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  • [Federal Register: November 27, 2007 (Volume 72, Number 227)]

    [Proposed Rules]

    [Page 66097-66103]

    From the Federal Register Online via GPO Access [wais.access.gpo.gov]

    [DOCID:fr27no07-41]

    =============================================================

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 150

    RIN 3038-AC40

    Risk Management Exemption From Federal Speculative Position

    Limits

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

    -------------------------------------------------------------

    SUMMARY: Section 150.2 of the Commodity Futures Trading Commission's

    (``Commission'') regulations imposes limits on the size of speculative

    positions that traders may hold or control in futures and futures

    equivalent option contracts on certain designated agricultural

    commodities named therein. Section 150.3 lists certain types of

    positions that may be exempted from these Federal speculative position

    limits. The Commission is proposing to provide an additional exemption

    for ``risk management positions.'' A risk management position would be

    defined as a futures or futures equivalent position, held as part of a

    broadly diversified portfolio of long-only or short-only futures or

    futures equivalent positions, that is based upon either: A fiduciary

    obligation to match or track the results of a broadly diversified index

    that includes the same commodity markets in fundamentally the same

    proportions as the futures or futures equivalent position; or a

    portfolio diversification plan that has, among other substantial asset

    classes, an exposure to a broadly diversified index that includes the

    same commodity markets in fundamentally the same proportions as the

    futures or futures equivalent position. The exemption would be subject

    to conditions, including that the positions must be passively managed,

    must be unleveraged, and may not be carried into the spot month.

    DATES: Comments must be received on or before January 28, 2008.

    ADDRESSES: Comments should be submitted to David Stawick, Secretary,

    Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

    Street, NW., Washington, DC 20581. Comments also may be sent by

    facsimile to (202) 418-5521, or by electronic mail to

    secretary@cftc.gov. Reference should be made to ``Proposed Risk

    Management Exemption from Federal Speculative Position Limits.''

    Comments may also be submitted by connecting to the Federal eRulemaking

    Portal at http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.regulations.gov and following comment submission

    instructions.

    FOR FURTHER INFORMATION CONTACT: Donald Heitman, Senior Special

    Counsel, Division of Market Oversight, Commodity Futures Trading

    Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,

    DC 20581, telephone (202) 418-5041, facsimile number (202) 418-5507,

    electronic mail dheitman@cftc.gov; or John Fenton, Director of

    Surveillance, Division of Market Oversight, telephone (202) 418-5298,

    facsimile number (202) 418-5507, electronic mail jfenton@cftc.gov.

    SUPPLEMENTARY INFORMATION:

    [[Page 66098]]

    I. Background

    A. Statutory Framework

    Speculative position limits have been a tool for the regulation of

    the U.S. futures markets since the adoption of the Commodity Exchange

    Act of 1936. Section 4a(a) of the Commodity Exchange Act (``Act''), 7

    U.S.C. 6a(a), states that:

    Excessive speculation in any commodity under contracts of sale

    of such commodity for future delivery made on or subject to the

    rules of contract markets or derivatives transaction execution

    facilities causing sudden or unreasonable fluctuations or

    unwarranted changes in the price of such commodity, is an undue and

    unnecessary burden on interstate commerce in such commodity.

    Accordingly, section 4a(a) of the Act provides the Commission with

    the authority to:

    Fix such limits on the amounts of trading which may be done or

    positions which may be held by any person under contracts of sale of

    such commodity for future delivery on or subject to the rules of any

    contract market or derivatives transaction execution facility as the

    Commission finds are necessary to diminish, eliminate, or prevent

    such burden.

    This longstanding statutory framework providing for Federal

    speculative position limits was supplemented with the passage of the

    Futures Trading Act of 1982, which acknowledged the role of exchanges

    in setting their own speculative position limits. The 1982 legislation

    also provided, under section 4a(e) of the Act, that limits set by

    exchanges and approved by the Commission were subject to Commission

    enforcement.

    Finally, the Commodity Futures Modernization Act of 2000 (``CFMA'')

    established designation criteria and core principles with which a

    designated contract market (``DCM'') must comply to receive and

    maintain designation. Among these, Core Principle 5 in section 5(d) of

    the Act states:

    Position Limitations or Accountability--To reduce the potential

    threat of market manipulation or congestion, especially during

    trading in the delivery month, the board of trade shall adopt

    position limitations or position accountability for speculators,

    where necessary and appropriate.

    B. Regulatory Framework

    The regulatory structure based upon these statutory provisions

    consists of three elements, the levels of the speculative position

    limits, certain exemptions from the limits (for hedging, spreading/

    arbitrage, and other positions), and the policy on aggregating commonly

    owned or controlled accounts for purposes of applying the limits. This

    regulatory structure is administered under a two-pronged framework.

