Comment Text:
10-002
COMMENT
CL-08286
From:
Sent:
To:
Cc:
Subject:
Attach:
[email protected]
Monday, April 26, 2010 5:07 PM
secretary
[email protected]
Federal Speculative Position Limits for Referenced Energy Contracts and
Associated Regulations
Shell Trading Comments.pdf
Dear Mr. Stawick,
Attached, please find Shell Trading's comments in the matter referenced above.
will be delivered to you and each of the Commissioners tomorrow.
If you have any questions or concerns regarding the attached document, please contact me.
Hard copies
Robert Reilley
Vice President, Regulatory Affairs
Shell Energy North America
Phone: 713/767-5632
Fax: 713/265-5632
robert, rei Iley@shell. comApril 26, 2010
David A. Stawick
Secretary
Commodity Futures Trading Commission
1155 21
st
Street, NW
Washington, DC 20581
Shell Energy North America
Two Houston Center
909 Fannin, Plaza Level 1
Houston, TX 77010
w,vvv.shell.corn/us/energy
Re:
Federal Speculative Position Limits for Referenced Energy Contracts and
Associated Regulations
Dear Mr. Stawick:
Shell Trading (US) Company and Shell Energy North America (US), L.P. (together
"Shell Trading") are the North American commodity trading arm of Royal Dutch Shell,
plc.
1
Shell Trading actively participates in the US energy futures, options and broader
derivatives markets, and accordingly has a strong interest in the Commodity Futures
Trading Commission's ("Commission") propose(~ rule on position limits.
Federal
Speculative Position Limits for Referenced Energy Contracts and Associated
Regulations,
Notice of Proposed Rulemaking, 75 Fed. Reg. 4143 (Jan. 26, 2010)
(hereinafter, "NOPR" or "Proposed Rule").
Shell Trading's role in the energy commodities markets gives it a unique perspective on
the issues raised in this rulemaking, and Shell Trading appreciates the opportunity to
comment.
I.
Introduction
Shell Trading's business is dependent on the orderly functioning of the physical and
finan~.isl ener£y commodities rnerk~ts. Accordingly, it is import~.~nt th~..~t [~ny new rul,~s
relating to US exchanges do not reduce liquidity or transparency; are clear and do not
create either unintended incentives or an unwarranted compliance burden. Shell
Trading is concerned that the proposed rule could impair the efficient operations of the
energy derivatives markets and impose new costs and risks without providing the
benefits intended by the Commission.
~ Shell Energy North America (US), L.P. ("Shell Energy") and Shell Trading (US) Company (STUSCO)
are indirect subsidiaries of Royal Dutch Shell plc. Shell Energy and STUSCO are a part of the Shell
Trading global network. Shell Energy markets and trades natural gas, electricity and environmental
products, including the natural gas produced by its affiliates. STUSCO trades various grades of crude oil,
refinery feedstocks, bio-components and finished oil-related products, and it provides supply and hedging
functions (including imports and exports) for affiliated companies. Both Shell Energy and STUSCO
transact in the US energy derivativ~.~ markets.
-1-Thus, Shell Trading believes that the proposai requires further refinement. Indeed,
without further clarification, it is not possible to comment on important aspects of the
rule such as its applicability to foreign boards of trade (FBOT), the criteria for hedge
exemptions, data collection and the protection of confidential commercially sensitive
information. If after receiving comments on the current NOPR, the Commission
believes it should establish a new system o~
~
position limits, Shell Trading would
welcome the opportunity to work with the Commission to develop a revised proposal
that meets the Commission's objectives and addresses the concerns and uncertainties
described below. Due to its significant energy marketing business, Shell Trading has a
material stake in the rules governing markets for energy products. It is willing to offer
whatever insight it can to assist the Commission in evolving the proposal to its next
stage if the Commission desires to move forward with a rule.
At the highest level, Shell Trading notes that, while the proposed rule is put forth in the
context of addressing excessive speculation, its substance solely concerns
concentration. If the Commission desires to address "burdens" related to excessive
speculation, it should identify those burdens and t~rget rules to address them.
Many of Shell Trading's substantive concerns grow out of the fact that it, like many
participants in the energy trading markets, cannot be bucketed as a hedger, speculator
or swap dealer. It is a diverse energy commodity merchant that manages risk and
optimizes value across dynamic physical and financial, exchange-traded and over the
counter markets. As an adjunct to the hedging of its physical exposures, Shell Trading
takes speculative positions and it enters into swap transactions related to energy
commodities with a variety of counterparties to o~{:~et its risks, including credit risks, and
to facilitate physical transactions. By failing to recognize the nature and scope of the
energy commodity merchant business, the proposed rule may create unintended
limitations on legitimate activities.
Because it is responsible for the transportation, storage, delivery and marketing of large
volumes of physical energy commodities each day, Shell Trading is concerned about
any development that might constrain its ability to manage the risks associated with its
physical portfolio. The uncertainty about the appli~cation and oversight of the proposed
position limits together with the manner in which they interact with each other and the
existing position limits is problematic due to the complexity and associated compliance
burden of the proposal.
