The US CFTC has issued a USD $3million penalty against Ceres Global Ag Corp, a Minnesota, for alleged market abuse in Oats futures on the CBOT instance of the CME in 2016 and 2017.
The salient aspects of the case are briefly summarised as follows:
- Going into June 2016, the company carried a short position in the July 2016 oats futures contract as part of its normal hedging strategy;
- In a bid to increase the price of the July 2016 oats futures contract, a senior manager of the firm decided to take physical delivery in the July 2016 contact in an apparent bid to squeeze short position holders that had insufficient physical to meet their delivery obligations;
- To execute the plan, the manager instructed the Oats traders to exit their short position around 13 June 2016 and to instead build a long position of around 600 July futures contracts (approx. 3 million bushels). The order notes that this was (and still appears to be) the speculative position limit for the Spot month in Oats futures. Also note that CBOT currently also imposes a 600 contact physical delivery limit on this contract;
- The order states that the firm had no immediate need for the additional physical oats as it already held more than 6 million bushels of oats in its inventory and its pending sales did not require the additional purchases;
- By 30 June 2016 the company had built a long position of 537 contracts (nearly 2.6 million bushels). On 1 July 2016 they held 100% of the long open interest in the July 2016 contract;
- Going into July 2016 delivery they took physical delivery of 484 contracts and netted out on an additional 53 contracts. The order notes that the senior manager emailed the desk shortly prior to this, overtly stating that the position was “not quite where we wanted to be, but big enough to benefit if this thing really inverts.”;
- In addition to building the long July 2016 futures position, the same senior manager also instructed the traders to buy back shipping certificates which the company had previously tendered to other market participants but to do so in a way that would not reveal their plan to take delivery on contract expiration;
- It should be noted that the delivery of an oats futures contract is effected when a short-position holder tenders a shipping certificate or “delivery receipt” which gives the recipient ownership of 5,000 bushels of oats at a designated delivery facility. The certificate owner has the right (but not the obligation) to cancel and load out the oats represented by the shipping certificate;
- The company hoped that the repurchasing of the shipping certificates would reduce the amount of lower quality oats available to other market participants thereby making it harder for short-position holders to obtain lower quality oats to make delivery, potentially allowing the company to take delivery of higher quality oats at the lower delivery price;
- The order states that the company performed similar actions with the March 2017 contract where during the March 2017 delivery period, the company took delivery of 337 contracts and netted out on an additional 224 contracts;
- Again, their appears to have been incriminating internal communications from the senior manager acknowledging the disruption their trading scheme had induced;
- The order finds that the company had intended to manipulate the price of the July 2016 and March 2017 oats futures contracts to benefit their derivatives positions and its physical positions to the extent they received higher quality oats through the delivery mechanism at below-market prices in breach of Section 9(a)(2) of the Commodity Exchanges Act (CEA) which makes it unlawful for “any person to manipulate or attempt to manipulate the price of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity.”;
- On the question of intent, the order notes that the company had built large long positions close to or at the exchange-set speculative limits and held those positions into deliver with the “specific intent of raising the prices of oats future outside the ordinary forces of supply and demand”.
The order also notes that the company had already undertaken several remediation actions under its own volition to ensure compliance with the CEA and relevant Regulations including:
- Engagement third-parties to assist in the review of their policies, procedures and training;
- Implemented training for all personnel involved in commodity trading;
- Implemented new policies and procedures to ensure compliance when it takes or makes delivery of a commodity; and
- Designated a new role of Chief Compliance Officer (CCO).
Two CFTC Commissioners published statements supporting the enforcement action.
Commissioner Johnson (click here) noted that Ceres operates four of the thirteen warehouse facilities designated by the CME for the regular delivery of oats and that the case ”shows how a large company can leverage its position for its own benefit, at the expense of others in the marketplace“ and that “this kind of activity undermines market participants’ confidence that futures contracts can serve their hedging and price discovery functions”.
Commissioner Goldsmith Romero (click here) noted that “The oats futures market is a small market. Smaller markets are easier to attempt to manipulate than larger markets, particularly by large players.” and like Commissioner Johnson, clearly taking a dim view on attempts to manipulate commodities that directly impact food prices given the current political sensitivity around inflation.
RegTrail Insights
Such short squeezes are not new by any means, but there were clear indications that the trading activity arguably should have been detected including the sudden and unexplained shift from short to long, an excessively large share of open interest combined with the close proximity to the speculative spot position limit for the contract (as well as the physical delivery limit).
At a deeper level, the business rationale for the switch to a long position was not supported by the prevailing physical inventory levels and pending customer orders. Finally, the senior manager involved in the scheme also hardly disguised his/her intentions via internal communications. These red flags were missed due, evidently, to a lack compliance monitoring capabilities that might otherwise have aroused suspicion and internal inquiry from compliance.
The manipulation of commodities that directly impact food prices carry an additional political premium as clearly indicated by the Commissioners’ supporting comments – abuse, perceived or otherwise, is frowned upon more so in Agricultural markets than for other commodity classes. Firms active in such markets are strongly advised to place additional emphasis on monitoring for abuse in these markets.