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Chicago Farmers Learn About the Workings of the CME Group

Makenzie Billings, manager, CME Livestock and Alternative Investment Products, and Josh Kravitt, director, CME Ventures, were the guest speakers for The Chicago Farmers March 14^th webinar. They presented an overview of the workings of CME.

In discussing futures, Ms. Billings related that people seek out the CME to manage price risk and engage with people. She noted that a futures contract is a legal, binding agreement facilitated through an exchange and clearing house. Futures deal in such areas as agricultural commodities, energy, fixed income, stock indices, foreign currency, and metals.

Giving a brief history of the futures industry, Ms. Billings said that Chicago became a key spot for people to gather in the, 1800s because of the access to the Great Lakes and railroads. During the 1800s, agricultural producers and consumers were subject to drastic seasonal food supply fluctuations and inconsistent, chaotic prices. At the same time, commercial agricultural hubs came into being as the American Industrial Revolution took hold and infrastructure grew. The Chicago Board of Trade (CBOT) was formed in 1848 as a central grain exchange allowing producers to sell their crops at set prices and consumers to purchase at transparent pricing throughout the year. The first forward contract on corn was written on March 13, 1857. The CBOT introduced standardized futures contracts in 1865. Corn, wheat and oat futures were introduced in 1877. The Chicago Produce Exchange established a dedicated cash butter and egg trading exchange, with defined product grades and rules of trade. To ensure quality, each keg of butter was individually smelled and tasted on the spot and a price was agreed upon. Surplus butter was salted and stored in the basement for future sale, which drove the introduction of the ‘time contract’ in 1882.

Over the years live cattle and live hog futures contracts and a feeder cattle contract and silver futures were added. The International Monetary Market, a division of the CME, was formed in 1972 to offer seven foreign currency futures contracts. In 1992, CME introduced CME Globex for electronic trading and to provide 24-hour access to all CME Group products.

Ms. Billings discussed the importance of the Exchange and a Clearing House. She said an exchange is a central marketplace where futures contracts and options on futures can be traded. It provides a facility and trading platform that can be either physical or electronic. It brings buyers and sellers together and establishes and enforces rules to ensure that trading is open and competitive.

A clearing house is an agency or separate corporation responsible for clearing trades, collecting and maintaining margin monies, regulating delivery, and reporting trading activities. Some clearing houses become the trade counterparty between brokers and, therefore, become the buyer and guarantees the trades, such as CME, CBOT. Ms. Billings related that in a live contract, such as a cattle contract, the CME sets the rules for delivery and the USDA oversees the delivery process. She noted that the majority of contracts is cash settled with only about three percent being physically delivered.

In agricultural options on futures contracts, the contract is sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation to buy (call) or sell (put) at an agreed-upon price (the strike price) during a certain period of time before or on a specific date.

She said that options are often equated to insurance. There is a premium (the cost of putting on the positon) to get protection. If the futures price moves favorably, the option position is not exercised and the holder of the option loses the premium. If the futures price moves adversely, the option position automatically exercises and the holder is given the futures position specified by the option.

The CME’s total average daily trade volume today is around 27 million contracts; the agricultural product’s average daily trade volume is around 1.6 million contracts. Regarding average open interest, which is the average total number of open futures contracts held by market participants at the end of the trading day:

• Across all asset classes, about 105 million contracts
• Agricultural produces, about 8 million contracts

Ms. Billings said that the people who come to the CME either financially back themselves with large capital requirements or are backed by a Futures Commission Merchant (FCM) who also has a capital requirement based on the amount of customer funds they hold. With this structure, along with the clearing house model, there has never been a trade default in the history of the exchange. She said the National Futures Association ensures that all regulations of the Futures Commission Merchants are followed.

To add to these protections, she said the National Futures Association (NFA) then ensures that all regulations determined by the Commodity Futures Trading Commission (CFTC) are followed. Further, exchanges have their own market regulation departments to ensure the rules of each market are followed. There are strict processes for addressing those who do not adhere to the rules and regulations.

Mr. Kravitt discussed CME Ventures (CMEV), which is the corporate venture capital arm of the CME group. He explained that CMEV comes across thousands of startups raising capital – across FinTech, AgTech, and other sectors. Mr. Kravitt said the group serves as the bridge between their external network that touches the private markets space and CME’s internal business lines, such as their agricultural business line. The team’s primary objective is to unlock long-term growth opportunities for CME. He relayed that CMEV provides insights into:

• Industry trends
• Problems being solved
• Where capital is deployed

CME Ventures receives “inbounds” from their vast external network, bankers or brokers that represent private companies, and from colleagues internally at CME. An inbound is a startup that is raising capital to pursue growth. Once an inbound is received, it is categorized. CME Ventures then vets the potential strategic value of a select few through pilots. If successful, CMEV may pursue partnerships and/or minority investments with the specific company.

Networking with companies that touch agriculture and colleagues provide the names of companies that are potential “inbounds.” Once a company has been identified, it is categorized, and its partners and strategic opportunities are vetted through pilots. Then, CMEV pursues partnerships and minority investments.

Mr. Kravitt said that CMEV has received more than 100 ag-related inbounds since early 2020, tagging notable companies across the following categories:

• Emerging PRAs and Spot Platforms, which encompasses organics and non-GMOs, hemp and cannabis, ingredients, water, and life sciences
• Index linked risk management, such as commodity risk management and climate-related insurance
• Carbon sequestration and regenerative agriculture, which includes MVR/Data Providers, ecosystem services markets
• Supply chain traceability using blockchain technology
• Farming operations and supply chain management
• Farmland as an asset class

Mr. Kravitt said that according to Pitchbook, there has been 40 percent annual growth in the venture capital investment in AgTech since 2012.  While the carbon farming space has seen tremendous recent growth, it still only represented less than two percent of overall investment in the AgTech space in 2021.

Mr. Kravitt briefly walked through current AgTech unicorns (AgTech startups with a valuation greater than $1 billion). These unicorns are offering solutions that fall across three broad buckets – sustainability and climate, supply chain challenges, and farmer productivity and profitability.

He went on to say that shifting consumer preferences plus technology, regulatory, and environmental factors are transforming the Ag industry. Mr. Kravitt identified four main takeaways in terms of where the space is moving:

• The continued acceleration of data and digitization tools to drive profitability
• Improved access to markets, physical supply, and better risk management tools
• The trend towards differentiated commodities
• Outsized growth in select product areas, such as alternative proteins, hemp and cannabis, organics, and micro-ingredients (vitamins, minerals). He said growth is expected in this category.

The above takeaways are driven by shifting consumer preferences, advances in technology, the shifting regulatory environment, and the implications of climate change.

In response to a question, Mr. Kravitt said that there are many challenges that are preventing wide-scale adoption in the regenerative agriculture/carbon farming space, including the concepts of additionality and performance. Challenges also exist on the measurement verification side and there is a lack of regulation and clarity. He said that farmers ae also questioning the economic benefits of transitioning to regenerative ag practices.

In response to another question, Ms. Billings explained that in forward contracts a producer selling a cattle feeder, for instance, is not backed by anything. A futures contract is standardized and the clearing house is between the buyer and the seller so that the counter party risk is minimized.  

Ms. Billings and Mr. Kravitt said that CME is a global company, with customers across Asia, EMEA, Australia, and Latin America.