Comment Text:
10-002
COMMENT
CL-08323
From:
Sent:
To:
Cc:
Subject:
Attach:
Krupka, Catherine
Monday, April 26, 2010 3:26 PM
secretary
Sherrod, Stephen ; Van Wagner, David
; Heitman, Donald H. ;
Fekrat, Bruce
Comment File 10-002: FIEG Comments on Federal Speculative Position Limits
for Referenced Energy Contracts and Associated Regulation
FIEG Position Limit Comments.pdf
All:
Please find attached the comments of the Financial Institutions Energy Group on Federal Speculative Position
Limits for Referenced Energy Contracts and Associated Regulation.
Catherine Krupka
I
Partner
Sutherland Asbill & Brennan LLP
1275
Pennsylvania Avenue NW I Washington,
DC 20004-2415
202.383.0248 direct I 202.637.3593 facsimile
[email protected] I www.sutherland.com
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Via Electronic Mail: [email protected]
David Stawick, Secretary
U.S. Commodity Futures Trading Commission
Three Lafayette Centre
1155 21 st Street, NW
Washington, DC 20581
Re:
Proposed Federal Speculative Position Limits for
Referenced Ener~y Contracts and Associated Regulations
Dear Mr. Stawick,
On January 26, 2010, the Commission in its Federal Register notice, 75 Fed. Reg.
4144 (the "Proposal"), invited public comment in the above-referenced rulemaking. The
Financial Institutions Energy Group ("FIEG") herein submits comments for consideration
by the Commission.
For the reasons stated below, FIEG urges the Commission not to adopt the
Proposal. In addition to being ill-timed due to impending legislation, factually
unsupported in the record, and inconsistent with the Commodity Exchange Act ("CEA"),
FIEG believes the Proposal, if adopted, would reduce participation in U.S. futures
markets and ultimately hurt consumers. Speculation is an important working component
of futures markets. Without the liquidity created by speculators, hedging would become
more expensive as there is an inverse correlation between market liquidity and bid-offer
spreads. Thus, if the Commission adopts the Proposal, FIEG is concerned that current
U.S. futures market participants, both hedgers and speculators, will migrate to offshore
futures or less transparent over-the-counter markets.
FIEG also notes that thousands of nearly-identical comments filed in this
rulemaking by individuals have been generated electronically through other commenters'
web sites.1 To ensure that substantive comments are not lost in a sea of nearly-identical
form-letter comments, FIEG respectfully requests that its comments and others'
1 For example, see the comment generator on the Petroleum Marketers Association of America ("PMAA")
web site at
http://pmaa.www.capwiz.com/pmaa/issues/alert/?alertid=14925776
that helps individuals file
comments endorsing the PMAA's April 9, 2010, comments. While this type of form-letter generator does
not appear to violate the Commission's public comment rules, 17 C.F.R. § 13.4 (2009), or instructions in
the Proposal, the filing of thousands of repetitive comments may obscure the substantive comments of
other individuals, companies and industry associations when coupled with the Commission's practice of
bundling filed comments for posting on its web site. Those attempting to review the Commission record
may find it difficult to locate substantive comments in a file also containing hundreds or thousands of
repetitive form-letter comments. Even the PMAA's April 9, 2010, substantive comments are located
within a group of 194 form-letter comments that have been bundled together on the Commission's
comment file web page.FIEG Comments
April 26, 2010
substantive comments be posted separately from form-letter comments on the
Commission's comment file web page.
Background
FIEG is comprised of investment and commercial banks that provide a broad
range of financial services to all segments of the U.S. and global economy. Its Members
and their affiliates act as marketers, lenders, underwriters of debt and equity securities,
and proprietary investors. FIEG Members are active participants in various organized
commodity and commodity derivatives markets.
Comments
FIEG agrees with several other commenters that the Proposal is premature given
ongoing legislative action and that the Commission has not met its burdens of
demonstrating factual and legal bases in support of the Proposal.
