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NEW YORK, Sept 16 (Reuters) - CME Group said on Tuesday it allowed American International Group Inc, the ailing insurer that also sponsors a major commodities index, to conduct limited block trades in livestock and grains contracts.

The emergency move appeared to allow AIG, which was bailed out of potential bankruptcy on Tuesday by a $85 billion Federal Reserve rescue package, to offload some of the positions it built up by selling investment based on its co-owned Dow Jones-AIG Commodities Index, the second-largest of its type.

The CME said it would permit AIG to conduct block trades, which are held outside the public auction market, of soybeans, soybean oil, corn, wheat, live cattle and lean hogs futures, allowing AIG and its subsidiaries to reduce their positions.

It said the order was effective through Sept. 17.

Analysts said the move should help ensure prices aren't roiled by sudden big buy or sell orders coming onto the exchange, whose relatively small turnover compared to big financial markets makes it susceptible to volatility.

"Should AIG be forced to redeem their positions on the open market, the sheer volume of bids entering the market would severely limit its ability to operate effectively," said Doug Whitehead, ANZ's soft commodity strategist.

"This decision allows the market to continue operating effectively, while allowing AIG to offload held positions to viable counterparties."

The DJ-AIG index of 19 major contracts had attracted investment of about $55 billion by the end of the second quarter, just before commodities markets tumbled by a third, putting it second behind the S&P-GSCI in the index business, which has surged in recent years to an estimated up to $200 billion.

AIG not only sponsors and helps manage the index but sells it directly to investors, making the giant insurer a counterparty as well as an index provider. It was not clear how much of the index's exposure was carried directly by AIG.

The index will have a nearly 28 percent weighting to CME agricultural and livestock contracts next year, according to rebalanced weightings released in August. Most of the rest is split evenly between energy and metals, with a total of 19 contracts in the index.

Chicago traders had reported market talk on Tuesday that AIG was going to execute block trades with two investment banks at the close of trading, switching over all of its index fund positions in CBOT commodities.

That came just as the U.S. government agreed to rescue insurer AIG with an $85 billion Fed loan, preventing the world's biggest corporate bankruptcy just days after investment bank Lehman's collapse this week threw global markets into turmoil.

The upheaval in the U.S. financial system led global markets into free-fall this week, sending commodities from oil, grains to metals tumbling, but traders said it was not clear whether AIG's actions were having an impact on prices.

"Market participants are closely looking at how AIG will play in the futures market, reflecting unwinding of DJ-AIG index related funds," said one Tokyo-based grains analyst.

Chicago Board of Trade corn, soybean and wheat futures, which finished sharply lower on Tuesday, recovered in Asian trade amid a broad-based recovery in commodity markets.

At least some investors moved this week to limit their exposure to AIG's commodities business. Canada's Criterian Investments Ltd said its small $25 million commodity fund expects to redeem money invested in index-linked commodity notes issued by a unit of AIG by Wednesday.

A spokesperson for the New York Mercantile Exchange, the main marketplace for U.S. crude, natural gas and other energy contracts that are also part of the DJ-AIG index, was not available for comment. The NYMEX was bought this year by the CME.

At the Chicago Board of Trade, funds sold an estimated 12,000 contracts of corn on Tuesday, 8,000 contracts of soybeans and 3,000 contracts of wheat. Each contract is worth 5,000 bushels. (Additional reporting by Naveen Thukral in Singapore) (Reporting by Sinead Carew; Editing by Clarence Fernandez) Keywords: CME/AIGBLOCK

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