During the years from 200 through 2011, grain traders noticed wider-than-usual discrepancies between futures and cash prices for wheat, corn and soybeans. This “non-convergence” created concerns over the viability of those futures contracts as price-discovery and risk-management tools. In response, commodities markets made some changes to contract specifications beginning in 2008, and a new report from USDA’s Economic Research Service indicates those changes have brought better convergence of prices during the delivery period of expiring futures contracts.
According to the report, a lack of convergence between futures and cash prices, and uncertain behavior of the basis leads to less effective hedging and disruption of markets.
A basis of $0.10 per bushel above or below zero during a contract delivery period is considered normal convergence, the authors note. But during the years in question, wheat, corn and soybean futures prices at times exceeded delivery location cash prices by $1.00 per bushel.
In response, the Commodity Futures Trading Commission (CFTC) began working with the Chicago Board of Trade (CBOT) and the Kansas City Board of Trade (KCBT) to identify causes behind non-convergence and potential solutions. The CFTC formed the Subcommittee on Convergence in Agricultural Commodity Markets on March 9, 2009. In cooperation with the CFTC, the CBOT and KCBT took several steps between 2008 and 2011, modifying their contracts to better reflect market conditions. These include:
- Aligning contract storage rates with industry storage costs.
- Adding delivery locations to sufficiently fulfill the soft red winter wheat contract during the delivery period.
- Strengthening wheat quality requirements, such as reducing vomitoxin levels to conform to industry standards.
- Limiting the number of shipping certificates for CBOT contracts that an individual firm can hold at any one time.
The report shows that since most of these changes were implemented in 2011, convergence has improved for the grain contracts in question for most contract months. “These changes have improved convergence and hedging effectiveness and helped preserve the futures market’s vital functions: commodity price discovery, risk management, and allocation of inventories through time,” the authors conclude.
The full report is available online from USDA/ERS.