2011-28809-1
Federal Register, Volume 76 Issue 223 (Friday, November 18, 2011)[Federal Register Volume 76, Number 223 (Friday, November 18, 2011)]
[Rules and Regulations]
[Pages 71626-71706]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-28809]
[[Page 71625]]
Vol. 76
Friday,
No. 223
November 18, 2011
Part II
Commodity Futures Trading Commission
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17 CFR Parts 1, 150 and 151
Position Limits for Futures and Swaps; Final Rule and Interim Final
Rule
Federal Register / Vol. 76, No. 223 / Friday, November 18, 2011 /
Rules and Regulations
[[Page 71626]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 150 and 151
RIN 3038-AD17
Position Limits for Futures and Swaps
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule and interim final rule.
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SUMMARY: On January 26, 2011, the Commodity Futures Trading Commission
(``Commission'' or ``CFTC'') published in the Federal Register a notice
of proposed rulemaking (``proposal'' or ``Proposed Rules''), which
establishes a position limits regime for 28 exempt and agricultural
commodity futures and options contracts and the physical commodity
swaps that are economically equivalent to such contracts. The
Commission is adopting the Proposed Rules, with modifications.
DATES: Effective date: The effective date for this final rule and the
interim rule at Sec. 151.4(a)(2) is January 17, 2012.
Comment date: The comment period for the interim final rule will
close January 17, 2012.
Compliance dates: For compliance dates for these final rules, see
SUPPLEMENTARY INFORMATION.
FOR FURTHER INFORMATION CONTACT: Stephen Sherrod, Senior Economist,
Division of Market Oversight, at (202) 418-5452, [email protected]; B.
Salman Banaei, Attorney, Division of Market Oversight, at (202) 418-
5198, [email protected], Neal Kumar, Attorney, Office of General
Counsel, at (202) 418-5353, [email protected], Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street NW., Washington,
DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
A. Introduction
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act (``Dodd-Frank Act'').\1\ Title VII
of the Dodd-Frank Act \2\ amended the Commodity Exchange Act (``CEA'')
\3\ to establish a comprehensive new regulatory framework for swaps and
security-based swaps. The legislation was enacted to reduce risk,
increase transparency, and promote market integrity within the
financial system by, among other things: (1) Providing for the
registration and comprehensive regulation of swap dealers and major
swap participants; (2) imposing clearing and trade execution
requirements on standardized derivative products; (3) creating robust
recordkeeping and real-time reporting regimes; and (4) enhancing the
Commission's rulemaking and enforcement authorities with respect to,
among others, all registered entities and intermediaries subject to the
Commission's oversight.
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
\2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\3\ 7 U.S.C. 1 et seq.
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As amended by the Dodd-Frank Act, section 4a(a)(2) of the CEA
mandates that the Commission establish position limits for futures and
options contracts traded on a designated contract market (``DCM'')
within 180 days from the date of enactment for exempt commodities and
270 days from the date of enactment for agricultural commodities.\4\
Under section 4a(a)(5), Congress required the Commission to
concurrently establish limits for swaps that are economically
equivalent to such futures or options contracts traded on a DCM. In
addition, the Commission must establish aggregate position limits for
contracts based on the same underlying commodity that include, in
addition to the futures and options contracts: (1) Contracts listed by
DCMs; (2) swaps that are not traded on a registered entity but which
are determined to perform or affect a ``significant price discovery
function''; and (3) foreign board of trade (``FBOT'') contracts that
are price-linked to a DCM or swap execution facility (``SEF'') contract
and made available for trading on the FBOT by direct access from within
the United States.
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\4\ Section 1a(20) of the CEA defines the term ``exempt
commodity'' to mean a commodity that is not an excluded or an
agricultural commodity. 7 U.S.C. 1a(20). Section 1a(19) defines the
term ``excluded commodity'' to mean, among other things, an interest
rate, exchange rate, currency, credit risk or measure, debt or
equity instrument, measure of inflation, or other macroeconomic
index or measure. 7 U.S.C. 1a(19). Although the CEA does not
specifically define the term ``agricultural commodity,'' section
1a(9) of the CEA, 7 U.S.C. 1a(9), enumerates a non-exclusive list of
agricultural commodities, and the Commission recently added section
1.3(zz) to the Commission's regulations defining the term
``agricultural commodity.'' See 76 FR 41048, Jul. 13, 2011.
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To implement the expanded mandate under the Dodd-Frank Act, the
Commission issued Proposed Rules that would establish federal position
limits and limit formulas for 28 physical commodity futures and option
contracts (``Core Referenced Futures Contracts'') and physical
commodity swaps that are economically equivalent to such contracts
(collectively, ``Referenced Contracts'').\5\ The Commission also
proposed aggregate position limits that would apply across different
trading venues to contracts based on the same underlying commodity. In
addition to developing position limits for the Referenced Contracts,
the Proposed Rules would implement a new statutory definition of bona
fide hedging transactions, revise the standards for aggregation of
positions, and establish position visibility reporting requirements.
The Proposed Rules would require DCMs and SEFs that are trading
facilities to set position limits for exempt and agricultural commodity
contracts and establish acceptable practices for position limits and
position accountability rules in other commodities.
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\5\ See Position Limits for Derivatives, 76 FR 4752, 4753 Jan.
26, 2011. Specifically, the Commission proposed to withdraw its part
150 regulations, which set out the current position limit and
aggregation policies, and replace them with new part 151
regulations.
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B. Overview of Public Comments
The Commission received 15,116 comments from a broad range of the
industry and other interested persons, including DCMs, trade
organizations, banks, investment companies, commercial end-users,
academics, and the general public. Of the total comments received,
approximately 100 comment letters provided detailed comments and
recommendations concerning whether, and how, the Commission should
exercise its authority to set position limits pursuant to amended
section 4a, as well as other specific aspects of the proposal. The
majority of the over 15,000 comment letters received were generally
supportive of the proposal. Many urged the Commission promptly to
``restore balance to commodities markets.'' \6\ On the other hand,
approximately 55 commenters requested that the Commission either
significantly alter or withdraw the proposal. The Commission considered
all of the comments received in formulating the final regulations.
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\6\ See e.g., Letter from Professor Greenberger, University of
Maryland School of Law on March 28, 2011 (``CL-Prof. Greenberger'')
at 6-7; and Petroleum Marketers Association of America (``PMAA'')
and New England Fuel Institute (``NEFI'') on March 28, 2011 (``CL-
PMAA/NEFI'') at 5. Also, over 6,000 comment letters urged the
Commission to ``act quickly'' to adopt position limits.
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[[Page 71627]]
II. The Final Rules
A. Statutory Framework
In the proposal, the Commission provided general background on the
scope of its statutory authority under section 4a (as amended by the
Dodd-Frank Act), together with the related legislative history, in
support of the Proposed Rules.\7\ Many commenters responded with their
views and interpretations of the Commission's mandate under the CEA,
and in particular whether the Commission must first make findings that
position limits are ``necessary'' to diminish, eliminate, or prevent
undue burdens on interstate commerce resulting from excessive
speculation before imposing them.\8\
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\7\ A more detailed background on the statutory and legislative
history is provided in the proposal. See 76 FR at 4753-4755.
\8\ See e.g., CME Group, Inc. (``CME I'') on March 28, 2011
(``CL-CME I'') at 4, 7.
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As discussed in the proposal, CEA section 4a states that
``excessive speculation'' in any commodity traded on a futures exchange
``causing sudden or unreasonable fluctuations or unwarranted changes in
the price of such commodity is an undue and unnecessary burden on
interstate commerce'' and directs the Commission to establish such
limits on trading ``as the Commission finds necessary to diminish,
eliminate, or prevent such burden.'' \9\ This basic statutory mandate
has remained unchanged since its original enactment in 1936 and through
subsequent amendments to section 4a, including the Dodd-Frank Act.\10\
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\9\ See section 4a(a)(1) of the CEA, 7 U.S.C. 6a(a)(1).
\10\ As further detailed in the Proposed Rules, this long-
standing statutory mandate is based on Congressional findings that
market disruptions can result from excessive speculative trading. In
the 1920s and into the 1930s, a series of studies and reports found
that large speculative positions in the futures markets for grain,
even without manipulative intent, can cause ``disturbances'' and
``wild and erratic'' price fluctuations. To address such market
disturbances, Congress was urged to adopt position limits to
restrict speculative trading notwithstanding the absence of
manipulation. In 1936, based upon such reports and testimony,
Congress provided the Commodity Exchange Authority (the predecessor
of the Commission) with the authority to impose Federal speculative
position limits. In doing so, Congress expressly observed the
potential for market disruptions resulting from excessive
speculative trading alone and the need for measures to prevent or
minimize such occurrences. This mandate and underlying Congressional
determination of its need has been re-affirmed through successive
amendments to the CEA. See 76 FR at 4754-55.
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In section 737 of the Dodd-Frank Act, Congress made major changes
to CEA section 4a; among other things, Congress extended the
Commission's reach to the heretofore unregulated swaps market.\11\ In
doing so, Congress reinforced and reaffirmed the Commission's broad
authority to set position limits to prevent undue and unnecessary
burdens associated with excessive speculation. Specifically, section
4a, as amended by the Dodd-Frank Act, provides that the Commission
``shall'' set position limits ``as appropriate'' and ``to the maximum
extent practicable, in its discretion'' in order to protect against
excessive speculation and manipulation while ensuring that the markets
retain sufficient liquidity for bona fide hedgers and that their price
discovery functions are not disrupted.\12\ Further, the Dodd-Frank Act
amended the CEA to direct the Commission to define the relevant factors
to be considered in identifying swaps that serve a ``significant price
discovery'' function and thus become subject to position limits.\13\
Congress also authorized the Commission to exempt persons or
transactions ``conditionally or unconditionally'' from position
limits.\14\
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\11\ In particular, Congress expanded the scope of transactions
that could be subject to position limits to include swaps traded on
a DCM or SEF, and swaps not traded on a DCM or SEF, but that perform
or affect a significant price discovery function with respect to
registered entities. See section 4a(a)(1) of the CEA, 7 U.S.C.
6a(a)(1). Congress also directed the Commission to establish
aggregate limits on the amount of positions held in the same
underlying commodity across markets for DCM contracts, FBOTs (with
respect to certain linked contracts) and swaps that perform a
``significant price discovery function.'' section 4a(a)(6) of the
CEA, 7 U.S.C. 6a(a)(6).
\12\ See sections 4a(a)(3) to 4a(a)(5) of the CEA, 7 U.S.C.
6a(a)(3) to 6a(a)(5). Additionally, new section 4a(a)(2)(c) states
that, in establishing limits, the Commission ``shall strive to
ensure'' that FBOTs trading in the same commodity will be subject to
``comparable'' limits and that any limits imposed by the Commission
will not cause the price discovery in the commodity to shift to
FBOTs.
\13\ See section 4a(a)(4) of the CEA, 7 U.S.C. 6a(a)(4).
\14\ See section 4a(a)(7) of the CEA, 7 U.S.C. 6a(a)(7).
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In reaffirming the Commission's broad authority to set position
limits, Congress also made clear that the Commission must impose them
expeditiously. Under amended section 4a(a)(2), Congress directed that
the Commission ``shall'' establish limits on the amount of positions,
as appropriate, that may be held by any person in physical commodity
futures and options contracts traded on a DCM. In section 4a(a)(5),
Congress directed the Commission to establish, concurrently with the
limits established under section 4a(a)(2), limits on the amount of
positions, as appropriate, that may be held by any person with respect
to swaps that are economically equivalent to the DCM contracts subject
to the required limits under section 4a(a)(2). The Commission was
directed to establish the limits within 180 days after enactment for
exempt commodities and 270 days after enactment for agricultural
commodities.
As discussed in the proposal, the Commission construes the amended
CEA to mandate the Commission to impose position limits at the level it
determines to be appropriate to diminish, eliminate, or prevent
excessive speculation and market manipulation.\15\ In setting such
limits, the Commission is not required to find that an undue burden on
interstate commerce resulting from excessive speculation exists or is
likely to occur. Nor is the Commission required to make an affirmative
finding that position limits are necessary to prevent sudden or
unreasonable fluctuations in prices. Instead, the Commission must set
position limits prophylactically, according to Congress' mandate in
section 4a(a)(2), and, in establishing the limits Congress has
required, exercise its discretion to set a limit that, to the maximum
extent practicable, will, among other things, ``diminish, eliminate, or
prevent excessive speculation.'' \16\
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\15\ See 76 FR at 4754.
\16\ Section 4a(a)(3)(B)(i) of the CEA, 7 U.S.C. 6a(a)(3)(B)(i).
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Commenters were divided on the scope of the Commission's authority
under CEA section 4a. A number of commenters supported the view that
the Dodd-Frank Act, in extending the Commission's authority to swaps,
imposed on the Commission a mandatory obligation to impose position
limits.\17\ For example, Professor Michael Greenberger stated that
``[s]ection 737 emphatically provides that the Commission `shall by
rule, regulation, or order establish limits on the amount of positions,
as appropriate, other than bona fide hedge positions that may be held
by any person[.]' The language could not be clearer. The Commission is
required to establish position limits as Congress intentionally used
the word, `shall,' to impose the mandatory obligation.'' \18\ Professor
Greenberger further noted, ``the plain reading of the phrase `as
appropriate' modifies only those position limits mandated to be
imposed, i.e., the mandatory position limits must be promulgated `as
appropriate.' The term `as appropriate' does not modify the heavily
emphasized
[[Page 71628]]
mandate that there `shall' be position limits.'' \19\
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\17\ See e.g., American Public Gas Association (``APGA'') on
March 28, 2011 (``CL-APGA'') at 2-3; Americans for Financial Reform
(``AFR'') on March 28, 2011 (``CL-AFR'') at 5; U.S. Senator Harkin
on December 15, 2010 (``CL-Sen. Harkin''). See also CL-PMAA/NEFI
supra note 6 at 4-5.
\18\ CL-Prof. Greenberger supra note 6 at 4 (emphasis added).
\19\ Id. at 5. In addition, Professor Greenberger noted that
Section 719 of the Dodd-Frank Act specifically requires the
Commission `to conduct a study of the effects of the position limits
imposed pursuant to the other provisions of this title on excessive
speculation and on the movement of transactions.' The Commission is
required to submit the report `within 12 months after the imposition
of position limits pursuant to the other provisions of this title.'
Why would Congress specifically require the Commission to submit a
report after imposing position limits if it had provided by statute
(as opponents of position limits mistakenly argue) that the data
must be available before the position limit rule is finally
promulgated? The short answer is that Congress clearly understood
the imminent danger excessive speculation and passive betting on
price direction had caused by uncontrollable increases in the prices
of energy and agricultural commodities. Therefore, the Commission is
statutorily obligated to impose the `appropriate' position limits.
Id. at 6-7.
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Other commenters expressed similar views, asserting that the
Commission is not required to demonstrate price fluctuations caused by
excessive speculation or the efficacy of position limits in reducing
excessive speculation or market manipulation. The Petroleum Marketers
Association of America and the New England Fuel Institute (``PMAA/
NEFI'') in a joint comment letter argued, for example, that
the purpose of position limits is not to punish past wrongdoing, but
rather to deter and prevent potential future dysfunctions in the
commodity staples derivatives markets and to prevent harm to market
participants and burdens on interstate commerce. Because the purpose
of position limits is to prevent future violations, the Commission
should not be required to appreciate the complete and precise level
of excessive speculation prior to taking action.''\20\
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\20\ CL-PMAA/NEFI supra note 6 at 5. See also Delta Airlines,
Inc. (``Delta'') on March 28, 2011 (``CL-Delta'') at 11. Delta
believes that the Commission should instead strive to establish
meaningful speculative position limits using sampling and other
statistical techniques to make reasonable, working assumptions about
positions in various market segments and refining the speculative
limits based upon market experience and better data as it is
developed. See also CL-Sen. Harkin supra note 17 at 1 (opposing any
delay in the implementation of position limits); and 56 National
coalitions and organizations and 28 International coalitions and
organizations from 16 countries (``ICPO'') on March 28, 2011 (``CL-
ICPO'') at 1 (stating that the proposal regarding position limits
should be implemented fully).
On the other hand, numerous commenters posited that the Commission
did not adequately demonstrate, or perform sufficient analysis
establishing, the need for or appropriateness of the proposed limits
and related requirements.\21\ For example, according to the CME Group,
Inc. (``CME''),
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\21\ See e.g., CL-CME I supra note 8; Commodity Markets Council
(``CMC'') on March 28, 2011 (``CL-CMC''); PIMCO on March 28, 2011
(``CL-PIMCO''); Edison Electric Institute (``EEI'') and Electric
Power Supply Association (``EPSA'') on March 28, 2011 (``CL-EEI/
EPSA''); BlackRock, Inc. (``BlackRock'') on March 28, 2011 (``CL-
BlackRock''); International Working Group on Trade-Finance Linkages
(``IWGTFL'') on March 28, 2011(``CL-IWGTFL''); Coalition of Physical
Energy Companies (``COPE'') on March 28, 2011 (``CL-COPE''); Utility
Group on March 28, 2011 (``CL-Utility Group'');ISDA/SIFMA on March
28, 2011 (``CL-ISDA/SIFMA''); Futures Industry Association (``FIA
I'') on March 25, 2011 (``CL-FIA I''); Katten Muchin Rosenman LLP
(``Katten'') on March 31, 2011 (``CL-Katten''); Colorado Public
Employees' Retirement (``PERA'') on March28, 2011 (``CL-PERA'');
American Petroleum Institute (``API'') on March 28, 2011 (``CL-
API''); Sullivan & Cromwell LLP (``Centaurus Energy'') on March 28,
2011 (``CL-Centaurus Energy''); ICI on March 28, 2011 (``CL-ICI'');
Morgan Stanley on March 28, 2011 (``CL-Morgan Stanley''); Asset
Management Group (``AMG''), Securities Industry and Financial
Markets Association (``SIFMA'') on April 5, 2011(``CL-SIFMA AMG
I''); World Gold Council (``WGC'') on March 28, 2011 (``CL-WGC'');
and Managed Funds Association (``MFA'') on March 28, 2011 (``CL-
MFA'').
the CEA sets up a two-pronged approach for imposing limits on
speculative positions. First, [under CEA section 4a(a)(1)] the
Commission must `find' that any position limits are `necessary'--a
directive that Congress reaffirmed in [the Dodd-Frank Act]. Second,
once the Commission makes the `necessary' finding, [CEA sections
4a(a)(2)(A) and 4a(a)(3) provide that the Commission] must establish
a particular position limit regime only `as appropriate'--a
statutory requirement added by Dodd-Frank.''\22\
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\22\ CME argued the Commission's interpretation of section
4a(a)(1) of the CEA would render the ``as the Commission finds are
necessary'' language a nullity, effectively replacing it with
statutory language imposing a lower threshold than is found
elsewhere in the CEA. See CL-CME I supra note 8 at 3, citing Keene
Corp. v. United States, 508 U.S. 200, 208 (1993) (``where Congress
includes particular language in one section of a statute but omits
it in another * * *, it is generally presumed that Congress acts
intentionally and purposely in the disparate inclusion or
exclusion'' quoting Russello v. United States, 464 U.S. 16, 23
(1983).
In this connection, CME and many other commenters asserted that because
the Commission did not make a finding that position limits are
necessary to prevent undue burdens on interstate commerce resulting
from excessive speculation, it did not satisfy the pre-condition to
establishing position limits.
Some of these commenters, such as the International Swaps and
Derivatives Association and the Securities Industry and Financial
Markets Association (``ISDA/SIFMA'') (in a joint comment letter) and
the Futures Industry Association (``FIA''), argued that the Commission
is directed to set position limits ``as appropriate,'' and ``as
appropriate'' requires empirical evidence demonstrating that such
limits would diminish, eliminate, or prevent excessive speculation. FIA
claimed that in the absence of evidence concerning the impact of
excessive speculation, it would be impossible to set position limits
that comply with the statutory objectives of section 4a(a)(3).
Similarly, Centaurus Energy Master Fund, LP (``Centaurus'') and ISDA/
SIFMA commented that the ``as appropriate'' language in section
4a(a)(2)(A) requires factual support before imposing position limits,
and that ``the imposition of position limits `prophylactically' is not
mandated by Dodd-Frank and is not supported by the facts.'' \23\
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\23\ CL-ISDA/SIFMA, supra note 21 at 3; and CL-Centaurus Energy,
supra note 21 at 2. See also CL-COPE supra note 21 at 2-3; and CL-
Utility Group supra note 21 at 3. Along similar lines, COPE and the
Utility Group opined that ``the deadline of 180 days after the date
of enactment in clause (B)(i) is only triggered upon a determination
that such limits are appropriate. Congress unambiguously modified
the word `shall' with the requirement that limits only be
established `as appropriate.'' Id.
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CME also contended that imposing position limits on ``economically
equivalent swaps'' would be counter to Dodd-Frank because it will
encourage market participants to enter into bespoke, uncleared, non-DCM
or SEF-traded swaps.\24\ Finally, CME and other commenters, suggested
that position limits and position accountability levels should be set
and administered by futures exchanges.
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\24\ CL-CME I, supra note 8 at 11.
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Upon careful consideration of the commenters' views, the Commission
reaffirms its interpretation of amended section 4a. The Commission
disagrees that it must first determine that position limits are
necessary before imposing them or that it may set limits only after it
has conducted a complete study of the swaps market. Congress did not
give the Commission a choice. Congress directed the Commission to
impose position limits and to do so expeditiously.\25\ Section
4a(a)(2)(B) states that the limits for physical commodity futures and
options contracts ``shall'' be established within the specified
timeframes, and section 4a(a)(2)(5) states that the limits for
economically equivalent swaps ``shall'' be established concurrently
with the limits required by section 4a(a)(2). The congressional
directive that the Commission set position limits is further reflected
in the repeated references to the limits ``required'' under section
4a(a)(2)(A).\26\ Section 4a(a)(6) similarly states, without
qualification, that the Commission ``shall'' establish aggregate
position
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limits.\27\ While some commenters seize on the phrase ``as
appropriate,'' which appears in sections 4a(a)(2)(A), 4a(a)(3), and
4a(a)(5), that phrase, when considered in the context of the position
limits provisions as a whole, is most sensibly read as directing the
Commission to exercise its discretion in determining the extent of the
limits that Congress required the Commission to impose.\28\
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\25\ See also CL-Sen. Harkin, supra note 17 at 1 (opposing any
delay in the implementation of position limits); and CL-ICPO, supra
note 20 at 1 (stating that the Proposed Rules regarding position
limits should be implemented fully).
\26\ See sections 4a(a)(2)(B)(i)-(ii), 4a(a)(2)(C), and 4a(a)(3)
of the CEA, 7 U.S.C. 6a(a)(2)(B)(i)-(ii), 6a(a)(2)(C), 6a(a)(3).
\27\ Section 4a(a)(6) of the CEA directs the Commission to
impose aggregate limits for contracts based on the same underlying
commodity across: (a) DCM contracts, (b) FBOT contracts offered via
direct access from inside the United States that are linked to
contracts listed on a registered entity; and (c) swap contracts that
perform or affect a significant price discovery function (``SPDF'')
with respect to registered entities. 7 U.S.C. 6a(a)(6). Although the
scope of SPDF swaps is currently limited to economically equivalent
swaps discussed herein, the Commission intends to address in a
subsequent rulemaking, as was discussed in the proposal, a process
by which SPDF swaps can be identified. See Position Limits for
Derivatives, 76 FR 4752, 4753, Jan. 26, 2011.
\28\ Section 719 of the Dodd-Frank Act requires the Commission
to submit a report on the effects of the position limits imposed
pursuant to the other provisions of this title. Such a provision
gives further support to the Commission's view that Congress
mandated that the Commission impose position limits, setting levels
as appropriate, because the reporting requirement presupposes that
limits will be imposed. Congress did not intend the Commission to
have to demonstrate that such limits are ``necessary'' or that
position limits in general are ``appropriate'' before imposing them
and reporting on their operation. See also CL-Prof. Greenberger
supra note 6 at 6-7.
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In accordance with the statutory mandate, the Commission has
established position limits and has exercised its discretion to set
position limit levels to further the congressional objectives set out
in section 4a(a)(3)(B) based upon the Commission's experience with
existing position limits.\29\ In adding section 4a(a)(3)(B), Congress
reaffirmed the Commission's broad discretion to fix position limit
levels (and to adopt related requirements) aimed at combating excessive
speculation and market manipulation, while also protecting market
liquidity (for bona fide hedgers) and price discovery. The provision
reflects the Commission's historical approach to setting position
limits, and it is consistent with the longstanding congressional
directive in section 4a(a)(1) that the Commission set position limits
in its discretion to prevent or minimize burdens that could result from
excessive speculative trading.\30\
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\29\ The Commission has applied those limits to specified
Referenced Contracts based on their high levels of open interest and
significant notional value or their capacity to serve as a reference
price for a significant number of cash market transactions.
\30\ Consistent with the congressional findings and objectives,
the Commission has previously set position limits without finding
excessive speculation or an undue burden on interstate commerce, and
in so doing has expressly stated that such additional determinations
by the Commission were not necessary in light of the congressional
findings in section 4a of the Act. In its 1981 rulemaking to require
all exchanges to adopt position limits for commodities for which the
Commission itself had not established limits, the Commission stated,
in response to similar comments that it had not made any factual
determinations that excessive speculation had occurred or
analytically demonstrated that the proposed limits were necessary to
prevent excessive speculation in the future:
[T]he prevention of large or abrupt price movements which are
attributable to the extraordinarily large speculative positions is a
congressionally endorsed regulatory objective of the Commission.
Further, it is the Commission's view that this objective is enhanced
by the speculative position limits since it appears that the
capacity of any contract to absorb the establishment and liquidation
of large speculative positions in an orderly manner is related to
the relative size of such positions, i.e., the capacity of the
market is not unlimited.
Establishment of Speculative Position Limits, 46 FR 50938, Oct.
16, 1981 (adopting then Sec. 1.61 (now part of Sec. 150.5)). The
Commission reiterated this point in the proposed rulemaking in early
2010, before enactment of the Dodd-Frank Act. Federal Speculative
Position Limits for Referenced Energy Contracts and Associated
Regulations,75 FR 4144, at 4146, 4148-49, Jan. 26, 2010 (``[t] he
Congressional endorsement [in section 4a] of the Commission's
prophylactic use of position limits rendered unnecessary a specific
finding that an undue burden on interstate commerce had actually
occurred'' because section 4a(a) represents an explicit
Congressional finding that extreme or abrupt price fluctuations
attributable to unchecked speculative positions are harmful to the
futures markets and that position limits can be an effective
prophylactic regulatory tool to diminish, eliminate or prevent such
activity''); withdrawn, 75 FR 50950, Aug. 18, 2010. During the
consideration of the Dodd-Frank Act--as well as in the nearly three
decades since the Commission issued its interpretation of section 4a
in 1981--Congress was aware of the Commission's longstanding
approach to position limits, including its interpretation that the
Commission is not required to make a predicate finding prior to
establishing limits. Congress did not disturb the language under
which the Commission previously acted to impose position limits, and
added new language that makes clear that the types of limits
described in sections 4a(a)(2), (a)(5), and (a)(6) are required.
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In sum, the contention that the Commission is required to
demonstrate that position limits (or position limit levels) are
necessary is contrary not only to the language of, and congressional
objectives underlying, amended section 4a, but also to the regulatory
history of position limits and to the choices Congress made in the
Dodd-Frank Act in light of that history.\31\
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\31\ The Commission also notes that Congress has reauthorized
the Commission several times, both before and after the Commission
established a position limit regime, without making a finding that
position limits were ``necessary'' to combat excessive speculation.
In this regard, Congress was aware of the Commission's historical
interpretation of section 4a and has not elected to amend the
relevant text, including in the Dodd-Frank Act, of that section. If
Congress intended a different interpretation, Congress would have
amended the language of section 4a. See Commodity Futures Trading
Commission v. Schor, 478 U.S. 833, 846 (1986) (``It is well
established that when Congress revisits a statute giving rise to a
longstanding administrative interpretation without pertinent change,
the `congressional failure to revise or repeal the agency's
interpretation is persuasive evidence that the interpretation is the
one intended by Congress''') citing NLRB v. Bell Aerospace Co., 416
U.S. 267, 274-275 (1974).
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For the reasons stated above, and for the reasons provided in the
proposal, the Commission finds that it has authority under CEA section
4a, as amended by the Dodd-Frank Act, to impose the position limits
herein.\32\
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\32\ Some commenters submitted a number of studies and reports
addressing the issue of whether position limits are effective or
necessary to address excessive speculation. For the reasons
explained above, the Commission is not required to make a finding as
to whether position limits are effective or necessary to address
excessive speculation. Accordingly, these studies and reports do not
present facts or analyses that are material to the Commission's
determinations in finalizing the Proposed Rules. A discussion of
these studies is provided in section III A infra.
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B. Referenced Contracts
The Commission identified 28 Core Referenced Futures Contracts and
proposed to apply aggregate limits on a futures equivalent basis across
all derivatives that are (i) Directly or indirectly linked to the price
of a Core Referenced Futures Contract; or (ii) based on the price of
the same underlying commodity for delivery at the same delivery
location as that of a Core Referenced Futures Contract, or another
delivery location having substantially the same supply and demand
fundamentals (such derivative products are collectively defined as
``Referenced Contracts'').\33\ These Core Referenced Futures Contracts
were selected on the basis that such contracts: (1) Have high levels of
open interest and significant notional value; or (2) serve as a
reference price for a significant number of cash market transactions.
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\33\ 76 FR at 4752, 4753. These Core Referenced Futures
Contracts are: Chicago Board of Trade (``CBOT'') Corn, Oats, Rough
Rice, Soybeans, Soybean Meal, Soybean Oil and Wheat; Chicago
Mercantile Exchange Feeder Cattle, Lean Hogs, Live Cattle and Class
III Milk; Commodity Exchange, Inc. Gold, Silver and Copper; ICE
Futures U.S. Cocoa, Coffee C, FCOJ-A, Cotton No.2, Sugar No. 11 and
Sugar No. 16; Kansas City Board of Trade (``KCBT'') Hard Winter
Wheat; Minneapolis Grain Exchange Hard Red Spring Wheat; and New
York Mercantile Exchange Palladium, Platinum, Light Sweet Crude Oil,
New York Harbor No. 2 Heating Oil, New York Harbor Gasoline
Blendstock and Henry Hub Natural Gas.
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Edison Electric Institute and the Electric Power Supply Association
argued that the Commission did not provide a reasoned explanation for
selecting the 28 Referenced Contracts.\34\ Other commenters requested
that the Commission clarify the definition of Referenced Contracts or
restrict it to
[[Page 71630]]
those contracts sharing a common delivery point.\35\
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\34\ CL-EEI/EPSA, supra note 21 at 5.
\35\ Alternative Investment Management Association (``AIMA'') on
March 28, 2011 (``CL-AIMA'') at 2; CL-API supra note 21 at 5; BG
Americas & Global LNG (``BGA'') on March 28, 2011 (``CL-BGA'') at
18; Chris Barnard on March 28, 2011 at 1; CL-COPE supra note 21 at
6; CL-ISDA/SIFMA supra note 21 at 20; Shell Trading (``Shell'') on
March 28, 2011 (``CL-Shell'') at 7-8; CL-Utility Group supra note 21
at 7; and Working Group of Commercial Energy Firms (``WGCEF'') on
March 28, 2011 (``CL-WGCEF'') at 22.
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Some commenters argued that the Commission should narrow the
definition of economically equivalent swaps to cleared swaps.\36\
Conversely, other commenters asked the Commission to broaden its
definition of Referenced Contracts. For example, Better Markets asked
the Commission to consider a ``market-based approach'' to determine
whether to include a contract within a Referenced Contract category,
including hedging relationships used by market participants, cross-
contract netting practices of clearing organizations, enduring price
relationships, and physical characteristics.\37\
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\36\ CL-API, supra note 21 at 13; and CL-BGA, supra note 35 at
18. American Petroleum Institute explained that extending the
definition of ``Referenced Contract'' beyond standardized cleared
contracts would not be cost-effective. Similarly, BGA argued that
because the Commission cannot identify uncleared contracts until
they are executed, the scope of economically equivalent swaps should
be limited to only those that are cleared.
\37\ Better Markets, Inc. (``Better Markets'') on March 28, 2011
(``CL-Better Markets'') at 68-69.
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The Edison Electric Institute and Electrical Power Suppliers
Association opined that the Commission should allow market participants
to define what constitutes an economically equivalent contract
consistent with commercial practices and to allow for a good-faith
exemption for market participants relying on their own determination
consistent with Commission guidance.\38\ ISDA/SIFMA argued that the
Commission should ensure that the concept of an economically equivalent
derivative contract covers contracts whose correlation with futures can
be established through accepted models that address features such as
maturity, payout structure, locations basis, product basis, etc.\39\
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\38\ CL-EEI/EPSA, supra note 21 at 12.
\39\ CL-ISDA/SIFMA supra note 21 at 23.
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The proposed Sec. 151.1 definition of Referenced Contract excluded
basis contracts and commodity index contracts.\40\ Proposed Sec. 151.1
defined basis contract as those contracts that are ``cash settled based
on the difference in price of the same commodity (or substantially the
same commodity) at different delivery points.'' Commodity index
contracts were defined in the proposal as contracts that are ``based on
an index comprised of prices of commodities that are not the same nor
[sic] substantially the same.'' The proposal further excluded
intercommodity spread contracts,\41\ calendar spread contracts, and
basis contracts from the definition of ``commodity index contract.''
Many commenters appeared to interpret the proposal as subjecting
positions in basis contracts or commodity index contracts to the
position limits set forth in proposed Sec. 151.4.\42\ The Coalition of
Physical Energy Companies and the Utility Group found that the
definition of Referenced Contract was ``vague'' and ``clearly
extraordinarily broad'' because, inter alia, it appeared to include
some over-the-counter (``OTC'') swaps that utilized a Core Referenced
Futures Contract price as a component of a floating price
calculation.\43\ The Coalition of Physical Energy Companies and the
Utility Group opined that even if the proposed class of Referenced
Contracts that are priced based on ``locations with substantially the
same supply and demand fundamentals, as that of any Core Referenced
Futures Contract'' it is unclear whether the definition of Referenced
Contract extends to ``those [swaps] that are actually economically
equivalent, e.g., look alikes.'' \44\
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\40\ The proposed definition of a Referenced Contract included
contracts (i) Directly or indirectly linked, including being
partially or fully settled on, or priced at a differential to, the
price of any Core Referenced Futures Contract; or (ii) directly or
indirectly linked, including being partially or fully settled on, or
priced at a differential to, the price of the same commodity for
delivery at the same location, or at locations with substantially
the same supply and demand fundamentals, as that of any Core
Referenced Futures Contract.
\41\ Proposed Sec. 151.1 defined ``intercommodity spread''
contracts as those contracts that ``represent[] the difference
between the settlement price of a Referenced Contract and the
settlement price of another contract, agreement, or transaction that
is based on a different commodity.''
\42\ See e.g., CL-Utility Group supra note 21 at 7-8; CL-COPE
supra note 21 at 6; Commercial Alliance (``Commercial Alliance I'')
on June 5, 2011 (``CL-Commercial Alliance I'') at 5-10 (arguing for
the extension of the bona fide hedge exemption for physical market
transactions and anticipated physical market transactions that could
be hedged with a basis contract position).
\43\ CL-Utility Group supra note 21 at 7-8 (arguing that
``virtual tolling swaps'' that utilize a Referenced Contract-derived
price series as a component of a floating price appear to be covered
by the definition of ``Referenced Contract''); and CL-COPE supra
note 21 at 6.
\44\ Id.
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The Commission is adopting the proposal regarding Referenced
Contracts with modifications and clarifications responsive to the
comments. The Commission clarifies that the term ``Referenced
Contract'' includes: (1) The Core Referenced Futures Contract; (2)
``look-alike'' contracts (i.e., those that settle off of the Core
Referenced Futures Contract and contracts that are based on the same
commodity for the same delivery location as the Core Referenced Futures
Contract); (3) contracts with a reference price based only on the
combination of at least one Referenced Contract price and one or more
prices in the same or substantially the same commodity as that
underlying the relevant Core Referenced Futures Contract;\45\ and (4)
intercommodity spreads with two components, one or both of which are
Referenced Contracts. These criteria capture contracts with prices that
are or should be closely correlated to the prices of the Core
Referenced Futures Contract.\46\
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\45\ E.g., a swap with a floating price based on the average of
the settlement price of the New York Mercantile Exchange (``NYMEX'')
Light, Sweet Crude Oil futures contract and the settlement price of
the IntercontinentalExchange (``ICE'') Brent Crude futures contract.
\46\ Under amended section 4a(a)(1), the Commission is required
to establish aggregate position limits on contracts based on the
same underlying commodity, including those swaps that are not traded
on a DCM or SEF but which are determined to perform or affect a
significant price discovery function (``SPDF''). 7 U.S.C. 6a(a)(1).
The Commission currently lacks the data necessary to evaluate the
pricing relationships between potential SPDF swaps and Referenced
Contracts and therefore has determined not to set forth, at this
time, standards for determining significant price discovery function
swaps. As the Commission gathers additional data on the effect of
position limits on the 28 Referenced Contracts and these contracts'
relationship with other contracts, it could, in its discretion,
extend position limits to additional contracts beyond the current
set of Referenced Contracts. The Commission could determine, for
example, that a contract, due to certain shared qualitative or
quantitative characteristics with Referenced Contracts, performs a
SPDF with respect to Referenced Contracts.
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In response to commenters, the Commission is eliminating a proposed
category of Referenced Contracts, namely, those based on
``substantially the same supply and demand fundamentals.'' The
Commission notes that the ``substantially the same supply and demand
fundamentals'' criterion would require individualized evaluation of
certain trading data to determine whether the price of a commodity may
or may not be substantially related to a Core Referenced Futures
Contract. Such analysis may require access to, among other things, data
concerning bids and offers and transaction information regarding the
cash market, which are not readily available to the Commission at this
time.
The remaining categories of Referenced Contract, i.e., derivatives
that are directly or indirectly linked to or based on the same
commodity for delivery at the same delivery location as
[[Page 71631]]
a Core Referenced Futures Contract, are based on objective criteria and
readily available data, which should provide market participants with
clarity as to the scope of economically equivalent contracts.\47\ The
Commission clarifies that if a swap contract that utilizes as its sole
floating reference price the prices generated directly or indirectly
\48\ from the price of a single Core Referenced Futures Contract, then
it is a look-alike Referenced Contract and subject to the limits set
forth in Sec. 151.4.\49\ If such a swap is priced based on a fixed
differential to a Core Referenced Futures Contract, it is similarly a
Referenced Contract.\50\
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\47\ In finalizing the Commission's Large Trader Reporting for
Physical Commodity Swaps rulemaking, and also in response to
comments, the Commission modified the proposed definition of
``paired swap'' to exclude contracts based on the same commodity at
different locations with substantially the same supply and demand
fundamentals as that of any Core Referenced Futures Contract. See 76
FR 43855, Jul. 22, 2011.
\48\ An ``indirect'' price link to a Core Referenced Futures
Contract includes situations where the swap reference price is
linked to prices of a cash-settled Referenced Contract that itself
is cash-settled based on a physical-delivery Referenced Contract
settlement price.
\49\ The Commission clarifies, by way of example, that a swap
based on the difference in price of a commodity (or substantially
the same commodity) at different delivery locations is a ``basis
contract'' and therefore not subject to the limits set forth in
Sec. 151.4. In addition, if a swap is based on prices of multiple
different commodities comprising an index, it is a ``commodity index
contract'' and therefore is not subject to the limits set forth in
Sec. 151.4. In contrast, if a swap is based on the difference
between two prices of two different commodities, with one linked to
a Core Referenced Futures Contract price (and the other either not
linked to the price of a Core Referenced Futures Contract or linked
to the price of a different Core Referenced Futures Contract), then
the swap is an ``intercommodity spread contract,'' is not a
commodity index contract, and is a Referenced Contract subject to
the position limits specified in Sec. 151.4. The Commission further
clarifies that a contract based on the prices of a Referenced
Contract and the same or substantially the same commodity (and not
based on the difference between such prices) is not a commodity
index contract and is a Referenced Contract subject to position
limits specified in Sec. 151.4.
\50\ The Commission has clarified in its definition of
``Referenced Contract'' that position limits extend to contracts
traded at a fixed differential to a Core Referenced Futures Contract
(e.g., a swap with the commodity reference price NYMEX Light, Sweet
Crude Oil +$3 per barrel is a Referenced Contract) or based on the
same commodity at the same delivery location as that covered by the
Core Referenced Futures Contract, and not to unfixed differential
contracts (e.g., a swap with the commodity reference price Argus
Sour Crude Index is not a Referenced Contract because that index is
computed using a variable differential to a Referenced Contract).
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With respect to comments that the Commission should broaden the
scope of Referenced Contracts, the Commission notes that expanding the
scope of position limits based, for example, on cross-hedging
relationships or other historical price analysis would be problematic.
Historical relationships may change over time and, additionally, would
require individualized determinations. For example, if the standard for
determining economic equivalence was some level of historical
correlation, then a commodity derivative might have met the correlation
metric yesterday, fail it today, and again meet the metric
tomorrow.\51\ Under these circumstances, the Commission does not
believe that it is necessary to expand the scope of position limits
beyond those proposed. In this regard, the Commission notes that the
commenters did not provide specific criteria or thresholds for making
determinations as to which price-correlated commodity contracts should
be subject to limits.\52\ The Commission further notes that it would
consider amending the scope of economically equivalent contracts (and
the relevant identifying criteria) as it gains experience in this area.
For clarity, the Commission has deleted the definition of the proposed
term ``Referenced paired futures contract, option contract, swap, or
swaption'' since that term was only used in the definitions section and
incorporated the relevant provisions of that proposed term into the
definition of Referenced Contracts. Lastly, the Commission has made
amendments in Sec. 151.2 that clarify that ``Core Referenced Futures
Contracts'' include options that expire into outright positions in such
contracts.
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\51\ Nevertheless, a trader may decide to assume the risk that
the historical price relationship might not hold and enter into a
cross-hedging transaction in a derivative that has been and is
expected to be price-fluctuation-related to that trader's cash
market commodity and seek (and obtain) a bona fide hedge exemption.
\52\ For example, the commenters did not address whether a
derivatives contract on a commodity should be included if there were
observed historical associated price correlations but no identified
causation relationship.
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C. Phased Implementation
The Commission proposed to implement the position limit rule in two
phases. In the first phase, the spot-month limits for Referenced
Contracts would be set at a level based on existing limits determined
by the appropriate DCM. In the second phase, the spot-month limits
would be adjusted on a regular schedule, set to 25 percent of the
Commission's determination of estimated deliverable supply, which would
be based on DCM-provided estimates or the Commission's own estimates.
The Commission believes that spot-month position limits can be
implemented on an advanced schedule, because such limits will initially
be based on existing DCM limits or on estimates of deliverable supply
for which data is available.
In the proposal, non-spot-month energy, metal, and ``non-
enumerated'' \53\ agricultural Referenced Contract limits would be
based on open interest and would be set in the second phase pending the
availability of certain positional data on physical commodity
swaps.\54\
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\53\ In the final rulemaking, the term ``legacy'' replaced the
term ``enumerated'' used in the proposal. The Commission has made
this change in order to avoid unnecessary confusion.
\54\ As discussed in the proposal, the Commission retained the
position limits for the enumerated agricultural Referenced Contracts
``as an exception to the general open interest based formula.'' 76
FR at 4752, 4760.
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In general, commenters were divided on whether the Commission
should, in whole or in part, delay the imposition of position limits.
Some commenters stated that the Commission should stay or withdraw its
proposal until such time that the Commission has gathered and analyzed
data to determine if position limits are necessary or appropriate.\55\
CME asserted that the Commission cannot impose spot-month limits until
it has received and analyzed data on economically equivalent swaps
since the limits cover such swaps.\56\ Conversely, some commenters
rejected the phased implementation of non-spot-month position limits
and urged the Commission to implement such limits on a more expedited
timeframe. One such commenter, Delta, argued ``that the Commission
should instead strive to establish meaningful speculative position
limits using sampling and other statistical techniques to make
reasonable, working assumptions about positions in various market
segments and refining the speculative limits based upon market
experience and better data as it is developed.'' \57\ The Commission
also received many letters requesting that the Commission impose
position limits generally on an expedited basis.\58\
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\55\ CL-FIA I, supra note 21 at 8; CL-COPE, supra note 21 at 4;
CL-Utility Group, supra note 21 at 5; CL-EEI/EPSA supra note 21 at
2; CL-Centaurus Energy, supra note 21 at 3; CL-PIMCO supra note 21
at 6; CL-SIFMA AMG I, supra note 21 at 15-16; CL-PERA, supra note 21
at 2; CL-Morgan Stanley, supra note 21 at 1; and CL-CMC, supra note
21 at 2.
\56\ CL-CME I, supra note 8 at 7-8.
\57\ CL-Delta, supra note 20 at 11.
\58\ See e.g., Gary Krasilovsky on February 6, 2011 (``CL-
Krasilovsky''); and Alan Murphy (``Murphy'') on January 6, 2011
(``CL-Murphy'').
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The Commission is finalizing the phased implementation schedule
generally as proposed and in furtherance of the congressional directive
that the Commission establishes position limits on an
[[Page 71632]]
expedited timeframe. As stated above, spot-month limits, which are
based on existing DCM limits and data that is available, can be
implemented on an expedited timeframe. In addition, non-spot-month
legacy limits do not require swap positional data to set the limits,
and, thus, can be set on an expedited timeframe.\59\ With respect to
non-spot-month limits for non-legacy Referenced Contracts, which are
dependent on open interest levels and thus dependent on swaps
positional data, the Commission will initially set such limits
following the collection of approximately 12 months of swaps positional
data.\60\
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\59\ Non-spot-month limits for agricultural contracts currently
subject to Federal position limits under part 150 are referred to
herein as ``legacy limits.'' As noted earlier, such Referenced
Contracts are generally referred to as ``enumerated'' agricultural
contracts. 17 CFR 150.2.
\60\ The Commission recently adopted reporting regulations that
require routine position reports from clearing organizations,
clearing members, and swap dealers. See 76 FR 43851, Jul. 22, 2011.
The swaps positional data obtained through these reports are
expected to serve as a primary source for determining open
interests.
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1. Compliance Dates
In light of the above referenced timeframe for implementation, the
compliance date for all spot-month limits and non-spot-month legacy
limits shall be 60 days after the term ``swap'' is further defined
pursuant to section 721 of the Dodd-Frank Act (i.e., 60 days after the
further definition of ``swap'' as adopted by the Commission and the
Securities and Exchange Commission is published by the Federal
Register). Prior to the Commission further defining the term swap,
market participants shall continue to comply with the existing position
limits regime contained in part 150 and any applicable DCM position
limits or accountability levels. After the compliance date, the
Commission will revoke part 150, and persons will be required to comply
with all the provisions of this part 151, including Sec. 151.5 for
bona fide hedging and Sec. 151.7 related to the aggregation of
accounts. For non-spot-month non-legacy Referenced Contracts, the
compliance date shall be set forth by Commission order establishing
such limits approximately 12 months after the collection of swap
positional data.\61\
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\61\ Prior to the compliance date, persons shall continue to
comply with applicable exchange-set position limits and
accountability levels.
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Although the Commission proposed to revoke part 150 in the Proposed
Rules, the Commission is retaining this provision until the compliance
dates set forth above.
2. Transitional Compliance
As discussed below in detail in section II.B. of this release,
Sec. 151.1 excludes ``basis contracts'' and ``commodity index
contracts'' from the definition of Referenced Contract. However, part
20 of the Commission's regulations requires reporting entities to
report commodity reference price data sufficient to distinguish between
basis and non-basis swaps and between commodity index contract and non-
commodity index contract positions in covered contracts.\62\ Therefore,
the Commission intends to rely on the data elements in Sec. 20.4(b) to
distinguish data records subject to Sec. 151.4 position limits from
those contracts that are excluded from Sec. 151.4. This will enable
the Commission to set position limits using the narrower data set
(i.e., Referenced Contracts subject to Sec. 151.4 position limits) as
well as conduct surveillance using the broader data set.
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\62\ See Sec. 20.2, 17 CFR 20.11 for a list of covered
contracts.
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In addition, Sec. 151.9 provides that traders may determine to
either exclude (i.e., not aggregate) or net their pre-existing swap
positions (as discussed below), while part 20 does not require a
distinction to be made for reporting pre-existing swap positions. The
Commission believes it is appropriate to include pre-existing swap
positions in the basis for setting position limits and, thus, the part
20 data collection will provide this broader data set. This is because
limits based on a narrower data set (that is, excluding pre-existing
swaps) may be overly restrictive and, thus, may not provide adequate
liquidity for bona fide hedgers, in light of the biennial reset of most
non-spot-month position limits under Sec. 151.4(d)(3). Nonetheless,
and consistent with the statutory exclusion of swaps pre-existing the
Dodd-Frank Act, position limits will not apply to such pre-existing
swap positions.\63\
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\63\ While requiring reporting entities to submit data
sufficient to allow the Commission to distinguish pre-existing
positions from other positions would be helpful to the Commission,
the Commission does not currently believe it would be cost-effective
to impose this requirement broadly as it would require reporting
entities to revisit transaction trade confirmation records that may
or may not be readily linked to position-tracking databases.
Moreover, the Commission could develop a reasonable estimate of the
extent of a trader's pre-existing positions by comparing their
positions as of the effective date with the positions held on a date
in interest (e.g., when a trader appears to establish a position
exceeding a position limit).
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The Commission understands that most uncleared swaps are executed
opposite a clearing member or swap dealer and would therefore result in
positions reportable to the Commission under part 20. Part 20 reports
will not provide data on positions where neither party to a swap is a
clearing member or swap dealer, but these positions represent a small
fraction of all uncleared swaps. Since most uncleared swaps will be
reportable under part 20, the Commission believes the swaps' data set
will be adequate to set position limits.\64\
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\64\ Proposed Sec. 151.4(e)(3) based the uncleared swap
component of the open interest figure used to set non-spot-month
position limits on open interest attributed to swap dealers. Section
20.4 requires position reporting from swap dealers as well as
clearing organizations and clearing members. Final rule Sec.
151.4(b)(2)(ii) permits estimation of the uncleared swap component
using clearing organization or clearing member data obtained under
Sec. 20.4 reports.
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In order to determine a trader's compliance with position limits in
light of the pre-existing position exemption and the sampling inherent
in requiring swap position data reporting from clearing members and
swap dealers, the Commission will utilize one existing and one new
means to conduct the necessary market surveillance. First, the
Commission may issue special calls under Sec. 20.6(b) in instances
where traders appear to have positions exceeding part 151 position
limits. Traders subject to these special calls would then be afforded
an opportunity to provide information on their positions demonstrating
compliance with a part 151 position limit. Second, the Commission notes
that traders are required to provide position visibility on their
uncleared swaps positions under Sec. 151.6(c) in 401 filings that
would reflect all of their uncleared swap positions in Referenced
Contracts as well as their total positions in Referenced Contracts,
irrespective of whether these swaps were executed opposite a clearing
member or swap dealer. These filings would allow the Commission to
determine whether the trader is in compliance with part 151 position
limits. The Commission clarifies that such 401 filings require the
reporting of gross long and gross short positions in Referenced
Contracts, excluding those positions that are not included in the
definition of Referenced Contracts (e.g., excluding those positions
arising from basis contract positions, pre-existing swap positions, and
diversified commodity index positions).\65\
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\65\ See supra under II.B. discussing the definition of
Referenced Contract.
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D. Spot-Month Limits
Proposed Sec. 151.4 would apply spot-month position limits
separately for physically-delivered contracts and cash-settled
contracts (i.e., cash-settled
[[Page 71633]]
futures and swaps).\66\ A trader could therefore hold positions up to
the spot-month position limit in both the physical-delivery and cash-
settled contracts but a trader could not net cash-settled contracts
with the physical-delivery contracts.\67\ The proposed spot-month
position limits for physical-delivery Core Referenced Futures Contracts
initially would be set at existing DCM levels; cash-settled Referenced
Contracts would be subject to limits set at the same level. As
discussed above, during the second phase of implementation, the spot-
month limits would be based on 25 percent of estimated deliverable
supply, as determined by the Commission in consultation with DCMs. The
Commission has determined to adopt the spot-month limits substantially
as proposed but with certain changes to address commenters' concerns.
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\66\ For the ICE Futures U.S. Sugar No. 16 (SF) and CME Class
III Milk (DA), the Commission proposed to adopt the DCM single-month
limits for the nearby month or first-to-expire Referenced Contract
as spot-month limits. These contracts currently have single-month
limits that are enforced in the spot month.
\67\ Thus, for example, if the spot-month limit for a Referenced
Contract is 1,000 contracts, then a trader could hold up to 1,000
contracts long in the physical-delivery contract and 1,000 contracts
long in the cash-settled contract. However, the same trader could
not hold 1,001 contracts long in the physical-delivery contract and
hold 1 contract short in the cash-settled and remain under the limit
for the physical-delivery contract. A trader's cash-settled contract
position would be a function of the trader's position in Referenced
Contracts based on the same commodity that are cash-settled futures
and swaps. For purposes of applying the limits, a trader shall
convert and aggregate positions in swaps on a futures equivalent
basis consistent with the guidance in the Commission's Appendix A to
Part 20, Large Trader Reporting for Physical Commodity Swaps. See 76
FR 43851, 43865 Jul. 22, 2011.
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1. Definition of ``Deliverable Supply''
In the proposal, the Commission defined ``deliverable supply''
generally as ``the quantity of the commodity meeting a derivative
contract's delivery specifications that can reasonably be expected to
be readily available to short traders and saleable by long traders at
its market value in normal cash marketing channels at the derivative
contract's delivery points during the specified delivery period,
barring abnormal movement in interstate commerce.'' \68\ Several
commenters supported ``deliverable supply'' as an appropriate basis for
spot-month limits for physical-delivery contracts.\69\ Other commenters
disagreed, stating that ``deliverable supply'' was inappropriate, even
for physical-delivery contracts, because it would result in overly
stringent limits.\70\ ISDA/SIFMA suggested that the Commission instead
base spot-month limits on ``available deliverable supply,'' a broader
measure of physical supply.\71\
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\68\ 76 FR at 4752, 4757.
\69\ See CL-AFR supra note 17 at 7-8; CL-AIMA supra note 35 at
2; CL-Prof. Greenberger supra note 6 at 17; InterContinental
Exchange, Inc. (``ICE I'') on March 28, 2011 (``CL-ICE I'') at 5;
and Natural Gas Exchange (``NGX'') on March 28, 2011 (``CL-NGX'') at
3.
\70\ CL-ISDA/SIFMA supra note 21 at 21; and CL-FIA I supra note
21 at 9.
\71\ ``Available deliverable supply'' includes: (1) All
available local supply (including supply committed to long-term
commitments); (2) all deliverable non-local supply; and (3) all
comparable supply (based on factors such as product and location).
See CL-ISDA/SIFMA supra note 21 at 21. Another commenter, the
Alternative Investment Management Association, similarly advocated a
more expansive definition of ``deliverable supply.'' CL-AIMA supra
note 35 at 3 (``This may include all supplies available in the
market at all prices and at all locations, as if a party were
seeking to buy a commodity in the market these factors would be
relevant to the price.'')
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Similarly, two commenters suggested that the Commission include
supply committed to long-term supply contracts in its definition of
``deliverable supply'' to avoid artificially reduced spot-month
position limits.\72\ In the Commission's experience overseeing the
position limits established at the exchanges as well as federally-set
position limits, ``spot-month speculative position limits levels are
`based most appropriately on an analysis of current deliverable
supplies and the history of various spot-month expirations.' '' \73\
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\72\ National Grain and Feed Association (``NGFA'') on March 28,
2011 (``CL-NGFA'') at 5; and CL-CME I supra note 8 at 9 (suggesting
that if the Commission decides to retain this exclusion, it should
define what it understands a ``long-term'' agreement to be and
ensure consistency with the deliverable supply definition in the
Core Principles and Other Requirements for Designated Contract
Markets proposed rulemaking). Id. citing Appendix C of Part 38, 75
FR 80572, 80631, Dec. 22, 2010. (In Appendix C, the Commission
states that commodity supplies that are ``committed to some
commercial use'' should be excluded from deliverable supply, and
requires DCMs to consult with market participants to estimate these
supplies on a monthly basis).
\73\ 64 FR 24038, 24039, May 5, 1999.
