On May 7, the U.S. Commodity Futures Trading Commission hosted a meeting of its Energy and Environmental Advisory Committee to discuss the agency's proposal to establish speculative position limits for commodity derivatives. The meeting gave the members of the advisory committee, most of whom work for commercial end-users in the energy sector, an opportunity to express their views. The proposal is now in its third iteration since Congress revised the Commodity Exchange Act and authorized an expansion of position limits in the Dodd-Frank Act of 2010.
The discussion, conducted via webcast, revealed broad support for the proposal from most of the end-users on the advisory committee. Several end-users commented favorably on the proposal's exemptions for hedging transactions, one of the issues that has sparked opposition to previous versions. Susan Bergles of Exelon, one of the largest electricity producers in the U.S., called the current proposal a "significant improvement over prior proposals." Kaiser Malik of Calpine, another large power producer, said the proposal "strikes us as well aligned with current commercial hedging practices and less burdensome than prior proposed position limit rules." Jenny Fordham of the Natural Gas Supply Association commented that the proposal creates "a viable path to the finish line" and expressed the hope that years of uncertainty around this issue are coming to an end.
The discussion also provided a preview of the comment letters that will be filed with the CFTC as the comment period comes to an end on May 15. End-users asked the CFTC to expand the range of transactions eligible for hedge exemptions, to provide greater transparency into the exemption approval process, and to provide more information about exactly which contracts will be subject to the position limits when they are implemented.
Not all of the participants were supportive, however. Tyson Slocum, who represents Public Citizen, a public interest group, asserted that the recent volatility in oil futures prices showed that the futures market is not working properly, and he urged the CFTC to analyze what happened before finalizing the proposal. And two end-users urged the CFTC to take a more stringent approach by including more energy contracts, saying this is needed to prevent speculation from disrupting those markets.
CFTC to investigate May expiration of crude oil futures
CFTC Commissioner Dan Berkovitz, the sponsor of the advisory committee, opened the meeting by calling attention to the extreme volatility in the price of the WTI crude oil futures contract as it approached expiration on April 21.
Berkovitz, one of two Democrats on the CFTC, warned that the next expiration in June may face similar volatility, and he said an analysis of trading positions and market liquidity is needed to "inform" the agency's understanding of the effectiveness of position limits as well as the impact of exchange-traded funds and other speculative investors on the crude oil futures market.
"The CFTC must determine the causes of this unprecedented price movement and divergence from physical markets," Berkovitz said in a statement released during the discussion. He called for the commission to work alongside CME Group, the exchange where that contract trades, to "ensure that trading in upcoming WTI expirations is orderly, supports convergence, and reflects supply and demand in the physical market."
CFTC Chairman Heath Tarbert acknowledged challenges in the May WTI futures contract and promised to undertake "a deep dive" into the matter. But he noted that the forward months were not as volatile, and as such, the position limits proposal still seems appropriate. He explained that the proposal would put position limits only on spot month contracts because that is where the potential for disruption is the highest, and he asserted that the proposal sets the right balance between preventing harmful speculation and promoting healthy markets.
"These markets need speculative traders to provide liquidity for producers and end users who use these markets to hedge," said Tarbert, who took office in July 2019. "Without market makers, these markets will be illiquid, making it more expensive to hedge. So we need to be mindful first that our limits are high enough to permit liquidity provision and a healthy level of speculative trading, but at the same time low enough to prevent bad speculative trading from disrupting delivery or otherwise causing excessive volatility."
Calls for further modifications to position limits proposal
In addition to representatives of commercial end-users, the advisory committee discussion included representatives of exchanges such as CME and Intercontinental Exchange and financial institutions such as Morgan Stanley. During the discussion, the participants highlighted several areas where they would like to see further changes before the proposal is finalized.