Beyond its ambiguity and complexity, the proposal's "crowding out" provision that would
prohibit entities that use hedge exemptions from holding any speculative positions is a
significant disincentive to obtain hedge exemptions. It also unnecessarily limits the
ability of commodity merchants to undertake the legitimate trading they do today. Shell
Trading seriously questions the rationale for such a prohibition, but also has the
practical concern that, in many cases, positions I~ld for hedging are indistinguishable
from those that might be held speculatively.
-2-The following comments provide additional detail on these and other issues of concern.
Shell Trading is not alone in expressing these concerns. The Comments filed by the
Futures Industry Association (FIA), International Swaps and Derivatives Association
(ISDA), the Electric Power Supply Association (EPSA), the Natural Gas Supply
Association (NGSA), the American Petroleum Institute (API) and the Energy Marketing
and Trading Group note many of the same problems with the proposed rule and raise
additional issues that deserve the Commission's attention.
II.
Comments
GLOBAL COMMENTS
Market
A fundamental misconception that shapes many parts of the rule is the categorization of
market participants into discreet segments: hedgers, speculators and swap dealers. In
reality, some market participants, including energy commodity merchants, function in
multiple segments of the futures, options and over the counter (OTC) markets in
conjunction with their physical positions to create trading books that support their
fundamentally physical businesses.
Commodity merchant/traders must efficiently optimize and hedge physical, futures,
options and OTC positions within the confines of the risk tolerance of their firm. They
are managing their book to limit risk and optimize economics. They are not placing
"financial bets" on exchanges. This process does not lend itself to a matching between
futures exposure and then-current physical exposure. If entities that need to manage
their commercial risks are unable to efficiently hedge and optimize their businesses on
regulated exchanges, they will need to find other vehicles. Therefore, a rule based
around a preconception that commercial firms are pure "hedgers" (or designed to force
related segmentation) could result in significant consequences, including a flight of
transaction activity from US exchanges.
Participants in commodity markets, almost by definition, have significant exposure to
risks related to their physical positions, which can include natural resources that have
yet to be extracted as well as materials that are being transported or processed (like oil
in refineries) to stocks being held to meet peak demand, for example, natural gas held
in storage facilities. This is true for both the suppliers of commodities as well as their
consumers. There are numerous financial risks associated with buying, selling or
holding commodities. These include differences in prices across locations, periods of
time and product grades, as well as supply/demand related volatility; credit, weather,
currency, interest rate and other macro-economic related risks. Financial products,
-3-including futures, options and swaps, provide cost-effective means for the participants in
energy commodities markets to manage these risks.
Such hedging positions are not always in the same energy commodity. For example,
market participants may use crude oil as a proxy for a number of other products, such
as fuel oil. While there is a fuel oil swaps market, it is often not liquid enough to hedge
an entire position. A trader may hedge what it can with fuel oil swaps and then put on a
crude oil futures position to hedge the balance until the fuel oil swaps liquidity improves.
In fact, non-energy commodities can be used to hedge energy positions as well, for
example, gold may be used as a vehicle to hedge currency risk associated with energy
commodities moved across international borders.
Parties that do not hold physical positions in underlying commodities, or take financial
positions apart from their physical positions, are also critical to the efficiency of the
derivatives market. Indeed, without the liquidity provided by these speculators and their
willingness to take on risks, hedging would be more difficult and more costly.
The risk mitigation and reduction of price volatility offered by financial derivatives
significantly benefits the US economy and US citizens by affording commodity
producers, marketers and customers efficient mechanisms to lock-in reliable pricing and
provide confidence that their businesses will not be impacted by unpredictable price
volatility, which can have severe consequences, including bankruptcy. Reduced risks
ensure that financial institutions will lend, and at the highest level, reduces systemic risk
in the economy.
The Tradin.q Activities of Commodity Merchants
A primary public benefit of financial derivatives markets is to provide firms that produce,
market, use as a feedstock, and consume physical commodities with a liquid,
transparent and reliable market to hedge risk, optimize value and discover price. Firms
with material physical commodities exposure often employ trading desks that can
manage the dynamic movements in supply, demand, and pricing for an ever changing
variety of customers and suppliers. The one constant in a broad-based physical
commodity-based business is that it is always changing due to variables such as
weather driven volatility, business cycle related-demand volatility, supply volatility
(which can be driven by global events) and numerous other factors.
A commodity merchant's trading desks manage the firm's overall dynamic physical
position by understanding the risk to which the firm is exposed through its overall
physical and financial position. The purpose of this activity is to manage risk and
optimize economics. Given the dynamic nature of physical supply and demand
positions coupled with price volatility, a trading desk is best situated to limit the risk to
the firm's portfolio as a whole, rather than try to match physical supply to financial
he~ge~ on .a. tr;~nsactiom~l b~:~si,~. Further, in or~:t~,,~" to b(~: eff~c, ti~v~, a tredin~ desk ne,~ds
to be "in the market" to assure that it is truly tracking price and market dynamics. There
-4-is a material difference between a market observer and a market participant in
understanding and anticipating market movemems.
