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Comment for Proposed Rule 75 FR 4143

  • From: John M Damgard
    Organization(s):
    Futures Industry Association

    Comment No: 11687
    Date: 3/18/2010

    Comment Text:

    2(}01 Pc.nnsyiwmia Awe. NW
    Was/:~[n$ton, DC 20(}06-t 823
    10-002
    COMMENT
    CL-02687
    March 18, 2010
    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, 75 Fedo Re~. 4144 ¢Jan. 26, 2010)
    Dear Mr. Stawick:
    The Futures Industry Association
    ~
    submits these comments on the Commodity Futures
    Trading Commission's Notice of Proposed Rulemaking entitled "Federal Speculative Position
    Limits for Referenced Energy Contracts and Associated Regulations." For the many reasons set
    forth in this letter, FIA respectfully urges the Commission not to adopt its proposaI. Instead, F!A
    requests that the CFTC defer any further action on its proposal until Congress completes its
    deliberations this session on financiaI regulatory reform legislation, which may include major
    changes to the provisions of the Commodity Exchange Act which authorize the Commission to
    impose position limits.
    In the last decade, through a combination of aggressive enforcement and pervasive
    market surveillance, the Commission has continued to police effectively price manipulation and
    attempted manipulation, especially in the energy commodity markets. The combined CFTC and
    exchange systems, including large trader reporting, position accoumabi!ity, targeted spot month
    position limits, special calls and constant vigilance, have worked and worked well. As new
    markets develop, whether over-the-counter or overseas, the Commission must adapt its market
    surveillance systems and Congress must update the Commission's authority, as it has done as
    For the record, FIA is a principal spokesman for the commodity futures and options industry. FIA's regular
    membership is comprised of approximately 30 of the largest futures cormnission merchants ("FCMs') in the
    United States. Among its associate members are representatives from virmalty all other segments of the futures
    industry, both national and international. Reflecting the scope and diversity of its membership, FIA estimates
    that its members effect more than eighty percent of atl customer transactions executed on United States
    designated contract markets.David Stawick, Secretary
    March 18, 2010
    Page 2
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    COMMENT
    CL-02687
    recently as 2008.
    FIA strong!y suol?orts these efforts.
    Price manipulation corrodes the public
    interests in price discovery and hedging. It can never be tolerated.
    But speculation is not manipulation. Too often, our public debate on commodity prices
    misses this fundarnental and irrefutable point. Instead, we hear that speculators have caused
    artificially high or low prices. Public relations campaigns to scapegoat speculators have fueled
    further misimpressions. Yet, FIA is no~t aware of any convincing or even credible evidence that
    large traders with speculative positions in energy futures markets have trumped market
    fundamentals as the determining factor in energy futures prices. Similarly, the CFTC's Federal
    Register Notice does not contain a finding that the proposed position limits are "necessary to
    eliminate or diminish" burdensome speculation, as the law contemplates. CEA § 4a(a).
    The record actually supports just the opposite result: where position limits have been
    imposed we have observed no change in pricing patterns. FIA is
    not aware of any convincing or
    credible evidence that existing CFTC-set position limits have caused prices in agricultural
    markets to move in any materially different, let alone more fundamentals-driven, pattern than
    prices in energy and other commodity markets that lack CFTC-set position limits. Given the
    absence of evidence that any speculation has caused aberrant price fluctuations or changes, or
    that position limits have had any price impact, it is unsurprising that the CFTC's Federal Register
    Notice does not contain a finding that the proposed position limits are "necessary to prevent"
    burdensome speculation, as the law contemplates. CEA § 4a(a).
    in considering the Commission's position limit proposal, FIA has applied one standard:
    would the proposed limits help or harm the ability of the U.S. futures markets to serve the public
    interests in price discovery and efficient price risk management? Based on the available record,
    FIA must answer that the proposal would actually harm. these public interests and should not be
    adopted. This letter will explain "why."
    Summar?
    Speculation is essential to properly functioning futures markets and therefore serves the
    public interest as Congress has recognized. Speculators play a vital role in futures trading by
    assuming the risk hedgers want to avoid and by providing market liquidity which promotes
    reIiable commodity price discovery for businesses world-wide. On the other hand, any market
    participant, whether a speculator or a hedger, thin intentionally creates artificial prices-
    manipulators - compromises the public interests served by futures markets.
    For that reason, many of the Commodity Exchange Act's provisions focus on preventing
    artificial prices that deplete futures markets of their many public benefits. One of those
    provisions is Section 4a, the source of the CFTC's position limit authority. CEA § 4a states that
    "excessive speculation ... causing sudden or unreasonable fluctuations or unwarranted changes
    in the price" of a traded commodity
    "is
    an undue and unnecessary burden on commerce in thatDavid Stawick, Secretary
    March 18, 2010
    Page 3
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    COMMENT
    CL-02687
    commodity." To address that potential, burden, in CI~A § 4a(a) Congress has authorized, not
    required, the CFTC to impose position limits on speculators "as the Commission finds are
    necessary to diminish, eliminate or prevent such burden." Under this authority, if the
    Commission found that excessive speculation already existed, then it would need to show any
    position limits it would impose were "necessary to diminish [or] eliminate" that excessive
    speculation. But if excessive speculation is not found to exist, the CFTC may still impose
    position limits at a level the Commission finds to be "necessary to prevent" the burden of
    excessive speculation that might otherwise exist in the future.
    This statutory map is vital to navigating the CFTC's Federal Register Notice and its
    accompanying proposal. In that Notice, the CFTC does not find that energy futures mm'kets
    have suffered or currently suffer from excessive speculation- that is, speculation ~causing
    sudden or unreasonable fluctuations or unwarranted changes in the price" of any energy
    commodity. FtA agrees. There is no evidence that speculators have caused or are causing either
    of the two conditions Congress considered to be a burden or~ interstate commerce.
    Under CEA § 4a(a), the CFTC could still impose limits if it found that its proposed
    limits are "necessary to prevent" the burdens of excessive speculation in the future. The
    Commission's Notice, however, disclaims its legal responsibility to make such a finding,
    asserting that "a specific demonstration of the need for position limits is contrary to section 4a(a)
    of the Act, which provides that the Commission shall set position limits from time to time,
    among other things, to prevent excessive speculation." 75 Fed. Reg. at 4146 n.13. The statutory
    language, however, clearly
    requires
    a ~necessary" finding. The Commission never makes that
    required statutory ~indir~g for its proposal; it ~ever attempts to explain how the proposal is
    "necessary to prevent" what the CFTC believes to be "sudden or unreasonable price fluctuations
    or unwarranted price changes" which burden commerce.
    This omission creates two legal flaws in the Commission's proposal: one substantive and
    one procedural. Both confirm that the proposal should not be adopted.
    Substantively, in the absence of the ~necessary" finding, the CFTC lacks the statutory
    authority to adopt position limits. The absence of tlae required ~°neeessary" finding as part of the
    proposal makes it impossible to determine whether the CFTC would have a rational basis for
    making such. a finding. In modem futures markets, prices fluctuate and change constantly and
    dynamically. Trying logically to link a certain level of open speculative positions- long and
    short ~ to those price fluctuations or changes in order to prevent fluctuations or changes that are
    "unreasonable" or "unwarranted" may be a difficult task. But that is what the statute requires
    and the CFTC proposal's silence on this critical legal point precludes its adoption. (See pages
    t6-17.)David Stawick, Secretary
    March i8, 2010
    Page 4
    i0-002
    COMMENT
    CL-02687
    Procedurally, even if the CFTC made the required "necessary,' finding in a Federal
    Register Notice adopting final rules, that finding would be too late to afford meaningful
    comment on this proposal under the Administrative Procedure Act. Congress allowed the CFTC
    to impose position limits only when "necessary." If the CFTC finds its proposed limits are
    "necessary to prevent" the burdens of excessive speculation, the public is entitled to cornment on
    the basis for that finding. The public is not required to guess at the Commission's reasoning.
    But, here, in the absence of the CFTC's "necessary" finding, guessing is all the public could do.
    The CFTC does ask the public to comment on whether any limits are necessary. That question is
    the kind of question the Commission would ask in a three-step rulemaking at the Advanced
    Notice of Proposed Rulemaking stage, not when it is seeking comment on a specific proposed
    rule it intends to adopt as its next rulemaking action. This is further evidence that the CFTC
    should not proceed next to consider whether to adopt its position limit proposal. Public commetat
    is required on how the CFTC "finds" its proposed limits are "necessary" to "prevent" the
    burdens of excessive speculation. (See pages 13-15.)
    Even if the CFTC had accompanied its proposal with the legally-required "necessary"
    finding, FtA would oppose adoption of this proposal for many reasons.
    The proposals are premature. Congress is considering legislation to amend the
    Commission's position limit authority. If that legislation is enacted, the CFTC
    position limit proposals would likely have to be amended as they in many ways
    conflict with at least the bill passed by the House: H.R. 4173. The CFTC should
    wait for Congress to act, especially where the CFTC has not found, that a burden
    resulting from excessive speculation exists today. (See pages 11-13.)
    The proposals would harm the public interests in futures trading. The CFTC's
    proposed new energy position limits will drive considerable trading activity and
    market liquidity to over-the-counter swap and overseas markets where the CFTC
    today lacks statutory power to impose limits. That means less liquidity in the
    open and transparent price discovery markets the CFTC regulates. That means
    less liquidity to provide efficient price risk management for hedgers. That means
    more trading activity in markets where the CFTC has no, or at least weaker,
    market surveillance vision, thereby undermining the CFTC's ability to prevent
    price manipulation and ensure market integrity. (See pages 13, 28.)
    The CFTC has not stated a rational basis for its proposal. The "excessive
    concentration" and "uncontrolled speculation" themes the CFTC cites are both
    factuatiy unproven and legally irrelevant. The statute provides that position
    limits may be imposed only when the CFTC finds limits would be "necessary" to
    prevent unreasonable price fluctuations or unwarranted price changes. The CFTC
    is bound by its statutory authority. (See pages 17-20.)David Stawick, Secretary
    March 18, 2010
    Page 5
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    COMMENT
    CL-02687
    FIA believes the Commission has other, more effective means for addressing its
    market surveillance challenges. Where multiple trading platforms exist for a
    commodity, the CFTC could adopt its own system of accountability rules to give
    it a more appropriate means of dealing with its market-,vide surveillance
    concerns. Position limits should be a last resort; they are "necessary" only when
    other less intrusive means have failed. (See pages 6, 19 and 29.)
    The CFTC's "crowding out" proposal is not "necessary" to prevent excessive
    speculation and contravenes CEA § 4a(c). By definition, allowing hedgers,
    including swap dealers, to establish speculative positions below the limits adopted
    to prevent excessive speculation should not make that speculation excessive in
    any way. By statute, the CFTC may not transform bona fide hedge positions into
    speculation because the hedger also engages in some speculation in other trading.
    The Commission should subject all positions characterized as "speculative" to any
    adopted limits, and not bar any party otherwise qualifying for an exemption from
    engaging in permissible levels of speculation. (See pages 21-23.)
    Swap dealers are recognized u.nder the proposed rules to be bona fide hedgers.
    FIA agrees. Dealers should therefore be treated for purposes of exemptions like
    at1 other hedgers. The CFTC has not offered any reason to discriminate against
    swap dealers through a more restrictive hedge exemption than all other hedgers
    may receive. (See pages 23-26.)
    The CFTC's aggregation proposal should not be adopted. The CFTC's Notice
    does not explain why its existing Part 150 account controller aggregation standard
    would be inadequate for energy commodities. The proposed "ownership"
    standard would be maworkable for many funds as well as those FCMs that are part
    of large financial institutions and have decentralized, extensive and liquidity-
    providing trading operations. Independent account controllers should not have
    their positions aggq'egated; when two or more independent traders trade for the
    same fund or FCM, they can not logically be viewed as a single speculative
    trading entity that is trading in concert or trying to affect prices in the same way.
    Likewise, when any entity's trading is independent from that of its affiliates or
    parent, the entity, its affiliates and its parent, should not be lumped together as a
    single trader or treated as if they were trading in concert. It distorts economic
    reality and proper corporate governance to do so. (See pages 26-28.)