- Linked contracts: The proposal would apply position limits to 25 "core" commodity futures as well as similar contracts based on the same commodities. The end-user community disagreed on what contracts should be included on the list of "linked" contracts. Electricity generation companies such as Exelon and Calpine expressed support for the list now in the proposal, while industrial end-users called for the addition of location basis contracts in the natural gas markets, explaining that these markets tend to be smaller and are more exposed to potential market abuse.
- Definition of an economically equivalent swap: Tom LaSala of CME urged the CFTC to expand this definition to include a wider range of swaps that track penultimate settlement dates. Bill McCoy of Morgan Stanley cautioned against expanding the list, noting the operational challenges of identifying the swaps that are subject to the limits and designing an infrastructure to track those positions.
- Definition of risk: Several end-users commented that the proposal's definition of risk is too narrow. They explained that they use commodity derivatives to hedge many types of risk, not just price risk. One end-user added that the list of hedge exemptions should include transactions designed to hedge storage.
- Risk management exemption: As proposed, the position limits rule would eliminate an existing risk management exemption that has allowed financial companies to engage in certain types of trading without triggering position limits. Bill McCoy of Morgan Stanley warned that eliminating this type of exemption would constrain the ability of swap dealers to offer hedges to their customers and would push liquidity out of the physically delivered futures contracts that are subject to position limits. He urged the CFTC to restore this exemption, or alternatively, reserve the authority to grant risk management exemptions "on a targeted basis" when one of the 25 core contracts "is suffering an impairment of liquidity and price discovery."
- Implementation concerns: Several end-users called for the CFTC to clearly identify the contracts that will be subject to the position limits through some form of public notice. Without that certainty, market participants would have to review the contract specifications for each related futures contract in order to determine whether it is linked to one of the 25 core contracts, which could lead to different determinations made by different companies.
- Exemption process: There was broad support for delegating this process to exchanges as the most efficient approach. But several participants called for more transparency into the results, so that all market participants would know if a new type of exemption has been granted. In addition, Commissioner Berkovitz said the 10-day period for CFTC review of exemption approvals by exchanges should be extended to 30 days.
Background on proposal
The current position limits proposal was issued in January by a 3-2 vote. The proposal, if finalized, would extend the existing federal position limits regime in three ways:
- First, in the agriculture markets, it would extend the existing federal position limit regime, which covers nine "legacy" agricultural futures including corn, cotton, soybeans and wheat, to cover a wider range of agricultural commodities such as coffee, sugar and cocoa.
- Second, it would establish for the first time a federal position limit regime for certain metals and energy contracts. Those markets currently are subject to limits set by exchanges rather than the CFTC.
- Third, it would extend the position limits to include not only exchange-traded futures and options on futures but also economically equivalent swaps.
Three other features of the proposal will have an important impact on how the position limits are administered:
- First, the proposed limits would apply only to the spot month for all contracts except the nine legacy agricultural contracts.
- Second, the proposal includes several provisions designed to avoid disrupting bona fide hedging. These provisions include a list of exemptions for established hedging practices and a process for seeking exemptions for transactions that do not fit into the hedging practices on that list.
- Third, the process for seeking exemptions would be administered by the exchanges, rather than the CFTC, in line with the current practices for setting limits on speculative trading at the exchange level.
FIA's work on position limits
FIA plans to file its comments with the CFTC before the May 15 deadline as the current position limits proposal moves ahead. This is in addition to previous work on position limits and an ongoing commitment engage with regulators in the U.S. and Europe on this issue to help avoid the disruption of legitimate trading activities and harming the liquidity of the commodity derivatives markets.
- Opening Statement of Chairman Heath P. Tarbert before the Energy and Environmental Markets Advisory Committee
- Opening Statement of Commissioner Brian Quintenz before the CFTC Energy and Environmental Markets Advisory Committee
- Statement of Commissioner Dan M. Berkovitz on Recent Trading in the WTI Futures Contract before the Energy and Environmental Markets Advisory Committee Meeting
CFTC factsheet summary of the position limits proposal
- Position Limits