Comment Text:
10-002
COMMENT
CL-08303
From:
Sent:
To:
Subject:
Attach:
Pantano, Paul
Monday, April 26, 2010 7:02 PM
secretary
Proposed Federal Speculative Position Limits for Referenced Energy Contracts
and Associated Regulations
EEl Comment Letter.pdf
Dear Mr. Stawick:
Attached are the comments of the Edison Electric Institute in the rulemaking proceeding noted above.
Please contact us if you have any questions.
Respectfully submitted,
Paul J. Pantano Jr.
I
McDermott Will & Emery LLP
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EDISON ~LECTRIC
April 26, 2010
Via Email:
David A. Stawick
Secretary
Commodity Futures Trading Commission
1155 21st Street, N.W.
Washington, DC 20581
Re:
"Notice of Proposed Rulemaking for Federal Speculative Position
Limits for Referenced Energy Contracts and Associated
Regulation," 75 Fed. Reg. 4144 (January 26, 2010)
Dear Mr. Stawick:
I.
Introduction / Our Members' Interest In The Proposed Rule
The members of the Edison Electric Institute ("EEI") submit this letter in response to the
notice of proposed rulemaking issued by the Commodity Futures Trading Commission (the
"CFTC" or "Commission") seeking comment on its proposal to implement speculative position
limits on futures and option contracts in four energy commodities (the "Proposed Rule").1
EEI is the association of shareholder-owned electric companies, international affiliates
and industry associates worldwide. Our U.S. members serve 95% of the ultimate customers in
the shareholder-owned segment of the industry, and represent approximately 70% of the U.S.
electric power industry. Many of EEI's electric utility company members utilize financial
instruments, including energy futures contracts and swaps, to hedge the price risks associated
with buying the fuels, including natural gas, used to produce wholesale power, and selling
wholesale power. These risk management tools are a key method used by utilities to provide
reliable electric service to consumers at stable prices that could, without adequate hedging
mechanisms, become more volatile because of volatile wholesale electricity prices. As a result,
EEl and its member companies have a direct interest in the Proposed Rule.
1
Federal Speculative Position Limits' for Referenced Energy Contracts' and Associated Regulations.
75 Fed.
Reg. 4144 (Jan. 26, 2010). The comments contained in this filing represent the position of EEI as an organization,
but not necessarily the views of any particular member.Pursuant to its authority under Section 4a(a) of the Commodity Exchange Act ("CEA"),
the CFTC is proposing to adopt federal speculative position limits for contracts traded on the
New York Mercantile Exchange ("NYMEX") related to Henry Hub natural gas, light sweet
crude oil, New York Harbor No. 2 heating oil and New York Harbor gasoline blendstock. The
rules also would apply to substantially similar contracts, including those traded on the
IntercontinentalExchange, Inc. ("ICE"), that the CFTC has found to be significant price
discovery contracts ("SPDCs").
2
EEI's letter focuses on the following issues about which the
CFTC has sought comment:
The impact of the Proposed Rule on the ability of commercial enterprises to
engage in sound risk management practices.
¯
How should hedge exemptions be determined for commercial entities?
Should the CFTC aggregate positions from multiple accounts using a 10%
common ownership or common control standard?
It is critically important to EEI members and their customers that the CFTC continue to
fulfill its mission to protect all market users and the public from fraud, manipulation and abusive
practices and to ensure that the futures and options markets are competitive, efficient and
financially sound. Accordingly, EEI supports the CFTC's work to promote markets that
accurately reflect the forces of supply and demand and that are free from abusive trading activity.
Nevertheless, EEI has concerns with several aspects of the Proposed Rule. Moreover, in light of
the fact that Congress currently is considering several legislative proposals that, if passed, would
substantially amend the CEA, and specifically address issues covered by the Proposed Rule, we
urge the CFTC to wait until this legislative process is complete before taking any further action
with respect to the Proposed Rule. If the CFTC decides to proceed before that time, we ask that
it consider the amendments to the Proposed Rule that we propose herein, keeping in mind that
our member companies depend on the energy futures, options and swaps markets to manage their
commercial risk.