    Under the first prong, the Commission establishes and enforces

    speculative position limits for futures contracts on a limited group of

    agricultural commodities. These Federal limits are enumerated in

    Commission regulation 150.2, and apply to the following futures and

    option markets: Chicago Board of Trade (``CBOT'') corn, oats, soybeans,

    wheat, soybean oil, and soybean meal; Minneapolis Grain Exchange

    (``MGE'') hard red spring wheat and white wheat; ICE Futures U.S.

    (formerly the New York Board of Trade) cotton No. 2; and Kansas City

    Board of Trade (``KCBOT'') hard winter wheat. Under the second prong,

    individual DCMs establish and enforce their own speculative position

    limits or position accountability provisions (including exemption and

    aggregation rules), subject to Commission oversight and separate

    authority to enforce exchange-set speculative position limits approved

    by the Commission. Thus, responsibility for enforcement of speculative

    position limits is shared by the Commission and the DCMs.\1\

    ---------------------------------------------------------------------------

    \1\ Provisions regarding the establishment of exchange-set

    speculative position limits were originally set forth in CFTC

    regulation 1.61. In 1999, the Commission simplified and reorganized

    its rules by relocating the substance of regulation 1.61's

    requirements to part 150 of the Commission's rules, thereby

    incorporating within part 150 provisions for both Federal

    speculative position limits and exchange-set speculative position

    limits (see 64 FR 24038, May 5, 1999). With the passage of the

    Commodity Futures Modernization Act in 2000 and the Commission's

    subsequent adoption of the Part 38 regulations covering DCMs in 2001

    (66 FR 42256, August 10, 2001), Part 150's approach to exchange-set

    speculative position limits was incorporated as an acceptable

    practice under DCM Core Principle 5--Position Limitations and

    Accountability. Section 4a(e) provides that a violation of a

    speculative position limit set by a Commission-approved exchange

    rule is also a violation of the Act. Thus, the Commission can

    enforce directly violations of exchange-set speculative position

    limits as well as those provided under Commission rules.

    ---------------------------------------------------------------------------

    Commission regulation 150.3, ``Exemptions,'' lists certain types of

    positions that may be exempted from (and thus may exceed) the Federal

    speculative position limits. For example, under Sec. 150.3(a)(1), bona

    fide hedging transactions, as defined in Sec. 1.3(z) of the

    Commission's regulations, may exceed the limits. The Commission has

    periodically amended the exemptive rules applicable to Federal

    speculative position limits in response to changing conditions and

    practices in futures markets. These amendments have included an

    exemption from speculative position limits for the positions of multi-

    advisor commodity pools and other similar entities that use independent

    account controllers,\2\ and an amendment to extend the exemption for

    positions that have a common owner but are independently controlled to

    include certain commodity trading advisors.\3\ In 1987, the Commission

    also issued an agency interpretation clarifying certain aspects of the

    hedging definition.\4\ The Commission has also issued guidance with

    respect to exchange speculative limits, including guidelines regarding

    the exemption of risk-management positions from exchange-set

    speculative position limits in financial futures contracts.\5\ However,

    the last significant amendment to the Commission's exemptive rules was

    implemented in 1991.

    ---------------------------------------------------------------------------

    \2\ 53 FR 41563 (October 24, 1988).

    \3\ 56 FR 14308 (April 9, 1991).

    \4\ 52 FR 27195 (July 20, 1987).

    \5\ 52 FR 34633 (September 14, 1987).

    ---------------------------------------------------------------------------

    C. Changes in Trading Practices

    The intervening 16 years have seen significant changes in trading

    patterns and practices in derivatives markets, thus prompting the

    Commission to reassess its policies regarding exemptions from the

    Federal speculative position limits. These changes primarily involve

    trading strategies and programs based on commodity indexes. In

    particular, pension funds and other investors (including individual

    investors participating in commodity index-based funds or trading

    programs) have become interested in taking on commodity price exposure

    as a way of diversifying portfolios that might otherwise be limited to

    stocks and interest rate instruments. Financial research has shown that

    the risk/return performance of a portfolio is improved by acquiring

    uncorrelated or negatively correlated assets, and commodities

    (including agricultural commodities) generally perform that role in a

    portfolio of other financial assets.\6\

    ---------------------------------------------------------------------------

    \6\ The argument has also been made that commodities act as a

    general hedge of liability obligations that are linked to inflation.

    ---------------------------------------------------------------------------

    The components of a commodity index-based investment might include

    energy commodities, metals (both precious metals and industrial

    metals), agricultural commodities that are subject to exchange limits

    (including coffee, sugar, cocoa, and orange juice, as well as livestock

    and meat), and those agricultural commodities named above that are

    subject to Federal speculative position limits (grains, the soybean

    complex and cotton). With respect to agricultural commodities subject

    to Federal limits, the Commission has responded to various instances

    where

    [[Page 66099]]

    index-based positions in such commodities exceed (or might grow to

    exceed) the Federal speculative position limits. In certain cases, the

    Commission has granted exemptive or no-action relief from Federal

    speculative position limits. In granting such relief, the Commission

    has included conditions to protect the market from the potential for

    the sudden or unreasonable fluctuations or unwarranted changes in

    prices that speculative limits are designed to prevent.

