 4 receipt, new delivery territories, and seasonal

 5 storage rates were implemented, and then finally,

 6 variable storage rates were implemented effective

 7 with the July 2010 contract; also improved quality

 8 specifications by lowering the vomitoxin

 9 allowed-in deliveries.

 10 The results of all of these changes we

 11 had good convergence in the March, May, and July

 12 Expirations. As Dave said, we have had load-outs

 13 against each of those three expirations in some of

 14 the delivery territories, and we've seen the

 15 calculated FOB elevator values at delivery

 16 equivalent in March of this year and USDA cash

 17 bids at delivery equivalent in July of this year.

 18 We've also seen strong growth in volume

 19 and Open Interest in the contract since VSR was

 20 announced with Open Interest up about 47 percent,

 21 and year-to-date volume up 20 percent through

 22 June. And that's grown a little more. I got an

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 125

 1 update this morning; it's now up about 29 percent

 2 as of this morning's volatility.

 3 Slide 3 explains how VSR works. I won't

 4 really walk through this, but it essentially

 5 allows the storage rate to increase by three cents

 6 per bushel per month if the nearby spread is a

 7 ratio to financial full carry is 80 percent or

 8 greater, and then also allows storage rates to

 9 decrease by three cents per bushel per month if

 10 that spread is 50 percent of financial full carry

 11 or less.

 12 And it's interesting right now, we're

 13 looking at the -- we're monitoring for the

 14 September/December spread. That's running right

 15 around full carry, about 100 percent, 105

 16 somewhere in that range, but if you look out into

 17 the smart spread, we're about 50 percent 

 18 March/May; May/July are flat right now. So it's

 19 going to be very interesting I think to observe

 20 how VSR works as we get into this environment in

 21 the 2011 part of the forward curve where we have a

 22 very flat market.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 126

 1 Just to give you a visual of the July

 2 Expiration, these are cash bids at various

 3 delivery points. Chicago, I know there are a lot

 4 of lines here. The top dark blue one is the New

 5 Orleans Gulf. That should always be a premium to

 6 Chicago because there's a transportation

 7 differential imbedded in that price. And then the

 8 various delivery points: Chicago, Cincinnati,

 9 Mount Vernon, Ohio, the Gulf, Toledo, and Memphis

 10 on the Mississippi River.

 11 The Northwest Ohio is not represented

 12 here, and that was in a shuttle-loading location

 13 in 2009, and that's a location that we've seen

 14 very active deliveries and also load-outs against

 15 canceled certificates in that location. But as

 16 you can see, we have a few points of above

 17 delivery equivalent value and a few points,

 18 delivery points below delivery equivalent value.

 19 And what we expect and as we go through an

 20 expiration is that we'll converge to the

 21 cheapest-to-deliver location.

 22 The next two slides are just the May and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 127

 1 March contracts. I really won't talk much about

 2 those. We didn't have quite as good a convergence

 3 with the cash bids. Again this is a number that

 4 we talked about last fall at the meeting here that

 5 these aren't always the best representation of

 6 whether an elevator is going to make delivery;

 7 it's really what they can sell the wheat for in

 8 the cash market that should be compared to the

 9 future price, and that's this calculated FOB value

 10 in Chicago which is slide 7.

 11 And this was the first snapshot of this

 12 data, first collection of this data that we were

 13 able to provide. It showed, you know, convergence

 14 back in mid-February and very close to delivery

 15 equivalent value through the March Expiration.

 16 Just to drill in a little more into the

 17 composition of Open Interest in the Chicago Wheat

 18 Contract. This chart plots the supplemental

 19 commitments to traders or commodity index trader

 20 data that CFTC began collecting and reporting in

 21 2006. The red dash line is Open Interest. You

 22 can see a very strong growth in Open Interest, and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 128

 1 we're up near record levels of Open Interest, and

 2 this growth upward has occurred since late '08 or

 3 early '09.

 4 What's also encouraging to see is that

 5 the middle dark blue line is the commercial

 6 hedging Open Interest in the contract. The top

 7 gray line is a trend following fund or

 8 noncommercial. It's not the index fund, but it's

 9 other noncommercial traders. They're beginning to

 10 converge, and that's what we want. We want to see

 11 an even distribution of Open Interest between

 12 noncommercial traders and commercial hedgers.

 13 The index portion is the lighter blue

 14 line, and it has stayed relatively constant in

 15 terms of its percentage of Open Interest.

 16 Just another snapshot to see that our

 17 Open Interest is maintaining or growing, actually,

 18 since VSR was announced, and year over year we

 19 looked on July 20th of this year. Total Open

 20 Interest $5.83 over $4.21 when VSR was announced,

 21 so up 38 percent. Commercial short Open Interest

 22 up 34 percent since VSR was announced. Commercial

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 129

 1 long up 137 percent since VSR was announced, and

 2 index long up 22. So I think the most encouraging

 3 number here is the commercial long Open Interest

 4 that's really come back into the market since VSR

 5 was announced, and VSR is thought to perhaps

 6 benefit the short hedger or the seller who may

 7 earn greater carrying charges as a result of

 8 increased storage rates but yet commercial long

 9 traders are embracing the improved convergence, it

 10 appears, as well.

 11 Another concern that we've heard about

 12 VSR is that it's making the deferred spreads more

 13 difficult to trade and more difficult to price

 14 because of the uncertainty of what storage rates

 15 will be in the future, so what we've done in

 16 slides 10 and 11 is look at -- we've calculated a

 17 ratio of deferred Open Interest to nearby, and

 18 we've gone back five years with that data and are

 19 showing the five-year average as the purple line.

 20 The 2010 number is a light blue line

 21 that stops over here in May. When we did this

 22 analysis, we were only through May, and then the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 130

 1 2009 number is the orange line. So that chart's a

 2 little hard to read, but the next chart give a

 3 table of the actual data points behind the chart,

 4 and what I'd like to point out is that since VSR

 5 was announced, this ratio of deferred to nearby

 6 Open Interest is at 58.9 percent, and the average

 7 over the five-year time period is 41 percent. So

 8 we're well above that average, and we're almost at

 9 the maximum with the exception of 2007- 2008. And

 10 these are looking at the same time periods,

 11 December 1 through May of each of these years

 12 since that's the time period that we've had since

 13 VSR was announced and the period of time that the

 14 market has possibly had concerns about how to

 15 price deferred spreads.

 16 So just another indicator that looks

 17 like we're tracking or we're holding and in fact

 18 growing the Open Interest in those deferred

 19 months.

 20 This is the same chart that Dave showed

 21 only this is just the Soft Red Winter Wheat. In

 22 addition to the stocks to use ratio, it also

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 131

 1 includes ending stocks themselves, so we have seen

 2 a significant drawdown in ending stocks in the

 3 Soft Red Winter Wheat market. We think that

 4 certainly has been a big factor in why we've seen

 5 this improvement in convergence. We had

 6 lower-planted acreage last fall because of wet

 7 weather during planting period, and as a result

 8 lower production.

 9 So to kind of sum it up to give what our

 10 view is in terms of improved performance of the

 11 Chicago contract, we think it has a lot to do with

 12 the additional delivery points that we added that

 13 are more in the primary production inflow of

 14 wheat. We think it also has a lot to do with the

 15 changes in the fundamentals of the market, and we

 16 think variable storage rate has contributed to

 17 that as well, but it's really too early to give

 18 much of the credit, I think, to VSR.

 19 Commissioner Dunn, I know we're running

 20 behind on time. I included a slide that you

 21 suggested when we last spoke that I might, about

 22 what our current activities are with regard to the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 132

 1 swaps market, and we look forward to providing

 2 comments into Mr. Heitman's presentation. But, as

 3 you know, and I'd just like to let the Committee

 4 know that we have a pending petition submitted to

 5 the Commission in April of this year to list

 6 another 12 agricultural swaps in addition to the

 7 nine that we already have listed.

 8 We also have submitted a petition to the

 9 Commission to request an exemption from the Ag

 10 trade option rules for cleared OTC Ag options. So

 11 if OTC Ag options are brought into a clearing

 12 house and in the same conditions that are applied

 13 to Ag swaps such as reporting daily settlement

 14 prices, market-to-market daily -- market-to- 

 15 market Volume and Open Interest, market

 16 surveillance, we think those conditions would

 17 actually provide just as much secured, if not more

 18 than the Commission's ATO program does. And so we

 19 have those two petitions on file.

 20 Thank you very much.

 21 CHAIRMAN DUNN: Thank you, Mr. Lehman.

 22 Mr. Borchardt, if we could get you and then we'll

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 133

 1 go right into Mr. Campbell, since you're

 2 tag-teaming us today.

 3 MR. BORCHARDT: Sure. Mr. Chairman,

 4 Commissioners, and Committee members, the Kansas

 5 City Board of Trade appreciates the opportunity to

 6 come before you today to discuss the weak basis

 7 issue and the Hard Red Winter Wheat. My name is

 8 Jeff Borchardt. I'm the president of the

 9 Exchange, and with me today is Steve Campbell with

 10 Louis Dreyfus Corporation. Steve is also our

 11 vice-chairman and a member of the Wheat Contract

 12 Committee as well.

 13 Over the last couple of months, we've

 14 had we've had many visitors and guests where we've

 15 had discussions and input has been received from

 16 the interested parties concerning the weak basis

 17 issue and Hard Red Winter Wheat and lack of

 18 convergence, including CFTC Commissioners and

 19 staff. We've had National Grain and Feed

 20 Association in and the Kansas Grain and Feed

 21 Association, Kansas Association of Wheat Growers,

 22 and we've also had some discussions with members

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 134

 1 of the American Bakers Association.

 2 The Exchange understands the concerns

 3 that have been expressed by all these parties

 4 regarding the weak basis issue and the lack of

 5 convergence at the delivery during the delivery

 6 month and in, here of late, and we've tasked our

 7 Wheat Contract Committee with coming up with

 8 proposed solutions to foster better convergence.

 9 The Exchange Wheat Contract Committee is

 10 made up of a balanced diverse group of industry

 11 and commercial market participants. We have

 12 milos, we have exporters, we have grain

 13 merchandisers, we have elevator operators, and we

 14 also have Futures Commission merchant members with

 15 commercial grain customers. This committee has

 16 for many weeks now been actively and deliberately

 17 reviewing the Kansas City Hard Red Winter Wheat

 18 contract for consideration of structural changes

 19 to the contract to foster better convergence

 20 during the delivery period.

 21 Many weeks ago, the Committee came to

 22 the decision that doing nothing was not an option,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 135

 1 that, you know, something had to be done under

 2 these circumstances to foster better convergence.

 3 The Committee is aware of and has been looking at

 4 many different options available to them to foster

 5 convergence, and many of those have been discussed

 6 in prior years relating to the Soft Red Winter

 7 Wheat contract with their convergence issues. So

 8 they're looking at those proposed alternatives

 9 that were discussed as well as others.

 10 Some of the more material potential

 11 fixes have a common theme and that is it moves the

 12 basis volatility into the futures spreads. You

 13 can do that one or two ways: You can come up with

 14 more immediate convergence types of fixes that

 15 drop it into the front month spreads, or you can

 16 come up with more gradual fixes that feather in

 17 over time and achieve convergence over a longer

 18 period of time. What the Committee is endeavoring

 19 to achieve is a balanced solution that fosters

 20 convergence during the delivery period without

 21 creating unintended consequences for market

 22 participants either on the long or short side of

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 136

 1 the market.

 2 The Committee has -- and I've sat in on

 3 committee meetings since 1993 when we first headed

 4 the Hutchinson delivery point in '96, the

 5 deliberations began in '93 -- and I can tell you

 6 over the years their primary focus, and I think

 7 correctly so, has been to offer packages of

 8 change, of structural changes to provide the

 9 requisite balance to the contract so as to equally

 10 disincentivize longs and shorts from making or

 11 taking delivery and incentivizing them to

 12 liquidate their futures positions and foster that

 13 convergence.

 14 We've received quite a few questions

 15 here of late about the deliberation process that

 16 the Committee goes through, and I wanted to kind

 17 of expound on that a bit. Historically, the Wheat

 18 Contract Committee has met in private to

 19 deliberate and hash through the different

 20 alternatives, which is the process that they're

 21 going through right now. What they're trying to

 22 do is come up with consensus or at least near

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 137

 1 consensus to be able to offer thoughtful

 2 recommendations to the Board of Directors for

 3 implementation of structural changes.

 4 At the time that they get to the point

 5 where they achieve near consensus, or consensus on

 6 that, what they've traditionally done is at that

 7 point invite in outside parties to come in and go

 8 through the process that they have been through,

 9 the discussions, and the ultimate conclusion that

 10 they've reached so that they can receive input

 11 from the outside parties to make sure that there's

 12 something that they haven't missed before

 13 forwarding and on to the Board of Directors.

 14 At the time they forward it to the Board

 15 of Directors, that proposal then goes public in

 16 the form of a circular that we put out that lets

 17 the market participants know that the Wheat

 18 Contract Committee has made a set of structural

 19 change recommendations to the Board, and they have

 20 an implementation date proposed, and it's to put

 21 all market participants on notice that if you

 22 intend to transact business in that effective

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 138

 1 contract month forward, that you'll be subject to

 2 the new terms and conditions assuming membership

 3 ratification and then Commission approval.

 4 So that's kind of an overview of what

 5 we're facing right now, the Committee's challenges

 6 and what the process is, and what I'd like to do

 7 now is turn it over to Steve Campbell who can, for

 8 the benefit of the committee members who we

 9 haven't had one-on-one discussions with, can maybe

 10 enlighten you a little bit as to the factors that

 11 influencing the weak basis situation right now.

 12 MR. CAMPBELL: Thank you, Jeff. I, too,

 13 would like to thank the Commissioners, Mr.

 14 Chairman. Thank you for visiting us in Kansas

 15 City and, certainly, Commissioner O'Malia and

 16 Commissioners Sommers as well.

 17 You know, honestly, I think today that

 18 the market has, whether we're talking about cotton

 19 and wheat or Kansas City Hard Wheat has, in

 20 essence, covered the generic, the basic foundation

 21 of where we are in the market today. We are in a

 22 marketplace that is in transition. We are in a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 139

 1 marketplace that has seen massive investment into

 2 our, you know,into the marketplace over the last

 3 four to five years.

 4 We are a marketplace that has gone from

 5 serving a traditional producer with a traditional

 6 consumer, with a speculator that would ease the

 7 price transfer between the two, to today, which

 8 we've all discussed and had discussion about, to 

 9 today trying to also serve an investor, an

 10 investor as created commercial demand and wants a

 11 place to hedge that demand, that risk. And so

 12 he's come to our markets and the commodity markets

 13 to lay that off. So we are in a transition.

 14 We are 150-plus, that is slow to

 15 necessarily at times respond to transition, to

 16 those changes, but that is also with some 

 17 understanding that unintended consequences can

 18 come about by making irrational changes subject

 19 to, you know, certain fads in the marketplace, so

 20 to speak. So again, it's sort of in the interest

 21 of time, I think David did a good job of

 22 illustrating the marketplace as it is today. I

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 140

 1 think Nicole did a good job in saying where is the

 2 breakdown. We understand that, you know, the --

 3 that the deliver economics link the cash market

 4 with the futures market.

 5 Today we have strong massive growth in

 6 our futures market, and in the Hard Wheat specific

 7 market, we have free stocks, free stocks growing

 8 at historical levels. In past years when we had

 9 those same surpluses in the market, we had the

 10 farmer moving towards a loan program that would

 11 maybe the go to commodity credit corporation

 12 stocks, and a lot of those stocks would be held

 13 off the market. The farmer could still get

 14 operating loans and, you know, move forward.

 15 Today that's not in the case because

 16 prices aren't allowed to break that low because of 

 17 this massive influx of -- so we have a divergence

 18 going on between our demand for our futures

 19 contracts, that balance sheet in conjunction with

 20 the overall demand of the balance sheet in the

 21 supply/demand situation in the real physical

 22 market.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 141

 1 So delivery economics, we understand

 2 that delivery economics allows us to cap the

 3 upside to premiums; that is to say I can always

 4 buy option price, my freight to the location I

 5 needed caps the high side of where premiums should

 6 go.

 7 We also understand that delivery

 8 economics should cap the downside to premiums,

 9 meaning I can sell option price my freight to

 10 Kansas City market, for instance, is 50 cents, so

 11 therefore premiums at my location should never go

 12 below 50.

 13 Now, we have also any of us who have

 14 traded cash markets, any of us who understands

 15 those markets understand that there's an asterisk

 16 on the capping of premiums to the downside, and

 17 that is to say when my elevator is full, where do

 18 I go with the next bushel? So we look at it and

 19 we say, well, we need to clear it, so we'd have to

 20 go and find the next home or the next place where

 21 it can go.

 22 So delivery economics, while we

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 142

 1 understand their function. they also, you know,

 2 have some -- the downside premiums have some

 3 linkage problem there naturally. We've seen that

 4 before in other years, but again the future market

 5 responded such that, you know, such that the

 6 effects of that break in the linkage weren't felt

 7 as bad.

 8 So the cause really, I think the cause

 9 for lack of convergence under the current contract

 10 design is due to the fact that the wheat markets

 11 have experienced a structural demand shift in the

 12 balance sheet for futures without a corresponding

 13 structural shift in the consumption of physical

 14 wheat. So we have this strong growth in the

 15 futures; we have this strong growth in our free

 16 caria of Hard Red Winter Wheat. The farmer, you

 17 know, is selling it, and he wants a place to go

 18 with it, so we, you know, we've got a huge massive

 19 storage issue throughout the Midwest this year.

 20 So, consequently, our warehouse space,

 21 whether due to constraints on actual physical

 22 space or to the constraints on credit and position

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 143

 1 limits -- you know, it's not just that my

 2 elevator's full -- it's that I'm at my maximum

 3 credit exposure with my bank because, you know,

 4 I've got the futures sold, but I'm getting margin

 5 calls. He's wanting to know if it's going to

 6 work, we got a problem with convergence. All

 7 that's tied together, so it is -- it is definitely

 8 a stress on the system because of the overall

 9 space.

 10 If you look at Kansas, Colorado,

 11 Nebraska, all of the surrounding space for this

 12 year, we're projected in the fall to be 115 to 120

 13 percent of the total space.

 14 Now, you know, we can always, you know,

 15 say, well, we'll take milo and put it on the

 16 ground temporarily, or we'll do some other things.

 17 But the market becomes a bit concerned about that

 18 because really, are we comfortable with

 19 convergence. So we, you know, there is a

 20 breakdown. It is pressed on us because of the

 21 space utilization.

 22 In previous years, the surplus future

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 144

 1 prices have responded. Wheat was put under loan

 2 maybe forfeited and held by the CCC. That

 3 situation is not there today because of the

 4 strength in the futures market and a break in the

 5 linkage.

 6 So we have this structural change and

 7 massive demand for our futures. We have this year

 8 a very high growth in our free stocks. We have a

 9 great deal of pressure upon the space, elevator

 10 space in the interior, and we have a market that's

 11 concerned down the road, are we going to take care

 12 of this lack of convergence and actually fix it?

 13 So that is also putting pressure no the markets

 14 today.

 15 Kansas City Futures Contract was

 16 designed for a preindex investor marketplace, i.e.

 17 it has, as Nicole and David pointed, a fixed

 18 storage rate, and thus it has a fixed financial

 19 full carry. So, as Nicole pointed out in the

 20 warehouse receipt example, you will see a

 21 warehouse enroll at full carry; there is no

 22 incentive for them to put it out.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 145

 1 Now, that was, you know, the idea, the

 2 optionality behind that was to understand that,

 3 you know, if I sell boats today for -- if I sell

 4 vessels today for Oct., Nov., Dec., where do I put

 5 that hedge? If I put a hedge in the Sept. and

 6 then I actually cannot cover the cash and need to

 7 execute the September, it's going to take -- you

 8 know, I can't take it all out in the next day. I

 9 need some optionality to carry that, but I also

 10 need the optionality to carry it because, if, by

 11 doing that transaction what do you really want to

 12 happen? You really want the market to respond.

 13 Premiums go up, the spreads narrow, the flat price

 14 responds, the farmer moves a little bit of wheat,

 15 and the wheat flows because I've held onto that

 16 hedge, and the market starts to be pushed in.

 17 But the market, you know, on the

 18 warehouse receipt is the market of last resort.

 19 So if the dynamic relationship between the cash

 20 markets, the spreads, and the futures are working,

 21 that's why you should never have to really see a

 22 great deal of taking or making delivery. But if

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 146

 1 you have no optionality and you want to just take

 2 and force it onto the market and say you've got to

 3 move it up, well, then, that becomes burdensome on

 4 the other side, on the -- uh, so when you look,

 5 you know, it is a balance contract that we're

 6 seeking.

