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"It was actually told to me by the chairwoman that these [big companies] don't need us regulating them and hampering them, because they can take care of themselves. That missed the point. The point was, sure they can take care of themselves - but it wasn't them I was worried about." Still, despite this apparently favourable treatment, many swap dealers and derivatives traders remained nervous: Although the CFTC had provided welcome assurances, the regulator did not have the formal power to enshrine these exemptions as binding rules. Brokerage firms, energy traders and other financial players aggressively lobbied Congress on the issue, and in 1992, the U.S. government passed new legislation that enabled the CFTC to determine which derivatives could be considered forward contracts and receive exemptions. Armed with this new power, the CFTC quickly handed out nine different exemptions for certain energy contracts. One of the recipients was a Houston-based pipeline entity called Enron Corp. that was branching out into the energy trading arena. In January 1993, just as President Bill Clinton was being inaugurated, Ms. Gramm left the CFTC. Five weeks later she joined the board of Enron. Congress, however, wasn't done. In 2000, it introduced an array of exemptions, including one for electronic trading of energy contracts. This new rule, which prompted the creation of numerous overthe-counter trading systems allowing buyers and sellers to avoid scrutiny, was later given a nickname: the Enron Loophole. Beyond the Enron Loophole Oddly enough, the CFTC's decision to exempt swap dealers from trading limits did not incite an immediate rush of fund money into agricultural commodities. Many pension plans, in particular, were still inherently conservative and viewed commodities as a high-risk playground better suited to speculators. One of the earliest funds to venture into commodities futures was the Ontario Teachers' Pension Plan. It began with a tentative $100-million (Canadian) investment in 1997, and is now one of the world's larger commodities investors, with about $3-billion committed. Not long after Teachers made its first commodities investment, Leo de Bever, then a vice-president with the fund, acknowledged in a speech at a New York conference that the strategy was unconventional for a fund like his. "We are probably an exception, rather than the rule in North America," he said. That didn't last long. Throughout the 1990s, pension funds from Japan to Canada began accumulating assets at a furious clip. Around the world, the bulging baby boom demographic was contributing record amounts of new money into pension plans and retirement funds. At the same time, pension funds were freed from the traditional shackles of fixed-income investments, like bonds, which produce low returns, and began depositing cash in stock markets, infrastructure and real estate. This boosted returns, and added further bulk to their growing assets. Worldwide institutional fund assets have soared from around $200-billion (U.S.) in 1980 to over $20-trillion today. But that growth didn't come without setbacks. The dot-com crash in 2001 wiped out billions of dollars worth of value, and offered a painful lesson in the need for further diversification. Suddenly, commodities emerged as a logical vehicle to help pension plans spread around their risk, and at the same time get a measure of protection against inflation.
It didn't hurt that when pension and index funds descended en masse into these markets, they found ready-made loopholes that enabled them to make much larger investments than they would otherwise have been able to. Consider the scale of the increase over the past seven years. In 2000, long-only speculative investors - that is, investors like these funds who are only betting that prices will climb higher - had committed about $4.7-billion to commodities, according to figures compiled by Gresham Investments, a New York firm specializing in commodities. That number has almost doubled every year since, hitting $80-billion in 2005, and $175-billion in 2007. As of today, most estimates peg total fund investment at approximately a quarter of a trillion dollars. Indeed, a study this month by Greenwich Associates found that almost 40 per cent of commodities investors have only been active in these markets for the past three years. Meanwhile, as this fund money stormed in and demand rose, prices for a range of food staples, such as wheat, soybeans and corn, began escalating. Between 2000 and 2007, the price of wheat increased 147 per cent on the Chicago Board of Trade. Over the same period, corn increased 79 per cent and soybeans 72 per cent. In the past year, in particular, the price moves have been dramatic.The CFTC's moves to deregulate the sector, meanwhile, only inspired calls for more deregulation. As more funds piled in, stoking demand for agricultural futures contracts, speculators began clamouring for more flexibility with trading limits. In 2005, the CFTC obliged by expanding trading limits on the amount of wheat, corn, oats and soybeans that traders could buy or sell at any one time on the futures markets. Then, in 2006, Deutsche Bank and another undisclosed index fund operator asked the CFTC to exempt them from all trading limits, much as it had done for swap dealers. The CFTC didn't provide an outright exemption, but gave these two funds pretty much the same thing: a "no-action letter," assuring the funds that they would not be subject to penalties if they breached the limits. Last fall, after other funds began jockeying for similar treatment, the regulator issued a proposal to offer index and pension funds full exemptions, meaning they wouldn't have to go through a swap dealer to circumvent trading limits. The CFTC also asked for comments on a proposal to once again raise trading limits for speculative investors, such as hedge funds. For many in the food industry, who had begun to suspect a strong link between the market's wild swings and this influx of new fund money, this was the last straw. The One Hundred Years War On a Tuesday morning in late April, a group of more than 100 people shoehorned themselves into a cramped conference room in the Washington headquarters of the CFTC. There were farmers and bakers, brokers and stock exchange officials, pension fund executives, professors, and even cotton growers, all convening for what was, by any measure, an extraordinary meeting: In the midst of skyrocketing prices for food and unheard of gyrations in futures contracts, the chief commodities regulator was trying to figure out whether the markets it oversees still worked properly. Almost immediately, fault lines emerged between the "commercial" players - farmers, grain elevators, processors, and anyone else directly involved in the food chain - and "speculators" - index funds, pension plans, hedge funds, and other investors who buy futures to bet on price movements, but who never intend to take physical possession of the commodity.
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