The Proposal is Ill-Timed
As noted in the filed comments of the Futures Industry Association ("FIA
Comments"), Congress is actively considering legislation amending the Commission's
position limit authority.
2
The Commission cites CEA section 4a(a) as a legal basis for the
Proposal. On December 11, 2009, the U.S. House of Representatives passed a financial
regulation bill that includes derivatives regulation reform provisions. Since then, two
derivatives reform proposals have been introduced in the U.S. Senate. The House bill
and each of the Senate proposals would modify the Commission's statutory authority to
set position limits under CEA section 4a(a). The Senate Majority leadership has set a
procedural vote to begin debate on a derivatives reform bill by Monday, April 26, 2010,
3
the same day comments on the Proposal are due. If the Proposal is adopted and
derivatives reform legislation is enacted shortly thereafter, the Commission likely would
have to amend the Proposal to the extent it conflicts with the legislation, increasing costs
for the Commission and market participants alike. As there is no urgent need for the
Proposal, the Commission should indefinitely postpone consideration of the Proposal
until Congress has acted on the derivatives reform proposals.
The Proposal is Not Supported Factually
Section 4a(a) of the CEA requires the Commission to explain why it thinks the
Proposal is necessary to diminish, eliminate or prevent sudden or unreasonable
fluctuations or unwarranted changes in commodity prices resulting from excessive
speculation. The Commission has not complied with this requirement. As noted by the
FIA, without notice of the factual basis for the Proposal, the public cannot comment on
FIA Comments at 13, available at http ://www.cftc. ¢ov/L awReCulation/PublicComments/10-002.html.
See Senators Close to Deal on Financial Regulation,
New York Times, Apr. 25, 2010, available at
http ://www.nvtimes.com/reuters/2010/04/25/business/business-us-usa-financial-senate.html?src=busln.
2FIEG Comments
April 26, 2010
the Commission's justification for it.
4
Thus, FIEG urges the Commission to either
withdraw this rulemaking entirely or suspend it to make the required showing.
The Proposal Does Not Comply with the CEA
As discussed in the FIA Comments, the Commission has proposed a "crowding
out" rule that counts a hedger's bona fide hedging positions against the speculative
position limit where that hedger holds at least one speculative position.
5
This "crowding
out" rule violates section 4a(c) of the CEA, which states, "No rule, regulation, or order
issued under subsection (a) of this section shall apply to transactions or positions which
are shown to be bona fide hedging transactions or positions .... " Therefore, FIEG
believes that the "crowding out" restriction in the Proposal must be abandoned.
Responses to Commission Questions
In addition to its comments, see Attachment A for FIEG' s responses to some of
the Commission's questions from the Proposal.
Conclusion
FIEG respectfully urges the Commission to abandon the Proposal because it is ill-
timed, factually unsupported, and inconsistent with the CEA. FIEG also agrees with the
FIA that the costs of the Proposal are high and its benefits, if any, are uncertain
6
and that
the proposal would be arbitrary and capricious if adopted in its current form.
v
FIEG
appreciates the Commission's consideration of its comments.
Sincerely
/s/ Catherine M. Krupka
Catherine M. Krupka
Sutherland Asbill & Brennan LLP
1275 Pennsylvania Ave., NW
Washington, DC 20004
(202) 383-0248
[email protected]
Attorneys for the Financial Institutions Energy Group
4 FIA Comments at 14.
5 FIA Comments at 5, 21-23.
6 FIA Comments at 28-29.
7 FIA Comments at 29-30Attachment A: FIEG Responses to Questions
April 26, 2010
1.
Are Federal speculative position Bruits for energy contracts traded on reporting
markets necessary to "diminish, efminate, or prevent" the burdens on interstate
commerce that may result from position concentrations in such contracts?
The Commission's proposed limits on West Texas Intermediate crude oil,
natural gas, heating oil, and gasoline futures and options contracts (the "referenced
energy contracts") are not necessary to diminish, eliminate or prevent any burdens on
interstate commerce that may result from position concentrations.