 7 And, but, so today this leaves a cash

 8 market, i.e., the basis to compensate because of

 9 the fixed storage rate and because of the high

 10 amount of free starch in our market, it leaves the

 11 cash markets the basis to compensate for the

 12 increasing demand for space over and above the

 13 fixed rate on the futures market, and has led to a

 14 lack of convergence facing the Kansas City wheat

 15 contract the past 12 months. The Committee does

 16 understand the concern. The Committee is working

 17 overtime to try to come to a consensus resolution

 18 on it to provide a balance contract, to not rush

 19 to, you know, not make an irrational mood that

 20 will have the unintended consequences that we

 21 fear.

 22 I'll must stop there, Mr. Chairman.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 147

 1 CHAIRMAN DUNN: Thank you very much. I 

 2 appreciate that.

 3 I have gotten requests from Josh Curley,

 4 who is our trader, to be able to make a short

 5 presentation, and Josh has done this in the past,

 6 so, Josh, if we can get you to kind of keep this

 7 short -- we're running way over, but I appreciate

 8 you coming in. Josh comes in at his own expense,

 9 and we greatly appreciate that.

 10 MR. CURLEY: Thank you, Chairman,

 11 Commissioners, and members of the Agricultural

 12 Advisory Committee. I will do my best to keep

 13 this brief.

 14 While I'm certainly not qualified to

 15 speak on VSR's role in restoring convergence to

 16 the CBOT Wheat Futures Contract, as one of the

 17 more active high-volume traders, I am confident in

 18 discussing the effect VSR has had on the deferred

 19 months and spread markets. To put it bluntly,

 20 spreads, especially past the second month, have

 21 become virtually untradeable. In terms of

 22 liquidity, they are thin and skittish. It's not a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 148

 1 healthy marketplace.

 2 A healthy market is one where traders

 3 and customers can afford to be wrong, where they

 4 are able to offset a bad position and come back to

 5 trade another day. Currently in our back month

 6 and spread markets, this is not the case. Lately

 7 there are simply no out, making it nearly

 8 impossible to manage risk.

 9 Many of these spreads are not actually

 10 trading. What I mean is that there is no longer a

 11 natural progression where bids take out offers one

 12 tick at a time. We are subject to just violent

 13 repricings often driven by relatively small

 14 orders. Liquidity majors like myself are exposed

 15 to several times the risk with a fraction of the

 16 position. I believe this is because VSR has

 17 destabilized our contract. Spread orders that

 18 were once absorbed by the market in one or two

 19 ticks are now moving at 10 or 20. Desk managers

 20 and floor brokers are reluctant to take orders

 21 past the first two months because positions are so

 22 difficult to get into and out of.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 149

 1 Spread order books are a skeleton of

 2 what they once were. I believe the variable

 3 storage rate has created needless uncertainty.

 4 Going forward five times each year, VSR will

 5 unnecessarily impose more volatility into our

 6 spread futures. What is worse is that by design

 7 VSR rewards rather than discourages market

 8 manipulation. Predatory funds that have the

 9 capital and ammunition will more easily profit if

 10 they're able either to hold the spreads above 80

 11 percent or below 50 percent of financial full

 12 carry during the review period.

 13 While there has been a significant

 14 recent spike in Volume and Open Interest, this

 15 merely served the interest of the Exchange. It

 16 would take an interest -- excuse me, and increase

 17 in true liquidity to benefit the core participants

 18 in a long-term viability of the markets. These

 19 increases in volumes and improved ratios between

 20 the third and front month Open Interest have not

 21 meant greater liquidity. To me, liquidity is how

 22 easily you can execute and order with minimal

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 150

 1 price movement.

 2 Let's say you have to go to the market

 3 with 50 Dec/July wheat spreads. It doesn't matter

 4 if you are a broker in the pit or a trader on the

 5 screen, this is vastly more difficult and more

 6 expensive to execute than it ever was prior to

 7 VSR, and there's not a single market participant

 8 that will tell you otherwise.

 9 And just real quick, a real like example

 10 because of what's going on in the market right

 11 now. If you went home yesterday with 50 Dec./July

 12 wheat spreads on, which is not a huge position,

 13 you woke up today $100,000 poorer, and that's just

 14 market to market. It'll probably cost you another

 15 $20,000 to get out of that position in terms of

 16 market movement.

 17 Even if VSR has solved convergence, I

 18 don't know at what cost. The futures market is of

 19 no utility if you cannot trade past the front

 20 month.

 21 Again, thank you very much for your

 22 time.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 151

 1 COMMISSIONER SOMMERS: Thank you, Josh.

 2 Commissioner Dunn had to step out for a few

 3 minutes, but he will come back, and I'm sure will

 4 want to engage in the conversations on wheat

 5 convergence.

 6 I'll turn it over to my colleagues if

 7 they have any questions they want to ask this

 8 panel. Do you have any questions?

 9 CHAIRMAN GENSLER: And I apologize 

 10 'cause I had a meeting that I had to attend to,

 11 and I missed some of this. But, so if I'm

 12 repetitive, I apologize.

 13 My question is, what do we do to fix the

 14 problem? I thought the slides -- maybe I'm

 15 complimenting our own staff, but, Nicole, great

 16 slides, and whether you all accept -- maybe my

 17 first question is everybody accept what Nicole

 18 writes on page 2. She has a little "x", and it

 19 says, "breakdown in linkage," I think.

 20 When I was in Kansas City and I met with

 21 a bunch of people, I said it's a broken contract,

 22 and I didn't even coordinate with Nicole. But, so

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 152

 1 my first question is, do people believe that there

 2 is this breakdown in the linkage?

 3 MR. BORCHARDT: Well, Commissioner, I

 4 think that, as I said in my presentation, the

 5 Wheat Contract Committee weeks ago came to the

 6 conclusion that there is not a sufficient backstop

 7 mechanism in our contract to handle the type of

 8 situations we're in right now. Historically,

 9 we've been on the flip side. Normally, we have

 10 shorter supplies, and we're worried about short

 11 squeezes, and so we're trying to formulate

 12 packages of changes to bring assets to bear and

 13 diversity on the market to compel convergence that

 14 way.

 15 We're not used to the situations we're

 16 in now. We normally. We did have a little bit of

 17 it in 1998, but we worked through it pretty

 18 quickly. But we're just not accustomed to having

 19 the tremendous supplies and scrambling for storage

 20 space in the interior like we have today.

 21 So I think they understand that there is

 22 an issue and that there needs to be some sort of a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 153

 1 mechanism brought to bear on the contract to

 2 alleviate the stress and to compel conversions,

 3 and there are several different ways to accomplish

 4 that, and they're in the process of trying to

 5 flesh out those alternatives.

 6 CHAIRMAN GENSLER: And I know we were

 7 all together, however, and I thank you for that.

 8 It was four or five weeks ago, so it's a little

 9 bit of a blur. And at that stage I think I had

 10 asked you whether you thought you'd be ready by

 11 August 15th or something. But how long do you

 12 think you'll be ready before you have some firm

 13 recommendations?

 14 MR. BORCHARDT: I feel confident that we

 15 will not be ready by August 15th.

 16 CHAIRMAN GENSLER: You mentioned that

 17 four or five weeks ago, and --

 18 MR. BORCHARDT: The committee -- you

 19 know, the Committee has had really good marathon,

 20 helpful discussions working towards trying to

 21 formulate consensus, which is really difficult

 22 because with the myriad of alternatives available

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 154

 1 to you, obviously you're going to have differences

 2 of opinion, you're going to have some that prefer

 3 one method for whatever reasons and others that

 4 prefer different methods because of maybe some

 5 unintended consequences or whatever.

 6 So we're trying to work forward to come

 7 up with enough consensus to work down a particular

 8 path to flesh it out to see whether it's the right

 9 solution for our contract. And then at that

 10 point, once we have the mechanism decided on, then

 11 you can dress it up with other enhancements to the

 12 contract to create the requisite balance.

 13 CHAIRMAN GENSLER: Will that be before

 14 the kids go back to school?

 15 MR. BORCHARDT: Which year?

 16 CHAIRMAN GENSLER: No, more seriously,

 17 this year. I really, you know, I respect that

 18 these are challenging things, but -- and I

 19 expressed this in Kansas City -- I'm just hopeful

 20 that you don't have meetings until, you know,

 21 Christmas and the, you know, people go on holiday,

 22 and then it's meetings until the spring and --

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 155

 1 MR. BORCHARDT: I hope we don't have

 2 multiple meetings each week or twice a week before

 3 Christmas as well, but I think the Committee, in

 4 my opinion, I'm there as an observer, have been

 5 since 1993, I sit in on all the meetings 'cause I

 6 have to write the rules to accomplish what they

 7 decide, but I think they're making some good

 8 progress. I think they're looking at alternatives

 9 that foster convergence either immediately or over

 10 time, and, you know, I think most people can

 11 imagine what those solutions might be. It's

 12 either, you know, we all know about variable

 13 storage rate which I think can, taken by itself

 14 without the influences outside of the market like

 15 the Russian deal or whether you're going to have a

 16 short crop or what not, taken just by itself would

 17 be, in my opinion, a more gradual solution over

 18 time as the spread widens out to accommodate.

 19 There are more immediate solutions, one

 20 of which I think the NGFA toiled for a couple

 21 years in putting together and recommending, and

 22 that was modified compelled load-out. I mean

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 156

 1 compelled load-out or a modified compelled

 2 load-out or some variation thereof, will

 3 effectuate convergence immediately. So --

 4 CHAIRMAN GENSLER: Yes. I thank you,

 5 and I don't have any other questions, really. But

 6 I do think that it's important for each of the

 7 contracts that the CFTC oversees that convergence

 8 works. I think it goes to the heart of the market

 9 mechanism and that wonderful chart that Nicole put

 10 together that the cash market and the futures

 11 market for a certain number of days in the spot

 12 month should converge. And that's what farmers

 13 ultimately get confidence in that this contract,

 14 which is often so caught up in the financial

 15 markets and caught up whether it's index investors

 16 or other investors, but at some point in time it

 17 actually has a, you know, a relevance to the cash

 18 markets, and then they have the confidence that

 19 they can deliver into that contract on occasion --

 20 not always but on occasion.

 21 And so I would hope -- I'm glad that we

 22 agree that there is a problem -- I just hope that

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 157

 1 whatever solutions you come up with are soon, not,

 2 you know, many months.

 3 COMMISSIONER SOMMERS: I had a question,

 4 actually for Mr. Curley. Thank you so much for

 5 being here and for your comments on the VSR, and I

 6 want to make sure that I understand correctly

 7 what's going on. And this is probably a little

 8 bit of a question for Dave, too.

 9 The way I understood Dave's presentation

 10 is that as we look towards the future, the spreads

 11 are showing us the carry, it may be less than 80

 12 percent. So this variable storage rate actually

 13 may lower in the future as we're looking forward.

 14 And so my question for Mr. Curley is, is that

 15 helpful that you're saying that the fluctuations

 16 in the VSR is a problem? Or just it, in general?

 17 MR. CURLEY: It's a problem because the

 18 greater the variability, and variability increases

 19 the further away you get from the spot month the

 20 more difficult it is to price spread against that

 21 front month. If there is a static full carry,

 22 it's easier to price markets going forward in the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 158

 1 second, third, and fourth option. If, you know,

 2 there's the possibility of it increasing every

 3 time or decreasing every time between now and

 4 then, it's much more difficult to price for

 5 someone like me that has to, you know, do rough

 6 math and price something, say, July 11 against 

 7 Dec. in 2010. So it makes our job more difficult.

 8 And you can see just by looking at the

 9 screens and since, you know, this is past, they're

 10 not as deep spread. They used to be a few hundred

 11 on the bid and offer and a tick wide; now it may

 12 be 10 on a bid and offer. Now they're pennywide.

 13 So, you know, people have this great

 14 Open Interest in the back months, and when they go

 15 to get out of there, it's going to be very, very

 16 difficult. Whether they're taking losses or

 17 profits, it's going to move the market more when

 18 they go to get out of anything that's not in the

 19 spot month.

 20 COMMISSIONER SOMMERS: You know, we

 21 talked for a very long time on solutions to the

 22 convergence issues in Chicago, and this was the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 159

 1 solution that was put forward by the Exchange. Do

 2 you have other suggestions if the VSR isn't

 3 working for you in the market, but it is causing

 4 convergence? And what are our other choices?

 5 MR. CURLEY: I have no idea. There's

 6 probably 20 Ph.D.s in economics in this room, and

 7 I've barely gotten an undergraduate amount of

 8 history. I really don't understand all that, you

 9 know, that abstract economics behind what's going

 10 on, but I can see the effects in the actual

 11 marketplace of somebody that stands in the pit and

 12 bids and offers and goes to the screen and looks

 13 at these markets, you know, you know, 16 hours a

 14 day, five days a week for the last however many

 15 years, these are the worse, unhealthiest markets

 16 I've seen in terms of if you have position, and

 17 right or wrong, there is no getting out of them.

 18 But I don't have an alternative proposal, no.

 19 Sorry.

 20 COMMISSIONER SOMMERS: Thanks.

 21 COMMISSIONER O'MALIA: Mr. Campbell, you

 22 had mentioned, you kind of pointed to strong

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 160

 1 problems with storage, fixed storage rates and the

 2 massive demand for storage. I'd like to get your

 3 impressions of what Nicole's thoughts, some of the

 4 options that she presented in her paper,

 5 specifically the expiration or revaluation of the

 6 certificates. What impact might that have on your

 7 market?

 8 MR. CAMPBELL: Yeah, you know, honestly,

 9 that's a cotton. That works in cotton because

 10 cotton actually does devalue over the course of a

 11 lifetime. In the course of wheat from one year to

 12 the next, you really don't lose if it's properly

 13 stored. You really don't honestly lose much value

 14 vis-a-vis the quality degradation. So, you know,

 15 to just lose value in a financial sense, I guess

 16 -- and I don't know how one would measure that --

 17 but in applicability from futures to cash --

 18 COMMISSIONER O'MALIA: Well, I mean she

 19 -- you know, the charts she put up there, you

 20 know, played out that the incentive to carry this,

 21 if we took away that incentive, how would the

 22 market function, in your opinion?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 161

 1 MR. CAMPBELL: If you took away the

 2 incentive.

 3 COMMISSIONER O'MALIA: Reduce that

 4 wedge.

 5 MR. CAMPBELL: Well, if you can reduce

 6 the wedge, yeah. I mean it would perform better.

 7 COMMISSIONER O'MALIA: Well, she had

 8 proposed a couple of solutions -- or not proposed

 9 but she outlined a couple of solutions that might

 10 do that. Do you have an opinion about that?

 11 MR. CAMPBELL: Anything that moves the

 12 volatility from the basis to the spreads is going

 13 to aid in convergence. There's -- I mean there's,

 14 you know, as Jeff mentioned earlier, there's

 15 several, perhaps, tools. VSR is one way. Whether

 16 it is the perfect way is questionable.

 17 Compelled load-out would certainly force

 18 convergence in a heartbeat. Would it have

 19 unintended consequences that would be, you know --

 20 COMMISSIONER O'MALIA: Do you have a

 21 preference for either one of those?

 22 MR. CAMPBELL: Probably not as a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 162

 1 representative of the Kansas City port of trade,

 2 you know, Wheat Contract Committee.

 3 COMMISSIONER O'MALIA: You have no --

 4 MR. CAMPBELL: I do have a preference.

 5 COMMISSIONER O'MALIA: You have no

 6 preference.

 7 MR. BORCHARDT: Well, I'm sure he does,

 8 but I guess what he's trying to say -- and I'll

 9 answer since I'm not a member of the Wheat

 10 Contract Committee -- is that right now in the

 11 fleshing out process of trying to drill down,

 12 which is the most preferred, and some of them had

 13 differing opinions from others, and it might not

 14 be proper for Steve to voice his particular --

 15 COMMISSIONER O'MALIA: Well, I wasn't

 16 going to put you on the spot, but I thought I

 17 might get an answer out of him, though.

 18 MR. CAMPBELL: Well, I read these

 19 presentations, you know, I mean online yesterday

 20 in the Reuters article, and so I'm a bit hesitant

 21 to put that out there today as I am a member of

 22 the committee, and that we are in the middle of

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 163

 1 the deliberations.

 2 CHAIRMAN GENSLER: Can I say something?

 3 With all respect, I don't -- I don't think that's

 4 real. I mean you're a member of this Advisory

 5 Panel, too, aren't you? You're not a member?

 6 MR. CAMPBELL: You're not a member? We

 7 haven't just --

 8 CHAIRMAN GENSLER: Nor am I.

 9 MR. CAMPBELL: I'm not a member, but --

 10 CHAIRMAN GENSLER: All right.

 11 MR. CAMPBELL: I understand what you're

 12 saying, Commissioner -- I mean, Chairman, and I do

 13 have an opinion, but --

 14 CHAIRMAN GENSLER: If you can share with

 15 us, we'd love to know it.

 16 MR. CAMPBELL: Look, the bottom line is,

 17 if you want to force -- if your own -- if your

 18 single re -- if your single goal -- if Your single

 19 goal is to force convergence, is to impact

 20 convergence, there's absolutely no question some

 21 form of compelled load-out will do that the most

 22 efficiently, pure and simple.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 164

 1 COMMISSIONER O'MALIA: Do you have a

 2 preference over VSR over compelled load-out? I'm

 3 trying to figure out how severe this problem is

 4 and what the appropriate solutions are. And we're

 5 going to have a responsibility. Whatever

 6 solutions you all develop, we have to enforce them

 7 and oversee them to make sure that we get the

 8 markets. We're going to be back here again.

 9 We're trying to get a better understanding of what

 10 you think is the preference, and happy to have the

 11 Committee's impression as well.

 12 MR. BORCHARDT: Again, Commissioner, I

 13 appreciate your question, and I understand it.

 14 And I'm not sure that it would be appropriate at

 15 this time for Steve, as a member of the Committee,

 16 to voice his particular bias or preference with

 17 respect to the alternatives available.

 18 Like he said, there's really -- there's

 19 VSR, you know. There's shipping certificates have

 20 been mentioned. You know, there's been forms of

 21 compelled load-out. I mean there are multiple

 22 different forms of variations of compelled

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 165

 1 load-outs, so I think that's really the circle of

 2 alternatives that we're looking at right now.

 3 We're not looking at cash shuttle contracts, so

 4 we're looking at, you know, the VSR shipping

 5 certificates and some variation of compelled

 6 load-out, which would be the -- I would guess

 7 would be the population that they're really

 8 focusing in on right now in trying to flesh out

 9 which would be the best alternative and the most

 10 balanced alternative in connection with maybe some

 11 other changes that could be made to the contract

 12 to provide that balance for the Kansas City Board

 13 of Trade.

 14 CHAIRMAN DUNN: Commissioner Chilton,

 15 are you on the line? Do you have a question?

 16 Let's go ahead.

 17 COMMISSIONER CHILTON: Commissioner

 18 Dunn, I'm sorry, I'm here.

 19 CHAIRMAN DUNN: Sorry, Bart. 

 20 COMMISSIONER CHILTON: Sorry about that.

 21 I wanted a follow-up on Commissioner O'Malia and

 22 the question and what Chairman Gensler said for

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 166

 1 Mr. Borchardt. I mean I know you all take this

 2 very seriously, Jeff, and I want to give you a

 3 chance to talk about it a little bit more, because

 4 there a lot of pissed off farmers out there and a

 5 lot of people who use this contract and are upset.

 6 They contacted us and they want us to work as hard

 7 as we can -- obviously this is your contract and

 8 you guys got to figure out how you want to go

 9 forward -- but they don't care if you worked very

 10 day from now until Christmas and beyond; they want

 11 it fixed.

 12 So I want to sort of impart what I think

 13 what the Chairman was getting at, too, Chairman

 14 Gensler, is that there is some urgency to this.

 15 Obviously, you want to get it right, but this is

 16 important stuff for a lot of people out there who

 17 rely on this. And so I don't know if you had

 18 anything further you wanted to say on it, but, uh

 19 --

 20 MR. BORCHARDT: No, I appreciate --

 21 COMMISSIONER CHILTON: -- I hope you

 22 move forward expeditiously and thoughtfully.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 167

 1 MR. BORCHARDT: And I appreciate those

 2 words, Commissioner, believe me. You're not the

 3 only ones receiving the phone calls. We're

 4 hearing it from the production community, we're

 5 hearing it from our legislators, we're hearing it

 6 from, obviously, the Commission, and as well as

 7 the Associations that have people that are

 8 involved in the production side of the business.

