A substantial number of live cattle positions were much larger than the speculative limits for individual futures in the most actively traded months. The largest live cattle positions were held by cattle feeders who are also cattle processors, although individual shares of the total market were quite small. Commercials together comprised, on average over the period studied, a greater portion of live cattle futures than in either live hog or pork belly markets. Further, commercials' share of the long side of the live cattle futures market rose substantially during the recent two years.

The analysis of the cash and related futures activities of the selected large hedgers over an 18 month period also revealed that the firms produce, process, and merchandise livestock and meat products and employ futures in numerous and diverse manners. Executives that were interviewed reported futures were used in increasing volume for forward pricing purchases and sales of livestock and meats as well as to hedge inventories.

Commercial use of livestock futures is apparently expanding, particularly to facilitate the competitive forward pricing activities of cattle processors. Indirect beneficiaries of these activities include institutional food preparers and cattle feeders who buy and sell at forward fixed prices without committing margin money, paying brokerage commissions, or assuming basis risk from direct futures hedging. Live hog futures also facilitate fixed forward pricing of producers' hogs to hedgers who are both hog processors and hog merchandisers, with the advantage to producers of not requiring direct positioning in futures contracts. Pork belly futures provide a significant risk shifting device to facilitate financing major pork belly storage programs from surplus to deficit supply periods.

The large hedgers studied tended to maintain substantially different futures positions and different cash business exposures, and a majority tended to change their positions often as measured by monthend reports. Because 10 of the 12 traders practiced selective hedging, the data suggest that the traders' price and market views at any one time were dissimilar and changed frequently, sometimes causing their futures positions to change substantially.

In conclusion, the 12 large hedgers studied closely for 18 months used three livestock futures markets extensively to shift inventory risk and increasingly to fix forward prices with producers and other commercials. Although these hedgers at times held large futures positions, the CFTC and the CME market surveillance programs have adequate powers to be effective deterrents to abusive trading by large hedgers in livestock and other futures markets. Specifically, we found no evidence that any commercial trader used a CME hedge exemption to disrupt the live cattle, live hog, or pork belly futures markets. In fact, on the two occasions when large livestock hedgers did become involved in problem situations, the CFTC was primarily concerned that the traders wanted to take too many deliveries-not that

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speculators. The Commission and the exchange have the power to preserve or restore orderly trading in threatened markets. The effectiveness of these emergency powers was demonstrated by the CME when it acted to facilitate the liquidation of the August 1983 pork belly future.

One of the most significant deterrents to excessive futures positions by large livestock hedgers is the hedge exemption procedure of the CME with respect to their speculative position limit rules. Hedgers are exempted from these limits to the extent they can justify greater futures market positions required to hedge their cash operations. Nonetheless, hedgers routinely are required to reduce their positions in expiring livestock futures to designated levels. Thus, during the sensitive liquidation periods of livestock futures contracts, large hedgers are prevented from having extraordinarily large positions that could exert undue market power. Analysis of position data confirmed that no commercial trader accounted for an excessively large share of the open interest in an expiring livestock future during the last few days of trading for the contract.

Nevertheless, commercial traders did appear to contribute to the two contract liquidations that were of some concern in the livestock markets between October 1982 and June 1984. In both instances, however, the most worrisome commercial positions were below the speculative limits and were small compared to the open interest. Yet, the traders caused concern by standing for, or announcing plans to stand for, a substantial number of deliveries.

This surveillance experience suggests that the greatest potential for unwarranted price impact on the part of large livestock hedgers-at least during liquidation periods-may stem from attempts to use these futures markets as a major source of supply for their businesses. Cash settlement rather than delivery may present a solution, provided requirements for appropriate cash price series can be satisfactorily met for the respective livestock commodities. Nevertheless, both the CFTC and the CME currently are prepared to take any necessary steps to protect the markets from attempted manipulations or major market disruptions. The CME's action in the case of August 1983 pork bellies provides a clear indication of that exchange's determination to prevent disruptions in its markets.

In addition to examining the trading of large livestock hedgers during delivery periods, data also were examined for evidence that the traders used their hedge exemptions to affect deferred futures prices. Although large commercials made extensive use of livestock futures in the 21 months observed, there appeared to be only one commercial trader whose positions in deferred delivery months-in this case hogs-tended to be both larger than the positions speculators were allowed to hold and large enough relative to the open interest to raise serious concerns about the trader's ability to affect futures prices. A review of that trader's activity, however, did not reveal any


Mr. WHITTEN. We note on page 36 of the explanatory notes that you expect the number of options contracts traded to increase from 7 to 22 as agricultural options are introduced and as the existing pilot program expands. In light of the major cuts proposed for your agency and the fact that you claim to have trouble accomplishing all your work with existing resources, is this a good idea to expand the pilot program?

Ms. PHILLIPS. When the pilot program for the trading of options was first proposed by the Commission, it determined by stressing its oversight role, to rely to a great degree on the efforts of the selfregulatory organizations. Thus, although the Commission has noted its difficulty in accomplishing its mission with existing resources, expansion of the pilot option should not be at the expense of customer protections. In addition, the nonagricultural options pilot program has been expanded twice to allow additional options on futures. In this area, few exchanges have applied for the maximum currently allowable under the pilot, so it is not likely that a deluge of new applications in the nonagricultural options pilot program would be forthcoming. Moreover, the Commission has previously noted that the options program potentially offers great economic benefits. Accordingly, were the Commission to delay the program due to its lack of resources the economy would be denied these potential benefits.

