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Will A World Wheat Contract Replace CBOT Futures?

“The market is going to take care of itself, the banking system will be back in order, the risk management of the grain companies will be back in order, and everybody is not going to be terrified.”

– GLENN HOLLANDER

Is the grain industry ready for a world wheat futures contract?

A year-long campaign to force changes in the Chicago Board of Trade’s wheat contract has revived talk of a global contract for wheat. Creation of such a contract is still in the brainstorming stages, with no concrete proposals as of yet.

“With the interest in commodities as an asset class which will come and go with time, I think it would be instructive and useful for the exchange to look at how a world wheat contract might be constructed – where delivery might be, whether it’s cash settled, whether it’s physically settled, delivery locations,” said Diana Klemme, vice-president of Grain Service Corp. in Atlanta and a top consultant to the grain industry.

For a century, CBOT’s futures contract has come closest to being the de facto pricing vehicle for the world wheat industry – a market where growers, millers and exporters can buy and sell with confidence to hedge cash market risks.

The CBOT contract is based on physical deliveries of U. S. Soft Red Winter wheat, a type which accounts for just a quarter of the country’s wheat crop. Still, CBOT’s success as a market maker has long attracted more speculative money than other grain exchanges around the world, and also has created the best liquidity for easy wheat pricing.

However, for more than a year the CBOT’s parent, CME Group, has been under fire from big U. S. grain handlers who say the CBOT wheat contract is “broken” as a hedging tool. They argue that futures prices no longer “converge” with cash market prices during delivery, as they have for a century.

The 900-member National Grain and Feed Association has demanded and won some changes in the contract from the CME and its regulator, the Commodity Futures Trading Commission.

The latest changes, proposed in January, limit the number of delivery instruments – warehouse receipts and shipping certificates – that non-grain companies like hedge funds can hold during cash delivery periods. The proposals were dramatic and appeared to favour the NGFA’s demands, but NGFA has yet to endorse them.

Some traders think CME should let the market correct itself.

“Our contract doesn’t work because the world looked at the volume and said we could use it for other things,” said veteran CBOT grain merchant Glenn Hollander, referring to Wall Street’s commodity investment boom that has since cooled off.

“The markets are correcting,” he said, citing the cash grain market’s “basis” spreads – the difference between local wheat prices and the CBOT futures price.

“Everyone was moaning last summer when the basis was 200 under the July and basis today is 110 under the March. So it’s taken time for the shock waves to subside,” Hollander said.

“The market is going to take care of itself, the banking system will be back in order, the risk management of the grain companies will be back in order, and everybody is not going to be terrified,” Hollander said.

LIQUIDITY EQUALS SUCCESS

Open interest in the CBOT’s wheat contract, though down 30 per cent from a year ago at 306,497 lots, is still triple the next-biggest U. S. wheat market, Kansas City wheat futures.

But the uproar over the CBOT’s contract has stirred fresh interest in whether CME – in a world with significant players in the wheat markets like China, India, Russia – should think of overhauling its contract or risk losing out to others.

“It would make for some good discussions,” Klemme said.

But coming up with the right mix of ingredients for a successful contract is tough. Freight, currency differences, local wheat varieties, possible delivery points – all would have to be integrated into a global wheat contract.

“From that perspective it seems more prudent to have a variety of local wheat markets that are in major points of interest such as an Australian wheat contract, a U. S. wheat contract, a European contract and a Latin American wheat contract,” Patrick J. Catania, chief executive of Asia West Group and a former top official at the CBOT, told Reuters.

Exchanges could list these global centres on a common electronic platform “so traders are actually looking at a screen with global pricing,” Catania added.

Cross-listing and alliances may be a trend to watch.

CME in recent weeks appeared to move to more global integration of its commodities complex, announcing various deals with the Johannesburg Stock Exchange, the Dubai Mercantile Exchange and Sao Paulo’s BM&FBOVESPA exchange.

But the biggest hurdle is an age-old impediment: liquidity.

In 2005, CBOT launched a South American soybean futures contract hoping that Brazilian and Argentine exporters and processors would flock to the contract to hedge. They didn’t, sticking with CBOT’s benchmark soybean contract instead.

“That is going to be key,” said Prudential Bache analyst Shawn McCambridge. “They might say this market, while it may not be perfect, works for me. I know I can get in and out.”

“Very rarely once an exchange has a successful contract can another exchange come up with a contract that takes the volume away,” Hollander said.

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