Comment Text:
10-002
COMMENT
CL-08312
From:
Sent:
To:
Cc:
Subject:
Attach:
Medero, Joanne
Monday, April 26, 2010 7:06 PM
secretary
Sherrod, Stephen ; Van Wagner, David
; Heitman, Donald H. ;
Lewis, Bradford
Proposed Federal Speculative Position Limits for Referenced Energy Contracts
BLK_CommentCFTC4-26-10filed.pdf
Mr. Stawick--Attached please find the submission of BlackRock on the above referenced proposal.
With best regards,
Joanne Medero
Managing Director
BlackRock
Ph: 415 670 2620
<>
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Submitted via electronic delivery
April 26, 2010
David Stawick
Secretary
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21
st
Street, N.W.
Washington, D.C. 20581
Re: Federal Speculative Position Limits for Referenced Energy Contracts-Proposed Rule
BlackRock welcomes the opportunity to comment on the Commodity Futures Trading
Commission's proposed rules on Federal Speculative Position Limits for Referenced Energy
Contracts ("Proposed Rules").
Introduction
BlackRock is one of the world's largest asset management firms, managing approximately $3.3
trillion on behalf of institutional and individual clients worldwide through a variety of equity,
fixed income, cash management, alternative investment and advisory products. Headquartered in
New York City, we have offices in 24 countries and employ over 8500 people. Our clients
include public and corporate pension plans, endowments, foundations, insurance companies and
exchange traded fund/mutual fund investors. Our clients are both institutional and retail, but it is
important to note that our institutional clients represent in turn hundreds of thousands of defined
benefit and defined contribution pension participants and beneficiaries. BlackRock does not
engage in proprietary trading whether in commodities, commodity derivatives or any other asset
class. As a fiduciary for our clients, we have a strong interest in a regulatory regime that
supports liquid, fair and orderly markets.
Our comments will focus primarily on the proposed changes to the CFTC's long established
aggregation principles, and the impact of this on large, global asset managers such as BlackRock.
We will also touch briefly on the role of passive/index investors in the commodity futures
markets--those institutional managers that follow strategies that seek to match the return of a
specified commodity index--and how the Proposed Rule would impact these strategies and
futures trading in the referenced energy contracts.Background
In order to achieve portfolio diversification, to manage the volatility risk to which investment
portfolios are subject, and to improve risk-adjusted returns, institutional investors are
increasingly seeking investment in asset classes that exhibit neither positive nor inverse
correlation to traditional equity and fixed income assets. Investment research indicates that
appropriately structured indices and baskets of physical commodities exhibit investment return
characteristics that are uncorrelated with traditional portfolio asset categories. The investment
officers of these institutional investors source these investments to managers with ability to
match the desired return stream at the lowest possible cost. Through economies of scale,
BlackRock is able to offer these investors exposure to the commodity markets at a competitive
cost with best-in-class risk management. On a global basis, BlackRock manages approximately
$5 billion in commodity-based strategies.
1
One of the principal tenets of the Commodity Exchange Act is the recognition that speculative
(but not excessive speculative) liquidity is critical to the successful operations of the futures
markets. Further, commercial hedgers m'e plainly not the only legitimately interested
constituency when it comes to the regulation of energy and other physical commodities.
Ordinary citizens, whose current and retirement incomes are significantly affected by physical
commodity prices, have an equal stake in their ability to obtain asset management services
(directly or indirectly through pension plans) designed to manage the corresponding risks to
which their current and retirement savings are subject.
Impact of Aggregation Proposal on Large Asset Managers and their Clients
As the Commission is aware, Federal speculative position limits (and to some extent, exchange
set position accountability levels) act as a constraint on the use of regulated futures contracts as a
vehicle for obtaining the investment exposures necessary to achieve targeted levels of portfolio
diversification through investment in commodities. As a result, institutional investors are
relegated to sub-optimal investment diversification or must turn to alternative, and potentially
less efficient, instruments for obtaining targeted commodity exposures.
2
The Commission's current proposal to eliminate independent account controller status and to
require aggregation across enterprises with as little as 10% common ownership will further
1 These strategies can be either indexed or absolute return and are offered as institutional private funds or separate
accounts, and as exchange traded products ("ETPs"). Some BlackRock ETPs invest directly in physical
commodities ( iShares® COMEX Gold Trust and iShares® Silver Trust). BlackRock's ETPs are listed and traded
on regulated securities exchanges and offer the benefits of real-time transparency and liquidity.