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Other commenters argued that ``deliverable supply'' should not be
the basis for position limits on cash-settled Referenced Contracts.\74\
Niska, for example, asked the Commission to explain why spot-month
limits for cash-settled contracts should be linked to deliverable
supply.\75\ Another commenter, BGA, opined that the Commission should
set position limits for cash-settled swap Referenced Contracts based on
the size of the swap market because swap contracts do not contemplate
delivery of the underlying contract and therefore are not ``tied to the
physical limits of the market.'' \76\
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\74\ Minneapolis Grain Exchange, Inc. (``MGEX'') on March 28,
2011 (``CL-MGEX'') at 4; CL-MFA supra note 21 at 16; Niska Gas
Storage LLC (``Niska'') on March 28, 2011 (``CL-Niska'') at 2. See
also CL-AIMA supra note 35 at 2 (asking the Commission to reconsider
position limits on cash-settled contracts).
\75\ CL-Niska supra note 75 at 2.
\76\ CL-BGA supra note 35 at 19. See also Cargill, Incorporated
(``Cargill'') on March 28, 2011 (``CL-Cargill'') at 13 (urging the
Commission to study the impact of applying any position limit based
on ``deliverable supply'' to the swaps market).
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The Commission finds that the use of deliverable supply to set
spot-month limits is wholly consistent with its historical approach to
setting spot-month limits and overseeing DCMs' compliance with Core
Principles 3 and 5.\77\ Currently, in determining whether a physical-
delivery contract complies with Core Principle 3, the Commission staff
considers whether the specified contract terms and conditions may
result in a deliverable supply that is sufficient to ensure that the
contract is not conducive to price manipulation or distortion. In this
context, the term ``deliverable supply'' generally means the quantity
of the commodity meeting a derivative contract's delivery
specifications that can reasonably be expected to be readily available
to short traders and saleable by long traders at its market value in
normal cash marketing channels at the derivative contract's delivery
points during the specified delivery period, barring abnormal movement
in interstate commerce.\78\ The spot-month limit pursuant to Core
Principle 5 is similarly established based on the analysis of
deliverable supplies. The Acceptable Practices for Core Principle 5
state that, with respect to physical-delivery contracts, the spot-month
limit should not exceed 25 percent of the estimated deliverable
supply.\79\ Lastly, with
[[Page 71634]]
respect to cash-settled contracts on agricultural and exempt
commodities, the spot-month limit is set at some percentage of
calculated deliverable supply. Accordingly, the Commission is adopting
deliverable supply as the basis of setting spot-month limits. In
response to commenters, the Commission added Sec. 151.4(d)(2)(iv) to
clarify that, for purposes of estimating deliverable supply, DCMs may
use any guidance issued by the Commission set forth in the Acceptable
Practices for Core Principle 3.
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\77\ Core Principle 3 specifies that a board of trade shall list
only contracts that are not readily susceptible to manipulation,
while Core Principle 5 obligates a DCM to establish position limits
or position accountability provisions where necessary and
appropriate ``to reduce the threat of market manipulation or
congestion, especially during the delivery month.''
\78\ See e.g., the discussion of deliverable supply in Guideline
No. 1. 17 CFR part 40, app. A. See also the discussion of
deliverable supply in the first publication of Guideline No. 1. 47
FR 49832, 49838, Nov. 3, 1982.
\79\ Indeed, with three exceptions, the Sec. 151.2-listed
contracts with DCM-defined spot months are currently subject to
exchange-set spot-month position limits, which would have been
established in this manner. The only contracts based on a physical
commodity that currently do not have spot-month limits are the COMEX
mini-sized gold, silver, and copper contracts that are cash settled
based on the futures settlement prices of the physical-delivery
contracts. The cash-settled contracts have position accountability
provisions in the spot month, rather than outright spot-month
limits. These cash-settled contracts have relatively small levels of
open interest.
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2. Twenty-Five Percent as the Deliverable Supply Formula
ICE commented that spot-month limits for physical-delivery
contracts (but not cash-settled contracts) set at 25 percent of
deliverable supply are necessary to prevent corners and squeezes.\80\
Other commenters, however, opined that spot-month position limits based
on 25 percent of deliverable supply are insufficient to prevent
excessive speculation.\81\ Americans for Financial Reform (``AFR''),
for example, argued that while ``deliverable supply'' is an appropriate
basis for setting spot-month limits,\82\ the proposed spot-month limit
addresses manipulation by a single actor and would not be set low
enough to combat excessive speculation in the market as a whole and the
volatility and delinking of commodities prices from economic
fundamentals caused by excessive speculation.\83\ Some commenters
recommended that the Commission set the spot-month limits based on the
``individual characteristics'' of each Core Referenced Futures
Contract, and not necessarily an exchange's deliverable supply
estimate.\84\
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\80\ CL-ICE I supra note 69 at 5.
\81\ CL-AFR supra note 17 at 5; American Trucking Association
(``ATA'') on March 28, 2011 (``CL-ATA'') at 3; Food & Water Watch
(``FWW'') on March 28, 2011 (``CL-FWW'') at 10; National Farmers
Union (``NFU'') on March 28, 2011 (``CL-NFU'') at 2; and CL-PMAA/
NEFI supra note 6 at 7.
\82\ CL-AFR supra note 17 at 7-8.
\83\ See CL-AFR supra note 17 at 5, 7.
\84\ CL-FIA I supra note 21 at 9; CL-ISDA/SIFMA supra note 21 at
21; and CL-MFA supra note 21 at 18.
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The Commission has determined to adopt the 25 percent level of
deliverable supply for setting spot-month limits. This formula is
consistent with the long-standing Acceptable Practices for Core
Principle 5,\85\ which provides that, for physical-delivery contracts,
the spot-month limit should not exceed 25 percent of the estimated
deliverable supply. The use of the existing industry standard would
provide clarity concerning the underlying methodology. Further, the
Commission believes that, based on its experience, the formula has
appeared to work effectively as a prophylactic tool to reduce the
threat of corners and squeezes and promote convergence without
compromising market liquidity.\86\ In making an estimate of deliverable
supply, the Commission reminds DCMs to take into consideration the
individual characteristics of the underlying commodity's supply and the
specific delivery features of the futures contract.\87\
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\85\ Core Principle 5 obligates a DCM to establish position
limits and position accountability provisions where necessary and
appropriate ``to reduce the threat of market manipulation or
congestion, especially during the delivery month.''
\86\ In this respect, the proposed limits formula is not
intended to address speculation by a class or group of traders.
\87\ As under current practice, DCM estimates of deliverable
supplies (and the supporting data and analysis) will be subject to
Commission staff review.
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3. Cash-Settled Contracts
With respect to cash-settled contracts, proposed Sec. 151.4
incorporated a conditional spot-month limit permitting traders without
a hedge exemption to acquire position levels that are five times the
spot-month limit if such positions are exclusively in cash-settled
contracts (i.e., the trader does not hold positions in the physical-
delivery Referenced Contract) and the trader holds physical commodity
positions that are less than or equal to 25 percent of the estimated
deliverable supply. The proposed conditional-spot-month position limits
generally tracked exchange-set position limits currently implemented
for certain cash-settled energy futures and swaps.\88\
---------------------------------------------------------------------------
\88\ For example, the NYMEX Henry Hub Natural Gas Last Day
Financial Swap, the NYMEX Henry Hub Natural Gas Look-Alike Last Day
Financial Futures, and the ICE Henry LD1 swap are all cash-settled
contracts subject to a conditional-spot-month limit that, with the
exception of the requirement that a trader not hold large cash
commodity positions, is identical in structure to the proposed
limit.
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Currently, with the exception of significant price discovery
contracts, traders' swaps positions are not subject to position limit
restrictions. The Commission is aware that counterparties to uncleared
swaps may impose prudential credit restrictions that may directly (for
example, by one party setting a maximum notional amount restriction
that it will execute with a particular counterparty) or indirectly (for
example, by one party setting a credit annex requirement such as
posting of initial collateral by a counterparty) restrict the amount of
bilateral transactions between the parties. However, the proposed spot
month limits would be the first broad position limit r[eacute]gime
imposed on swaps.
Several commenters questioned the application of proposed spot-
month position limits to cash-settled contracts.\89\ Some of these
commenters suggested that cash-settled contracts, if subject to any
spot-month position limits at all, should be subject to relatively less
restrictive limits that are not based on estimated deliverable
supply.\90\ BGA, for example, argued that position limits on swaps
should be set based on the size of the open interest in the swaps
market because swap contracts do not provide for physical delivery.\91\
Further, certain commenters argued that imposing a single speculative
limit on all cash-settled contracts would substantially reduce the
cash-settled positions that a trader can hold because currently, each
cash-settled contract is subject to a separate limit.\92\ Other
commenters urged the Commission to eliminate class limits and allow for
netting across futures and swaps contracts so as not to impact
liquidity.\93\
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\89\ CL-ISDA/SIFMA supra note 21 at 6-7, 19; Goldman, Sachs &
Co. (``Goldman'') on March 28, 2011 (``CL-Goldman'') at 5; CL-ICI
supra note 21 at 10; CL-MGEX supra note 74 at 4 (particularly
current MGEX Index Contracts that do not settle to a Referenced
Contract should be considered exempt from position limits because
cash-settled index contracts are not subject to potential market
manipulation or creation of market disruption in the way that
physical-delivery contracts might be); CL-WGCEF supra note 35 at 20
(``the Commission should reconsider setting a limit on cash-settled
contracts as a function of deliverable supply and establish a much
higher, more appropriate spot-month limit, if any, on cash-settled
contracts''); CL-MFA supra note 21 at 16-17; and CL-SIFMA AMG I
supra note 21 at 7.
\90\ CL-BGA supra note 35 at 19; CL-ICI supra note 21 at 10; CL-
MFA supra note 21 at 16-17; CL-WGCEF supra note 35 at 20; CL-Cargill
supra note 76 at 13; CL-EEI/EPSA supra note 21 at 9; and CL-AIMA
supra note 35 at 2.
\91\ CL-BGA supra note 35 at 10.
\92\ See e.g., CL-FIA I supra note 21 at 10; and CL-ICE I supra
note 69 at 6
\93\ See e.g., CL-ISDA/SIFMA supra note 21 at 8.
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A number of commenters objected to limiting the availability of a
higher limit in the cash-settled contract to traders not holding any
physical-delivery contract.\94\ For example, CME argued that the
proposed conditional limits would encourage price discovery to migrate
to the cash-settled contracts, rendering the physical-delivery contract
``more susceptible to sudden price
[[Page 71635]]
movements during the critical expiration period.'' \95\ AIMA commented
that the prohibition against holding positions in the physical-delivery
Referenced Contract will cause investors to trade in the physical
commodity markets themselves, resulting in greater price pressure in
the physical commodity.\96\
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\94\ American Feed Industry Association (``AFIA'') on March 28,
2011 (``CL-AFIA'') at 3; CL-AFR supra note 17 at 6; Air Transport
Association of America (``ATAA'') on March 28, 2011 (``CL-ATAA'') at
7; CL-BGA supra note 35 at 11-12; CL-Centaurus Energy supra note 21
at 3; CL-CME I supra note 8 at 10; CL-WGCEF supra note 35 at 21-22;
and CL-PMAA/NEFI supra note 6 at 14.
\95\ CL-CME I supra note 8 at 10. Similarly, BGA argued that
conditional limits incentivize the migration of price discovery from
the physical contracts to the financial contracts and have the
unintended effect of driving participants from the market and
thereby increasing the potential for market manipulation with a very
small volume of trades. CL-BGA supra note 35 at 12.
\96\ CL-AIMA supra note 35 at 2.
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Some of these commenters, including the CME and the KCBT, argued
against the proposed restriction with respect to cash-settled contracts
and recommended that cash-settled Referenced Contracts and physical-
delivery contracts should be subject to the same position limits.\97\
Two commenters opined that if the conditional limits are adopted, they
should be increased from five times 25 percent of deliverable
supply.\98\ ICE recommended that they be increased to at least ten
times 25 percent of deliverable supply.\99\
---------------------------------------------------------------------------
\97\ CL-CME I supra note 8 at 10; Kansas City Board of Trade
(``KCBT I'') on March 28, 2011 (``CL-KCBT I'') at 4; and CL-APGA
supra note 17 at 6, 8. Specifically, KCBT argued that parity should
exist in all position limits (including spot-month limits) between
physical-delivery and cash-settled Referenced Contracts; otherwise,
these limits would unfairly advantage the look-alike cash-settled
contracts and result in the cash-settled contract unduly influencing
price discovery. Moreover, the higher spot-month limit for the
financial contract unduly restricts the physical market's ability to
compete for spot-month trading, which provides additional liquidity
to commercial market participants that roll their positions forward.
CL-KCBT I at 4.
\98\ CL-AIMA supra note 35 at 2; and CL-ICE I supra note 70 at
8.
\99\ CL-ICE I supra note 69 at 8. ICE also recommended that the
Commission remove the prohibition on holding a position in the
physical-delivery contract or shorten the duration to a narrower
window of trading than the final three days of trading.
---------------------------------------------------------------------------
In support of their view, the CME submitted data concerning its
natural gas physical-delivery contract.\100\ The data, however,
generally indicates that the trading volume in the contract in the spot
month has increased since the implementation of a conditional-spot-
month limit, suggesting little (if any) adverse impact on market
liquidity for the contract. Moreover, according to the same data set,
both the outright volume and the average price range in the settlement
period on the last trade day in the closing range have declined.\101\
Other measures of average price range in the spot period also have
declined.
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\100\ CME Group, Inc. (``CME III'') on August 15, 2011 (``CL-CME
III'').
\101\ ``Outright volume'' means the volume of electronic
outright transactions that the DCM used for purposes of calculating
settlement prices and excludes, for example, spread exemptions
executed at a differential.
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The CME also submitted, for the same physical-delivery contract, a
measure of the relative closing range as a ratio to volatility
(``RCR'')--that is, the ratio of the closing range to the 20-day
standard deviation of settlement prices. The RCR measure has declined
on average after implementation of the conditional limits across 17
expirations, while the RCR on two individual expirations was higher
after implementation of the conditional limits, indicating a higher
relative price volatility on those two days. However, during one of
those two days, certain traders were active in the physical-delivery
futures contracts and concurrently held cash-settled contracts, in
excess of one times the limit on the physical-delivery contract; in the
other day, this was not the case. In summary, the Commission does not
believe that the data submitted by CME supports the assertion that
setting the existing conditional limits on cash-settled contracts in
the natural gas market has materially diminished the price discovery
function of physical-delivery contracts.
Considering the comments that were received, the Commission is
adopting, on an interim final rule basis, the proposed spot-month
position limit provisions with modifications. Under the interim final
rule, the Commission will apply spot-month position limits for cash-
settled contracts using the same methodology as applied to the
physical-delivery Core Referenced Future Contracts, with the exception
of natural gas contracts, which will have a class limit and aggregate
limit of five times the level of the limit for the physical-delivery
Core Referenced Futures Contract. As further described below, the
Commission is adopting these spot-month limit methodologies as interim
final rules in order to solicit additional comments on the appropriate
level of spot-month position limits for cash-settled contracts.
Specifically, the Commission is adopting, on an interim final rule
basis, a spot-month position limit for cash-settled contracts (other
than natural gas) that will be set at 25 percent of estimated
deliverable supply, in parity with the methodology for setting spot-
month limit levels for the physical-delivery Core Referenced Futures
Contracts. The Commission believes, consistent with the comments, that
parity should exist in all position limits (including spot-month
limits) between physical-delivery and cash-settled Referenced Contracts
(other than in natural gas); otherwise, these limits would permit
larger position in look-alike cash-settled contracts that may provide
an incentive to manipulate and undermine price discovery in the
underlying physical-delivery futures contract. However, the Commission
has a reasonable basis to believe that the cash-settled market in
natural gas is sufficiently different from the cash-settled markets in
other physical commodities to warrant a different spot-month limit
methodology.
With respect to NYMEX Light, Sweet Crude Oil (``WTI crude oil''),
NYMEX New York Harbor Gasoline Blendstock (``RBOB''), and NYMEX New
York Harbor Heating Oil (``heating oil'') contracts, administrative
experience, available data, and trade interviews indicate that the
sizes of the markets in cash-settled Referenced Contracts (as measured
in notional value) are likely to be no greater in size than the related
physical-delivery Core Referenced Futures Contracts. This is because
there are alternative markets which may satisfy much of the demand by
commercial participants to engage in cash-settled contracts for crude
oil. These include a market for generally short-dated WTI crude oil
forward contracts, as well as a well-developed forward market for Brent
oil and an active cash-settled WTI futures contract (the cash-settled
ICE Futures (Europe) West Texas Intermediate Light Sweet Crude Oil
futures contract). That futures contract had, as of October 4, 2011, an
open interest of less than one-third that of the physical-delivery
NYMEX Light Sweet Crude Oil futures contract, as reported in the
Commission's Commitment of Traders Report. That contract is subject to
a spot-month limit equal to the spot-month limit imposed by NYMEX on
the relevant physical-delivery futures contract, as a condition of a
Division of Market Oversight no-action letter issued on June 17, 2008,
CFTC Letter No. 08-09. A review of the Commission's large trader
reporting system data indicated fewer than five traders recently held a
position in that cash-settled ICE contract in excess of 3,000 contracts
in the spot month, pursuant to exemptions granted by the exchange.
Accordingly, given that the size of the cash-settled swaps market
involving WTI does not appear to be materially larger than that of the
physical-delivery Core Referenced Futures Contract, parity in spot
month limits in WTI crude oil between physical-delivery and cash-
settled contracts should ensure sufficient
[[Page 71636]]
liquidity for bona fide hedgers in the cash-settled contracts.
With respect to the other energy commodities, based on
administrative experience, available data, and trade interviews, the
Commission understands the swaps markets in RBOB and heating oil are
small relative to the relevant Core Referenced Futures Contracts. In
this regard, unlike natural gas, there has been a small amount of
trading in exempt commercial markets in RBOB and heating oil. Thus,
parity in spot month limits in RBOB and heating oil between physical-
delivery and cash-settled contracts should ensure sufficient liquidity
for bona fide hedgers in the cash-settled contracts.
With respect to agricultural commodities, administrative
experience, available data, and trade interviews indicate that the
sizes of the markets in cash-settled Referenced Contracts (as measured
in notional value) are small and not as large as the related Core
Referenced Futures Contracts. This is likely due to the fact that,
currently, off-exchange agricultural commodity swaps (that are not
options) may only be transacted pursuant to part 35 of the Commission's
regulations. Under current rules, exempt commercial markets and exempt
boards of trade have not been permitted to, and have not, listed
agricultural swaps (although the Commission has repealed and replaced
part 35, effective December 31, 2011, at which point the Commission
regulations would permit agricultural commodity swaps to be transacted
under the same requirements governing other commodity swaps). Regarding
off-exchange agricultural trade options, part 35 is not available; such
transactions must be pursuant to the Commission's agricultural trade
option rules found in Commission regulation 32.13. Under regulation
32.13, parties to the agricultural trade option must have a net worth
of at least $10 million and the offeree must be a producer, processor,
commercial user of, or merchant handling the agricultural commodity
which is the subject of the trade option. Based on interviews with
offerors of agricultural trade options believed to be the largest
participants, administrative experience is that the off-exchange
markets are smaller than the relevant Core Referenced Futures
Contracts. Accordingly, parity in spot month limits in agricultural
commodities between physical-delivery and cash-settled contracts should
ensure sufficient liquidity for bona fide hedgers in the cash-settled
contracts.
With respect to the metal commodities, based on administrative
experience, available data, and trade interviews, the Commission
understands the cash-settled swaps markets also are small. Based on
interviews with market participants, the Commission understands there
is an active cash forward market and lending market in metals,
particularly in gold and silver, which may satisfy some of the demand
by commercial participants to engage in cash-settled contracts. The
cash-settled metals contracts listed on DCMs generally are
characterized by a low level of open interest relative to the physical-
delivery metals contracts. Moreover, as is the case for RBOB and
heating oil, there has not been appreciable trading in exempt
commercial markets in metals. Accordingly, parity in spot month limits
in metals commodities between physical-delivery and cash-settled
contracts should ensure sufficient liquidity for bona fide hedgers in
the cash-settled contracts.
In contrast, regarding natural gas, there are very active cash-
settled markets both at DCMs and exempt commercial markets. NYMEX lists
a cash-settled natural gas futures contract linked to its physical-
delivery futures contract that has significant open interest.
Similarly, ICE, an exempt commercial market, lists natural gas swaps
contracts linked to the NYMEX physical-delivery futures contract.
Moreover, both NYMEX and ICE have gained experience with conditional
spot-month limits in natural gas where the cash-settled limit is five
times the limit for the physical-delivery futures contract. In this
regard, NYMEX imposed the same limit on its cash-settled natural
contract as ICE imposed on its cash-settled natural gas contract when
ICE complied with the requirements of part 36 of the Commission's
regulations regarding SPDCs. As discussed above, the Commission
believes the existing conditional limits on cash-settled natural gas
contracts have not materially diminished the price discovery function
of physical-delivery contracts. The final rules relax the conditional
limits by removing the condition, but impose a tighter limit on cash-
settled contracts by aggregating all economically similar cash-settled
natural gas contracts.\102\
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\102\ The Commission is removing the proposed restrictions for
claiming the higher limit in cash-settled Referenced Contracts in
the spot month. Unlike the proposed conditional limit, under the
aggregate limit, a trader in natural gas can utilize the five times
limit for the cash-settled Referenced Contract and still hold
positions in the physical-delivery Referenced Contract. In addition,
there is no requirement that the trader not hold cash or forward
positions in the spot month in excess of 25 percent of deliverable
supply of natural gas. Although the Commission's experience with
DCMs using the more restrictive conditional limit in natural gas has
been generally positive, the Commission, in agreeing with
commenters, will wait to impose similar conditions until the
Commission gains additional experience with the limits in the
interim final rule. In this regard, the Commission will monitor
closely the spot-month limits in these final rules and may revert to
a conditional limit in the future in response to market
developments.
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Thus, the Commission has determined that the one-to-one ratio
(between the level of spot-month limits on physical-delivery contracts
and the level of the spot-month limits on cash-settled contracts in the
agricultural, metals, and energy commodities other than natural gas)
maximizes the objectives enumerated in section 4a(a)(3). Specifically,
such limits ensure market liquidity for bona fide hedgers and protect
price discovery, while deterring excessive speculation and the
potential for market manipulation, squeezes, and corners. The
Commission further notes that the formula is consistent with the level
the Commission staff has historically deemed acceptable for cash-
settled contracts, as well as the formula for physical-delivery
contracts under Acceptable Practices for Core Principle 5 in part 38.
Nevertheless, the Commission recognizes that after experience with the
one-to-one ratio and additional reporting of swap transactions, it may
be possible to maximize further these objectives with a different ratio
and therefore will revisit the issue after it evaluates the effects of
the interim final rule.
In addition to the spot-month limit for cash-settled natural gas
contracts, the interim final rule also provides for an aggregate spot-
month limit set at five times the level of the spot-month limit in the
relevant physical-delivery natural gas Core Referenced Futures
Contract. A trader therefore must at all times fall within the class
limit for the physical-delivery natural gas Core Referenced Futures
Contract, the five-times limit for cash-settled Referenced Contracts in
natural gas, and the five-times aggregate limit.
To illustrate the application of the spot-month limits in natural
gas contracts, assume a physical-delivery Core Referenced Futures
Contract limit on a particular commodity is set to a level of 100.
Thus, a trader may hold a net position (long or short) of 100 contracts
in that Core Referenced Futures Contract and a net position (long or
short) of 500 contracts in the cash-settled Referenced Contracts on
that same commodity, provided that the total directional position of
both contracts is below the aggregate limit. Therefore, to comply with
the aggregate
[[Page 71637]]
limit, if a trader wanted to hold the maximum directional position of
100 contracts in the physical-delivery contract, the trader could hold
only 400 contracts on the same side of the market in cash-settled
contracts.\103\ Thus, while the aggregate limit in isolation may appear
to allow a trader to establish a position of 600 contracts in cash-
settled contracts and 100 contracts on the opposite side of the market
in the physical-delivery contract (that is, an aggregate net position
of 500 contracts), the class limits restrict that trader to no more
than 500 contracts net in cash-settled contracts. The aggregate limit
is less restrictive than the proposed conditional limit in that a
trader may elect to hold positions in both physical-delivery and cash-
settled contracts, subject to the aggregate limit.
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\103\ Further to this example, if a trader wanted to hold 100
contracts in the physical-delivery contract in one direction, the
trader could hold 500 cash-settled contracts in the opposite
direction as the physical-delivery contract.
---------------------------------------------------------------------------
The Commission believes that, based on current experience with
existing DCM and exempt commercial market (``ECM'') conditional limits,
the one-to-five ratio for natural gas contracts maximizes the statutory
objectives, as set forth in section 4a(a)(3)(B) of the CEA, of
preventing excessive speculation and market manipulation, ensuring
market liquidity for bona fide hedgers, and promoting efficient price
discovery. Nevertheless, the Commission recognizes that after
experience with the one-to-five ratio and additional reporting of swap
transactions, it may be possible to maximize further these objectives
with a different ratio and therefore will revisit the issue after it
evaluates the effects of the interim final rule. Accordingly, the
Commission is implementing the one-to-five ratio in natural gas
contracts on an interim final rule basis and is seeking comments on
whether a different ratio can further maximize the statutory objectives
in section 4a(a)(3)(B) of the CEA.
The Commission notes that, as would have been the case with the
proposed conditional limits, the spot-month limits on cash-settled
natural gas contracts will be more restrictive than the current natural
gas conditional spot-month limits. The NYMEX Henry Hub Natural Gas
(``NG'') physical-delivery futures contract has a spot-month limit of
1,000 contracts. Both the NYMEX cash-settled natural gas futures
contract (``NN'') and the ICE Henry Hub Physical Basis LD1 contract
(``LD1'') have conditional-spot-month limits equivalent to 5,000
contracts in the NG futures contract. In contrast to the LD1 contract,
swap contracts that are not significant price discovery contracts
(``SPDCs'') have not been subject to any position limits. However, the
final rule aggregates the related cash-settled contracts, whether swaps
or futures. For example, a trader under current rules may hold a
position equivalent to 5,000 NG contracts in each of the NN and LD1
contracts (10,000 in total), but under the final rule, a speculative
trader may hold only 5,000 cash-settled contracts net under the
aggregate spot month limit (since a trader must add its NN position to
its LD1 position). Further, other economically-equivalent contracts
would be aggregated with a trader's cash-settled contracts in NN and
LD1.
Proposed Sec. 151.11(a)(2) required that a DCM or SEF that is a
trading facility adopt spot-month limits on cash-settled contracts for
which no federal limits apply, based on the methodology in proposed
Sec. 151.4 (i.e., 25 percent of deliverable supply). Proposed Sec.
151.4(a) did not establish spot-month limits in the cash-settled Core
Referenced Futures Contracts (i.e., Class III Milk, Feeder Cattle, and
Lean Hog contracts). Thus, under the proposal, a DCM or SEF that is a
trading facility would be required to set a spot-month limit on such
contracts at a level no greater than 25 percent of deliverable supply.
The final rules provide that the spot-month position limit for
cash-settled Core Referenced Futures Contracts (i.e., Class III Milk,
Feeder Cattle, and Lean Hog contracts) and related cash-settled
Referenced Contracts will be set by the Commission at a level equal to
25 percent of deliverable supply.\104\
---------------------------------------------------------------------------
\104\ See Sec. 151.4(a).
---------------------------------------------------------------------------
The Commission is also retaining class limits in the spot month for
physical-delivery and cash-settled contracts. Under the class limit
restriction, a trader may hold positions up to the spot-month limit in
the physical-delivery contracts, as well as positions up to the
applicable spot-month limit in cash-settled contracts (i.e., cash-
settled futures and swaps), but a trader in the spot month may not net
across physical-delivery and cash-settled contracts.\105\ Absent such a
restriction in the spot month, a trader could stand for 100 percent of
deliverable supply during the spot month by holding a large long
position in the physical-delivery contract along with an offsetting
short position in a cash-settled contract, which effectively would
corner the market.\106\
---------------------------------------------------------------------------
\105\ As discussed above, the Commission is eliminating the
conditional spot-month limit.
\106\ As will be discussed further below, the Commission is
eliminating class limits outside of the spot month.
---------------------------------------------------------------------------
In the Commission's view, the aggregate limit for natural gas will
ensure that no trader amasses a speculative position greater than five
times the level of the physical-delivery Referenced Contract position
limit and thereby, the limit ``diminishes the incentive to exert market
power to manipulate the cash-settlement price or index to advantage a
trader's position in the cash-settlement contract.'' \107\
---------------------------------------------------------------------------
\107\ 76 FR at 4752, 4758.
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As noted above, the Commission has developed the limits on
economically equivalent swaps concurrently with limits established for
physical commodity futures contracts and has established aggregate
requirements for cash-settled futures and swaps. In establishing the
spot-month limits for cash-settled futures, options, and swaps, the
Commission seeks to ensure, to the maximum extent practicable, that
there will be sufficient market liquidity for bona fide hedgers in
swaps, especially those seeking to offset open positions in such
contracts. Permitting traders to hold larger positions in natural gas
cash-settled contracts near expiration should not materially affect the
potential for market abuses, as the current Commission surveillance
system serves to detect and prevent market manipulation, squeezes, and
corners in the physical-delivery futures contracts as well as market
abuses in cash-settled contracts on which position information is
collected. In this regard, the Swaps Large Trader Reporting system will
enhance the Commission's surveillance efforts by providing the
Commission with transparency for the positions of traders holding large
swap positions. The Commission will monitor closely the effects of its
spot-month position limits to ensure that they do not disrupt the price
discovery function of the underlying market and that they are effective
in addressing the potential for market abuses in cash-settled
contracts.
4. Interim Final Rule
The Commission believes that, based on administrative experience,
available data, and trade interviews, the spot month limits formulas
for energy, agricultural and metals contracts, as described above, at
this time best maximizes the statutory objectives set forth in CEA
section 4a(a)(3)(B) of preventing excessive speculation and market
manipulation, ensuring market liquidity for bona fide hedgers, and
promoting efficient price discovery. However, commenters presented a
range of views as to the appropriate formula with respect to cash
settled contracts. Some commenters believed that either a
[[Page 71638]]
larger ratio was appropriate or there should be no limit on cash-
settled contracts at all.\108\ Other commenters believed there should
be parity in the limits between physical-delivery contracts and cash-
settled contracts.\109\ Accordingly, the Commission is implementing the
spot month limits on an interim rule basis and is seeking comments on
whether a different ratio (e.g., one-to-three or one-to-four) can
maximize further the statutory objectives in section 4a(a)(3)(B).
---------------------------------------------------------------------------
\108\ See e.g., CL-ICE I, supra note 69 at 8, CL-Centaurus,
supra note 21 at 3; CL-BGA, supra note 35 at 12.
\109\ See e.g., CL-CME I, supra note 8 at 10; CL-KCBT, supra
note 97 at 4; CL-APGA, supra note 17 at 6,8.
---------------------------------------------------------------------------
Specifically, the Commission invites commenters to address whether
the interim final rule best maximizes the four objectives in section
4a(a)(3)(B). The Commission also seeks comments on whether it should
set a different ratio for different commodities. Should the Commission
consider setting the ratio higher than one-to-one and, if so, in which
commodities? Commenters are encouraged, to the extent feasible, to be
comprehensive and detailed in providing their approach and rationale.
Commenters are requested to address how their suggested approach would
better maximize the four objectives in section 4a(a)(3).
Additionally, commenters are encouraged to address the following
questions:
Should the Commission consider the relationship between the open
interest in cash-settled contracts in the spot month and open interest
in the physical-delivery contract in the spot month in setting an
appropriate ratio?
Are there other metrics that are relevant to the setting of a spot-
month limit on cash-settled contracts (e.g., volume of trading in the
physical-delivery futures contract during the period of time the cash-
settlement price is determined)?
What criteria, if any, could the Commission use to distinguish
among physical commodities for purposes of setting spot-month limits
(e.g., agricultural contracts of relatively limited supplies
constrained by crop years and limited storage life) and how would those
criteria be related to the levels of limits?
The Commission also invites comments on the costs and benefits
considerations under CEA section 15a. The Commission further requests
commenters to submit additional quantitative and qualitative data
regarding the costs and benefits of the interim final rule and any
suggested alternatives. Thus, the Commission is seeking comments on the
impact of the interim final rule or any alternative ratio on: (1) The
protection of market participants and the public; (2) the efficiency,
competitiveness, and financial integrity of the futures markets; (3)
the market's price discovery functions; (4) sound risk management
practices; and (5) other public interest considerations.
The comment period for the interim final rule will close January
17, 2012.
After the Commission gains some experience with the interim final
rule and has reviewed swaps data obtained through the Swaps Large
Trader Reports, the Commission may further reevaluate the appropriate
ratio between physical-delivery and cash-settled spot-month position
limits and, in that connection, seek additional comments from the
public.
5. Resetting Spot-Month Limits
The Proposed Rules required that DCMs submit estimates of
deliverable supply to the Commission by the 31st of December of each
calendar year. The Proposed Rules also provided that the Commission
would rely on either these DCM estimates or its own estimates to revise
spot-month position limits on an annual basis.\110\ Two commenters
commented that the Commission's proposed process for DCMs providing
their deliverable supply estimates within the proposed timeframe was
operationally infeasible.\111\
---------------------------------------------------------------------------
\110\ See Sec. 151.4(c). Under the Proposed Rules, spot-month
legacy limits would not be subject to periodic resets.
\111\ CL-CME I supra note 8 at 9; and CL-MGEX supra note 75 at
2. In addition, the MGEX stated that it is impractical to try to
ascertain an accurate estimate of deliverable supply because there
are too many variable and unknown factors that affect an
agricultural commodity's production and the amount that is sent to
delivery points. CL-MGEX supra note 74 at 2.
---------------------------------------------------------------------------
Others criticized the setting of spot-month limits on an annual
basis. MFA commented that the limits should reflect seasonal
deliverable supply by using either data based on the prior year's
deliverable supply estimates or more frequent re-setting.\112\ The
Institute for Agriculture and Trade Policy (``IATP'') commented that
the spot-month position limits for legacy agricultural commodities will
likely require more than annual revision due to the effects of climate
change on the estimated deliverable supply for each Referenced
Contract.\113\ IATP also urged the Commission to amend the proposal to
provide for emergency meetings to estimate deliverable supply if prices
or supply become volatile.\114\
---------------------------------------------------------------------------
\112\ CL-MFA supra note 21 at 18.
\113\ IATP on March 28, 2011 (``CL-IATP'') at 5.
\114\ Id. at 3.
---------------------------------------------------------------------------
Two commenters expressed concern about the potential volatility in
the limit levels introduced by the Commission's proposed annual process
for setting spot-month limits. BGA commented that spot-month limits
that are changed too frequently (annually would be too frequent in
their view) could result in a ``flash crash'' as traders make large
position changes in order to comply with a potentially new lower
limit.\115\ BGA suggested that this concern could be addressed through,
among other things, less frequent changes to the spot-month position
limit levels and by providing the market a several-month ``cure
period.'' \116\ ISDA/SIFMA suggested that year-to-year spot-month limit
level volatility could be addressed by using a five-year rolling
average of estimated deliverable supply.\117\
---------------------------------------------------------------------------
\115\ CL-BGA supra note 35 at 20.
\116\ Id.
\117\ CL-ISDA/SIFMA supra note 21 at 22.
---------------------------------------------------------------------------
The Commission recognizes the concerns regarding the necessity and
desirability of an annual updating of the deliverable supply
calculations on a single anniversary date, and that under normal market
conditions, agricultural, energy, and metal commodities typically do
not exhibit dramatic and sustained changes in their supply and demand
fundamentals from year-to-year. Accordingly, the Commission has
determined to update spot-month limits biennially (every two years) for
energy and metal Referenced Contracts instead of annually, and to
stagger the dates on which estimates of deliverable supply shall be
submitted by DCMs. These changes should mitigate the costs of
compliance for DCMs to prepare and submit estimates of deliverable
supply to the Commission. Under the final rule, DCMs may petition the
Commission to update the limits on a more frequent basis should supply
and demand fundamentals warrant it.
Finally, in response to comments, the Commission has made minor
modifications to the definition of the ``spot month'' to provide for
consistency with DCMs' current practices in the administration of spot-
month limits for the Referenced Contracts.
E. Non-Spot-Month Limits
The Commission proposed to impose aggregate position limits outside
of the spot month in order to prevent a speculative trader from
acquiring excessively large positions and, thereby, to help prevent
excessive speculation and deter and prevent market
[[Page 71639]]
manipulations, squeezes, and corners.\118\ Furthermore, the Commission
provided that the ``resultant limits are purposely designed to be high
in order to ensure sufficient liquidity for bona fide hedgers and avoid
disrupting the price discovery process given the limited information
the Commission has with respect to the size of the physical commodity
swap markets.'' \119\
---------------------------------------------------------------------------
\118\ 76 FR at 4752, 4759.
\119\ Id.
---------------------------------------------------------------------------
In the proposal, the formula for the non-spot-month position limits
is based on total open interest for all Referenced Contracts in a
commodity. The actual position limit is based on a formula: 10 percent
of the open interest for the first 25,000 contracts and 2.5 percent of
the open interest thereafter.\120\ The limits for each Referenced
Contracts included class limits with one class comprised of all futures
and option contracts and the second class comprised of all swap
contracts. A trader could net positions within the same class, but
could not net its position across classes. The limits also included an
aggregate all-months-combined limit and a single month limit; however,
the limit for the single month would be the same size as the limit for
all months.
---------------------------------------------------------------------------
\120\ By way of example, assuming a Referenced Contract has
average all-months-combined aggregate open interest of 1 million
contracts, the level of the non-spot-month position limits would
equal 26,900 contracts. This level is calculated as the sum of 2,500
(i.e., 10 percent times the first 25,000 contracts open interest)
and 24,375 (i.e., 2.5 percent of the 975,000 contracts remaining
open interest), which equals 26,875 (rounded up to the nearest 100
under the rules (i.e., 26,900)).
---------------------------------------------------------------------------
The Commission received many comments about the rationale for and
design of the proposed non-spot-month limits. Many commenters opined
that the proposed aggregate non-spot-month limits would not be
sufficiently restrictive to prevent excessive speculation.\121\ Better
Markets explained, for example, that the proposed non-spot-month limits
address manipulation by limiting the position size of a single
individual while position limits intended to reduce excessive
speculation should aim to reduce total speculative participation in the
market.\122\ These commenters recommended that, in order to address
excessive speculation, the Commission should set limits designed to
limit speculative activity to a target level.\123\
---------------------------------------------------------------------------
\121\ CL-ATA supra note 81 at 3-4; CL-ATAA supra note 94 at 7;
CL-Better Markets supra note 37 at 70-71; CL-Delta supra note 20 at
2-6; CL-FWW supra note 81 at 11; and CL-PMAA/NEFI supra note 6 at 7,
10. 3,178 form comment letters asked the Commission to impose a
limit of 1,500 contracts on Referenced Contracts in silver.
\122\ See e.g., CL-Better Markets supra note 37 at 61-64.
\123\ CL-ATA supra note 81 at 4-5; CL-AFR supra note 17 at 5-6;
CL-ATAA supra note 94 at 3, 6, 9-10, 12; CL-Better Markets supra
note 37 at 70-71 (recommending the Commission to limit non-commodity
index and commodity index speculative participation in the market to
30 percent and 10 percent of open interest, respectively); CL-Delta
supra note 20 at 5; and CL-PMAA/NEFI supra note 6 at 7. See also
Daniel McKenzie on March 28, 2011 (``CL-McKenzie'') at 3. The
Petroleum Marketers Association of America and the New England Fuel
Institute, for example, suggested that the distribution of large
speculative traders' positions in the market may be an appropriate
factor to be considered in developing these speculative target
limits.
---------------------------------------------------------------------------
Other commenters questioned the utility of non-spot-month limits
generally.\124\ AIMA, for example, opined that ``[a]lthough * * *
limits within the spot-month may be effective to prevent `corners and
squeezes' at settlement, the case for placing position limits in non-
spot-months is less convincing and has not been made by the
Commission.'' \125\ The FIA commented that non-spot-month position
limits are not necessary to prevent excessive speculation.\126\
---------------------------------------------------------------------------
\124\ American Gas Association (``AGA'') on March 28, 2011
(``CL-AGA'') at 13; CL-AIMA supra note 35 at 3; CL-BlackRock supra
note 21 at 18; CL-CME I supra note 8 at 21; CL-FIA I supra note 21
at 11 (Commission's prior guidance does not provide a basis today
for an exemption from hard speculative position limits for markets
with large open-interest, high trading volumes and liquid cash
markets); CL-Goldman supra note 89 at 6; CL-ISDA/SIFMA supra note 21
at 18; CL-MGEX supra note 74 at 1 (Commission's proposed formulaic
approach to non-spot-month position limits seems arbitrary); Natural
Gas Supply Association (``NGSA'') and National Corn Growers
Association (``NCGA'') on March 28, 2011, (``CL-NGSA/NCGA'') at 4-5
(position limits outside the spot month should be eliminated or be
increased substantially because threats of manipulation and
excessive speculation are primarily of concern in the physical-
delivery spot month contract); CL-PIMCO supra note 21 at 6; Global
Energy Management Institute, Bauer College of Business, University
of Houston (``Prof. Pirrong'') on January 27, 2011 (``CL-Prof.
Pirrong'') at para. 21 (Commission has provided no evidence that the
limits it has proposed are necessary to reduce the Hunt-like risk
that the Commission uses as a justification for its limits); CL-
SIFMA AMG I supra note 21 at 8; Teucrium Trading LLC (``Teucrium'')
on March 28, 2011 (``CL-Teucrium'') at 2 (limiting the size of
positions that a non-commercial market participant can hold in
forward (non-spot) futures contracts or financially-settled swaps,
the Commission will restrict the flow of capital into an area where
it is needed most--the longer term price curve); and CL-WGCEF supra
note 35 at 4.
\125\ CL-AIMA supra note 35 at 3.
\126\ CL-FIA I supra note 21 at 11.
---------------------------------------------------------------------------
A number of commenters opined that the Commission should increase
the open interest multipliers in the formula used in determining the
non-spot-month position limits.\127\ Other commenters opined that the
Commission should decrease the open interest multipliers to 5 percent
of open interest for first 25,000 contracts and then 2.5 percent.\128\
PMAA and the NEFI commented that the formula, which was developed in
1992 in the context of agricultural commodities, is inappropriate for
current markets with larger open interest relative to the agricultural
markets.\129\
---------------------------------------------------------------------------
\127\ See CL-AIMA supra note 35 at 3; CL-CME I supra note 8 at
12 (for energy and metals); CL-FIA I supra note 21 at 12 (10 percent
of open interest for first 25,000 contracts and then 5 percent); CL-
ICI supra note 21 at 10 (10 percent of open interest until requisite
market data is available); CL-ISDA/SIFMA supra note 21 at 20; CL-
NGSA/NCGA supra note 125 at 5 (25 percent of open interest); and CL-
PIMCO supra note 21 at 11.
\128\ See CL-Prof. Greenberger supra note 6 at 13; and CL-FWW
supra note 82 at 12.
\129\ CL-PMAA/NEFI supra note 6 at 9 (PMAA/NEFI commented that
as open interest in markets has grown well beyond the open interest
assumptions made in 1992, the size of large speculative positions
has not grown commensurately and that therefore the Commission
should decrease the marginal multiplier in the position limit
formula as open interest increases. PMAA/NEFI commented further that
the Commission should look at the actual positions by traders and
set limits to constrain the largest positions in the resulting
distribution).
---------------------------------------------------------------------------
Goldman Sachs recommended that the Commission use a longer
observation period than one year for setting position limits and
provided as an example five years in order to reduce pro-cyclical
effects (e.g., a decrease in open interest due to decreased speculative
activity in one period results in a limit in the subsequent period that
is excessively restrictive or vice-versa).\130\
---------------------------------------------------------------------------
\130\ See CL-Goldman supra note 90 at 6-7.
---------------------------------------------------------------------------
As stated in the proposal, the non-spot-month position limits are
intended to maximize the CEA section 4a(a)(3)(B) objectives, consistent
with the Commission's historical approach to setting non-spot-month
speculative position limits.\131\ Such a limits formula, in the
Commission's view, prevents a speculative trader from acquiring
excessively large positions and thereby would help prevent excessive
speculation and deter and prevent market manipulations, squeezes, and
corners. The Commission also believes, based on its experience under
part 150, that the 10 and 2.5 percent formula will ensure sufficient
liquidity for bona fide hedgers and avoids disruption to the price
discovery process.
---------------------------------------------------------------------------
\131\ The Commission has used the 10 and 2.5 percent formula in
administering the level of the legacy all-months position limits
since 1999. See e.g., 64 FR 24038, 24039, May 5, 1999. See also 17
CFR 150.5(c)(2).
---------------------------------------------------------------------------
The Commission notes that Congress implicitly recognized the
inherent uncertainty regarding future effects associated with setting
limits prophylactically and therefore directed the Commission, under
section 719(a) of the Dodd-Frank Act, to study on a
[[Page 71640]]
retrospective basis the effects (if any) of the position limits imposed
pursuant to section 4a on excessive speculation and on the movement of
transactions from DCMs to foreign venues.\132\ This study will be
conducted in consultation with DCMs and is to be completed within 12
months after the imposition of position limits. Following Congress'
direction, the Commission will conduct an evaluation of position limits
in performing this study and, thereafter, the Commission plans to
continue monitoring these limits, considering the statutory objectives
under section 4a(a)(3), and, if warranted, amend by rulemaking, after
notice and comment, the formula adopted herein to determine non-spot-
month position limits. The Commission may determine to reassess the
formula used to set non-spot-month position limits based on the study's
findings.
---------------------------------------------------------------------------
\132\ Dodd-Frank Act, supra note 1, section 719(a).
---------------------------------------------------------------------------
1. Single-Month, Non-Spot Position Limits
Under proposed Sec. 151.4(d)(1), the Commission proposed to set
the single-month limit at the same level as the all-months-combined
position limit. Several commenters requested that the Commission
reconsider this approach.\133\ The Air Transportation Association of
America, for example, argued that the proposed level would exacerbate
the problem of speculative trading in the nearby (next to expire)
futures month, the month upon which energy prices typically are
determined.\134\
---------------------------------------------------------------------------
\133\ CL-APGA supra note 17 at 2-3; CL-ATAA supra note 94 at 6,
13; CL-PMAA/NEFI supra note 6 at 11. 6,074 form comment letters
asked the Commission to adopt ``single-month limits that are no
higher than two-thirds of the all-months-combined levels.''
\134\ CL-ATAA supra note 94 at 6. They also asserted that the
Commission did not provide adequate justification for substantially
raising the single month limit to the same level as the all-months
combined limit. Id. at 13.
---------------------------------------------------------------------------
Three commenters, including ICE, cautioned the Commission not to
impose position limits that constrain speculative liquidity in the
outer month expirations of Referenced Contracts, that is, in contracts
that expire in distant years, as opposed to nearby contract
expirations.\135\ ICE further asked the Commission to consider whether
all-months-combined limits are necessary or appropriate in energy
markets in the outer months. ICE stated that such limits would decrease
liquidity for hedgers in the outer months and, moreover, all-months
limits are not appropriate for energy markets where hedging is done on
a much longer term basis relative to the agricultural markets where
hedging is primarily conducted to hedge the next year's crops.\136\
Teucrium Trading argued that by limiting the size of positions that a
non-commercial market participant can hold in forward (non-spot)
futures contracts or financially-settled swaps, the Commission would
restrict the flow of capital into an area where it is needed most--the
longer term price curve, that is, contracts that expire in distant
years.\137\
---------------------------------------------------------------------------
\135\ CL-ICE I supra note 69 at 9-10; CL-ISDA/SIFMA supra note
21 at 19; and CL-Teucrium supra note 124 at 2.
\136\ CL-ICE I supra note 69 at 9-10.
\137\ CL-Teucrium supra note 124 at 2.
---------------------------------------------------------------------------
The Commission has determined to set the single-month position
limit levels at the same level as the all-months-combined limits,
consistent with the proposal. Under current part 150, the Commission
sets a single-month limit at a level that is lower than the all-months-
combined limit; it also provides a limited exemption for calendar
spread positions to exceed that single-month limit under Sec.
150.4(a)(3), as long as the single month position (including calendar
spread positions) is no greater than the level of the all-months-
combined limit. Further, the Commission does not have a standard
methodology for determining how much smaller the level of the single-
month limit is set in comparison to the level of the all-months-
combined limit.
The Commission has made this determination for two reasons. First,
setting the single-month limit to the same level as that of the all-
months-combined limit simplifies the compliance burden on market
participants and renders the calendar spread exemption unnecessary.
Second, setting the limits at the same level for both spreaders and
other speculative traders will permit parity in position size between
these speculative traders in a single calendar month and, thus, may
serve to diminish unwarranted price fluctuations.\138\
---------------------------------------------------------------------------
\138\ The Commission notes that commenters arguing for more
restrictive individual month limits did not provide any supporting
data.
---------------------------------------------------------------------------
With respect to objections to deferred-month limits, the Commission
notes that Congress instructed the Commission to set limits on the spot
month, each other month, and the aggregate number of positions that may
be held by any person for all months.\139\
---------------------------------------------------------------------------
\139\ CEA section 4a(a)(3)(A), 7 U.S.C. 6a(a)(3)(A).
---------------------------------------------------------------------------
Finally, the Commission will continually monitor the size,
behavior, and impact of large speculative positions in single contract
months in order to determine whether it should adjust the single-month
limit levels.
2. ``Step-Down'' Position Limit
Three commenters recommended that the Commission adopt, in addition
to the spot-month limit and the single-month and all-months-combined
limits, an intermediate ``step-down'' limit between the spot-month
position limit and the single-month non-spot-month position limit.\140\
This ``step-down'' limit would be less restrictive than the spot-month
limit, but more restrictive than the single-month limit. BGA
recommended that the single-month limit should be scaled down
rationally before it reaches the spot month so that the market will not
be disrupted by panic selling on the day before the spot-month limit
becomes effective.\141\ The commenters did not propose alternative
criteria for imposing a step-down provision.
---------------------------------------------------------------------------
\140\ CL-BGA supra note 35 at 11; GFI Group (``GFI'') on January
31, 2011 (``CL-GFI'') at 2 (progressively tighter limits should
apply for physically-delivered energy contracts as they near
expiration/delivery); and CL-PMAA/NEFI supra note 6 at 11.
\141\ CL-BGA supra note 35 at 11.
---------------------------------------------------------------------------
Currently, the Commission and DCMs establish a single date when the
spot-month limit becomes effective. DCMs publicly disseminate this date
as part of their contracts' rules. The advance notice provides
sufficient time for market participants to reduce their positions as
necessary. The Commission is not aware of material issues related to
these provisions regarding the implementation of spot month limits. The
Commission further believes this practice ensures sufficient market
liquidity for bona fide hedgers and helps to deter and prevent squeezes
and corners in the spot period while providing trader flexibility to
manage positions and remain in compliance with the limits. The
Commission notes, however, that it will monitor trading activity and
resulting changes in prices in the transition period into the spot
month in order to determine whether it should impose a new ``step-
down'' limit for Referenced Contracts nearing the spot-month period.
3. Setting and Resetting Non-Spot-Month Limits
The Commission proposed all-months-combined aggregate limits and
single-month aggregate limits in proposed Sec. 151.4(d)(1). The
Commission is adopting those proposed limits in final Sec.
151.4(b)(1), which sets forth single-month and all-months-combined
position limits for non-legacy Referenced Contracts (i.e., those
agricultural contracts that currently are not subject to Federal
position limits as well as energy and metal contracts).
[[Page 71641]]
These limits would be fixed based on the following formula: 10 percent
of the first 25,000 contracts of average all-months-combined aggregated
open interest and 2.5 percent of the open interest for any amounts
above 25,000 contracts of average all-months-combined aggregated open
interest.
Under proposed Sec. 151.4(b)(1)(i), aggregated open interest is
derived from month-end open interest values for a 12-month time period.
The Commission would use open interest to determine the average all-
months-combined open interest for the relevant period, which, in turn,
will form the basis for the non-spot-month position limits.
Under the Proposed Rules, the Commission would calculate, for all
Referenced Contracts, open interest on an annual basis for a 12-month
period, January to December, and then, based on those calculations,
publish the updated non-spot-month position limits by January 31st of
the following calendar year. The updated limits would become effective
30 business days after such publication. With respect to the initial
limits, they would become effective pursuant to a Commission order
under proposed Sec. 151.4(h)(3) and would be based on 12 months of
open interest data.
Several commenters urged the Commission to use a transparent and
accessible methodology to determine non-spot-month position
limits.\142\ Some of these commenters recommended that updated non-
spot-month limits be determined through rulemaking, and not through
automatic annual recalculations as proposed.\143\
---------------------------------------------------------------------------
\142\ CL-FIA I supra note 21 at 12; CL-BlackRock supra note 21
at 18; CL-CME I supra note 8 at 12; CL-EEI/EPSA supra note 21 at 11;
CL-KCBT I supra note 97 at 3; CL-NGFA supra note 72 at 3; CL-WGC
supra note 21 at 5; and CL-ISDA/SIFMA supra note 21 at 21.
\143\ CL-BlackRock supra note 21 at 18; CL-CME I supra note 8 at
12; CL-EEI/EPSA supra note 21 at 11; CL-KCBT I supra note 97 at 3;
CL-NGFA supra note 70 at 3; and CL-WGC supra note 21 at 5. BlackRock
argued that a formal rulemaking process for adjusting position limit
levels would provide market participants with advanced notice of any
potential changes and an opportunity to express their views on such
changes.
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The World Gold Council argued that uncertainty associated with
floating, annually-set position limits may inadvertently discourage
market participants from providing the requisite long-term hedges.\144\
Encana asked the Commission to consider adopting procedures for a
periodic reevaluation of the formulas to ensure that they do not reduce
liquidity or impair the price discovery function of the markets.\145\
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\144\ CL-WGC supra note 21 at 5.
\145\ Encana Marketing (USA) Inc. (``Encana'') on March 28, 2011
(``CL-Encana'') at 2.
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Many commenters objected to the proposed timeline for setting
initial limits.\146\ For example, many comments urged the Commission to
act ``expeditiously.'' Delta recommended the Commission should use
sampling and other statistical techniques to make reasonable, working
assumptions about positions in various market segments to set initial
limits.
---------------------------------------------------------------------------
\146\ See e.g., CL-Delta supra note 20 at 11.
---------------------------------------------------------------------------
In response to comments, the Commission has determined to amend the
proposed process for setting initial and subsequent non-spot-month
position limits. With respect to initial non-spot-month position
limits, under Sec. 151.4(d)(3)(i) the initial non-spot-month limits
for non-legacy Referenced Contracts will be calculated and published
after the Commission has received data sufficient to determine average
all-months-combined aggregate open interest for a full 12-month period.
The aggregate open interest will be derived from various sources,
including data received from DCMs pursuant to part 16, swaps data under
part 20, and data regarding linked, direct access FBOT contracts under
a condition of a no-action letter and subsequently under part 48
regarding FBOT registration with the Commission, when finalized and
made effective. The Commission accepts part of Delta's recommendation
to utilize reasonable, working assumptions about positions in various
market segments to set initial limits. In this regard, the Commission
will strive to establish non-spot-month position limits in an expedited
manner that complies with the directives of Congress, while ensuring
that it has sufficient swaps data to properly estimate open interest
levels for Referenced Contracts.
To compute 12 months of open interest data in uncleared all-months-
combined swaps open interest, prior to the timely reporting of all swap
dealers' net uncleared open swaps and swaptions positions by
counterparty, the Commission may estimate uncleared open swaps
positions, based upon uncleared open interest data submitted by
clearing organizations or clearing members under part 20, in lieu of
the aggregate of swap dealers' net uncleared open swaps. In developing
accurate estimates of aggregate open interest under Sec.
151.4(b)(2)(i), the Commission will adjust such uncleared open interest
data submitted by clearing organizations or clearing members by an
appropriate ratio if it determines, using data regarding later periods
submitted by swap dealers and clearing members, that the uncleared open
interest data submitted by clearing members differ significantly from
the open interest data submitted by swap dealers.\147\ The Commission
has accordingly provided, under Sec. 151.4(b)(2)(ii), that, based on
data provided to the Commission under part 20, it may estimate
uncleared swaps open positions for the purpose of setting initial non-
spot-month position limits.
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\147\ An appropriate ratio is the ratio of uncleared open
interest submitted by swap dealers in such later periods to the
uncleared open interest submitted by clearing members in such later
periods.
