Comment Text:
10-002
COMMENT
CL-02680
April 26, 2010
C.F.T.O.
OFFIOE OF
THE
SECRETARIAT
2010 FIPR 28 PPI t2 q8
Vitollnc.
1100 Louisiana - Suite 5500
Houston, Texas 77002 - 5255
Phone:
(713) 230-1000
Fax:
(713) 230-1111
REVISED
Mr. David Stawick
Secretary
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, N.W.
Washington, D.C. 20581
Proposed Federal Speculative Position Limits for Referenced
Energy Contracts and Associated Regulations
Dear Mr. Stawick:
This letter is submitted on behalf of Vitol Inc. ("Vitol") in response to the proposed rule
issued by the Commodity Futures Trading Commission (the "CFTC" or the "Commission")
regarding whether tile CFTC should directly ilnpose speculative position li~nits on futures and option
contracts in four energy commodities and whether to create a limited risk management exemption,
administered by the CFTC for swap dealers holding positions outside the spot month (the "Proposed
Rule").
Vitol is part of the Vitol Group of companies, one of the world's largest independent energy
trading organizations. The Vitol Group extracts, trades, stores and transports energy co~nmodities
arouud the globe, helping to bring those commodities to the places where supply/demand factors
dictate they are needed.
I.
Introduction
We are pleased to share our comments with tile Commission on the Proposed Rule to the
extent that it relates to the commercial trading activities of Vitol. While we raise issues of particular
concern to Vitol in this comment letter, we also support the concerns addressed in the comment
letters submitted to the Commission by tile Futures Industry Association and the International Swaps
and Derivatives Association, Inc., particularly with respect to the proposed "crowding out" of
speculative trading activity, the elimination of the independent account controller exemption, the
arbitrary cap on risk management exemptions, and the significant operational burden of the Proposed
Rule on market participants.10-002
COMMENT
CL-02680
Vitollnc.
II.
Restrictions on Speculative Activity
A.
"Crowding Out"
Our concerns about the "crowding out" provisions of the Proposed Rule are ve~¢
straightforward. As a large commercial market participant, Vitol may well need to avail itself of an
exemption from the speculative position limits for bona fide hedging transactions. Under the
Proposed Rule, if it held positions at the level of the position limit it would be prohibited from
maintaining a single speculative position. This is a significant change to current market practice.
Currently, a market participant may hold a combination of hedge and speculative positions
pursuant to a hedge exemption, provided that the speculative component did not exceed the
speculative position limit. The Commission has not explained its rationale, and we can see no basis,
for abandoning that paradigm. We are aware of no study (nor even prior assertions) that suggests
that "concentration" has been an issue in the markets - namely, that a party that has a large position
that is part speculative and part bona fide hedge poses a greater threat to market stability than a party
with a position of the same size containing exclusively bona fide hedge positions. We do not believe
that to be the case. In fact, to the contrary, it has been well established that futures markets require
speculative activity to absorb risk that commercials are unwilling to bear and to even out the
telnporm~¢ imbalances between supply and demand (i.e. provide liquidity). We would submit that
speculation by commercial market participants, properly managed, best serves that purpose, as a
commercial speculator could choose to make or take delivery on a speculative position rather than
liquidate it in a distressed market -- conduct which would add to, rather than detract from, market
stability.
