Chicago Board of Trade Futures Contracts in Corn and Soybeans; Notice That Delivery Point Specifications Must Be Amended

COMMODITY FUTURES TRADING COMMISSION

Chicago Board of Trade Futures Contracts in Corn and Soybeans;

Notice That Delivery Point Specifications Must Be Amended

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of, and request for public comment on, Notification to

chicago board of trade to amend delivery specifications.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') has

notified the Board of Trade of the City of Chicago (``CBT''), under

Section 5a(a)(10) of the Commodity Exchange Act (``Act''), 7 U.S.C.

7a(a)(10), that the delivery terms of the CBT corn and soybean futures

contracts no longer accomplish the objectives of that section of the

Act; and that the CBT has seventy-five days from the date of this

notice to submit proposed amendments to those contracts which will

accomplish the objectives of that section.

The Commission has determined that publication of the notification

to the CBT for public comment is in the public interest, will assist

the Commission in considering the views of interested persons, and is

consistent with the purposes of the Commodity Exchange Act.

DATES: Comments must be received by February 24, 1997.

ADDRESSES: Comments should be mailed to the Commodity Futures Trading

Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington,

D.C. 20581, attention: Office of the Secretariat; transmitted by

facsimile at (202) 418-5521; or transmitted electronically at

[[email protected]]. Reference should be made to ``Corn and Soybean

Delivery Points.''

FOR FURTHER INFORMATION CONTACT: Blake Imel, Acting Director, or Paul

M. Architzel, Chief Counsel, Division of Economic Analysis, Commodity

Futures Trading Commission, Three Lafayette Centre, 1155 21st Street,

N.W., Washington, D.C. 20581, (202) 418-5260, or electronically, Mr.

Architzel at [PA[email protected]].

SUPPLEMENTARY INFORMATION: Section 5a(a)(10) of the Act provides that

as a condition of contract market designation, boards of trade are

required to:

permit the delivery of any commodity, on contracts of sale thereof

for future delivery, of such grade or grades, at such point or

points and at such quality and locational price differentials as

will tend to prevent or diminish price manipulation, market

congestion, or the abnormal movement of such commodity in interstate

commerce. If the Commission after investigation finds that the rules

and regulations adopted by a contract market permitting delivery of

any commodity on contracts of sale thereof for future delivery, do

not accomplish the objectives of this subsection, then the

Commission shall notify the contract market of its finding and

afford the contract market an opportunity to make appropriate

changes in such rules and regulations.

The Commission, by letter dated December 19, 1996, notified the CBT

under Section 5a(a)(10) of the Act, that its futures contracts for corn

and soybeans no longer were in compliance with the requirements of that

section of the Act. The text of that notification is set-forth below.

December 19, 1996.

Patrick Arbor

Chairman, Chicago Board of Trade, 141 W. Jackson Blvd., Chicago,

Illinois 60604

Re: Delivery Point Specifications of the Corn and Soybean Futures

Contracts.

Dear Chairman Arbor: The Commodity Futures Trading Commission

(``CFTC'' or ``Commission'') hereby notifies the Board of Trade of

the City of Chicago (``CBT or Exchange'') under Section 5a(a)(10) of

the Commodity Exchange Act (``Act''), 7 U.S.C. 7a(a)(10), that the

delivery terms of the CBT corn and soybean futures contracts no

longer accomplish the statutory objectives of ``permit[ting] the

delivery of any commodity * * * at such point or points and at such

quality and locational price differentials as will tend to prevent

or diminish price manipulation, market congestion, or the abnormal

movement of such commodity in interstate commerce.'' 1

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\1\ The full text of Section 5a(a)(10) of the Commodity Exchange

Act is appended to this letter.

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The Commission, as detailed below, bases this finding on the

following: (1) the continuing diminution of the role of terminal

markets in the cash market for grain; (2) the increasing shift of the

locus of the main channels of commodity flows away from the delivery

points on the contracts, particularly the par-delivery point of

Chicago; (3) the continuing decline in cash market activity generally

at the contracts' delivery points, particularly Chicago; and (4) the

serious, precipitous drop in regular warehouse storage capacity at the

Chicago delivery point

[[Page 67999]]

over the past fourteen months. These conclusions are supported by a

number of CFTC staff inquiries into these issues and by four separate,

comprehensive studies of these issues completed in 1991 (one of which

was sponsored by the CBT). Each of these inquiries and studies

identified the above trends and indicated that deliverable supplies on

the subject contracts were not available in normal cash market channels

in amounts sufficient to tend to prevent or to diminish price

manipulation, market congestion, or the abnormal movement of such

commodity in interstate commerce.

Although the CBT has attempted previously to respond to these

problems by amending the contracts, those steps, such as the addition

of St. Louis as a delivery point, have proven to be ineffective. With

the recent precipitous drop in warehouse capacity in Chicago, the

problem has reached a critical juncture. Recognizing this, the CBT

convened a Task Force to consider changes to the grain contracts. More

than a year after the Task Force began its deliberations, the Exchange

membership rejected the modifications to the terms of the corn and

soybean contracts recommended by the CBT's Board of Directors.

And, as provided under section 5a(a)(10) of the Act, the Commission

hereby notifies the CBT that the Exchange is afforded the opportunity

to submit for Commission approval proposed amendments to the delivery

terms of the corn and soybean futures contracts that will accomplish

the statutory objectives by March 4, 1997, a period of seventy-five

days from the date of this letter. In determining whether its proposal

is adequate to accomplish the objectives of section 5a(a)(10) of the

Act, the CBT should be guided by a number of illustrative alternatives

provided below. Failure to respond in a manner which in the

Commission's judgment is ``necessary to accomplish the objectives'' of

this section of the Act will result in further proceedings under

section 5a(a)(10).

In light of the Commission's determination that the CBT's futures

contracts in corn and soybeans no longer comply with the requirements

of section 5a(a)(10) of the Act, the CBT should refrain from listing

additional months for trading in those contracts during the pendency of

these proceedings.

By limiting this notification under Section 5a(a)(10) of the Act to

the CBT's futures contracts for corn and soybeans, the Commission is

not thereby making any determination regarding any other CBT futures

contract. The Commission notes, however, that the delivery

specifications for the CBT wheat futures contract are also subject to

many of the same trends which have affected adversely the corn and

soybean contracts. In light of the importance of these issues, the

Commission determined to limit this Section 5a(a)(10) notification to

the corn and soybean contracts, which have been fully considered by the

CBT in the first instance. The Commission believes that such a full

consideration by the CBT of the delivery specifications of its wheat

contract is also warranted and should be undertaken immediately. The

Commission is of the view that this reconsideration should be completed

within 120 days.

In notifying the CBT of the Commission's finding that the terms of

the corn and soybean futures contracts do not accomplish the objectives

of Section 5a(a)(10) of the Act, the Commission is not questioning the

continued utility of the contracts for hedging or price basing under

ordinary conditions or their role as the world's premiere futures

contracts for corn and soybeans. Rather, the Commission's action, as

explained in greater detail below, is predicated upon its finding that

bringing the delivery terms of the contracts into closer alignment with

an otherwise broad and active cash market is necessary to meet the

requirements of Section 5a(a)(10), tending to prevent or to diminish

price manipulation, market congestion, or the abnormal movement of such

commodities in interstate commerce.

