[House Hearing, 118 Congress]
[From the U.S. Government Publishing Office]
RISING RISKS: MANAGING VOLATILITY IN GLOBAL COMMODITY DERIVATIVES
MARKETS
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTEENTH CONGRESS
FIRST SESSION
__________
MARCH 9, 2023
__________
Serial No. 118-3
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Printed for the use of the Committee on Agriculture
agriculture.house.gov
_________
U.S. GOVERNMENT PUBLISHING OFFICE
52-557 PDF WASHINGTON : 2023
COMMITTEE ON AGRICULTURE
GLENN THOMPSON, Pennsylvania, Chairman
FRANK D. LUCAS, Oklahoma DAVID SCOTT, Georgia, Ranking
AUSTIN SCOTT, Georgia, Vice Minority Member
Chairman JIM COSTA, California
ERIC A. ``RICK'' CRAWFORD, Arkansas JAMES P. McGOVERN, Massachusetts
SCOTT DesJARLAIS, Tennessee ALMA S. ADAMS, North Carolina
DOUG LaMALFA, California ABIGAIL DAVIS SPANBERGER, Virginia
DAVID ROUZER, North Carolina JAHANA HAYES, Connecticut
TRENT KELLY, Mississippi SHONTEL M. BROWN, Ohio
DON BACON, Nebraska SHARICE DAVIDS, Kansas
MIKE BOST, Illinois ELISSA SLOTKIN, Michigan
DUSTY JOHNSON, South Dakota YADIRA CARAVEO, Colorado
JAMES R. BAIRD, Indiana ANDREA SALINAS, Oregon
TRACEY MANN, Kansas MARIE GLUESENKAMP PEREZ,
RANDY FEENSTRA, Iowa Washington
MARY E. MILLER, Illinois DONALD G. DAVIS, North Carolina
BARRY MOORE, Alabama JILL N. TOKUDA, Hawaii
KAT CAMMACK, Florida NIKKI BUDZINSKI, Illinois
BRAD FINSTAD, Minnesota ERIC SORENSEN, Illinois
JOHN W. ROSE, Tennessee GABE VASQUEZ, New Mexico
RONNY JACKSON, Texas JASMINE CROCKETT, Texas
MARCUS J. MOLINARO, New York JONATHAN L. JACKSON, Illinois
MONICA De La CRUZ, Texas GREG CASAR, Texas
NICHOLAS A. LANGWORTHY, New York CHELLIE PINGREE, Maine
JOHN S. DUARTE, California SALUD O. CARBAJAL, California
ZACHARY NUNN, Iowa ANGIE CRAIG, Minnesota
MARK ALFORD, Missouri DARREN SOTO, Florida
DERRICK VAN ORDEN, Wisconsin SANFORD D. BISHOP, Jr., Georgia
LORI CHAVEZ-DeREMER, Oregon
MAX L. MILLER, Ohio
______
Parish Braden, Staff Director
Anne Simmons, Minority Staff Director
(ii)
C O N T E N T S
----------
Page
Bost, Hon. Mike, a Representative in Congress from Illinois,
submitted letter............................................... 81
Scott, Hon. David, a Representative in Congress from Georgia,
opening statement.............................................. 3
Thompson, Hon. Glenn, a Representative in Congress from
Pennsylvania, opening statement................................ 1
Prepared statement........................................... 2
Witnesses
Gelchie, Michael ``Mike'', Group Chief Executive Officer, Louis
Dreyfus Company, Wilton, CT.................................... 4
Prepared statement........................................... 6
Submitted material........................................... 82
Sammann, Derek, Senior Managing Director, Global Head of
Commodities, Options, and International Markets, CME Group
Inc., Chicago, IL.............................................. 7
Prepared statement........................................... 9
Submitted material........................................... 82
Crighton, Alicia, Chair, Board of Directors, Futures Industry
Association, New York, NY...................................... 11
Prepared statement........................................... 13
Submitted material........................................... 83
Edmonds, Christopher S., Chief Development Officer,
Intercontinental Exchange, Inc., Atlanta, GA................... 16
Prepared statement........................................... 18
Submitted material........................................... 84
Berkovitz, Hon. Dan M., former Commissioner, Commodity Futures
Trading Commission, Bethesda, MD............................... 21
Prepared statement........................................... 22
Submitted material........................................... 85
Submitted question........................................... 86
RISING RISKS: MANAGING VOLATILITY IN GLOBAL COMMODITY DERIVATIVES
MARKETS
----------
THURSDAY, MARCH 9, 2023
House of Representatives,
Committee on Agriculture,
Washington, D.C.
The Committee met, pursuant to other business, at 10:14
a.m., in Room 1300 of the Longworth House Office Building, Hon.
Glenn Thompson [Chairman of the Committee] presiding.
Members present: Thompson, Lucas, Austin Scott of Georgia,
Crawford, DesJarlais, LaMalfa, Rouzer, Bacon, Bost, Johnson,
Baird, Mann, Feenstra, Miller of Illinois, Moore, Finstad,
Rose, Jackson of Texas, Molinaro, De La Cruz, Langworthy,
Duarte, Nunn, Alford, Van Orden, Chavez-DeRemer, Miller of
Ohio, David Scott of Georgia, Costa, McGovern, Adams, Hayes,
Brown, Davids of Kansas, Slotkin, Caraveo, Salinas, Perez,
Davis of North Carolina, Tokuda, Budzinski, Vasquez, Crockett,
Jackson of Illinois, Casar, Carbajal, Craig, Soto, and Bishop.
Staff present: Paul Balzano, Caleb Crosswhite, Kevin Webb,
Erin Wilson, John Konya, Emily German, Josh Lobert, Amar Nair,
Ashley Smith, and Dana Sandman.
OPENING STATEMENT OF HON. GLENN THOMPSON, A REPRESENTATIVE IN
CONGRESS FROM PENNSYLVANIA
The Chairman. With the consideration of our budget views
and estimates letter complete, the Committee will now proceed
to our hearing today entitled, Rising Risks: Managing
Volatility in Global Commodity Derivatives Markets. After brief
opening remarks, Members will receive testimony from our
witnesses today, and then the hearing will be open to
questions.
So with that, I call this hearing to order on behalf of the
House Committee on Agriculture.
Over the past several years, we have seen unexpected events
that have shocked global commodity markets. The COVID-19-
related shutdowns and Russia's invasion of Ukraine have each
caused significant global disruptions to the supply and demand
of commodities. We are fortunate our derivatives markets showed
resiliency throughout these events. There is perhaps no greater
testament to the importance of well-regulated, professional,
and liquid derivatives markets than their continued operation
during times of significant market stress.
Yet, the strength of our derivatives markets should not be
taken for granted. Building deep, liquid, and safe derivative
markets is the result of informed trade-offs and negotiated
compromises between the needs of different market participants.
It takes constant work to uncover, understand, and manage the
risks that can develop.
Widespread clearing is one reason for the success of our
derivatives markets despite the recent turmoil. Clearing
provides access to essential risk management tools for hedgers
and creates a safe financial system for all Americans. Our
cleared markets perform so well due to the public servants and
the professionals who work every day to understand and manage
market risks, both at the Commodity Futures Trading Commission
and across the derivatives industry, including our five
witnesses here today.
Clearing manages risk by spreading it through multiple
layers of market participants, recalibrating risk levels daily,
and putting money aside in the form of initial margin and the
default fund. This system is well-understood and has proven
resilient time and time again. But after all that work,
residual risks remain. One risk is the timely cash margin
payments demanded by the clearing system will not be made on
time or in full. This risk is remote but also expected. There
is no way to completely eliminate risk from derivatives
markets, only ways to better manage it. As clearing continues
to grow in size and importance, the needs for this Committee to
better understand its value and its mechanics, especially under
times of extreme stress, grows, too.
And I want to thank our witnesses for joining us today.
Each of them is an expert in cleared markets, and I am looking
forward to hearing the discussion today.
[The prepared statement of Mr. Thompson follows:]
Prepared Statement of Hon. Glenn Thompson, a Representative in Congress
from Pennsylvania
Over the past several years, we've seen several unexpected events
that have shocked global commodity markets. The COVID-19 related
shutdowns and Russia's invasion of Ukraine have each caused significant
global disruptions in the supply and demand of commodities.
We are fortunate our derivatives markets showed resiliency
throughout these events. There is perhaps no greater testament to the
importance of well-regulated, professional, and liquid derivatives
markets than their continued operation during times of significant
market stress.
Yet, the strength of our derivatives markets should not be taken
for granted. Building deep, liquid, and safe derivatives markets is the
result of informed trade-offs and negotiated compromises between the
needs of different market participants. It takes constant work to
uncover, understand, and manage the risks that can develop.
Widespread clearing is one reason for the success of our
derivatives markets, despite the recent turmoil. Clearing provides
access to essential risk management tools for hedgers and creates a
safer financial system for all Americans.
Our cleared markets perform so well due to the public servants and
professionals who work every day to understand and manage market risks,
both at the Commodity Futures Trading Commission and across the
derivatives industry, including our five witnesses.
Clearing manages risk by spreading it through multiple layers of
market participants, recalibrating risk levels daily, and putting money
aside in the form of initial margin and the default fund. This system
is well understood and has proven resilient time and time again.
But, after all that work, residual risks remain. One risk is the
timely cash margin payments demanded by the clearing system will not be
made on time and in full. This risk is remote, but also expected. There
is no way to completely eliminate risk from derivatives markets, only
ways to better manage it.
As clearing continues to grow in size and importance, the need for
this Committee to better understand its value and its mechanics,
especially under times of extreme stress, grows, too.
I want to thank our witnesses for joining us today. Each of them is
an expert in cleared markets and I am looking forward to hearing the
discussion today.
The Chairman. And with that, I would like to once again
welcome the distinguished Ranking Member, the gentleman from
Georgia, Mr. Scott, for any opening remarks he would like to
give.
OPENING STATEMENT OF HON. DAVID SCOTT, A REPRESENTATIVE IN
CONGRESS FROM GEORGIA
Mr. David Scott of Georgia. Yes, thank you, Chairman
Thompson, for convening this very important and timely hearing
today, Rising Risks: Managing Volatility in Global Commodity
Derivatives Markets, very important. We are dealing with an
$800 trillion piece of the world's economy here.
Global commodities markets help consumers and producers
manage price risk and protect them from exposure to global
events, such as a time as this. The past several years have
been rife with uncertainty and volatility that has tested the
strength and resiliency of our derivatives markets. This
uncertainty and volatility has been driven by unexpected global
challenges such as the devastating and ungodly Russian war in
Ukraine and the COVID-19 pandemic. These events have disrupted
global trade and the transportation of food, fuel, and
fertilizer, creating supply shortages and price fluctuations.
This is arena in which we have to deal now with derivatives.
Now, as we examine the reactions of our global commodity
derivatives markets to these major events, it is very important
that we also take the time to focus on other sources of
volatility and uncertainty that have emerged in recent years
and will continue in the years ahead such as an increase in the
occurrence of extreme weather events, cybersecurity concerns,
and the growth of fintech, and the preeminent impact of Russia
producing nearly 66 percent of the ammonium nitrate that we
need to produce our own fertilizer. This is a very critical
issue, to have this kind of power over fertilizer concentration
in the hands of Russia. And we are moving expeditiously with
our own agriculture system to put in encouragements and support
funding so we can produce our own fertilizer and not have to
depend on Russia or anybody else.
These concerns and challenges have presented a new test for
our agriculture markets, from historically low water levels
that have cut river traffic in the Mississippi River Basin, to
reduced access to critical crop inputs and energy as a result
of global trade restrictions and interruptions. For example,
wheat prices have experienced historic swings due to the
disruption caused by Russia's invasion of Ukraine and fears of
a global wheat shortage. And that is the other reason, because
when you put Russia and Ukraine together, they produce a
gigantic amount of the world's wheat. Ensuring the orderly
operation of our derivatives markets and preserving their role
as a tool for price discovery and crisis management is most
important, now more than ever.
And finally, I want to note that this year marks 10 years
since the expiration of the Commodity Futures Trading
Commission's reauthorization. I chaired this Committee, this
subcommittee. And time after time, I have tried to put through
legislation to reauthorize. And when we had the threat from the
European Union of wanting to take over from the CFTC, their
authority, to operate in Europe as the source because Congress
has failed to reauthorize the CFTC. Let's get it done this
time.
I work closely with our Republican colleagues to pass
reauthorization, and I appreciate that it is a bipartisan
effort to get this done. And I know that Chairman Thompson
agrees with me, and we need to reauthorize the CFTC, and that
is one of my major priorities.
The testimony of each of you, our distinguished witnesses
here today, will be very critical for our Committee to
guarantee that the CFTC has all the necessary and appropriate
tools to ensure the integrity, the resilience, and the vibrancy
of the U.S. derivatives market. And I look forward to hearing
from this distinguished panel. I met several of them and had a
brief conversation with them before we started, and they are
here to share their expertise, their knowledge of the state of
our commodity derivatives markets and the effectiveness of our
existing tools for risk management.
I yield back, and deeply apologize for my cold.
The Chairman. No need to apologize for what we can't
control. And I thank the gentleman, and I share your
commitment. In addition to obviously an on-time, good,
bipartisan farm bill, we need to get the CFTC reauthorized. I
share that priority with you.
The chair would request that other Members submit their
opening statements for the record so that the witnesses may
begin your testimony and to ensure that there is ample time for
questions.
Our first witness today is Mr. Michael Gelchie, the Group
Chief Executive Officer of the Louis Dreyfus Company. Our next
witness then will be Mr. Derek Sammann, Senior Managing
Director, Global Head of Commodities, Options, and
International Markets for the CME Group. Our third witness
today will be Ms. Alicia Crighton, the Chair of the Board of
the Futures Industry Association. Our fourth witness today will
be Mr. Christopher Edmonds, the Chief Development Officer of
the Intercontinental Exchange. And our fifth and final witness
today is Hon. Dan Berkovitz, who is a former Commissioner of
the Commodity Futures Trading Commission.
Thank you to all of our impressive witnesses for joining us
today. We are now going to proceed your testimony. You will
each have 5 minutes. The timer in front of you will count down
to 0, at which time I may give a little bit of a tap and
reminder to wrap up whatever thought that you are on so that we
have lots of time for questions. I assure you, your written
testimony has been circulated. All Members of the Committee
have that in front of them. And your efforts at that were
greatly appreciated.
So with that, Mr. Gelchie, please begin when you are ready.
STATEMENT OF MICHAEL ``MIKE'' GELCHIE, GROUP CHIEF EXECUTIVE
OFFICER, LOUIS DREYFUS COMPANY, WILTON, CT
Mr. Gelchie. Chairman Thompson, Ranking Member Scott, and
Members of the Committee, thank you for holding this hearing on
topics relevant to global market risks for agricultural
commodities. I am honored to have the opportunity to contribute
my testimony and appreciate your attention to these acutely
important matters in the context of the extreme market
volatility we have seen in recent years.
My name is Mike Gelchie. I serve as Group Chief Executive
Officer for Louis Dreyfus Company. We are a 172 year old
agribusiness active in over 100 countries with approximately
17,000 employees worldwide, including more than 1,000 right
here in the United States. Our North American headquarters is
in Wilton, Connecticut.
LDC is a leading merchant and processor of agricultural
goods. We absorb and manage risks on our customers' collective
behalf, provide liquidity to all value chain participants, and
execute logistics services to deliver essential commodities
domestically and globally in a safe, timely, and reliable
manner. We are proud to fulfill these roles, the effective
execution of which acts as a shock absorber by both buyers and
sellers along the food and agricultural value chain, ultimately
contributing to competitive agriculture in the United States,
which is particularly important in today's volatile and
challenging markets.
With regards to global market volatility, I feel compelled
to give a broad response that recognizes the significant
macroeconomic and geopolitical factors that have, in our
opinion, been the primary contributors to contemporary market
volatility. I will do my best to summarize our observations.
Since 2018, agriculture in the United States has ridden a
roller coaster of macroeconomic and geopolitical market impacts
and challenges. These started with trade tensions between the
United States and China, followed by acute and unprecedented
supply chain disruptions as a result of the COVID-19 pandemic.
Today, global stagflation and resulting currency crises around
the world are negatively impacting the availability of U.S.
dollar currency reserves required to execute contractual
obligations that govern agricultural trade. Additionally, over
ten percent of the world's calories are held in uncertain
availability due to the Russian-Ukraine crisis.
Each of these topics individually warrants the attention of
this Committee, and while I have mentioned them expeditiously,
I hope that each Member and guests here today will consider the
depth and magnitude of their influence on all aspects of global
agri-commodity markets.
Like many other participants in the agricultural sector,
LDC relies on derivatives markets to hedge risk of the
underlying cash commodity. It is important to acknowledge the
value that speculative traders provide by injecting liquidity
into derivatives markets. Many are also quick to blame
speculative traders in times of volatility. However, we feel
strongly that the recent volatility in agri-commodity markets
is primarily due to the various risks and uncertainties facing
the agricultural sector, some of which I have already
mentioned.
I would also be remiss not to take this opportunity to
applaud this Committee's collective work and oversight of the
Commodity Futures Trading Commission. The hierarchy of
jurisdiction from your Committee to the Commission to the self-
policing efforts of commodity exchanges and the National
Futures Association brings a level of market certainty that we
depend upon to accurately hedge our significant risks and
continue to serve both producers and consumers of agricultural
products.
The system has shown remarkable resilience in the face of
extraordinary pressure and has created the gold standard for
risk management around the world. Your leadership and that of
the CFTC is critical to maintaining these benchmarks in the
United States, where users like us benefit from clear rules and
proper market oversight without stifling innovation and
development. Maintaining liquid, agile, and well-functioning
markets will allow the U.S. to continue leading in risk
management.
Mr. Chairman, I have intentionally kept these comments at a
high altitude to provide an overview of the matters addressed
by this hearing, and I look forward to responding to your
questions, and I am prepared to give more granular analysis
during our dialogue. Thank you.
[The prepared statement of Mr. Gelchie follows:]
Prepared Statement of Michael ``Mike'' Gelchie, Group Chief Executive
Officer, Louis Dreyfus Company, Wilton, CT
Regarding Global Market Volatility and Its Impact on Commercial End-
User Risk Management
Chairman Thompson, Ranking Member Scott, and Members of the
Committee, thank you for holding this hearing on topics relevant to
global market risks for agricultural commodities. I am honored to have
the opportunity to contribute my testimony and appreciate your
attention to these acutely important matters, in the context of the
extreme market volatility we have seen in recent years.
My name is Mike Gelchie. I serve as the Group Chief Executive
Officer for Louis Dreyfus Company, or LDC, which is a 172 year old
agribusiness, active in over 100 countries, with approximately 17,000
employees worldwide, including more than 1,000 in the United States.
Our North American headquarters are in Wilton, Connecticut.
LDC is a leading merchant and processor of agricultural goods. We
absorb and manage risks on our customers' collective behalf, provide
liquidity to all value chain participants, and execute logistics
services to deliver essential commodities domestically and globally in
a safe, timely and reliable manner. We are proud to fulfil these roles,
the effective execution of which acts as a shock absorber for both
buyers and sellers along the food and agricultural value chain,
ultimately contributing to competitive agriculture in the United
States, which is particularly important in today's volatile and
challenging markets.
With regard to global market volatility, I feel compelled to give a
broad response that recognizes the significant macroeconomic and
geopolitical factors that have, in our opinion, been the primary
contributors to contemporary market volatility. I will do my best to
summarize our observations.
Since 2018, agriculture in the United States has ridden a roller
coaster of macroeconomic and geopolitical market impacts and
challenges. These started with trade tensions between the United States
and China, followed by acute and unprecedented supply chain disruptions
as a result of the COVID-19 pandemic. Today, global stagflation and
resulting currency crises around the world are negatively impacting the
availability of U.S. dollar currency exchange required to execute
contractual obligations that govern agricultural trade. Additionally,
over 10% of the world's calories are held in uncertain availability due
to the Russia-Ukraine crisis.
Each of these topics individually warrants the attention of this
Committee, and while I have mentioned them expeditiously, I hope that
each Member and guest here today will consider the depth and magnitude
of their influence on all aspects of global agri-commodity markets.
Like many other participants in the agricultural sector, LDC relies
on derivative markets to hedge risk of the underlying cash commodity.
It is important to acknowledge the value that speculative traders
provide by injecting liquidity into derivatives markets. Many are also
quick to blame speculative traders in times of volatility, however we
feel strongly that the recent volatility in agri-commodity markets is
primarily due the various risks and uncertainties facing the
agricultural sector, some of which I have already mentioned.
I would be remiss not to take this opportunity to applaud this
Committee's collective work and oversight of the Commodity Futures
Trading Commission (or CFTC). The hierarchy of jurisdiction--from your
Committee to the Commission, to the self-policing efforts of commodity
exchanges and the National Futures Association--brings a level of
market certainty that we depend upon to accurately hedge our
significant risks and continue to serve both producers and consumers of
agricultural products.
The system has shown remarkable resilience in the face of
extraordinary pressure and has created the gold-standard for risk
management around the world. Your leadership and that of the CFTC is
critical to maintaining these benchmarks in the United States, where
users like us benefit from clear rules and proper market oversight,
without stifling innovation and development. Maintaining liquid, agile
and well-functioning markets will allow the U.S. to continue leading in
risk management.
Mr. Chairman, thank you for this opportunity to offer my testimony
and I look forward to addressing your questions.
The Chairman. Thank you, Mr. Gelchie. That is much
appreciated.
Mr. Sammann, please begin when you are ready with 5
minutes.
STATEMENT OF DEREK SAMMANN, SENIOR MANAGING
DIRECTOR, GLOBAL HEAD OF COMMODITIES, OPTIONS, AND
INTERNATIONAL MARKETS, CME GROUP INC., CHICAGO, IL
Mr. Sammann. Chairman Thompson, Ranking Member Scott, and
Members of the Committee, I am Derek Sammann, Senior Managing
Director and Global Head of Commodities, Options, and
International Markets for CME Group, the world's leading and
most diverse derivatives marketplace. Thank you for the
opportunity to testify today.
Commodity derivatives markets are essential to both
consumers and producers to help manage price risk and hedge
exposures to rising input costs. America's agricultural and
energy producers and end-users compete on a global level and
are affected by trade policy, geopolitics, and weather events
that can cause demand shocks and supply disruptions. These
events directly impact prices for commodities, which are linked
to real economies in the U.S. and worldwide, therefore
impacting main street consumers.
To combat these global uncertainties, commodities market
participants need tools to deal with instability that creates
unwanted price risk. U.S. derivatives markets provide market
participants with a robust and well-regulated venue to
efficiently hedge price risk, effectively discover prices, and
powerfully mitigate unwanted counterparty risk. Derivatives
exchanges like those at CME Group allow both commodity
producers and end-users to lock in future prices, providing
predictability of both input and output costs.
Over the last 3 years, we have seen significant disruptions
to global commodities markets. While the war in Ukraine created
supply shocks in markets like wheat and crude oil, the global
pandemic similarly created significant demand shifts in energy
markets, all of which created record levels of volatility
across commodities.
Thanks to the well-functioning and well-regulated
derivatives markets that this Committee oversees, U.S. and
global market participants were able to accurately determine
prices of core commodities and manage risk with minimal
disruptions during these unprecedented events. Let me provide
three examples of how these markets and the risk controls and
financial safeguards functioned effectively over the past year,
focusing on markets for wheat, energy, and metals.
Before the war, Russia and Ukraine contributed roughly 25
percent of total global wheat exports. Following Russia's
invasion of Ukraine, wheat prices increased 70 percent from
their January 2022 levels. CME Group's clearinghouse followed
transparent margin practices, which helped our markets to
operate smoothly during this volatile period. The ability to
adapt margin requirements is an important risk management tool
that helps our clearinghouse assess overall risk portfolio risk
to protect market participants.
In March 2022, we saw the largest daily price move in wheat
triggering a price limit in our wheat futures, one of the pre-
trade risk controls used by CME Group to maintain an orderly
market. We promptly worked with the CFTC to get expedited
approval to increase price limits and later to implement a
dynamic price limit mechanism in the wheat market that allows
the price limit to adjust with volatility and restore trading
more quickly. These actions respectively allowed market
participants to effectively manage risk and discover prices as
markets normalized and will prepare the market for future
events.
Turning to the crude oil market, the story is largely the
same. Trade in energy spiked as the war in Ukraine broke out.
As with wheat, prices in our West Texas Intermediate, or WTI,
crude oil contract, a global benchmark for the price of oil,
increased over 60 percent. This is the largest upside move in
over 10 years. But thanks to our market risk controls and the
clear, predictable margin practices employed by CME Group's
clearinghouse, market participants were able to effectively
hedge, and our markets accurately reflected the price of this
core commodity.
Last, the invasion of Ukraine constrained Russia's ability
to trade, which was felt by players across the metals supply
chain in markets like aluminum and nickel. In addition, China,
the world's largest consumer of many industrial metals,
continued a zero-COVID policy that led to fears of significant
demand destruction. By early March of 2022, new all-time highs
were observed in the nickel market, contributing to an
unprecedented disruption in the trade of nickel at one of the
world's largest metals exchanges in London. Independent reviews
of that disruption have specifically noted the absence of
market oversight and risk management procedures such as those
routinely deployed by CME Group's exchange and clearinghouse,
including, for example, position limits, assessing
concentration risk, liquidity-based margin add-ons, and daily
price bands.
CME Group's clearinghouse provides sophisticated financial
safeguards and risk management and has a long history of
successfully handling extreme market events. CME clearing was
well-prepared for the commodities market events that began last
March, making multiple proactive margin increases leading up to
Russia's invasion in Ukraine so that customers would be
prepared for market changes as volatility grew.
In conclusion, as CME Group's CEO Terry Duffy recently
wrote in a Financial Times \1\ op-ed piece, ``With near
constant market challenges ahead, effective risk management
will be crucial. To navigate this new age of uncertainty . . .
.'' U.S. derivatives markets, as regulated by the CFTC and
overseen by this Committee, are essential to ensure that global
market participants can continue to manage those risks
confidently and securely.
---------------------------------------------------------------------------
\1\ Editor's note: the Financial Times article entitled, Risk
management is the alpha for a time of uncertainty, dated February 28
2023, is retained in Committee file and is available at: https://
www.ft.com/content/a3459cb1-b98c-457a-8e4a-e99860709b88.
---------------------------------------------------------------------------
Thank you for inviting me today, and I look forward to
taking any questions you may have.
[The prepared statement of Mr. Sammann follows:]
Prepared Statement of Derek Sammann, Senior Managing Director, Global
Head of Commodities, Options, and International Markets, CME Group
Inc., Chicago, IL
Chairman Thompson, Ranking Member Scott, and Members of the
Committee, I am Derek Sammann, Senior Managing Director and Global Head
of Commodities, Options, and International Markets for CME Group. As
the world's leading and most diverse derivatives marketplace, CME Group
offers the widest range of global benchmark products across all major
asset classes and provides clearing services for our customers around
the globe through our clearinghouse, CME Clearing. Thank you for the
opportunity to testify today regarding global commodity markets,
volatility, and the importance of robust, secure, well-regulated and
deeply liquid derivatives markets.
Commodity Derivatives Markets in Times of Volatility
Commodities derivatives markets are essential to both consumers and
producers to help manage price risk and hedge exposures to rising input
costs. Given the importance of U.S. agricultural production and the
magnitude of U.S. exports of agricultural products to global consumers,
America's agricultural producers and global end-users are not strangers
to market volatility. They compete on a global level and are affected
by trade policy, geopolitics and weather events half-a-world away.
Similarly, energy products like crude oil and natural gas, as well
as metals products like silver, copper and aluminum, are also affected
by global demand shocks and supply disruptions. These events directly
impact prices for those commodities as well as agricultural products,
which are directly linked to the real economies in the U.S. and
worldwide--therefore impacting Main Street consumers.
To combat these global uncertainties, commodities market
participants need robust tools to deal with instability that creates
unwanted price risk. U.S. derivatives markets provide market
participants all over the world with a robust and well-regulated venue
to efficiently hedge price risk, effectively discover prices and
powerfully mitigate unwanted counterparty risk. Derivatives exchanges
like those at CME Group offer futures and options contracts that allow
both commodity producers and end-users to lock in future prices,
providing predictability on both input and output costs.
As regulated derivatives markets enable open and transparent price
discovery, they also help to support price stability. In turn, market
participants and end-users benefit from these markets, even those that
do not directly buy or sell futures contracts.
Recent Commodity Markets Volatility
Over the last 3 years, we have seen significant disruptions to
global commodities markets. While the war in Ukraine created supply
shocks in markets like wheat, crude oil and natural gas, the global
pandemic similarly created significant demand shifts in energy markets,
all of which created record levels of volatility across commodities.
Thanks to the well-functioning and well-regulated listed futures and
options markets that this Committee oversees, U.S. and global market
participants were able to accurately determine prices of core
commodities and manage risk with limited disruptions during these
unprecedented events. Let me provide three examples of how these
markets and their risk controls and financial safeguards functioned
effectively over the past year, focusing on the markets for wheat,
energy, and metals.
Before the war, Russia and Ukraine contributed roughly 25% of total
global wheat exports. Following Russia's invasion of Ukraine, wheat
market prices increased 70% from their January 2022 levels. During this
time, CME Group's clearinghouse followed transparent margining
practices, notifying market participants of incremental margin
increases 24 to 48 hours in advance, which helped our markets to
operate smoothly during this volatile period. Initial margin deposits
(also called ``performance bonds'') by clearing members vary according
to product and market volatility and ensure that a clearing member can
cover potential losses and meet its obligations to customers and the
clearinghouse. The ability to adapt margin requirements is an important
risk management tool that helps our clearinghouse assess overall
portfolio risk to protect market participants and the market as a
whole.
In March 2022, we saw the largest daily price move in wheat--with
an implied price up 26% vs. a 7.1% hard limit that day--triggering a
price limit on wheat futures. Price limits are one of the pre-trade
risk controls used by CME Group exchanges to maintain an orderly
market. Price limits cause trading to temporarily stop, preventing a
market from moving too far too fast and helping to recover market
equilibrium. We promptly worked with the CFTC to get expedited approval
to increase price limits and later to implement a ``dynamic'' price
limit mechanism in wheat that allowed the price limit to adjust with
volatility and restore trading more quickly following limit events. The
first action allowed market participants to effectively manage risk and
discover prices as they returned to normal, while the second will
prepare the market for future events.
Turning to oil markets, the story is largely the same. Trading
volumes in energy spiked as the war in Ukraine broke out. As with
wheat, prices that February in our West Texas Intermediate (or WTI)
crude contract, a global benchmark for the price of oil, increased over
60% from their January levels. Both wheat and oil had the same high
spikes and implied volatility. These were the largest upside price
risks that we have seen in over 10 years. Thanks to our market risk
controls and the clear, predictable margin practices employed by our
clearinghouse, market participants were able to effectively hedge, and
our markets accurately reflected the prices of this core commodity.
