Wheat futures prices reached near historic highs recently, increasing by 50% in the globally price influential Chicago futures market since the Russian military began its invasion of Ukraine on February 24. Then, the wheat futures prices fell by 18% from March 8 to March 10. For people who live in low-income wheat import dependent countries, however, even if those prices fell again by half over the next few months, the result will be yet higher levels of hunger. High and extremely volatile prices in international markets mean the perennially underfunded humanitarian food assistance system will also be highly stressed, just as demand increases exponentially. Countries dependent on wheat imports in the Middle East and North Africa, where pasta and couscous are consumed daily, are especially vulnerable to the wheat price shock, particularly if their reserves of the U.S. dollars needed to pay for the imports are depleted.
The wheat price crisis is an extreme case of recent record high agricultural commodity and food prices reported by the U.N. Food and Agriculture Organization. The food price spikes are receiving a lot of public attention, and rightly so. Less discussed, however, is the role of futures market price increases in non-agricultural commodities that, through the huge “bets” placed by investors in commodity index funds and exchange traded funds, link to and exacerbate high and volatile agricultural futures prices and cash prices for food. The role of commodity futures exchanges in food security is hidden from public view and poorly understood yet critically important.
On March 8, the Chicago wheat futures contract hit an all-time price high of $13.635/bushel. The headlines reporting the story implied that the 77% price increase since January 1 was just a matter of supply and demand. That reporting missed the effects of the failure to successfully regulate commodity futures exchanges, a task that falls to the globally influential U.S. Commodity Futures Trading Commission (CFTC). The CFTC’s failure has global impacts because of the market power of U.S. futures trading exchanges, the size of U.S. production and exports, and the role of the U.S. dollar as a principal currency of global trade. The failure to regulate has left farmers and commercial users of wheat unable to make use of futures contracts to manage price volatility risks.
Indeed, wheat futures price increases and volatility since the outbreak of the war have reached a point where wheat storage elevators are refusing to accept farmer bids to sell their wheat to the elevators. Futures prices, inflated by excessive speculation, are failing to converge with wheat cash prices by the end of the futures contract period. Elevators need reliable price convergence to have a benchmark for determining the price they offer farmers for their wheat. The elevators’ inability to accept bids is one consequence of the failure of the CFTC to regulate commodity futures exchanges’ contracts.
The exchanges helped to defeat CFTC attempts at regulation during the Obama and Trump administrations, insisting instead that they be left to regulate themselves. However, the exchanges have been unable or unwilling to use their internal regulations and trade data monitoring of contract positions to protect commodity users and producers from the flood of financial institutions’ hyper-short-term bets. By allowing excessive speculation, the exchanges fail to protect those who buy and sell physical commodities to rely on futures contracts to manage price risks.
On October 15, 2020, the CFTC lost a decade-long struggle against Wall Street and commodity exchanges to establish a rule that would limit financial institution positions in 26 critical commodity futures contracts, including wheat. The rule was defeated in a 3-to-2 vote of CFTC commissioners. In IATP’s summary of the fight over the final position limit rule, which in the end delegated nearly all CFTC authority to the exchanges (technically, “Designated Contract Markets”), we cited part of Commissioner Dan Berkovitz’s dissent: “the proposed rule demoted the Commission from head coach to Monday morning quarterback. The Final Rule declares that the players on the field are the referees. In this arena, the public interest loses.” The trading exchanges referee their own game, in part, by expanding price up down limits on volatility to avoid having to throw computer code “kill switches” to temporarily stop trading. The exchange referees should seek to keep excessive speculation from making the margin collateral to trade so expensive that commercial hedgers dump their positions.
The CFTC has yet to announce if it will investigate the current extreme commodity price increases and volatility. They need to act, and not just in wheat but in energy futures prices, too. Energy prices are tightly linked to food commodity prices in the cash and futures markets. Astonishingly, at the March 2 U.S. Senate agriculture committee hearing to confirm four nominees to become CFTC commissioners, nominee testimony and questions from the Senators focused on the regulation of digital currencies. There was no line of questioning about record high commodity prices and price volatility, not even from Senators from wheat growing states. Even then, although Securities and Exchange Commission Chair Gary Gensler had said that digital currency cash and futures markets are “rife with fraud, scams and abuse,” the Senate finance committee Chair Ron Wyden (D-OR) claimed that tough regulation would kill the financial technology innovation he championed. The chair of the agriculture committee, Senator Debbie Stabenow, made very brief and perfunctory reference to the agricultural and energy price crisis following the Russian invasion.