I. Background.

The CBT's corn and soybean futures contracts are major United

States (U.S.) futures markets and principal vehicles for hedging and

pricing by U.S. firms with commercial interests in these two important

agricultural commodities. They rank among the most actively traded

commodity futures contracts in the world and are used extensively by

foreign commercial interests. In this regard, for the 1995/96 crop

year, the average daily open interest was nearly two billion bushels

for CBT corn futures and approached one billion bushels for CBT soybean

futures. The total trading volume over the same period was

approximately 95 billion bushels for corn futures and 70 billion

bushels for soybean futures.

These activity levels for corn represent a greater than eight-fold

increase in the levels of volume and open interest experienced in these

markets in the early 1970s. For soybeans, these current levels are more

than four times the levels experienced in the early 1970s. This

increased overall level of trading activity can be attributed to an

approximate 80 percent increase in the combined U.S. annual production

of corn and soybeans over the last 25 years; a steadily decreasing

level of federal crop price support activities, which has led to

increased commercial uncertainty and need for hedging; and an increased

internationalization of cash markets for feed grains and soybeans,

which has also led to increased foreign participation in these futures

markets for purposes of hedging and price-basing.

The preponderant use of these markets is commercial in nature. For

example, in mid-November of this year, reportable commercial traders

held 60 and 70 percent of the reportable long and short sides,

respectively, of the soybean futures market and 85 and 64 percent of

the reportable long and short sides, respectively, of the corn

market.2 Presumably, commercial traders also held a substantial

proportion of the non-reportable positions.

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\2\ Reportable traders are individuals or firms that hold

futures positions of 500,000 bushels or more in soybeans or 750,000

bushels or more in corn in any one contract month through any U.S.

or foreign broker.

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The predominant economic function of the CBT corn and soybean

futures markets is risk-transfer and price-basing, rather than

merchandising or title transfer for the underlying commodity.

Consistent with this, the preponderance of positions established in

these markets are liquidated through the purchase or sale of offsetting

futures contracts, rather than through making or taking delivery of the

commodity. Nonetheless, the orderly convergence of futures prices and

cash market merchandising values is essential to these contracts' risk-

transfer and price-basing functions, and this convergence is dependent

on the unimpeded opportunity of market participants to conduct

arbitrage between the cash and futures markets. As a result, it is

essential that the delivery specifications of these contracts

effectively link futures trading to a substantial segment of the

underlying cash markets.

The manner in which cash and futures prices are linked through the

delivery mechanism is straightforward. If, at contract expiration,

short position holders believe that expiring futures prices are higher

than the current value of the commodity, they can satisfy their

contractual obligations by acquisition and delivery of the physical

commodity, rather than through the purchase of offsetting futures

contracts. Likewise, if long position holders believe that

[[Page 68000]]

expiring futures prices are lower than the current merchandising value

of the commodity, they can require delivery in lieu of selling

offsetting contracts in the futures market. To the extent that this

arbitrage process is not impeded, convergence of cash and futures

prices at contract expiration is assured.

The terms of delivery are critical in determining the degree of

arbitrage between cash and futures markets and the strength of the

linkage between cash and futures prices. When contract delivery terms

do not correspond to a substantial segment of the cash market, the

strength of the arbitrage linkage is diminished. In particular, when

the futures market requires delivery at a location or of grades for

which the commodity is not sufficiently available, short position

holders may not be able to acquire the commodity or gain access to the

delivery facilities in the event they believe that cash and futures

prices are misaligned. Long position holders, seeking to profit from

their positions, have no incentive to liquidate their positions through

offset, and futures prices may take a course that is independent of the

cash market. The resulting market congestion, or distortion of prices,

is disruptive to proper functioning of the futures market, because

prices no longer reflect cash market fundamentals. Thus, the nature of

the delivery terms is critical to use of the CBT's corn and soybean

futures contracts throughout the U.S. and abroad in the hedging and

pricing of corn and soybean transactions and directly determines the

degree to which the prices of the futures markets may be manipulated or

otherwise become independent of fundamental conditions in those cash

markets.

As discussed in detail below, the CBT's corn and soybean contracts

currently specify delivery through the use of warehouse receipts for

stocks held in specified facilities at Chicago, Toledo, and St. Louis.

It is the location of these delivery points, as well as the nature of

the delivery instrument, that is the subject of the Commission's

analysis regarding the CBT's compliance with the provisions of Section

5a(a)(10) of the Act.

II. General Cash Market Trends

Chicago and Toledo, the primary delivery points of the CBT's corn

and soybean futures contracts, are now situated at the periphery of

current major cash market channels for these commodities. Their

declining importance as cash market centers is the result of long-term

trends in the storage, transportation, and processing of grains. As

discussed below, these trends include: (1) increasing shipment of corn

and soybeans from production areas directly to domestic users or export

locations, bypassing intermediate locations such as terminal markets;

(2) increasing processor use of corn and soybeans in production areas,

to produce food, feed, and other products, thereby reducing the

relative quantity of corn and soybeans shipped to locations outside of

production areas including terminal markets; (3) substantially

declining export activity from the Great Lakes relative to the growth

of exports from Gulf of Mexico and Pacific Northwest ports; and (4)

increasing decentralization in grain storage capacity, with marked

increases in both on-farm and commercial storage capacity in production

areas.

1. Changes in Transportation Patterns

The increasing shipment of corn and soybeans directly from

production areas to domestic users or export locations, bypassing the

traditional terminal markets, is related, in large part, to the

deregulation of railroad freight rates. Prior to rail freight-rate

deregulation in 1980, a practice called ``transit'' or

[[Page 68001]]

``proportional billing'' permitted grain to be shipped from production

areas to an intermediate point for storage, such as a traditional

terminal market, and then to the final destination at a single, fixed

rate. After 1980, negotiated point-to-point rates replaced transit

billing, favoring direct shipments of corn and soybeans to domestic

users or export locations, to the detriment of traditional terminal

markets located at major railroad centers such as Chicago.

2. Processing Trends

Substantial increases in corn and soybean processing at new and

existing locations within the major production areas has further

reduced the role of traditional terminal markets. According to U. S.

Department of Agriculture (USDA) data, the quantity of corn processed

into corn sweeteners, ethanol, and other products quadrupled between

1970 and 1995 (from about 400 million bushels to over 1.6 billion

bushels) and the quantity of soybeans crushed in the U.S. approximately

doubled over the same time period (from about 760 million bushels to

about 1.34 billion bushels). Most of these new or expanded facilities

are located in production areas, in which the processors obtain their

supplies of corn and soybeans directly from nearby grain warehouses or

producers. Moreover, even processing facilities located at terminal

markets now purchase the majority of their supply directly from lower-

cost production-area locations rather than from terminal market

elevators. The inability to participate in this growth sector of the

cash market has further eroded the relative importance of traditional

terminal-market elevators.

3. Export Marketing Channel Changes

Over the past 25 years, corn and soybean exports have grown

dramatically. However, the trends favor the all-year export facilities

of the lower Mississippi River. In addition, the growth in exports to

Asia has favored export facilities at Pacific Northwest ports. The

growth in exports from these two areas has relatively disadvantaged the

third major export route--the Great Lakes. More fundamentally, corn and

soybean exports from the Great Lakes have declined absolutely, as well.

This decline is, in part, attributable to the fall in exports to

Northern European countries where Great Lakes ports sometimes have a

cost advantage relative to other U.S. ports. In addition, exports from

the Great Lakes are limited by the relatively high cost of shipping

corn and soybeans by vessel from Great Lakes ports. This is partially

due to the fact that the St. Lawrence Seaway, through which all vessels

from Great Lakes ports must pass, can accommodate only relatively small

vessels, which tend to charge higher freight rates for grain shipments

than those assessed by larger vessels. In view of this consideration,

corn and soybeans frequently are transferred from such smaller ships to

larger vessels at Canadian ports.