Finally, the invasion of Ukraine constrained Russia's ability to
trade, which was felt by players across the metals supply chain and
their end customers in markets like aluminum and nickel. In addition to
the geopolitical constraint, China--the world's largest consumer of
many metals--continued a [COVID]-zero policy that severely restricted
economic activity and led to fears of demand destruction for many
industrial metals. By early March of 2022, new all-time highs were
observed in palladium and nickel markets. These dynamics contributed to
an unprecedented disruption in the trading of nickel at one of the
world's largest metals exchanges in London. Independent reviews \1\ of
this disruption have specifically noted the absence of market oversight
and risk management procedures such as those routinely deployed by CME
Group's exchanges and clearinghouse. These tools include assessing
concentration risk, margin add-ons, liquidity-based margin add-ons,
daily price bands, daily variation margin calls, setting price limits
guided by volatility dynamics, and utilizing mechanisms such as dynamic
circuit breakers and velocity logic to manage market moves.
---------------------------------------------------------------------------
\1\ https://www.lme.com/-/media/Files/Trading/New-initiatives/
Nickel-independent-review/Independent-Review-of-Events-in-the-Nickel-
Market-in-March-2022---Final-Report.pdf; https://
www.bankofengland.co.uk/news/2023/march/boe-announces-supervisory-
action-on-lme-clear; https://www.fca.org.uk/news/statements/update-our-
public-statement-london-metal-exchange.
---------------------------------------------------------------------------
Central Clearing in Extreme Market Conditions
During times of extreme market volatility, central clearing, which
is required for all listed futures contracts, is a critical component
of a secure derivatives marketplace. Clearing helps to ensure that each
party to a futures contract lives up to its financial obligations,
thereby mitigating counterparty risk. CME Group's clearinghouse
provides sophisticated financial safeguards and risk management and has
a long history of successfully handling extreme market events.
CME Clearing takes extensive steps to ensure markets run smoothly,
including during times of exceptionally high market volatility as we
have seen recently. In addition to responsible margining practices, the
clearinghouse provides risk monitoring 24 hours a day, 6 days a week,
daily mark-to-market monitoring of clearing members' and customers'
exposures, margin review and maintenance, trend analysis of clearing
members, stress testing, back testing, risk reviews, and default
management--to name just a few.
CME Clearing was well prepared for the commodities market events
that began last March. We were in regular contact with the CFTC
throughout these periods of heightened volatility, while following our
standard practice when dealing with event risk. We made multiple,
proactive margin increases leading up to Russia's invasion of Ukraine,
so that customers would be prepared for market changes as volatility
grew.
Importance of Market Liquidity
While risk controls and central clearing are essential components
of the safety and security of derivatives trading, there would be no
market, no risk mitigation, and no price discovery without adequate
market liquidity. It is liquidity that enables the kind of trading
volumes that normally accompany markets in times of stress. Market
participants must have absolute confidence that when they are ready to
either establish a position to lock in a price or close out their
position, a counterparty will be there to take the other side of their
trade. Without this liquidity, markets would not exist.
A record of over 23 million contracts were traded on CME Group
every day, on average, in 2022. These deeply liquid markets are
possible because buyers and sellers trust in the investor protections
and safeguards that CME Group, in partnership with the CFTC as our
regulator, and the critical intermediaries like our clearing firms,
offers market participants. CME Group markets provide exemplary risk
management standards and create tailored products that meet the
market's risk hedging and price discovery needs.
Conclusion
As we move forward in an ever more uncertain world, commodity risk
management will continue to be a focus in 2023 and beyond. Due to the
integrated nature of commodity markets, all global events will
reverberate through America's markets. U.S. derivatives markets, as
regulated by the CFTC, and overseen by this Committee, are essential to
ensure that global market participants can continue to manage those
risks confidently and securely.
Thank you for inviting me to testify today and I look forward to
taking any questions you may have.
The Chairman. Mr. Sammann, thank you so much for your
testimony.
Now, I am pleased to recognize Ms. Crighton. Please begin
your testimony whenever you are ready.
STATEMENT OF ALICIA CRIGHTON, CHAIR, BOARD OF
DIRECTORS, FUTURES INDUSTRY ASSOCIATION, NEW YORK, NY
Ms. Crighton. Chairman Thompson, Ranking Member Scott, and
Members of the Committee, thank you for the opportunity to
testify. It is an honor to be here.
My name is Alicia Crighton. I am head of the clearing and
co-head of the futures businesses for Goldman Sachs. I am
testifying today as Chair of the Futures Industry Association,
the FIA, which is the leading global trade organization for the
futures, options, and centrally cleared derivatives markets.
During periods of increased market volatility, including
the pandemic and the Russian invasion of Ukraine, futures
markets take on additional importance as a critical risk
management tool for agriculture and energy end-users. Markets
function well, but our experience also underscored ways in
which we can strengthen the resilience of the cleared
derivatives markets. Today, I will explain the role of clearing
members in helping end-users manage risk. Then, I will discuss
margin as a foundational component of clearinghouse risk
management, also commonly referred to as CCPs. Last, I will
briefly touch on diversity and inclusion in the industry, an
issue that is personally important.
Through connectivity to exchanges and CCPs around the
world, clearing members provide end-users access to global
markets to manage risk. We are intermediaries and stand between
an end-user and the CCP and act as the first and last line of
defense for the cleared ecosystem.
As the first line of defense, we underwrite the risk of a
client's portfolio before it ever reaches the CCP and monitor
it on an ongoing basis. This includes determining suitability
of leveraged products, monitoring clients for money laundering,
and other risks to market integrity, collecting and
safeguarding customer margin, and guaranteeing the performance
of clients to CCPs.
Perhaps less known is that clearing members are also the
last line of defense. We contribute substantially all of the
financial resources that backstop the CCP in the event of a
major market disruption or default. For CFTC-regulated
clearinghouses alone, clearing members contribute close to $50
billion in default funds. The volume of transactions flowing
through clearinghouses globally has increased significantly in
the last decade in large part due to post-financial crisis
clearing mandates. While this has a positive and risk-reducing
effect for markets, it also increases the systemic relevance of
central clearinghouses and the market's exposure to them.
Clearing members, end-users, and investors must rely on the
strength of a clearinghouse's risk management, and ensuring the
regulatory and risk management framework for CCPs is keeping
pace with their role in the market is essential. For example,
margin is the primary tool available to clearinghouses to
manage credit risk and the first layer of resources that they
can access in the event of a default. Following the market
volatility that stemmed from the Russian invasion of Ukraine,
we saw dramatic margin increases by CCPs across futures
contracts globally. To meet margin calls, end-users need high-
quality liquid assets, driving up demand and at the same time
scarcity of those assets. This can intensify market turmoil,
cause a spill-over into other markets, and potentially create
systemic risk.
European energy companies sought liquidity support from
central banks and governments to ensure they could maintain
their hedges and meet their margin calls. While margin
requirements for listed futures contracts should increase
during volatile periods and decrease when markets normalize,
the magnitude of the increases signal that margin levels had
fallen too low. Improving the transparency of CCP margin models
and the opportunity for market participants to provide input to
the clearinghouse will help clearing members and end-users be
better prepared for periods of volatility.
The CFTC proposed enhanced clearinghouse governance rules
last year and outcome of market participants and clearinghouses
working together through the Market Risk Advisory Committee. In
addition, margin floor is designed to ensure baseline levels
remain appropriately calibrated and more stable through time
will help to dampen these extreme swings in margin.
Clearing members provides substantially all of the
resources available to a CCP to manage a default, but there is
a layer of capital contributed by the CCP itself. The skin in
the game is essential to align the incentives between a
clearinghouse and its members for effective risk management,
including the adequacy of margin requirements. Some progress is
being made globally, and the FIA looks forward to continuing to
work with regulators and clearinghouses to advance these
discussions.
As the first female Chair of the Board in FIA's 68 year
history, I can attest that we are making progress in enhancing
diversity in our industry. The face of our industry is
changing, and we don't have to look any further than the CFTC
and the historic confirmation of four female Commissioners last
year. There is clearly more we need to do, and I am happy to
discuss this further.
Again, it is an honor to be with you today and to work with
this Committee as you consider these important issues. Thank
you.
[The prepared statement of Ms. Crighton follows:]
Prepared Statement of Alicia Crighton, Chair, Board of Directors,
Futures Industry Association, New York, NY
Chairman Thompson, Ranking Member Scott, and Members of the
Committee, thank you for the opportunity to testify.
I am the head of the clearing businesses for Goldman Sachs and the
co-head of its Global Futures business. I am testifying as Chair of the
Futures Industry Association (FIA), the leading global trade
organization for the futures, options and centrally cleared derivatives
markets.
During periods of economic stress and increased market volatility,
futures markets take on additional importance because they serve as a
critical risk management tool for agricultural and energy end-users.
Through the market volatility related to the pandemic in March 2020,
and the Russian invasion of Ukraine in 2022, futures markets continued
to function amid tremendous stress in the financial system.
However, these experiences have also driven the industry to
consider what can be done to put cleared derivatives markets, and the
end-users that rely on them, on even stronger footing through future
cycles of volatility.
Today, I'll start by explaining the role of clearing members \1\ in
helping end-users manage risk and supporting market resilience. Then
I'll highlight issues that warrant additional attention from
policymakers. And lastly, I'll talk about diversity and inclusion in
the futures industry, an issue that is personally important to me.
---------------------------------------------------------------------------
\1\ For this testimony, the use of ``clearing members'' is intended
to include futures commission merchants (FCMs).
---------------------------------------------------------------------------
The Role of Clearing Members
Through connectivity to exchanges and clearinghouses around the
world, clearing members provide customers, including agricultural and
energy end-users, with access to global markets to manage the risks of
their operations. For example, many FIA members participate in
clearinghouses across dozens of jurisdictions to ensure their clients
have the ability to transact in any region in which they do business.
Clearing members are intermediaries, which means we stand between
an end-user and the clearinghouse, and we act as the first and the last
line of defense in fostering stability in cleared derivatives markets.
We act as a first line of defense by underwriting the risk of a
client's portfolio before it ever reaches the clearinghouse and
monitoring that risk on an ongoing basis. This includes determining the
appropriateness and suitability of leveraged products, monitoring
clients for money laundering and other risks to market integrity,
collecting and safeguarding customer margin and guaranteeing the
performance of clients to the clearinghouse.
Perhaps less known is that clearing members contribute
substantially all the financial resources that backstop the
clearinghouse in the event of a major market disruption or default by a
market participant. Looking at just the ten clearinghouses regulated by
the CFTC, clearing members contribute $47.6 \2\ billion in default
funds.
---------------------------------------------------------------------------
\2\ The clearinghouses included are: CME, Eurex, Ice Clear Credit,
Ice Clear Europe, Ice Clear U.S., LCH LTD, LCH SA, MGEX Clearing, Nodal
Clearing, OCC. Clearinghouse financial data is sourced from the Q3
public quantitative disclosures, published at year end. These
calculations do not include the default insurance policy taken out by
ICE as an additional layer of defense, to complement its ``Skin-in-the-
Game.''
---------------------------------------------------------------------------
Clearing members also hold a significant amount of regulatory
capital, which serves as an additional layer of protection to the
system that helps ensure clearing members themselves can withstand a
severe market disruption. The total amount of capital held by the
clearing members regulated by the CFTC was $175 billion as of December
last year.\3\
---------------------------------------------------------------------------
\3\ Source: The CFTC's Financial Information for FCMs report for
December 2022. Total capital is the aggregate amount of ``adjusted net
capital'' reported by the 63 FCMs registered with the CFTC as of that
date.
---------------------------------------------------------------------------
Together, these financial resources reduce the risk that a major
market event or default creates wider market contagion.
The Importance of Robust Exchange Risk Controls
Volatility control mechanisms including exchange risk controls
provide important protections against extreme price volatility that can
disrupt markets and create systemic risk. A recent example of this:
over the course of 3 days in March last year, the price of nickel
increased by over 270% on the London Metals Exchange (LME). As a result
of the volatility and market disruption, LME took the extraordinary
step of halting trading for 5 days but also canceled potentially
billions of dollars of trade notional that had taken place during the
twelve hours prior to the halt.
It's important to note that CFTC regulated exchanges have a long
history of supporting robust volatility control mechanisms, especially
in the agricultural markets. This brings confidence to our markets and
supports the needs of commodity end-users. FIA is working in
partnership with exchanges to develop global best practices for
exchange risk controls.
Clearinghouse Resilience
The volume of transactions flowing through clearinghouses around
the world has increased significantly in the last decade, in large part
due to post-financial crisis clearing mandates. While this has had a
positive and risk reducing effect for derivatives markets, it has also
increased the systemic importance of clearinghouses.
Around the world, regulators continue to make progress in enhancing
the regulatory standards applicable to clearinghouses, and there are
international standards in place to foster consistency among
jurisdictions. But recent market events underscore that more can be
done to strengthen the resilience of clearinghouses, and by extension,
cleared derivatives markets.
In addition, over the last twenty years, the number of clearing
firms in the U.S. futures industry has decreased significantly. Using
data from the CFTC, we estimate that the total number of clearing firms
that clear futures for their customers has decreased by half, while the
amount of customer margin held by these clearing firms has increased by
almost six times, from $60 billion in March of 2002 to $347 billion
this past December.
Clearing members, end-users and investors have to rely on the
strength of a clearinghouse's risk management, particularly as many
products by regulation require clearing. A core feature of a
clearinghouse is its ability to spread losses incurred from a default
across non-defaulting clearing members, known as ``loss
mutualization.'' This makes it essential that the risk management
standards and regulatory frameworks governing a clearinghouse are
sufficiently robust to safeguard their role as a critical market
infrastructure, including membership criteria, the risk profile of new
products it clears and, as I'll discuss more later, margin practices.
FIA supports greater strengthening and standardization of these
requirements globally.
Transparency and Adequacy of Margin
Margin is the first layer of resources available to a clearinghouse
if a participant defaults, and it is foundational to the risk
management of the clearinghouse. In recent periods of volatility, such
as the onset of the pandemic or the Russian invasion of Ukraine, we saw
significant margin increases across futures contracts globally.
In October 2020, FIA released a white paper \4\ that examined the
increase in margin requirements at derivatives clearinghouses during
the first quarter of 2020 due to increased market volatility related to
the pandemic. Although the clearing system performed well, the increase
in margin requirements created a large and sudden demand for liquid
assets that added stress in markets.
---------------------------------------------------------------------------
\4\ https://www.fia.org/sites/default/files/2020-10/
FIA_WP_Procyclicality_CCP%20Margin
%20Requirements_1.pdf.
---------------------------------------------------------------------------
To highlight key findings:
Initial margin requirements for certain benchmark contracts
in the U.S., Europe and Japan jumped by more than 100% between
the beginning and the end of the first quarter of 2020 with
most of the increase happening during the month of March
Initial margin held by the ten major derivatives
clearinghouses in those jurisdictions rose from $563.6 billion
at the end of 2019 to $833.9 billion at the end of the first
quarter of 2020, an increase of $270.3 billion or 48%
More recently, we experienced a very sharp increase in margin
requirements in the European power and gas and oil markets in 2022
after the Russian invasion of Ukraine. Several large European energy
companies that use these markets to hedge their risks faced extremely
large margin calls, and in some cases they had to turn to their
governments for financial support.\5\ This experience demonstrated how
margin calls can drive up demand for high quality liquid assets and
intensify market turmoil. While margin requirements for listed futures
contracts certainly should increase during volatile periods and
decrease when markets are under normalized conditions, the magnitude of
the increases that we saw in the European power and gas markets were a
sign that margin levels had fallen too low.
---------------------------------------------------------------------------
\5\ For examples, see: https://www.bankofengland.co.uk/markets/
energy-markets-financing-scheme; https://www.bmwk.de/Redaktion/EN/
Pressemitteilungen/2022/06/20220617-new-hedging-instrument-margining-
launched-by-the-german-federal-government-to-protect-companies-
affected-by-war.html; https://www.ft.com/content/4ea1dab0-d1a8-4324-
97e2-22caed5ed55c.
---------------------------------------------------------------------------
There are a few ways in which this can be addressed. First,
improving the transparency of clearinghouse margin models, as well as
the opportunity for market participants to provide input to the
clearinghouse, will help clearing members and end-users be better
prepared for periods of volatility. The Commodity Futures Trading
Commission (CFTC) issued a proposal last year to enhance clearinghouse
governance that was the outcome of market participants and
clearinghouses working together towards a solution through its Market
Risk Advisory Committee \6\ (MRAC).
---------------------------------------------------------------------------
\6\ https://www.cftc.gov/media/6201/MRAC_CCPRGS_RCCOG022321/
download.
---------------------------------------------------------------------------
Second, implementing margin floors that are designed to ensure
baseline levels remain appropriately calibrated and more stable through
time will help to dampen extreme swings in margin.
In our October 2020 white paper, FIA identified several additional
recommendations for regulators to improve the transparency and adequacy
of clearinghouse margin models to drive this outcome in the future.
Additionally, in February 2021, the MRAC approved several consensus
recommendations \7\ for the CFTC to consider related to clearinghouse
margin methodologies. Recommendations include:
---------------------------------------------------------------------------
\7\ https://www.cftc.gov/media/5706/MRAC_CRGSubcommittee-
DiscussionPaperOnBestPrac
ticesinCCPMarginMethodologies022321/download.
Clearinghouse margin methodologies should be sufficiently
transparent to market participants so they can understand how
models react to certain market conditions for liquidity
---------------------------------------------------------------------------
planning and risk management purposes
The CFTC should enhance its flexible approach to supervising
how CCPs manage procyclical margin requirements that
prioritizes the desired outcome of reducing procyclicality, not
the specific means of reducing it
Third, the role of incentives in driving prudent margin practices
by clearinghouses has been an important topic for the industry and
regulators for many years.\8\ This is because nearly all of the capital
that would be used to manage a default comes from the clearing members
\9\ and not the clearinghouses. In other jurisdictions, regulators are
in the process of developing new policy \10\ to require clearinghouses
to put more of their own capital at risk \11\ to better align their
incentives for strong risk management practices, including strong
margin models.
---------------------------------------------------------------------------
\8\ https://www.bis.org/publ/work866.pdf.
\9\ While the rate of contributions varies among CFTC-regulated
clearinghouses, on average, clearinghouses contribute less than 5% of
their own capital to their default funds. The clearinghouses included
in this analysis are: CME, Eurex, Ice Clear Credit, Ice Clear Europe,
Ice Clear U.S., LCH LTD, LCH SA, MGEX Clearing, Nodal Clearing, OCC.
Clearinghouse financial data is sourced from the Q3 public quantitative
disclosures, published at year end. These calculations do not include
the default insurance policy taken out by ICE as an additional layer of
defense, to complement its ``Skin-in-the-Game.''
\10\ https://www.risk.net/regulation/7955130/boe-official-signals-
tough-stance-on-ccp-skin-in-the-game.
\11\ Last year, European authorities took steps to require European
CCPs to hold an additional amount of pre-funded dedicated own resources
and noted ``This additional layer of capital, or `second skin-in-the
game', exposes the CCP's capital before relying on further
contributions from clearing members and is meant as an incentive for
proper risk management.'' https://www.esma.europa.eu/sites/default/
files/library/esma91-372-1706_fr_rts_ssitg_art_915.pdf.
---------------------------------------------------------------------------
Bank Capital
Capital levels for banks have significantly increased since the
financial crisis due to the adoption of Dodd-Frank, Basel III and other
reforms. These reforms have made the banking system more resilient to
volatility and extreme shocks.
The U.S. banking agencies are in the process of developing a
proposal to revise the capital regime for banks that has the potential
to further increase the cost of capital.
It will be important that the forthcoming proposal be calibrated
correctly so that it does not increase the cost for banks to provide
commodity derivatives to end-users to meet their hedging needs.
Diversity & Inclusion
As the first female Chair of the Board in FIA's 68 year history, I
can attest that we are making progress in enhancing diversity in our
industry. There are many signs that the face of our industry is
changing. We don't have to look any further than the CFTC and the
historic confirmation of four female Commissioners last year. I do
think there's a lot more we need to do, and I have some practical ideas
drawn from my own career that I would be very happy to discuss further
with any Members or staff on the Committee.
Conclusion
FIA greatly appreciates the Committee's interest in these topics
that affect global derivatives markets and the end-users who rely on
derivatives products to hedge their risks.
It is an honor to be with you today and to work with this Committee
as you consider these important issues.
The Chairman. Ms. Crighton, thank you, and thanks so much
for your testimony.
I am now pleased to recognize Mr. Edmonds. Please begin
when you are ready.
STATEMENT OF CHRISTOPHER S. EDMONDS, CHIEF
DEVELOPMENT OFFICER, INTERCONTINENTAL EXCHANGE, INC., ATLANTA,
GA
Mr. Edmonds. Chairman Thompson, Ranking Member Scott,
Members of the Committee, I am Chris Edmonds, Chief Development
Officer for Intercontinental Exchange, or ICE. I appreciate the
opportunity to be here before you today as this Committee looks
at the global commodity market volatility and the impacts on
central clearing and margin.
Clearinghouses play a critical role in the financial
markets that serves the needs of participants around the globe.
Policymakers across the world, including this Committee, have
an interest in safe and efficient markets, and commercial
market participants rely on ICE's exchanges and clearing
services to assess price risk, find market opportunities, and
transact with confidence.
ICE has a successful and innovative history of clearing
exchange-traded and OTC derivatives across a spectrum of asset
classes, including energy, agriculture, and financial products.
Today, ICE owns and operates six geographically diverse
clearinghouses that serve markets and customers across North
America, Europe, and Asia.
The risk-reducing benefits of central clearing have long
been recognized by users of exchange-traded derivatives, you
know as futures, and the performance of the clearing model
throughout the even most challenging financial situations made
it the foundation of financial reforms. As part of the
increased use of clearing, clearinghouses and market
participants have worked to make the clearing process robust
and resilient, supported by suitable financial risk management
and operational resources.
The combination of market events in 2022 have been unique.
The uneven and unpredictable reopening of global economies
following the COVID-19 pandemic, the Russian invasion of
Ukraine significantly reconfigured global energy supply, rising
inflation, and subsequent central bank tightening of monetary
policy, and increasing political and investor pressure around
energy markets, energy security, affordability, and
sustainability. These events have impacted the financial and
commodity markets and have combined to create significant
uncertainty, high levels of volatility, and high energy prices
at a time where the cost of capital has also increased. Despite
the challenges related to these events, derivative markets have
again proven to be resilient, liquid, and well-functioning and
continue to provide transparent price discovery.
As a result of market events, volatility increased and
market participants faced increased liquidity demands,
including risk-based initial and variation margin calls. Market
participants made these margin calls--or paid their bill--or
received margin payments--or were paid what they were owed. The
fact these parties paid their margin calls is further evidence
the markets operated as expected and market participants
confidently relied on ICE's markets to manage the risk.
ICE recognizes the volatile situation occurring in the
energy markets and its subsequent impact on consumers. We also
acknowledge the responsibility governments have to combat
inflationary natural gas prices and supply concerns for their
citizens. ICE, however, does not support the recent imposition
of a market correction mechanism in the European Union and
believes it will fail to achieve its primary objective of
lowering energy prices and could distort the trading of EU
natural gas derivatives. The market correction mechanism
incentivizes market participants to use less transparent over-
the-counter hedging tools or refrain from hedging, which could
have a detrimental impact on liquidity and market confidence,
resulting in long-term damage to the functioning and
competitiveness of the global natural gas market.
Clearinghouses collect and manage billions of dollars in
customer funds pledged as collateral against derivative
positions, including margin posted by commercial hedgers and
farmers. The amount of collateral posted to clearinghouses has
substantially increased due to the recent market volatility.
Accordingly, expanding clearinghouse access to central bank
deposit accounts for client margin is an important systemic
risk mitigation tool and a means to protect client funds held
by clearinghouses and ensure liquidity of these funds during
stressed market conditions.
For this reason, ICE, along with other non-systemically
designated central counterparties, support legislation
providing central counterparties registered with the CFTC and
the SEC access to deposit accounts offered by the Federal
Reserve, as it is the safest and most liquid place to hold U.S.
dollar client funds and ask this Committee to assist in
advancing such legislation as you have in the past.
We look forward to continuing to work closely with
governments and regulators at home and abroad to address
evolving challenges and to expand the use of demonstrably
beneficial clearing services, underpinning the best and safest
marketplace as possible.
Mr. Chairman, Members of the Committee, thank you for the
opportunity to share our views. I would be happy to answer any
questions you and the Members may have.
[The prepared statement of Mr. Edmonds follows:]
Prepared Statement of Christopher S. Edmonds, Chief Development
Officer, Intercontinental Exchange, Inc., Atlanta, GA
Introduction
Chairman Thompson, Ranking Member Scott, I am Chris Edmonds, Chief
Development Officer for Intercontinental Exchange, or ICE. I appreciate
the opportunity to appear before you today, as this Committee looks at
the global commodity market volatility and the impacts on central
clearing and margin.
Clearing houses play a critical role in the financial markets that
serve the needs of participants around the globe. Policy makers across
the world, including this Committee, have an interest in safe and
efficient markets. To further the common interest of well-functioning
markets and well-regulated clearing houses, we appreciate the
opportunity to participate in this hearing.
Background
Since launching an electronic over-the-counter (OTC) energy
marketplace in 2000 in Atlanta, Georgia, ICE has expanded both in the
U.S. and internationally. Over the past seventeen years, we have
acquired or founded derivatives exchanges and clearing houses in the
U.S., Europe, Singapore and Canada. In 2013, ICE acquired the New York
Stock Exchange, which added equity and equity options exchanges to our
business.
ICE has a successful and innovative history of clearing exchange-
traded and OTC derivatives across a spectrum of asset classes,
including energy, agriculture and financial products. Today, ICE owns
and operates six geographically diverse clearing houses that serve
markets and customers across North America, Europe and Asia. Each of
these clearing houses is subject to direct oversight by local national
regulators, often in close coordination and communication with other
regulatory authorities with important interests, and subject to
regulations reflective of the G20 reforms and IOSCO principles.
ICE acquired its first clearing house, ICE Clear U.S., as a
part of the 2007 purchase of the New York Board of Trade. ICE
Clear U.S. clears a variety of agricultural and financial
derivatives and is primarily regulated by the Commodity Futures
Trading Commission (CFTC) and is recognized by the European
Securities and Markets Authority (ESMA).
In 2008, ICE launched ICE Clear Europe, the first new
clearing house in the UK in over a century. ICE Clear Europe
clears derivatives in several asset classes, including energy,
interest rates, equity and credit derivatives, and is primarily
supervised by the Bank of England, in close cooperation with
the CFTC, the Securities and Exchange Commission (SEC) and
ESMA.
ICE Clear Credit was established as a trust company in 2009
under the supervision of the Federal Reserve Board and the New
York State Banking Department and converted to a derivatives
clearing organization (DCO) following implementation of the
Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act). ICE Clear Credit clears a global set of
credit default swaps on indices, single names and sovereigns,
and is primarily regulated by the CFTC and SEC and is also
recognized by ESMA. ICE Clear Credit has been designated as
``systemically important'' by the Financial Stability Oversight
Council (FSOC).
In 2017, ICE acquired ICE NGX. ICE NGX operates a non-
intermediated model for clearing of North American energy
products and is regulated by the Alberta Securities Commission
and the CFTC.
ICE also operates ICE Clear Netherlands under the regulatory
supervision of De Nederlandsche Bank, Autoriteit Financiele
Markten and ESMA, and ICE Clear Singapore which is overseen by
the Monetary Authority of Singapore.
Clearing Houses Vital Role in the Derivatives Market
Clearing has consistently proven to be a fundamentally safe and
sound process for managing systemic risk. The risk-reducing benefits of
central clearing have long been recognized by users of exchange-traded
derivatives (futures), and the performance of the clearing model
throughout even the most challenging financial situations made it the
foundation of financial reforms. Observers frequently point to non-
cleared derivative contracts as a significant factor in the broad reach
and complexity of the 2008 financial crisis, while noting the relative
stability of cleared markets.
The disciplined and transparent risk management practices of
regulated clearing houses serve to reduce systemic risk. A clearing
house, by acting as a central counterparty, to clearing members'
transactions, eliminates the bilateral counterparty credit risk and
imposes on clearing members a transparent set of rules and prudent risk
management practices, such as margin requirements, to minimize risks
managed by the clearing house. Clearing house risk management practices
have been repeatedly tested and proven in resolving defaults including
large bankruptcy proceedings, such as Lehman Brothers and MF Global,
and during extreme market events such as the COVID-19 pandemic and the
Russian invasion of Ukraine.
As part of the increased use of clearing, clearing houses and
market participants have worked to make the clearing process robust and
resilient, supported by suitable financial, risk management, and
operational resources. The Principles for Market Infrastructure (PFMI)
represent the internationally agreed-to framework for achieving these
goals and are designed to ensure that fundamental protections apply
internationally. National regulators in G20 jurisdictions have reduced
the risk of regulatory arbitrage by implementing the key aspects of the
PFMIs into their regulatory frameworks. This process has set an
appropriate standard across numerous jurisdictions for the regulation
of a clearing house.
The Purpose of Liquid Markets
This past year is a reminder that well-hedged utility and energy
firms serve a wider public good by increasing resilience of the energy
supply chain and serving the interests of many stakeholders. In periods
of heightened uncertainty and volatility, risk transfer mechanisms are
most needed as the risks in the underlying commodity markets are most
acute. The primary objective of market operators and policymakers
should be to keep markets open and available to all market
participants, especially during times of increased stress.
Commercial market participants rely on ICE's exchanges and clearing
services to assess price risks, find market opportunities and transact
with confidence. Futures markets allow market participants to manage
their risk of adverse price moves by securing the price for future
consumption or delivery of a commodity. By managing price risk, market
participants can make business decisions with more confidence, creating
an environment that is conducive to infrastructure investments that
reinforce the security of supply or that facilitate the energy
transition. ICE is proud to operate the liquid markets that contribute
to energy security, which in turn promotes national security and allows
policy makers to make informed decisions.
In addition, futures markets provide commercial market participants
with tools for effective hedging and price certainty, which reduces the
cost of capital and, in turn, reduces costs to consumers. ICE's global
exchanges offer commodity derivative contracts such as power, gas and
oil which enable commercial market participants including utility and
energy firms to optimize cash flows associated with underlying physical
deals through buying and selling futures and options.