    For example, in 1991, the Commission received a request from a

    large commodity merchandising firm that engaged in commodity related

    swaps \7\ as a part of a commercial line of business. The firm, through

    an affiliate, wished to enter into an OTC swap transaction with a

    qualified counterparty (a large pension fund) involving an index based

    on the returns afforded by investments in exchange-traded futures

    contracts on certain non-financial commodities meeting specified

    criteria. The commodities making up the index included wheat, corn and

    soybeans, all of which were (and still are) subject to Federal

    speculative position limits. As a result of the swap, the swap dealing

    firm would, in effect, be going short the index. In other words, it

    would be required to make payments to the pension fund counterparty if

    the value of the index was higher at the end of the swap payment period

    than at the beginning. In order to hedge itself against this risk, the

    swap dealer planned to establish a portfolio of long futures positions

    in the commodities making up the index, in such amounts as would

    replicate its exposure under the swap transaction. By design, the index

    did not include contract months that had entered the delivery period

    and the swap dealer, in replicating the index, stated that it would not

    maintain futures positions based on index-related swap activity into

    the spot month (when physical commodity markets are most vulnerable to

    manipulation and attendant unreasonable price fluctuations). The result

    of the hedge was that the composite return on the futures portfolio

    would offset the net payments the swap dealer would be required to make

    to the pension fund counterparty.

    ---------------------------------------------------------------------------

    \7\ A swap is a privately negotiated exchange of one asset or

    cash flow for another asset or cash flow. In a commodity swap, at

    least one of the assets or cash flows is related to the price of one

    or more commodities.

    ---------------------------------------------------------------------------

    Because the futures positions the swap dealer would have to

    establish to hedge its exposure on the swap transaction would be in

    excess of the speculative position limits on wheat, corn and soybeans,

    it requested, and was granted, a hedge exemption for those positions.

    The swap transaction allowed the pension fund to add commodities

    exposure to its portfolio indirectly, through the OTC trade with the

    swap dealer--something it could have done directly, but only in a

    limited fashion.\8\

    ---------------------------------------------------------------------------

    \8\ The pension fund would have been limited in its ability to

    take on this commodities exposure directly, by putting on the long

    futures position itself, because the pension fund--having no

    offsetting price risk incidental to commercial cash or spot

    operations--would not have qualified for a hedge exemption with

    respect to the position. (See Sec. 1.3(z) of the Commission's

    regulations.)

    ---------------------------------------------------------------------------

    Similar hedge exemptions were subsequently granted in other cases

    where the futures positions clearly offset risks related to swaps or

    similar OTC positions involving both individual commodities and

    commodity indexes. These non-traditional hedges were all subject to

    specific limitations to protect the marketplace from potential ill

    effects. The limitations included: (1) The futures positions must

    offset specific price risk; (2) the dollar value of the futures

    positions would be no greater than the dollar value of the underlying

    risk; and (3) the futures positions would not be carried into the spot

    month.

    The Commission's Division of Market Oversight (``Division'' or

    ``DMO'') has also recently issued two no-action letters involving

    another type of index-based trading.\9\ Both cases involved trading

    that offered investors the opportunity to participate in a broadly

    diversified commodity index-based fund or program (``index fund''). The

    futures positions of these index funds differed from the futures

    positions taken by the swap dealers described above. The swap dealer

    positions were taken to offset OTC swaps exposure that was directly

    linked to the price of an index. For that reason, the Division granted

    hedge exemptions to these swap dealer positions. On the other hand, in

    the index fund positions described in the no-action letters, the price

    exposure results from a promise or obligation to track an index, rather

    than from holding an OTC swap position whose value is directly linked

    to the price of the index. The Division believed that this difference

    was significant enough that the index fund positions would not qualify

    for a hedge exemption. Nevertheless, because the index fund positions

    represented a legitimate and potentially useful investment strategy,

    the Division granted the index funds no-action relief, subject to

    certain conditions, described below, that were intended to protect the

    futures markets from potential ill effects.

    ---------------------------------------------------------------------------

    \9\ CFTC Letter 06-09 (April 19, 2006); CFTC Letter 06-19

    (September 6, 2006).

