Chicago Board of Trade Futures Contracts in Corn and Soybeans; Proposed Order To Change and To Supplement Proposal

COMMODITY FUTURES TRADING COMMISSION

Chicago Board of Trade Futures Contracts in Corn and Soybeans;

Proposed Order To Change and To Supplement Proposal

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of, and Request for Public Comment on, Proposed Order to

Chicago Board of Trade to Change and to Supplement Chicago Board of

Trade Proposal on Delivery Specifications.

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

issued a Proposed Order to 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), to Change and to Supplement its Proposal

regarding the delivery terms of the CBT corn and soybean futures

contracts. The CBT proposal was submitted in response to a December 19,

1996, notification to the CBT by the Commission that the CBT corn and

soybean futures contracts no longer accomplish the objectives of that

section of the Act. The Commission in its Proposed Order, proposes to

change and to supplement the CBT proposal for its soybean futures

contract by: i) retaining the Toledo, Ohio, switching district as a

delivery location; ii) retaining St. Louis-East St. Louis-Alton as a

delivery location for shipping stations; and iii) making soybeans from

the Toledo delivery location deliverable at contract price and from all

other locations at a premium over contract price of 150 percent of the

difference between the Waterways Freight Bureau Tariff No. 7 rate

applicable to that location and the rate applicable to Chicago,

Illinois, with Chicago at contract price. The Commission, with respect

to the CBT corn contract, is proposing to make corn from shipping

locations on the northern Illinois River deliverable at a premium over

contract price of 150 percent of the difference between the Waterways

Freight Bureau Tariff No. 7 rate applicable to that location and the

rate applicable to Chicago, Illinois, with Chicago at contract price.

With respect to both the CBT corn and soybean futures contracts, the

Commission also proposes to change and to supplement the proposed

contingency plan for alternative delivery procedures when traffic on

the northern Illinois River is obstructed and to eliminate the $40

million minimum net worth eligibility requirement for issuers of

shipping certificates. Finally, the Commission is proposing to

disapprove the proposed terms of the July and December 1999 corn

futures contracts and the July and November 1999 soybean futures

contracts and is proposing to apply the changes and supplements

described above to such contracts under sections 5a(a)(10), 5a(a)(12),

and 8a(7) of the Act.

The Commission has determined that publication of the Proposed

Order 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: Comment must be received by October 22, 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

[[Page 49475]]

be made to ``Proposed Order--Corn and Soybean Delivery Points.''

FOR FURTHER INFORMATION CONTACT: John Mielke, 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. If the contact market within

seventy-five days fails to make the changes which in the opinion of

the Commission are necessary to accomplish the objectives of this

subsection, then the Commission after granting the contract market

an opportunity to be heard, may change or supplement such rules and

regulations of the contract market to achieve the above objectives *

* *.

The Commission, on September 15, 1997, issued a Proposed Order

under section 5a(a)(10) of the Act to change and to supplement the

proposal of the CBT relating to the delivery specifications of the corn

and soybean futures contracts. That proposal was submitted in response

to prior Commission notification to the CBT that its futures contracts

for corn and soybeans no longer were in compliance with the

requirements of section 5a(a)(10) of the Act. The text of the Proposed

Order is set forth below.

In the Matter of the Section 5a(a)(10) Notification to the Board

of Trade of the City of Chicago, Dated December 19, 1996, Regarding

Delivery Point Specifications of the Corn and Soybean Futures

Contracts.

Dated: September 15, 1997.

Proposed Order of the Commodity Futures Trading Commission to

Change and to Supplement Proposed Rules of the Board of Trade of the

City of Chicago, Submitted for Commission Approval in Response to a

Section 5a(a)(10) Notice Relating to Futures Contracts in Corn and

Soybeans.

The Commodity Futures Trading Commission (CFTC or Commission)

hereby:

(1) proposes under section 5a(a)(10) of the Commodity Exchange Act

(Act) to change and to supplement the proposed delivery specifications

of the Board of Trade of the City of Chicago (CBT) soybean futures

contract by making all changes to such rules and regulations as

required to effect the following:

i. retaining the Toledo, Ohio, switching district as a delivery

location;

ii. retaining St. Louis-East St. Louis-Alton as a delivery location

for shipping stations; and

iii. making soybeans from the Toledo delivery location deliverable

at contract price and making soybeans from shipping locations within

the St. Louis-East St. Louis-Alton and the northern Illinois River

delivery locations deliverable at a premium over contract price of 150

percent of the difference between the Waterways Freight Bureau Tariff

No. 7 rate applicable to that location and the rate applicable to

Chicago, Illinois, with Chicago at contract price;

(2) proposes under section 5a(a)(10) of the Act to change and to

supplement the proposed delivery specifications of the CBT corn futures

contract by making all changes to such rules and regulations as

required to make corn from shipping locations on the northern Illinois

River deliverable at a premium over contract price of 150 percent of

the difference between the Waterways Freight Bureau Tariff No. 7 rate

applicable to that location and the rate applicable to Chicago,

Illinois, with Chicago at contract price;

(3) proposes under section 5a(a)(10) of the Act to change and to

supplement the proposed CBT contingency plan for alternative delivery

when river traffic is obstructed by reducing the continuous period of

lock closure which triggers application of the plan's special

procedures from the 45 days proposed to 15 days, by eliminating the

condition which triggers the contingency plan that notice of the lock

closure must have been given six-months prior to such closure, by

making the contingency plan applicable whenever a majority of shipping

stations within the northern Illinois River delivery area are affected

by closure of any lock or locks and by changing the differential from

100 percent of the Waterways Freight Bureau Tariff No. 7 rate as

proposed to 150 percent.

(4) proposes under sections 5a(a)(10) and 15 of the Act to change

and to supplement the proposed CBT corn and soybean futures contracts

by eliminating the $40 million minimum net worth eligibility

requirement for issuers of shipping certificates; and

(5) proposes to disapprove under sections 5a(a)(10), 5a(a)(12), and

15 of the Act and Commission rule 1.41(b) the terms of the July and

December 1999 corn futures contracts and the July and November 1999

soybean futures contracts and proposes to apply the changes and

supplements described above to such contracts under sections 5a(a)(10),

5a(a)(12), and 8a(7).

The complete text of the revisions proposed by the Commission to

the proposed CBT rules appears in attachment 1 of this Order.

The Commission, as detailed below, bases these proposed actions on

its finding that the response of the CBT to the section 5a(a)(10)

notification relating to its corn and soybean futures contracts does

not meet the requirements, or accomplish the statutory objectives, of

that section and also violates section 15 of the Act. The Commission's

determination is based upon: (1) the inadequate amount of deliverable

supplies of soybeans available under the proposed contract terms in the

delivery area as proposed; (2) the failure of the proposed corn and

soybean contracts to include necessary locational differentials; (3)

the failure of the proposed corn and soybean contracts to provide an

adequate rule for alternative deliveries if river transportation is

obstructed; and (4) the substantial impediment to eligibility for

issuing corn and soybean shipping certificates imposed by the $40

million net worth requirement.

Specifically, under the CBT proposal, the amount of deliverable

supplies of soybeans during the critical summer delivery months of

July, August, and September fails to meet the minimum level that, in

the opinion of the Commission, is necessary to tend to prevent or

diminish price manipulation, market congestion, or the abnormal

movement of soybeans in interstate commerce. The gross amount of

potentially deliverable supplies historically has failed to reach the

minimum level on a significant number of occasions during the past 11

years the Commission has examined. Moreover, on those occasions when

the gross amount of potentially deliverable supplies did exceed that

minimum level, it frequently did so only because of supplies available

at the Chicago/Burns Harbor (Chicago) delivery point, the continuing

decline of which precipitated the section 5a(a)(10) notification in the

first instance. This inadequacy is further heightened when appropriate

downward adjustments are made to reflect only that portion of the

[[Page 49476]]

gross deliverable supply which would likely be available for futures

deliveries. Thus, gross deliverable supplies would be diminished by the

effects of the proposed three-day barge queuing rule, prior commercial

commitments of available stocks, the lack of locational price

differentials, and the unjustifiably high financial eligibility

requirements. The frequent interruptions in barge transportation on the

northern Illinois River due to lock closings and weather conditions

also create foreseeable disruptions to deliverable supplies under the

CBT proposal. The inadequacy of deliverable supplies of soybeans under

the CBT proposal requires the retention of the CBT's current delivery

points at Toledo and St. Louis, where additional deliverable supplies

would be available.

The Commission does not find that available deliverable supplies of

corn under the CBT's proposal are inadequate under section 5a(a)(10) so

as to require additional delivery points. However, the adequacy of corn

supplies cannot be accurately and fully ascertained until after there

is a history of deliveries occurring under the proposal. To the extent

that in operation the proposal results in inadequate deliverable

supplies of corn, the Commission will reconsider the need to require

additional delivery points for the corn contract. To that end, the

Commission directs the CBT to report on the experience with deliveries

and expiration performance in the corn futures contract on an annual

basis for a five-year period after contract expirations begin under the

revised contract terms.

Neither the CBT proposal for soybeans nor its proposal for corn

provides for locational price differentials among spatially separated

delivery points, as section 5a(a)(10) of the Act requires. In addition

to tending to reduce deliverable supplies, the lack of locational price

differentials reflecting the differentials in the underlying cash

markets for corn and soybeans would render the futures contracts

susceptible to price manipulation, market congestion, and the abnormal

movement of the commodities in interstate commerce.1

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\1\ The lack of locational price differentials not only violates

section 5a(a)(10) of the Act, but also is contrary to Commission

Guideline No. 1 and the Commission's policy on differentials. See,

CFTC Guideline No. 1, 17 CFR part 5, appendix A; and Memorandum from

Mark Powers, Chief Economist to the Commission, dated March 22,

1977, (1977), adopted by the Commission at its meeting of May 3,

1977.

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In addition, the proposed contingency plan providing for

alternative delivery procedures when river traffic is obstructed

violates the provisions of section 5a(a)(10). By requiring lengthy

advance notice of a river obstruction before the contingency plan

applies, by limiting the contingency plan only to instances of river

obstructions south of the delivery area, and by specifying a

differential that does not conform to the differential proposed by the

Commission, the proposed plan fails to diminish the potential for price

manipulation, market congestion, or the abnormal movement of the

commodities in interstate commerce.

Finally, in addition to its likely detrimental effect on the amount

of available deliverable supplies on the contracts, the proposed $40

million net worth eligibility requirement for issuers of shipping

certificates poses a significant, unnecessary, and unjustified barrier

to entry to those wishing to participate as issuers of shipping

certificates on the contracts in violation of section 15 of the Act.

This proposed $40 million net worth requirement is in addition to other

minimum financial requirements that shipping certificate issuers must

meet, including minimum working capital of $2 million, a bond or other

financial guarantee equal to the full market value of all outstanding

shipping certificates, and a limitation on the value of outstanding

certificates an issuer may issue to 25 percent of the issuer's net

worth. These requirements are fully adequate to ensure the financial

ability of issuers to perform their responsibilities under the

contracts. The burden imposed by the additional $40 million net worth

requirement on those otherwise eligible to participate in the contract

as shipping certificate issuers would not only be unnecessary, but

would act as a significant barrier to participation as an issuer and

would preserve a high level of concentration among issuers.

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

Commission hereby notifies the CBT that it will have an opportunity to

be heard on this proposed Order by the Commission. To that end, the

Commission will convene a public hearing at its Washington, D.C.,

office, on October 15, 1997, beginning at 1:00 p.m. (or at an earlier

date if the CBT requests), in order to provide the CBT with an

opportunity to appear before the Commission to make an oral

presentation regarding the matters raised in this proposed Order. The

Commission will also accept written comments from the CBT on the

proposed Order on or before the date of the hearing.