These changes have significantly eroded the role, and general

business activity, of the Great Lakes ports and the traditional

terminal markets located there. For example, USDA data indicate that

average annual exports of corn from Chicago and Toledo combined fell by

33 percent between 1968-70 and 1993-95. Average annual soybean exports

from Toledo and Chicago over this same period fell by 53 percent. In

addition, the percentage of total U.S. exports of corn and soybeans

accounted for by Chicago and Toledo combined declined from an average

of about 17 percent in the 1968-70 period to an average of about four

percent in the 1993-95 period.

As the following charts indicate, the decline in the export role of

Chicago and Toledo has been associated with, and is in contrast to, the

increasing importance of corn and soybean exports through ports on the

Gulf of Mexico and on the Pacific Coast.3

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\3\ Ports located on the lower Mississippi River accounted for

about 93 percent of average annual soybean and corn exports from

Gulf of Mexico ports over the period 1993-95. Virtually all Pacific

Coast exports of corn and soybeans move through Pacific Northwest

ports located on the Columbia River and Puget Sound.

BILLING CODE 6351-01-P

[[Page 68002]]

[GRAPHIC] [TIFF OMITTED] TN26DE96.000

[[Page 68003]]

[GRAPHIC] [TIFF OMITTED] TN26DE96.001

BILLING CODE 6351-01-C

[[Page 68004]]

4. Geographic Changes in Storage Capacity Location

Finally, the role of some terminal markets as grain storage centers

has declined as increasing storage capacity has been constructed in

production areas, both off-farm and on-farm. Increases in off-farm

storage capacity in production areas is due, in part, to the

deregulation of rail freight rates, increased processing activity in

production areas, and the need for additional storage capacity due to

the significant growth in corn and soybean production in recent

decades. In addition, on-farm storage capacity has increased

significantly over the past 25 years to allow producers to maintain

harvesting efficiency and access to lower cost storage. As a result,

the role of terminal markets as storage centers has greatly diminished.

III. Cash Market Conditions at CBT Delivery Points.

As indicated above, general cash market trends disfavor traditional

terminal markets such as Chicago. Moreover, cash market activity in

Chicago and Toledo, the primary delivery locations for the CBT's corn

and soybean futures contracts, has declined substantially, both on an

absolute and relative basis, in recent decades. USDA production data

and CBT data on grain receipts by elevators and processors at the

primary delivery locations indicate that, despite U.S. corn production

nearly doubling from 1970 to 1995, total corn receipts at Chicago and

Toledo combined increased only by about 26 percent from 1970 to 1995,

representing a mere 2.5 percent of total U.S. corn production in 1995.

These data also indicate that, while U.S. soybean production also

nearly doubled over this period, total soybean receipts in these

locations actually fell by about 64 percent during the 1970-95 period,

representing less than 2 percent of total 1995 U.S. soybean production.

These trends illustrate the peripheral nature of the delivery points of

the CBT's corn and soybean futures contracts to the cash market for

these commodities.

The decline in the importance of the primary CBT delivery locations

relative to the cash market is further illustrated by the trends in

storage capacity at these locations in relation to changes in storage

capacity in states which contain primary production areas for corn and

soybeans. In particular, USDA data indicate that, from January 1, 1970,

to December 1, 1995, total off-farm storage capacity in Illinois more

than doubled, whereas CBT data for the same period indicate that the

registered storage capacity of regular elevators at Chicago remained

essentially constant until 1995, when it fell by about 58 percent.

Similarly, during the period January 1, 1978, through December 1, 1995,

total off-farm storage capacity in Illinois, Indiana and Ohio combined

increased by about 42 percent, whereas total regular storage capacity

in Chicago and Toledo combined declined by about 15 percent. This

decline includes the 25 percent decrease in total regular storage

capacity during 1995.

The decline in the cash market importance of the primary CBT

delivery points has not been uniform. Rather, the declining cash-market

importance of Chicago, the par delivery point, has recently been

particularly acute.

1. Cash Market Trends at Chicago

Chicago's decreasing cash market role has been reflected over the

years in a gradual loss in regular elevator storage capacity and in the

number of firms operating such elevators. As discussed in more detail

below, this loss has recently become precipitous. According to CBT

data, in 1970, five firms operated seven regular elevators with a total

registered storage capacity of about 52.4 million bushels. Currently,

there are only three firms operating three regular elevators, with a

total registered storage capacity of 22.8 million bushels. Further, one

of the three remaining regular elevators, representing about 8.1

million bushels of storage capacity, recently ceased accepting grain

and soybeans and appears to be closing down its operations, leaving

total registered storage capacity at 14.7 million bushels.

Currently, soybean cash market activity in the Chicago area is

limited to the merchandising by regular elevators of soybeans received

from production locations, generally at harvest time. In this regard,

total annual soybean receipts by regular CBT elevators declined by

about 86 percent from 1970 to 1995, to about 8 million bushels. The

merchandising role played by CBT regular elevators essentially is

limited to shipping soybeans into export channels, either by barge to

lower Mississippi River export points or via vessels through the Great

Lakes and the St. Lawrence Seaway.

The existing corn cash market in the Chicago area primarily

consists of purchases of corn by two local processing facilities and

the merchandising by regular elevators of corn received from production

locations. Annual receipts of corn in Chicago in 1995 totaled 112

million bushels, remaining relatively unchanged since 1970. CBT data

indicate that a very small share of these receipts is received by

regular elevators, with these elevators accounting for only about 14

percent of total corn receipts in 1995. Further, corn processing

facilities in Chicago purchase essentially all of their annual corn

requirements directly from production areas rather than from regular

elevators. As with soybeans, regular elevators merchandise the limited

quantities of corn they receive primarily into export channels.

USDA data indicate that average corn exports via the Great Lakes,

during the period 1993-95, declined in absolute terms by over 60

percent relative to the average levels observed in 1968-70 and, as a

percentage of total U.S. exports, from about 11.3 to 1.2 percent.4

These data also indicate that average soybean exports via the Great

Lakes declined by approximately 70 percent between these same two time

periods and, as a percentage of total U.S. exports, from about 7.3 to

about 1.1 percent.

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\4\ These data actually overstate the level of corn and soybean

exports from Chicago, because the USDA's export data for Chicago

also include exports from Milwaukee.

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2. Cash Market at Toledo

Corn and soybean cash market activity in Toledo has been less

affected by these trends than the par delivery point of Chicago. Since

Toledo was added as a delivery point for corn and soybeans in the mid-

to late 1970s, the number of regular elevators in Toledo has remained

relatively stable, although overall registered storage capacity has

increased from about 36 million bushels in 1978 to about 57 million

bushels today. Currently, there are seven regular elevators at the

Toledo delivery point. The cash market for corn and soybeans at Toledo

consists exclusively of the merchandising activities of the regular

elevators; there are no processing facilities for these commodities at

this location.

From 1970 to 1995, annual receipts of corn at Toledo doubled,

increasing to an average of about 65 million bushels during 1994-95.

Despite the overall doubling of receipts, however, average corn exports

via the Great Lakes, during the period 1993-95, exceeded by only about

20 percent the average levels observed in 1968-70. In contrast, soybean

receipts at Toledo declined in absolute amount by about 30 percent over

this same period to an average of about 30 million bushels during 1994-

95. Average soybean exports from Toledo declined by an even greater

amount--approximately 47 percent between these same two time periods.

Thus, while these data indicate that

[[Page 68005]]

Toledo, unlike Chicago, has retained a larger measure of cash market

activity, it is of a decidedly mixed nature.