The NOPR fails to appreciate the breadth and depth of activity of the trading activities of
commodity merchant/traders. Any proposal attempting to address the financial energy
commodities market should be reflective of how market participants behave and interact
with the market.
The proposed rule appears to stratify the energy derivatives market into three mutually
exclusive categories: ("Hedgers .... Speculators" and "Swap Dealers") and then impose
specific requirements and restrictions on each. In reality, this neat taxonomy does not
exist. There are parties that use derivatives strictly for hedging. There are others that
use them as a means to take speculative positions. There are also entities that act as
market makers and enter into swaps with third parties as a primary part of their
business. What the proposed rule does not recognize, however, is that there are
entities, including physical commodity merchant/traders, that operate in all or at least
portions of all these three capacities. The scheme for imposing position limits that is
contemplated in the NOPR would fundamentally change the way that such entities
operate in the financial products market.
This compartmentalized mindset is most apparer!t when one considers the proposed
exemptions to the position limits. The proposed rules allow for
bona fide
hedge
exemptions for entities that can demonstrate thet their large physical positions require
them to hold a sufficient number of futures and swaps to hedge their physical
exposures. However, the proposed rule appears to prevent entities using hedge
exemptions from holding any "speculative positions". As is explained below, this
prohibition is both unprecedented and unwise. The necessity of allowing speculation in
derivatives markets is well accepted, and is frequently articulated by the Commission.
When they speculate, commodity merchants play an especially valuable role not only
because they provide liquidity, but because their extensive involvement in the physical
markets informs their trading activity which tends to move derivatives prices towards
leve!:s s~J, pport.gd by ec~.nomic fundamentals.
The NOPR also seeks to segregate speculators and swap dealers. Swap dealers can
obtain "risk management" exemptions that allow them to hold positions equivalent to
two times the default position limits; but they aiso are prohibited from holding any
speculative positions. Moreover, the expansive definition of "Swap Dealer" appears to
be intended to prevent entities with hedge exemptions or those that can speculate from
being involved in the bilateral swap market. (As is described below, the proposed
definition of "Swap Dealer" is highly problematic in its own right). The NOPR provides
no explanation of dividing market participants into these artificial segments or how it
meets the Commission's objectives. Nor does the NOPR discuss the treatment of
entities that might fall into more than one classification.
-5-As noted by the Commission, the Commodity Exchange Act (CEA) provides that it may
fix limits on amounts of trading to address "excessive speculation in any commodity ....
causing sudden or unreasonable fluctuations or unwarranted changes in the price of
such commodity" creating "an undue and unnecessary burden on interstate commerce
in such commodity" Section 4a(a) of the CEA, 7 U.S.C. § 6a(a) (2006). Accordingly, in
order to establish position limits for the four affected energy commodities, the
Commission should associate the proposal to addressing excessive speculation that is
the proximate cause of sudden, unreasonable or unwarranted price fluctuations.
Rather than focus on speculation in the proposed rule, the Commission has focused
upon concentration. Although, the Commission notes that, "[I]arge concentrated
positions in the energy futures and option markets can facilitate abrupt price movements
and price distortions," NOPR, slip op. at 18, 75 Fed. Reg. at 4148, it does not provide
any factual examples of such large positions resulting in price distortions or other
detriments. In addition, while the Commission recounts the price rise in energy prices
from 2007 to mid-2008, it does not show a linkage to excessive speculation and omits
reference to its own staff report and other analyses of that period finding otherwise.
2
In sum, the Commission has not meaningfully supported a linkage of its proposed rule
to remediating excessive speculation. Instead, it focuses on concentration and implicitly
suggests that large concentrated positions can facilitate price movements and
distortions. The Commission appears to believe that concentration equals excessive
speculation and there is no other measure or manner in which it can occur or be
tracked.
These issues are addressed in greater detail in the Comments filed by the FIA and
ISDA. Shell Trading agrees with and supports the comments of those groups on these
issues and, in the interest of brevity, will not discuss them further in its comments.
COMMENTS ON SPECIFIC ASPECTS OF THE PROPOSED RULE
As noted by several other commenters, the NOPR's unprecedented proposal to prevent
many market participants from holding any speculative positions is of significant
concern. The NOPR provides no explanation to justify this fundamental change in
policy.
2
The FIA comments filed in this proceeding on March 18, 2010 include reference to multiple
contemporaneous studi~s finding price movements were not due to excessive speculation.
See, FIA
Comments @ Footnote 7.
-6-The proposed rule provides for
bona
fide hedge exemptions upon application
demonstrating need. While the NOPR does not address the critical function of
administration of the exemptions, Shell Trading'~ business is fundamentally a physical
business, and therefore, it would likely be eligible for
bona fide
hedge exemptions.
