CME to monitor alternate hog pricing system to prevent manipulation

Tue Oct 8, 2013 6:48pm EDT
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By Theopolis Waters and Tom Polansek

CHICAGO Oct 8 (Reuters) - CME Group Inc, the largest U.S. futures market operator, said on Tuesday that it will step up surveillance of its lean hog futures next week to prevent price manipulation under a pricing formula the exchange adopted to cope with the shut down of the U.S. government.

The closer look from the exchange-operator's market regulation department will guard against potential price manipulation during an adjusted settlement procedure for the contracts, said Dave Lehman, CME's managing director of commodity research and product development.

If the government's shutdown extends to Oct. 15-the day after the CME October lean hog contract expires-the exchange operator will base the final settlement on a "volume weighted average" of trades made the previous two trading days-Friday, Oct. 11 and Monday, Oct. 14. Data from the U.S. Department of Agriculture, normally used to calculate final settlement, would not be available.

CME had no choice but to revamp its settlement calculation after the USDA pulled the plug on its daily, weekly and monthly reports, including those containing livestock and meat prices. The reports are the industry's benchmarks and have been the basis of U.S. cash contracts between hog processors and producers.

Using a volume weighted average of futures prices over two trading days is the best way to reflect USDA data in the absence of the government reports, Lehman told Reuters. Spreading the calculation period over two days reduces the risk of manipulation, he said.

"There's extra scrutiny being put on this expiration," Lehman said. "Our market regulation department can see who's in the market, who holds positions, who's trading, and they can monitor that and take action if they need to, if it looks like prices are being distorted."

Some traders worry that CME's revised methodology could create an opportunity for potential manipulation because more volume at a specific price on those days will have a greater influence in calculating the final settlement price. Any trader holding an open position at expiration will be paid or charged based on the final settlement figure.

"I fail to see how CME's solution ties to cash prices when I know there is little or no authoritative cash price information available right now," R.J. O'Brien hog futures trader Tom Cawthorne said. "It brings up more questions than answers."   Continued...