3. Cash Market Conditions at St. Louis

Cash market activity at the contracts' St. Louis delivery point is

of a substantially different nature than at the contracts' two primary

delivery points. This location primarily serves as a barge loading area

for corn and soybeans for shipment to the lower Mississippi River

export market. The four regular elevators currently at St. Louis have a

registered storage capacity of 12.2 million bushels. CBT data indicate

that these elevators handle relatively large quantities of corn and

soybeans. Specifically, receipts of corn averaged 52 million bushels

during the period 1994-95, while receipts of soybeans averaged 23

million bushels over this same period. Similar quantities of corn and

soybeans were shipped (almost exclusively by barge) during these two

years. However, regular elevators at this location do not store

significant quantities of corn or soybeans for extended periods of time

due to the need to keep storage space unencumbered in order efficiently

to conduct the unloading/loading process. Accordingly, because delivery

on the CBT's corn and soybean contracts calls for the issuance of

warehouse receipts that require regular elevators to store the

commodity until the receipt is redeemed, there have been only a token

number of futures deliveries at St. Louis.

IV. History of Revisions to the CBT Corn and Soybean Futures Delivery

Point Specifications--1973 to 1993

The trends discussed above are long-term in nature. There has been

an equally long history of modest attempts, made only in response to

the urging of the federal regulator, to address the effect of these

trends on the continued viability of the delivery terms of these

futures contracts, while retaining the primacy of Chicago. Until the

1970's, Chicago was the sole delivery point on the CBT's corn and

soybean futures contracts. At that time, a number of problem

liquidations and price manipulation investigations in these futures

markets focused attention on the inadequacy of Chicago as a delivery

point and the need for additional delivery points. In particular, in

the summer of 1973, both futures markets experienced problem

liquidations, due, in part, to a general tightness in supplies

associated with large Soviet grain purchases. Later that year,

Congressional hearings were held in response to these problems.

Ultimately, as part of far-reaching amendments to the Act, Section

5a(a)(10) was added, providing for new federal authority to address

directly the delivery point provisions of futures contracts.

1. Proposals to Add Toledo and St. Louis

In 1974, the CBT submitted proposals to the USDA's Commodity

Exchange Authority, the Commission's predecessor agency, to add Toledo

and St. Louis as delivery points on the corn and soybean contracts at a

discount of 5 cents per bushel to Chicago.5 The CBT never placed

these amendments into effect, because the proposed discounts were

thought to be too great relative to cash market pricing relationships

between Chicago and the proposed delivery points. In 1975, these same

amendments were resubmitted to the newly formed CFTC for its approval.

The Commission approved the proposal for corn (effective with the

December 1976 contract month); and the CBT withdrew the soybean

proposal. In 1978, the CBT resubmitted the proposal to add Toledo (but

not St. Louis) as a delivery point for the soybean contract at a

discount of 8 cents per bushel. The Commission approved those

amendments, effective with the November 1979 contract month.

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\5\ Toledo was established by the CBT as a delivery point for

its wheat futures contract in the early 1970s.

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2. Proposal to Add St. Louis as a Soybean Futures Delivery Point

In July 1989, a commercial long trader held large long positions

that exceeded the amount of soybeans that short traders were able to

deliver at the contract's then existing delivery points and indicated

that it would stand for delivery on its positions. This prompted the

CBT to declare a market emergency, taking action to ensure an orderly

liquidation of that futures contract month. In response to the

outpouring of concerns over the adequacy of the contract's delivery

provisions expressed by market participants after this incident, the

CBT in 1990 proposed a number of changes to its soybean and grain

futures contracts. These included adding St. Louis as a delivery point

for soybeans at a discount of 4 cents per bushel to Chicago. Based upon

evidence that the proposed discount for St. Louis delivery was too

great relative to cash market pricing relationships, the Commission

returned this submission for further justification under Commission

Rule 1.41(b). The Commission also reiterated its view that the CBT

should consider more substantive changes to its soybean and grain

futures contracts in order to ensure adequate deliverable supplies.

In response to the heightened concerns over the adequacy of the CBT

grain and soybean delivery points renewed by the July 1989 market

emergency, the National Grain and Feed Association, the CBT, the

General Accounting Office, and the Commission all conducted or

sponsored studies on the delivery terms of the soybean and grain

futures contracts. These separate studies were all completed in 1991.

They generally found that long-term trends in the structure of the

grain industry had affected adversely the viability of the cash markets

at Chicago and Toledo. Their specific conclusions are summarized below.

a. MidAmerica Institute

The CBT commissioned the MidAmerica Institute to conduct a study of

its corn and soybean futures contracts. The study concluded that, based

on an analysis of cash and futures price data for the 1984-89 period,

the delivery process for these contracts effectively resulted in the

convergence of futures prices and cash prices at the contracts' Chicago

and Toledo delivery points. The study noted, however, that the Chicago-

Great Lakes-East Coast cash market for grains and soybeans had declined

markedly in importance relative to the Mississippi-Gulf of Mexico area.

The study concluded that this decline had reduced the benefits of

retaining Chicago as the primary delivery point and of relying upon

Toledo as the alternative delivery point. In this respect, the study

concluded that Chicago had become a relatively low price point because

it is located near the origin, rather than at the destination, of grain

and soybean flows for most of the year. The study indicated that this

feature enhances the potential for manipulation, since deliverable

supplies may only be increased to address a manipulation attempt by

drawing these commodities from higher value locations. The study noted

that such an action to increase deliverable supplies is costly and that

a manipulator can profitably exploit this cost to inflate futures

prices artificially under conditions that recur periodically in grain

markets. The study also noted that the decline in Chicago's tributary

area means that more hedgers must bear additional basis risk when

Chicago is the primary delivery point.

This increased susceptibility to manipulation and basis risk, the

study concluded, could be ameliorated by improving the alignment of the

contracts' delivery mechanisms with

[[Page 68006]]

prevailing cash market conditions and pricing relationships. In

particular, the addition of an effective Mississippi River delivery

point, such as St. Louis, and the establishment of price differentials

for all delivery locations at levels reflecting typical cash price

relationships, was recommended. The addition of a delivery point at an

active cash market location such as St. Louis, the Institute noted,

would enhance the futures contracts' hedging performance by improving

the extent to which their prices reflect prices in primary cash market

channels. In this regard, however, the MidAmerica Institute cautioned

that, because of their limited storage capacity and throughput nature,

the addition of St. Louis warehouses would only modestly enhance

deterrence of manipulative activity.\6\

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\6\ Providing for emergency barge or rail delivery, or for some

mechanism of ensuring access of throughput elevators in the vicinity

of that city to the delivery process, would, according to the

MidAmerica Institute, address these shortcomings in St. Louis as a

potential additional delivery point.

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b. Food Research Institute

The Food Research Institute of Stanford University was commissioned

by the National Grain and Feed Association to study these issues as

well. This study concluded that deliverable stocks at the contracts'

delivery points were, in the years preceding the study's completion in

1991, too low relative to the size of positions normally held by the

largest traders. It concluded that, in this respect, positions held by

the largest traders were of such a size relative to deliverable stocks

that neither delivery nor the threat of delivery was a credible

alternative. Moreover, this limited level of deliverable stocks was not

due to any warehouse capacity constraints existing at that time, but

rather to the general inexorable decline of cash market activity at

grain terminal markets--Chicago, in particular.