 9 So the Committee absolutely gets it. We

 10 understand that, you know, a mechanism needs to be

 11 put into place to avoid the types of basis

 12 extremes that we've experienced over the last

 13 year.

 14 So now they're working very diligently,

 15 but, you know, you have to also remember that this

 16 is our contract that we've had for 150 years.

 17 It's really the only contract of the Kansas City

 18 Board of Trades, and we've done, I think, a

 19 spectacular job over the years of handling it.

 20 The key for us is to get it done right.

 21 Like Steve said, a knee-jerk reaction

 22 putting some mechanism into place that you're

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 168

 1 going to end up having to replace with something

 2 else and create more confusion down the road is

 3 probably not the best way to go; it probably would

 4 be better to take just a little bit more time as,

 5 you know, as painful as that might be, and to get

 6 it right the first time. And, you know, they're

 7 working diligently on it, and as soon as they come

 8 up with a consensus, we invite people in to

 9 discuss that. Then I think maybe we'll be in a

 10 position to try and, working with the Commission,

 11 to try and determine an implementation time frame

 12 with those changes.

 13 COMMISSIONER CHILTON: Yeah.

 14 MR. BORCHARDT: Thank you.

 15 CHAIRMAN DUNN: Do you have a time frame

 16 that you may come up with a proposal

 17 contract-wise?

 18 MR. BORCHARDT: Not at this time.

 19 They're in the process of, you know, fleshing out

 20 proposals going through the pros and cons, trying

 21 to formulate consensus on one in particular to be

 22 able to flesh it out, and at that point in time

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 169

 1 try and garnish consensus along with other changes

 2 to the contract.

 3 So at the rate they're going, there's a

 4 lot -- there's a lot involved here. I mean I sit

 5 in on these. There's a lot of -- lot of

 6 discussions about impact, about time frames and

 7 what not, so I'm guessing three weeks or so, six

 8 to eight weeks probably. Because some of these

 9 have a lot of moving parts to them. There's

 10 things that have to be taken into consideration

 11 that you would definitely want to get right if you

 12 implemented them.

 13 CHAIRMAN DUNN: Thank you. Mr. Lehman,

 14 just stay here, and I don't think you've escaped

 15 everything. On your slide No. 4 on the CBOT wheat

 16 bases at selected locations. I thought I heard

 17 you say that you did not include some of the new

 18 delivery points that you had and that there were a

 19 lot of activities in one of those. Could you

 20 expand upon that a little bit?

 21 MR. LEHMAN: Sure, Commissioner Dunn.

 22 The location that we didn't include is the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 170

 1 Northwest Ohio 21- county territory that's had a

 2 new territory as of July of last year. And it's

 3 simply that we don't have a USDA cash bid for that

 4 location specifically. All of these other

 5 locations we're using a USDA cash bid that USDA

 6 collects and publishes to the market. So we don't

 7 have that data for the Northwest Ohio territory.

 8 My comment about being active is that we

 9 have had active deliveries in that location, and

 10 we've actually had load-outs of unit car trains

 11 from that location in a couple of the recent

 12 expirations.

 13 CHAIRMAN DUNN: Thank you. I'd like to

 14 open it up now for the Advisory Committee for any

 15 questions or comments that they may have, and

 16 we'll start and work our way around.

 17 MR. WANDS: Well, again, thank you for

 18 allowing me to speak. I'm representing the

 19 American Bakers Association, and we are users of

 20 all three of the Exchanges -- Kansas City,

 21 Chicago, and Minneapolis -- and I think what the

 22 trader, the gentleman, the floor trader of the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 171

 1 Chicago Board of Trade, I think was alluding to is

 2 the problem that we have with the marketplace.

 3 It's not necessarily convergence of the cash and

 4 futures price; what we have to deal with on a

 5 daily basis if the ever increasing volatility that

 6 we've seen in all three Exchanges.

 7 Just to give you an idea of what we have

 8 seen in the last 30 days, we've seen a 60 percent

 9 increase in our flour prices due to the

 10 volatility. And over the last 24 hours, we've

 11 seen a 15 percent increase in our flour prices due

 12 to the volatility of the marketplace. So it has

 13 caused us to drastically reexamine how we hedge

 14 our positions. For some of our smaller members it

 15 has been such a financial impact that they've

 16 simply gone out of business, and there's been a

 17 lot of consolidation.

 18 And what we keep on talking -- we've met

 19 with the CFTC before, and we've met with a number

 20 of the commissioners. What we want to keep

 21 addressing is the presence of the index funds in

 22 our marketsplace. I mean we can talk about

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 172

 1 convergence and we can talk about why the contract

 2 is not working, but I think what we should

 3 initially address is who are the new players that

 4 have come into the marketplace, and that has been

 5 the index funds.

 6 To give you a size of their presence,

 7 they own 367 percent of this year's Soft Wheat

 8 crop alone. I mean so their size is really what

 9 we think has caused the volatility in the

 10 marketplace, and we're not talking about high

 11 prices; we're talking about price moves. For

 12 example, the Chicago wheat opened up the limit

 13 today, and now it's trading up 42 cents. So it

 14 moved 20 cents in less than two hours. So to a

 15 baker that has to price flour, that is just an

 16 extremely expensive move on our part if we guess

 17 it wrong.

 18 So I would just -- I would like to see

 19 if we could limit the -- we would like to have the

 20 limit on the index funds in the marketplace and

 21 treat them as traditional speculators instead of

 22 hedgers. So --

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 173

 1 CHAIRMAN DUNN: Thank you, Mr. Wands.

 2 Next?

 3 MR. ANDERSON: Yeah, John Anderson with

 4 American Farm Bureau. I guess I think I want to

 5 follow up a little bit on what Commissioner

 6 O'Malia was talking about. In the course of that

 7 conversation, we talked a little bit about forcing

 8 convergence, and there are a number of things can

 9 be done to force convergence, and, certainly, for

 10 our members who are affected by this, convergence

 11 is a big issue. But, really, I think to talk

 12 about forcing convergence is really to focus more

 13 on a symptom and not so much on the disease. The

 14 bigger issue here is, how do we make sure that

 15 cash and futures markets both reflect the same

 16 underlying fundamentals?

 17 And as I understand the CFTC analysis --

 18 I thought it was very good -- the primary issue

 19 there seems to be that because of the delivery

 20 process, there's an option value attached to these

 21 warehouse receipts that's reflected in futures

 22 prices. I guess I'd like to hear a little bit of

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 174

 1 follow up on that. If that's the fundamental

 2 issue, the most straightforward approach to

 3 dealing with this would seem to be to change the

 4 characteristics of the warehouse receipts that

 5 give it an option value so that that's not

 6 creating this divergence between the fundamentals

 7 of the cash and futures markets.

 8 CHAIRMAN DUNN: Panelists, like to

 9 respond?

 10 MR. BORCHARDT: Uh, with respect to the

 11 warehouse receipts, I know what you're saying and,

 12 like Steve said, they utilize that in the cotton

 13 area because cotton does devalue. But I think

 14 just sitting in on the meetings and what not, I

 15 think it's still good to have the warehouse

 16 receipt as an option in Steve's case, where he has

 17 a contract on and needs to stand on the market of

 18 last resort, if he needs to, to procure the

 19 procure the wheat.

 20 I think there are other, maybe perhaps

 21 better mechanisms that can be put into place that

 22 will allow the warehouse receipts to preserve

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 175

 1 their attributes and contribute to the marketplace

 2 and yet compel convergence at the same time. And,

 3 really, what you're doing is you're, through

 4 whatever mechanism, you're allowing the front

 5 months in the case of not VSR but some variation

 6 of compelled load-out, you're forcing the futures

 7 price down to cash in the front month to what the

 8 true values are.

 9 I mean that's what the farmer's getting

 10 is the real cash price. So if you're just looking

 11 for a mechanism that would force the longs to

 12 liquidate their positions rather than carrying and

 13 compel that convergence in the front, front end of

 14 the spreads.

 15 MR. ANDERSON: If I could follow up, you

 16 know, I'd like to hear just fairly plainly what

 17 would be the consequence, operationally, for these

 18 end users if, for example, the warehouse receipts

 19 had an expiration date, for instance, an

 20 expiration that coincided with the termination of

 21 a contract month. What kind of difficulty would

 22 that present?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 176

 1 MR. CAMPBELL: Well, I think at the end

 2 of the day that would simply make a compelled

 3 load-out, right?

 4 MR. ANDERSON: The difference I see

 5 between that and a compelled load-out would be

 6 that there wouldn't necessarily be a reason that

 7 the grain would have to leave its current

 8 position; it would just be then later stored at

 9 the prevailing commercial rate as opposed to the

 10 fixed rate under the warehouse receipt. It

 11 wouldn't necessarily be a compelled load-out.

 12 MR. CAMPBELL: It doesn't move, though.

 13 It doesn't clear space, and it doesn't allow the

 14 local bases to improve. I mean it's -- that's

 15 sort of the whole function of it.

 16 MR. ANDERSON: Well, there would be more

 17 incentive to move it because the -- I see it being

 18 similar to the VSR. It would -- it VSR increases

 19 the cost of exercising that option value, and so

 20 it's less attractive to exercising and so it's not

 21 exercised as frequently, be it a different way of

 22 doing the same thing.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net 
 177

 1 MR. CAMPBELL: Look, whether a bank

 2 holds the receipt or whether a warehouseman holds

 3 the receipt, I don't know that there's really a --

 4 there's really a difference. I mean if the

 5 warehouse hold the receipt, the actual value of

 6 his grain is not going to be reduced, so, you

 7 know, the space is still full no matter sort of

 8 who's holding the receipt.

 9 If the bank holds the receipt and it

 10 loses value, then, yeah, you'll probably just put

 11 more pressure on them and that bank won't be there

 12 to stop the receipt. But the warehouseman today

 13 still have -- would still have that opportunity to

 14 roll a full carry, which is what they're doing

 15 today. I mean we saw very little deliveries on

 16 the marketplace because there's no incentive to

 17 deliver. The market's sending you the opposite

 18 signal. Why would you deliver? So the

 19 warehouseman will just do it.

 20 I mean, you know, the fact that a few

 21 banks hold some receipts and can roll them is no

 22 different. That activity would simply move to the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 178

 1 warehouseman.

 2 MR. LEHMAN: If I could respond to Mr.

 3 Anderson's question, I think one of the things

 4 that we looked at when we -- and we considered

 5 compelled load-out or modified compelled load-out

 6 when we were working on the Board of Trade

 7 contract -- some of the difficulties are in

 8 transportation. You would put the, you know, the

 9 responsibility on the take of delivery whose

 10 receipt was expiring at that option to arrange

 11 transportation, and that's not always possible.

 12 You are really forcing the long out of

 13 the market as I think Steve mentioned. And so

 14 it's really a tradeoff of the, you know, the

 15 distortions you might be causing in the

 16 transportation markets versus, you know, this wide

 17 basis. And from our view, VSR was maybe a little

 18 less onerous on the long side of the market

 19 because at least you're able to trade this spread

 20 or this opportunity. You have a maximum amount

 21 that that spread an widen over a one- year period

 22 of time, over a six-year period of time, and you

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 179

 1 can, you know, make bets. You can put your money

 2 in the market on where that spread is going to go.

 3 And I'd kind of be curious to hear

 4 Josh's comment on whether a compelled load-out

 5 contract would be more tradeable or more conducive

 6 to liquidity into third-month spreads than VSR is.

 7 MR. CURLEY: And the way I understand

 8 compelled load-out is the -- a similar effect to

 9 VSR, and there would be little reason to trade

 10 past for a month because the longs wouldn't be

 11 able to roll from one month in to the next. So my

 12 guess is it would still put the liquidity in the

 13 first option and not in deferred months. But

 14 that's just my take, and I'd, you know, maybe have

 15 to see it implemented and look at the markets and

 16 see how they react to know for sure.

 17 MS. COCHRAN: Hi, I'm Christine Cochran

 18 at the Commodity Markets Council. I really have

 19 more of a comment than a question. Our

 20 organization represents both Exchanges and

 21 Exchange users, and we've had a number of

 22 conversations related to the contract in Kansas

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 180

 1 City and also in years previous contract in

 2 Chicago.

 3 And one of the things that I'm here

 4 today to communicate is our confidence in what the

 5 process is at the Kansas City Board of Trade. We

 6 believe that the Exchange is the expert, that

 7 they're talking to their constituents and the

 8 market participants, and we believe that they

 9 should have the ability and freedom to look at the

 10 range of options to address the problem.

 11 I'm encouraged today to hear Josh make

 12 comments about trying to provide a balanced

 13 solution. We think that that is one of the most

 14 important things that they do as they go through

 15 this process is come up with a solution, which we

 16 do think there needs to be a solution, but one

 17 that is balanced: it doesn't favor the longs or

 18 the shorts.

 19 CHAIRMAN DUNN: Thank you, Christine.

 20 MS. PETERSON: My name is Dana Peterson

 21 with the National Association of Wheat Growers. I

 22 think the commissioners have a great handle on the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 181

 1 issues that we're hearing from our grower members,

 2 and I would like to just publicly thank you for

 3 your attentiveness during this past year or so,

 4 and we have been in conver- --

 5 CHAIRMAN DUNN: We don't get much of

 6 that, thank you.

 7 MS. COCHRAN: In the last year, we have

 8 been communicating very closely with the Exchanges

 9 and with the growers. Our growers are just very

 10 supportive of having convergence happen, and we

 11 appreciate all of the attention and detail that's

 12 being paid by the Exchanges in making a decision

 13 on a long-term contract, one that is -- that

 14 provides our marketplace a competitive advantage

 15 over other production regions of the world where

 16 we do have the ability to have price discovery

 17 that everyone can participate in. Thank you.

 18 CHAIRMAN DUNN: Thank you, Dana.

 19 MR. DOUD: Commissioner Dunn, Greg Doud

 20 with the National Cattlemen's Beef Association.

 21 I, first of all, want to thank Commissioner

 22 Chilton for his comments and Chairman Gensler for

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 182

 1 his comments about convergence. I couldn't have

 2 said it better myself.

 3 A couple questions I have -- one

 4 question I think you've already answered -- was,

 5 which would we prefer here in Kansas City, a

 6 compelled load-out or a cash settlement? And I

 7 think I heard that the answer to that was, Dave,

 8 with all due respect to you and all the great work

 9 you've done on variable storage rates, I think

 10 actually we're down to those, picking one of

 11 those, too, and I think we're going to have to get

 12 to that point.

 13 Nicole, my question really is for you,

 14 though. Great presentation, and with regard to

 15 these warehouse receipts I have two quick

 16 questions for you: Did the fact that we have a

 17 lot of low protein weed in Kansas City affect any

 18 of this getting clogged up?

 19 And the second question that is really

 20 the big question on my mind is that: What is --

 21 how many people are in control of these warehouse

 22 receipts? Do we have a lot of these receipts and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 183

 1 a very small, tightly held group of people, small

 2 number of hands? I'm a little concerned here that

 3 there might be a little market power at play with

 4 regard to this warehouse receipt issue in Kansas

 5 City.

 6 MS. AULERICH: Well, first to address

 7 your protein question, three is no protein

 8 specification on the Kansas City Board of Trade,

 9 so it's supposed to represent the quality of the

 10 underlying crop is why they don't have a

 11 specification on that. So that really wasn't a

 12 factor here.

 13 And, second, about the concentration of

 14 the warehouse receipts, I can't comment on that

 15 because that's proprietary information.

 16 CHAIRMAN DUNN: Come around to the other

 17 side.

 18 MR. CRYAN: Commissioner Dunn, I'm Roger

 19 Cryan with the National Milk Producers Federation,

 20 and I think the economic staff has done a good job

 21 today in previously demonstrating this issue, the

 22 wedge between the futures value and the cash value

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 184

 1 being associated with the optionality of the for

 2 storage in the contract. And it seems to me

 3 because -- the breakdown is because the warehouse

 4 receipt is not strictly -- it's not strictly the

 5 commodity, it's the combination of the commodity

 6 and that optionality.

 7 One solution is to price that

 8 optionality separately. The variable storage rate

 9 approach is a kind of a clumsy attempt to do that,

 10 but it's very indirect. It assumes a certain

 11 relationship between spread and storage value.

 12 One, it may be possible that the Exchanges could

 13 come up with some approach that would offer maybe

 14 posted rates for storage as it to be attached to

 15 the contracts at the time of the execution instead

 16 of having just an option that a lot of people

 17 don't want.

 18 So, for example, if somebody's buying a

 19 contract, if they want to carry it for six months,

 20 they can buy that option or buy that six-month

 21 storage rate; if you can separate the price

 22 discovery for the underlying -- for the storage

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 185

 1 commodity from the price discovery for the

 2 storage, you might be able to solve everybody's

 3 problem. That's all I've got, and thank you very 

 4 much.

 5 CHAIRMAN DUNN: Thank you, Roger.

 6 Edgar?

 7 MR. HICKS: I have a couple of questions

 8 for Steve. First, Steve, you've got a great deal

 9 of credibility with me. I know who you are, so --

 10 MR. CAMPBELL: Thank you.

 11 MR. HICKS: -- I say that with a great

 12 deal of respect. But I also am here representing

 13 the National Grange and Farmers of Kansas and

 14 Nebraska, and I'll get roasted if I don't ask you

 15 some of the questions.

 16 MR. CAMPBELL: Okay, fire away.

 17 MR. HICKS: All right. You mentioned a

 18 couple of times the word "massive," and you

 19 applied it to investors, and you talked about

 20 influx, and are you giving equal significance to

 21 investors in this process as you are to farmers

 22 and as people we serve?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 186

 1 MR. CAMPBELL: I'm sorry, what was your

 2 name?

 3 MR. HICKS: Edgar.

 4 MR. CAMPBELL: Edgar. Okay, I just

 5 can't read them.

 6 MR. HICKS: Maybe I should turn it down

 7 so you can't see it.

 8 MR. CAMPBELL: Edgar, I don't know that

 9 I'm weighting one versus the other, and the

 10 reality of it is forget that I'm a trader, forget

 11 -- I'm wearing an economist's hat, and all I'm

 12 saying is we have had a massive inflow for the

 13 demand for our futures contract. That demand for

 14 our futures contract has not been offset by a

 15 physical demand for our cash wheat.

 16 So, therefore, our futures contract

 17 market has responded to that demand whereas our

 18 free stocks in Hard Red Winter Wheat have grown

 19 substantially. They are -- so my point being

 20 they're not in sync. And when they have a

 21 financial futures investment type product that we

 22 sort of serve today that is going in an opposite

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 187

 1 direction of your cash market, you will have

 2 divergence. And when you then get -- you can have

 3 convergence up until you plug all your space; and

 4 once you plug all your space, you're done.

 5 MR. HICKS: Okay, you mentioned --

 6 MR. CAMPBELL: Under the current market.

 7 MR. HICKS: You mentioned laying off.

 8 You mentioned the investor laying off. What is,

 9 relative to the farmer -- I see what the farmer's

 10 laying off -- what is the spec guy -- maybe I

 11 shouldn't say that because we need him -- the

 12 index fund guy, what is he laying off? You

 13 mentioned that he's laying off. What is he

 14 actually laying off?

 15 MR. CAMPBELL: Again, I'm really not

 16 sure what --

 17 MR. HICKS: Well, I'm --

 18 MR. CAMPBELL: -- you're -- what in

 19 reference to.

 20 MR. HICKS: I'm asking you that because

 21 the index is being qualified as a hedger, so --

 22 MR. CAMPBELL: Oh, no. Listen. What

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 188

 1 you say -- okay, I'm not sure I made that comment

 2 -- well, maybe I did. Look, I mean he's taking

 3 the investor, the investor's being pulled under

 4 one umbrella, because of that he's generating

 5 what's considered commercial risk, and much like

 6 we were talking about in the previous cotton

 7 example, that commercial risk has been deemed a

 8 bona fide hedge.

 9 I'm not making comment if that's good or

 10 bad. I'm simply saying that we have now created

 11 demand which has gone to the bona fide hedge

 12 exemption status, and that's moved into our

 13 marketplace.

 14 MR. HICKS: Okay.

 15 MR. CAMPBELL: The farmer, he's laying

 16 off real risk vis-a-vis his long crop, and he's

 17 selling futures, and he's laying -- that's a

 18 traditional hedge.

 19 MR. HICKS: Okay. Jeff, you mentioned

 20 how long the contract has been around. And,

 21 traditionally, in the early provocations of the

 22 Exchange, you have examples like in Tom

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 189

 1 Hieronymus' book on the economics of futures

 2 trading which everybody, any commercial firm had

 3 to read when I came into the business. There was

 4 examples of freight rates in issues. The staggers

 5 -- deregulation, does that have anything to do

 6 with the challenges that we have now?