Not any one rule would be enough to ensure well-regulated markets, no matter how well drafted and implemented the rule. For example, a position limit rule on its own would not capture the excessive speculation by automated trading systems (ATS) that close positions with a single trading session. Automated trading is not just a computer-to-computer messaging technology but the means to implement trading strategies encoded in algorithms that can disrupt price formation contrary to fundamental factors, such as supply, demand and commodity storage and transportation logistics. Semi-automated agricultural traders told the CFTC in 2018 that hyper-speed ATS outrace them to bid on contracts to hedge price risks for their clients. In response, the CFTC lauded the efficiency and lower transaction costs of ATS.
Exchanges report to the CFTC the end of the trading day “open interest,” i.e., the contract price bids that have not been settled by price offers. Most of the trading volume, exchange facilitation fees, price volatility and trader profits result from intraday automated trading. The Chicago Mercantile Exchange Group, which “facilitates at least 92 percent of U.S. exchange-traded derivatives (futures, options and swaps contract] volumes,” according to Better Markets and the Open Markets Institute, was among the groups that defeated an enforceable automated trading rule in 2020.
The public usually finds out about CFTC or industry regulatory failure after the fact — often long after. For example, in August 2019, the CFTC released only very general information about its enforcement settlement against Kraft Mondelez for violation of the soft winter wheat contract position limit and market manipulation. The Chicago Mercantile Exchange system to enforce position accountability failed to detect the market manipulation for three years, from 2012 to 2015. No sooner were the violations made public than a judge in Chicago overseeing the settlement put a gag order on the terms of the settlement and threatened two CFTC commissioners with contempt of court for making general statements about the case.
Russia’s invasion of Ukraine is the latest shock to already volatile commodity markets. The Extraordinary Meeting of G7 Agriculture Ministers issued a communiqué on March 11 that stated, “We will not tolerate artificially inflated prices that could diminish the availability of food and agricultural products. We will also fight against any speculative behaviour that endangers food security or access to food for vulnerable countries or populations. Therefore, we are closely monitoring markets affecting the food system, including futures markets, to ensure full transparency.” In 2008, the then-G8 Agriculture Ministers’ communique did not mention “speculative behavior” or “futures markets,” despite evidence of problems in the futures exchanges. Now we must hope the ministers’ governments will move from words to actions and take regulation of futures markets seriously.
Climate change is widely predicted to deliver even greater, more frequent and longer lasting shocks to food and agriculture systems. The “Summary for Policymakers” of the most recent report of the Intergovernmental Panel on Climate Change (IPCC) stated, “Weather and climate extremes are causing economic and societal impacts across national boundaries through supply-chains, markets, and natural resource flows, with increasing transboundary risks projected across the water, energy and food sectors (high confidence). Supply chains that rely on specialized commodities and key infrastructure can be disrupted by weather and climate extreme events.” (p. 19) The consequences of these “impacts” and disruptions to physical and futures markets will grow sharply, particularly under the “catastrophic pathway” of the greenhouse gas emissions reductions pledged in advance of last year’s UNFCCC meeting in Glasgow. Many developing countries prefer the term “losses and damages” to “impacts” as a more accurate term for what they are now suffering because of decades of high emissions from predominantly developed countries.
The continued defiance of commodity exchanges to effective regulation has created a system that amplifies rather than absorbs the price shocks of the Russian invasion. How, then, can the exchanges hope to manage the financial and commodity market consequences of irreversible and severe climate tipping points? In March 2021, the CFTC announced the formation of a Climate Risk Unit. As far as IATP knows, the unit has yet to hold a public meeting or issue a request for information to help it propose policy to meet climate risks to the markets and market participants the CFTC regulates. Presumably, once the Senate confirms the four nominees to become CFTC commissioners, the whole Commission, together with its advisory committees and the Climate Risk Unit, will finally begin their work in earnest. Last September, IATP co-authored a letter to the CFTC stating that part of that work should be a thorough study of the proposed credits for greenhouse gas emissions offset projects. These projects provide the underlying assets for offset futures contracts that the CFTC oversees yet the futures exchanges have proven they are prone to excessive speculation and even market manipulation.
Former President Trump appointees pledged to eviscerate the regulations authorized by the Dodd Frank Wall Street Reform and Consumer Financial Protection Act, including the regulations overseen by the CFTC. Trump’s appointees achieved most of their objectives. Now a weakened CFTC must reorganize to face urgent regulatory and enforcement challenges. If the CFTC’s primary focus, as implied in the Senate confirmation hearings, is a fight over the regulation of cryptocurrencies, then the public interest in effective regulation of physical commodity futures markets and greenhouse gas emissions offset markets will lose. The costs and losses of regulatory failure will very likely be huge. The Wall Street induced economic crash of 2007-2009 together with the subsequent bailouts are estimated to have cost the U.S. economy over $20 trillion and counting.
