Analysis: As ICE threat melts, 'long, dull' CME grain hours draw fire

CHICAGO Fri Oct 26, 2012 6:10am EDT

CHICAGO (Reuters) - CME Group's (CME.O) bid to cement its dominance in grain markets with longer trading hours may be backfiring, with some traders reducing activity and others including major merchant Bunge calling for a return to a shorter day.

Five months after the exchange moved to an uninterrupted 21-hour trading session for its Chicago Board of Trade agricultural contracts, overall volume in corn futures has fallen to the lowest level since December and is the lightest on a per-hour basis since March 2010, according to Reuters calculations based on CME data. Previously, the contracts had traded for 17 hours.

Average soybean and wheat trade has also dipped below levels seen early this year, before hours were extended, a trend that has encouraged more than 600 local traders, brokers and farmers to sign a petition calling for a return to shorter hours.

On Thursday, Bunge Ltd (BG.N), one of the world's largest agricultural trading houses, threw its weight behind the effort to reduce hours, saying 21-hour trading was "too much."

"The merchandisers and traders, they just can't be paying attention (21) hours a day," Chairman Alberto Weisser said in an interview. "It should be more restricted."

The CME says it is too early to judge how expanded hours have impacted grain markets, and that a host of factors are affecting liquidity and volatility, including weather events like this summer's drought, the worst in half a century.

In fact, agricultural products fared better than any other CME asset class in the third quarter. Daily volume in grain, oilseed and livestock futures rose 13.5 percent from a year ago, whereas total trade in all six segments dropped 26 percent, led by deep declines in interest rate and equity derivatives.

But some traders say the increased trading hours are also to blame for reducing liquidity and amplifying volatility.

"I think it was a very, very bad error on the part of the exchange," said William Plummer, president of brokerage Frontier Risk Management, which has farmers for clients.

Plummer said he is trading less as liquidity seeps across a longer day, leaching away from the 3-3/4 hour period of open-outcry trading that used to define the "trading day" and into less-active early morning hours when key U.S. data is released.

"How can I move 500 contracts of something quickly without the liquidity being there?"

ICE SURPRISE

Until May, CBOT grains traded for 17 hours a day, with a 2-1/4 hour pause in electronic trading from 7:15 a.m. to 9:30 a.m. CDT, the start of open-outcry dealing, and another gap from 1:15 p.m. to 6 p.m. EDT.

But arch-rival IntercontinentalExchange's (ICE.N) surprise launch this spring of look-alike wheat, corn and soy contracts - on a 22-hour basis - forced CME's hand, spurring it to join other major commodity markets that years ago moved to near round-the-clock trade to cater to hedge funds and Asian traders.

Now it trades nonstop from 5 p.m. CDT in the evening until 2 p.m. the next day.

While some complaints are rooted in the deep traditions of CBOT trading - including an open-outcry trading period that was only 3-3/4 hours long - even some of the market's more sophisticated participants say longer hours were a bad move.

Malinda Goldsmith, a partner at $55 million agriculture-focused Four Seasons Commodities, says she has stopped trading flat-price grain futures because of increased volatility, switching instead to spread trades because sharp price swings have become more common in prolonged out-of-hours trading.

"The liquidity at any particular given moment seems to have declined," said Goldsmith.

Ashmead Pringle, president of the GreenHaven Continuous Commodity Index Fund, is blunt: "I hate them."

Critics also note that the threat of ICE poaching business from the CME has so far proven mostly hollow.

ICE's five U.S. grain contracts saw a total of 35,632 lots traded in September, the lowest volume since they were launched in May. Activity peaked in July, with 84,024 contracts traded. The five equivalent contracts traded 13 million contracts on CME.

The Chicago-based CME is expected to formally survey users about the extended hours soon.

"It's something we continue to monitor and talk with our customers about," said Tim Andriesen, CME managing director of agricultural commodities.

TRADING SHIFTS TO MORNING

Opinions about the early-morning trading period are by no means unanimous, and activity has picked up over time.

In the two hours prior to the start of open-outcry trading at 9:30 a.m. CDT (1430 GMT), average volume for the most active corn contract reached 16,349 trades during the last two weeks of September and early October, more than double the volume in the first month of the extended session, according to Reuters data.

In soybeans, trading during the early hours before the pit opens has risen to 15,799 contracts from 5,901. Wheat volume during that time has remained below 5,000 lots.

"I buy grain all day long so if the market is open all day long, I can relieve my risk immediately," says Darrell Fredrickson, vice president at the Kentland Elevator in Indiana.

At least a portion of the volume is seen coming from high-frequency traders, who can now trade the U.S. Department of Agriculture's monthly crop reports and weekly export data, released at 8:30 a.m. EST, on a "live" basis.

Reviled by some traditional traders, algorithmic firms say the early hours have actually democratized trading. Prior to the change, only larger hedgers had been able to trade over-the-counter grain swaps in the period when futures markets were not open immediately following USDA reports.

"Having the reports issued during trading hours allows all market participants to respond to the news at the same time," said Robert Creamer, president and chief executive of Geneva Trading, a high-speed firm that likes the longer cycle.

NEW HOURS LEACH VOLUME

But critics say early-morning liquidity is cannibalizing business that was previously conducted during the day rather than expanding overall liquidity.

Total activity in CBOT corn futures was down 1.2 million contracts in September when compared to a year earlier, a drop of 23 percent, exchange data shows. Wheat volume was off 6.2 percent and soybean volume was 3.1 percent lower.

The drop appears even deeper when accounting for the longer day. Average hourly volume for corn has declined every month since the shift, reaching 10,438 contracts last month, the lowest since March 2010 and half as much as the first quarter.

Average hourly wheat volume also has dropped for four months in a row and hit 3,864 lots in September, the lowest since last December, typically the quietest month of the year.

Soybean volume has been more erratic, but its September average of 9,839 per hour was the lowest since January.

SEARCHING FOR LIQUIDITY

To be sure, it is still early days, and a host of other factors may be accounting for diminished activity.

Outside observers say the fact that this year's drought-hit corn crop came in 28 percent smaller than first forecast five months ago diminished hedging.

On a call with analysts on Thursday, CME Chairman Terrence Duffy said 'regulatory issues' as well as the sluggish economy and tax policy uncertainty were a "disaster" for trading activity. Traders say those factors affected financial and energy markets more than grains.

Bart Chilton, the Commodity Futures Trading Commission's most vigorous defender of everyday traders, said in an interview that he had not yet seen evidence proving that longer hours have reduced liquidity or increased volatility.

But for many veterans, the loss of the traditional adrenaline rush at the 9:30 a.m. CST open of pit trading - when trading volume would spike as two hours and 15 minutes of pent-up activity burst into the pits - has been wrenching.

"You have taken away a grain opening which had traditionally been a time of urgency and anticipation that had been a spark to the markets," said Terry Linn, analyst for the Linn Group who got his start in the commodities business as a runner and phone clerk on the CBOT grain floor.

"It has become a long, dull day."

(Editing by Jim Marshall)

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