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Under final Sec. 151.4(d)(3)(i), the Commission will review the
staff computations, including the assumptions made in estimating 12
months of uncleared all-months-combined swap open interest, for
consistency with the formula in the final rules. Once the Commission
determines that the staff computations conform to the established
formula, the Commission will approve and issue an order under final
Sec. 151.4(d)(3)(iii), publishing the initial levels of the non-spot-
month position limits.
Under final Sec. 151.4(d)(3)(ii), subsequent non-spot-month limits
for non-legacy Referenced Contracts will be updated and published every
two years, commencing two years after the initial determinations. These
subsequent position limits would be based on the higher of the most
recent 12 months average all-months-combined aggregate open interest or
24 months average all-months-combined aggregate open interest.\148\
Under Sec. 151.4(e), these limits would be made effective on the first
calendar day of the third calendar month after the date of publication
on the Commission's Web site.
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\148\ For example, assume in a particular Referenced Contract
that open interest has declined over a 24-month period; the average
all-months-combined aggregate open interest levels are 900,000
contracts for the most recent 12 months and 1,000,000 contracts for
the most recent 24 months. Position limits would be based on the
higher 24-month average level of 1,000,000 contracts. Thereby, the
higher level of the position limit may serve to ensure sufficient
market liquidity for bona fide hedgers in the event, for example, a
decline in use of derivatives occurred in the historical measurement
period that may be associated with a recession. Because position
limits apply to prospective time periods, the use of the higher
level may be appropriate, for example, with a subsequent
expansionary period.
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This procedure may provide for limits that would be generally less
restrictive than the proposed limits, since, by way of example, a
continued decline in open interest over two years under the Proposed
Rule would result in a lower
[[Page 71642]]
limit each year, whereas under the final rule the limit for the first
year would not decline and the limit for the second year would be based
on the higher 24-month average open interest. The Commission also notes
that under Sec. 151.4(e) the public would have notice of updated
position limit levels at least two months in advance of the effective
date of such limits (i.e., such limits would be made effective on the
first calendar day of the third calendar month immediately following
the publication of new limit levels).\149\ Final Sec. 151.5(e)
requires the Commission to provide all relevant open interest data used
to derive updated position limit levels. By making public this open
interest data, the public can monitor and anticipate future position
limit levels, consistent with the transparency suggestions made by
several commenters.
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\149\ For example, any limits fixed during the month of October
would take effect on January 1.
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In addition, Sec. 151.4(b)(2)(i)(C) provides that, upon the entry
of an order under Commission regulation 20.9 of the Commission's
regulations determining that operating swap data repositories
(``SDRs'') are processing positional data that will enable the
Commission to conduct surveillance in the relevant swaps markets, the
Commission shall rely on such data in order to determine all-months-
combined swaps open interest.
4. ``Legacy Limits'' for Certain Agricultural Commodities
The Proposed Rule would set non-spot-month limits for Reference
Contracts in legacy agricultural commodities at the Federal levels
currently in place (referred to herein as ``legacy limits''). Several
commenters recommended that the Commission should keep the legacy
limits.\150\ The American Bakers Association argued that raising these
legacy limits would increase hedging margins and increase volatility
which would ultimately undermine commodity producers' ability to sell
their product to consumers.\151\ Amcot opined that the Commission need
not proceed with phased implementation for the legacy agricultural
markets because it could set their limits based on existing legacy
limits.\152\
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\150\ American Bakers Association (``ABA'') on March 28, 2011
(``CL-ABA'') at 3-4; CL-AFIA supra note 94 at 3; Amcot on March 28,
2011 (``CL-Amcot'') at 2; CL-FWW supra note 81 at 13; CL-IATP supra
note 113 at 5; and CL-NGFA supra note 72 at 1-2.
\151\ CL-ABA supra note 150 at 3-4.
\152\ CL-Amcot supra note 150 at 3.
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Several other commenters recommended that the Commission abandon
the legacy limits.\153\ U.S. Commodity Funds argued that the Commission
offered no justification for treating legacy agricultural contracts
differently than other Referenced Contract commodities.\154\ Some of
these commenters endorsed the limits proposed by CME.\155\ Other
commenters recommended the use of the open interest formula proposed by
the Commission in determining the position limits applicable to the
legacy agricultural Referenced Contract markets.\156\ Finally, four
commenters expressed their preference that non-spot position limits be
kept consistent for the three wheat Core Referenced Futures
Contracts.\157\
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\153\ CL-AIMA supra note 35 at 4; Bunge on March 28, 2011 (``CL-
Bunge'') at 1-2; Deutsche Bank AG (``DB'') on March 28, 2011 (``CL-
DB'') at 6; Gresham Investment Management LLC (``Gresham'') on
February 15, 2011 (``CL-Gresham'') at 4-5; CL-FIA I supra note 21 at
12; CL-MGEX supra note 74 at 2; CL-MFA supra note 21 at 18-19; and
United States Commodity Funds LLC (``USCF'') on March 25, 2011
(``CL-USCF'') at 10-11.
\154\ CL-USCF supra note 153 at 10-11.
\155\ CL-Bunge supra note 153 at 1-2; CL-FIA I supra note 21 at
12; and CL-Gresham supra note 153 at 5. See CME Petition for
Amendment of Commodity Futures Trading Commission Regulation 150.2
(April 6, 2010), available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/df26_cmepetition.pdf.
\156\ CL-CMC supra note 21 at 3; CL-DB supra note 153 at 10; and
CL-MFA supra note 21 at 19.
\157\ CL-CMC supra note 21 at 3; CL-KCBT I supra note 97 at 1-2;
CL-MGEX supra note 74 at 2; and CL-NGFA supra note 72 at 4.
---------------------------------------------------------------------------
The Commission has determined to adopt the position limit levels
proposed by the CME for the legacy Core Referenced Futures Contracts.
Such levels would be effective 60 days after the publication date of
this rulemaking and those levels would be subject to the existing
provisions of current part 150 until the compliance date of these
rules, which is 60 days after the Commission further defines the term
``swap'' under the Dodd-Frank Act. At that point, the relevant
provisions of this part 151, including those relating to bona-fide
hedging and account aggregation, would also apply. In the Commission's
judgment, the CME proposal represents a measured approach to increasing
legacy limits, similar to that previously implemented.\158\ The
Commission will use the CME's all-months-combined petition levels as
the basis to increase the levels of the non-spot-month limits for
legacy Referenced Contracts. The petition levels were based on 2009
average month-end open interest. Adoption of the petition levels
results in increases in limit levels that range from 23 to 85 percent
higher than the levels in existing Sec. 150.2.
---------------------------------------------------------------------------
\158\ 58 FR 18057, April 7, 1993.
---------------------------------------------------------------------------
The Commission has determined to maintain the current approach to
setting and resetting legacy limits because it is consistent with the
Commission's historical approach to setting such limits. To ensure the
continuation of maintaining a parity of limit levels for the major
wheat contracts at DCMs and in response to comments supporting this
approach, the Commission will also increase the levels of the limits on
wheat at the MGEX and the KCBT to the level for the wheat contract at
the CBOT.\159\
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\159\ For a discussion of the historical approach, see 64 FR
24038, 24039, May 5, 1999.
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5. Non-Spot Month Class Limits
The Commission proposed to create two classes of contracts for non-
spot-month limits: (1) Futures and options on futures contracts and (2)
swaps. The Proposed Rule would apply single-month and all-months-
combined position limits to each class separately.\160\ The aggregate
position limits across contract classes are in addition to the position
limits within each contract class. Therefore, a trader could hold
positions up to the allowed limit in each class (futures and options
and swaps), provided that their overall position remains within the
applicable position limits. Under the proposal, a trader could net
positions within a class, such as a long swap position with a short
swap position, but could not net positions in different classes, such
as a long futures position with a short swap position. The class limits
were designed to diminish the possibility that a trader could have
market power as a result of a concentration in any one submarket and to
prevent a trader that had a flat net aggregate position in futures and
swaps combined from establishing extraordinarily large offsetting
positions.
---------------------------------------------------------------------------
\160\ Within a contract class, the limits would be set at an
amount equal to 10 percent of the first 25,000 contracts of average
all-months-combined aggregate open interest in the contract and 2.5
percent of the open interest for any amounts above 25,000 contracts.
The aggregate all-months-combined limits across contract classes
would be set at 10 percent of the first 25,000 contracts of average
all-months-combined aggregated open interests, and 2.5 percent of
the open interest thereafter. The average all-months-combined
aggregate open interest, which is the basis of these calculations,
is determined annually by adding the all-months futures open
interest and the all-month-combined swaps open interest for each of
the 12 months prior to the effective date and dividing that amount
by 12. Each trader's positions would be netted for the purpose of
determining compliance with position limits.
---------------------------------------------------------------------------
Several commenters stated that the class limits proposal was flawed
and therefore should not be adopted.\161\ For
[[Page 71643]]
example, the CME argued that because the class limits would not permit
netting across contract classes (that is, across futures and swaps),
the class limits would not appropriately limit a trader's actual (net)
speculative positions. CME further objected to this proposal by stating
that the Commission provided no rationale as to why the positions in
two futures contracts could be netted but positions in swaps and
futures could not be netted.\162\ Another commenter similarly argued
that economically equivalent contracts (futures or swaps) are simply
two components of a broader derivatives market for a particular
commodity and, therefore, the concept of establishing limits on a class
of economically equivalent derivatives was logically flawed.\163\
---------------------------------------------------------------------------
\161\ CL-AIMA supra note 35 at 3 (they add ``an unnecessary
level of complexity''); CL-BlackRock supra note 21 at 17; CL-Cargill
supra note 76 at 10; CL-CME I supra note 8 at 13; CL-DB supra note
153 at 8-9; CL-Goldman supra note 89 at 6; CL-ICE I supra note 69 at
9; CL-ISDA/SIFMA supra note 21 at 23; CL-MFA supra note 21 at 18;
CL-Prof. Pirrong supra note 124 at paras. 24-30; and CL-Shell supra
note 35 at 6.
\162\ CL-Shell supra note 35 at 6; CL-BlackRock supra note 21 at
17 (arguing that the Commission failed to demonstrate that large
positions in a submarket implies market power). See also CL-Cargill
supra note 76 at 10; CL-AIMA supra note 35 (commenting that the
proposed class limits add ``an unnecessary level of complexity'');
CL-ISDA/SIFMA supra note 21 at 23; CL-ICE I supra note 69 at 9; CL-
CME I supra note 8 at 13; CL-DB supra note 153 at 8-9; CL-Goldman
supra note 89 at 6; CL-MFA supra note 21 at 18; and CL-Prof. Pirrong
supra note 124 at paras. 24-30.
\163\ CL-ICE I supra note 69 at pg. 9.
---------------------------------------------------------------------------
In response to the comments, the Commission has determined to
eliminate class limits from the final rules. The Commission believes
that comments regarding the ability of market participants to net swaps
and future positions that are economically equivalent have merit. The
Commission believes that concerns regarding the potential for market
abuses through the use of futures and swaps positions can be addressed
adequately, for the time being, by the Commission's large trader
surveillance program. The Commission will closely monitor speculative
positions in Referenced Contracts and may revisit this issue as
appropriate.
F. Intraday Compliance With Position Limits
The Commission proposed to apply position limits on an intraday
basis, and some commenters urged the Commission to reconsider such a
requirement.\164\ Barclays commented that the Commission should
recognize intraday violations of aggregate limits as a form of
excusable overage because of the challenge of sharing and collating
position information on a real-time basis.
---------------------------------------------------------------------------
\164\ CL-Shell supra note 35 at 6-7; CL-API supra note 21 at 14
(Commission should engage in a rigorous analysis of the regulatory
burdens of intraday limits and ultimately clarify that position
limits will only apply at the end of each trading day); Barclays
Capital (``Barclays I'') on March 28, 2011 (``CL-Barclays I'') at 4-
5 (Commission should reconsider requiring intraday compliance for
non-spot-month position limits).
---------------------------------------------------------------------------
In the Commission's judgment, intraday compliance would constitute
a marginal compliance cost and not be overly-burdensome. The Commission
notes that firms may impose risk limits (i.e., position limits
determined by the internal risk management department or equivalent
unit) on individual traders and among related entities required to
aggregate positions under Sec. 151.7 to mitigate the need to create
systems to ensure intraday compliance. Moreover, the expected levels of
limits outside of the spot-month are not expected to affect many firms
and those affected firms should have the capability to establish
internal risk limits or real-time position reporting to ensure intraday
compliance with position limits. Finally, the Commission notes that
intraday compliance with position limits is consistent with existing
Commission \165\ and DCM \166\ policy. The Commission's policy on
intraday compliance reflects its concerns with very large speculative
positions, whether or not they persist through the end of a trading
day.
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\165\ Commodity Futures Trading Commission Division of Market
Oversight, Advisory Regarding Compliance with Speculative Position
Limits (May 7, 2010), available at http://www.cftc.gov/ucm/groups/public/@industryoversight/documents/file/specpositionlimitsadvisory0510.pdf.
\166\ See e.g., CME Rulebook, Rule 443, available at http://
www.cmegroup.com/rulebook/files/CME_Group_RA0909-5.pdf'') (amended
Sept. 14, 2009); ICE OTC Advisory, Updated Notice Regarding Position
Limit Exemption Request Form for Significant Price Discovery
Contracts, available at https://www.theice.com/publicdocs/otc/advisory_notices/ICE_OTC_Advisory_0110001.pdf (Jan. 4, 2010).
---------------------------------------------------------------------------
G. Bona Fide Hedging and Other Exemptions
The new statutory definition of bona fide hedging transactions or
positions in section 4a(c)(2) of the CEA generally follows the
definition of bona fide hedging in current Commission regulation
1.3(z)(1), with two significant differences. First, the new statutory
definition recognizes a position in a futures contract established to
reduce the risks of a swap position as a bona fide hedge, provided that
either: (1) The counterparty to such swap transaction would have
qualified for a bona fide hedging transaction exemption, i.e., the
``pass-through'' of the bona fides of one swap counterparty to another
(such swaps may be termed ``pass-through swaps''); or (2) the swap
meets the requirements of a bona fide hedging transaction. Second, a
bona fide hedging transaction or position must represent a substitute
for a physical market transaction.\167\
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\167\ In 1977, the Commission proposed a general or conceptual
definition of bona fide hedging that did not include the modifying
adverb ``normally'' to the verb ``represent.'' 42 FR 14832, Mar. 17,
1977. The Commission introduced the adverb normally in the
subsequent final rulemaking in order to accommodate balance sheet
hedging that would otherwise not have met the general definition of
bona fide hedging. 42 FR 42748, Aug. 24, 1977. The Commission noted
that, for example, hedges of asset value volatility associated with
depreciable capital assets might not represent a substitute for
subsequent transactions in a physical marketing channel. Id. at
42749.
---------------------------------------------------------------------------
Section 4a(c)(1) of the CEA authorizes the Commission to define
bona fide hedging transactions or positions ``consistent with the
purposes of this Act.'' Congress directed the Commission, in amended
CEA section 4a(c)(2), to adopt a definition of bona fide hedging
transactions or positions for futures contracts (and options) for
purposes of setting the position limits mandated by CEA section
4a(a)(2)(A). Pursuant to this authority, the Commission proposed a new
regulatory definition of bona fide hedging transactions or positions in
proposed Sec. 151.5(a).\168\ The Commission also proposed Sec. 151.5
to establish five enumerated exemptions from position limits for bona
fide hedging transactions or positions for exempt and agricultural
commodities.
---------------------------------------------------------------------------
\168\ By its terms, the definition of bona fide hedging applies
only to futures (and options). Pursuant to section 4a(c), the
Commission proposed to extend the definition of bona fide hedging
transactions and positions to all Referenced Contracts, including
swaps. The Commission is adopting the definition of bona fide
hedging substantially as proposed. The Commission believes that
applying the statutory definition of bona fide hedging to swaps is
consistent with congressional intent as embodied in the expansion of
the Commission's authority to swaps (i.e., those that are
economically-equivalent and SPDFs). In granting the Commission
authority over such swaps, Congress recognized that such swaps
warrant similar treatment to their economically equivalent futures
for purposes of position limits and therefore, intended that the
statutory definition of bona fide hedging also be extended to swaps.
---------------------------------------------------------------------------
Under the proposal, a trader must meet the general requirements for
a bona fide hedging transaction or position in proposed Sec.
151.5(a)(1) and also meet the requirements for an enumerated hedging
transaction in proposed Sec. 151.5(a)(2). The general requirements
call for the bona fide hedging transaction or position to represent a
substitute for transactions in a physical marketing channel (that is,
the cash market for a physical commodity), to be economically
appropriate to the reduction of risks in
[[Page 71644]]
the conduct and management of a commercial enterprise, and to arise
from the potential change in the value of certain assets, liabilities,
or services. The five proposed enumerated hedging transactions are
discussed below. The proposed section did not provide for non-
enumerated hedging transactions or positions, which current Commission
regulations 1.3(z)(3) and 1.47 permit. Under the proposal, Commission
regulation 1.3(z) would be retained only for excluded commodities.
Proposed Sec. 151.5(b) established reporting requirements for a
trader upon exceeding a position limit. The trader would be required to
submit information not later than 9 a.m. on the business day following
the day the limit was exceeded. Proposed Sec. 151.5(c) specified
application and approval requirements for traders seeking an
anticipatory hedge exemption, incorporating the current requirements of
Commission regulation 1.48. Proposed Sec. 151.5(d) established
additional reporting requirements for a trader who exceeded the
position limits in order to reduce the risks of certain swap
transactions, discussed above.
Proposed Sec. 151.5(e) specified recordkeeping requirements for
traders that acquire positions in reliance on bona fide hedge
exemptions, as well as for swap counterparties for which a counterparty
represents that the transaction would qualify as a bona fide hedging
transaction. Swap dealers availing themselves of a hedge exemption
would be required to maintain a list of such counterparties and make
that list available to the Commission upon request. Proposed Sec. Sec.
151.5(g) and (h) provided procedural documentation requirements for
such swap participants.
Proposed Sec. 151.5(f) required a cross-commodity hedger to
provide conversion information, as well as an explanation of the
methodology used to determine such conversion information, between the
commodity exposure and the Referenced Contracts used in hedging.
Proposed Sec. 151.5(i) required reports by bona fide hedgers to be
filed for each business day, up to and including the day the trader's
position level first falls below the position limit that was exceeded.
The Commission has responded to the many comments received by
making substantial changes to the Proposed Rules. A full discussion of
the comments received and of the Commission's responses is found below.
In summary, in the final rules, the Commission: (1) Clarifies that a
transaction qualifies as a bona fide hedging transaction without regard
to whether the hedger's position would otherwise exceed applicable
position limits; (2) expands the list of enumerated hedging
transactions to include hedging of anticipated merchandising activity,
royalty payments, and service contracts; (3) clarifies the conditions
under which swaps executed opposite a commercial counterparty would be
recognized as the basis for bona fide hedging; (4) reduces the burden
of claiming a pass-through swap exemption; (5) introduces new Sec.
151.5(b) to make the aggregation and bona fide hedging provisions of
part 151 consistent; (6) clarifies that cash market risk can be hedged
on a one-to-one transactional basis or can be hedged as a portfolio of
risk; (7) eliminates the restriction on holding hedges in cash-settled
contracts up through the last trading day; (8) reduces the daily filing
requirement for cash market information on the Form 404 and Form 404S
to a monthly filing of daily reports; (9) allows for self-effectuating
notice filings for those hedge exemptions that require such a filing;
and (10) provides an exemption for situations involving ``financial
distress.''
1. Enumerated Hedges
Under proposed Sec. 151.5(a)(1), no transaction or position would
be classified as a bona fide hedging transaction unless it also
satisfies the requirements for one of five categories of enumerated
hedging transactions.\169\
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\169\ Thus, for example, an anticipatory merchandising
transaction could only serve as a basis of an enumerated hedge if
it, inter alia, reduces the risks attendant to transactions
anticipated to be made in the physical marketing channel.
---------------------------------------------------------------------------
The Commission received many comment letters regarding the proposed
definition of bona fide hedging, with a number of commenters expressing
concern that the proposed definition was ambiguous and overly
restrictive.\170\ Morgan Stanley, for example, opined that the ``very
narrow'' definition of bona fide hedging in the Proposed Rule would
unnecessarily limit the ability of many market participants to engage
in ``many well-established risk reducing activities.'' \171\ Several
commenters requested bona fide hedging recognition for transactions
beyond those expressly enumerated.\172\ In this respect, some
commenters, including the FIA and Morgan Stanley, urged the Commission
to exercise its broad exemptive authority under CEA section 4a(a)(7) to
accommodate a wider range of legitimate hedging activities, including
the hedging of general swap position risk, otherwise known as a risk
management exemption.\173\
---------------------------------------------------------------------------
\170\ See e.g., CL-FIA I supra note 21 at 14-15; CL-Morgan
Stanley supra note 21 at 4, 5; and CL-ISDA/SIFMA supra note 21 at 9.
\171\ CL-Morgan Stanley supra note 21 at 5. According to Morgan
Stanley, the proposed definition may preclude market participants
from (i) netting exposure across different categories of related
futures and swaps; (ii) hedging long-term risks in illiquid markets,
common in the development of large infrastructure projects; and
(iii) assuming the positions of a less stable market participant
during times of market distress.
\172\ See e.g., CL-Commercial Alliance I supra note 42 at 2-3;
CL-FIA I supra note 21 at 13; and Economists Inc. on March 28, 2011
(``CL-Economists Inc.'') at 2.
\173\ See e.g., CL-FIA I supra note 21 at 13; CL-ISDA/SIFMA
supra note 21 at 8; CL-BlackRock supra note 21 at 16; CL-Barclays I
supra note 164 at 3; and CL-ICI supra note 21 at 9.
---------------------------------------------------------------------------
Several commenters argued that not permitting a risk management
exemption would be inconsistent with other parts of the Act and
Commission rulemakings.\174\ For example, CME argued that the hedging
standard under the major swap participant (``MSP'') definition includes
swap positions ``maintained by [pension plans] for the primary purpose
of hedging or mitigating any risk directly associated with the
operation of the plan.'' \175\ CME also pointed to the commercial end-
user exception to mandatory clearing requirements, where the
Commission's proposed definition of hedging ``covers swaps used to
hedge or mitigate any of a person's business risks.'' \176\
---------------------------------------------------------------------------
\174\ See e.g., CL-CME I supra note 8 at 18.
\175\ See id. at 18 citing New CEA section 1a(33), 7 U.S.C.
1a(33).
\176\ See id. at 18 citing 75 FR 80747 (Dec. 23, 2010).
---------------------------------------------------------------------------
As discussed above, the Commission is authorized to define bona
fide hedging for swaps. The Commission, however, does not believe that
including a risk management provision is necessary or appropriate given
that the elimination of the class limits outside of the spot-month will
allow entities, including swap dealers, to net Referenced Contracts
whether futures or economically equivalent swaps. As such, under the
final rules, positions in Referenced Contracts entered to reduce the
general risk of a swap portfolio will be netted with the positions in
the portfolio.
Some commenters also objected to the Commission's failure to
recognize as bona fide hedging swap transactions that qualify for the
end-user clearing exception. Such omission, these commenters added,
will lead to unnecessary disruption to commercial hedgers' legitimate
business practices.\177\ The end-user clearing exception is available
for swap transactions used to hedge or mitigate
[[Page 71645]]
commercial risk. When Congress inserted a general definition of bona
fide hedging in CEA section 4a(c)(2), Congress did not include language
that paralleled the end-user clearing exception; rather, Congress
included different criteria for bona fide hedging transactions or
positions.\178\ Accordingly, the Commission believes that the end-user
exception's broader sweep, that the swap be used for ``hedg[ing] or
mitigat[ing] commercial risk,'' is not appropriate for a definition of
a bona fide hedging transaction.\179\
---------------------------------------------------------------------------
\177\ See e.g., CL-FIA I supra note 21 at 15l and CL-EEI/EPSA
supra note 21 at 15.
\178\ The Commission notes that Congress also referred to
positions held ``for hedging or mitigating commercial risk'' in the
definition of major swap participant. CEA section 1a(33), 7 U.S.C.
1a(33). Due to the nearly identical wording, the Commission has
proposed to interpret this phrase in the implementation of the end-
user exception in a near-identical manner in the further definition
of major swap participant. CFTC, Notice of Proposed Rulemaking, End-
User Exception to Mandatory Clearing of Swaps, 75 FR 80747, 80752-3,
Dec. 23, 2010. In light of Congress's nearly identical use of this
language in two separate provisions of the Dodd-Frank Act, but not
within the definition of bona fide hedging, the Commission does not
believe that Congress intended that the different wording in section
4a(c)(2) should be interpreted in an identical manner to these
differently worded provisions.
\179\ Under the new statutory definition of a bona fide hedge,
positions must meet the following requirements: (1) They must
represent a substitute for transactions made or to be made or
positions taken or to be taken at a later time in the physical
marketing channel; (2) they must be economically appropriate to the
reduction of risk in the conduct and management of a commercial
enterprise; and (3) the hedge must manage price risks associated
with specific types of activities in the physical marketing channel
(e.g., the production of commodity assets). CEA section 4a(c)(2), 7
U.S.C. 6a(c)(2). The conditions for the end-user exception may
overlap with the general statutory definition of bona fide hedging
on one of the latter's three prongs. Similarly, the statutory
direction to define bona fide hedging does address whether at least
one counterparty is not a financial entity and does not address how
one meets its financial obligations, which are conditions for
claiming the end-user exception.
---------------------------------------------------------------------------
Several commenters expressed concern that exemptions were not
provided for arbitrage or spread positions in the list of enumerated
bona fide hedges.\180\ Some commenters, such as ISDA/SIFMA, argued that
the Commission should use its exemptive authority under CEA section
4a(a)(7) to include an exemption for inter-commodity spread and
arbitrage transactions, ``which reflect a relationship between two
commodities rather than an outright directional position in the spread
components * * *. Arbitrage and inter-commodity spreads do not raise
the same price volatility concerns as outright positions. On the
contrary, they constitute a standard investment practice that minimizes
exposure while capturing inefficiencies in an established relationship
and aiding price discovery in each contract.'' \181\
---------------------------------------------------------------------------
\180\ See e.g., CL-CME I supra note 8 at 18; CL-Commercial
Alliance I supra note 42 at 3, 7, 9, CL-ISDA/SIFMA supra note 21 at
11; and CL-MFA supra note 21 at 18.
\181\ CL-ISDA/SIFMA supra note 21 at 17.
---------------------------------------------------------------------------
With regard to spread exemptions, under current Sec. 150.3(a)(3),
a trader may use this exemption to exceed the single-month limit
outside the spot month in a single futures contract or options thereon,
but not to exceed the all-months limit in any single month. As
explained in the proposal, the Commission proposed to set the single-
month limit at the level of the all-months limit, making the ``spread''
exemption no longer necessary. Since the final rule retains the
individual-month limit at the same level as the all-months-combined
limit, it remains unnecessary to extend an exemption to spread
positions.
With respect to the existing DCM arbitrage exemptions, under
existing DCM rules a trader may receive an arbitrage exemption to the
extent that the trader has offsetting positions at a separate trading
venue. The Commission does not believe that it is necessary to provide
for such an exemption from aggregate position limits because the
Commission has eliminated class limits in these final rules for non-
spot-month position limits. As such, a trader's offsetting positions
among Referenced Contracts outside of the spot month, whether futures
or economically-equivalent swaps, would be netted for purposes of
applying the position limits and, therefore, there is no need for
arbitrage exemptions. As discussed in further detail under II.N.3.
below, however, the Commission has provided for an arbitrage exemption
from DCM or SEF position limits under certain circumstances.
With regard to inter-commodity spreads, traders would not be able
to net such positions unless the positions fall within the same
category of Referenced Contracts. However, a trader offsetting multiple
risks in the physical marketing channel may be eligible for a bona fide
hedging exemption. For example, a processor seeking to hedge the price
risk associated with anticipated processing activity may receive bona
fide hedging treatment for an inter-commodity spread economically
appropriate to the reduction of its anticipated price risks under final
Sec. 151.5(a)(ii)(C).
As discussed above, the final rules retain the class limits within
the spot-month. Otherwise, if a trader were permitted to claim an
arbitrage exemption in the spot-month across physically-delivered and
cash-settled spot-month class limits, then that trader would be able to
amass an extraordinarily large long position in the physically-
delivered Referenced Contract with an offsetting short position in a
cash-settled Referenced Contract, effectively cornering the market at
the entry prices to the contracts. In the proposal, the Commission
asked whether it should grant a bona fide hedge exemption to an agent
that is not responsible for the merchandising of the cash positions,
but is linked to the production of the physical commodity, e.g., if the
agent is the provider of crop insurance. Amcot recommended that the
Commission deny exemptions to crop insurance providers.\182\ Similarly,
Food and Water Watch questioned whether agents merely linked to
production should be allowed to claim bona fide hedges.\183\ CME, in
contrast, argued that extending the bona fide hedge exemption to these
entities would be appropriate.\184\ The Commission notes that crop
insurance providers and other agents that provide services in the
physical marketing channel could qualify for a bona fide hedge of their
contracts for services arising out of the production of the commodity
underlying a Referenced Contract under Sec. 151.5(a)(2)(vii).
---------------------------------------------------------------------------
\182\ CL-Amcot supra note 150 at 2.
\183\ CL-FWW supra note 81 at 2.
\184\ CL-CME I supra note 8 at 8.
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In response to comments, the Commission clarifies in the final rule
that whether a transaction qualifies as a bona fide hedging transaction
or position is determined without regard to whether the hedger's
position would otherwise exceed applicable position limits.\185\
Accordingly, a person who uses a swap to reduce risks attendant to a
position that qualifies for a bona fide hedging transaction may pass-
through those bona fides to the counterparty, even if the person's swap
position is not in excess of a position limit.
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\185\ The Commission also notes that the bona fide hedge
definition in new CEA section 4a(c)(2), 7 U.S.C. 6a(c)(2), deals
with an entity's transaction and not the entity itself. As such, the
Commission declines to provide bona fide hedge status to an entity
without reference to the underlying transaction.
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Proposed Sec. 151.5(a)(2)(ii) stated that purchases of Referenced
Contracts may qualify as bona fide hedges. However, the language in
proposed Sec. 151.5(a)(2)(i) provided that sales of any commodity
underlying Referenced Contracts may qualify as bona fide hedges.
Existing Commission regulation 1.3(z) treats equally purchases and
sales of futures contracts (and does not explicitly cover sales or
purchases of any commodity
[[Page 71646]]
underlying). BGA requested that the Commission harmonize the perceived
difference between the current and Proposed Rule texts.\186\ The
Commission has deleted the phrase ``any commodity underlying'' from
``sales of any commodity underlying Referenced Contracts'' in Sec.
151.5(a)(2)(i) in order to clarify that it does not intend to treat
hedges involving the sales of Referenced Contracts any differently than
hedges involving the purchases of Referenced Contracts.
---------------------------------------------------------------------------
\186\ CL-BGA supra note 35 at 15. See also CL-FIA I supra note
21 at 15; and CL-Morgan Stanley supra note 21 at 5.
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The Commission received many comments describing transactions that
the commenters believed would not be covered by the Commission's
proposed bona fide hedging provisions. Appendix B to part 151 has been
added to list some of the transactions or positions that the Commission
deems to qualify for the bona fide hedging exemption.\187\ The appendix
includes an analysis of each fact pattern to assist market participants
in understanding the enumerated hedging transactions in final Sec.
151.5(a)(2). As discussed in section II.G.4. and provided for in Sec.
151.5(a)(5), if any person is engaging in other risk-reducing practices
commonly used in the market which the person believes may not be
specifically enumerated above, such person may ask for relief regarding
the applicability of the bona fide hedging exemption from the staff
under Sec. 140.99 or the Commission under section 4a(a)(7) of the CEA.
---------------------------------------------------------------------------
\187\ Many of these transactions were described in comment
letters. See e.g., CL-Economists Inc. supra note 172 at 10-17; CL-
Commercial Alliance I supra note 42 at 5-10; and CL-FIA I supra note
21 at 14-15.
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Further, to provide transparency to the public, the Commission is
considering publishing periodically general statistical information
gathered from the bona fide hedging exemptions to inform the public of
the extent of commercial firms' use of exemptions. This summary data
may include the number of persons and extent to which such persons have
availed themselves of cash-market, anticipatory, and pass-through-swaps
bona fide hedge exemptions.
2. Anticipatory Hedging
As discussed in II.G.1. above, some commenters objected that
proposed Sec. 151.5(a)(1) included the anticipated ownership or
merchandising of an exempt or agricultural commodity, but such
transactions were not included in the list of enumerated hedges.\188\
Commenters pointed out that, while the statutory definition of bona
fide hedging appears to contemplate hedges of asset price risk,\189\
including royalty or volumetric production payments,\190\ hedges of
liabilities or services,\191\ and anticipatory ownership and
merchandising,\192\ these types of hedge transactions are not
recognized among enumerated hedge transactions in the proposal.
---------------------------------------------------------------------------
\188\ See e.g., CL-FIA I supra note 21 at 15; CL-BGA supra note
35 at 14; CL-ISDA/SIFMA supra note 21 at 11; and CL-EEI/EPSA supra
note 21 at 15.
\189\ See CL-Commercial Alliance I supra note 42 at 3. See also
CL-Bunge supra note 153 at 3-4 (describing ``enterprise hedging''
needs arising from, inter alia, investments in operating assets and
forward contract relationships with farmers and consumers that
create timing mismatches between the cash flow associated with the
physical commodity commitment and the hedge's cash flow).
\190\ See e.g., CL-FIA I supra note 21 at 15.
\191\ See e.g., CL-FIA I supra note 21 at 14; CL-Commercial
Alliance I supra note 42 at 3; CL-BGA supra note 35 at 14; CL-ISDA/
SIFMA supra note 21 at 11; and CL-EEI/EPSA supra note 21 at 14.
\192\ See e.g., CL-FIA I supra note 21 at 15; CL-BGA supra note
35 at 14; CL-ISDA/SIFMA supra note 21 at 11; and CL-EEI/EPSA supra
note 21 at 15.
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In response to commenters, the Commission is expanding the list of
enumerated hedging transactions to recognize, in final Sec. Sec.
151.5(a)(2)(v)-(vii), the hedging of anticipated merchandising
activity, royalty payments (a type of asset), and service contracts,
respectively, under certain circumstances as discussed below in detail.
The Commission has determined that the transactions fall within the
statutory definition of bona fide hedging transactions and are
otherwise consistent with the purposes of section 4a of the Act.
The Commission had never recognized anticipated ownership and
merchandising transactions as bona fide hedging transactions,\193\ due
to its historical view that anticipatory ownership and merchandising
transactions generally fail to meet the second ``appropriateness''
prong of the Commission's definition of a bona fide hedging
transaction, \194\ which requires that a hedge be economically
appropriate and that it reduce risks in the conduct and management of a
commercial enterprise. For example, a merchant may anticipate that it
will purchase and sell a certain amount of a commodity, but has not
acquired any inventory or entered into fixed-price purchase or sales
contracts. Although the merchant may anticipate such activity, the
price risk from merchandising activity is yet to be assumed and
therefore a transaction in Referenced Contracts could not reduce this
yet-to-be-assumed risk. Such a merchant would not meet the second prong
of the bona fide hedging definition. To the extent that a merchant
acquires inventory or enters into fixed-price purchase or sales
contracts, the merchant would have established a position of risk and
may meet the requirements of the second prong and the long-standing
enumerated provisions to hedge those risks.
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\193\ The Commission historically has recognized a merchandising
transaction as a bona fide hedge in the narrow circumstances of an
agent responsible for merchandising a cash market position which is
being offset. 17 CFR 1.3(z)(3).
\194\ The ``appropriateness'' test was contained in Commission
regulation 1.3(z)(1). Congress incorporated that provision in the
new statutory definition in 4a(c)(2)(A)(ii), 7 U.S.C.
6a(c)(2)(A)(ii).
---------------------------------------------------------------------------
In response to comments, the Commission recognizes that in some
circumstances, such as when a market participant owns or leases an
asset in the form of storage capacity, the market participant could
establish market positions to reduce the risk associated with returns
anticipated from owning or leasing that capacity. In these narrow
circumstances, the transactions in question may meet the statutory
definition of a bona fide hedging transaction. However, to address
Commission concerns about unintended consequences (e.g., creating a
potential loophole that may result in granting hedge exemptions for
types of speculative activity), the Commission will recognize
anticipatory merchandising transactions as a bona fide hedge, provided
the following conditions are met: (1) The hedger owns or leases storage
capacity; (2) the hedge is no larger than the amount of unfilled
storage capacity currently, or the amount of reasonably anticipated
unfilled storage capacity during the hedging period; (3) the hedge is
in the form of a calendar spread (and utilizing a calendar spread is
economically appropriate to the reduction of risk associated with the
anticipated merchandising activity) with component contract months that
settle in not more than twelve months; and (4) no such position is
maintained in any physical-delivery Referenced Contract during the last
five days of trading of the Core Referenced Futures Contract for
agricultural or metal contracts or during the spot month for other
commodities.\195\ In addition, the anticipatory merchandiser must meet
specific new filing requirements under Sec. 151.5(d)(1). As is the
case with other anticipated hedges, the Commission clarifies in the
final rule that such a hedge can only be maintained so long as
[[Page 71647]]
the trader is reasonably certain that he or she will engage in the
anticipated merchandising activity.
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\195\ A specific example of this type of anticipated
merchandising is described in Appendix B to the final rule.
---------------------------------------------------------------------------
New Sec. Sec. 151.5(a)(2)(vi)-(vii) provide for royalty and
services hedges that are available only if: (1) The royalty or services
contract arises out of the production, manufacturing, processing, use,
or transportation of the commodity underlying the Referenced Contract;
and (2) the hedge's value is ``substantially related'' to anticipated
receipts or payments from a royalty or services contract. Specific
examples of what types of royalties or service contracts would comply
with Sec. 151.5(a)(1) and would therefore be eligible as a basis for a
bona fide hedge transaction are described in Appendix B to the final
rule.
Under proposed Sec. 151.5(c), the Commission also limited the
availability of an anticipatory hedge to a period of one year after the
request date, in contrast to proposed Sec. 151.5(a)(2), which only
imposed this requirement for Referenced Contracts in agricultural
commodities. Several commenters requested that the Commission expand
the scope of anticipatory hedging to include hedging periods beyond one
year.\196\ These commenters opined that limiting anticipatory hedging
to one year may make sense in the agricultural context because the
risks are typically associated with an annual crop cycle; however, this
same analysis does not apply to other commodities, particularly for
electricity generators, utilities, and other energy companies.\197\ For
example, this restriction would be commercially unworkable for
infrastructure projects that require multi-year hedges in order to
secure financing.\198\
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\196\ CL-Cargill supra note 76 at 5; CL-FIA I supra note 21 at
16; CL-AGA supra note 124 at 7-8; and CL-EEI/EPSA supra note 21 at
5.
\197\ See CL-EEI/EPSA supra note 21 at 18.
\198\ See CL-FIA supra note 21 at 6; and CL-Morgan Stanley supra
note 21 at 6.
---------------------------------------------------------------------------
The Commission has amended the appropriate exemptions for
anticipatory activities under Sec. 151.5(a)(2) to clarify that the
one-year limitation for production, requirements, royalty rights, and
service contracts applies only to Referenced Contracts in an
agricultural commodity, except that a one-year limitation for
anticipatory merchandising, applies to all Referenced Contracts.
The Commission proposed in Sec. 151.5(a)(2)(i) to recognize the
hedging of unsold anticipated production as an enumerated hedge. The
Commission clarifies in the final rule that anticipated production
includes anticipated agricultural production, e.g., the anticipated
production of corn in advance of a harvest.
3. Pass-Through Swaps
In the proposal, the Commission explained that under CEA section
4a(c)(2)(B), pass-through swaps are recognized as the basis for bona
fide hedges if the swap was executed opposite a counterparty for whom
the transaction would qualify as a bona fide hedging transaction
pursuant to CEA section 4a(c)(2)(A). Further, a swap in a Referenced
Contract may be used as a bona fide hedging transaction if that swap
itself meets the requirements of CEA section 4a(c)(2)(A). CEA section
4a(c)(2)(A) provides the general definition of a bona fide hedge
transaction.
Several commenters requested clarification concerning the so-called
pass-through provision.\199\ For example, Cargill maintained that the
rule is not clear on whether the non-hedging counterparty may claim a
hedge exemption for the swap, and without such an exemption there would
be less liquidity available to hedgers using swaps because potential
counterparties would be subject to position limits for the swap
itself.\200\
---------------------------------------------------------------------------
\199\ See e.g., CL-Cargill supra note 76 at 6; and CL-FIA I
supra note 21 at 17.
\200\ See CL-Cargill supra note 76 at 6; and CL-EEI/EPSA supra
note 21 at 17.
---------------------------------------------------------------------------
The Commission clarifies through new Sec. 151.5(a)(3) (entitled
``Pass-through swaps'') that positions in futures or swaps Referenced
Contracts that reduce the risk of pass-through swaps qualify as a bona
fide hedging transaction. In response to comments regarding the bona
fide hedging status of the pass-through swap itself, \201\ the
Commission also clarifies that the non-bona-fide counterparty (e.g., a
swap-dealer) may classify this swap as a bona fide hedging transaction
only if that non-bona-fide counterparty enters risk reducing positions,
including in futures or other swap contracts, which offset the risk of
the pass-through swap. For example, if a person entered a pass-through
swap opposite a bona fide hedger, either within or outside of the spot-
month, that resulted in a directional exposure of 100 long positions in
a Referenced Contract, that person could treat those 100 long positions
as a bona fide hedging transaction only if that person also entered
into 100 short positions to reduce the risk of the pass-through swap.
Absent this restriction, a non-bona-fide counterparty could create a
large speculative directional position in excess of limits simply by
entering into pass-through swaps.
---------------------------------------------------------------------------
\201\ See e.g., CL-Cargill supra note 76 at 6.
---------------------------------------------------------------------------
The Commission notes that regardless of the bona fide status of the
pass-through swap, outside of the spot-month the risk-reducing
positions in a Referenced Contract will net with the positions from the
pass-through swap. Similarly, within the spot-month, if the non-bona-
fide counterparty to a pass-through swap reduces the risk of that swap
with cash-settled Referenced Contracts, the risk reducing positions in
cash-settled contracts would net with the pass-through swap for
purposes of the spot-month position limit.
Because the spot-month limits include class limits for physical-
delivery futures contracts and cash-settled contracts, the bona fide
hedging status of the pass-through swap would impact spot-month
compliance if the non-bona-fide counterparty reduced the risk of the
pass-through swap with physical-delivery futures contracts in the spot-
month. However, as discussed above, so long as the risk of the pass-
through swap is offset, these final rules would treat both the pass-
through swap and the risk reducing positions as bona fide hedges. In
this connection, the Commission notes that the non-bona-fide
counterparty would still be subject to 151.5(a)(1)(v), and must exit
the physical delivery futures contract in an orderly manner as the
person ``lifts'' the hedge of the pass-through swap. Similarly, as with
all transactions in Referenced Contracts, the person would be subject
to the intra-day application of position limits. Therefore, as the
person ``lifts'' the hedge of the pass-through swap, if the pass-
through swap is no longer offset, only the extent of the pass-through
swap that is offset would qualify as a bona fide hedge.
The Commission clarifies through new Sec. 151.5(a)(4) (entitled
``Pass-through swap offsets'') that a pass-through swap position will
be classified as a bona fide hedging transaction for the counterparty
for whom the swap would not otherwise qualify as a bona fide hedging
transaction pursuant to paragraph (a)(2) of this section (the ``non-
hedging counterparty''), provided that the non-hedging counterparty
purchases or sells Referenced Contracts that reduce the risks attendant
to such pass-through swaps.
Commenters also requested further clarity concerning proposed Sec.
151.5(g), which set forth certain procedural requirements for pass-
through swap counterparties. FIA and ISDA, for example, stated that it
was unclear whether the pass-through provision is limited to
transactions where the swap counterparty is relying on an exemption
[[Page 71648]]
to exceed the limits, and not simply entering a swap with a
counterparty that is a bona fide hedger.\202\ Other commenters
requested clarification as to whether the hedger must wait until all
written communications have been exchanged before it can enter into a
hedging transaction.\203\ According to these commenters, such a
requirement could delay entering a swap for hours if not days,\204\
forcing the hedger to assume the risk of price changes during the
period between when it enters the swap and when the parties complete
the written documentation process.\205\ Finally, commenters believed
the rule was unclear on the type of representation that must be
provided by an end-user and may be relied upon by dealers.\206\
---------------------------------------------------------------------------
\202\ See e.g., CL-FIA I supra note 21 at 19; and CL-ISDA/SIFMA
supra note 21 at 10.
\203\ See CL-FIA I supra note 21 at 18.
\204\ See CL-EEI/EPSA supra note 21 at 17.
\205\ See CL-FIA I supra note 21 at 19.
\206\ See e.g., CL-BGA supra note 35 at 16.
---------------------------------------------------------------------------
Some commenters recommended a less-costly verification regime that
would allow parties to rely upon a one-time representation concerning
eligibility for the bona fide hedging exemption.\207\ ISDA/SIFMA also
argued that the Commission should confirm the bona fide hedger status
of a party in order to prevent, among other things, unwarranted
disclosure of confidential information from an end-user to a
dealer.\208\ Further, ISDA/SIFMA argued that the determination should
be on an entity-by-entity basis, and not on a transaction-by-
transaction basis, in order to promote certainty for bona fide hedgers
and their swap counterparties.\209\ BGA argued that the proposal to
require a dealer to continuously monitor whether the underlying swap
continues to offset the cash commodity risk of the hedging counterparty
would result in significant and costly burdens on end-users and other
hedgers.\210\
---------------------------------------------------------------------------
\207\ See e.g., CL-EEI/EPSA supra note 21 at 17; CL-ISDA/SIFMA
supra note 21 at 12; and CL-FIA I supra note 21 at 19.
\208\ See CL-ISDA/SIFMA supra note 21 at 13.
\209\ See id.
\210\ See e.g., CL-BGA supra note 35 at 17; and ISDA/SIFMA supra
note 21 at 12.
---------------------------------------------------------------------------
In response to these comments, the Commission has determined to
reduce the burden of claiming a pass-through swap exemption. Under new
Sec. 151.5(i), in order to rely on a pass-through exemption, a
counterparty would be required to obtain from its counterparty a
representation that the swap, in its good-faith belief, would qualify
as an enumerated hedge under Sec. 151.5(a)(2). Such representation
must be provided at the inception (i.e., execution) of the swap
transaction and the parties to the swap must keep records of the
representation. This representation, which may be made in a trade
confirmation, must be kept for a period of at least two years following
the expiration of the swap and furnished to the Commission upon
request.
Deutsche Bank also requested clarification as to whether the
immediate counterparty to the swap must be a bona fide hedger or
whether the Commission will look to a series of transactions to
determine if it was connected to a bona fide hedger.\211\ Deutsche Bank
argued that given the complexity of the swaps marketplace, market
participants often hedge their risk through multiple combinations of
intermediaries; hence, the Commission should not require that the
immediate counterparty be a bona fide hedger, but rather part of a
network of transactions connected to a bona fide hedger.\212\
---------------------------------------------------------------------------
\211\ See CL-DB supra note 153 at 8.
\212\ See id. Barclays similarly noted that it should not matter
whether the original holder of a pass-through swap risk manages the
risk itself or asks another to manage it for them and that overall
systemic risk would increase if risk transfer is made more
difficult. CL-Barclays I supra note 164 at 4.
---------------------------------------------------------------------------
The Commission rejects extending the pass-through exemption to a
series of swap transactions. Rather, consistent with this Congressional
direction, a pass-through swap will be recognized as a bona fide hedge
only to the extent it is executed opposite a counterparty eligible to
claim an enumerated hedge exemption.\213\
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\213\ See CEA section 4a(c)(2)(B)(i), 7 U.S.C. 6a(c)(2)(B)(i).
The Commission notes that the same restrictions on holding a
position in the spot month or the last five days of trading of
physical-delivery Core Referenced Futures Contracts that would apply
to the swap counterparty with the underlying bona fide risk also
apply to the holder of the pass-through swap. For example, if a swap
dealer enters into a crude oil swap with an anticipatory production
hedger, then it would be subject to the same restrictions on holding
the hedge of that pass-through swap into the spot month of the
appropriate physical-delivery Referenced Contract.
---------------------------------------------------------------------------
The Commission clarifies that the pass-through swap exemption will
allow non-hedging counterparties to such swaps to offset non-Referenced
Contract swap risk in Referenced Contracts.\214\
---------------------------------------------------------------------------
\214\ For example, Company A owns cash market inventory in a
non-Referenced Contract commodity and enters into a Swap N with Bank
B. Swap N would be an enumerated bona fide hedging transaction for
Company A under the rules of a DCM or SEF. Because Swap N is not a
Referenced Contract, Bank B does include Swap H in measuring
compliance with position limits. However, Bank B, as is economically
appropriate, may enter into a cross-commodity hedge to reduce the
risk associated with Swap N. That risk reducing transaction is a
bona fide hedging transaction for Bank B.
---------------------------------------------------------------------------
Some commenters recommended that the Commission exclude inter-
affiliate swaps from any calculation of a trader's position for
position limit compliance purposes.\215\ API, for example, argued that
swaps among affiliates would have no net effect on the positions of
affiliated entities and the final rule should therefore make it clear
that the Commission will not consider such swaps for purposes of
position limits.\216\ API commented further that this approach would be
consistent with the Commission's treatment of inter-affiliate swaps in
other proposed rulemakings, for example, the proposed rulemaking
further defining, inter alia, swap dealer.\217\
---------------------------------------------------------------------------
\215\ CL-COPE supra note 21 at 13; CL-API supra note 21 at 11;
CL-Shell supra note 35 at 4-5; and CL-WGCEF supra note 35 at 23.
\216\ CL-API supra note 21 at 11.
\217\ Id.
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In light of the structure of the aggregation rules regarding the
treatment of a single person or a group of entities under common
ownership or control, as provided for under Sec. 151.7, the Commission
has introduced Sec. 151.5(b). This subsection clarifies that entities
required to aggregate accounts or positions under Sec. 151.7 shall be
considered the same person for the purpose of determining whether a
person or persons are eligible for a bona fide hedge exemption under
Sec. 151.5(a) to the extent that such positions are attributed among
these entities. The Commission's intention in introducing new Sec.
151.5(b) is to make the aggregation and bona fide hedging provisions of
part 151 consistent. For example, a holding company that owns a
sufficient amount of equity in an operating company would need to
aggregate the operating company's positions with those of the holding
company in order to determine compliance with position limits.
Commission regulation 151.5(b) would clarify that the holding company
could enter into bona fide hedge transactions related to the operating
company's cash market activities, provided that the operating company
has itself not entered into such hedge transactions with another person
with whom it is not aggregated (i.e., the holding company's hedge
activity must comply with the appropriateness requirement of Sec.
151.5(a)(1)). Appendix B to the final regulations provides an
illustrative example as to how this provision would operate.
4. Non-Enumerated Hedges
Many of the commenters objecting to the proposed definition of bona
fide
[[Page 71649]]
hedging requested that the Commission reintroduce a process for
claiming non-enumerated hedging exemptions.\218\ The Working Group of
Commercial Energy Firms (``Working Group''), for example, argued that
the Commission should maintain its current flexibility and preserve its
ability to allow exemptions.\219\ FIA commented further that such a
provision is expressly authorized under CEA section 4a(a)(7).\220\ The
Commission has considered the comments and has expanded the list of
enumerated hedge transactions, consistent with the statutory definition
of bona fide hedging.
---------------------------------------------------------------------------
\218\ See e.g., CL-FIA I supra note 21 at 15; CL-EEI/EPSA supra
note 21 at 15; CL-CME I supra note 8 at 19; CL-Morgan Stanley supra
note 21 at 6; and CL-WGCEF supra note 35 at 5. It should be noted,
however, that at least 184 comment letters opined that the
Commission should define the bona fide hedge exemption ``in the
strictest sense possible'' and that ``[b]anks, hedge funds, private
equity and all passive investors in commodities should not be deemed
as bona fide hedgers.''
\219\ CL-WGCEF supra note 35 at 5.
\220\ CL-FIA I supra note 21 at 15.
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In response to questions raised by commenters, the Commission notes
that market participants may request interpretive guidance (under Sec.
140.99(a)(3)) regarding the applicability of any of the provisions of
this part, including whether a transaction or class of transactions
qualify as enumerated hedges under Sec. 151.5(a)(2). Market
participants may also petition the Commission to amend the current list
of enumerated hedges or the conditions therein. Such a petition should
set forth the general facts surrounding such class of transactions, the
reasons why such transactions conform to the requirements of the
general definition of bona fide hedging in Sec. 151.5(a)(1), and the
policy purposes furthered by the recognition of this class of
transactions as the basis for enumerated bona fide hedges.
5. Portfolio Hedging
Some commenters requested clarification as to whether the new bona
fide hedging exemption would require one-to-one tracking, and argued
that portfolio hedging should be allowed because the combination of
hedging instruments, such as futures, swaps and options, generally
cannot be individually identified to particular physical
transactions.\221\ Some of these commenters argued that if the
Commission does not permit portfolio hedging, the requirement to one-
to-one track physical commodity transactions with corresponding hedge
transactions will increase risk by preventing end-users from
effectively hedging their commercial exposure.\222\
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\221\ See e.g., CL-Cargill supra note 76 at 2-3; CL-BGA supra
note 35 at 15; and CL-ISDA/SIFMA supra note 21 at 10-11.
\222\ See e.g., CL-BGA supra note 35 at 15.
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The Commission notes that the final Sec. 151.5(a)(2) provides for
bona fide hedging transactions and positions. The Commission intends to
allow market participants either to hedge their cash market risk on a
one-to-one transactional basis or to combine the risk associated with a
number of enumerated cash market transactions in establishing a bona
fide hedge, provided that the hedge is economically appropriate to the
reduction of risk in the conduct and management of a commercial
enterprise, as required under Sec. 151.5(a)(1)(ii). The Commission has
clarified this intention by adding after ``potential change in the
value of'' in Sec. 151.5(a)(1)(iii) the phrase ``one or several.''
\223\
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\223\ Similarly, and in light of comments, the Commission has
elected not to adopt proposed Sec. 151.5(j) in recognition of the
confusion this provision could have caused to market participants
who hedge on a portfolio basis and to reduce the burden of requiring
a continuing representation of bona fides by the swap counterparty.
The proposed Sec. 151.5(j) provided that a party to a swap opposite
a bona fide hedging counterparty could establish a position in
excess of the position limits, offset that position, and then re-
establish a position in excess of the position limits, so long as
the swap continued to offset the cash market commodity risk of a
bona fide hedging counterparty.
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6. Restrictions on Hedge Exemptions
Proposed Sec. 151.5(a)(2)(v) generally followed the Commission's
existing agricultural commodity position limits regime, which restricts
cross-commodity hedge transactions from being classified as a bona fide
hedge during the last five days of trading on a DCM.\224\ Some
commenters recommended that the Commission eliminate this prohibition,
otherwise market participants will have to assume risks during that
time period instead of shifting risks to those willing to assume
them.\225\ According to the FIA, unhedged risk, such as a commercial
company unable to hedge jet fuel price exposure with heating oil
futures or swap contracts in the last five days of trading, would
reduce market liquidity and increase the risk of operating a commercial
business.\226\ Further, ISDA opined that the Commission did not
adequately justify the purpose of applying a prohibition from the
Commission's agricultural commodity position limits to other
commodities.\227\
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\224\ See Sec. 1.3(z)(2)(iv). In the proposal, anticipatory
hedge transactions could not be held during the five last trading
days of any Referenced Contract. This restriction has been clarified
to be aligned with the trading calendar of the Core Referenced
Futures Contract and applies to all anticipatory transaction hedges.
\225\ See e.g., CL-FIA I supra note 21 at 16l and CL-ISDA/SIFMA
supra note 21 at 11.
\226\ See CL-FIA I supra note 21 at 16.
\227\ See CL-ISDA/SIFMA supra note 21 at 11.
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The Commission recognizes the restriction on holding cross-
commodity hedges in the last five days of trading may increase tracking
risk if the trader were forced out of the Referenced Contract into a
lesser correlated contract, or into a deferred contract month that was
less correlated with the relevant cash market risk than the spot month.
However, the Commission also continues to believe that such cross-
commodity hedges are not appropriately recognized as bona fide in the
physical-delivery contracts in the last five days of trading for
agricultural and metal Referenced Contracts or the spot month for
energy Referenced Contracts since the trader does not hold the
underlying commodity for delivery against, or have a need to take
delivery on, the underlying commodity The Commission agrees with the
comments regarding the elimination of the restriction on holding a
cross-commodity hedge in cash-settled contracts during the last five
days of trading for agricultural and metal contracts and the spot month
for other contracts and has relaxed this restriction for hedge
positions established in cash-settled contracts. Under the final rules,
traders may maintain their cross-commodity hedge positions in a cash-
settled Referenced Contract through the final day of trading.