The Commission's conclusions, as discussed in greater detail below,

are supported by factual analyses made by the CFTC staff and by a large

number of well-informed written comments submitted to the Commission by

commercial users of the corn and soybean futures contracts and by other

interested persons. The Commission also analyzed the documentary

evidence submitted by the CBT and other commenters in support of the

CBT proposal. In addition, the CBT and other interested members of the

public presented oral and written comments to the Commission during an

open meeting of the Commission. Written and oral comments received were

reviewed by the Commission and were considered by the Commission in

arriving at its conclusions.

I. The Section 5a(a)(10) Proceeding

The Commission, by letter dated December 19, 1996, commenced this

proceeding by issuing to the CBT a notification under section 5a(a)(10)

of the Act finding that the delivery specifications of its 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.''

Letter of December 19, 1996, to Patrick Arbor from the Commission, 61

FR 67998 (December 26, 1996) (section 5a(a)(10) notification). The

section 5a(a)(10) notification detailed long-term trends in the

storage, transportation and processing of corn and soybeans, related

those trends to changes in cash market conditions at the CBT delivery

locations, and analyzed the lack of consistency between the cash market

for these commodities and the delivery provisions of these contracts.

Id., 68000-68004.

The section 5a(a)(10) notification also recounted the CBT's failure

over the last 25 years adequately to address these structural problems

with the contracts. As noted in the section 5a(a)(10) notification,

section 5a(a)(10) was itself expressly added to the Act in 1974 after a

number of apparent manipulations and problem liquidations involving the

CBT grain contracts. Id. 68005. In July 1989 an emergency action was

required relating to CBT's soybean contract because of a commercial

trader's holding of futures positions which exceeded the total amount

of soybeans that could be delivered at the contract's delivery points.

By 1991 several major

[[Page 49477]]

studies had been completed demonstrating the inadequacy of the CBT's

delivery points. Nevertheless, the CBT's response to these problems was

limited. Id. 68006. As the Commission noted in the section 5a(a)(10)

notification, when in 1992 it approved certain changes proposed by the

CBT to address these problems, the Commission cautioned that the CBT's

response was merely a short-term palliative, and the Commission urged

the CBT to consider actively more significant contract changes. Id.

68007.

Only three years later, three of the existing six Chicago

warehouses regular for delivery ceased operations, a symptom of the

serious, fundamental problems with the contracts' delivery

specifications. At the urging of the Commission, the CBT formed a

special task force to address the delivery problems. That task force

took a year developing proposed changes to the contracts'

specifications which were modified by the CBT's board of directors. The

modified proposal was then defeated by a vote of the CBT membership on

October 17, 1996.

Subsequently, on December 19, 1996, after an additional Chicago

delivery warehouse stopped accepting soybeans and corn in late October

1996, the Commission formally commenced this proceeding under section

5a(a)(10) of the Act. The section 5a(a)(10) notification found that the

CBT corn and soybean futures contracts no longer met the requirements

of that section of the Act and notified the CBT that it had until March

4, 1997, the statutory period of 75 days, to submit for Commission

approval proposed amendments to the contracts' delivery specifications

to bring them into compliance with the Act. Neither the CBT nor the

nearly 700 comments filed with the Commission regarding the CBT

proposal have challenged the factual basis for the December

notification, and indeed, both the CBT and many commenters have

acknowledged the correctness of that Commission action.

The CBT, on April 16, 1997, submitted its response to the section

5a(a)(10) notification in the form of proposed exchange rule

amendments.2 Previously, the Commission had published the

substance of the proposed amendments in the Federal Register for a 15-

day comment period.3 62 FR 12156 (March 14, 1997). In

response to requests for additional time to comment on the proposal,

the Commission on April 24, 1997, extended the comment period until

June 16, 1997. 62 FR 1992.4

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\2\ While the CBT labeled its submission of the proposed rule

amendments as having been made pursuant to section 5a(a)(12), as

well as section 5a(a)(10), of the Act, the Commission is applying

its specific authority and procedures set forth in section 5a(a)(10)

with regard to its consideration of the CBT's submission.

Section 5a(a)(12) of the Act provides that ``the Commission

shall disapprove after appropriate notice and opportunity for

hearing any such rule which the Commission determines at any time to

be in violation of the provisions of this Act or the regulations of

the Commission.'' In addition, section 8a(7) of the Act empowers the

Commission to alter or to supplement exchange rules as necessary or

appropriate ``to insure fair dealing in commodities traded for

future delivery on such contract market.'' Such changes or

alterations may address contract terms or conditions, among other

matters.

The Commission is exercising its authority under section

5a(a)(10) of the Act to change and to supplement the CBT proposals.

Nevertheless, the Commission, for the reasons detailed below,

necessarily also finds that the CBT proposal must be disapproved

under section 5a(a)(12) of the Act as being inconsistent with the

requirements of sections 5a(a)(10), 8a(7) and 15 of the Act and must

be altered and supplemented under section 8a(7) of the Act.

\3\ On March 4, 1997, the CBT had notified the Commission that

its Board had authorized the submission of the proposed amendments

to the CBT membership for a formal vote. On April 15, 1997, the CBT

membership voted in favor of the proposed amendments, and the CBT

formally submitted them for Commission review the next day.

\4\ Also on April 24, 1997, the CBT informed the Commission by

letter that it would the next day list, or relist, for trading the

July and December 1999 corn futures contract months and the July and

November 1999 soybean futures contract months. By letter dated May

2, 1997, the Commission notified the CBT that the listing or

relisting of these contract months ``is not legally authorized at

the present time,'' that the Commission ``reserves all of its

authority under sections 5a(a)(10), 5a(a)(12) and 8a(7) of the Act

to approve, disapprove, supplement, or modify the proposed delivery

specifications of the CBT corn and soybeans futures contract and to

apply that determination to the[se] * * * trading months,'' and that

the CBT ``must notify all market participants that the Commission

has not approved the listing of these contract months.''

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The CBT requested the opportunity to appear before the Commission

``to address issues that have been generated during the comment

period.'' 5 The Commission granted the CBT's request (62 FR

29107 (May 29, 1997)), holding a public meeting on June 12, 1997, to

accept oral and written statements by the CBT and interested members of

the public. The participants represented a cross-section of views, both

favoring and opposing the CBT proposal.6

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\5\ The Commission received close to 700 comments on the CBT's

proposal, the largest number of comments ever received by the

Commission on any issue before it. The vast majority of the comments

were opposed to the CBT proposal for a variety of reasons. Many of

the comments were well reasoned and contained valuable factual

information and data which were important supplements to the

information provided by the CBT in its submission.

\6\ Both written and oral statements in connection with the

meeting were submitted to the Commission for inclusion in the record

and, along with a transcription of the meeting, have been entered

into the Commission's comment file. Participants included a United

States Senator from the State of Ohio (transcript at 69-75) and

United States Representatives from the States of Michigan

(transcript at 9-14) and Ohio (transcript at 14-26); representatives

of six commercial users of the contracts (transcript at 116-168);

and representatives of three producer associations (transcript at

169-183). The CBT presented its views through the statements of six

persons (transcript at 27-29, 36-69).

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II. The CBT Proposal Responding to the Section 5a(a)(10)

Notification

In correspondence dated April 16, 1997, the CBT responded to the

section 5a(a)(10) notification by submitting proposed amendments to the

terms and conditions of its corn and soybean futures contracts for

Commission review. The data submitted by the CBT to justify its

proposal were inadequate to permit a determination of whether the

proposal met the requirements of section 5a(a)(10) of the Act and

contained certain flaws.7 Therefore, the Commission was

required independently to collect and to analyze the data necessary for

a proper analysis of the CBT's proposal. The CBT supplemented its

original submission on more than one occasion--most recently on August

25, 1997.

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\7\ In this regard, the Act, Guideline No. 1, and Commission

rule 1.41 provide that the Exchange must demonstrate that its

proposed rule amendments meet the requirements of the law. When

exchange submissions fail to provide sufficient information to

permit the Commission to make a determination, the Commission can

refuse to consider a proposed amendment and can remit the proposed

rule for further justification. See, 17 CFR 1.41(b). However, in

this case the Commission chose to supplement the CBT submission with

its own research and to act on the CBT proposal.

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The CBT's proposal would replace the existing delivery system

involving delivery of warehouse receipts representing stocks of grain

in store at terminal elevators in Chicago, Toledo, and St. Louis with

delivery of shipping certificates.8 The shipping

certificates would provide for corn or soybeans to be loaded into a

barge at a shipping station located along a 153-mile segment of the

Illinois River from Chicago (including Burns Harbor, Indiana) to Pekin,

Illinois. Delivery in Chicago would also be permitted by rail or

vessel. Delivery at all eligible locations would be at par. (See map

below.)

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\8\ A shipping certificate is a negotiable instrument that

represents a commitment by the issuer to deliver (i.e., load into a

barge) corn or soybeans to the certificate holder, pursuant to terms

specified by the CBT, whenever the holder decides to surrender the

certificate to the issuer. Unlike an issuer of a corn or soybean

warehouse receipt, which must have the product in storage to back

the receipt, an issuer of a shipping certificate would be able to

honor its delivery obligation not only from inventories, but also

from anticipated receipts or purchases of corn or soybeans after the

holder surrenders the certificate.

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In addition to being located along the defined segment of the

Illinois River

[[Page 49478]]

and capable of loading barges, firms eligible to issue shipping

certificates would be required to meet a minimum net worth standard of

$40 million. This minimum net worth standard is not applicable to the

CBT's other agricultural futures contracts and would be in addition to

the CBT's existing requirement of $2 million working capital required

of firms regular for delivery of all agricultural products. The

proposal also would require the issuer to have a letter of credit or

other guaranteed credit instrument collateralizing the full market

value of the issued certificates and would establish limits on the

amount of outstanding shipping certificates by firm.9 In

addition, the proposal would impose requirements regarding an issuer's

rate of loading barges.10 Once a shipping certificate has

been surrendered to the issuer, the issuer would have to begin loading

product within three business days of surrender and receipt of loading

orders or one business day after placement of the certificate holder's

barge, whichever is later. This loading would be required to take

precedence over all other barge loadings for eight hours per day at the

issuer's loading facility.

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\9\ These limitations are: (a) for northern Illinois River

locations, 30 times the registered daily barge loading rate; (b) a

value no greater than 25% of the operator's net worth; and (c) for

Chicago and Burns Harbor locations only, the registered storage

capacity of the facility.

\10\ The issuer's registered daily rate of loading shall be not

less than (a) for northern Illinois River locations, one barge per

day per shipping station and (b) for Chicago and Burns Harbor

locations only, three barges per day per shipping station.

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Shipping certificate holders would be required to pay shipping

certificate issuers a daily premium charge until the certificate is

surrendered.11 The last trading day for expiring corn and

soybean futures months would be the business day preceding the 15th

calendar day of the delivery month, with all deliveries of shipping

certificates required to be completed by the second business day

following the last trading day. Currently, the last trading day is the

eighth-to-last business day of the delivery month, with futures

delivery of warehouse receipts continuing through the end of the month.

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\11\ This charge is \12/100\ of one cent per bushel for Chicago

and \10/100\ of one cent per bushel for issuers along the northern

Illinois River.

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The CBT's proposal would eliminate the current delivery points on

its corn and soybean futures contracts at Toledo, Ohio, and St. Louis,

Missouri.

BILLING CODE 6351-01-P

[[Page 49479]]

[GRAPHIC] [TIFF OMITTED] TN22SE97.000

BILLING CODE 6351-01-C

[[Page 49480]]

III. Deliverable Supplies of Soybeans Are Inadequate Under Section

5a(a)(10)

A. The Standard for Measuring Adequacy of Deliverable Supplies

Pursuant to section 5a(a)(10), the Commission must assess whether

the CBT proposal meets the standard set by that section to ``permit the

delivery * * * at such point or points and at such * * * locational

price differentials as will tend to prevent or diminish price

manipulation, market congestion, or the abnormal movement of such

commodity in interstate commerce.''