Market Performance and Central Clearing
The combination of market events in 2022 has been unique--the
uneven and unpredictable reopening of global economies following the
COVID-19 pandemic, the Russian invasion of Ukraine significantly
reconfiguring global energy supply, rising inflation and subsequent
central banks tightening of monetary policy and increasing political
and investor pressure around energy markets and energy security,
affordability and sustainability. These events have impacted the
financial and commodity markets and have combined to create significant
uncertainty, high levels of volatility and high energy prices at a time
where the cost of capital has also increased.
Despite the challenges related to these events, derivative markets
have again proven to be resilient, liquid and well-functioning and
continue to facilitate price discovery through liquid and fair markets.
As a result of market events, volatility increased and market
participants faced liquidity demand increases including initial and
variation margin calls. Margin levels were near record highs, as
clearing houses' margin requirements responded as designed to protect
against rapidly shifting prices. Clearing house margin requirements are
risk-based and respond on a dynamic basis to changing market
conditions. These margin models are designed by risk experts, vetted
with clearing members, approved by regulators, and regularly back-
tested in compliance with international standards and regulatory
requirements.
Market participants made variation margin calls (paid their bill)
or received variation margin payments (were paid what they were owed).
The fact that these parties paid their margin calls is further evidence
that the markets operated as expected and that market participants
confidently relied on ICE's markets to manage their risks. Global
regulators and market operators have also observed and acknowledged
that the derivative markets operated efficiently and effectively as
intended.\1\
---------------------------------------------------------------------------
\1\ Please refer to the testimony of Chairman Benham at the 2022
U.S. Treasury Market Conference where he discussed the resiliency and
well-functioning of markets during recent market volatility. https://
www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam27.
---------------------------------------------------------------------------
European Price Caps
ICE recognizes the volatile situation occurring in energy markets
and its subsequent impact on consumers. We also acknowledge the merits
of governments exploring solutions to address high natural gas prices
and supply concerns. ICE however does not support the recent imposition
of a market correction mechanism in the European Union (``EU'') and
believes it will not achieve its primary objective of lowering energy
prices and could distort the trading of EU natural gas derivatives.
The implementation of the market correction mechanism undermines
the ability of the market to perform vital risk transfer mechanisms
resulting in commercial market participants being unable to manage
their risk. Gas derivatives, such as the ICE TTF futures contract, are
a crucial tool for producers and consumers to hedge against the risk of
changes in future gas spot prices. If a change to future supply or
demand occurs, market participants need the ability to react to these
changes in order to remain properly hedged. Imposing a price limit on
exchange-traded products subjects market participants to greater risk
exposure and uncertainty. The market correction mechanism incentivizes
market participants to use less transparent over-the-counter hedging
tools or refrain from hedging, which could have a detrimental impact on
liquidity and market confidence and result in long-term damage to the
functioning and competitiveness of the European gas market.
Furthermore, a critical feature of central clearing is the ability
to manage the default of market participants and to prevent systemic
risk by unwinding the positions of a defaulting clearing member and
returning the market to a balanced book. The introduction of a price
cap on a contract prevents the clearing house from performing this
function, increasing risks to the clearing house and systemic risks to
the broader market. A price cap undermines financial stability with no
remedy. It is critical that the U.S. not jeopardize robust and well-
functioning markets through government intervention.
Central Counterparties Access to Central Bank Accounts
Clearing houses collect and manage billions of dollars in customer
funds pledged as collateral against derivatives positions including
margin posted by commercial hedgers and farmers. The amount of
collateral posted to clearing houses has substantially increased due to
recent market volatility. Accordingly, expanding clearing house access
to central bank deposit accounts for client margin is an important
systemic risk mitigation tool and a means to protect client funds held
by clearing houses and ensure liquidity of these funds during stressed
market conditions.
Clearing houses without access to central bank deposit accounts
rely on alternatives for cash management of client funds, such as money
market funds, repurchase agreements, and deposits at commercial banks.
Jurisdictions including the United Kingdom and EU allow clearing houses
access to central bank deposit accounts under certain circumstances. In
the U.S., under Title VIII of the Dodd-Frank Act, the Federal Reserve
was authorized to provide deposit account access only to financial
market utilities deemed systemically important by the FSOC. During
times of stress and increased market volatility, access to a Federal
Reserve deposit account for all clearing houses will improve liquidity
across the cleared derivatives ecosystem and reduce the systemic risk
created by the interconnectedness of clearing houses and banks. It will
also protect customers and end-users using the derivatives markets to
hedge risk.
ICE supports legislation providing all central counterparties
registered with the CFTC and SEC access to deposit accounts offered by
the Federal Reserve as it is the safest and most liquid place to hold
U.S. dollar client funds and asks the Committee to assist in advancing
such legislation.
Conclusion
ICE has always been, and remains, a strong proponent of open and
competitive markets with appropriate regulatory oversight. As an
operator of global futures and derivatives markets, ICE understands the
importance of confidence in its markets, and we take seriously our
obligations to mitigate systemic risk. ICE has observed its markets
operating efficiently and effectively especially in times of market
stress. To that end, we have worked closely with regulatory authorities
in the U.S. and abroad to ensure they have access to all relevant
information available to ICE regarding trade execution and clearing
activity on our markets. We look forward to continuing to work closely
with governments and regulators at home and abroad to address evolving
challenges and to expand the use of demonstrably beneficial clearing
services that underpin the best and safest marketplaces possible.
Mr. Chairman, thank you for the opportunity to share our views with
you. I would be happy to answer any questions you and Members of the
Committee may have.
The Chairman. Mr. Edmonds, thank you so much for your
testimony, much appreciated.
And now I am pleased to recognize the former Commissioner,
Mr. Berkovitz. Please begin when you are ready.
STATEMENT OF HON. DAN M. BERKOVITZ, FORMER
COMMISSIONER, COMMODITY FUTURES TRADING
COMMISSION, BETHESDA, MD
Mr. Berkovitz. Chairman Thompson, Ranking Member Scott, and
Members of the Committee, thank you for the invitation to
appear before you today. I offer you my perspective on the
recent volatility in the commodity derivative markets after
having spent the past 20+ years in various regulatory,
oversight, and private-sector capacities related to these
markets. My appearance before you today is in my own personal
capacity. I am not representing or speaking on behalf of any
other person, governmental agency, or private-sector entity.
I am particularly pleased to be appearing again before this
Committee. The Agriculture Committee's oversight of, guidance
to, and support for the Commodity Futures Trading Commission
has been critical to the CFTC's ability to fulfill its mission
to ensure that commodity derivative markets operate in a fair
and secure manner to discover prices and manage commodity price
risks.
Commodity markets and the associated commodity derivative
markets have experienced extraordinary volatility in recent
years. Increasing demands for commodities as the U.S. and other
economies recover from the shutdowns caused by the COVID-19
pandemic, the Russian invasion of Ukraine, monetary tightening
by central banks, China COVID policies, and extreme weather all
have contributed to this volatility. This price volatility has
caused financial hardships across many sectors of the economy,
including the agricultural sector, as well as for the American
families and households who will ultimately pay the bill for
higher commodity prices.
In addition to the carefully constructed derivatives
contracts that are traded on commodity derivatives exchanges,
these exchanges have a variety of tools to help ensure market
prices and volatility reflect the true forces of supply and
demand and that market activity does not present systemic
risks. Margin levels, speculative position limits, daily price
limits, and trading halts can help ensure that prices are not
caused by artificial means such as manipulation, fraud, or
other disruptive trading practices, that market participants
have a sufficient opportunity to respond to changing market
conditions, and that counterparties will not default.
None of these tools, however, can insulate market
participants from price changes due to the basic forces of
supply and demand, and each must be carefully calibrated so
that they accomplish their intended purpose of limiting
excessive speculation, ensuring orderly trading, and avoiding
systemic risks, while also not unnecessarily impairing the
basic price discovery or risk management functions of the
markets, as prices change rapidly to reflect changes in supply
and demand.
The mission of the CFTC is to ensure the integrity of the
commodity derivative markets, prevent manipulation, avoid
systemic risks, protect market participants from fraud and
other abuses, and promote innovation and fair competition among
market participants and markets. CFTC regulations established
the basic requirements for margin position limits and orderly
trading.
The CFTC conducts market surveillance to ensure that
trading is fair, orderly, and not subject to manipulation or
other artificial disruptions and brings enforcement actions for
violations of its regulations in the Commodity Exchange Act.
The CFTC must vigorously pursue its surveillance and
enforcement responsibilities to ensure the integrity of these
markets and maintain public confidence in the markets it
regulates.
Generally, the types of risks affecting commodity prices in
recent years are not unique. Political disputes, general
economic fluctuations, disease, war, transportation
disruptions, and extreme weather have affected commodity
markets and indeed mankind throughout history. However, severe
weather events are increasing in unprecedented intensity and
frequency. There is substantial evidence that climate-related
risks now pose a recurring existential threat to many
households, businesses, and communities and threaten the
stability of financial markets.
It is prudent, therefore, that we improve our tools to
manage such risks in the commodity derivative markets. This
work includes the development and use of new risk management
products and markets, increased disclosures regarding climate-
related risks, and vigorous oversight of these products and
markets by the CFTC to ensure the integrity of new markets and
products. The CFTC has begun this important work with the
assistance of public input, and I look forward to the progress
of the agency and market participants in this area.
Thank you again, Mr. Chairman, and Ranking Member, and I
look forward to any questions you might have.
[The prepared statement of Mr. Berkovitz follows:]
Prepared Statement of Hon. Dan M. Berkovitz, Former Commissioner,
Commodity Futures Trading Commission, Bethesda, MD
Chairman Thompson, Ranking Member Scott, and Members of the
Committee, thank you for the invitation to appear before you today to
discuss managing the risks arising from the recent volatility in the
global commodity derivatives markets. I offer you my perspective on the
current market volatility after having spent the past twenty-plus years
in various regulatory, oversight, and private sector advisory
capacities related to the commodity derivative markets. My appearance
before you today is in my own personal capacity; I am not representing
or speaking on behalf of any other person, governmental agency or
private sector entity.
I am particularly pleased to be appearing again before this
Committee. The Agriculture Committee's oversight of, guidance to, and
support for the Commodity Futures Trading Commission (CFTC) has been
critical to the CFTC's ability to fulfill its mission to ensure the
commodity derivative markets operate in a fair and secure manner to
discover prices and manage commodity price risks. This Committee's
jurisdiction over these markets is not only a reminder of the
historical origins of the futures markets in the agricultural markets
of the 19th and early 20th centuries, but also reflects and emphasizes
the continued importance of those agricultural derivative markets--and
the people who produce the commodities underlying these markets--to our
national well-being and economy.
In my testimony today I will discuss the factors contributing to
the recent spike in volatility in the commodity markets, describe the
regulatory and market-based tools for managing volatility and price
risks in the derivative markets, and offer some suggestions on how some
of those market-based tools could be improved.
Summary
Commodity markets and the associated commodity derivative markets
have experienced extraordinary price volatility in recent years. In the
past year, factors contributing to this price volatility have included
increasing demands for commodities as the U.S. and other economies
recover from the shutdowns caused by the [COVID]-19 pandemic, the
Russian invasion of Ukraine, monetary tightening by central banks,
China [COVID] policies, and extreme weather. This price volatility has
caused financial hardships across many sectors of the economy,
including the agricultural sector, as well as for the American families
and households who ultimately pay the bill for higher commodity prices.
In addition to the derivatives contracts themselves that are traded
on commodity derivative exchanges, these exchanges have a variety of
tools to help ensure market prices and volatility reflect the true
forces of supply and demand. Margin levels, speculative position
limits, daily price limits and trading halts can help ensure that
prices are not caused by artificial means, such as manipulation, fraud,
disruptive trading practices, and that market participants have a
sufficient opportunity to respond to changing market conditions. None
of these tools, however, can insulate market participants from price
changes due to the basic forces of supply and demand, and each must be
carefully calibrated so that they accomplish their intended purpose of
limiting excessive speculation, ensuring orderly trading, and avoiding
systemic risks, while also not unnecessarily impairing the basic price
discovery or risk management functions of the markets.
The mission of the CFTC is to ensure the integrity of the commodity
derivative markets, prevent manipulation, avoid systemic risks, protect
market participants from fraud and other abuses, and promote innovation
and fair competition among market participants and markets. CFTC
regulations establish the basic requirements for margin, position
limits, and orderly trading. The CFTC also is responsible for
conducting market surveillance to ensure that trading is fair, orderly,
and not subject to manipulation or other artificial disruptions, and
for bringing enforcement actions for violations of its regulations and
the Commodity Exchange Act (CEA).
Generally, the types of risks affecting commodity prices in recent
years are not unique. Political disputes, general economic
fluctuations, war, transportation disruptions, and extreme weather have
affected commodity markets throughout history. However, severe weather
events are increasing in unprecedented intensity and frequency. There
is substantial evidence that climate-related risks now pose a recurring
existential threat to many households, businesses, and communities, and
threaten the stability of financial markets. It is prudent, therefore,
that we improve our tools to manage such risks in the commodity
derivative markets. This work includes the development and use of new
risk-management products and markets, increased disclosures regarding
climate-related risks, and vigorous oversight of these products and
markets by the CFTC to ensure the integrity of new markets and
products. The CFTC has begun this important work with the assistance of
public input, and I look forward to the progress of the agency and
market participants in this area.
Recent Commodity Market Volatility
Several factors have contributed to commodity market volatility in
2022 and continuing into 2023. These include:
Post-pandemic economic recovery. As consumer spending increased and
the U.S. and other economies recovered from the shutdowns caused by the
[COVID]-19 pandemic, supply-chain bottlenecks contributed to supply
shortages, increased storage and transportation costs, increased
counterparty risks, and therefore, ultimately, increases in prices.\1\
---------------------------------------------------------------------------
\1\ See, e.g., Oya Celasun, Niels-Jakob Hansen, Aiko Mineshima,
Mariano Spector, and Jing Zhou, International Monetary Fund, Supply
Bottlenecks: Where, Why, How Much, and What Next?, Working Paper, Feb.
2022, available at: https://www.imf.org/-/media/Files/Publications/WP/
2022/English/wpiea2022031-print-pdf.ashx.
---------------------------------------------------------------------------
Russian invasion of Ukraine. The Russian invasion of Ukraine in
late February 2022 and the resulting U.S. and European Union economic
sanctions led to significant increases in prices and volatility in a
variety of key commodities, including oil, wheat, and corn. As the
notional value of these commodities increased, due both to inflation
and the Russian invasion, margin levels increased as well.\2\
---------------------------------------------------------------------------
\2\ CME, Commodity Market Performance, Presentation to the CFTC
Global Markets Advisory Committee, Feb. 13, 2023, available at: https:/
/www.cftc.gov/PressRoom/Events/opaeventgmac021323.
---------------------------------------------------------------------------
Monetary tightening. Beginning in March 2022, the Federal Reserve
began to raise short-term interest rates by increasing its Federal
funds target interest rate. Overall, in the past year the Federal
Reserve has increased short-term interest rates by 4.25%. One effect of
the increase in these rates has been the strengthening of the dollar
against other major currencies. Over the long term the increased rates
and the resulting increase in the cost of credit are anticipated to
reduce investment and consumption, thereby lowering inflation and
prices.\3\
---------------------------------------------------------------------------
\3\ See, e.g., Juan M. Sanchez and Olivia Wilkinson, Federal
Reserve Bank of St. Louis, Tightening Monetary Policy and Patterns of
Consumption, Feb. 9, 2023, available at: https://www.stlouisfed.org/
publications/regional-economist/2023/feb/tightening-monetary-policy-
patterns-consumption.
---------------------------------------------------------------------------
China [COVID] policies. The reopening of the Chinese economy after
several years of [COVID]-related restrictions has contributed to
commodity price volatility. As the world's second-largest economy, and
largest consumer of a variety of commodities, including soybeans and
copper, changes in China's demand for industrial, energy, and
agricultural commodities can significantly affect global supply chains
and prices.\4\
---------------------------------------------------------------------------
\4\ See, e.g., Ann Cooban, CNN, China's reopening isn't all good
news. Inflation could get a second wind, Jan. 27, 2023 (``The revival
of the world's second largest economy--and its biggest consumer of
commodities--threatens to push up global prices for fuel, industrial
metals and food this year.''), available at: https://www.cnn.com/2023/
01/27/business/china-commodities-energy-inflation/index.html; Carl
Surran, Seeking Alpha, Commodities surge as China cools COVID
restrictions, Nov. 11, 2022 (``Commodity prices are popping Friday
after China took significant steps to ease COVID-19 lockdowns and
optimism from lighter-than-expected U.S. inflation data that sparked
yesterday's huge stock market rally and sent the dollar sharply lower
overnight.'', available at: https://seekingalpha.com/news/3906371-
commodities-surge-as-china-cools-covid-restrictions.
---------------------------------------------------------------------------
Severe weather. As the National Oceanic and Atmospheric
Administration (NOAA) reports, ``[r]ecord drought gripped much of the
U.S. in 2022,'' ``the nation [was] struck with $18 billion disasters,''
and ``[t]he year was also marked by numerous severe weather events,
devastating hurricanes and deadly flooding across parts of the
country.'' \5\ The extreme drought conditions in the west, high plains,
and several southern states led to the smallest hard red winter wheat
crop since 1963, lowest corn yields since possibly 2012, and the
smallest U.S. cotton crop in 12 years.\6\ The drought led to
historically low levels of the Mississippi River, disrupting barge
traffic and increasing transportation and storage costs for
agricultural commodities normally transported downriver. Flows along
the Colorado River in the western U.S., as well as water levels at the
Glen Canyon and Hoover dams also have been significantly reduced,
[threatening] the supply of water and power for communities,
industries, and ranching and farming in the Colorado River basin.
---------------------------------------------------------------------------
\5\ NOAA, Record drought tripped much of the U.S. in 2022, Jan. 10,
2023, available at: https://www.noaa.gov/news/record-drought-gripped-
much-of-us-in-2022. According to NOAA, Hurricane Ian was the single
most costly event of 2022, with a cost of $113 billion. Severe weather
events have been recurring in recent years. Over the past 7 years,
``122 separate billion-dollar disasters have killed at least 5,000
people, with a total cost of more than $1 trillion in damages.'' Id.
\6\ Source: CFTC.
---------------------------------------------------------------------------
Severe weather struck globally in 2022. Extreme heat, drought, and
wildfires plagued Europe, reducing electricity generation and affecting
agricultural production, leading to increased imports of corn.\7\
``Relentless drought'' in Brazil is expected to limit soybean
production; in previous years the drought also affected coffee and
orange juice supplies.\8\ Devastating floods in Pakistan that submerged
\1/3\ of the country, killed thousands of people and displaced
millions, damaged or destroyed over 8 million acres of agricultural
lands, affecting cotton, rice, and wheat production and exports.\9\ A
record heatwave in India ``is threatening to damage grains and dent the
country's wheat production for the second straight year.'' \10\ China
experienced a record heat wave.
---------------------------------------------------------------------------
\7\ World Meteorological Organization, Climate and weather extremes
in 2022 show need for more action, Dec. 23, 2022, available at: https:/
/public.wmo.int/en/media/news/climate-and-weather-extremes-2022-show-
need-more-action; Marianne Lehnis, 2022 Was A Year Of Record-Breaking
Extreme Weather Events, Forbes, Dec. 29, 2022, available at: https://
www.forbes.com/sites/mariannelehnis/2022/12/29/2022-was-a-year-of-
record-breaking-extreme-weather-events/?sh=66128a65736b.
\8\ Nayara Figueiredo, Reuters, Brazil drought threatening national
output potential, southern farmers say, Feb. 14, 2023; available at:
https://www.reuters.com/world/americas/brazil-drought-threatening-
national-output-potential-southern-farmers-say-2023-02-14/; CFTC.
\9\ jaz Nabi, Brookings, Responding to Pakistan floods, Feb. 10,
2023, available at: https://www.brookings.edu/blog/future-development/
2023/02/10/pakistan-floods/; CFTC.
\10\ Rajendra Jahav, India's wheat output dented by heatwave, could
limit government stock building, Reuters, March 3, 2023, available at:
https://www.reuters.com/world/india/indias-wheat-output-dented-by-
heatwave-could-limit-government-stock-building-2023-03-03/.
---------------------------------------------------------------------------
Risk Management in Derivative Markets
Commodity derivative markets enable market participants--such as
farmers, ranchers, producers, manufacturers, processors, marketers, and
consumers--to discover prices and manage commodity price risks. For
example, by selling contracts for future delivery on a futures exchange
(a ``designated contract market'' or ``DCM'') a farmer can, in effect,
lock in a sales price for a commodity such as wheat to be delivered at
a future time, thereby hedging against price changes (decreases or
increases) between the time of sale and the time of actual delivery of
the commodity. Similarly, a buyer of a futures contract on the
exchange, such as a food processor, can lock in a purchase price for
wheat to be delivered at a specific time in the future, thereby hedging
against any price increases (or decreases) between the time of the
purchase of the futures contract and the delivery of the wheat. Because
in a commodity market there often is not an exact balance between
purchasers and sellers, speculators play an important role in providing
liquidity and assuming price risks that physical market participants
may be unwilling or unable to assume.
Indeed, futures markets in the United States developed in the mid-
18th century--including the use of standardized contracts for future
delivery, the development of quality standards and inspections, and the
establishment of the Chicago Board of Trade--in order to enable buyers
and sellers of agricultural commodities to manage the very same type of
price risks prevalent in today's markets. For example, just as these
new types of contracts were being developed to manage prices risks from
storage and transportation, the Civil War broke out, leading to
substantial volatility, price increases, and trading, including
speculative trading, for key agricultural commodities, particularly
oats (which the Union army needed to feed its horses), corn, and
wheat.\11\ By 1875, ``trading rules were fairly complete, there was a
substantial volume of trading, and merchants used futures to hedge
inventories to earn carrying charges . . . .'' \12\
---------------------------------------------------------------------------
\11\ William G. Ferris, The Grain Traders, The Story of the Chicago
Board of Trade (Michigan State University Press, 1988), at pp. 21-26.
See also, G. Wright Hoffman, Future Trading Upon Organized Commodity
Markets in the United States (University of Pennsylvania Press, 1932).
\12\ Thomas A. Hieronymus, Economics of Futures Trading For
Commercial and Personal Profit (Commodity Research Bureau, 1971), at p.
74.
---------------------------------------------------------------------------
One of the leading authorities on the futures markets described the
beginnings of the futures markets as follows:
[F]utures trading evolved out of risk financing, inventory,
and pricing problems of handlers and processors of cash
commodities . . . . The first fifty years of the history of
futures trading in the U.S. is the history of feverish
speculative activity, of contests among giants, and of attempts
to manipulate prices. These contests resulted in the evolution
of a set of competitive rules.\13\
---------------------------------------------------------------------------
\13\ Id. at pp. 81-2.
Congress has recognized the price discovery and risk management
purposes of the commodity derivative markets, and it has charged the
CFTC with the regulation and oversight of those markets. Section 3(a)
of the Commodity Exchange Act (CEA) declares: ``The transactions
subject to this Act are entered into regularly in interstate and
international commerce and are affected with a national public interest
by providing a means for managing and assuming price risks, discovering
prices, or disseminating pricing information through trading in liquid,
fair and financially secure trading facilities.'' \14\ Section 3(b)
states that the purpose of the CEA is to serve this national interest
``through a system of effective self-regulation of trading facilities,
clearing systems, market participants and market professionals under
the oversight of the [CFTC].'' Section 3(b) states the further purpose
of the CEA ``to deter and prevent price manipulation or any other
disruptions to market integrity,'' to ``ensure the financial integrity
of transactions . . . and avoidance of systemic risk,'' to protect
market participants from fraud and abusive practices, and to ``promote
responsible innovation and fair competition amongst boards of trade,
other markets, and market participants.'' \15\
---------------------------------------------------------------------------
\14\ 7 U.S.C. Sec. 5(a).
\15\ 7 U.S.C. Sec. 5(b).
---------------------------------------------------------------------------
The CFTC and the designated contract markets (i.e., exchanges
licensed to trade contracts for future delivery, referred to
hereinafter as ``exchanges'') have established a number of requirements
for and parameters around the trading of futures contracts to ensure
the futures markets continue to perform their intended function of
facilitating price discovery and risk management.\16\ These include
margin requirements, speculative position limits, price limits and
``circuit breakers'' or trading halts. Both the CFTC and the exchanges
also conduct market surveillance, potentially followed-up with
enforcement activity or, in the case of the exchanges, disciplinary
action, to detect, deter, and prevent fraud, manipulation, and other
disruptive trading activity.
---------------------------------------------------------------------------
\16\ Similar requirements and parameters apply in the swaps
markets; for ease of reference, I only refer to the futures markets
here.
---------------------------------------------------------------------------
Margin requirements. The purpose of margin requirements in the
commodity derivative markets is to help ensure that a market
participant with a long position (i.e., buyer of a contract for future
delivery) or short position (i.e., seller of a contract for future
delivery) in a commodity has posted sufficient funds to the
clearinghouse so that the participant will not default upon an adverse
price movement. CFTC regulations establish minimum margin requirements
for futures contracts traded on an exchange; the clearinghouses have
flexibility to adopt higher margin requirements, but they cannot
establish lower margin requirements.
Futures commission merchants (``FCMs'') are critically important
intermediaries that execute trades on an exchange on behalf of their
customers, post the requisite amount of margin to the clearinghouse,
and collect the margin for those trades from their customers. FCMs also
guarantee the performance of their customers to the clearinghouse,
providing another level of protection to exchange participants if a
participant defaults. FCMs also may be called upon to contribute funds
in the event of a default of another FCM. FCMs also perform a variety
of other critical functions to and for market participants. They
provide information, analyses, and advice to their customers, safeguard
customer funds, and they are responsible for ``know-your-customer''
requirements and preventing money-laundering.
In times of significant increases in prices and volatility, margin
levels generally will increase. Increases in margin requirements as
prices are increasing can place significant financial burdens on market
participants at a time when they can least afford it, as well as
potentially create systemic risks as many market participants may be
seeking additional funding for margin requirements at the same time.
Increases in margin levels also can place stresses on FCMs, who must
carry larger amounts of funding and capital to temporarily cover the
increases in margin requirements for their customers.
One way to potentially avoid sharp increases in margin requirements
would be to raise margin requirements generally, so that the increases
would not be so sharp when prices and volatility increase. However,
this would raise costs generally for end-users in the futures markets,
as well as increase costs for many of the FCMs that serve these end-
users, at a time when these end-users and intermediaries already are
under financial stresses. Margin levels therefore require careful
calibration to ensuring that margin requirements continue to mitigate
counterparty risk, help prevent systemic risks, yet do not unduly
impair market liquidity or the availability of intermediaries to serve
end-users.
Speculative position limits. Limits on the amount of speculative
positions a person may hold or control on an exchange are intended to
ensure that prices on the exchange reflect the forces of supply and
demand rather than distortions due to excessive speculation in the
price of the commodity. Speculative position limits also help prevent
price manipulation, particularly squeezes and corners as futures
contracts near expiration. In conformance with the requirements of the
Dodd-Frank Act, in January 2021, the Commission finalized the most
recent revisions to its speculative position limit rules. As provided
by the CEA and the Dodd-Frank Act, positions that constitute bona fide
hedging are exempt from the speculative position limits. Although the
CFTC establishes the overall requirements for position limits, the
exchanges are responsible for implementing those limits.
Price limits and circuit breakers. Daily price limits (i.e., limits
on how much the price of a contract can increase or decrease in a
single day) and circuit breakers (i.e., pauses in trading for limited
periods of time following extreme price moves) serve to pause trading
during extraordinarily large price movements or periods of extreme
volatility, to help ensure the price movements accurately reflect the
forces of supply and demand rather than speculative excesses or panic
buying and selling, or ``fat-finger'' or other types of errors in trade
execution.\17\ These pauses in trading and price movements enable
exchanges and the CFTC to review such movements and respond as may be
appropriate, provide market participants with a ``cooling-off period''
to analyze the recent changes in price, adjust their positions
accordingly, and meet any additional margin requirements resulting from
such movements. As with margin levels, price limits and trading halts
must be calibrated so that such limits or halts accomplish their
purpose in a manner that does not unduly interfere with the price
discovery or risk management functions of the market.
---------------------------------------------------------------------------
\17\ See IOSCO, Principles for the Regulation and Supervision of
Commodity Derivatives Markets, Final Report (Jan. 31, 2023), at p. 51,
available at: https://www.iosco.org/library/pubdocs/pdf/IOSCOPD726.pdf.
---------------------------------------------------------------------------
Market surveillance. Both the exchanges and the CFTC have a
responsibility to conduct market surveillance to detect fraud,
manipulation, or other artificial disruptions to the legitimate forces
of supply and demand as expressed through prices on the exchange. The
CFTC's market surveillance program monitors trading activity, large
trader positions, and deliverable supplies as physical commodity
contracts near expiration to ensure the integrity of settlement prices
as contracts near expiration, the relationships between cash markets
and futures markets generally, and, working in conjunction with the
Securities and Exchange Commission, monitors the arbitrage between the
equities markets and the exchanges that trade indexes based on those
equities.\18\
---------------------------------------------------------------------------
\18\ CFTC, CFTC Market Surveillance Program, available at: https://
www.cftc.gov/IndustryOversight/MarketSurveillance/
CFTCMarketSurveillanceProgram/index.htm.
---------------------------------------------------------------------------
The CFTC's market surveillance program also is responsible for
monitoring compliance with CFTC or exchange-set position limits.
Although positions that constitute bona fide hedging are exempt from
the speculative position limits, the CFTC also monitors hedgers'
compliance with their exemption levels.\19\
---------------------------------------------------------------------------
\19\ Id.
---------------------------------------------------------------------------
During times of unusual market activity or extraordinary price
movements, the Commission may conduct detailed investigations or
examinations to traders' positions and market activity to determine
whether there has been any artificial disruption to or interference
with the normal forces of supply and demand. In addition to detecting
potential wrongdoing, these investigations and examinations may reveal
issues in contract or market design that can cause disruptions under
certain market stresses or conditions, and that can be remedied to
improve market operation. Vigorous surveillance of the derivative
markets, including detailed examination or investigation of unusual or
extreme market conditions, is necessary not just to detecting
wrongdoing and improving market design, but also to maintaining public
confidence--and thereby liquidity--in these markets.
Enforcement actions. Investigations of market disruptions and
enforcement actions for violations of the CEA and Commission
regulations is critical to preserving market integrity. Punishing
violators deters future violations and provides market participants
with confidence that the derivative markets reflect legitimate forces
of supply and demand and are not determined by manipulation, fraud, or
other disruptive activity. Traders that engage is disruptive,
fraudulent, or manipulative behavior on an exchange may also be subject
to disciplinary action by the exchange, which has the front-line
responsibility to monitor trading on the exchange to ensure it is
conducted in accordance with the rules of the exchange.