The Commission received a number of comments on similar
restrictions proposed to apply to other enumerated hedge
transactions.\228\ The National Milk Producers Federation, for example,
argued that the restriction on holding a hedge position through the
last days of trading for cash-settled contracts should be eliminated
because if a trader carried positions through the last days of trading
in a cash-settled contract then it could not impact the orderly
liquidation of the market.\229\
---------------------------------------------------------------------------
\228\ See e.g., CL-Commercial Alliance I supra note 42 at 9; and
National Milk Producers Federation (``NMPF'') on July 25, 2011
(``CL-NMPF'') at 3-4.
\229\ CL-NMPF, supra note 228 at 3-4.
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In response to these comments, the Commission has eliminated all
restrictions on holding a bona fide hedge position for cash-settled
contracts and narrowed the restriction on holding a bona fide hedge
position in physical-delivery contracts. Specifically, a bona fide
hedge position for anticipatory hedges for production, requirements,
merchandising, royalty rights, and service contract, and unfixed-price
calendar spread risk hedges
[[Page 71650]]
(Sec. 151.5(a)(2)(iii), and, as discussed above, cross-commodity
hedges in all bona fide hedge circumstances will not retain bona fide
hedge status if held, for physical-delivery agricultural and metal
contracts, in the last five trading days and in the spot month for all
other physical-delivery contracts. The Commission has modified the
Proposed Rule in recognition of potential circumstances where
inefficient hedging would be required if the restriction were
maintained as proposed, the reduced concerns with a negative impact on
the market of maintaining such a hedge if held in a cash-settled
contract (as opposed to a physical-delivery contract), and a generally
cautious approach to imposing new restrictions on the ability of
traders active in the physical marketing channel to enter into cash-
settled transactions to meet their hedging needs.
7. Financial Distress Exemption
Some commenters requested that the Commission introduce an
exemption for market participants in financial distress scenarios.
Morgan Stanley, for example, commented that during periods of financial
distress, it may be beneficial for a financially sound entity to assume
the positions (and corresponding risk) of a less stable market
participant.\230\ Morgan Stanley argued that not providing for an
exemption in these types of situations could reduce liquidity and
increase systemic risk. Similarly, Barclays argued that the Commission
should preserve the flexibility to accommodate situations involving,
for example, the exit of a line of business by an entity, a customer
default at a futures commission merchant (``FCM''), or in the context
of potential bankruptcy.\231\
---------------------------------------------------------------------------
\230\ CL-Morgan Stanley supra note 21 at 16.
\231\ CL-Barclays I supra note 164 at 5.
---------------------------------------------------------------------------
In recognition of the public policy benefits of including such an
exemption, the Commission has provided, in Sec. 151.5(j), for an
exemption for situations involving financial distress. The Commission's
authority to provide for this exemption is derived from CEA section
4a(a)(7).\232\ In this regard, the Commission clarifies that this
exemption for financial distress situations does not establish or
otherwise represent a form of hedging exemption.
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\232\ New CEA section 4a(a)(7) provides that the Commission may
``by rule, regulation, or order * * * exempt * * * any person or
class of persons'' from any requirement it may establish under
section 4a. 7 U.S.C. 6a(a)(7). This provision requires that any
exemption, general or bona fide, to position limits granted by the
Commission, be done by Commission action.
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8. Filing Requirements
Under the proposal, once an entity's total position exceeds a
position limit, the entity must file daily reports on Form 404 for cash
commodity transactions and corresponding hedge transactions and on Form
404S for information on swaps used for hedging.\233\ Several commenters
argued that bona fide hedgers should only be required to file monthly
reports to the Commission because daily reporting is onerous and
unnecessary.\234\ In addition, the commenters pointed out that daily
reporting will also be costly for the Commission,\235\ and argued that
the Commission should instead utilize its special call authority on top
of monthly reporting to ensure that it has sufficient information.\236\
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\233\ See Sec. Sec. 151.5(b) and (d).
\234\ See e.g., CL-Cargill supra note 76 at 3; CL-FIA I supra
note 21 at 20; CL-Commercial Alliance I supra note 42 at 3-4; CL-BGA
supra note 35 at 17; CL-EEI/EPSA supra note 21 at 15-16; and CL-
Utility Group supra note 21 at 14. See also CL-ISDA/SIFMA supra note
21 at 12 (opposing daily reporting).
\235\ See CL-FIA I supra note 21 at 21; and CL-ISDA/SIFMA supra
note 21 at 12.
\236\ See e.g., CL-Cargill supra note 76 at 4.
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The Commission has determined to address these concerns by
requiring that a trader file a Form 404 three business days following
the day that a position limit is exceeded and thereafter file daily
data on a monthly basis. These monthly reports would, under Sec.
151.5(c)(1), provide cash market positions for each day that the trader
exceeded the position limits during the monthly reporting period. This
amendment would reduce the filing burden on market participants. The
Commission believes the monthly reports, though less timely, would
generally provide information sufficient to determine a trader's daily
compliance with position limits, without requiring a trader to file
additional information under a special call or, as discussed below,
follow-up information on his or her notice filings. The Commission has
also reduced the filing burden by allowing all such reports of cash
market positions to be filed by the third business day following the
day that a position limit is exceeded, rather than on the next business
day.
Final Sec. 151.5(d) asks for information relevant to the three new
anticipatory hedging exemptions--for merchandising, royalties, and
services contracts--that would be helpful for the Commission in
evaluating the validity of such claims. For anticipated merchandising
hedge exemptions, the Commission is most interested in understanding
the storage capacity relating to the anticipated and historical
merchandising activity. For anticipated royalty hedge exemptions, the
Commission is interested in understanding the basis for the projected
royalties. For anticipated services, the Commission is interested in
understanding what types of service contracts have given rise to the
trader's anticipated hedging exemption request.
The Commercial Alliance recommended that Form 404A filings for
anticipatory hedgers be modified to require descriptions of activity,
as opposed to calling for the submission of data reflecting a one-for-
one correlation between an anticipated market risk and a hedge
position.\237\ The Commercial Alliance stated that companies are not
managed in this manner and the data could not be collated and provided
to the Commission in this way.\238\ The Commercial Alliance provided
recommended amendments to the requirements for Form 404A filers to
reflect that information concerning anticipated activities would be
appropriate to justify a hedge position, in accordance with regulations
151.5(a)(1) and (a)(2).
---------------------------------------------------------------------------
\237\ Commercial Alliance (``Commercial Alliance II'') on July
20, 2011 (``CL-Commercial Alliance II '') at 1.
\238\ Id.
---------------------------------------------------------------------------
The Commission agrees with many of the Commercial Alliance's
suggestions. For example, Sec. 151.5(c)(2) closely tracks the
Commercial Alliance's suggested language revisions. The information
required by this section should allow the Commission to understand
whether the trader's bona fide hedging activity complies with the
requirements of Sec. 151.5(a)(1). Final Sec. 151.5(c)(2) clarifies
that the 404 filing is a notice filing made effective upon submission.
Many commenters opined that the application and approval process
for receiving an anticipatory hedge exemption set forth in proposed
Sec. 151.5(c) would impose an unnecessary compliance burden on
hedgers.\239\ In response to such comments, the Commission has amended
the process for claiming an anticipatory hedge in Sec. 151.5(d)(2) to
allow market participants to claim an exemption by notice filing. The
notice must be filed at least ten days in advance of the date the
person expects to exceed the position limits and is effective after
that ten-day period unless so notified by the Commission.
---------------------------------------------------------------------------
\239\ See e.g., CL-ICE I supra note 69 at 12; and CL-WGCEF supra
note 35 at 2-3.
---------------------------------------------------------------------------
In response to commenters seeking greater procedural certainty for
obtaining bona fide hedge
[[Page 71651]]
exemptions,\240\ Sec. 151.5(e) clarifies the conditions of the
Commission's review of 404 and 404A notice filings submitted under
Sec. Sec. 151.5(c) and 151.5(d), respectively. Traders submitting
these filings may be notified to submit additional information to the
Commission in order to support a determination that the statement filed
complies with the requirements for bona fide hedging exemptions under
paragraph (a) of Sec. 151.5.
---------------------------------------------------------------------------
\240\ See e.g., CL-WGCEF supra note 35 at 2-3.
---------------------------------------------------------------------------
H. Aggregation of Accounts
The proposed part 151 regulations would significantly alter the
existing position aggregation rules and exemptions currently available
in part 150. Specifically, the aggregation standards under proposed
Sec. 151.7 would eliminate the independent account controller
(``IAC'') exemption under Sec. 150.3(a)(4), restrict many of the
disaggregation provisions currently available under Sec. 150.4, and
create a new owned-financial entity exemption. The proposal would also
require a trader to aggregate positions in multiple accounts or pools,
including passively-managed index funds, if those accounts or pools
have identical trading strategies. Lastly, disaggregation exemptions
would no longer be available on a self-executing basis; rather, an
entity seeking an exemption from aggregation would need to apply to the
Commission, with the relief being effective only upon Commission
approval.\241\
---------------------------------------------------------------------------
\241\ The Commission did not propose any substantive changes to
existing Sec. 150.4(d), which allows an FCM to disaggregate
positions in discretionary accounts participating in its customer
trading programs provided that the FCM does not, among other things,
control trading of such accounts and the trading decisions are made
independently of the trading for the FCM's other accounts. As
further described below, however, the FCM disaggregation exemption
would no longer be self-executing; rather, such relief would be
contingent upon the FCM applying to the Commission for relief.
---------------------------------------------------------------------------
Some commenters supported the proposed aggregation standards,
contending that the revised standards would enhance the Commission's
ability to monitor and enforce position limits by preventing
institutional investors, including hedge funds, from evading
application of position limits by creating multiple smaller investment
funds.\242\ However, many of the commenters on the account aggregation
rules objected to the change in the aggregation policy and, in
particular, the proposed elimination of the IAC exemption.\243\
Generally, these commenters expressed concern that the proposed
aggregation standards would result in an inappropriate aggregation of
independently controlled accounts, potentially cause harmful
consequences to investors and investment managers, and potentially
reduce liquidity in the commodities markets.
---------------------------------------------------------------------------
\242\ See e.g., CL-PMAA/NEFI supra note 6 at 16-17; CL-Prof.
Greenberger supra note 6 at 18; CL-AFR supra note 17 at 8; and CL-
FWW supra note 81 at 16.
\243\ See e.g., CL-FIA I supra note 21; CL-Commercial Alliance
II supra note 237 at 1; CL-DB supra note 153 at 6; CL-CME I supra
note 8 at 15-16; ICI supra note 21 at 8; CL-BlackRock supra note 21
at 9; New York City Bar Association--Committee on Futures and
Derivatives (``NYCBA'') on April 11, 2011 (``CL-NYCBA'') at 2; and
CL-SIFMA AMG supra note 21 at 10. One commenter did ask that the
Commission allow for a significant amount of time for an orderly
transition from the IAC to the more limited account aggregation
exemptions in the proposed rules. See CL-Cargill supra note 76 at 7.
---------------------------------------------------------------------------
In response to comments, the Commission is adopting the proposed
aggregation standard, with modifications as discussed below. In brief,
the final rules largely retain the provisions of the existing IAC
exemption and pool aggregation standards under current part 150. The
final rules reaffirm the Commission's current requirements to aggregate
positions that a trader owns in more than one account, including
accounts held by entities in which that trader owns a 10 percent or
greater equity interest. Thus, for example, a financial holding company
is required to aggregate house accounts (that is, proprietary trading
positions of the company) across all wholly-owned subsidiaries.
1. Ownership or Control Standard
Under proposed Sec. 151.7, a trader would be required to aggregate
all positions in accounts in which the trader, directly or indirectly,
holds an ownership or equity interest of 10 percent or greater, as well
as accounts over which the trader controls trading.\244\ The Proposed
Rule also treats positions held by two or more traders acting pursuant
to an express or implied agreement or understanding the same as if the
positions were held by a single trader.
---------------------------------------------------------------------------
\244\ In this regard, the Commission interprets the ``hold'' or
``control'' criterion as applying separately to ownership of
positions and to control of trading decisions.
---------------------------------------------------------------------------
As proposed, a trader also would be required to aggregate interests
in funds or accounts with identical trading strategies. Proposed Sec.
151.7 would require a trader to aggregate any positions in multiple
accounts or pools, including passively-managed index funds, if those
accounts or pools had identical trading strategies. The Commission is
finalizing this provision as proposed.\245\
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\245\ Barclays requested that, in light of the fundamental
changes to the aggregation policy, the Commission should reconsider
the 10 percent ownership standard. Specifically, Barclays stated
that the ownership test should be tied to a ``meaningful actual
economic interest in the result of the trading of the positions in
question,'' and that 10 percent ownership, in absence of control, is
no longer a ``viable'' standard. See CL-Barclays I supra note 164 at
3. In view of the fact that the Commission is finalizing the
aggregation provisions with modifications to the proposal that will
substantially address the concerns of the comments, the Commission
has determined to retain the long-standing 10 percent ownership
standard that has worked effectively to date. In response to a point
raised by Commissioner O'Malia in his dissent, the Commission
clarifies that it will continue to use the 10 percent ownership
standard and apply a 100 percent position aggregation standard, and
therefore will not adopt Barclays' recommendation that ``only an
entity's pro rata share of the position that are actually controlled
by it or in which it has ownership interest'' be aggregated. Id. at
3. In the future, the Commission may reconsider whether to adopt
Barclays' recommendation.
---------------------------------------------------------------------------
2. Independent Account Controller Exemption
The Commission proposed to eliminate the IAC exemption in part 150.
Numerous commenters asserted that the Commission failed to provide a
reasoned explanation for the departure from its long-standing exception
from aggregation for independently controlled accounts.\246\ These
commenters also asserted that the elimination of the IAC exemption
would force aggregation of accounts that are under the control of
independent managers subject to meaningful information barriers and,
hence, do not entail risk of coordinated excessive speculation or
market manipulation.\247\ Morgan Stanley asserted that the rationale
for permitting disaggregation for separately controlled accounts is
that ``the correct application of speculative position limits hinges on
attributing speculative positions to those actually making trading
decisions for a particular account.'' \248\ In absence of the IAC
[[Page 71652]]
exemption, commenters further noted that otherwise independent trading
operations would be required to communicate with each other as to their
trading positions so as to avoid violating position limits, raising the
risk for concerted trading.\249\
---------------------------------------------------------------------------
\246\ See e.g., CL-FIA I supra note 21 at 22-23; CL-CME I supra
note 8 at 15; and CL-CMC supra note 21 at 4; CL-ISDA/SIFMA supra
note 21 at 14-16; CL-Katten supra note 21 at 3; CL-MFA supra note 21
at 13; CL-Morgan Stanley supra note 21 at 7; CL-NYCBA supra note 243
at 2; Barclays Capital (``Barclays II'') on June 14, 2011 (``CL-
Barclays II'') at 1; and U.S. Chamber of Commerce (``USCOC'') on
March 28, 2011 (``CL-USCOC'') at 6.
\247\ See e.g., CL-CME I supra note 8 at 15; CL-ICI supra note
21 at 9; CL-BlackRock supra note 21 at 4, 9; CL-Katten supra note 21
at 3; CL-ISDA/SIFMA supra note 21 at 14; CL-AIMA supra note 35 at 5-
6; DB Commodity Services LLC (``DBCS'') on March 28, 2011 (``CL-
DBCS'') at 7; and CL-Barclays I supra note 164 at 2.
\248\ CL-Morgan Stanley supra note 21 at 7. Morgan Stanley added
that the resulting inability to disaggregate separately controlled
accounts of its various affiliates will have ``[a] significantly
adverse effect on Morgan Stanley's ability to provide risk
management services to its clients and will reduce market
liquidity.''
\249\ See e.g., CL-MFA supra note 21 at 13.
---------------------------------------------------------------------------
The Commission has carefully considered the views expressed by
commenters and has determined to retain the IAC exemption largely as
currently in effect, with clarifications to make explicit the
Commission's long-standing position that the IAC exemption is limited
to client positions, that is, only to the extent one trades
professionally for others can one avail him or herself of this IAC
exemption. Such a person has a fiduciary relationship to those clients
for whom he or she trades.\250\ Accordingly, eligible entities may
continue to rely upon the IAC exemption to disaggregate client
positions held by an IAC. This means that the IAC exemption does not
extend to proprietary positions in accounts which a trader owns.
---------------------------------------------------------------------------
\250\ See e.g., 56 FR 14308, 14312 (Apr. 9, 1991) (clarifying,
among other things, that the IAC exemption is limited to those who
trade professionally for others, and who have a fiduciary
relationship to those for whom they trade).
---------------------------------------------------------------------------
After reviewing the comments in connection with the terms of the
proposal, the Commission believes that retaining the IAC exemption for
independently managed client accounts is in accord with the purposes of
the aggregation policy. The fundamental rationale for the aggregation
of positions or accounts is the concern that a single trader, through
common ownership or control of multiple accounts, may establish
positions in excess of the position limits and thereby increase the
risk of market manipulation or disruption. Such concern is mitigated in
circumstances involving client accounts managed under the discretion
and control of an independent trader and subject to effective
information barriers. The Commission also recognizes the wide variety
of commodity trading programs available for market participants. To the
extent that such accounts and programs are traded independently and for
different purposes, such trading may enhance market liquidity for bona
fide hedgers and promote efficient price discovery.
Under the current IAC exemption provision, an eligible entity,
which includes banks, CPOs, commodity trading advisors (``CTAs''), and
insurance companies, may disaggregate customer positions or accounts
managed by an IAC from its proprietary positions (outside of the spot
months), subject to the conditions specified therein. Specifically, an
IAC must trade independently of the eligible entity and of any other
IAC trading for the eligible entity and have no knowledge of trading
decisions by any other IAC.\251\
---------------------------------------------------------------------------
\251\ If the IAC is affiliated with the eligible entity or
another IAC trading on behalf of the eligible entity, each of the
affiliated entities must, among other things, maintain written
procedures to preclude them from having knowledge of, or gaining
access to data about trades of the other, and each must trade such
accounts pursuant to separately developed and independent trading
systems. See Sec. 150.3(a)(4)(i).
---------------------------------------------------------------------------
A central feature of the IAC exemption is the requirement that the
IAC trades independently of the eligible entity and of any other IAC
trading for the eligible entity. The determination of whether a trader
exercises independent control over the trading decisions of the
customer discretionary accounts or trading programs within the meaning
of the IAC exemption must be decided case-by-case based on the
particular underlying facts and circumstances. In this respect, the
Commission will look to certain factors or indicia of control in
determining whether a trader has control over certain positions or
accounts for aggregation purposes.\252\
---------------------------------------------------------------------------
\252\ 64 FR 33839, Jun. 13, 1979 (``1979 Aggregation Policy
Statement''). In that release, the Commission provided certain
indicia of independence, which included appropriate screening
procedures, separate registration and marketing, and a separate
trading system.
---------------------------------------------------------------------------
A non-exclusive list of such indicia of control includes existence
of a proper firewall separating the trading functions of the IAC and
the eligible entity. That is, the Commission will consider, in
determining whether the IAC trades independently, the degree to which
there is a functional separation between the proprietary trading desk
of the eligible entity and the desk responsible for trading on behalf
of the managed client accounts. Similarly, the Commission will consider
the degree of separation between the research functions supporting a
firm's proprietary trading desk and the client trading desk. For
example, a firm's research information concerning fundamental demand
and supply factors and other data may be available to an IAC who
directs trading for a client account of the firm. However, specific
trading recommendations of the firm contained in such information may
not be substituted for independently derived trading decisions. If the
person who directs trading in an account regularly follows the trading
suggestions disseminated by the firm, such trading activity will be
evidence that the account is controlled by the firm. In the absence of
a proper firewall separating the trading or research functions, among
other things, an eligible entity may not avail itself of the IAC
exemption.
3. Exemptions From Aggregation
Several commenters expressed concern that forced aggregation of
independently controlled and managed accounts would effectively require
independent trading operations of commonly-owned entities to coordinate
trading activities and commercial hedging opportunities, in potential
violation of contractual and legal obligations, such as FERC affiliate
rules,\253\ bank regulatory restrictions, and antitrust
provisions.\254\ Some commenters also asserted that asset managers and
advisers may be required to violate their fiduciary duty to clients by
sharing confidential information with third parties, and which could
also lead to anti-competitive activity if two unrelated entities, such
as competitors in a joint-venture, are required to share such
confidential information.\255\ FIA also added that a company with an
affiliate underwriter may not be aware that its affiliate has acquired
a temporary, passive interest in another company trading commodities.
Under the aggregation proposal, the first company would be required to
share trading information with a temporary affiliate. In such instance,
FIA concludes, the cost of aggregation ``greatly outweighs the
unarticulated regulatory benefits.'' \256\
---------------------------------------------------------------------------
\253\ See e.g., CL-FIA I supra note 21 at 23-24; CL-EEI/ESPA
supra note 21 at 20; CL-ISDA/SIFMA supra note 21 at 16; and CL-AGA
supra note 124 at 9.
\254\ See e.g., CL-FIA I supra note 21 at 24; CL-API supra note
21 at 11; CL-DBCS supra note 247 at 3; CL-CME I supra note 8 at 17;
CL-ISDA/SIFMA supra note 21 at 16; CL-MFA supra note 21 at 13; CL-
Morgan Stanley supra note 21 at 8; CL-SIFMA AMG I supra note 21 at
11; and CL-Barclays I supra note 164 at 2. See e.g., CL-Morgan
Stanley supra note 21 at 8 (For example, advisors to private
investment funds may not be able to permit certain investors to view
position information unless the information is made available to all
of the fund's investors on an equal basis).
\255\ See e.g., CL-CME I supra note 8 at 17; CL-Barclays II
supra note 2468 at 2; CL-MFA supra note 21 at 13; CL-Morgan Stanley
supra note 21 at 9; and CL-SIFMA AMG I supra note 21 at 11. See also
CL-NYCBA supra note 243 at 4.
\256\ CL-FIA I supra note 21 at 24.
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According to commenters, this problem is exacerbated if aggregate
limits are applied intraday as it requires real-time sharing of
information, and, when added to the attendant dismantling of
information barriers and restructuring of information systems, would
impose significant operational
[[Page 71653]]
challenges and massive costly infrastructure changes.\257\
---------------------------------------------------------------------------
\257\ See e.g., CL-DBCS supra note 247 at 3; CL-CME I supra note
8 at 17; CL-FIA I supra note 21 at 24; CL-ICI supra note 21 at 8-9;
CL-ISDA/SIFMA supra note 21 at 17; CL-Barclays II supra note 246 at
2; and CL-Morgan Stanley supra note 21 at 8.
---------------------------------------------------------------------------
In view of these considerations, and as discussed above, the
Commission is reinstating the IAC exemption. The majority of the
contentions from the commenters stemmed from the removal of the IAC
exemption, and therefore, incorporating this exemption into the final
rules should address these concerns. In response to comments,\258\ and
to further mitigate the impact of the aggregation requirements that
apply to commonly-owned entities or accounts, the Commission is
adopting new Sec. 151.7(g), which will allow a person to disaggregate
when ownership above the 10 percent threshold also is associated with
the underwriting of securities. In addition to a limited exemption for
the underwriting of securities, new Sec. 151.7(i) will provide for
disaggregation relief, subject to notice filing and opinion of counsel,
in instances where aggregation across commonly-owned affiliates (i.e.,
above the 10 percent ownership threshold) would require position
information sharing that, in turn, would result in the violation of
Federal law.\259\ The Commission notes, however, when a trader has
actual knowledge of the positions of an affiliate, that trader is
required to aggregate all such positions.
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\258\ See e.g., CL-FIA I supra note 21 at 24.
\259\ Assume, for example, that Company A owns 10 percent of
Company B. Company B may not share with Company A information
regarding its positions unless it makes such data public. In this
instance, Company A would file a notice with the Commission, along
with opinion of counsel, that requiring the aggregation of such
positions will require Company A to obtain information from Company
B that would violate federal law.
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4. Ownership in Commodity Pools Exemption
Under current Sec. 150.4(b), a trader who is a limited partner or
shareholder in a commodity pool (other than the pool's commodity pool
operator (``CPO'')) generally need not aggregate so long as the trader
does not control the pool's trading decisions. Under Sec. 150.4(c)(2),
if the trader is also a principal or affiliate of the pool's CPO, the
trader need not aggregate provided that the trader does not control or
supervise the pool's trading and the pool operator has proper
informational barriers. In addition, mandatory aggregation based on a
25 percent ownership interest is only triggered with respect to a pool
exempt from CPO registration under existing Sec. 4.13.
The Commission's proposal would eliminate the disaggregation
exemption for passive pool participants (i.e., participants who are not
principals or affiliates of the pool's CPO). Under the Commission's
proposal, all passive pool participants (with a 10 percent or greater
ownership or equity interest and regardless of whether they are a
principal or affiliate) would be subject to the aggregation requirement
unless they meet certain exemption criteria. These criteria include:
(i) An inability to acquire knowledge of the pool's positions or
trading due to informational barriers maintained by the CPO, and (ii) a
lack of control over the pool's trading decisions. The proposal would
also require aggregation for an investor with a 25 percent or greater
ownership interest in any pool, without regard to whether the operator
operates a small pool exempt from CPO registration.
Commenters objected to the changes to the disaggregation provision
applicable to interests in commodity pools, arguing that forcing
aggregation of independent traders would increase concentration, limit
investment opportunities, and thus potentially reduce liquidity in the
U.S. futures markets.\260\ Morgan Stanley stated that the current
disaggregation exemption for interests in commodity pools ``reflect the
current reality of investing in commodity pools structured as private
investment funds.'' \261\ It would be, Morgan Stanley explained,
``extraordinarily difficult to monitor and limit ownership thresholds
given that an investor's stake in a fund may rise due to actions of
third parties, e.g., redemptions.'' \262\ MFA likewise noted that
``monitoring of ownership percentages of investors in a commodity pool
is burdensome, difficult to manage, and creates a potential trap for
investors who may unintentionally violate limits.'' \263\
---------------------------------------------------------------------------
\260\ See e.g., CL-MFA supra note 21 at 14-15; and CL-BlackRock
supra note 21 at 6-7.
\261\ CL-Morgan Stanley supra note 21 at 8.
\262\ Id.
\263\ CL-MFA supra note 21 at 14.
---------------------------------------------------------------------------
Upon further consideration, and in response to the comments, the
Commission has determined to retain the current disaggregation
exemption for interests in commodity pools. The exemption was
originally intended in part to respond to the growth of professionally
managed futures trading accounts and pooled futures investment. The
Commission finds that disaggregation for ownership in commodity pools,
subject to appropriate safeguards, may continue to provide the
necessary flexibility to the markets, while at the same time protecting
the markets from the undue accumulation of large speculative positions
owned by a single person or entity.
5. Owned Non-Financial Entity Exemption
The Commission proposed a limited disaggregation exemption for an
entity that owns 10 percent or more of a non-financial entity
(generally, a non-financial, operating company) if the entity can
demonstrate that the owned non-financial entity is independently
controlled and managed.\264\ The Commission explained that this limited
exemption was intended to allow disaggregation primarily in the case of
a conglomerate or holding company that ``merely has a passive ownership
interest in one or more non-financial operating companies. In such
cases, the operating companies may have complete trading and management
independence and operate at such a distance from the holding company
that it would not be appropriate to aggregate positions.'' \265\
Several commenters argued that the non-financial entity provision was
too narrow to provide meaningful disaggregation relief and supported
its extension to financial entities.\266\ These commenters also
asserted that the failure to extend the exemption was discriminatory
against financial entities without a proper basis.\267\ Other
commenters asked for guidance from the Commission on whether business
units of a company could qualify as owned non-financial
[[Page 71654]]
entities for aggregation purposes.\268\ These commenters argued that
functionally these business units operate the same as separately
organized entities, and should not be forced to undergo the costs and
inefficiencies of becoming separately organized for position limit
purposes.\269\
---------------------------------------------------------------------------
\264\ The proposed regulations included a non-exclusive list of
indicia of independence for purposes of this exemption, including
that the two entities have no knowledge of each other's trading
decisions, that the owned non-financial entity have written policies
and procedures in place to preclude such knowledge, and that the
entities have separate employees and risk management systems.
\265\ 76 FR 4752, at 4762.
\266\ See e.g., CL-FIA I supra note 21 at 23-24; CL-DBCS supra
note 238 at 6; CL-PIMCO supra note 21 at 3; National Rural Electric
Cooperative (``NREC''), Association American Public Power
(``AAPP''), and Association Large Public Power Council (``ALLPC'')
on March 28, 2011 (``CL-NREC/AAPP/ALLPC'') at 20; CL-MFA supra note
21 at 14; CL-CME I supra note 8 at 16; CL-ISDA/SIFMA supra note 21
at 15; CL-BlackRock supra note 21 at 9; CL-Morgan Stanley supra note
21 at 9; and CL-NYCBA supra note 243 at 4.
\267\ See e.g., CL-FIA I supra note 21 at 22-23; CL-CME I supra
note 8 at 16-17; CL-ISDA/SIFMA supra note 21 at 15; CL-Morgan
Stanley supra note 21 at 9; CL-USCOC supra note 246 at 6; CL-DBCS
supra note 247 at 6; CL-PIMCO supra note 21 at 5 (position limits
are not high enough to offset elimination of IAC as explained in the
proposed Sec. ); CL-MFA supra note 21 at 14; Akin Gump Strauss
Hauer & Field LLP (``Akin Gump'') on March 25, 2011 (``CL-Akin
Gump'') at 4; and CL-CMC supra note 21 at 4.
\268\ See e.g., CL-BGA supra note 35 at 21; and CL-Cargill supra
note 76 at 7.
\269\ See e.g., CL-Cargill supra note 76 at 7.
---------------------------------------------------------------------------
In view of the Commission's determination to retain the IAC
exemption and the aggregation policy in general (which the Commission
believes has worked effectively to date), provide an exemption for
Federal law information sharing restrictions in final Sec. 151.7(i)
and provide an exemption for underwriting in final Sec. 151.7(g), the
Commission believes that it would not be appropriate, at this time, to
expand further the scope of disaggregation exemptions to owned non-
financial or financial entities. As described above, the final rules
include express disaggregation exemptions to mitigate the impact of the
aggregation requirements that apply to commonly-owned entities or
accounts. These disaggregation exemptions are appropriately limited to
situations that do not present the same concerns as those underlying
the aggregation policy, namely, the sharing of transaction or position
information that may facilitate coordinated trading; as such, the
Commission does not believe further expansion of the disaggregation
exemptions is warranted at this time.
6. Funds With Identical Trading Strategies
The proposal would require aggregation for positions in accounts or
pools with identical trading strategies (e.g., long-only position in a
given commodity), including passively-managed index funds. Under this
provision, the general ownership threshold of 10 percent would not
apply; rather, positions of any size in accounts or pools would require
aggregation.
Several commenters objected to forcing aggregation on the basis of
identical trading strategies because it did not, in their view, further
the purpose of preventing unreasonable or unwarranted price
fluctuations. \270\ These commenters argued that the proposal would
lead to a decrease in index fund participation, which will reduce
market liquidity, especially in deferred months, as well as impact
commodity price discovery. One commenter indicated support for
extending the aggregation requirement to commodity index funds, and the
swaps which are indexed to each individual index.\271\ PMAA/NEFI opined
that positions of passive long speculators should be aggregated to the
extent that they follow the same trading strategies regardless of
whether their positions are held or controlled by the same trader in
order to shield the markets from the cumulative impact of multiple
passive long speculators who follow the same trading strategies.\272\
---------------------------------------------------------------------------
\270\ See e.g., CL-CME I supra note 8 at 18; and CL-BlackRock
supra note 21 at 14.
\271\ See e.g., CL-Better Markets supra note 37 at 69-70.
\272\ CL-PMAA/NEFI supra note 6 at 14.
---------------------------------------------------------------------------
The Commission is adopting this aggregation provision as proposed,
with the clarification that a trader must aggregate positions
controlled or held in one account with positions controlled or held in
one pool with identical trading strategies. As the Commission stated in
the NPRM, this aggregation provision is intended to prevent
circumvention of the aggregation requirements. In absence of such
aggregation requirement, a trader can, for example, acquire a large
long-only position in a given commodity through positions in multiple
pools, without exceeding the applicable position limits.
7. Process for Obtaining Disaggregation Exemption
In contrast to the existing practice, the proposed aggregation
exemptions were not self-effectuating. A trader seeking to rely on any
aggregation exemption would be required to file an application for
relief with the Commission, and the trader could not rely on the
exemption until the Commission approved the application.\273\ Further,
the trader would be subject to an annual renewal application and
approval.
---------------------------------------------------------------------------
\273\ See e.g., CL-FIA I supra note 21 at 25; CL-CMC supra note
21 at 5; and CL-EEI/EPSA supra note 21 at 19-20.
---------------------------------------------------------------------------
Several commenters objected to the proposed change from self-
executing disaggregation exemptions to an application-based exemption
on the basis that it would create an additional burden on traders
without any benefits. Some of these commenters argued that the
disaggregation exemptions for FCMs should continue to be self-
effectuating because FCMs are subject to direct oversight by the
Commission, and the Proposed Rule does not provide a sufficient
explanation for the change in policy.\274\ MFA recommended that instead
of requiring an application for exemptive relief and annual renewals,
IACs should be required to file a notice informing the Commission that
they intend to rely on the exemption and a representation that they
meet the relevant conditions.\275\
---------------------------------------------------------------------------
\274\ See e.g., CL-Morgan Stanley supra note 21 at 7. See also
Futures Industry Association (``FIA II'') on May 25, 2011 (``CL-FIA
II'') at 6.
\275\ See CL-MFA supra note 21 at 16.
---------------------------------------------------------------------------
Some of the commenters, objecting to the application-based
exemption, requested that the Commission make the necessary
applications for an exemption conditionally effective, rather than
effective after a Commission determination.\276\ Other commenters
argued that the Commission should only require that exemption
applications be initially filed with material updates as opposed to an
annual reapplication process.\277\
---------------------------------------------------------------------------
\276\ See e.g., CL-FIA I supra note 21 at 25; Willkie Farr &
Gallagher LLP (``Willkie'') on March 28, 2011 (``CL-Willkie'') at 7;
CL-API supra note 21 at 12; Gavilon Group, LLC (``Gavilon'') on
March 28, 2011(``CL-Gavilon'') at 8; and CL-CMC supra note 21 at 4.
See also CL-BGA supra note 35 at 22.
\277\ See e.g., CL-Cargill supra note 76 at 9.
---------------------------------------------------------------------------
With regard to the specific conditions for applying for an
aggregation exemption, several commenters requested that the Commission
remove or clarify the condition that entities submit an independent
assessment report.\278\ Similarly, commenters opined that the
Commission should not require applicants to designate an office and
employees responsible for coordinating compliance with aggregation
rules and position limits.\279\
---------------------------------------------------------------------------
\278\ See e.g., CL-FIA I supra note 21 at 26-27; and CL-BGA
supra note 35 at 22.
\279\ See e.g., CL-FIA I supra note 21 at 27.
---------------------------------------------------------------------------
The Commission is adopting the proposal with modifications to
address the concerns expressed in the comments. Specifically, the
Commission is eliminating the requirement that a trader seeking to rely
on a disaggregation exemption file an application for exemptive relief
and annual renewals. Instead, the trader must file a notice, effective
upon filing, setting forth the circumstances that warrant
disaggregation and a certification that they meet the relevant
conditions.
The Commission believes that the new notice process (with its
attendant certification requirement) for disaggregation relief
represents a less burdensome, yet effective, alternative to the
proposed application and pre-approval process. The notice procedure
will allow market participants to rely on aggregation exemptions
without the potential delay of Commission approval, thus lessening the
burden on both market participants and the Commission to respond to
such applications. In addition, the notice filings will give the
Commission insight into the application
[[Page 71655]]
of the various exemptions, which the Commission could not do under a
self-certification regime.
Under the notice provisions, upon call by the Commission, any
person claiming a disaggregation exemption must provide relevant
information concerning the claim for exemption.\280\ Thus, for example,
if the Commission identifies potential concerns regarding the integrity
of the information barrier supporting a trader's reliance on the IAC
exemption, it can audit the subject trader for adequacy of such
information barrier and related practices. To the extent the Commission
finds that a trader is not appropriately following the conditions of
the exemption, upon notice and opportunity for the affected person to
respond, the Commission may amend, suspend, terminate, or otherwise
modify a person's aggregation exemption.
---------------------------------------------------------------------------
\280\ See Sec. 151.7(h)(2).
---------------------------------------------------------------------------
In response to the concerns of commenters, the Commission has
determined to remove the conditions that a person submit an independent
assessment report and designate an office and employees responsible for
coordinating compliance with aggregation rules and position limits as
part of the notice filing for an exemption.
I. Preexisting Positions
The Commission proposed to apply the good-faith exemption under CEA
section 4a(b) for pre-existing positions in both futures and swaps.
This provided a limited exemption for pre-existing positions that are
in excess of the proposed position limits, provided that they were
established in good-faith prior to the effective date of a position
limit set by rule, regulation, or order. However, ``[s]uch person would
not be allowed to enter into new, additional contracts in the same
direction but could take up offsetting positions and thus reduce their
total combined net positions.'' \281\ Thus, the Commission would
calculate a person's pre-existing position for purposes of position
limit compliance, but a person could not violate position limits based
upon pre-existing positions alone.
---------------------------------------------------------------------------
\281\ 76 FR at 4752, 4763.
---------------------------------------------------------------------------
The Commission also proposed a broader scope of the good-faith
exemption for swaps entered before the effective date of the Dodd-Frank
Act. Such swaps would not be subject to position limits, and the
Commission would allow pre-effective date swaps to be netted with post-
effective date swaps for the purpose of complying with position limits.
Finally, the Commission proposed to permit persons with risk-
management exemptions under current Commission regulation 1.47 to
continue to manage the risk of their swap portfolio that exists at the
time of implementation of the legacy limits, and no new swaps would be
covered.
The Working Group and BGA requested that the Commission grandfather
any positions put on in good faith prior to the effective date of any
final rule implementing position limits for Referenced Contracts.\282\
CME and Blackrock urged that the Commission instead phase in position
limits to minimize market disruption.\283\
---------------------------------------------------------------------------
\282\ See CL-BGA supra note 35 at 20; and CL-WGCEF supra note 35
at 20.
\283\ CL-CME I supra note 8 at 19-20; CL-BlackRock supra note 21
at 17; and CL-SIFMA AMG I supra note 21 at 16.
---------------------------------------------------------------------------
Commenters addressing the pre-existing positions exemption in the
context of index funds recommended that these funds be grandfathered in
order that they may ``roll'' their futures positions after the
effective date of any position limits rule.\284\ Absent such
grandfather treatment, commenters such as SIFMA opined that funds and
accounts could be prevented from implementing rollovers in the most
advantageous manner, and could conceivably be put in the anomalous
positions of having to liquidate positions to return funds to investors
if pre-existing positions cannot be replaced as necessary to meet
stated investment goals.'' \285\ CME also put forth that ``[i]ndex fund
managers who do not or cannot roll-over positions would also be
deviating from disclosed-to-investors trading strategies.\286\
---------------------------------------------------------------------------
\284\ See e.g., CL-CME I supra note 8 at 19-20; CL-SIFMA AMG I
supra note 21 at 16; CL-BlackRock supra note 21 at 17; CL-MFA supra
note 21 at 19. These commenters generally explained that these funds
``typically replace or `roll over' their contracts in a staggered
manner, before they reach their spot months, in order to maintain
position allocations in as stable a manner as possible and without
causing price impact.''
\285\ CL-SIFMA AMG I supra note 21 at 16.
\286\ CL-CME I supra note 8 at 19-20; and CL-BlackRock supra
note 21 at 17.
---------------------------------------------------------------------------
With regard to the proposal to permit swap dealers to continue to
manage the risk of a swap portfolio that exists at the time of
implementation of the proposed regulations, CME requested that such
relief be extended to swap dealers with swap portfolios in contracts
that were not previously subject to position limits and therefore did
not require exemptions.\287\
---------------------------------------------------------------------------
\287\ CL-CME I supra note 8 at 19.
---------------------------------------------------------------------------
The Commission is finalizing the scope of the pre-existing position
and grandfather exemption as proposed, subject to modifications below,
in final Sec. 151.9. The exemption for pre-existing positions
implements the provisions of section 4a(b)(2) of the CEA, and is
designed to phase in position limits without significant market
disruption. In response to concerns over the scope of the pre-existing
position exemption, the Commission clarifies that a person can rely on
this exemption for futures, options and swaps entered in good faith
prior to the effective date of the rules finalized herein for non-spot
month-position limits.\288\ Such pre-existing futures, options and
swaps transactions that are in excess of the proposed position limits
would not cause the trader to be in violation based solely on those
positions. To the extent a trader's pre-existing futures, options or
swaps positions would cause the trader to exceed the non-spot-month
limit, the trader could not increase the directional position that
caused the positions to exceed the limit until the trader reduces the
positions to below the position limit.\289\ As such, persons who
established a net position below the speculative limit prior to the
enactment of a regulation would be permitted to acquire new positions,
but the Commission would calculate the combined position of a person
based on pre-existing positions with any new position.\290\
---------------------------------------------------------------------------
\288\ Notwithstanding the pre-existing exemption in non-spot
months, a person must comply with spot-month limits. Any spot-month
limit that is initially set or reset under Final Sec. 151.4(a) will
apply to all spot month periods. The Commission notes it will
provide at least two months advance notice of changes to levels of
such spot-month limits under Final Sec. 151.4(e).
\289\ For example, if the position limit in a particular
reference contract is 1,000 and a trader's pre-existing position
amounted to 1,005 long positions in a Referenced Contract, the
trader would not be in violation of the position limit. However, the
trader could not increase its long position with additional new long
positions until its position decreased to below the position limit
of 1,000. Once below the position limit of 1,000, this hypothetical
trader would be subject to the position limit of 1,000.
\290\ 76 FR at 4763.
---------------------------------------------------------------------------
Notwithstanding the combined calculation of pre-existing positions
with new positions, the Commission is also retaining the broader
exemption for swaps entered prior to the effective date of the Dodd-
Frank Act and prior to the initial implementation of position limits
under final Sec. 151.4. The pre-effective date swaps would not be
subject to the position limits adopted herein, and persons may, but
need not, net swaps entered before the effective date of Dodd-Frank
with swaps entered after the effective date.
With regard to comments addressing index funds that ``roll'' their
pre-existing positions, the Commission
[[Page 71656]]
notes that CEA section 4a(b)(2) only extends the exemption for pre-
existing positions that were entered ``prior to the effective date of
such rule, regulation, or order [establishing position limits].'' Given
this statutory stricture, index funds that ``roll'' their pre-existing
positions after the effective date of a position limit rule do not fall
within the scope of the pre-existing position exemption.\291\
---------------------------------------------------------------------------
\291\ The Commission also notes that absent this limitation on
pre-existing positions, any entity that rolls futures positions
would in effect not be subject to position limits because the
subsequent positions would be subject to exemption.
---------------------------------------------------------------------------
With regard to persons with existing exemptions under Commission
regulation 1.47 to manage the risk of their existing swap portfolio,
the Commission is adopting this provision as proposed. Specifically,
the Commission is adopting a limited exemption to provide for
transition into these position limit rules for persons with existing
Sec. 1.47 exemptions under final Sec. 151.9(d). This limited
exemption is also designed to limit market disruptions as market
participants transition to these position limit rules. However, the
Commission will only apply this relief to market participants with
existing Sec. 1.47 exemptions because the transitional nature of
providing such relief dictates that the Commission should not extend a
general exemption for persons to manage their existing swap book
outside of Sec. 1.47 exemptions. Further, since the proposed non-spot
month class limits are not being adopted, such a person may net
positions across futures and swaps in a Referenced Contract. This
largely mitigates the need for a risk management exemption.
J. Commodity Index or Commodity-Based Funds
The definition of ``Referenced Contract'' in Sec. 151.1 expressly
excludes commodity index contracts. A commodity index contract is
defined as a contract, agreement, or transaction ``that is not a basis
or any type of spread contract, [and] based on an index comprised of
prices of commodities that are not the same nor substantially the
same.'' Thus, by the terms of this provision, contracts with
diversified commodity reference prices are excluded from the proposed
position limit regime. As a result, single commodity index contracts
fall within the scope of the proposal. Further, under amended section
4a(a)(1) of the CEA, the Commission is empowered to establish position
limits by ``group or class of traders,'' and new section 4a(a)(7) gives
the Commission authority to provide exemptions from those position
limits to any ``person or class of persons.''
A number of commenters argued that commodity index funds (``CIFs'')
should be exempted from the final rulemaking for position limits.\292\
DB Commodity Services argued that passive CIFs apply ``zero net buying
pressure across the commodity term structure.'' \293\ Gresham
Investments argued that ``unleveraged, solely exchange-traded, fully
transparent, clearinghouse guaranteed'' CIFs that pose ``no systemic
risk'' should be treated differently than highly leveraged futures
traders, who pose a continuing systemic risk to the commodity
markets.\294\ Three commenters argued that CIFs increase market
liquidity for bona fide hedgers.\295\ Finally, BlackRock also argued
that there is no empirical evidence supporting a causal connection
between CIFs and commodity price volatility.\296\ Senator Blanche
Lincoln argued that position limits should not apply to diversified,
unleveraged index funds because they provide ``necessary liquidity to
assist in price discovery and hedging for commercial users * * * [and]
are an effective way [for] investors to diversify their portfolios and
hedge against inflation.'' \297\ Further, Senator Lincoln opined that
that the Commission should distinguish between ``trading activity that
is unleveraged or fully collateralized, solely exchange-traded, fully
transparent, clearinghouse guaranteed, and poses no systemic risk and
highly leveraged swaps trading in its implementation of position
limits.'' \298\
---------------------------------------------------------------------------
\292\ CL-BlackRock supra note 21 at 15; CL-DB supra note 153 at
2-4; CL-PIMCO supra note 21 at 9; ETF Securities on March 28, 2011
(``CL-ETF Securities'') at 3-4; and CL-SIFMA AMG I supra note 21 at
13.
\293\ CL-DBCS supra note 247 at 3.
\294\ CL-Gresham supra note 153 at 2, 6-7.
\295\ CL-BlackRock supra note 21 at 15; CL-PIMCO supra note 21
at 10 (citing Sen. Lincoln's remarks on index funds); and CL-DBCS
supra note 247 at 3-4.
\296\ CL-BlackRock supra note 21 at 15.
\297\ See Senator Lincoln (``Sen. Lincoln'') on Dec. 16, 2010
(``CL-Sen. Lincoln'') at 1-2 (``I urge the CFTC not to unnecessarily
disadvantage market participants that invest in diversified and
unleveraged commodity indices.'')
\298\ Id.
---------------------------------------------------------------------------
Commenters also submitted studies regarding index traders. In
particular, several studies conducted by two agricultural economists
were highlighted by commenters. The authors of the studies contended
that there is no evidence that the influx of index fund trading unduly
influences prices.\299\ Commenters also cited the Commission's 2008
Staff Report on Commodity Index Traders and Swap Dealers, in which
Commission staff provided an overview for the public regarding the
participation of these types of traders in commodity derivatives
markets.\300\
---------------------------------------------------------------------------
\299\ Irwin, Scott and Dwight Sanders ``The Impact of Index and
Swap Funds on Commodity Futures Markets'', OECD Food, Agriculture,
and Fisheries Working Papers, (2010); Sanders, Dwight and Scott
Irwin ``A Speculative Bubble in Commodity Futures Prices? Cross-
Sectional Evidence'', Agricultural Economics, (2010); Sanders,
Dwight, Scott Irwin, and Robert Merrin ``The Adequacy of Speculation
in Agricultural Futures Markets: Too Much of a Good Thing?''
University of Illinois at Urbana-Champaign, (2008).
\300\ U.S. Commodity Futures Trading Commission ``Staff Report
on Commodity Swap Dealers and Index Traders with Commission
Recommendations'' (2008). While the majority of the report is broad
in scope and serves as a guide to the special calls issued to swap
dealers and index traders by the Commission, there is a discussion
of the impact of these types of participants (generally considered
to be speculators in most markets). Specifically, the report looks
at the vast increase in notional value of NYMEX crude oil futures
contracts in relationship to the vast increase in commodity index
investment from December 2007 to June 2008. Staff concluded that the
increase in notional value is due to the appreciation of existing
positions, and not the influx of new money into the market, citing
the observation that the actual number of futures-equivalent
contracts declined over the same period.
---------------------------------------------------------------------------
Other commenters, however, asserted that CIFs should be subject to
special, more restrictive position limits.\301\ Some of these
commenters argued that the presence of CIFs upsets the price discovery
function of the market because investors buy interests in CIFs without
regard to the market fundamentals price.\302\ The Air Transport
Association of America recommended that the Commission undertake a
study to analyze and determine the effect of such passive, long-only
traders on the price discovery function of the markets.\303\
---------------------------------------------------------------------------
\301\ CL-ABA supra note 150 at 4; CL-ATAA supra note 94 at 15;
CL-ATA supra note 81 at 4,5; CL-PMAA/NEFI supra note 6 at 12-14; CL-
ICPO supra note 20 at 1; CL-Better Markets supra note 37 at 71
(``limiting commodity index funds to 10 percent of total market open
interest would likely have significant beneficial effects [on
excessive speculation]''); and International Pizza Hut Franchise
Holders Association (IPHFHA'') on March 24, 2011 (``CL-IPHFHA'') at
1. There were 6,074 form comment letters that urged the Commission
to adopt ``lower speculative position limits for passive, long-only
traders.''
\302\ CL-PMAA/NEFI supra note 6 at 12-13; CL-Delta supra note 20
at 7-8; CL-Better Markets supra note 37 at 35-36; and Industrial
Energy Consumer of America (``IECA'') on March 28, 2011 (``CL-
IECA'') at 2.
\303\ CL-ATAA supra note 94 at 15.
---------------------------------------------------------------------------
Some studies opined that the recent influx of CIF trading has
caused an increase in prices that is not explained by market
fundamentals alone.\304\ For
[[Page 71657]]
example, one study argued that index speculators have been at least
partially responsible for the tripling of commodity futures prices over
the last five years.\305\
---------------------------------------------------------------------------
\304\ Tang, Ke and Wei Xiong ``Index Investing and the
Financialization of Commodities'', Working Paper, Department of
Economics, Princeton University, (2010).; Mou, EthanY. ``Limits to
Arbitrage and Commodity Index Investment: Front-Running the Goldman
Roll'', Working Paper, Columbia University, (2010).; Gilbert,
Christopher L. ``Speculative Influences on Commodity Futures Prices,
2006-2008'', Working Paper, Department of Economics, University of
Trento, Italy, (2009).; Gilbert, Christopher L. ``How to Understand
High Food Prices'', Journal of Agricultural Economics, 61(2): 398-
425. (2010).
\305\ Masters, Michael and Adam White ``The Accidental Hunt
Brothers: How Institutional Investors are Driving up Food and Energy
Prices'', White Paper, (2008). ``As hundreds of billions of dollars
have poured into the relatively small commodities futures markets,
prices have risen dramatically. Index Speculators working through
swaps dealers have been the single biggest source of new speculative
money. This has driven prices far beyond the levels that supply and
demand would indicate, and has done tremendous damage to our economy
as a result.''
---------------------------------------------------------------------------
Regardless of whether a CIF is non-diversified or diversified, the
Commission did not propose to impose different position limits on CIFs
or to exempt CIFs from position limits. In addition to considering
comments regarding the role of CIFs in commodity derivatives markets,
the Commission has reviewed and evaluated studies cited by commenters
presenting conflicting views on the effect of certain groups of index
traders.\306\ Historically, the Commission has applied position limits
to individual traders rather than a group or class of traders, and does
not have a similar level of experience with respect to group or class
limits as it has with position limits for individual traders.
Therefore, the Commission believes more analysis is required before the
Commission would impose a separate position limit regime, or establish
an exemption, for a group or class of traders, including CIFs.\307\ The
Commission welcomes further submissions of studies to assist in
subsequent rulemakings on the treatment of various groups or classes of
speculative traders.
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\306\ In addition, the Commission has reviewed all other studies
submitted by commenters; a detailed description can be found in
Section III of this release.
\307\ In this regard, the lack of consensus in the studies
submitted demonstrates the need for additional analysis.
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K. Exchange Traded Funds
CME commented that the Commission should coordinate its position
limit policy with the Securities and Exchange Commission (``SEC'') in
order to avoid encouraging market participants to replace their
commodity derivatives exposures with physical commodity exchange-traded
fund (``ETF'') exposures.\308\ As previously stated, the Commission
believes that the final rules will ensure sufficient market liquidity
for bona fide hedgers in accordance with CEA section 4a(a)(3)(B)(iii).
With respect to the potential increase in ETF exposures, the Commission
notes that such products are not within the scope of this rulemaking.
---------------------------------------------------------------------------
\308\ CL-CME I supra note 8 at 20.
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L. Position Visibility
The Proposed Rule established an enhanced reporting regime for
traders who hold or control positions in certain energy and metal
Referenced Contracts above a specified number of net long or net short
positions.\309\ These ``position visibility levels'' are set below the
proposed non-spot-month position limit levels. A trader's positions in
all-months-combined for listed Referenced Contracts would be aggregated
under the Proposed Rule, including bona fide hedge positions. Once a
trader crosses a proposed position visibility level, the trader would
have to file monthly reports with the Commission that generally capture
the trader's physical and derivatives portfolio in the same commodity
and substantially same commodity as that underlying the Referenced
Contract.\310\
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\309\ See Proposed Rule 151.6. The position visibility levels
did not apply to agricultural commodity contracts.
\310\ While the proposed position visibility regime would only
trigger reporting requirements, the preamble did note that trading
at or near such levels was ``in no way intended to imply that
positions at or near such levels cannot constitute excessive
speculation or be used to manipulate prices or for other wrongful
purposes.'' See Proposed Rule at 4759.
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The general purpose behind the position visibility levels was to
enhance the Commission's surveillance functions to better understand
the largest traders for energy and metal Referenced Contracts, and to
better enable the Commission to set and adjust subsequent position
limits, as appropriate.\311\
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\311\ 75 FR 4752, 4761-62, Jan. 26, 2011.
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Commenters were divided on the utility of position visibility
levels. A number of commenters supported the proposed visibility
levels, with some urging the Commission to expand their application to
agricultural contracts.\312\ Many of the supportive commenters stated
that the Commission should extend the position visibility regime to
agricultural Referenced Contracts.\313\ At least one commenter
specifically requested that the Commission expand the position
visibility levels to metal-based ETFs as well as contracts traded on
the London Metals Exchange as a method to deter excessive speculation
and manipulation.\314\
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\312\ See e.g., CL-Prof. Greenberger supra note 6 at 18; CL-AFR
supra note 17 at 8; and CL-AIMA supra note 35 at 4.
\313\ See e.g., CL-FWW supra note 81 at 15.
\314\ See e.g., Vandenberg & Feliu LLP (``Vandenberg'') on March
28, 2011 (``CL-Vandenberg'') at 2-3.
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Several commenters stated that the enhanced reporting requirements
would be onerous to implement along with other Dodd-Frank Act
requirements with little benefit to combating excessive
speculation.\315\ Certain commenters also asserted that the reporting
requirements would disproportionately impact bona fide hedgers because
such entities would have to produce reports surrounding their hedging
activity whereas a speculative trader would not have to produce similar
reports.\316\ One commenter pointed out that the Commission could
instead utilize its special call authority under Sec. 18.05 to receive
data similar to the data to be reported in the position visibility
regime.\317\ One commenter argued that the reporting frequency should
be semi-annual as opposed to monthly because the Commission would not
need to analyze this additional data on a monthly basis.\318\ Another
commenter assumed that the reporting requirements would be daily and
therefore requested the Commission alter the requirement to
monthly.\319\ Some commenters opined that the scope of the position
visibility reports was vague because it required reporting of uncleared
swap positions in substantially the same commodity.\320\
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\315\ See e.g., CL-BGA supra note 35 at 20-21; CL-FIA I supra
note 21 at 13; CL-EEI/EPSA supra note 21 at 6 (EEI alternatively
argued that the Commission should raise the threshold levels for
certain contracts if the Commission retained the visibility regime);
CL-MFA supra note 21 at 3; CL-Utility Group supra note 21 at 13-14;
CL-NREC/AAPP/ALLPC supra note 266 at 12; CL-USCF supra note 153 at
11; and CL-WGCEF supra note 35 at 23. Some commenters expressed
concern that the Commission would not have sufficient resources to
review the data, and therefore the cost of compliance would not
produce a benefit. See e.g., CL-MFA supra note 21 at 3.
