USDA helps High Frequency Traders now; promises help for farmers later

With an eye on the U.S. elections in November, rural members of Congress are waiting anxiously for U.S. Department of Agriculture (USDA) Secretary Sonny Perdue to produce a plan to compensate farmers and ranchers for falling commodity prices and reduced agribusiness exports. The falling prices and export volumes are, in part, attributed to tariff retaliation against President Donald Trump’s tariffs on U.S. imports from Mexico, Canada, the European Union and, above all, China. For example, the week before China was to apply a 25 percent tariff on U.S. goods beginning July 6, the price of soybean futures contracts fell by four percent. Since the beginning of announced tariffs in mid-June, the soybean futures price has fallen more than 15 percent.

Senator Pat Roberts (R-KS), chair of the agriculture committee, said, according to the July 12 Politico Morning Trade, “there’s been talk of making anywhere between $15 billion and $30 billion available for aid to farmers hurt by the tariffs.” (By comparison, the Congressional Budget Office estimated in April that commodity program subsidies in the yet-to-be-enacted 2018 Farm Bill will cost about $61 billion by 2028.) According to a July 17 article in Inside U.S. Trade (subscription required), Secretary Perdue will announce the retaliatory tariff agricultural compensation plan by Labor Day, when farmers begin to harvest crops and deliver warehoused crops to meet forward contracting commitments to nearby grain elevators. Congressional approval and USDA implementation will come later.

Whatever the eventual scale and legislated source of this aid, it will not have the immediate impact on commodity prices of another decision taken by Secretary Perdue. On July 10, USDA announced a change to the decades old policy of releasing its monthly World Agricultural Supply and Demand Estimate (WASDE) first to accredited media representatives and 90 minutes later to the public. In theory, the media interpret WASDE information to the benefit of their subscribers, including traders. But starting in August, the media will receive the WASDE report at the same time as everyone else, due to a policy change made with the analytic assistance of the Commodity Trading Futures Commission (CFTC).

Secretary Perdue, the founding partner of a grain trading company, stated, “Everyone who has interest in the USDA reports should have the same access as anyone else. Modern technology and current trading tactics have made microseconds a factor. This change addresses the ‘head start’ of a few microseconds that can amount to a market advantage. The new procedures will level the playing field.” However, some traders have much more technological capacity to profit from simultaneously released WASDE information than do others.  

As a July 17 article in DTN noted (subscription required), more than 30 percent of rural America lacks broadband internet access, so farmers in those areas won’t have equal access to WASDE to decide how  to use forward or futures contracts to hedge against falling prices. Furthermore, one grain trader told DTN that 9 times out of 10, it takes a few minutes to access WASDE on the USDA website because information demand exceeds the website’s capacity. A few minutes of lost information advantage can be the difference between profit and loss.

According to a July 11 article in Bloomberg, the USDA policy change is “the latest saga for crop markets that have seen high speed algorithms taking over and running circles around slower human counterparts.” The algorithms can plug WASDE and other USDA statistical information into their trading formula and grab available commodity futures contracts to buy or sell before computer-aided human traders can act on the information.

But this is not just a story about technology-induced economic disruption: It is also about regulation and enforcement of rules, or the lack thereof.  

There are currently no CFTC rules tailored to regulate the market participants and practices of automated trading systems (ATS). IATP commented in March 2016 on a notice of proposed CFTC rulemaking for ATS, but there is no sign that the CFTC intends to propose a ATS rule, much less finalize one, in 2018.

Nevertheless, as IATP wrote in May 2016 and April 2018, agricultural commodity traders continue to charge that ATS users, and particularly High Frequency Traders, distort the futures prices that are the benchmarks for prices offered to farmers and ranchers by their county grain elevators and stockyards. As we noted in the April 2018 blog, “According to a CFTC study about 48 percent of agricultural futures contracts on the Chicago Mercantile Exchange (CME) were traded by ATS in 2016, up from 38 percent in 2014.”

During the past three weeks, the CFTC has issued two staff reports in response to trader concerns that commodity futures markets are not serving the needs of commercial users and price hedgers of agricultural and energy contracts. One report concerned the impact of non-public trading of large blocks of agricultural futures and options contracts by hedge funds and investment banks, offered by the CME since January. Large block traders will benefit from the simultaneous release of the WASDE reports as they incorporate its information into their non-public trading algorithms.

The CFTC staff summarized how large block trading could affect the ability of traditional market participants to buy and sell without being impacted by block trading-induced price volatility: “The impact of a large order could trigger prices of resting orders to be traded through rapidly, only to snap right back – possibly even causing a flash crash. Because the liquidity in some markets is not large enough to accommodate the execution of larger sized orders, participants may be harmed.” However, based on a review of non-public proprietary trading data, the CFTC staff concluded that the block trading patterns complied with the CME’s own rules regarding “fair and reasonable” price formation. Unaddressed was whether large block trading reduced the liquidity required to enable price discovery of contracts by smaller market participants under the CFTC’s own rules.

The other report concerns “sharp price movements” in contracts regulated, ostensibly, under CFTC authority. High Frequency Traders almost always complete their trades within seconds, if not micro-seconds, and so are not required to report their end of the day trading positions to exchanges and to the CFTC. Trading positions that are not reported provide no data for regulation. High Frequency Traders, despite experiencing a dip in 2017 profits, have a lot of room to grow among emerging markets actors that can package the WASDE information in trading algorithms, while not returning information to U.S. markets.  

The CFTC 13-page staff study “was primarily designed to determine what sharp price movements can reveal about the healthy functioning of exchange traded futures markets.” The methodology was to analyze data from 2.2 billion transactions from 2012-2017 through the filter of the 100 largest price swings during a three-minute interval in the 16 most frequently traded commodity contracts. The report concluded, “The U.S. commodity futures markets are very efficient, incorporate new information quickly, and continue to be the premier price discovery mechanism for global commodity markets.” The conclusion could be part of the CFTC’s justification for not regulating automated trading systems, notwithstanding dozens of mini-flash crashes (extreme and extremely rapid price disruptions) documented by the CFTC during the Obama administration.

In June 2018, Professor Michael Greenberger of the University of Maryland, and a former CFTC staffer, published a long essay that detailed how the failure to regulate commodity and financial markets and actors lead to the 2007-2009 Wall Street insolvencies and government bailouts, and the development of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010. Professor Greenberger characterized the rationales for past and current reigns of financial deregulation as “regulatory alchemy.” Part of that alchemy is the CFTC’s policy, announced in September 2017, to change its enforcement practices to encourage regulated entities to self-report violations of CFTC rules.

It is very likely that the agricultural price decreases and volatility triggered by tariffs levied by China, the European Union, Canada and Mexico against U.S. agribusiness exports will be exacerbated by deregulated or unregulated U.S. commodity markets. Investors in agricultural futures index funds are selling their shares in the funds in anticipation of more bad tariff-related price news to come, further driving down agricultural futures prices.

President Trump’s threats of tariffs can be withdrawn quickly if the tariffs are intended as a trade policy negotiating tactic, rather than the tip of the spear to destroy multilateral trading rules. But there is no alchemy to restore farm prosperity based on cash receipts, rather than taxpayer subsidies, if financial entities are allowed again to dominate commodities trading and trigger a price and solvency crisis, followed by more taxpayer-funded bailouts.