Need for Improvements in Risk Management for Climate-Related Events
Although the particular way in which the particular risks leading
to price increases and volatility over the past several years have
become manifest may have been idiosyncratic, the general nature of
these risks is new or unique. War, bad weather, disease, political
strife, and economic ups and downs have been prevalent for as long as
civilization has existed. Over the past century and a half our
derivative markets and the regulatory system overseeing those markets
have developed a variety of tools, as described above, to enable
producers, marketers and consumers of commodities to manage these
risks. Further, as described above, these tools need continuous
oversight and calibration to ensure that they continue to serve their
intended function.
Of these general risks, however, there is one significant
qualitative and quantitative difference: the severity and frequency of
weather-related disruptions has increased significantly in recent years
and is anticipated by many to continue to increase in severity and
frequency in the future. There are a number of ways existing risk
management tools potentially could be improved to enable market
participants to better to manage these increasingly severe weather or
climate-related risks. These include the development of new products
and markets to manage climate-related risks, and improved disclosures
of climate-related risk data. In light of the potential magnitude of
the threat posed by these climate-related risks to individual
businesses and overall financial stability, it is critical that work
continue towards these improvements in our risk management
capabilities.
There is substantial evidence that climate change poses significant
risks to communities across the United States, including ``growing
challenges to human health and safety, quality of life, and the rate of
economic growth.'' \20\ With respect to agriculture, in 2019 the Fourth
National Climate Assessment reported, ``Rising temperatures, extreme
heat, drought, wildfire on rangelands, and heavy downpours are expected
to increasingly disrupt agricultural productivity in the United States.
Expected increases in challenges to livestock health, declines in crop
yields and quality, and changes in extreme events in the United States
and abroad threaten rural livelihoods sustainable food security, and
price stability.'' \21\
---------------------------------------------------------------------------
\20\ U.S. Global Change Research Program, Fourth National Climate
Assessment (June 2019), at p. 25; available at: https://
nca2018.globalchange.gov/downloads/.
\21\ Id., at p. 29.
---------------------------------------------------------------------------
In September 2021, the CFTC's Market Risk Advisory Committee (MRAC)
issued a Report titled ``Managing Climate Risk in the U.S. Financial
System,'' which concluded that ``Climate change poses a major risk to
the stability of the U.S. financial system and to its ability to
sustain the American economy.'' \22\ The MRAC noted that derivative
markets ``can be part of the solution,'' and suggested new derivative
contracts could be developed to manage these new climate-related risks.
The MRAC also recommended that ``[f]inancial regulators, in
coordination with the private sector, should support the availability
of consistent, comparable, and reliable climate risk data and analysis
to advance the effective measurement and management of climate risk.''
\23\
---------------------------------------------------------------------------
\22\ Market Risk Advisory Committee, CFTC, Managing Climate Risk in
the U.S. Financial System (Sept. 2021), at p. 1; available at: https://
www.cftc.gov/sites/default/files/2020-09/9-9-
20%20Report%20of%20the%20Subcommittee%20on%20Climate-
Related%20Market%20Risk%20-
%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20fo
r%20
posting.pdf.
\23\ Id., at p. 70.
---------------------------------------------------------------------------
In October 2021, the Financial Stability Oversight Council (FSOC)
identified climate-related financial risks as an emerging threat to the
financial stability of the United States.\24\ The FSOC assessed the
actions-to-date of the council members to incorporate climate-related
financial risk into their regulatory or supervisory activities, and
recommended a variety of additional measures for the council members to
take, either individually or in coordination with other members, to
improve the identification, consideration and management of these
risks. Public disclosure of climate-related financial risks was one of
the key measures identified by the FSOC as integral to sound risk
management practices for climate-related risks. The FSOC stated:
---------------------------------------------------------------------------
\24\ FSOC, Report on Climate-Related Financial Risk (2021), at pp.
1-2; available at: https://home.treasury.gov/system/files/261/FSOC-
Climate-Report.pdf.
The resiliency of the financial system is, in part, dependent
upon the resiliency of the firms that comprise it. In general,
an individual firm is more resilient when it has sound
processes for assessing risks and applies appropriate risk
management practices. The disclosure of risks, and plans for
managing them, can help foster the resilience of the financial
system by allowing investors and market participants to factor
that risk into their decision-making. This, in turn,
facilitates better pricing of that risk information into
financial markets. This pricing of climate-related risk can
help reduce the likelihood of a financial shock associated with
a sudden repricing of assets exposed to climate-related
risks.\25\
---------------------------------------------------------------------------
\25\ Id., at p. 68. See also, The Task Force on Climate Related
Financial Disclosures, Final Report, Recommendations of the Task Force
on Climate-related Financial Disclosures (June 2017).
During my tenure as a Commissioner of the CFTC, I had the privilege
of sponsoring the Energy and Environmental Markets Advisory Committee
(EEMAC). In 2021, during my sponsorship, the EEMAC held several
meetings to explore how new derivative products and new derivative
markets can help manage climate-related financial risks. At the time, I
recommended three principal ways for the CFTC to improve the management
of climate-related risks. First, the Commission must ensure the
integrity of the markets it regulates, including any markets associated
with climate-related derivatives. Second, the CFTC should work with
exchanges and market participants in the development of new products
that will help companies manage climate-related risks. And third, the
CFTC should ``ensure appropriate management and disclosure of climate-
related risks.'' \26\
---------------------------------------------------------------------------
\26\ Opening Statement of Commissioner Dan M. Berkovitz before the
Energy and Environmental Markets Advisory Committee, June 3, 2021,
available at: https://www.cftc.gov/PressRoom/SpeechesTestimony/
berkovitzstatement060321.
---------------------------------------------------------------------------
I am pleased that the Commission is continuing to make progress in
these areas. In June 2022, the CFTC issued a Request for Information
(RFI) to better inform the agency's understanding and oversight of
climate-related financial risk related to the commodity derivatives
markets. The Commission stated the responses to the RFI will help to
inform the Commission's next steps in this area and its response to the
FSOC's recommendations. The RFI asked questions and sought information
in a variety of areas, including with respect to risk management
regulations and industry practices as they relate to climate-related
financial risks, disclosure requirements regarding climate-related
financial risks, and risk management product innovation. I understand
that the Commission staff is currently reviewing the public responses
to the RFI, and I look forward to the Commission's next steps in this
area. It is imperative for our commodity derivative markets and our
financial system in general that we continue to make progress in the
development of these mechanisms for managing climate-related financial
risks.
Thank you again for providing me with the opportunity to appear
before the House Agriculture Committee.
The Chairman. Well, Mr. Berkovitz, thank you so much for
your testimony. And thank you to all of you for your testimony
today.
At this time, Members will be recognized for questions in
order of seniority, alternating between Majority, Minority
Members and in order of arrival for those who joined us after
the hearing convened. You will be recognized for 5 minutes each
in order to allow us to get to as many questions as possible.
And so given what so far--since we started the 118th Congress--
has been outstanding participation, and I want to continue to
encourage that on both sides of the aisle. I will try to be
prompt with letting you know when the 5 minutes are done.
So with that, I am going to recognize myself for 5 minutes.
Let me start by thanking our witnesses again, and we really
appreciate you all being here. I know you all have busy
schedules, but what an impressive panel that we have gathered
today.
We have a lot of new Members this year, and I recognize
that this is a very complex topic, so I am going to use my time
to try to level set a bit before we dive deeper into the
substance of the hearing with additional questions from the
Members.
Mr. Gelchie, in your testimony, you mentioned the hierarchy
of oversight in the derivatives market, and I can't reiterate
it enough that this concept is so important for market
integrity. The layers of responsibilities, risk management,
incentives, and oversight are essential to understanding how
this industry protects the market and participants within the
market.
So my question is--and it will be for each of you.
Hopefully, we can get some comments from each. Could each of
you briefly describe your role in the marketplace and,
importantly, how you interact with each other from market
participant, the FCM, to the exchange, to clearinghouse, to
regulators? And, Mr. Gelchie, we will start with you.
Mr. Gelchie. Sure. Thank you, Mr. Chairman, Louis Dreyfus'
role in the market is essentially a commodity merchant. We
essentially buy from the farmer, sell to the end-user. Through
that, we use financial derivatives to hedge those risks. We
trade in a multitude of commodities across the agricultural
spectrum. And from that perspective, we use what I would say
the financial derivatives both on the long, short side, as well
as down the curve, if you will, most agricultural futures
markets have long dated futures positions. And in effect, we
act as that intermediary or shock absorber, as I had mentioned
earlier on, where a producer may be looking to sell a given
commodity at a specific period in time, perhaps much further
out in time, and a user or a consumer may be looking to buy a
specific commodity at a different point in time. So we
essentially bridge that gap. To that extent, we will, as I
mentioned, use commodity futures. Those ultimately get cleared
by the FCM that we ultimately give the derivatives up to, and
essentially, that is what we do in brief.
The Chairman. Very good. Mr. Sammann?
Mr. Sammann. So as a vertically integrated model, that
owner of a clearinghouse, as well as our four underlying
exchanges, we provide, as I mentioned in my written and oral
testimony, platforms and products for customers to trade. Now,
we service all customers, the entire ecosystem from producers,
end-users, farmers, ranchers, all the way through to financial
intermediaries like Louis Dreyfus, like large E&P folks in the
energy space, all the way through to financial players that are
looking to gain access to different asset classes, whether it
is hedge funds, asset managers, pension funds, long-only funds,
et cetera, all the way through to retail. So our mission and
purpose is to provide price transparency and price discovery
mechanisms in lit electronic markets 23\1/2\ hours a day so
that as global risk travels, risk mitigation travels with
customers as well.
We also engage with folks across the table here at multiple
levels. FIA is an industry body that brings all interested
participants together. We don't always agree on everything, but
it is a forum to work out those disagreements, and that is
okay. We have constant client communication. We are constantly
engaged via our sales force to understand what is driving them
and what they need. We have a number of client advisory forums
where we bring customers in to hear what is challenging them,
what has been difficult to them.
And finally, as it relates to Mr. Berkovitz's previous role
as a Commissioner in the CFTC, we participate in all of the
CFTC's advisory committees that also brings together
stakeholders across the industry, so lots of ways in which we
engage, serve, and understand the needs of different
constituents in our market.
The Chairman. Very good. I don't have much time left, but,
Ms. Crighton, I would love to have you respond.
Ms. Crighton. Sure. Just briefly, I guess the best way to
describe the role of the FCM is we stand in between firms like
Louis Dreyfus and Mr. Gelchie, his peers, other types of
financial institutions, we stand in between them, exchanges,
and clearinghouses. We do that not only for CFTC-regulated
clearinghouses, but for clearinghouses and exchanges globally.
The Chairman. Very good. Thank you very much. My time has
expired. I am pleased to recognize our Ranking Member for 5
minutes.
Mr. David Scott of Georgia. Thank you. Thank you, Mr.
Chairman.
Mr. Berkovitz, let me start with you. In your testimony,
you mentioned severe weather events occurring with
unprecedented intensity and frequency, and the need to update
the tools of the CFTC to manage such risk. Last June, the CFTC
issued a request for information, an RFI to solicit public
input on climate-related financial risk. So Mr. Berkovitz, as a
previous sponsor of the CFTC's Energy and Environmental Markets
Advisory Committee, during your tenure as Commissioner, are
there any specific actions, updates to risk management tools,
or market surveillance that you would like to see come out of
this process?
Mr. Berkovitz. Thank you. Thank you, Ranking Member Scott,
for the question. Yes, as you mentioned, during my service, my
term at the CFTC, I had the privilege of sponsoring the Energy
and Environmental Markets Advisory Committee, and in 2021, just
a couple years ago, indeed, we had an advisory committee
meeting that the other witnesses at this table have mentioned
that--the CFTC has advisory committees, which are composed of a
wide diversity of market participants, academics, and other
persons familiar with the commodity markets, examining the
topic, as you mentioned, new products and markets to deal with
climate-related risks. And we heard some testimony of that--or
some presentations. It wasn't testimony. It was presentations
by the advisory committee members. I think Mr. Sammann
participated in that by the exchanges, a variety of exchanges
and markets as to the products they are developing. So that was
a very encouraging development. New products don't always take
on immediately. Sometimes they take a while for the market to
see the wisdom of the products or the need for the products.
But I was very encouraged that there is active engagement by
the exchanges and by market participants to develop these
products and market, so I find that encouraging. And I am
looking forward to the CFTC's analysis of the request for
information in terms of what market participants are suggesting
and offering.
And I would say the other thing I think is very important
is the increased disclosures of risk so that people are aware
of where the impacts of weather-related events might be and
things like that so they can take proper--so that these tools
that are developed, they can use, or the existing tools as
well.
Mr. David Scott of Georgia. And to the rest of the panel,
as I noted earlier, this year is 10 years since the expiration
of the last CFTC reauthorization legislation. Can each of you
discuss the impacts that you have seen or experienced as a
result of Congress' inability to get together and pass the
reauthorization legislation specifically as it relates to the
effectiveness of the industry's risk and management tools? And
as I mentioned to you, the European Union used this as a weapon
to take away the authority of the CFTC in our cross-border
negotiations. And with the help and the combined help of our
Republican Chairman at that time, Mike Conaway, and Collin
Peterson, my good friend Austin Scott, and Chairman Thompson,
we stopped it. But they are still using it. What is the impact
of our failure here in Congress to reauthorize the CFTC?
Please, any of you.
Mr. Berkovitz. I will take a shot at that, Ranking Member
Scott, and I will tell you a story about you. I had the
opportunity to oversee six clearinghouses and not all of them
are in the U.S., and one of the other regulators once pulled me
aside across the pond and said we don't have a Congressman
David Scott who is willing to stand up and say what he did
about what others maybe see as opportunistic opportunity to
impact legislation and the certainty that provides.
I think the short way to answer your question is the lack
of certainty. And we all deal in a level of certainty, whether
it is Mr. Gelchie wants to know exactly what it is going to
cost him to put a hedge on my competitor, and Mr. Sammann
wanting to make sure he knows what we are doing under the
regulation so he can compete, and I do the same thing. Our
members, represented by Ms. Crighton, we all look for
certainty. That is what is expected of us. And if you can't
provide it within the regulatory means that we have, it becomes
more difficult to explain exactly the behavior you are going to
receive or observe at exactly the highest moment of stress in
the marketplace.
Mr. David Scott of Georgia. Thank you very much. My time
has expired. But as Chairman Thompson said, we are working
together here. We have to get this done. It is an international
issue now and an international embarrassment for us here in
Congress. And I appreciate working with you on this subject.
The Chairman. Absolutely. Thanks. I thank the gentleman.
The Ranking Member asked an incredibly important question, and
your input on making sure we have the continuity, the
reauthorization of CFTC, your thoughts and inputs on that, I
think we would really welcome that. And I would just ask, the
witnesses that didn't get an opportunity to respond, if you
would do that in writing for us because this is a task that we
need to complete. And having your input would be very helpful.
Now we recognize another former Chairman and the gentleman
from Oklahoma, Mr. Lucas, for 5 minutes.
Mr. Lucas. Thank you, Chairman Thompson, for holding this
hearing. And thank you to our witnesses for appearing before
the Committee.
The U.S. banking regulators are in the initial phases of
proposed changes to bank capital requirements. And as I raised
to the Federal Reserve Chairman Powell yesterday during his
testimony before the Financial Services Committee, I am
concerned that this could increase the cost of hedging to end-
users. Ms. Crighton, could you discuss potential adverse
consequences to reducing access to these products, particularly
during periods of financial uncertainty? If we make it harder
to hedge, what is going to happen when things get tough?
Ms. Crighton. Yes, thank you very much for the question. I
think it is a topic we think about certainly within the firm
and across the membership of FIA and I think really across the
panelists sitting at this table.
When we think about the impact of bank capital on clearing
members, one of the first topics that comes to mind is the
amount of capacity that we are able to provide in the system.
When we engage with clients, when we work with clients and we
think about providing access to global markets, there are a few
lenses that we think about and analyze their portfolio. The
first is from an exchange margin perspective, the second is
from a risk perspective, and the third is from a bank capital
perspective. One of those three will ultimately define the
amount of capacity that we give. The more punitive bank capital
becomes, the harder it is for us to be willing to stand in and
continue to provide that capacity. So we do urge policymakers,
going forward, as capital rules are considered and reconsidered
to not continue to increase bank capital because it will
further impact banks in providing the amount of capacity that
they do.
Mr. Lucas. Thinking about my colleague's comments, as we
have seen over the past several years, it is essential for U.S.
customers to be able to hedge risk on a global basis. Again,
Ms. Crighton, could you discuss the importance of cross-border
access for U.S. customers, particularly as it relates to non-
U.S. swap markets?
Ms. Crighton. Sure, and thank you again, for that question.
I think, as I mentioned in my opening statements as well, part
of what we do as a clearing member and other clearing members
that are members of FIA, is provide access to clients globally.
And when we think about the importance of U.S. clients, CFTC,
and U.S. regulated markets, our role is to facilitate access to
those markets and access from U.S. clients to global markets.
In addition, we also sit in the role of providing access to
global clients into U.S. markets, so it is very interconnected,
and it is also critically important to be able to facilitate
clients trading across the globe to facilitate what their risk
management needs are.
Mr. Lucas. The swaps market faces a tremendous technical
challenge as we transition away from LIBOR. Mr. Sammann, could
you broadly discuss CME's conversion plan for LIBOR swaps? How
big of an undertaking is this going to be?
Mr. Sammann. Yes, we thank you for that question,
Congressman. This has been a huge undertaking for CME Group. As
you know, the LIBOR that has underpinned the short-term U.S.
dollar market in U.S. dollars on our market had been around for
over 40 years. Now that has had to move to a secured overnight
funding rate, or SOFR (Secured Overnight Financing Rate),
market. We have been working with the industry since 2015. We
have been a member of the Fed's ARRC, the Alternative Rate
Reference Committee, since 2015 with all the stakeholders in
determining where and at what point does this mechanism need to
move away from LIBOR-based into SOFR-based. We have been a
member of the CFTC's MRAC interest rate subcommittee since
2018. It has been a massive undertaking. We have had to work
with all stakeholders, central banks, and all participants from
vendors, clearing firms, all the way through to other
exchanges.
To the extent that this was a heavy lift that we have
undertaken over the last 5 years, we have actually almost
completely converted everything in our short-term interest rate
complex from LIBOR-based over to SOFR-based over the last 8
months. We are almost complete with the balance of our Euro
dollar that hasn't yet already converted to SOFR, and our
market will convert on April 1, and the balance of the swaps
that haven't converted will be converted over on April 15th as
well. This is not something that has happened in the last 6 to
12 months. This has been a 7 to 8 year process of working with
all industry participants. I am happy to say that our term SOFR
licenses now total over 2,200 firms in 88 countries, and our
licensing term SOFR there is over 6,000 loans with a face value
of $3.5 trillion tied to CME SOFR. That is according to
Refinitiv deal screen data. And if you look at the amount of
open interest that has transitioned inside of our exchanging
clearinghouse, almost 90 percent of that is now complete. So
job converted, and certainly the final transition phase we are
in right now. So relatively smooth, thanks to those in FIA and
the CFTC to help us get that done.
Mr. Lucas. Thank you for those insights. And I yield back,
Mr. Chairman.
The Chairman. I thank the gentleman.
I am now pleased to recognize the gentlelady from Ohio,
Congresswoman Brown, for 5 minutes.
Ms. Brown. Thank you, Mr. Chairman. And thank you, Ranking
Member Scott, for holding this hearing today. And thank you to
our panel of witnesses for being here.
The financial markets in our country have been turbulent
and unpredictable in recent years. From the COVID-19 pandemic
to Putin's war on Ukraine, commodity markets have taken a hit.
As of late, it appears that the only predictable thing about
our markets is that they will be unpredictable.
So I would love to hear from anyone on the panel because
yesterday I met with the Ohio Farm Bureau, and they expressed
concerns about mandatory climate incentives tied to crop
insurance. So while we may face restrictions in predicting
global pandemics or certain natural disasters, to what extent
can markets prepare for those events to improve resilience?
Mr. Sammann. So maybe I will take the first crack at that.
Since agriculture is a huge part of what we do, it is also the
history of CME Group going back 170 years now. We have the
physical agricultural markets in our blood. It is the lifeblood
of what we do. The focal point is that rancher, farmer family
that has exposure to crop risk. We have been in the business of
effectively providing deep, liquid, globally traded derivatives
markets in markets like corn, wheat, and beans. The U.S. under
CFTC jurisdiction runs the world's largest grains markets on
CME Group exchanges. Those are providing critical access to
end-users or co-ops to manage their risk. As Ranking Member
Scott mentioned before, we saw moves in wheat this year alone,
not to mention soybeans have been extreme both up and back
down. So our goal is to continue to create as much liquid deep
market access to all consumers, and firms like Louis Dreyfus
and others in that space are critical intermediaries for
providing the tools to manage that risk and exposure.
That is important for everybody, whether you are in the
wholesale futures markets or not. Customers that find
themselves able to access these markets are able to manage that
price risk, and that gets handed down to the eventual end
consumer. This hits main street America 100 percent, so our
goal is to continue to provide as much access in our liquid
grains markets and ag markets, whether it is cheese, livestock,
dairy products, or grains and oilseeds to create as much access
to price certainty through derivatives. And that is our core
mission for end-users.
Ms. Brown. All right. Thank you for that. Dodd-Frank was
passed over 10 years ago, and we have had time to understand
what worked well and what could use improvement to make our
financial systems stronger and more resilient. Ms. Crighton--is
it Crighton or Crighton? I want to make sure I am saying it
correctly.
Ms. Crighton. Crighton.
Ms. Brown. Okay. Ms. Crighton, looking ahead, what should
we be thinking about over the next 10 years to make our system
more durable?
Ms. Crighton. Thank you for the question. We do think some
of the benefits of Dodd-Frank have certainly been reduced risk
in the markets and greater transparency. We also think the
systemic importance of clearinghouses has dramatically
increased given the amount of products that have moved to
clearing and the amount that are continuing to be contemplated
to be moved to clearing.
So we think there are a couple of things that we can focus
on as the markets continue to evolve. One is continued
transparency from a clearinghouse perspective on margin models,
and we think better calibration of margin, particularly focused
on commodities markets. If we look at what has happened over
the course of the last few years, we can go back as far as
Brexit or certainly through the pandemic and the Russian
invasion of Ukraine, we continue to see significant increases
in margin. When we get into a period of extreme volatility or a
shock to the system, margin levels increase dramatically. As we
get back into calm markets, they slowly drift down into what we
think are at times artificially low levels.
So our goal here is to encourage stability and resilience
of the cleared markets. We think that has a direct benefit and
impact to end-user clients, and we think further transparency
and potentially the introduction of margin floors and other
mechanisms that we have talked about through the CFTC's MRAC
would really be an added benefit as we think about how to
evolve further and deal with sustained shocks.
Ms. Brown. Thank you very much. And finally, Ms. Crighton,
I see you are the only woman on the panel today. And I know
from your testimony that you are the first female Chair of the
FIA board in almost a 70 year history. So first of all,
congratulations on your accomplishment.
Ms. Crighton. Thank you.
Ms. Brown. But can you tell me why is having more women and
people from underrepresented groups in the industry important,
and what can be done to address the opportunity and equity
gaps?
Ms. Crighton. Thank you so much for the question. I feel
like it is certainly an important question, particularly during
Women's History Month, as we acknowledged, International
Women's Day yesterday, so it is pretty historic to be here. I
think it is, as I mentioned before, a topic incredibly
important to the firm, to Goldman Sachs, to FIA, and certainly
to me, as I think about my two daughters and opportunities that
they may have, going forward.
I will speak primarily about FIA. When I first joined the
board, I was one of two and then quickly the only woman in the
room. And when I sat with FIA leadership, we quickly recognized
that were probably pretty representative of the industry and
that more needed to be done to be able to think about ways to
begin to address that. As a trade organization, it is difficult
to think of the role that we play and how do we actually drive
the way maybe the clearinghouses think about it or clearing
members think about it.
And when I looked at my own sort of almost 25 year career
at Goldman, I thought of a few key things that were so
critical. Really, it is information, access, mentorship, and
opportunity. So the programs that we have designed in launching
the FIA's Diversity Committee are really geared towards that.
We don't think we can solve this alone. It really takes
everyone around the table. We have partnered with a lot of
groups where we have offered mentorship. We know some of you in
this room, on this panel, have participated with us in that, so
thank you. And we have offered mentorship opportunities,
internships that have been converted to full-time offers. We
are so excited about what we can do on the forward. It does
take a lot of people to be able to participate in that, and we
think FIA is uniquely positioned to help drive that going
forward.
Ms. Brown. I see my time has expired. Thank you so much.
And with that, Mr. Chairman, I yield back.
The Chairman. I thank the gentlelady. I now recognize the
gentleman from Georgia, Mr. Scott, for 5 minutes.
Mr. Austin Scott of Georgia. Thank you.
Madam Chairman, Ms. Crighton, I am coming right back to you
because Mr. Edmonds spoke directly to my question. And I will
tell you just briefly, my degree is risk management from the
University of Georgia. And aside from being the best football
team in the country, they have one of the best risk management
schools there. And I will tell you that my good friend, David
Scott, went to Wharton, so I would put my University of Georgia
education not quite up to yours.
But anyway, enough of that. Just the risk levels throughout
the world are higher today than I recall them being in many
years. And they seem to be coming faster, right? I mean, COVID
happened and the war in Ukraine. And if you go back prior to
that, we didn't have really a major occurrence other than the
2008; but, they seem to be coming faster and with much more
risk and volatility.
So clearinghouses, they hold billions of dollars in
customer funds. They are pledged against derivative positions.
And under title VIII of the Dodd Frank Act, the Federal Reserve
was authorized to provide deposit accounts to some of the
clearinghouses that hold U.S. customer funds but not all of
them. Would access to Federal Reserve deposit accounts for all
clearinghouses improve liquidity during times of incredible
volatility across the cleared derivative ecosystem? Is there
any safer place in the world for deposits than the Federal
Reserve?
Ms. Crighton. I think the answer is we fully support access
by all clearinghouses or U.S.-regulated clearinghouses to have
access to the Fed deposit window. We agree with your sentiments
that there is no safer place in the world, particularly during
times of stress, that will increase market stability and
resilience, so we fully support that.
Mr. Austin Scott of Georgia. Because it would protect
customer funds, and that should be one of our goals as a
Committee.
Ms. Crighton. That is right.
Mr. Austin Scott of Georgia. Mr. Edmonds, you hit on the
issue directly. Do you have anything else to say about it?
Mr. Edmonds. Well, look, we want to mandate more products
if we don't provide that opportunity. I mean, I have one
clearinghouse that is systemically important, Derek and his
organization, they are systemically important. But if we don't
make it all, you are creating a bifurcation there, and the
level of protection is different. And there is not really a
great reason for it. So you can't explain it, so then why is it
there?
Mr. Austin Scott of Georgia. Mr. Gelchie, we talked in New
York about Vladimir Putin's invasion of Ukraine and the
disruption. You mentioned that ten percent of the calories in
the world come out of the Ukraine. That whole Black Sea region
is extremely important to the global food system. Could you
speak to how the war in that part of the world has created
market disruptions not just in the United States but abroad?
And last year, there was actually some reprieve that allowed
some of the grain to move out of the ports in Ukraine. Could
you speak to the shipping issues and whether or not people are
actually willing to send ships back into the Ukraine to load?
Mr. Gelchie. Thank you for the question, Congressman. Look,
let's start perhaps with the second question here. As you may
know, the export corridor is scheduled to close on March 20,
right, or the agreement that both sides have is scheduled to
stop on that day. So there have no doubt been discussions as to
whether or not that export corridor will remain open. The delay
time from the standpoint of putting a vessel into the export
corridor has tended to be anywhere from 10 to 12 days from the
time that it goes into inspect to ultimately the time that it
begins to load grains. That delay has resulted in an increase
in freight costs out of Ukraine that has been to the detriment
of the farmer and also impacts bases in international markets.
So the prospect of that closure can have very extreme volatile
effects on futures markets, going forward.
Mr. Austin Scott of Georgia. My time is expiring. I would
just tell you that the issue of shipping through there is an
extremely important part of the cost to the end-user.
Mr. Gelchie. Yes.
Mr. Austin Scott of Georgia. My concern is that you are not
going to be able to get the ships insured, even to go into the
Black Sea in the future. And that disruption in transportation
even if the crop is grown is going to create very serious
problems for the world. I appreciate all of you being here.
Thank you.
The Chairman. All right. I thank the gentleman.
I now recognize the gentlelady from Oregon, Congresswoman
Salinas, for 5 minutes.
Ms. Salinas. Thank you, Mr. Chairman. Thank you to all the
panelists. As a new Member, this has been quite an education
this morning.
These questions are for both Mr. Edmonds and Mr. Berkovitz.
We have discussed the role of volatility a lot here this
morning from whether it is energy or commodity markets, and
particularly unpredictable volatility poses the risk of
affecting prices and stability. And we have heard again in the
conversation this morning that large events such as the war in
Ukraine and the COVID pandemic, those are events that really
could not have been predicted. So to what extent can the
markets prepare for events such as these and the volatility
that they could bring?
Mr. Edmonds. I think the most important thing that our
clients--and when I say our clients, we have members
represented by Ms. Crighton. We have clients of a firm like Mr.
Gelchie there. They need to have certainty, and they need to
understand how the model is going to react, how we are going to
call them for more margin.
If we looked at some of the prudential requirements placed
on the members, that sometimes is not as clear as it can be. In
the time of stress, typically, the most blunt instrument is
more is better. I can't really tell you why more or how much
more, it is just more. I get to sleep a little bit better at
night.
Statistically, the way the models work, we go out there, we
provide offsets, so we got to correlate a position where you
have a long here and a short there, and different products that
are highly correlated, you get a benefit of that on the capital
side. So we end up in a healthy tension. And I like to think
that if you would walk away from here with one thing, it is
probably right for Mr. Sammann and I if Ms. Crighton and Mr.
Gelchie are both equally unhappy, okay? That is a healthy
tension in the ecosystem that we work in where they would like
for us to charge more because they have a prudential
requirement on the other side, and Mr. Gelchie would like to be
less because he has more business that he needs to facilitate
along the way. Sometimes that is possible, sometimes it is not,
and we find ourselves in that vise, typically on a daily basis,
especially those days that are stressed.
Ms. Salinas. Thank you.
Mr. Berkovitz. Thank you. Let me provide the perspective of
a former regulator what the agency would do in the situation.