 7 MR. BORCHARDT: Yeah, I'm going to let

 8 Steve take that, and I think it has, but in answer

 9 to your earlier question, you were asking about

 10 the Committee and their preferences to funds

 11 versus commercials, and I think what I want to

 12 make clear here is it's irrelevant in my opinion

 13 whether -- the Committee should not base the

 14 decision on one party or another.

 15 The major point is, as the Chairman and

 16 commissioners have pointed out, you're supposed to

 17 have convergence at delivery time. The funds roll

 18 a month ahead of time, so if the funds have

 19 already rolled and they're out of the market

 20 interior, you're supposed to converge. We do not

 21 have, under these circumstances, an adequate

 22 mechanism for compelling that convergence at the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 190

 1 delivery time.

 2 And so that's what the Committee is

 3 charged with to come up with, is funds

 4 notwithstanding, there still needs to be a

 5 mechanism put into place that would not allow the

 6 basis to get that weak before some mechanism

 7 would kick in that would force the longs to

 8 liquidate their positions and for the basis to

 9 resume its normal levels accordingly.

 10 So I don't think that their based in any

 11 decision based on any particular market class, if

 12 I was reading your first question correctly.

 13 MR. HICKS: Okay. But the issue in my

 14 mind should be some of that market obligation

 15 should fall on the spreads. But like in Western

 16 Nebraska and Kansas, that obligation is being

 17 excessively put on the basis. And going to your

 18 point about the spreads, you know, as a hedger --

 19 again I'm representing farm groups here, but I'm

 20 wearing another hat, too -- as a hedger, if I

 21 don't have his confidence in those spreads, how

 22 can I take advantage of the opportunities that the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 191

 1 market today is giving us when we're at the limit,

 2 and I want to go out and take advantage of that?

 3 If I can't suck him in to take the other side of

 4 my trade, then my farmers are cooked. And I don't

 5 know what that --

 6 CHAIRMAN DUNN: I'm familiar with some

 7 of those technical terms.

 8 MR. HICKS: I don't know what -- I don't

 9 know the answer, Steve, but I just know I regard

 10 your opinion highly, but I don't think that's good

 11 enough for me to go back to Nebraska with, I

 12 guess.

 13 MR. CAMPBELL: Well, Edgar, I think

 14 we've -- and, look, there's no defense here. We,

 15 as I said in the beginning, we have seen

 16 structural changes, the market -- the Committee is

 17 dealing with those structural changes.

 18 Frankly, with all due respect, I mean we

 19 saw Chicago struggle, we saw the actions that they

 20 took. We had not at that point in time seen the

 21 level of activity toward necessarily movement on

 22 our part as far as committee and our lack of

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 192

 1 convergence on Hard Wheat; we've really seen that

 2 just over the last nine months, and we've seen

 3 that in conjunction with free stocks building to a

 4 record level. That, set aside, Edgar, we

 5 understand that there is an issue.

 6 Now, as far as, you know, as far as I

 7 think where Jeff was going, is, look, if Kansas

 8 City is trading a close to par value, and the

 9 freight back to, you know, your farmers in Western

 10 Nebraska is higher, then by default the absolute

 11 basis, you know, that could fall into this

 12 current, you know -- I mean is going to be less.

 13 MR. HICKS: But we had a period of time

 14 -- again I'm talking when I came into the industry

 15 -- we have a period of time where you knew that

 16 when you came out a year ahead that you could

 17 start, let's say corn. You knew that you could

 18 start in Central Nebraska even when that option

 19 first came on, that new crop option came on, you

 20 knew you could start at 40 under. I mean you

 21 didn't even have to have any -- you didn't have to

 22 have any -- you knew you could --

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 193

 1 MR. CAMPBELL: No, listen --

 2 MR. HICKS: You can't do that now. And

 3 you can't do that now because the guys like him

 4 that we can't get to participate.

 5 MR. CAMPBELL: Again, Edgar, I'm not

 6 defending it. I understand. I mean we as a

 7 Committee do understand that you cannot do that,

 8 and you partially can't do it --

 9 MR. HICKS: I know we can't come up with

 10 the answer. I -- Matt, I'm going to defer to you.

 11 The Commission's done three hours with what's

 12 going on in the marketplace right now, you know.

 13 I mean that's what I've heard, you know. You

 14 going to spend three hours on this when we're up

 15 the limit like this?

 16 Matt, it's your turn. We just don't --

 17 it doesn't seem like it's enough time to address

 18 this issue of what we're going through right now.

 19 It really doesn't.

 20 CHAIRMAN DUNN: Thank you, Edgar, but

 21 this is the tip of the iceberg. The Chairman has

 22 been out to Kansas, all three of the commissioners

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 194

 1 have been out there.

 2 MR. HICKS: Have you been to Nebraska?

 3 CHAIRMAN DUNN: I have not been in

 4 Nebraska recently, but I have been out and

 5 listening to folks on this issue, and this is --

 6 what we can do here is bully pulpit, and that's

 7 what I'm using today, and both these Exchanges

 8 have been bullied by me during my tenure.

 9 MR. BORCHARDT: We have the scars to

 10 prove it, if you want.

 11 CHAIRMAN DUNN: I really appreciate your

 12 coming in because my saying things to them and

 13 others saying things to them doesn't reflect the

 14 passion that you have in reflecting those members

 15 of the Grange that you represent, and I really

 16 appreciate that. And I think it's good to hear

 17 the concern for the producer out there and the

 18 impact it's having on them.

 19 With that, Matt, we'll go to you.

 20 MR. BRUNS: Thank you, Commissioner

 21 Dunn. My name is Matt Bruns. I represent the

 22 National Grain and Feed Association. I want to

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 195

 1 start with the major point, convergence matters.

 2 It matters to our groups, it's critical to her

 3 hedgers and producers in able to be confidence to

 4 hedge a risk and afford in a Futures Exchange.

 5 So far, we are pleased to see the

 6 improved performance of the CBOTs. We contract

 7 over recent contract periods. Part of the

 8 performance, improved performance, could be due to

 9 the variable storage rate, but it's probably too

 10 early to say for sure. There are other factors at

 11 work, also, and we'll be watching closely with

 12 interest as the VSR takes full effect.

 13 Now we see some challenges with

 14 convergence to the Kansas City Board of Trade

 15 Wheat Contract, and historically wide basis swings

 16 oppose challenges to producers and commercial

 17 grain hedgers. There are a number of factors at

 18 work in this market: a big Hard Red Winter Wheat

 19 crop, some quality concerns, extreme tightness of

 20 storage space, sluggish export demand, and an

 21 impact on investment capital that's, you know,

 22 come into our egg futures market.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 196

 1 These things in the Kansas City market

 2 are not terribly different, what we saw in the

 3 Chicago Board of Trade market here in the last few

 4 years. It's critically important that we

 5 reestablish the convergent as quickly as possible.

 6 We've been in close contact with the Kansas City

 7 Board of Trade to view our concerns, share

 8 information, and to discuss potential solutions.

 9 We know that KCBOT is working hard to respond to a

 10 challenge market situation to analyze the changes

 11 for their contract.

 12 As of today, the NGFA has not made

 13 specific recommendations for changes to the Kansas

 14 City contract. We have discussed several

 15 potential solutions, and we have expressed our

 16 desire to the Kansas City Board of Trade to be

 17 involved in their process to help evaluate

 18 potential changes and provide feedback.

 19 Our member companies rely on the Kansas

 20 City Board of Trade Contract. We have a lot of

 21 experience and expertise that we hope that the

 22 Kansas City Board of Trade will invite us to share

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 197

 1 as their process moves forward.

 2 Back to our core message, convergence

 3 matters, and we urge the Kansas City Board of

 4 Trade to move as quickly as possible to implement

 5 the changes that will be needed to reestablish

 6 convergence that both producers and grain hedgers

 7 rely upon.

 8 Thank you.

 9 CHAIRMAN DUNN: Thank you, Matt. Kevin?

 10 MR. SOMBKE: Hi, I'm Doug Sombke

 11 representing National Farmers Union. I'm a crane

 12 farmer in South Dakota. I appreciate the panel's

 13 presentations, and, Nicole, yours was exceptional.

 14 I think you nailed it on the head.

 15 In light of time, I have to agree with

 16 Edgar what he was saying, and also what Hayden was

 17 saying. I think the speculators have created a

 18 huge mess here for us, and I just want you to know

 19 that what Commissioner Chilton was saying is, his

 20 passion is exactly what we have. Farmers are

 21 feeling this today, and I hope that you guys can

 22 get this fixed because we are -- we're hurting,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 198

 1 and we do need the likes of the trader.

 2 So with that, I just want to say the

 3 National Farmers Union supports the efforts of the

 4 Board, but at the same time, long enough already.

 5 CHAIRMAN DUNN: Thank you, Doug. I

 6 appreciate that.

 7 MR. NATZ: Thank you, Mr. Chairman, I

 8 have nothing to add.

 9 CHAIRMAN DUNN: John, do you want to put

 10 a cotton shot in here?

 11 SPEAKER: Well, I really, really

 12 appreciate this panel. This is something that I

 13 think you can hear from the Advisory Committee,

 14 from the members of the Commission is something

 15 that we're greatly concerned on for the Exchanges.

 16 There's a lot of pressure on you to fix it. It's

 17 your contracts, but if you can't use them to

 18 hedge, if you can't use them for price discovery,

 19 then they're actually worthless. And I'd have to

 20 go back and say, why do we even have those?

 21 Thank you.

 22 MR. WANDS: Can I just add one more

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 199 

 1 thing, Chairman Dunn? I don't think we've really

 2 talked about it here too much, but we're subject

 3 -- half of our wheat is exported, so we are

 4 subject to the price of world wheat.

 5 Well, obviously, and we can about

 6 convergence but the basis levels in Hard Wheat

 7 down at the Gulf represent we need to compete on a

 8 world level. And right now, because of where the

 9 futures are and who's in the futures arena, the

 10 cash market's doing the job of what the futures

 11 should do. So that's going to continue as long as

 12 we have the entities in there, as long as we don't

 13 have those limits because we've got to sell half

 14 our wheat to the world. Has to. So --

 15 CHAIRMAN DUNN: Again, I would encourage

 16 all of you to take a look at what we're going to

 17 be doing -- am I stealing your --

 18 CHAIRMAN GENSLER: No, no, no. I was

 19 going to ask --

 20 CHAIRMAN DUNN: -- of what we're doing

 21 under the new legislation and to get on and get

 22 your input into that. Mr. Chairman?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 200

 1 CHAIRMAN GENSLER: I was just -- Jeff, I

 2 was mulling over something you said. You said six

 3 to eight weeks. So I just want to confirm, here

 4 you say it again, you think that you're not going

 5 to have it before the kids go back to school, but

 6 you're certainly going to have it before

 7 homecoming dance, before October 1st.

 8 MR. BORCHARDT: I guess what I was

 9 saying is that at the current rate of production,

 10 so to speak, to try and drive to a consensus I'm

 11 hopeful that the Committee members will be able to

 12 come to consensus 7-3, whatever it takes -- it

 13 would be nice if there were all 10 of them -- in

 14 consensus with a solution to go forward with and

 15 nail down and bring in the outside parties to

 16 bounce it off of them, and then try and work

 17 towards a -- well, I guess before bringing the

 18 parties in part of that consensus, though, being

 19 you have the other aspects that come into play --

 20 CHAIRMAN GENSLER: I wasn't really

 21 terribly interested in your process, I was

 22 interested in the deadline. Six to eight weeks.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 201

 1 MR. BORCHARDT: I'm hopeful of that, but

 2 --

 3 CHAIRMAN GENSLER: All right, I don't

 4 know what our legal authorities are. I think

 5 every one of the people in the room wants you to

 6 figure out a solution.

 7 MR. BORCHARDT: None more than -- more

 8 than --

 9 CHAIRMAN GENSLER: I'm more than hopeful

 10 that you do it in the six to eight weeks.

 11 MS. AULERICH: We're working as hard as

 12 we can.

 13 MR. HICKS: Commissioner Dunn, I have a

 14 question on -- just as comment on your Open

 15 Interest sheet. And so I guess this is your

 16 official CFTC document. Open Interest from an

 17 index fund piece, I think this is a little bit

 18 skewed because we have a lot of participants that

 19 are in and out the same day, and this isn't

 20 reflecting, and I think that's part of a lot of

 21 the problems that we're having with Fund.

 22 I think if you're going to use this

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 202

 1 chart in making a decision, somewhere it needs to

 2 say that a commercial hedger will put the position

 3 on, he may have it on for months, whereas the

 4 index fund may be five or ten minutes. And I

 5 think that skews the value of this a great deal.

 6 CHAIRMAN DUNN: Edgar, you make a great

 7 point in here, and the massive passives, as some

 8 of the CITs have been called, are the ones that

 9 stay there for a long time. But it is a whole

 10 other related problem that we have of the high

 11 frequency traders. And that, again, is something

 12 that we're looking at here at the Commission, and,

 13 you know, our Commerce Office has been working on

 14 that as well. The Chairman has them tasked with

 15 doing a few things, and it's a great point and

 16 something that is good for us to keep in mind.

 17 With the indulgence of my commissioners,

 18 I'm here. I apologize because I have run way over

 19 our time frame, but I think it's extremely

 20 important that we talk about the livestock

 21 situation, and I do want the Advisory Committee to

 22 be privy to what we are planning on doing on

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 203

 1 implementing the new legislation. So without

 2 taking a break, if we could go to the next group,

 3 or, if anybody feels like they've got to get up

 4 and leave, that's just great, go ahead and do

 5 that, except for the panelists. They can't get up

 6 while they're going.

 7 But a shrinking negotiated marked and

 8 consolidated packing industries are combining with

 9 a poorly structured and nontransparent cash market

 10 price reporting system to cause a rise in

 11 complaints and an increase in the future of

 12 contracts susceptible to manipulation.

 13 Our next panel will address some of the

 14 key issues in there. We have Harry Hild from the

 15 CFTC's Division of Market Oversight; Jay Johnson

 16 from GIPSA from USDA; Warren Preston, who is with

 17 AMS from USDA; with Reactor Group Paul Peterson

 18 from CME Group; Don Close from Texas Cattle

 19 Feeders Association; and Neil Dierks from National

 20 Pork Council. And so they are getting in place

 21 now, and soon as they do we'll ask Harry to begin.

 22 MR. DIERKS: Yes, Commissioner, I grew

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 204

 1 up about two miles -- his brother was my school

 2 bus driver, so.

 3 CHAIRMAN DUNN: Harry, are you prepared?

 4 MR. HILD: Yes.

 5 CHAIRMAN DUNN: All right, if you will

 6 kick it off, I'd greatly appreciate it.

 7 MR. HILD: Thank you, Commissioner Dunn,

 8 Chairman Gensler, and fellow commissioners. Today

 9 we'll discuss some observations in livestock

 10 markets related to price reporting and in-district

 11 trends. My comments will focus on the hog market

 12 specifically. I've prepared these comments, and

 13 views are my own.

 14 The USDA's Grain Inspection, Packer's

 15 and Stockyard's Administration is here as well to

 16 comment on this trend, and the Agricultural

 17 Marketing Service is here as well, and I believe

 18 the Chicago Mercantile Exchange is on hand next to

 19 talk more specifically about the contract itself.

 20 I will begin with a very brief

 21 description of the futures contract and how it's

 22 connected to the cash market. I'll then have a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 205

 1 very brief description of the connection between

 2 the cash and futures market, but also I'll

 3 highlight some outlier situations and market

 4 transparency issues and how those issues relate to

 5 surveillance concerns. Finally, I will conclude

 6 with some discussion of industry trends, some

 7 concentration issues, and a reference to an

 8 academic study related to these issues.

 9 The very next slide here is a screen

 10 shot of the 201 report. This is a USDA AMS report

 11 from which the CME derives the values that they

 12 use for their Lean Hog Index calculation. It's a

 13 two- to three-page report. There's a lot of

 14 information on this report, but I've highlighted

 15 the six cells that the calculation uses. As you

 16 can see, it is what they call producer-sold

 17 negotiated and producer-sold swine or pork market

 18 formula variables. There's a head count. There

 19 is an average net price and an average carcass

 20 weight. These numbers are multiplied each day.

 21 They get a value for one day. They have a value

 22 for another day, the next day, and those two are

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 206

 1 combined together. I think the CME can get into

 2 more details and question about that.

 3 But what I do want to highlight from

 4 this screen shot in this report is that it's a

 5 daily transparent report, but you can see there's

 6 a big difference between the total head count in

 7 the Negotiated category compared to the SPMF

 8 category, and that's just -- that is something I

 9 think that we'll see a little bit more detail

 10 later on. But it is important also to note here

 11 that these are net prices. These are prices that

 12 are derived from hogs that have been delivered and

 13 have been slaughtered. I'll get a little bit

 14 deeper into that later.

 15 And one final point from this slide is

 16 that in the SPMF category, it is industry practice

 17 for packers to buy hogs using long-term contracts,

 18 and each day a certain undetermined percentage of

 19 these contracts use the Western Corn Belt or the

 20 Iowa/Southern Minnesota negotiated base price as a

 21 reference base price, and we'll get into that on

 22 the next slide here.

 ANDERSON COURT REPORTING 

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 207

 1 This is the Western Corn Belt USDA

 2 Report. It's an afternoon report, and it's

 3 actually a report for July 30th. Lower down on

 4 the screen you can see that this is one of the

 5 more referenced prices and head counts in the

 6 industry. I've highlighted there that it's

 7 barrels and gilts on a carcass basis. The head

 8 count on that particular day was 4,953 and the

 9 base price range that day -- that's a range of

 10 obviously highs, lows, and a weighted average

 11 middle price -- the range that day was 75 to 8378,

 12 roughly $8.78, and the weighted average was 8149.

 13 The hog market generally trades and reports trades

 14 using these base prices. Again, the CME uses net

 15 prices for the index, but the cash market trades

 16 are base price. The base price becomes a net

 17 prices when the hogs are delivered and

 18 slaughtered. Each net price is determined by the

 19 base price and the packer's grid or matrix. Each

 20 packer has a different matrix, because each packer

 21 values different hog attributes differently.

 22 These attributes are weight, target weight,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 208

 1 leanness, and just general yield of the animal.

 2 So, each packer has his own value for those. As

 3 the hogs are processed, this base price becomes a

 4 net price. The net price accounts for the hog's

 5 yield and determines what the hog seller gets

 6 paid. The CME, again, uses these net prices to

 7 calculate their index.

 8 Before we leave this slide, I'd like to

 9 make a couple of quick points about the negotiated

 10 market. The negotiated market is spot

 11 transactions. The hogs are to be delivered within

 12 14 days. There are some other rules, but I'm just

 13 going to highlight a few. The transaction sizes

 14 in the negotiated market can be quite large, and

 15 as you can see, the head count on this particular

 16 day on this particular report was roughly 5,000,

 17 but one of the other attributes of a negotiated

 18 transaction is that negotiated transactions can be

 19 can canceled after being reported. So, in other

 20 words, the price and the head count could get into

 21 this report but the transaction could be canceled

 22 and never been delivered.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 209

 1 And packers also have choices on where

 2 to purchase negotiated hogs and how and when to

 3 report the prices. This is an afternoon report.

 4 It compiles some of the prices and head counts

 5 from a morning report, and then later on there's a

 6 full day report, so there are different times and

 7 cutoffs from which packers can choose to report.

 8 And prices can also be reported on either a live

 9 or carcass basis, and that's kind of a real

 10 deep-in-the-weeds type characterization, which we

 11 can get into later, but the point I wanted to make

 12 is that it is a choice.

 13 The next slide here shows hog

 14 procurement and pricing methods using that 201

 15 report that I used on my third slide. It's kind

 16 of a summary of the head counts, how they've

 17 changed over time. Note that the Producer-Sold

 18 category is decreasing and, most notably, that the

 19 Negotiated category has dropped off quite

 20 significantly. Currently, the Negotiated category

 21 is about 5.5 percent year to date for 2010. Also

 22 note that the Packer-Owned category is increasing.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 210

 1 Further note that as currently reported by AMS,

 2 there are a lot of hogs in the 201 report that are

 3 not included in the CME index.

 4 The next slide uses those two categories

 5 of SPMF and Negotiated. It boils out just those

 6 two categories in terms of how they changed over

 7 time. Now, this graph shows each category's

 8 percentage of the head count that went into the

 9 Lean Hog Index calculation. As you can see, the

 10 SPMF went from 78 percent of the head count in

 11 2003 and is now about 91 percent and the

 12 Negotiated category was 22 percent and is down to

 13 9 percent currently.