Under the "crowding out" provisions of the Proposed Rule, three traders with similarly-
sized total positions would apparently pose a different threat to the market. Assume an all months
speculative limit of 50,000 contracts; that Traders A and B have hedge exemptions that allow them
to hold 55,000 contracts; and that Trader C has no hedge exemption. Trader A is short 49,000
hedges and 4,000 speculative positions; Trader B is long 4,000 hedges and 45,000 speculative
positions; and Trader C is long 49,000 speculative positions. Trader A, the party with the least
speculative position, would be prohibited from hedging an additional cargo of petroleum products at
the level of 2,000 contracts unless, at its cost and risk, it exits the speculative position it carried. We
do not see how, in the name of"preventing excessive speculation", Trader A's position of 51,000
hedges and 4,000 speculative positions, could be deemed to present a greater risk of"causing sudden
or unreasonable fluctuations or unwan'anted changes in the price of such commodity" than the
substantially greater speculative positions of Traders B and C. We also do not see the material
difference in risk of Trader A's position were it to be comprised as above, or if all 55,000 positions
were hedges. Yet the Proposed Rule, without any empirical basis to support the "concentration"
concerns, would require Trader A to engage in the cost and risk of a "forced liquidation" of
its
speculative position if the additional commercial opportunity arose.
Another significant issue with the Proposed Rule is regulatory and enforcement risk. A
commercial market participant often holds a large, complex, diversified and dynamic portfolio of
market positions, including futures and exchange traded options on more than one exchange, cleared
and over-the-counter swaps and options, inventory and executory physical delivery contracts. The
position of a firm in the energy markets is a composite of the positions of multiple product managers
- divided regionally and among crude oil and the many grades of petroleum products. Vitol submits
that determining when such a portfolio is precisely balanced or hedged, and contains no speculative
positions, is so far to the extreme of virtually impossible that is may be more appropriate to say that
it simply is not possible. In many respects, the conclusion "is in the eye of the beholder". Would
this subject a market participant to second-guessing of, for example, its volatility assumptions and,
therefore, the risk to be hedged over the forward curve of its position? The Proposed Rule does not,
and probably can not, adequately address the issues associated with determining whether there is a
speculative component in any dynamic, portfolio hedged position.
210-002
COMMENT
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Vitollnc.
Timing issues are also significant in that respect. Take the case of a commercial lnarket
participant with a hedge exemption that is using the exemption to hedge inventory positions in
excess of the speculative position limit. An opportunity arises to sell some of the inventory and it
does so. It then seeks to lift its hedge. Must it place an immediate order to liquidate the entire hedge
position, or may it "work" its order to ensure that it does not create short-term market
disequilibrium, resulting in a mm'ket impact and worse prices for its own transactions? Does holding
the positions while the order is "worked" constitute speculating? If not immediately, how long does
one have to work an order, an hour, a day, more than a day if the product/instrument/delivel~¢ month
is less liquid? Is it a subjective test? If so, that would put a commercial market participant in a
world of uncertain regulato~¢ exposure. Again, the Proposed Rule does not, and probably can not,
adequately address that issue.
The Proposed Rule probably imposes a bias to "under-hedge" rather than risk holding an
"over-hedged" position. An "under-hedge" in this regulato~2¢ construct would constitute
"speculating" in the physical market, with no regulatory ramification. By contrast, an "over-hedged"
position would constitute "speculating" in futures or options, in violation of the Proposed Rule for a
party operating under a hedge exemption. Clearly, driving parties to take physical market risk to
avoid regulatory exposure would not be a good policy outcome.
Finally, the "crowding out" provisions create practical problems when coupled with other
provisions in the Proposed Rule. For exalnpte, Vitol may be in a position to obtain and use an
exemption for bona fide hedging. Under the rules as they exist today, it could hold a risk-free
position in an OTC swap against a listed futures contract. Under the Proposed Rule, that position
would not qualify as a bona fide hedge. While it may qualify as a "risk management" position under
the Proposed Rule, that position would also be "crowded out" and Vitol would be required to
liquidate it. Ironically, this would force us to take risk in the name of reducing the risk of
"speculative" activity. We do not believe that is an intended consequence of the Proposed Rule or
good policy.
B.