20TC derivatives and structured notes may be more costly than futures contracts, introduce tracking error and
present individual counterparty risk. Even if regulated futures contracts on the relevant commodities are accessible
in non-US venues, it may also be inefficient from a margining and operational perspective to establish multiple
trading accounts for the same strategy. However, as a global firm we are also well positioned to react to US
regulatory changes in order to continue to provide strategies that meet our clients' needs.exacerbate the impact of the proposed position limits, impose considerable implementation costs,
and likely not achieve the objective of the Commission to reduce price volatility in these
contracts. In fact, if the combination of position limits, new aggregation rules and the so-called
"crowding out provision" were adopted as proposed, we believe that this would result in reduced
liquidity in these contracts making them more susceptible to sudden price movements and also
undercutting their effectiveness for commercial hedgers.
Independent Account Controllers.
Disaggregation based on the independence of control over
trading decisions has been a long-standing policy of the Commission, premised on a recognition
that accounts that are under separate management need not be, and should not be, aggregated
because they have no combined effect on the market. Asset managers may utilize both passive
and active trading programs, which by their very nature are based on different investment
decisions and time horizons. Asset managers also participate in ~fund of funds' structures in
order to provide their investors access to diversified independently managed investment
strategies. As the Commission has recognized for most of its 40 year existence, there is no reason
to aggregate these independent positions because different investment approaches provide (and
require) different types of market liquidity.
The Commission now proposes to prohibit previously eligible entries from disaggregating
positions in the specified energy contracts, notwithstanding the independence of trading control.
For asset managers that have relied on Regulation 150.3 and guidance provided thereunder in the
establishment and continued conduct of their commodity futures related strategies, this change
could be extremely disruptive to the strategies an asset manager provides to its clients.
3
Among
other thing, this new aggregation rule may cause asset managers to reduce their trading in the US
energy futures markets, and/or shift their activities to other instruments or other venues. It may
cause some asset managers to close funds to new investors or to even close down some strategies
completely. This all will then result in reduced volume and liquidity for US futures exchanges.
The elimination of independent account controllers for the specified energy contracts -but not
agricultural contracts--also will present significant operational challenges for asset managers to
design a system that can comply, real-time, with two different aggregation regimes.
4
Further this
will need to be coordinated across business units or legal entries that have specifically designed
their operations to comply with Regulation 150.3 and not share information.
If the Commission is concerned that the condkions for reliance on the disaggregation rules are
not being met by a particular set of affiliated entities, it has inspection and enforcement tools at
its disposal to remedy the matter. It should not eliminate a long-standing regime without further
3 BlackRock is an 'eligible entity' under Regulation 150.3 which complies with the processes and procedures for
affiliated independent account controllers.
4 The proposal also creates a dual regulatory regime, with the Commission setting position limits in the referenced
energy contracts and the exchanges continuing to administer position accountability---each with different
aggregation rules. This will add to the compliance burden, create potential for confusion, and contribute to errors.empirical evidence that the 'concentration' that might exist poses a threat to the efficiency and
effectiveness of the markets in the referenced energy contracts.
Controlled Entities.
The proposal also would require market participants to aggregate positions
globally on all entities in which they have a 10% equity interest.
5
There is no exception for asset
managers who are passive investors in a potentially large number of companies--located in the
US and elsewhere-- that may be engaged in trading the reference energy contracts, as
commercial hedgers or otherwise. Instead, the proposal would require these "commonly
controlled" enterprises to aggregate their positions, regardless of whether there is any true
control being exercised. The proposal would have the perverse effect of requiring otherwise
independent trading operations of otherwise independently managed companies to communicate
with each other as to their trading positions and intentions, raising the potential for trading in
concert, which is presumably the sort of behavior the Commission seeks to preclude by the
proposed rules.
Requiring an asset manager to share proprietary trading information with entities in which it
holds a 10% equity interest (25% for pools) and allocate limited position volumes across these
entities raises concerns about the ability of the asset manager to comply with its fiduciary duties
to its clients. It also raises concerns about the ability of an asset manager to maintain the
confidentiality of its trading strategies. There is a risk that an asset manager's trading strategies
could be copied, destroying the value of the intellectual property employed, along with the
managers ability to generate returns for its clients. Additionally, for firms that are global and
have global investments, the operational aspects of compliance with such a process are
exceedingly complex and will be difficult to implement in a real-time system for US trading
hours.