 14 Slide 7 -- this slides breaks into the

 15 cash transaction site. We're talking about

 16 purchase data right now. This is the Western Corn

 17 Belt 212 report. This is the afternoon report, as

 18 I mentioned, and this is kind of a medium-term

 19 graph on the range. The Purchase report

 20 information -- it shows the high, the low, and

 21 then the weighted average of the day. A point

 22 from this slide would be that the weighted average

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 211

 1 tends to be near the high of the day. Again, it's

 2 a weighted average. It's kind of a special

 3 concept here in this type of reporting, but from

 4 the surveillance perspective here, we always see

 5 that there's a range and that there is a low and

 6 so we take note of that, because, you know, on a

 7 day where the weighted average is near the high,

 8 in surveillance we see that there is always

 9 cheaper hogs available.

 10 Slide No. 8 takes that range from the

 11 Western Corn Belt, goes a little farther back, and

 12 does a 10-day moving average of that. The graph

 13 shows a 10-day moving average of the range, and

 14 that range tends to be about 10 to 15 cents per

 15 hundredweight. The graph also shows a period of

 16 outlier ranges, periods where the range exceeded

 17 15 cents, and was as wide as 20 cents per

 18 hundredweight. Periods of sustained wide ranges

 19 can lead to surveillance or transparency problems.

 20 On such days, hogs appear in great supply on the

 21 low end and in very short supply on the high end.

 22 This is the Western Corn Belt range. It's not a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 212

 1 range from the National Report.

 2 Now, an example of this range -- if you

 3 take cents as a range, as an outlier, if hogs are

 4 trading roughly 40 cents or $40 per hundredweight,

 5 a 20 cent range if you split, it means that hogs

 6 are trading as low as 30 or as high as 50. If

 7 you're buying hogs at 40 and your next purchase

 8 happens to be at 50, that's a 25 percent increase

 9 just in one transaction. So, these outlier

 10 situations, again, lend themselves to some

 11 surveillance concerns.

 12 Slide 9 again uses the Western Corn Belt

 13 purchase data but compares it to something else.

 14 It's called the carcass cutout. This is really

 15 essentially the USDA's estimate of the value of

 16 pork. The graph shows what could be called a

 17 packer margin, because it's the price of the

 18 product, which is the pork minus the cost of the

 19 input, which is the hog. Up until about February

 20 of 2008, the cost of hogs rarely exceeded the

 21 price of pork. Then you can see there was a

 22 sustained period where the cost of the hog was

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 213

 1 more than the value of the pork that was being

 2 sold. And I think there's been some recent

 3 developments in terms of the reporting of pork

 4 prices. Previously -- or currently I should say

 5 -- the reporting of pork sales is not mandatory,

 6 but I think one of the drafts of the new farm bill

 7 or one of the new suggestions, which Warren might

 8 mention, is that it's being proposed that pork

 9 price reporting become mandatory. So, this is a

 10 situation that was in the past that could remedy

 11 itself in the near future.

 12 Slides 10 and 11 kind of get into some

 13 concentration issues. This is a pie chart of some

 14 of the larger packers in the industry from

 15 estimates that we took in 2009. It think Mr.

 16 Johnson of Packers & Stockyards has some comments

 17 about this, so I'll be brief on this slide. As

 18 you can see, the names of the major participants

 19 are Smithfield, Tyson, Swift, Cargill, and Hormel;

 20 and of those big one, two, three, four, five

 21 packers, I believe Smithfield is -- they're all

 22 pretty -- they all have some degree, I believe, of

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 214

 1 vertical integration, but I think Smithfield has

 2 the greatest percentage of vertical integration.

 3 And, again, slide -- this is slide 11 -- shows how

 4 the four-firm concentration has changed. Other

 5 than some of the statistics that Mr. Johnson will

 6 mention, I would add to this slide that in 1997 is

 7 when the CME first listed the Lean Hog Index

 8 futures contract, and there's been some

 9 significant changes in the four-firm concentration

 10 since then.

 11 But before I defer to Packers and

 12 Stockyards, I would like to make one final

 13 reference to the following. In the fall of 2009,

 14 there was an academic study by Gomez, Frank,

 15 Kunda, and Garcia, which was published in the fall

 16 2009 Review of Futures Markets. It was published

 17 by Kent State University. Academics as well as

 18 the public have taken note of the recent cash

 19 price reporting outliers, as well as the industry

 20 concentration trends. This study highlighted an

 21 increase in the basis variability of the cash hog

 22 market relative to the lean hog market. The study

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 215

 1 compares basis behavior, basis forecasting, and

 2 marketing strategies for both physically delivered

 3 hog futures and cash-settled hog futures, the

 4 difference between the two regimes, the physically

 5 delivered and the cash settlement period. They

 6 concluded that among other things, and I quote,

 7 "basis level and variability increased in the cash

 8 settlement period." The study also finds, "The

 9 use of futures generally reduces the variability

 10 in cash prices, but it's the ability to do so that

 11 has declined during the cash settlement period due

 12 to an increased basis variability." The study

 13 suggests that a possible cause of this behavior is

 14 the shrinking negotiated market and these industry

 15 concentration and vertical integration trends.

 16 I will conclude my remarks, and if

 17 there's any questions specific to the slides that

 18 I've presented, I can take those. If not, we've

 19 got Jay Johnson here from the Packers and

 20 Stockyards Administration.

 21 CHAIRMAN DUNN: Thank you. And, Jay,

 22 welcome. Jay and I had worked very closely in the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 216

 1 past when I was Undersecretary for Marketing

 2 Regulatory, as with Warren. These are two guys

 3 that I have a lot of trust and confidence in, and

 4 I really appreciate them being here, and I note

 5 that Chris Sarcone from Ag Marketing Service is

 6 here from Public Affairs. So, I appreciate USDA

 7 sending us their very, very best here. And with

 8 that, gentlemen, if you would give your

 9 presentations.

 10 MR. JOHNSON: Thank you, Commissioner

 11 Dunn and your fellow commissioners for inviting

 12 the Grain Inspection, Packers and Stockyards

 13 Administration to join you today to discuss the

 14 structural issues in the pork industry.

 15 Examination of the pork production

 16 sector shows that producers raising more than

 17 5,000 hogs per year produced 61 percent of the

 18 market hogs in this country. Producers raising

 19 more than 2,000 hogs per year produced 85 percent

 20 of the hogs. We have some truly large producers

 21 in this country. In 2009, the top 10 producers

 22 owned approximately 2.3 million, or 40 percent, of

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 217

 1 the nation's sows that raised about 46 million

 2 pigs. The top 20 producers have 2.8 million sows,

 3 or about 48 percent of the nation's sow herd.

 4 Successful Farming magazine's annual

 5 survey of pork producers shows that Smithfield

 6 Foods in Smithfield, Virginia, was the largest

 7 producer in 2009 with over 922,000 sows, which

 8 represents about 16 percent of the U.S. herd.

 9 Triumph Foods, St. Joan, Missouri, was second with

 10 371,500 sows; Seaboard Foods, Shawnee Mission,

 11 Kansas, was third with 213,600; and Iowa Select,

 12 Iowa, Iowa, was fourth with 152,500 sows. As a

 13 point of reference, each sow produces about 19.5

 14 pigs per year. The top three hog producers are

 15 also included in the list of the top 10 pork

 16 slaughter firms. Currently, the top four

 17 slaughter firms have a market share of

 18 approximately 65 percent, or also known as the

 19 four-firm concentration ratio. In alphabetical

 20 order, these firms are Cargill, Smithfield, JBS

 21 Swift, and Tyson Foods.

 22 The hog slaughter industry has become

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 218

 1 significantly more concentrated over the past 30

 2 years with the majority of the structural changes

 3 resulting from mergers and acquisitions in the

 4 industry. In 1980, the four-firm concentration

 5 ratio, which measures the total market share of

 6 the largest four firms in the industry, was 34

 7 percent.

 8 By 1990, the ratio rose to 40 percent

 9 and then to 56 percent in 2000. By 2003, the

 10 four-firm ratio had risen to 64 percent and has

 11 remained relatively steady since that time. Pork

 12 production and slaughter is very geographically

 13 concentrated in the Corn Belt as well as in the

 14 Mid-Atlantic Region, which is comprised of

 15 Virginia and North Carolina. There are other

 16 isolated areas of production in Pennsylvania,

 17 Utah, Oklahoma, and Texas. Probably the largest

 18 change in the hog industry in the past 15 years is

 19 how hogs are marketed. Today a very large

 20 percentage of hogs are sold on a formula basis or

 21 other type of purchase arrangement as opposed to

 22 on a negotiated basis.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 219

 1 In 2009, formula or purchase

 2 arrangements accounted for 62.2 percent of all

 3 hogs slaughtered. Most of the hogs sold with the

 4 formula or purchase arrangement are committed via

 5 long-term contracts. The formula-basis hogs

 6 generally use a publicly available price series as

 7 a basis for determining their price. The most

 8 widely used is the Iowa/Southern Minnesota

 9 Afternoon Report.

 10 The popularity of contracts -- they

 11 increased significantly after the collapse of the

 12 hog market in 1998 and 1999. During the period,

 13 prices were as low as $8 a hundredweight, because

 14 there was not sufficient slaughter capacity to

 15 handle the supply of market-ready hogs. As a

 16 result, many producers were determined not to ever

 17 get in a position again where they did not have an

 18 assurance of shackle space to handle their

 19 production. By entering into long-term contracts

 20 or agreements, producers are guaranteed shackle

 21 space by the packer and, likewise, the packer is

 22 guaranteed a supply of hogs. A couple of plants

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 220

 1 were even opened by producer-owned cooperatives

 2 after that time.

 3 In addition, the number of packer-owned

 4 hogs has increased from 19.5 percent of all hogs

 5 slaughtered to 31 percent in 2009. Currently,

 6 approximately 3 percent to percent on a weekly

 7 basis of all hogs marketed are on a negotiated

 8 basis. Of this amount, approximately one-third

 9 are sold on a live-weight basis and two-thirds on

 10 a carcass- weight basis. In 2002, the number of

 11 hogs marketed on a negotiated basis was

 12 approximately 15 percent.

 13 In concluding, once again I would like

 14 to thank Commissioner Dunn and your fellow

 15 commissioners for allowing GIPSA to come before

 16 you today to discuss the current structural issues

 17 in the pork industry.

 18 CHAIRMAN DUNN: Thank you very much,

 19 Jay. Warren?

 20 MR. PRESTON: Thank you, Commissioner

 21 Dunn, and I appreciate the confidence that you

 22 have in us. I've had to edit my remarks here, and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 221

 1 I'm no longer going to say good morning,

 2 Commissioner Dunn; I'll say good afternoon,

 3 Commissioner Dunn, your fellow Commissioners, the

 4 members of the Agricultural Advisory Committee,

 5 and all the guests. I appreciate the opportunity

 6 to represent USDA's Agricultural Marketing Service

 7 at this meeting today.

 8 You may recall in 2006 I had the

 9 privilege to speak before this committee in a

 10 similar meeting on the role of price discovery

 11 markets in USDA programs during a session on the

 12 economic and market implications of thinly traded

 13 priced discovery markets. It seems that we've

 14 returned to that same theme today. In the

 15 meantime, negotiated cash trade on the markets

 16 that we report continues to become thinner as

 17 evidenced by decreasing percentages of negotiated

 18 spot or cash-market trades.

 19 My purpose here today though is not to

 20 speak as an economist but rather to provide an

 21 overview of how we at AMS provide price

 22 transparency to the marketplace through both

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 222

 1 Voluntary and Mandatory Livestock Reporting

 2 Programs.

 3 USDA's Livestock and Grain Market News

 4 consists of about two dozen field offices with

 5 about 75 federal market news reporters. Our

 6 Livestock Mandatory Reporting Program is carried

 7 out in two of those offices -- Des Moines, Iowa,

 8 and St. Joseph, Missouri. For our voluntary

 9 programs, we also have cooperative agreements with

 10 29 states through which we train and supervise

 11 about 130 market reporters employed by those

 12 states. These cooperative agreements enable us to

 13 leverage our resources to provide greater breadth,

 14 in depth for livestock and grain market reporting,

 15 particularly at auction markets that might be of

 16 primarily local or regional interest.

 17 However, continuing state budget

 18 shortfalls are threatening these state-funded

 19 programs. In 2008, for example, Wisconsin

 20 terminated its state market news program, and as a

 21 result we no longer provide coverage of livestock

 22 auctions in that state. As we monitor this

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 223

 1 situation, we will continue to deploy our

 2 resources to provide priority for markets of

 3 regional or national interest.

 4 One of the most important roles for our

 5 supervisors for our Voluntary Market News Program

 6 is to ensure uniform reporting of the commodities

 7 that we cover. For the voluntary side, this means

 8 that we provide continual training on live animal

 9 evaluation. For example, when a state or federal

 10 market news reporter covers an auction market, we

 11 want a feeder steer report as a large frame number

 12 2 thickness animal to represent the same

 13 characteristics whether that steer is reported at

 14 an auction in the far southeastern part of the

 15 country in Florida or in the far northwestern part

 16 of the country in Washington. That way, when

 17 reports are compared across regions or over time,

 18 users have the assurance that the categories of

 19 animals reported are similar in terms of class and

 20 grade.

 21 Our mandatory reporting program operates

 22 quite a bit differently than our voluntary

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 224

 1 programs. The Livestock Mandatory Reporting Act

 2 of 1999 was enacted in October of that year, and

 3 the first reports under the program were released

 4 in April of 2001. Under the Mandatory Reporting

 5 Program, larger packers were required to report

 6 their transaction level data to us on cattle, hog,

 7 and sheep and lamb purchases as well as box beef,

 8 box lamb, and lamb carcass sales; and, as Harry

 9 mentioned, wholesale pork cuts are not currently

 10 included as part of the mandatory program. Larger

 11 lamb importers are also required to report to us

 12 their lamb imports. Processing plants

 13 slaughtering at least 125,000 head of cattle or

 14 100,000 head of hogs per year are required to

 15 report livestock purchase information to us, as

 16 well as packers that slaughter at least 200,000

 17 head of sows and boars regardless of individual

 18 plant size. In all, we have about 115

 19 establishments that report to us under this

 20 mandatory program. 

 21 Plants slaughtering steers and heifers

 22 report purchase transactions to us at least twice

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 225

 1 a day, and plants slaughtering barrels and gilts

 2 report purchases at least three time daily.

 3 There's also some weekly reporting and some

 4 additional daily reporting that sometimes bumps

 5 those numbers up on particular days.

 6 Under the Mandatory Reporting Program,

 7 within one hour following the data submission

 8 deadlines, we validate the data received from

 9 packers and lamb importers to prepare and

 10 disseminate over 100 daily, weekly, and monthly

 11 reports. These published reports cover an

 12 estimated 77 percent of slaughter cattle, 93

 13 percent of box beef, 95 percent of slaughter hogs,

 14 60 percent of slaughter sheep, 41 percent of box

 15 lamb, and 26 percent of the carcass lamb markets.

 16 Each entity required to report under livestock

 17 mandatory reporting is audited at least twice a

 18 year. Our auditors examine randomly selected

 19 transactions to ensure that the information is

 20 reported to us correctly, timely, and completely.

 21 Tabulations or the results of our compliance

 22 visits are posted quarterly on our website, and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 226

 1 beginning in 2009 we also began posting monthly

 2 summaries of excluded transactions. These are

 3 transactions that would be omitted from our public

 4 reports at the discretion of our market news

 5 reporters. For example, in the process of

 6 validating transaction-level data, a reporter may

 7 market transaction to be excluded from publication

 8 for price aberrations, notably lower or higher

 9 than the bulk of the market due to discounts for

 10 premiums, for weight, quality, yield, dressing

 11 percentage, inferior livestock, or mixed classes

 12 of livestock in the same lot. A review of our

 13 excluded transaction summary shows that few

 14 transactions are omitted, and when there are

 15 transactions excluded, the impact on our weighted

 16 average prices is minimal.

 17 In addition to our standard published

 18 reports, we have launched two new items to make

 19 our information more readily available and easy to

 20 understand. First, we now have a growing number

 21 of reports that are formatted for mobile devices,

 22 such as cell phone and PDAs. Users who have

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 227

 1 subscribed to these reports receive concise

 2 summaries of key information from some of our most

 3 popular reports. And I have little cards here if

 4 anyone's interested to pick up that tells you

 5 where to go to sign up for the mobile reports.

 6 Secondly, just in the last month we

 7 released our direct slaughter cattle reporting

 8 dashboard. This dashboard was created as a result

 9 of a directive to the Secretary from the 2008 Farm

 10 Bill, and this interactive tool enables users to

 11 visualize key cattle market information in charts,

 12 in tables that can be customized and easily

 13 downloaded for further analysis and presentation.

 14 Links to both the mobile reports and the cattle

 15 dashboard can be found in the livestock market --

 16 in the Livestock and Grain Market news section of

 17 the USDA market news portal at

 18 marketnews.usda.gov.

 19 On a final note, I'd like to make the

 20 Committee aware that the Livestock Mandatory

 21 Reporting Act does expire on September 30th of

 22 this year. Bills have been reported by both the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 228

 1 House and the Senate Agricultural Committees to

 2 renew the statute for another five years. The

 3 House and Senate Bills are identical, and in

 4 addition to reauthorizing mandatory reporting,

 5 they would also require mandatory reporting of

 6 wholesale pork cuts and add weekly pork export

 7 reporting, as well as require electronic reporting

 8 to conduct the Mandatory Dairy Product Information

 9 Reporting Program. We believe that continuation

 10 of the Livestock Mandatory Reporting Program in

 11 addition of wholesale pork reporting to the

 12 program are important to provide transparency and

 13 full information to all market participants.

 14 Thank you for your time, and I will

 15 welcome any questions that the Commission or the

 16 Advisory Committee may have.

 17 CHAIRMAN DUNN: Thank you, Warren. I

 18 must say that Harry and I have discussed the new

 19 dashboard, and it's really a great new asset for

 20 all of us to use, and so kudos to you and the

 21 Department in putting that up.

 22 Mr. Peterson, could you comment on the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 229

 1 CME Group and how this affects your contracts

 2 please.

 3 MR. PETERSON: Certainly. Thank you

 4 very much, and we appreciate the opportunity to be

 5 here.

 6 I was asked to actually cover, in

 7 addition to the hog issues that Harry outlined, to

 8 cover the other livestock area, so I've got quite

 9 a bit of material to cover, so I'm going to go

 10 through it rather quickly, and would be --

 11 CHAIRMAN DUNN: We do have your written

 12 pieces.

 13 MR. PETERSON: Yes, you do.

 14 CHAIRMAN DUNN: And --

 15 MR. PETERSON: Yes, you do, so --

 16 CHAIRMAN DUNN: And if you can hit the

 17 high points, we'd appreciate it.

 18 MR. PETERSON: I will hit the high

 19 points. I will do that.

 20 CHAIRMAN DUNN: Thank you very much,

 21 Paul.

 22 MR. PETERSON: Okay, and Harry, you're

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 230

 1 going to drive.

 2 MR. HARVEY: (Off mic)

 3 MR. PETERSON: Okay. Okay, just by way

 4 of background, CME offers futures and options

 5 contracts on three major classes of livestock --

 6 live cattle, which is slaughter-weight steers;

 7 feeder cattle, which are partially grown steers

 8 which are destined for a feed lot where they will

 9 be fed to slaughter weight, so that's sort of an

 10 intermediate category; and then lean hogs, which

 11 is slaughter-weight barrels and gilts. Especially

 12 I want to highlight the difference between live

 13 cattle and feeder cattle. That always seems to

 14 lead to a lot of questions.

 15 Originally all three of these contracts

 16 were virtually clones. They had almost identical

 17 contract specifications, and that's because when

 18 the live-cattle contracts started in 1964 when the

 19 plans came to start what was then the live hogs in

 20 '66, they simply took the live- cattle contract

 21 and used that as a template. Likewise, when

 22 feeder cattle came along in '71, that served as

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 231

 1 the template once again. But over the years,

 2 because of differences in these different markets,

 3 it was necessary for those contracts to diverge,

 4 and today they are all substantially different.

 5 Only live cattle is still physically delivered.

 6 Both lean hogs and feeder cattle are cash settled.

 7 However, all three of these are highly dependent

 8 on the USDA AMS data and personnel.

 9 Briefly, to go through the live cattle,

 10 as I said it's a live-delivery process.

 11 (Inaudible) delivery unit is 40,000 pounds of

 12 steers. Final settlement is by physical delivery

 13 in two methods. They can either be delivered live

 14 to one of thirteen delivery points where they're

 15 graded by Market News personnel -- USDA personnel

 16 -- or they can be delivered to one of fifteen

 17 packing plants where they're graded by meat- 

 18 grading personnel, both under USDA.

