Comment for Proposed Rule 75 FR 4143

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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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COMMENT
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"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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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.
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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?
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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