However, if Shell Trading received hedge exemptions, the proposed rule would prohibit
Shell Trading from holding any "speculative" positions.
Traders holding positions outside the spot month, and
traders holding spot month positions with respect to spot-
month positions only, that are greater than or equal to a
bona fide
hedge exemption shall not own or control positions
speculatively.
NOPR, slip op. at 90, 75 Fed. Reg. at 4169.
Shell Trading submits that this provision will not only inflict significant economic harm to
it and other commodity merchants, it would reduce liquidity and weaken the critical price
discovery function by limiting the activities of the most informed market participants.
There is no justification for preventing entities that hedge large physical positions from
having the same ability to enter into non-hedging transactions as other parties are
allowed. The "crowding out" prohibition is a significant departure from the current
practice of the exchanges. Further, as the Commission's concern appears to relate to
concentration, it would seem to be less relevant if there are some positions are held
"speculatively." As long as a market participant's positions are within the allowed limits
(including the hedge exemptions), it will not create unapproved concentration.
Much of the recent concern about speculators has been focused on the "massive
passives", entities that take and hold large long positions, simply betting that prices will
increase. In contrast to hedge funds and other passive investors, commodity merchants
actively manage consolidated physical and financial trading books made up of both long
and short positions, identifying discontinuities between prices and fundamental
conditions. In some situations this "speculation" may take the form of leaving physical
positions unhedged. In others, it may mean entering into derivative transactions without
the anticipation of taking offsetting physical positions. Regardless, the positions taken
by commodity merchants reflect their in-depth understanding of physical supply,
demand and global market conditions.
In this way, commodity merchants' trading activities help keep market prices in line with
fundamental economic conditions, allowing derivatives markets to provide accurate
price discovery. Therefore, it would be especi:.~lly poor policy to prevent them from
holding speculative positions.
Even putting aside the unjustified harm caused by this prohibition, the proposed rule
presents almost insurmountable compliance issues. It is extremely difficult to separate
speculative positions and hedges. Any lot of a physical commodity might be subject to
multiple hedges related specifically to it, but is likely also subject to hedges related to a
commodity merchant's entire portfolio of that product or other products. Hedges may be
-7-entered into in contemplation of production theft does not occur or cargoes that are
diverted. When such events occur (as they frequently do) the positions that were taken
should not, in hindsight, be considered to be "speculative".
For example, a business can have a physical exposure to transatlantic freight prices.
The freight swaps market is a highly illiquid, relatively immature market making it very
improbable the business can hedge its freight exposure in a forward freight swaps
market. The WTI vs. Brent spread mows relative to the changing refining economics of
Brent-based crudes in the US but it will also tend to rise as transatlantic freight costs
rise and fall when those costs fall. If a business hedges its freight costs by buying WTI
and selling Brent using the oil futures or swap markets would the rule recognize that as
a hedge or speculating on the oil market or both?
Another example might be a power marketer that owns a natural gas-fired generation
facility and desires to hedge its exposure to fluctuating power prices. Because gas is the
fuel used to generate the power, the power marketer could sell a gas swap to hedge its
physical position. However, if weak demand or low power prices require the plant to
stay offline, and not produce electric energy, the marketer would still hold its natural gas
swap position. Is this still hedging or has this position now become speculative? If it is
considered to be speculative, the marketer might have to liquidate the swap at a time
that could result in additional revenue loss.
For these reasons, Shell Trading requests that '~he Commission modify its proposal to
allow entities with
bone fide
hedge exemptions to hold speculative positions, consistent
with other market participants, and further that the Commission clarify its definition of
"bona fide
hedge" to recognize the dynamic nature of the trading activities and make
clear that hedging of physical positions includes trading related to the commercial risks
and economic optimization of portfolios of physical commodities.
Position Limits
Shell Trading does not oppose reasonable position limits, such as those in place today,
that specify the maximum net number of an exchange-traded derivative contracts that
an entity can hold on a US exchange; however, it has several concerns with the overall
set of limits proposed in the NOPR, including i~s reliance on possibly unnecessary
contract "classes" (see below) and the lack of cladty about how some of the proposed
limits would be calculated. For example, how would the "delta-adjusted month-end
open interest" be derived?
Shell Trading also has practical concerns with how the limits would be developed and
enforced. In particular, there are significant potential issues with how the proposed
limits interact with themselves and with existing exchange limits. For example, in the
spot month, the proposed rule would impose its own single exchange limits on top of the
existing limits maintained by each exchange. Moreover, it appears that both types of
limits are based on the same information. Little value will be obtained from adding a
duplicative set of limits.
-8-For "any month" and "all months" positions there will be both single exchange and
aggregate exchange limits. With the creation of the aggregate limits, the role of the
single exchange limit is unclear. As long as the po~;ition held by an entity was below the
aggregated limit, why would it be important whether that position is held on one or
multiple exchanges? Additionally, it is unclear how these new position limits would
interact with existing exchange accountability limits.