    Although FIA opposes adoption of the proposals, FIA would support effective CFTC
    enhancements to its already strong efforts to prevent price manipulation and distortion in energy
    markets. FIA has long championed a more active CFTC market surveillance effort where
    multiple trading platforms are competing for market share in the same commodity. TheDavid Stawick, Secretary
    March 18, 2010
    Page 6
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    COMMENT
    CL-02687
    Commission is right that in these instances no exchange or similar platform is able to see clearly
    the "whole field" and make fully informed market surveillance judgments solely in the public
    interest. FIA would support stepped-up CFTC surveillance programs in the energy markets
    where competing exchanges or other trading platforms are operating.
    For example, FIA believes the CFTC should explore the adoption of its own version of
    position accountability rules, to allow it to monitor better and more directly the trading activities
    of market participants with significant positions in energy commodity futures or options on more
    than one trading platfoma. The CFTC is in the best position to impose these aggregate
    accountability levels in order to monitor the trading activities of all major market participants,
    whether hedgers or speculators, and could also use its special call authority to amplify its market
    surveillance systems for OTC markets, when timely and warranted. In these ways, the
    Commission could serve the statutory purpose of deterring price manipulation and preserving
    market integrity without the unintended and adverse consequences we fear would flow out of its
    energy position limit proposal.
    I.
    SPECULATION AND THE PUBLIC INTEREST
    Protecting price discovery and efficient price risk management is at the core of the
    Commission's mission under the CEA. Speculation plays an essential role in furthering both of
    these goals. Trading by speculators provides market liquidity which promotes more effective
    commodity price discovery for businesses and. economies world-wide. The dissemination of
    reliable price benchmarks to producers, consumers, processors and other businesses allows them
    to use the pricing information to make important commercial decisions. For example, it is
    reported that attractive futures prices for corn induced farmers to plant new corn acreage and
    bring it to market.
    See
    CFTC Staff Report on Cotton Futures and Option Market Activity
    (Jan. 4, 20t0) at 7,
    available at http:i/www.cftc.goviucm/~oupsipt~blici@newsroom/documents/
    fileicottonfuturesrnarketreport0110.pdf.
    Speculators also play an important role in futures trading by assuming the price risks that
    hedgers seek to avoid. As a result, a hedger - such as an oil producer - is abte to conduct daily
    operations or invest in capital improvements to its operations with greater certainty, knowing
    today the price it can sell at in the future. Without speculators to assume the risk that hedgers
    ¯ wish to avoid, futures market prices would be so volatile and unpredictable that the markets
    would be unable to serve the public interest in providing efficient risk management and reliable
    price benchmarks.
    Congress itself has found that speculators- as market participants that "assume risks"-
    me integral to the benefits of futures trading. In Section 3(a) of the Commodity Exchange Act,
    Congress stated that those who "manag[e] and
    assure[el risl¢s,
    discover[] prices, or disseminat[e]
    pricing information" through trading in "liquid, fair and financially secure trading facilities"David Stawick, Secretary
    March 18, 2010
    Page 7
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    COMMENT
    CL-02687
    serve the national punic interest. 7 U.S.C. § 5(a) (emphasis added). Thus, Congress has
    recognized that speculators contribute to the "national public interest" served by futures trading.
    HISTORICAL BACKGROUND ON FEDERAL POSITION LIMITS
    The Federal Register Notice's historical background on federal position limits, 75 Fed.
    Reg. at 4145-4t48, illustrates the different perspectives on speculative position limits adopted by
    regulators over the years, both. the federally-imposed limits on agricultural commodities and the
    exchange-imposed limits on all other commodities. A complete understanding of this history
    woutd include a number of additional facts.
    When the Commission was created in 1975, it convened an Advisory Committee
    of experts to assess the efficacy of speculative position limits. As described in
    Appendix E to the September 2008 CFTC Staff Report on Commodity Swaps
    Dealers and Index Traders, in the 1975 Advisory Committee's study "serious
    questions were raised concerning the effectiveness of position limits as a
    regulatory tool." 2008 Report at 52. Following its review, the 1975 Advisory
    Committee recommended: "Speculative position limits should not play a major
    role in the CFTC's future regulatory program. In the long run they should be
    supplanted by an improved monitoring and surveillance progr0an designed to
    achieve orderly liquidation of expiring contract months." 2008 Report at 53. A
    subsequent CFTC staff study concluded, however, that "position limits should be
    set in some, but not all, markets." 2008 Report at 53 (quoting 1977 CFTC
    Economists' Study).
    The Commission thereafter decided to continue to impose federal position limits
    only on certain agricultural commodities. All other position limits for all other
    commodities were imposed by the exchanges. Those exchange rules were subject
    to CFTC review and approval prior to 2000. Then, as today, the CFTC could alter
    or supplement any position limit adopted by any designated contract market under
    its CEA § 8a(7) authority to alter and supplement DCM rules.
    From 1922 to 2000, federal regulation was premised on a congressional finding
    that speculation was dangerous and needed to be regulated. The Grain Futures
    Act of 1922 found that regulation was needed because futures were "susceptible
    to speculation, manipulation and control" that could lead to "sudden or
    unreasonable fluctuations in price." Grain Futures Act of 1922, Section3,
    42 Stat. 999 (1922). In 1982, Congress changed that statutory finding to express
    concern that futures were "susceptible to excessive speculation and can. be
    manipulated, controlled, cornered or squeezed," but dropped the reference to
    sudden or unreasonable price fluctuations. Futures Trading Act of 1982, 96 Stat.David Stawick, Secretary
    March 18, 2010
    Page 8
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    COMMENT
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    2298 (Jan. 11, 1983). In 2000, Congress repealed the finding that futures were
    susceptible to "'exeessive speculation." Now, as we have seen, Section 3(a) of the
    CEA recognizes that speculation contributes to allowing the futures markets to
    serve the national public interest, while Section 3(b) identifies as one of the
    CEA's purposes the prevention of price manipulation and other disruptions to
    market integrity.
    In 2000, Congress also left untouched the findings and position limit authority in
    CEA § 4a. Congress decided not to apply most of the 2000 Act amendments to
    trading in agricultural commodities because it wanted to retain virtually all of the
    pre-2000 regulation of agricultural commodities without change. Congress knew
    that the CFTC had used its authority under Section 4a to impose position limits
    only on certain agricultural commodities and. it logically retained those provisions
    as part of its overall goal to leave agricultural commodity trading undisturbed.
    2
    In. 2000, Congress expressly endorsed the concept of using accountability levels
    for speculators to protect market integrity. It added statutory Core Principles for
    DCMs calling for them to "monitor trading to prevem mar@ulation, price
    distortion and disruptions of the delivery or cash-settlement process." CEA
    § 5(d)(4). Congl"ess also provided tt~at "'to reduce the potential threat of market
    manipulation or congestion, especially during trading in the delivery month, the
    [DCM] shall adopt position limitations or position accountability for speculators,
    where necessary and appropriate." CEA §§ 5(d)(4) and (5).
    After passage of the 2000 amendments, the CFTC issued Acceptable Practices for
    implementing these Core Principles, which included the following: 1) position
    limits may be needed in certain commodities "to address the threat of disorderly
    liquidations and excessive speculation," 2) position limits are not necessary where
    the threat of manipulation or excessive speculation is low in futures in
    commodities with "very liquid and deep underlying cash markets," and 3)'~A
    contract market may provide for position accountability provisions in lieu of
    position limits for contracts on financial instruments, intangible commodities, or
    certain tangible commodities. Markets appropriate for position accountability
    rules include those with. large open-interest, high daily trading volumes and liquid
    2
    In 2008, Congress did amend CEA § 4a to authorize the CFTC to impose position timits on energy contracts
    found to be Significant Price Discovery Contracts. Congress did not, however, mandate in any way that the
    CFTC impose limits on those energy contracts.David Stawick, Secretary
    March 18, 2010
    Page 9
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    COMMENT
    CL-02687
    cash markets." 17 CFR Part 38 App. B. Among other things, these Practices
    provided flexibility to DCMs.
    The CFTC thereafter left undistmbed the decisions of DCMs to impose
    accountability levels for many energy futures markets° Apparently, these DCMs
    believed these energy commodities had "large open-interest, high daily trading
    volumes and liquid cash markets." 1.n any event, the CFTC has never found that
    accountability levels are not effective to prevent excessive speculation.
    iii.
    CEA § 4a AUTHORIZES SPECULATIVE POSITION LIMITS
    Section 4a of the CEA is the source of the Commission's position limit authority.
    Section 4a(a) states:
    "Excessive speculation in any commodity under contracts of sale
    of such commodity for future delivery made on or subject to the
    rules of contract markets or derivatives transaction execution
    facilities, or on electronic trading facilities with respect to a
    significant price discovery contract causing sudden or
    unreasonable fluctuations or unwarranted changes in the price of
    such commodity, is an undue and unnecessary burden on interstate
    commerce in such. commodity. For the purpose of diminishing,
    eliminating, or preventing such burden,
    the Commission shall,
    .from time to time, after due notice and opportunity for hearing, by
    rule, regulation, or order, proclaim and fix such limits" on the
    amounts of trading which may be done or positions which may be
    held by any person
    under contracts of sale of such commodity for
    future delivery on or subject to the rules of any contract market or
    derivatives transaction execution facility, or on an electronic
    trading facility with respect to a significant price discovery
    contract,
    as the Commission finds are necessary to diminish,
    eliminate, or prevent such burden."
    (emphasis added)
    Section 4a also exempts bona ~de hedge positions from speculative positions limits and
    the CEA allows the CFTC to adopt other appropriate exemptions as it sees fit. Section 4a does
    not extend the CFTC's position limit authority to over-the-counter swap transactions or to
    futures trading on a foreigna board of trade. CFTC position limits imposed under Section 4a(a)
    are restricted to those futures that are traded on designated contract markets or derivatives
    transaction execution facilities as well as significant price discovery contracts traded on an
    electronic trading facility. In 2000 and 2008, Congress also authorized designated contractDavid Stawick, Secretary
    March t8, 2010
    Page 10
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    COMMENT
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    markets and electronic trading facilities to impose position limits or accountability levels as these
    self-regulatory bodies determined to be necessary and appropriate.
    IV.
    CEA § 4a DOES NOT MANDATE CFTC-IMPOSED POSITION LIMITS
    Much has been made of the word "shall" in the second sentence of Section 4a(a). The
    argument is made that Congress used the word "shall" to mandate federal-set position limits?
    The statute's terms and history, as well as the CFTC's own application of its statute, establish
    that CEA § 4a(a) does not mandate CFTC-imposed position limits.
    The statute is clear. The Commission "shall" impose positions limits "as the Commission
    finds are necessary to diminish, eliminate, or prevent" the burdens of excessive speculation-
    commodity price fluctuations or changes that are sudden, unreasonable or unwarranted. The
    Commission's authority to impose position limits (i.e. the "shall") is therefore conditioned on a
    finding that limits are "necessary." Importantly, the statutory prerequisite requires a finding that
    the position limits are "necessary" - not just appropriate or helpful - to perform one of three
    functions: "diminish," "eliminate,"
    or
    "prevent" a burden, on interstate commerce resulting from
    excessive speculation. Thus, where a barden does not already exist (to be diminished or
    eliminated), Section 4a still requires the Commission to find that speculative position limits are
    necessary to
    prevent
    such a bus'den.
    The history also is clear. From 1936 to today, no federal regulator has interpreted
    Section 4a to mandate federal position limits. In 1938, the Commodity Exchange Commission
    having conducted evidentiary hearings beginning December 1, 1937, made specific factual
    findings that certain levels of open net speculative positions "tend to cause sudden and
    unreasonable fluctuations and changes in the price of [grain] not warranted by changes in the
    conditions of supply or demand" and then concluded:
    For example, CFTC Chairman Gary Gensler stated, "The CFTC is directed in its original 1936 statute to set
    position limits to protect against the burdens of excessive speculation, including those caused by hrge
    concentrated positions. In that law the Commodity Exchange Act (CEA) Congress said that the CFTC
    'shaw impose limits as necessary to eliminate, diminish or prevent the undue burden that may come as a result
    of excessive speculation. We are directed by statute to act in this regard to protect the public."