One criterion for whether a delivery proposal meets the standards

of section 5a(a)(10) is whether the available deliverable supplies of

the commodity at the delivery points specified are adequate to prevent

manipulation, market congestion, and the abnormal movement of the

commodity in interstate commerce. As discussed below, other aspects of

a proposed futures contract may violate section 5a(a)(10) by tending to

cause the prohibited results, but adequate deliverable supplies are a

sine qua non for any contract under section 5a(a)(10).

The Commission believes that, to meet the statutory requirement of

tending to prevent manipulation, market congestion, or the abnormal

movement of a commodity in interstate commerce, a futures contract

should have a deliverable supply that, for all delivery months on the

contract, is sufficiently large and available to market participants

that futures deliveries, or the credible threat thereof, can assure an

appropriate convergence of cash and futures prices. To prevent

unwarranted distortion of futures prices in relation to the cash

market, the futures contract's delivery terms must reflect a product--

in quality, form, location, mode of transportation, etc.--that is

readily saleable in the cash market.

Commission Guideline No. 1 (17 CFR part 5, appendix A) provides

some guidance with respect to the adequacy of the delivery terms of a

futures contract. Guideline No. 1 requires that exchanges provide

justification concerning significant contract terms--particularly

delivery provisions--for new or amended futures contracts. This

justification should provide evidence that the proposed contract terms

and conditions are in conformity with practices in the underlying cash

market, that those terms and conditions will provide for a deliverable

supply that will not be conducive to price manipulation or distortion,

and that such a supply reasonably can be expected to be available to

the short trader and saleable by the long trader at its market value in

normal cash market channels.

Judging the adequacy of deliverable supply in the context of a

section 5a(a)(10) proceeding is more important than and significantly

different from determining adequacy in the routine review of

applications for new contract market designations. This section

5a(a)(10) proceeding involves contracts that are known to have very

large and well-established markets, a history of large trader

positions, and a decades-long history of surveillance problems. Indeed,

the Commission has already made an affirmative and unchallenged finding

that the delivery provisions of the current contracts violate the terms

of section 5a(a)(10) of the Act, and the issue before it is whether the

CBT's proposal goes far enough to cure the illegality of the contracts.

To determine an appropriate standard for measuring the adequacy of

deliverable supplies under the CBT proposal, the Commission has

examined separately for corn and soybeans the relationship between the

level of deliverable stocks and the presence of a price premium for the

expiring futures month over the next futures month (a price inverse).

The presence of such a premium is an indication of tight deliverable

supplies, potentially creating a price distortion. In situations where

limited deliverable supplies lead to such a price inverse, futures

contracts are significantly vulnerable to price manipulation, market

congestion, and the abnormal movement of the commodity in interstate

commerce under the terms of section 5a(a)(10).

For soybeans, the Commission's staff analysis demonstrated a

consistent positive relationship between price inverses and deliverable

stocks of less than 12 million bushels (2,400 contracts). Price

inversions occurred in ten of the 15 expirations when deliverable

stocks were less than 12 million bushels. This level of deliverable

stocks constitutes four times the speculative position limit for the

contract (2,400 contracts), a benchmark historically used by the

Commission's staff in analyzing deliverable supplies for new

contracts.12

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\12\ The size of the largest long position in an expiring

futures contract was also found to be associated with price inverses

when deliverable stocks were less than 2,400 contracts. Of the five

expirations in which the largest long position was 600 contracts or

less, price inverses occurred only once. However, for the ten

expirations in which the largest long position exceeded 600

contracts, inversions occurred nine times. At higher stock levels--

that is, above the 2,400-contract level for soybeans--that

relationship between position size and price inverses was not

observed.

---------------------------------------------------------------------------

The analysis for the corn market found a comparable relationship

between price inverses and deliverable supplies at the stock level of

15 million bushels (3,000 contracts). Price inverses occurred in seven

of the ten corn expirations when deliverable stocks were less than

3,000 contracts.13 This analysis supports using as a measure

of an inadequate level of deliverable supplies under section 5a(a)(10)

a level below 12 million bushels (2,400 contracts) for soybeans and

below 15 million bushels (3,000 contracts) for corn.

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\13\ In all seven expirations the largest long position exceeded

600 contracts.

---------------------------------------------------------------------------

However, the history of these contracts may demonstrate that a

higher level of supplies is, in fact, necessary to protect against

manipulation. In particular, an additional measure would be based on

historic experience with manipulation and price distortion in these

contracts. During the July 1989 soybean expiration, the Commission

exercised its surveillance powers to force the reduction of the long

futures position of the Ferruzzi group of companies, and the CBT

declared a market emergency and ordered the phased reduction of all

positions above a specified size. Both the Commission and the CBT

believed that the position of the Ferruzzi group posed a significant

threat of manipulation and acted on that belief.14 Just

prior to the CBT emergency action, Ferruzzi's long position in the July

1989 soybean future was about 20 million bushels (4,000 contracts). To

avoid a repetition of such a situation, deliverable supplies of at

least 4,000 contracts would be necessary.

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\14\ Although this incident involved soybean futures, it was

recognized to have broader implications for CBT's grain contracts

and led to an appraisal of the adequacy of the CBT's delivery terms

generally for its wheat, corn, and soybean futures and to revisions

to all three contracts.

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In its analysis of the adequacy of the deliverable supplies under

the CBT proposal, the Commission has considered both of these measures,

as well as other relevant information.

B. The CBT Submission Does Not Demonstrate That Its Proposal Meets the

Statutory Standard of Adequate Deliverable Supplies

The CBT has failed to provide data that demonstrates the adequacy

of available deliverable supplies. It supports its proposal by general

statements about production and transactions in the cash markets in the

vicinity of the delivery area, contending, for example, that its

proposed delivery area

[[Page 49481]]

* * * is located along more than 150 miles of the northern Illinois

River, which is one of the world's largest and most active cash

grain markets, handling over 500 million bushels of corn and

soybeans per year. It substantially increases the supply of grain

eligible for delivery on our futures contracts over the current

delivery system, thereby minimizing the potential for price

distortions and manipulation.

CBT July 1, 1997, submission, p. 2-2.

Data concerning corn and soybean production and handling in the

areas near the delivery points are not an adequate measure of

deliverable supplies under the contracts in light of the CBT proposal's

heavy reliance on barge delivery along the northern Illinois River

which involves product primarily destined for the export market. Most

production and handling of corn and soybeans in the vicinity of the

delivery points historically have involved product destined for the

domestic market, and only a portion of that product has traditionally

been loaded on barges as provided in the CBT proposal. Therefore, the

proper measure of available supplies must be based on barge shipment

data. To rely on additional supplies currently destined for the

domestic market would be to assume that the futures contract would

divert those supplies to the export market, thus causing an abnormal

movement in interstate commerce forbidden by section 5a(a)(10).

The CBT argues that the supplies available for delivery along the

northern Illinois River are adequate by citing the delivery capacity of

firms along the river. The CBT states that there are seven firms with a

cumulative daily barge loading capacity of 5.5 million bushels of grain

and a 30-day loading capacity of 171.8 million bushels of

grain.15 (CBT April 16, 1997, submission at attachment 4.)

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\15\ According to the CBT, the firms and their percentage share

of loading capacity are: Archer Daniels Midland Co., 41 percent;

Continental Grain Company, 23 percent; Cargill, Inc., 12 percent;

Consolidated Grain and Barge, ten percent; Sours Grain Company, six

percent; American Milling Company, six percent; and Garvey

International, two percent. (CBT April 16, 1997, submission,

attachment 14.)

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The CBT's reliance on the loading capacity of firms in the delivery

area as an indicator of adequacy of deliverable supply is misplaced. As

the unused delivery capacity in Chicago clearly demonstrates, delivery

capacity bears little relation to the amount of deliverable supplies

actually available at a particular location. The CBT's capacity

measure, which is based on its proposed maximum limits on the shipping

station's ability to issue shipping certificates (30 times a station's

daily (8-hour) loading capacity), far exceeds the highest observed

level of actual combined monthly corn and soybean barge shipments at

the delivery points during the 11-year period studied, 1986 through

1996.

Moreover, the CBT overstated the loading capacity related to the

contracts by including the capacity of three firms that would not meet

contract requirements, particularly the $40 million net worth

requirement, to qualify as shipping certificate issuers under the

contracts. In doing so, it also significantly understated the level of

concentration of the proposed delivery system and ignored the

exclusionary effect of its $40 million net worth requirement.

The CBT, in its submission, also provided inflated data on barge

shipments. These data significantly overstated the amount of barge

shipments by including shipments from a certain part of the Illinois

River outside of the defined delivery area of the contracts. CBT's data

also included barge shipments by all shippers, including those not

meeting the eligibility requirements to be issuers of certificates

under the contracts and thus overstated the deliverable amounts

available in that respect as well.

C. The CBT Proposal Fails to Meet the Minimum Threshold for Deliverable

Supply for Soybeans

1. Methodology. The Commission staff compiled an extensive amount

of data from which the Commission could estimate deliverable supplies.

These data were assembled from information supplied by the United

States Department of Agriculture (USDA), the Army Corps of Engineers,

the Coast Guard, grain merchants, and the CBT.

The CBT proposal provides for delivery from Chicago by rail,

vessel, and barge and along the northern Illinois River by barge. The

contracts are essentially reflections of the export market for corn and

soybeans, since the vast majority of corn and soybeans loaded on

vessels and barges at Chicago and on barges along the northern Illinois

River are destined for export markets. While Chicago rail shipments may

play some role in the domestic market, that role has diminished so as

to be very small.

The northern Illinois River's potentially available deliverable

stocks for each delivery month were estimated by summing barge

shipments from relevant points on the northern Illinois River for that

month and all subsequent months of the same crop year to and including

September, which was assumed to be the end of the crop

year.16 Since the amount shipped during a given month and in

each succeeding month of the crop year must have been in transit or in

storage in some location tributary to the river at the beginning of the

month, this summing procedure provides an estimate of the corn and

soybean stocks available to the proposed delivery points at the

beginning of each delivery month.17

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\16\ Corn and soybeans are both harvested beginning in September

or October, the beginning of a new crop year. All deliveries of corn

and soybeans throughout the year subsequent to harvest are made from

stored supplies. These supplies are consumed over time, reaching

their lowest level over the summer until the next harvest

replenishes the supply.

\17\ To account for the fact that a portion of the corn and

soybeans shipped during September may include some new crop supplies

that are not available earlier in the crop year, the estimated

northern Illinois River deliverable stocks for delivery months

preceding September were reduced in certain years to reflect the

likelihood that part of the September shipments consisted of new

crop supplies. The indicated reductions were made only in years

where available USDA data on harvesting progress for crop-reporting

districts in northern/central Illinois and Illinois production data

by county indicated that significant quantities of corn and soybeans

had been harvested in September. Deliverable supplies for all months

of a given crop year prior to September were reduced by an amount

equal to 50 percent of the September shipments (an amount suggested

by trade sources) whenever the quantity of new crop supplies

available in September in those counties within 25 miles of the

proposed northern Illinois River and Chicago delivery area exceeded

the quantity shipped during the month. The use of new crop supplies

from counties within 25 miles of the revised delivery points was

based on the assumption that most new crop supplies available early

in the harvest period are likely to be moved to the delivery points

by trucks moving relatively short distances from farms to avoid

creating unnecessary delays in harvesting. In addition, trade

sources indicated that most supplies that move to the proposed

northern Illinois River delivery points are trucked from locations

within 25 miles of these points.