The Food Research Institute recommended that the CBT address this

fundamental problem by rethinking its specifications requiring delivery

of grain and soybeans in-store via warehouse receipts. Suggested

alternatives included barge delivery, incorporating aspects of a call

on production, or delivery at Mississippi River export facilities, with

the receiver given the option as to when the product is loaded upon one

month's notice.\7\

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\7\ The Food Research Institute study suggested that the CBT

consider adopting the delivery procedures used on the New York

Mercantile Exchange's crude and heating oil futures contracts if the

CBT selects a Gulf of Mexico delivery point system.

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c. The CFTC

The Commission staff's study of the contracts' delivery terms

reviewed and analyzed the general cash market trends and the specific

cash market conditions at Chicago and Toledo during the period 1960

through 1990. The study found that Chicago and, to a lesser extent,

Toledo had declined substantially as storage locations for corn and

soybeans to be exported via the Great Lakes and shipped to other U.S.

destinations for domestic consumption purposes. In addition, the study

analyzed several potential alternative delivery-point specifications

for the corn and soybean futures contracts, which would locate the

contracts' delivery points within the commodities' primary cash market

channels. These included delivering corn and soybeans in-store at

Central Illinois warehouses via warehouse receipts; making delivery at

Illinois River barge-loading, or Mississippi River vessel-loading

export facilities via shipping certificates; and cash settlement. The

study concluded that these alternatives, by aligning the contracts'

terms more closely with the underlying cash markets for corn and

soybeans, would thereby reduce the potential for market problems and

concomitant regulatory interventions.

d. General Accounting Office (GAO)

At the request of the Chairman of the Agriculture Committee of the

U.S. House of Representatives, the GAO completed a review of the CBT

grain and soybean futures delivery-point issues in 1991. The GAO

conducted interviews of interested parties, including CBT and

Commission officials, and reviewed the above-noted studies prepared by

the MidAmerica Institute and the Stanford University Food Research

Institute.

In its study, the GAO noted that CBT officials believed that

changing delivery points might interfere with the economic purposes of

futures trading and that surveillance and disciplinary action programs

rather than changing delivery points might be better suited to

preventing potential market manipulation. The GAO noted that, in

contrast, the Commission was reluctant not to alter futures contract

terms that in its judgement resulted in an increased threat of

manipulation and required an excessive level of regulatory intervention

to prevent frequent market congestion, price distortions or

manipulation. The GAO also noted that the MidAmerica and Food Research

Institute studies supported the need for the CBT and the 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 Act.

e. Symposium on CBT Grain and Soybean Delivery Point Issues

In conjunction with the completion of these studies, in September

1991, the Commission sponsored a symposium to discuss these issues.

Attendees at that symposium represented a broad cross section of

interested parties, including major grain companies, academic

institutions, the CBT, and the Commission. Members of the grain

industry generally agreed that the performance of the futures contracts

under their current delivery specifications was not satisfactory in all

respects, but disagreed on the degree of the problem and the nature of

the possible solutions. Although acknowledging that Chicago was a

declining cash market, a CBT representative nevertheless maintained

that Chicago was still a viable delivery point based upon the variety

of transportation alternatives available to long traders taking

delivery at that location. The CBT representative further indicated

that the CBT was continuing to study the situation and develop

appropriate revisions to the contracts' delivery specifications.

f. Final CBT Proposals Responding to July 1989 Soybean Incident

In 1992, the CBT re-submitted its proposal to add St. Louis as a

delivery point for soybeans, at a premium of 8 cents per bushel rather

than at a discount of 4 cents per bushel as previously proposed in

1990. The CBT also proposed to revise the price differential for St.

Louis corn futures deliveries to a premium of 7 cents per bushel from

the then existing 4 cents per bushel discount and to reduce the

discount for the delivery of corn in Toledo to 3 from 4 cents per

bushel. Although approving these proposals in April 1992 for

implementation beginning with the December 1993 corn contract month and

the November 1993 soybean contract month, the Commission, in its

approval letter, stated that it:

understands that the addition of St. Louis as a delivery point for

soybeans and wheat and revisions to locational differentials for

corn were intended by the Exchange to provide additional deliverable

supplies for these contracts. Nevertheless, the Commission is

concerned that these changes may not be sufficiently responsive to

the long run changes in the cash market, and therefore may not

significantly alleviate concerns about the contracts' specifications

in either the immediate future or the long run.

[[Page 68007]]

In particular, in view of the long term trends in the cash

market, the Commission is concerned about the continued reliance on

warehouse receipts in terminal markets as the sole source of

deliverable supplies for each of these contracts. Further, the

Commission notes that the limited warehouse space at St. Louis may

be devoted primarily to ``through-put'' merchandising activities

and, as a result, operators of these facilities may be reluctant to

make significant space and/or receipts available for purposes of

futures delivery.

The Commission concluded by again putting the CBT on notice that:

[i]n consideration of this, the Commission believes that the CBT

should continue its efforts to develop comprehensive contract

revisions that will enhance deliverable supply and reduce the need

for formal and informal market intervention by the Exchange or the

Commission. It is the Commission's belief that such revisions may

require linking contract terms more directly to commodity flows or

to decentralized storage. In the Commission's view, continued active

consideration of this matter is particularly advisable in view of

the possibility of further declines in the viability of the Chicago

delivery area and the time necessary to develop and fully implement

more substantive contract changes.

V. Recent Events--1995 to the Present

As predicted by the Commission in 1992, the CBT's response to the

continuing deterioration of the cash market at its delivery points

proved to be a solution of limited effect and short duration. In the

fall of 1995, three of the existing six Chicago delivery warehouses

ceased operations. As a result, Chicago delivery capacity was

immediately reduced by more than half--from 53.9 to 22.8 million

bushels. Significant as this drop in capacity is, it must be kept in

mind that actual supplies available in those warehouses have been a

fraction of the total capacity. Nevertheless, the precipitous drop in

warehouse capacity served to reawaken concerns over the viability of

the contracts' delivery points.8

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\8\ Moreover, as also anticipated by the Commission in 1992,

there have been few, if any, warehouse receipts registered for

delivery on the soybean (or wheat) futures contracts at St. Louis,

since it became a soybean (and wheat) delivery point in 1993. In

addition, despite the substantial increase in the locational price

differential applicable to St. Louis corn futures deliveries under

the 1992 amendments, there continues to be very little futures

delivery activity in corn at that location.

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Commission Chairman Mary Schapiro, in an October 11, 1995, letter

to the CBT, expressed once again the Commission's concerns regarding

the adequacy of the contracts' delivery provisions, stressing that the

Commission's concerns were heightened by this further deterioration.

Chairman Schapiro requested that the Exchange keep the Commission staff

informed on a frequent basis of the progress of a Special Task Force

established by the CBT to study the situation. Chairman Schapiro's

letter further noted the Commission's recommendation that the Exchange

not limit its consideration to short-term responses to the closure of

the above-noted Chicago regular elevators. The letter noted,

specifically, that the Exchange should consider, in the context of

long-run cash market trends, comprehensive contract revisions that

would enhance deliverable supply and provide a viable price-basing

service for the international grain industry.

1. CBT Task Force.

As noted above, the halving of deliverable storage capacity at

Chicago prompted the CBT to form a Special Task Force on September 25,

1995, to determine what changes, if any, were needed to be made to the

contracts' delivery terms to ensure adequate deliverable supplies. The

Special Task Force held numerous meetings from the date of its

establishment through early June 1996. It invited a significant number

of individuals, representing a broad cross section of the industry and

other interests, to express their views. It considered in depth the

merits of a number of suggested alternatives. The Special Task Force's

Chairman also briefed the Commission on its progress.