\316\ See e.g., CL-EEI/EPSA supra note 21 at 6; and CL-WGCEF
supra note 35 at 23.
\317\ See e.g., CL-BGA supra note 35 at 20-21.
\318\ See e.g., CL-USCF supra note 153 at 11.
\319\ See e.g., CL-NGFA supra note 72 at 5.
\320\ See e.g., CL-AGA supra note 124 at 12.
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Commenters also argued that the Commission should alter the
position visibility levels to a position accountability regime similar
to the rules on DCMs. However, among the commenters who supported
converting position visibility levels to position accountability
levels, there were two distinct approaches. Some commenters wanted the
Commission to implement position accountability levels as an interim
measure until the Commission
[[Page 71658]]
could fully implement hard position limits outside of the spot-
month.\321\ The second group requested that the Commission eliminate
visibility levels and position limits, and in their place implement
position accountability levels.\322\
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\321\ See e.g., CL-PMAA/NEFI supra note 6 at 15; CL-ATAA supra
note 94 at 5, 16; CL-APGA supra note 17 at 8-9; and CL-Delta supra
note 20 at 11.
\322\ See e.g., CL-BlackRock supra note 21 at 18-19; and CL-CME
I supra note 8 at 6. See also, CL-FIA I supra note 21 at 13; and CL-
EEI/EPSA supra note 21 at 10.
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The Commission is adopting the position visibility proposal with
certain modifications in response to comments. The Commission continues
to believe that position visibility levels represent an important
surveillance tool in the metal and energy Referenced Contracts because
the Commission does not anticipate that the number of traders with
positions in excess of the limits for metal and energy Referenced
Contracts will constitute a significant segment of the market. As such,
the Commission would not receive a large number of bona fide hedging
reports and other data for many traders in excess of the position
limit, and the position visibility levels would improve the
Commission's ability to monitor the positions of the largest traders in
the markets. In this regard, the Commission anticipates that more
traders in the agricultural Referenced Contracts will be above the
anticipated position limits, and therefore, the Commission does not
currently anticipate a similar need to apply the position visibility
levels to agricultural Referenced Contracts.
To accommodate compliance cost concerns raised by some commenters
the position visibility level will be raised to approximately 50
percent of the projected aggregate position limit (based on current
futures and swaps open interest data), with the exception of NYMEX
Light Sweet Crude Oil (CL) and NYMEX Henry Hub Natural Gas (NG)
Referenced Contracts where the levels have been set lower to
approximate the point where ten traders, on an annual basis, would be
subject to position visibility reporting requirements. The Commission
believes that this increase is appropriate in order to reduce the
number of traders burdened by the associated reporting obligations. In
addition, under Sec. 151.6(b)(2)(ii), the Commission will require
position visibility reports to include uncleared swaps in Referenced
Contracts, but will not require reporting of swaps in substantially the
same commodity.\323\ The position visibility rule will become effective
on the date that new Federal spot month limits become effective.
Additionally, the Commission has eliminated the requirement to submit
404A filings under Sec. 151.6 in order to further reduce the
compliance burden for firms reporting under that provision. The
Commission believes it will receive sufficient information on the cash
market activity for general surveillance purposes through 404 filings
under Sec. 151.6(c).\324\
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\323\ Proposed Sec. 151.6(c) required reporting of uncleared
swaps in substantially the same commodity.
\324\ The Commission has also amended Sec. 151.6(b)(1) to
require the reporting of the dates, instead of the total number of
days, that a trader held a position exceeding visibility levels.
---------------------------------------------------------------------------
The Commission has eliminated the separate 402S filing and will
gather information on uncleared swaps through the revised 401 filing.
The revised 401 filing will provide information for general
surveillance purposes in light of the data management issues discussed
in II.C. of this release.
The Commission has also reduced the required frequency of reporting
on the 401 and 404 filings. The Commission may request more specific
data, either in terms of data granularity (e.g., a break-out of data
based on expirations) or with respect to a trader's position on a
specific date or dates under its existing authority under Commission
regulations 18.05 and 20.6. The Commission clarifies that 401 and 404
filings required under Sec. 151.6 are to reflect the reporting
person's relevant positions as of the first business Tuesday of a
calendar quarter and on the date on which the person held the largest
net position in excess of the level in all months. The Commission would
require such a filing to be made within ten business days of the last
day of the quarter in which the trader held a position exceeding
position visibility levels.
M. International Regulatory Arbitrage
Section 4a(a)(2)(C) of the CEA, as amended by section 737 of the
Dodd-Frank Act, requires the Commission to ``strive to ensure that
trading on foreign boards of trade in the same commodity will be
subject to comparable limits and that any limits to be imposed by the
Commission will not cause price discovery in the commodity to shift to
trading on the foreign boards of trade.'' The Commission received
several comments expressing concerns regarding the regulatory arbitrage
opportunities that might arise as a result of the imposition of
position limits.\325\
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\325\ See e.g., CL-BlackRock supra note 21 at 18 (``The
variability of position limits from year to year also will create
uncertainty for market participants as to what limits will apply to
their long-term trading strategies, causing some participants to
shift their commodity-risk positions to markets with no limits at
all or possibly even fixed limits.''); and CL-ISDA/SIFMA supra note
21 at 24-25 (``* * * we believe that the Proposed Rules will likely
result in market participants, especially those that operate outside
the U.S., shifting their trading activity to non- U.S. markets.'').
---------------------------------------------------------------------------
The U.S. Chamber of Commerce stated that ``hasty and ill-conceived
limits on the U.S. derivatives markets will undoubtedly lead to a
significant migration of market participants to less-regulated overseas
markets.'' \326\ Similarly, ISDA/SIFMA stated that a permanent position
limit regime should be postponed until the Commission has fully
consulted with its counterparts around the globe about harmonizing
limits and phasing them in simultaneously, so as to ensure that
position limits imposed on U.S. markets do not shift business
offshore.\327\ Accordingly, ISDA/SIFMA strongly urged ``the CFTC to
work with foreign regulators to ensure that foreign commodity market
participants are subject to position limits that are comparable to
those imposed on U.S. market participants.'' \328\ Michael Greenberger,
on the other hand, opined that the proposed position limits would
result in minimal international regulatory arbitrage because (i) The
Commission has extraterritorial jurisdiction reach under Dodd-Frank Act
section 722, (ii) many swap dealers would be required to register under
the Dodd-Frank Act thereby ensuring that the Commission would have
jurisdiction over them, (iii) other authorities are working to
harmonize their rules and have expressed a hostility to the
financialization of commodity markets, and (iv) many other authorities
have shown a willingness to impose additional requirements on
expatriate U.S. banks.\329\
---------------------------------------------------------------------------
\326\ CL-USCOC supra note 246 at 4.
\327\ CL-ISDA/SIFMA supra note 21 at 24-25 (``* * * we believe
that the Proposed Rules will likely result in market participants,
especially those that operate outside the U.S., shifting their
trading activity to non-U.S. markets.'')
\328\ Id.
\329\ CL-Prof. Greenberger supra note 6 at 20.
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The Commission agrees that it should seek to avoid regulatory
arbitrage and participate in efforts to raise regulatory standards
internationally. The Commission has worked to achieve that general goal
through its participation in the International Organization of
Securities Commissions (``IOSCO'').
[[Page 71659]]
Most recently, the Commission assisted in the development of an
international consensus on principles for the regulation and
supervision of commodity derivatives markets, which included a
requirement that market authorities should have the authority, among
other things, to establish ex-ante position limits, at least in the
delivery month.\330\ The Commission intends, through its activities
within IOSCO, to seek further elaboration on the degree to which
commodity derivatives market authorities implement those principles,
including the extent to which position limits are been imposed.
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\330\ See Principles for the Regulation and Supervision of
Commodity Derivatives Markets, IOSCO Technical Committee (2011).
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The Commission rejects the view, however, that section 4a(a)(2)(C)
of the CEA prohibits Commission rulemaking unless and until there is
uniformity in position limit policies in the United States and other
major market jurisdictions. Such a view would subordinate the explicit
statutory directive to impose position limits as a means to address
excessive speculation in U.S. derivatives markets to a potentially
lengthy period of policy negotiations with foreign regulators.
The Commission also rejects the view suggested in some of the
comment letters that it is a foregone conclusion that the mere
existence of differences in position limit policies will inevitably
drive trading abroad. The Commission's prior experience in determining
the competitive effects of regulatory policies reveals that it is
difficult to attribute changes in the competitive position of U.S.
exchanges to any one factor. For example, prior concerns with regard to
the competitive effect on U.S. contract markets of alleged lighter
regulation abroad led the CFTC to study those concerns both in 1994,
pursuant to a congressional directive,\331\ and again in 1999.\332\ In
both cases, the Commission's staff reports concluded that differences
in regulatory regimes between various countries did not appear to have
been a significant factor in the competitive position of the world's
leading exchanges.\333\
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\331\ The Futures Trading Practices Act of 1992 (``FTPA'')
required the CFTC to study the competitiveness of boards of trade
over which it has jurisdiction compared with the boards of trade
over which ``foreign futures authorities'' have jurisdiction. The
Commission submitted its report on this issue, ``A Study of the
Global Competitiveness of U. S. Futures Markets'' (``1994 Study''),
to the Senate and House agriculture committees in April 1994.
\332\ The Global Competitiveness of U.S. Futures Markets
Revisited, CFTC Division of Economic Analysis (November 1999) http://www.cftc.gov/dea/compete/deaglobal_competitiveness.htm.
\333\ CFTC press release 4333-99F (November 4, 1999)
http://www.cftc.gov/opa/press99/opa4333-99.htm Among other things,
the 1999 report concluded that the U.S. share of total worldwide
futures and option trading activity appears to be stabilizing as the
larger foreign markets have matured. As in 1994, the most actively
traded foreign products tend to fill local or regional risk
management needs and few products offered by foreign exchanges
directly duplicate products offered by U.S. markets; and the
increased competition among mature segments of the global futures
industry, particularly in Europe, may reflect industry restructuring
and the introduction of new technologies, particularly electronic
trading.
---------------------------------------------------------------------------
Nonetheless, the Commission takes seriously the need to avoid
disadvantaging U.S. futures exchanges and will monitor for any
indication that trading is migrating away from the United States
following the establishment of the position limit structure set forth
in this rulemaking.\334\
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\334\ As discussed above in II.E., section 719(a) of the Dodd-
Frank Act directs the Commission to study the ``effects (if any) of
the positions limits imposed pursuant to [section 4a] on excessive
speculation and on the movement of transactions'' from DCMs to
foreign venues and to submit a report on these effects to Congress
within 12 months after the imposition of position limits. This study
will be conducted in consultation with DCMs. See Dodd-Frank Act,
supra note 1, section 719(a).
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N. Designated Contract Market and Swap Execution Facility Position
Limits and Accountability Levels
For contracts subject to Federal position limits imposed under
section 4a(a) of the CEA, sections 5(d)(5)(B) and 5h(f)(6)(B) require
DCMs and SEFs that are trading facilities,\335\ respectively, to set
and enforce speculative position limits at a level no higher than those
established by the Commission. Section 4a(a)(2) of the CEA, in turn,
directs the Commission to set position limits on ``physical commodities
other than excluded commodities.'' Section 5(d)(5)(A) of the CEA
requires that DCMs set, ``as is necessary and appropriate, position
limitations or position accountability for speculators'' for each
contract executed pursuant to their rules. A similar duty is imposed on
SEFs that are trading facilities under section 5h(f)(6)(A) of the CEA.
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\335\ All references to ``SEFs'' below are to SEFs that are
trading facilities.
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1. Required DCM and SEF Position Limits for Referenced Contracts
Proposed Sec. 151.11(a) would have required DCMs and SEFs to set
spot month, single month, and all-months position limits for all
commodities, with exceptions for securities futures and some excluded
commodities. Under proposed Sec. 151.11(a)(1), DCMs and SEFs would be
required to set additional, DCM or SEF spot-month and non-spot-month
position limits for Referenced Contracts at a level no higher than the
Federal position limits established pursuant to proposed Sec. 151.4.
For other contracts (including other physical commodity contracts),
under proposed Sec. 151.11(a)(2), DCMs and SEFs would be required to
set position limits utilizing the Commission's historic approach to
position limits.
Shell requested that if the Commission adopts Federal spot month
limits, exchange-based position limits should be eliminated because
these limits will be redundant, at best, and may cause unintended
apportionment of trading across exchanges, at worst.\336\ Several other
commenters opined that the Commission should require exchanges to set
spot month limits and to refrain from setting Federal position
limits.\337\
---------------------------------------------------------------------------
\336\ CL-Shell supra note 35 at 5-6.
\337\ See e.g., CL-ICE I supra note 69 at 6-8 (Cash-settled
contract limits should apply to each exchange-traded contract
separately and there should not be an aggregate spot-month limit.);
CL-DB supra note 153 at 9-10; and CL-Centaurus supra note 21 at 4.
---------------------------------------------------------------------------
The Commission has determined, consistent with the statute and the
proposal, to require the establishment of position limits by DCMs and
SEFs for Referenced Contracts.\338\ As discussed above under II.A, the
Commission has been directed under section 4a(a)(2) of the CEA to
establish position limits on physical commodity DCM futures and options
contracts and has been granted discretion to determine the specific
levels. The Commission has exercised this discretion by imposing
federally-administered position limits under Sec. 151.4 for 28
``Referenced Contract'' physical commodity derivatives markets and
under Sec. 151.11 by directing DCMs and SEFs to establish
methodologically similar position limits for Referenced Contracts.\339\
While DCM or SEF limits are not administered by the Commission, the
Commission may nonetheless enforce trader compliance with such limits
as violations of the Act.\340\ The Commission did not propose
federally-administered position limits over other physical commodity
[[Page 71660]]
contracts and intends to do so as practicable in the future. In the
interim, the Commission will rigorously enforce DCM and SEF compliance
with Core Principles 5 and 6.
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\338\ As discussed below in II.M.3, the Commission has
recognized an arbitrage exemption for registered entity limits for
all but physical-delivery contracts in the spot month. This is
consistent with the Commission's approach on non-spot month class
limits as it ensures that registered entity limits do not create a
marginal incentive to establish a position in a class of otherwise
economically equivalent contracts outside of the spot month.
\339\ The Commission notes that under Core Principle 1 for DCMs
and SEFs, the Commission may ``by rule or regulation'' prescribe
standards for compliance with Core Principles. Sections 5(d)(1)(B)
and 5h(f)(1)(B) of the CEA, 7 U.S.C. 7(d)(1)(B), 7b-3(f)(1)(B).
\340\ See section 4a(e) of the CEA, 7 U.S.C. 6a(e).
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The Commission notes that section 4a(a)(2) of the CEA requires the
Commission to establish speculative position limits on physical
commodity DCM contracts. This requirement does not extend to SEF
contracts. The Commission has determined that SEF limits for physical
commodity contracts are ``necessary and appropriate'' because the
policy purposes effectuated by establishing such limits on DCM
contracts are equally present in SEF markets.\341\ The Commission notes
that the Proposed Rules would have required SEFs to establish limits
for all physical commodity derivatives under proposed Sec.
151.11(a).\342\ Accordingly, the Commission has determined to establish
essentially identical standards for establishing position limits (and
accountability levels) for DCMs and SEFs.
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\341\ See Core Principle 6 for SEFs, section 5h(f)(6)(A) of the
CEA, 7 U.S.C. 7b-3(f)(6)(A).
\342\ The Commission further notes that it did not receive any
comments on this specific proposed requirement for SEFs.
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Under Sec. 151.11(a), the Commission requires DCMs and SEFs to
establish spot-month limits for Referenced Contracts at levels no
greater than 25 percent of estimated deliverable supply for the
underlying commodity and no greater than the limits established under
Sec. 151.4(a)(1).
The requirement in proposed Sec. 151.11(a)(2) for position limits
for contracts at designation has been modified in Sec. 151.11(b)(3) in
three important ways. First, consistent with the congressional mandate
to establish position limits on all DCM physical commodity contracts,
the Commission is requiring that DCMs (and SEFs by extension) \343\
establish position limits for all physical commodity contracts. Second,
the Commission has clarified this provision to apply to new contracts
offered by DCMs and SEFs. The Commission has further clarified that it
will be an acceptable practice that the notional quantity of the
contract subject to such limits corresponds to a notional quantity per
contract that is no larger than a typical cash market transaction in
the underlying commodity. For example, if a DCM or SEF offers a new
physical commodity contract and sets the notional quantity per contract
at 100,000 units while most transactions in the cash market for that
commodity are for a quantity of between 1,000 and 10,000 units and
exactly zero percent of cash market transactions are for 100,000 units
or greater, then the notional quantity of the derivatives contract
offered by the DCM or SEF would be atypical. This clarification is
intended to deter DCMs and SEFs from setting non-spot-month position
limits for new contracts at levels where they would constitute non-
binding constraints on speculation through the use of an excessively
large notional quantity per contract. This clarification is not
expected to result in additional marginal cost because, among other
things, it reflects current Commission custom in reviewing new
contracts and is an acceptable practice for Core Principle compliance
and not a requirement per se for DCMs or SEFs.
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\343\ As discussed above, the Commission has determined that SEF
limits for physical commodity contracts are ``necessary and
appropriate'' in order to effectuate the policy purposes underlying
limits on DCM contracts.
---------------------------------------------------------------------------
Finally, the Commission in the preamble to the Proposed Rule
indicated that a DCM or SEF could elect to establish position
accountability levels in lieu of position limits if the open interest
in a contract was less than 5,000 contracts.\344\ The Commission did
not, however, provide for this in the Proposed Rule's text. One
commenter specifically supported the position taken by the Commission
in the Proposed Rule's preamble because it recognized that position
accountability may be more appropriate for certain contracts with lower
levels of open interest.\345\
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\344\ 76 FR at 4752, 4763.
\345\ CL-AIMA supra note 35 at 6.
---------------------------------------------------------------------------
The Commission clarifies that it is not adopting the preamble
discussion for low open interest contracts. Rather, final Sec.
151.11(b)(3) provides that it shall be an acceptable practice to
provide for speculative limits for an individual single-month or in
all-months-combined at no greater than 1,000 contracts for non-energy
physical commodities and at no greater than 5,000 contracts for other
commodities.\346\
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\346\ Proposed Sec. 151.11(a)(2) and Final Sec. 151.11(b)(3).
---------------------------------------------------------------------------
2. DCM and SEF Accountability Levels for Non-Referenced and Excluded
Commodities
Under proposed Sec. 151.11(c), consistent with current DCM
practice, DCMs and SEFs have the discretion to establish position
accountability levels in lieu of position limits for excluded
commodities.\347\ DCMs and SEFs could impose position accountability
rules in lieu of position limits only if the contract involves either a
major currency or certain excluded commodities (such as measures of
inflation) or an excluded commodity that: (1) Has an average daily open
interest of 50,000 or more contracts, (2) has an average daily trading
volume of 100,000 or more contracts, and (3) has a highly liquid cash
market.
---------------------------------------------------------------------------
\347\ See Section 1a(19) of the Act, 7 U.S.C. 1a(19).
---------------------------------------------------------------------------
Under final Sec. 151.11(c)(1), the Commission provides that the
establishment of position accountability rules are an acceptable
alternative to position limits outside of the spot month for physical
commodity contracts when a contract has an average month-end open
interest of 50,000 contracts and an average daily volume of 5,000
contracts and a liquid cash market, consistent with current acceptable
practices for tangible commodity contracts. With respect to excluded
commodities, consistent with the current DCM practice, DCMs and SEFs
may provide for exemptions from their position limits for ``bona fide
hedging.'' The term ``bona fide hedging,'' as used with respect to
excluded commodities, would be defined in accordance with amended Sec.
1.3(z).\348\ Additionally, consistent with the current DCM practice,
DCMs and SEFs could continue to provide exemptions for ``risk-
reducing'' and ``risk-management'' transactions or positions consistent
with existing Commission guidelines.\349\ Finally, though the
Commission is removing the procedure to apply to the Commission for
bona fide hedge exemptions for non-enumerated transactions or positions
under Sec. 1.3(z)(3), the Commission will continue to recognize prior
Commission determinations under that section, and DCMs and SEFs could
recognize non-enumerated hedge transactions subject to Commission
review.
---------------------------------------------------------------------------
\348\ See Sec. 151.11(d)(1)(ii) of these proposed regulations.
As explained in section G of this release, the definition of bona
fide hedge transaction or position contained in Sec. 4a(c)(2) of
the Act, 7 U.S.C. 6a(c)(2), does not, by its terms, apply to
excluded commodities.
\349\ See Clarification of Certain Aspects of Hedging
Definition, 52 FR 27195, Jul. 20, 1987; and Risk Management
Exemptions From Speculative Position Limits Approved under
Commission regulation 1.61, 52 FR 34633, Sept. 14, 1987.
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3. DCM and SEF Hedge Exemptions and Aggregation Rules
Final Sec. Sec. 151.11(e) and 151.11(f)(1)(i) require DCMs and
SEFs to follow the same account aggregation and bona fide exemption
standards set forth by Sec. Sec. 151.5 and 151.7 with respect to
exempt and agricultural commodities (collectively ``physical''
commodities). Section 151.11(f)(2) requires traders seeking a hedge
exemption to ``comply with the procedures of the designated
[[Page 71661]]
contract market or swap execution facility for granting exemptions from
its speculative position limit rules.''
MGEX commented on the role of DCMs and SEFs in administering bona
fide hedge exemptions. MGEX noted that while Sec. 151.5 contemplated a
Commission-administered bona fide hedging regime, proposed Sec.
151.11(e)(2) would require persons seeking to establish eligibility for
an exemption to comply with the DCM's or SEF's procedures for granting
exemptions. MGEX recommended that the Commission be the primary entity
for administering bona fide hedge exemptions and that when necessary
that information be shared with the necessary DCMs and SEFs.
With respect to a DCM's or SEF's duty to administer hedge
exemptions, the Commission intended that DCMs and SEFs administer their
own position limits under Sec. 151.11. Accordingly, under its
rulemaking, the Commission is requiring that DCMs and SEFs create rules
and procedures to allow traders to claim a bona fide hedge exemption,
consistent with Sec. 151.5 for physical commodity derivatives and
Sec. 1.3(z) for excluded commodities. Section 151.11 contemplates that
DCMs and SEFs would administer their own bona fide hedge exemption
regime in parallel to the Commission's regime. Traders with a hedge
position in a Referenced Contract subject to DCM or SEF limits will not
be precluded from filing the same bona fide hedging documentation,
provided that the hedge position would meet the criteria of Commission
regulation 151.5 for both the purposes of Federal and DCM or SEF
position limits.
Section 4a(a) of the CEA provides the Commission with authority to
exempt from the position limits or to impose different limits on
spread, straddle, or arbitrage trades. Current Sec. 150.4(a)(3)
recognizes these exemptions in the context of the single contract
position limits set forth under Sec. 150.2. MFA opined that the
Commission should restore the arbitrage exemptions because they are
central to managing risk and maintaining balanced portfolios.\350\
---------------------------------------------------------------------------
\350\ CL-MFA supra note 21 at 18.
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The Commission has determined to re-introduce a version of this
exemption in the final rulemaking in response to commenters that opined
directly on this issue \351\ as well as those that argued against the
imposition of the proposed class limits, as discussed above in II.D.5.
The Commission has therefore introduced an arbitrage exemption for DCM
or SEF limits under Sec. 151.11(g)(2) that allows traders to claim as
an offset to their positions on a DCM or SEF positions in the same
Referenced Contracts or in an economically equivalent futures or swap
position.\352\ This arbitrage exemption does not, however, apply to
physical-delivery contracts in the spot month. The Commission has
reintroduced this exemption, available to those traders that
demonstrate compliance with a DCM or SEF speculative limit through
offsetting trades on different venues or through OTC swaps in
economically equivalent contracts.
---------------------------------------------------------------------------
\351\ See the discussion of non-spot month class limits under
II.D.5 and II.F.1 supra discussing comments expressing concern that
arbitrage exemptions were not recognized in the proposal. See e.g.,
CL-ISDA/SIFMA supra note 21 at 11; and CL-MFA supra note 21 at 18.
See also, CL-Shell supra note 35 at 5-6.
\352\ See section 4a(a)(1) of the CEA, 7 U.S.C. 6a(a)(1).
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4. DCM and SEF Position Limits and Accountability Rules Effective Date
Section 151.11(i) provides that generally the effective date for
the position limits or accountability levels described in Sec. 151.11
shall be made effective sixty days after the term ``swap'' is further
defined. The Commission has set this effective date to coincide with
the effective date of the spot-month limits established under Sec.
151.4. The one exception to this general rule is with respect to the
acceptable guidance for DCMs and SEFs in establishing position limits
or accountability rules for non-legacy Referenced Contracts executed
pursuant to their rules prior to the implementation of Federal non-
spot-month limits on such Referenced Contracts. Under Sec. 151.11(j),
the acceptable practice for these contracts during this transition
phase will be either to retain existing non-spot-month position limits
or accountability rules or to establish non-spot-month position limits
pursuant to the acceptable practice described in Sec. 151.11(b)(2)
(i.e., to impose limits based on ten percent of the average combined
futures and delta-adjusted option month-end open interest for the most
recent two calendar years up to 25,000 contracts with a marginal
increase of 2.5 percent thereafter) based on open interest in the
contract and economically equivalent contracts traded on the same DCM
or SEF.
O. Delegation
Proposed Sec. 151.12 would have delegated certain of the
Commission's proposed part 151 authority to the Director of the
Division of Market Oversight and to other employee or employees as
designated by the Director. The delegated authority would extend to:
(1) Determining open interest levels for the purpose of setting non-
spot-month position limits; (2) granting an exemption relating to bona
fide hedging transactions; and (3) providing instructions, determining
the format, coding structure, and electronic data transmission
procedures for submitting data records and any other information
required under proposed part 151. The purpose of this delegation
provision was to facilitate the ability of the Commission to respond to
changing market and technological conditions and thus ensure timely and
accurate data reporting.
The Commission requested comments on whether determinations of open
interest or deliverable supply should be adopted through Commission
orders. With respect to spot-month position limits, a few commenters
contended that spot month limits should be set by rulemaking.\353\ With
respect to non-spot-month position limits, several commenters submitted
that such limits should be calculated by rulemaking not by annual
recalculation so that market participants can have sufficient advance
notice and opportunity to comment on changes in position limit
levels.\354\ CME, for example, commented that the Commission should set
initial limits through this rulemaking and make subsequent limit
changes subject to notice and comment, unless the formula's automatic
annual application would result in higher limits.\355\ BlackRock
commented that the Commission could mitigate the adverse effects of
volatile limit levels by setting limits subject to notice and
comment.\356\
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\353\ See e.g., CL-WGCEF supra note 35 at 19-20 (proposing a
specific schedule for the setting of spot-month position limits by
notice and comment); CL-BGA supra note 35 at 20. See also, CL-ISDA/
SIFMA supra note 21 at 22.
\354\ See e.g., CL-BlackRock supra note 21 at 18; CL-CME I supra
note 8 at 12; CL-NGFA supra note 72 at 3; CL-EEI/EPSA supra note 21
at 11; CL-KCBT I supra note 97 at 3; and CL-WGC supra note 21 at 5.
\355\ CL-CME I supra note 8 at 12.
\356\ CL-BlackRock supra note 21 at 18.
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The Commission has determined to adopt proposed Sec. 151.12
substantially unchanged with some additional delegations provided for
in the final rule text. Under Sec. 151.4(b)(2)(i)(A), the Commission
has addressed concerns about the volatility of non-spot-month position
limit levels for non-legacy Referenced Contracts by providing for
automatic adjustments based on the higher of 12 or 24 months of
aggregate open interest data. As discussed earlier in this release, the
Commission believes that adjustments to Referenced Contract spot month
and non-legacy Referenced
[[Page 71662]]
Contracts non-spot-month position limit levels on a scheduled basis by
Commission order provide for a process that is responsive to the
changing size of the underlying physical and financial market for the
relevant Referenced Contracts respectively.
III. Related Matters
A. Consideration of Costs and Benefits
In this final rulemaking, the Commission is establishing position
limits for 28 exempt and agricultural commodity derivatives, including
futures and options contracts and the physical commodity swaps that are
``economically equivalent'' to such contracts. The Commission imposes
two types of position limits: Limits in the spot-month and limits
outside of the spot-month. Generally, this rulemaking is comprised of
three main categories: (1) The position limits; (2) exemptions from the
limits; and (3) the aggregation of accounts.
Section 15(a) of the CEA requires the Commission to ``consider the
costs and benefits'' of its actions 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; (4) sound risk management
practices; and (5) other public interest considerations.\357\ The
Commission may, in its discretion, give greater weight to any one of
the five enumerated areas and may determine that, notwithstanding
costs, a particular rule protects the public interest.
---------------------------------------------------------------------------
\357\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
In the Notice of Proposed Rulemaking, the Commission stated,
``[t[he proposed position limits and their concomitant limitation on
trading activity could impose certain general but significant costs.''
\358\ In particular, the Commission noted that ``[o]verly restrictive
position limits could cause unintended consequences by decreasing
speculative activity and therefore liquidity in the markets for
Referenced Contracts, impairing the price discovery process in their
markets, and encouraging the migration of speculative activity and
perhaps price discovery to markets outside of the Commission's
jurisdiction.'' \359\ The Commission invited comments on its
consideration of costs and benefits, including a specific invitation
for commenters to ``submit any data or other information that they may
have quantifying or qualifying the costs and benefits of proposed part
151.'' \360\
---------------------------------------------------------------------------
\358\ See 76 FR at 4764.
\359\ Id.
\360\ Id.
---------------------------------------------------------------------------
In consideration of the costs and benefits of the final rules, the
Commission has, wherever feasible, endeavored to estimate or quantify
the costs and benefits of the final rules; where estimation or
quantification is not feasible, the Commission provides a qualitative
assessment of such costs and benefits.\361\ In this respect, the
Commission notes that public comment letters provided little
quantitative data regarding the costs and benefits associated with the
Proposed Rules.
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\361\ Accordingly, to assist the Commission and the public to
assess and understand the economic costs and benefits of the final
rule, the Commission is supplementing its consideration of costs and
benefits with wage rate estimates based on salary information for
the securities industry compiled by the Securities Industry and
Financial Markets Association (``SIFMA''). The wage estimates the
Commission uses are derived from an industry-wide survey of
participants and thus reflect an average across entities; the
Commission notes that the actual costs for any individual company or
sector may vary from the average. In response to comments, the
Commission has also addressed its PRA estimates in this
Considerations of Costs and Benefits section.
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In the following discussion, the Commission addresses the costs and
benefits of the final rules, considers comments regarding the costs and
benefits of position limits, and subsequently considers the five broad
areas of market and public concern under section 15(a) of the CEA
within the context of the three broad areas of this rule: Position
limits; exemptions; and account aggregation.
1. General Comments
A number of commenters argued that the Commission did not make the
requisite finding that position limits are necessary to combat
excessive speculation.\362\ Specifically, one commenter argued that the
Commission has ignored the wealth of empirical evidence supporting the
view that the proposed position limits and related exemptions would
actually be counterproductive by decreasing liquidity in the CFTC-
regulated markets which, in turn, will increase both price volatility
and the cost of hedging especially in deferred months.\363\ Similarly,
some commenters opposing position limits questioned the benefits that
would be derived from speculative limits in all markets or in
particular markets.\364\ Several commenters denied or questioned that
the Commission had demonstrated that excessive speculation exists or
that the proposed speculative limits were necessary.\365\ Other
commenters suggested that speculative limits would be inappropriate
because the U.S. derivatives markets must compete against exchanges
elsewhere in the world that do not impose position limits.\366\ Some
commenters argued that even with the provisions concerning contracts on
FBOTs, speculators could easily circumvent limits by migrating to
FBOTs, and in fact the Proposed Rules could encourage such
behavior.\367\ Other commenters opined that certain physical
commodities, such as gold, should not be subject to position limits due
to considerations unique to those particular commodities.\368\
---------------------------------------------------------------------------
\362\ See e.g., CL-CME I supra note 8 at 2; and CL-COPE supra
note 21 at 2-5.
\363\ CL-CME I supra note 8 at 2. See also CL-Blackrock supra
note 21 at 3.
\364\ See e.g., CL-Utility Group supra note 21 at 2 (submitting
that the compliance burden of the Commission's position limits
proposal is not justified by any demonstrable benefits); and CL-COPE
supra note 21 (stating that there is no predicate for finding
federal position limits to be appropriate at this time; and the
Position Limits NOPR is overly complex and creates significant and
burdensome requirements on end-users).
\365\ See e.g., CL-Morgan Stanley supra note 21 at 4.
\366\ See e.g., CL-CME I supra note 8 at 2.
\367\ See e.g., CL-USCOC supra note 246 at 3; CL-PIMCO, supra
note 21 at 8; and CL-ISDA/SIFMA, supra note 21 at 24.
\368\ See e.g., CL-WGC supra note 21 at 3.
---------------------------------------------------------------------------
One commenter stated that the Commission's cost estimates did not
accurately reflect the true cost to the market incurred as a result of
the Proposed Rules because the wage estimates used were inaccurate;
this commenter also stated that cost estimates in the PRA section were
not addressed in the costs and benefits section of the Proposed
Rule.\369\
---------------------------------------------------------------------------
\369\ See CL-WGCEF supra note 34 at 25-26.
---------------------------------------------------------------------------
As discussed above in sections II.A and II.C of this release, in
section 4a(a)(1) Congress has determined that excessive speculation
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.'' Further, Congress directed
that for the purpose of ``diminishing, eliminating, or preventing such
burden,'' the Commission ``shall * * * proclaim and fix such [position]
limits * * * as the Commission finds are necessary to diminish,
eliminate, or prevent such burden.'' \370\ New sections 4a(a)(2) and
4a(a)(5) of the CEA contain an express congressional directive that the
Commission ``shall'' establish position limits, as appropriate, within
an expedited timeframe after the date of enactment of the Dodd-Frank
Act. In requiring these position limits, Congress specified in section
4a(a)(3)(B) that in
[[Page 71663]]
addition to establishing limits on the number of positions that may be
held by any person to diminish, eliminate, or prevent excessive
speculation, the Commission should also, to the maximum extent
practicable, set such limits at a level to ``deter and prevent market
manipulation, squeezes and corners,'' ``ensure sufficient market
liquidity for bona fide hedgers,'' and ``to ensure that the price
discovery function of the underlying market is not disrupted.''
---------------------------------------------------------------------------
\370\ Section 4a(a)(1) of the CEA, 7 U.S.C. 6a(a)(1).
---------------------------------------------------------------------------
In light of the congressional mandate to impose position limits,
the Commission disagrees with comments asserting that the Commission
must first determine that excessive speculation exists or prove that
position limits are an effective regulatory tool. Section 4a(a)
expresses Congress's determination that excessive speculation may
create an undue and unnecessary burden on interstate commerce and
directs the Commission to establish such limits as are necessary to
``diminish, eliminate, or prevent such burden.'' Congress intended the
Commission to act to prevent such burdens before they arise. The
Commission does not believe it must first demonstrate the existence of
excessive speculation or the resulting burdens in order to take
preventive action through the imposition of position limits. Similarly,
the Commission need not prove that such limits will in fact prevent
such burdens.
In enacting the Dodd-Frank Act, Congress re-affirmed the findings
regarding excessive speculation, first enacted in the Commodity
Exchange Act of 1936, as well as the direction to the Commission to
establish position limits.\371\ In the Dodd-Frank Act, Congress also
expressly required that the Commission impose limits, as appropriate,
to prevent excessive speculation and market manipulation while ensuring
the sufficiency of liquidity for bona fide hedgers and the integrity of
price discovery function of the underlying market. Comments to the
Commission regarding the efficacy of position limits fail to account
for the mandate that the Commission shall impose position limits. By
its terms, CEA Section 15(a) requires the Commission to consider and
evaluate the prospective costs and benefits of regulations and orders
of the Commission prior to their issuance; it does not require the
Commission to evaluate the costs and benefits of the actions or
mandates of Congress.
---------------------------------------------------------------------------
\371\ See Commodity Exchange Act of 1936, Pub L. 74-675, 49
Stat. 1491 (1936).
---------------------------------------------------------------------------
2. Studies
A number of commenters submitted or cited studies to the Commission
regarding excessive speculation.\372\ Generally, the comments and
studies discussed whether or not excessive speculation exists, the
definition of excessive speculation, and/or whether excessive
speculation has a negative impact on derivatives markets. Some of these
studies did not explicitly address or focus on the issue of position
limits as a means to prevent excessive speculation or otherwise, while
some studies did generally opine on the effect of position limits on
derivatives markets.
---------------------------------------------------------------------------
\372\ Twenty commenters cited over 52 studies by institutional,
academic, and industry professionals.
---------------------------------------------------------------------------
Thirty-eight of the studies were focused on the impact of
speculative activity in futures markets, i.e., how the behavior of non-
commercial traders affected price levels.\373\ These 38 studies did not
provide a view on position limits in general or on the Commission's
implementation of position limits in particular. While the Commission
reviewed these studies in connection with this rulemaking, the
Commission again notes that it is not required to make a finding on the
impact of speculation on commodity markets. Congress mandated the
imposition of position limits, and the Commission
[[Page 71664]]
does not have the discretion to alter an express mandate from Congress.
As such, studies suggesting that there is insufficient evidence of
excessive speculation in commodity markets fail to address that the
Commission must impose position limits, and do not address issues that
are material to this rulemaking.
---------------------------------------------------------------------------
\373\ See e.g., Anderson, David, Joe L. Outlaw, Henry L. Bryant,
James W. Richardson, David P. Ernstes, J. Marc Raulston, J. Mark
Welch, George M. Knapek, Brian K. Herbst, and Marc S. Allison, The
Agricultural and Food Policy Center Texas A&M University, Research
Report 08-1, The Effects of Ethanol on Texas Food and Feed (2008);
Antoshin, Sergei, Elie Canetti, and Ken Miyajima, IMF, Global
Financial Stability Report, Financial Stress and Deleveraging,
Macrofinancial Implications and Policy: Annex 1.2. Financial
Investment in Commodities Markets, at 62-66 (2008); Baffes, John,
and Tasos Haniotos, World Bank, Washington DC, Policy Research
Working Paper 5371, Placing the 2006/08 Commodity Boom into
Perspective (2010); Brunetti, Celso, and Bahattin Buyuksahin, CFTC,
Working Paper Series, Is Speculation Destabilizing? (2009);
Buyuksahin, Bahattin, and Jeff Harris, The Energy Journal, The Role
of Speculators in the Crude Oil Market (2011); Buyuksahin, Bahattin,
and Michel Robe, CFTC, Working Paper, Speculators, Commodities, and
Cross-Market Linkages (2010); Buyuksahin, Bahattin, Michael Haigh,
Jeff Harris, James Overdahl, and Michel Robe, CFTC, Working Paper,
Fundamentals, Trader Activity, and Derivative Pricing (2008);
Eckaus, R.S., MIT Center for Energy and Environmental Policy
Research, Working Paper 08-007WP, The Oil Price Really Is A
Speculative Bubble (2008); Einloth, James T., Division of Insurance
and Research, Federal Deposit Insurance Corporation, Washington, DC,
Working Paper, Speculation and Recent Volatility in the Price of Oil
(2009); Gilbert, Christopher L., Department of Economics, University
of Trento, Italy, Working Paper, Speculative Influences on Commodity
Futures Prices, 2006-2008 (2009); Gilbert, Christopher L., Journal
of Agricultural Economics, How to Understand High Food Prices
(2010); Government Accountability Office (GAO), Issues Involving the
Use of the Futures Markets to Invest in Commodity Indexes (2009);
Haigh, Michael, Jana Hranaiova, and James Overdahl, CFTC OCE, Staff
Research Report, Price Dynamics, Price Discovery, and Large Futures
Trader Interactions in the Energy Complex (2005); Haigh, Michael,
Jeff Harris, James Overdahl, and Michel Robe, CFTC, Working Paper,
Trader Participation and Pricing in Energy Futures Markets (2007);
Hamilton, James, Brookings Paper on Economic Activity, The Causes
and Consequences of the Oil Shock of 2007-2008 (2009); HM Treasury
(UK), Global Commodities: A Long Term Vision for Stable, Secure, and
Sustainable Global Markets (2008); Interagency Task Force on
Commodity Markets, Interim Report on Crude Oil (2008); International
Monetary Fund, World Economic Outlook, Is Inflation Back? Commodity
Prices and Inflation, at 83-128 (2008); Irwin, Scott and Dwight
Sanders, OECD Food, Agriculture, and Fisheries Working Papers, The
Impact of Index and Swap Funds on Commodity Futures Markets (2010);
Irwin, Scott, Dwight Sanders, and Robert Merrin, Journal of
Agricultural and Applied Economics, Devil or Angel? The Role of
Speculation in the Recent Commodity Price Boom (and Bust) (2009);
Jacks, David, Explorations in Economic History, Populists vs
Theorists: Futures Markets and the Volatility of Prices (2006);
Kilian, Lutz, American Economic Review, Not All Oil Price Shocks Are
Alike: Disentangling Demand and Supply Shocks in the Crude Oil
Market (2009); Kilian, Lutz, and Dan Murphy, University of Michigan,
Working Paper, The Role of Inventories and Speculative Trading in
the Global Market for Crude Oil (2010); Korniotis, George, Federal
Reserve Board of Governors, Finance and Economics Discussion Series,
Does Speculation Affect Spot Price Levels? The Case of Metals With
and Without Futures Markets (2009); Mou, Ethan Y., Columbia
University, Working Paper, Limits to Arbitrage and Commodity Index
Investment: Front-Running the Goldman Roll (2010); Nissanke,
Machinko, University of London School of Oriental and African
Studies, Commodity Markets and Excess Volatility: Sources and
Strategies To Reduce Adverse Development Impacts (2010); Phillips,
Peter C.B., and Jun Yu, Yale University, Cowles Foundation
Discussion Paper No. 1770, Dating the Timeline of Financial Bubbles
During the Subprime Crisis (2010); Plato, Gerald, and Linwood
Hoffman, NCCC-134 Conference on Applied Commodity Price Analysis,
Forecasting, and Market Risk Management, Measuring the Influence of
Commodity Fund Trading on Soybean Price Discovery (2007); Robles,
Miguel, Maximo Torero, and Joachim von Braun, International Food
Policy Research Institute, IFPRI Issue Brief 57, When Speculation
Matters (2009); Sanders, Dwight, and Scott Irwin, Agricultural
Economics, A Speculative Bubble in Commodity Futures Prices? Cross-
Sectional Evidence (2010); Sanders, Dwight, Scott Irwin, and Robert
Merrin, University of Illinois at Urbana-Champaign, The Adequacy of
Speculation in Agricultural Futures Markets: Too Much of a Good
Thing? (2008); Smith, James, Journal of Economic Perspectives, World
Oil: Market or Mayhem? (2009); Technical Committee of the
International Organization of Securities Commission. IOSCO, Task
Force on Commodity Futures Markets Final Report (2009); Stoll, Hans,
and Robert Whaley, Vanderbilt University, Working Paper, Commodity
Index Investing and Commodity Futures Prices (2009); Tang, Ke, and
Wei Xiong, Department of Economics, Princeton University, Working
Paper, Index Investing and the Financialization of Commodities
(2010); Trostle, Ronald, ERS (USDA), Global Agricultural Supply and
Demand: Factors Contributing to the Recent Increase in Food
Commodity Prices (2008); U.S. Commodity Futures Trading Commission,
Staff Report on Commodity Swap Dealers and Index Traders With
Commission Recommendations (2008); Wright, Brian, World Bank, Policy
Research Working Paper, International Grain Reserves and Other
Instruments To Address Volatility in Grain Markets (2009).
---------------------------------------------------------------------------
The remaining studies did generally addresses the concept of
position limits as part of their discussion of speculative activity.
The authors of some of these studies and papers expressed views that
speculative position limits were an important regulatory tool and that
the CFTC should implement limits to control excessive speculation.\374\
For example, one author opined that ``* * * strict position limits
should be placed on individual holdings, such that they are not
manipulative.'' \375\ Another stated, ``[S]peculative position limits
worked well for over 50 years and carry no unintended consequences. If
Congress takes these actions, then the speculative money that flowed
into these markets will be forced to flow out, and with that the price
of commodities futures will come down substantially. Until speculative
position limits are restored, investor money will continue to flow
unimpeded into the commodities futures markets and the upward pressure
on prices will remain.'' \376\ The authors of one study claimed that
``Rules for speculative position limits were historically much stricter
than they are today. Moreover, despite rhetoric that imposing stricter
limits would harm market liquidity, there is no evidence to support
such claims, especially in light of the fact that the market was
functioning very well prior to 2000, when speculative limits were
tighter.'' \377\
---------------------------------------------------------------------------
\374\ Greenberger, Michael, The Relationship of Unregulated
Excessive Speculation to Oil Market Price Volatility, at 11 (2010)
(On position limits: ``The damage price volatility causes the
economy by needlessly inflating energy and food prices worldwide far
outweighs the concerns about the precise application of what for
over 70 years has been the historic regulatory technique for
controlling excessive speculation in risk-shifting derivative
markets.''.); Khan, Mohsin S., Peterson Institute for International
Economics, Washington, DC, Policy Brief PB09-19, The 2008 Oil Price
`Bubble', at 8 (2009) (``The policies being considered by the CFTC
to put aggregate position limits on futures contracts and to
increase the transparency of futures markets are moves in the right
direction.''); U.S. Senate, Permanent Subcommittee on
Investigations, Excessive Speculation in the Wheat Market, at 12
(2009) (``The activities of these index traders constitute the type
of excessive speculation the CFTC should diminish or prevent through
the imposition and enforcement of position limits as intended by the
Commodity Exchange Act.''); U.S. Senate, Permanent Subcommittee on
Investigations, Excessive Speculation in the Natural Gas Market at
8'' (2007) (The Subcommittee recommended that Congress give the CFTC
authority over ECMs, noting that ``[to] ensure fair energy pricing,
it is time to put the cop back on the beat in all U.S. energy
commodity markets.''); UNCTAD, The Global Economic Crisis: Systemic
Failures and Multilateral Remedies: Report by the UNCTAD Secretariat
Task Force on Systemic Issues and Economic Cooperation, at 14,
(2009) (The UNCTAD recommends that ``* * * regulators should be
enabled to intervene when swap dealer positions exceed speculative
position limits and may represent `excessive speculation.'); UNCTAD,
United Nations, Trade and Development Report, 2009: Chapter II: The
Financialization of Commodity Markets, at 26 (2009) (The report
recommends tighter restrictions, notably closing loopholes that
allow potentially harmful speculative activity to surpass position
limits.).
\375\ De Schutter, O., United Nations Special Report on the
Right to Food: Briefing Note 02, Food Commodities Speculation and
Food Price Crises at 8 (2010).
\376\ Masters, Michael, and Adam White, White Paper: The
Accidental Hunt Brothers: How Institutional Investors Are Driving up
Food and Energy Prices at 3 (2008).
\377\ Medlock, Kenneth, and Amy Myers Jaffe, Rice University:
Who Is in the Oil Futures Market and How Has It Changed?'' at 8
(2009).
---------------------------------------------------------------------------
One study claimed that position limits will not restrain
manipulation,\378\ while another argued that position limits in the
agricultural commodities have not significantly affected
volatility.\379\ Another study noted that while position limits are
effective as an anti-manipulation measure, they will not prevent asset
bubbles from forming or stop them from bursting.\380\ One study
cautioned that while limits may be effective in preventing
manipulation, they should be set at an optimal level so as to not harm
the affected markets.\381\ One study claimed that position limits
should be administered by DCMs, as those entities are closest to and
most familiar with the intricacies of markets and thus can implement
the most efficient position limits policy.\382\ Finally, one commenter
cited a study that notes the similar efforts under discussion in
European markets.\383\
---------------------------------------------------------------------------
\378\ Ebrahim, Muhammed: Working Paper, Can Position Limits
Restrain Rogue Traders?'' at 27 (2011) (``* * * binding constraints
have an unintentional effect. That is, they lead to a degradation of
the equilibria and augmenting market power of Speculator in addition
to other agents. We therefore conclude that position limits are not
helpful in curbing market manipulation. Instead of curtailing price
swings, they could exacerbate them.''
\379\ Irwin, Scott, Philip Garcia, and Darrel L. Good: Working
Paper, The Performance of Chicago Board of Trade Corn, Soybean, and
Wheat Futures Contracts After Recent Changes in Speculative Limits
at 16 (2007) (``The analysis of price volatility revealed no large
change in measures of volatility after the change in speculative
limits. A relatively small number of observations are available
since the change was made, but there is little to suggest that the
change in speculative limits has had a meaningful overall impact on
price volatility to date.'').
\380\ Parsons, John: Economia, Vol. 10, Black Gold and Fools
Gold: Speculation in the Oil Futures Market at 30 (2010)
(``Restoring position limits on all nonhedgers, including swap
dealers, is a useful reform that gives regulators the powers
necessary to ensure the integrity of the market. Although this
reform is useful, it will not prevent another speculative bubble in
oil. The general purpose of speculative limits is to constrain
manipulation . * * * Position limits, while useful, will not be
useful against an asset bubble. That is really more of a
macroeconomic problem, and it is not readily managed with
microeconomic levers at the individual exchange level.'').
\381\ Wray, Randall, The Levy Economics Institute of Bard
College: The Commodities Market Bubble: Money Manager Capitalism and
the Financialization of Commodities at 41, 43 (2008) ``(''While the
participation of traditional speculators offers clear benefits,
position limits must be carefully administered to ensure that their
activities do not ``demoralize'' markets. * * *The CFTC must re-
establish and enforce position limits.'').
\382\ CME Group, Inc.: CME Group White Paper, Excessive
Speculation and Position Limits in Energy Derivatives Markets at 6
(``Indeed, as the Commission has previously noted, the exchanges
have the expertise and are in the best position to fix position
limits for their contracts. In fact, this determination led the
Commission to delegate to the exchanges authority to set position
limits in non-enumerated commodities, in the first instances, almost
30 years ago.'').
\383\ European Commission, Review of the Markets in Financial
Instruments Directive (2010), note 282:
European Parliament resolution of 15 June 2010 on derivatives
markets: future policy actions (A7-0187/2010) calls on the
Commission to develop measures to ensure that regulators are able to
set position limits to counter disproportionate price movements and
speculative bubbles, as well as to investigate the use of position
limits as a dynamic tool to combat market manipulation, most
particularly at the point when a contract is approaching expiry. It
also requests the Commission to consider rules relating to the
banning of purely speculative trading in commodities and
agricultural products, and the imposition of strict position limits
especially with regard to their possible impact on the price of
essential food commodities in developing countries and greenhouse
gas emission allowances.
Id. at 82.
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Although these studies generally discuss the impact of position
limits, they do not address or provide analysis of how the Commission
should specifically implement position limits under section 4a. As the
Commission explained in the proposal, ``overly restrictive'' limits can
negatively impact market liquidity and price discovery. These
consequences are detailed in several of the studies criticizing the
impact of position limits.\384\ Similarly, limits that are set too high
fail to address issues surrounding market manipulation and excessive
speculation. Market manipulation and excessive speculation are also
detailed in several of the studies claiming the need for position
limits.\385\ In section 4a(a)(3)(B) Congress sought to ensure that the
Commission would ``to the maximum extent practicable'' ensure that
position limits would be set at a
[[Page 71665]]
level that would ``diminish, eliminate, or prevent excessive
speculation'' and deter or prevent market manipulation, while at the
same time ensure there is sufficient market liquidity for bona fide
hedgers and the price discovery function of the market would be
preserved. The Commission historically has recognized the potential
impact of both overly restrictive and unrestrictive limits, and through
the consideration of the statutory objectives in section 4a(a)(3)(B) as
well as the costs and benefits, has determined to finalize these rules.
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\384\ See e.g., Wray, Randall, supra.
\385\ See e.g., Medlock, Kenneth and Amy Myers Jaffe, supra.
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3. General Costs and Benefits
As stated in the Proposed Rule, the Commission anticipates that the
final rules establishing position limits and related provisions will
result in costs to market participants. Generally, market participants
will incur costs associated with developing, implementing and
maintaining a method to ensure compliance with the position limits and
its attendant requirements (e.g., bona fide hedging exemptions and
aggregation standards). Such costs will include those related to the
monitoring of positions in the relevant Referenced Contracts, related
filing, reporting, and recordkeeping requirements, and the costs (if
any) of changes to information technology systems. It is expected that
market participants whose positions are exclusively in swaps (and hence
currently not subject to any position limits regime) will incur larger
initial costs relative to those participants in the futures markets, as
the latter should be accustomed to operating under DCM and/or
Commission position limit regimes.
The final rules are also expected to result in costs to market
participants whose market participation and trading strategies will
need to take into account and be limited by the new position limits
rule. For example, a swap dealer that makes a market in a particular
class of swaps may have to ensure that any further positions taken in
that class of swaps are hedged or offset in order to avoid increasing
that trader's position. Similarly, a trader that is seeking to adopt a
large speculative position in a particular commodity and that is
constrained by the limits would have to either diversify or refrain
from taking on additional positions.\386\
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\386\ In this respect, the costs of these limits may not in fact
be additional expenditures or outlays but rather foregone benefits
that would have accrued to the firm had it been permitted to hold
positions in excess of the limits. For ease of reference, the term
``costs'' as used in this context also refers to foregone benefits.
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The Commission does not believe it is reasonably feasible to
quantify or estimate the costs from such changes in trading strategies.
Quantifying the consequences or costs of market participation or
trading strategies would necessitate having access to and understanding
of an entity's business model, operating model, and hedging strategies,
including an evaluation of the potential alternative hedging or
business strategies that would be adopted if such limits were imposed.
Because the economic consequences to any particular firm will vary
depending on that firm's business model and strategy, the Commission
believes it is impractical to develop any type of generic or
representative calculation of these economic consequences.\387\
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\387\ Further, the Commission also believes it would be
impractical to require all potentially affected firms to provide the
Commission with the information necessary for the Commission to make
this determination or assessment for each firm. In this regard, the
Commission notes that none of the commenters provided or offered to
provide any such analysis to the Commission.
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The Commission believes that many of the costs that arise from the
application of the final rules are a consequence of the congressional
mandate that the Commission impose position limits. As described more
fully below, the Commission has considered these costs in adopting
these final rules, and has, where appropriate, attempted to mitigate
costs while observing the express direction of Congress in section 4a
of the CEA.
In the discussions below as well as in the Paperwork Reduction Act
(``PRA'') section of this release, the Commission estimates or
quantifies the implementing costs wherever reasonably feasible, and
where infeasible provides a qualitative assessment of the costs and
benefits of the final rule. In many instances, the Commission finds
that it is not feasible to estimate or quantify the costs with reliable
precision, primarily due to the fact that the final rules apply to a
heretofore unregulated swaps markets and, as previously noted, the
Commission does not have the resources or information to determine how
market participants may adjust their trading strategies in response to
the rules.\388\
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\388\ Further, as previously noted, market participants did not
provide the Commission with specific information regarding how they
may alter their trading strategies if the limits were adopted.
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At present, the Commission has limited data concerning swaps
transactions in Referenced Contracts (and market participants engaged
in such transactions).\389\ In light of these data limitations, to
inform its consideration of costs and benefits the Commission has
relied on: (1) Its experience in the futures markets and information
gathered through public comment letters, its hearing, and meetings with
the industry; and (2) relevant data from the Commission's Large Trader
Reporting System and other relevant data concerning cleared swaps and
SPDCs traded on ECMs.\390\
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\389\ The Commission should be able to obtain an expanded set of
swaps data through its swaps large trader reporting and SDR
regulations. See Large Trader Reporting for Physical Commodity
Swaps, 76 FR 43851, Jul. 22, 2011; and Swap Data Repositories:
Registration Standards, Duties and Core Principles, 76 FR 54538,
Sept. 1, 2011.
\390\ Prior to the Dodd-Frank Act and at least until the
Commission can begin regularly collecting swaps data under the Large
Trader Reporting for Physical Commodity Swaps regulations (76 FR
43851, Jul. 22, 2011), the Commission's authority to collect data on
the swaps market was generally limited to Commission regulation
18.05 regarding Special Calls, and Part 36 of the Commission's
regulations.