---------------------------------------------------------------------------

Because these stocks reflect the quantity of soybeans and corn

actually shipped via the northern Illinois River, they represent a

reasonable and accurate historical estimate of the quantity of these

commodities that were economically available to the proposed northern

Illinois River delivery points at prevailing cash market price

relationships. While other supplies of corn and soybeans are in the

vicinity, they historically moved to other demand centers rather than

for delivery into the export market by barge shipments. If the CBT

contracts under the proposed delivery terms were to draw these supplies

from their usual destinations in the domestic market to futures

deliveries, an abnormal movement in interstate commerce would occur.

Therefore, such other supplies should not be considered in determining

the adequacy of potentially available deliverable supplies.

[[Page 49482]]

For Chicago, potentially available deliverable supplies were

estimated as the sum of stocks available at the beginning of each

delivery month plus receipts of corn or soybeans during that month.

Receipts were included because shipping certificates do not require the

commodity to be in store at the delivery point. Thus, Chicago warehouse

operators potentially could issue shipping certificates against stocks

in store at the beginning of a delivery month and against actual and/or

anticipated receipts of corn or soybeans as well.

These potentially available deliverable supply estimates were

adjusted to reflect the effect of the proposed financial requirements

on the number of firms that would be eligible to make delivery and, for

Chicago, the proposed limits on the number of shipping certificates

that could be issued by those firms. The proposal restricts eligibility

of issuers of shipping certificates to firms meeting a $40 million net

worth requirement. This eligibility requirement would eliminate barge

shipments made by ineligible firms and likely would reduce deliverable

supplies originating from the proposed northern Illinois River delivery

area by an average of about five percent. However, it is possible that

a portion of the supplies that normally are shipped by the three firms

not meeting that eligibility requirement--although by no means all

those supplies--would be made available for futures delivery by

diversion of the supplies to the four eligible firms. Accordingly, the

Commission calculated two separate estimates of potentially available

deliverable supplies: one excluding shipments made by firms not

eligible to issue shipping certificates on the contract and the second

including such ineligible firms' shipments.

Another adjustment was made to reflect current capacity restraints.

Because of the recent closure of four of the six elevators in Chicago,

prior years' data for Chicago were adjusted to reflect current maximum

capacity levels in that area.

Through this analysis, the Commission arrived at potentially

available gross deliverable supplies, discussed below. As is also

described in more detail below, those amounts must be reduced because

of various additional factors limiting the available deliverable

supplies.

2. Gross Deliverable Soybean Supplies. Delivery months under the

CBT proposed soybean futures contract include July, August, and

September, months which are at the end of the crop year and which

therefore historically reflect the lowest available supplies. As shown

in the following charts for soybeans attributable to the four firms

which would be eligible to issue shipping certificates, gross

deliverable supplies under the CBT proposal (Chicago supplies plus

northern Illinois River supplies) for July, August, and September do

not meet the minimum level considered by the Commission to be required

by section 5a(a)(10) of the Act. Specifically, for July, the total

deliverable supply of soybeans was less than the 2,400-contract level

in four of the 11 years covered by the analysis, while the 4,000-

contract level was not reached in six of the 11 years. For August,

gross deliverable soybean supplies for the four eligible firms fell

below 2,400 contracts in five years, and the 4,000-contract level was

not reached in any of the 11 years. Soybean deliverable supplies for

the four eligible firms in September were less than the 2,400-contract

level in seven of the 11 years and did not reach the 4,000-contract

level on any occasion.18 As demonstrated in the following

charts, Chicago supplies played a critically important role in almost

all instances in which the 2,400-contract level was reached or

exceeded.

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\18\ As shown in the charts for shipments by all firms,

including those firms that would be ineligible to issue certificates

under the CBT proposal, the proposal improved marginally in that

gross deliverable supplies for all firms were less than 2,400

contracts in two rather than four years for July.

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[[Page 49485]]

3. Gross Deliverable Corn Supplies. The CBT proposed corn contract

would include the contract months of July and September, inter

alia.19 In the case of corn, the estimated gross deliverable

supplies for July attributable to the four eligible firms reached or

exceeded the 3,000-contract levels in all years and the 4,000-contract

level in all years but one. However, gross deliverable supplies of corn

for the four eligible firms in September fell below the 3,000-contract

level in eight of the 11 years in the period analyzed and were less

than 4,000 contracts in nine years. The gross deliverable supply

estimates for all existing firms differed only slightly from the

results for the four eligible firms.

\19\ Unlike the soybean futures contract, there is no August

contract month listed for corn.

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[[Page 49486]]

[GRAPHIC] [TIFF OMITTED] TN22SE97.004

BILLING CODE 6351-01-C

[[Page 49487]]

4. September New Crop Production. Although neither corn nor

soybeans reached adequate minimum levels of potentially available gross

deliverable supplies for September, because September is a transition

month between old and new crop, deliverable supply estimates based upon

barge shipments data for September may understate actual September

deliverable supplies. The harvest of the new crops in corn and soybeans

begins in September, and thus, new crop production may be available for

delivery on the September contracts. Accordingly, the Commission also

calculated estimates of new crop production of corn and soybeans that

may have become available during the month of September.

The following table shows estimated September new crop production

within 25 miles (trucking distance) of the proposed delivery points for

corn and soybeans derived from USDA data. While these stocks might have

been available for delivery during September, the extent to which this

new crop production has already been included in the September Illinois

River shipment data shown above or was already committed to other uses,

particularly processing, cannot be ascertained.

A significant amount of corn was produced during September in most

years and potentially might augment to some extent the gross

deliverable supplies discussed above. However, there were very low

levels of September soybean production during at least five of the 11

years analyzed, and even taking September production into account,

September soybean supplies fall below a minimum adequate level.

Further, September soybean production does not in any way supplement

the inadequate gross deliverable supplies of soybeans in July and

August.

The likelihood of price manipulation in September may be somewhat

lessened because it is a transitional month between old and new crop

years. The end of the crop year generally is a period of low supplies

and relatively high prices. However, at harvest supplies are

replenished, and the arrival of these new crop supplies frequently

leads to lower prices. Significant new crop supplies usually become

available in areas tributary to the northern Illinois River by mid

October. The incentive to manipulate prices of the September futures

contracts by attempting to corner the low remaining old crop supplies

would be reduced by the potential losses that a manipulator might incur

in reselling the shipping certificates or product obtained through

September deliveries at lower prices after the arrival of new crop

supplies.

Under the CBT proposal, the use of Illinois River shipping

certificates rather than Chicago or Toledo warehouse receipts to effect

delivery might also permit expanded deliveries of new crop production

under the September contract. Rather than requiring movement of new

crop supplies into a warehouse at a terminal market before delivery, as

is necessary under current warehouse receipt delivery, the CBT proposal

allows the issuance of shipping certificates for locations much closer

to the production area and for up to 30 days of loading capacity and

thus would give issuers more opportunity to deliver new crop

production. They may issue shipping certificates on the basis that new

crop supplies which are not immediately in hand will be available by

the time loading is required under the shipping certificate.

The Commission considers the low levels of gross deliverable

supplies of corn in September to be of less regulatory concern than the

low levels of soybeans, which extend throughout the three summer

months. Not only is the shortage of corn supplies of brief duration,

but the fact that abundant supplies of new crop production are expected

soon lessens the likelihood that corn shortage in that month would lead

to the prohibited effects under section 5a(a)(10).

Estimated Corn and Soybean Production Located Near Proposed Delivery

Points During September

[5,000-Bushel Contract Units]

------------------------------------------------------------------------

Estimated September

production

Year -------------------------

Corn Soybeans

------------------------------------------------------------------------

1986.......................................... 15,219 3,109

1987.......................................... 26,78 36,056

1988.......................................... 6,354 2,046

1989.......................................... 2,013 583

1990.......................................... 2,686 782

1991.......................................... 41,663 8,729

1992.......................................... 1,284 1,356

1993.......................................... 644 29

1994.......................................... 2,800 6,471

1995.......................................... 2,574 487

1996.......................................... 1,926 46

------------------------------------------------------------------------

* The estimated production by September 30 of each year was calculated

by multiplying USDA harvesting progress estimates for the Illinois and

Indiana crop reporting districts that are adjacent to the revised

delivery points by USDA production data for counties located within

about 25 miles of the proposed delivery points.

5. Reductions From the Gross Deliverable Supplies. Additional

factors must be considered which necessarily reduce the above estimates

of gross deliverable supplies. These factors include: (a) the reliance

on Chicago as a source of deliverable supplies; (b) the three-day barge

queuing and priority load-out requirement; and (c) prior commercial

commitments of available supplies. In addition, further reductions must

be made from gross deliverable supplies resulting from the CBT

proposal's lack of locational price differentials, the $40 million net

worth requirement for issuers of shipping certificates, and foreseeable

disruptions in barge transportation on the Illinois River; these

additional factors are analyzed separately in later sections of this

proposed Order.

a. Reliance on Chicago. To the extent that gross deliverable

supplies of soybeans in some years have been at or above the 2,400- and

4,000-contract levels, they have generally depended on Chicago supplies

to do so. For July, deliverable supplies of soybeans originating solely

from the northern Illinois River delivery area reached or exceeded the

2,400-contract level in only three of the 11 years. In August and

September, soybean deliverable supplies originating from the northern

Illinois River alone did not exceed the 2,400-contract level on any

occasion. The 4,000-contract level was not exceeded by northern

Illinois River deliverable supplies of soybeans in any year in the

July, August, or September delivery months. Thus, to the very limited

extent that gross deliverable supplies in the past would have reached a

minimum level, they would have done so because of the supplies in

Chicago.

Cash market activity in Chicago is likely to continue its

historical decline. While the estimation procedure for gross

deliverable supplies used in this analysis tried to correct for the

precipitous decline of Chicago by using 100 percent of the current

capacity as a constraint on past supplies, that method certainly

overstates the actual deliverable supplies that may originate from that

location in the future. Chicago for many years has held stocks well

below their maximum capacity levels, particularly in the critical

summer months. The following chart demonstrates that underutilization

of the remaining capacity in Chicago is continuing, despite the

dramatic contraction in available capacity, and is most likely to

continue to do so in the future. The likely result is that Chicago

supplies will be reduced significantly in the future and would not be

available in significant quantities under the CBT proposal.

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[[Page 49489]]

b. The Three-Day Barge Loading Requirement. The CBT proposal

includes a provision requiring a shipping certificate issuer to begin

loading grain into the receiver's barges within three business days

after it receives loading instructions and the receiver's barges are at

the delivery facility ready to load. Most significantly, the issuer

would be required to give preference to shipping certificate holders

relative to any other customer or proprietary business for eight hours

of load-out capacity per day. This requirement is contrary to the

current contracts' delivery terms and to cash market practice, where

new shippers are accommodated on a first-come, first-served basis.

Concerns have been expressed by some commenters that, by requiring

issuers to cease loading corn and soybeans in barges for their cash

market business in order to meet the requirements of the shipping

certificates and by requiring that only limited advance notice would

have to be given to issuers, the CBT proposal would discourage

potential issuers from issuing shipping certificates for futures

delivery.

The CBT, on the other hand, has argued that the impact of the

proposed preferential load-out requirement for futures deliveries on an

issuer's willingness to issue shipping certificates would be limited

because the rules would require the issuer to load out only eight hours

per day, leaving the remaining 16 hours of each day to load other

barges. CBT's position assumes, without providing supporting data, that

labor physically and economically would be available for such a 24-hour

day and that additional transportation and grain supplies could quickly

be procured and coordinated to move the grain to the waiting barges.

While the effect of the proposed loading requirements on the

willingness of issuers to issue shipping certificates for futures

delivery is difficult to measure, it represents a significant departure

from cash market practice and most likely would reduce the amount of

available deliverable supplies.

c. Prior Commercial Commitments of Stocks. An additional factor

which would reduce the above estimates of gross deliverable supplies is

prior commitment of stocks. Determining deliverable supplies on the

basis of shipment information does not make necessary deductions for

that amount of the shipments which would be unavailable for futures

delivery because they were otherwise committed and because no

substitution was possible at an equivalent market price. While a number

of commenters indicated that much of the corn and soybeans shipped on

the Illinois River is not irrevocably committed, at least up to the

point when the grain is loaded into a barge, the ability of firms

economically to obtain supplies to meet existing commitments from

alternative sources would be limited at times. This situation would be

more likely to occur in those periods when supplies are limited, such

as during the critical summer months of July, August, and September.