    See
    75 Fed Reg.
    at 4169 (Statement o f Chainzaan Gary Gensler).David Stawick, Secretary
    March 18, 2010
    Page 11
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    COMMENT
    CL-02687
    "in order to diminish, elevate, or prevent excessive speculation in
    grain futures whieh causes unwarranted price changes,
    it is
    necessary
    to establish limits on the amount of speculative trading
    ... which may be done by any one person."
    3 Fed. Reg. 3145, 3148 (Dec. 24, 193 8) (emphasis added).
    Significantly, the CEC made these limits applicable only to some commodities regulated under
    the CEA - "wheat, corn, oats, barley, rye, and flaxseed."
    ]d.
    at 3145. Cotton, rice, grain
    sorghums, mill feeds, butter, eggs and irish potatoes were not subject to any CEC limits. Thus,
    contemporaneous with the enactment of CEA § 4a in 1936, the officials charged with
    administering its provisions did not interpret the "shall" in Section 4a to direct the CEC to
    impose limits on all regulated commodities.
    The Commission's application of CEA § 4a also is clear. The Commission has never
    interpreted the word "shall" in Section 4a to require the imposition of position limits. Even the
    current proposal does not apply to all commodities, just energy commodities. But perhaps the
    best evidence that CEA § 4a does not direct the CFTC to impose anything is the CFTC's
    decision in 1979 to repeal daily trading limits. From 1936 to today, Section 4a(a) of the CEA
    expressly has authorized federally-imposed daily trading limits for speculators. For many years,
    federal regulators imposed such limits. In 1979, the CFTC repealed, the daily trading limits
    finding they were no longer "necessary." 44 Fed. Reg. 7124 (1979). Thus, the Commission
    itself has interpreted the "shall" in CEA § 4a to be secondary to the finding of necessity the
    agency must make before imposing any speculative limits.
    Vo
    TIlE PROPOSAL IS PREMATURE AND PROCEDURALLY FLAWED
    FIA urges the Commission not to adopt its proposal for prudential and procedural
    reasons. First, until Congress has finished its work this session on legislation to amend the
    CFTC's position limit authority, it is premature for the Commission to adopt final position limit
    rules. Second, the Commission has not complied with the Administrative Procedure Act's
    mandate that the public be afforded an opportunity ~br meaningful comment on important
    aspects of the proposal, specifically the finding the Commission must make that its proposal is
    "necessary to prevent" excessive speculation resulting in a burden on interstate commerce.
    A.
    Premature in Light of Legislation.
    On December !1, 2009, the U.S. House of Representatives passed H.R. 4173. Section
    3113 of that Iegislation contains ten pages of substantive amendments to Section 4a of the
    Commodity Exchange Act. The scope and significance of these amendments demonstrate why it
    would be premature for the Commission to adopt its position limit prop~)sal. The amendments
    would extend the Commission's position limit setting authority in physical commodities toDavid Stawick, Secretary
    March 18, 2010
    Page 12
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    COMMENT
    CL-02687
    certain swaps, both those that are economically equivalent to futures and those found to be
    significant price discovery swaps (authority the CFTC would be required to exercise
    concurrently). The CFTC also would obtain authority to impose position limits on U.S. traders
    with direct access to trading in futures contracts listed on foreign boards of trade (FBOTs) when
    those foreign contracts are linked through settlement prices to U.S. traded contracts. Section
    3113 would also revise the process and relevant factors by which the CFTC sets limits. It would
    empower the CFTC to impose aggregate, commodity-wide limits on futures, swaps and FBOT
    futures. Section 3113 would also amend the Commission's authority to establish exemptions for
    bona fide hedging m~d s~vap dealing activity. It is tmclear, in fact, whether the criteria for the
    CFTC's proposed risk management exemption for swap dealers would even be compatible with
    the limitations Section 3113 would impose.
    Even so, the CFTC's proposed risk management exemption for dealers perfectly
    illustrates why the CFTC should defer action for now. Under Section 3113, the CFTC must
    adopt simultaneously position limits in energy commodities for futures and economically
    equivalent swaps. Those limits would make the dealer risk management exemption largely
    irrelevant in many circumstances because dealers that use futures to offset their price risk from
    their swap positions (in short to hedge) should not exceed, or even approach, any reasm~able
    speculative position limit the CFTC would set.
    An example may be helpful. Assume Section 3113 is enacted and the CFTC sets a limit
    of 1000 contracts for both crude oil futures and swaps. A swap dealer and its counterparty enter
    into a swap with a notional amount equal to 2000 contracts; the dealer is long the equivalent of
    2000 futures contracts. The dealer then enters into a short futures position to hedge that risk of
    2000 contracts. The next day the dealer adds one short speculative contract to its position.
    Under Section 3113, the dealer should be found at that point to have a net one short position; it is
    well within the position limit and would not need an exemption. In contrast, under the CFTC's
    proposal, the swap positions are not included (and cannot be netted). Therefore the dealer - for
    the same conduct - would be found
    to violate the CEA because its futures position exceeds the
    2000 contract limit on risk management exempt positions. (In fact, under the proposal, the one
    short speculative position also would cause the dealer to lose its risk management exemption; the
    dealer would then be 1001 contracts over the CFTC's speculative position limit.) It would be
    odd if the CFTC were to adopt a proposal that would make a swap dealer potentially guilty of a
    criminal felony for violating the terms of CFTC position limits when Congress may act soon to
    make the same conduct perfectly legal.
    Moreover, if the CFTC adopts its proposals and then proposes and adopts a second set of
    position limit ruIes after the reform legislation is enacted, it will increase costs for the CFTC,
    futures commission merchants and market participants alike. Many of these costs will be
    operational and administrative as FCMs and market participants build systems to take into
    account the CFTC's new rules. Those substantial costs would be avoided if the CommissionDavid Stawick, Secretary
    March 18, 2010
    Page 13
    i0-002
    COMMENT
    CL-02687
    waited a few months for Congress to finish its deliberations and then addressed position limits
    under any new authority the CFTC might receive.
    FIA agrees with some and disagrees with many of the statutory changes in the House
    bill's Section 3113. We also know that no one knows whether Congress will enact finsdacial
    regulatory reform legislation, generally or any position limit amendments specifically. But there
    is no doubt that the CFTC's position limit authority is the subject of active congressional
    consideration at this time. Until those deliberations are resolved, at least for this session of
    Congress, FIA believes it would be prudent for the CFTC to refi'ain from acting on its proposal
    for position limits for energy commodities.
    Most importantly, deferring action would be consistent with the public interest. As
    Section 3113 makes clear, swaps and foreign futures are offered now on many energy
    commodities. None of those transactions would be subject to the CFTC's proposed limits.
    Some of those transactions- foreign futures contracts entered into by foreign entities- could
    never be subject to the CFTC's proposed limits, even if the provisions of Section 3113 are
    enacted. Some market participants likely will want price exposures beyond those allowed by the
    proposed limits, or will want to avoid the legal uncertainty and regulatory compliance costs the
    proposals will surely cause. Those traders can reasonably be expected to move their activities to
    the swap or FBOT platfomas. This shi.~ in market liquidity wilt harm the public interest in price
    discovery and efficient risk management. It will also compromise the ability of the Commission
    itself to conduct market surveillance and could thwart CFTC eftbrts to serve one of the major
    purposes of the CEA- to prevent price manipulation and preserve market integrity.
    4
    These arguments are not original. A number of members of the Commission have
    expressed similar concerns. FIA believes those Commissioners are right to be concerned. If the
    Commission had found that excessive speculation has existed or now exists in the market, FIA
    would understand the CFTC's need to move quickly. But the Commission has not found
    excessive speculation to exist now. There is no pressing, urgent need for these proposals. The
    Commission should not move forward to adopt them at least until the end of Congress's
    deliberations.
    Swaps and foreign futures contracts are not the only means available to those who seek price exposure to energy
    commodities. As the Commission's hearings last summer revealed, well-capitalized parties, both foreign and
    domestic, could buy and hold physical inventories as a means of obtaining price exposure without regard to
    CFTC-imposed position limits. The Commission does not take into account this phenomenon as a possible
    consequence of its proposal.David Stawick, Secretary
    March. 18, 2010
    Page 14
    i0-002
    COMMENT
    CL-02687
    B.
    Failure to Al!ow Meaningfu! Comment.
    The Commission should not proceed next to consider adopting its energy limits proposal
    because it has not afforded the public an opportunity to meaningfully comment on the proposal
    under the Administrative Procedure Act (APA). The APA requires that °'notice of a proposed
    rule . . . include sufficient detail on its content and basis in law and evidence to allow for
    meaningful and informed comment."
    See Amer. Med. Ass'n v. Reno,
    57 F.3d 1129, 1132 (D.C.
    Cir. 1995) (interpreting the APA's requirements in 5 U.S.C. § 553(b,c)). In
    American Medical
    Association,
    the Drug Enforcement Agency (DEA) had issued a notice of proposed rulemaking
    to increase controlled substance registration fees based on its statutory authority to set fees "at a
    1.evel that ensures the recovery of the full costs of operating the various aspects of [the diversion
    control] program." The D.C. Circuit found that the DEA's notice did not provide a meaningful
    opportunity for comment because it failed to explain how the increase in fees would ensure the
    recovery of the program's operating costs.
    See id.
    at 1130-33.
    s
    Like the DEA's notice in
    American Medical Association,
    the CFTC's Notice lacks the
    required basis for its proposed rules. That is, the CFTC has not explained why it thinks the
    proposed speculative position limits would be "necessary" to "prevent" a "burden on interstate
    commerce" resulting from excessive speculation. The CFTC does not make the required
    "necessary" finding in its notice because, in our view-, it misreads the statute to say that finding is
    not necessary.
    See
    75 Fed. Reg. at 4146 n.13 (Jan. 26, 2010). But, without being given a basis
    for the proposed rules, the public can not comment on the Commission's reasoning for its
    proposal. As
    American Medical Association
    made clear, "meaningful" public comment is
    rendered impossible in such a situation.
    In the past, the CFTC and its predecessor have complied with the meaningful comment
    man.date by explaining the basis for the "necessary" finding in CEA § 4a. This is exactly what
    This rule of administrative law has been applied in many cases.
    See, e.g., Owner-Operator Indep. Drivers
    Ass'n v. Fed. Motor Carrier Safety Admin.,
    494 F.3d 188 (D.C. Cir. 2007) (no meaningful opportunity for
    public comment where agency's notice of proposed rule revising Iong-haul truck drivers' hours failed to
    disclose methodology behind operator-fatigue model that was central to agency's decision to adopt proposed
    rule; agency's disclosure of methodology when it published final rule was "too late for interested parties to
    comment");
    Chamber of Commerce v. SEC,
    443 F.3d 890 (D.C. Cir. 2006) (no meaningful opportunity for
    public comment where agency extensively relied on extra-record materials in arriving at cost estimates for
    proposed rule that adjusted qualification standards for mutual funds to get exemptions under Investment
    Company Act);
    Engine Mfrs. Ass'n v. EPA,
    20 F.3d 1177 (D.C. Cir. 1994) (no meaningful opportunity for
    public comment where agency's notice of proposed rule to assess engine manufacturers full cost for EPA's
    Motor Vehicle and Engine Compliance Program did not present intelligible data to support agency's
    assumptions and therefore failed to adequately explain the basis upon which agency computed fees).David Stawick, Secretary
    March 18, 2010
    Page 15
    i0-002
    COMMENT
    CL-02687
    the Comm.odity Exchange Commission did in 1938 when it implemented Section 4a for the first
    time. In 1938, the CEC issued a proposed order to impose position and daily trading limits in
    grain futures. In that notice, the CEC made explicit that establishing the proposed limits was
    "necessary" to °'diminish, eliminate, or prevent the undue burden of excessive speculation in
    grain futures which causes unwarranted price changes" and invited public comment on its basis
    for that finding. 3 Fed. Reg. at 1409 (June 11, 1938). The CFTC itself followed the same
    practice in I978 when it proposed to repeal daily trading limits under Section 4a. Before acting,
    the CFTC offered its basis for tl~e proposed statutory finding that daily trading limits were no
    longer "necessary" or "required" and requested public comment on its proposed finding. 43 Fed.