The burdens on interstate commerce specifically referenced in the CEA are
sudden or unreasonable fluctuations or unwarranted changes in the price of a
commodity (hereinafter "SUFUCIPs'). Assuming,
arguendo,
that the energy
commodity price movements in 2008 were SUFUCIPs, the Commission has not shown
that the proposed limits would have in any way diminished, eliminated, or prevented
their occurrence. By way of comparison, the agricultural commodities that were
already subject to speculative limits imposed by the Commission experienced similar
price movements in 2008. If Commission-imposed limits previously were not effective
in diminishing, eliminating or preventing alleged SUFUCIPs in agricultural products,
then the logic for their use to accomplish that goal in energy products is undermined.
The CEA authorizes the Commission to address only "excessive speculation"
that leads to SUFUCIPs, not speculation generally, position concentrations, or even
excessive speculation that results in reasonable and warranted price changes.1 The
Commission has yet to demonstrate that large position concentrations can lead or
materially contribute to SUFUCIPs.
2
2.
Are there methods other than Federal speculative position Bruits that shouM be
utilized to diminish, eliminate, or prevent such burdens?
To state that a method
should
be utilized to diminish, eliminate, or prevent the
burdens of SUFUCIPs caused by excessive speculation, presumes that SUFUCIPs and
excessive speculation have occurred, that the Commission or someone has identified
them, or at a minimum distinguished them from reasonable market activity and
1 If numerous market participants anticipate a dislocation of physical supply, even excessive speculation
may result in reasonable and warranted price fluctuations, and any limits inhibiting such activity are
beyond the scope of CEA section 4a(a).
2 In fact, an argument can be made that speculation, if anything, tends to moderate excessive price
swings. Presumably, a speculator chooses to buy or sell a commodity because he or she believes that the
current price does not accurately reflect the fundamentals of supply and demand, and will soon change in
the speculated direction. Thus, when a speculator takes a long position (buys), it is because he or she
believes the current price is below the "correct" value, and that the price will soon rise. Conversely,
when a speculator takes a short position (sells), presumably it is because he or she believes the price is
excessive and will soon revert to the mean by going down. Therefore, when prices are "overheated,"
speculators are likely to contribute to "reigning in" the excess, because they can be expected, on average,
to bet on the price to soon decline. These actions will tend to contribute to price modulation, not price
amplification.Attachment A: FIEG Responses to Questions
April 26, 2010
resulting price movements. It is exceedingly difficult to propose a remedy for the
burdens of SUFUCIPs without defining, describing, or even questioning what makes
certain fluctuations or changes in price sudden, unreasonable, or unwarranted. It is
essential that excessive speculation resulting in SUFUCIPs be described and
distinguished from beneficial market activity. Thus, it is unclear what additional
regulation beyond the existing exchange accountability level regime is needed to
address these undefined threats.
Even if the Commission had defined what constitutes excessive speculation or
SUFUCIPs, as opposed to reasonable speculation or price changes, the Commission
should consider existing or less invasive measures (than position limits) that may be
less disruptive to the futures and spot energy markets than the proposed limits.
3.
How shouM the Commission evaluate the potential effect of Federal speculative
position Bruits on the #quidity, market efficiency and price discovery capabiBties of
referenced energy contracts in determining whether to estabBsh position Bruits for such
contracts?
Because the proposed position limits do not address any actual problems in the
relevant energy contract markets, there likely will be no improvement in the liquidity,
market efficiency or price discovery capabilities in these markets. In fact, the proposed
limits have the potential to reduce liquidity, market efficiency, and price discovery
capabilities in the relevant energy contract markets and in the related market for risk
management services. Clearly, liquidity will be reduced because several market
participants will be required to reduce their positions on the futures markets to comply
with the new limits.
