Should Delivery Terms for Grain Futures Change

Article excerpt

After the 1989 soybean market disruption involving the grain trade branches of Ferruzzi Finanziaria, the Chicago Board of Trade (CBOT) along with the grain trade and regulators decided to study how effectively grain futures contracts served their economic and regulatory functions.

The CBOT sought answers from The MidAmerica Institute for Public Policy Research. The National Grain and Feed Association appealed to Anne E. Peck and Jeffrey C. Williams of the Stanford University Food Research Institute. Congress asked the U.S. General Accounting Office (GAO).

The MidAmerica study funds "the existing system has worked well."

Peck and Williams say, "The evidence here leads to the conclusion both short-term adjustments are needed and the search for long-term solutions should begin."

Taking a middle view, the GAO says, "Current research supports the need for CBOT and CFTC (Commodity Futures Trading Commission) to assess alternatives for improving how delivery points for grain and soybean futures contracts meet the economic purposes and anti-manipulation goals of the Commodity Exchange Act. However, the studies did not provide . . . answers to questions about how best to select delivery points."

Glenn Hollander, CBOT agricultural executive committee chairman, says, "These studies mark the beginning of the learning curve." As yet, he sees in them no mandate to act.

Federal law imposes two duties on commodities exchanges: to provide economic benefit in the form of price discovery and hedging facilities and to prevent or diminish market manipulation. The CBOT sees the former as more crucial, the CFTC the latter. But the GAO says the dual focus helps ensure both goals are considered when delivery points are chosen.

Key to these deliberations is the delivery mechanism and the adequacy of deliverable grain supplies.

Echoing physicals

To work, the delivery process must echo the dynamics of the physical market. And the supply of grain must be large enough to facilitate effective arbitrade that forces prices into alignment and contributes to price discovery and effective hedging.

Also, ample deliverable stocks forestall manipulation. In a typical long squeeze, the GAO says, "Traders might try to manipulate prices by purchasing a large number of futures contracts and most or all of the commodity at every delivery point, making it unavailable to futures contract sellers for delivery. The resulting artificial shortage could push futures and cash market prices at all delivery points to unjustifiably high levels, resulting in profits for buyers of futures contracts and losses for sellers."

Short squeezes, less talked about, could be a problem if the terminal space concentrates in too few hands.

The studies find the decentralization of grain markets and the diminished importance of the terminal markets (especially Chicago, the primary CBOT delivery location) could threaten the system. An important result is a "paucity of deliverable stocks," say Peck and Williams which may threaten the function of the market, making it more manipulable.

To assess the depth of the problem this trend may pose, the studies consider just how much delivery takes place, cash-futures price convergence

            Deliveries as percent of
           open interest and stocks
(Wheat, corn and soybean deliveries from 1964-65 to 1986-87)
                      Wheat    Corn   Soybeans
Peak open interest
 1964-65 to 1972-73    18.6    14.7      18.5
 1973-74 to 1978-79     17.2   10.6      18.2
 1979-80 to 1986-87    17.8     7.2      20.1
 1987-88 to 1988-89    13.8     7.8      14.0
Open interest at beginning
 of delivery month (*)
 1964-65 to 1972-73    47.1    36.7      41.0
 1973-74 to 1978-79    60.2    31.8      43.1
 1979-80 to 1986-87    63.0    23.4      59.8
 1987-88 to 1988-89    55.7    31.5      44. …