Eli~nination of tile Independent Account Controller Exemption
The Proposed Rule would require aggregation of the positions in accounts in which any
person has an ownership or equity interest of 10% or more, or with respect to which such person
controls the trading, in determining compliance with the position limits. We would urge tile
Commission to consider an exemption from the aggregation requirements for any accounts that are
commonly owned, but separately controlled. There is a perverse result in the Proposed Rule that
would actually require communication and coordination among account controllers that are
otherwise independent, creating the risk of intended or inadvertent common patterns of trading that
would otherwise not exist. Any two accounts, whether managed by CTAs or part of a corporate
family should not be aggregated if common control is not present.
The problem with the Proposed Rule is compounded by the imposition of the "crowding
out" restrictions across affiliates and independent business units where common control did not
exist. Under the proposal, if one affiliate or business unit of a market participant were trading in a
manner that does not qualify for a hedge exemption, the other independent business units would be
forced to reduce their positions so that all the units were below the position limit, even if the other
units had received bona fide hedge exemptions. Thus, the speculative trading activity of one entity
will preclude the other units fi'om trading in the market above the aggregated position limit. We
believe the elimination of the independent account controller exemption, in combination with the
"crowding out" provision, will significantly reduce the liquidity in the futures market, with no
discernable benefit to market participants. Commercial hedgers such as Vitol will be particularly
harmed. As the Commission is well aware, reduced liquidity harms consumers, as well, as it often
results in greater market volatility, reduced ability to absorb short-term supply/demand finbalances
and higher prices.10-002
COMMENT
CL-02680
Vitol Inc.
IlL
Calculation and Structure of Position Limits
Under the Proposed Rule, the CFTC would impose position limits on an annual basis, based
on tile open interest in the relevant contract. We believe that for Vitol to comply with these position
limits, we will need a thorough understanding of the way the CFTC will calculate the open interest
for the four energy commodities. Wenote that following the release of the Proposed Rule, there has
been considerable confusion as to bow the CFTC derived the open interest used to generate the
potential position limits cited in the Proposed Rule. If the CFTC does implement the Proposed Rule,
we strongly urge the CFTC to provide all market participants with the information they will need to
calculate the position limits in a timely manner, in order to prevent any disruptions to the market.
We believe that the data used by the CFTC to calculate the position limits will need to be completely
transparent in order to enable market participants to protect against any emergency liquidation of
positions that may be necessary to comply with the position limits.
We also believe that there is a structural flaw in the Proposed Rule. As market participants
are likely to stay below the position limits, open interest will decrease. This will, by definition, lead
to lower position limits the following year and create a cycle of lower open interest and lower
position limits every year.
IV.
Treat~nent of Arbitrage
aud Spread Trades
Market participants employ a wide variety of trading strategies to precisely manage their
risks, including arbitrage and spread trades. These trading strategies have been recognized by
exchanges, such as NYMEX, as a valid basis for granting an exemption fi'om speculative position
limits. The Proposed Rule does not appear to address these hedging strategies, and we strongly urge
the CFTC to do so.
V.
Definition of"Gross Basis"
Section 151.2(b)(2)(ii) of the Proposed Rule, a market participant's positions in contracts of
the same class in a single month, measured on a "gross basis," could be no larger than two times the
all-months-combined class position limit fixed for that reporting market. However, the Proposed
Rule does not define "gross basis" and it is unclear how the CFTC would define and then measure
"class" positions, which may actually involve more than one futures and or options contract, on a
"gross basis." Would each "contract" rather than the "class" be measured on a "gross basis"? To
prevent any confusion by market participants, we urge the CFTC to clarify how positions would be
measured on a "gross basis."
410-002
COMMENT
CL-02680
Vitollnc.
VI.
Conclusion
Vitol appreciates the opportunity to provide the Commission with its comlnents on the
Proposed Rule. We would be pleased to discuss the issues raised in our letter in greater detail, at
your convenience.
cc: Chairman Gary Gensler
Commissioner Bart Chilton
Commissioner Michael Dunn
Commissioner Scott D. O'Malia
Commissioner Jill E. Sommers
Respectfully submitted,
Miguel A.
President