 19 The interesting point in live cattle is

 20 that the value of each animal or carcass is

 21 determined using published market-based premiums

 22 and discounts published by USDA Market News. From

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 232

 1 these we get the quality grade differentials for

 2 prime choice select and so forth. The yield grade

 3 differentials for yield grade 1, 2, 3, 4, 5 and

 4 also for carcass deliveries at the packing plants

 5 we also get differentials for light and heavy

 6 carcasses and condemned livers. So, the result is

 7 virtually any steer within the allowable weight

 8 range is deliverable, and this whole evaluation

 9 process, while it may seem rather complex on the

 10 surface of it, it's actually consistent with the

 11 grid or value-based marketing processes that are

 12 widely used in the cash market for slaughter

 13 cattle.

 14 These various premiums and discounts

 15 come from a variety of USDA reports. I've

 16 detailed that on -- I believe it's slide 6 of your

 17 deck, so with the information that comes from each

 18 of those reports I won't belabor that point. In

 19 short, this has been a very successful process,

 20 and volume has grown. Recently -- actually, I

 21 believe it was in May -- we set an all-time record

 22 for volume and also had record open interest as

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 233

 1 well, so that's all been very encouraging.

 2 Shifting to feeder cattle for a moment,

 3 here is one where final settlement is by cash

 4 settlement to the CME Feeder Cattle Index. Feeder

 5 cattle futures -- there's actually the oldest

 6 cash-settled agricultural contract. It was

 7 converted to cash settlement way back in 1986 when

 8 physical delivery proved to be unworkable.

 9 In the case of feeder cattle, the Cash

 10 Settlement Index -- it's calculated by the

 11 exchange. It's a seven-day weighted average

 12 price. In other words, total dollars divided by

 13 total pounds, and it's calculated from all

 14 auction, direct trade, video sale, and internet

 15 sale transactions that are reported as weighted

 16 averages by USDA AMIs from a 12-state region, and

 17 those states are listed below. This index is

 18 designed to reflect a broad cross section of cash

 19 market transactions for feeder steers during the

 20 fall and springtime when we have peak marketing

 21 runs. The index includes reports from

 22 approximately 120 locations in these 12 states,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 234

 1 and this is on a week, because the feeder cattle

 2 transactions, the feeder cattle auctions, tend to

 3 occur on a weekly basis, so it's a once-a-week

 4 affair. Therefore, we have a seven-day index so

 5 that as new information comes in, old information

 6 drops out. In 2009, this covered almost 1.6

 7 million head that were used in that index

 8 calculation.

 9 These are voluntary reports. Earlier

 10 Warren made the distinction between mandatory and

 11 voluntary. These are voluntary reports for the

 12 simple fact that the mandatory reporting system is

 13 set up to capture information collected from

 14 packers. Since these are the intermediate stage,

 15 they haven't yet made it to the packing plant.

 16 It's necessary to collect this on a voluntary

 17 basis, and that's done by the market reporters at

 18 auction facilities and various other venues.

 19 We use a transparent calculation

 20 process. Again, it's performed by exchange staff.

 21 We post the results on the CME website each day

 22 with the complete calculation, along with a long

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 235

 1 history of historical data, and there's a

 2 surprising number of individuals who conduct

 3 parallel calculations and basically double check

 4 our figures. So, again, it's a very transparent

 5 process open and easily reproducible.

 6 Looking at the average daily volume and

 7 open interest, you can see the seasonal patterns

 8 in marketings are matched by the seasonal

 9 variations in volume, and on the open interest

 10 we've seen a recent upswing in open interest.

 11 So, finishing up with lean hogs. Here

 12 again, this is a cash-settled contract. This

 13 one's settled to the CME Lean Hog Index. This is

 14 the largest cash-settled agricultural contract.

 15 We converted to cash settlement in 1997 in

 16 response to some structural shifts in the hog

 17 industry. These shifts included a big move

 18 towards carcass basis pricing rather than live

 19 animal pricing.

 20 In addition, we were losing our delivery

 21 facilities. We had had a number of terminal

 22 markets close, and because the industry was moving

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 236

 1 from sales through terminal markets or buying

 2 stations to sales direct to packers, that movement

 3 to a terminal market was actually taking hogs out

 4 of their normal market flows. This was

 5 inefficient, and it was clear that we needed to

 6 move. So, the result was conversion to cash

 7 settlement in 1997. We have made a number of

 8 improvements and adjustments to that since '97,

 9 which I'll talk about in a minute, but basically

 10 the Lean Hog Index was modeled after the Feeder

 11 Cattle Index but with several important changes.

 12 It's a 40,000-pound contract, keeping it

 13 consistent with the old live hog contract, but in

 14 terms of the calculation, here is a two-day

 15 weighted average -- two-day rather than seven-day

 16 because the hog market is much more volatile and

 17 we did not want it to be burdened by some stale

 18 prices or other outdated information.

 19 As Harry indicated, we use net slaughter

 20 prices. This is not the base prices that he

 21 talked about. These are net slaughter prices that

 22 include all premiums and discounts, so this

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 237

 1 reflects the final payment by the packers to the

 2 producers, and it's for barrels and gilts. We use

 3 negotiated and swine and pork market formula

 4 transactions from that 201 report that he put up

 5 earlier. The reason we use those two categories

 6 is those are the two that are best suited for this

 7 process, and they also represent the cleanest sort

 8 of data. These represent approximately 50 percent

 9 of all the hogs marketed, and there are some good

 10 reasons not to include some other categories in

 11 there -- for example, packer-owned hogs, which I

 12 believe were something like 31 percent of the

 13 total. That's not an arm's length transaction, so

 14 that's not something that we would want to include

 15 in the index.

 16 The index is, again, designed to reflect

 17 final payments from packers to producers and it's,

 18 again, a transparent calculation process performed

 19 by exchange staff. All the results are posted

 20 each day on the website, and it's a totally open

 21 and reproducible process.

 22 I would also add on all of these cash

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 238

 1 settlement calculations the hogs and the feeder

 2 cattle, as well as the reports that we use for the

 3 live cattle delivery adjustments. We pull those

 4 down from the USDA AMS website just like everybody

 5 else. There's no special arrangements. We don't

 6 receive any non-public information from them. We

 7 go in and grab them off the website just like

 8 everybody else does. So, it's consistent across

 9 the board.

 10 In terms of volume, the volume has

 11 recovered recently. We were up 15 percent for the

 12 first half of 2010 versus the same period a year

 13 ago. There was a very nasty drop-off -- you can

 14 see in the middle of that chart on page 16 -- and

 15 that was largely traceable to this very ugly

 16 collapse in the hog market. Neil is nodding his

 17 head. It was just a brutal period for a couple of

 18 years, and that really hurt our volume. But,

 19 fortunately, things have turned around and are on

 20 the upswing, and we hope it continues.

 21 Likewise, on the open interest side, you

 22 can almost see where the bad times hit on page 17.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 239

 1 Things dropped off dramatically but have been on

 2 the upswing.

 3 So, just in summary, each of our three

 4 livestock contracts in the final settlement

 5 processes we use is different. These reflect the

 6 unique needs and different cash market practices

 7 of each commodity. All three of them are highly

 8 dependent on USDA AMS data and personnel, whether

 9 it be for grading or for cash settlement purposes

 10 or for other adjustments. CME Group is one of

 11 many consumers of these data. We are not a

 12 producer of the data. We are a consumer, and

 13 these data are used to create the indexes on which

 14 these contracts are based.

 15 And, finally, the underlying livestock

 16 markets have detailed data on actual transactions.

 17 This is a big difference from, for example, the

 18 grain markets or the cotton markets. I think we

 19 heard today how difficult it is to get anything

 20 besides elevator bids or truck bids or things like

 21 this. Here we have actual transaction data --

 22 actual dollars that change hands between buyer and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 240

 1 seller -- which gives you a much better, much more

 2 accurate measure of actual economic value, and as

 3 a result these are -- because of the better price

 4 data as well as the wide coverage that we have,

 5 the wide geographical area and the different

 6 categories that these can be divided up in, we

 7 have a high degree of detail which is extremely

 8 useful in monitoring contract performance.

 9 So, with that, thank you for your time

 10 and would be happy for any questions.

 11 CHAIRMAN DUNN: Thank you, Paul, and we

 12 will have some questions I can guarantee.

 13 If we can now move to Don Close to talk

 14 about the perspective from the Texas Cattle.

 15 MR. CLOSE: Good afternoon,

 16 commissioners, remaining counsel members. Thank

 17 you for the opportunity to be here today.

 18 My role with the Cattle Feeders is

 19 market director, and the Texas Cattle Feeders

 20 represents cattle feeders and feed yards in the

 21 Texas, Oklahoma, and New Mexico feeding area. Our

 22 members will market just over 51.2 million cattle

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 241

 1 annually. That represents just under 30 percent

 2 of the fed cattle supply in the United States. A

 3 primary service that my group provides to our

 4 members -- we start off each Monday morning, and

 5 we will canvass members to get an idea from them

 6 of how many cattle they have on their show list

 7 and their formula list each week. We'll compile

 8 that data and have it reported by 10:30 a.m.

 9 central time on Monday mornings not only to our

 10 members but to the wire services, and that total,

 11 on a typical week with the two different sources,

 12 will be between 75 and a 100,000 cattle.

 13 Initially, when those numbers are released on

 14 Monday, we will start canvassing our members of

 15 what their communication is with the packer buyers

 16 as they get to their feed yards and evaluate their

 17 show list every week, and when they start to bid

 18 on cattle we assimilate that information and turn

 19 it around to our members as rapidly as possible.

 20 That goes on to whenever in the week that trade

 21 starts to take place. Once trade is started, we

 22 have members calling in, reporting to us both the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 242

 1 volume of cattle traded and the price, and we will

 2 turn that information around as rapidly as we can,

 3 and so in a typical week cash trade may last

 4 between an hour, hour and a half, and to get that

 5 volume of cattle reported in that time, it's a

 6 very active period in our office I can tell you

 7 that. But once that's done, we then will total --

 8 at the end of the week we will total how many

 9 cattle have been sold and marketed, and we will

 10 match that against that initial show list to show

 11 just what our carryover is at the end of the week.

 12 Now, I think there's two points to going

 13 through all this detail. The first is I think it

 14 clearly demonstrates that the price discovery

 15 process is alive and well. The second part of

 16 that is our service is probably the closest

 17 replication to the AMS mandatory system that is

 18 out there, and I can attest to the fact that at

 19 the end of the week our cash price and that

 20 reported by AMS will not differ by more than 1 to

 21 3 cents per hundredweight on any given week. So,

 22 we're using that as a benchmark number, and it's

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 243

 1 extremely tightly correlated.

 2 Before I go on with the AMS Group, Mr.

 3 Preston, the branch office in St. Joe, the Meats

 4 Office in Omaha, and all the field offices, I want

 5 to give them every compliment. They are extremely

 6 cooperative in working with us and answering any

 7 questions that we have and working with us in any

 8 way they can.

 9 When you look at the mandatory price

 10 reporting service, I certainly don't think that

 11 any issues with the mandatory is due to a lack of

 12 information, nor do I think there are issues with

 13 the timeliness with the twice-a-day reports we get

 14 from packers. I think they're handling an

 15 enormous, mind-boggling amount of information and

 16 they get it turned around at breakneck speeds.

 17 I do think that we can see some modest

 18 changes and recommendations that would make the

 19 system more transparent, make it somewhat more

 20 user friendly, and with those I would like to go

 21 in with -- we would like to see a report created

 22 that shows daily the intensions of all

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 244

 1 non-cash-traded cattle that are committed for

 2 slaughter for at least seven days forward. This

 3 report would be a replacement for the existing

 4 system that is intended to show a forward supply

 5 of the all cattle committed all/cattle delivered

 6 system that's -- it's just so aggregated it's

 7 difficult to pull out the detail that we're trying

 8 to get.

 9 We would like to see AMS provided with

 10 the flexibility to request additional information

 11 as needed on a timely basis and largely seasonal.

 12 Two examples of this would be currently with the

 13 cattle imported from Mexico. Our members are

 14 having to sell those cattle at a $40-a-head

 15 discount. We would like to see the question

 16 picked up as is it a Mexican or Canadian animal

 17 and, in turn, if that is true what is the

 18 discount? Another good example would be

 19 seasonally, typically in the spring, with the

 20 Japanese deal we'll have a problem with some

 21 30-month cattle, and when we get into those

 22 30-month cattle they'll trade at typically about a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 245

 1 $15 a 100 discount, but that price varies. But

 2 those are two examples of how just a little bit

 3 more information on that packer questionnaire each

 4 day could provide our members significantly more

 5 detail.

 6 We would like to see the transfer of

 7 responsibility to collect the retail price scan

 8 data to AMS and provide them with adequate funding

 9 to collect and analyze and report that

 10 information. I will remind this panel that that

 11 retail scan data was originally part of mandatory

 12 price reporting and it fell between the cracks

 13 along the way, and that's very valuable

 14 information to us in measuring that relationship

 15 of farm-to-retail prices.

 16 We'd like to see and remove the existing

 17 category in the Premiums and Discounts Schedule.

 18 It currently reads "Carcasses weighting in excess

 19 of 1000 pounds." We would like to make a small

 20 change there and have a category of 1000 to 1050

 21 and then "Carcasses weighing 1050 and over."

 22 There's two reasons there. One is because of the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 246

 1 current live weights and yields on these cattle,

 2 we can have a 1000 to 1050 carcass that a

 3 legitimate carcass. If he gets over 1050, he

 4 really falls outside the grid. So, it impacts our

 5 cash market, but it also affects the delivery

 6 process with the CME. So, just that small change

 7 would make a big improvement.

 8 We would like to see --

 9 CHAIRMAN DUNN: Just a point of

 10 clarification here and, Paul, CME does

 11 periodically change its weights. Is that correct?

 12 MR. PETERSON: Yes. Yes. In fact, we

 13 just recently changed them for the October 11 and

 14 beyond, so, yes, we change them periodically based

 15 on market trends.

 16 MR. CLOSE: And I further share that

 17 Paul was in communication with us and asked for

 18 our input when they made those changes.

 19 We'd like to see -- develop through USDA

 20 -- can collect, analyze, and report market price

 21 data relevant to mandatory country of origin

 22 labeling for feeder cattle, live cattle, wholesale

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 247

 1 beef, and HRI beef sales. I'll say again because

 2 of those imported cattle, our members are selling

 3 at a $40-a-head discount, but because there's no

 4 mandatory reporting on where that product goes

 5 into the HRI business, we're not convinced that

 6 the packers are suffering a $40-a- head expense in

 7 trying to handle those cattle. So, we would like

 8 to have the data to work on that one.

 9 And then the last point I would make is

 10 because of the recovery in beef exports and larger

 11 exports and recovery of exports since the BSE

 12 occurrence in December of '03, I think it's

 13 critically important that we get an expanded

 14 recovery of short-term export sales and imports

 15 that we can more timely measure that flow of

 16 product in and out of the whole S&D balance table.

 17 And by implementing these changes and mandatory

 18 would make it more user friendly and would provide

 19 a needed degree of flexibility that would enable

 20 NPR to be much more responsive in improving the

 21 transparency for all market participants without

 22 radically disrupting the entire marketplace.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 248

 1 Thank you very much.

 2 CHAIRMAN DUNN: Thanks very much, Don.

 3 I appreciate that.

 4 Neil, let's hear from the pork side.

 5 MR. DIERKS: Thank you, Mr. Dunn. If

 6 it's okay with you, I submitted written comments,

 7 that you have, and I would just as soon short it

 8 up, take a hint, and maybe move on and give

 9 everybody time for questions.

 10 A couple of things. One -- and actually

 11 I was told this. I'm going to tell you about

 12 price reporting, not structure but it's going to

 13 be difficult to not talk about the structure of

 14 the industry as we talk about reporting, and I

 15 liken back hearing Mr. Farley this morning when he

 16 talked a about he never wanted to see his industry

 17 basically have his market short the entire

 18 production in the industry in a three-day period

 19 of time.

 20 Commissioner, Dunn, unfortunately I know

 21 you were in place at USDA, and I was working with

 22 producers in the fall of 1998 where we saw

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 249

 1 literally for three weeks a panic done differently

 2 but we swamped our production capacities, and

 3 that's where Mr. Johnson talked about $8 hogs.

 4 The point that went with that is that that is, as

 5 he said, a major driver for why producers have

 6 chosen to look at other marketing ideas as far as

 7 to ensure and deal with some of the risk in the

 8 marketplace, which is taking hogs out of the spot

 9 market.

 10 Now, in my comments I have reference to

 11 the fact that our counsel and our committees have

 12 been looking at this issue for some time. In

 13 fact, as recently as this summer we had some noted

 14 economists visit with us, and we asked the

 15 question: You know, we've been watching the spot

 16 market on negotiated numbers decline over time and

 17 is 5 percent too thin for confidence in the

 18 market? And the response was: We don't know.

 19 They did make the point that while just because

 20 the market is thin doesn't mean that it doesn't

 21 necessarily properly discover prices. So, the

 22 next follow-up question of course was: Okay, well,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 250

 1 when will we know it's too thin? And the response

 2 was: Well, when people start using other

 3 mechanisms for pricing.

 4 Well, a ramification of this spot market

 5 on the negotiated side is obviously, as Paul

 6 talked about earlier, a function of the CME's

 7 formula for settlement, for cash settlement, which

 8 is critically important to our industry for risk

 9 management. And as we look, obviously, at the

 10 fluidity of the markets -- now, there's other

 11 things going that -- I could make an argument that

 12 would maybe do away with our spot market very

 13 rapidly, but the reality of it is right now there

 14 tends -- I'm picking up, and I've had a lot of

 15 discussion with producers and been involved in

 16 several meeting with producers -- that there's an 

 17 awareness of this issue by producers. They of

 18 course moved to formula pricing as a price

 19 volatility mechanism to reduce volatility and some

 20 risk, and now they're seeing the point that, you

 21 know, well, if I'm not participating in the spot

 22 market I'm not helping set the price. And I'm

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 251

 1 actually quite hardened since this last March of

 2 our annual meeting of producers saying well, I'm

 3 willing to take some time and negotiate into the

 4 marketplace.

 5 I don't think we're going to see any

 6 move from percent to 10 percent overnight, but I

 7 do think there's a growing awareness by producers

 8 because of the concern that we want to make sure

 9 that we have options here. Now, with that -- and

 10 Warren talked about it; it's been talked about

 11 earlier, and obviously it was yesterday when the

 12 House -- Senate Ag Committee approved the

 13 Mandatory Price Reporting Bill -- it does include,

 14 as was talked about, mandatory wholesale price

 15 reporting which for the pork industry is very

 16 intricate, because as a specie we have the most

 17 differentiated carcass that is sold in different

 18 ways and the largest percentage of the carcass

 19 that is processed. So, it's going to be a very

 20 intricate process as we move from voluntary

 21 wholesale price reporting to mandatory wholesale

 22 price reporting to capture from the product and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 252

 1 extrapolate back to cutouts, but again critically

 2 important for the exchanges because the cutout is

 3 also part of the formula for settling prices.

 4 All that being said, one of our concerns

 5 has been -- you know, we've been concerned that,

 6 gee, the live hog market's thinner. That is thin.

 7 I think the voluntary wholesale market is much

 8 thinner, and it's being used, and in fact we've

 9 had producers that have used it as a price

 10 discovery mechanism in these contracts for their

 11 own volatility. Thus, we're anxiously supportive

 12 of getting wholesale mandatory pork price

 13 reporting, and again kudos to AMS and to Warren,

 14 your staff. We have had an excellent relationship

 15 in the 10 years there has been mandatory price

 16 reporting.

 17 With that, the only other comment I

 18 would make, I get here, I think somebody said that

 19 packers can choose to report under mandatory live

 20 price reporting and under the -- they're required

 21 to report twice a day and again the next day.

 22 There are some issues in the industry with

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 253

 1 producers, because they look at some differences

 2 on what the market does in the morning report

 3 versus the afternoon report, but producers seem to

 4 be figuring that one out.

 5 So, with that I will end in saying that

 6 there is one piece of information and if it's okay

 7 I'll forward to your attention, Commissioner Dunn

 8 -- Chairman Dunn -- and that is a study that was

 9 done by USDA by Mr. Ted Schroeder, some other

 10 economists that actually looked at some more of

 11 these issues, and it might be some use as we move

 12 forward into this. Thanks for the time, and I'm

 13 open for any questions.