The commitment of supplies of corn and soybeans under forward contracts

or other marketing arrangements would at times make them unavailable to

the futures delivery process until futures prices were significantly

distorted relative to cash prices. Thus, it is likely that the actual

available deliverable supplies for the futures contracts would be

significantly less than indicated by the above gross estimates.

6. Conclusion. In summary, the proposed delivery provisions of the

soybean contract clearly fail to meet the statutory requirement for

minimum levels of deliverable supplies throughout the summer months of

July, August, and September even before the above reductions (plus

those discussed below) have been made, and the additional reductions

required by these factors would further reduce the available

deliverable supplies. For these reasons, price distortions and

manipulation, market congestion, and abnormal movements of soybeans in

interstate commerce would be likely to occur. Additional delivery

points to increase the available deliverable supplies of soybeans, as

well as other adjustments to CBT's proposal discussed below, are

necessary to achieve the objectives of section 5a(a)(10).

As to the CBT proposal for corn, gross deliverable supplies

throughout the year appear to be adequate except for September. While

gross deliverable supplies for September do not meet the minimum level,

they may be supplemented to some unknown extent by new crop production

in September, and the September corn contract would be less likely to

be subject to manipulation than other months with similar low levels

because of the expectation of abundant supplies of new crop production

in the immediate future. While these gross estimates of deliverable

supply overstate economic deliverable supplies and must be reduced by

the other factors discussed, the degree of reduction cannot be

estimated with any certainty. The Commission's proposed action in

changing and supplementing the proposed corn contract to add locational

differentials, to eliminate the net worth eligibility requirement, and

to broaden the contingency plan for river disruptions, discussed below,

will have the effect of alleviating some limitations on deliverable

supplies of corn under CBT's proposal. Accordingly, based on the record

before it, the Commission does not find that the available deliverable

corn supplies are inadequate under section 5a(a)(10) such that

additional delivery points are necessary. Actual trading experience

will reveal whether the level of deliverable supplies meets the

requirements of section 5a(a)(10). Accordingly, the Commission directs

the CBT to report on the actual delivery and contract expiration

experience on an annual basis for the first five years after contract

expirations begin under the revised contract terms.

IV. The Lack of Locational Price Differentials Violates Section

5a(a)(10)

Section 5a(a)(10) requires that, where more than one delivery point

or commodity grade is specified, a futures contract must specify

quality and locational price differentials to the extent necessary to

prevent price manipulation, market congestion, or the abnormal movement

of the commodity in interstate commerce. Guideline No. 1 and the

Commission's policy on price differentials are predicated upon, and

give further specificity to, section 5a(a)(10)'s requirements. As

discussed above, Guideline No. 1 requires that futures contract terms

and conditions provide for a deliverable supply that will not be

conducive to price manipulation or distortion and that such a supply

reasonably can be expected to be available to the short trader and

saleable by the long trader at its market value in normal cash market

channels. In addition, the Commission's policy on price differentials

requires that, where cash market locational or quality differentials

are stable, the futures contract should reflect ``normal commercial

price differences as they are represented by cash price differences * *

*.'' When cash market price differences are unstable or where the

product flow in the cash market is not relevant to the two futures

market points, the Commission's policy requires that differentials must

be set at levels which fall within the range of values which are

commonly observed.

The CBT's failure to specify locational price differentials

violates section 5a(a)(10) as well as the requirements of Guideline No.

1 and the Commission's policy on locational price differentials. The

cash market on the northern Illinois River clearly reflects a

unidirectional

[[Page 49490]]

flow of corn and soybeans and exhibits significant locational price

differences, which have a stable relationship with one another, at the

proposed delivery points. The failure of the CBT proposal to provide

for locational price differentials reflecting the cash market not only

would reduce available deliverable supplies on the contracts, but would

result in price distortions and susceptibility to price manipulation,

market congestion, and the abnormal movement of corn and soybeans.

Although the CBT describes its delivery system as a simple single

delivery area, in fact it is a multiple delivery point system without

differentials. This multiple delivery point system is comprised of

physically-linked, but spatially-separated points along the northern

Illinois River, which are affected by a unidirectional demand from the

Gulf market across five different barge freight zones, including

Chicago. Chicago may also be affected, at times, by a number of

competing cash market demand pulls.

The CBT argues that section 5a(a)(10) is not violated by its

proposal's lack of differentials because ``locational differentials for

corn and soybeans at par fall well within the expected values of cash

market differentials between the delivery points'' and that ``the

differences in barge freight costs between locations on the NIR are

typically * * * smallest during the summer.'' CBT June 16, 1997

submission, 40. However, this is not the appropriate review standard

because the relative value of these commodities among the northern

Illinois River delivery points is constant, quite transparent and based

on established barge freight differences. Furthermore, even if it were,

we find that a lack of price differentials is not commonly observed in

the cash market.20

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\20\ Available information suggests that the cash market value

of corn and soybeans loaded into vessels and rail cars at Chicago

may at times equal or exceed the value of corn or soybeans loaded

into barges at locations on the northern Illinois River delivery

area. However, with the precipitous decline in the available

deliverable supplies in Chicago, such occasional variances from the

prices loaded on barges at Chicago and along the northern Illinois

River will likely play a small role in the cash market in the future

and are not considered to be a significant factor in setting

locational differentials under the CBT's proposal.

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Moreover, differences in barge freight costs, while lower during

the late spring and early summer months, begin to increase and are

quite significant during the critical July and August period.

The value of corn and soybeans loaded into barges generally is

greater at barge-loading facilities located down river relative to the

value of grain loaded in barges at upriver locations, including

Chicago. As indicated above, the CBT proposal essentially would price

corn and soybeans when they are loaded on barges along the northern

Illinois River destined for the export market centered in New Orleans.

The futures contracts would be priced free on board (FOB) barge at the

loading facilities.21 Currently, the cash market for such

products prices them at the CIF New Orleans price, which is uniform and

widely known.22 The cost of barge freight to New Orleans

included in that price varies based on established barge freight costs

that are higher at Chicago and lower as one descends the northern

Illinois River and thus is closer to New Orleans. Those freight rates

are transparent and widely reported. While they vary to some extent,

they are expressed and reported publicly as a varying percentage of the

fixed amounts found in the Waterways Freight Bureau Tariff No. 7. By

backing out the freight amounts from the CIF price, one can calculate

the differences in the value of the commodity FOB various Illinois

River points.

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\21\ The acronym FOB, free on board, means that, under the terms

of the sale of a commodity, the price agreed between the buyer and

seller includes the cost of loading the product into transportation

equipment (barges, rail cars, vessel, etc.) at a designated

location.

\22\ CIF New Orleans means that, under the terms of the sale,

the price agreed upon between the buyer and the seller includes the

freight and insurance to transport the products to New Orleans and

to deliver them there. This market, which calls for grain to be

shipped at the cost of the seller to export points in New Orleans,

is very liquid, with corn and soybeans being actively traded

throughout the year.

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During the critical summer months the price differential based on

the freight rate between Chicago (the most northerly Illinois River

delivery point) and Pekin (the most southerly Illinois River delivery

point) has ranged in recent years between 4.1 and 5.3 cents per bushel

of corn and between 4.4 and 5.7 cents per bushel of soybeans. These

differences are very significant and are sufficient to distort prices,

to limit deliverable supplies, and to divert them from one delivery

point to another.23

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\23\ The CBT implicitly recognized these cash market value

relationships and the importance of barge-freight differences in

valuing the commodities in formulating its proposed plan to price

alternative delivery locations in response to transportation

disruptions on the Illinois River. As described below, that proposal

provides that alternative localities must be priced CIF New Orleans

with the delivery taker reimbursing the maker for the cost of

freight to New Orleans from the original delivery location.

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Where, as here, a contract requires multiple delivery points in

order to yield sufficient deliverable supplies and significant normal

commercial price differences exist in the cash market between those

locations, section 5a(a)(10) requires that the terms of the futures

contract include locational price differentials. The failure to set

locational price differentials reflecting normal cash market price

differences has the economic effect of excluding the disadvantaged

delivery point from being used for delivery. Such an exclusion may

result in abnormal movement of the commodity away from the

disadvantaged delivery point and to the advantaged delivery point. In

order for a disadvantaged delivery point to function, the futures price

has to increase above the commodity's underlying cash market value at

the disadvantaged delivery point to overcome this built-in penalty.

This opens the door to price distortion and price manipulation in the

amount of the ``differential penalty.'' Alternatively, market

congestion at the advantaged delivery point may result. These are

precisely the types of market abuse that section 5a(a)(10) sought to

avoid by requiring exchanges to ``permit delivery * * * at such * * *

locational price differentials as will tend to prevent or diminish

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

commodity in interstate commerce.'' For these reasons, the Commission

finds that the lack of locational price differentials violates section

5a(a)(10).

V. The Failure Adequately to Address Foreseeable Interruptions to

Deliveries Violates Section 5a(a)(10)

An additional concern regarding the operation of the CBT proposal

applicable to both the corn and soybean contracts is its reliance

chiefly upon a single mode of transportation to effect delivery--

Illinois River barge transportation. A large number of commenters

questioned the reliability of barge transportation on the Illinois

River from the standpoint of assuring that takers of futures delivery

would be able to receive and to transport their grain promptly in the

event of a disruption of barge transportation on the river due to

weather or lock maintenance.

There has been a long history of repeated, significant

interruptions in transportation along the northern Illinois River. In

three of the last 13 years, one or more of the locks on this portion of

the river have been closed for repair by the Army Corps of Engineers

for 60 or more consecutive days during the critical summer months, with

the result that no barge traffic could pass through that point on the

river on its

[[Page 49491]]

way south to New Orleans.24 In addition, traffic on the

Illinois River is frequently impacted by weather conditions, including

wind, high water during the spring and summer, and icing during the

winter. The Coast Guard, an agency of the U.S. Department of

Transportation, is responsible for maintaining safe passage along the

nation's waterways and, when conditions warrant, issues safety

advisories or compulsory safety zones restricting transportation on

certain segments of the river. Between January 1991 and June 1997 the

Coast Guard issued compulsory safety zones on segments of the northern

Illinois River on 21 separate occasions. The delivery area on the

northern Illinois River was affected by such a safety zone for

substantial portions of the river from early June through the middle of

August in 1993.25

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\24\ Specifically, in 1984 the Lockport and Brandon Road locks

were closed for 60 days in July, August, and September; in 1987 the

Peoria lock was closed for 60 days in July, August, and September;

and in 1995 the Lockport, Brandon Road, Dresden Island, and

Marseilles locks each were closed for between 64 days and 77 days in

July, August, and September.

\25\ In addition to actions taken by the Coast Guard, the U.S.

Army Corps of Engineers, which has operational control over river

locks, may close a lock when it determines that icing conditions so

require.

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The CBT proposal's heavy reliance on barge delivery would

disadvantage receivers during those periods when barge traffic is

negatively impacted by weather conditions or lock maintenance and

repair. Prolonged closure of the river would increase the

susceptibility of the futures contract to manipulation by issuers, who

could issue large numbers of certificates during periods when those

taking delivery would be unable to transport and to sell the product at

an economic value in relation to the CIF New Orleans market.