So at least when I was on the Commission--and I believe they
have continued it, although I am not sure--we would have
regular, once a week, every Friday, a briefing by our Market
Intelligence Bureau on current events in the markets. And that
is a function of that division within the CFTC, market
intelligence. A number of economists and other market analysts
try to look ahead both for the staff level and provide the
Commission with a look ahead at what is happening in the
markets. Market Intelligence staff gets their information. They
read the press, they follow current events, but they also talk
to the exchanges. They talk to market participants, ``What are
you seeing, what is on the radar screen, what might be coming
up,'' events such as--we even talked about closures in the
Black Sea, other possible events, and they are particularly
focused on contract settlements.
When these futures contracts go to settlement and people
actually have to deliver the physical commodity in the case of
physically delivered commodities or financial contracts that
are priced off of certain physical events, those times, the
prices at those times are very critical, so our staff or the
CFTC staff works very closely with the exchange staff to see
what is going on in the market, whether there is--maybe even
call a market participant. If you have a large position, why do
you have such a large position at this point in time? And maybe
you should think of gradually reducing it or gradually change
the position. So your particular trading does not unduly impact
market volatility.
So from the regulator's perspective, that is what--I will
use the we, although it is not me anymore, but that is what we
would do. We would work with the markets, work with the
exchanges, work with the clearinghouses, follow the data, and
try to have a look ahead to avoid disruptions to trading.
Obviously, things occur that are not always anticipated, and
then the Commission will do retrospective analyses and try to
figure out what happened. Potentially, if there is wrongdoing
involved, that will be a matter for the investigation staff,
but otherwise, it would be the economists and the market
surveillance folks who would examine those events.
Ms. Salinas. Thank you both. I yield back.
The Chairman. I thank the gentlelady.
I now recognize the gentleman from North Carolina, Mr.
Rouzer, for 5 minutes.
Mr. Rouzer. Thank you, Mr. Chairman. I appreciate all of
our panelists for being here.
Mr. Berkovitz, quick question for you, and I will open this
up to the others on the panel, too. A lot of my constituents
back home are quite concerned about the increase in interest
rates. I personally anticipate those rates will continue to go
up. What type of impact is this going to have on the commodity
markets, on the financial markets in general, but the
derivative markets specifically do you think?
Mr. Berkovitz. Well, if the interest rates go up, the costs
for consumers and producers all along the value chain
ultimately will go up. And at the end of the day, it is going
to be the American consumer who is going to pay higher prices
for commodities when there are higher interest rates.
Mr. Rouzer. Anybody else want to comment on that real
quick?
Mr. Sammann. Yes, I think it is worth noting, I know we are
here to talk about commodities markets, but CME runs the
world's largest fixed income market as well, and derivatives
risk covers any unexpected or potentially expected risk that
you would want to manage. So no one can control for those level
of rates, but our job as a market provider, as we talked about
earlier, is to provide a full suite of products and tools for
customers, end-users to be able to hedge as best as possible
and eliminate whatever--it could be price risk in corn, it
could be price risk in gold, it could be price risk in rates
going up or down. So I think it is a proof point for the
validity and the need and the power of derivatives markets and
the effect it can have on mitigating the significant swings in
underlying balance sheets of a home, a corporation, a farm, or
otherwise.
So I think it is important to note that this Committee
oversees the regulatory body that oversees the world's largest
U.S. interest rate market in both the short and the long end of
the curve, and those markets had an extraordinary year in
volume and open interest last year for that very reason, that
rates are back on the move right now.
Mr. Rouzer. So, Mr. Gelchie, in your testimony, you discuss
the importance of speculators in the market. Most of my
constituents back home, they don't like speculators. They think
they manipulate the market. Talk about that a little bit. This
is a big topic for a lot of people.
Mr. Gelchie. Sure. Thank you, Congressman. Look, the role
of speculators are essentially to provide liquidity in the
market, right? And in order to have deep, robust markets,
speculators have a role. There are times--typically what we
tend to see, speculators engage during more volatile times than
not, but the effect of that tends to enable consumers as well
as producers to hedge their price risks in an effective manner.
In a rising market, if you will, many of the farmers if you
will are on the other side of that speculative purchasing. And
conversely, on the sell side, there are many consumers that
take the other side of speculative activity. So we see
speculators as just providing an essential role from a
liquidity standpoint and are often on the other side of many of
our hedges in the derivatives market.
Mr. Rouzer. So would that be fair to say that they are not
the ones causing the wild swings in the market?
Mr. Gelchie. I wouldn't attribute wild swings in the market
to speculators. I would attribute the wild swings in the market
to many of the factors that I had addressed previously,
geopolitics, weather, COVID-19, supply chain disruptions. They
are to me the underlying reasons as to why the volatility
exists.
Mr. Sammann. And, Congressman, I think it is worth noting
that the importance of--if you talk about speculators and you
talk about the regulatory infrastructure that manages their
ability to impact markets, whether it is--in our markets, for
example, we have position limits, so the maximum amount of
positions that anyone can hold in markets. We have smaller
position limits for speculators than hedgers, hedgers that have
underlying physical exposures, whether it is wheat, whether it
is corn, gold, or otherwise. They can show that underlying
physical exposure, they can carry larger positions. So I think
unregulated, unmanaged speculation is very different than the
critical role that risk transfer agents that is served by
speculators is important, with the caveat of appropriate
regulatory controls around how they actively participate in
markets.
Mr. Rouzer. Yes. Anybody else want to comment on that?
Mr. Edmonds. I would just say, simply put, without the
speculators in the market, your price disparity is going to be
much wider, and you are going to be paying much, much larger
prices on an everyday basis. The shock absorber analogy Mr.
Gelchie uses is correct.
Mr. Rouzer. Anybody else? With that, my time has expired,
Mr. Chairman. I yield back.
The Chairman. Well, I thank the gentleman. And keeping with
the North Carolina theme, I am pleased to recognize the other
gentleman from North Carolina, Mr. Davis, for 5 minutes.
Mr. Davis of North Carolina. Thank you so much, Mr.
Chairman, and to the Ranking Member.
As we come together today, I want to thank the witnesses,
too, and have a question I would like to direct towards Mr.
Edmonds, Ms. Crighton, and Mr. Sammann. Soybeans are a top
three crop in my district in North Carolina's First
Congressional District. Unfortunately, soybean farmers had to
cope with the fallout of the U.S.-China trade war that
commenced in 2017. From where you sit, are tariffs on
agricultural imports, including soybeans, a threat to stability
and commodity derivatives markets, or are they a necessary tool
that our government can selectively utilized to combat unstable
regimes like the PRC, who pose a threat to market fundamentals?
Mr. Edmonds. Well, I am going to defer soybeans directly to
Mr. Sammann because I know that is where they trade, but let me
just make a point on tariffs in general. Anytime that there is
an additional market price impacting activity, it is going to
be passed through to the end consumer. That could be a higher
price. That could be a lack of supply, which typically leads to
higher prices along the way. Typically, you will find tariffs
in that arena that causes that stress on the marketplace that
have to be taken into consideration, and those who are
ultimately making the trading price decision factor that into
the price they are willing to pay or which they are willing to
sell.
Ms. Crighton. Thanks. I guess I will comment on it from the
perspective of volatility. And I think similar to comments Mr.
Edmonds made earlier, we prepare for various types of
volatility in the markets. It is how we partner with clients.
It is how we think about our own risk management tools, whether
that is driven by terrorists or other types of factors, we are
constantly thinking about and evaluating what are the different
ways that we can be prepared and appropriately prepare our
clients for different shocks that may impact the market, and
how does it impact them, and how does that impact us in our
role as a clearing member to be able to facilitate the capacity
they need to continue to execute and maintain the hedges that
are so critical to their price management?
So I think some of the points that we talked about, and I
know you mentioned earlier the healthy tension, and I would
agree, there is a healthy tension. There is a lot of robust
discussion about the different ways that we think about this.
From a cost perspective, one of the things that we think we can
do is really stabilize the costs for end-users. Part of the way
that we stabilize the cost is having more predictable margin
levels, more transparency in that, and then that ultimately
leads to more capacity that clearing members can provide.
I will hand it to you for soybeans.
Mr. Sammann. Yes, so thank you. Yes, we run the world's
largest market for soybeans. And just to level set in 2022 I
believe Secretary Dan Glickman just penned a piece on this last
week confirming that there was a record of $36.4 billion of
agricultural exports to China last year, biggest ever. I think
that follows up on maybe 2020 as the new number one year. There
were significant disruptions to market.
I would echo what Mr. Edmonds said earlier about any
impacts that interfere with price discovery and artificial
impacts to trade are extremely difficult to manage. And what we
certainly support is open, free access to markets, and where
that can be enabled, we see that as the best outcome. Layers of
impacts, be they taxes or tariffs otherwise that disrupt
market, creates that very regulatory uncertainty the markets
dislike. Our customers and market participants are used to
price uncertainty, rates uncertainty, regulatory uncertainty,
which is why the CFTC is so critical as a leader in this space.
That is what market participants need. With the regulatory
uncertainty in a jurisdiction, customers know that they have
access to risk mitigation tools, whatever come.
So I am not sure that fully answers your question, but we
can certainly say that the export markets to China just
reflective of the dollars exported this past year, absolutely
crucial, and both ends of that hedging takes place on our
markets.
Mr. Davis of North Carolina. Yes, thank you.
And, Mr. Edmonds, real quick, energy markets are still
reeling as a result of Russian-Ukraine war that is taking place
and remains a protracted stalemate, and the economic
aftershocks following the pandemic continue to reverberate. Mr.
Edmonds, do you think an 83 percent annualized volatility rate
for natural gas is sustainable? I am hearing from folks back
home that instability in the energy markets is putting the
squeeze on fertilizer production and resulting in high prices.
Farmers can't break-even if their input costs continue to
outpace price points for their products. And what stabilizing
factors exist in the energy markets that can help give our
producers some assurance of price stability?
Mr. Edmonds. Well, I will be very quick because I know your
time has expired, but I would tell you at the end of the day,
it is not 100 percent because of what is happening. The face of
it right now is the Russian invasion of Ukraine and where that
is going. There are also a number of regulatory challenges here
in this country that we need to address in order to provide
clarity for those willing to make the investment and do that.
We haven't seen that yet. Last year, we were looking at $7.50
natural gas, everyone thought it was going to $10. This year,
we have people going is it going to less than $1? So while the
volatility is great, the price has been reduced here. We have a
lot of it. What are we going to do with it?
Mr. Davis of North Carolina. Thank you so much. I yield
back, Mr. Chairman.
Mr. Crawford [presiding.] Thank you. I recognize myself for
5 minutes.
And I got here a little bit late, so if I am repeating
myself, forgive me. But I got in on the tail end of Mr.
Rouzer's questions. Mr. Edmonds, you said that spec trading
actually increased or improved liquidity? Is that right?
Mr. Edmonds. It does improve liquidity from our vantage
point because what it does is reduces the level that you see
because you have people willing to stand in and take a price
that if you are purely a commercial player, are you going to
share your very best price all the time? Is it going to be as
transparent? Typically, it is not, and that is the role the
speculator provides to frame that up.
Mr. Crawford. Got you. Let me ask you this. So we use this
term liquidity, but liquidity does not necessarily equate to
stability, correct?
Mr. Edmonds. Well, I will say without liquidity, you are
not going to get stability.
Mr. Crawford. Correct. But they are not one in the same?
They are not----
Mr. Edmonds. They are not one in the same, no.
Mr. Crawford. So here is my concern. And obviously, we need
spec traders to take the other side of the trade in either
case, but my concern with volatility is the lack of actuals in
the marketplace. Does that create a volatile climate? And what
do we need to do to incent more actuals? And where I am going
with this if you can follow me is farmers, for example, they
don't hedge on the scale, on the level that they should, and so
that means the actuals, they are long actuals but they are not
short in the market.
Mr. Edmonds. And I am trying to make sure I understand your
question correctly. When you say actuals, are you talking about
the end-user on the production side.
Mr. Crawford. The underlying crops.
Mr. Edmonds. The underlying crops.
Okay. So I think at the end of the day the value that
speculators like Mr. Gelchie's firm provides is they don't have
to operate there because he has given them a price, and they
can make the decision to go out at their own. He has a lot of
sophisticated tools available to him and a lot more access that
maybe one single farm can't really afford to put into place. So
they have a choice to make. They are now educated. They know
what is there through this process. They know what they can do
on their own. They can make a rational decision when they get
to that point.
Now, in the purest form, if the end-user, instead of me
going to the grocery store, I can buy directly from the farm, I
understand that transaction. I go to the farmers' market. I can
do that on a daily basis. I understand. Do I know exactly what
they paid for fertilizer, how much they watered the plant,
whatever? No, I want an ear of corn, I get an ear of corn, I
put it on the grill and have a good time with it, a party. But
at the end of the day, in mass bulk, it is very difficult to do
it. As the cost of that infrastructure continues to increase,
the number of parties able to do that effectively and engage
with the right risk limits when they go through a membership
review and things of that nature becomes incredibly difficult.
And that is just the term that we have built over a long time.
But the price transparency that the exchange groups and the
clearing mechanisms provide is the benchmark they go to look at
in order to evaluate whether that offer from Mr. Gelchie's firm
versus doing it on their own is appropriate.
Mr. Crawford. So I guess my concern is how integral a role
do farmers actually play in price discovery today? So, I mean,
if basically these transactions are taking place with hedge
funds on either side of the trade, I know you are looking at
fundamentals, I know you are looking at technicals, and you are
making evaluations, and so on. But at the turn row level, a lot
of times farmers are--their risk management strategy consists
of a basis contract that is local. However, that is pegged to
the board, right? So there is still an element of that
connectivity there, but I am just wondering, what is the direct
role that farmers have in price discovery today?
Mr. Edmonds. I would just take this and I will turn it over
to Mr. Sammann. If they don't deliver the crop, it doesn't
matter what the price is. It all falls apart. They have to
deliver the crop. And that is why they are so critical, and
that is why we have to do all that we can to make sure that
they have a path to participate in a way that works for their
size operation.
Mr. Sammann. So I think this ties back a little bit to your
question on speculation as well. When we think about what a
healthy market looks like, it has to be a full healthy
ecosystem of all participants. You need market makers, you need
market takers, those that have the risk, whether they are E&P
energy firms on the production side or farmers or miners or
whether it is a mortgage servicer for that matter, or you need
somebody on the other side to take that price. I am looking to
get exposure to a particular asset class. So we think about how
to build that healthy, diversified ecosystem of participants so
that price transparency can take place so farmers know the
price of soybeans for this particular product and it is worth
X. And I think that price transparency piece is critical so
that they are informed about what the value of their product
is. Whether they can directly impact those markets or not is a
question of their intermediary access to these markets.
Mr. Crawford. What would you estimate the percentage of
participants in the market today are bona fide hedgers?
Mr. Sammann. So I would probably say--it is going to vary
by product--probably 20+ percent of end-users. And you can see
some of that from the CFTC's Commitment of Traders Report. It
will vary by product. It will be higher in commodities markets.
It will be lower in financial markets, between 20 and 40
percent, but I would rather come back to you with a more
specific answer.\2\ But if I were to spitball, that is where I
would put it.
---------------------------------------------------------------------------
\2\ Editor's note: the information referred to is located on p. 82.
---------------------------------------------------------------------------
Mr. Crawford. Thank you. I appreciate it. Thank you all.
Ms. Budzinski, you are recognized for 5 minutes.
Ms. Budzinski. Thank you, Mr. Chairman. And thank you,
Ranking Member, for putting together this very informative
hearing today. I appreciate that.
We have spent a lot of time obviously talking about market
volatility and the different factors. We know obviously a war
in Ukraine is contributing, also a public health emergency. The
energy markets, though, are no stranger as well to volatility.
And my colleague, Congressman Davis, also touched a little bit
on that related to natural gas. My district, the 13th District
of Illinois, is really a hub for innovations in our energy
markets, specifically around biofuels and other sustainable
fuels. And that can help increase what I would hope is
certainty and security in these markets. And so maybe I could
start by directing this question to Mr. Berkovitz but then open
it up to the rest of the panel on your thoughts on the impacts
of biofuels and how they relate to the commodity markets as
well.
Mr. Berkovitz. Thank you, Congresswoman. So biofuels are
incredibly important as part of the energy mixture and part of
the input into fuel, people driving their cars and other
vehicles. So as another input, it affects a number of other
commodities, too. It is related to the price of corn, increases
demand. The price of corn and other biofuels people plant for
biofuels in addition to agricultural demand, it affects the
price of gasoline. It is another component there and reduces
the demand for oil to a certain extent, so it affects that
commodity. So it is an absolutely critical component. And I
know, like other folks on the panel who are actually from the
exchanges can explain, well, the actual interaction the
exchange and the suite of fuels and the interactions between
these various commodities, but it is well-studied economically
how increases or decreases in demand for biofuels affect the
demand for gasoline. But it is an integral part the energy risk
management sector, as well as the agricultural sector.
Mr. Sammann. Yes, I think it is a great question. It speaks
to the broader question of energy transition and what is this
market going to look like in 20, 30 years? There are very
different opinions on the timeline of that and the shape and
the scope and the scale and the speed with which we will get
there.
Specifically to your point, soybean oil is a critical
feedstock for products like renewable diesel. It is also in and
of itself hugely important to the ag market. Our bean complex
is effectively three products. It is soybeans, it is crush, and
its meal, and those are used for very different reasons. And
increasingly, kind of the differences between what used to be
an energy market and an ag market are now blurring because of
markets like biofuels and ethanol. Is ethanol a corn product or
is it actually a fuel product that should be run inside an
energy business, for example? Ethanol feedstock for gasoline--
and this is a global product. There is a European ethanol
market. There is a U.S. ethanol market, and those are being
derived from U.S. stocks here as well. Methanol, biofuel
feedstock used in bunker fuel, for example, so there are a
number of products out there that I think are also, well, these
are still relatively small, probably soybean oil is the biggest
of these, are rising in importance. And at various points in
time we have had discussions, food versus fuel, where is that
efficient frontier, and what is the best outcome for use of
these products? So it is a changing time for the environmental
products market. We partner with our customers, end-users, and
intermediaries to develop those products that reflect the risks
that they are trying to manage through an uncertain speed and
shape of what will be an energy transition story.
Ms. Budzinski. Thank you. I don't know if any other
panelists would like to add, and if not, I have one other
question maybe for Ms. Crighton.
It is very clear in the global derivatives markets that
practices abroad can have a domino effect across the sector. In
the same light, inconsistency among risk management methods can
stifle securities and the derivatives market's ability to
withstand volatility. Can you speak to the work that is being
done across the globe that can add to protections for our
participants here at home?
Ms. Crighton. Sure, thank you. It is a great question. I
guess I will use a couple of examples. One is--and I think Mr.
Sammann referred to it in his testimony--the events that we saw
on the London Metal Exchange in March of last year. We have
been asked many times as an industry, I think as individuals,
does that have the ability--can that happen here? Can that
happen in U.S. markets? I think first thing we would point to
is the volatility control mechanisms that many of us refer to.
Whether it is risk controls, price controls, position limits,
we think they are all critically important to helping resilient
and stable markets.
We think the U.S.-regulated, CFTC-regulated exchanges and
clearinghouses do a terrific job in that regard, and we think
they do--and FIA is doing a lot of work to kind of create that
as a set of global standards to be able to share with that
global community. When we think about how we provide global
access, that really becomes critically important of having a
set of standards, right? We operate a portfolio of providing
access to exchanges and clearinghouses globally. For many of
us, that is north of 60 and dozens of jurisdictions around the
world. You want to know that you have the same set of
principles that govern how we think about risk, how we think
about the volatility control mechanisms. All of those are
consistent really around the globe.
I think the other good example to highlight when we debate
skin in the game, for example, it has been a longtime
discussion in the U.S. We think that will continue to evolve.
If we look at regulation that is happening across Europe from a
European perspective, the EU has passed regulation where they
are actually mandating clearinghouses to have more skin in the
game. The UK is actually looking at similar regulation as well.
We think that is an important step forward, and we look forward
to continuing the discussion here.
Ms. Budzinski. Thank you so much. I will go ahead and yield
back my time. Thank you.
Mr. Crawford. Thank you.
Mr. Bost, you are recognized.
Mr. Bost. Thank you, Mr. Chairman. And I would like to put
on the record and thank Chairman Thompson for allowing me to be
back on this vitally important Committee to my district. I
spent 6 years on the Committee right after being elected, and
then I have spent 2 years and 2 months off and begging the
whole time to get back, so I am really feeling great about
being back on the Committee. And reason being is my district in
southern Illinois is one of the most diverse agricultural
districts in the country. And I am happy to provide them a
voice here on this Committee.
Now, one of the things that I hear about often from the
producers back in the district is the importance of liquidity
and access to capital. Mr. Sammann, in your written testimony,
you referred to an independent review of what happened in the
London nickel market in March 2022 as an example of the need
for strong oversight and risk management. Did that study
provide any more details about what we can learn from the
distribution in that market, and also, as input prices go up
like what my constituents are seeing with fertilizer prices
and--how does that work and what the CFTC is doing to mitigate
some of the effects on the producer?
Mr. Sammann. So that is great question, Congressman. Thank
you for that. I think the importance of what we saw happen in
London in the nickel market, really, as I mention in my
testimony, written specifically is to highlight the incredible
importance of the risk mitigation tools both at the exchange
level and at the clearinghouse level to ensure orderly markets.
I will give you a quick rundown of a couple of things, your
position limits, number one. There were not necessarily a
position limits regime on that market, in that market. This is
something that is part and parcel of CFTC regulation. We have
different size limits for speculators and hedgers, as I
mentioned before. That is critically important. If you are
carrying a large amount of physical underlying, then you should
have access to an appropriately off-size position as long as
you can show market reg departments that here is my risk, here
is my offset, and that is why I am carrying that. Speculators
have smaller positions. We have position limits that differ by
spot month versus deferred month across all contract months.
That is important to make sure that there is not an outsized
impact of any position holder in the market. Things like daily
price limits, and we have those in enumerated commodities like
eggs where we have hard limits where, as you know, Congressman,
wheat, corn, beans, there is only a set amount that market can
move on a daily basis. And then we have very clear, transparent
rules for if we lock limit up consecutive days, how that opens
the following day.
Determination and a deterministic market behavior is what
market providers need and users need. They did not have that in
the case of the London market. Other areas, circuit breakers,
things like Velocity Logic in our market that slow market moves
that if a market moves beyond a specified amount in a specified
time period, we implement market halts. So at the exchange
level, we are slowing markets before they start to run away
where we don't have hard limits in certain markets.
We have talked a lot about margin today, talked about
initial margin. Variation margin is critical. Variation margin
is what flows every day to top up accounts that have lost money
on that day and credits for those customers that have seen
gains in their positions every day. CME Group runs twice daily
variation margin runs to ensure that no excess loss is built up
in the system anywhere, also something that was missing at that
other particular exchange.
Market reg oversight to ensure not just appropriate
activity for users in our market but positions that they are
holding as well, and they have the power to go investigate what
those customers claim they have. Proactive margin management,
liquidity-based margin add-ons, concentration-based add-ons,
all of the ways in which we ensure that our markets are safe,
secure, deterministic for users and people know what the rules
are going to be and how markets will react when you have market
stress. Mr. Edmonds mentioned that before. That is what users
flock to. That is what the CFTC has helped us provide. That is
why we are in this regulatory framework the benchmark globally
of derivatives markets.
Mr. Bost. I appreciate that. Thank you. I also have heard
from my constituents obviously with serious concerns about the
recent action taken by Mexico in banning GMO corn. This is
serious concern of mine, and I have joined with several of my
colleagues in writing a letter to the Administration calling
for action from the USMCA.\3\ What effects has the CME seen on
the global--I am not sure what my tongue is doing--derivative
markets so far based on Mexico's action, and if no substantive
effects have occurred, can the CFTC help absorb any changes in
the market?
---------------------------------------------------------------------------
\3\ Editor's note: the letter referred to is located on p. 81.
---------------------------------------------------------------------------
Mr. Sammann. Great question. I think relative to how we
answered the question earlier on tariffs and kind of market
disruptions, we see disruptions to free trade flow and price
setting as problematic for all users and that just increases
instability. It increases the eventual price that gets--cost
passed on to the end consumer is not good for anybody. We have
not seen a direct impact on our corn market, which is we run
the largest corn market in the world. We haven't seen that yet.
That said, we are in constant conversation with both the
farmers, producers, end-users, folks like Louis Dreyfus and how
that impacts them, and the agency. And I would probably defer
to Mr. Berkovitz for his thoughts on how to answer a CFTC
perspective on that.
Mr. Crawford. We will have to defer that.
Mr. Bost. I think we will have to wait on that because I am
out of time.
Mr. Crawford. We have run out of time. Thank you, Mr. Bost.
Ms. Adams, you are recognized.
Ms. Adams. Thank you, Mr. Chairman and Ranking Member. Let
me also thank all of our witnesses today. And I want to address
my questions to Mr. Berkovitz first.
In your testimony, sir, you noted the need for improvements
to our risk management tools in order to adequately and
accurately respond to severe weather or climate-related risks.
So would you elaborate on what updates are necessary and the
extent to which the CFTC has the authority to implement such
changes?
Mr. Berkovitz. Thank you, Congresswoman. So the three areas
that I outlined in my testimony are, one is the development of
new products and markets to provide better risk management
tools to address severe weather-related events. The CFTC
doesn't have authority to mandate new products or new markets,
but it can encourage it and facilitate it. And that is what the
advisory committee process is for. And the CFTC has put out a
request for information, asking the very questions that you
just identified, what can the CFTC do? What is the CFTC's role?
But this is really a market-based solution that--the products
in the markets and the markets themselves to develop.
So my suggestion or my encouragement is for the CFTC to
work closely with market participants and try to facilitate the
development. To the extent that there are regulatory issues or
obstacles to the development of any of these products or it
needs expedited approval, the CFTC can certainly expedite the
approval.
Ms. Adams. So let me ask you, where should the focus of
Congress be to ensure the effectiveness of commodity markets
and derivatives products as tools for risk management and price
discovery?
Mr. Berkovitz. So I think continued support of the
Committee, which this Committee has always been very, very
supportive of the efforts of the CFTC and providing direction
to the CFTC in the areas that the Committee believes the
Commission should focus on. So if the Committee were to believe
that this is an area that the Commission should focus on and
work with the private-sector to develop these new products and
to develop these new markets and to oversee these new markets,
that would be of great assistance to the Commission in
conducting those activities.
Ms. Adams. Thank you, sir. Let me move quickly to Mr.
Sammann. I appreciate your focus on the importance of the U.S.
agricultural production to global economy, commodity markets,
and their vulnerability to trade policy. It speaks to the
importance of the work that this Committee and our nation's
farmers do. Farmers are long-experienced with the risk posed by
weather events, and as a result, the Agriculture Committee and
USDA have focused on improving our commodity safety net through
investment in title I commodity programs.
Last summer, CFTC issued a request for information
soliciting public input on climate-related financial risks,
including physical and transitional risks. To what extent has
CME participated in conversations on climate risk with the
CFTC, and what has been your primary focus? And what role if
any can Congress play in providing guidance to CFTC?
Mr. Sammann. So terrific question. Thank you for that. As
actually Mr. Berkovitz indicated, I represent CME Group on his
old committee, the Energy and Environmental Markets Advisory
Committee that is chaired by Commissioner Mersinger now. And
the point of that is to actually address some of these issues
head on. So we are very deeply involved with the CFTC both at
the committee level, but also bilaterally in terms of issues
that we see, whether that is on the product development side.
And products that we are hearing from our customers, we have
been asked to develop transition fuels, things like battery
metals and how those markets evolve. It is critical for us that
we not only go through that due diligence process for
validating an idea, we then go to the CFTC, as this Committee
knows, and have to approve that these markets are ready for a
derivative contract, that they are deep and liquid, satisfy all
the core principles of the CFTC. So from product development
and a solutions point of view, that is a direct dialogue.
At the committee level and at the enterprise level, CME
Group is very actively involved in not only managing and
reporting on our own client, or say, risks around environmental
change but those in the industry as well. And I think the
industry is communicating on these issues. There are a number
of regulatory bodies bringing this discussion together so that
we understand what the impacts are in industry as a whole and
how we each individually contribute to that.
Ms. Adams. Thank you, sir. And thank you both. And, Mr.
Chairman, and I am out of time. I yield back.
Mr. Crawford. Thank you.
Mr. LaMalfa, you are recognized.
Mr. LaMalfa. Thank you, Mr. Chairman. Apologies for missing
much of this hearing, as there are always multiple committees
going on. So I do have a couple of questions we prepared on the
topic, so let me go to Mr. Gelchie.
With the Russian invasion of Ukraine, we have ripple
effects through many aspects of our economy and our industries,
but agriculture has been hit hard, as well as energy. What
policies can Congress implement to better reduce the volatility
in our food and fiber markets? What should we be doing to have
more integrity and fewer ups and downs?
Mr. Gelchie. Thank you, Congressman. I think, really, some
of the factors that they perhaps have related to Russia-Ukraine
clearly impacts the consumers here in the United States, as you
mentioned. But what I think is important to also note is that
the wheat, the corn markets are global markets, right? And so
while the U.S. farmers are essentially also--and the U.S. users
are also participants in these, the volatility that you
mentioned is just a function of these markets in order to
attempt to find what its proper price should be, given those
circumstances insomuch as the geopolitics does create
uncertainty of supply out of Russia, out of Ukraine. At the
same time, as I had mentioned earlier, the notion of the
prospect of closing the export corridor can have further
impacts on not only supply coming out of Ukraine, but then it
shifts the focus in terms of where the demand base needs to
originate from such as Central America, South America, and in
the U.S.
And so, really, I think in terms of factors that can reduce
that volatility, we had mentioned the various inputs from the
exchanges, in terms of position limits for speculative
purposes. But ultimately, I think the market will set the price
of what those commodities need to be.
Mr. LaMalfa. Certainly, all right. Well, as a farmer, I
certainly understand the aspect that on the farming side, at
least we are price takers, not price makers, applies more
widely to.
Ms. Crighton, what can end-users do to better prepare for
the next period of volatility? The end-users, what can they do?
Ms. Crighton. Yes. Thank you. It is a great question. We do
spend a lot of time with our clients, end-users included, to
think about how to prepare for the next round of volatility.
Really where we focus is predominantly around margin. What is
the sufficiency of margin that the clearinghouses are charging
on the portfolios? What do we think are potential shocks? What
are the sizes of those shocks? And how much may that increase
exchange margin? We work with end-users to think about what
their liquidity needs and to appropriately forecast what those
are. We think that is the best way for end-users and clients to
prepare for periods of volatility, being prepared from a
liquidity and funding standpoint to withstand that.
Mr. LaMalfa. Excellent, thank you. Thank you.