    Reg. at 43034 (Sept. 22, t978).
    In each case under Section 4a, the agency explained why its proposed limits were
    "necessary" or not "necessary" and asked for public comment on its reasoning. Then the agency
    proceeded to final action on its proposal. In this proposal, however, the Commission deviated
    from its prior practice and eschewed taking the first required step. Therefore, the CFTC should
    not take the second step and approve the proposed rules.
    ]In this regard, the Notice actually treats the issue of whether limits are "r~ecessary" as if
    the CIzTC was conducting a three-stage rutemaking process and had begun that process with an
    Advanced Notice of Proposed Rulemaking.
    6
    In the Notice, the Commission asks the public for
    comment on the generic question of whether any speculative position limits are "necessary."
    That question is the kind of question the Commission usually poses in a three-step rulemaking at
    the Advanced Notice of Proposed Rulemaking stage, when the Commission requests information
    needed to develop a proposed role. For example, in a 1986 Advance Notice of Proposed
    Rulemaking, the Commission asked the public the verysimilar question of whether revisions to
    speculative position limits on agricultural commodities were "necessary." 51 Fed. Reg. at 31649
    (Sept. 4, 1986).
    Ultimately, what the Commission has done here - asking for public comment on whether
    limits generally are necessary without explaining why it finds the proposed limits to be
    "necessary" - is what the Commission typically does at the Advance Notice of Proposed
    Rulemaking stage, not the Notice of Proposed Rulemaking stage. Consistent with the APA and
    its own practice, the Commission should not proceed next to consider whether to adopt its
    position limit proposal.
    6
    FIA has attached to this comment letter our answers to the 17 specific questions the CFTC poses in its Federal
    Register Notice.David Stawick, Secretary
    March 18, 2010
    Page 16
    i0-002
    COMMENT
    CL-02687
    VI.
    THE PROPOSAL CONTRAVENES THE CEA AND HAS NO RATIONAL BASIS
    Even if the Commission's proposal was not premature and had affbrded the public a
    meaningful opportunity for comment, it should not be adopted. The proposal is contrary to the
    CEA and is not rationally related to preventing excessive speculation as defined by law. The
    proposal's restrictive exemptions compound these infirmities and are incompatible with the
    CEA. The proposed departure from tl~e existing Part 150 aggregation standards is unjustified.
    The costs of the proposaI also greatly exceed any cited benefits. The Commission has better
    attern.atives available to enhance its market surveillance effbrts and sl~ould pursue those
    enhancements, not this proposal.
    A.
    No Statutorily-Required "Necessary to Prevent" Finding.
    The Commission's Federal Register Notice does not find that excessive speculation has
    created a burden on interstate commerce as contemplated by CEA § 4a. The Commission
    therefore does not find that position limits are necessary to "diminish" or "eliminate" an extant
    burden. FIA agrees that the record does not support a finding that excessive speculation is
    causing unreasonable price fluctuations or changes that have resulted in a burden on interstate
    commerce. Instead, the available evidence - including the CFTC's own data and analysis -
    support the conclusion that market fundamentals drove the 2008 price spikes in various
    commodities.7
    The CFTC's own research indicates that the rise in oil prices was largely attributable to supply and demand
    factors.
    See
    Commodity Futures Trading Commission, Commodity Swap DeaIers& Index Traders with
    Commission Recommendations (Sept. 11, 2008),
    available at http:!iwww.cftc.gov/stellent/groupsi
    public/@newsroom/documents/fileicftcstaffi'eportonswapdealersO9.pdO; see atso
    interagency Task Force on
    Commodity Markets, Interim Report on Crude Oil (July 22, 2008) at 3-4,
    available at
    http://www.cf~c.gov/ucm/gr~ups/p~b~c/@newsr~om/d~cume~ts/file/itf~nt~rimrep~oncrude~i~7~8~pdf
    (concluding that large or rapid movements in oil prices are consistent with the fundamentals of supply and
    demand); U.S. Government Accountability Office, Issues Involving the Use of the Futures Markets to Invest in
    Commodity Indexes (Jan. 30, 2009) at 5,
    available at http:/iwww.gao.govinew.items!dO9285r.pdf
    (concluding
    fl~at the eigh.t empirical studies reviewed "generally found limited statistical evidence of a causal relationship
    between speculation in the futures markets and changes in commodity prices - regardless of whether the studies
    focused on index traders, specifically, or speculators, generally"). Testimony during the CFTC's energy
    hearings further confirms that price spikes were not caused by speculators. For example, Professor Philip
    Verteger, Jr. (Haskayne School of Management, University of Calgary, PK Verleger LLC) testified that, "The
    increase in crude oil prices between 2007 and 2008 was caused by the incompatibility of environmental
    regulations with the then-current global crude supply.
    See
    FIA Supplement to Comment Letter re
    Commission's "Concept Release on Bona Fide Hedge Exemption" (Aug. 12, 2009) at t (restating VerIeger's
    testimony). A survey of a significant cross-section of economists also revealed that, "The global surge in food
    and energy prices is being driven primarily by fundamental market conditions, rather than an investment bubble
    (Footnote Continued...)David Stawick, Secretary
    March 18, 20t0
    Page 17
    i0-002
    COMMENT
    CL-02687
    FIA also agrees that the CFTC does not have to make a finding that its limits are
    necessary to "diminish" or "eliminate" extant burdensome excessive speculation in order to
    exercise its position limit authority. However, FIA does not agree with the Commission's
    statement that demonstrating any "need" for the proposed position limits "is contrary to section
    4a(a) of the Act."
    See
    75 Fed. Reg. at 4146 n.13. Section 4a(a) expressly requires the
    Commission to find that its position limits are "necessary" to perform at least one of three
    functions: "diminish, eliminate, or prevent" the burdens of excessive speculation. Thus, where
    no burden exists to be diminished or eliminated, the Commission is still required to find that its
    limits are "necessary" to "prevent" the burden of excessive speculation that may someday exist.
    The Commission does not make that finding. The Commission also has not shown that
    key aspects of its proposed framework are "necessary"- namely, adopting "crowding out" rules
    that would treat hedgers' hedges as speculation and abandoning the independent controller rules
    for aggregation. Without these findings, the Commission cannot impose its proposed position
    limits on energy contracts in compliance with CEA § 4a(a).
    B.
    No Rational Basis far Proposed Limits.
    The CFTC has not stated a rational foundation for its proposal. The extra-statutory
    justifications offered by the CFTC are overbroad extrapolations of unsupportable concerns
    relating to speculative position concentrations generally. The Commission's reliance on its
    experience with position limits on agricultural commodities is also misplaced.
    1.
    The Proposal's '*Excessive Concentration" Focus is
    Misguided.
    The CEA allows for federal position limits to prevent excessive speculation, not position
    concentrations. It does not provide the CFTC with explicit authority to decide on the proper
    allocation of net "tong" or "short" market share. Nevertheless, and in lieu of the statutorily
    required "necessary to prevent" finding, the Commission argues that its proposed energy
    (Footnote Continued)
    [caused by speculators on the buy side]."
    See
    Phil Izzo, Bubble Isn't Big Factorin Inflation, WALL ST. J., May
    9, 2008, at A2. Paul Krugman, New York Times columnist and Professor of Economics at Princeton
    University, has written extensively on the cause of the energy price spikes and also concludes that they were not
    driven by speculators.
    See e.g,
    The Oil Nonbubble, N.Y. TIMES, May 12, 2008,
    available at
    http:!/www.nytimes.comi200g¢OS/12iopinioni12kmgman.htmI
    ("IT]he rise in oil prices isn't the result of
    runaway speculation; it's the result of growing difficulty of finding oil and the rapid growth of emerging
    economies like China.").David Stawick, Secretary
    March 18, 2010
    Page 18
    i0-002
    COMMENT
    CL-02687
    commodity position limits would "further" the objective of preventing harms that might arise
    from concentrations of large speculative positions. According to the Commission, "the potential
    exists" that "large speculative positions" could result in "unreasonable and abrupt price
    movements" should "the positions be traded out of or liquidated in a disorderly manner." 75
    Fed. Reg. at 4149.
    In addition to failing far short of what the statute requires, the problem with the CFTC's
    argument is that it does not describe any harm that is unique to concentrations of speculative
    positions, and might be addressed by limits on speculative positions. "Unreasonable and abrupt
    price movements" would seem to result from the "disorderly" liquidation of concentrations of
    any
    large positions, regardless of their characterization as speculation or not. The Commission
    itself seems to acknowledge this flaw in its logic by sometimes stating that concentrations of
    large positions in general - as opposed to large speculative positions in particular - can cause
    abrupt price changes.
    8
    In any event, experience teaches that the disorderly liquidation concern is one that is most
    acute in the delivery month. Exchanges and the Commission already are armed with a well-
    equipped tool box of systems and methods to prevent disorderly liquidations. Those tools have
    worked well, which is not surprising as Congress made disorderly liquidation prevention the
    foca! point of a Core Principle for designated contract markets as well as specific emergency
    actions Congress has authorized the CFTC and exchanges to take. CEA §{} 5(d)(4) and (6) and
    8a(9). Nor is there any proof or even a suggestion in the Commission's Federal Register Notice
    that disorderly liquidations in the deferred months have plagued or present a realistic threat to
    energy commodity pricing.
    Without showing how concentrations of speculative positions are more harnaful and have
    a greater impact on price than concentrations of other positions, the Commission cannot assert
    that the proposed limits on speculation arc "necessary" to prevent the alleged harms arising from
    speculative position concentrations. Those perceived harms would occur despite the limits on
    speculative positions if concentrations of other large positions were reduced or liquidated in a
    See, e.g.,
    75 Fed. Reg. at 4162 (Request for Comment, Question l): "Are Federa[ speculative position limits for
    energy contracts traded on reporting markets necessary to "diminish, eliminate, or prevent" the burdens on
    interstate commerce that may result from
    position concentrations
    in such contracts?") (emphasis added);
    Id.
    at
    4162 ("Central to these responsibilities is our duty to protect the public from the undue burden of excessive
    speculation that may arise, including those fi'om
    concentrations
    in the market place.") (emphasis added);
    Id.
    at
    4163 ("Large
    concentrated positions
    in the eneTNy futures and options markets can. potentially facilitate abrupt
    price movements and price distortions.") (emphasis added).David Stawick, Secretary
    March 18, 2010
    Page 19
    i0-002
    COMMENT
    CL-02687
    disorderly manner. Thus, the Commission has no basis for linking speculative limits to the
    prevention of deferred month disorderly liquidations of excessively concentrated positions.
    2.
    The Proposal Bans Non-Excessive Concentrations.
    Even if the Commission had shown that concentrations of speculative positions are more
    prone to causing unreasonable price changes than concentrations of large positions in general,
    the Commission's proposed limits are not rationally designed to prevent
    excessive
    concentrations. A hypothetical illustrates this point. Assume that the speculative position limit
    is 2500 (based on a prior year's open interest of 25,000 contracts) and there are 19 speculators on
    the long side, 18 of which hold t250 positions and 1 of which holds 2499 positions. If the
    speculator with 2499 contracts decides the next day to establish two more long positions, it
    would exceed the speculative position limit. However, no one could seriously maintain that the
    two additional tong positions in any meaningful way create "excessive" concentration on the
    long side of the market in this scenario. Thus, even if limiting concentrations of speculative
    positions was statutorily relevant under CEA § 4a and was sound policy, the Commission's
    proposal overshoots the mark; it would ban activity that cannot rationally be viewed to have any
    impact on concentration.
    As this example shows, a position limit formula based on last year's open interest does
    not measure accurately the level of concentration in a market today. No fo~Tnula is an
    appropriate substitute for an informed market surveillance judgment that market participants
    have an "excessively concentrated" position in a market. In fact, as the example demonstrates,
    the proposed formula seems destined to result in many "false positives" which will reduce
    positions and market liquidity even when no threat of excessive concentration exists.
