On October 15, by a 3-to-2 vote, the Commodity Futures Trading Commission (CFTC) approved a woefully inadequate final rule to prevent market manipulation and excessive speculation in physical commodity derivatives contracts. The rulemaking process had begun in 2010, but a successful Wall Street lawsuit in 2012 concerning a few words in the Dodd Frank Wall Street Reform and Consumer Financial Protection Act of 2010, prevented its finalization while there was a Democratic majority of commissioners. This final rule is based on a May 15, 2020 proposal, following the majority’s vote to withdraw 2013 and 2016 proposals and supplements to proposals. IATP has commented on all the proposed rules, beginning in 2010 and up to the May proposal.
Commissioner Rostin Behnam noted in his dissent to the 899-page voting draft of the rule that the CFTC was still investigating an unprecedently large April 20-21 price swing in the West Texas Intermediate (WTI) crude oil contract. Why rush to finalize the rule before the completion of the WTI investigation? The majority needed to vote before Commissioner Brian Quintenz departs the CFTC at the end of October.
Viewed less opportunistically, the majority stated their sincere belief that trading exchanges were best equipped to prevent market manipulation and excessive speculation and that the rule did not surrender CFTC authority to the exchanges. Commissioner Dan Berkovitiz rejected this belief, stating, “the proposed rule demoted the Commission from head coach to Monday-morning quarterback. The Final Rule declares that the players on the field are the referees. In this arena, the public interest loses.” Exchanges suffer no CFTC penalty when they fail to enforce the CFTC authority delegated to them in this and other rules.
The final rule puts no position limits on contracts held in commodity index funds (CIFs) whose speculators have no commercial interest in the contracts in the CIF. CIF trading creates price booms and busts that benefit CIF investors, usually to the detriment of those who produce, process and trade physical commodities. The approved rule would allow a financial speculator with no commercial interest in 25 “core referenced” physical derivatives contracts, including nine agricultural contracts previously subject to position limits plus seven new agricultural contracts, to hold up to 25% of all positions in each of the referenced contracts. This is an unreasonably large allocation for any one investor to control.
For example, earlier this year, on April 20, an exchange traded fund (ETF), U.S. Oil Fund, held a 25% position in the WTI contract. (The ETF is a CIF variant.) U.S. Oil Fund could not take physical delivery when the contract was scheduled to expire in May because the ETF is a financial speculator that packages contracts with various expiration dates into the fund’s tradeable shares. U.S. Oil Fund was forced to sell its contracts expiring in May at any price because it had no ability to take delivery of the oil represented by its speculative position. Because U.S. Oil Fund held one-quarter of all WTI positions, the WTI price collapsed from $17/barrel to minus $37 in less than 24 hours. The more than $50/barrel price rebound on April 21 could not be explained by supply/demand or oil storage shortage factors. Investors scrambled to buy the June WTI contract for a negative price that went positive quickly as the WTI positions dumped by U.S. Oil Fund were snapped up.
The final rule includes position limits on the WTI contract, plus three other energy contracts and five metals contracts. If U.S. Oil Fund holds a 25% position in the WTI contract, it can now do so with no fear of violating the law against market manipulation and excessive speculation. The final rule gives the exchanges the authority to determine a wide array of position limit exemptions for financial speculators in the 25 referenced contracts, related futures and options contracts and “economically equivalent swaps.” Swaps are slightly customized contracts that are exempt from near real time reporting rules that apply to futures and options contracts. Major swaps dealers, such as Goldman Sachs and Morgan Stanley, will benefit from futures and options price and position information, while legally delaying reporting their own swaps trading data.
The CFTC chair and two other concurring commissioners’ faith in the vigilance of the for-profit exchanges to monitor market participants’ positions and other activities has been sorely tested. On September 29, the CFTC announced that it had reached a settlement with JP Morgan to allow it to pay a $920 million dollar fine for 2008-2016 market manipulation in precious metals futures contracts and Treasury bond futures. (Treasury bonds are a global safe haven for private investors and foreign governments. Commenting on the massive Federal Reserve Bank intervention to prevent the collapse of the bond market in March, the Financial Times stated in September, “The Treasury market is simply too important to be left to its own devices.”)
During the period of market manipulation, there was no position limit on precious metals (gold, silver and palladium) contracts. JP Morgan was convicted instead of violating the Commodity Exchange Act and the Dodd-Frank prohibition against “spoofing,” the flooding of an exchange with orders intended to create artificial demand with no intention to complete the orders in bona fide transactions. Two JP Morgan traders, who pled guilty in 2019 to spoofing precious metals contracts, had carried out their crimes through Morgan subsidiaries in London and Singapore (as well as in New York), illustrating the cross-border dimension of the trading strategy.