 14 CHAIRMAN DUNN: Thank you, Mr. Dierks.

 15 And I've got just a preliminary question, because,

 16 Harry, you had said that negotiated price can be

 17 cancelled after they're reported, and how

 18 prevalent is that and how much of an impact does

 19 that have?

 20 MR. HILD: Well, there are two parts of

 21 that question is -- the impact that it has is that

 22 it's all about weighted averages and that that

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 254

 1 SPMF category that's in the MER calculation.

 2 There's some -- you know, you can use math to get

 3 to that, I guess is what I'm saying. If 50

 4 percent of that SPMF category refers to the

 5 negotiated Western Corn Belt price, the impact is

 6 going to be weighted each day, so if you have a

 7 day where, say, 80 percent of the SPMF category

 8 refers to the negotiated market and, you know, a

 9 high-range price in the negotiated market -- you

 10 know, and the high side or the low side gets

 11 canceled -- all those contracts that priced off of

 12 that Western Corn Belt are essentially inaccurate

 13 for that day or maybe the next day. It's that

 14 unknown percentage that it's hard to categorize,

 15 so the impact is hard to get exact on. You know,

 16 there's ways to get through that, but I can't

 17 speak to any of those specific percentages in this

 18 meeting.

 19 Does that answer your question?

 20 CHAIRMAN DUNN: It does, and I think it

 21 gets to a point that Don made in his written

 22 testimony that the need for transparency here is

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 255

 1 just extremely important for all of us. But then

 2 it gets to my larger question, and that is the

 3 nexus between the futures price and this shrinking

 4 negotiated price, and Neil hit the nail on the

 5 head: When does it become an important factor, and

 6 how do we know it at that time? And I'd like to

 7 have all the panelists discuss that, because I

 8 think it's extremely important that this contract

 9 that is so important to all livestock producers.

 10 Paul, since it's your contract, I may

 11 start with you on that.

 12 MR. PETERSON: Okay, fair enough, fair

 13 enough. Well, from our standpoint -- I'm going to

 14 refer to guideline No. 1, which drives the

 15 requirements for all futures contracts for those

 16 of you who may not be familiar with it, and one of

 17 the parts of guideline 1 is that cash settlement,

 18 you know, must be at a price reflecting the

 19 underlying cash market. Well, in the case of the

 20 hogs, since we're using mandatory data, we trust

 21 that -- and since we're using mandatory data on

 22 roughly half of the hogs that are transacted --

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 256

 1 and I'd say almost all of the hogs are done on

 2 some sort of an arms-length arrangement, so it

 3 doesn't have other side conditions that might

 4 affect the validity of the data, but since we're

 5 using all of the best data that are available,

 6 we're confident that our contract does in fact

 7 reflect the prices that producers are actually

 8 seeing out in the country. Maybe not every last

 9 one of them, but in total I believe that's the

 10 case. So, you know, that's one of our

 11 requirements. Other things that might feed into

 12 this are questions like, you know, well, are those

 13 data accurate? Well, they're mandatory, so I

 14 believe that they are. If they aren't, Warren,

 15 you've got a problem. If -- and then if the cash

 16 prices are being distorted in some fashion, well,

 17 we really have no way of knowing that, so, Jay, I

 18 think that's your problem. So, this is a very

 19 complex issue.

 20 CHAIRMAN DUNN: But, Paul, doesn't that

 21 become a futures problem if the cash price

 22 actually manipulates the futures price?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 257

 1 MR. PETERSON: Well, that's the

 2 assumption, but --

 3 CHAIRMAN DUNN: I mean, that's the nexus

 4 here and the reason why we're having this

 5 discussion.

 6 MR. PETERSON: But -- fair enough, fair

 7 enough. But, again, you know, there's a lot of

 8 things that we don't know. We don't know what the

 9 percentage of Western Corn Belt-based formulas are

 10 in the SPMF category, do we? Do we have a

 11 percentage? Either one.

 12 MR. HILD: No, I --

 13 MR. PETERSON: No. No, we don't.

 14 MR. HILD: Well, I can't answer that in

 15 this meeting.

 16 MR. PETERSON: Okay, okay. So, so, that

 17 -- and that's just one example. There are a lot

 18 of the inner things that we don't know. But at a

 19 high level, yes, I think we're doing the best we

 20 can with what we have to work with.

 21 MR. CLOSE: I think the first thing that

 22 I would bring up on this point is as anybody

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 258

 1 knows, the economic performance of cattle feeding

 2 over the past three years has been less than

 3 stellar, and as we have seen as enormous erosion

 4 of equity in the industry, the lender -- loan --

 5 the covenants of the loan agreements have forced

 6 hedge protection. So, that's caused a huge

 7 increase.

 8 The last point that I would bring up on 

 9 this is that we talk a great deal about the

 10 escalation and open interest because of the fund

 11 activity over the last several years and how those

 12 increased funds -- that open interest has forced

 13 those fund positions to roll further and further

 14 into the deferreds, that escalation and price

 15 premium in those deferred contracts is exactly

 16 what has enabled cattle feeders the loft in those

 17 deferred contracts to profitably hedge. So, you

 18 know, I'm not going to say that the escalation in

 19 outside money doesn't have -- isn't a double- edge

 20 sword. It is. But the positive side of it is it

 21 has provided tremendous opportunity in those deep

 22 deferreds.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 259

 1 CHAIRMAN DUNN: Jay, go.

 2 MR. JOHNSON: Well, any time that the

 3 market has become thinner in a concentrated

 4 industry makes the opportunity that there could be

 5 potential for manipulation or effects in the

 6 prices on a spot market, and we do have specific

 7 section 202(e) of the Act that prohibits any firm

 8 from engaging in any practice in the course of

 9 their business with the purpose or effect of

 10 manipulating prices, and I will say that, you

 11 know, that is one area that we do take very

 12 seriously and when we have allegations of price

 13 manipulations that we actively pursue them.

 14 CHAIRMAN DUNN: Harry.

 15 MR. HILD: I'll go next. In

 16 surveillance, much like Packers and Stockyards,

 17 we're very concerned about powerful market

 18 players. Our surveillance programs are designed

 19 to detect and act on situations that are

 20 concerning to us, so these trends of increased

 21 concentration in the packing industry, a well as

 22 vertical integration, have changed things for us,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 260

 1 and the example that I laid out in terms of, you

 2 know, the negotiated market that determines, you

 3 know, what all these contracts are priced at has

 4 us raising some flags, and that's why we're here.

 5 So, I think this is an appropriate forum to

 6 discuss that trend, that possibility, and, you

 7 know, where do we go from here. So, it has our

 8 attention from a surveillance perspective.

 9 CHAIRMAN DUNN: Warren.

 10 MR. PRESTON: Let me just comment

 11 briefly on the issue of canceled negotiated

 12 transactions. I guess our view would be that

 13 those are aberrations. We don't see those very

 14 often. And I know that we have shared data with

 15 both the CFTC and with Packers and Stockyards for

 16 their investigations, and perhaps they've had a

 17 different viewpoint on that, but at least in our

 18 audit of the program we haven't seen that those

 19 negotiated prices get canceled that often.

 20 I guess in terms of price discovery, I

 21 think -- very encouraged to hear -- Neil mentioned

 22 that we do have producers who are looking to get

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 261

 1 into the spot market, because there needs to be a

 2 place for price discovery, and I do agree with the

 3 statement that you don't necessarily have to have

 4 huge volumes to have efficient and effective price

 5 discovery. I do agree with the concerns, though,

 6 that, you know, when you have big players then,

 7 you know, small movements by big players can have

 8 big ripple effects. That's not really a price

 9 reporting issue per se, but it obviously spills

 10 over into CFTC and Packers and Stockyards issues.

 11 We, you know, we go in; we look at the

 12 markets; we feel like our coverage of the

 13 negotiated wholesale pork trade is fairly

 14 complete. We think we're probably getting 75 to

 15 80 percent of that market. But it's very thin.

 16 And one of the things that we think that mandatory

 17 gives is that you do have that assurance that

 18 there's no selective reporting. We get

 19 everything. So, even though those markets may be

 20 thin, at least we are getting the assurance that

 21 we have everything. The double-edged sword,

 22 though, that Don mentioned that comes into play

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 262

 1 here, too, is that I think as the industry becomes

 2 more and more confident that our prices are

 3 accurate and replicable and meaningful, then

 4 they're willing to use those for formula trades.

 5 And then they go out of the negotiated market, and

 6 then there's nobody left to make the market, and

 7 that's where I guess if -- I think that if it gets

 8 to the point where people don't believe in the

 9 negotiated prices anymore, they'll just have to go

 10 to some other fixed price contracts or some other

 11 vertical coordination types of arrangements if

 12 they completely lose confidence in the reported

 13 negotiated prices.

 14 CHAIRMAN DUNN: Neil.

 15 MR. DIERKS: About three quick things --

 16 one, to Don's comment's -- exactly right, the

 17 pressure from lenders on risk management is a

 18 powerful force group for the producer on what your

 19 options are. Also with that, and a little bit to

 20 Warren's comment and to Don's earlier comment, as

 21 we take a look at how mandatory price reporting is

 22 reauthorized, we were advocates that five-year

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 263

 1 reauthorization is appropriate. There were some

 2 that wanted to make it permanent, and we think

 3 it's important to visit these issues, like I would

 4 come in the advisory committee for visiting them

 5 now and being aware of them, because some healthy

 6 skepticism is a good thing.

 7 With that, I'd also -- Mr. Johnson's

 8 gotten this lecture from me in the past. I will

 9 submit it to you, Mr. Chairman. As producer

 10 perspective, we expect the referees to be doing

 11 their job, and I realize you might not be able to

 12 talk in an open forum but the point being is that

 13 what we all need is a transparent, open

 14 marketplace that we have faith in, and if there

 15 are dangers they need to be addressed.

 16 CHAIRMAN DUNN: I appreciate that.

 17 Sometimes you have to tug on the referee's jersey

 18 and make sure that they're observing when

 19 something has gone amiss, and that's what we're

 20 about here.

 21 MR. DIERKS: Well, if I could be so

 22 bold, Mr. Chairman, I would suggest we'd like to

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 264

 1 see lots of referees like the umpire that cost the

 2 guy the perfect game this summer that actually

 3 recognized that, you know, sometimes we get in

 4 places as opposed to the referees that cost the

 5 U.S. soccer team its goal at the end of -- the

 6 work, but we appreciate that, and, again, the

 7 importance of it -- it does need monitoring.

 8 Thank you.

 9 CHAIRMAN DUNN: Commissioner Sommers.

 10 COMMISSIONER SOMMERS: I just have one

 11 quick clarification from Mr. Close on your

 12 recommendations that are in your testimony. I

 13 think some of them may need a statutory change,

 14 and some of them may be administrative. But of

 15 the ones that would take a statutory change, were

 16 those included in what was marked up by the House

 17 and the Senate?

 18 MR. CLOSE: I believe -- no, they were

 19 not.

 20 COMMISSIONER SOMMERS: They were not.

 21 MR. CLOSE: No.

 22 CHAIRMAN DUNN: Commissioner Chilton?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 265

 1 COMMISSIONER CHILTON: (Inaudible)

 2 CHAIRMAN DUNN: Well, I'd like to thank

 3 this group, but what is apparent to me is it would

 4 really behoove us to, as Congress goes into the

 5 reauthorization this September of mandatory price

 6 reporting, for the futures industry as a whole or

 7 individually to make recommendations so that we

 8 can be assured that we have everything out there

 9 we need to ensure that we've got a viable futures

 10 industry, and I know you're going to be doing that

 11 individually, but I think collectively it would

 12 help as well.

 13 Let's open it up here for the Advisory

 14 Committee, and Kevin, we'll start on your side

 15 over here if you've got any questions.

 16 MR. NATZ: I don't at this time. This

 17 has all been an education on the livestock side

 18 for me, so I appreciate your presentations today.

 19 Thank you.

 20 MR. CRYAN: We look forward to mandatory

 21 dairy reporting.

 22 CHAIRMAN DUNN: On this side. John?

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 266

 1 Well, thank you all very much, and, again, I think

 2 it would behoove us to take the opportunity that's

 3 coming up here this September and make sure --

 4 I'll be talking to my fellow commissioners along

 5 with the area about anything that we think we

 6 ought to be telling -- the various committees and

 7 the House and the Senate to ensure that we've got

 8 this ability to have a futures market that works.

 9 With that, I would like -- is Don

 10 Heitman here? Oh. There's Don hiding -- this is

 11 the absolute final things we've got on here today.

 12 Don is going to go over an overview of what the

 13 new Financial Regulatory Bill has to offer for us

 14 in the area of agricultural swaps.

 15 And, Don, it's yours just as soon as you

 16 get in the chair and pull up your presentation.

 17 MR. HICKS: Commissioner Dunn, can I ask

 18 the CME guy a question before -- I just have a

 19 question for the CME --

 20 CHAIRMAN DUNN: Paul?

 21 MR. HICKS: Is there anything in your

 22 arsenal that justifies that electronic trading may

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 267

 1 be doing more good than -- more harm than good

 2 because of the fact you don't have the visibility

 3 -- transparency doesn't exist? Is there anything

 4 -- as a trader, I like the electronic process,

 5 especially the way we get fills and everything,

 6 but I have a concern that it impacts -- the part

 7 of -- the issue is the lack of visibility and

 8 being on the floor and recognizing that

 9 transparency issue and seeing who's executing the

 10 trades and making -- even if the wrong

 11 identification, you do at least have an ability to

 12 identify or assume who's representing who on the

 13 floor. Any comment on that?

 14 MR. PETERSON: No, I really don't have

 15 any comment on that except to say that the bulk of

 16 the trading is now on the electronic Globex

 17 platform, and that offers some advantages that you

 18 actually don't have with the floor- traded

 19 environment. For example, on most of the trading

 20 front-ends, you can see a portion of the book --

 21 either the top three or top five bids and offers

 22 -- so, if you're planning to execute a substantial

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 268

 1 trade, a substantial, you know, volume, you can

 2 see where the air pockets are. So, you know where

 3 the next bid or offer is rather than just step

 4 into a hole. So, there are some advantages and

 5 disadvantages to each venue, and we've chosen to

 6 just let the marketplace decide where they want to

 7 conduct business.

 8 CHAIRMAN DUNN: Anything else, Edgar?

 9 MR. HICKS: Just so you know,

 10 Commissioner Dunn, I accept it -- as a commercial

 11 I accept that, but as representing a farm

 12 organization, that is a real concern of many

 13 farmers, many farm organizations that the

 14 electronic process is doing us more harm than

 15 good.

 16 CHAIRMAN DUNN: And I think that is a

 17 concern that we have had as well, when I came on

 18 to the Commisssion as a commissioner in December

 19 of 2004, there wasn't hardly any electronic

 20 trading; it was all in the pits, and today there's

 21 hardly any pits and it's all electronic trading.

 22 I recently had the opportunity to visit the CME

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 269

 1 and looked at their old trading floor, which is

 2 now all of the monitoring that they do of the

 3 electronic trading, and I'm sure they could

 4 arrange something for you and the grange or

 5 anybody else that wants to come up there to take a

 6 look at that, we're very well trained here at the

 7 CFTC to look at pit traders and make sure they're

 8 not doing anything that would -- we've got videos

 9 trained on them and all kinds of other things.

 10 Well, that's out the window now. That's the

 11 bygone years, and your point is right spot on that

 12 the electronic trading is something that we've got

 13 to gear up for. Fortunately, Congress did give us

 14 some additional money to gear up for the new laws

 15 in developing our regulations.

 16 And let me defer to the chairman of our

 17 Technology Committee and let him talk about what

 18 we're doing in that area.

 19 COMMISSIONER O'MALIA: I don't think

 20 it's -- we ought to not waste any time to get on

 21 with Don here, but the trading styles and

 22 monitoring trading is very important in adapting

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 270

 1 to new trading techniques and practices. That is

 2 something that we are looking at, trying to

 3 understand what impacts they are having. The

 4 concern about whether -- I do -- we're not going

 5 to put this back in the bottle -- this genie back

 6 in the bottle. We're going to more and more

 7 electronic, and it is evolving, and we need to be

 8 prepared to address it head-on any trading styles,

 9 behaviors, etc. We need to understand that,

 10 because we can't, as Chairman Dunn said, go back

 11 to the old enforcement styles that we had. We

 12 need to adapt and use technology in a much more

 13 significant way.

 14 I'm going to leave it at that, and let's

 15 get on with Don here and go from there.

 16 MR. PETERSON: If I could just make one

 17 final comment, Chairman. I want to pick up on

 18 your statement of your tour.

 19 I'd like to extend an open invitation to

 20 anyone here, anyone on the committee. If you want

 21 to come in individually or bring a group in, we

 22 would love to take you down and tour this facility

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 271

 1 that Chairman Dunn referred to. We affectionately

 2 call it Mission Control, because it is just

 3 breathtaking. So, we're very proud of it, and

 4 we'd love to show it off. So, please, come visit

 5 us.

 6 CHAIRMAN DUNN: You all will probably

 7 understand a lot more than I did, too.

 8 Don, if we can get you to go through.

 9 MR. HEITMAN: All righty. I'd like to

 10 start out with just the standard disclaimer that

 11 we've got a bunch of interdivisional teams working

 12 on various rulemakings that came out of the

 13 Dodd-Frank Bill, and I'm in charge of the Ag Swaps

 14 Team, and we're just at a very early stage, so

 15 anything I say here is kind of preliminary and

 16 subject to change, and the opinions are my own,

 17 even not necessarily my own.

 18 And I have one more disclaimer, and that

 19 is one of our team members is Nicole, and you saw

 20 Nicole earlier give an example of a really good

 21 PowerPoint presentation. This is a terrible

 22 PowerPoint presentation, and there's way too much

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 272

 1 information crammed on to every slide. My intent

 2 is that by the end of this presentation you will

 3 be so hopelessly confused that you will actually

 4 look at the hard copy and read it, because there

 5 is a lot of good information in there. But I'm

 6 going to --

 7 CHAIRMAN DUNN: Some of us are already

 8 there, Don.

 9 MR. HEITMAN: I'm going to be going

 10 through it at warp speed. So, looking at an

 11 overview of Dodd-Frank, some things don't change.

 12 The forward contract exclusion doesn't change. If

 13 a weak farmer goes to his local elevator to

 14 forward contract his crop, that's still excluded

 15 from the CFTC's jurisdiction, and Dodd-Frank

 16 doesn't change that at all. The rules for

 17 exchange-traded futures and options aren't going

 18 to change, because the exchange-traded futures and

 19 options are excluded from the definition of a

 20 swap. However, the definition of a swap is

 21 otherwise extremely broad. It includes not only

 22 traditional swaps, including Ag swaps and

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 273

 1 commodity swaps but also options of any kind. Any

 2 kind of an OTC option is now a swap and is going

 3 to be covered by whatever rules the Commission

 4 does for swaps, and as far as agricultural swaps

 5 go, the Bill says any swap in an agricultural

 6 commodity will be prohibited when Dodd-Frank takes

 7 effect -- and the next slide has got the timeline

 8 in it -- unless it's traded pursuant to an

 9 exemption under Section 4(c), which is the

 10 Commission's general exemptive authority. And

 11 anything that's already under a 4(c) exemption is

 12 grandfathered. So, the effective dates of

 13 Dodd-Frank -- some provisions are on a shorter

 14 timeline than others. The general timeline is --

 15 the provisions take effect in 360 days from July

 16 22, but speculative limits for exempt commodities

 17 have a 180-day deadline, and speculative limits

 18 for Ag commodities have a 270-day deadline.

 19 What kind of transactions are going to

 20 be affected by the Ag swaps provisions of

 21 Dodd-Frank? There's basically four things. One

 22 is OTC agricultural swaps that are currently

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 274

 1 trading under Part 35 of the rules. They're

 2 grandfathered, and they may continue for now, but

 3 it is anticipated that whatever we do by way of Ag

 4 swaps rules would substantially revise or possibly

 5 completely replace Part 35, and it's not hard to

 6 figure out why that is, because the way Part 35 is

 7 drafted now, it would not allow cleared swaps, and

 8 obviously the Dodd-Frank Bill has a preference to

 9 push things into the cleared environment. So,

 10 Part 35 is almost certainly going to change

 11 substantially.

