Comment Text:
While we don’t doubt that our colleagues at CME are operating in good faith with their proposal to increase spot month trading limits, we believe that the Exchange is misguided in this regard and we thank the CFTC for the opportunity to submit these comments for their consideration. Our critique of this proposal addresses both shortcomings in the data presented as evidence by the CME as well as the proposal’s timing.
Concerning Methodology/Data:
• We applaud the CME’s addition of delivery points to the contract, but it is overstated in their submission. The 2017 figure appears to be calculated by accounting for additional delivery points approved since that date but neglecting to account for three delivery locations which are no longer approved. Using the submission made by CME to the CFTC in February of that year as a baseline the capacity has increased by approximately 17% rather than 26 %.
• The CME reports that 6.6% of cattle are undeliverable due to weight restrictions. This is calculated using a standard deviation and average weights and we concur for steers. However in attempts to replicate their results with the same methods I am finding that nearly 34% of heifers are undeliverable, mostly due to being over the 1350 pound maximum weight.
• The CME correctly identifies delivery capacity as a limiting constraint on deliverable supply. However, their submission fails to account for regional differences in capacity. Over 45% (1716 loads/13 days) of the nation’s delivery capacity is in the Texas/Oklahoma/New Mexico region of AMS market reporting. This region has seen a marked decline in cash trade, indicating that the supply of non-committed cattle is decreasing. In fact, the cash trade totals for this region have been below its capacity each of the past 36 reported months, even before accounting for those cattle undeliverable due to weight specs. On average, this region has reported a cash trade of 41% of its monthly CME delivery capacity. Therefore, to utilize the deliverable capacity, a near herculean (and economically prohibitive) effort of shipping cattle from northern regions into Texas, Oklahoma and New Mexico is needed.
• The CME acknowledges that a financial penalty exists one month of the year for the Iowa/Minnesota region. This discount effectively handicaps this delivery point in October and makes the economics of utilizing over 12% of the nation’s capacity questionable. While it is true that this capacity would come in to play during a severe lack of convergence or a blatant manipulation attempt, this still accounts for an effective reduction of capacity.
Concerning Timing:
• An increase in the ability of speculators to hold positions past first notice day clearly has the potential to delay, even if it does not disrupt, convergence of cash and futures. This is problematic to long and short hedgers alike. When a hedge is placed the hedger has effectively taken a basis position. Market participants throughout the supply chain enter into these positions with an expectation of future basis. These expectations rely in large part on the timely convergence of cash and futures prices. Given the importance of this factor in determining basis, and the irreversibility of the prior decision to enter into a futures transaction, we request that any changes to trading limits be applied to newly listed contracts, giving all market participants time to adjust to a new convergence reality.