The uncertainty about the mechanics of the limits presents significant compliance risks
that may prompt market participants to take a cautious approach by maintaining
positions well below the limits. The result would be a reduction in liquidity and a
movement towards off-exchange transactions. Because the proposed limits are based
on a percent of open interest, as transactions move away from the exchanges, the limits
will contract further, creating a downward spiral that will exacerbate this effect.
Additionally, the NOPR does not specify who will be responsible for the daunting task of
monitoring and enforcing the aggregate limits. Under exchange-based limits, exchange
compliance personnel can monitor positions c:n their exchange and interface with
traders, as they do today. Unless the Commission plans to take over position
monitoring or merge exchange compliance teams, there will be a gap in monitoring of
aggregated positions.
For these reasons, Shell Trading recommends that the Commission reevaluate the
proposed limits with an eye towards simplification, enforceability and clarity. The
Commission may want to eliminate the use of aggregate limits in favor of one set of
single exchange limits, which would provide clarity, allow exchange compliance staff
oversight, and eliminate Foreign Board of Trade i~;sues and ambiguity.
Contract Classes and Agqre~ated Limits
Shell Trading questions the need to establish separate classes of contracts (Physical
Delivery and Cash-Settled). As a practical matter, both types of contracts cash-settle,
and, as such, are not meaningfully constrained by physical delivery limitations. The
~gr~g~tion into differed-It cla~ subject to dff~÷~-~l: li~fi~ would ~.~,~t~ unimpeded
complexity and could lead to unforeseen consequences. As the contracts have the
same underlying commodity and are economic substitutes to one another,
differentiating among them could lead to differentiated trading and market distinctions
based solely upon "class" and associated position limits - not on any substantive
difference.
Also, it is only because of the class distinction that there is a need to utilize the concept
of "Deliverable Supply." If, like contracts, whether physical or financial, were subject to
a single position limit based upon open interest, then the equivalent economic
instrument (for example, NG Physical Delivery NYMEX & NG Cash-Settled NYMEX
futures) would be collectively subject to the same position limit, which could be
-9-established from the objective measure of open interest. There would be no reason to
define and specify "Deliverable Supply.
''3
Thus, Shell Trading believes that any position limits should be designed to cover like
contracts which are effectively the same economic instrument whether taking the form
of a notionally physically delivered contract or a cash-settled contract. This approach
would permit traders to simplify compliance and the Commission to use a
straightforward measure to establish limits (open interest).
Aq_qreqation of Affiliate Positions
Shell Trading shares the concerns voiced by other commenters regarding the problems
associated with aggregating the contract positions of all entities that have common
ownership of 10 percent or more for purposes of applying position limits. Although it
might be appropriate to aggregate the positions of entities that are under common
ownership and control and that coordinate t!~e management of their derivatives
positions, in the case where there is independent control, no aggregation is appropriate.
Shell Trading supports the comments of ISDA and FIA regarding the account controller
exemption for position limits that currently exists i~'-i Regulation 150.3(a)(4).
Tres~r~e..."~.,t of Foreiq~-~ Boards of: Trade (FBOTS)
As noted by the Commission, FBOTs accommodate contracts which cash-settle to
NYMEX physically settled energy futures contracts. These FBOTs operate subject to
Commission no action letters, which are conditioned in part, upon a requirement that the
FBOT implement the position limit requirements that NYMEX contracts are subject to.
The Commission states such linkage is necessary to "ensure the integrity of prices for
CFTC regulated contracts." NOPR, slip op. at 3, n.3, 75 Fed. Reg. at 4144.
Shell Trading believes that the Commission should directly address the treatment of
FBOTs in its proposed rule. Unlike the current structure with exchange-based limits, the
proposed rule covers aggregate positions ~cross like contracts across all ~xchanges. If
an FBOT includes like contracts, will positions on that exchange be aggregated? As the
position limit is a function of open interest, will the FBOT's open interest be included? If
the FBOT does not set its rules in accordance with Commission requirements, will the
Commission revoke its no action letters?
As it is more likely that FBOTs will add more contracts rather than cease trading those
traded today, it is essential that the Commission provide clarity on these critical points.
3
If the Commission proceeds with the notion of Deliverable Supply, Shell Trading believes the
Commission should give guidance and define the term. Issues to be addressed should include: Is this
definition limited to the precise specified product and delivery point in a physically delivered contract?
Does it include any substitutes? Does it vary by month? Is Deliverable Supply different under differing
~.~nd a~-~d
o~
~
p~"i~i~g ~na~i~? a~d d~ it i~~uda o~~ly ~;;l~::,~~.~i,'i.
".
supply aad
~:~i~.~tif~e
~a~:.i~:y. or dO~
it envision the practical reality of imports?