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4. Position Limits
To implement the Congressional mandate under Dodd-Frank, the
proposal identified 28 core physical delivery futures contracts in
proposed Regulation 151.2 (``Core Referenced Futures Contracts''),\391\
and would apply aggregate limits on a futures equivalent basis across
all derivatives that are (i) directly or indirectly linked to the price
of a Core Referenced Futures Contracts, or (ii) based on the price of
the same underlying commodity for delivery at the same delivery
location as that of a Core Referenced Futures Contracts, or another
delivery location having substantially the same supply and demand
fundamentals (``economically equivalent contracts'') (collectively with
Core Referenced Futures Contracts, ``Referenced Contracts'').\392\
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\391\ This is discussed in greater detail in II.B. of this
release. These Core Referenced Futures Contracts are listed in
regulation 151.2 of these final rules.
\392\ 76 FR at 4753.
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As explained in the proposal, the 28 Core Referenced Futures
Contracts were selected on the basis that (i) they have high levels of
open interest and significant notional value or (ii) they serve as a
reference price for a significant number of cash market transactions.
The Commission believes that contracts that meet these criteria are of
particular significance to interstate commerce, and therefore warrant
the imposition of federally administered limits. The remaining physical
commodity contracts traded on a DCM or SEF that is a trading facility
will be subject to limits set by those facilities.\393\
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\393\ The Commission further considers registered entity limits
in section III.A.3.e.
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[[Page 71666]]
With regard to the scope of ``economically equivalent'' contracts
that are subject to limits concurrently with the 28 Core Referenced
Futures Contract limits, this definition incorporates contracts that
price the same commodity at the same delivery location or that utilize
the same cash settlement price series of the Core Referenced Futures
Contracts (i.e., ``look-alikes'' as discussed above in II.B.).\394\ The
Commission continues to believe, as mentioned in the proposal, that
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\394\ The Commission notes economically equivalent contracts are
a subset of ``Referenced Contracts.''
``[t]he proliferation of economically equivalent instruments
trading in multiple trading venues, * * * warrants extension of
Commission-set position limits beyond agricultural products to
metals and energy commodities. The Commission anticipates this
market trend will continue as, consistent with the regulatory
structure established by the Dodd-Frank Act, economically equivalent
derivatives based on exempt and agricultural commodities are
executed pursuant to the rules of multiple DCMs and SEFs and other
Commission registrants. Under these circumstances, uniform position
limits should be established across such venues to prevent
regulatory arbitrage and ensure a level playing field for all
trading venues.'' \395\
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\395\ See 75 FR 4755.
In addition, by imposing position limits on contracts that are based on
an identical commodity reference price (directly or indirectly) or the
price of the same commodity at the same delivery location, the final
rules help to prevent manipulative behavior. Absent such limits on
related markets, a trader would have a significant incentive to attempt
to manipulate the physical-delivery market to benefit a large position
in the cash-settled market.
The final rule should provide for lower costs than the proposal
with respect to determining whether a contract is a Referenced Contract
because the final rule provides an objective test for determining
Referenced Contracts and does not require case by case analysis of the
correlation between contracts. In response to comments, the Commission
eliminated the category of Referenced Contracts regarding contracts
that have substantially the same supply and demand fundamentals of the
Core Referenced Futures Contracts because this category did not
establish objective criteria and would be difficult to administer when
the correlation between two contracts change over time.
The final categories of economically equivalent Referenced
Contracts should also limit the costs of determining whether a contract
is a Referenced Contract because the scope is objectively defined and
does not require case by case analysis of the correlation between
contracts. In this regard, the Commission eliminated the category of
Referenced Contracts regarding contracts that have substantially the
same supply and demand fundamentals of the Core Referenced Futures
Contracts because this category did not establish objective criteria
and would be difficult to administer when the correlation between two
contracts change over time.
The definitional criteria for the core physical delivery futures
contracts, together with the criteria for ``economic equivalent''
derivatives, are intended to ensure that those contracts that are of
major significance to interstate commerce and show a sufficient nexus
to create a single market across multiple venues are subject to Federal
position limits.\396\ Nevertheless, the Commission recognizes that the
criteria informing the scope of Referenced Contracts may need to evolve
given the Commission's limited data and changes in market structure
over time. As the Commission gains further experience in the swaps
market, it may determine to expand, restrict, or otherwise modify
through rulemaking the 28 Core Referenced Futures Contracts and the
related definition of ``economically equivalent'' contracts.
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\396\ One commenter (CL-WGC supra note 21 at 3) opined that gold
should not be subject to position limits because ``gold is not
consumed in a normal sense, as virtually all the gold that has ever
been mined still exists'' and given the ``beneficial qualities of
gold to the international monetary and financial systems.'' Section
4a requires the Commission to impose limits on all physical-delivery
contracts and relevant ``economically equivalent'' contracts. The
Commission notes that Congress directed the Commission to impose
limits on physical commodities, including exempt and agricultural
commodities. The scope of such commodities includes metal
commodities.
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The Commission anticipates that the additional cost of monitoring
positions in Referenced Contracts should be minimal for market
participants that currently monitor their positions throughout the day
for purposes such as compliance with existing DCM or Commission
position limits, to meet their fiduciary obligations to shareholders,
to anticipate margin requirements, etc. The Commission estimates that
trading firms that currently track compliance with DCM or Commission
position limits will incur an additional implementation cost of two or
three labor weeks in order to adjust their monitoring systems to track
the position limits for Referenced Contracts. Assuming an hourly wage
of $78.61,\397\ multiplied by 120 hours, this implementation cost would
amount to approximately $12,300 per firm, for a total across all
estimated participants affected by such limits (as described in
subsequent sections) of $4.2 million.\398\ These costs are generally
associated with adjusting systems for monitoring futures and swaps
Referenced Contracts to track compliance with position limits.\399\
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\397\ The Commission staff's estimates concerning the wage rates
are based on salary information for the securities industry compiled
by the Securities Industry and Financial Markets Association
(``SIFMA''). The $78.61 per hour is derived from figures from a
weighted average of salaries and bonuses across different
professions from the SIFMA Report on Management & Professional
Earnings in the Securities Industry 2010, modified to account for an
1800-hour work-year and multiplied by 1.3 to account for overhead
and other benefits. The wage rate is a weighted national average of
salary and bonuses for professionals with the following titles (and
their relative weight): ``programmer (senior)'' (30 percent);
``programmer'' (30 percent); ``compliance advisor'' (intermediate)
(20 percent); ``systems analyst'' (10 percent); and ``assistant/
associate general counsel'' (10 percent).
\398\ Although one commenter provided a wage estimate of $120
per hour, the Commission believes that the SIFMA industry average
properly accounts for the differing entities that would be subject
to these limits. See CL-WGCEF supra note 35 at 26, ``Internal data
collected and analyzed by members of the Working Group suggest that
the average cost per hour is approximately $120, much higher than
SIFMA's $78.61, as relied upon by the Commission.'' In any event,
even using the Working Group's higher estimated wage cost, the
resulting cost per firm of approximately $18,000 per firm would not
materially change the Commission's consideration of these costs in
relation to the benefits from the limits, and in light of the
factors in CEA section 15(a), 7 U.S.C. 19(a).
\399\ Among other things, a market participant will be required
to identify which swap positions are subject to position limits
(i.e., swaps that are Referenced Contracts) and allocate these
positions to the appropriate compliance categories (e.g., the spot
month, all months, or a single month of a Referenced Contract).
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Participants currently without reportable futures positions (i.e.,
those who trade solely or mostly in the swaps marketplaces, or ``swaps-
only'' traders), and traders with certain positions outside of the spot
month in Referenced Contracts that do not currently have position
limits or position accountability levels, would likely incur an initial
cost in excess of those traders that do monitor their positions for the
purpose of compliance with position limits. Because firms with
positions in the futures markets should already have systems and
procedures in place for monitoring compliance with position limits, the
Commission believes that firms with positions mostly or only in the
swaps markets would be representative of the highest incremental costs
of the rules. Specifically, swaps-only traders may incur larger start-
up costs to develop a compliance system to monitor their
[[Page 71667]]
positions in Referenced Contracts and to comply with an applicable
position limit. The Commission estimates that approximately 100 swaps-
only firms would be subject to position limits for the first time.
The Commission believes that many swaps-only market participants
potentially affected by the spot month limits are likely to have
developed business processes to control the size of swap positions for
a variety of business reasons, including (i) managing counterparty
credit risk exposure, (ii) limiting the value at risk to such swap
positions, and (iii) ensuring desired accounting treatment (e.g., hedge
accounting under Generally Accepted Accounting Principles (``GAAP'')).
These processes are more likely to be well developed by people with a
larger exposure to swaps, particularly those persons with position
sizes with a notional value close to a spot-month position limit. For
example, traders with positions in Referenced Contracts at the spot-
month limit in the final rule would have a notional value of
approximately $8.2 million to a maximum of $544.3 million, depending on
the underlying physical commodity.\400\ The minimum value in this range
represents a significant exposure in a single payment period for swaps;
therefore, the Commission expects that traders with positions at the
spot-month limit will have already developed some system to control the
size of their positions on an intraday basis. The Commission also
anticipates, based on current swap market data, comment letters, and
trade interviews, that very few swaps-only traders would have positions
close to the non-spot-month position limits imposed by the final rules,
given that the notional value of a position at an all-months-combined
limit will be much larger than that of a position at a spot-month
limit.
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\400\ These notional values were determined based on notional
values determined as of September 7, 2011 closing prices. The
computation used was a position at the size of the spot-month limit
in appendix A to part 151 (e.g., 600 contracts in wheat) times the
unit of trading (e.g., 5,000 bushels per contract) times the closing
price per quantity of commodity (e.g., dollars per bushel).
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As explained above, the Commission expects that traders with
positions at the spot-month limit will have already developed some
system to control the size of their positions on an intraday basis.
However, the Commission recognizes that there may be a variety of ways
to monitor positions for compliance with Federal position limits. While
specific cost information regarding such swaps-only entities was not
provided to the Commission in comment letters, the Commission
anticipates that a firm could implement a monitoring regime amid a wide
range of compliance systems based on the specific, individual needs of
the firm. For example, a firm may elect to utilize an automatic
software system, which may include high initial costs but lower long-
term operational and labor costs. Conversely, a firm may decide to use
a less capital-intensive system that requires more human labor to
monitor positions. Thus, taking this range into account, the Commission
anticipates, on average, labor costs per entity ranging from 40 to
1,000 annual labor hours, $5,000 to $100,000 in total annualized
capital/start-up costs, and $1,000 to $20,000 in annual operating and
maintenance costs.\401\
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\401\ These costs would likely be lower for firms with swaps-
only positions far below the speculative limit, as those firms may
not need comprehensive, real-time analysis of their swaps positions
for position limit compliance to observe whether they are at or near
the limit. Costs may be higher for firms with very large or very
complex positions, as those firms may need comprehensive, real-time
analysis for compliance purposes. Due to the variation in both
number of positions held and degree of sophistication in existing
risk management systems, it is not feasible for the Commission to
provide a greater degree of specificity as to the particularized
costs for firms in the swaps market.
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During the initial period of implementation, a large number of
traders are expected to be able to avail themselves of the pre-existing
position exemption as defined in Sec. 151.9. As preexisting positions
are replaced with new positions, traders will be able to incorporate an
understanding of the new regime into existing and new trading
strategies. The Commission has also incorporated a broader exclusion
for swaps entered into before the effective date of the Dodd-Frank Act
in addition to the general application of position limits to pre-
existing futures and swaps positions entered into before the effective
date of this rulemaking, which should allow swaps market participants
to gradually transition their trading activity into compliance with the
position limits set forth in part 151.
The final position limit rules impose the costs outlined above on
traders who hold or control Referenced Contracts to monitor their
futures and swaps positions on both an end-of-day and on an intraday
basis to ensure compliance with the limit.\402\ Commenters raised
concerns regarding the ability for their current compliance systems to
conduct the requisite tracking and monitoring necessary to comply with
the Proposed Rules, citing the additional contracts and markets needing
monitoring in real-time.\403\
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\402\ The Commission notes that generally, entities have not
previously tracked their swaps positions for purposes of position
limit compliance. With regard to implementing systems to monitor
positions for this rule, the Commission also notes that some
entities that engage in only a small amount of swaps activity
significantly below the applicable position limit may determine,
based on their own assessment, not to track their position on an
intraday basis because their positions do not raise concerns about a
limit.
\403\ CL-COPE supra note 21 at 5; and CL-Utility Group supra
note 21 at 6. See also CL-Barclays I supra note 164 at 5; CL-API
supra note 21 at 14; and CL-Shell supra note 35 at 6-7.
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The Commission and DCMs have historically applied position limits
to both intraday and end-of-day positions; the regulations do not
represent a departure from this practice.\404\ In this regard, the
costs necessary to monitor positions in Referenced Contracts on an
intraday basis outlined above do not constitute a significant
additional cost on market participants.\405\ Positions above the limit
levels, at any time of day, provide opportunity and incentive to trade
such large quantities as to unduly influence market prices. The absence
of position limits during the trading day would make it impossible for
the Commission to detect and prevent market manipulation and excessive
speculation as long as positions were below the limit at the end of the
day.
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\404\ See section II.F of this release. See also Commodity
Futures Trading Commission Division of Market Oversight, Advisory
Regarding Compliance with Speculative Position Limits (May 7, 2010),
available at http://www.cftc.gov/ucm/groups/public/@industryoversight/documents/file/specpositionlimitsadvisory0510.pdf. See e.g., CME Rulebook, Rule
443, quoted at http://www.cmegroup.com/rulebook/files/CME_Group_
RA0909-5.pdf'') (amended Sept. 14, 2009); ICE OTC Advisory, Updated
Notice Regarding Position Limit Exemption Request Form for
Significant Price Discovery Contracts, available at https://www.theice.com/publicdocs/otc/advisory_notices/ICE_OTC_Advisory_0110001.pdf (Jan. 4, 2010).
\405\ The Commission notes that the CEA mandates DCMs and SEFs
to have methods for conducting real-time monitoring of trading.
Sections 5(d)(4)(A) and 5h(f)(4)(B) of the CEA, 7 U.S.C. 7(d)(4)(A),
7b-3(f)(4)(B).
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Further, as discussed above, the Commission anticipates that the
cost of monitoring positions on an intraday basis should be marginal
for market participants that are already required to monitor their
positions throughout the day for compliance purposes. For those
entities whose positions historically have been only in the swaps or
OTC markets, the costs of monitoring intraday positions have been
calculated as part of the costs to create and monitor compliance
systems for position limits in general, discussed above in further
detail.
As the Commission gains further experience and data regarding the
swaps market and market participants trading
[[Page 71668]]
therein, it may reevaluate the scope of the Core Referenced Futures
Contracts, including the definition of economically equivalent
contracts.
a. Spot-Month Limits for Physical Delivery Contracts
The Commission is establishing position limits during the spot-
month for physically delivered Core Referenced Futures Contracts. For
non-enumerated agricultural, as well as energy and metal Referenced
Contracts, the Commission initially will impose spot-month position
limits for physical-delivery contracts at the levels currently imposed
by the DCMs. Thereafter, the Commission will establish the levels based
on the 25 percent of estimated deliverable supply formula with DCMs
submitting estimates of deliverable supply to the Commission to assist
in establishing the limit. For legacy agricultural Reference Contracts,
the Commission will impose the spot-month limits currently imposed by
the Commission.
Pursuant to Core Principles 3 and 5 under the CEA, DCMs generally
are required to fix spot-month position limits to reduce the potential
for manipulation and the threat of congestion, particularly in the spot
month.\406\ Pursuant to these Core Principles and the Commission's
implementing guidance,\407\ DCMs have generally set the spot-month
position limits for physical-delivery futures contracts based on the
deliverable supply of the commodity in the spot month. These spot-month
limits under current DCM rules are generally within the levels that
would be established using the 25 percent of deliverable supply formula
described in these final rules. The Commission received several
comments regarding costs of position limits in the spot month.
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\406\ Core Principle 3 specifies that a board of trade shall
list only contracts that are not readily susceptible to
manipulation, while Core Principle 5 obligates a DCM to establish
position limits and position accountability provisions where
necessary and appropriate ``to reduce the threat of market
manipulation or congestion, especially during the delivery month.''
\407\ See appendix B, part 38, Commission regulations.
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One commenter noted the definition of deliverable supply was vague
and could increase costs to market participants.\408\ One commenter
suggested that the Commission instead base spot-month limits on
``available deliverable supply,'' a broader measure of physical
supply.\409\ Commenters also raised an issue with the schedule for
resetting limits, explaining that resetting the limits on an annual
basis would introduce uncertainty into the market, increase the burden
on DCMs, and increase costs for the Commission.\410\
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\408\ See e.g., CL-API supra note 21 at 5.
\409\ ``Available deliverable supply'' includes (i) all
available local supply (including supply committed to long-term
commitments), (ii) all deliverable non-local supply, and (iii) all
comparable supply (based on factors such as product and location).
See CL-ISDA/SIFMA supra note 21 at 21. Another commenter, AIMA,
similarly advocated a more expansive definition of deliverable
supply. CL-AIMA supra note 35 at 3 (``This may include all supplies
available in the market at all prices and at all locations, as if a
party were seeking to buy a commodity in the market these factors
would be relevant to the price.'').
\410\ See e.g., CL-MGEX supra note 74 at 2-4; and CL-BGA supra
note 35 at 20.
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In addition to the costs associated with generally monitoring
positions in Referenced Contracts, the Commission anticipates some
costs associated with the level of this spot-month position limit for
physical-delivery contracts. The Commission estimates,\411\ on an
annual basis, 84 traders in legacy agricultural Core Referenced Futures
Contracts, approximately 50 traders in non-legacy agricultural
Referenced Contracts, 12 traders in metal Referenced Contract, and 85
traders in energy Referenced Contracts would hold or control positions
that could exceed the spot-month position limits in Sec.
151.4(a).\412\ For the majority of participants, the 25 percent of
deliverable supply formula is estimated to impose limits that are
sufficiently high, so as not to affect their hedging or speculative
activity; thus, the number of participants potentially in excess of
these limits is expected to be small in proportion to the market as a
whole.\413\
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\411\ The Commission's estimates of the number of affected
participants for both spot-month and non-spot-month limits are based
on the data it currently has on futures, options, and the limited
set of data it has on cleared swaps. As such, the actual number of
affected participants may vary from these estimates.
\412\ These estimates are based on the number of unique traders
holding hedge exemptions for existing DCM, ECM, or FBOT spot-month
position limits for Referenced Contracts.
\413\ To illustrate this, the Commission selected examples from
each category of Core Referenced Futures Contracts. In the CBOT Corn
contract (a legacy agricultural Referenced Contract), only
approximately 4.8 percent of reportable traders are estimated to be
impacted using the methods explained above. Using the ICE Futures
Coffee contract as an example of a non-legacy agricultural
Referenced Contract, COMEX Gold as an example of a metal Referenced
Contracts, and NYMEX Crude Oil as an example of an energy Referenced
Contract, the Commission estimates only 1.7 percent, 1.2 percent,
and 8 percent (respectively) of all reportable traders in those
markets would be impacted by the spot-month limit for physical-
delivery contracts. These estimates indicate that the number of
affected entities is expected to be small in comparison to the rest
of the market.
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To estimate the number of traders potentially affected by the spot-
month position limits in physically delivered contracts, the Commission
looked to the number of traders currently relying on hedging and other
exemptions from DCM position limits.\414\ While the Commission believes
that the statutory definition of bona fide hedging will to a certain
extent overlap with the bona fide hedging exemptions applied at the
various DCMs, the definitions are not completely co-extensive. As such,
the costs of adjusting hedging strategies or reducing the size of
positions both within and outside of the spot-month are difficult to
determine. For example, some of the traders relying on a current DCM
hedging exemption may be eligible for bona fide hedging or other
exemptions from the limits adopted herein, and thus incur the costs
associated with filing exemption paperwork. However, other traders may
incur the costs associated with the reduction of positions to ensure
compliance. Absent data on the application of a bona fide hedge
exemption, the Commission cannot determine at this time the number of
entities who will be eligible for an exemption under the revised
statute, and thus cannot determine the number of participants who may
realize the benefits of being exempt from position limits and would
incur a filing cost for the exemption, compared to those who may need
to reduce their positions.\415\ The estimated monetary costs associated
with claiming a bona fide hedge exemption are discussed below in
consideration of the costs and benefits for bona fide hedging as well
as in the PRA section of this final rule.
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\414\ Currently, DCMs report to the Commission which
participants receive hedging and other exemptions that allow those
participants to exceed position limit levels in the spot month.
\415\ The Commission notes that under the pre-existing positions
exemption, a trader would not be in violation of a position limit
based solely upon the trader's pre-existing positions in Referenced
Contracts. Further, swaps entered into before the effective date of
the Dodd-Frank Act will not count toward a speculative limit, unless
the trader elects to net such swaps positions to reduce its
aggregate position.
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Regarding costs related to market participation and trading
strategies that need to take into account the new position limits rule,
as mentioned above, the Commission is currently unable to estimate
these costs associated with the spot-month position limit. Market
participants who are the primary source of such information did not
provide the Commission with any such information in their comments on
the proposal. Additionally, the Commission believes it would not be
feasible to require market participants to share such strategies with
the Commission, or for the Commission to attempt its own
[[Page 71669]]
assessment of the costs of potential business strategies of market
participants. While the Commission does anticipate some cost for
certain firms to adjust their trading and hedging strategy to account
for position limits, the Commission does not believe such costs to be
overly burdensome. All of the 28 Core Referenced Futures Contracts have
some form of spot-month position limits currently in place by their
respective DCMs, and thus market participants with very large positions
(at least those whose primary activity is in futures and options
markets) should be currently incurring costs (or foregoing benefits)
associated with those limits. Further, the Commission notes that CEA
section 4a(a) mandates the imposition of a spot-month position limit,
and therefore, a certain level of costs is already necessary to comply
with the Congressional mandate.
The Commission further notes that the spot limits continue current
market practice of establishing spot-month position limits at 25
percent of deliverable supply. This continuity in the regulatory scheme
should reduce the number of strategy changes that participants may need
to make as a result of the promulgation of the final rule, particularly
for current futures market participants who already must comply with
this limit under the current position limits regimes.
With regard to the use of deliverable supply to set spot-month
position limits, in the Commission's experience of overseeing the
position limits established at the exchanges as well as federally-set
position limits, ``spot-month speculative position limits levels are
`based most appropriately on an analysis of current deliverable
supplies and the history of various spot-month expirations.' '' \416\
The comments received provide no compelling reason for changing that
view. The Commission continues to believe that deliverable supply
represents the best estimate of how much of a commodity is actually
available in the cash market, and is thus the best basis for
determining the proper level to deter manipulation and excessive
speculation while retaining liquidity and protecting price discovery.
In this regard, the Commission and exchanges have historically applied
the formula of 25 percent of deliverable supply to set the spot-month
position limit, and in the Commission's experience, this formula is
effective in diminishing the potential for manipulative behavior and
excessive speculation without unduly restricting liquidity for bona
fide hedgers or negatively impacting the price discovery process.
Further, the definition of deliverable supply adopted in these final
rules is consistent with the current DCM practice in setting spot-month
limits. The Commission believes that this consistent approach
facilitates an orderly transition to Federal limits.
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\416\ 64 FR 24038, 24039, May 5, 1999.
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The final rules require DCMs to submit estimates of deliverable
supply to the Commission every other year for each non-legacy
Referenced Contract. The Commission will use this information to
estimate deliverable supply for a particular commodity in resetting
position limits. The Commission does not anticipate a significant
additional burden on DCMs to submit estimates of deliverable supply
because DCMs currently monitor deliverable supply to comply with Core
Principles 3 and 5 and they must, as part of their self-regulatory
responsibilities, make such calculations to justify initial limits for
newly listed contracts or to justify changes to position limits for
listed contracts. Given that DCMs that list Core Referenced Futures
Contracts have considerable experience in estimating deliverable supply
for purposes of position limits, this expertise will be of significant
benefit to the Commission in its determination of the level of
deliverable supply for the purpose of resetting spot-month position
limits. The additional data provided by DCMs will help the Commission
to accurately determine the amounts of deliverable supply, and
therefore the proper level of spot-month position limits.
Moreover, the Commission has staggered the resetting of position
limits for agricultural contracts, energy contracts, and metal
contracts as outlined in II.D.5. and II.E.3. of this release in order
to further reduce the burden of calculating and submitting estimates of
deliverable supply to the Commission. As explained in the PRA section,
the Commission estimates the cost to DCMs to submit deliverable supply
data to be a total marginal burden, across the six affected entities,
of 5,000 annual labor hours for a total of $511,000 in labor costs and
$50,000 in annualized capital and start-up costs and annual total
operating and maintenance costs.
b. Spot-Month Limits for Cash-Settled Contracts
A spot-month limit is also being implemented for cash-settled
contract markets, including cash-settled futures and swaps. Under the
final rules, with the exception of natural gas contracts, a market
participant could hold positions in cash-settled Referenced Contracts
equal to twenty-five percent of deliverable supply underlying the
relevant Core Referenced Futures Contracts. With regard to cash-settled
natural gas contracts, a market participant could hold positions in
cash-settled Referenced Contracts that are up to five times the limit
applicable to the relevant physical-delivery Core Referenced Futures
Contracts. The final rules also impose an aggregate spot-month limit
across physical-delivery and cash-settled natural gas contracts at a
level of five times the spot month limit for physical-delivery
contracts. The Commission has determined not to adopt the proposed
conditional spot-month limit, under which a trader could maintain a
position of five times the position limit in the Core Referenced
Futures Contract only if the participant did not hold positions in
physical-delivery Core Referenced Futures Contracts and did not hold 25
percent or more of the deliverable supply of the underlying cash
commodity.
Several commenters questioned the application of proposed spot-
month position limits to cash-settled contracts.\417\ Some of these
commenters suggested that cash-settled contracts should not be subject
to spot-month limits based on estimated deliverable supply, and should
be subject to relatively less restrictive spot-month position limits,
if subject to any limits at all.\418\
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\417\ CL-ISDA/SIFMA supra note 21 at 6-7, 19; CL-Goldman supra
note 90 at 5; CL-ICI supra note 21 at 10; CL-MGEX supra note 74 at 4
(particularly current MGEX Index Contracts that do not settle to a
Referenced Contract should be considered exempt from position limits
because cash-settled index contracts are not subject to potential
market manipulation or creation of market disruption in the way that
physical-delivery contracts might be); CL-WGCEF supra note 35 at 20
(``the Commission should reconsider setting a limit on cash-settled
contracts as a function of deliverable supply and establish a much
higher, more appropriate spot-month limit, if any, on cash-settled
contracts''); CL-MFA supra note 21 at 16-17; and CL-SIFMA AMG I
supra note 21 at 7.
\418\ CL-BGA supra note 35 at 19; CL-ICI supra note 21 at 10;
CL-MFA supra note 21 at 16-17; CL-WGCEF supra note 35 at 20; CL-
Cargill supra note 76 at 13; CL-EEI/EPSA supra note 21 at 9; and CL-
AIMA supra note 35 at 2. See also CL-NGSA/NCGA supra note 124 at 4-5
(cash-settled contracts should have no limits, or at least limits
much greater than the proposed limit, given the different economic
functions of the two classes of contracts).
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BGA, for example, argued that position limits on swaps should be
set based on the size of the open interest in the swaps market because
swap contracts do not provide for physical delivery.\419\ Further,
certain commenters argued that imposing an aggregate speculative limit
on all cash-settled contracts will reduce substantially the cash-
settled positions that a trader can
[[Page 71670]]
hold because, currently, each cash-settled contract is subject to a
separate, individual limit, and there is no aggregate limit.\420\ Other
commenters urged the Commission to eliminate class limits and allow for
netting across futures and swaps contracts so as not to impact
liquidity.\421\
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\419\ CL-BGA supra note 35 at 10.
\420\ See e.g., CL-FIA I supra note 21 at 10; and CL-ICE I supra
note 69 at 6.
\421\ See e.g., CL-ISDA/SIFMA supra note 21 at 8.
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A number of commenters objected to limiting the availability of a
higher limit in the cash-settled contract to traders not holding any
physical-delivery contract.\422\ For example, CME argued that the
proposed conditional limits would encourage price discovery to migrate
to the cash-settled contracts, rendering the physical-delivery contract
``more susceptible to sudden price movements during the critical
expiration period.'' \423\ AIMA commented that the prohibition against
holding positions in the physical-delivery Core Referenced Futures
Contract will cause investors to trade in the physical commodity
markets themselves, resulting in greater price pressure in the physical
commodity.\424\
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\422\ CL-AFIA supra note 94 at 3; CL-AFR supra note 17 at 6; CL-
ATAA supra note 94 at 7; CL-BGA supra note 35 at 11-12; CL-Centaurus
Energy supra note 21 at 3; CL-CME I supra note 8 at 10; CL-WGCEF
supra note 35 at 21-22; and CL-PMAA/NEFI supra note 6 at 14.
\423\ CL-CME I supra note 8 at 10. Similarly, BGA argued that
conditional limits incentivize the migration of price discovery from
the physical contracts to the financial contracts and have the
unintended effect of driving participants from the market, thereby
increasing the potential for market manipulation with a very small
volume of trades. CL-BGA supra note 35 at 12.
\424\ CL-AIMA supra note 35 at 2.
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Some of these commenters, including the CME Group and KCBT,
recommended that cash-settled Referenced Contracts and physical-
delivery contracts be subject to the same position limits.\425\ Two
commenters opined that if the conditional limits are adopted, they
should be greater than five times the 25 percent of deliverable supply
formula.\426\ ICE recommended that they be increased to at least ten
times the 25 percent of deliverable supply.\427\
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\425\ CL-CME I supra note 8 at 10; CL-KCBT I supra note 97 at 4;
and CL-APGA supra note 17 at 6, 8. Specifically, the KCBT argued
that parity should exist in all position limits (including spot-
month limits) between physical-delivery and cash-settled Referenced
Contracts; otherwise, these limits would unfairly advantage the
look-alike cash-settled contracts and result in the cash-settled
contract unduly influencing price discovery. Moreover, the higher
spot-month limit for the financial contract unduly restricts the
physical market's ability to compete for spot-month trading, which
provides additional liquidity to commercial market participants that
roll their positions forward. CL-KCBT I supra note 97 at 4.
\426\ CL-AIMA supra note 35 at 2; and CL-ICE I supra note 69 at
8.
\427\ CL-ICE I supra note 69 at 8. ICE also recommended that the
Commission remove the prohibition on holding a position in the
physical-delivery contract or the duration to a narrower window of
trading than the final three days of trading.
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Several commenters expressed concern that the conditional spot-
month limits would ``restrict the physically-delivered contract
market's ability to compete for spot-month speculative trading
interest,'' thereby restricting liquidity for bona fide hedgers in
those contracts.\428\ Another noted that the limit may be detrimental
to the physically settled contracts because it restricts the ability of
a trader to be in both the physical-delivery and cash-settled
markets.\429\ Conversely, one commenter expressed concern that the
anti-manipulation goal of spot-month position limits would not be met
because the structure of the conditional limit in the Proposed Rule
allowed a trader to be active in both the physical commodity and cash-
settled contracts, and so could use its position in the cash commodity
to manipulate the price of a physically settled contract to benefit a
leveraged cash-settled position.\430\
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\428\ See e.g., CL-KCBT I supra note 97 at 4 ``[T]he higher
spot-month limit for the financial contract unduly restricts the
physical market's ability to compete for spot month speculative
trading interests, which provide additional liquidity to commercial
market participants (bona fide hedgers) as they unwind or roll their
positions forward.'')
\429\ See e.g., CL-Centaurus Energy supra note 21 at 3.
\430\ See e.g., CL-Prof. Pirrong supra note 124.
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With regard to the application of position limits to cash-settled
contracts, the Commission notes that Congress specifically directed the
Commission to impose aggregate spot-month limits on DCM futures
contracts and swaps that are economically equivalent to such contracts.
Therefore, the Commission is required to impose limits on such
contracts. As explained in the proposal, the Commission believes that
``limiting a trader's position at expiration of cash-settled contracts
diminishes the incentive to exert market power to manipulate the cash-
settlement price or index to advantage a trader's position in the cash-
settlement contract.'' Further, absent such limits on related markets,
a trader would have a significant incentive to attempt to manipulate
the physical-delivery market to benefit a large position in the cash-
settled economically equivalent contract.
The Commission is adopting, on an interim final rule basis, spot-
month limits for cash-settled contract, other than natural gas
contracts, at 25 percent of the estimated deliverable supply. These
limits will be in parity with the spot-month limits set for the related
physical-delivery contracts. As discussed in section II.D.3. of this
release, the Commission has determined that the one-to-one ratio for
commodities other than natural gas between the level of spot-month
limits on physical-delivery contracts and the level on cash-settled
contracts maximizes the objectives enumerated in section 4a(a)(3) of
the CEA by ensuring market liquidity for bona fide hedgers, while
deterring the potential for market manipulation, squeezes, and corners.
The Commission further notes that this formula is consistent with the
level the Commission staff has historically deemed acceptable for cash-
settled contracts, as well as the formula for physical-delivery
contracts under Acceptable Practices for Core Principle 5 set forth in
part 38 of the Commission's regulations.
At this time, the Commission's data set does not allow the
Commission to estimate the specific number of traders that could
potentially be impacted by the limits on cash-settled contracts in the
spot-month for agricultural, metals and energy commodities (other than
natural gas). However, given the Commission's understanding of the
overall size of the swaps market in these commodities, the Commission
believes that a one-to-one ratio of position limits for physical-
delivery and cash-settled Referenced Contracts maximizes the four
statutory factors in section 4a(a)(3)(B) of the CEA.
The Commission is also adopting, on an interim final rule basis, an
aggregate spot-month limit for physical-delivery and cash-settled
natural gas contracts, as well as a class limit for cash-settled
natural gas contracts, both set at a level of five times the level of
the spot-month limit in the relevant Core Referenced physical-delivery
natural gas contract.
As discussed in section II.D.3. of this release, the Commission has
determined that the one-to-five ratio between the level of spot-month
limits on physical-delivery natural gas contracts and the level of
spot-month limits on cash-settled natural gas contracts maximizes the
objectives enumerated in section 4a(a)(3) of the CEA by ensuring market
liquidity for bona fide hedgers, while deterring the potential for
market manipulation, squeezes, and corners. The Commission notes that
this formula is consistent with the administrative experience with
conditional limits in DCM and exempt commercial market natural gas
contracts.
As described in section II.D.3. of the release, this aggregate
limit for natural gas contracts responds to commenters'
[[Page 71671]]
concerns regarding potentially negative impacts on liquidity and the
price discovery function of the physical-delivery contract if traders
are not permitted to hold any positions in the physical-delivery
contract when they hold contracts in the cash-settled Referenced
Contract (which are subject to higher limits than the physical-delivery
contracts).
The Commission is also no longer restricting the higher limit for
cash-settled natural gas contracts to entities that hold or control
less than 25 percent of the deliverable supply in the cash commodity.
As pointed out by certain commenters,\431\ this provision would create
significant compliance costs for entities to track whether they meet
such a condition. The Commission believes at this time that the class
and aggregate limits in the spot month for natural gas contracts should
adequately account for market manipulation concerns with regard to
entities with large cash-market positions; however, the Commission will
continue to monitor developments in the market to determine whether to
incorporate a cash-market restriction in the higher cash-settled
contract limit, and the extent of the benefit provided through
restricting cash-market positions.
---------------------------------------------------------------------------
\431\ CL-ISDA/SIFMA supra note 21 at 7.
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The Commission expects that its estimate as to the number of
traders affected by the limits in cash-settled contracts will change as
swap positions are reported to the Commission through its Large Swaps
Trader Reporting and SDR regulations. Given the Commission's limited
data with regard to swaps, the Commission looked to exemptions from
position limits granted by DCMs and ECMs to estimate the number of
traders that may be affected by the finalized limits for cash-settled
contracts. At this time, the only data available pertains to energy
commodities. The Commission estimates that approximately 70 to 75
traders hold exemptions from DCM and ECM limits and therefore at least
this number of traders may be impacted by the spot-month limit for
cash-settled contracts. Until the Commission has accurate information
on the size and composition of off-exchange cash-settled Referenced
Contracts for agricultural, metal, and energy contracts, it is unable
more precisely to determine the number of traders potentially impacted
by the aggregate limit.\432\ As discussed above, by implementing the
one-to-one and one-to-five ratios on an interim basis, the Commission
can further gather and analyze the ratio and its impact on the market.
---------------------------------------------------------------------------
\432\ The Commission notes that it is currently unable to
determine the applicability of bona fide hedge exemptions because of
differences in the revised statutory definition compared to the
current definition applied by DCMs and ECMs. In addition, traders
may net cash-settled contracts for purposes of the class limit in
the spot month. Thus, absent complete data on swaps positions, the
Commission cannot accurately estimate a trader's position for the
purposes of compliance with spot-month limits for cash-settled
contracts.
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The Commission also notes that swap dealers and commercial firms
enter into a significant number of swap transactions that are not
submitted to clearing.\433\ Based on the nature of the commercial
counterparty to such transactions, the Commission anticipates that many
of these transactions involving commercial firm counterparties would
likely be entitled to bona fide hedging exemptions as provided for in
Sec. 151.5, which should limit the number of persons affected by the
spot-month limit in cash-settled contracts without an applicable
exemption.
---------------------------------------------------------------------------
\433\ This observation is based upon Commission staff
discussions with members of industry. See https://www.cftc.gov/LawRegulation/.
---------------------------------------------------------------------------
The Commission also notes that swaps and other over-the-counter
market participants may face additional costs (including foregone
benefits) in terms of adjusting position levels and trading strategies
to the position limits on cash-settled contracts. While current data
precludes estimating the extent of the financial impact to swap market
participants, these costs are inherent in establishing limits that
reach swaps that are economically equivalent to DCM futures contracts,
as required under section 4a(a)(5).
c. Non-Spot-Month Limits
Section 151.4(b) provides that the non-spot-month position limits
for non-legacy Referenced Contracts shall be fixed at a number
determined as a function of the level of open interest in the relevant
Referenced Contract. This formula is defined as 10 percent of the open
interest up to the first 25,000 contracts plus 2.5 percent of open
interest thereafter (``10-2.5 percent formula''). This is the same
formula that has been historically used to set position limits on
futures exchanges.\434\ With regard to the nine legacy agricultural
Core Referenced Futures Contracts, which are currently subject to
Commission imposed non-spot-month position limits, as described in
section II.E.4. of this release, the Commission is raising those
existing position limits to the levels described in the CME petition.
---------------------------------------------------------------------------
\434\ See 17 CFR part 150 (2010).
---------------------------------------------------------------------------
Commenters expressed concern that non-spot-month limits could be
harmful, potentially distorting price discovery or liquidity and
damaging long term hedging strategies.\435\ Others argued that there
should be no limits outside the spot-month or that the Commission had
not adequately justified non-spot-month limits.\436\ One commenter
argued that the proposed non-spot-month class limits would increase
costs for hedgers and harm market liquidity.\437\ Several commenters
opined that the Commission should increase the open interest
multipliers used in determining the non-spot-month position
limits,\438\ while some commenters explained that the Commission should
decrease the open interest multipliers to 5 percent of open interest
for first 25,000 contracts and 2.5 percent thereafter.\439\ Other
commenters suggested significantly different methodologies for setting
limits that would result in relatively more restrictive limits on
speculators.\440\
---------------------------------------------------------------------------
\435\ See e.g., CL-Teucrium supra note 124 at 2; and CL-ICE I
supra note 69 at 6.
\436\ See e.g., CL-WGCEF supra note 35 at 5; and CL-Goldman
supra note 89 at 2.
\437\ See e.g., CL-DBCS supra note 247 at 8-9.
\438\ CL-AIMA supra note at 35 pg. 3; CL-CME I supra note 8 at
12 (for energy and metals); CL-FIA I supra note 21 at 12 (10% of
open interest for first 25,000 contracts and then 5%); CL-ICI supra
note 21 at 10 (10% of open interest until requisite market data is
available); CL-ISDA/SIFMA supra note 21 at 20; CL-NGSA/NCGA supra
note 124 at 5 (25% of open interest); and CL-PIMCO supra note 21 at
11.
\439\ CL-Greenberger supra note 6 at 13; and CL-FWW supra note
81 at 12.
\440\ See e.g., CL-ATA supra note 81 at 4-5; CL-AFR supra note
17 at 5-6; CL-ATAA supra note 94 at 3, 6, 9-10, 12; CL-Better
Markets supra note 37 at 70-71 (recommending the Commission to limit
non-commodity index and commodity index speculative participation in
the market to 30% and 10% of open interest respectively); CL-Delta
supra note 20 atpg.5; and CL-PMAA/NEFI supra note 6 at 7.
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Several commenters recommended that the Commission should keep the
legacy limits for legacy agricultural Referenced Contracts.\441\ One
commenter argued that raising these limits would increase hedging
margins and increase volatility which would ultimately undermine
commodity producers' ability to sell their product to consumers.\442\
Another opined that the Commission need not proceed with phased
implementation for the legacy agricultural markets because it could set
[[Page 71672]]
their limits based on existing legacy limits.\443\
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\441\ CL-ABA supra note 150 at 3-4; CL-AFIA supra note 94 at 3;
CL-Amcot supra note 150 at 2; CL-FWW supra note 81 at 13; CL-IATP
supra note 113 at 5; and CL-NGFA supra note 72 at 1-2.
\442\ CL-ABA supra note 150 at 3-4.
\443\ CL-Amcot supra note 150 at 3.
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Several other commenters recommended that the Commission abandon
the legacy limits.\444\ One commenter argued that the Commission
offered no justification for treating legacy agricultural contracts
differently than other Referenced Contract commodities.\445\ Some of
these commenters endorsed the limits proposed by CME.\446\ Other
commenters recommended the use of the open interest formula proposed by
the Commission in determining the position limits applicable to the
legacy agricultural Referenced Contract markets.\447\ Finally, four
commenters expressed their preference that non-spot position limits be
kept consistent for the wheat Referenced Contracts.\448\
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\444\ CL-AIMA supra note 35 at 4; CL-Bunge supra note 153 at 1-
2; CL-DB supra note 153 at 6; CL-Gresham supra note 153 at 4-5; CL-
FIA I supra note 21 at 12; CL-MGEX supra note 74 at 2; CL-MFA supra
note 21 at 18-19; and USCF supra note 153 at 10-11.
\445\ CL-USCF supra note 153 at 10-11.
\446\ CL-Bunge supra note 153 at 1-2; CL-FIA I supra note 21 at
12; and CL-Gresham supra note 153 at 5. See CME Petition for
Amendment of Commodity Futures Trading Commission Regulation 150.2
(April 6, 2010), available at http//www.cftc.gov/LawRegulation/DoddFrankAct/Rulemaking/DF_26_PosLimits/index.htm.
\447\ CL-CMC supra note 21 at 3; CL-DB supra note 153 at 10; and
CL-MFA supra note 21 at 19.
\448\ CL-CMC supra note 21 at 3; CL-KCBT I supra note 97 at 1-2;
CL-MGEX supra note 74 at 2; and CL-NGFA supra note 72 at 4.
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In addition to the costs associated with generally monitoring
positions in Referenced Contracts on an intraday basis, the Commission
anticipates some costs to result from the establishment of the non-
spot-month position limit, though the Commission expects the resulting
costs should be minimal for most market participants. To determine the
number of potentially affected entities, the Commission took existing
data and calculated the number of traders whose positions would be over
the final non-spot-month limits.\449\ For the majority of participants,
the non-spot-month levels are estimated to impose limits that are
sufficiently high so as to not affect their hedging or speculative
activity; thus, the Commission projects that relatively few market
participants will have to adjust their activities to ensure that their
positions are not in excess of the limits.\450\ According to these
estimates, the position limits in Sec. 151.4(d) would affect, on an
annual basis, eighty traders in agricultural Referenced Contracts,
twenty-five traders in metal Referenced Contracts, and ten traders in
energy Referenced Contracts.\451\
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\449\ The data was based on the Commission's large trader
reporting data for futures contracts and limited swaps data covering
certain cleared swap transactions.
\450\ To illustrate this, the Commission selected examples from
each category of Core Referenced Futures Contracts. In the CBOT Corn
contract (an agricultural Referenced Contract), only approximately
4.8% of reportable traders are estimated to be impacted using the
methods explained above. Using the COMEX Gold contract as an example
of a metal Referenced Contracts, and NYMEX Crude Oil as an example
of an energy Referenced Contract, the Commission estimates only 1.4%
and .2% (respectively) of all reportable traders in those markets
would be impacted by the non-spot-month limit. These estimates
indicate that the number of affected entities is expected to be
small in comparison to the rest of the market.
\451\ These estimates do not take into account open interests
from a significant number of swap transactions, and therefore, the
Commission believes that the size of the non-spot position limit
will increase over this estimate as the Commission is able to
analyse additional data.
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As noted above, the Commission's data on uncleared swaps is
limited. The information currently available to the Commission
indicates that the uncleared swaps market is primarily comprised of
transactions between swap dealers and commercial entities. As such,
some of the above entities that may hold positions in excess of the
non-spot-month limits may be entitled to bona fide hedging exemptions
as provided for in Sec. 150.5. Moreover, the Commission understands
that swap dealers, who constitute a large percentage of those
anticipated to be near or above the position limits set forth in Sec.
151.4, generally use futures contracts to offset the residual portfolio
market risk of their uncleared swaps positions.\452\ Under these final
rules, market participants can net their physical delivery and cash-
settled futures contracts with their swaps transactions for purposes of
complying with the non-spot-month limit. In this regard, the netting of
futures and swaps positions for such swap dealers would reduce their
exposure to an applicable position limit.
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\452\ The estimated monetary costs associated with claiming a
bona fide hedge exemption are discussed below in consideration of
the costs and benefits for bona fide hedging as well as in the
Paperwork Reduction Act section of this final rule.
---------------------------------------------------------------------------
Taking these considerations into account, the Commission
anticipates that for the majority of participants, the non-spot month
levels are estimated to impose limits that are sufficiently high so as
to not affect their hedging or speculative activity as these
participants could either rely on a bona fide hedge exemption or hold a
net position that is under the limit. Thus, the Commission projects
that relatively few market participants will have to adjust their
activities to ensure that their positions are not in excess of the
limits.
The economic costs (or foregone benefits) of the level of position
limits is difficult to determine accurately or quantify because, for
example, some participants may be eligible for bona fide hedging or
other exemptions from limits, and thus incur the costs associated with
filing exemption paperwork, while others may incur the costs associated
with altering their business strategies to ensure that their aggregate
positions do not exceed the limits. In the absence of data on the
extent to which the bona fide hedge exemption will apply to swaps
transactions, at this time the Commission cannot determine or estimate
the number of entities that will be eligible for such an exemption.
Accordingly, the Commission cannot determine or estimate the total
costs industry-wide of filing for the exemption.\453\
---------------------------------------------------------------------------
\453\ As previously noted, the costs to an individual firm of
filing an exemption are estimated at section III.A.3.
---------------------------------------------------------------------------
Similarly, the Commission is unable to determine or estimate the
number of entities that may need to alter their business
strategies.\454\ Commenters did not provide any quantitative data as to
such potential impacts from the proposed limits, and the Commission
cannot independently evaluate the potential costs to market
participants of such changes in strategies, which would necessarily be
based on the underlying business models and strategies of the various
market participants.
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\454\ The Commission notes that under the pre-existing positions
exemption, a trader would not be in violation of a position limits
based solely upon the trader's pre-existing positions in Referenced
Contracts. Further, swaps entered before the effective date of the
Dodd-Frank Act will not count toward a speculative limit, unless the
trader elects to net such swaps positions to reduce their aggregate
position.
---------------------------------------------------------------------------
While the Commission is unable to quantify the resulting costs to
the relatively few number of market participants that the Commission
estimates may be affected by these limits; to a certain extent costs
associated with a change in business or trading strategies to comply
with the non-spot-month position limits imposed by the Commission are a
consequence of the Congressionally-imposed mandate for the Commission
to establish such limits. Commenters suggesting that the Commission
should not adopt non-spot-month position limits fail to address the
mandate of Congress in CEA section 4a(a)(3)(A) that the Commission
impose non-spot-month limits. Based on the Commission's long-standing
experience with the application of the 10--2.5 percent formula to
establish non-spot-month limits in the futures market as
[[Page 71673]]
well as the Commission's limited swaps data, the Commission anticipates
that the application of this similar formula to both the futures and
swaps market will appropriately maximize the statutory objectives in
section 4a(a)(3). The data regarding the swaps market that is currently
available to the Commission indicates that a limited number of market
participants will be at or near the speculative position limits and
that the imposition of these limits should not result in a significant
decrease in liquidity in these markets. Accordingly, the Commission
believes that non-spot-month limits imposed as a result of these final
rules will ensure there continues to be sufficient liquidity for bona
fide hedgers and the price discovery of the underlying market will not
be disrupted.
The Commission has determined to adopt the position limit levels
proposed by the CME for the legacy Referenced Contracts. Such levels
would be effective 60 days after the publication date of this
rulemaking and those levels would be subject to the existing provisions
of current part 150 until the compliance date of these rules, which is
60 days after the Commission further defines the term ``swap'' under
the Dodd-Frank Act. At that point, the relevant provisions of this part
151, including those relating to bona-fide hedging and account
aggregation, would also apply. In the Commission's judgment, the CME
proposal represents a measured approach to increasing legacy limits,
similar to that previously implemented.\455\ The Commission will use
the CME's all-months-combined petition levels as the basis to increase
the levels of the non-spot-month limits for legacy Referenced
Contracts. The petition levels were based on 2009 average month-end
open interest. Adoption of the petition levels results in increases in
limit levels that range from 23 to 85 percent higher than the levels in
existing Sec. 150.2.
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\455\ 58 FR 18057, April 7, 1993.
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The Commission has determined to maintain the current approach to
setting and resetting legacy limits because it is consistent with the
Commission's historical approach to setting such limits and ensures the
continuation of maintaining a parity of limit levels for the major
wheat contracts at DCMs. In response to comments supporting this
approach, the Commission will also increase the levels of the limits on
wheat at the MGEX and the KCBT to the level for the wheat contract at
the CBOT.\456\
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\456\ For a discussion of the historical approach, see 64 FR
24038, 24039, May 5, 1999.
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d. Position Visibility
As discussed in II.L. of this release, the Commission is adopting
position visibility levels as a supplement to position limits. These
levels will provide the Commission with the ability to conduct
surveillance of market participants with large positions in the energy
and metal Reference Contracts.\457\ As discussed in the Paperwork
Reduction Act section of these final rules, the Commission increased
the position visibility levels and reduced the reporting requirements
in order to decrease the compliance costs associated with position
visibility levels.
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\457\ As discussed in section II.L of this release, the
Commission is not extending position visibility reporting to
agricultural contracts because the Commission believes that
reporting related to bona fide hedging and other exemptions should
provide the Commission with sufficient data on the largest traders
in agricultural Referenced Contracts.
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Commenters generally stated that the position visibility
requirements are unnecessary, redundant, burdensome, and overly
restrictive.\458\ While some commenters acknowledged the usefulness of
the data collected through position visibility requirements, they
maintained the burden associated with complying with these requirements
was too great.\459\ One commenter noted that it is too costly to
require monthly visibility reporting; another suggested these
compliance costs would most affect bona fide hedgers because of the
extra information required of those claiming a bona fide hedging
exemption.\460\ Another commenter noted that position visibility
requirements may prove duplicative once the Commission can evaluate
data received from swaps dealers and major swaps participants, DCOs,
SEFs and SDRs.\461\
---------------------------------------------------------------------------
\458\ See e.g., CL-BGA supra note 35 at 19-20; CL-CME I supra
note 8 at 6; CL-WGCEF supra note 35 at 23; and CL-MFA supra note 21
at 3.
\459\ See e.g., CL-USCF supra note 153 at 11.
\460\ See e.g., CL-USCF supra note 153 at 11; and CL-WGCEF supra
note 35 at 22-23.
\461\ CL-FIA I supra note 21, at 13.
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The comments that suggested semi-annual reporting or no reporting
at all, instead of monthly reporting, have not been adopted because of
the surveillance utility afforded by the visibility reporting. The
Commission notes that once an affected person adopts processes to
comply with the standard reporting format, visibility reporting may
result in a lesser burden when compared to the alternative of frequent
production of books and records under special calls. With regard to
frequency, reporting that is too infrequent may undermine the
effectiveness of the Commission's surveillance efforts, as one goal of
reporting under position visibility levels is to provide the Commission
with timely and accurate data regarding the current positions of a
market's largest traders in order to detect and deter manipulative
behavior. The Commission notes that until SDRs are operational and the
Commission's large trader reporting for physical commodity swaps are
fully implemented, the Commission would not have access to the data
necessary to have a holistic view of the marketplace and to set
appropriate position limit levels.
To further mitigate costs on reporting entities, the Commission has
determined to reduce the filing burden associated with position
visibility to one filing per trader per calendar quarter, as opposed to
a monthly filing. This reduced reporting is not anticipated to
significantly impact the overall surveillance benefit provided through
the position visibility reporting. However, if the large position
holders subject to position visibility reporting requirements were to
submit reports any less often, then the reports would not provide
sufficiently regular information for the Commission to be able to
determine the nature (hedging or speculative) of the largest positions
in the market. This data should assist the Commission in its required
report to Congress regarding implementation of position limits,\462\
and in ongoing assessment of the appropriateness of the levels of such
limits.
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\462\ See section 719 of the Dodd-Frank Act.
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The Commission has also raised the visibility levels to
approximately 50 to 60 percent of the projected aggregate position
limits for the Reference Contract (from 10 to 30 percent of the limit
in the Proposed Rule), with the exception of the Light, Sweet Crude Oil
(CL) and Henry Hub Natural Gas (NG) Referenced Contracts, for which
these levels have been raised from the proposal but are still lower
than 50 to 60 percent of projected aggregate position limits in order
to capture a target number of traders.\463\ Based on the Commission's
current data regarding futures and certain cleared swap transactions,
the higher visibility levels as compared to the Proposed Rule will
reduce the number of traders (including bona fide hedgers) subject to
the reporting requirements, while still providing the Commission
sufficient data on the positions of the largest traders in the
respective Referenced Contract.
---------------------------------------------------------------------------
\463\ See Sec. 151.6.
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The Commission estimates that, on an annual basis, at most 73
traders would
[[Page 71674]]
be subject to position visibility reporting requirements. As discussed
in the PRA section of this release, the Commission estimates the costs
of compliance to be a total burden, across all of these entities, of
7,760 annual labor hours resulting in a total of $611,000 in annual
labor costs and $7 million in annualized capital and start-up costs and
annual total operating and maintenance costs.
The Commission estimates that 25 of the traders affected by
position visibility regulations would be bona fide hedgers.
Specifically with regard to bona fide hedgers, the Commission estimates
compliance costs for position visibility reporting to be a total
burden, across all bona fide hedgers, of 2,000 total annual labor hours
resulting in a total of $157,200 in annual labor costs and $1.625
million in annualized capital and start-up costs and annual total
operating and maintenance costs. The Commission notes that these
estimated costs for bona fide hedgers are a subset of, and not in
addition to, the costs for all participants combined enumerated above.
The information gained from position visibility levels provides
essential transparency to the Commission as a means of preventing
potentially manipulative behavior. In the Commission's judgment, such
data is a critical component of an effective position limit regime as
it will help to maximize to the extent practicable the statutory
objectives of preventing excessive speculation and manipulation, while
ensuring sufficient liquidity for bona fide hedgers and protecting the
price discovery function of the underlying market. It allows the
Commission to monitor the positions of the largest traders and the
effects of those positions in the affected markets. While the extent of
these benefits is not readily quantifiable, the ability to better
understand the balance in the market between speculative and non-
speculative positions is critical to the Commission's ability to
monitor the effectiveness of position limits and potentially
recalibrate the levels in order to ensure the limits sufficiently
address the statutory objectives that the Commission must consider and
maximize in establishing appropriate position limits. In this way,
position visibility levels are not unlike position accountability
levels that are currently utilized for many DCM contracts. Finally, as
discussed under section II.C.2. of this release, position visibility
reporting will enable the Commission to address data gaps that will
exist prior to the availability of comprehensive data from SDRs.
e. DCMs and SEFs
Pursuant to Core Principle 5(B) for DCMs and Core Principle 6(B)
for SEFs that are trading facilities, such registered entities are
required to establish position limits ``[f]or any contract that is
subject to a position limitation established by the Commission pursuant
to section 4a(a).'' The core principles require that these levels be
set ``at a level not higher than the position limitation established by
the Commission.'' As such, the final rules require DCMs and SEFs to set
position limits on the 28 physical commodity Referenced Contracts
traded or executed on such DCMs and SEFs.