    FIA agrees that position concentrations should be of market surveillance concern to the
    Commission and the exchaslges. Our position is that the blunt instrument of position limits is not
    suitable in dynmzoic, ever-changing energy markets to address across-the-board the threat to
    market prices that concentrations may pose in certain limited circumstances. As an alternative,
    FIA strongly recommends the surgical tools of aggressive accountability levels and vigilant
    market surveillance to address excessive concentrations. Through these tools, the CFTC could
    respond quickly to what it perceives to be emerging threats to the integrity of the price discovery
    process. It could issue special calls for information in special market circumstances to
    complement its existing large trader reporting system. When appropriate, these special calls
    could be issued intra-month, in the periods between the monthly regular special calls the CFTC
    has instituted. Based on this information and its aggregate accountability levels, the Commission
    could monitor position concentrations effectively and prevail upon market participants to reduce
    positions when necessary. Importantly, these measures to strengthen market surveillance all
    could be taken now by the Commission without waiting for any congressional action and withoutDavid Stawick, Secretary
    March 18, 2010
    Page 20
    i0-002
    COMMENT
    CL-02687
    the adverse impact on market liquidity and price discovery that witl inevitably foll.ow from over-
    broad speculative position limits as the Commission has proposed.
    o
    The CFTC Has Not Shown That Position Limits Result in More Fair
    and Reliable Prices.
    In lieu of finding that the federal energy position timits would be "necessary" to prevent
    burdensome excessive speenlation, the Commission cannot simply point to its history of setting
    agricultural position limits to justify its proposed energy limits, tn other words, its history with
    agricultural limits does not authorize it to circumvent or disregard the preconditions Congress
    has placed on its position limit authority. Ct~A § 4a still requires that position limits on any
    commodity, including energy commodities, have their own independent statutory basis - i.e. a
    finding that the limits are "necessm'y" to prevent burdensome excessive speculation)
    Importantly, the CFTC's Notice does not make the case that the proposed position limits
    would even be helpful or appropriate (let alone necessary) because t~e agricultural markets with
    CFTC-imposed hard position limits have generated better or more accurate prices (or more
    orderly liquidations) than markets that rely primarily on accountability levels. FIA respectfully
    submits that the CFTC would be hard pressed to make that case. We have seen no evidence that
    price limits have helped price discovery in any futures comract. Conversely, we have seen no
    evidence that accountability levels have not worked to improve market surveillance or promote
    reliable price discovery and orderly liquidations.
    To th.e contrary, FIA agrees with Commissioner O'Malia's observation that the CFTC's
    agricultural limits did not cause agricultural market prices to behave in a manner very different
    from energy mm'kets. 75 Fed. Reg. at 4172. That evidence would surely be dispositive if the
    CFTC asserted that it must apply its agricultural lfinit approach to energy markets to diminish or
    eliminate existing excessive speculation. If the markets with, and the markets without, limits
    followed similar price trends, it i.s hard to see how limits would have made any difference in
    energy prices. To the extent the Commission is arguing that its proposed limits would
    prevent
    future energy price distortions, the evidence of the apparent past impact (or tack of impact)
    position limits have had on agricultural market prices is still quite relevant. As Commissioner
    O'Matia points out, this experience surely heightens the burden on the Commission to
    The agricultural and energy markets are not twins, Limits that may be necessary for agricultural commodities
    are not automatically necessary for energy commodities. In fact, the high seasonality of production mad the
    highly variable nature of old-crop inventory carry-over for agriculture can significantly affect the susceptibility
    of some agricultural markets to price manipulation or price distortions. These conditions are not generally
    present in the more continuously-produced and worldwide fungibflity of many energy markets.David Stawick, Secretary
    March 18, 2010
    Page 21
    i0-002
    COMMENT
    CL-02687
    demonstrate that applying the proposed position limits to energy markets is likely to have a
    different result. The Commission has not met that burden.
    C.
    Proposed Exemptions
    Are Unworkable and in Conflict with the
    CEA.
    The Commission proposes to allow two kinds of market participants to exceed the energy
    position limits: bona fide hedgers qualifying as swap dealers that offset risks associated with
    swap agreements and all other bona fide hedgers. Both exemptions deviate from the Part 150
    exemptions the CFTC has provided for agricultural position
    limits.
    The CFTC has not
    articulated any compelling reason to support its apparent decision to abandon its Part 150
    exemptions for energy limits. Nor has it offered any justification for saddling market
    participants and their futures commission merchants with the considerable compliance cost of
    maintaining different operational systems for meeting different position limit exemption
    standards. Most importantly, the CFTC's proposed exemptions do not comply with the CEA.
    The statute bars the Commission from treating bona fide hedge positions as speculative
    positions. Therefore the proposal's so-called crowding out restrictions are incompatible with the
    statute and must be abandoned.
    All Bona Fide Hedgers Should Be Allowed to Speculate Up to the
    Speculative Position Limit.
    As a matter of logic and consistency, if the Commission believes its agricuIturaI position
    limit experience is a relevant model for the energy position limit regime, then it should also
    apply the Part 150 agricultural Iimit exemptions to its energy regime. Under the agricultural
    framework, those qualifying for a bona fide hedge exemption can hold speculative positions up
    to the speculative position limit and still enter into hedge tra~nsactions up to the limit set for their
    hedge exemption. Thus, if the speculative limit is 1000 contracts and a bona fide hedger holds
    1500 hedge positions (pursuant to an exemption allowing the hedger to hold up to 2000 hedging
    positions), the hedger could still speculate independently of its hedge up to the 1000 speculative
    position limit. In short, in our example, an agricultural hedger could hold 1000 speculative
    positions
    in addition to
    its 1500 hedging positions.
    However, under the bona fide hedge exemption from the energy position limits, a bona
    fide hedger would violate the speculative position limit if it engages in any speculation (even one
    contract) and the combination of its hedging positions and speculative position(s) exceeds the
    speculative position limit. For example, assume that the energy speculative position limit is
    1000 contracts and a bona fide hedger holds 1000 hedging positions (pursuant to an exemption
    that allows him to hold up to 2000 hedging positions). The bona fide hedger then enters into one
    speculative contract, for a total of 1001 positions. Under the Commission's "crowding out"
    proposal, the hedger has violated the speculative position limit. Remarkably, under the CFTCDavid Stawick, Secretary
    March 18, 2010
    Page 22
    i0-002
    COMMENT
    CL-02687
    proposal, the Commission would interpret the hedger's one speculative contract to constitute
    excessive speculation.
    As the Commission well knows, it is difficult in every instance to apply with certainty the
    legal borders of speculation and hedging. Some blurring is inevitable. Hedge positions entered
    into in good faith can become speculative even without any action by the hedger. (A farmer's
    hedge position based on an over-projection of crop size could be considered to be speculation, in
    part.) U.S. Treasury Secretary Timothy F. Geithner made this very point on March 26, 2009
    when he testified in Confess: "It's too hard to distinguish what is a legitimate hedge that has
    some economic value from what people might just feel is a speculative bet on some future
    outcome." The Need for Comprehensive Regulatory Reform: Hearing Before H. Fin. Servs.
    Comm. I 1 lth Cong. (2009) (statement of Timothy F. Geithner, Treasury Sec'y of the United
    States).
    This weIl-aecepted legal uncertainty makes the "crowding out" rule even. more
    dangerous. Legitimate market participants may leave the futures markets because they will not
    accept the legal risk of violating CFTC position limits due to the crowding out proposal, and the
    possible attendant civil and criminal consequences. If that occurs, futures market liquidity, price
    discovery and efficient risk management will surely suffer.
    Even if the CFTC disagrees with these policy arguments, it should not adopt the
    "crowding out" rule because it violates the CEA in two ways. First, the proposal violates Section
    4a(c) by applying the CFTC's speculative position limit to a hedger's bona fide hedge positions
    if the hedger also holds any speculative positions. Section 4a(c) of the CEA precludes this result.
    It clearly states that, "No, rule, regulation, or order issued under subsection (a) of this section
    shall apply to transactions or positions which are shown to be bona fide hedging transactions or
    positions .... " In effect, CEA § 4a(c) grants a hedger an automatic exemption from the
    specuiative position limit for all positions shown to be bona fide hedging positions. The
    Commission's proposal to count a hedger's bona fide hedging positions against the speculative
    position limit where that hedger holds at least one speculative position is thus inconsistent with
    CEA § 4a(c).
    Consider again the example from the beginning of this section. Under the proposal, with
    a speculative limit of 1000 contracts, a party with a bona fide hedge position of 1200 contracts
    (under at 2000 position hedge exemption) that enters into one speculative contract, trips the
    CFTC-set speculative limit. That result conflicts with CEA §4a(c) because it would allow the
    one speculative contract to transform the 1200 bona fide hedge contracts into speculative
    positions subject to the proposed limits. By statute, however, speculative limits may not beDavid Stawick, Secretary
    March 18, 2010
    Page 23
    10-002
    COMMENT
    CL-02687
    imposed on hedge positions. The CFTC's proposal thereby contradicts directly the statute's
    terms.10
    Second, the Commission's proposal exceeds the CFTC's legal authority under Section
    4a(a) by prohibiting speculation that would not be "excessive." In Section 4a(a), Congress
    recognized that
    excessive
    speculation - not de minimis or moderate speculation - could create a
    burden on interstate commerce if it caused unreasonable or unwarranted price changes. As
    shown above, the Commission's proposal would not be addressing the excessive speculation
    with which Congress was concerned, but would ban. a long hedger with hedge positions up to the
    speculative position limit from holding even one net long speculative position. The Commission
    nowhere explains how a hedger's establishment of speculative positions well under (or even up
    to) the speculative limit would amount to "excessive" speculation. In addition, without finding
    that its "crowding out" proposal is necessary to prevent the burdens of "excessive" speculation,
    the Commission camaot sustain this aspect of its proposal under CEA § 4a(a).
    The Commission's "crowding out" proposal is ill-advised and inconsistent with CEA
    § 4a. Rather than adopt this aspect of its proposal, the Commission should follow its Part 150
    approach by subjecting all positions characterized as speculative - and only those positions - to
    the adopted limits on speculation.
    2.
    Swap Dealers Should Be Treated Like All Other Bona Fide Hedgers.
    Proposed new Section 151.3(a)(1) of the Commission's regulations provides: "positions
    that are held to offset risks associated with swap agreements under paragraph (a)(2) of this
    section" are bona fide hedge transactions to which special exemption criteria apply. Proposed
    new
    T
    Section 151.3(a)(2) provides those criteria and grants an exemption from the proposed
    energy position limits for qualified swap dealers that are using futures markets "outside of the
    spot month .... to offset risks associated with swap agreements entered into to accommodate swap
    customers and are either directly linked to the referenced energy contracts or the fluctuations in
    the value of the swap agreements are st~bstantialty related to the fluctuations in value of the
    referenced energy contracts." The dealer exemption is set at twice the all-months combined or
    I0
    The statutory mandate to exempt hedge positions from position limits is solid evidence that Congress did not
    intend the speculative position limit at~thority in CI~A §4a to be focused on preventing excessive concentrations.
    Congress knew that some hedgers would maintain some level of speculative trading and determined that was a
    permissible outcome so long as the speculative trading did not exceed the speculative limit. By its terms
    excluding hedge positions from limits, CEA §4a(c) rebuts the argument that position timits are supposed to
    focus on excessive concentrations,David Stawick, Secretary
    March 18, 2010
    Page 24
    i0-002
    COMMENT
    CL-02687
    non-spot single month limits, as applicable. The Commission also proposes to impose its
    crowding out restrictions on dealers in a manner that is similar to all other bona fide hedgers.
    The dealer exemption suffers from the same deficiencies as the exemption for other bona
    fide hedgers, and more. The CFTC has deviated from its Part t 50 policy for dealers for no stated
    reason° The Commission would render the dealer exemption unworkable by precluding dealers
    from maintaining or establishing speculative positions while relying on the dealer exemption to
    establish positions at or above the speculative position limit.
    11
    The proposed crowding out
    feature runs afoul of CEA § 4a(c) by nullifying the hedge exemption for dealer positions and
    CEA §4a(a) by refusing to allow dealers to hold speculative positions up to the reqnired limit
    even though the CFTC offers no basis for concluding that the combined risk management and
    speculative positions of the dealer constitute excessive speculation under the law.
