How vital is the Commodity Futures Trading Commission’s (CFTC) commitment of traders report to futures traders? Judging from the volume of and invective in the responses to the CFTC query to either amend or possibly end producing the report, very.
Traders responsible for some of the more colorful responses, many of which couldn’t be published here, can rest easy. The COT report will continue as before, and beginning Jan. 5, in a two-year pilot program, the CFTC will add an additional report to gauge the activity of index funds.
The report, “COT Supplemental,” will aggregate futures and option positions of index traders and come out of the numbers reported in both the commercial and non-commercial category. The supplemental report will cover 12 agricultural commodities but will not include energy or metal contracts.
“People wanted to see that commercial category better represent the traditional hedgers — people involved in the physical corn market, for example — not this commingling of those types of participants in the physical market with the financial participants, namely institutional accounts,” says CFTC senior economist David Kass.
In the early 1990s the CFTC began offering hedge exemptions to “non-traditional hedgers,” typically swap dealers who were not commercials in the traditional sense but who came into the market to hedge their OTC exposure. The percentage of the market these dealers represent has exploded with the growth of long-only index funds that have approximately $100 billion benchmarked to them.
Kass says the reason the CFTC is not including metal and energy is because it would be impossible to accurately reflect index trading participation in these sectors. “Any data we might publish for these same traders would be totally in error in terms of representing index trading.” The CFTC’s executive summary says the numerous U.S. and non-U.S. exchanges and OTC markets coupled with swap dealers’ penchant for being involved as both hedgers and speculators and on the cash side makes getting an accurate picture of their index activity too difficult. It states, “As a result of these activities, the overall futures positions held by these energy and metals traders in Commission-related markets do not necessarily correspond closely with their hedging of OTC commodity index transactions.”
But excluding the energy and metals sector from the report takes out the largest portion of index activity. Money benchmarked to the largest index, the Goldman Sachs Commodity Index (GSCI), has approximately 90% allocation to markets that will not be included in the report according to trader and COT expert Steve Briese.
“Twelve markets are not a large factor in the index business,” Briese says. “It is disappointing that the CFTC is not going further. They have the data to provide a more detailed report.”
The CFTC report noted that the International Swaps and Derivatives Association (ISDA) was the only notable responder opposed to creating a separate category. ISDA noted that the top four swap dealers represent 70% of the non-traditional commercial category and disclosing those positions would give other market participants an unfair advantage.
Kass says it may be possible for traders to reverse engineer the broad impact of index traders in the energy and metals markets through data in the new report and does not rule out the CFTC adding markets to the report once it can ensure the accuracy of the data.
Briese doesn’t expect the data provided to allow for reverse engineering. “One of things the swap dealers were concerned about is reverse engineering, so I have an idea that when we see this report, it is not going to make enough sense for us to actually do that.”
COT expert Floyd Upperman says the CFTC delivered what the market wanted. “The market dynamics have changed and the report wasn’t as useful in its current format as it had been in the past. [The CFTC] realized that some of the data had been skewed on the commercial side because of the index funds and they have done exactly what we wanted them to do, which is to break that data out [and] put it in its own category so we can get a handle on what’s happening there and get back to tracking the traditional commercial consumers and commercial producers the way it used to be.”
Why is it important?
Upperman says having a true picture of commercial activity is vital to understanding the markets. “The traditional commercial consumer/producer cares about the prices. A producer has a cost involved in production and if the price drops below that production cost, they are going to lose money. So they are going to hedge around that production cost. A consumer on the other hand obviously needs the commodity for their business; if prices move higher and higher or if they think prices will move higher, they will increase their hedging to protect themselves,” Upperman says.
“We want to get into their minds and see what they are thinking because if they are doing a lot of hedging it tells us something. They know these markets, they know the fundamentals, we look at what they are doing to get a handle on what the fundamentals likely are. That is what the COT reports are all about.”
Upperman says that has been harder to do because the commercial category included swap dealers. “This other data, when it ends up in there, it muddies that all up and we can’t get a clear picture of what these producer and consumers really know. We can’t see that anymore.”
He says the new report will do that. “It is going to give us traders more insight into what is happening; we are going to find some great trading opportunities.”
Briese doesn’t agree, “The new report is not going to resolve the question of who is in what category.”