The Market is Broke. Can We Fix it?

By Drew Harris
dharris@meistermedia.com

Sometimes it isn’t enough to be right when the odds are stacked against you. You make valid point after valid point, and it seems as if you’re up against a brick wall.

The cotton industry was well-represented at the Commodity Futures Trading Commission public forum on April 22, and the contingency served the industry well. Merchants had a say, co-ops had a say, and growers’ interests were defended as well. But in the end, the CFTC decided it wasn’t going to make any quick moves – at least not without more discussions and considerations.

“Your suggestions may alleviate your particular problem; however, individualized solutions may cause bigger problems for the market as a whole,” said CFTC Commissioner Michael Dunn. “There is not a silver bullet or single solution to address the problems we are currently facing.”

Amid a group of stakeholders representing a wide swath of the commodity markets, cotton leaders argued that speculative investors and index funds were responsible for the futures market volatility in late February and early March that made hedging impossible, effectively shutting down cotton trading temporarily.

“The market is broken, it is out of whack, and somebody’s got to step in and give some relief,” said Billy Dunavant Jr. of Dunavant Enterprises.

“We need to get back to trying to function as a futures market that has some stability, and we certainly don’t have it now. The traders and commercial hedgers need to be treated completely different than the speculators and commodity funds. We need to be margined completely different because we are physical traders on the market, and we ask that you review our feelings very carefully.”

Specifically, the cotton industry asked for greater margin limits and more regulation by the CFTC and Intercontinental Exchange on speculative investors and index funds. Andy Weil III of Weil Brothers Cotton spoke as current president of the American Cotton Shippers Association, asking that:

• an index fund with a hedge exemption should restrict its position in a commodity to the dollar allocation or the percentage of funds allocated to that commodity as defined in its prospectus and recorded with the CFTC.
• ICE and its clearing members adhere to the practice of margining futures to futures settlements and options to option settlements and that only those involved in the physical handling of the agricultural commodity (cotton) be eligible for hedge margin levels.
• the CFTC monitor and oversee all swaps and OTC activity by requiring the reporting of all swap and OTC contracts by market participants, and that it determine the aggregation of positions from all sources, including the exchanges, ETFs, swaps, OTC, and all other trading entities.

Joe Nicosia, Allenberg Cotton Company CEO and incoming ACSA president, also weighed-in on the discussion, explaining that the proper tools are not currently in place to regulate and monitor all positions by market participants.
“I find it very interesting in the opening comments that I didn’t hear anything about the OTC market place, aggregate positions, swap market or any of those problems that exist. It is no secret that it is a fully developed market place and used to totally circumvent position limits,” Nicosia said.

Later in the discussion, Nicosia added, “The problem is that you don’t even have the tools to look at what went wrong and who did it. So much is taking place off the exchange, and you aren’t able to track it. Certain entities had multiple times their spec limits and still continued to push, and you don’t have that (information) to look at, because you don’t require it.”

“As a real hedger, as a hedger in the cash business, you require us to give you massive amounts of information – our cash sales and the number of bales we have. Yet you give freedom to these other groups who have no requirements to you. You should at least ask for all of those people to put forth their swap and/or cash activities to see if there is any reasonable reason if they have both sides of the positions.”

The cotton industry’s requests seem reasonable and transparent – a few common sense ideas that could stabilize the market. But sometimes being right isn’t enough, and CFTC acting Chairman Walter Lukken said the commission would be slow to enact any new rules or initiatives.

“Given current market conditions and the uncertainty surrounding additional speculative money in these markets, I will be very cautious about moving forward with such initiatives at this time,” Lukken said.

That is unfortunate, as U.S. export sales should pick up during the latter half of the year. The cotton industry needs help now, especially to recover from some of the devastating margin calls in March. During the next two weeks, the CFTC is accepting written statements for the official record, and given the speed at which government usually plods along, we probably won’t see any major decisions soon. But don’t think other wheels aren’t turning.

A lot of rumors are swirling around out there, including one that involves an inactive cotton contract on the Chicago Board of Trade.

Stay tuned – things are just getting warmed up.