    ---------------------------------------------------------------------------

    II. Proposed Amendment

    A. Introduction

    In light of the changing trading practices and conditions described

    above, the Commission is now considering whether to amend its Part 150

    regulations to create a new exemption from Federal speculative position

    limits. In addition to the above-described policy of granting index-

    based hedge exemptions to swap dealers, which policy would remain in

    effect, the proposal would create an additional risk management

    exemption. That exemption would apply to positions held by: (1)

    Intermediaries, such as index funds, who pass price risks on to their

    customers; and (2) pension funds and other institutional investors

    seeking to diversify risks in portfolios by including an allocation to

    commodity exposure. As noted above, pension funds can already benefit

    from a hedge exemption indirectly, by entering into an OTC position

    with a swap dealer who, in turn, puts on an offsetting futures position

    in reliance on the existing hedge exemption policy. The proposed rules

    would allow a pension fund to receive an exemption directly, by putting

    on a futures position itself pursuant to the new risk management

    exemption provision.

    In determining whether the new risk management exemption proposed

    herein is appropriate, it is important to recall that the purpose of

    position limits, as specified in Section 4a(a) of the Act, is to

    diminish, eliminate, or prevent sudden or unreasonable fluctuations or

    unwarranted changes in the prices of commodities. Within this

    constraint, it is appropriate that the Commission (and the exchanges)

    not unduly restrict trading activity. A position limit is a means to an

    end, not an end in itself. Accordingly, to the extent that a type of

    trading activity can be identified that is unlikely to cause sudden or

    unreasonable fluctuations or unwarranted changes in prices, it is a

    good candidate to qualify for an exemption from position limits.

    Commodity index-based trading has characteristics that recommend it on

    that score: (1) It is generally passively managed, so that positions

    tend not to be changed based on market news or short-term price

    volatility; (2) it is generally unleveraged, so that financial

    considerations should not cause rapid liquidation of positions; and (3)

    it is inherently diversified, in that futures positions are normally

    held in many

    [[Page 66100]]

    different markets, and its purpose typically is to diversify a

    portfolio containing assets with different risk profiles.

    B. Conditions for the Exemption

    To be eligible for an exemption as a ``risk management position''

    under the proposed amendments to Part 150, a futures position would

    need to comply with several conditions designed to protect the futures

    markets from sudden or unreasonable fluctuations or unwarranted changes

    in prices. First, Sec. 150.3(a) would be amended to add a requirement

    that all positions subject to the exemptive provisions must be

    ``established and liquidated in an orderly manner.'' This requirement

    already applies to the positions referred to in Sec. 150.3(a)(1),

    which exempts bona fide hedging transactions, by virtue of similar

    language appearing in the bona fide hedging definition (see Sec.

    1.3(z)(1)). However, the proposed amendment would clarify that the same

    requirement would apply not only to the risk management positions to be

    exempted under proposed new Sec. 150.3(a)(2), but also to the spread

    or arbitrage positions already exempted under current Sec. 150.3(a)(3)

    and the positions carried in the separate account of an independent

    account controller already exempted under current Sec. 150.3(a)(4).

    Second, the proposed rules would define a ``risk management

    position'' as a futures or futures equivalent position, held as part of

    a broadly diversified portfolio of long-only or short-only \10\ futures

    or futures equivalent \11\ positions, that is based upon either: (1) A

    fiduciary obligation to match or track the results of a broadly

    diversified index that includes the same commodity markets in

    fundamentally the same proportions as the futures or futures equivalent

    position; or (2) a portfolio diversification plan that has, among other

    substantial asset classes, an exposure to a broadly diversified index

    that includes the same commodity markets in fundamentally the same

    proportions as the futures or futures equivalent position. The first of

    these alternatives covers positions held by index funds, such as those

    that were the subject of the Commission No-action letters discussed

    above. The second alternative covers positions held directly by pension

    funds and other institutional investors.

    ---------------------------------------------------------------------------

    \10\ The long-only or short-only qualification would limit risk

    management positions to positions offsetting either a long index or

    portfolio or a short index or portfolio, and thus would not allow

    for spread or straddle positions. With respect to short-only

    positions, it should be noted that all the applications for index-

    based trading relief received by the Commission to date, whether for

    hedge exemptions or no-action relief, have involved long-only

    futures positions. However, the proposed rules would also provide

    for an entity that might offer investors a ``bear market index.''

    Such an index would require the offeror to be long opposite its

    customers. It would, therefore, need to offset that exposure with

    short futures positions.

    \11\ For example, a long call option combined with a short put

    option is equivalent to a long futures contract.

    ---------------------------------------------------------------------------

    A ``broadly diversified index'' would be defined to limit the

    weighting of certain agricultural commodities in the index so that

    commodities subject to Federal speculative position limits would not

    comprise a disproportionate share of the index. Thus, a ``broadly

    diversified index'' would mean an index based on physical commodities

    in which: (1) not more than 15% of the index is composed of any single

    agricultural commodity named in Sec. 150.2 (for which purposes, wheat

    shall be regarded as a single commodity, so that positions in all

    varieties of wheat, on all exchanges, combined, may not exceed 15% of

    the index, and the soybean complex shall likewise be regarded as a

    single commodity, so that positions in soybeans, soybean oil and

    soybean meal, on all exchanges combined, may not exceed 15% of the

    index); and (2) not more than 50% of the index as a whole is composed

    of agricultural commodities named in Sec. 150.2. The Commission

    believes that a narrowly based index could be used to evade speculative

    position limits. For example, the grains all tend to have similar risk

    profiles--i.e, they tend to respond similarly to common market factors,

    such as weather. Therefore, the Commission is concerned that an index

    composed, for example, of 25% each of corn, wheat, oats and soybeans--

    rather than constituting a means of portfolio diversification--could

    operate as a mechanism for evading speculative position limits in one

    or more of those commodities.