2
Under Section 2(h)(7) of the CEA, over-the-counter COTC") contracts traded on an electronic trading facility
that have been determined by the CFTC to be SPDCs are subject to CFTC regulation, including the position limit
and large trader reporting requirements. Exempt commercial markets listing SPDCs also are deemed to be
registered entities with self-regulatory responsibilities with respect to such contracts. To date, ICE's Henry
Financial LD 1 Fixed Price natural gas contract is the first and only contract to have been determined by the CFTC to
be an SPDC under the CEA.
See
74 Fed. Reg. 37988 (July 30, 2009). The CFTC announced that it will hold a
public meeting on April 27, 2010, to consider whether other contracts offered for trading on the ICE, the Natural
Gas Exchange, Inc. and the Chicago Climate Exchange, Inc. perform a significant price discovery function, and
should thus be designated as SPDCs.
See, e.g., Notice of Intent, Pursuant to the Authority in Section 2~)(7) of the
Commodity Exchange Act and Commission Rule 36.3(c)(3), to Undertake a Determination Whether the Mid-C
Financial Peak Contract," Mid-C Financial Peak Daily Contract," Mid-C Financial off-Peak Contract," and Mid-C
Financial Off-Peak Daily Contract, Offered for Trading on the IntercontinentalExchange, Inc., Perform Significant
Price Discovery Functions,
74 Fed. Reg. 51,261 (Oct. 6, 2009). EEI has filed comments in the Mid-C, SP-15 and
PJM proceedings.H.
The Proposed Rule Will Negatively Impact EEl's Members Without
Reducing Excessive Speculation
Our members firmly support the CFTC in its goal of maintaining competitive and
effective energy markets. However, based upon our members' considerable experience in the
energy markets, we believe that certain provisions in the Proposed Rule are not consistent with,
and will cause considerable disruption to, the way our members conduct their businesses) The
following aspects of the Proposed Rule cause particular concern for our members:
The provision that will preclude commercial market participants relying on
a bona fide hedge exemption from holding a single speculative position;
The aggregation of accounts of related entities based solely on a 10%
ownership test regardless of whether there is any common control; and
The lack of clarity about the size of position limits in the future, which is
likely to make it much more difficult to secure financing for investments in
energy infrastructure projects.
Entities Utilizing A Bona Fide Hedge Exemption Should Be Allowed
To Speculate Up To The Applicable Position Limit
EEI respectfully submits that the practical effect of the Proposed Rule will be the
opposite of what the CFTC intends. Instead of preventing excessive speculation, it will
unnecessarily restrict the hedging activities of commercial market participants who need to
manage the risks associated with their physical energy businesses. Under the Commission's
proposal, members who need to rely on a bona fide hedge exemption are prohibited from taking
a single speculative position
(i.e.,
their speculative positions are "crowded out"). This restriction
will not prevent excessive speculation. In fact, the CFTC, by proposing to set the limits at a
particular level, essentially is making the determination that speculation up to those limits is not
excessive. Given that the intent of position limits is to prevent excessive speculation, the CFTC
should not prohibit commercial market participants from taking speculative positions up to the
limit that the CFTC has determined is not excessive.
4
While the CFTC proposes to deny commercial market participants relying on a hedge
exemption from executing a single speculative trade, it would allow speculators who do not have
a physical commodity business to speculate up to the limit. There is no apparent justification for
this disparate treatment, which could significantly reduce our members' ability to manage the
price risks associated with their commercial operations. It may also reduce liquidity in the
energy futures markets, widen the bid-offer spread and, thereby, increase our members'
transaction costs.
3
See
Comments of Commissioner O'Malia, Proposed Rule at 4172: "If position limits are implemented, the
Commission must ensure that such limits do not affect market liquidity and thus hinder the market's fundamental
purpose of allowing commercial hedgers to manage risk."
4
Section 4a(a) Commodity Exchange Act, 7 U.S.C. §6a(a).Speculation increases market liquidity and enables meaningful price discovery in the
energy futures markets. Indeed, EEI members and other commercial enterprises rely upon the
transactions of speculators to help make the energy markets function in a competitive and
efficient manner. For example, the price data generated by speculative transactions provide
electric companies with insights that help them establish effective hedges to reduce the exposure
of their industrial, commercial and residential customers to wholesale price volatility.