-10-This necessity is magnified by the fact that firms may be affiliated with non-US entities
that trade on FBOTs. Will the proposed rules consolidated account requirement apply
to firms trading only on FBOTs? The Commission should not move forward towards a
final rule without clearly and decisively addressing issues related to like contracts traded
on FBOTs. Until the Commission clarifies its intentions, parties cannot understand the
legal underpinnings of the Commission's plans to be involved in FBOT practices, and
therefore cannot meaningfully comment. If the Commission were to limit its proposal to
one set of single exchange limits, there would t,~(-~ no need to further address FBOTs,
and no aggregation of positions potentially affecting FBOTs would be implicated.
Reportin.q Requirements
While Shell Trading believes reporting can help improve transparency and regulation of
derivatives markets, the reporting aspects of the proposed rule require further
development.
An important element of the proposed rule is reporting and tracking of positions. While
reporting is addressed at a high level and forms (such as Form 404) are referenced,
there is little specificity indicating the particular information to be provided. For
example, a trader must submit its "spot and forward positions priced in relation to the
relevant energy contract or the contract's underlying commodity." NOPR, slip op. at 53,
75 Fed. Reg. at 4159. It is unclear what data is required (Is this limited to exchange
traded contracts? If so, shouldn't the pricing relate to the exchange traded price? If this
requirement extends beyond exchange-traded contracts, what is the scope of the data
requested?)
As Form 404 has not yet been developed, parties have not been provided a meaningful
opportunity to comment on its contents. As it appears to be a significant element of the
data collection aspect of the proposed rule, the scope of data sought, the form in which
it will be submitted and the associated burden aie very unclear. The Commission has
estimated 800 hours of effort by regulated firms to complete the report. As new
computer systems will almost certainly be neected to create the data requested, our
~xi~.~'ier~ce sugge~t~ that the effort to comply will almost certainly be much greater (at
least at the outset).
Shell Trading is also concerned that the data requested may include its proprietary
overall physical and financial positions. If this highly sensitive commercial data is
sought, the Commission must provide a clear process showing that the data will be
treated confidentially and protected against inadvertent disclosure and FOIA inquiries.
In order to limit the potential exposure of proprietary commercial data, Shell Trading
encourages the Commission to create a Form 404 that limits the amount of proprietary
data requested.
-11-Definition of "Swap Dealer"
As discussed above, Shell Trading believes that it is ill advised to segment the
derivatives market into artificial categories such as "swap dealers". It is certainly
unnecessary to do so in this rule. Entities that qualify for the "limited risk management"
exemption should be allowed to regardless of a "swap dealer" label. Accordingly, Shell
Trading recommends that references to "swap d~,aler" be omitted from the proposed
rule. Should the Commission elect to retain this concept, however, the proposed
definition must be substantially revised.
Section 151.1 of the proposed regulation would define swap dealer as
"any person who as a significant part of their business holds
itself out as a dealer in swaps, makes a market in swaps,
regularly engages in the purchase of swaps and their resale
'~
in the ordinary course of business or engages in any activity
causing the person to be commonly known in the trade as a
dealer or market maker in swaps."
NOPR, slip op. at 86, 75 Fed. Reg. at 4168.
This definition, as written, is so vague as to be meaningless. Per the definition, a "swap
dealer" is a dealer in swaps; makes a market in swaps; or is called a swap dealer by
those in the "trade." "Dealer", "market maker", "significant" and "trade" are not defined.
In effect, the definition could be construed to apply to virtually any party party to a swap
on the basis of the subjective opinion of an un~.:nown group of individuals in some
undefined "trade".
If the Commission desires to designate a category of market participants considered
"swap dealers," Shell Trading suggests it construct a clear definition indicating what
criteria and activities merit this status. There s~lould be no potential that commercial
merchants such as Shell Trading be considered a swap dealer. As Shell Trading
understands it, a swap dealer is a financially-based firm that is not exposed to physical
risk but r~{|~-~.r acts ~,~ count~q~.~ty to ~wap~ ~ a pril.~cipal part oi
~
its business, and
actively makes bids and offers. It may require access to futures and options markets to
hedge the financial risk of its non-physical swap book. The fact that a predominately
physical commodity merchant is counterparty to swaps should in no manner make it a
swap dealer.
Like many companies in today's energy industry, Shell Trading makes regulatory
compliance a top priority. It takes a conservative approach to compliance assurance.
The proposed rule contains many ambiguities relating to items such as: the "crowding
out" proposal; the interplay between the existing exchange-based position limits and the
~ In practice, swaps are not "purchased and resold".
-12-proposed single exchange and aggregate limits; the consolidation of affiliates; data
reporting and the calculation of deliverable s~.~pply among others, Shell Trading is
concerned that a likely effect of this complex and unclear proposal will be for market
participants to intentionally maintain positions well under the limits even if that means
they will need to move away from regulated exchanges to other risk management
vehicles. The outcome of this transfer will be to reduce liquidity on regulated
exchanges, increase costs as less efficient anc~ riskier risk management tools are
employed, and potentially move trading offshore. None of these outcomes is beneficial
to the US economy, markets or consumers.
