The U.S. Commodity Futures Trading Commission advanced a proposed rulemaking on position limits in a 3-2 vote on Jan. 30.
The proposal, which will be open for public comment for 90 days, addresses an issue that the CFTC has been grappling with since the Dodd-Frank Act updated the statutory provisions related to speculative limits in 2010. As proposed, the rulemaking would expand the range of commodity derivatives subject to federal position limits. However, the rulemaking also seeks to avoid interfering with the ability of end-users that use derivatives to hedge their market risks.
Details of the position limits proposal are as follows:
- Speculative position limits would apply to the 25 most liquid, physically settled core commodity futures. These 25 contracts including five metals, four energy, and seven agricultural futures in addition to the nine "legacy" agricultural futures covered by existing federal position limits. The proposal also covers swaps, futures and options that are economically equivalent to or linked to or related to those 25 core futures products. Under the proposal, the limits would apply to spot months only, except for the legacy contracts which would continue to have limits in the non-spot months.
- The rulemaking would allow exchanges to issue exemptions without CFTC approval for trades that fall under the CFTC's definition of "enumerated hedge transactions." If a market participant pursues a hedge not specifically enumerated in the rulemaking, it must request the exemption directly from the exchange and the CFTC has 10 business days to object to the exemption. In the event sudden or unforeseen bona fide hedging brings a participant above position limits, it would be required to notify the exchange, and then the CFTC would have two business days to disallow those positions. The CFTC also defers to exchanges to set limits for longer-term positions that exist outside the spot month, based on the exchange's internal standards and accountability levels.
- The CFTC included a "necessity finding" to establish the position limits on the 25 commodities in this proposal and would require similar justification for any additions to the initial list of core products and related derivatives in the future. This is, in part, to address a legal challenge and subsequent court ruling in 2012 regarding a prior proposal of the position limit regime.
- The rulemaking will move away from the "five-day rule" that applies to final trading days of a delivery month, and eliminate the CFTC’s use of Form 204s . It will also allow market participants to choose between gross or net hedging based on business needs.
- The prior "risk management" exemption for banks has been removed in favor of a "pass through" exemption that does not count a position against the limit if it offsets risk taken on behalf of a customer with bona fide hedging needs.
CFTC Chairman Heath Tarbert called the proposal the "closing chapter in the long saga of position limits." He underscored that position limits apply only to speculative activity and that "Congress has always intended that positions that are a bona fide hedge of price risk should not be subject to limits," which means "the exception is as important as the rule itself."
Commissioner Brian Quintenz supported the proposal, noting that it offers "new flexibility combined with new regulation," and that it "appropriately focuses on the time period and contract type where position limits can have the most positive, and the least negative, impact—the spot month of physically settled contracts." Commissioner Dawn Stump also supported the proposal, commenting that action is overdue on this issue and that "we cannot let the perfect be the enemy of the good."
Commissioners Rostin Behnam and Dan Berkovitz both voted against the proposal, largely expressing concerns over the CFTC ceding oversight authority to exchanges and the statutory basis for doing so.
"While the proposal purports to respect the Congressional intent" of position limits set out under Dodd-Frank, Behnam said "it pushes the bounds of reasonable interpretation by deferring to the exchanges." He also expressed concern that by ceding oversight the Commission would struggle to maintain leadership or reclaim authority in this area.
Berkovitz echoed those concerns and warned the rulemaking "demotes the Commission from its traditional role of head coach to Monday morning quarterback, second-guessing the exchanges." He also spoke at length about the possibility of alternate methods of creating a position limits rulemaking without the reliance on strict necessity findings.