With respect to the markets for the referenced energy contracts, the demand for
the contracts is comprised of participants willing to buy the referenced energy contracts
while supply is comprised of participants willing to sell the referenced energy
contracts.
3
A graph of supply and demand would meet at a point represented by the
equilibrium price, P, and equilibrium quantity,
Q.4 Because
the proposed limits would
reduce the ability of both longs and shorts to participate in the futures markets, reducing
the amount either are able to buy or sell, respectively, at each unit price, we can imagine
3 A hypothetical all-months market for each of the four classes of referenced energy contracts would be
comprised of the open interest for a year in all of the related instruments listed in the Commission's
proposed rule for each class of commodity. The fungibility of the futures and options contracts within a
class may be established by the Commission's limits proposal covering all the related instruments within
a class, with due regard for conversion factors and delta-adjustments. Inclusion of near and distant
months within a year follows the Commission's convention for the proposed limits. For ease of
discussion, the markets in the referenced energy contracts are discussed generally, though it is not
intended to imply that there is fungibility across commodity classes.
4 While the quantity, Q, likely would be a year's total open interest in each class of referenced energy
contract, the price, P, perhaps would be the average commodity price for the year's open interest within a
class. Though a more rigorous study of these markets is beyond the scope of these comments, these
markets are sufficiently defined to discuss them in the context of the Commission's proposed limits.
2Attachment A: FIEG Responses to Questions
April 26, 2010
the demand and supply curves both would be shifted to the left. Assuming both curves
shifted more or less equally, the new equilibrium price, P', would be similar to the
original equilibrium price P. However, it is clear that the movement of both demand
and supply curves to the left would result in a decrease in quantity to Q'. Thus, the
effect of the proposed limits on price would be negligible, but there would be a
reduction in open interest. Note that even with no change in prices, there would be a
dead weight loss of consumer welfare, similar to that caused by the actions of a
monopolist or taxation by a regulator, denoted by the triangular shape running from the
original equilibrium point (P, Q) to intersections of the reduced quantity, Q', with the
original supply and demand curves.
5
See Figure 1, below.
Figure 1
p' p
Q' Q
The provision of risk management services depends on the availability of various OTC
derivatives that are hedged using the referenced energy contracts. A reduction in open
interest in the referenced energy contract markets resulting from the imposition of
position limits likely would result in an overall decrease in the supply of related risk
management services. If we imagine the supply and demand curves for risk
management services in the relevant commodities meeting at a point represented by
equilibrium price, P, and equilibrium quantity, Q, the imposition of position limits
would shift the supply curve to the left, resulting in a higher price, P', and a lower
5 A corollary to this argument is that by removing all position limits on agricultural commodities, it is
likely that there would be no appreciable effect on prices even though the level of futures open interest
would increase. This increase in open interest would have the effect of increasing overall consumer
welfare.Attachment A: FIEG Responses to Questions
April 26, 2010
quantity, Q'. Again, a dead weight loss can be denoted on the graph in Figure 2.
6
Thus,
the Commission's proposed limits likely would reduce open interest and increase costs
to entities that require risk management services.
Figure 2
D
S
Q' Q
6 It may be assumed that demand for risk management services would not be greatly affected by the
imposition of position limits as commercial enterprises and other hedgers would continue to desire risk
management services. However, as a result of the imposition of position limits in the referenced energy
contracts, it is possible that market participants formerly using futures for risk management purposes may
be forced to resort to OTC swaps and options instead. This would have the effect of increasing the
demand for risk management services, moving the risk management demand curve to the right and
resulting in a new equilibrium price, P", and quantity, Q".
See
Figure 3.
Figure 3
Q
Note that while this new equilibrium quantity, Q", may or may not be close to the original equilibrium
quantity, Q, it is certain that the resulting new equilibrium price, P", will be higher than the original
equilibrium price, P.Attachment A: FIEG Responses to Questions
April 26, 2010
Additionally, price discovery likely would also be inhibited by the proposed limits as
market participants that are currently active in both the futures and underlying physical
markets will be inhibited from engaging in the arbitrage between futures and spot
prices, the front month and second to the front month, or between similar contracts on
different exchanges. The reduction in this type of arbitrage may harm price
convergence between futures and spot prices and between futures contracts whose
prices normally converge.