EFFECT OF SURVEILLANCE STAFF CUTS Mr. WHITTEN. Please describe for us the impact a 15 percent personnel cut will have on the Market Surveillance staff in its ability to monitor options markets.

Ms. PHILLIPS. If a 15 percent cut were applied to Market Surveillance, 10 positions would be lost. If we had to absorb reductions of that magnitude, we would try to concentrate the reductions in the areas of clerical support and by terminating publications while increasing our utilization of ADP support. Nevertheless, we still would be forced to make some reductions in our staff of surveillance economists, which, when accompanied by an increase in the number of futures and options markets that must be monitored, means that we would not be able to monitor options markets as closely as we do now. We have found that an optimal surveillance load per economist is about four active markets. With a 15 percent cut in staff, that workload might double in FY 1986.


Mr. WHITTEN. We note that your workload projections for the Market Surveillance staff assumes an adequate ADP support. What would happen if the support were not available?

Ms. PHILLIPS. Any reductions in ADP support for Market Surveillance would have very serious consequences for that program, particularly as it applies to options. We are in the process of modernizing our ADP support for Market Surveillance. In the past year we made significant progress in increasing the amount and quality of opment work is in progress that will enable surveillance economists to analyze routinely large quantities of data from a variety of sources that in the past were not available in computerized form. Since options data are more voluminous than futures data, it is vital that we complete our development of a computerized options surveillance system that is fully integrated with our futures surveillance system. Our ability to examine trading strategies involving futures and options markets to detect potential violations will be impaired greatly if adequate ADP support is not available. Without adequate ADP support we will only be able to conduct limited surveillance on the largest options markets because we would have to rely upon manual compilation of options position data.


Mr. WHITTEN. Last year the Market Analysis staff completed economic reviews of 8 applications for new futures contracts. Please list these contracts.

Ms. PHILLIPS. I will provide that information for the record:
[The information follows:)
Chicago Board of Trade's Amex Major Market Index.
Chicago Board of Trade's Amex Market Value Index.
Chicago Mercantile Exchange's Standard and Poor's 500 Energy Index.
Chicago Mercantile Exchange's gold coins.
Commodity Exchange, Inc.'s gold coins.
Commodity Exchange, Inc.'s aluminum.
MidAmerica Commodity Exchange's platinum.
Minneapolis Grain Exchange's white wheat.


Mr. WHITTEN. Backlog of pending futures designation applications was reduced to the lowest level of over 5 years. To what do you attribute this?

Ms. PHILLIPS. The futures backlog was reduced to 25 contracts by the end of fiscal year 1984 due to the approval of 8 contracts during that fiscal year as well as the withdrawal of a large number of applications. The exchanges withdrew 28 pending futures applications in connection with the Commission decision to impose a $10,000 fee on the processing of each designation application. However, exchanges have submitted 15 option applications during FY 84 under the agricultural and nonagricultural pilot programs.

28 PENDING APPLICATIONS WITHDRAWN Mr. WHITTEN. Why were 28 pending applications withdrawn? Ms. PHILLIPS. In August 1983 the Commission established a $10,000 fee for the review of contract market designation applications. At that time, exchanges with pending applications were allowed 30 days to withdraw these contracts from the Commission to avoid payment of the fee. In response to the implementation of the fee schedule, 28 contracts were withdrawn by 5 exchanges.


Mr. WHITTEN. We note that one of your efforts for the Market

of the leverage program to determine the adequacy of existing regulations and the need to amend these regulations. What is the status of this evaluation and when do you expect it to be complete?

Ms. PHILLIPS. On January 2, 1985, the Commission adopted certain technical and conforming amendments to its leverage regulations to incorporate and accommodate "short” leverage transactions into the Commission's regulatory framework. At the same time, as a result of an ongoing review of the Commission's regulations governing leverage transactions, the Commission published in the Federal Register, and solicited comment on, certain proposed substantive amendments to its leverage rules which, while principally related to short leverage contracts, would also have some impact on long leverage contracts. Commission staff is continuing to evaluate the adequacy of the proposed substantive amendments to rules governing both long and short leverage transactions. However, in light of the potential for reduced staff levels projected for fiscal year 1986, it may be necessary for the Commission staff to limit its ongoing evaluation of the leverage program, and the Commission may be limited in its ability to enhance the current regulatory framework for leverage transactions through additional amendments to the rules.


Mr. WHITTEN. How many employees are in the Market Research element of the Commission?

Ms. PHILLIPS. There are twelve employees in the Division of Economic Analysis's Market Research Section-the director, seven staff economists, two full-time and one half-time research assistants and one secretary.

Mr. WHITTEN. Is any of this work contracted out?

Ms. PHILLIPS. No, all of the work is performed by Commission staff.

COMMODITY POOL CONCERNS Mr. WHITTEN. On page 46 of the notes you state that the commodity pools have been a source of growing concern in the enforcement area. Please explain why this is so.

Ms. PHILLIPS. The objective of the study mentioned in the notes is to determine if commodity pools show any evidence of common trading plans and whether their trading should be of any particular concern in our market surveillance efforts.


Mr. WHITTEN. Currently, the National Futures Association is the only futures association registered with the Commission. What is the possibility of other associations being registered during the next few years?

Ms. PHILLIPS. Although section 17 of the Act does not preclude other registered futures associations, the Commission is not aware of any efforts within the commodities industry to establish another association at this time. An effective self-regulatory organization

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