Notwithstanding a dissent from Commissioner Berkovitz, JP Morgan was not declared a “bad actor.” That designation would have required the multi-recidivist global megabank to increase its record keeping and reporting to the CFTC and to the Securities Exchange Commission, which regulates Treasury bonds. Also, on September 29, the Department of Justice (DoJ) announced a deferred prosecution of JP Morgan, allowing it to pay the $920 million fine with shareholder money without copping to a guilty plea and with no penalties for senior executives. Better Markets issued a six-point proposal for a settlement proportionate to the crime, including a $3.6 billion fine and a guilty plea.
The failure of shareholder-paid fines to prevent corporate recidivism has long been criticized. The $110 million fine levied in mid-October by the DoJ against Pilgrim’s Pride was derided by the Financial Times as “chicken feed.” The crime to which Pilgrim’s Pride pled guilty is, of course, price fixing and bid rigging in broiler chicken cash contracts from 2012-2019. In 2019 alone, Pilgrim’s Pride reported $456 million in profits on $11.4 billion in sales.
(Pilgrim’s Pride is owned by the multi-recidivist meatpacker and convicted foreign exchange futures contract manipulator JBS. In a separate settlement DoJ announced on October 14, J&F Investimentos, the JBS parent company, would pay a $128 million fine for violating the Foreign Corrupt Practices Act. According to the Wall Street Journal, a DoJ official said “executives at the highest levels of the company used U.S. banks and real estate to pay tens of millions of dollars in bribes to corrupt government officials in Brazil to obtain hundreds of millions of dollars in financing for the company and its affiliates,” including the purchase of Pilgrim’s Pride.)
However, the DoJ Pilgrim’s Pride deal, still subject to court approval, does not require restitution to be provided to injured parties, nor will Pilgrim’s Pride be subject to probation and independent monitoring. Other companies charged in the still developing price-fixing and bid-rigging investigation include Tyson Foods Inc., Koch Foods Inc., Perdue Farms Inc. and Claxton Poultry Farms.
There is no referenced contract in the position limit rule for the broiler chickens whose prices have been fixed by rigged bids. Why not? The theory of futures and options trading is that prices are discovered in the bid-offer-settlement process and that the futures prices will serve as reliable benchmarks for energy, metals and livestock auctions and for the forward contracting of grains to county grain elevators (storage facilities from which they are shipped). The captive supply by poultry processors is so extensive that there is too little public pricing information in the cash market to enable price discovery in a broiler chicken futures contract. (See “An Economic History of the Failure of Broiler Futures” by S. Aaron Hegde and a fine Washington Post article from 2014 regarding other market failure factors.) Why manage futures price risks when a poultry processor can control cash prices now by any means necessary?
Do these notable cases of price fixing, and market manipulation and excessive speculation, unconstrained by a position limit rule that allows the exchanges to determine how the rule is to be implemented, mean that futures markets are and will be too corrupted to serve farmers, ranchers and agricultural processors and traders?
According to a USDA Economic Research Service report released in October, about 47,000 U.S. farmers and ranchers used futures contracts at some point in 2016 to manage price risks in their commodities. Another 156,000 farmers (overlapping with the 47,000) used what ERS termed “marketing contracts,” which include forward contracts that are not as standardized in quantity and quality as futures contracts. The majority were corn and soy farmers, most of whom forward contract some part of their production to lock in a price in those volatile markets.
The ERS report also counts as a price risk management tool “production contracts [that] governed 85 percent of poultry and 66 percent of hog production [in 2016], with much of the rest occurring under vertical integration, on farms owned by a processor.” (p. 10) However, pricing information about this production relies on self-reporting by the poultry and livestock processor. In October, the National Cattlemen’s Beef Association proposed a “Voluntary Framework to Achieve Robust Price Discovery in the Fed Cattle Market.” The CFTC has yet to complete its investigation of unusual price movements in the feeder and live cattle futures markets, including the Chicago Mercantile Exchange live cattle futures contract, which belatedly is now subject to a position limit in the final rule.
In 2017, the Trump administration finalized a rule, criticized by IATP, to make it all but impossible for independent producers to challenge in court anti-competitive business practices, including production contracts whose opaque pricing greatly impedes timely discovery of pricing information required for independent producers’ marketing strategies. In 2020, the Trump administration’s final position limit rule will place price discovery in physical commodity contracts at the mercy of the exchanges who will decide whether their most important customers — financial speculators — merit exemptions from position limits.
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