    The dealer exemption is ill-advised on additional grounds. The CFTC cites no basis to
    treat swap dealers any differently than. other bona fide hedgers. Swap dealers use futures to
    offset price risk and the CFTC agrees that dealers are hedgers. Yet, the CFTC would, for no
    stated reason, bar swap dealers from holding hedge positions in the spot month, unlike all other
    hedgers. F~[A can not think of any justification for treating swap deaters rand other hedgers
    differently in th~s way. ~z
    Moreover, while other bona fide hedgers may exceed the speculative position limit by an
    undetermined amount depending on their demonstration of need to the reporting market, the
    dealer exemption is limited to an absolute cap of twice the speculative position limit. The
    11
    12
    Dealers may be even more susceptible to adverse unintended consequences than other hedgers. If a dealer's
    swap counterparty reduces the size of its swap position, the dealer will often, for a time, assume that market risk
    as a speculator until the futures position has been rebalanced with the swap exposure. For example, a dealer
    might not liquidate its futures position immediately to equal the reduction in the size of its swap position with a
    counterparty because to do so automatically without concen~ for the then extant liquidity could result in a
    pattern of trading in the futures market that coutd be considered to be disorderly. This concern is particularly
    relevant when the swap counterparty is based overseasand the agreement to reduce the swap position may
    occur at a time when the relevant futures exchange is either not open for trading or has limited liquidity during
    overnight tradin.g hours, tn these situations, by the time the dealer rebalances its futures position with the swap
    exposure, the dealer would have lost its risk management exemption under the proposal and could be in
    violation of the position ~imit.
    FIA is concen~.ed that excluding dealers from tradirtg at all in the spot month could adversely affect market
    liquidity and increase price volatility in the delivery month. This concern may well be heightened during the
    last three trading days because of the imer-relationship of the proposal's physical delivery and cash settlement
    trading limits.David Stawick, Secretary
    March I8, 20t0
    Page 25
    i0-002
    COMMENT
    CL-02687
    Commission provides no rationale for its decision to discriminate against swap dealer bona fide
    hedges in this manner. But dealers need to be treated like other hedgers. Dealers may be
    hedging long term swap transactions of, for example, 5 years or longer. The proposal calls for
    the position limit to change annually. If the CFTC-imposed position limit shrinks during one
    year of the dealer's multi-year hedge it could cause a dealer to now have a speculative futures
    position, and. therefore a limit violation, without any action on the part of the dealer.
    13
    If a dealer can prove to a reporting market or the Commission that it needs three times or
    more the speculative limit to offset the risk on its swap book, there is no reason not to allow the
    dealer to hedge its market risk on the futures market, tn fact, there is good reason to allow it.
    The dealer will be bringing liquidity to open and transparent trading markets thereby
    contributing to price discovery and the ability of hedgers to effectively manage their risk.
    Imposing an artificial hard cap on the size of market risk that a dealer may hedge using futures
    could simply lead to more risk being held outside the CFTC regulated markets with their
    attendant counterparty credit risk protections. It is difficult to reconcile that result with the
    public interest.
    Proposed Rule § 151o3(a)(1)(ii), 75 Fed. Reg. at 4169, recognizes tha~ swap dealers may
    themselves, or through affiliates, also use futures markets to hedge physical energy transaction
    price risk. However, the proposed rule is unclear regarding whether a dealer may enter into
    physical hedge positions without having those physical hedges count against the two times
    position limit cap on swap dealer risk management positions. What is cIear under the proposed
    rule, however, is that where a dealer uses the futures markets to hedge its physical energy
    transaction price risk under a general bona fide hedging exemption equal to or exceeding twice
    the speculative position limit, the dealer may not hold or control any positions pursuant to the
    risk management exemption. (Proposed Rule § 151.3(a)(t)(ii), 75 Fed. Reg. at 4169.) Thus, to
    the extent that a dealer that wishes to remain as a market maker in the swap markets also wishes
    !3
    Suppose the CF'rC sets the position limit at 1000 contracts, A dealer enters into a 5-year swap with a n.otionat
    amount ecl.ual to 2000 futures contracts. The dealer then enters into an offsetting futures position to hedge that
    swap risk. tn year two of the hedge, the CFTC-set limit is reduced to 900 contracts because of lower open
    interest in the prior trading year. The dealer's hedge exemption falls to 1800 contracts. The dealer's futures
    hedge is now larger than the CFTC-imposed 1800 contract limit for dealers. The dealer is in violation even
    though it didn't change its futures position at all. A variation of this scenario ill.ustrates a similar problem. If
    during the 5-year swap, the dealer ente~ into a new swap with a new counterparty that would reduce its market
    exposure on its original swap from 2000 contracts to 1600 contracts before the dealer is able to reduce its
    futures position COlvespondingly, the dealer's futures hedge position would automatically become, in part, a
    speculative position and would automatically disqualify the dealer from the risk management exemption. The
    dealer would, therefore be in violation of the CFTC-set position limit.David Stawick, Secretary
    March 18, 2010
    ]?age 26
    i0-002
    COMMENT
    CL-02687
    to use futures to hedge its physical energy transaction price risk, the proposal would have the
    effect of disqualifying or unduly limiting this bona fide hedging activity from being treated as a
    separate hedge for position limit purposes. This aspect of the proposal conflicts with CEA §§
    4a(a) and (c). As stated above, Congress foreclosed the CFTC from subjecting bona fide hedge
    transactions to speculative position lhnits, regardless of the identity of the hedger or its
    affiliates.
    14
    In addition to its Iegal flaws, the proposal's dealer exemption restrictions fail to account
    for the different levels of hedging activities in the futures markets and the breadth of activities
    engaged in by dealers and their affiliates. Using futures to offset or manage price risks created
    by swap transactions or physical transactions serves the national public interest, as Congress has
    found (CEA § 3(a)), whether or not both types of hedge transactions were entered into by a
    dealer itself or its affiliates. If the Commission maintains a separate exemption for dealer risk
    management activities, the Commission should amend its proposal to allow a dealer that meets
    the qualifications for both the general bona fide hedging exemption and the dealer exemption to
    apply for and obtain both exemptions, without allowing one exemption to restrict the IeveI of
    permissible activity under the other exemption.
    CFTC Part 150 Aggregation Standards Should Be Applied to Energy
    Commodities.
    The Commission's aggregation proposal for energy contracts is a major departure from.
    longstanding CFTC poIiey and practice and. should not be adopted. It aggregates all positions
    held in accounts subject to common ownership (based on a 10% or more direct or indirect
    ownership standard) even where trading for these accounts is independently controlled.
    However, an "independent account controller" aggregation exemption has been and is currently
    available for "eligible entities" dealing in
    agricultural commodities
    and for good reason - when
    two traders who are completely independent trade for the same corporate entity they cannot be
    viewed in any way as trading in concert or trying to affect prices in the same way.
    See
    CFTC
    14
    An example may make this easier to mxd.erstand. Assmne a position limit of 1000 contracts~ Proposed Rule
    151.3(a)(1 )(ii) states that if Dealer enters into a physical futures hedge of 2000 contracts (or more), Dealer may
    not qualify for the swap risk management exemption in Proposed Rule 151.3(a)(2). In effect, the proposal
    thereby would treat any of DeaIer's futures positions that offset swap risk as weI1 as its physica! hedges as if
    they were speculative positions. That contradicts CEA § 4a(c). What if Dealer enters into a physical hedge of
    only 1500 contracts? The proposal is clear that Dealer may put on some futures positions to offset the risk of its
    swaps. But the proposal is unclear whether Dealer is free to invoke Proposed Rule 151.3(a)(2) up to double the
    speculative limit (2000 contracts) or only up to 500 contracts, l[n either case, the proposal's imposition of an
    m~cificial cap on Dealer's risk management activity is problematic from both a legal and practical standpoint.David Stawick, Secretary
    March 18, 2010
    Page 27
    i0-002
    COMMENT
    CL-02687
    Regulation §§ 150.1(e) and 150.4. The CFTC cites no problems with its existing standard.
    Thus, there is no reason for aggregating the positions of those independent account controllers.
    ~s
    As an explanation for its decision to depart from Part 150, the Commission states that the
    proposal calls ~br high limits on energy positions and the traditional Commission "eligible entity
    exemption that would allow traders to establish a series of positions each near a proposed outer
    bound position limit without aggregation, may not be appropriate." 75 Fed. Reg. at 4161. The
    Commission, however, never offers any reasoning beyond this assertion of "possible
    inappropriateness" and never explains why it would ever be inappropriate.
    Independent traders should be able to establish positions at the outer bound of any
    position limit. Those traders are merely complying with the taw and the outer bounds set by the
    Commission which, by law, must be "necessary to prevent" excessive speculation. It would be a
    different case if the traders were not independent and they were acting in concert to amass
    positions that greatly exceeded CFTC position limits.
    16
    But if the account controllers are
    "independent," then aggregation is inappropriate and, more statutorily relevant, "unnecessary to
    prevent" excessive speculation. CEA § 4a(a).
    The CFTC's proposal suggests that passive investments in an entity which engages in
    energy futures trading in connection with its business will trigger an automatic aggregation
    requirement by virtue of the "common ownership" standard. This aspect of the proposal has
    potentially major implications for investments in the energy sector. Similarly, the proposat calls
    into question the ability of FCMs to rely on Rule 150.4(d) which codifies the CFTC 1979
    Statement of Aggregation Policy. For example, an FCM might not be able to disaggregate
    proprietary positions of the FCM and those entered into independently by its advisory affiliate on
    behalf of clients.
    15
    The exchanges have applied the CF2"C Part 150 aggregation standards as well for many years; the potential
    impact o f the CFTC' s proposals could extend beyond j ust the energy sector.
    Per.haps this is what the CFTC hints at when it states: "[C]urrent account disaggregation exceptions for the
    agricultural contracts eIaumerated in regulation 150.2 may be incompatible with the proposed Federal
    speculative position limit framework, however, and used to circumvenl its requirements." 75 Fed. Reg. at 4161.
    The answer to that concern is to enforce the independence requirements to catch anyone trying to circumvent
    them, not to bar those who are truly independent from trading under posi.tio~ limits. This might be different if
    the CFTC had identified any instances of abuse under the current standards which need to be addressed. The
    Commission has not, however, identified any such. problems with the current standards.David Stawick, Secretary
    March t8, 20t0
    Page 28
    10-002
    COMMENT
    CL-02687
    The proposal's departure from the Commission's Part 150 standards also may be
    unworkable and surely will sharply increase the cost of compliance. Both market participants
    that qualify as "eligible entities," including FCMs, which maintain decentralized and
    international trading operations with multiple independent account controllers would find it
    extremely difficult, and very costly, to monitor and keep a running tally of each of these
    disparate trading operations in the over 100 different contracts affected by the proposal. Market
    participants and their FCMs will need to develop or purchase expensive new compliance systems
    in this area. They will also have to build new Information Technology (IT) programs for the
    proposed aggregation standards because their current IT programs only code for the Part 150
    standards. Implementing these new compliance systems will come at a cost that would be
    burdensome and have no identifiable corresponding benefit other than the Commission's "may
    not be appropriate" assertion. FCMs have implemented effective systems for complying with the
    CFTC's Part 150 rules. The Commission should allow FCMs to continue to rely on those
    systems by applying the Part ! 50 standards to aggregation and disaggregation for energy limits.
    E.
    The Proposal's Costs Are High, Not "Minimal;" Its Benefits Are Uncertain.
    The Commission concludes that the costs of its proposal would be "minimal." 75 Fed.
    Reg. at 4164. This assessment includes both compliance costs and the impact of the proposal on
    market liquidity, price discovery, efficient hedging and market surveillance effbrts. FIA
    respectfully disagrees with the Commission.
    We agree with CFTC Commissioner Michael Dunn's statement in the Federal Register.
    Having reprised his August 2009 feat" of the adverse consequences that would flow out of any
    energy position limits that did not apply to OTC and foreign markets, Commissioner Dunn
    wrote: "I believe this is still true today, and that forging ahead on a position limits regime for
    political expediency is not the course of action that this agency needs or one that promotes the
    health and integrity of the futures industry in the United States." 75 Fed. Reg. at 4164. FIA too
    is concerned with the health and integrity of the futures industry and, as we have discussed
    earlier in this letter, we believe the costs of the proposal are high in terms of compromising the
    public interests served by the energy futures markets.
