Comment Text:
10-002
COMMENT
CL-08011
From:
Sent:
To:
Cc:
Subject:
David Pais
Tuesday, April 20, 2010 7:44 AM
secretary
Sherrod, Stephen
Comment on Federal Speculative Position Limits for Referenced Energy
Contracts, Federal Register Release 75 FR 4143
To,
The Secretary,
Commodity Futures Trading Commission,
Three Lafayette Centre,
Washington, DC 20581.
Subject: Comment on Federal Speculative Position Limits for Referenced Energy Contracts,
Federal Register Release 75 FR 4143
Dear Mr. Stawick,
I am an economist who has worked for Morgan Stanley and Citigroup and would like to use the CFTC's
requests for comments on proposed energy position limits to make a proposal which is similar in spirit
to the CFTC's, which achieves all the CFTC's objectives but which, crucially, also bypasses the debate
over whether financial players are distorting energy prices.
I have outlined this proposal in greater detail below. It allows for 'speculative' positions for market
making purposes while ensuring that it is only 'commercial' participants who ultimately determine
energy prices. I do hope you will take the time to go through it, as I believe it is more elegant than the
one currently proposed by the CFTC and more likely to achieve its objectives. If you require any further
clarification, I can be contacted at this email address.
Regards,
David Pais
Firedoors for Commodity Markets
The central issue which the CFTC's proposed rule on "Federal Speculative Position Limits for
Referenced Energy Contracts" seeks to address is the role of financial institutions in commodity
markets. Large financial institutions like Morgan Stanley and Goldman Sachs claim that they are only
providing much needed liquidity services to commodity markets and that their proprietary trading
interests are negligible. Notwithstanding President Obama's proposed 'Volcker Rule', it will be virtually
impossible to distinguish a trading desk's liquidity provision services ('bona fide risk management
positions') from its prop trading (' speculative positions'). This raises the possibility that excess liquidity
resulting from large increases in leverage at banks could flow into the commodity markets. Whether or
not large financial institutions have been distorting commodity prices (and my own personal view is that
they have) could actually be made irrelevant for the CFTC's purposes going forward.10-002
COMMENT
CL-08011
The solution lies in limiting access to commodity markets to two kinds of participants -
'commercials' (airlines, refiners etc.) and a new category of Specialist Commodity Brokers (SCBs).
These SCBs would be allowed to provide all the 'liquidity' and 'market making' services currently
provided by investment banks like Morgan Stanley and Goldman Sachs, but would be precluded from
offering any other financial services outside of the commodity markets. Additionally, the SCBs could be
regulated such that they only engage in broking (matching buy and sell orders over a few days or so) and
not dealing (taking longer term risk on to their books).
The SCBs would also be limited to taking orders only from certified 'commercial' interests (airlines,
refiners etc) and not from financial players with 'non-commercial' interests (investment banks, hedge
funds, ETFs etc.). The intellectual basis for this restriction lies in the fact that commodities do not pay
dividends like stocks, nor do they pay interest like bonds. They can only be consumed. They should
therefore not be considered an 'asset class'.
The CFTC could auction a fixed number of licenses for SCBs on a 3 or 5 year basis depending on the
CFTC's assessment of the competitive conditions for SCBs. Since SCBs must be standalone entities,
they would not be allowed to be a part of the operations of any bank, hedge fund, insurance company
etc. They would have to raise the funds for their market making activities independently but would also
be insulated from large increases in leverage which typically occur during financial booms. By all
accounts, market making in commodities is a steady and profitable business and it should be fairly
straightforward for the SCBs to raise the requisite funds at relatively cheap rates.
Stable commodity markets which reflect the fundamentals of the real economy are a global public good.
This proposal of a firedoor for commodity markets would ensure that the legitimate task of market
making could still be provided by SCBs on Wall St. but would be insulated from the excesses of the rest
of the financial system. It has the added benefit that it would obviate the need for the CFTC to have to
try and distinguish 'bona fide risk management positions' from 'speculative positions'.
This solution achieves all the CFTC's objectives without burdening it with having to micro-investigate
and monitor the trading books of investment banks and the trading activities of the rest of the financial
community. It allows for the participation of financial players in market making activities in the
commodity markets. Most importantly, commercial participants (airlines, refiners etc.) would receive
the liquidity services they need without the undue influence of 'non-commercial' participants.
Accordingly, commodity prices would be determined solely by demand and supply in the real economy.
To borrow President Obama's analogy, this solution of instituting firedoors via the SCBs uses a scalpel
rather than an axe to ensure that financial markets are functioning and serving the needs of ordinary
Americans.