III. ~or~ses to Questions
Re.questin_q Comment
Based on the positions described above and its experience in energy derivatives, Shell
Trading provides the following responses to certain of the questions posed by the
Commission in the Notice of Proposed Rulemaking.
1.
Are Federal 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?
As noted in Shell Trading's comments above and in the preamble to the proposed rule,
the CEA speaks of "excessive speculation," no'~ ~)osition concentration as a potential
burden on interstate commerce. The Proposed Rule is not designed to prevent
excessive speculation. Shell Trading believes thai: properly designed and implemented
exchange position limits can prevent undue concentration.
2.
Are there methods other than Federa| speculative position limits that
should be utilized to diminish, eliminate, or prevent such burdens?
Shell Trading does not believe new limits are needed to address "burdens" related to
speculation; however, an alternative to positior~: limits would be to follow a practice
~Jr~ly u~:~.~ ~.~-.~!iw-:-,.ly by the ox(;i~ang~adjus{i~~g ini-[ial rr~argin rat~. In other
words, instead of imposing an outright limit o~ the positions held by an entity, the
exchanges could require higher initial margin requirements for entities holding higher
percentages of open interest e.g. : 0-5 % of open interest - standard initial margin rates;
5-10% of open interest - a higher margin rate; above 10% - yet a higher rate. These
increasing cash requirements would strongty discourage entities from taking
unnecessarily large positions. This approach would tend to discourage speculation. It
would require speculators to put more capital up to speculate. The more speculation,
the more capital will be required, creating a disincentive to excessive speculation.
3.
How should the Commission evaluate the potential effect of Federal
speculative position limits on the liquidity, m~rket efficiency and price discovery
capabilities of referenced energy contracts in determining whether to establish
position limits for such contracts?
-13-Problematic position limits have a damaging effect on liquidity, market efficiency and
price discovery capability. Shell Trading believes that elements of the proposed rule
may lead to the migration of risk management off-exchange. This movement will tend
to reduce liquidity, market efficiency and negatively impact price discovery.
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 sub-group of contracts within a class be treated
during the spot month for the purposes of e=lforcing the proposed speculative
position limits?
Please see comments above relating to the elimination of class distinctions.
5.
Under proposed regulation 151.2(b)(1)(i), the Commission would establish
an all-months-combined aggregate position limit equal to 10% of the average
combined futures and option contract open interest aggregated across all
reporting markets for the most recent calendz~r year up to 25,000 contracts, with a
marginal increase of 2.5% of open interest thereafter. As an alternative to this
approach to an all-months-combined aggregate position limit, the Commission
requests comment on whether an additional increment with a marginal increase
larger than 2.5% would be adequate to prevent excessive speculation in the
referenced energy contracts. An additional increment would permit traders to
hold larger positions relative to total open positions in the referenced energy
contracts, in comparison to the proposed formula. For example, the Commission
could fix the all-months-combined aggregate position limit at 10% of the prior
year's average open interest up to 25,000 contracts, with a marginal increase of
5% up to 300,000 contracts and a marginal increase of 2.5% thereafter. Assuming
the prior year's average open interest equaled 300,000 contracts, an all-months-
combined aggregate position limit would be fixed at 9,400 contracts under the
proposed rule and 16,300 contracts under the alternative.
The need for position limits is more related to assudng the orderly function of the market
than to restraining "excessive speculation". Thus, the proposal set out in this question
is unlikely to impact excessive speculation. However, should the Commission set
federal position limits, using a rolling six month average of open interest as a basis for
those limits is worthy of further consideration because it would dampen the impact of
seasonality and limit the effect of unexpected market events.
7.
Rep~'~g m~kets that list referenced energy contracts, as defined by the
proposed regu|atio~s, would continue to be responsible for maintaining their own
position limits (so long as they are not h~gher than the limits fixed by the
Commission) or position accountability rules. The Commission seeks comment
on whether it should issue acceptable practices that adopt formal guidelines and
procedures for implementing position accountability rules.
As noted above, Shell Trading believes that limits should be applied on an exchange
basis. In no case should there be duplicative CFTC and the exchange limits. As a
-14-practical matter, a market participant will always ~e..ek to maintain its positions below the
lower limit, making the higher limit unnecessary.
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?
Imposing the type of position limits proposed in the NOPR on FBOTs raises legal and
practical issues. For example, if "open interest" included the open interest on all
exchanges, the chance of a single entity actually exceeding the limit is smaller because
the denominator of the equation will increase a~ additional contracts are added. For
these reasons, Shell Trading recommends that new position limits not be imposed on
FBOTs.
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. The Commission seeks comment on how it
should take this pending legislation into account in proposing Federal
speculative position limits.
Future statutory changes may necessitate changes in this regulation and all other
agency rules. There is no certainty regarding tile form and timing of legislation that
would impose regulations on OTC derivatives and FBOT contracts. Accordingly, this
rule should either be designed to operate under current law or the Commission should
wait until new legislation is enacted to issue rule~; related to position limits. In no case
should the final rule be based on a guess of the form of future legislation.