    If the proposals are adopted, many market participants are likely to shift their market
    activities to other venues to avoid the legal uncertainty regarding the application of the limits and
    their proposed exemptions. In particular, as our examples have shown, the proposals' crowding
    out rules would be particularly difficult to apply in a dynamic market with ever-changing trading
    operations and strategies. Even worse, failure to comply with the CFTC-set limits carries serious
    legal consequences. Moreover, the proposed energy position limits will impose significant
    compliance, monitoring, and management costs on market participants. The tack of clarity
    imbuing the proposal will further complicate their efforts. For example, no industry sourceDavid Stawick, Secretary
    March 18, 2010
    Page 29
    i0-002
    COMMENT
    CL-02687
    seems to be able to replicate the CFTC's open interest calculation that serves as the basis for
    computing position limits.
    The Commission answers by saying that the position limits it proposes would "possibly"
    affect only ten traders. 75 Fed. Reg. at 4170. This assessment surely understates the compliance
    costs and challenges that would be imposed by the new rules and grossly underestimates the
    substantial market-wide impact of the proposed rules. By diverting liquidity, the limits would
    likely affect most, if not all, of those who trade energy or use energy futures prices in their
    businesses. The exemptions also could add to energy price volatility and risks by discouraging
    hedging activity at least by swap dealers, if not other hedgers. Moreover, it is unclear whether
    the Commission's determination was made after taking into account the possible effect of the
    proposal's departure from the Commission's Part 150 aggregation standards. If nothing else, the
    CFTC's changes to its aggregation policies mean that it is likely that many multiples of ten
    traders would actually have to reduce positions in th.e energy futures markets.
    Against this assessment of costs, the CFTC asserts only unspecified possible
    "prophylactic" benefits the proposal "may" cause. 75 Fed. Reg. at 4164. Having found no
    extant "excessive speculation," the Commission is left to propose limits that "may" prevent
    adverse prices, even though the Coinmission has multiple weapons in its arsenal already to
    achieve market integrity. The Commission's desire to improve its market surveillance of
    multiple trading platforms in the same commodity is commendable but could be achieved, more
    effectively through a Commission-initiated position accountability effort, not hard limits that
    would affect only futures and that are contrary to the public interest.
    FIA urges the Commission to reassess its cost-benefit analysis of the proposal.
    The
    Proposal Would
    Be Arbitrary
    And Capricious If Adopted In Its Current
    Form.
    FIA respectfully urges the Commission not to adopt these proposals, hopefully for any, or
    many, of the reasons we express in this letter. As always, FtA stands ready to work with the
    Commission and its staff to address any market integrity issues. We would be pleased to discuss
    how best to improve market surveillance given the modern evolution of derivatives trading. As
    we noted at the outset, price manipulation and price distortions are public enemy number one and
    should never be tolerated.
    If the Commission adopts its proposals in their current form, however, FIA believes that a
    reviewing court would find them to be arbitrary and capricious under the Administrative
    Procedure Act. In order for an agency to show that its action is not arbitrary and capricious, the
    agency must have "examine[d] the relevant data and articulate[d] a satisfactory explanation for
    its action."
    Motor Vehicle Mfrs. Ass 'n 1,. State Farm Mutual Auto Ins. Co.,
    463 U.S. 29, 43
    (1983). The Commission has not done either here. More specifically, its failure to make aDavid Stawick, Secretary
    March I8, 2010
    Page 30
    i0-002
    COMMENT
    CL-02687
    statutorily required finding and its failure to ground its assumptions in the factual record are
    indicative of arbitrary and capricious agency action.
    See Pub. Citizen v. Fed. Motor Carrier
    Safety Admin.,
    374 F.3d 1209 (D.C. Cir. 2004) (agency's promulgation of a rule increasing the
    num.ber of hours truck drivers could spend behind the wheel, but decreasing maximum work day,
    was arbitrary and capricious where the agency did not make a statutorily required finding about
    how the rule would affect the "physical condition" of the drivers);
    Comeast Corp. v. FCC,
    579
    F.3d 1, 8 (D.C. Cir. 2009) (agency's rule capping market share any single cable operator could
    serve at 30% was arbitrary and capricious where the record failed to support the agency's
    assumption that an operator serving 30% of the market posed a threat to competition).
    CONCLUSION
    FtA knows the Commission is under great pressure from members of Congress and
    certain market participants to address the volatile energy pricing allegedly caused by speculation.
    FIA has commended the Commission for the informative and fact-based hearings the
    Commission held on this subject last summer. Our review of the hearing record confirmed to us
    the complexity of energy pricing generally and the issues related to any necessary position limits
    specifically. We still do not believe the case has been made, in any credible way, that any type
    of speculation drove energy prices to artificial levels, either high or low. We are pleased that the
    Commission's Federal Register Notice in this rulemaking reach.es a similar conclusion.
    FtA strongly urges the Commission to defer action on position limits until Congress
    enacts its financial reform legislation. The Commission's existing market integrity protection
    systems are strong and its special call program has enhanced even those traditional safeguards.
    FIA respectfully submits that the Commission's proposals would disserve the congressionally-
    identified national public interests and should not be adopted, even if they complied with the
    relevant statutes. We look forward to working with the Commission to help it achieve our
    shared objective of preventing price manipulations and distortions in the energy markets.
    Respectfully yours,
    Jotm M. Damgard
    President
    Futures Industry AssociationDavid Stawiek, Secretary
    March I8,2010
    Page 31
    i0-002
    COMMENT
    CL-02687
    Honorable Gary Genster, Chairman
    Honorable Michael Dunn, Commissioner
    Honorable Jilt E. Sommers, Commissioner
    Honorable Bart Chilton, Commissioner
    Honorable Scott O'Malia, Commissioner
    Stephen Sherrod, Acting Director of Surveillance
    David P. Van Wagner, Chief Counsel
    Donald Heitman, Senior Special Counsel
    Bruce Fekrat, Special CounselResponse o~ the ~'utures Industry Association ~o the Questmns Raised
    by the CFTC in its Federal Register Notice dated January 26~ 2010
    10-002
    COMMENT
    CL-02687
    1.
    Are
    Federal speculative position limits for energy contracts traded on
    reporting marke*s necessary to "diminish, eliminate, or prevent" the burdens on interstate
    commerce that may result frown position concentrations in such contracts?
    No. If the CFTC found existing burdensome excessive speculation, it could
    impose limits as necessary to eliminate or diminish that condition. The CFTC
    has not found excessive speculation to exist. FIA agrees with the "non-
    finding." tn the absence of extant excessive speculation, by law the CFTC
    must find that speculative limits are "necessary to prevent" the burdens of
    sudden or unreasonable price fluctuations or unwal~:anted price changes. CEA
    § 4a. The CFTC has not made that required finding for its proposal. Perhaps
    the CFTC believes its proposed limits would be "helpful" but are not
    "necessary." FIA does not believe the proposed limits (or federal limits
    generally) could be found to be necessary now because other, more effective
    means exist to enhance CFTC market surveillance and wevent energy price
    manipulations and distortions. Existing CFTC and exchange market
    surveillance, special call, position limit and position accountability systems
    provide a strong system to deter and. detect artificial, manipulated prices. The
    CFTC might want to consider adopting its own accountability levels for
    energy commodities traded on multiple trading platforms. When used with
    targeted CFTC special calls, accountability levels would assist the
    Commission in promoting market integrity and fair trading.10-002
    COMMENT
    CL-02687
    lhe question is not posed ~n a manner consistent with the statute. l'he hrst
    two sentences of Section 4a which authorize the imposition of limits never use
    the term "position concenn'ations." In any event, as our comment letter
    shows, the Commission's proposal would limit speculation even in markets
    where position concentrations do not exist. Position limits are a blunt
    instrument to address concerns about excessive concentrations.
    2.
    Are there methods other than Federal speculative position limits that should
    be utilized to diminish, eliminate, or prevent such burdens?
    The burden referred to is the burden of excessive speculation. Section 4a
    defines that term to mean speculation that causes prices to fluctuate suddenly
    or unreasonably or change in an unwarranted manner. Futures markets are
    dynamic. Prices fluctuate or change constantly in order to make certain that
    futures markets serve their price discovery and risk management purposes.
    The fact that these fluctuations or changes occur does not make them
    unreasonable or unwarranted.
    ® But prices can be affected by artificial manipulative forces. When that occurs,
    FIA believes the CFTC already has excellent tools to conduct effective market
    surveillance and deter or detect any misconduct by any market participants,
    whether speculators or hedgers.
    FIA is not aware of any gaps or weaknesses in the CFTC market surveillance
    system. FIA strongly endorses an active CFTC market surveillance effort.
    The CFTC does have a greater market surveillance responsibility when
    competing exchanges or platforms trade the same or similar commodities
    because no single exchange is able to see the whole market as the CFTC
    210-002
    COMMENT
    CL-02687
    could. In tllose situations, tl~e t~l: lt5 might consl(ler implementing ItS owI1
    accountability levels and using its special call authority to obtain more
    information about the activities of specific market participants.
    3.
    How should the Commission evaluate the potential effect of Federal
    speculative position limits on the liquidity, market efficiency and price
    discovery
    capabilities of referenced energy contracts in determining whether to establish position
    limits for such contracts?
    FIA believes the imposition of CFTC position limits now would harm the
    punic interests in price discovery and efficient risk management. The CFTC
    has no authority to impose limits on OTC swaps or foreign markets. Traders
    that want more price exposure than would be possible under the CFTC-
    imposed limits could be expected to move their trading activity to swap
    markets, foreign, futures exchanges or worse to physical markets. This shift
    would harm the public interests in price discovery and efficient risk
    management that are served by U.S. futures markets while also harming
    CFTC market surveillance. In the absence of new legislative authority in this
    area, the CFTC should postpone imposing limits on energy commodities
    while Congress continues its deliberations. Of course, the CFTC should also
    continue its vigorous market surveillance efforts.
    4.
    Under the class approach to grouping contracts
    as discussed
    herein, how
    should contracts that do not cash settle to the price of a single contract, but settle to the
    average price of a subgroup of contracts within a class be treated during the spot month for
    the purposes of enforcing the proposed speculative position limits?
    o FIA has no comment.
    5.
    Under proposed regulation 151.2(b)(1.)(i), the Commission would establish an
    all-months-combined aggregate position limit equal to !t!% of the average combined
    futures
    and option contract open interest aggregated across all reporting markets for the
    most recent calendar year up to 25,000 contracts, with a marginal increase of 2.5% of open
    interes~ thereafter. As an alternative to this approach to an all-months-combined
    310-002
    COMMENT
    CL-02687
    aggregate posmon l~m~, ~ne ~=omm~ss~on requests comment on wne~er an a~monal
    increment with a marginal increase larger than 2.5% would be adequate to prevent
    excessive speculation
    in
    the referenced energy c~ntracts. An additional increment w~uld
    permit traders 1o hold larger positions relative to total open positions in the referenced
    energy contracts~ in comparison to the proposed for~nula. For example~ the Commission
    could fix the aH-mon~hs-combined aggregate, position limit at 1~% ~f the pH~r year's
    average open ~nterest up to 25,000 contracts, with a marginal ~ncrease of 5% up t~ 300,~00
    contracts and a marginal increase of 2.5% thereafter. Assuming the pH~r year's average
    open interest equaled 300,000 contracts, an all-months-combined aggregate position Hmit
    would be fixed a~ 9,400 contracts under the proposed rule and 16~300 contracts under the
    alternative.
    FIA does not believe the proposed limits have been shown to be necessary to
    prevent excessive speculation in energy commodities. That is the statutory
    precondition for limits. FIA also does not believe generally that excessive
    speculation exists for energy commodities, as the statute defines that term.
    (The CFTC has l~ever found excessive speculation to exist.) Given that
    position, FIA would support any limits that are higher than those proposed
    because they would have less impact on market liquidity and price discovery.
    16,300 would be better than 9,400. But FIA still does not believe that any
    limits are or have been shown to be necessary.
    Question 5 asks whether a higher limit would be adequate; the statute asks a
    different question: whether any limits are necessary. We believe the answer
    to the statute's question is "no" based on the evidence we have seen.