On June 4, 1996, the CBT Special Task Force issued its final

recommendations for changing the delivery provisions of the grain

futures contracts. The Special Task Force recommended: (1) adding

delivery points in East Central Illinois, Northern Illinois River

locations, and Milwaukee, Wisconsin, for the corn and soybean

contracts, with warehouse receipts continuing to serve as the delivery

instrument; (2) reducing the locational price differentials for

delivery of corn, soybeans, and wheat at Toledo, Ohio; (3) deleting St.

Louis as a delivery point for the corn, soybean, and wheat futures

contracts; (4) reducing the daily barge load-out requirement for

Chicago elevators from 3 to 2 barges, but permitting the receivers of

corn or soybeans to request up to 4 barges per day, which the Chicago

warehouseman could provide either entirely from the Chicago elevator or

through a combination of loadings at the Chicago elevator and a

separate loading point along the Northern Illinois River; and (5)

establishing higher minimum financial requirements for regular

warehousemen.

2. March 1996 Wheat Expiration Problem

In the midst of the Special Task Force's deliberations, the March

1996 wheat futures contract experienced a problematic

liquidation.9 On the last trading day of this future, a major

commercial trader maintained a significant long position against export

sales contracts and a major commercial trader who did not own wheat in

deliverable position maintained a significant short position until the

final few minutes of trading. The commercial short trader and several

other short position holders elected to offset their positions rather

than make delivery. During the final minutes of trading, this buying

interest was met by a lack of selling interest--the large commercial

long trader had determined to stand for delivery and had not entered

any orders on the close. As a result, wheat futures prices were bid

sharply higher, from about $5.00 to over $7.00 per bushel during and

after the close of trading. Although the Commission staff report

10 on this incident was not addressed to the causal links, if any,

between the delivery specifications for the contract and the problem

liquidation, the recent problem in the expiration of the March wheat

futures contract may foreshadow similar problems for the corn and

soybean futures contracts.

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\9\ As noted above, although this notification under section

5a(a)(10) of the Act applies only to the CBT corn and soybean

futures contracts, many of the same trends affecting the corn and

soybean futures contracts have affected the wheat futures contract,

as well. The Commission is requesting the CBT to conduct an in-depth

reconsideration of the delivery specifications for its wheat

contract within the next 120 days, similar to that which it

undertook for its corn and soybeans futures contracts.

\10\ See, Report on Chicago Board of Trade March 1996 Wheat

Future Expiration on March 20, 1996, (November 26, 1996).

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3. CBT Action on Proposals to Revise the Contracts

On September 18, 1996, the CBT's Board of Directors considered the

Special Task Force's recommendations and approved for membership

balloting all of the Special Task Force's recommended changes except

the proposal to add East Central Illinois as a delivery area. On

October 17, 1996, the Exchange membership voted to reject the

recommended changes by a margin approximately of 2 to 1.

4. More Recent Developments

In the last week of October 1996, Commission staff were notified

that one of the three remaining Chicago elevators, operated by

Countrymark, has stopped accepting soybeans and grain for the

indefinite future. Accordingly, at

[[Page 68008]]

present, there are only two functioning regular Chicago elevators. They

have a combined rated storage capacity of 14.7 million bushels.11

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\11\ Trade sources indicate that, if the latest elevator to stop

accepting grain and soybeans closes, the effective regular storage

capacity in Chicago which is available to hold grain and soybeans

will be reduced to an even lower level, to about 12.0 to 12.5

million bushels. These lower effective capacity estimates reflect

the fact that a certain proportion of storage within an elevator

must be kept empty to allow blending of the stored grain and

soybeans and for the efficient movement of these commodities into

and out of the facility.

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VI. Requirements of Section 5a(a)(10) of the Act

The Commodity Exchange Act was extensively amended in 1974. Those

amendments substantially expanded the Act's scope, created a regulatory

system for the trading of all commodity futures contracts, and created

the Commission as an independent regulatory agency to administer and to

enforce the Act's provisions. Many of these amendments were designed to

address apparent weaknesses in the prior statutory scheme. In this

regard, the Commission's predecessor agency, charged with administering

the Act, testified before the House Committee on Agriculture, that:

For many years, the Department has been urging the exchanges to

provide an adequate number of delivery points in the production

areas and along the routes by which the various commodities move

from the producer to the consumer. The need for such points is

readily apparent. On July 20, 1973, the last trading day for July

corn on the Chicago Board of Trade, the futures price rose $1.20 per

bushel. * * * Transportation problems made it difficult to move corn

into the Chicago area and warehouses in that area were either filled

or reluctant to accept corn coming in for delivery on the futures

contract. The result was that many who would have made delivery had

there been provision for delivery at other points where supplies are

ordinarily available * * * were * * * forced to buy futures

contracts at an escalating price largely caused, not by an overall

change in the supply or demand for corn, but an artificial shortage.

* * *

[T]he establishment of * * * additional delivery points * * *

ought to be made by the exchanges in the first instance. Our concern

here is simply making sure that if they do not do the job properly,

adequate authority is present for the regulatory agency to take

action should such be desirable.

H.R. Rep. No. 975, 93rd Cong. 2d Sess. 77 (1974).

In recognition of the crucial role played by adequate deliverable

supplies in promoting orderly markets, Congress enacted Section

5a(a)(10) of the Act, which specifies, in part, that each contract

market is required to:

permit the delivery of any commodity, on contracts for sale

thereof for future delivery of such grade or grades, at such point

or points and at such quality and locational price differentials as

will tend to prevent or diminish price manipulation, market

congestion, or the abnormal movement of such commodity in interstate

commerce.

7 U.S.C. Sec. 7a(a)(10).

Moreover, Congress granted the Commission authority under Section

5a(a)(10) of the Act to determine whether exchange rules regarding

delivery terms fail to accomplish these objectives and to take

appropriate remedial action.

As an aid to the exchanges in meeting the statutory requirements

for designation, including the provisions of Section 5a(a)(10), the

newly formed Commission published Guideline No. 1 (now codified at 17

CFR Part 5, Appendix A). As explained in Guideline No. 1, to

demonstrate continuing compliance with the Act, exchanges must provide

evidence that each individual contract term conforms with the

underlying cash market and provides for a deliverable supply that will

not be conducive to price manipulation or distortion and which can be

expected to be available to the short trader, and saleable by the long

trader at its cash market value in normal cash marketing

channels.12

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\12\ Specifically, with respect to delivery points, Guideline

No. 1 provides that exchanges must consider: (1) the nature of the

cash market at the delivery point; (2) the composition of the market

at that point; (3) the normal commercial practice for establishing

cash market values and the availability of published cash prices

reflecting the value of the deliverable commodity; (4) the level of

deliverable supplies normally available, including the seasonal

distribution of such supplies; and (5) any locational price

differentials that would be applicable to the delivery points,

including the economic basis for discounts or premiums, or lack

thereof, applying to delivery points. In addition, Guideline No. 1

specifies that contract markets must provide information which

describes the delivery facilities, including: (1) the type of

delivery facility at each delivery point; (2) the number and total

capacity of facilities meeting contract requirements; (3) the

proportions of such capacity expected to be available for traders

who may wish to make delivery, and seasonal changes in such

proportions; and (4) the extent to which ownership and control of

such facilities is dispersed or concentrated.