14. Under proposed regulation 151.2, the Commission would set spot-month
and all-months-combined position limits annuafly.
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. Exchanges currently have an effective mechanism for handling special
events and situations relative to spot month. This is done by raising and lowering
initial margin rates.
b.
Should the Commission establish, by using a rolling-average of open
interest instead of a simple average for example, all-months-combined
-15-position limits on a more frequent bas.is? If so, what reasons would
support such action?
Notwithstanding our objections related to th~ proposed position limits described
in Shell Trading's comments, some form of rolling average would provide for an
orderly adjustment of limits over time. A rolling 6 month average might be
appropriate because it would dampen se.~sonal cycles, but is short enough to
reflect current (rather than historical) market conditions.
16. The proposed definition of referenced energy contract, diversified
commodity index, and contracts of the same class are intended to be simple
definitions that readily identify the affected contracts through an objective and
administerial process without relying on the Commission's exercise of discretion.
a.
Is the proposed definition of contracts of the same class for spot and
non-spot months sufficiently inclusive?
The definitions related to contract "classes" are needlessly complex. Shell
Trading does not believe that the physically-settling and cash-settling instruments
should be put in different classes. As a starting point, we recommend using the
current NYMEX "rollups" as a means to group contracts for this purpose.
Although it does not appear to be an issue with the contracts currently proposed
for limits under this regulation, care should also be taken to avoid grouping
together contracts based on different products, for example, different grades of
oil.
b.
Is it appropriate to define contracts of the same class during spot
months to only include contracts that expire on the same day?
No. The exact expiry date is not important. The commonality of the underlying
commodity is the key.
17. Under the proposed regulations, a swap dealer seeking a risk management
exemption would apply directly to the Commission for the exemption. Should
such exemptions be processed by the reporting markets, as would be the case
with
bona fide
hedge exemptions under the proposed regulations?
Yes, they should. Ideally, all exemptions should be handled under a single process.
18.
In implementing initial spot-month speculative position limits, if the notice
of proposed rulemaking is finalized, should the Commission:
a.
Issue special calls for information to the reporting markets to assess
the size of a contract's deliverable supply;
b.
Use the levels that are currently used by the exchanges; or
-16-c.
Undertake an independent calculation of deliverable supply without
substantial reliance on exchange estimates?
As indicated above, Shell Trading believes that the Commission can eliminate the need
to estimate Deliverable Supply by simplifying its approach to contract classes. It the
Commission elects to retain a structure that requires estimates of Deliverable Supply, it
should better define that term. Then, the best means of estimating Deliverable Supply
can be determined.
IV.
Conclusion
For the reasons described in its Comments, Shell Trading is concerned that the
proposed rule could impair the efficient operation of the US exchange-traded energy
derivatives market without providing the benefits intended by the Commission. The
results could include higher costs, reduced liquidit:y, and greater compliance risks and
costs, all of which would encourage market participants to move their activities to OTC
products and offshore markets. If the Commission continues to pursue the
development of federal position limits, Shell Tradlng recommends that it issue a revised
NOPR that addresses the concerns raised by Shell Trading and other commenters.
Most important, Shell Trading urges the Commission to avoid the approach of
segmenting market participants into discreet categories for purposes of restricting the
types of positions they hold or the size of those positions. The categories of market
participants contemplated by the NOPR are not reflective of the activities of many
market participants. Prohibiting companies using hedge exemptions from holding
speculative positions would needlessly reduce liquidity and prevent commodity
merchants--the entities that have the strongest knowledge of supply and demand
fundamentals--from fully contributing to price formation. Should federal position limits
be created, Shell Trading recommends that they should be as simple and well-defined
as possible, avoiding situations where both exchange-set and CFTC limits are
applicable to the same position. Shell Trading's comments have noted many areas in
the proposed rule that require clarification. In particular, clarity on the application of the
limits and on reporting requirements is a prerequisite to the ability of market participants
to comply with the new rule. It is also important that a revised NOPR clearly state the
Commission's intentions regarding the aggregation of positions held by affiliates and the
application of new position limits to FBOTs. An understanding of the Commission's
expectations would allow affected parties to meaningfully comment on those critical
issues.
Again, Shell Trading appreciates the opportunity to provide these comments. We will
be pleased to provide additional information regarding our views on the regulation of
energy derivatives, and would welcome the oppo{~tunity work with the Commission to
develop an approach to meeting the Commission's objectives regarding excessive
speculation and concentration while maintaining the liquidity and efficiency of today's
~nergy derivatives markets.
-17-Respectfully submitted,
Vice P~esiden!:-.-F~#~i'~i~,,,t%y Affairs
Shell Enerqy N~::.,.~H[: A~.~i:~c~.:.~ (US), L.P.
CC:
Chairman Gensler
Commissioner Dunn
Commissioner Chilton
Commissioner Sommers
Commissioner O'Malia
Daniel Berkovitz, General Counsel
-18-