There are also practical reasons not to prohibit all speculative trading by hedgers. It is
very difficult for many of our members to maintain a perfectly hedged position at all times, as
the nature of their businesses require them to manage a broad portfolio of trades. Their
portfolios include, in addition to futures and options transactions, forwards and swaps that may
not equate exactly to listed futures contracts. Given the components of their trade portfolios, it
would be extremely challenging, and likely unachievable, for many of our members to maintain
a book of trades without a single speculative position.
Because market conditions can change rapidly and unexpectedly, it is important that our
members retain the flexibility that allows them to manage their portfolios in a manner that is
commercially viable and in their best interests. This may, and often will, result in a need to have
some speculative positions, sometimes simply because an underlying physical trade expires or is
otherwise terminated, or because the demand for certain physical inputs or outputs changes
vis-a-
visa
member's existing hedge position. For example, in the electric power industry, decisions
about which plants to operate often depend upon changes in the supply and demand for different
fuels. In many markets, plant dispatch priorities are determined by third parties. All of these
factors can affect the composition of our members' physical transactions and their related hedge
positions.
Electric utilities' load serving obligations also can vary materially from projections due
to exogenous factors, including weather, a broad economic downturn or a cyclical or seasonal
shift in regional industrial demand. To illustrate the problem, consider a situation where a major
manufacturing facility closes due to outsourcing or some other reason, thus permanently
affecting realized electricity demand. This could require a member to adjust a long-term hedge
(such as selling gas forward as a proxy for power) taken based upon expected demand. Because
futures positions may not be able to be offset immediately, they could appear to be speculative in
the short-term
EEI, therefore, urges the Commission to amend the Proposed Rule to allow entities
utilizing a bona fide hedge exemption to engage in speculative trades up to the applicable
position limit, as the CFTC and the exchanges historically have permitted with respect to energy
and agricultural futures contracts. We see no reason for the Commission to depart from this
long-standing precedent. This is especially true because the Commission's proposal to prohibit
commercial companies that rely on a hedge exemption from taking a single speculative position
could increase volatility in, and may raise our members' costs, which, in the ordinary course of
business, likely will need to be passed onto consumers. We assume that it is not the
Commission's intent to issue a rule that would increase energy costs for retail electricity
customers.Uo
The Proposed Aggregation Rules Will Unreasonably Restrict
Legitimate Hedging Activity
Under the Proposed Rule, positions will be aggregated across the corporate group
structures of our members based upon an inflexible 10% ownership test. This is contrary to the
CFTC's long-standing regulations which allow exchanges to aggregate positions based solely on
whether a person exercises direct or indirect "control" over the futures trading accounts of
affiliated companies.
5
In practice, many corporate structures include entities that share a 10%
ownership interest, but that have no control or even knowledge of each others' positions. In fact,
even if two entities would otherwise be subject to common control, state and federal energy
regulators often require information barriers be put in place between regulated and unregulated
affiliated utility trading operations, to ensure each entity is operated independently.
6
If an
unregulated and regulated entity were forced to aggregate their positions based solely upon 10%
ownership, either could (and likely at some stage would) be in a position where it was unable to
hedge all of its commercial risk. If this does occur, the Proposed Rule will have had the effect of
precluding a regulated utility from prudently hedging its price risk.
For these and other reasons, many EEI members do not have systems in place that would
enable them to aggregate trading positions among affiliates with whom they do not share control.
In addition to creating possible federal and state regulatory problems, the imposition of the 10%
ownership aggregation requirement will place a significant administrative and financial burden
on EEI's members. It will require costly new group-wide collaborative monitoring systems,
which our members believe will make no discernable contribution to the CFTC's goal of
reducing excessive speculation. EEl, therefore, urges the CFTC to amend the Proposed Rule to
provide for only commonly controlled positions to be aggregated.