The Commission is of the view that it is not an appropriate use of

exchange emergency authority to address such significant and

foreseeable disruptions to the operation of contract

terms.26 In response to repeated requests by the Commission

staff, the CBT, by submission dated August 22, 1997, sought to cure

this defect by proposing a plan to be followed in the case of

transportation disruptions. This proposed contingency plan provides

that, in the event that either the Peoria or LaGrange lock on the

Illinois River (the two most southerly locks without an auxiliary) is

scheduled, with six-months prior notice, to be closed for a period of

45 days or more, then the delivery maker and taker may mutually agree

to alternative terms, or failing such agreement, the deliverer is

obligated to provide loaded barges to the receiver at a point between

the lowest closed lock and St. Louis or on the mid-Mississippi River

between St. Louis and Dubuque, inclusive. The loaded barges would be

valued CIF New Orleans, with the delivery taker responsible for paying

to the delivery maker the transportation cost between the original

shipping station and New Orleans. The reimbursement in transportation

cost would be computed based upon 100 percent of the Waterways Freight

Bureau Tariff No. 7 barge freight rate.

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\26\ The CBT proposed a separate rule, regulation

1081.01(12)(G)(8), to address possible disruptions to shipping

traffic within the delivery area. That proposed rule provides that,

if it becomes impossible to load at a designated shipping station

``because of an Act of God, fire, * * * an act of government, labor

difficulties, or unavoidable mechanical breakdown, the shipper will

arrange for water conveyance to be loaded at another regular

shipping station * * *'' and will compensate the taker for resulting

transportation costs, if any. It further provides, however, that if

the impossibility of delivery exists at a majority of shipping

stations within the delivery area, then shipment may be delayed.

Although this proposed rule addresses conditions impeding delivery

at one or some locations within the delivery area, it does not offer

an acceptable solution to the contingency that all or most

deliveries may be rendered impossible due to disruptions of river

traffic south of the delivery area or at points affecting a majority

of shipping stations within the delivery area. Because of the

increased likelihood of price manipulation or market congestion

arising from delayed delivery in such circumstances, a different and

more effective contingency plan is required under section 5a(a)(10).

---------------------------------------------------------------------------

This proposal falls short of achieving its apparent objective of

addressing the susceptibility of the corn and soybean futures contracts

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

the commodity in interstate commerce resulting from disruptions to

river traffic. First, the proposed rule only addresses sustained

blockages due to lock closures south of the delivery area. However, a

similar situation could be precipitated by closure of one or a number

of locks within the delivery area sufficient to disrupt traffic at a

majority of shipping stations. Repairs are often made to more than one

set of locks at a time, having the potential to increase the breadth of

the disruption within the delivery area from such projects. Thus,

although the same foreseeable situation rendering the contracts

vulnerable to price manipulation or market congestion exists when the

disruption is within the delivery area as when it is south of the

delivery area, the contingency plan fails to address the former

situation.

Secondly, when a sustained river closure of less than 45 days is

announced, vulnerability to price manipulation is foreseeable. This is

also true when locks are closed on less than the six-months notice,

which the CBT has proposed as a condition for triggering the

contingency procedures. This vulnerability arises from the ability of

shipping certificate issuers under the CBT proposal to issue

certificates representing up to 30 days of their capacity. Thus, an

announced river closure of between 30 and 45 days, for example, would

enable eligible issuers to deliver into the market the maximum number

of shipping certificates permitted, secure in the knowledge that the

holders of those certificates could not accept delivery of the corn or

soybeans while the river is closed and that, once the obstruction to

river movement was ended, the issuer could only be required to deliver

on cancelled certificates over an entire-month period. In this

connection, it should be noted that closings are announced for lock

repairs, which generally are scheduled for the late summer months, the

time when deliverable supplies are lowest and river traffic is

generally at its lowest level. Futures contracts during these months

would be most susceptible to manipulation if a prolonged closure

extending to the arrival of the new crop allows futures deliverers to

depress the price of an old crop futures month to levels reflecting new

crop values, when the broader cash market is reflecting the usual old

crop-new crop supply and demand conditions.

In addition, the proposal to value alternate delivery locations

using 100 percent of the Waterways Freight Bureau Tariff No. 7 rate is

inconsistent with the locational price differential found by the

Commission to be required, as discussed below. The application of

divergent differentials to the contracts, depending upon whether

deliveries were subject to the contingency rule or to normal delivery

procedures, could also contribute to price manipulation, market

congestion, or the abnormal movement of commodities in interstate

commerce. 27

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\27\ Even if such differing tariffs would not have such adverse

results, it would be ``necessary or appropriate * * * to insure fair

dealing * * *'' in such futures contracts to apply the same

differential in both instances under section 8a(7) of the Act.

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VI. The Minimum Net Worth Eligibility Requirement for Issuers Violates

Section 15

In addition to the CBT's existing requirement of $2 million working

capital required of firms regular for delivery under all its

agricultural contracts, the CBT has proposed to require that firms

eligible to issue shipping certificates under its proposed soybean and

corn contracts must also

[[Page 49492]]

meet a minimum net worth standard of $40 million. This requirement has

the effect of reducing the amount of economically deliverable supplies

by making ineligible for delivery certain existing loading facilities

in the delivery areas owned by otherwise eligible firms. In addition,

the requirement also constitutes a barrier to entry of firms wishing to

establish facilities and to become eligible to issue shipping

certificates. The Commission has analyzed this requirement under the

provisions of section 15 of the Act and finds that it constitutes an

unjustifiable barrier to entry and leads to undue market concentration

when considered in the context of the other requirements those firms

must meet.

Section 15 of the Act requires the Commission, when considering

exchange rule proposals or amendments, to consider the public interest

to be protected by the antitrust laws and to endeavor to take the least

anticompetitive means of achieving the objectives of the

Act.28 Therefore, the CBT proposal's possible

anticompetitive effects must be evaluated against its potential

effectiveness in achieving the policies and purposes of the Act.

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\28\ British American Commodity Options Corp. v. Bagley, [1975-

1977 Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 20,245 at

21,334 (S.D.N.Y. 1976) aff'd in part and rev'd in part on other

grounds, 552 F. 2d. 282 (2d. Cir. 1977, cert. denied, 98 S. Ct. 427

(1977).

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Because shipping certificates for contract delivery purposes are

unsecured, all existing futures contracts that use shipping certificate

delivery specify certain financial requirements for certificate

issuers. Consistent with this approach, the CBT proposal requires that

issuers of certificates have through-loading facilities on the northern

Illinois River, obtain an irrevocable letter of credit in an amount

equal to the value of their delivery commitments, and maintain a

minimum of two million dollars in working capital. These requirements

are comparable to those imposed on shipping certificate issuers in

other futures markets, including the CBT's own soybean meal, diammonium

phosphate and anhydrous ammonia futures contracts, the New York Cotton

Exchange's frozen concentrated orange juice futures contract and the

Minneapolis Grain Exchange's white wheat futures contract. Moreover,

issuers of a shipping certificate under the CBT proposal would also be

limited to issuing certificates of a value no greater than 25 percent

of the issuer's net worth. However, in addition to all these

requirements, the CBT's proposed corn and soybean contracts would

require shipping certificate issuers to have a net worth of $40

million, a requirement that is not imposed in any other futures

contract involving shipping certificates.

The effect of the proposed $40 million net worth requirement would

be to limit issuance of shipping certificates to four large grain firms

among the seven firms with shipping stations. At least three firms

which currently operate shipping stations on the designated segment of

the northern Illinois River and participate in the cash market by

selling barges of corn and soybeans would be excluded from issuing

shipping certificates for those same commodities on the CBT futures

contracts. The Commission does not believe the CBT has presented a

reasonable justification for this requirement.

Although the CBT's objective of protecting the financial integrity

of the delivery process is reasonable, it is adequately achieved

through the working capital and letter of credit requirements, as it

has been for all other shipping certificate contracts, and through the

limit on the value of certificates issued to 25 percent of an issuer's

net worth. Forty million dollars is a high level of net worth that

excludes three of the seven existing firms with loading facilities

along the northern Illinois River and would act as a barrier to other

new entrants. The resulting extremely high level of concentration of

the market restricted to four issuers is demonstrated by the fact that

the Herfindahl-Hirschman Index (HHI) for the proposed market is

approximately 3,300.29 This increase in concentration as

compared with the current delivery system--530 points in the HHI--is

likely to create or enhance market power or facilitate its exercise in

this already highly concentrated market.

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\29\ The HHI is calculated by summing the squares of the

individual market share of all of a market's participants. The 3,300

figure was obtained using rated delivery capacity of the four firms

currently meeting the proposed capital requirements to measure

market share. Those firms and their respective market shares are

Archer Daniels Midland Co. (49 percent), Continental Grain Company

(22 percent), Cargill, Incorporated (19 percent), and Consolidated

Grain and Barge (10 percent). Adding in the three firms (American

Milling Company, Garvey International, and Sours Grain Company) who,

absent the proposal's $40 million net worth requirement, also would

be eligible to issue delivery certificates in the proposed markets

would lower the HHI to 2,511, still a high level of concentration

but substantially less than that under the CBT proposal.

---------------------------------------------------------------------------

The CBT has failed to demonstrate a need for this particular

requirement. Accordingly, the Commission finds that the $40 million net

worth requirement is an unjustified barrier to entry into a highly

concentrated market and violates section 15 of the Act.30

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\30\ Concerns about this concentration among those firms

eligible to issue shipping certificates are compounded by the

sizeable control some of the firms have over barge ownership, Gulf

exports, and processing facilities. Several commenters expressed

concern that this concentration increases the opportunity for price

manipulation.

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VII. Proposed Changes and Supplements to Comply With Sections 5a(a)(10)

and 15

Under the provisions of section 5a(a)(10) of the Act, the

Commission, having found that the response of the CBT to the

notification relating to its corn and soybean futures contracts does

not accomplish the statutory objectives of that section and ``after

granting the contract market an opportunity to be heard, may change or

supplement such rules and regulations of the contract market to achieve

the above objectives * * *'' The Commission has determined that the

following changes and supplements to CBT's proposal are necessary to

achieve the objectives of section 5a(a)(10) and compliance with section

15 of the Act. The Commission has determined that deliverable supplies

of soybeans should be increased through the retention of the delivery

points under CBT's current contracts that the CBT has proposed to

eliminate and that appropriate locational differentials should be

applied to such delivery points. In addition, the Commission has

determined for both the corn and soybean contracts to revise the

proposed rule to impose appropriate locational differentials for

Illinois River delivery points. The Commission has determined to revise

the proposed eligibility requirements for issuers of corn and soybean

shipping certificates by eliminating the net worth requirement of $40

million, which the Commission believes is an unnecessary barrier to

entry. The Commission also has determined to revise the river closure

contingency rule by reducing the continuous period of lock closure from

45 days as proposed to 15 days, by making it applicable whenever a

majority of shipping stations within the northern Illinois River

delivery area are affected by closure of any lock or locks, by making

it applicable to all announced closures with no minimum notification

period specified and by changing the differential from 100 percent of

the Waterways Freight Bureau Tariff No. 7 rate as proposed to 150

percent.

[[Page 49493]]

A. Delivery Points

In determining how to remedy the inadequacy of deliverable supplies

under the CBT soybean proposal, the Commission accepts the delivery

points in the proposal itself as a starting point and believes that the

most reasonable and feasible way to enhance deliverable supplies is by

adding additional delivery points. To do so, the Commission has decided

to retain the delivery points under which the CBT's existing contract

has been operating for years. Thus, the Commission had determined to

retain Toledo and St. Louis as delivery points for soybeans.

In this regard, many commenters supported retaining the delivery

point at Toledo, pointing out that Toledo's effectiveness as a delivery

point is proven. They also maintained that Toledo brings with it the

strength of having transportation ties to both the export markets via

vessels on the Great Lakes and the expanding livestock feed demand in

the southeastern U.S. via rail transportation. Although St. Louis has

not been a significant delivery point under the current contract, it

likely would become one under the contract's revised shipping

certificate format.31

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\31\ Some commenters advocated the addition of new and

completely untried delivery points, such as locations in the

interior of Iowa, or delivery points that have been used for other

contracts, such as Minneapolis, Minnesota. Although those

suggestions may have merit, the Commission has decided that the

experience with the current delivery points is entitled to

significant weight.

