Statement of the National Grain Trade Council

Before the Senate Committee on Agriculture, Nutrition, and Forestry

February 13, 1997

Good morning. Mr. Chairman, I am Jerry Osborne, Vice President and General Manager of the Specialty Grains Division of ConAgra in Omaha, Nebraska. I am also Chairman of the National Grain Trade Council, on whose behalf I speak this morning.

The National Grain Trade Council is a national trade association representing markets and market users and is uniquely positioned to comment on the regulatory framework for the nation's commodity markets. The Council's membership includes boards of trade, grain exchanges, national trade associations, grain merchandisers, processors, futures commissions merchants, transportation firms, and banks. The Council appreciates this second opportunity to testify on legislation to update and modernize the Commodity Exchange Act.

Before getting into the nuts and bolts of S. 257, allow me to briefly discuss with you a question raised during last year's hearings that is important in agricultural circles -- what is being done to help producers become better managers of risk? I am pleased to say that since passage of the 1996 farm bill, the Council has joined with several farm groups to organize a private sector Risk Management Alliance. The group has grown to include 16 producer groups, agribusiness organizations, and government agencies. The Risk Management Alliance hopes to complement the currently existing risk management information by serving as a resource and information clearinghouse that will help producers improve their risk management decision-making skills.

Let me begin my comments about S. 257 by complimenting you, Chairman Lugar, and your colleagues Senators Harkin and Leahy for reintroducing legislation that we think is a step in the right direction. This morning I will briefly review the issues and concerns the Council has relating to the Commodity Exchange Act and will then assess them in the context of S. 257.

Over the last couple of years, the Council has called for revising the CEA in three ways. First, the Council called for a wholesale review of the regulatory framework, saying that such a review would be important to the long-term health of the risk management marketplace. The Council identified four keys to success: rationalizing regulation; minimizing duplication of effort; adding integrity to the regulatory system; and providing some measure of parity in regulating similar on and off-exchange instruments. Second, the Council urged the adoption and inclusion of a hedge definition. Third, and finally, the Council urged repeal of Section 5a(a)(7) of the CEA -- a warehouse delivery provision that had over the years become obsolete. By comparison to some other issues facing the Committee, these issues might be considered small. However, the Council believes action on each will foster a more efficient and healthy industry.

Reforming the Regulatory Framework

The Council is pleased to see that S. 257 would begin addressing broad concerns about the adequacy of the current regulatory framework. The Council would make the following observations.

A more streamlined new contract approval process, as proposed in §7 of the bill recognizes that federal regulation should be in the model of oversight. The proposed provision is a good example of rationalizing regulatory functions. The proposal would also address some of the Council's concerns about the need for some measure of regulatory parity between the on and off-exchange contract markets.

While we applaud the CFTC for announcing late last year its own plan to streamline the current contract approval process, we think legislative action is warranted. Without change, Congress would be perpetuating a system that enables the CFTC to delay the introduction of new contracts by second-guessing some of the private sector's best economic analysis. The Council's exchange members and commercial members are agreed that exchanges and their members are best suited to have the primary role in determining whether a contract is economically viable.

The Council is encouraged by the "Sense of the Congress" resolutions found in Sections 12 and 13 of the legislation. Those provisions essentially ask the CFTC to review the current system to determine how the agency can avoid duplication of enforcement activities and delegate additional functions to exchanges or the National Futures Association, respectively. These are two items that Council members believe could and should be accomplished. Each represents a source of frustration for market users and at least the potential for significant savings in cost and labor. The Council is not cavalier in its call for these steps. Council members view the elements of minimizing duplication, delegating authority, and the counter demand for strong oversight as a package. As duplication of effort is eased and activities delegated, the federal regulator must be given the necessary tools to ensure strict adherence to the law.

In truth, the Council would prefer that S. 257 be more direct in requiring the CFTC to minimize duplication of effort in investigation and audit activities. However, we respect the decision made by the sponsors and will work to ensure a good end result that maintains effective oversight.

Hedge Definition

Mr. Chairman, the Council appreciates your willingness to address our stated concerns about the need for a hedge definition. We recognize that addressing this issue more comprehensively has been difficult in light of significant opposition from the Commodity Futures Trading Commission last year. Nonetheless, we are pleased that the CFTC has endorsed the modest changes included in S. 257.