Uncertainty About The Size Of Future Position Limits May Inhibit
Investments In Power Generation Assets And Related Infrastructure
The Proposed Rule allows the CFTC to adjust the position limits each year based on an
"open interest formula." This could adversely affect the risk-reward characteristics of long-term
investments, including those in crucial infrastructure, such as solar, wind and other renewable
power and transmission projects. In order to secure financing for these types of investments, our
members must be able to hedge price risk many years into the future. Unpredictability as to how
5
17 C.F.R. 150.5.
6
The Federal Energy Regulatory Commission's CFERC") roles require that a public utility with captive
customers function independently of its market-regulated power sales affiliate and restrict the sharing of certain non-
public information between them.
See
18 C.F.R. 35.39. Those regulations currently are subject to a proposed
rulemaking that likely will result in further clarification about the type of information that may not be shared.
See
FERC Order and Notice of Proposed Rulemaking dated April 15, 2010 (respectively the "April 15 FERC Order"
and the "April 15 NOPR", and collectively the "April 15 FERC Announcements"). Paragraphs 41-43 of the April
15 FERC Order prohibit the sharing of information dealing with resource planning and fuel procurement between
traditional regulated public utilities and market-regulated power sales affiliates. Depending on the outcome of the
April 15 FERC Announcements, many of EEI's members may not be permitted to share the information necessary
for them to coordinate their use of the futures markets to ensure that their positions (when aggregated) do not violate
the speculative position limits.position limits will vary from year to year may reduce the number of entities, especially financial
institutions, that are willing and able to enter into hedging transactions with energy asset owners
because of the uncertainty about whether they will be able to maintain effective hedges for the
full duration of the projects. If our members are unable to hedge their project risk, or are forced
to hedge at higher prices because of regulatory uncertainty, this will adversely affect their ability
to secure funding for such projects.
Section 151.3(b) of the Proposed Rule allows position limits to be "exceeded to the
extent that such positions remain open and were entered into in good faith prior to the effective
date of any rule, regulation, or order that specifies a limit." In order to increase the predictability
necessary for effective hedging and financing, EEI requests that the Commission clarify that this
exemption applies to adjustments made by the Commission pursuant to the "open interest
formula" in the Proposed Rule.
III.
The CFTC Should Wait For Legislation Pending In Congress
As the CFTC is aware, Congress is considering several legislative proposals which, if
passed, would substantially amend the CEA. Among other things, the proposals specifically
would address speculative position limits, expand the CFTC's jurisdiction over swap
transactions, and provide the CFTC with additional authority over foreign boards of trade.
Enacting the Proposed Rule prior to the conclusion of pending legislation, would increase
regulatory uncertainty in the energy markets. This, combined with the other concerns described
above, may lead market participants to move their businesses to OTC markets or less-regulated
foreign markets.
7
EEl, therefore, strongly urges the CFTC to suspend taking any further action
with respect to the Proposed Rule until the legislative process is complete.
IV.
Conclusion And Recommendations
For the foregoing reasons, EEI respectfully recommends that the CFTC suspend
consideration of the Proposed Rule while the legislative process is ongoing. If, before or after
the completion of the legislative process, the CFTC decides to proceed with implementation of
the Proposed Rule, EEl respectfully requests that the Commission amend certain aspects of the
Proposed Rule, so that:
(1)
commercial entities utilizing a bona fide hedge exemption are permitted to engage
in speculative trades up to the applicable position limit;
(2)
only commonly controlled positions are aggregated; and
7
See
closing statement of Commissioner Dunn, Meeting on Energy Position Limits and Hedge Exemptions,
January 14, 2010: "IT] he adoption of this proposed regulation, without the corresponding OTC regulatory authority
and similar undertakings by other nations' regulators, may result in less transparency in the futures markets if those
presently trading on an exchange move to OTC and other opaque markets to circumvent the proposed position
limits."(3)
the exemption set forth in Section 151.3(b) with respect to grandfathered futures
positions applies to adjustments made by the Commission pursuant to the "open interest
formula."
Please contact me at (202) 508-5571, or Aaron Trent, Manager, Financial Analysis, at
(202) 508-5526, if you have any questions regarding EEI's comments.
Respectfully submitted,
Richard F. McMahon, Jr.
Executive Director
Edison Electric Institute
701 Pennsylvania Avenue, N.W.
Washington, DC 20004
Phone: (202) 508-5571
Email: rmcmahon~
