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CME Parries ICE With First Contract on East European Crop

CME Group Inc.’s decision to spend a year-and-a-half developing its first futures contract on an Eastern European crop began with a newspaper article. Leo Melamed couldn’t believe it when he read that Vladimir Putin wished there was a way to insure a wheat harvest after Russia’s disastrous 2010 drought.

“I said, ‘Wait, I know how to insure a crop,’” says Melamed, the chairman emeritus of the world’s largest futures exchange who’s known as the father of financial futures for his role in creating currency contracts in the early 1970s, Bloomberg Businessweek reports in its May 28 issue.

When negotiations stalled with Russia, the world’s third-largest wheat exporter, CME Group shifted its efforts to Ukraine. In May 2011, the exchange signed memorandums of understanding with the Ukrainian government and the Ukraine Futures Exchange. “The Ukrainians wanted to be first,” Melamed says. “They were ready to move.”

On June 6, Chicago-based CME Group will start trading in a Black Sea wheat contract on its electronic network, giving investors, producers and companies that buy grain a chance to lock in prices or speculate on them.

With the new contract, CME Group, whose predecessors introduced commodity futures to the world in 1848, is expanding its reach and playing some defense against its much younger rival, Intercontinental Exchange Inc., the nation’s second-largest futures market. Intercontinental, known as ICE, began trading corn, wheat, soybeans and soy-oil contracts on May 14.

‘A Little Crazy’

While it might seem a quixotic effort -- CME Group accounts for 98 percent of all U.S. futures trading -- ICE has beat daunting odds before. In 2006 it took 30 percent of the U.S. oil futures market from the New York Mercantile Exchange. CME Group bought Nymex in 2008.

“We think we’re in as good a position as any to be successful,” says Benjamin Jackson, the chief operating officer of ICE Futures U.S., ICE’s New York exchange, where the grain contracts trade. “At a minimum, we’re responding to what our customers want, and if it doesn’t work, they owe us one.”

CME Group is not dismissing the challenge. “We take everything seriously as a competitive issue, even though I don’t think they will succeed,” says Melamed, who adds a note of skepticism: “This is a little crazy.”

Marlboro Cigarettes

Melamed has a long history in the Black Sea region. He fled the Nazis with his parents across the Soviet Union in 1939. Half a century later, in 1990, he got a call from Mikhail Gorbachev, during the waning days of the Soviet Union. The leader persuaded Melamed to help the Russians set up the Moscow Commodity Exchange, which was meant to show the world that the country was changing.

After Melamed cut the ribbon to open the market, the first trade was 1 million Marlboro cigarettes in exchange for a computer, he recalls. “It was not free-market at all, it was just a prearranged trade, which I explained to them is not exactly what I had in mind,” he says. “We laughed all the way home.”

Ukraine will export 23 million tons of wheat and other grain in the 12 months through June, making it the world’s eighth-largest seller of the grain. So CME Group’s interest in a futures contract is understandable, says Rodion Rybchinsky, head of business projects at agriculture consulting firm APK-Inform in the Ukrainian city of Dnipropetrovsk. Yet he wonders whether it will take hold. “There are very few market players who are familiar with futures” in the region, he says.

Local Corruption

Producers and traders will be wary of futures because local corruption could block possession of grain bought via the contracts, according to two grain merchants in Ukraine who asked not to be named for fear of government reprisal.

Ukraine also has a long history of government intervention in the grain industry, which discourages customers, says Terry Reilly, an analyst at Citigroup Global Markets in Chicago. “How it starts out will determine if it’s going to be successful,” he says. “Is there going be enough trading volume? Are investors willing to bear risks that local government could intervene and set export restrictions?”

Authorities in Ukraine imposed limits on shipments of corn, wheat and barley in October of 2010 in a bid to limit domestic price increases after drought damaged crops, reducing production by 19 percent from a year earlier. The quotas were lifted eight months later.

Drought Restrictions

Ukraine Prime Minister Mykola Azarov’s government in February asked grain traders to restrict wheat exports after weeks of freezing temperatures aggravated drought damage to winter plantings. The government later said it had no plans to impose restrictions this year.

Some traders in Egypt, the world’s biggest importer of wheat, also are skeptical. “In the beginning, it’s going to be a bit difficult to get buyers using this contract,” says Amr Kassem, the owner and general manager of East Med Commodities Trading LLC, a brokerage in Cairo.

At the same time, the new contract could get the attention of buyers who already use Black Sea grain priced with CME’s soft red wheat contract as a proxy, Kassem says. “Buyers who are doing this will switch definitely to the Black Sea wheat contract.”

To reassure customers, CME Group is planning as many as four delivery points. When contracts expire, customers who wish to take delivery will be able to pick up their grain in Russia, Ukraine and Romania, CME Group has said. And it may add a port in Varna, Bulgaria, according to David Lehman, the managing director of commodity research and product development, who spent the last year and a half traveling monthly to Ukraine to set up the contract. “There’s always a risk when you design a new contract,” he says.

The expansion to the Black Sea also fits with CME Group’s larger strategy of partnering with international markets in Brazil and China. “The potential is enormous, and that includes Russia and it includes Kazakhstan” as well as Poland, Melamed says. “They all want to become important market economies, and we are part of that.”

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