Beyond the effects on liquidity, market efficiency, and price discovery noted above, the
proposed speculative position limits likely would negatively affect commodity
producers, users, processors, and merchant handlers (collectively "commercial entities")
and lead to higher prices for consumers; the opposite of what is intended. Commercial
entities look to risk management services providers to enable long-term hedging while
freeing up balance sheet capital, for instance, via lien-based ISDA swaps. Large and
sophisticated risk managers have the capability and the risk appetite to provide these
services, which in turn allow commercial entities to invest more of their capital in
research, development, or inputs. Smaller risk managers may not have the
infrastructure, balance sheet, or the risk appetite to provide long-term services of this
nature. As commercial entities are left with less capital to invest in technology or
production, ultimately consumers will face fewer choices and higher prices.
5.
Under proposed regulation 151.2(b)(1)(i), the Commission wouM estabBsh an
all-months-combined aggregate position Bruit equal to 10% of the average combined
futures and option contract open interest aggregated across all reporting markets for
the most recent calendar year up to 25, 000 contracts, with a marginal increase of 2.5%
of open interest thereafter. As an alternative to this approach to an all-months-
combined aggregate position Bruit, the Commission requests comment on whether an
additional increment with a marginal increase larger than 2.5% wouM be adequate to
prevent excessive speculation in the referenced energy contracts. An additional
increment wouM permit traders to hoM larger positions relative to total open positions
in the referenced energy contracts, in comparison to the proposed formula. For
example, the Commission couM ftx the all-months-combined aggregate position Bruit 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 Bruit wouM be fixed at 9, 400 contracts under the
proposed rule and 16,300 contracts under the alternative.
As discussed above, any position limits will only serve to reduce consumer welfare
and/or raise the prices of futures, risk management services, and commodities.
However, to the extent the Commission is able to show that position limits are
necessary to diminish, eliminate or prevent the burdens on interstate commerce that
may result from excessive speculation, FIEG would not support any position limits less
than ten percent of the total open interest of the instruments that aggregate into any one
of the referenced energy contracts.Attachment A: FIEG Responses to Questions
April 26, 2010
Based on the Herfindahl-Hirschman Index measure of market concentration used by the
United States' primary competition regulators, the U.S. Department of Justice ("DOJ")
and U.S. Federal Trade Commission ("FTC"), a ten percent position limit likely would
be consistent with the existence of a competitive market. Under the DOJ/FTC HHI
methodology, the sum of the squares of all market participants' shares of a defined
market are compared to the following benchmarks: an HHI under 1000 is viewed as
competitive and not susceptible to exercises of market power or collusion; an HHI
between 1000 and 1800 is viewed as moderately concentrated and somewhat
susceptible to exercises of market power or collusion; and an HHI above 1800 is viewed
as highly concentrated and susceptible to exercises of market power or collusion]
A ten-percent market share position limit would be sufficient to promote a competitive
market as it corresponds to no fewer than ten market participants and a maximum HHI
value of 1000, which under the DOJ/FTC guidelines constitutes an unconcentrated and
competitive market. In fact, under the HHI methodology it is even possible for a
market participant to have a market share of 30 percent without exceeding the 1000
HHI threshold.* Thus, even if the Commission were to set a ten percent position limit
for the referenced energy contracts, it should allow for exemptions up to 30 percent
under appropriate circumstances.
7 Transactions that increase the HHI by more than 100 points in concentrated markets presumptively raise
antitrust concerns under the Horizontal Merger Guidelines issued by the DOJ and FTC. See the
description available on the DOJ's Internet web site at
s This would occur if all other market participants had shares of one percent or less.