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These two delivery points have the strong advantage of having been

chosen by CBT as appropriate delivery points for its soybean contract

and having been used as delivery points for the contract for several

years. Toledo has been a delivery point on the CBT soybean contract

since 1979; St. Louis has been a delivery point since 1993. The

resulting experience and familiarity with these delivery points of the

CBT, its members and commercial users of the soybean contract are

strong indicators that the delivery points are feasible, workable and

acceptable.

As discussed below, they also provide a substantial increase in the

available deliverable supplies of soybeans. When Toledo and St. Louis

are retained as delivery points, gross deliverable supplies are at or

above the 2,400-contract level for all observations in both July and

August during the past 11 years and in September for all but four of

the last 11 years. The gross deliverable supplies are at or above the

4,000-contract level for 21 of 33 observations. The following chart

shows the increases in gross deliverable supplies of soybeans which

result from the retention of Toledo and St. Louis as delivery points.

BILLING CODE 6351-01-P

[[Page 49494]]

[GRAPHIC] [TIFF OMITTED] TN22SE97.006

BILLING CODE 6351-01-C

[[Page 49495]]

Accordingly, the retention of Toledo and St. Louis as delivery

points is necessary and appropriate to provide sufficient levels of

gross deliverable supplies of soybeans for July and August. Although

the retention of Toledo and St. Louis does not yield gross deliverable

supplies which meet the 2,400-contract level in four of the last 11

years in September, September is a transition month between the old and

new crop year, as discussed above. New crop production is in the

offing. Thus, even when September supplies on occasion fall below the

2,400-contract level, the incentive to manipulate prices based on a

shortfall of old crop supplies is reduced because of the likelihood of

rapidly falling prices as new crop supplies become available in the

near future. In light of the reduced threat of price manipulation due

to the imminence of new crop production, the Commission is not ordering

that additional delivery points be added to the contract beyond

retention of Toledo and St. Louis. Should September deliverable

supplies of soybeans appear to be inadequate once trading under the

revised soybean contract begins, the Commission would take appropriate

steps to provide for additional delivery locations.32

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\32\ Should actual trading experience reveal that September

supplies must be supplemented, one means of accomplishing that

objective would be to expand the proposed definition of the northern

Illinois River to include a greater segment of the river's delivery

area. With the specification of appropriate locational

differentials, this change can be made at a later time with little

or no disruption to the contract.

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Accordingly, the Commission finds that retention of Toledo and St.

Louis is necessary and appropriate to provide the level of economically

available deliverable supplies required by section 5a(a)(10).

B. Differentials

Section 5a(a)(10) specifies that where more than one delivery point

is specified, the contracts must specify locational differentials to

the extent necessary to prevent price manipulation, market congestion,

or the abnormal movement of the commodity in interstate commerce. As

discussed above, in light of the significant locational differentials

in the cash market among the proposed delivery locations, the CBT's par

delivery proposal for all potential corn and soybean delivery locations

would reduce the level of economically available deliverable supply and

would increase the susceptibility of the contracts to the prohibited

effects under section 5a(a)(10). Accordingly, to meet the objectives of

section 5a(a)(10), locational differentials must be set for the

delivery locations on the corn and soybean contracts.

In setting those differentials, the Commission has been guided by

commonly observed cash market price differences among the delivery

points. The cash market differences in the prices of corn and soybeans

for delivery points on the northern Illinois River are based primarily

upon the cost of barge freight--the price of the product increases as

one goes down the river, and the cost of freight to New Orleans

decreases. These differences in freight prices are transparent, readily

available, and commonly accepted as the best measure of cash price

values. An analysis of barge freight rate data indicates that 150

percent of the Waterways Freight Bureau Rate Tariff No. 7 rate relative

to Chicago, Illinois, is an appropriate differential.

Barge freight rate data for the years 1990 through 1996 indicate

that 150 percent of tariff is well within the range of commonly

observed freight rates, and it closely approximates the average percent

of tariff quoted by barge companies for Illinois River shipment during

this period. These data also indicate that 150 percent of tariff

approximates the average percent of tariff quoted for July, August, and

September, the months when deliverable supply concerns and the need to

maximize available deliverable supplies are the greatest. In addition,

a majority of those commenting on the issue agreed that it was

appropriate to base price differentials on barge freight cost

differences, and several of the commenters that suggested a fixed rate

recommended 150 percent of tariff.

St. Louis is being retained as a delivery point for soybeans. The

relative price of soybeans in the cash market among the various

delivery points on the northern Illinois River and St. Louis is

consistently determined based on the difference in freight costs to New

Orleans, and therefore the Commission has decided to base the

differential of St. Louis on 150 percent of freight tariff as well.

Most commenters agreed that this approach is the appropriate measure of

such price differences.

The differential applicable to Toledo, which is retained as a

delivery point for soybeans, cannot be set based on the differentials

relating to barge freight since Toledo is not located on the Illinois

River and does not tend to deliver soybeans CIF New Orleans. The

Commission's policy on differentials provides that such differentials

must fall within the range of commonly observed cash market

differences. Available data indicate that cash price differentials

between Chicago and Toledo commonly range from Chicago's being at a

premium to its being at a discount to Toledo. Therefore, establishing

Toledo deliveries at par with Chicago is well within the range of

commonly observed cash market price differences and provides an

adequate approximation of the cash market price relationship between

the two delivery points. Most commenters expressing an opinion on this

issue agreed that soybeans should be deliverable in Toledo at par with

Chicago.

Accordingly, the Commission has determined that for soybeans

Chicago and Toledo should be at contract price with all other points at

a premium over contract price based on 150 percent of the Waterways

Freight Bureau Tariff No. 7 rate. For corn, Chicago should be at

contract price with all other points at a premium over contract price

of 150 percent of the difference between the Waterways Freight Bureau

Tariff No. 7 rate applicable to that location and the rate applicable

to Chicago, Illinois.

C. Disruptions to River Traffic

The CBT proposal's reliance chiefly on a single mode of

transportation to effect delivery renders the contract susceptible to

significant possible disruption of the delivery process, increasing the

possibility of price manipulation, market congestion, or the abnormal

movement of corn and soybeans in interstate commerce. Although the CBT

submitted a contingency plan to address such disruptions to river

traffic, that plan only addressed long-term disruption to river traffic

resulting from closure of locks south of the delivery area announced

six months in advance. As the Commission discussed above, however, the

threat of manipulation of prices arises from the possible inability of

long position holders to take delivery from all, or a significant

number, of shipping stations due to the closures of a lock or locks

located either within or south of the delivery area. The longer the

period of the delay before alternate delivery procedures can be

invoked, the greater the potential for manipulation. Moreover, this

threat exists equally when a lock or locks have been closed with less

than six-months notice. Accordingly, compliance with section 5a(a)(10)

of the Act requires that this threat be diminished by reducing the

period during which delivery may be delayed by eliminating the six-

month notice requirement and by applying the contingency delivery

provision to similar circumstances caused by obstructions to movement

on the river

[[Page 49496]]

arising either inside or outside of the delivery area.

In determining the length of an announced obstruction which should

give rise to a contingency delivery plan, the Commission analyzed

information on past lock closures by the Army Corps of Engineers and on

the issuance of river advisories or safety zones by the Coast Guard.

During the last 17 years for which this information could be

ascertained, it appears that there have been no unplanned and

unannounced river closures of greater than two weeks duration.

Accordingly, obstructions lasting at least 15 days after they are

announced are appropriately addressed by application of the contingency

delivery plan.

In addition, as discussed above, the application of divergent

differentials to the contracts depending upon whether the delivery is

subject to the contingency rule might also contribute to a price

manipulation or to market congestion. Since the Commission has

determined that a differential based on 150 percent of the Waterways

Freight Bureau Tariff No. 7 rate should be applied to the corn and

soybean futures contracts, the Commission believes that the provision

in the contingency plan should be conformed to that differential, which

will be applicable to all other deliveries made on the contracts at

non-par locations.

Accordingly, the Commission is proposing under section 5a(a)(10) of

the Act to change and to supplement the provisions of this part of the

CBT proposal by reducing the continuous period of lock closure from 45

days as proposed to 15 days, by making the rule applicable to the

closure of any lock or locks which affects shipments from a majority of

shipping stations within the northern Illinois River delivery area, by

making the rule applicable to all announced closures with no minimum

notification period specified and by changing the differential from 100

percent of the Waterways Freight Bureau Tariff No. 7 rate as proposed

to 150 percent.

D. Net Worth

As the Commission found above, although the CBT's objective of

protecting the financial integrity of the delivery process is

reasonable, it would be adequately achieved through requirements on

working capital, letters of credit, and the ceiling on issuance of

shipping certificates to 25 percent of net worth. Contrary to the

policies underlying the federal antitrust laws, the $40 million net

worth requirement would operate as a significant bar to entry for

entities that would be eligible in all other respects, and the

resulting market concentration would be very high. The CBT has failed

to demonstrate a regulatory need for the requirement. Accordingly, the

Commission is proposing to eliminate it under sections 15 and 5a(a)(10)

of the Act.

E. 1999 Contract Months

By letter dated April 24, 1997, to the Chairperson of the

Commission, the CBT advised the Commission that it had determined to

list or to relist for trading the July 1999 and November 1999 soybean

contracts and the July 1999 and December 1999 corn contracts,

respectively, prior to Commission review and approval of the proposed

changes to the delivery specifications. In doing so, the CBT indicated

that it would

list the aforementioned contracts with a special indicator * * *

denot[ing] that the Exchange's Board of Directors and Membership

have approved the terms of the listed contracts; however, the terms

are subject to CFTC approval.

By letter dated May 2, 1997, the Commission responded that it

``will consider whether to approve the listing of these contract months

as part of its ongoing proceeding pursuant to section 5a(a)(10) of the

Act * * *.'' The Commission found that the ``listing of these trading

months is not consistent with Commission rule 1.41(l) and that * * *

their listing for trading by the CBT is not legally authorized at the

present time.''

The Commission by this proposed Order announces its intention to

change and to supplement the CBT's proposed amendments to those

contracts on the grounds that they violate sections 5a(a)(10) and 15 of

the Act. Accordingly, the Commission proposes to disapprove the terms

of the 1999 corn and soybean contracts and proposes to apply the

changes described above to such contracts under sections 5a(a)(10),

5a(a)(12), 8a(7), and 15 of the Act. The CBT may propose to list the

1999 corn and soybean contracts incorporating the Commission's proposed

changes and supplements, and the Commission would approve such listing.

The CBT should give notice to all traders that the Commission has

proposed to disapprove the CBT's proposed amendments to the 1999

soybean and corn contracts.33

\33\ The Commission notes that historically there has been very

little or no open interest in delivery months for corn or soybeans

that mature two years or more in the future.

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By the Commission (Chairperson Born, Commissioner Dial,

Commissioner Spears; Commissioner Tull Dissenting With Opinion,

Commissioner Holum Dissenting Without Opinion)

CBOT Proposed Delivery Terms for Corn and Soybeans--Dissenting

Opinion of Commissioner John E. Tull, Jr.

I strongly disagree with the majority's decision regarding the

Chicago Board of Trade's proposed amendments to the delivery

specifications to their corn and soybean contracts and vote to

approve them.

Section 5a(a)(10) of the Commodity Exchange Act requires us to

determine whether the delivery terms proposed by the CBOT ``will

tend to prevent or diminish price manipulation, market congestion,

or the abnormal movement of such commodity in interstate commerce.''