 12 Another ongoing kind of transaction --

 13 our cleared swaps, like, for example, the corn and

 14 soybean basis swaps and calendar swaps that are

 15 already trading on the CBOT, and those in fact are

 16 also subject to a 4(c) exemption, because they

 17 couldn't trade under Part 35 unless they were

 18 exempted, because the base -- Part 35 rules don't

 19 provide for clearing. So, those -- the corn and

 20 soybean basis swabs and calendar swabs are

 21 grandfathered, but any new, similar cleared swabs

 22 would likewise have to a 4(c) exemption.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 275

 1 The other two categories of transactions

 2 that are going to be covered are options and trade

 3 options, and there's basically two classes of

 4 commodities that are going to be covered, and one

 5 is the traditional, enumerated commodities that

 6 are listed in the Ag -- wheat, corn, soybeans,

 7 livestock -- and there is actually a whole set of

 8 rules in the CFTC rulebook for trading

 9 agricultural trade options. And as people that

 10 have been on this committee for a while know if

 11 you've been to previous meetings, the Commission's

 12 Ag trade option rules have been a complete and

 13 total failure. Only one firm ever registered as

 14 an Ag trade option merchant, and they withdrew

 15 their registration after a couple of years. So,

 16 the only trade options in the enumerated

 17 commodities that are currently trading are

 18 pursuant to an exemption in those rules, and the

 19 exemption basically says that you're exempt from

 20 the Ag trade option rules if the buyer is a

 21 commercial -- a producer, processor, merchant

 22 handling the commodity, and the buyer is using the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 276

 1 transaction for hedging, and both the buyer and

 2 the seller have to have $10 million net worth.

 3 And the other type of agricultural trade

 4 option -- what most people would think of as a

 5 trade option in an agricultural commodity --

 6 involve agricultural commodities that are not

 7 enumerated and not on that list in Section 1(a)(4)

 8 of the Act, and those -- the obvious examples of

 9 those are coffee, sugar, cocoa; and coffee, sugar,

 10 and cocoa trade under the basic trade option

 11 provision that would likewise apply to petroleum

 12 or gold or anything else, and that's an even

 13 simpler requirement. The only requirement is the

 14 buyer has to be a commercial -- again, hedging,

 15 using the transaction to hedge, and that's it.

 16 There's no financial requirements for those trade

 17 options. And all of those agricultural trade

 18 options are not covered by a 4(c) exemption, and

 19 they are not grandfathered, and they will become

 20 illegal when Dodd-Frank takes effect unless the

 21 Commission adopts some other rule under Section

 22 4(c).

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 277

 1 So, how do we approach any exemption for

 2 Ag swaps? The Ag Swaps Rulemaking Team -- we're

 3 shooting for publishing proposed rule for Ag swaps

 4 in November, and they -- again, we have to do it

 5 under the Section 4(c) exemptive authority, and

 6 one of the -- so, for example, there's a public

 7 interest test in 4(c), and so they have to be

 8 consistent with the public interest, but, more

 9 significantly, the most significant requirement

 10 for Ag swaps is, like all OTC swaps, OTC

 11 agricultural swaps could only be bought by

 12 eligible contract participants. That's OTC.

 13 Now, if it's a swap that's listed on an

 14 exchange, then anybody could trade that. But if

 15 it's an OTC swap, it could only be purchased by

 16 eligible contract participants. Who is that?

 17 Eligible contract participants would generally

 18 include large institutional or commercial traders,

 19 and as far as agricultural producers go, that's

 20 going to be the subcategory within NECP that's

 21 going to fit farmers -- is a corporation,

 22 partnership, proprietorship, organization, trust,

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 278

 1 or other entity that, one, has a net worth

 2 exceeding a million dollars and, two, is hedging.

 3 And that's who would be in NECP and that's who

 4 could purchase an agricultural swap.

 5 The other category that might apply

 6 would be just an individual with amounts invested

 7 on a discretionary basis, the aggregate of which

 8 is in excess of $10 million or $5 million if they

 9 enter the transaction for hedging. And I'm not

 10 sure what the hell that's supposed to mean. The

 11 Congress stuck that in there when they -- as part

 12 of the Dodd-Frank Bill.

 13 The major policy issue that we're facing

 14 in trying to come up with an Ag swap's rule is

 15 that Congress -- when Congress said CFTC, you can

 16 only adopt an Ag swaps rule if you do it under

 17 4(c), that seems to imply that farmers and other

 18 persons trading Ag swaps should be subject to some

 19 kind of additional special protections beyond

 20 those available to people trading swaps and other

 21 physical commodities, because there's a little bit

 22 higher threshold for a 4(c) exemption than for a

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 279

 1 normal rulemaking action. So, that leaves us with

 2 the question: Should OTC agricultural swaps be

 3 subject to any special conditions or protections

 4 beyond those that would apply to OTC swaps in

 5 other physical commodities, and if so, you know,

 6 what should those protections be -- more

 7 restrictions on who can buy, more requirements for

 8 who can sell, or some other type of restrictions

 9 or conditions?

 10 COMMISSIONER O'MALIA: Don, can I ask a

 11 quick question. On part -- the relationship to an

 12 exemption under 4(c) and Part 35 rules, is there

 13 any guidance there that might answer this question

 14 about special protections that you can think of --

 15 condition to Part 35? Anything special?

 16 MR. HEITMAN: Not off the top of my

 17 head, Commissioner, that Don -- Part 35 originally

 18 wasn't even put in with agriculture in mind. Part

 19 35 was put in, in 1993, and it was the exemption

 20 for all swaps, and then when the CFMA came in and

 21 the CFMA basically pulled everything else over

 22 into Section 2(g), it exempted all the rest of the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 280

 1 swaps' business and Part 35 was just left over.

 2 Agricultural were all that was left, because

 3 agricultural commodities couldn't be traded under

 4 2(g) -- under the swaps exemption that was in the

 5 CFMA.

 6 CHAIRMAN DUNN: Let me interject in

 7 here, Don, if I can, because these two questions

 8 that you're raising here are really important for

 9 the Ag Advisory Committee to have input on, and as

 10 I said at the beginning of this that you can go on

 11 CFTC.gov --

 12 MR. HEITMAN: Commissioner, you're

 13 stepping on my presentation.

 14 CHAIRMAN DUNN: Okay.

 15 MR. HEITMAN: I've got a whole big pitch

 16 for this.

 17 CHAIRMAN DUNN: Oh, okay. Continue

 18 then.

 19 MR. HEITMAN: Alternatively, rather than

 20 making Ag swaps subject to some special

 21 protections, should Ag swaps be allowed to trade

 22 subject to the same terms and conditions as OTC

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 281

 1 swaps and other physical commodities? And really,

 2 it's a balancing act. Do we want to give

 3 agricultural producers additional protections and

 4 restrictions on swap trading so -- to avoid the

 5 kind of a situation that people got into under

 6 hedge-to-arrive contracts where people got into

 7 contracts that they didn't really understand, and

 8 nobody really understood the potential

 9 implications and a lot of people suffered serious

 10 financial harm -- or, alternatively, are we

 11 concerned that if we put extra bells and whistles

 12 on producers' ability to trade Ag swaps, are you

 13 denying them opportunities to hedge their risks,

 14 that they -- you know, they need in their farming

 15 operations? So, that's the question, and that's

 16 one of the questions we're going to be asking in

 17 the proposed rules, and we certainly hope that

 18 when those proposed rules come out -- and again

 19 we're shooting for late November -- that the

 20 members of the committee will comment. And in the

 21 meantime, if anybody has any preliminary thoughts

 22 or suggestions, there is a special Ag swaps web

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 282

 1 page on CFTC.gov on the Commission's website, and

 2 the very last slide has a MapQuest map of how to

 3 get to that section on the website.

 4 COMMISSIONER O'MALIA: Don, I hate to

 5 interrupt again. I've got to run another meeting.

 6 But I'm curious as the relationship between Ag

 7 swaps under either the exemptions they have -- and

 8 I understand the current exemptions are they're

 9 exchange traded but not cleared?

 10 MR. HEITMAN: The current conditions --

 11 there are four conditions for agricultural swaps

 12 under Part 35, and I can't give you all four of

 13 them off the top of my head, but one of them is

 14 that counterparty credit risk is not a material

 15 consideration -- or -- I'm sorry -- is a material

 16 consideration, and so if it's a cleared contract,

 17 you don't care about counterparty credit risk,

 18 because the clearinghouse is standing in between.

 19 So, that effectively means that an agricultural

 20 swap under Part 35 couldn't be cleared. And

 21 there's another one of the four is that it can't

 22 be fungible, and that's another -- so that again

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 283

 1 would take you out of clearing, which is why when

 2 the CME Group came in with the calendar swaps and

 3 basis swaps we had to give them -- they wanted a,

 4 you know, clear OTC calendar and basis swaps.

 5 They wanted it clear on the CBOT. The only way

 6 they could do that is if we gave them a 4(c)

 7 exemption from those provisions of Part 35.

 8 COMMISSIONER O'MALIA: Let me ask -- my

 9 question is what is the relationship between the

 10 4(c) exemptions we have or the Part 35 rules we

 11 have today and what we're doing in the policy

 12 decisions we're making regarding energy products

 13 under the Clearport model where we have blocked in

 14 -- they're not exchange traded but they are

 15 cleared, and we're trying to understand what the

 16 future of that exchange will be going forward.

 17 What is the policy relationship? Are we trying to

 18 tie those together?

 19 MR. HEITMAN: You just exceeded -- you

 20 just exceeded my area of expertise, Commissioner,

 21 because I haven't been involved in that part of

 22 the Commission's mission.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 284

 1 COMMISSIONER O'MALIA: Fair enough.

 2 Thanks.

 3 MR. HEITMAN: So, another part of the

 4 Dodd-Frank Bill says that another part of the

 5 actual Ag swaps provision says that they apply to

 6 any swap in an agricultural commodity as defined

 7 by the Commission, which means that -- and for the

 8 first time ever the CFTC has to publish a

 9 definition of the term "agricultural commodity."

 10 And the Ag Swaps Team is also doing that. And

 11 that is actually on the 180-day deadline, because

 12 the spec limits for exempt commodities apply to --

 13 well, under Section 1(a)(14) of the Act, an exempt

 14 commodity is a commodity that is neither an

 15 excluded commodity nor an agricultural commodity,

 16 and there's only one term in there that's defined

 17 in the Act, and that's an excluded commodity.

 18 So, if you want to have spec limits for

 19 exempt commodities, you've got to define

 20 "agricultural commodity" so you've established the

 21 boundary between agricultural and exempt. So, the

 22 Ag commodity definition is on that 180-day

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 285

 1 deadline, and what we we're hoping to do is that

 2 we would actually publish the agricultural

 3 commodity definition in the same issue of the

 4 Federal Register as the proposal to establish spec

 5 limits for exempt commodities, which would be

 6 things like oil and petroleum and metals. And

 7 then you'd cross reference the two definitions in

 8 the Federal Register. And in terms of what the

 9 definition is going to be, we're generally trying

 10 to draw a line between products that are derived

 11 from living organisms and are used for human food,

 12 animal feed, or natural fiber, which would be

 13 covered by the definition, and plant- or

 14 animal-based industrial products -- things like

 15 butenol or denatured ethanol, which would be

 16 outside the definition.

 17 And so again we would hope everybody

 18 would be on the lookout for the proposed

 19 definition rules, which will -- those should come

 20 out around mid-October, and we would hope to get

 21 your comments. And then the Ag commodity

 22 definition would also be used in the speculative

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 286

 1 position limits contract, because Dodd-Frank

 2 requires the Commission to issue spec limits for

 3 agricultural commodities, and that, as I think has

 4 been mentioned multiple times, including just now,

 5 is a 270-day timeline.

 6 And again when those come out, again we

 7 would love to have comments from the members of

 8 the Ag Advisory Committee, and in the meantime we

 9 don't want anybody to wait until these Federal

 10 Register rulemaking proposals come out. By all

 11 means, if you have any preliminary comments, we

 12 would love to hear them, and this last slide has a

 13 link to the spot on the CFTC website where you

 14 could submit your comments, and alternatively

 15 there's a little roadmap of how to get there. You

 16 know, go to the CFTC website and it shows you what

 17 dropdown menus to click on and you should -- when

 18 you finally get on it, you'll come up with

 19 something that will just have a little email

 20 address that says AgSwaps@CFTC, and by all means

 21 send us an email. And that's my presentation.

 22 CHAIRMAN DUNN: Any questions or comment

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 287

 1 to Mr. Heitman?

 2 MR. HICKS: Just a question. Any

 3 comment on what impact this would have on

 4 farmer-owned cooperatives as they try to originate

 5 grain and compete with the larger international

 6 companies in this area?

 7 MR. HEITMAN: We -- I don't even have an

 8 outline of proposed rules yet, so, I mean, that --

 9 but, please, if you've got any thoughts on that,

 10 send them to the website. But, I mean, literally,

 11 we're just at the very, very early stages of

 12 drafting, so I can't predict anything that's going

 13 to be in the rules. And anything we do put in the

 14 rules -- you know, that's just a staff proposal.

 15 The Commission makes the final decision obviously.

 16 CHAIRMAN DUNN: The last point that Don

 17 made is that they make recommendations to us. But

 18 it's much better if they hear from you early on

 19 what you'd like to see in there. To ensure what

 20 you'd like to see in there are part and parcel of

 21 that recommendation, and that's why I said in my

 22 opening statement it was so important to take part

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 288

 1 in this.

 2 And I really appreciate, Don, the

 3 roadmap there on how to get into it.

 4 Roger, do you have a question?

 5 MR. CRYAN: Yeah, I do have a question.

 6 It was my understanding as I looked at least at

 7 the pieces of the bill that I was asked to look

 8 at, that there were very broad exemptions for end

 9 users which included producers -- farm Ag

 10 producers from requirements for clearing and I

 11 thought regulations generally, but if I understand

 12 you right, the swaps are basically going to

 13 require reporting and regulation of all sorts of

 14 farmer transactions. Is that right?

 15 MR. HEITMAN: Well, I -- again, I -- the

 16 traditional, you know, forwards and

 17 exchange-traded items aren't going to change at

 18 all. The rules for Ag swaps -- one of the

 19 questions is would they be treated the same as

 20 other swaps transactions or would they have some

 21 special different rules? But I -- the

 22 agricultural producers are not going to be exempt

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 289

 1 from -- there is going to be a basic requirement

 2 of who can trade agricultural swaps, and that's

 3 going to eligible contract participants. And so

 4 farmers are going to have to fit into one of those

 5 categories, and as I said on one of the slides,

 6 the logical category that you would expect a

 7 farmer to be able to fit into would be, you know,

 8 a million dollars net worth and hedging, and it's,

 9 you know, a corporation, partnership, or some

 10 other entity like that as opposed to just an

 11 individual.

 12 MR. CRYAN: And both sides have to be

 13 eligible swap participants? I'll give you an

 14 example. It's my understanding that there's a

 15 large processor that is trying to do some price

 16 hedging by basically doing swaps with producers

 17 that are not necessarily delivering milk to their

 18 own -- to their plants. There, as I understand

 19 from your presentation, would be an agricultural

 20 swap that would be subject to all this regulation.

 21 MR. HEITMAN: Well, I -- presumably -- I 

 22 mean, we haven't written the rules yet, but I'm --

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 290

 1 any large commercial that's on the other side

 2 would almost automatically be an eligible contract

 3 participant. You know, a big coop or a big

 4 business would meet one of the tests.

 5 MR. CRYAN: So, that's still a question

 6 then whether both sides would have to be eligible,

 7 or you're saying just one side -- 

 8 MR. HEITMAN: Well, no, I'm saying --

 9 yeah, no, I was just -- in this context I was

 10 trying to look at it from the viewpoint of

 11 agricultural producers, but you'd have to have an

 12 ECP on both sides, but --

 13 MR. CRYAN: On both sides.

 14 MR. HEITMAN: But -- yeah, the seller's

 15 side would -- it would be hard to envision

 16 somebody that would be a big commercial firm

 17 offering swaps that wouldn't qualify as an ECP.

 18 MR. CRYAN: But you're saying both sides

 19 would have to qualify.

 20 MR. HEITMAN: Yeah. I mean, the farmer

 21 has to qualify as an eligible contract participant

 22 as well.

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 291

 1 MR. CRYAN: With assets over a million

 2 dollars?

 3 MR. HEITMAN: That's what the statute

 4 says.

 5 MR. CRYAN: Okay. Thank you.

 6 CHAIRMAN DUNN: Yes.

 7 MR. NATZ: Thank you for that

 8 presentation, Don. Did a good job of outlining

 9 what your rulemaking group is doing. We've gone

 10 through the Bill and picked out a handful of

 11 rulemaking areas as you've defined where our

 12 co-ops have interest, and we appreciate having the

 13 opportunity to weigh in, in the process, and look

 14 forward to doing that shortly.

 15 Now that we know who you are, I'm hoping

 16 that we can maybe find out some of the other

 17 individuals in those different rulemaking areas so

 18 we can start providing input.

 19 CHAIRMAN DUNN: If -- again, if you will

 20 follow that roadmap that Don has or what I said in

 21 my opening statement on how to get in there, it

 22 will give you an address to the persons that are

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 292

 1 making those changes, that are writing those

 2 rules. So, you're going to have direct input to

 3 the staff, and there are 30 of them, you'll see,

 4 when you get in there. And, I mean, I feel sorry

 5 for these folks because they've got deadlines that

 6 they've got to do, and they've got to do their

 7 regular jobs as well. But they arethere and that

 8 gives you the ground floor, and what I will commit

 9 to the members of the Advisory Committee is I'll

 10 have my staff let you know when key thresholds are

 11 coming up so that you can get in there. But it's

 12 in your own best interest to go in, take a look at

 13 those 30 areas, find out what you are interested

 14 in, and then before -- as Don says, he's grappling

 15 with all of that stuff. As they begin to take pen

 16 to paper, now is the time to get your concerns in

 17 there, because, believe me, it's a lot easier to

 18 get them in early on than after something is

 19 written. So, this is an opportunity and, as the

 20 Chair of the Ag Advisory Committee, I want to make

 21 sure that you all have as much input as you can

 22 into this major watershed in the way the

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 293

 1 Commission operates.

 2 MR. HEITMAN: And I'd just like to

 3 second that, because just speaking from the

 4 perspective of trying to put these rules together,

 5 you know, the more -- the better we -- you guys

 6 understand how your business works better than we

 7 ever could, and we're trying to write rules that

 8 make sense for your businesses. The better we

 9 understand your issues, your concerns, your

 10 problems, then the better we are able to write a

 11 rule that makes sense and works for you. So,

 12 again, the more background information we can get,

 13 the easier it makes our job and the better the

 14 rules are going to look from your perspective.

 15 CHAIRMAN DUNN: Don sometimes is a

 16 standup comedian, and he's milked a laugh but he's

 17 never milked a cow, so those of you that have,

 18 it's good for you to give some information to him.

 19 Well, with that, I want to thank all of

 20 you. I want to thank my commissioners, that we

 21 ran way over on our time, but these were very,

 22 very important issues, and I want to thank, as

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 294

 1 always, the Ag Advisory Committee for you giving

 2 up your time coming in today, but we've got a lot

 3 for you to do in the future, and anything that you

 4 think we ought to be conveying to the agricultural

 5 committees as they begin meeting their deadline on

 6 the mandatory price reporting reauthorization --

 7 oh, Bart is back on the phone? Is that -- am I

 8 right?

 9 COMMISSIONER CHILTON: Yeah, yeah, yeah,

 10 but I don't need to say anything. Thank you for

 11 everything, Mike. Thank your staff, and thank the

 12 Committee members.

 13 CHAIRMAN DUNN: Oh, thank you very much,

 14 Bart, for staying with us. The good thing about

 15 being on audio --

 16 COMMISSIONER CHILTON: Yeah, I wish

 17 that's what I was doing.

 18 CHAIRMAN DUNN: Thanks.

 19 (Whereupon, at 2:48 p.m., the

 20 PROCEEDINGS were adjourned.)

 21 * * * * *

 22

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314

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

 www.andersonreporting.net
 295

 1 CERTIFICATE OF NOTARY PUBLIC

 2 I, Carleton J. Anderson, III do hereby

 3 certify that the forgoing electronic file when

 4 originally transmitted was reduced to text at my

 5 direction; that said transcript is a true record

 6 of the proceedings therein referenced; that I am

 7 neither counsel for, related to, nor employed by

 8 any of the parties to the action in which these

 9 proceedings were taken; and, furthermore, that I

 10 am neither a relative or employee of any attorney

 11 or counsel employed by the parties hereto, nor

 12 financially or otherwise interested in the outcome

 13 of this action.

 14 /s/Carleton J. Anderson, III

 15

 16

 17 Notary Public in and for the

 18 Commonwealth of Virginia

 19 Commission No. 351998

 20 Expires: November 30, 2012

 21

 22

 ANDERSON COURT REPORTING

 706 Duke Street, Suite 100

 Alexandria, VA 22314 

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

 www.andersonreporting.net