The Council continues to believe that the Commodity Exchange Act is the appropriate place for the law to define the business activities classed as hedges. The lack of any meaningful definition in the law will continue to place hedgers at risk from other agencies, courts, or private standards groups -- each defining for their own purposes what transactions constitute hedges and how they will be treated.

As you know, the most prominent example was between 1988 and 1994 when hedgers faced uncertainty in the tax treatment of their hedge transactions. The issue, commonly referred to as Arkansas Best, involved the Internal Revenue Service's questionable interpretation of the Supreme Court case Arkansas Best Corporation v. Commissioner. In effect, the IRS challenged the legitimacy of modern hedging strategies and required that companies treat the gains and losses from many hedges as capital, rather than ordinary income. While in the end, most issues were successfully resolved through new regulations, several areas remain outside the scope of the IRS' action. In fact, commercial grain companies thinking of using the Chicago Board of Trade's new corn yield futures or options contracts may still face Arkansas Best-related problems.

The Council understands the CFTC's concerns about safeguarding their ability to enforce speculative position limits. However, we also believe there is a middle ground that can provide the CFTC with effective enforcement and give the industry assurance that hedging strategies will be recognized as legitimate hedges by all entities.

One final point related to this issue. As you know, the provisions of S. 257 that affect the notion of hedging merely strike a phrase in §3 of the CEA that ties hedging to transactions to price fluctuations. This change is helpful. However, a more ideal solution would be to rewrite §3 entirely and advance a more modern and comprehensive definition of a hedge.

Toward that end, we were encouraged by comments in the bill summary accompanying S. 257 asking whether additional changes to §3 should be considered. The current law, which dates back to 1922, has been amended periodically and needs sharper focus. The Council would support a complete rewrite of the section that clarifies and expands on the purposes of regulation -- including what kinds of transactions are contemplated when discussing modern hedging strategies.

We would point out that Congressman Ewing introduced H.R. 467 in the 105th Congress on January 21 contains a complete revision of §3. Included in the language is a clear statement about what hedging includes and, for the first time, introduces the concept of managing risk into the law. We encourage you to undertake a similar effort.

Elimination of Warehouse Delivery Provisions

Finally, Mr. Chairman, the Council supports the elimination of §5a(a)(7) of the CEA. We are pleased that the CFTC has endorsed this change. In short, the provision is a vestige of days gone by. As first pointed out by the Kansas City Board of Trade, there is no reason today to allow a federally licensed warehouse to issue warehouse receipts in satisfaction of futures contracts if the warehouse is not approved by the exchange as registered for delivery.

Conclusion

Before concluding I would like to briefly address a point indirectly raised in the legislation. Section 5 of S. 257 clarifies the exemptive authorities of the CFTC relating to swaps and certain hybrid derivative contracts. We understand that the bill, in referencing the trade option provisions of Rule 32.2, simply affirms the CFTC's current authority to administratively consider lifting the existing ban on agricultural trade options. We commend Chairman Lugar for leaving the ultimate authority with the Commission. As the Committee may be aware, the issue is a source of some discussion within the agricultural community. The Council, while open to considering proposals, remains skeptical about whether lifting the ban on agricultural trade options is in the best interests of the agriculture industry.

Last year, I participated in a CFTC-sponsored round table on agricultural trade options. The questions we raised then remain relevant for Council members today: (1) What is the potential effect of trade options on the liquidity of exchange-trade options and the underlying futures contract? (2) What types of transactions would be considered trade options? (3) Do current accounting rules shed light on the risks assumed by off-exchange trade options transactions? (4) Who can offer trade options? These are important questions and I am confident that they will receive careful consideration by CFTC staff and Commissioners in the coming months.

Again, thank you for allowing the Council this opportunity to comment on S. 257 and reiterate the need for reforming the Commodity Exchange Act. For agriculture, effective regulation that fosters an efficient market is key to the industry's success. We are pleased to say that overall, S. 257 is a significant step in the right direction.

The bill represents a departure from previous legislative efforts, which were often driven by crisis and the need to reauthorize the Commodity Futures Trading Commission. We encourage you to seize this opportunity to ensure that the laws regulating the futures, options, and other derivative markets actually reflect these markets.

Thank you, Mr. Chairman.