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VII. Compliance of the CBT's Corn and Soybean Delivery Point

Specifications with Section 5a(a)(10) of the Act

The Commission believes that the CBT's corn and soybean futures

contracts currently do not meet the requirements of Section 5a(a)(10)

of the Act that delivery terms be specified which ``tend to diminish

price manipulation, market congestion, or the abnormal movement of such

commodity in interstate commerce.'' As noted, the current level of

total regular capacity in Chicago available for the storage of

deliverable corn, soybeans, wheat, and oats has been reduced by about

60 percent since the fall of 1995, as three of the six regular Chicago

warehouse operators closed operations. Moreover, effective regular

storage capacity could decline to even lower levels (about 12 million

bushels of effectively available storage capacity) in the very near

future in view of the potential that another existing regular elevator

may cease operations. With the withdrawal of three--and now, apparently

four--elevators at the contracts' Chicago delivery point, the available

deliverable supplies potentially have been reduced to levels which

increase the futures contracts' susceptibility to price manipulation or

distortion.

The recent closure of these elevators in Chicago greatly

exacerbates a deliverable supply situation that is already severely

limited due to the low levels of cash market activity in Chicago. These

closures confirm that Chicago is at the periphery of normal cash market

channels for corn and soybeans. The reduced number of regular

warehouses, the frequently low levels of stocks available, and the lack

of commodity flows to Chicago resulting from normal cash market

activities increase the likelihood that futures prices may become

distorted and that abnormal interstate movements of corn or soybeans

may be required to meet futures delivery requirements.

Moreover, this situation is not confined to Chicago, the primary

delivery point on the contracts. The inadequacy of the contracts'

overall delivery point specifications is suggested by the very low

deliverable supply conditions frequently observed at season-end for the

corn and soybean futures contracts during recent years. As shown in

Chart 3, season-end deliverable stocks of corn at all CBT delivery

points combined have often fallen to very low levels from 1980 to the

present, independent of the recent precipitous decline in regular

storage capacity in Chicago. In particular, deliverable stocks of corn

fell to as low as 2 million bushels (400 contracts) on September 1,

1990. As shown in Chart 4, since 1980, deliverable stocks of soybeans

at all delivery points combined also have declined to levels as low as

1.2 million bushels (240 contracts) in 1985 and 1.05 million bushels

(210 contracts) in 1996.13 Further, effective deliverable stocks

of corn (stocks at Toledo and Chicago minus stocks at St. Louis) have

declined to even lower levels on other occasions.\14\ For instance, on

September 1, 1996, effective corn stocks fell to about 1.1 million

bushels (about 220 contracts).

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\13\ The low levels of corn and soybean stocks at the contracts'

delivery points observed in September 1996 were associated with low

stock levels throughout the U.S. Nevertheless, it is clear that low

stocks at the contracts' delivery points are

[[Page 68009]]

also a problem in years where U.S. stock levels are not at uniformly

low levels.

\14\ As discussed above, there have been very few deliveries at

St. Louis since this location became a delivery point in the 1970s.

The lack of deliveries at this point reflects the fact that

elevators in St. Louis, unlike the regular elevators in Chicago and

Toledo, operate as barge-loading facilities rather than storage

facilities. Corn and soybeans received at St. Louis elevators are

stored only temporarily until they can be loaded into barges.

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BILLING CODE 6351-01-P

[[Page 68010]]

[GRAPHIC] [TIFF OMITTED] TN26DE96.002

[[Page 68011]]

[GRAPHIC] [TIFF OMITTED] TN26DE96.003

BILLING CODE 6351-01-C

[[Page 68012]]

Charts 3 and 4 also indicate the comparative levels of open

interest for the expiring September contract month and the spot month

speculative position limits for the corn and soybean futures contracts.

These figures indicate, for instance, that total stock levels

frequently have fallen to levels near or below the maximum number of

contracts a single speculative trader may hold during the delivery

periods of expiring contract months (600 contracts). Moreover,

commercial firms may have been granted exemptions from these limits for

purposes of bona fide hedging. These comparisons show that the

potential requirements for futures delivery frequently exceed, by a

substantial degree, the level of deliverable stocks available for

futures contracts. They thereby indicate the increased potential for

market problems as well as the increased potential for regulatory

intervention required to ensure that positions are liquidated in an

orderly fashion.

Moreover, the recent loss of substantial regular warehouse capacity

likely will cause further deterioration in the chronically low

deliverable stock situation. The primary factor drawing deliverable

supplies to Chicago has been the existence of warehouse capacity for

futures contract deliveries at that location, rather than traditional

cash market demand. Numerous trade sources and cash market experts have

verified that the cash market flow of corn and soybeans to Chicago

elevators for purposes other than futures delivery is weak or non-

existent. Accordingly, the Commission believes that the recent decline

in the number of grain merchandisers in Chicago will necessarily result

in a further decline of stocks from the low levels depicted in the

charts.

In such situations, where stocks are available for delivery only at

chronically low-levels due to the location of a contract's delivery

points at the periphery of cash market channels, futures prices can

more become distorted relative to cash market prices. This results from

the need to attract the necessary quantities of corn or soybeans, which

are otherwise not normally available, to the contracts' delivery points

to fulfill delivery requirements. Thus, when the delivery points for a

futures contract are not located within active cash market channels for

the underlying commodity, the likelihood increases that abnormal

interstate movements of the commodity will be required to meet futures

delivery requirements. In contrast, when a contract's delivery points

are located within active cash market channels for a commodity,

deliverable supplies readily can be made available for delivery from

stocks at, or flows of the commodity through, the contract's delivery

points at a price that is representative of prevailing cash market

prices for the commodity.

These circumstances were clearly envisioned by the MidAmerica

Institute study discussed above, which concluded that because Chicago

had become a low price point, deliverable supplies required to respond

to an attempted manipulation could only be drawn from higher value

locations, thereby enhancing the potential for, and possible

profitability of, market manipulations.\15\

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\15\ The inclusion of Toledo does not cure this fundamental flaw

because it, too, is on the periphery of the cash market.

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The situation is critical in that, except for cash-settled

contracts, the threat of delivery is the mechanism through which the

market forces futures and cash prices to converge. To the extent that

delivery is not a viable alternative because of inadequate deliverable

supplies, trading will increasingly require regulatory intervention to

remain orderly, particularly during contract month expirations.

Accordingly, the Commission has determined to notify the CBT under

the provisions of Section 5a(a)(10) of the Act, that for the reasons

discussed above, and in light of the CBT's failure to date to take

appropriate corrective action, the Commission finds that the CBT rules

specifying the terms of its corn and soybean futures contracts do not

accomplish the Section 5a(a)(10) objectives of ``tend[ing] to prevent

or diminish price manipulation, market congestion, or the abnormal

movement of such commodity in interstate commerce.''

Further, the Commission hereby notifies the CBT, under the

provisions of Section 5a(a)(10) of the Act, that the CBT has until

March 4, 1997 to adopt and submit for Commission approval ``appropriate

changes'' to CBT rules.

VIII. Alternative Contract Specifications.

To avoid further proceedings under Section 5a(a)(10), the CBT must

make changes to the contracts which, in the opinion of the Commission,

are necessary to accomplish the objectives of this subsection of the

Act. Although the Commission has not reached a conclusion as to the

exact nature of the changes which are ``necessary to accomplish the

objectives'' of providing delivery terms ``as will tend to prevent or

diminish price manipulation,'' it is providing guidance to the CBT on a

range of possibilities which could constitute ``appropriate changes''

by providing for the necessary, viable linkage with the cash market. By

providing these alternatives, the Commission is not limiting the CBT's

ability to respond to this Section 5a(a)(10) notification, nor is it

specifying exact design criteria. Rather, these are examples of various

means by which the Commission believes the objectives of the section

could be met. In any event, the particular contract specifications

proposed by the CBT in response to this notification, in order to meet

the statutory requirement, should provide for a linkage with the cash

market through specific terms which are in conformity with a

substantial segment of that underlying market.