Mr. Edmonds, derivative markets are evolving faster than
the regulations can keep up with, so what would you propose for
us at the Federal level and the state regulators as well to
follow and ensure that developments are being kept up with at
least in a somewhat timely fashion?
Mr. Edmonds. I think you are seeking certainty at the end
of the day. And when proposed regulation comes before you and
you haven't a chance to opine on that, asking the question, why
is this helping the question of certainty? And if you can get a
very good answer you have confidence in, it is probably
worthwhile. And if you get an answer that you walk away from
very confused, it is probably not worthwhile at the end of the
day. The healthy tension we talked about, there are all agendas
that are represented here, and we see things in a very
different lens that sometimes has an impact on the regulatory
process. Sometimes that is captured correctly, and sometimes
that is captured incorrectly, and that is where we spend lots
of our time debating that issue. But ask the question why and
make sure for certainty.
Mr. LaMalfa. I appreciate that. I just came up the hall
from the Natural Resources Committee where I am constantly
confused at some of the environmental regulations and how they
have been reinterpreted over 50 years and come out of there a
little confused as what their goal is there.
So, Mr. Chairman, I appreciate it. Thank you, and thank you
to our panelists. I yield back.
Mr. Crawford. The gentleman yields back.
Ms. Crockett, I have to apologize. I should have recognized
you the last time. I hope you will forgive me, but you are
recognized for 5 minutes.
Ms. Crockett. Do not apologize. I will always defer to Ms.
Alma. Good morning, and thank you so much to all of you being
here, and thank you, Mr. Chairman.
We have heard a lot today about the benefits farmers get
from using futures contracts because it creates stability. I
have heard so many farmers and ranchers concerned about
changing global conditions. In fact, our first hearing was on
the uncertainty facing American agriculture. So it seems to me
that all farmers would stand to benefit from being able to
hedge against this uncertainty, which is what these products
that we have been talking about, what they do. Do I have that
right, Ms. Crighton?
Ms. Crighton. You do, yes.
Ms. Crockett. Thank you. But I do have some concerns. As I
was reviewing the USDA report from October of 2020, it states
that less than three percent of farmers are using these
options. Does that sound about right to you?
Ms. Crighton. I don't actually have that information, but
we would be happy to look into it and follow up with you.
[The information referred to is located on p. 83.]
Ms. Crockett. What is concerning if this is accurate is
that for decades, small farmers have lost their farms because
they can't compete with larger, better-resourced competitors.
In human terms, these farms, they represent someone's hopes and
dreams. In the case of new farmers, they don't have the same
opportunities. And so I am concerned that our small and/or
underserved farmers aren't using these tools because we know
that, sadly enough, the lender of last resort, the USDA, has a
troubled history when it comes to serving minority farmers
specifically.
So I must ask, Ms. Crighton, what is your firm doing and
what can this Committee do to increase utilization of these
financial products for beginning and underserved farmers?
Ms. Crighton. Sure. I will provide perspective from the
FIA's standpoint, and I will answer that really in two ways.
One, the FIA--and I think there are resources across the
exchanges and clearinghouses that provide information and
educational resources about how to effectively use these
markets for risk management purposes. Part of the challenge we
find at times is the amount of information that persists
throughout the system of what is available and how to access
the capacity that is available.
The other perspective that I will answer it from is, what
we think about really is providing access and how do we ensure
that we and other clearing members can continue to stand in and
provide capacity, and a lot of that really comes down to the
risk management topics that we are discussing today.
I think in terms of some more specifics to your question,
again, I think there are others within FIA and the firm that
can help provide information on follow up, and we are happy to
do that.
Ms. Crockett. I appreciate that. It just feels sometimes--
and not just in this space, I want to be clear--that there are
multiple financial services, right? Like there is one for the
largest growers, which we are hearing a lot about today, and
then there are ones for the hundreds of millions of small
farmers who face the same hardships with fewer resources at
their disposal.
Mr. Chairman, I hope that this Committee can work on these
issues to set our farmers up for success for generations to
come. And with that, I will yield back. Thank you so much.
Mr. Johnson [presiding.] Thank you very much, Ms. Crockett.
I will recognize myself for 5 minutes. Mr. Jackson, you are
on deck.
Ms. Crighton, you talked about the importance of analyzing
the sufficiency of margin and that that requires obviously
analyzing the potential shocks. I mean, give us some sense,
what types of events are assessed to create the most shocks? I
mean, not black swan events because I guess you guys are
thinking about them and talking about them, but what gray swan
events are most concerning to the system?
Ms. Crighton. Yes, thank you for the question. It is
something that we spend a lot of time thinking about, again,
really across our members and certainly internally. When we
look at what has happened over the course of the last few
years, I think as we have discussed over time, the number of
shocks, the number of 1-in-100-year events seem to happen more
and more frequently. So how do we prepare for those?
Again, the exchanges run their margin models. In addition,
clearing members typically run their own margin models, and we
compare and contrast those, right? We think there are a number
of different ways to be informed on better ways and more
efficient ways to risk manage, and we do take into account a
number of macroeconomic factors as we think about what are the
shocks to apply to a particular portfolio.
Mr. Johnson. But is there a particular type of event that
shocks the system in a particularly egregious way?
Ms. Crighton. I think we are finding there are multiple
types of events that can shock the system in an egregious way.
And we try and take into account what has history informed us
of the types of shocks, the magnitude of those shocks, and what
do we need to be prepared for on the forward? I don't think we
focus on any particular type of event, just the fact that they
can occur, they seem to occur more frequently, and ensuring
that margin models can predict or help users predict what their
margin requirements may move to.
Mr. Johnson. And you talked about the LME situation with
nickel in your testimony. On its surface it seems like the
cause is pretty obvious. People were concerned about the
availability of Russian nickel. Is there more to it, more
nuances to the causation that we should keep in mind?
Ms. Crighton. Yes, I think it goes back to a number of
items that we are discussing today. In terms of the volatility
control mechanisms that we have talked about the benefits of
from price banding, price controls, circuit breakers, position
limits, all of those are a crucial layer of controls that exist
at the exchanges themselves. We think U.S.- and CFTC-regulated
exchanges do a particularly good job in that regard. We think
in that vein they continue to be informed by market events and
refine those controls and improve them on the forward. That was
largely unavailable on the LME.
In addition, we looked at the size of the margin that was
being charged on the contracts themselves. We view that to be
insufficient. And then if we think about the skin in the game
layer that was available, and this is all publicly reported,
LME had $25 million as their capital at risk. Clearing members,
there was roughly 40 at the time, had $1 billion at risk. At
the end of the month, that was March of 2022. At the end of the
month margin levels had increased. Some circuit breakers were
put in place. The CCP capital at risk stayed the same at $25
million. Member contributions were doubled to $2 billion,
right? So it highlights the importance----
Mr. Johnson. So there were some impacts and some
improvements, lessons learned if you will?
Ms. Crighton. I think it highlighted some of the
deficiencies and the reactions to those deficiencies. And that
is what we are trying to really highlight here in our
conversations, ensuring that can't happen anywhere else.
Mr. Johnson. I mean, I am a lay person, but when I look at
$4 billion worth of trades canceled, that seems to me to be a
critical failure. But that is like the last place you want to
get to.
Ms. Crighton. We would agree.
Mr. Johnson. I can't imagine that happens very often with
American-based exchanges.
Ms. Crighton. We don't think it does, and we wouldn't
expect it to happen here.
Mr. Johnson. Yes.
Ms. Crighton. Again, the importance of each of those layers
of controls working in coordination with each other are
critically important. It is about aligning incentives from a
risk perspective, but each of those layers is foundational to
ensuring that that doesn't happen here.
Mr. Johnson. So we had some good back-and-forth with I
think Mr. Bost, Mr. Sammann about some of the differences. But,
Mr. Edmonds, let's talk about ICE. Could something like that
happen on ICE?
Mr. Edmonds. Just to be clear, your question is could
something like LME happened at ICE?
Mr. Johnson. Right.
Mr. Edmonds. We have all the same controls that have been
referenced by Mr. Sammann and Ms. Crighton here. I have said
this a couple of times today. It is about certainty. It is
about certainty of how we are going to behave. It is about
certainty that we, the clearinghouse or the exchange, are going
to execute our rulebook because that is what all of the members
and the customers expect us to do at the moment in time. And in
the case of LME, I think it is pretty clear in what is being
publicly reported that that did not happen.
Mr. Johnson. Last question, Ms. Crighton. We talked about
some of the reforms LME has made to learn lessons from that
shock to the system. What percentage of the way are they to
completely have integrating these lessons learned?
Ms. Crighton. We think they have made a number of
improvements. They still have a number of things to do. There
have been studies that have been conducted by independent
consultants that we are continuing to wait for data from the
market to inform additional steps that they need to take. The
Bank of England has also been doing a review and recommending
actions that they need to take as well. So we think they are
part of the way through. They are not all the way through.
Mr. Johnson. Thanks very much. I am over time. Mr. Jackson
and then Mr. Mann is on deck.
Mr. Jackson of Illinois. Thank you very much. Thank you,
Mr. Chairman. Thank you, Ranking Member Scott.
I have the great opportunity to be a runner at the Chicago
Board of Trade, a runner at the New York Stock Exchange, and
now that world has gone away because of technology and
electronics. And so let us say that evolution is natural and
risk is not a bad four-letter word, that it is something that
we have to live with. We are going to have risk in energy, risk
in weather. Risk is here to stay.
Mr. Gelchie, I would like to first direct a question to you
and your testimony. You reference the self-policing effort of
the commodities exchanges. I would like to get further
information on why you would say that we can look forward to
self-policing as a good thing. We have seen in our lifetime the
long-term capital, we've seen Morgan Stanley, we have seen
Lehman Brothers, we have seen risk that was supposed to have
been contained because of self-interest and some economic
theories. How can we ensure that self-policing is the best
mechanism to have an orderly market?
Mr. Gelchie. Sure. Thank you, Congressman. I think when I
refer to self-policing and the gold standard of risk
management, I think many of the comments today, by the
panelists here I think reflect the notion of position limits
that the oversight here of this Committee, to the CFTC, the
interrelationship that they have with the various exchanges,
the compliance, individuals within the exchanges and their
interaction with the various members. So to me, it is that
regard of being as close to the trading itself that ensures a
robust discussion should volatility come up that reflects the
need to elevate and escalate. I think we have the appropriate
mechanisms in place within the U.S. markets here to address
that. And thus, my point being the self-policing methodology is
best-in-class.
Mr. Jackson of Illinois. Okay. Thank you.
Ms. Crighton, we have seen a concentration now, the
clearinghouses after market shocks and after market challenges.
Is this a good trend or is it a bad trend in your opinion?
Ms. Crighton. Yes, thank you for the question. It is
definitely something we worry about. The area specifically that
we focus on is the concentration or the reduced number of
clearing members that are providing capacity to the system. If
we look at the last 20 years, the number of clearing members
providing capacity has reduced by about half while the margin
in the system has increased by about 600 percent. Just by that
magnitude alone, you can see that there are some capacity
considerations. There are really high barriers to entry. There
are high barriers to continuing to wanting to provide capacity.
But it is something that we do worry about, and it is a
concerning trend.
Mr. Jackson of Illinois. Thank you.
Mr. Sammann, thank you for your leadership at the CME.
That is a shameless plug for the Chicagoans that are in the
Agriculture Committee. But I am proud to be on the Agriculture
Committee from the First District of Illinois in the City of
Chicago. And Chicago still has the leadership for the nation
and the world in this market in these derivative products.
Anything on the horizon that you can see that would be a
challenge or what we can do as regulators to make sure that we
keep this great financial piece of architecture in the City of
Chicago, more importantly, in the United States, that we
continue to have the edge, if you will, on this open market
with securitization and transparency and liquidity?
Mr. Sammann. Yes, we absolutely support the engagement we
have with the CFTC. As we have talked about tangentially, but I
just want to say directly, coming through Dodd-Frank, speaking
from an exchange point of view, we were concerned that coming
out of the financial crisis of 2008 and 2009 that with the U.S.
regulatory jurisdiction going first and what looked like a
significant lift and change to how margin practices and how
businesses are run, we thought that there was a real danger
that that would push markets out into less well-regulated
jurisdictions and outside of the U.S.
In the reality how it worked out is Dodd-Frank was the
first to be minted to the point that you have heard from all of
us today and in our testimony, market participants need
determinism. They need to know the governance of the clearing
firms and the clearinghouses and the exchanges on which they
operate. So when something happens, they know the rulebook says
it is going to do this. That is, coming back to the standing
Chairman's point, did not exist in the LME, kind of made up
rules on the fly.
So I think to answer your question directly, the most
important thing we can do to maintain leadership in the global
derivatives industry to make sure that markets trade on CFTC-
regulated markets that are represented across this panel here
today, well-regulated markets continue to partner with the
industry and with the providers through FIA, through the
exchanges, through the clearinghouses and the Commission
through commitments, to make sure that we are listening to
customers, we are being innovative in how we develop and
advance our markets in light of what is certainly not a
decreased amount of risk in the world. Energy transition is
tangential to what we talked about today, but it impacts
everything. So we think that is an important part to get in
front of. So thank you for your support, and hopefully, that
answered your question.
Mr. Jackson of Illinois. Thank you for your participation
and all of the witnesses that gave testimony today. I think
someone is knocking on the door.
Mr. Johnson. Thank you, Mr. Jackson.
Mr. Mann will be followed by Mr. Casar.
Mr. Mann. Thank you, Chairman Johnson. Thank you all for
being here this morning. I represent the First District of
Kansas, which is about \2/3\ of our state, one of the biggest
ag-producing districts in the country. My district is about the
same size as Illinois, which is large for some, small compared
to Dusty Johnson's district of South Dakota.
But, we grow a lot of beef, number one wheat producer in
the country, number one sorghum producer in the country. I am
constantly viewing all these issues through the eyes of our ag
producers, making sure that these markets function for the
folks that are growing these crops.
First question would be for you, Mr. Gelchie. I understand
when you started off with your company, you came to Kansas and
were auditing the grain levels in some of our elevators. How
would you say what you do today impacts producers in Kansas and
throughout this country? And explain the important role that
your company plays in these markets and everyone's interest in
making sure all these markets are functioning effectively?
Mr. Gelchie. Sure. Thank you, Congressman. Again, what I
would say is Louis Dreyfus harmonizes the very different needs
of its customers. I had mentioned earlier as to the fact that
we have buyers, sellers that we transact with on a variety of
different agricultural products on a minute-by-minute basis,
right, whether that is at our production facility in Claypool
or at our ethanol facility in Grand Junction, for example. But
also from a global standpoint, as these markets are global, we
have producers from Brazil that may be hedging through and
selling us cash contracts that we in turn hedge into the
futures markets.
So what I think our role, if you will, is to provide them
with the services, understanding of what is happening in our
view in terms of the underlying markets that are most
interesting to them to give them the information they need to
hedge and price effectively. And then at the same time, we
warehouse much of that risk in our book as a hedger. And so we
are perpetually getting in and out of these derivatives markets
as a result of the transactions that our group is involved in.
Mr. Mann. And then if you could speak to speculation a
little bit, in your testimony you discussed the importance of
speculators in the market. Can you elaborate on why you believe
speculators are important to a healthy market and how that
impacts our ag producers all over the country?
Mr. Gelchie. Yes, thank you. Again, it is our view that in
order to encourage deep and robust markets that speculation is
a required element of the market. As a hedger, we often rely
also on that speculative activity to provide enough volume for
us to hedge into those markets. So in our view, the necessity
of the speculator, provided that they are managed appropriately
by the exchanges, vis-a-vis position limits, is a crucial part
to market participation.
Mr. Mann. Yes, I agree. And I think it is an important
thing that we have to keep bringing up and making sure that
everyone involved understands their important role.
Next question would be for you, Ms. Crighton. In your
testimony, you mentioned forthcoming revisions to the bank
capital standards. Can you elaborate more on the interaction
between capital standards and access to clearing services and
what you kind of see happening here moving forward?
Ms. Crighton. Sure. We think bank capital standards have a
direct impact on the amount of clearing capacity that clearing
members can provide. The more punitive those capital standards
are, the less ability clearing members have to potentially
provide much needed capacity to end-users and other investors.
As we think forward, and we know there are new phases of
the Basel rules coming, we would encourage policymakers and
regulators to ensure that bank capital rules don't become even
more punitive to banks. Otherwise, that will impact their
ability to provide capacity.
Mr. Mann. Great, thank you.
One last quick question for you, Mr. Edmonds. How can we
best anticipate and manage the emerging risks to cleared
markets? What is the best way in your view that we look ahead?
It is easy to look back. How do we anticipate what is coming
down and how we manage that risk?
Mr. Edmonds. Well, we look around every corner, right? I
mean, ultimately, at the end of the day, that is our job to
make sure that we are prepared for as many things defined, as
Mr. Johnson was asking earlier about, what are we looking for,
it can be anything that impacts the price. It can be
regulation, it can be the lack of regulation, it can be
disruption in shipping lines, it could be cyber, as we have
learned as an industry over the past month or so. All of those
things have an impact that we have to be prepared for, and we
are never going to know everything, but we have to let people
know how we are going to behave when something unknown is
staring us in the face.
Mr. Mann. Great. Thank you. With that, Mr. Chairman, I
yield back.
The Chairman [presiding.] I thank the gentleman. I am now
pleased to recognize the gentleman, Mr. Casar, for 5 minutes.
Mr. Casar. Thank you, Mr. Chairman. I am still getting used
to this microphone.
So egg prices, as we know, have doubled for consumers in
the course of about a year, going from $1.78 in December of
2021 to $4.25 in 2022 for a dozen eggs. And the production and
distribution of eggs, as we know, is dominated by just a
handful of companies. The Big Four meatpacking corporations
control, as we heard in recent testimony, about 85 percent of
the beef market. Beef prices are up by double digits, and these
company's net profits have increased considerably, potentially
by over 300 percent through the course of the pandemic. In my
view, it is up to us to help working families and to set up an
economy that works for small businesses and agriculture, not
just the big guys.
So, Mr. Berkovitz, my question is for you, sir. Thanks so
much for your service and for your testimony. We have heard a
lot and talked a lot about in this Committee and others about
Russia's war on Ukraine and its contribution to inflation,
supply chains, the pandemic, but haven't heard as much about
how anticompetitive practices and market consolidation also
contribute to the volatilities that we have seen for consumers
and in commodities markets. So in your view, to what extent
does market consolidation contribute to those price increases
and to market volatility?
Mr. Berkovitz. Thank you, Congressman. I can't really
separate out that component in terms of all the factors that
you have mentioned in terms of the risks and whether indeed--I
wouldn't be the appropriate person to say exactly what that
impact would have been, particularly in light of all the other
factors that have contributed to the price.
But each one of these components itself contributes to a
certain degree, and that is why the markets exist. To say,
well, there is a whole world of risk out there. I am a small
business, I am a small farmer, I might not have all these
tools, but if I can access a market and I can go on a futures
market and get certainty as to what price I am going to get for
my product, then I am going to go on the market and lock in
that price.
Mr. Casar. Understood. And I appreciate that is part of the
mission of the CFTC, as you so perfectly put in your testimony,
that the mission is the integrity of those commodity markets,
to prevent manipulation, and promote fair competition amongst
market participants. I saw in your testimony--good work--and
conversation about regulating rampant speculation, regulating
against fraud. But in your view, does the CFTC have a mandate
to think about competition when they are trying to achieve that
mission of making sure there is fairness amongst market
participants? So do you think that there is a mandate to better
regulate competition in those markets?
Mr. Berkovitz. Competition in terms of the services we are
talking about in terms of access to the market and getting
access to the market and clearing--there are multiple
clearinghouses, there are multiple exchanges, there are
multiple futures commission merchants, there are different
people competing within the derivatives markets in the futures
industry for customer business to provide services. The CFTC's
mission and charge in the statute is to provide fair
competition in the provision of those services. We are not a
fair competition in terms of the Federal Trade Commission in
terms of generalized economic competition in the economy.
Mr. Casar. But when the underlying economic conditions have
had such consolidation, do you not think that within the CFTC's
mandate that should be something that you are ultimately----
Mr. Berkovitz. Well, one of the things I was particularly
concerned about is something that has been mentioned by other
panelists here, consolidation in the futures commission
merchant sector in terms of the availability of multiple
futures commission merchants, particularly for farmers and the
smaller traders. We have seen a large shrinkage in the number
of FCMs over the past decade or so. The number continues to
decrease. It hasn't been a particularly profitable business, so
that is the type of competition that the CFTC should be focused
on.
In terms of whether there is too much consolidation in an
industry like an airline industry or some other types of
industries, that is not really the CFTC's mandate.
Mr. Casar. Well, and I think there is a storied history to
all of these agencies. There is a lot in the authorizing bills,
and so it is something we would like to continue to dig in on
the issues you have raised but some of those underlying issues
where might we have the ability to stand up for some of these
smaller businesses, smaller market participants to have a fair
shake. Thank you. And I yield back my time. Made it right at 5.
The Chairman. There you go, perfect. The gentleman yields
back.
Now, I am pleased to recognize the gentleman from Iowa, Mr.
Feenstra for 5 minutes.
Mr. Feenstra. Thank you, Chairman Thompson and Ranking
Member Scott. And I want to thank our witnesses for being here
today and discussing these important issues. They are very
critical.
In my district, the global commodity markets play a
critical role in mitigating risk and providing certainty for
our farmers, our producers, and obviously, our small
businesses. And during periods of extreme volatility derivative
markets provide predictability and allow our rural communities
to prosper. It all goes together.
So my question, Ms. Crighton, following the market
disruptions we saw during the early days of the pandemic and
Russia's invasion of Ukraine, end-users saw clearinghouse
initial margin requirements rise significantly. Both events
caused liquidity demands totaling over $100 billion for market
participants. In order to hopefully lessen the severity for
future liquidity crunches, do you think it makes sense for
clearinghouse margins to be enhanced so that there are more
robust and stable market cycles, both in the good times and the
bad times?
Ms. Crighton. Yes, thank you very much for the question. As
I mentioned before, margin generally is something we spend a
lot of time thinking about and discussing and as FIA working
with the clearinghouses and suggesting different ways to
improve the margin regimes.
I think I will credit the CFTC's MRAC committee. Through
that committee, originally under the sponsorship of then-
Commissioner Behnam, now under the sponsorship of Commissioner
Johnson, we convened a group of clearinghouses, end-users, and
FCMs to discuss topics under the guise of CCP risk and
governance. One of the most critical topics we discussed in our
view was margin, and we produced a paper that is in front of
the CFTC now. We are hoping that we will have further
consideration as we get through the governance proposals that
they have moved forward.
To your point specifically on the large and dramatic
increases in margin, it is something that we do worry about. We
think it increases costs to end-users. We think it creates a
destabilizing effect, ultimately having the potential for
systemic risk, right? In times of low volatility, we think
margin levels decrease, and they ultimately end up too low. In
times of high volatility, margin rates ultimately end up
needing to chase the risk, becoming incredibly high, increasing
short-term funding demands on clients. As you have multiple
end-users and clients looking to source those same short-term
liquidity, it increases costs for end-users across the board.
So what we want to do is we are encouraging for the
introduction of floors, the constant reevaluation for the CCPs
that do have them in place so margin levels can't go too low in
times of low volatility. It sort of mutes the impact when the
margin increases need to chase that risk up and we think
creates a more stable funding environment for end-users.
Mr. Feenstra. So for the CFTC, I mean, what do you think--
your paper that was sent to them, when do you think we will
hear from them? Have they given you any information that or----
Ms. Crighton. We are hoping for the second half of this
year. We had provided some recommendations from a governance
standpoint, that, and we had also provided rule text in that
regard. That is being considered by the CFTC for vote on those
rule proposals shortly. We hope once that moves through, then
we can focus as a group on the margin recommendations that were
made. So we are hoping for the second half of this year.
Mr. Feenstra. Thank you, Ms. Crighton.
Ms. Crighton. Thank you.
Mr. Feenstra. Very valuable. I have a quick question for
Mr. Gelchie. In your testimony, you discussed the limited
availability of the dollar currency exchange. Can you quickly
expand on that point and how it impacts your ability to manage
your business?
Mr. Gelchie. Sure, thank you, Congressman.
It strengthened the U.S. dollar, but relative to interest
rates here have actually created a void of dollars overseas
with respect to end-users. So from that standpoint, it has made
it a bit challenging for some users overseas of the U.S.
products in terms of opening up letters of credit, for example.
So that in and of itself has been one of the challenges that we
have faced as a result of perhaps an accelerated interest rate
increase. That is right, yes.
Mr. Feenstra. Thank you.
Ms. Crighton, just one more question. I have 40 seconds
left. A recent survey by the Committee on Payments and Market
Infrastructures indicated that only around 20 percent of the
clearinghouse provides tools for end-users to estimate how
their margin requirements could change during periods of market
volatility. I am going back to this. Can you speak more about
the possible solution clearinghouses could make to enhance the
transparency of margin requirements to help farmers and
ranchers and other users better prepare for these future stress
events? Ms. Crighton?
Ms. Crighton. Apologies. I wasn't sure if that was for Mr.
Edmonds. Yes, we do think tools from clearinghouses would be
helpful, web-based tools, information that is provided to the
clearing members to be able to then share with their end-users
and clients. We think there are a number of different ways that
that information can be disseminated through the system. We
think the education needs to happen. The transparency needs to
happen up-front rather than through disclosures that happen
multiple months or quarters behind.
Mr. Feenstra. That is right. Thank you so much, Ms.
Crighton.
Ms. Crighton. Thank you.
Mr. Sammann. Can I just add one thing to that very quickly?
Mr. Feenstra. Sure.
Mr. Sammann. I know the question came how can you sort of
get an assessment for that margin requirement, just to be
clear, at least on the CME Group side, we have a tool to allow
customers to upload a portfolio that will calculate the margin.
This is a pre-trade tool because margin has become an important
part in cost of capital, as you talked about today.
Mr. Feenstra. Right.
Mr. Sammann. It is making everything more expensive. So
from a transparency point of view, enable customers to upload
portfolios that they might trade and say this is what the
margin requirement would be.
Now, in terms of forward-looking how that might change,
that is less clear, but in terms of the ability to have an
assessment, this is the margin that would be required to carry
this sort of position. Those tools exist. And that is an
important pre-trade risk decision that customers have access
to.
Mr. Feenstra. Significant. Glad to hear that. Thank you,
and I yield back.
The Chairman. I thank the gentleman.
Now, I am pleased to recognize the gentleman from
California, Mr. Carbajal, for 5 minutes.
Mr. Carbajal. Thank you, Mr. Chairman. And thank you to all
the witnesses being here today.
Mr. Berkovitz, you mentioned that some of the events
leading to market volatility could not have been predicted like
COVID and Russia's war in Ukraine. Could you speak to what
extent you have seen the volatility in agricultural commodity
markets impact farmers' and producers' ability to use the
derivatives market for price risk management?
Mr. Berkovitz. Thank you, Congressman. I think one of the
items that has been mentioned by a number of panelists is the
margin requirements, the certainty of margin requirements, but
also the level of margin requirements as volatility goes up and
prices go up. These margin requirements, which is how much
money you have to put up when you place a trade, increases and
therefore makes the cost of hedging more expensive. So the time
you need the hedging the most, the price increases, which makes
it even more difficult to use these risk management tools. So I
think that is the primary concern that I have heard regarding
margin and prices.
Now, generally, it is also talked about, it is a fairly
sophisticated market. These tools, it takes a fair degree of
sophistication to use them, so there needs to be, also has been
discussed, an educational effort to make sure that the market
participants and farmers know what the advantages of the tools
are and know how the tools can benefit them.
Mr. Carbajal. And how do you think we could expand that
education?
Mr. Berkovitz. Well, I think market participants have a
function in that, and CFTC has a component. If you look at the
CFTC's website, it has educational materials on the markets. So
I think it is a combined effort to make CFTC transparency and
benefits but also the industry and I know the exchanges and the
brokers, the futures commission merchants also have a program
to do that as well.
Mr. Carbajal. Thank you. In your testimony, you spoke to
systemic risks and the tools we have in place to avoid them.
Could you elaborate further on the nature of these systemic
risks and the barriers to their mitigation?
Mr. Berkovitz. Well, there are a number of risks, and one
of the critical functions of the markets and the other
witnesses at the table is the system that we have of clearing.
So when you put on a trade, the clearinghouse, your trade
actually of the counterparties is assumed by the clearinghouse.
So it is basically guaranteed. And we have a system of futures
commission merchants that if you are a farmer and you want to
trade and you want to hedge your crop on the exchange, you go
to a futures commission merchant, the futures commission
merchant will trade on the exchange, the futures commission
merchant will post margin and then collect the margin from you,
the farmer. So at the clearinghouse is all the funds deposited
by the futures commission merchants and ultimately, the
customers, and it is guaranteed by the futures commission
merchants, and that has been discussed also. So all the trades
on the clearinghouse are guaranteed.
Now, in extreme market events when people are stressed and
there is a lot of stress in the system and possibly there might
be adverse price movements that somebody might default on, that
places stress on other members. And in times of extreme stress
when many people are stressed, then other people have to put up
money for the defaulted trades, and that creates systemic risks
because it is the system. Somebody has got to pay for it, and
if it is a very large market participant that fails, then other
people have to put up a large amount of money for it.
So those types of systemic risks and these extreme events
where a lot of people are losing money and other people might
have to cover the trades, those are the types of systemic risks
that the regulatory system is concerned about and has all sorts
of mechanisms to prevent those buildups and all sorts of
mechanisms to ensure that there is trade on the performance
because the last thing you want is a domino effect where
failure of one person means another person fails and their
failure means another person, and that is a systemic failure.
So we have built up a system that was strengthened by the
Dodd-Frank Act to prevent those types of consecutive or
multiple failures. But nonetheless, we are always looking at it
and always looking for ways because each time there has been a
failure, each time there has been a systemic risk, it hasn't
been anticipated before. So we are trying to anticipate the
unanticipated and build robustness in the system and always
have to look and see whether it can be improved.
Mr. Carbajal. Thank you, Mr. Chairman. I yield back a whole
6 seconds.
Mr. Baird [presiding.] Thank you for your testimony, and I
appreciate all the witnesses being here. Mr. Moore, I think you
are up next.
Mr. Moore. Thank you, Mr. Chairman.
Mr. Sammann, energy prices are important to families and
businesses in my district. How have the disruptions from COVID
and the Russian invasion impacted American energy policies?
That is pretty broad.
Mr. Sammann. I am sorry. Can you repeat the question?
Mr. Moore. Yes. That is pretty broad. So how has the war in
Russia and COVID-19 impacted American energy prices? You can
talk about policy as well, but I would like to hear your take.