Under the proposal, DCMs and SEFs would have been required to
implement a position limit regime for all physical commodity contracts
executed on their facility. This proposal would effectively create a
class limit for the trading facility's contracts. Because the
Commission determined to eliminate class limits outside of the spot-
month for the 28 contracts subject to Commission limits, the Commission
has determined not to adopt the proposed requirements that would have
effectively created class limits for a particular trading venue.
Accordingly, the final rules permit the trading facility to grant
spread or arbitrage exemptions regardless of the trading facility or
market in which such positions are held. To remain consistent with the
Commission's class limits within the spot-month, DCMs and SEFs cannot
grant spread or arbitrage exemptions with regard to physical-delivery
commodity contracts. These provisions allow DCMs and SEFs to comply
with the core principles for contracts subject to Commission position
limits without creating an incentive for traders to migrate their
speculative positions off of the trading facility to avoid the SEF or
DCM limit.\464\
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\464\ For example, traders could utilize swaps not traded on a
DCM or SEF.
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The Commission notes that the establishment of Federal limits on
the 28 Core Referenced Futures Contracts should not significantly
affect the compliance costs for DCMs because they currently impose
spot-month limits for physical commodity contracts in compliance with
existing Core Principle 5.\465\ DCMs in particular have long enforced
spot-month limits, and the Commission notes that such spot-month
position limits are currently in place for all physical-delivery
physical commodity futures under Core Principle 5 of section 5(d) of
the CEA. The final rule on physical-delivery spot-month limits should
impose minimal, if any, additional compliance costs on DCMs.
---------------------------------------------------------------------------
\465\ The Commission has further provided for acceptable
practices for DCMs and SEFs seeking compliance with their respective
position limit and accountability-related Core Principles in other
commodity contracts.
---------------------------------------------------------------------------
As outlined above in this section III.A.3, the Commission believes
that the position limits finalized herein will likely cause relevant
DCMs, SEFs, and market participants to incur various additional costs
(or forego benefits). At this time, the Commission is unable to
quantify the cost of such changes because the effect of this
determination will vary per market and because the requirements
applicable to SEFs extend to swaps, which heretofore were generally not
subject to federally-set position limits. The Commission also notes
that to a certain extent these costs are a consequence of the statutory
requirement for DCMs and SEFs to set and administer position limits on
contracts that have Federal position limits in accordance with the Core
Principles applicable to such facilities.
For the remaining physical commodity contracts executed on a DCM or
SEF that is a trading facility, i.e., those contracts which are not
Referenced Contracts, DCMs and SEFs are required to comply with new
Core Principle 5 for DCMs and Core Principle 6 for SEFs in establishing
position limitations or position accountability levels. The costs
resulting from this requirement also are a consequence of the statutory
provision requiring DCMs and SEFs to set and administer position limits
or accountability levels.
f. CEA Section 15(a) Considerations: Position Limits
As stated above, section 15(a) of the CEA requires the Commission
to consider the costs and benefits of its actions 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; (4) sound
risk management practices; and (5) other public interest
considerations.
i. Protection of Market Participants and the Public
Congress has determined that excessive speculation 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.'' Further, Congress directed that for the
purpose of ``diminishing, eliminating, or preventing such burden,'' the
[[Page 71675]]
Commission ``shall * * * proclaim and fix such [position] limits * * *
as the Commission finds are necessary to diminish, eliminate, or
prevent such burden.'' \466\ This rulemaking responds to the
Congressional mandate for the Commission to impose position limits both
within and outside of the spot-month on DCM futures and economically
equivalent swaps.
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\466\ Section 4a(a)(1) of the CEA, 7 U.S.C. 6a(a)(1).
---------------------------------------------------------------------------
The Congressional mandate also directed that the Commission set
limits, to the maximum extent practicable, in its discretion, to
diminish, eliminate or prevent excessive speculation, deter or prevent
market manipulation, ensure sufficient liquidity for bona fide hedgers,
and ensure that the price discovery function of the underlying market
is not disrupted.\467\ To that end, the Commission evaluated its
historical experience setting limits and overseeing DCMs that
administer limits, reviewed available futures and swaps data, and
considered comments from the public in order to establish limits that
address, to the maximum extent practicable within the Commission's
discretion, the above mentioned statutory objectives.
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\467\ See section 4a(a)(3)(B) of the CEA, 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------
The spot-month limit, set at 25% of deliverable supply, retains
current practice in setting spot-month position limits, and in the
Commission's experience this formula is effective in diminishing the
potential for manipulative behavior and excessive speculation within
the spot-month. As evidenced by the limited number of traders that may
need to adjust their trading strategies to account for the limits, the
Commission does not believe that this formula will impose an overly
stringent constraint on speculative activity; and therefore, should
ensure sufficient liquidity for bona fide hedgers and that the price
discovery function of the underlying market is not disrupted. In
addition, continuing the practice of registered entity spot-month
position limits should serve to more effectively monitor trading to
prevent manipulation and in turn protect market participants and the
price discovery process.
With regard to the interim final rules for cash-settled contracts
in the spot-month, as previously explained the Commission believes that
the level of five times the applicable limit for the physical-delivery
natural gas contracts should protect market participants through
maximizing, to the extent practicable, the objectives set forth by
Congress in CEA section 4a(a)(3)(B). In addition, based upon the
Commission's limited swaps data, the limits on cash-settled
agricultural, metals, and energy (other than natural gas) contracts
should ensure sufficient liquidity for bona fide hedgers and avoid
disruption to price discovery in the underlying market due to the
overall size of the swap market in those commodities. Nevertheless, the
Commission intends to monitor trading activity under the new limits to
determine the effect on market liquidity of these limits and whether
the limits should be modified to further maximize the four statutory
objectives set forth in CEA section 4a(a)(3)(B). The Commission also
invites public comment as to these determinations.
With regard to the non-spot-month position limits, which are set at
a percentage of open interest, the Commission believes such limits will
also protect market participants and the public through maximization,
to the extent practicable, the four objectives set forth in CEA section
4a(a)(3)(B). The Commission selected the general 10-2.5% formula for
calculating position limits as a percentage of market open interest
based on the Commission's longstanding experience overseeing DCM
position limits outside of the spot-month, which are based on the same
formula. Further, as evidenced by the relatively few traders that the
Commission estimates would hold positions in excess of such levels, the
relatively small percentage of total open interest these traders would
hold in excess of these limits, and that many large traders are
expected to be bona fide hedgers; the Commission concludes that these
limits should protect the public through ensuring sufficient liquidity
for bona fide hedgers and protecting the price discovery function of
the underlying market.
Finally, the position visibility levels established in these final
rules should protect market participants by giving the Commission data
to monitor the largest traders in Referenced metal and energy
contracts. The data reported under position visibility levels will help
the Commission in considering whether to reset position limits to
maximize further the four statutory objectives in section 4a(a)(3(B) of
the CEA. Further, monitoring the largest traders in these markets
should provide the Commission with data that may help prevent or detect
potentially manipulative behavior.
ii. Efficiency, Competiveness, and Financial Integrity of Futures
Markets
The Federal spot-month and non-spot-month formulas adopted under
the final rules are designed, in accordance with CEA section
4a(a)(3)(B),to deter and prevent manipulative behavior and excessive
speculation, while also maintaining sufficient liquidity for hedging
and protecting the price discovery process. To the extent that the
position limit formulas achieve these objectives, the final rules
should protect the efficiency, competitiveness, and financial integrity
of futures markets.
iii. Price Discovery
Based on its historical experience, the Commission believes that
adopting formulas for position limits that are based on formulas that
have historically been used by the Commission and DCMs to establish
position limits maximizes the extent practicable, at this time, the
four statutory objectives set forth by Congress in CEA section
4a(a)(3). Based on its prior experience with these limits, the
Commission believes that the price discovery function of the underlying
market will not be disrupted. Similarly, as effective price discovery
relies on the accuracy of prices in futures markets, and to the extent
that the position limits described herein protect prices from market
manipulation and excessive speculation, the final rules should protect
the price discovery function of futures markets.
iv. Sound Risk Management Practices
To the extent that these position limits prevent any market
participant from holding large positions that could cause unwarranted
price fluctuations in a particular market, facilitate manipulation, or
disrupt the price discovery process, such limits serve to prevent
market participants from holding positions that present risks to the
overall market and the particular market participant as well. To this
extent, requiring market participants to ensure that they do not
accumulate positions that, when traded, could be disruptive to the
overall market--and hence themselves as well--promotes sound risk
management practices by market participants.
v. Public Interest Considerations
The Commission has not identified any other public interest
considerations related to the costs and benefits of the rules
establishing limits on positions.
5. Exemptions: Bona Fide Hedging
As discussed section II.G. of this release, the Dodd-Frank Act
provided a definition of bona fide hedging for futures contracts that
is more narrow than the Commission's existing definition under
regulation Sec. 1.3(z). Pursuant to sections 4a(c)(1) and (2) of the
CEA, the Commission incorporated the narrowed definition of bona fide
[[Page 71676]]
hedging into the Proposed Rules, and incorporates this definition into
these final rules. The Commission also limited bona fide hedging
transactions to those specifically enumerated transactions and pass-
through swap transactions set forth in final Sec. 151.5. In response
to commenters' inquiries over whether certain transactions qualified as
an enumerated hedge transaction, the Commission expanded the list of
enumerated hedge transactions eligible for the bona fide hedging
exemption, and also gave examples of enumerated hedge transactions in
appendix B to this release.\468\
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\468\ This appendix provides examples of transactions that would
qualify as an enumerated hedge transaction; the enumerated examples
do not represent the only transactions that could qualify.
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Pursuant to CEA section 4a(c)(1), the Commission also proposed to
extend the definition of bona fide hedging transactions to all
referenced contracts, including swaps transactions. The Commission is
adopting the definition of bona fide hedging as proposed. The
Commission believes that applying the statutory definition of bona fide
hedging to swaps is consistent with congressional intent as embodied in
the expansion of the Commission's authority to swaps (i.e., those that
are economically-equivalent and SPDFs). In granting the Commission
authority over such swaps, Congress recognized that such swaps warrant
similar treatment to their economically equivalent futures for purposes
of position limits and therefore, intended that statutory definition of
bona fide hedging also be extended to swaps.\469\
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\469\ The Commission notes that the impact of the definition of
bona fide hedging for both futures and swaps will vary depending of
the positions of each entity. Due to this variability among
potentially affected entities, the specifics of which are not known
to the Commission, and cannot be reasonably ascertained, the
Commission cannot reasonably quantify the impact of applying the
same definition of bona fide hedging for swaps and futures
transactions.
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The Commission also established a reporting and recordkeeping
regime for bona fide hedge exemptions. Under the proposal, a trader
with positions in excess of the applicable position limit would be
required to file daily reports to the Commission regarding any claimed
bona fide hedge transactions. In addition, all traders would be
required to maintain records related to bona fide hedging exemptions,
including the exemption for ``pass-through'' swaps. In response to
comments, the Commission has reduced the reporting frequency from daily
to monthly, and streamlined the recordkeeping requirements for pass-
through swap counterparties. These modifications should permit the
Commission to retain its surveillance capabilities to ensure the proper
application of the bona fide hedge exemption as defined in the statute,
while addressing commenters' concerns regarding costs.
Commenters argued that the definition of bona fide hedging, as
proposed, was too narrow and, if applied, would reduce liquidity in
affected markets.\470\ These commenters suggested that the list of
enumerated transactions did not adequately take into account all
possible hedging transactions.\471\ The lack of a broad risk management
exemption also caused concerns among some commenters, who noted that
the cost of reclassifying transactions would be significant and could
induce companies to do business in other markets.\472\ Other commenters
expressed concerns regarding the pass-through exemption for swap
dealers whose counterparties are bona fide hedgers, suggesting that the
provision implied bona fide hedgers must manage the hedging status of
their transactions and report them to the swap dealer, thus burdening
the hedger in favor of the swap dealer.\473\ Some commenters suggested
that the Commission develop a method for exempting liquidity providers
in order to retain the valuable services such participants
provide.\474\ One commenter urged the Commission to remove limit
exemptions for index fund investors in agricultural markets in order to
decrease volatility and allow for true price discovery.\475\ Another
commenter requested that the Commission allow categorical exemptions
for trade associations to reduce the burden on smaller entities.\476\
---------------------------------------------------------------------------
\470\ See e.g., CL-Gavilon supra note 276 at 6; CL-FIA I supra
note 21 at 14-15.
\471\ See e.g., CL-Commercial Alliance I supra note 42 at 2; CL-
FIA I supra note 21 at 14; and CL-Economists Inc. supra note 172 at
19.
\472\ See e.g., CL-Gavilon supra note 276 at 6.
\473\ CL-BGA supra note 35 at 17.
\474\ See e.g., CL-FIA I supra note 21 at 17-18; and CL-Katten
supra note 21 at 2-3.
\475\ CL-ABA supra note 150 at 6.
\476\ CL-NREC/AAPP/ALLPC supra note 266 at 27.
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Many commenters argued that the reporting requirements were overly
burdensome and requested monthly reporting of bona fide hedging
activity as opposed to the daily reporting that would be required by
the Proposed Rule.\477\ The commenters also criticized proposed
restrictions on holding a hedge into the last five days of
trading.\478\ Some commenters on anticipatory hedging exemptions noted
the proposed one year limitation on anticipatory hedging was biased
toward agricultural products and did not take into account the
different structure of other markets.\479\ One commenter noted that the
requirement to obtain approval for anticipatory hedge exemptions at a
time close to when the position may exceed the limit is
burdensome.\480\
---------------------------------------------------------------------------
\477\ See e.g., CL-API supra note 21 at 10; CL-Encana supra note
145 at 3; CL-FIA I supra note 21 at 21; CL-WGCEF supra note 35 at
14-15; CL-ICE I supra note 69 at 11-12; CL-COPE supra note 21 at 12;
CL-EEI/ESPA supra note 21 at 6-7.
\478\ See e.g., CL-FIA I supra note 21 at 16; and CL-ISDA/SIFMA
supra note 21 at 11.
\479\ See e.g., CL-Economists, Inc. supra note 172 at 20-21.
\480\ See e.g., CL-AGA supra note 124 at 7.
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The Commission is implementing the statutory directive to define
bona fide hedging for futures contracts as provided in CEA section
4a(c)(2). In this respect, the Commission does not have the discretion
to disregard a directive from Congress concerning the narrowed scope of
the definition of bona fide hedging transactions.\481\ Thus, for
example, as discussed in section II.G. of this release, the final rules
do not provide for risk management exemptions, given that the statutory
definition of bona fide hedging generally excludes the application of a
risk management exemption for entities that generally manage the
exposure of their swap portfolio.\482\ As discussed above, the
Commission is authorized to define bona fide hedging for swaps and in
this regard, may construe bona fide hedging to include risk management
transactions. The Commission, however, does not believe that including
a risk management provision is necessary or appropriate given that the
elimination of the class limits outside of the spot-month will allow
entities, including swap dealers, to net Referenced Contracts whether
futures or economically equivalent swaps.\483\ As such, under the final
rules, positions in
[[Page 71677]]
Referenced Contracts entered to reduce the general risk of a swap
portfolio will be netted with the positions in the portfolio outside of
the spot-month.\484\
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\481\ Some commenters suggested that the Commission should use
its exemptive authority in section 4a(a)(7) of the CEA, 7 U.S.C.
6a(a)(7), to expand the definition of bona fide hedging to include
certain transactions; however, the Commission cannot use its
exemptive authority to reshape the statutory definition provided in
section 4a(c)(2) of the CEA, 7 U.S.C. 6a(c)(2).
\482\ As discussed in II.G.1, the plain text of the new
statutory definition directs the Commission to define bona fide
hedging for futures contracts to include hedging for physical
commodities (other than excluded commodities derivatives) only if
such transactions or positions represent substitutes for cash market
transactions and offset cash market risks. This definition excludes
hedges of general swap position risk (i.e., a risk-management
exemption), but does include a limited exception for pass-through
swaps.
\483\ The removal of class limits should also generally mitigate
the impact of not having a risk management exemption across futures
and swaps because affected traders can net risk-reducing positions
in the same Referenced Contract outside of the spot-month.
\484\ The statutory definition of bona fide hedging does not
include a risk management exemption for futures contracts. The
impact of not having a risk-management exemption will vary depending
on the positions of each entity, and the extent of mitigation
through netting futures and swaps outside of the spot-month will
also vary depending on the positions of each entity. Due to this
variability among potentially affected entities, the specifics of
which are not known to the Commission, and cannot be reasonably
ascertained, the Commission cannot reasonably quantify the impact of
not incorporating a risk-management exemption within the definition
of bona fide hedging. Further, as noted above, the Commission is
currently unable to quantify the cost that a firm may incur as a
result of position limits impacting trading strategies.
---------------------------------------------------------------------------
The Commission estimates that there may be significant costs (or
foregone benefits) associated with the implementation of the new
statutory definition of bona fide hedging to the extent that the
restricted definition of bona fide hedging may require traders to
potentially adjust their trading strategies. Additionally, there may be
costs associated with the application of the narrowed bona fide hedging
definition to swaps. The Commission anticipates that certain firms may
need to adjust their trading and hedging strategies to ensure that
their aggregate positions do not exceed position limits. As previously
noted, however, the Commission is unable to estimate the costs to
market participants from such adjustments in trading and hedging
strategies. Commenters did not provide any quantitative data as to such
potential impacts from the proposed limits and the Commission does not
have access to any such business strategies of market participants;
thus, the Commission cannot independently evaluate the potential costs
to market participants of such changes in strategies.
In light of the requests from commenters for clarity on whether
specific transactions qualified as bona fide hedge transactions, the
Commission developed Appendix B to these Final Rules to detail certain
examples of bona fide hedge transactions provided by commenters that
the Commission believes represent legitimate hedging activity as
defined by the revised statute.\485\
---------------------------------------------------------------------------
\485\ See II.G.1. of this release.
---------------------------------------------------------------------------
As described further in the PRA section, the Commission estimates
the costs of bona fide hedging-related reporting requirements will
affect approximately 200 entities annually and result in a total burden
of approximately $29.8 million across all of these entities, including
29,700 annual labor hours resulting in a total of $2.3 million in
annual labor costs and $27.5 million in annualized capital and start-up
costs and annual total operating and maintenance costs. These estimated
costs amount to approximately $149,000 per entity. The reduction in the
frequency of reporting from daily in the proposal to monthly in the
final rule will decrease the burden on bona fide hedgers while still
providing the Commission with adequate data to ensure the proper
application of the statutory definition of bona fide hedging
transaction. Further, the advance application required for an
anticipatory exemption has also been changed to a notice filing, which
should also decrease costs for bona fide hedgers as such entities can
rely on the exemption and implement hedging strategies upon filing the
notice as opposed to incurring a delay while awaiting the Commission to
respond to the application.
The Commission has also eliminated restrictions on maintaining
certain types of bona fide hedges (e.g., anticipatory hedges) in the
last five days of trading for all cash-settled Referenced Contracts.
The Commission will maintain this general restriction for physically-
delivered Referenced Contracts. However, the Commission is clarifying
the time period for these restrictions in the physical delivery
contracts, distinguishing the agricultural physical-delivery contacts
from the non-agricultural physical delivery contracts. The Commission
will retain the proposed restrictions for the last five days of trading
in agricultural physical-delivery Referenced Contracts, while non-
agricultural physical delivery Referenced Contracts will be subject to
a prohibition that applies to holding the hedge into the spot month.
The Commission has removed these restrictions in cash settled contracts
in order to avoid, for example, requiring a trader with an anticipatory
hedge exemption either to apply for a hedge exemption based on newly
produced inventories (i.e., the hedge no longer being anticipatory) or
to roll before the spot period restriction. The restriction on holding
an anticipatory hedge into the last days of trading on a physical-
delivery contract mitigates concerns that liquidation of a very large
bona fide hedging position would have a negative impact on a physical-
delivery contract during the last few days since such an anticipatory
hedger neither intended to make nor take delivery and, thus, would
liquidate a large position at a time of reduced trading activity,
impacting orderly trading in the contracts. Such concerns generally are
not present in cash-settled contracts, since a trader has no need to
liquidate to avoid delivery. The Commission believes that permitting
the maintenance of such hedges in cash settled contracts will not
negatively affect the integrity of these markets.
Also in response to commenters, the one-year limitation on
anticipatory hedging has been amended in the final rules to apply only
to agricultural markets; the limitation has been lifted on energy and
metal markets, in recognition of the differences in the characteristics
of the markets for different commodities, such as the annual crop cycle
for agricultural commodities, that are not present in energy and metal
commodities.
a. CEA Section 15(a) Considerations: Bona Fide Hedging
Congress established the definition of bona fide hedge transaction
for contracts of future delivery in CEA section 4a(c)(2), and the
Commission incorporated this definition into the final rules. As
described in section II.G. of this release and in the consideration of
costs and benefits, Congress limited the scope of bona fide hedging
transactions to those tied to a physical marketing channel.\486\ The
Commission believes the enumerated hedges provide an appropriate scope
of exemptions for market participants, consistent with the statutory
directive for the Commission to define bona fide hedging transactions
and positions.
---------------------------------------------------------------------------
\486\ For the reasons discussed above in this section III.A.4.,
the Commission is defining bona fide hedging for swaps to replicate
the statutory definition for futures contracts.
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i. Protection of Market Participants and the Public
The Commission's filing and recordkeeping requirements for bona
fide hedging activity are intended to enhance the Commission's ability
to monitor bona fide hedging activities, and in particular, to
ascertain whether large positions in excess of an applicable position
limit reflect bona fide hedging and thus are exempt from position
limits. The Commission anticipates that the filing and recordkeeping
provisions will impose costs on entities. However, the Commission
believes that these costs provide the benefit of ensuring that the
Commission has access to information to determine whether positions in
excess of a position limit relate to bona fide hedging or speculative
activity. To reduce the compliance burden on bona fide hedgers, the
Commission has reduced the reporting frequency from daily to monthly.
As a necessary
[[Page 71678]]
component of an effective position limits regime, the Commission
believes that the requirements related to bona fide hedging will
protect participants and the public.
ii. Efficiency, Competitiveness, and Financial Integrity of Futures
Markets
In CEA section 4a, as amended by the Dodd-Frank Act, Congress
explicitly exempted those market participants with legitimate bona fide
hedge positions from position limits. In implementing this definition,
the final rules' position limits will not constrict the ability for
hedgers to mitigate risk--a fundamental function of futures markets. In
addition, as previously noted, the Commission has set these position
limits at levels that will, in the Commission's judgment, to the
maximum extent practicable at this time, meet the objectives set forth
in CEA section 4a(a)(3)(B), which includes ensuring sufficient
liquidity for bona fide hedgers. In maximizing these objectives, the
Commission believes that such limits will preserve the efficiency,
competitiveness, and financial integrity of futures markets. Similarly,
the filing and recordkeeping requirements should help to ensure the
proper application of the bona fide hedge exemption.
However, Congress also narrowed the definition of what the
Commission could consider to be a bona fide hedge for contracts as
compared to the Commission's definition in regulation 1.3(z). The
Commission has attempted to mitigate concerns regarding any potential
negative impact to the efficiency of futures markets based upon the new
statutory definition. For instance, the Commission has expanded the
list of enumerated hedging transactions to clarify the application of
the statutory definition.\487\ In addition, the Commission has removed
the application of class limits outside of the spot-month, which should
mitigate the impact of narrowing the bona fide hedge exemption, since
positions taken in the futures market to hedge the risk from a position
established in the swaps market (or vice versa) can be netted for the
purpose of calculating whether such positions are in excess of any
applicable position limits. In light of these considerations, the
Commission anticipates that the Commission's implementation of the
statutory definition of bona fide hedging will not negatively affect
the competitiveness or efficiency of the futures markets.
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\487\ As described in earlier sections and as found in Appendix
B of these rules.
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iii. Price Discovery
As discussed above, the Commission is implementing the new
statutory definition of bona fide hedging. Based on its historical
experience with position limits at the levels similar to those
established in the final rules, and in light of the measures taken to
mitigate the effects of the narrowed statutory definition of bona fide
hedging, the Commission does not anticipate the rules relating to the
bona fide hedge exemption will disrupt the price discovery process.
iv. Sound Risk Management Practices
While the bona fide hedging requirements will cause market
participants to monitor their physical commodity positions to track
compliance with limits, the bona fide hedging requirements do not
necessarily affect how a firm establishes and implements sound risk
management practices.
v. Public Interest Considerations
The Commission has not identified any other public interest
considerations related to the costs and benefits of the rules with
respect to bona fide hedging.
6. Aggregation of Accounts
The final regulations, as adopted, largely clarify existing
Commission aggregation standards under part 150 of the Commission's
regulations. As discussed in section II.H. of this release, the
Commission proposed to significantly alter the current aggregation
rules and exemptions. Specifically, proposed part 151 would eliminate
the independent account controller (IAC) exemption under current Sec.
150.3(a)(4), restrict many of the disaggregation provisions currently
available under Sec. 150.4 and create a new owned-financial entity
exemption. The proposal would also require a trader to aggregate
positions in multiple accounts or pools, including passively managed
index funds, if those accounts or pools have identical trading
strategies. Lastly, disaggregation exemptions would no longer be
available on a self-executing basis; rather, an entity seeking an
exemption from aggregation would need to apply to the Commission, with
the relief being effective only upon Commission approval.\488\
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\488\ The Commission did not propose any substantive changes to
existing Sec. 150.4(d), which allows an FCM to disaggregate
positions in discretionary accounts participating in its customer
trading programs provided that the FCM does not, among other things,
control trading of such accounts and the trading decisions are made
independently of the trading for the FCM's other accounts. As
further described below, however, the FCM disaggregation exemption
would no longer be self-executing; rather, such relief would be
contingent upon the FCM applying to the Commission for relief.
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Commenters asserted that the elimination of the longstanding IAC
exemption would lead to a variety of negative effects, including
reduced liquidity and distorted price signals, among many other
things.\489\ One commenter mentioned that without the IAC exemption,
multi-advisor commodity pools may become impossible.\490\ Commenters
also expressed concerns that the proposed owned non-financial entity
exemption lacked a rational basis for drawing a distinction between
financial and non-financial entities; and the absence of the IAC
exemption could force a firm to violate other Federal laws by sharing
of position information across otherwise separate entities.\491\ Other
commenters criticized the costs of the aggregation exemption
applications, stating that the process would be burdensome for
participants.\492\
---------------------------------------------------------------------------
\489\ See e.g. CL-DBCS supra note 247 at 6; CL-Morgan Stanley
supra note 21 at 8-9; and CL-PIMCO supra note 21 at 4.
\490\ CL-Willkie supra note 276 at 3-4.
\491\ See e.g. CL-PIMCO supra note 21 at 4-5; CL-BGA supra note
35 at 22; CL-FIA I supra note 21 at 24; CL-ICE I supra note 69 at 6;
and CL-CME I supra note 8 at 16.
\492\ See e.g. CL-ICE I supra note 69 at 13; CL-CME I supra note
8 at 17; CL-FIA I supra note 21 at 26-27; and CL-Cargill supra note
76 at 9.
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In addition, commenters objected to the changes to the
disaggregation exemption as it applies to interests in commodity pools,
arguing that forcing aggregation of independent traders would increase
concentration, limit investment opportunities, and thus potentially
reduce liquidity in the U.S. futures markets.\493\ Commenters also
objected to the Commission's proposal to aggregate on the basis of
identical trading strategies, arguing that it would decrease index fund
participation and reduce liquidity.\494\
---------------------------------------------------------------------------
\493\ See e.g. CL-MFA supra note 21 at 14-15; and CL-Blackrock
supra note 21 at 6-7.
\494\ See e.g. CL-CME I supra note 8 at 18; and CL-Blackrock
supra note 21 at 14.
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The primary rationale for the aggregation of positions or accounts
is the concern that a single trader, through common ownership or
control of multiple accounts, may establish positions in excess of the
position limits--or otherwise attain large concentrated positions--and
thereby increase the risk of market manipulation or disruption.
Consistent with this goal, the Commission, in its design of the
aggregation policy, has strived to ensure the participation of a
minimum number of traders that are independent of each
[[Page 71679]]
other and have different trading objectives and strategies.
Upon further consideration, and in response to commenters, the
Commission is retaining the IAC exemption in existing Sec. 150.4,
recognizing that to the extent that an eligible entity's client
accounts are traded by independent account controllers,\495\ with
appropriate safeguards, such trading may enhance market liquidity and
promote efficient price discovery without increasing the risk of market
manipulation or disruption.\496\
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\495\ The Commission has long recognized that concerns regarding
large concentrated positions are mitigated in circumstances
involving client accounts managed under the discretion and control
of an independent trader, and subject to effective information
barriers.
\496\ In retaining the IAC exemption, the Commission has decided
not to adopt the proposed exemption for owned non-financial
entities, which addresses commenters' concern that the proposal
would have resulted in unfair over discriminatory treatment of
financial entities.
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The final rules expressly provide that the Commission's aggregation
policy will apply to swaps and futures. The extension of the
aggregation requirement to swaps may force a trader to adjust its
business model or trading strategies to avoid exceeding the limits. The
Commission is unable to provide a reliable estimation or quantification
of the costs (including foregone benefits) of such changes because,
among other things, the effect of this determination will vary per
entity and would require information concerning the subject entity's
underlying business models and strategies, to which the Commission does
not have access.\497\
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\497\ The Commission notes that this cost is directly
attributable to the congressional mandate that the Commission impose
limits on economically equivalent swaps. That is to say, unless the
aggregation policy is extended to swaps on equal basis, the express
congressional mandate to impose limits on futures (options) and
economically equivalent swaps would be undermined.
---------------------------------------------------------------------------
To further respond to concerns from commenters, the Commission is
establishing an exemption from the aggregation standards in
circumstances where the aggregation of an account would result in the
violation of other Federal laws or regulations, and an exemption for
the temporary ownership or control of accounts related to underwriting
securities. In addition, in response to commenters' concerns regarding
potential negative market impacts on liquidity and competitiveness, the
Commission is not adopting the proposed changes to the standards for
commodity pool aggregation and is instead retaining the existing
standards. However, the Commission is retaining the provision that
requires aggregation for identical trading strategies in order to
prevent the evasion of speculative position limits.\498\
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\498\ The cost to monitor positions in identical trading
strategies is reflected in the Commission's general estimates to
track positions on a real-time basis.
---------------------------------------------------------------------------
In light of the importance of the aggregation standards in an
effective position limits regime, it is critical that the Commission
effectively and efficiently monitor the extent to which traders rely on
any of the disaggregation exemptions. During the period of time that
the exemptions from aggregation were self-certified, the Commission did
not have an adequate ability to monitor whether entities were properly
interpreting the scope of an exemption or whether entities followed the
conditions applicable for exemptive relief. Accordingly, traders
seeking to rely on any disaggregation exemption will be required to
file a notice with the Commission; the disaggregation exemption is no
longer self-executing. As discussed in the PRA section, the Commission
estimates costs associated with reporting regulations will affect
approximately ninety entities resulting in a total burden, across all
of these entities, of 225,000 annual labor hours and $5.9 million in
annualized capital and start-up costs and annual total operating and
maintenance costs.
a. CEA Section 15(a) Considerations: Aggregation
The aggregation standards finalized herein largely track the
Commission's longstanding policy on aggregation, which will now apply
to futures and swaps transactions. The Commission has added certain
additional safeguards to ensure the proper aggregation of accounts for
position limit purposes.
i. Protection of Market Participants and the Public
The Commission's general policy on aggregation is derived from CEA
section 4a(a)(1), which directs the Commission to aggregate based on
the positions held as well as the trading done by any persons directly
or indirectly controlled by such person.\499\ The Commission has
historically interpreted this provision to require aggregation based
upon ownership or control. The commenters largely supported the
existing aggregation standards, and as noted above, the Commission has
largely retained the aggregation policy from part 150 and extended its
application to positions in swaps.
---------------------------------------------------------------------------
\499\ Section 4a(a)(1) also directs that the Commission
aggregate ``trading done by, two or more persons acting pursuant to
an express or implied agreement or understanding, the same as if the
positions were held by, or trading were done by, a single person.''
7 U.S.C. 6a(a)(1).
---------------------------------------------------------------------------
As discussed above, the Commission anticipates that the aggregation
standards will impose additional costs to various market participants,
including the monitoring of positions and filing for an applicable
exemption. However, the benefits derived from a notice filing, which
ensure proper application of aggregation exemptions, and the general
monitoring of positions, which are a necessary cost to the imposition
of position limits, warrant adoption of the final aggregation rules.
The continued use of existing aggregation standards, which are followed
at the Commission and DCM level, may mitigate costs for entities to
continue to aggregate their positions. In addition, the new aggregation
provision related to identical trading strategies furthers the
Commission policy on aggregation by preventing evasion of the limits
through the use of positions in funds that follow the same trading
strategy. Accordingly, as a necessary component of an effective
position limit regime, and based on its experience with the current
aggregation rules, the Commission believes that the provisions relating
to aggregation in the final rules will promote the protection of market
participants and the public.
ii. Efficiency, Competitiveness, and Financial Integrity of Futures
Markets
For reasons discussed above, an effective position limits regime
must include a robust aggregation policy that is designed to prevent a
trader from attaining market power through ownership or control over
multiple accounts. To the extent that the aggregation policy under the
final rules prevent any market participant from holding large positions
that could cause unwarranted price fluctuations in a particular market,
facilitate manipulation, or disrupt the price discovery process, the
aggregation standards finalized herein operate to help ensure the
efficiency, competitiveness and financial integrity of futures markets.
In addition to the existing exemptions under part 150, to address
commenter concerns over forced information sharing in violation of
Federal law and regarding the underwriting of securities, the
Commission is providing for limited exemptions to cover such
circumstances.
iii. Price Discovery
For similar reasons, the Commission believes that the aggregation
requirements will further the price discovery process. An effective
[[Page 71680]]
aggregation policy has been a longstanding component of the
Commission's position limit regime. As a necessary component of an
effective position limit regime, and based on its experience with the
current aggregation rules, the Commission believes that the provisions
relating to aggregation in the final rules will also help protect the
price discovery process.
iv. Sound Risk Management
As a necessary component of an effective position limits regime,
and based on its experience with the current aggregation rules, the
Commission believes that the provisions relating to aggregation in the
final rules will promote sound risk management.
v. Public Interest Considerations
The Commission has not identified any other public interest
considerations related to the costs and benefits of the rules with
respect to aggregation.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires Federal agencies
to consider the impact of its rules on ``small entities.'' \500\ A
regulatory flexibility analysis or certification typically is required
for ``any rule for which the agency publishes a general notice of
proposed rulemaking pursuant to'' the notice-and-comment provisions of
the Administrative Procedure Act, 5 U.S.C. 553(b).\501\ In its
proposal, the Commission explained that ``[t]he requirements related to
the proposed amendments fall mainly on [DCMs and SEFs], futures
commission merchants, swap dealers, clearing members, foreign brokers,
and large traders.'' \502\
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\500\ 5 U.S.C. 601 et seq.
\501\ 5 U.S.C. sections 601(2), 603, 604 and 605.
\502\ 76 FR 4765.
---------------------------------------------------------------------------
In response to the Proposed Rules, the Not-For-Profit Electric End
User Coalition (``Coalition'') submitted a comment generally
criticizing the Commission's ``rule-makings [as] an accumulation of
interrelated regulatory burdens and costs on non-financial small
entities like the NFP Electric End Users, who seek to transact in
Energy Commodity Swaps and ``Referenced Contracts'' only to hedge the
commercial risks of their not-for-profit public service activities.''
\503\ In addition, the Coalition requested ``that the Commission
streamline the use of the bona fide hedging exemption for non-financial
entities, especially for those that engage in CFTC-regulated
transactions as `end user only/bona fide hedger only' market
participants.'' \504\ However, such persons necessarily would be large
traders.
---------------------------------------------------------------------------
\503\ Not-For-Profit Electric End User Coalition (``EEUC'') on
March 28, 2011 (``CL-EEUC'') at 29.
\504\ Id. at 15.
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The Commission has determined that this position limits rule will
not have a significant economic impact on a substantial number of small
businesses. With regard to the position limits and position visibility
levels, these would only impact large traders, which the Commission has
previously determined not to be small entities for RFA purposes.\505\
The Commission would impose filing requirements under final Sec. Sec.
151.5(c) and (d) associated with bona fide hedging if a person exceeds
or anticipates exceeding a position limit. Although regulation Sec.
151.5(h) of these rules requires counterparties to pass-through swaps
to keep records supporting the transaction's qualification for an
enumerated hedge, the marginal burden of this requirement is mitigated
through overlapping recordkeeping requirements for reportable futures
traders (Commission regulation 18.05) and reportable swap traders
(Commission regulation 20.6(b)). Further, the Commission understands
that entities subject to the recordkeeping requirements for their swaps
transactions maintain records of these contracts, as they would other
documents evidencing material financial relationships, in the ordinary
course of their businesses. Therefore, these rules would not impose a
significant economic impact even if applied to small entities.
---------------------------------------------------------------------------
\505\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, Apr. 30, 1982 (FCM, DCM and large trader
determinations).
---------------------------------------------------------------------------
The remaining requirements in this final rule generally apply to
DCMs, SEFs, futures commission merchants, swap dealers, clearing
members, and foreign brokers. The Commission previously has determined
that DCMs, futures commission merchants, and foreign brokers are not
small entities for purposes of the RFA.\506\ Similarly, swap dealers,
clearing members, and traders would be subject to the regulations only
if carrying large positions.
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\506\ See 47 FR at 18618; 72 FR 34417, Jun. 22, 2007 (foreign
broker determination).
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The Commission has proposed, but not yet determined, that SEFs
should not be considered to be small entities for purposes of the RFA
for essentially the same reasons that DCMs have previously been
determined not to be small entities.\507\ Similarly, the Commission has
proposed, but not yet determined, that swap dealers should not be
considered ``small entities'' for essentially the same reasons that
FCMs have previously been determined not to be small entities.\508\ For
all of the reasons stated in those previous releases, the Commission
has determined that SEFs and swap dealers are not ``small entities''
for purposes of the RFA.
---------------------------------------------------------------------------
\507\ See 75 FR 63745, Oct. 18, 2010.
\508\ See 76 FR 6715, Feb. 8, 2011.
---------------------------------------------------------------------------
The Commission notes that it has not previously determined whether
clearing members should be considered small entities for purposes of
the RFA. The Commission does not believe that clearing members who will
be subject to the requirements of this rulemaking will constitute small
entities for RFA purposes. First, most clearing members will also be
registered as FCMs, who as a category have been previously determined
to not be small entities. Second, any clearing member effected by this
rule will also, of necessity be a large trader, who as a category has
also been determined to not be small entities. For all of these
reasons, the Commission has determined that clearing members are not
``small entities'' for purposes of the RFA.
Accordingly, the Chairman, on behalf of the Commission, certifies,
pursuant to 5 U.S.C. 605(b), that the actions to be taken herein will
not have a significant economic impact on a substantial number of small
entities.
C. Paperwork Reduction Act
1. Overview
The Paperwork Reduction Act (``PRA'') \509\ imposes certain
requirements on Federal agencies in connection with their conducting or
sponsoring any collection of information as defined by the PRA. Certain
provisions of the regulations will result in new collection of
information requirements within the meaning of the PRA. An agency may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number. The Commission submitted the proposing release to the Office of
Management and Budget (``OMB'') for review in accordance with 44 U.S.C.
3507(d) and 5 CFR 1320.11. The Commission requested that OMB approve
and assign a new control number for the collections of information
covered by the proposing release.
---------------------------------------------------------------------------
\509\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
The Commission invited the public and other Federal agencies to
comment on any aspect of the reporting and recordkeeping burdens
discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
[[Page 71681]]
Commission solicited comments in order to (i) Evaluate whether the
proposed collections of information are necessary for the proper
performance of the functions of the Commission, including whether the
information will have practical utility, (ii) evaluate the accuracy of
the Commission's estimate of the burden of the proposed collections of
information, (iii) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected, and
(iv) minimize the burden of the collections of information on those who
are to respond, including through the use of automated collection
techniques or other forms of information technology.
The Commission received three comments on the burden estimates and
information collection requirements contained in its proposing release.
The World Gold Council stated that the recordkeeping and reporting
costs were not addressed.\510\ MGEX argued that the Commission's
estimated burden for DCMs to determine deliverable supply levels was
too low.\511\ Specifically, it commented that the Commission's estimate
of ``6,000 hours per year for all DCMs at a combined annual cost of
$50,000 among all DCMs'' would result ``in an hourly wage of less than
$10'' to comply with the rules.\512\ The combined annual cost estimate
cited by MGEX appears to be the amount the Commission estimated for
annualized capital and start-up costs and annual total operating and
maintenance costs; \513\ this estimate is separate from any calculation
of labor costs. The Working Group commented that it could not
meaningfully respond to the costs until it had a complete view of all
the Dodd-Frank Act rulemakings, that the Commission did not provide
sufficient explanation for its estimates of the number of market
participants affected by the final regulations, and that the Commission
underestimated wage and personnel estimates.\514\ As further discussed
below, the Commission has carefully reviewed its burden analysis and
estimates, and it has determined its estimates to be reasonable.
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\510\ CL-WGC supra note 21 at 5.
\511\ CL-MGEX supra note 74 at 4.
\512\ Id.
\513\ In this regard the Commission notes that the cost estimate
for annualized capital and start-up costs and annual total operating
and maintenance costs was $55,000.
\514\ CL-WGCEF supra note 35 at 25-26.
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Responses to the collections of information contained within these
final rules are mandatory, and the Commission will protect proprietary
information according to the Freedom of Information Act and 17 CFR part
145, headed ``Commission Records and Information.'' In addition, the
Commission emphasizes that section 8(a)(1) of the Act strictly
prohibits the Commission, unless specifically authorized by the Act,
from making public ``data and information that would separately
disclose the business transactions or market positions of any person
and trade secrets or names of customers.'' \515\ The Commission also is
required to protect certain information contained in a government
system of records pursuant to the Privacy Act of 1974.\516\
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\515\ 7 U.S.C. 12(a)(1).
\516\ 5 U.S.C. 552a.
---------------------------------------------------------------------------
The title for this collection of information is ``Part 151--
Position Limit Framework for Referenced Contracts.'' OMB has approved
and assigned OMB control number 3038-[----] to this collection of
information.
2. Information Provided and Recordkeeping Duties
Proposed Sec. 151.4(a)(2) provided for a special conditional spot-
month limit for traders under certain conditions, including the
submission of a certification that the trader met the required
conditions, to be filed within a day after the trader exceeded a
conditional spot-month limit. The Commission anticipated that
approximately one hundred traders per year would submit conditional
spot-month limit certifications and estimated that these one hundred
entities would incur a total burden of 2,400 annual labor hours,
resulting in a total of $189,000 in annual labor costs \517\ and $1
million in annualized capital, start-up,\518\ total operating, and
maintenance costs. As described above, the Commission has eliminated
the conditional spot-month limit as described in the Proposed Rules.
These final rules now provide for a limit on cash-settled Referenced
Contracts of five times the limit on the physical-delivery Referenced
Contract. The cash-settled and physical-delivery contracts would also
be subject to separate class limits, and the Commission would impose an
aggregate limit set at five times the level of the spot-month limit in
the relevant Core Referenced Futures Contract that is physically
delivered. As such, traders need not file a certification to avail
themselves of the conditional limit for cash-settled contracts.
Therefore, these capital and labor cost estimates do not apply to the
final regulations.
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\517\ The Commission staff's estimates concerning the wage rates
are based on salary information for the securities industry compiled
by the Securities Industry and Financial Markets Association
(``SIFMA''). The $78.61 per hour is derived from figures from a
weighted average of salaries and bonuses across different
professions from the SIFMA Report on Management & Professional
Earnings in the Securities Industry 2010, modified to account for an
1800-hour work-year and multiplied by 1.3 to account for overhead
and other benefits. The wage rate is a weighted national average of
salary and bonuses for professionals with the following titles (and
their relative weight): ``programmer (senior)'' (30 percent);
``programmer'' (30 percent); ``compliance advisor (intermediate)''
(20 percent); ``systems analyst'' (10 percent); and ``assistant/
associate general counsel'' (10 percent).
\518\ The capital/start-up cost component of ``annualized
capital/start-up, operating, and maintenance costs'' is based on an
initial capital/start-up cost that is straight-line depreciated over
five years.
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Section 151.4(c) requires that DCMs submit an estimate of
deliverable supply for each Referenced Contract that is subject to a
spot-month position limit and listed or executed pursuant to the rules
of the DCM. Under the Proposed Rules, the Commission estimated that the
reporting would affect approximately six entities annually, resulting
in a total marginal burden, across all of these entities, of 6,000
annual labor hours and $55,000 in annualized capital, start-up, total
operating, and maintenance costs. As discussed above, in response to
comments concerning the process for determining deliverable supply, the
Commission has determined to update spot-month limits biennially (every
two years) instead of annually in the case of energy and metal
contracts, and to stagger the dates on which estimates of deliverable
supply shall be submitted by DCMs. As a result of these changes, the
Commission estimates that this reporting will result in a total
marginal burden, across the six affected entities, of 5,000 annual
labor hours for a total of $511,000 in annual labor costs and $50,000
in annualized capital, start-up, total operating, and maintenance
costs.
Section 151.5 sets forth the application procedure for bona fide
hedgers and counterparties to bona fide hedging swap transactions that
seek an exemption from the Commission-set Federal position limits for
Referenced Contracts. If a bona fide hedger seeks to claim an exemption
from position limits because of cash market activities, then the hedger
would submit a 404 filing pursuant to Sec. 151.5(b). The 404 filing
would be submitted when the bona fide hedger exceeds the applicable
position limit and claims an exemption or when its hedging needs
increase. Similarly, parties to bona fide hedging swap transactions
would be required to submit a 404S filing to qualify for a hedging
exemption, which would also be submitted when the bona fide hedger
exceeds the applicable position limit and claims an exemption or when
its
[[Page 71682]]
hedging needs increase. If a bona fide hedger seeks an exemption for
anticipated commercial production or anticipatory commercial
requirements, then the hedger would submit a 404A filing pursuant to
Sec. 151.5(c).
Under the Proposed Rules, 404 and 404S filings would have been
required on a daily basis. In light of comments concerning the burden
of daily filings to both market participants and the Commission, the
final regulations require only monthly reporting of 404 and 404S
filings. These monthly reports would provide information on daily
positions for the month reporting period.
The Commission estimated in the Proposed Rules that these bona fide
hedging-related reporting requirements would affect approximately two
hundred entities annually and result in a total burden of approximately
$37.6 million across all of these entities, 168,000 annual labor hours,
resulting in a total of $13.2 million in annual labor costs and $25.4
million in annualized capital, start-up, total operating, and
maintenance costs. As a result of modifications made to the Proposed
Rules, under the final regulations these bona fide hedging-related
reporting requirements will affect approximately two hundred entities
annually and result in a total burden of approximately $28.6 million
across all of these entities, 29,700 annual labor hours, resulting in a
total of $2.3 million in annual labor costs and $26.3 million in
annualized capital, start-up, total operating, and maintenance costs.
With regard to 404 filings, under the Proposed Rules, the
Commission estimated that 404 filing requirements would affect
approximately ninety entities annually, resulting in a total burden,
across all of these entities, of 108,000 total annual labor hours and
$11.7 million in annualized capital, start-up, total operating, and
maintenance costs. Under the final regulations, 404 filing requirements
will affect approximately ninety entities annually, resulting in a
total burden, across all of these entities, of 108,000 total annual
labor hours and $11.7 million in annualized capital, start-up, total
operating, and maintenance costs.
With regard to 404A filings, under the Proposed Rules, the
Commission estimated that 404A filing requirements would affect
approximately sixty entities annually, resulting in a total burden,
across all of these entities, of 6,000 total annual labor hours and
$4.2 million in annualized capital, start-up, total operating, and
maintenance costs. In addition to adjustments in these estimates
stemming from the change in the frequency of filings, the estimate of
entities affected by 404A filing requirements has been modified to
reflect the fact that the final regulations include certain
anticipatory hedging exemptions that were absent from the Proposed
Rules. Thus, under the final regulations, 404A filing requirements will
affect approximately ninety entities annually, resulting in a total
burden, across all of these entities, of 2,700 total annual labor hours
and $6.3 million in annualized capital, start-up, total operating, and
maintenance costs.
With regard to 404S filings, under the Proposed Rules the
Commission estimated that 404S filing requirements would affect
approximately forty-five entities annually, resulting in a total
burden, across all of these entities, of 54,000 total annual labor
hours and $9.5 million in annualized capital, start-up, total
operating, and maintenance costs. Under the final regulations, 404S
filing requirements will affect approximately forty-five entities
annually, resulting in a total burden, across all of these entities, of
16,200 total annual labor hours and $9.5 million in annualized capital,
start-up, total operating, and maintenance costs.
Section 151.5(e) specifies recordkeeping requirements for traders
who claim bona fide hedge exemptions. These recordkeeping requirements
include complete books and records concerning all of their related
cash, futures, and swap positions and transactions and make such books
and records, along with a list of swap counterparties to the
Commission. Regulations 151.5(g) and 151.5(h) provide procedural
documentation requirements for those availing themselves of a bona fide
hedging transaction exemption. These firms would be required to
document a representation and confirmation by at least one party that
the swap counterparty is relying on a bona fide hedge exemption, along
with a confirmation of receipt by the other party to the swap.
Paragraph (h) of Sec. 151.5 also requires that the written
representation and confirmation be retained by the parties and
available to the Commission upon request.\519\ The marginal impact of
this requirement is limited because of its overlap with existing
recordkeeping requirements under Sec. 15.03. The Commission estimates,
as it did under the Proposed Rules, that bona fide hedging-related
recordkeeping regulations will affect approximately one hundred sixty
entities, resulting in a total burden, across all of these entities, of
40,000 total annual labor hours and $10.4 million in annualized
capital, start-up, total operating, and maintenance costs.
---------------------------------------------------------------------------
\519\ The Commission notes that entities would have to retain
such books and records in compliance with Sec. 1.31.
---------------------------------------------------------------------------
Section 151.6 requires traders with positions exceeding visibility
levels in Referenced Contracts in metal and energy commodities to
submit additional information about cash market and derivatives
activity in substantially the same commodity. Section 151.6(b) requires
the submission of a 401 filing which would provide basic position
information on the position exceeding the visibility level.
Section151.6(c) requires additional information, through a 402S filing,
on a trader's uncleared swaps in substantially the same commodity. The
Commission has determined to increase the visibility levels from the
proposed levels, meaning fewer market participants will be affected by
the relevant reporting requirements. In addition, the Proposed Rules
included a requirement to submit 404A filings under proposed Sec.
151.6, but the Commission has eliminated this requirement in order to
reduce the compliance burden for firms reporting under Sec. 151.6.
Requirements under 401 filing reporting regulations in the Proposed
Rules would have affected approximately one hundred forty entities
annually, resulting in a total burden, across all of these entities, of
16,800 total annual labor hours and $15.4 million in annualized
capital, start-up, total operating, and maintenance costs. In the final
regulations, these requirements will affect approximately seventy
entities annually, resulting in a total burden, across all of these
entities, of 8,400 total annual labor hours and $5.3 million in
annualized capital, start-up, total operating, and maintenance costs.
Requirements under 402S filing reporting regulations in the
Proposed Rules would have affected approximately seventy entities
annually, resulting in a total burden, across all of these entities, of
5,600 total annual labor hours and $4.9 million in annualized capital,
start-up, total operating, and maintenance costs. In the final
regulations, the Commission has eliminated the 402S filing, thus
eliminating any burden stemming from such reports.
Requirements under visibility level-related 404 filing reporting
regulations \520\ in the Proposed Rules
[[Page 71683]]
would have affected approximately sixty entities annually, resulting in
a total burden, across all of these entities, of 4,800 total annual
labor hours and $4.2 million in annualized capital, start-up, total
operating, and maintenance costs. In the final regulations, these
requirements will affect approximately thirty entities annually,
resulting in a total burden, across all of these entities, of 2,400
total annual labor hours and $2.1 million in annualized capital, start-
up, total operating, and maintenance costs.
---------------------------------------------------------------------------
\520\ For the visibility level-related 404 filing requirements,
the estimated burden is based on reporting duties not already
accounted for in the burden estimate for those submitting 404
filings pursuant to proposed Sec. 151.5. For many of these firms,
the experience and infrastructure developed submitting or preparing
to submit a 404 filing under Sec. 151.5 would reduce the marginal
burden imposed by having to submit filings under Sec. 151.6.
---------------------------------------------------------------------------
As noted above, 404A filing requirements under Sec. 151.6 have
been eliminated in the final regulations. Therefore, the burden
estimates for this requirement under the Proposed Rules (approximately
forty entities affected annually, resulting in a total burden, across
all of these entities, of 3,200 total annual labor hours and $2.8
million in annualized capital, start-up, total operating, and
maintenance costs) do not apply to the final regulations.
As a result of this modification and higher visibility levels,
estimates for the overall burden of visibility level-related reporting
regulations have been modified. In the Proposed Rules, the Commission
estimated that visibility level-related reporting regulations would
affect approximately one hundred forty entities annually, resulting in
a total burden, across all of these entities, of 30,400 annual labor
hours, resulting, a total of $2.4 million in annual labor costs, and
$27.3 million in annualized capital, start-up, total operating, and
maintenance costs. Under the final regulations, visibility level-
related reporting regulations will affect approximately seventy
entities annually, resulting in a total burden, across all of these
entities, of 8,160 annual labor hours, resulting in a total of $642,000
in annual labor costs and $7.4 million in annualized capital, start-up,
total operating, and maintenance costs.
Section 151.7 concerns the aggregation of trader accounts. Proposed
Sec. 151.7(g) provided for a disaggregation exemption for certain
limited partners in a pool, futures commission merchants that met
certain independent trading requirements, and independently controlled
and managed non-financial entities in which another entity had an
ownership or equity interest of 10 percent or greater. In all three
cases, the exemption would become effective upon the Commission's
approval of an application described in proposed Sec. 151.7(g), and
renewal was required for each year following the initial application
for exemption.
As discussed in greater detail above, in the final regulations the
Commission has made several modifications to account aggregation rules
and exemptions. The modifications include reinstatement of the IAC
exemption and exemption for certain interests in commodity pools (both
of which are part of current Commission account aggregation policy but
were absent from the Proposed Rules), an exemption from aggregation
related to the underwriting of securities, and an exemption for
situations in which aggregation across commonly owned affiliates would
require the sharing of position information that would result in the
violation of Federal law. In addition, the final regulations contain a
modified procedure for exemptive relief under Sec. 151.7. The
Commission has eliminated the provision in the Proposed Rules requiring
a trader seeking a disaggregation exemption to file an application for
exemptive relief as well as annual renewals. Instead, under the final
regulations the trader must file a notice, effective upon filing,
setting forth the circumstances that warrant disaggregation and a
certification that they meet the relevant conditions.
As a result of these modifications, estimates for the burden of
reporting regulations related to account aggregation have been
modified. Under the Proposed Rules, the Commission estimated that these
reporting regulations would affect approximately sixty entities,
resulting in a total burden, across all of these entities, of 300,000
annual labor hours and $9.9 million in annualized capital, start-up,
total operating, and maintenance costs. Under the final regulations,
these reporting regulations will affect approximately ninety entities,
resulting in a total burden, across all of these entities, of 225,000
annual labor hours and $5.9 million in annualized capital, start-up,
total operating, and maintenance costs.
List of Subjects
17 CFR Part 1
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
17 CFR Part 150
Commodity futures, Cotton, Grains.
17 CFR Part 151
Position limits, Bona fide hedging, Referenced Contracts.
In consideration of the foregoing, pursuant to the authority
contained in the Commodity Exchange Act, the Commission hereby amends
chapter I of title 17 of the Code of Federal Regulations as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,
13a-1, 16, 16a, 19, 21, 23, and 24, as amended by Title VII of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.
111-203, 124 Stat. 1376 (2010).
Sec. 1.3 [Revised]
0
2. Revise Sec. 1.3 (z) to read as follows:
(z) Bona fide hedging transactions and positions for excluded
commodities. (1) General definition. Bona fide hedging transactions and
positions shall mean any agreement, contract or transaction in an
excluded commodity on a designated contract market or swap execution
facility that is a trading facility, where such transactions or
positions normally represent a substitute for transactions to be made
or positions to be taken at a later time in a physical marketing
channel, and where they are economically appropriate to the reduction
of risks in the conduct and management of a commercial enterprise, and
where they arise from:
(i) The potential change in the value of assets which a person
owns, produces, manufactures, processes, or merchandises or anticipates
owning, producing, manufacturing, processing, or merchandising,
(ii) The potential change in the value of liabilities which a
person owns or anticipates incurring, or
(iii) The potential change in the value of services which a person
provides, purchases, or anticipates providing or purchasing.