    Third, the positions subject to the exemption must be passively

    managed. The proposed rules would define a ``passively managed

    position'' as a futures or futures equivalent position that is part of

    a portfolio that tracks a broadly diversified index, which index is

    calculated, adjusted, and re-weighted pursuant to an objective,

    predetermined mathematical formula the application of which allows only

    limited discretion with respect to trading decisions. This definition

    contemplates a certain limited amount of discretion in the manner in

    which the futures position tracks the underlying index. For example,

    index funds generally provide rules or standards for periodically re-

    weighting the index to account for price changes in the commodities

    that make up the index, or readjusting the composition of the index to

    account for changing economic or market factors. Such discretion would

    be permissible. However, the definition contemplates that the position

    holder's discretion would not extend to frequently or arbitrarily

    changing the composition of the index or the weighting of the

    commodities in the index. Such actions would indicate that the position

    was being actively managed with a view to taking advantage of short-

    term market trends. The definition also contemplates that the position

    holder could exercise some discretion as to when to roll futures

    positions forward into the next delivery month without violating the

    ``passively managed'' requirement (provided no positions were carried

    into the spot month). The Commission believes that limited discretion

    as to when a position must be rolled forward can mitigate the market

    impact that might otherwise result from large positions being rolled

    forward on a pre-determined date and, consequently, help to avoid

    liquidity problems.

    Fourth, the futures trading undertaken pursuant to the exemption

    must be unleveraged. An unleveraged position would be defined as a

    futures or futures equivalent position that is part of a portfolio of

    futures or futures equivalent positions directly relating to an

    underlying broadly diversified index, the notional value of which

    positions does not exceed the sum of the value of: (1) Cash set aside

    in an identifiable manner, or unencumbered short-term U.S. Treasury

    obligations so set aside, plus any funds deposited as margin on such

    position; and (2) accrued profits on such position held at the futures

    commission merchant. Because the futures positions would be fully

    offset by cash or profits on such positions, financial considerations

    (e.g., significant price changes) should not cause rapid liquidation of

    positions, which can cause sudden or unreasonable fluctuations or

    unwarranted changes in prices.

    Finally, positions may not be carried into the spot month, a period

    during which physical commodity markets are particularly vulnerable to

    manipulations, squeezes and sudden or unreasonable fluctuations or

    unwarranted changes in prices.

    Entities intending to hold risk management positions pursuant to

    the exemption in Sec. 150.3(a)(2) would be required to apply to the

    Commission and receive Commission approval in order to receive an

    exemption. The applicant would be required to provide the following

    information:

    [[Page 66101]]

    Application for a Risk Management Exemption as Defined in Sec.

    150.1(j)

    1. Initial application materials:

    A. For an exemption related to a ``fiduciary obligation''.

    A description of the underlying index or group of

    commodities, including the commodities, the weightings, the method and

    timing of re-weightings, the selection of futures months, and the

    timing and criteria for rolling from one futures month to another;

    A description of the ``fiduciary obligation;''

    The actual or anticipated value of the underlying funds to

    be invested in commodities within the next fiscal or calendar year and

    the method for calculating that value, as well as the equivalent

    numbers of futures contracts in each of the Sec. 150.2 markets for

    which the exemption is sought;

    A description of the manner in which the funds to be

    invested in commodities will be set aside;

    A statement certifying that the requirements of this

    exemption are met and will be observed at all times going forward and

    that the Commission will be notified promptly of any material changes

    in this information; and

    Such other information as the Commission may request.

    B. For an exemption based upon a ``portfolio diversification

    plan''.

    A description of the investment index or group of

    commodities, including the commodities, the weightings, the method and

    timing of re-weightings, the selection of futures months, and the

    timing and criteria for rolling from one futures month to another;

    A description of the entire portfolio, including the total

    size of the assets, the asset classes making up the portfolio, and a

    description of the allocation among the asset classes;

    The actual or anticipated value of the underlying funds to

    be invested in commodities and the method for calculating that value,

    as well as the equivalent numbers of futures contracts in each of the

    Sec. 150.2 markets for which the exemption is sought;

    A description of the manner in which the funds to be

    invested in commodities will be set aside;

    A statement certifying that the requirements of this

    exemption are met and will be observed at all times going forward and

    that the Commission will be notified promptly of any material changes

    in this information; and

    Such other information as the Commission may request.