    6.
    Should customary position sizes held by speculative traders be a factor in
    moderating the limit levels proposed by the Commission? In this connection, the
    Commission notes that current regulation 150.5(c) states contract markets may adjust their
    speculative limit levels ~based on position sizes customarily held by speculative traders on
    the contract market, which shall not be extraordinarily large relative to total open positions
    in the contract * * *"
    Today position limits apply to the last trading days in the spot month because
    of concerns relating to the potential for congestion and pricing abnormalities
    410-002
    COlvlIvINNT
    CL-02687
    in the delivery month, as suggested by the statutory provisions applicable to
    contract markets. CFTC Regulation. 150.5(c) allows contract markets to take
    into account customary positions for speculators as a factor in administering
    existing limits. That seems to be an appropriate regulatory interest for the
    delivery month.
    ® The fact that the largest speculators customarily hold positions of a certain
    size is often not a meaningful factor in terms of market surveillance or
    preventative position iimits. What is a customary position level for larger
    traders may depend on many market factors that have nothing to do with
    excessive speculation that could lead to price manipulations or distortions.
    Limits tied to customary levels might unduly restrict market liquidity when it
    would be better to allow more speculation to be brought to the market to
    assume some of the risk hedgers want to avoid.
    7.
    Reporting markets that list referenced energy contracts, as defined by the
    proposed regulations, would continue to be responsible for maintaining their own position
    limits (so long as they are not higher than the l~mits fixed by the Commission) or position
    accountability rules. The Com~nission seeks comment an whether it should issue
    acceptable practices that adopt formal guidelines and procedures for implementing
    position accountability rules.
    FIA does not see a need for acceptable practices in this area unless the CFTC
    identifies specific problems.
    8.
    Proposed regulation 151o3(a)(2) would establish a swap dealer risk
    management exemption whereby swap dealers would be granted a position limit exemption
    for positions that are held to offset risks associated with customer initiated swap
    agreements that are linked to a referenced energy contract but that do not quaIi~
    ~
    as
    bona
    fide
    hedge positions. The swap dealer risk management exemption would be capped at
    twice the size of any otherwise applicable all-months-combined or single non-spot-month
    position limit. The Commission seeks comment on any alternatives to this proposed
    approach. The Commission seeks particular corament on the feasibility of a 'qook-
    through" exemption for swap dealers such that dealers would receive exemptions for10-002
    COMMENT
    CL-02687
    pos~t~uns oI-Isett~ng risks res~zlt~ng I-tom swap agreements opposite counterpart~es who
    would
    have been
    entitled to a hedge exemption
    if they had hedged their exposure directly
    in
    the futures markets. How viable i.s
    such an
    approach given the Commissio~'s lack of
    regulatory authori~ over the OTC swap markets?
    ¯
    FIA does not believe that the "look through" for physical hedger exemption
    for swap dealers is viable or is an appropriate means of characterizing the
    status of a dealer's futures positions to offset price risk.
    ®
    FIA does believe that any swap dealer that establishes a futures positioa as an
    economically appropriate means of managing or reducing price risk from open
    swap transactions should not be subject to speculative position limits for those
    positions. Managing or reducing existing price risks should never be confused
    with speculation. But dealers should be subject to the speculative position
    limit for their speculative positions, just like every other market participant.
    Moreover, FIA believes that there is no reason to subject swap dealers to a
    more restrictive exemption than other bona fide hedgers through an absolute
    cap of twice the speculative position limit. Imposing an artificial cap may
    actually have the negative consequence of encouraging more risk to be held
    outside the CFTC regulated markets with their attendant counterparty credit
    risk protections. Just like other bona fide hedgers~ dealers should be allowed
    to exceed the speculative position limit by an amount based on their
    demonstration of need to a reporting market or the CFTC.
    ¯
    FIA also believes that if energy futures and economically equivalent swaps
    were subject to the same limits, most swap dealers would not need an
    exemption in any event. That is another reason we believe CFTC action on
    limits before Congress enacts regulatory reform legislation is premature.10-002
    COMMENT
    CL-02687
    !:'roposeO
    regulation 2U.O2 would require swap neuters ~o hie with
    Commission certain information in connection with their risk management exemptions to
    ensure ~hat the Commission can adequately assess their need for an exemption. The
    Commission invites comment on whether these requirements ~re sufficient. In
    alternafive~ should the Commission limit these filMg requirements, and ~nstead rely upon
    its regulation 18.05 special call authori~ to assess ~e merit of swap dealer risk
    management exemption requests?
    ¯
    FIA woutd defer to ISDA on this question generally.
    *
    We do not believe the CFTC's special call authority should be used on a
    regular basis to obtain information about exemption requests.
    t0. The Commission's proposed part 151 regulations for referenced energy
    contracts would set forth a comprehensive regime of position limit, exemption and
    aggregation requirements that would operate separately from the current position limit,
    exemption and aggregation requirements for agricultural contracts set forth in part 150 of
    the Commission's regulations. While proposed part 151 borrows many features of part
    150, there are notable distinctions between the two, including their methods of position
    limit calculation and treatment of positions held by swap dealers. The Commission seeks
    comment on what, if any, of the distinctive features of the position limit framework
    proposed herein, such as aggregate position limits and the swap dealer limited risk
    management exemption, should be applied to the agricultural commodities listed in part
    150 of the Commission's regulations.
    FIA believes that the question should be reversed. If the CFTC adopts energy
    limits in accordance with Section 4a of the CEA, the CFTC should follow its
    agricultural position limit policies for purposes of exemption and aggregation
    policy in the energy area. FIA knows of no basis for the CFTC to impose
    different standards for agriculture and energy. This disparity will increase
    compliance costs and uncertainty. We strongly urge the CFTC to reconsider.
    11. The Commission is considering establishing speculative position limits for
    contracts based on other physical commodities with finite supply such as precious metal
    and soft agricultural, commodity contracts. The Commission invites comment on which
    aspects of the current speculative position limit framework for the agricultural commodity
    contracts and the framework proposed herein for the major energy commodity contracts
    (such as proposed position limits based on a percentage of open interest and the proposed
    exemptions from the speculative position limits) are most relevant to contracts based on
    other physical commodities with finite supply such as precious metal and soft agricultural
    commodity contracts.
    710-002
    C OlvllvlNN T
    CL-02687
    I~'IA believes any new position limits are premature and would harm the public
    interest if adopted at this tim.e because limits on futures would encourage
    many market participants to shift their positions to swap markets or foreign
    futures exchanges which are not subject to CFTC limits.
    If the CFTC could adopt limits now that are consistent with its statutory
    obligations, FIA believes it should follow the exemption and aggregation
    framework from the CFTC Part 150 rules.
    12. As discussed previously, the Commission has followed a policy since 2008 of
    conditioning FBOT no-action relief on the requirement that FBOTs with contracts that
    link to CFTC-regulated contracts have position limits that are comparable to the position
    limits applicable to
    CFTC-regulated contracts, If
    the Commission adopts the proposed
    rulemaking, should it continue, or modify in any way, this policy to address FBOT
    contracts
    that would be linked
    to any referenced energy
    contract as defined by the
    proposed regulations?
    FIA has addressed this question before. We cominue to believe that the issue
    should only arise when an FBOT offers direct access to U.S, traders to a
    contract that is linked to the settlement price of a contract traded on a DCM
    (or a CFTC-found significant price discovery contract). In that situation, FIA
    strongly recommends that the CFTC work with foreign regulators to adopt an
    appropriate market surveillance system, that may or may not include position
    limits.
    13.
    The Commission notes that Congress is currently considering legislation
    that
    would
    revise the Commission's section 4a(a) position limit authority to extend beyond
    positions in reporting market contracts to reach positions in OTC derivative instruments
    and FBOT contracts. Under some of these revisions, the Commission would be authorized
    to set limits for positions held in OTC derivative instruments and FBOT contracts.
    1
    The
    Commission seeks comment on how it should take this pending legislation into account in
    proposing Federal speculative position limits.
    See., e.g.,
    Over-the-Counter Derivatives Markets Act of2009 (OCDMA), H.R. 3795, 111th Congress, 1st Sess
    (2009). OCDMA would also abotish the DTEF, ECM and ECM-SPDC market categories.10-002
    COlvlMENT
    CL-02687
    -
    FtA believes the CFTC should wait tbr Congress to act. CFTC action now
    would confuse market participants, harm the public interest and make more
    work for the CFTC itself at a time when it claims its resources are being
    strained. In addition, the CFTC's proposal might have to be substantially
    revised depending on the legislation Congress adopts.
    ,,
    FIA also notes that, in contrast to acting now, waiting to act would not create
    any significant harm given that the CFTC has not found that excessive
    speculation existed or now exists in the energy market.
    14.
    Under proposed regulation 1.51.2, the Commission would set spot-month and.
    all-months-combined position limits annually.
    a,
    Should spot-month position limits be set on a more frequent basis
    given the potential
    for
    disruptions in deliverable supplies for referenced energy contracts?
    ®
    No. The DCMs should handle spot-month limits and police directly the
    delivery process.
    b.
    Should the Commission establish, by using a rolling-average of open
    interest instead
    of a simple average for example,
    all months-combined position limits on
    a
    more frequent
    basis? If so, what reasons would support
    such action?
    No. More frequent adjustments would destabilize the markets by injecting
    uncertainty and would increase administrative costs for market participants'
    compliance activities. Congress has addressed a related issue and advised the
    CFTC against changing contract terms and other trading conditions for
    agricultural contracts with open interest. The CFTC should respect all traders'
    need for legal certainty when they establish positions in defen-ed months.
    15.
    Concerns have been raised about the impact of large, passive,
    and
    unleveraged long-only positions on the
    futures markets.
    Instead of using the
    futures
    markets for risk
    transference, traders
    that own such
    positions treat commodity futures
    contracts as distinct assets that can be held for an appreciable duration° This notice of
    rulemaldng
    does not propose regulations that would categorize such positions for the
    910-002
    CONMENT
    CL-02687
    purpose of applying different regulatory standards. Rather, the owners of such positions
    are treated as other investors that would be subject to the proposed speculative position
    limits.
    a.
    Should the Commission propose regulations to limit the positions of
    passive long traders?
    ~, No, as we said in August 2009, there is no credible case against index traders.
    b.
    If so, what criteria should the Commission employ to identify and
    define such traders and positions?
    c.
    Assuming that passive long traders can properly be identified and
    defined, how and to what extent should the Commission limit their participation in the
    futures markets?
    Passive long traders are difficult to define with certainty. Their participation
    should not be limited.
    d.
    If passive long positions shonld be limited in the aggregate, would it
    be feasible for the Commission to apportion market space amongst various traders that
    wish to establish passive long positions?
    ~ No.
    e.
    What unintended consequences are likely to result from the
    Commission's implementation of passive long position limits?
    Price discovery will be harmed and portfolio diversification will be made
    more expensive and inefficient. Hedging in deferred months would become
    more expensive. Index funds could buy and hold physicals. That could
    artificially impact prices, and the CFTC would have caused that harm
    inadvertently.
    Should
    f.
    diversified eomraodity indexes be defined with greater
    particularity?
    Yes, more legal certainty can't hurt.
    16. Under the proposed regulations, a swap dealer seeking a risk management
    exemption would apply directly to the Commission for the exemption. Should such
    10exemptions be processed by the reporting markets as would be
    the
    hedge exemptions under the proposed regulations?
    10-002
    COMMENT
    CL-02687
    case with
    bona fide
    ® FtA believes the BFH exemptions should be handled by the exchanges.
    ®
    FIA believes the RM exemptions could be handled by either the CFTC or the
    exchanges expeditiously, with the proper guidance.
    17.
    In implementing initial
    spot-month
    speculative position limits, if the notice of
    proposed rulemaldng is finalized, should the Commission:
    a.
    Issue special calls for ~nformation to the reporting markets to assess
    the size of a contract's deliverable s~lpply;
    b.
    Use the levels that are currently used by the exchanges; or
    c.
    Undertake an independent calculation of deliverable supply
    without
    substantial reliance an exchange estimates?
    Consistent with the reporting markets' regulatory interest in the delivery
    process, the CFTC should rely on those markets for deliverable supply
    information.
    11