1. Modified CBT Special Task Force Proposal

The contract amendments recommended by the CBT Special Task Force,

with certain modifications, could potentially provide for the necessary

increase in deliverable supplies. Under the Special Task Force

proposal, futures delivery would continue to be made at all locations

by the transfer of a warehouse receipt for grain in store. Chicago and

Toledo would continue as delivery points, with Chicago remaining the

par delivery location, St. Louis being deleted, and existing discounts

for Toledo delivery being reduced to 2 from 3 cents per bushel for corn

and to 4 from 8 cents per bushel for soybeans.

The Special Task Force also proposed that delivery be permitted at

regular warehouses in Milwaukee, in East Central Illinois (ECI), and on

the Northern Illinois River (NIR).16 Vessel deliveries of corn and

soybeans in Milwaukee would be at par, with rail and barge deliveries

subject to a discount of 8 cents per bushel. Corn and soybeans in store

at regular ECI warehouses would be deliverable at discounts of 4 cents

and 8 cents per bushel, respectively.17 Futures delivery at NIR

warehouses would be at par for corn and at a discount of 4 cents per

bushel for soybeans.

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\16\ The ECI delivery area would encompass the counties of

Champaign, Coles, Douglas, Ford, and Iroquois. The NIR delivery area

would consist of that part of the Illinois River that lies between

Creve Coeur and Chicago.

\17\ The recommended changes also would permit delivery

receivers to require ECI regular warehouses to load the delivery

corn and soybeans into barges at NIR barge-loading facilities at a

premium of 4 cents per bushel. This provision implies that corn

would be deliverable in barges on the NIR at par, while soybeans

would be deliverable on the NIR at a discount of 4 cents per bushel.

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[[Page 68013]]

However, as to this proposal, the following changes would be

necessary to provide for an economically effective linkage of the

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futures contracts with the cash market:

1. In view of the infrequent participation of St. Louis as a

delivery point, as well as the similarly limited storage capacity

and through-put nature of the barge-loading warehouses on the NIR,

the Special Task Force proposal to permit delivery in NIR barge-

loading warehouses must be modified to allow delivery at off-water

warehouses located within a specified distance of this portion of

the Illinois River, in order to make warehouses located on the NIR

an effective source of deliverable supplies.18 The specified

area should encompass corn and soybean storage facilities that

typically store these commodities on a seasonal basis and from which

substantial deliverable supplies would be available.

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\18\ As recommended by the Special Task Force for deliveries at

ECI warehouses, the receiver of corn and soybeans in an off-water

warehouse could be given the option of taking delivery of corn and

soybeans in barges from regular warehouses on the NIR or by rail

from the off-water facility.

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2. The recommended locational price differentials for delivery

in store at Toledo, the ECI, and warehouses located on or near the

NIR should be modified so that they reflect commonly observed cash

price relationships with the contracts' other delivery locations.

Specifically, for deliveries at NIR barge-loading facilities, the

price differential levels selected should reflect the fact that corn

and soybeans become more highly valued the further south the

delivery location is on the NIR.

2. Illinois River Shipping Certificate Delivery Alternative

An alternative specification that could also result in the

necessary increase to deliverable supplies would replace the existing

warehouse-receipt-delivery instrument with a shipping certificate and

provide for delivery at Illinois River barge loading facilities, in

addition to the contracts' existing Chicago, Toledo, and St. Louis

delivery points.19 The Illinois River delivery area could be

specified to include all or a substantial part of that River. The

contracts' par pricing location could be shifted to a delivery

location/area that has an active cash market, with locational price

discounts for other delivery points/areas set at levels that fall

within the range of commonly observed cash price differences between

the specified delivery locations.

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\19\ The terms of the shipping certificate could be specified in

several different ways. For example, the shipping certificate could

require that the issuer ship corn or soybeans in rail cars or trucks

to a location nominated by the buyer within the specified delivery

areas, with the buyer having the option of requiring that the corn

or soybeans be loaded into barges at a specified premium.

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3. Lower Mississippi River Export Alternative

This alternative would eliminate the contracts' existing delivery

locations and delivery instrument in favor of an export-oriented

contract with a shipping certificate as the delivery instrument. The

shipping certificate would call for delivery at export locations on the

lower Mississippi River.20

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\20\ As in alternative 2, the shipping certificate's terms may

be specified in different ways. In this case, for example, the

shipping certificate could require the issuer to deliver corn or

soybeans in barges or rail cars to an export location on the lower

Mississippi River specified by the buyer, with provision for

delivery corn and soybeans to be loaded into vessels at a specified

premium.

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4. Cash Settlement Alternative

This alternative would replace the contracts' existing delivery

provisions with cash settlement provisions. The cash price index could

be based on the USDA-quoted prices for corn and soybeans in the primary

production or export market areas on the last day of trading or any

other method of calculating a cash-settlement price consistent with

Guideline No. 1.

Section 5a(a)(10) of the Act authorizes the Commission to change or

supplement the terms and conditions of futures contracts. The

Commission would prefer, however, not to take such an action. Rather,

the Commission looks forward to receiving for its approval proposed

modifications from the CBT to the delivery specifications for the CBT's

corn and soybean futures contracts which satisfactorily address the

issues discussed in this letter. In the event that the Commission fails

to receive such proposed amendments by March 4, 1997, the Commission is

prepared to take appropriate action under Section 5a(a)(10) of the Act

to address the situation.

By the Commission,

Jean A. Webb,

Secretary of the Commission.

The Commission has determined that publication of the notification

to the CBT for public comment will assist the Commission in its

consideration of these issues, including in particular, the eventual

response of the CBT. Accordingly, the Commission is requesting written

data, views or arguments from interested members of the public.

Commenters are specifically requested to address the following issues:

1. To what extent do the current CBT delivery specifications for

corn and soybeans reflect the structure of the cash market for the

underlying commodity? To the extent the terms of the contracts depart

from commodity flows in the cash market, does this have any detrimental

impact on the trading of these contracts?

2. What is the likely effect of failing to modify the current terms

of the contract?

3. To what extent would the alternatives listed by the Commission

increase deliverable supplies on the contracts, and would such

increases be sufficient under the Act?

4. The Commission identified several changes to the CBT Task

Force's recommendations necessary to provide ``a meaningful increase in

the level of economically deliverable supplies available for futures

delivery.'' To what extent is it necessary to permit delivery in off-

water warehouses if delivery on the contract continues to call for

warehouse receipts at warehouses on the Illinois river, which largely

tend to be through-put facilities? What is the range of discounts or

premiums commonly observed in the cash market for corn and soybeans

that would be deliverable in Toledo, East Central Illinois, or the

Northern Illinois River, compared to Chicago?

5. Is modification of the contracts' delivery provisions likely to

enhance or detract from their hedging or price-basing utility?

6. On a related issue, to what extent do the current CBT delivery

specifications for the futures contract for wheat reflect the structure

of the cash market for the underlying commodity? To the extent that the

terms of the futures contract depart from commodity flows in the cash

market, does this have any detrimental impact of the trading of futures

contracts for wheat?

7. What is the likely effect of failing to modify the current

delivery specifications of the wheat contract?

8. What alternatives to the current delivery specifications would

increase deliverable supplies on the wheat contract, while maintaining

its utility for hedging and price basing?

Issued in Washington, D.C., this 19th day of December, 1996, by

the Commodity Futures Trading Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 96-32708 Filed 12-24-96; 8:45 am]

BILLING CODE 6351-01-P