Although we question in general the application of aggregation rules at an equity ownership of
10% (without a showing of some other significant indicia of operating control), if the
Commission were to proceed with such an approach, we respectfully suggest that asset managers
that are solely passive investors in equity interests in operating companies be excluded from such
aggregation policies. 6
Commodity Index Strategies
Investments in commodity index strategies are made in order to provide portfolio diversification
in an asset class whose returns are generally not correlated or negatively correlated with
traditional asset classes such as equities and bonds. Commodity index products have a variety of
forms, including private funds, separate accounts and ETPs. Many are benchmarked to well-
5 The aggregation test for commodity pools would be 25%.
6 A useful model may be the Securities and Exchange Commission's rules and interpretations under Section 13(d) of
the Securities Exchange Act of 1934.
4diversified and transparent commodity indices, and most are based on passive, long-only, fully
collateralized commodity futures positions. Most institutional investors in commodity index
strategies are long term investors in these strategies. An argument can be made that commodity
index investors are not speculators but in fact are hedging against the impact of inflation on their
current and future buying power.
Economist and academics, international agencies and US governmental entities, including the
Commission itself, have studied the role of index investors in the futures markets and have been
unable to find empirical evidence to support a causal connection between commodity index
investing and the value of commodity futures. The studies have correctly concluded that
fundamental supply and demand is the underlying cause of oil price volatility, not speculators.
Commodity index investors also provide liquidity to the futures markets, and their predominantly
long positions facilitate the shorting activity of commercial hedgers. The proposed position
limits, coupled with the proposed changes in aggregation rules has the potential of reducing the
participation of these investors in the US futures markets, and reducing liquidity in the
referenced energy contracts.
7
Rather than enhancing the efficacy of the markets for commercial
hedgers, the Commission's proposals could have the opposite effect.
BlackRock's commodity index strategies are conducted consistent with the operation of a fair
and orderly market. The orderly approach and longer term objectives of our strategies are
directed toward achieving optimal outcomes for, and acting in the best interests of, our clients,
many of whom are themselves charged with the management of retirement savings and the
investment assets of hundreds of thousands of beneficiaries.
As an alternative to imposing position limits on passive commodity index investors, the
Commission could instead utilize its regulatory tools to require reports and to examine these
activities. Further, the exchanges also have numerous mechanisms to assure orderly markets
through the application of position accountability and other rules.
Conclusion
BlackRock supports the efforts of the Commission to assure that the US futures markets remain
fair and orderly and provide effective price discovery for all market participants. It supports the
Commission's use of all surveillance tools at its current disposal, and the need for the
Commission to receive new surveillance and other powers as the markets evolve. However, we
believe the proposal to set Federal position limits on the referenced energy commodities will not
achieve the goal of decreased price volatility. BlackRock also believes the elimination of the
independent account controller provisions will be very disruptive to the investment strategies
7 As noted above, in order to achieve portfolio diversification, investors will seek alternative sources of commodity
index exposure, which are likely less efficient and pose a different set of risks than US exchange- traded futures.managed for its clients, will add significant compliance costs and also will not achieve the goal
of decreased price volatility. We believe that the proposals, taken as a whole, will likely result in
decreased liquidity in these contracts, and cause investors to seek alternative solutions to achieve
their desired diversification, including non-US venues and alternative instruments to the
detriment of US futures exchanges and the US fmancial markets in general.
We also share and support the views of other commentators that the CFTC's statutory authority
to impose Federal limits is predicated on its finding that such limits are "necessary to prevent"
the burdens of excessive speculation (CEA §4a(a)), and that the CFTC has failed in the
Proposing Release to make such a finding. Further, we also agree with other commentators that
the CFTC lacks a statutory basis to adopt regulations designed to restrict the 'concentration' of
positions. As other have commented on these matters., we will not repeat those comments here.
We note that regulatory reform legislation now pending before the US Congress may
substantially change the Commission's powers, including the ability to establish position limits
over OTC commodity derivatives. We urge the Commission to postpone action on this proposal
until this legislation is enacted, and the full scope of the agency's authority has been finally
determined.
We appreciate the opportunity to comment on the proposal, If you have any questions or would
like further information, please do not hesitate to contact us.
Sincerely,
Joanne T. Medero
Managing Director