    2. Supplemental Material: Whenever the purchases or sales that a

    person wishes to qualify under this risk management exemption shall

    exceed the amount provided in the person's most recent filing pursuant

    to this section, or the amount previously specified by the Commission

    pursuant to this section, such person shall file with the Commission a

    statement that updates the information provided in the person's most

    recent filing and provides the reasons for this change. Such statement

    shall be filed at least ten business days in advance of the date that

    such person wishes to exceed those amounts and if the notice filer is

    not notified otherwise by the Commission within the 10-day period, the

    exemption will continue to be effective. The Commission may, upon call,

    obtain such additional materials from the applicant or person availing

    themselves of this exemption as the Commission deems necessary to

    exercise due diligence with respect to granting and monitoring this

    exemption.

    Entities holding risk management positions pursuant to the

    exemption in Sec. 150.3(a)(2) would also be required to immediately

    report to the Commission in the event they know, or have reason to

    know,\12\ that any person holds a greater than 25% interest in such

    position. The reason for this requirement is to alert the Commission to

    the possibility that an individual might be attempting to use the

    exemption as a means of avoiding otherwise applicable speculative

    position limits.

    ---------------------------------------------------------------------------

    \12\ The Commission understands that not every entity that might

    qualify for this exemption would necessarily know the identities of

    all of the participants in the position. For example, a fund based

    on a commodity index may qualify for the exemption but the entity

    operating the fund may not know the identities of the owners of

    outstanding shares and, therefore, may not know when any given

    person had acquired a 25% or more interest in the position held by

    the fund.

    ---------------------------------------------------------------------------

    C. Questions

    The Commission would welcome public comments on any aspect of the

    proposed risk management exemption from Federal speculative position

    limits. However, the Commission is particularly interested in the views

    of commenters on the following specific questions:

    (1) Are any of the proposed conditions for receiving a risk

    management exemption unnecessary and, if so, why? Alternatively, should

    any of the proposed conditions be modified and, if so, why?

    (2) Should any other conditions, in addition to those set out in

    these proposed rules, be imposed as a prerequisite for receiving a risk

    management exemption? If so, what is the rationale for such additional

    conditions (i.e., what potential harm would they address)?

    (3) Is there any type of index-based trading that should be covered

    by the proposed rules, but is not? If so, how should the proposed rules

    be revised to apply to such trading?

    (4) The proposed rules would allow for a risk management exemption

    in the case of short-only futures or futures equivalent positions used

    to manage risks in connection with a ``bear market index.'' Would any

    of the exemptive rules, as proposed, create potential problems as

    applied to such an index? For example, in applying the definition of

    ``unleveraged position,'' would problems be encountered in comparing

    the notional value of an unleveraged short futures position to the

    value of the cash, margins and accrued profits on such position?

    (5) Should the proposed rules impose any restrictions or conditions

    regarding how broad- or narrow-based an index should be if a position

    based on the index is to qualify for an exemption? For example, with

    respect to narrow-based indices reflecting specific industry or

    commodity sectors, should the Commission be concerned that a narrow-

    based index composed entirely of agricultural commodities--for example,

    25% each of corn, wheat, oats and soybeans--could operate as a

    mechanism for evading speculative position limits in one or more of

    those commodities?

    (6) The proposed rules list the information that must be provided

    in an application for a risk management exemption. Are the requirements

    set out in the proposed rules appropriate? Should the requirements be

    revised and, if so, how?

    III. Related Matters

    A. Cost Benefit Analysis

    Section 15(a) of the Act requires the Commission to consider the

    costs and benefits of its action before issuing a new regulation under

    the Act. By its terms, section 15(a) does not require the Commission to

    quantify the costs and benefits of a new regulation or to determine

    whether the benefits of the proposed regulation outweigh its costs.

    Rather, section 15(a) requires the Commission to ``consider the costs

    and benefits'' of the subject rule.

    Section 15(a) further specifies that the costs and benefits of the

    proposed rule shall be evaluated in light of five broad areas of market

    and public concern: (1) Protection of market participants and the

    public; (2) efficiency, competitiveness, and financial integrity of

    futures markets; (3) price discovery;

    [[Page 66102]]

    (4) sound risk management practices; and (5) other public interest

    considerations. The Commission may, in its discretion, give greater

    weight to any one of the five enumerated areas of concern and may, in

    its discretion, determine that, notwithstanding its costs, a particular

    rule is necessary or appropriate to protect the public interest or to

    effectuate any of the provisions or to accomplish any of the purposes

    of the Act.