Mr. Sammann. Yes. So I will take a stab at that. Chris, you
can take a stab at that. We talk to customers every day about
what rising prices, what rising interest rates, what change in
value of the dollar means for our customers. There are so many
ways in which the U.S. economy and users and, frankly, the
infrastructure is impacted by this, number one. And certainly,
Mr. Edmonds can talk about this. With Russian crude oil and gas
coming off the global market due to sanctions, that
fundamentally has shifted the physical flows of crude oil. Now
the U.S. exported, I believe, a record for 4.1 million barrels
a day of U.S.-sourced WTI out of the U.S. just last month.
Natural gas sourced here in the U.S. is being exported at
record capacity right now only limited by the LNG facilities to
liquefy and ship that gas out to Europe and Asia as that market
has lost its ability to import piped gas from Russia. So you
have some structural shifts in the global energy market. You
have crude oil coming out of the Gulf and Saudi Arabia, which
that takes on a very vastly different important impact, given
the fact that oil can't go from Russia into so many other
sanctioned countries right now.
So you have a structural shift in energy markets, you have
had a significant impact, which initially drove energy prices
up, well, energy is an input cost to almost everything. We
talked about the impact of fertilizer, the impact of farmers
running diesel in your tractors, what we pay at the pump, what
we pay at the store for bread. It has impacted almost
everything. It is integrated into the risk that we engage in
our lives. So that war has impacted, taken 25 percent of the
global wheat off the market. You have sunflower oil and
rapeseed oil not coming out of the Black Sea. So it impacts us
in so many ways.
The one thing that I would say is the biggest impact is the
structural change in global flows of energy, particularly crude
oil and natural gas. And as I think Mr. Edmonds mentioned
before, there are some decisions around infrastructure here in
the U.S. that will impact those decisions and what that looks
like over time.
Mr. Moore. Yes, input costs in the data--and my cousin is
trying to start. He is a young farmer. And he told me, I asked
him, I said, how is it going, Garrett? And he said, well, he
said I budgeted for $3.31 a gallon diesel fuel when I was
starting, and he said that certainly--he is missing a number. I
had a great crop but no profit at the bottom end.
Mr. Edmonds, do you want to touch on any input that we
missed on----
Mr. Edmonds. The input is the point that we have made. I
mean, the margin, all of what Mr. Sammann just said creates
volatility, margins go up. It is not just the clearinghouses
that were represented here that are the margin. It is also the
clearing members. The clearing members also from time to time,
based on their risk profile, maybe of your cousin, maybe of
other participants that are out there make their own credit
decision, and they add on top of that. So as margins increase
because of the general market volatility, so does the review
the clearing members put on there. So there are constraints on
that, but we have to react to what is out there because what
you don't want is us sitting in front of you explaining why we
didn't execute our rulebook and there has been a large systemic
issue that Mr. Berkovitz just explained in the previous
question.
Mr. Moore. Mr. Edmonds, to follow up, I had a question I
wanted to address to you. How can we best anticipate and manage
emerging risks in cleared markets?
Mr. Edmonds. Well, we have to learn from our history, A. We
have to make sure that our models take into consideration
things that we have observed in the history. We also have to
make sure that we are doing an appropriate level of discounting
of some of those events that, because of regulatory changes,
are unlikely to happen again. It is not zero, but instead of it
happening every day and impacting the price and margin every
single day, we might discount that because we learn from the
past. We put that into the go forward look at it, as Ms.
Crighton referenced earlier.
So we are not going to anticipate everything, but what we
can do is be crystal clear of when something like that happens,
how we are going to respond to it. And I think that becomes the
most critical point of it, of how we respond to the unknown
that is now coming and staring us in the face.
Mr. Moore. Thank you. Mr. Sammann, do you want to follow
up?
Mr. Sammann. I will just add one more thing. We have talked
a lot about margin here today, and I think what we haven't
differentiated is initial margin, which is the amount of
collateral you put up to carry against taking on a derivative
position, and variation margin. And to be very, very clear, if
you look at the variation margin that flows, the variation
margin is the value that is exchanged between winning positions
and losing positions every day. That is a daily mark-to-market.
Now in the CME Group exchanges, it is twice a day mark-to-
market.
So when we talk about margin going up, a portion of that,
yes, is initial margin where, as volatility goes up, you expect
as a Prudential Regulator or the Committee that oversees our
Prudential Regulator, that we would require more collateral in
the system, which is still a low percentage of face value of
the overall contract value. But it is critical that we
understand that variation margin, i.e., mark-to-market twice a
day every single position, eliminates and pulls that systemic
risk out of the system so enormous losses are not allowed to
accrue. That is the danger of bilateral transactions, so we
want to be very clear about initial margin. That is a
conversation that we are going to have, but the variation
margin is that daily mark-to-market. You want us to be doing
that every single day to make winners whole and make losers
pony up more funds to make sure they are making whole on the
other side.
Mr. Moore. Thank you. I am out of time. I appreciate the
panel being here. You all are one of the best I have heard in a
while. Thank you. I yield back, Mr. Chairman.
Mr. Baird. Thank you. And the gentlelady from Connecticut,
Representative Hayes, is up next.
Mrs. Hayes. Thank you, Mr. Chairman. And I know that
Chairman Thompson left, but I do want to note that I
appreciated the way that he used his time in today's hearing.
It was very helpful for me. Thank you, Ranking Member Scott,
for holding this very important hearing and to all the
witnesses who are testifying today.
A 2020 study by USDA's Economic Research Services found
that small farms with less than $350,000 in gross cash farm
income are less likely to use futures or option contracts in
their businesses. Small farms account for 89 percent of the
farms in the United States and 93 percent of the farms in my
district in Connecticut. My district's small farms and dairies
are particularly susceptible to market volatility and rely on
robust and well-regulated commodity markets to keep their
businesses afloat. But unfortunately, the Commodity Futures
Trading Commission, the agency tasked with overseeing this
activity, has not been fully authorized in over 10 years.
Ms. Crighton, in your testimony, you pointed to
international events which contributed to market volatility
like the Russian invasion of Ukraine and the volatility of
nickel on the London Metals Exchange. You went on to mention
several instances where CFTC led the way to risk controls and
market transparency. In 2013, when the last long-term
authorization of the CFTC lapsed, the Futures Industry
Association submitted a letter to the Senate Agriculture
Committee making recommendations for the reauthorization. In
your view, has the CFTC had the necessary tools to be an
effective global leader? And is a full reauthorization
necessary to update their authority? And before you start your
answer, just congratulations on being the lone woman on that
panel.
Ms. Crighton. Thank you very much, and I appreciate the
question. I will answer it in two parts, one for the topics
that we have talked about today. We actually think the CFTC is
fully authorized to interact all the topics and the issues that
we raised. Consistent with the letter that FIA filed in 2013,
FIA fully supports the reauthorization of the CFTC. But thank
you again for the question and the congratulations.
Mrs. Hayes. Thank you. Mr. Gelchie, what impact does global
commodity volatility have on smaller producers that may not
directly interact with futures or options contracts? And do you
agree that properly updated practices protect everyone in the
agricultural sector?
Mr. Gelchie. Congresswoman, thank you for the question. I
think first, to your point in terms of small farmers' access to
futures markets, that also is perhaps a service that Louis
Dreyfus has provided to those farmers. To that point, I mean, I
think some of the inputs that we get from small farmers is that
hedging and/or having positions with FCMs is expensive and it
does require cash management. And from our standpoint, we feel
that we have been essentially that shock absorber to that
community.
Mrs. Hayes. Thank you. And I think that is why I noted my
appreciation for Chairman Thompson's comments. Much of what we
are talking about is very high level, but somebody has to
advocate for the little guy. And we have to make sure that the
work that we are doing goes all the way down and reaches those
93 percent of farmers in my district.
It looks like you want to--go ahead.
Mr. Sammann. I just want to add a quick point. So this has
been raised two or three times. I have been remiss in not
saying this before, but you make a really, really good point.
Mrs. Hayes. Well, thank you.
Mr. Sammann. There are a number of small ranchers and
farmers out there that don't have access to the wholesale
market. So one of the things we do, we try to meet the needs of
all of our customers, especially farmers, ranchers, small
family farmers. We have partnered with land-grant universities,
agricultural trade associations, regional introducing brokers,
those intermediaries, co-ops to get education, training,
understanding. We send our agricultural sales team out to 4-H
club and every state fair to get the word out. It is such a
dispersed group of users, so we have to go through not just our
own channels but sort of those institutional sales channels and
access points to make sure that there is an understanding for
these tools being available and how do we connect those end-
users.
So it is a great point that I am sorry I hadn't said it
before, but I just didn't want to miss that opportunity to talk
about the ways that we are using our own sales efforts that
connect with those folks to connect them with the markets.
Mrs. Hayes. You just said 4-H clubs. You are speaking my
love language. But I really do appreciate that because it is
one of my priorities as we go into the next farm bill to make
sure that farmers at every level of the sector, all markets get
the benefit of the work that we do here and that we are
intentional in the way that we legislate to make sure that the
impact is felt across the whole agricultural sector.
I have another question. I have 3 seconds. I want to be a
good student, so I am going to submit it for the record and
look forward to hearing a response to that. Thank you Mr.
Chairman. I yield back.
Mr. Baird. Thank you, Madam Hayes, and I appreciate you
being here with us today.
Next up is Mr. Rose, Representative John Rose from
Tennessee.
Mr. Rose. Thank you very much, Mr. Chairman. Thanks,
Chairman Thompson and Ranking Member Scott, for holding this
important hearing, and thanks to our witnesses for your
valuable time today.
Mr. Berkovitz, the U.S. is unique in that we have separate
securities and derivatives regulators. Do you think that having
separate regulators promotes market efficiencies?
Mr. Berkovitz. Historically, the reason we have separate
markets is because the commodity futures markets started in
agriculture with agricultural commodities and then securities
market developed differently. I think the system we have here
actually is very beneficial to our capital markets and promotes
both our securities and our commodity markets. I have worked at
both agencies. Both agencies are excellent agencies. Maybe if
we were starting out historically, had a clean slate, you might
put them both in the same agency, it would make sense from an
academic point of view, but I think as things have developed
and as things as they are now, I think the system is working
very well. I think each agency is doing its mission, and I
think that having a separate CFTC gives the prominence and
attention to the derivative markets that it deserves and the
farm communities and the importance of these markets to the
farmers and ranchers and agricultural sector is reflected in
that there is an agency, the Commodity Futures Trading
Commission, whose mission is to ensure that their interests and
the markets are fair and working for them. I think if you
combined both agencies and had one big agency, that mission may
not be as important as it is in the CFTC's mission right now.
I think the proof is also in the pudding is we have the
strongest and most liquid and safest capital formation
requirements globally, and we have the strongest, most liquid,
most efficient price discovery and risk management markets in
the world. This country and our markets are the leader globally
both on the derivatives side, on the securities side, and it is
due both to the market participants, but it is also to the
strength of the regulatory system. So I think our regulatory
system is actually very effective and enabled this country to
be a leader in all those markets.
Mr. Rose. Thank you. And I am curious about the opinions of
the other witnesses on the panel. So if you might just go from
my left, your right across, combined or separate, one word
answer.
Mr. Gelchie. I would agree with his statement.
Mr. Sammann. Remain separate.
Ms. Crighton. I would defer to Congress on that.
Mr. Edmonds. I will go with separate.
Mr. Rose. All right. Thank you very much. One of the major
themes of this hearing are the risks of black swan events to
the global derivatives markets. I would like to ask each of
you, are there any unlikely but plausible black swan events
that could pose a systemic risk to the global financial system
that any of you are worried about but that have not yet been
raised in this hearing today? And again, we will start on the
left, and you can go across with the limited time we have.
Mr. Gelchie. I would just say continued and increased
geopolitical tensions.
Mr. Sammann. Yes, I am not in the habit of being good about
figuring out the unknown unknowns. However, I would say
something that we haven't really talked about today is cyber
risk, and that is something that I know that we all are
cognizant of, and it is an industry body issue. It is an
individual firm issue. Every one of us faces that at a personal
level and on a corporate level, so that is one that it is a
known unknown, and I think that is something that is
systemically important to us. And I think we have working
groups across our industry, as well as with the government as
well to do the best we can to prepare for if and when that
happens.
Ms. Crighton. Two items I will touch on, one is clearly
cyber. I think Mr. Sammann said it well. The other is really
the systemic risk that we think a large default or other market
destabilizing event at a clearinghouse would have on the
ecosystem at large. I referenced Mr. Berkovitz's comments as
well in that regard. I think that is something that is worthy
of more exploration and discussion.
Mr. Edmonds. We are all going to say cyber, but I am going
to tell you that because of the global nature of our markets
and the interconnectedness of the players in these markets that
we have today, inconsistent regulation that is out of scope is
a big unknown that you don't know how other regulators are
going to react in a moment of stress.
Mr. Rose. I have other questions, but in view of the time
remaining, I might just end by saying I know by definition I am
asking you to think about the unknown unknowns, but I would
just ask you all to go back and contemplate that and share with
us anything that we might be missing that comes to mind.\4\
---------------------------------------------------------------------------
\4\ Editor's note: the responses to the information referred to are
located: for Mr. Gelchie, on p. 82; Mr. Sammann, on p. 83; Ms.
Crighton, on p. 84; Mr. Edmonds, on p. 84; and Mr. Berovitz, on p. 85.
---------------------------------------------------------------------------
Thank you, and I yield back.
Mr. Baird. Thank you. The gentleman yields back.
And next up, we have the gentleman from Georgia,
Representative Bishop.
Mr. Bishop. Thank you very much, Mr. Chairman. I apologize
for my tardiness in getting to the hearing. I want to, again,
welcome the witnesses and thank you for your contribution to
this very important discussion.
Market volatility obviously is something that affects all
of agricultural production and products, and I would just like
to--as you talk about the risk management that accrues to all
of our producers across the world but particularly here in
America, and as we lean into our preparation for the next farm
bill, I would like to ask each of you from your perspectives,
and you, of course, at the high level, but as we focus on the
farm bill and the safety net for American farmers and how the
farm bill will ultimately impact the global market in
agriculture, if you could just reflect quickly on what we need
to really focus on in the farm bill in terms of the ag
marketing services, its management, Farm Credit in order to
have the safety net built into our farm bill and our
preparations going forward. What do you think we need to make
sure that we take into account from your perspective, each of
you, if you would?
Mr. Gelchie. Thank you, Congressman. I would say, first,
support prices and stability in terms of, again, understanding
what the rules look like in that farm bill, right? That, to me,
is the most important thing that you can communicate in the
farm bill.
Mr. Sammann. I will specifically talk about some of the
pieces around the strengthening of the USDA. There are a number
of reports and ways in which our grain markets, our livestock
markets, and our dairy markets rely on reporting functions
inside the USDA, so it is important that continues to be robust
and is funded, to make sure that our markets that use those as
inputs into settlement prices and the daily price element are
continuing to be funded and supported.
Ms. Crighton. Thank you for the question. I think for us
from a clearing member perspective, given the importance of
cleared derivatives markets in risk management, price
discovery, certainty of access to those risk management
functions is critical, so ensuring capacity is available to
farmers, end-users, and ensuring the resilience and stability
of exchanges and cleared markets.
Mr. Edmonds. I would say education, making sure that there
is a component within there that is educating the potential
users of the product and those who use the product today. We
all do what we can individually, but understanding how that
goes within the policy objectives contained in the bill will be
massively important.
Mr. Berkovitz. Thank you, Congressman. And from my
perspective as someone who has worked with the CFTC and the
Agriculture Committee for many years, I am just very encouraged
by the statements today by Committee Members about the
importance of CFTC reauthorization. The CFTC can legally
operate without it, but it is so important that it get its
direction from Congress and any fine tuning. But when I was at
the Commission, we sent up a number of legislative proposals to
fine tune the Commodity Exchange Act. I leave it to the current
CFTC as to whether they have any of those that they are going
to propose, but to the extent they believe those would be
helpful, that would be really helpful as well.
Mr. Bishop. Thank you. I am not going to belabor the point,
but I was interested to know from your perspectives what you
thought we needed to do so that, through the farm bill, we
could help to reduce the market volatility of which we have
been discussing all day. So thank you very much.
I yield back, Mr. Chairman.
Mr. Baird. Thank you. The gentleman yields back.
And next up we have the gentleman from New York,
Representative Langworthy.
Mr. Langworthy. Thank you, Mr. Chairman. And thank you very
much for all of our witnesses for your testimony here today and
taking the time to be with us.
Global commodity markets play an important role in risk
management on the farm, and whether it is producers using
hedging or other risk management strategies directly or through
their co-op or other input suppliers or buyers of the
commodities that they produce, being able to mitigate the price
risk for their inputs and what they produce is critically
important, given the tight margins in the volatile markets.
Commodity price risk management is also important for our
food processors and our manufacturers, and commodity markets
are really the underpinning for these activities, so it is
important that they are reliable and they are transparent.
While beyond the scope of today's hearings, I really hope
that what we have heard today will inform us as we move forward
in our work on the farm bill for the next 5 years. It is, we
think, in the future direction of the programs that can help
producers mitigate the prices in the production risk.
And with that, Mr. Sammann, one insurance product that
provides price protection for some dairy farmers in my district
is the Dairy Revenue Protection product, which is linked to the
futures price of the dairy products traded on the CME. Given
that dairy doesn't have the history that grains and oilseeds
have on the futures market or the volume traded, what is your
long-term view of dairy products on the CME, and what can be
done to ensure that it is a stable, reliable market to ensure
that they can continue to play a part in risk management for
dairy producers and dairy processors?
Mr. Sammann. Yes, no, terrific question, Congressman. Thank
you for that. Dairy is an important part of our business. It is
not the biggest part of our business. It is smaller than
livestock, a lot smaller than grains and oilseeds, but it is
still an important part of the service we provide.
We continue to evolve the transparency, access, and price
provision in dairy markets, whether it is in the cheese market
or in the other parts of dairy, milk, for example. We have
actually migrated that price provision platform from what used
to be a PIP-traded platform now to a platform-based on what is
called Elysian technology within CME Group. So that is an
auction process, so there is clear, open, transparent mechanism
for setting that price, seeing that price.
As I mentioned before to the question about what the farm
bill could do, reauthorizing the USDA, making sure that is
robust so it connects our dairy market, which have struggled
setting the price of--85 percent of the price of cheese in the
U.S. is based on our settlement price. So to the extent that it
is an important part of our market, we continue to innovate and
make it as transparent as possible, it is never going to be a
market the size of even livestock, not to mention grains,
oilseeds, or treasury bonds. But it is a critical component of
price setting for the vast majority of cheese and dairy
products that are sold in the U.S.
So I am happy to go deeper with you and the groups that are
looking for better understanding for how that auction process
works, but we continue to evolve that, and we know electrifying
that process, bringing more people into that price provision
process and disseminating those prices as quickly as possible
creates that very transparency and I think market trust that is
critical to enable dairy producers to operate profitably.
Mr. Langworthy. Thank you. Thank you. And in speaking with
you, Mr. Sammann, how does crude oil in natural gases and input
price play a direct and indirect role as it relates to
agriculture production?
Mr. Sammann. It is probably one of the bigger--other than
fertilizer, it is one of the biggest changes and impacts to the
cost base of every farmer, every consumer in America, frankly.
This has been a wild ride. Natural gas, I believe Mr. Edmonds
mentioned before, 8 months ago, we were knocking on the door of
$9 an MMBtu here in U.S. natural gas, and now we are around to
$2, $2.50 with some downward pricing pressure now. That was
thanks largely to a very mild winter and well-supplied going
into what was a scary moment of losing Russian flows into
Europe. But I think the increase and now decrease as a tail
effect that has whipped some folks, and that is hard.
So markets can't mitigate all your risk, but market
providers like CME Group and ICE can provide tools to help end-
users that are reliant on volatile pricing cost inputs to their
business to at least mitigate price certainty around those
things. And it has just been hard for everybody, and it has
impacted the farmers themselves very drastically.
Mr. Langworthy. Well, having had the opportunity to spend
time in the district traveling to our farms in western New York
and the southern tier counties along the Pennsylvania line,
they are feeling those high prices, whether it be from rubber
or fuel prices or transporting feed, operating farms. I mean,
these things can't be any higher, and we have to do everything
we can to get things under control.
But I really thank you very much for your testimony, and,
Mr. Chairman, I yield back.
Mr. Baird. Thank you. The gentleman yields back.
And the next individual we have is Representative Nunn from
Iowa.
Mr. Nunn. Thank you very much, Mr. Chairman. I appreciate
it.
Thank you very much for providing your testimony today and
spending some time with the Agriculture Committee. This is
going to be an exciting year for the farm bill. This is a
bipartisan effort to really drive home where we can find
relation the farm bill and ideally move forward a farm bill
that will help all of our producers across the country.
I represent Iowa's Third Congressional District, and we are
proud to be the home of one of the leading producers of corn,
soybean, egg, pork and I am a sheep-farming family, so a little
bit of that as well.
With respect to corn specifically in 2022, Iowa produced
roughly 2.4 billion bushels, and this is seen as the nation's
most valuable crop going forward. As each of you know, our
farmers have faced several years of skyrocketing input costs,
both to the grower, to the producer, and ultimately to families
like mine with five girls and one 13 year old boy that really
make things expensive. The global market volatility, the lack
of competition, the consolidation, supply chain disruptions,
and ongoing war in Eastern Europe, and the continued placement
of increased strains on our producers that feed and fuel the
world has taken a toll.
You have mentioned this before, and so, Mr. Sammann, I
would like to begin with you. As we move deeper into our farm
bill discussions this year, what can Congress do to ensure that
farmers have access to the tools that best protect them from a
volatile commodities market and price risks? And further, how
might our producers best access and utilize future markets for
the purpose to manage these risks?
Mr. Sammann. So great question. I think we have touched on
this a little bit in different pieces. And this is why it is
important that, as an industry, we come before you because we
represent kind of the full ecosystem here, clearinghouses,
exchanges, industry bodies, end-users. And I think that,
relative to the farm bill piece, I mentioned some of the
specifics, very granular on the USDA side. There are so many
ways in which we are dependent on a fully functioning farm bill
to make sure that our processes work and create price
transparency and hedging tools available to all producers and
end-users.
I think Mr. Edmonds made a really good point, and I touched
on this before. Education and access: CME Group has 3,600
employees globally. We don't have enough to canvass every
single co-op across the U.S., so we rely on intermediaries,
regional co-ops in introducing brokers. As I mentioned, I am
not kidding, we canvass state fairs and 4-H clubs and we hand
out ribbons for prized heifers and things like that----
Mr. Nunn. That is right.
Mr. Sammann.--to make sure that people understand there is
a connection between family farms and setting the wholesale
price of that particular commodity, whether it is livestock,
whether it is dairy, whether it is grain. So, we can't do that
alone. We are simply not big enough, so we have worked through
partnerships of intermediaries introducing brokers that are
themselves not clearing members. They themselves use clearing
members to get access to our markets, so it is a long chain of
access and education.
So I just, again, come back to the point that Mr. Edmonds
said. It is very much down to educating people on both the
benefits of hedging. And I think this is a case study of the
last 2 years of why hedging can help manage some of these
costs. Number two, how you access these markets, what it means
to you. Even if you are not a direct consumer of trading
futures and options on derivatives changes, how you can benefit
from the transparency of standardized pricing so you know what
your crop is worth because you have some basis of differential
to a standardized crop. All of those pieces matter. And I think
education, access is things that we work at but we can't do
alone.
So anyway, we would welcome a discussion where we could use
that farm bill reauthorization and get that through to say we
need troops of folks to go out there and educate and train and
create more access. We would love to be a part of that
conversation.
Mr. Nunn. Thank you so much. I appreciate that.
And, Ms. Crighton, for you, according to a recent survey by
the Committee on Payments and Market Infrastructure, roughly 20
percent of our clearinghouses provide tools for end-users to
estimate how their margin requirements might change during a
period of market volatility. So staying on the same theme, can
you walk us through the possible solutions clearinghouses can
take to enhance transparency of margins required for farmers,
ranchers, and others to better help us prepare for future
stress events?
Ms. Crighton. Sure, thank you. Great question. Again, I
think we talked a bit about this before, but I think to add a
few points to the overall discussion, we think there are tools
that certain exchanges and CCPs have that they provide to end-
users and customers to be able to model their margin. We think
part of the benefit of what we can do on the forward is to be
able to provide tools and more transparency about what happens
during extremely volatile markets, right? How do margins move
in order to be able to help them project what their funding
needs are? That is what we think about when we risk manage our
clients directly. We spend a lot of time educating them on what
our risk models do, how they react during certain stresses so
they can appropriately understand what are the guardrails and
what is the funding that they need on hand to be able to
adequately prepare for that. So I think web-based tools,
interaction, and preparing clearing members and providing us
with access to that information so we can then further educate
clients, will be an important way to leverage the ecosystem and
to be able to provide that education back.
Mr. Nunn. That is wonderful. Thank you very much for being
here today. I hope your farming season goes well.
With that, Mr. Chairman, I yield back my time.
The Chairman [presiding.] All right. The Ranking Member has
an urgent conflict here, so I am going to ask him--we are kind
of kind of jumping ahead, and then we will come back to
Members. I recognize the Ranking Member for a closing
statement.
Mr. David Scott of Georgia. Yes. And first, thank you, Mr.
Chairman, for giving me this opportunity. We have a group of
veterans' organizations waiting on me, and we are putting
together a great event to help our veterans who need help
getting food and shelter. And so this is very important. Thank
you so much, Mr. Chairman.
I did not want to leave without saying thank you and let
you know just how important your testimony has been. And I
thank you, Mr. Chairman, for pulling this group together. They
are very knowledgeable. Your insights have been brilliant, and
you have opened many of our eyes because we have newer Members
on board. Two aspects of derivatives are cross-border, and this
burgeoning area, as I say to people, remind them, we are
dealing with $810 trillion of the world's economy in our hands
when we are dealing with derivatives and our swaps and using
this as very much needed balancing act for risk management
within a world that is full of surprise elements every day,
every moment. Who would have thought that Putin and Russia
would invade Ukraine? And who would have thought--and we are so
grateful that Ukraine has had the willingness and determination
to stand and fight back. But it has caused tremendous risk and
tremendous challenges for our agriculture industry and the
important role that derivatives and swaps played in it.
So I want to thank you. And please know that, as we move
forward with this farm bill, there may be some things that you
can help us with. We want to receive that help because you all
have a wealth of experience. And this is a very technical area.
It is not one that is often plainly seen, so we need experts
like you. I have worked with several of you for 20 years, the
CFTC Chairman and others and ICE. And we also have Mr. Michael
Gelchie, Group Chief Executive Officer of the Louis Dreyfus
Company.
Mr. Derek Sammann, Senior Manager, Director, Global Head of
Commodities, Options, and International Markets, the CME Group.
And make sure you tell your chief executive, Mr. Duffy, I said
hello. He is the good man, Terrence Duffy, longtime friend.
Ms. Alicia Crighton, let me join with the others. And it is
very important that all of our women Members pointed out this
historic moment. But let me also bring that congratulations to
you from deep in my heart because for you to be the first woman
on this burgeoning committee is very, very important.
Mr. Christopher Edmonds, Chief Development Officer of ICE,
another good partner. We have been together for over 21 years
working with different things.
And to you, Mr. Dan Berkovitz, former Commissioner,
Commodity Futures Trading Commission, you heard this Committee
say, and the Chairman, we are going to finally reauthorize the
CFTC. And both sides of the aisle here are committed to getting
that done, and we are going to do it. Thank you for your
participation. God bless each and every one of you. And again,
as I said, we have an open heart, an open mind, and open arms
to receive your help with these challenges and the technical
scientific progress we are dealing with in agriculture.
Thank you.
The Chairman. Well, I thank the Ranking Member and his
partnership.
I am now pleased to recognize the gentleman from Indiana,
Mr. Baird, for 5 minutes.
Mr. Baird. Thank you, Mr. Chairman. And, I really
appreciate you and the Ranking Member putting together this
Committee and this hearing. And I also appreciate, I am always
impressed with the knowledge and the expertise that you as
witnesses bring to this Committee and how important that is,
and so I just want to say thank you for that.
And then I only have--since I am getting toward the end of
the questioning period, I only a couple of questions that may
be a little different, so I will try to be brief because I am
sure you are getting tired of answering questions.
So my first one goes to Mr. Gelchie, and it deals with in a
little different area. You mentioned the limited availability
of U.S. dollar currency exchanges. Can you expand on that point
just a little and tell us----
Mr. Gelchie. Sure, Congressman, thank you. But, referring
to the continued rate increase in the United States, we have
continued to see currency fluctuations globally. Many of our
customers in countries overseas have had difficulties opening
up letters of credit recently. And as a result of having lack
of access to dollars as a function of their own currencies,
devaluing against the U.S. dollar, and that has created a bit
of a concern relative to our ability to supply our customers
but also for their ability to buy the grains that ultimately
they need to feed their people.
Mr. Baird. Thank you. Mr. Sammann, you mentioned a number
of tools that are used by the exchange to maintain orderly
markets, which I think is very important, including margin add-
ons, price limits, circuit breakers, and Velocity Logic. Would
you care to elaborate on that? Because they are relatively new
terms to me.
Mr. Sammann. Yes, I will just touch on a couple of those.
Position limits we talked about a little bit earlier, really
important that we talk about the need to make sure that if you
are an underlying hedger and you have a core exposure to an
asset, whether it is a treasury bond or a kilo gold bar or a
bushel of corn, end-users and those folks have larger position
limits when they can prove that they have offsetting physical
exposures. We have smaller position limits for speculators for
the obvious reasons that we don't want them to have the
outsized proportion. So that is an important kind of mechanism
we use to make sure concentration risk on our margin is
appropriate.
Daily price limits in enumerated commodities, and those are
primarily the ag products here, they have hard position limits.
So as you know, wheat, corn, and beans can only move so much
until they freeze on a day. They can go limit up multiple days,
and we have mechanisms in place when they reopen. They reopen
safely and everyone knows deterministically how they will
reopen. That is important you have heard again and again here.
We have mechanisms in markets that don't have hard position
limits. We utilize a mechanism called Velocity Logic, which, as
I said earlier, inhibits markets from moving too far, too fast.
For every market, there is a specific amount that a market can
move in a specified time period. And if it exceeds that, our
markets freeze for a specified time period. If it happens
again, it freezes again for, again, a predetermined specified
time period so people know how to expect markets react if they
start to run as it were.
The other things we talked about, the twice daily variation
margin runs circuit breakers are really a version of Velocity
Logic. And you have heard a lot of talk around margin levels
and proactively managing those as more instability comes into
the market. You would expect clearinghouses and in some cases,
to the point that was made earlier, top-ups by the clearing
firms themselves on top of exchange minimums. It is just the
way that the market is able to try to anticipate the volatility
and making sure there is enough collateral in the system to do
exactly what mutualized risk does, and that is ensure that
nobody loses money in a mutualized risk model. So hopefully,
that gives you some flavor for what I talked about.
