The Commodity Futures Trading Commission's (CFTC) first court battle interpreting its new anti-manipulation authority under Dodd-Frank amendments to the Commodity Exchange Act (CEA) is CFTC v. Kraft Foods Group Inc. (KFT) and Mondeléz Global LLC. The case alleges that Kraft manipulated the wheat futures and cash markets in 2011. The Complaint suggests that conduct intended to (or anticipated to) influence market prices is per se manipulation if the actor benefits from the impact on prices. This leaves commodity market participants with important questions to consider.
Specifically, does intentionally changing supply and demand fundamentals equal manipulation?
Kraft historically procured its wheat supply primarily in the local (Toledo, Ohio) cash market and used wheat futures to hedge its purchases, rarely taking delivery. However, in late 2011, the cash market was trading at a premium to the futures and, according to contemporaneous e-mails quoted in the Complaint, Kraft estimated that it could save more than $7 million if it sourced wheat in December 2011 through the futures market instead of the cash market. The Complaint explains that taking delivery through the futures market would result in lower quality wheat at less convenient locations.
Kraft also appears to have recognized that its move from cash to futures would reduce demand in the cash market and increase demand in futures. This was expected to reduce cash prices and increase futures prices. When this happened, Kraft liquidated its futures position and purchased supply in the now relatively cheaper cash market.
Put another way, Kraft historically behaved as a captive customer to the Toledo cash market and sought in 2011 to diversify its supply options and inject price competition by forcing suppliers in the cash market to compete with the futures market. Kraft’s behavior seems akin to a captive cable customer looking to switch to the dish. The Complaint seems to assert that acting on that threat can constitute fraud or manipulation.
It is not clear from the Complaint whether anything more than the threat to source from the futures market would be needed to give rise to manipulation allegations, but the CFTC takes issue with Kraft’s apparent decision to engage in speculative trading informed by non-public knowledge of its procurement plans. The Complaint first points to the anticipated effect of the move to the futures market on the cash market, then it highlights Kraft’s activity in the futures market designed to benefit from price changes as a result of the shift.
According to the Complaint, Kraft anticipated that the increased demand in the December 2011 futures contract — after Kraft’s shift to futures — would narrow the spread between the December and March contracts, and Kraft sought to take advantage of this by establishing a December/March futures spread. The CFTC appears particularly troubled by the fact that Kraft’s futures position exceeded its physical needs. In practical terms, this view might impose a new prohibition on commercial market participants establishing speculative positions based on the anticipated market impact of their own conduct.
If the CFTC claims that competitive behavior designed to obtain the lowest price available is manipulative when the trading strategy impacts market prices to the trader’s benefit, then end-users and other physical market participants will find themselves in a challenging position. Either they will need to assess the likely impact of trading activity on prices to avoid the appearance of trading to benefit a related position, or they will need to intentionally refrain from making otherwise economically rational trading decisions based on their expectations. Ultimately, this might leave commercial market participants unable or unwilling to speculate in any market in which they participate.
Notably, the CFTC has not accused Kraft of attempting to corner the wheat market. Nor has the CFTC alleged Kraft traded uneconomically. However, the CFTC might be inferring an intent to manipulate the market from the volume or timing of Kraft’s trading activity in the futures market. If Kraft’s trading was uneconomic or otherwise inconsistent with the legitimate business rationales described above, such facts would help market participants better distinguish between competitive, economically rational behavior and an unlawful manipulative scheme. The question remains whether Kraft’s strategy as described in the Complaint is itself manipulative, or if Kraft’s execution of the strategy may have been manipulative.
The larger point may be that these questions remain. At this stage, although market participants certainly can learn from the Complaint, the case raises more questions than it answers.