    The proposed rules would provide for a risk management exemption

    from the Federal speculative position limits applicable to certain

    agricultural commodities, thus giving entities such as index funds and

    pension funds an opportunity to more effectively manage risks for their

    investors through greater diversification of their portfolios. The

    rules would seek to protect the futures markets from potential ill

    effects of such risk management positions by imposing conditions on the

    exemption and creating an application process (including a requirement

    to file updates as necessary) to assure those conditions are met. The

    Commission, in proposing these rules, has endeavored to impose the

    minimum requirements necessary consistent with its mandate to protect

    the markets and the public from ill effects.

    The Commission specifically invites public comment on its

    application of the cost benefits criteria of the Act. Commenters are

    also invited to submit any quantifiable data that they may have

    concerning the costs and benefits of the proposed rules with their

    comment letter.

    B. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,

    requires Federal agencies, in proposing rules, to consider the impact

    of those rules on small businesses. The Commission believes that the

    proposed rule amendments to implement a new exemption from Federal

    speculative position limits would only affect large traders. The

    Commission has previously determined that large traders are not small

    entities for the purposes of the RFA.\13\ Therefore, the Chairman, on

    behalf of the Commission, hereby certifies, pursuant to 5 U.S.C.

    605(b), that the action taken herein will not have a significant

    economic impact on a substantial number of small entities.

    ---------------------------------------------------------------------------

    \13\ 47 FR 18618 (April 30, 1982).

    ---------------------------------------------------------------------------

    C. Paperwork Reduction Act

    When publishing proposed rules, the Paperwork Reduction Act of 1995

    (44 U.S.C. 3507(d)) imposes certain requirements on Federal agencies

    (including the Commission) in connection with their conducting or

    sponsoring any collection of information as defined by the Paperwork

    Reduction Act. In compliance with the Act, the Commission, through this

    rule proposal, solicits comment to: (1) Evaluate whether the proposed

    collection of information is necessary for the proper performance of

    the functions of the agency, including the validity of the methodology

    and assumptions used; (2) evaluate the accuracy of the agency's

    estimate of the burden of the proposed collection of information

    including the validity of the methodology and assumptions used; (3)

    enhance the quality, utility and clarity of the information to be

    collected; and (4) minimize the burden of the collection of the

    information on those who are to respond through the use of appropriate

    automated, electronic, mechanical, or other technological collection

    techniques or other forms of information technology, e.g., permitting

    electronic submission of responses.

    The Commission has submitted the proposed rule and its associated

    information collection requirements to the Office of Management and

    Budget (``OMB'') for its review.

    Collection of Information: Rules Establishing Risk Management

    Exemption From Federal Speculative Position Limits, OMB Control Number.

    The estimated burden was calculated as follows:

    Estimated number of respondents: 6.

    Annual responses by each respondent: 1.

    Total annual responses: 6.

    Estimated average hours per response: 10.

    Annual reporting burden: 60 hours.

    List of Subjects in 17 CFR Part 150

    Agricultural commodities, Bona fide hedge positions, Position

    limits, Spread exemptions.

    In consideration of the foregoing, pursuant to the authority

    contained in the Commodity Exchange Act, the Commission hereby proposes

    to amend part 150 of chapter I of title 17 of the Code of Federal

    Regulations as follows:

    PART 150--LIMITS ON POSITIONS

    1. The authority citation for part 150 is revised to read as

    follows:

    Authority: 7 U.S.C. 6a, 6c, and 12a(5), as amended by the

    Commodity Futures Modernization Act of 2000, Appendix E of Pub. L.

    106-554, 114 Stat. 2763 (2000).

    2. Section 150.1 is amended by adding new paragraphs (j) through

    (m) to read as follows:

    Sec. 150.1 Definitions.

    * * * * *

    (j) Risk management position, for the purposes of an exemption

    under Sec. 150.3(a)(2), means a futures or futures equivalent

    position, held as part of a broadly diversified portfolio of long-only

    or short-only futures or futures equivalent positions, that is based

    upon either:

    (1) A fiduciary obligation to match or track the results of a

    broadly diversified index that includes the same commodity markets in

    fundamentally the same proportions as the futures or futures equivalent

    position; or

    (2) A portfolio diversification plan that has, among other

    substantial asset classes, an exposure to a broadly diversified index

    that includes the same commodity markets in fundamentally the same

    proportions as the futures or futures equivalent position.

    (k) Broadly diversified index means an index based on physical

    commodities in which:

    (1) Not more than 15% of the index is composed of any single

    agricultural commodity named in Sec. 150.2 (for which purposes, wheat

    shall be regarded as a single commodity, so that positions in all

    varieties of wheat, on all exchanges combined, may not exceed 15% of

    the index, and the soybean complex shall be regarded as a single

    commodity, so that positions in soybeans, soybean oil and soybean meal,

    on all exchanges combined, may not exceed 15% of the index); and

    (2) Not more than 50% of the index as a whole is composed of

    agricultural commodities named in Sec. 150.2.