Mr. Baird. Very good. And thank you. And I have about 35
seconds left. So, Ms. Crighton, I know we have talked a lot
about margins and the fluctuation in margins and so on, so
could you share your concern about how these large and
fluctuating margin calls may be driving some commodity firms
away from doing hedging, which is important to ranchers and
farmers?
Ms. Crighton. Yes, we think these large fluctuations can
create a destabilizing effect. When these large swings in
margin happen, as Mr. Sammann mentioned, we would expect that
margin rates rise when volatility increases. But we think the
starting-off point for margin levels tends to be too low,
particularly in times of low volatility. So the natural course,
we expect margin levels to rise and increase. The problem is
when we see such pronounced swings, we think that is
destabilizing. It drives a number of members and a number of
end-users and clients to have to seek short-term, highly liquid
assets to be able to post to their clearing members, for them
to post onwards to the clearinghouse. We think the cost of
doing that can rise significantly, particularly in times of
high stress, which is when we least want to see those types of
stresses add to the burdens of risk management.
Mr. Baird. Thank you. And I am out of time, except that I
would like to say that, Mr. Edmonds and Mr. Berkovitz, I am
sorry I didn't have a chance to ask you questions. So thank
you. I yield back, Mr. Chairman.
The Chairman. I appreciate the gentlemen. And gentleman
yields back now.
I am now pleased to recognize the gentleman from New York,
Mr. Molinaro, for 5 minutes.
Mr. Molinaro. Thank you, Mr. Chairman. Mr. Edmonds and Mr.
Berkovitz, I don't have questions for you either, so I feel
badly, but I also feel a little bit out of sorts going after
the Ranking Member's closing comments.
Ms. Crighton, could you just explain a little bit more,
maybe go a little bit further down--you speak about increasing
the margin floors to ease some of those volatilities. Can you
just explain that, let's say, to the average American, as to
how that will help reduce risk?
Ms. Crighton. Sure. So I guess we think about it in a
couple of different ways, and I guess one of the examples that
I will use is when we think about the size of initial margin
and drawing the distinction that Mr. Sammann drew earlier of
initial margin and variation margin. When we think about the
size of initial margin, what we are really trying to do is
ensure that it is adequate to cover the risks in the market. In
futures markets in the U.S., that means that it sides to a one-
day--it is intended to cover a one-day price move, right? When
we see that we have large P&L swings, large mark-to-market,
that typically is then followed by a large increase in initial
margin. So what we are trying to say is, rather than allowing
margin levels to go so low, that when shocks do happen, they
have to increase so much to substantially cover for that risk,
which creates stress on clients and end-users and, in certain
parts, clearing members as well, that we want to kind of
increase that floor so margin levels can't go as low as we have
seen them go in times of low volatility.
We think it actually artificially masks costs to clients
and end-users. They think they can fund here, but where they
actually need to be funding is for the eventuality of needing
to post margin at these levels. And that difference can create
a lot of stress.
So we are not saying that we want to--sorry to add one more
point.
Mr. Molinaro. No, go ahead.
Ms. Crighton. We don't want to just unilaterally increase
margin. We are not trying to cover all risk. But we think there
is a better balance than what we have been seeing, and that
stability and predictability is better for all end-users and
clients here.
Mr. Molinaro. That was something even I can understand, so
I appreciate that very much.
Mr. Chairman, I wanted to return to my colleague, Mr.
Nunn's question. You spoke a little bit about the need for
greater education access. Could you point to some of the more
effective tools at--listen, I am very appreciative of being at
the county or state fair and handing out ribbons, but why don't
you speak to some of the more effective education tools and how
we might embed that in the farm bill?
Mr. Sammann. Sure. Great question. So, as I mentioned
before, we work with a lot of land-grant universities. We work
with various schools that actually have agricultural
departments. We run a global trading challenge for
universities, not just in the U.S. but globally, where we
actually create a trading challenge and allow customers and
students that are trying to understand these markets and how
they operate to compete to sort of a fictitious set of market
circumstances. They can interact with these markets and
understand the power, the tools, the capabilities of what
derivatives markets make available to them. So we would love to
partner with someone on the farm bill to extend our reach out
into via co-ops and introducing brokers in these rural
communities are so important. There is just not enough of them.
So those are folks that are connecting the individual farms to
co-ops and co-ops to wholesale markets to at least get access
to the price so they know what their crop is worth, and at best
be able to have access, via those intermediaries into some sort
of hedging tool of some sort. So I would love to be a part of
that discussion. If that is part of the farm bill, I think that
would go a long way to addressing a lot of the questions we
heard about today that single farms or small farms are getting
crowded out of that space.
I do want to come back just a moment on the margin piece.
And I think as we talked about elevating margins, we should be
clear, our contracts right now have a four margin level. We
could debate whether that is too high or too low, but just to
be clear, there is a floor under which margins don't drop. And
I think the other piece is there is certainly a danger--and I
think Ms. Crighton has pointed out--danger being margins too
low. I think there is absolutely a danger in the worst-case
scenario margins being too high. And I spoke at a BIS symposium
on Tuesday morning with global central banks on this very
topic, where there were three of the world's largest energy
producers represented. And they said margins went so high and
margin top-ups by clearing firms were multiples of the current
exchange minimums that it forced them into the OTC market. That
is the other ditch you want to avoid.
So I just want to make sure that we are talking about a
balanced view here that no one would disagree that too low
margins is not good, but there is a real danger that the worst-
case scenario is the margins that are too high end up pushing
people into unregulated bilateral markets. Now, you have
opacity in the market that was once transparent. So I just want
to be clear that there is a risk at both ends of that.
Mr. Molinaro. I appreciate that. And I would say, from the
education perspective, even reaching to K-12, Future Farmers,
really investing early on to create that understanding as
certainly smaller farms, family farms transition.
Mr. Chairman, I very much wanted to ask Mr. Gelchie a
question, but I have run out of time, and so I will just save
it for another----
The Chairman. Well, the gentleman is yielded some more
time. Go ahead.
Mr. Molinaro. Thank you, Mr. Chairman. The last hearing you
did take a whole minute away from us, so I appreciate that, Mr.
Chairman.
Mr. Gelchie, I just wanted to give you an opportunity
really to speak more broadly and briefly to what you foresee
from your perspective the biggest risks and opportunities for
American agriculture in the immediacy. As we develop this farm
bill, what would you point to is the thing we need to pay
attention to, to sustain American agriculture?
Mr. Gelchie. Sure, no, thank you. I think as we had
mentioned earlier, consistency, clarity in terms of what
support prices might look like for the farmer? That is
extremely important. We talked about the inputs and the rising
costs for fertilizer, land, and so these are criteria that I
would pay particular attention to in relation to the upcoming
farm bill.
Mr. Molinaro. Thank you. And thanks for the courtesy, Mr.
Chairman. I yield back.
The Chairman. Well, I thank the gentleman for reminding me
I cut his time last time. And now great job, well done.
I want to thank all our witnesses, as we close here, just
to say thank you for bringing your expertise to the table. We
have five talented individuals who have tremendous experience
and insight, and we benefited from that today.
I want to thank our Members, all of our Members for the
participation and, quite frankly, the insightful questions that
were generated. And I would be remiss if I didn't say a great
big thank you to all of our--if I didn't recognize Mr. Duarte
for--well, let me do my last thank you and then I will come
back and finish my closing when we actually close, and that is
to the staff, the staff, all of our staff that work so hard,
the staff and the personnel officers, certainly the staff on
our committees that staff us. We absolutely could not do our
jobs without them.
And so I am pleased to recognize the gentleman from
California, Mr. Duarte, for 5 minutes.
Mr. Duarte. You are a tolerant and thoughtful leader, G.T.
Thank you. Thank you to the chair. Sorry, lunch awaits you.
I am from California. I am from a farming district in
California that goes from Modesto down to Fresno. And there is
a large--not a large one, but there is a budding movement in
California to consolidate water rights down to the delta. And
then there are some who think that monetizing and securitizing
water rights and putting them on perhaps one of the boards of
trade that you govern or participate in would be a good idea. I
don't think it is a good idea. I think that commodities are
commodities. They move around the globe and they fill voids and
shortages through a free market system that you folks help
facilitate. But water is not a commodity. Water is local. Water
is constrained within its basins, and it does not have global
movement, and we cannot always make more of it when the market
demands that we might want to.
Could you please, any of you, comment on how you see the
limitations of water trading or how you see the opportunities
of water trading and what we should be concerned about or open
to in terms of opportunities when it comes to such?
Mr. Sammann. So I will comment because we list the
contract--it is not ours, but we list a contract that is a
NASDAQ contract that is a cash-settled water index. I think it
is basically the Veles index, as I recall, that listed probably
2+ years ago. It is an index cash-settled for--the idea that
NASDAQ believed--and we are just a listing agent for them so it
can trade on our exchange. And I believe their thought was that
there would be an interest for folks looking to get some sort
of economic exposure. You are absolutely right. Water is not a
physical product. It is uneconomical to transport the way you
can crude oil or natural gas or corn or gold for that matter.
So it has had a high degree of intellectual interest. It is had
very little traction economically in terms of very little
pickup on that, and I think there is a broadening discussion
around how that should be treated.
Mr. Duarte. Good.
Mr. Sammann. So I would probably point you to reach out to
NASDAQ on that contract since we are just the listing agent.
But I just want to make sure that the Committee knew that there
was a product, so I would point you to NASDAQ to have a further
conversation on that product.
Mr. Duarte. Thank you. Any other comments? Please, Mr.
Berkovitz.
Mr. Berkovitz. I would just comment that from the
perspective of the CFTC--I am not speaking for the CFTC in this
capacity, but from the derivatives markets in terms of a
derivatives contract, should anybody want to list them? Until
about the year 2000, the Commodity Futures Modernization Act,
the CFTC would look at what is the hedging utility, what is the
utility of these contracts, but since 2000, the change in the
law, the CFTC just looks at the integrity of the contract and
doesn't pass upon the value, so to speak, of the economic use.
It is basically up to the market to decide. So the CFTC, were
they asked to approve a contract, would pass upon certainly the
integrity of the contract, is it susceptible to manipulation,
but would not look at is this a good thing or a bad thing?
Mr. Duarte. Thank you. That is one of my concerns is the
manipulation. Somebody from far away outside our base and
outside our community, outside our state, outside our country
could play the water market through political or environmental
manipulations, create scarcity, and increase the value of their
securitized water interests, and that, I feel, is a huge
vulnerability this would bring to my district and to many, many
urban and rural water users.
Mr. Berkovitz. And if an exchange were to list one of those
contracts, that by law the contract would be required to be not
susceptible to manipulation. The exchange would have to have
mechanisms in place, and the CFTC would review those before the
contract could be approved.
Mr. Sammann. Just so you know, you may not be aware or may
be aware, in Australia, there is a water contract, and I
believe it is physical. I think that is probably set up within
5 or 8 years ago, and there have been some challenges with
that. So there is a case study as somebody trying to do it as a
deliverable contract, and it got into the questions that you
would wonder where is their financial interest? Where is the
end-user consumer interest? And are those in balance with one
another? So not passing judgment good or bad, but it is a case
study, and I think if you wanted to talk to your constituents
about that, that is probably a good place to start.
Mr. Duarte. Thank you. I have 53 seconds left. Any of you
wise folks have any more wisdom for me?
Thank you very much. Thank you, Mr. Chairman. I will get
out of the way of lunch.
The Chairman. I thank the gentleman. Lunch is over, though?
We are well beyond that.
Just, once again, all the thanks that I have offered
already. It really is helpful to understand how market
participants, intermediaries, and regulators work together to
ensure the markets operate efficiently and effectively.
Sustaining deep and vibrant derivatives markets often requires
compromises between the views of different actors. I appreciate
having heard more about those points of view today. This
hearing provided insight on how the industry works to reconcile
the different points of views that you all have, what
processes, formal or informal, are in place to help industry
participants, and regulators alike work through those ideas.
What we heard today, I believe, will better prepare us to
perform our oversight duties for the derivatives market.
And so, with that, under the Rules of the Committee, the
record of today's hearing will remain open for 10 calendar days
to receive additional materials and supplementary written
responses from witnesses to any questions posed by a Member.
This hearing of the Committee on Agriculture is adjourned.
[Whereupon, at 1:40 p.m., the Committee was adjourned.]
[Material submitted for inclusion in the record follows:]
Submitted Letter by Hon. Mike Bost, a Representative in Congress from
Illinois
March 1, 2023
Hon. Katherine Tai, Hon. Doug McKalip,
Ambassador, Chief Agricultural Negotiator,
United States Trade Representative, United States Trade Representative,
Washington, D.C.; Washington, D.C.
Dear Ambassador Tai and Chief Negotiator McKalip:
We write today to thank you for your continued work in holding
Mexico accountable regarding their pending ban on imports of
genetically modified (GM) corn from the United States. While
substantial progress has been made, we remain concerned that Mexico's
unscientific approach to GM corn would severely impact our local
farmers and set a harmful precedent. Mexico's failure to live up to its
transnational commitments would negatively impact the Illinois Corn
industry and we urge you to take every step necessary to resolve this
situation amicably. We request a full update on the ongoing
negotiations with Mexico on this subject, and given this decision is
clearly inconsistent with the United States-Mexico-Canada Agreement
(USMCA), we ask all enforcement mechanisms remain on the table.
As you know, Illinois farmers are the second-largest producer of
corn in the United States, with a large majority of such corn grown
with GM seeds. These scientific enhancements have helped our farmers
grow more with less, reduce their impact on the environment, and
conserve the use of water and pesticides, contributing to food security
at home and across the globe. According to the United States Department
of Agriculture, between 2020 and 2021, Mexico remained the number one
ranked importer of U.S. Corn. Mexico's plan to impose an import ban can
have long-term detrimental effects to local economies, family farmers
and the corn industry here in Illinois. Furthermore, the choice to ban
uses of GM corn but not other uses of biotechnology underscores the
lack of scientific basis for the action. On the heels of the public
health emergency and a war across the globe that has contributed to
higher energy costs as well as disrupted supply chains, our farmers
cannot afford additional challenges.
We've heard from family farmers across our districts and we want to
ensure that they will be protected and maintain certainty over the
future. We are grateful for your strong and swift response to Mexico's
unsubstantiated actions, and we urge you to use your full authority and
USMCA's enforcement mechanisms to come to an agreement as soon as
possible. Inability to do so will cause grave concern among our
constituents. We thank you for your attention to this matter and we
look forward to partnering with you to support Illinoisan and American
farmers to ensure their continued export of important commodities.
Sincerely,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Hon. Nikki Budzinski, Hon. Mike Bost,
Member of Congress Member of Congress
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Hon. Bill Foster, Hon. Darin LaHood,
Member of Congress Member of Congress
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Hon. Mary E. Miller,
Member of Congress
Supplementary Material Submitted by Michael ``Mike'' Gelchie, Group
Chief Executive Officer, Louis Dreyfus Company
Insert
Mr. Rose. . . . One of the major themes of this hearing are
the risks of black swan events to the global derivatives
markets. I would like to ask each of you, are there any
unlikely but plausible black swan events that could pose a
systemic risk to the global financial system that any of you
are worried about but that have not yet been raised in this
hearing today? And again, we will start on the left, and you
can go across with the limited time we have.
* * * * *
Mr. Rose. I have other questions, but in view of the time
remaining, I might just end by saying I know by definition I am
asking you to think about the unknown unknowns, but I would
just ask you all to go back and contemplate that and share with
us anything that we might be missing that comes to mind.
These global tensions are not new but seem to be as relevant as
ever in terms of market impact, with a tendency at times to overwhelm
market fundamentals. Markets are sensitive and there is plenty of
global unrest, so these risks are real.
Rapid technology advancements over the past decade have created
efficiencies in the markets, but also challenges in protection against
bad actors and market disruption. Cybersecurity is something all
responsible corporate organizations are allocating capital to guard--
against attack and to minimize vulnerabilities. We recently witnessed a
cyber-attack on a service provider in the futures markets, which
created challenges in market function for days.
Derivatives clearinghouses are critical to the functioning of our
commodity markets, and in our opinion, have operated successfully
through stressful events over many years. Should a key clearinghouse be
unable to function, the derivatives markets would be completely frozen,
and cash markets would see immediate and tangible ripple effects. We
believe the probability of such an event is low given the positive
track record of clearinghouse operations and the significant regulatory
focus on these functions.
______
Supplementary Material Submitted by Derek Sammann, Senior Managing
Director, Global Head of Commodities, Options & International Markets,
CME Group Inc.
Insert 1
Mr. Crawford. What would you estimate the percentage of
participants in the market today are bona fide hedgers?
Mr. Sammann. So I would probably say--it is going to vary by
product--probably 20+ percent of end-users. And you can see
some of that from the CFTC's Commitment of Traders Report. It
will vary by product. It will be higher in commodities markets.
It will be lower in financial markets, between 20 and 40
percent, but I would rather come back to you with a more
specific answer. But if I were to spitball, that is where I
would put it.
The best source of public information about the types of
participants in each market is the CFTC's Commitment of Traders
Report.\1\ * As you may know, this report is published weekly and is
based on futures and options position information provided to the CFTC
and exchanges by firms that exceed reportable position levels. The
report does not capture precisely the reason for each firm's position.
It will not, for example, depict whether a position of a producer or
[processor] was a hedge or speculative position. Nevertheless, it is an
informative report for purposes of understanding the types of
participants holding positions in each market. The data contained in
the report demonstrates how the market composition can change over time
and varies among different agricultural products.
---------------------------------------------------------------------------
\1\ cftc.gov/dea/options/ag_lof.htm.
* Editor's note: the report referenced is retained in Committee
file.
---------------------------------------------------------------------------
For instance, the April 11, 2023 Commitment of Traders Report
provides the following data on the Chicago Board of Trade's Wheat--SRW
futures and options contracts:
Producer/Merchant/Processor/User--67,505 (long) and 63,537
(short);
Swap Dealers--68,634 (long), 5,001 (short), and 17,084
(spreading);
Managed Money--56,306 (long), 160,553 (short), 72,858
(spreading);
Other Reportables 39,232 (long), 8,197 (short), and 101,738
(spreading).
Naturally, as depicted in the Commitment of Traders reports,
markets are comprised of both natural hedgers (commercials/producers/
processors and swap dealers) and natural speculators. Both are
essential to an efficient market that enables the transfer of risk
between participants. Efficient markets depend on active participation
of both hedgers and speculators.
Insert 2
Mr. Rose. . . . One of the major themes of this hearing are
the risks of black swan events to the global derivatives
markets. I would like to ask each of you, are there any
unlikely but plausible black swan events that could pose a
systemic risk to the global financial system that any of you
are worried about but that have not yet been raised in this
hearing today? And again, we will start on the left, and you
can go across with the limited time we have.
* * * * *
Mr. Rose. I have other questions, but in view of the time
remaining, I might just end by saying I know by definition I am
asking you to think about the unknown unknowns, but I would
just ask you all to go back and contemplate that and share with
us anything that we might be missing that comes to mind.
CME Group is in the business of risk management. Consequently, we
spend significant time and resources attempting to foresee and plan for
any plausible black swan events, even those that are very remote. We
have a risk management team, dedicated to monitoring CME's risks and
evaluating the likelihood of their occurrence. In addition, all of our
business lines are responsible for updating our risk profile, notifying
the risk team if risk increases, and refining our response plans.
One clear category of risk that went unmentioned in the hearing but
bears strong consideration is future pandemics. The COVID-19 pandemic
heightened volatility, put markets under stress, and increased the need
for risk management. While the pandemic's market turmoil was
significant, CME's risk management model was able to compensate for the
disruption. Trading and clearing functioned as intended and without
interruption. Future pandemics, however, may place supply chains, spot
commodity markets, and producers under even greater stress. Although
CME is confident that it has planned for and can address even extreme
market conditions, a hypothetical near-total shutdown of commodity
markets would have much further-reaching ramifications. It is CME's
hope that global policy makers will work with all market participants,
with a special focus at the producer and supply chain level to ensure
that the global marketplace is adaptable and equipped for dealing with
future, and possibly even more significant, pandemics.
______
Supplementary Material Submitted by Alicia Crighton, Chair, Board of
Directors, Futures Industry Association
Insert 1
Ms. Crockett. Thank you. But I do have some concerns. As I
was reviewing the USDA report from October of 2020, it states
that less than three percent of farmers are using these
options. Does that sound about right to you?
Ms. Crighton. I don't actually have that information, but we
would be happy to look into it and follow up with you.
FIA has reviewed the 2020 USDA report \1\ * titled `Farm Use of
Futures, Options, and Marketing Contracts,' which used data from the
2016 Agricultural Resource Management Survey to describe the use of
futures, options, and marketing contracts by producers, with a primary
focus on corn and soybeans. FIA agrees that farm producers must contend
with forces beyond their control and that risk management tools and
strategies, including the use of derivatives to hedge and protect
against price risk, are critical for end-users. While FIA cannot verify
the underlying data referenced in the report, we support efforts to
expand educational resources about the opportunities and risks of risk
management tools like derivatives to small- and mid-size farmers,
producers and end-users. Below are some examples of FIA's commitment to
education.
---------------------------------------------------------------------------
\1\ https://www.ers.usda.gov/webdocs/publications/99518/eib-
219.pdf?v=1241.2.
* Editor's note: the report referenced is retained in Committee
file.
---------------------------------------------------------------------------
FIA would also welcome the opportunity to partner with the House
Committee on Agriculture to consider whether there are opportunities--
perhaps through the farm bill, CFTC reauthorization, or another
vehicle--to expand educational resources to farmers, the CFTC, or other
entities, about risk management tools like futures and derivatives.
Additionally, the CFTC Agricultural Advisory Committee (AAC), which
was created in 1985 to advise the Commission on issues involving the
trading of agricultural commodity futures and options and facilitate
communications between the CFTC, the agricultural community, and
agriculture-related organizations, could be a great vehicle for a
discussion about engagement with small- and mid-size farms. FIA would
be happy to flag this as a suggested discussion topic for a future
meeting.
FIA's Commitment to Education
Futures Fundamentals
Futures Fundamentals is a collective, industry-wide effort to
develop and promote free education about derivatives markets and risk
management tools. Futures Fundamentals is made possible by a number of
contributing organizations across the futures industry, including FIA.
Through this partnership, the industry's leading tools, knowledge, and
resources have been made available to the public in order to further
educational empowerment across the globe. For more information, visit
here: https://www.futuresfundamentals.org/.
The Institute for Financial Markets
Established in 1989, the Institute for Financial Markets (IFM) is a
nonpartisan, nonprofit educational foundation and independent affiliate
of FIA. The IFM seeks to increase public awareness and understanding of
the importance of derivatives markets and the financial service
industry to the global economy and to improve the technical competence
of those in the industry who deal with the public. In advancement of
such purpose, the IFM engages in activities such as research,
publications dissemination, e-learning, courses and conferences. For
more information, visit here: https://www.theifm.org/.
Insert 2
Mr. Rose. . . . One of the major themes of this hearing are
the risks of black swan events to the global derivatives
markets. I would like to ask each of you, are there any
unlikely but plausible black swan events that could pose a
systemic risk to the global financial system that any of you
are worried about but that have not yet been raised in this
hearing today? And again, we will start on the left, and you
can go across with the limited time we have.
* * * * *
Mr. Rose. I have other questions, but in view of the time
remaining, I might just end by saying I know by definition I am
asking you to think about the unknown unknowns, but I would
just ask you all to go back and contemplate that and share with
us anything that we might be missing that comes to mind.
In my capacity as Chair of the FIA Board, I don't have anything
further to add to my comments in the hearing.
______
Supplementary Material Submitted by Christopher S. Edmonds, Chief
Development Officer, Intercontinental Exchange, Inc.
Insert
Mr. Rose. . . . One of the major themes of this hearing are
the risks of black swan events to the global derivatives
markets. I would like to ask each of you, are there any
unlikely but plausible black swan events that could pose a
systemic risk to the global financial system that any of you
are worried about but that have not yet been raised in this
hearing today? And again, we will start on the left, and you
can go across with the limited time we have.
* * * * *
Mr. Rose. I have other questions, but in view of the time
remaining, I might just end by saying I know by definition I am
asking you to think about the unknown unknowns, but I would
just ask you all to go back and contemplate that and share with
us anything that we might be missing that comes to mind.
For the past few years, derivatives clearing has been chiefly
handled by a small number of clearing members at CCPs globally.
Consolidation within the clearing industry has also left derivatives
contracts concentrated among a smaller subset of clearing members and
could be a potential source of systemic risk. To that end, the
concentration of bank-affiliated clearing members has become a barrier
to access for smaller, directional clients. With a limited and
shrinking number of global non-bank affiliated clearing members, some
market participants may find themselves without access to clearing
services and the ability to hedge their risks. The lack of access to
the derivatives markets could increase volatility, increase consumer
prices and impact the stability of financial and commodity markets. Due
to restrictive prudential capital requirements, only bank-affiliated
clearing members can provide more comprehensive services. In the case
of non-bank affiliated clearing members, there are limited and punitive
paths available for additional capitalization. This creates a divergent
framework for clearing member requirements and disincentivizes non-bank
affiliated clearing members from offering expanded services. If one of
the non-bank affiliated clearing firms fail, there are very limited
options remaining for their clients. Many clients will be unable to
procure additional clearing services. It is extremely difficult to
determine such an impact on the macro economy other than an extremely
negative outcome.
______
Supplementary Material Submitted by Hon. Dan M. Berkovitz, Former
Commissioner, Commodity Futures Trading Commission
Insert 1
Mr. Bost. I appreciate that. Thank you. I also have heard
from my constituents obviously with serious concerns about the
recent action taken by Mexico in banning GMO corn. This is
serious concern of mine, and I have joined with several of my
colleagues in writing a letter to the Administration calling
for action from the USMCA.\1\ What effects has the CME seen on
the global--I am not sure what my tongue is doing--derivative
markets so far based on Mexico's action, and if no substantive
effects have occurred, can the CFTC help absorb any changes in
the market?
---------------------------------------------------------------------------
\1\ Editor's note: the letter referred to is located on p. 81.
---------------------------------------------------------------------------
Mr. Sammann. Great question. I think relative to how we
answered the question earlier on tariffs and kind of market
disruptions, we see disruptions to free trade flow and price
setting as problematic for all users and that just increases
instability. It increases the eventual price that gets--cost
passed on to the end consumer is not good for anybody. We have
not seen a direct impact on our corn market, which is we run
the largest corn market in the world. We haven't seen that yet.
That said, we are in constant conversation with both the
farmers, producers, end-users, folks like Louis Dreyfus and how
that impacts them, and the agency. And I would probably defer
to Mr. Berkovitz for his thoughts on how to answer a CFTC
perspective on that.
The CFTC's market surveillance program monitors global political
and economic trends and developments that may affect the physical and
financial commodity derivative markets to ensure those markets continue
to operate in a fair and orderly manner, perform their price discovery
and risk management functions, and do not present systemic risks. The
CFTC staff is in regular contact with market participants, exchanges,
and other Federal agencies regarding events and actions that may affect
these markets. Although I do not have any specific information
regarding the CFTC's consideration of how Mexico's banning GMO corn may
have affected the U.S. derivative markets, the CFTC's market
surveillance program typically monitors its markets for market-related
issues that may arise from these types of developments.
Insert 2
Mr. Rose. . . . One of the major themes of this hearing are
the risks of black swan events to the global derivatives
markets. I would like to ask each of you, are there any
unlikely but plausible black swan events that could pose a
systemic risk to the global financial system that any of you
are worried about but that have not yet been raised in this
hearing today? And again, we will start on the left, and you
can go across with the limited time we have.
* * * * *
Mr. Rose. I have other questions, but in view of the time
remaining, I might just end by saying I know by definition I am
asking you to think about the unknown unknowns, but I would
just ask you all to go back and contemplate that and share with
us anything that we might be missing that comes to mind.
As a regulator, and now as a former regulator, I have been very
concerned about black swan events. By their nature, black swan events
are neither foreseeable nor predictable. The history of financial
markets demonstrates the fallacy of the belief that we can foresee or
anticipate all the types of events that may cause systemic risks. We
must protect against both foreseeable and unforeseeable events. Since
the passage of the Dodd-Frank Act we have made significant progress in
building protections into the financial system to mitigate systemic
risks that may arise from both foreseeable and unforeseeable events. We
must remain vigilant, however, as the nature and origin of these types
of events is continually changing. In addition to the risks mentioned
during the hearing, another specific emerging risk that I believe
deserves heightened attention and potential action stems from the
recent advances in artificial intelligence technology. This new
technology may present novel risks regarding fraud, manipulation,
market integrity, and as a result novel systemic risks.
______
Submitted Question
Question Submitted by Hon. Jahana Hayes, a Representative in Congress
from Connecticut
Response from Hon. Dan M. Berkovitz, former Commissioner, Commodity
Futures Trading Commission
Question. In your view, does the CFTC have the proper authority to
respond to present-day market conditions? How could a long-term
reauthorization improve the CFTC's ability to lead on these issues?
Answer. Typically, during the legislative reauthorization process
the CFTC submits to Congress proposals for amendments to the Commodity
Exchange Act to clarify or supplement this existing authority. Members
of Congress also may identify beneficial amendments during the
reauthorization process. The authorization process can therefore lead
to improvements to the CFTC's authority and ability to regulate these
markets.
Generally speaking, the CFTC has sufficient authority to respond to
present-day conditions in the derivative markets it regulates. As
described above, the reauthorization process could be used to fine-tune
this authority. Currently, however, the CFTC does not have regulatory
authority over spot commodity markets. The CFTC can bring actions for
fraud or manipulation that has occurred in the spot commodity markets,
but it does not have authority to regulate the trading of spot
commodities (unless such trading is on a leveraged or margin basis) to
help prevent such fraud or manipulation prior to its occurrence. At
present there is a significant amount of fraud and manipulation in the
spot market for cryptocurrencies or digital assets. It would improve
the CFTC's ability to protect the public from fraud and manipulation in
these markets--and the integrity of these markets--if the CFTC also had
regulatory authority over the trading in the spot market of
cryptocurrencies or digital assets commodities that are not securities.
Expanding the CFTC's jurisdiction to include regulatory authority over
the trading of non-security spot cryptocurrencies or digital assets
would significantly increase the CFTC's workload. To ensure that this
additional responsibility would not detract from the CFTC's mission
with respect to the derivatives markets, any such expansion of CFTC's
jurisdiction should be accompanied by a dedicated funding source to
cover the costs of regulation and oversight of these spot markets.
[all]