AFIA Submits Comments Regarding Harmful Speculative Activity to CFTC
By Joel G. Newman

The American Feed Industry Association last week submitted comments  to the Commodity Futures Trading Commission that document the significant effect that index funds and swaps have had on the price volatility of agricultural and energy commodities. AFIA believes the volatility of 2008, in particular, is partly the result of the current exemption of index funds and swaps from speculative position limits.

AFIA believes the issue may be readily addressed by the CFTC so the situation will not occur again. The volatility of 2008 will reoccur without the removal of the speculative position limit exemption for index funds on agricultural and energy commodities.

There is a large financial speculative interest in agricultural commodity futures markets today, according to AFIA’s comments to the CFTC. In some crops, the trading on a daily basis almost meets the entire U.S. crop volume, which significantly adds to price volatility.

The size and influence of these large financial players was never contemplated during enactment of the original Commodity Exchange Act. The net result is that speculator demand actually increases the more prices increase, providing unrealistic commodity prices relative to true demand. Index speculators do not normally sell, but rather buy and hold their index positions, thereby producing an artificial economic increase in demand and, in turn, commodity market pricing.

As a result, the physical commodity available to customers today is unable to attain convergence between its hedge position and the cash market. In this case, the physical purchaser is forced to borrow significant funds to cover margin calls and/or sell commodities, usually at an inopportune time, to cover these distorted hedge costs. Thus, hedging as a risk-management tool is no longer effective for its intended users.

The magnitude of the inflow of index speculator funds is dramatic, as is clear from the following examples:

• Index speculators increased investments in 25 commodities from $13 billion in 2003 to $260 billion in 2008;
• Index speculator investments in petroleum futures have increased by 848 million barrels over the last five years, almost matching the actual increase in Chinese demand of 920 million barrels of oil in the same five-year period;
• Index speculators have stockpiled enough corn futures to fuel the entire U.S. ethanol industry at full capacity for a year; and
• Index speculators have stockpiled sufficient wheat futures to supply every American citizen with all the bread, pasta and baked goods he or she can eat for the next two years.

A summary of AFIA’s recommendations to the CFTC follow:

• Swaps dealers should only be granted an exemption if they can certify to the CFTC that their clients are producers or users of the underlying agricultural or energy commodity;
• The CFTC should adopt a “see-through” policy to clearly identify the true commercial hedgers-the producers or users of the agriculture or energy commodities-versus the speculative investors; and
• The CFTC should change its classification of current hedge-exempted index funds andswaps dealers from the commercial designation because they neither take delivery of the commodity, nor are they physical participants.

In addition to these rulemaking comments, AFIA is also pursuing legislative authority, in conjunction with several other industry commodity users, to expand the CFTC’s authority to include the following items. The goals of this effort follow:

• Regulation of the over-the-counter markets that deal in the same agriculture and energy commodities;
• Holding market offenders accountable; and
• Securing adequate resources to fulfill the above responsibilities.