    (l) Passively managed position means a futures or futures

    equivalent position that is part of a portfolio that tracks a broadly

    diversified index, which index is calculated, adjusted, and re-weighted

    pursuant to an objective, predetermined mathematical formula the

    application of which allows only limited discretion with respect to

    trading decisions.

    (m) Unleveraged position means:

    (1) A futures or futures equivalent position that is part of a

    portfolio of futures or futures equivalent positions directly relating

    to an underlying broadly diversified index, the notional value of which

    positions does not exceed the sum of the value of:

    (i) Cash set aside in an identifiable manner, or unencumbered

    short-term U.S. Treasury obligations so set aside, plus any funds

    deposited as margin on such position; and

    [[Page 66103]]

    (ii) Accrued profits on such position held at the futures

    commission merchant.

    (2) [Reserved]

    3. Section 150.3 is amended by revising paragraph (a) introductory

    text, adding a new paragraph (a)(2), and adding a new paragraph (c) to

    read as follows:

    Sec. 150.3 Exemptions.

    (a) Positions which may exceed limits. The position limits set

    forth in Sec. 150.2 of this part may be exceeded to the extent such

    positions are established and liquidated in an orderly manner and are:

    * * * * *

    (2) Risk management positions, as defined in Sec. 150.1(j), that

    fulfill the following requirements:

    (i) Such risk management positions must comply with the following

    conditions:

    (A) The positions must be passively managed;

    (B) The positions must be unleveraged; and

    (C) The positions must not be carried into the spot month.

    (ii) Entities intending to hold risk management positions pursuant

    to the exemption in Sec. 150.3(a)(2) must apply to the Commission and

    receive Commission approval. Such applications must include the

    following information:

    (A) In the case of an exemption based on a fiduciary obligation, as

    described in Sec. 150.1(j)(1), an application must include:

    (1) A description of the underlying index or group of commodities,

    including the commodities, the weightings, the method and timing of re-

    weightings, the selection of futures months, and the timing and

    criteria for rolling from one futures month to another;

    (2) A description of the ``fiduciary obligation;''

    (3) The actual or anticipated value of the underlying funds to be

    invested in commodities within the next fiscal or calendar year and the

    method for calculating that value, as well as the equivalent numbers of

    futures contracts in each of the Sec. 150.2 markets for which the

    exemption is sought;

    (4) A description of the manner in which the funds to be invested

    in commodities will be set aside;

    (5) A statement certifying that the requirements of this exemption

    are met and will be observed at all times going forward and that the

    Commission will be notified promptly of any material changes in this

    information; and

    (6) Such other information as the Commission may request.

    (B) In the case of an exemption based on a portfolio

    diversification plan, as described in Sec. 150.1(j)(2), an application

    must include:

    (1) A description of the investment index or group of commodities,

    including the commodities, the weightings, the method and timing of re-

    weightings, the selection of futures months, and the timing and

    criteria for rolling from one futures month to another;

    (2) A description of the entire portfolio, including the total size

    of the assets, the asset classes making up the portfolio, and a

    description of the allocation among the asset classes;

    (3) The actual or anticipated value of the underlying funds to be

    invested in commodities and the method for calculating that value, as

    well as the equivalent numbers of futures contracts in each of the

    Sec. 150.2 markets for which the exemption is sought;

    (4) A description of the manner in which the funds to be invested

    in commodities will be set aside;

    (5) A statement certifying that the requirements of this exemption

    are met and will be observed at all times going forward and that the

    Commission will be notified promptly of any material changes in this

    information; and

    (6) Such other information as the Commission may request.

    (iii) Whenever the purchases or sales that a person wishes to

    qualify under this risk management exemption shall exceed the amount

    provided in the person's most recent filing pursuant to this section,

    or the amount previously specified by the Commission pursuant to this

    section, such person shall file with the Commission a statement that

    updates the information provided in the person's most recent filing and

    provides the reasons for this change. Such statement shall be filed at

    least ten business days in advance of the date that such person wishes

    to exceed those amounts and if the notice filer is not notified

    otherwise by the Commission within the 10-day period, the exemption

    will continue to be effective. The Commission may, upon call, obtain

    such additional materials from the applicant or person availing

    themselves of this exemption as the Commission deems necessary to

    exercise due diligence with respect to granting and monitoring this

    exemption.

    (iv) Entities holding risk management positions pursuant to the

    exemption in Sec. 150.3(a)(2) shall immediately report to the

    Commission in the event that they know, or have reason to know, that

    any person holds a greater than 25% interest in such position.

    * * * * *

    (c) The Commission hereby delegates, until such time as the

    Commission orders otherwise, to the Director of the Division of Market

    Oversight, or the Director's designee, the functions reserved to the

    Commission in Sec. 150.3(a)(2) of this chapter.

    Issued by the Commission this 20th day of November, 2007, in

    Washington, DC.

    David Stawick,

    Secretary of the Commission.

    [FR Doc. E7-22992 Filed 11-26-07; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: November 27, 2007



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