We must also ``take into consideration the public interest to be

protected by the antitrust laws in requiring or approving any rule

of a contract market.'' With all due respect to my colleagues and

our staff, based on my analysis of the data, I am convinced that the

proposed terms for both contracts as submitted meet these statutory

requirements.

I also note that the CBOT convened two task forces of industry

experts who debated the delivery points at length and the proposal

has been approved by the exchange membership. I believe it is the

right of a membership organization such as the CBOT to write the

specifications of its own contract, as long as those specifications

satisfy the statutory requirements.

Attachment 1

For the reasons explained in the ``Proposed Order of the

Commodity Futures Trading Commission to Change and to Supplement

Proposed Rules of the Board of Trade of the City of Chicago,

Submitted For Commission Approval in Response to a Section 5a(a)(10)

Notice Relating to Futures Contracts in Corn and Soybeans,'' the

Commission is proposing under section 5a(a)(10) of the Commodity

Exchange Act to change and to supplement rules and proposed rules of

the Board of Trade of the City of Chicago. As provided under the

Proposed Order, the Commission proposes to make the following

changes:\34\

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\34\ Bracketed type denotes the Commission's proposed changes or

supplements to the CBT proposal. Italics denote changes proposed by

the CBT. Deletions to proposed CBT language are not shown.

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1. To change and to supplement the paragraph of Rule 1036.00

immediately following the paragraph beginning with the words ``Corn

Differentials,'' to read as follows:

In accordance with the provisions of Rule 1041.00A, corn for

shipment from regular warehouses or shipping stations located within

the Chicago Switching District or the Burns Harbor, Indiana

Switching District may be delivered in satisfaction of corn futures

contracts at contract price, subject to the differentials for class

and grade outlined above. [Corn for shipment from shipping stations

located on the northern Illinois River may be delivered at a premium

over contract price of 150 percent of the difference between the

Waterways Freight Bureau Tariff No. 7 rate applicable to that

location and the rate applicable to Chicago, Illinois, subject to

the differentials for class and grade outlined above.

[[Page 49497]]

*The factor for converting the tariff rate quoted in tonnage to

a bushel basis shall be 35.714 bushels per ton.]

2. To change and to supplement the paragraph of Rule 1036.00

immediately following the paragraph beginning with the words

``Soybean Differentials,'' to read as follows:

In accordance with the provisions of Rule 1041.00D, soybeans for

shipment from regular warehouses or shipping stations located within

the Chicago Switching District, the Burns Harbor, Indiana Switching

District, [or the Toledo, Ohio Switching District] may be delivered

in satisfaction of soybean futures contracts at contract price,

subject to the differentials for class and grade outlined above.

[In accordance with the provisions of Rule 1041.00D, soybeans

for shipment from shipping stations located on the northern Illinois

River or from shipping stations within the St. Louis-East St. Louis

and Alton Switching Districts (i.e., the upper Mississippi River

between river miles 170 and 205) may be delivered in satisfaction of

soybean futures contracts at a premium over contract price of 150

percent of the difference between the Waterways Freight Bureau

Tariff No. 7 rate* applicable to that location and the rate

applicable to Chicago, Illinois, subject to the differentials for

class and grade outlined above.

*The factor for converting the tariff rate quoted in tonnage to

a bushel basis shall be 33.333 bushels per ton.]

3. To change and to supplement Rule 1041.00A to read as follows:

Corn. Corn for shipment from regular warehouses or shipping

stations located within the Chicago Switching District or the Burns

Harbor, Indiana, Switching District may be delivered in satisfaction

of corn futures contracts at contract price. [Corn for shipment from

shipping stations located within the northern Illinois River may be

delivered in satisfaction of corn futures contracts at a premium

over contract price of 150 percent of the difference between the

Waterways Freight Bureau Tariff No. 7 rate* applicable to that

location and the rate applicable to Chicago, Illinois, subject to

the differentials for class and grade outlined above.

*The factor for converting the tariff rate quoted in tonnage to

a bushel basis shall be 35.714 bushels per ton.]

4. To change and to supplement Rule 1041.00D to read as follows:

Soybeans. Soybeans for shipment from regular warehouses or

shipping stations located within the Chicago Switching District, the

Burns Harbor, Indiana, Switching District [or the Toledo, Ohio,

Switching District] may be delivered in satisfaction of soybean

futures contracts at contract price. [Soybeans for shipment from

shipping stations located on the northern Illinois River or from

shipping stations within the St. Louis-East St. Louis and Alton

Switching Districts (i.e., the upper Mississippi River between river

miles 170 and 205) may be delivered in satisfaction of soybean

futures contracts at a premium over contract price of 150 percent of

the difference between the Waterways Freight Bureau Tariff No. 7

rate* applicable to that location and the rate applicable to

Chicago, Illinois, subject to the differentials for class and grade

outlined above.

*The factor for converting the tariff rate quoted in tonnage to

a bushel basis shall be 33.333 bushels per ton.]

5. To change and to supplement Regulation 1044.01 following the

list of delivery locations and immediately prior to the issuer's

signature block by adding, as follows:

[soybeans only:

____ St. Louis, MO, river mile marker ______

____ Toledo, OH, Switching District]

6. To change and to supplement Regulation 1056.01 by adding

after the last paragraph the following:

[The premium charges on soybeans for delivery from regular

shippers within the Toledo, Ohio, Switching District shall not

exceed 12/100 of one cent per bushel per day.

The premium charges on soybeans for delivery from regular

shippers within the St. Louis-East St. Louis and Alton Switching

Districts (i.e., the upper Mississippi River between river miles 170

and 205) shall not exceed 10/100 of one cent per bushel per day.]

7. To change and to supplement the second paragraph of

Regulation 1081.01(1) to read as follows:

(c) and in the case of Chicago, Illinois, Burns Harbor, Indiana,

[and Toledo, Ohio,] Switching Districts only, his registered storage

capacity.

8. To change and to supplement the third paragraph of Regulation

1081.01(1)(a) to read as follows:

(a) one barge per day at each shipping station on the northern

Illinois River [and within the St. Louis-East St. Louis and Alton

Switching Districts (i.e., the upper Mississippi River between river

miles 170 and 205);] and

9. To change and to supplement Regulation 1081.01(2) to read as

follows:

Except for shippers located on the northern Illinois River [and

within the St. Louis-East St. Louis and Alton Switching Districts

(i.e., the upper Mississippi River between river miles 170 and

205),] such warehouse shall be connected by railroad tracks with one

or more railway lines.

10. To change and to supplement the first sentence of Regulation

1081.01(12)A to read as follows:

A. Load-Out Procedures for Wheat and Oats and Rail and Vessel

Load-Out Procedures for Corn and Soybeans from Chicago, Illinois,

Burns Harbor, Indiana, [and Toledo, Ohio, Switching Districts] Only

* * *.

11. To change and to supplement the first sentence of Regulation

1081.01(12)B to read as follows:

B. Load-Out Rates for Wheat and Oats and Rail and Vessel Load-

Out Rates for Corn and Soybeans from Chicago, Illinois, Burns

Harbor, Indiana, [and Toledo, Ohio, Switching Districts] Only * *

*.

12. To change and to supplement Regulation 1081.01(12)G(7) to

eliminate the words ``on the Illinois Waterway,'' to read as

follows:

Any expense for making the grain available for loading will be

borne by the party making delivery, provided that the taker of

delivery presents barge equipment clean and ready to load within ten

calendar days following the scheduled loading date of the barge. If

the taker's barges are not made available within ten calendar days

following the scheduled loading date, the taker shall reimburse the

shipper for any expenses for making the grain available. Taker and

maker of delivery have three days to agree to these expenses.

13. To change and to supplement the last sentence of Regulation

1081.10(12)(G)(8) to read as follows:

(8) * * *. If the aforementioned condition of impossibility

prevails at a majority of regular shipping stations, then shipment

[shall be made under the provisions of rule 1081.(12)(G)(9).]

14. To change and to supplement the first paragraph and

paragraph 9(b)(iii) and add a new paragraph at the end of Regulation

1081.01(12)(G)(9) to read as follows:

(9). In the event that [it has been announced that river traffic

will be obstructed for a period of fifteen days or longer as a

result of one of the conditions of impossibility listed in

regulation 1081.10(12)(G)(8) and in the event that the obstruction

will affect a majority of regular shipping stations located on the

northern Illinois River,] then the following barge load-out

procedures for corn and soybeans shall apply:

(b) * * *

(iii) The taker of delivery shall pay the maker 150% of the

Waterways Freight Bureau Tariff Number 7 barge benchmark rate from

the original delivery point stated on the Shipping Certificate to

NOLA.

[(c) In the event that the obstruction or condition of

impossibility listed in regulation 1081.10(12)(G)(8) will affect a

majority of regular shipping stations located on the northern

Illinois River, but no announcement of the anticipated period of

obstruction is made, then shipment may be delayed for the number of

days that such impossibility prevails.]

15. To change and to supplement the first paragraph of

Regulation 1081.01(13)A by eliminating the words ``and soybeans'' in

both instances in which they appear.

16. To change and to supplement Regulation 1081.01(13)D by

retaining it and changing it to read as follows:

[Soybeans. For the delivery of soybeans, regular warehouses or

shipping stations may be located within the Chicago Switching

District, within the Burns Harbor, Indiana, Switching District

(subject to the provisions of paragraph A above), within the Toledo,

Ohio, Switching District, or shipping stations may be located on the

northern Illinois River (subject to the provisions of paragraph A

above), or within the St. Louis-East St. Louis and Alton Switching

Districts (i.e., the upper Mississippi River between river miles 170

and 205).

Delivery in Toledo must be made at regular warehouses or

shipping stations providing water loading facilities and maintaining

water depth equal to normal seaway draft of 27 feet. However,

deliveries of soybeans may be made in off-water elevators within the

Toledo, Ohio, Switching District PROVIDED that the party making

delivery makes the

[[Page 49498]]

soybeans available upon call within five calendar days to load into

water equipment at one water location within the Toledo, Ohio,

Switching District. The party making delivery must declare within

one business day after receiving warehouse receipts and loading

orders the water location at which soybeans will be made available.

Any additional expense incurred to move delivery soybeans from an

off-water elevator into water facilities shall be borne by the party

making delivery PROVIDED that the party taking delivery presents

water equipment clean and ready to load within 15 calendar days from

the time the soybeans have been made available. Official weights and

official grades as loaded into the water equipment shall govern for

delivery purposes. Delivery in the greater St. Louis river-loading

area must be made at regular warehouses or shipping stations

providing water loading facilities and maintaining water depth equal

to the average draft of the current barge loadings in this delivery

area. Official weights and official grades as loaded into the water

equipment shall govern for delivery purposes.]

17. To change and to supplement Regulation 1081.01(14)E by

retaining it and changing it to read as follows:

[Soybeans. The warehouseman or shipper is not required to

furnish transit billing on soybeans represented by warehouse receipt

or shipping certificate delivery in Toledo, Ohio. Delivery shall be

flat.]

18. To change and to supplement the first paragraph of the

applicant's declaration contained in Regulation 1085.01 to read as

follows:

We, the ________ (hereinafter called the Warehouseman/Shipper)

owner or lessee of the warehouse located at ________ or shipping

station located at mile marker ________ [of the ________ River,]

having a storage capacity * * *.

19. To change and to supplement appendix 4E, paragraph 2, by

eliminating the sentence which reads, ``The net worth of a firm

regular to deliver corn or soybeans must be greater than or equal to

$40,000,000.''

The Commission has determined that publication of the Proposed

Order for public comment will assist the Commission in its

consideration of these issues. Accordingly, the Commission is

requesting written comments from interested members of the public.

Issued in Washington, D.C., this 16th day of September, 1997, by

the Commodity Futures Trading Commission.

Catherine D. Dixon,

Assistant Secretary of the Commission.

[FR Doc. 97-24948 Filed 9-19-97; 8:45 am]

BILLING CODE 6351-01-P