(iv) Notwithstanding the foregoing, no transactions or positions
shall be classified as bona fide hedging unless their purpose is to
offset price risks incidental to commercial cash or spot operations and
such positions are established and liquidated in an orderly manner in
accordance with sound commercial practices and, for transactions or
positions on contract markets subject to trading and position limits in
effect pursuant to section 4a of
[[Page 71684]]
the Act, unless the provisions of paragraphs (z)(2) and (3) of this
section have been satisfied.
(2) Enumerated hedging transactions. The definitions of bona fide
hedging transactions and positions in paragraph (z)(1) of this section
includes, but is not limited to, the following specific transactions
and positions:
(i) Sales of any agreement, contract, or transaction in an excluded
commodity on a designated contract market or swap execution facility
that is a trading facility which do not exceed in quantity:
(A) Ownership or fixed-price purchase of the same cash commodity by
the same person; and
(B) Twelve months' unsold anticipated production of the same
commodity by the same person provided that no such position is
maintained in any agreement, contract or transaction during the five
last trading days.
(ii) Purchases of any agreement, contract or transaction in an
excluded commodity on a designated contract market or swap execution
facility that is a trading facility which do not exceed in quantity:
(A) The fixed-price sale of the same cash commodity by the same
person;
(B) The quantity equivalent of fixed-price sales of the cash
products and by-products of such commodity by the same person; and
(C) Twelve months' unfilled anticipated requirements of the same
cash commodity for processing, manufacturing, or feeding by the same
person, provided that such transactions and positions in the five last
trading days of any agreement, contract or transaction do not exceed
the person's unfilled anticipated requirements of the same cash
commodity for that month and for the next succeeding month.
(iii) Offsetting sales and purchases in any agreement, contract or
transaction in an excluded commodity on a designated contract market or
swap execution facility that is a trading facility which do not exceed
in quantity that amount of the same cash commodity which has been
bought and sold by the same person at unfixed prices basis different
delivery months of the contract market, provided that no such position
is maintained in any agreement, contract or transaction during the five
last trading days.
(iv) Purchases or sales by an agent who does not own or has not
contracted to sell or purchase the offsetting cash commodity at a fixed
price, provided that the agent is responsible for the merchandising of
the cash position that is being offset, and the agent has a contractual
arrangement with the person who owns the commodity or has the cash
market commitment being offset.
(v) Sales and purchases described in paragraphs (z)(2)(i) through
(iv) of this section may also be offset other than by the same quantity
of the same cash commodity, provided that the fluctuations in value of
the position for in any agreement, contract or transaction are
substantially related to the fluctuations in value of the actual or
anticipated cash position, and provided that the positions in any
agreement, contract or transaction shall not be maintained during the
five last trading days.
(3) Non-Enumerated cases. A designated contract market or swap
execution facility that is a trading facility may recognize, consistent
with the purposes of this section, transactions and positions other
than those enumerated in paragraph (2) of this section as bona fide
hedging. Prior to recognizing such non-enumerated transactions and
positions, the designated contract market or swap execution facility
that is a trading facility shall submit such rules for Commission
review under section 5c of the Act and part 40 of this chapter.
* * * * *
Sec. 1.47 [Removed and Reserved]
0
3. Remove and reserve Sec. 1.47.
Sec. 1.48 [Removed and Reserved]
0
4. Remove and reserve Sec. 1.48.
PART 150--LIMITS ON POSITIONS
0
5. Revise Sec. 150.2 to read as follows:
Sec. 150.2 Position limits.
No person may hold or control positions, separately or in
combination, net long or net short, for the purchase or sale of a
commodity for future delivery or, on a futures-equivalent basis,
options thereon, in excess of the following:
Speculative Position Limits
----------------------------------------------------------------------------------------------------------------
Limits by number of contracts
----------------------------------------------------------------------------------------------------------------
Contract Spot month Single month All months
----------------------------------------------------------------------------------------------------------------
Chicago Board of Trade
----------------------------------------------------------------------------------------------------------------
Corn and Mini-Corn \1\.................................... 600 33,000 33,000
Oats...................................................... 600 2,000 2,000
Soybeans and Mini-Soybeans \1\............................ 600 15,000 15,000
Wheat and Mini-Wheat \1\.................................. 600 12,000 12,000
Soybean Oil............................................... 540 8,000 8,000
Soybean Meal.............................................. 720 6,500 6,500
----------------------------------------------------------------------------------------------------------------
Minneapolis Grain Exchange
----------------------------------------------------------------------------------------------------------------
Hard Red Spring Wheat..................................... 600 12,000 12,000
----------------------------------------------------------------------------------------------------------------
ICE Futures U.S.
----------------------------------------------------------------------------------------------------------------
Cotton No. 2.............................................. 300 5,000 5,000
----------------------------------------------------------------------------------------------------------------
Kansas City Board of Trade
----------------------------------------------------------------------------------------------------------------
Hard Winter Wheat......................................... 600 12,000 12,000
----------------------------------------------------------------------------------------------------------------
\1\ For purposes of compliance with these limits, positions in the regular sized and mini-sized contracts shall
be aggregated.
[[Page 71685]]
0
6. Add part 151 to read as follows:
PART 151--POSITION LIMITS FOR FUTURES AND SWAPS
Sec.
151.1 Definitions.
151.2 Core Referenced Futures Contracts.
151.3 Spot months for Referenced Contracts.
151.4 Position limits for Referenced Contracts.
151.5 Bona fide hedging and other exemptions for Referenced
Contracts.
151.6 Position visibility.
151.7 Aggregation of positions.
151.8 Foreign boards of trade.
151.9 Pre-existing positions.
151.10 Form and manner of reporting and submitting information or
filings.
151.11 Designated contract market and swap execution facility
position limits and accountability rules.
151.12 Delegation of authority to the Director of the Division of
Market Oversight.
151.13 Severability.
Appendix A to Part 151--Spot-Month Position Limits
Appendix B to Part 151--Examples of Bona Fide Hedging Transactions
and Positions
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6c, 6f, 6g, 6t, 12a, 19,
as amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
Sec. 151.1 Definitions.
As used in this part--
Basis contract means an agreement, contract or transaction that is
cash-settled based on the difference in price of the same commodity (or
substantially the same commodity) at different delivery locations;
Calendar spread contract means a cash-settled agreement, contract,
or transaction that represents the difference between the settlement
price in one or a series of contract months of an agreement, contract
or transaction and the settlement price of another contract month or
another series of contract months' settlement prices for the same
agreement, contract or transaction.
Commodity index contract means an agreement, contract, or
transaction that is not a basis or any type of spread contract, based
on an index comprised of prices of commodities that are not the same or
substantially the same; provided that, a commodity index contract used
to circumvent speculative position limits shall be considered to be a
Referenced Contract for the purpose of applying the position limits of
Sec. 151.4.
Core Referenced Futures Contract means a futures contract that is
listed in Sec. 151.2.
Eligible Entity means a commodity pool operator; the operator of a
trading vehicle which is excluded, or which itself has qualified for
exclusion from the definition of the term ``pool'' or ``commodity pool
operator,'' respectively, under Sec. 4.5 of this chapter the limited
partner or shareholder in a commodity pool the operator of which is
exempt from registration under Sec. 4.13 of this chapter; a commodity
trading advisor; a bank or trust company; a savings association; an
insurance company; or the separately organized affiliates of any of the
above entities:
(1) Which authorizes an independent account controller
independently to control all trading decisions with respect to the
eligible entity's client positions and accounts that the independent
account controller holds directly or indirectly, or on the eligible
entity's behalf, but without the eligible entity's day-to-day
direction; and
(2) Which maintains:
(i) Only such minimum control over the independent account
controller as is consistent with its fiduciary responsibilities to the
managed positions and accounts, and necessary to fulfill its duty to
supervise diligently the trading done on its behalf; or
(ii) If a limited partner or shareholder of a commodity pool the
operator of which is exempt from registration under Sec. 4.13 of this
chapter, only such limited control as is consistent with its status.
Entity means a ``person'' as defined in section 1a of the Act.
Excluded commodity means an ``excluded commodity'' as defined in
section 1a of the Act.
Independent Account Controller means a person:
(1) Who specifically is authorized by an eligible entity
independently to control trading decisions on behalf of, but without
the day-to-day direction of, the eligible entity;
(2) Over whose trading the eligible entity maintains only such
minimum control as is consistent with its fiduciary responsibilities
for managed positions and accounts to fulfill its duty to supervise
diligently the trading done on its behalf or as is consistent with such
other legal rights or obligations which may be incumbent upon the
eligible entity to fulfill;
(3) Who trades independently of the eligible entity and of any
other independent account controller trading for the eligible entity;
(4) Who has no knowledge of trading decisions by any other
independent account controller; and
(5) Who is registered as a futures commission merchant, an
introducing broker, a commodity trading advisor, or an associated
person of any such registrant, or is a general partner of a commodity
pool the operator of which is exempt from registration under Sec. 4.13
of this chapter.
Intercommodity spread contract means a cash-settled agreement,
contract or transaction that represents the difference between the
settlement price of a Referenced Contract and the settlement price of
another contract, agreement, or transaction that is based on a
different commodity.
Referenced Contract means, on a futures equivalent basis with
respect to a particular Core Referenced Futures Contract, a Core
Referenced Futures Contract listed in Sec. 151.2, or a futures
contract, options contract, swap or swaption, other than a basis
contract or commodity index contract, that is:
(1) Directly or indirectly linked, including being partially or
fully settled on, or priced at a fixed differential to, the price of
that particular Core Referenced Futures Contract; or
(2) Directly or indirectly linked, including being partially or
fully settled on, or priced at a fixed differential to, the price of
the same commodity underlying that particular Core Referenced Futures
Contract for delivery at the same location or locations as specified in
that particular Core Referenced Futures Contract.
Spot month means, for Referenced Contracts, the spot month defined
in Sec. 151.3.
Spot-month, single-month, and all-months-combined position limits
mean, for Referenced Contracts based on a commodity identified in Sec.
151.2, the maximum number of contracts a trader may hold as set forth
in Sec. 151.4.
Spread contract means either a calendar spread contract or an
intercommodity spread contract.
Swap means ``swap'' as defined in section 1a of the Act and as
further defined by the Commission.
Swap dealer means ``swap dealer'' as that term is defined in
section 1a of the Act and as further defined by the Commission.
Swaption means an option to enter into a swap or a physical
commodity option.
Trader means a person that, for its own account or for an account
that it controls, makes transactions in Referenced Contracts or has
such transactions made.
Sec. 151.2 Core Referenced Futures Contracts.
(a) Agricultural commodities. Core Referenced Futures Contracts in
agricultural commodities include the following futures contracts and
options thereon:
(1) Core Referenced Futures Contracts in legacy agricultural
commodities:
[[Page 71686]]
(i) Chicago Board of Trade Corn (C);
(ii) Chicago Board of Trade Oats (O);
(iii) Chicago Board of Trade Soybeans (S);
(iv) Chicago Board of Trade Soybean Meal (SM);
(v) Chicago Board of Trade Soybean Oil (BO);
(vi) Chicago Board of Trade Wheat (W);
(vii) ICE Futures U.S. Cotton No. 2 (CT);
(viii) Kansas City Board of Trade Hard Winter Wheat (KW); and
(ix) Minneapolis Grain Exchange Hard Red Spring Wheat (MWE).
(2) Core Referenced Futures Contracts in non-legacy agricultural
commodities:
(i) Chicago Mercantile Exchange Class III Milk (DA);
(ii) Chicago Mercantile Exchange Feeder Cattle (FC);
(iii) Chicago Mercantile Exchange Lean Hog (LH);
(iv) Chicago Mercantile Exchange Live Cattle (LC);
(v) Chicago Board of Trade Rough Rice (RR);
(vi) ICE Futures U.S. Cocoa (CC);
(vii) ICE Futures U.S. Coffee C (KC);
(viii) ICE Futures U.S. FCOJ-A(OJ);
(ix) ICE Futures U.S. Sugar No. 11 (SB); and
(x) ICE Futures U.S. Sugar No. 16 (SF).
(b) Metal commodities. Core Referenced Futures Contracts in metal
commodities include the following futures contracts and options
thereon:
(1) Commodity Exchange, Inc. Copper (HG);
(2) Commodity Exchange, Inc. Gold (GC);
(3) Commodity Exchange, Inc. Silver (SI);
(4) New York Mercantile Exchange Palladium (PA); and
(5) New York Mercantile Exchange Platinum (PL).
(c) Energy commodities. The Core Referenced Futures Contracts in
energy commodities include the following futures contracts and options
thereon:
(1) New York Mercantile Exchange Henry Hub Natural Gas (NG);
(2) New York Mercantile Exchange Light Sweet Crude Oil (CL);
(3) New York Mercantile Exchange New York Harbor Gasoline
Blendstock (RB); and
(4) New York Mercantile Exchange New York Harbor Heating Oil (HO).
Sec. 151.3 Spot months for Referenced Contracts.
(a) Agricultural commodities. For Referenced Contracts based on
agricultural commodities, the spot month shall be the period of time
commencing:
(1) At the close of business on the business day prior to the first
notice day for any delivery month and terminating at the end of the
delivery period in the underlying Core Referenced Futures Contract for
the following Referenced Contracts:
(i) ICE Futures U.S. Cocoa (CC) contract;
(ii) ICE Futures U.S. Coffee C (KC) contract;
(iii) ICE Futures U.S. Cotton No. 2 (CT) contract;
(iv) ICE Futures U.S. FCOJ-A (OJ) contract;
(v) Chicago Board of Trade Corn (C) contract;
(vi) Chicago Board of Trade Oats (O) contract;
(vii) Chicago Board of Trade Rough Rice (RR) contract;
(viii) Chicago Board of Trade Soybeans (S) contract;
(ix) Chicago Board of Trade Soybean Meal (SM) contract;
(x) Chicago Board of Trade Soybean Oil (BO) contract;
(xi) Chicago Board of Trade Wheat (W) contract;
(xii) Minneapolis Grain Exchange Hard Red Spring Wheat (MW)
contract; and
(xiii) Kansas City Board of Trade Hard Winter Wheat (KW) contract;
(2) At the close of business of the first business day after the
fifteenth calendar day of the calendar month preceding the delivery
month if the fifteenth calendar day is a business day, or at the close
of business of the second business day after the fifteenth day if the
fifteenth day is a non-business day and terminating at the end of the
delivery period in the underlying Core Referenced Futures Contract for
the ICE Futures U.S. Sugar No. 11 (SB) Referenced Contract;
(3) At the close of business on the sixth business day prior to the
last trading day and terminating at the end of the delivery period in
the underlying Core Referenced Futures Contract for the ICE Futures
U.S. Sugar No. 16 (SF) Referenced Contract;
(4) At the close of business on the business day immediately
preceding the last five business days of the contract month and
terminating at the end of the delivery period in the underlying Core
Referenced Futures Contract for the Chicago Mercantile Exchange Live
Cattle (LC) Referenced Contract;
(5) On the ninth trading day prior to the last trading day and
terminating on the last trading day for Chicago Mercantile Exchange
Feeder Cattle (FC) contract;
(6) On the first trading day of the contract month and terminating
on the last trading day for the Chicago Mercantile Exchange Class III
Milk (DA) contract; and
(7) At the close of business on the fifth business day prior to the
last trading day and terminating on the last trading day for the
Chicago Mercantile Exchange Lean Hog (LH) contract.
(b) Metal commodities. The spot month shall be the period of time
commencing at the close of business on the business day prior to the
first notice day for any delivery month and terminating at the end of
the delivery period in the underlying Core Referenced Futures Contract
for the following Referenced Contracts:
(1) Commodity Exchange, Inc. Gold (GC) contract;
(2) Commodity Exchange, Inc. Silver (SI) contract;
(3) Commodity Exchange, Inc. Copper (HG) contract;
(4) New York Mercantile Exchange Palladium (PA) contract; and
(5) New York Mercantile Exchange Platinum (PL) contract.
(c) Energy commodities. The spot month shall be the period of time
commencing at the close of business of the third business day prior to
the last day of trading in the underlying Core Referenced Futures
Contract and terminating at the end of the delivery period for the
following Referenced Contracts:
(1) New York Mercantile Exchange Light Sweet Crude Oil (CL)
contract;
(2) New York Mercantile Exchange New York Harbor No. 2 Heating Oil
(HO) contract;
(3) New York Mercantile Exchange New York Harbor Gasoline
Blendstock (RB) contract; and
(4) New York Mercantile Exchange Henry Hub Natural Gas (NG)
contract.
Sec. 151.4 Position limits for Referenced Contracts.
(a) Spot-month position limits. In accordance with the procedure in
paragraph (d) of this section, and except as provided or as otherwise
authorized by Sec. 151.5, no trader may hold or control a position,
separately or in combination, net long or net short, in Referenced
Contracts in the same commodity when such position is in excess of:
(1) For physical-delivery Referenced Contracts, a spot-month
position limit that shall be based on one-quarter of the estimated
spot-month deliverable supply as established by the Commission pursuant
to paragraphs (d)(1) and (d)(2) of this section; and
(2) For cash-settled Referenced Contracts:
(i) A spot-month position limit that shall be based on one-quarter
of the
[[Page 71687]]
estimated spot-month deliverable supply as established by the
Commission pursuant to paragraphs (d)(1) and (d)(2) of this section.
Provided, however,
(ii) For New York Mercantile Exchange Henry Hub Natural Gas
Referenced Contracts:
(A) A spot-month position limit equal to five times the spot-month
position limit established by the Commission for the physical-delivery
New York Mercantile Exchange Henry Hub Natural Gas Referenced Contract
pursuant to paragraph (a)(1); and
(B) An aggregate spot-month position limit for physical-delivery
and cash-settled New York Mercantile Exchange Henry Hub Natural Gas
Referenced Contracts equal to five times the spot-month position limit
established by the Commission for the physical-delivery New York
Mercantile Exchange Henry Hub Natural Gas Referenced Contract pursuant
to paragraph (a)(1).
(b) Non-spot-month position limits. In accordance with the
procedure in paragraph (d) of this section, and except as otherwise
authorized in Sec. 151.5, no person may hold or control positions,
separately or in combination, net long or net short, in the same
commodity when such positions, in all months combined (including the
spot month) or in a single month, are in excess of:
(1) Non-legacy Referenced Contract position limits. All-months-
combined aggregate and single-month position limits, fixed by the
Commission based on 10 percent of the first 25,000 contracts of average
all-months-combined aggregated open interest with a marginal increase
of 2.5 percent thereafter as established by the Commission pursuant to
paragraph (d)(3) of this section;
(2) Aggregate open interest calculations for non-spot-month
position limits for non-legacy Referenced Contracts. (i) For the
purpose of fixing the speculative position limits for non-legacy
Referenced Contracts in paragraph (b)(1) of this section, the
Commission shall determine:
(A) The average all-months-combined aggregate open interest, which
shall be equal to the sum, for 12 or 24 months of values obtained under
paragraph (B) and (C) of this section for a period of 12 or 24 months
prior to the fixing date divided by 12 or 24 respectively as of the
last day of each calendar month;
(B) The all-months-combined futures open interest of a Referenced
Contract is equal to the sum of the month-end open interest for all of
the Referenced Contract's open contract months in futures and option
contracts (on a delta adjusted basis) across all designated contract
markets; and
(C) The all-months-combined swaps open interest is equal to the sum
of all of a Referenced Contract's month-end open swaps positions,
considering open positions attributed to both cleared and uncleared
swaps, where the uncleared all-months-combined swaps open positions
shall be the absolute sum of swap dealers' net uncleared open swaps
positions by counterparty and by single Referenced Contract month as
reported to the Commission pursuant to part 20 of this chapter,
provided that, other than for the purpose of determining initial non-
spot-month position limits, open swaps positions attributed to swaps
with two swap dealer counterparties shall be counted once for the
purpose of determining uncleared all-months-combined swaps open
positions, provided further that, upon entry of an order under Sec.
20.9 of this chapter determining that operating swap data repositories
are processing positional data that will enable the Commission
effectively to conduct surveillance in swaps, the Commission shall rely
on data from such swap data repositories to compute the all-months-
combined swaps open interest;
(ii) Notwithstanding the provisions of this section, for the
purpose of determining initial non-spot-month position limits for non-
legacy Referenced Contracts, the Commission may estimate uncleared all-
months-combined swaps open positions based on uncleared open swaps
positions reported to the Commission pursuant to part 20 of this
chapter by clearing organizations or clearing members that are swap
dealers; and
(3) Legacy agricultural Referenced Contract position limits. All-
months-combined aggregate and single-month position limits, fixed by
the Commission at the levels provided below as established by the
Commission pursuant to paragraph (d)(4) of this section:
------------------------------------------------------------------------
Referenced contract Position limits
------------------------------------------------------------------------
(i) Chicago Board of Trade Corn (C) contract........ 33,000
(ii) Chicago Board of Trade Oats (O) contract....... 2,000
(iii) Chicago Board of Trade Soybeans (S) contract.. 15,000
(iv) Chicago Board of Trade Wheat (W) contract...... 12,000
(v) Chicago Board of Trade Soybean Oil (BO) contract 8,000
(vi) Chicago Board of Trade Soybean Meal (SM) 6,500
contract...........................................
(vii) Minneapolis Grain Exchange Hard Red Spring 12,000
Wheat (MW) contract................................
(viii) ICE Futures U.S. Cotton No. 2 (CT) contract.. 5,000
(ix) Kansas City Board of Trade Hard Winter Wheat 12,000
(KW) contract......................................
------------------------------------------------------------------------
(c) Netting of positions. (1) For Referenced Contracts in the spot
month. (i) For the spot-month position limit in paragraph (a) of this
section, a trader's positions in the physical-delivery Referenced
Contract and cash-settled Referenced Contract are calculated
separately. A trader cannot net any physical-delivery Referenced
Contract with cash-settled Referenced Contracts towards determining the
trader's positions in each of the physical-delivery Referenced Contract
and cash-settled Referenced Contracts in paragraph (a) of this section.
However, a trader can net positions in cash-settled Referenced
Contracts in the same commodity.
(ii) Notwithstanding the netting provision in paragraph (c)(1)(i)
of this section, for the aggregate spot-month position limit in New
York Mercantile Exchange Henry Hub Natural Gas Referenced Contracts in
paragraph (a)(2)(ii) of this section, a trader's positions shall be
combined and the net resulting position in the physical-delivery
Referenced Contract and cash-settled Referenced Contracts shall be
applied towards determining the trader's aggregate position.
(2) For the purpose of applying non-spot-month position limits, a
trader's position in a Referenced Contract shall be combined and the
net resulting position shall be applied towards determining the
trader's aggregate single-month and all-months-combined position.
(d) Establishing and effective dates of position limits. (1)
Initial spot-month position limits for Referenced Contracts. (i) Sixty
days after the term ``swap'' is
[[Page 71688]]
further defined under the Wall Street Transparency and Accountability
Act of 2010, the spot-month position limits for Referenced Contracts
referred to in Appendix A shall apply to all the provisions of this
part.
(2) Subsequent spot-month position limits for Referenced Contracts.
(i) Commencing January 1st of the second calendar year after the term
``swap'' is further defined under the Wall Street Transparency and
Accountability Act of 2010, the Commission shall fix position limits by
Commission order that shall supersede the initial limits established
under paragraph (d)(1) of this section.
(ii) In fixing spot-month position limits for Referenced Contracts,
the Commission shall utilize the estimates of deliverable supply
provided by a designated contract market under paragraph (d)(2)(iii) of
this section unless the Commission determines to rely on its own
estimate of deliverable supply.
(iii) Each designated contract market shall submit to the
Commission an estimate of deliverable supply for each Core Referenced
Futures Contract that is subject to a spot-month position limit and
listed or executed pursuant to the rules of the designated contract
market according to the following schedule commencing January 1st of
the second calendar year after the term ``swap'' is further defined
under the Wall Street Transparency and Accountability Act of 2010:
(A) For metal Core Referenced Futures Contracts listed in Sec.
151.2(b), by the 31st of December and biennially thereafter;
(B) For energy Core Referenced Futures Contracts listed in Sec.
151.2(c), by the 31st of March and biennially thereafter;
(C) For corn, wheat, oat, rough rice, soybean and soybean products,
livestock, milk, cotton, and frozen concentrated orange juice Core
Referenced Futures Contracts, by the 31st of July, and annually
thereafter;
(D) For coffee, sugar, and cocoa Core Referenced Futures Contracts,
by the 30th of September, and annually thereafter.
(iv) For purposes of estimating deliverable supply, a designated
contract market may use any guidance adopted in the Acceptable
Practices for Compliance with Core Principle 3 found in part 38 of the
Commission's regulations.
(v) The estimate submitted under paragraph (d)(2)(iii) of this
section shall be accompanied by a description of the methodology used
to derive the estimate along with any statistical data supporting the
designated contract market's estimate of deliverable supply.
(vi) The Commission shall fix and publish pursuant to paragraph (e)
of this section, the spot-month limits by Commission order, no later
than:
(A) For metal Referenced Contracts listed in Sec. 151.2(b), by the
28th of February following the submission of estimates of deliverable
supply provided to the Commission under paragraph (d)(2)(iii)(A) of
this section and biennially thereafter;
(B) For energy Referenced Contracts listed in Sec. 151.2(c), by
the 31st of May following the submission of estimates of deliverable
supply provided to the Commission under paragraph (d)(2)(iii)(B) of
this section and biennially thereafter;
(C) For corn, wheat, oat, rough rice, soybean and soybean products,
livestock, milk, cotton, and frozen concentrated orange juice
Referenced Contracts, by the 30th of September following the submission
of estimates of deliverable supply provided to the Commission under
paragraph (d)(2)(iii)(C) of this section and annually thereafter;
(D) For coffee, sugar, and cocoa Referenced Contracts, by the 30th
of November following the submission of estimates of deliverable supply
provided to the Commission under paragraph (d)(2)(iii)(D) of this
section and annually thereafter.
(3) Non-spot-month position limits for non-legacy Referenced
Contract. (i) Initial non-spot-month limits for non-legacy Referenced
Contracts shall be fixed and published within one month after the
Commission has obtained or estimated 12 months of values pursuant to
paragraphs (b)(2)(i)(B), (b)(2)(i)(C), and (b)(2)(ii) of this section,
and shall be fixed and made effective as provided in paragraph (b)(2)
and (e) of this section.
(ii) Subsequent non-spot-month limits for non-legacy Referenced
Contracts shall be fixed and published within one month after two years
following the fixing and publication of initial non-spot-month position
limits and shall be based on the higher of 12 months average all-
months-combined aggregate open interest, or 24 months average all-
months-combined aggregate open interest, as provided for in paragraphs
(b)(2) and (e) of this section.
(iii) Initial non-spot-month limits for non-legacy Referenced
Contracts shall be made effective by Commission order.
(4) Non-spot-month legacy limits for legacy agricultural Referenced
Contracts. The non-spot-month position limits for legacy agricultural
Referenced Contracts shall be effective sixty days after the term
``swap'' is further defined under the Wall Street Transparency and
Accountability Act of 2010, and shall apply to all the provisions of
this part.
(e) Publication. The Commission shall publish position limits on
the Commission's Web site at http://www.cftc.gov prior to making such
limits effective, other than those limits specified under paragraph
(b)(3) of this section and appendix A to this part.
(1) Spot-month position limits shall be effective:
(i) For metal Referenced Contracts listed in Sec. 151.2(b), on the
1st of May after the Commission has fixed and published such limits
under paragraph (d)(2)(vi)(A) of this section;
(ii) For energy Referenced Contracts listed in Sec. 151.2(c), on
the 1st of August after the Commission has fixed and published such
limits under paragraph (d)(2)(vi)(B) of this section;
(iii) For corn, wheat, oat, rough rice, soybean and soybean
products, livestock, milk, cotton, and frozen concentrated orange juice
Referenced Contracts, on the 1st of December after the Commission has
fixed and published such limits under paragraph (d)(2)(vi)(C) of this
section; and
(iv) For coffee, sugar, and cocoa Referenced Contracts, on the 1st
of February after the Commission has fixed and published such limits
under paragraph (d)(2)(vi)(D) of this section.
(2) The Commission shall publish month-end all-months-combined
futures open interest and all-months-combined swaps open interest
figures within one month, as practicable, after such data is submitted
to the Commission.
(3) Non-spot-month position limits established under paragraph
(b)(2) of this section shall be effective on the 1st calendar day of
the third calendar month immediately following publication on the
Commission's Web site under paragraph (d)(3) of this section.
(f) Rounding. In determining or calculating all levels and limits
under this section, a resulting number shall be rounded up to the
nearest hundred contracts.
Sec. 151.5 Bona fide hedging and other exemptions for Referenced
Contracts.
(a) Bona fide hedging transactions or positions. (1) Any person
that complies with the requirements of this section may exceed the
position limits set forth in Sec. 151.4 to the extent that a
transaction or position in a Referenced Contract:
(i) Represents a substitute for transactions made or to be made or
positions taken or to be taken at a later time in a physical marketing
channel;
(ii) Is economically appropriate to the reduction of risks in the
conduct and management of a commercial enterprise; and
[[Page 71689]]
(iii) Arises from the potential change in the value of one or
several--
(A) Assets that a person owns, produces, manufactures, processes,
or merchandises or anticipates owning, producing, manufacturing,
processing, or merchandising;
(B) Liabilities that a person owns or anticipates incurring; or
(C) Services that a person provides, purchases, or anticipates
providing or purchasing; or
(iv) Reduces risks attendant to a position resulting from a swap
that--
(A) Was executed opposite a counterparty for which the transaction
would qualify as a bona fide hedging transaction pursuant to paragraph
(a)(1)(i) through (iii) of this section; or
(B) Meets the requirements of paragraphs (a)(1)(i) through (iii) of
this section.
(v) Notwithstanding the foregoing, no transactions or positions
shall be classified as bona fide hedging for purposes of Sec. 151.4
unless such transactions or positions are established and liquidated in
an orderly manner in accordance with sound commercial practices and the
provisions of paragraph (a)(2) of this section regarding enumerated
hedging transactions and positions or paragraphs (a)(3) or (4) of this
section regarding pass-through swaps of this section have been
satisfied.
(2) Enumerated hedging transactions and positions. Bona fide
hedging transactions and positions for the purposes of this paragraph
mean any of the following specific transactions and positions:
(i) Sales of Referenced Contracts that do not exceed in quantity:
(A) Ownership or fixed-price purchase of the contract's underlying
cash commodity by the same person; and
(B) Unsold anticipated production of the same commodity, which may
not exceed one year of production for an agricultural commodity, by the
same person provided that no such position is maintained in any
physical-delivery Referenced Contract during the last five days of
trading of the Core Referenced Futures Contract in an agricultural or
metal commodity or during the spot month for other physical-delivery
contracts.
(ii) Purchases of Referenced Contracts that do not exceed in
quantity:
(A) The fixed-price sale of the contract's underlying cash
commodity by the same person;
(B) The quantity equivalent of fixed-price sales of the cash
products and by-products of such commodity by the same person; and
(C) Unfilled anticipated requirements of the same cash commodity,
which may not exceed one year for agricultural Referenced Contracts,
for processing, manufacturing, or use by the same person, provided that
no such position is maintained in any physical-delivery Referenced
Contract during the last five days of trading of the Core Referenced
Futures Contract in an agricultural or metal commodity or during the
spot month for other physical-delivery contracts.
(iii) Offsetting sales and purchases in Referenced Contracts that
do not exceed in quantity that amount of the same cash commodity that
has been bought and sold by the same person at unfixed prices basis
different delivery months, provided that no such position is maintained
in any physical-delivery Referenced Contract during the last five days
of trading of the Core Referenced Futures Contract in an agricultural
or metal commodity or during the spot month for other physical-delivery
contracts.
(iv) Purchases or sales by an agent who does not own or has not
contracted to sell or purchase the offsetting cash commodity at a fixed
price, provided that the agent is responsible for the merchandising of
the cash positions that is being offset in Referenced Contracts and the
agent has a contractual arrangement with the person who owns the
commodity or holds the cash market commitment being offset.
(v) Anticipated merchandising hedges. Offsetting sales and
purchases in Referenced Contracts that do not exceed in quantity the
amount of the same cash commodity that is anticipated to be
merchandised, provided that:
(A) The quantity of offsetting sales and purchases is not larger
than the current or anticipated unfilled storage capacity owned or
leased by the same person during the period of anticipated
merchandising activity, which may not exceed one year;
(B) The offsetting sales and purchases in Referenced Contracts are
in different contract months, which settle in not more than one year;
and
(C) No such position is maintained in any physical-delivery
Referenced Contract during the last five days of trading of the Core
Referenced Futures Contract in an agricultural or metal commodity or
during the spot month for other physical-delivery contracts.
(vi) Anticipated royalty hedges. Sales or purchases in Referenced
Contracts offset by the anticipated change in value of royalty rights
that are owned by the same person provided that:
(A) The royalty rights arise out of the production, manufacturing,
processing, use, or transportation of the commodity underlying the
Referenced Contract, which may not exceed one year for agricultural
Referenced Contracts; and
(B) No such position is maintained in any physical-delivery
Referenced Contract during the last five days of trading of the Core
Referenced Futures Contract in an agricultural or metal commodity or
during the spot month for other physical-delivery contracts.
(vii) Service hedges. Sales or purchases in Referenced Contracts
offset by the anticipated change in value of receipts or payments due
or expected to be due under an executed contract for services held by
the same person provided that:
(A) The contract for services arises out of the production,
manufacturing, processing, use, or transportation of the commodity
underlying the Referenced Contract, which may not exceed one year for
agricultural Referenced Contracts;
(B) The fluctuations in the value of the position in Referenced
Contracts are substantially related to the fluctuations in value of
receipts or payments due or expected to be due under a contract for
services; and
(C) No such position is maintained in any physical-delivery
Referenced Contract during the last five days of trading of the Core
Referenced Futures Contract in an agricultural or metal commodity or
during the spot month for other physical-delivery contracts.
(viii) Cross-commodity hedges. Sales or purchases in Referenced
Contracts described in paragraphs (a)(2)(i) through (vii) of this
section may also be offset other than by the same quantity of the same
cash commodity, provided that:
(A) The fluctuations in value of the position in Referenced
Contracts are substantially related to the fluctuations in value of the
actual or anticipated cash position; and
(B) No such position is maintained in any physical-delivery
Referenced Contract during the last five days of trading of the Core
Referenced Futures Contract in an agricultural or metal commodity or
during the spot month for other physical-delivery contracts.
(3) Pass-through swaps. Bona fide hedging transactions and
positions for the purposes of this paragraph include the purchase or
sales of Referenced Contracts that reduce the risks attendant to a
position resulting from a swap that was executed opposite a
counterparty for whom the swap transaction would qualify as a bona fide
hedging transaction pursuant to paragraph (a)(2) of this section
(``pass-through swaps''),
[[Page 71690]]
provided that no such position is maintained in any physical-delivery
Referenced Contract during the last five days of trading of the Core
Referenced Futures Contract in an agricultural or metal commodity or
during the spot month for other physical-delivery contracts unless such
pass-through swap position continues to offset the cash market
commodity price risk of the bona fide hedging counterparty.
(4) Pass-through swap offsets. For swaps executed opposite a
counterparty for whom the swap transaction would qualify as a bona fide
hedging transaction pursuant to paragraph (a)(2) of this section (pass-
through swaps), such pass-through swaps shall also be classified as a
bona fide hedging transaction for the counterparty for whom the swap
would not otherwise qualify as a bona fide hedging transaction pursuant
to paragraph (a)(2) of this section (``non-hedging counterparty''),
provided that the non-hedging counterparty purchases or sells
Referenced Contracts that reduce the risks attendant to such pass-
through swaps. Provided further, that the pass-through swap shall
constitute a bona fide hedging transaction only to the extent the non-
hedging counterparty purchases or sells Referenced Contracts that
reduce the risks attendant to the pass-through swap.
(5) Any person engaging in other risk-reducing practices commonly
used in the market which they believe may not be specifically
enumerated in Sec. 151.5(a)(2) may request relief from Commission
staff under Sec. 140.99 of this chapter or the Commission under
section 4a(a)(7) of the Act concerning the applicability of the bona
fide hedging transaction exemption.
(b) Aggregation of accounts. Entities required to aggregate
accounts or positions under Sec. 151.7 shall be considered the same
person for the purpose of determining whether a person or persons are
eligible for a bona fide hedge exemption under Sec. 151.5(a).
(c) Information on cash market commodity activities. Any person
with a position that exceeds the position limits set forth in Sec.
151.4 pursuant to paragraphs (a)(2)(i)(A), (a)(2)(ii)(A),
(a)(2)(ii)(B), (a)(2)(iii), or (a)(2)(iv) of this section shall submit
to the Commission a 404 filing, in the form and manner provided for in
Sec. 151.10.
(1) The 404 filing shall contain the following information with
respect to such position for each business day the same person exceeds
the limits set forth in Sec. 151.4, up to and through the day the
person's position first falls below the position limits:
(i) The date of the bona fide hedging position, an indication of
under which enumerated hedge exemption or exemptions the position
qualifies for bona fide hedging, the corresponding Core Referenced
Futures Contract, the cash market commodity hedged, and the units in
which the cash market commodity is measured;
(ii) The entire quantity of stocks owned of the cash market
commodity that is being hedged;
(iii) The entire quantity of fixed-price purchase commitments of
the cash market commodity that is being hedged;
(iv) The sum of the entire quantity of stocks owned of the cash
market commodity and the entire quantity of fixed-price purchase
commitments of the cash market commodity that is being hedged;
(v) The entire quantity of fixed-price sale commitments of the cash
commodity that is being hedged;
(vi) The quantity of long and short Referenced Contracts, measured
on a futures-equivalent basis to the applicable Core Referenced Futures
Contract, in the nearby contract month that are being used to hedge the
long and short cash market positions;
(viii) The total number of long and short Referenced Contracts,
measured on a futures equivalent basis to the applicable Core
Referenced Futures Contract, that are being used to hedge the long and
short cash market positions; and
(viii) Cross-commodity hedging information as required under
paragraph (g) of this section.
(2) Notice filing. Persons seeking an exemption under this
paragraph shall file a notice with the Commission, which shall be
effective upon the date of the submission of the notice.
(d) Information on anticipated cash market commodity activities.
(1) Initial statement. Any person who intends to exceed the position
limits set forth in Sec. 151.4 pursuant to paragraph (a)(2)(i)(B),
(a)(2)(ii)(C), (a)(2)(v), (a)(2)(vi), or (a)(2)(vii) of this section in
order to hedge anticipated production, requirements, merchandising,
royalties, or services connected to a commodity underlying a Referenced
Contract, shall submit to the Commission a 404A filing in the form and
manner provided in Sec. 151.10. The 404A filing shall contain the
following information with respect to such activities, by Referenced
Contract:
(i) A description of the type of anticipated cash market activity
to be hedged; how the purchases or sales of Referenced Contracts are
consistent with the provisions of (a)(1) of this section; and the units
in which the cash commodity is measured;
(ii) The time period for which the person claims the anticipatory
hedge exemption is required, which may not exceed one year for
agricultural commodities or one year for anticipated merchandising
activity;
(iii) The actual use, production, processing, merchandising (bought
and sold), royalties and service payments and receipts of that cash
market commodity during each of the three complete fiscal years
preceding the current fiscal year;
(iv) The anticipated use production, or commercial or merchandising
requirements (purchases and sales), anticipated royalties, or service
contract receipts or payments of that cash market commodity which are
applicable to the anticipated activity to be hedged for the period
specified in (d)(1)(ii) of this section;
(v) The unsold anticipated production or unfilled anticipated
commercial or merchandising requirements of that cash market commodity
which are applicable to the anticipated activity to be hedged for the
period specified in (d)(1)(ii) of this section;
(vi) The maximum number of Referenced Contracts long and short (on
an all-months-combined basis) that are expected to be used for each
anticipatory hedging activity for the period specified in (d)(1)(ii) of
this section on a futures equivalent basis;
(vii) If the hedge exemption sought is for anticipated
merchandising pursuant to (a)(2)(v) of this section, a description of
the storage capacity related to the anticipated merchandising
transactions, including:
(A) The anticipated total storage capacity, the anticipated
merchandising quantity, and purchase and sales commitments for the
period specified in (d)(1)(ii) of this section;
(B) Current inventory; and
(C) The total storage capacity and quantity of commodity moved
through the storage capacity for each of the three complete fiscal
years preceding the current fiscal year; and
(viii) Cross-commodity hedging information as required under
paragraph (g) of this section.
(2) Notice filing. Persons seeking an exemption under this
paragraph shall file a notice with the Commission. Such a notice shall
be filed at least ten days in advance of a date the person expects to
exceed the position limits established under this part, and shall be
effective after that ten day period unless otherwise notified by the
Commission.
(3) Supplemental reports for 404A filings. Whenever a person
intends to
[[Page 71691]]
exceed the amounts determined by the Commission to constitute a bona
fide hedge for anticipated activity in the most recent statement or
filing, such person shall file with the Commission a statement that
updates the information provided in the person's most recent filing at
least ten days in advance of the date that person wishes to exceed
those amounts.
(e) Review of notice filings. (1) The Commission may require
persons submitting notice filings provided for under paragraphs (c)(2)
and (d)(2) of this section to submit such other information, before or
after the effective date of a notice, which is necessary to enable the
Commission to make a determination whether the transactions or
positions under the notice filing fall within the scope of bona fide
hedging transactions or positions described under paragraph (a) of this
section.
(2) The transactions and positions described in the notice filing
shall not be considered, in part or in whole, as bona fide hedging
transactions or positions if such person is so notified by the
Commission.
(f) Additional information from swap counterparties to bona fide
hedging transactions. All persons that maintain positions in excess of
the limits set forth in Sec. 151.4 in reliance upon the exemptions set
forth in paragraphs (a)(3) and (4) of this section shall submit to the
Commission a 404S filing, in the form and manner provided for in Sec.
151.10. Such 404S filing shall contain the following information with
respect to such position for each business day that the same person
exceeds the limits set forth in Sec. 151.4, up to and through the day
the person's position first falls below the position limit that was
exceeded:
(1) By Referenced Contract;
(2) By commodity reference price and units of measurement used for
the swaps that would qualify as a bona fide hedging transaction or
position gross long and gross short positions; and
(3) Cross-commodity hedging information as required under paragraph
(g) of this section.
(g) Conversion methodology for cross-commodity hedges. In addition
to the information required under this section, persons who avail
themselves of cross-commodity hedges pursuant to (a)(2)(viii) of this
section shall submit to the Commission a form 404, 404A, or 404S
filing, as appropriate. The first time such a form is filed where a
cross-commodity hedge is claimed, it should contain a description of
the conversion methodology. That description should explain the
conversion from the actual commodity used in the person's normal course
of business to the Referenced Contract that is being used for hedging,
including an explanation of the methodology used for determining the
ratio of conversion between the actual or anticipated cash positions
and the person's positions in the Referenced Contract.
(h) Recordkeeping. Persons who avail themselves of bona fide hedge
exemptions shall keep and maintain complete books and records
concerning all of their related cash, futures, and swap positions and
transactions and make such books and records, along with a list of
pass-through swap counterparties for pass-through swap exemptions under
(a)(3) of this section, available to the Commission upon request.
(i) Additional requirements for pass-through swap counterparties. A
party seeking to rely upon Sec. 151.5(a)(3) to exceed the position
limits of Sec. 151.4 with respect to such a swap may only do so if its
counterparty provides a written representation (e.g., in the form of a
field or other representation contained in a mutually executed trade
confirmation) that, as to such counterparty, the swap qualifies in good
faith as a bona fide hedging transaction under paragraph (a)(3) of this
section at the time the swap was executed. That written representation
shall be retained by the parties to the swap for a period of at least
two years following the expiration of the swap and furnished to the
Commission upon request. Any person that represents to another person
that the swap qualifies as a pass-through swap under paragraph (a)(3)
of this section shall keep and make available to the Commission upon
request all relevant books and records supporting such a representation
for a period of at least two years following the expiration of the
swap.
(j) Financial distress exemption. Upon specific request made to the
Commission, the Commission may exempt a person or related persons under
financial distress circumstances for a time certain from any of the
requirements of this part. Financial distress circumstances are
situations involving the potential default or bankruptcy of a customer
of the requesting person or persons, affiliate of the requesting person
or persons, or potential acquisition target of the requesting person or
persons. Such exemptions shall be granted by Commission order.
Sec. 151.6 Position visibility.
(a) Visibility levels. A person holding or controlling positions,
separately or in combination, net long or net short, in Referenced
Contracts that equal or exceed the following levels in all months or in
any single month (including the spot month), shall comply with the
reporting requirements of paragraphs (b) and (c) of this section:
------------------------------------------------------------------------
------------------------------------------------------------------------
(1) Visibility Levels for Metal Referenced Contracts
------------------------------------------------------------------------
(i) Commodity Exchange, Inc. Copper (HG)............ 8,500
(ii) Commodity Exchange, Inc. Gold (GC)............. 30,000
(iv) Commodity Exchange, Inc. Silver (SI)........... 8,500
(v) New York Mercantile Exchange Palladium (PA)..... 1,500
(vi) New York Mercantile Exchange Platinum (PL)..... 2,000
------------------------------------------------------------------------
(2) Visibility Levels for Energy Referenced Contracts
------------------------------------------------------------------------
(i) New York Mercantile Exchange Light Sweet Crude 50,000
Oil (CL)...........................................
(ii) New York Mercantile Exchange Henry Hub Natural 50,000
Gas (NG)...........................................
(iii) New York Mercantile Exchange New York Harbor 10,000
Gasoline Blendstock (RB)...........................
(iv) New York Mercantile Exchange New York Harbor 16,000
No. 2 Heating Oil (HO).............................
------------------------------------------------------------------------
(b) Statement of person exceeding visibility level. Persons
meeting the provisions of paragraph (a) of this section, shall submit
to the Commission a 401 filing in the form and manner provided for in
Sec. 151.10. The 401 filing shall contain the following information,
by Referenced Contract:
(1) A list of dates, within the applicable calendar quarter, on
which the person held or controlled a position
[[Page 71692]]
that equaled or exceeded such visibility levels; and
(2) As of the first business Tuesday following the applicable
calendar quarter and as of the day, within the applicable calendar
quarter, in which the person held the largest net position (on an all
months combined basis) in excess of the level in paragraph (a) of this
section:
(i) Separately by futures, options and swaps, gross long and gross
short futures equivalent positions in all months in the applicable
Referenced Contract(s) (using economically reasonable and analytically
supported deltas) on a futures-equivalent basis; and
(ii) If applicable, by commodity referenced price, gross long and
gross short uncleared swap positions in all months basis in the
applicable Referenced Contract(s) futures-equivalent basis (using
economically reasonable and analytically supported deltas).
(c) 404 filing. A person that holds a position in a Referenced
Contract that equals or exceeds a visibility level in a calendar
quarter shall submit to the Commission a 404 filing in the form and
manner provided for in Sec. 151.10, and it shall contain the
information regarding such positions as described in Sec. 151.5(c) as
of the first business Tuesday following the applicable calendar quarter
and as of the day, within the applicable calendar quarter, in which the
person held the largest net position in excess of the level in all
months.
(d) Alternative filing. With the express written permission of the
Commission or its designees, the submission of a swaps or physical
commodity portfolio summary statement spreadsheet in digital format,
only insofar as the spreadsheet provides at least the same data as that
required by paragraphs (b) or (c) of this section respectively may be
substituted for the 401 or 404 filing respectively.
(e) Precedence of other reporting obligations. Reporting
obligations imposed by regulations other than those contained in this
section shall supersede the reporting requirements of paragraphs (b)
and (c) of this section but only insofar as other reporting obligations
provide at least the same data and are submitted to the Commission or
its designees at least as often as the reporting requirements of
paragraphs (b) and (c) of this section.
(f) Compliance date. The compliance date of this section shall be
sixty days after the term ``swap'' is further defined under the Wall
Street Transparency and Accountability Act of 2010. A document will be
published in the Federal Register establishing the compliance date.
Sec. 151.7 Aggregation of positions.
(a) Positions to be aggregated. The position limits set forth in
Sec. 151.4 shall apply to all positions in accounts for which any
person by power of attorney or otherwise directly or indirectly holds
positions or controls trading and to positions held by two or more
persons acting pursuant to an expressed or implied agreement or
understanding the same as if the positions were held by, or the trading
of the position were done by, a single individual.
(b) Ownership of accounts generally. For the purpose of applying
the position limits set forth in Sec. 151.4, except for the ownership
interest of limited partners, shareholders, members of a limited
liability company, beneficiaries of a trust or similar type of pool
participant in a commodity pool subject to the provisos set forth in
paragraph (c) of this section or in accounts or positions in multiple
pools as set forth in paragraph (d) of this section, any person holding
positions in more than one account, or holding accounts or positions in
which the person by power of attorney or otherwise directly or
indirectly has a 10 percent or greater ownership or equity interest,
must aggregate all such accounts or positions.
(c) Ownership by limited partners, shareholders or other pool
participants. (1) Except as provided in paragraphs (c)(2) and (3) of
this section, a person that is a limited partner, shareholder or other
similar type of pool participant with an ownership or equity interest
of 10 percent or greater in a pooled account or positions who is also a
principal or affiliate of the operator of the pooled account must
aggregate the pooled account or positions with all other accounts or
positions owned or controlled by that person, unless:
(i) The pool operator has, and enforces, written procedures to
preclude the person from having knowledge of, gaining access to, or
receiving data about the trading or positions of the pool;
(ii) The person does not have direct, day-to-day supervisory
authority or control over the pool's trading decisions; and
(iii) The pool operator has complied with the requirements of
paragraph (h) of this section on behalf of the person or class of
persons.
(2) A commodity pool operator having ownership or equity interest
of 10 percent or greater in an account or positions as a limited
partner, shareholder or other similar type of pool participant must
aggregate those accounts or positions with all other accounts or
positions owned or controlled by the commodity pool operator.
(3) Each limited partner, shareholder, or other similar type of
pool participant having an ownership or equity interest of 25 percent
or greater in a commodity pool the operator of which is exempt from
registration under Sec. 4.13 of this chapter must aggregate the pooled
account or positions with all other accounts or positions owned or
controlled by that person.
(d) Identical trading. Notwithstanding any other provision of this
section, for the purpose of applying the position limits set forth in
Sec. 151.4, any person that holds or controls the trading of
positions, by power of attorney or otherwise, in more than one account,
or that holds or controls trading of accounts or positions in multiple
pools with identical trading strategies must aggregate all such
accounts or positions that a person holds or controls.
(e) Trading control by futures commission merchants. The position
limits set forth in Sec. 151.4 shall be construed to apply to all
positions held by a futures commission merchant or its separately
organized affiliates in a discretionary account, or in an account which
is part of, or participates in, or receives trading advice from a
customer trading program of a futures commission merchant or any of the
officers, partners, or employees of such futures commission merchant or
its separately organized affiliates, unless:
(1) A trader other than the futures commission merchant or the
affiliate directs trading in such an account;
(2) The futures commission merchant or the affiliate maintains only
such minimum control over the trading in such an account as is
necessary to fulfill its duty to supervise diligently trading in the
account; and
(3) Each trading decision of the discretionary account or the
customer trading program is determined independently of all trading
decisions in other accounts which the futures commission merchant or
the affiliate holds, has a financial interest of 10 percent or more in,
or controls.
(f) Independent Account Controller. An eligible entity need not
aggregate its positions with the eligible entity's client positions or
accounts carried by an authorized independent account controller, as
defined in Sec. 151.1, except for the spot month provided in physical-
delivery Referenced Contracts, provided, however, that the eligible
entity has complied with the requirements of paragraph (h) of this
section, and that the overall positions
[[Page 71693]]
held or controlled by such independent account controller may not
exceed the limits specified in Sec. 151.4.
(1) Additional requirements for exemption of Affiliated Entities.
If the independent account controller is affiliated with the eligible
entity or another independent account controller, each of the
affiliated entities must:
(i) Have, and enforce, written procedures to preclude the
affiliated entities from having knowledge of, gaining access to, or
receiving data about, trades of the other. Such procedures must include
document routing and other procedures or security arrangements,
including separate physical locations, which would maintain the
independence of their activities; provided, however, that such
procedures may provide for the disclosure of information which is
reasonably necessary for an eligible entity to maintain the level of
control consistent with its fiduciary responsibilities and necessary to
fulfill its duty to supervise diligently the trading done on its
behalf;
(ii) Trade such accounts pursuant to separately developed and
independent trading systems;
(iii) Market such trading systems separately; and
(iv) Solicit funds for such trading by separate disclosure
documents that meet the standards of Sec. 4.24 or Sec. 4.34 of this
chapter, as applicable where such disclosure documents are required
under part 4 of this chapter.
(g) Exemption for underwriting. Notwithstanding any of the
provisions of this section, a person need not aggregate the positions
or accounts of an owned entity if the ownership interest is based on
the ownership of securities constituting the whole or a part of an
unsold allotment to or subscription by such person as a participant in
the distribution of such securities by the issuer or by or through an
underwriter.
(h) Notice filing for exemption. (1) Persons seeking an aggregation
exemption under paragraph (c), (e), (f), or (i) of this section shall
file a notice with the Commission, which shall be effective upon
submission of the notice, and shall include:
(i) A description of the relevant circumstances that warrant
disaggregation; and
(ii) A statement certifying that the conditions set forth in the
applicable aggregation exemption provision has been met.
(2) Upon call by the Commission, any person claiming an aggregation
exemption under this section shall provide to the Commission such
information concerning the person's claim for exemption. Upon notice
and opportunity for the affected person to respond, the Commission may
amend, suspend, terminate, or otherwise modify a person's aggregation
exemption for failure to comply with the provisions of this section.
(3) In the event of a material change to the information provided
in the notice filed under this paragraph, an updated or amended notice
shall promptly be filed detailing the material change.
(4) A notice shall be submitted in the form and manner provided for
in Sec. 151.10.
(i) Exemption for federal law information sharing restriction.
Notwithstanding any provision of this section, a person is not subject
to the aggregation requirements of this section if the sharing of
information associated with such aggregation would cause either person
to violate Federal law or regulations adopted thereunder and provided
that such a person does not have actual knowledge of information
associated with such aggregation. Provided, however, that such person
file a prior notice with the Commission detailing the circumstances of
the exemption and an opinion of counsel that the sharing of information
would cause a violation of Federal law or regulations adopted
thereunder.
Sec. 151.8 Foreign boards of trade.
The aggregate position limits in Sec. 151.4 shall apply to a
trader with positions in Referenced Contracts executed on, or pursuant
to the rules of a foreign board of trade, provided that:
(a) Such Referenced Contracts settle against any price (including
the daily or final settlement price) of one or more contracts listed
for trading on a designated contract market or swap execution facility
that is a trading facility; and
(b) The foreign board of trade makes available such Referenced
Contracts to its members or other participants located in the United
States through direct access to its electronic trading and order
matching system.
Sec. 151.9 Pre-existing positions.
(a) Non-spot-month position limits. The position limits set forth
in Sec. 151.4(b) of this chapter may be exceeded to the extent that
positions in Referenced Contracts remain open and were entered into in
good faith prior to the effective date of any rule, regulation, or
order that specifies a position limit under this part.
(b) Spot-month position limits. Notwithstanding the pre-existing
exemption in non-spot months, a person must comply with spot month
limits.
(c) Pre-Dodd-Frank and transition period swaps. The initial
position limits established under Sec. 151.4 shall not apply to any
swap positions entered into in good faith prior to the effective date
of such initial limits. Swap positions in Referenced Contracts entered
into in good faith prior to the effective date of such initial limits
may be netted with post-effective date swap and swaptions for the
purpose of applying any position limit.
(d) Exemptions. Exemptions granted by the Commission under Sec.
1.47 for swap risk management shall not apply to swap positions entered
into after the effective date of initial position limits established
under Sec. 151.4.
Sec. 151.10 Form and manner of reporting and submitting information
or filings.
Unless otherwise instructed by the Commission or its designees, any
person submitting reports under this section shall submit the
corresponding required filings and any other information required under
this part to the Commission as follows:
(a) Using the format, coding structure, and electronic data
transmission procedures approved in writing by the Commission; and
(b) Not later than 9 a.m. Eastern Time on the next business day
following the reporting or filing obligation is incurred unless:
(1) A 404A filing is submitted pursuant Sec. 151.5(d), in which
case the filing must be submitted at least ten business days in advance
of the date that transactions and positions would be established that
would exceed a position limit set forth in Sec. 151.4;
(2) A 404 filing is submitted pursuant to Sec. 151.5(c) or a 404S
is submitted pursuant to Sec. 151.5(f), the filing must be submitted
not later than 9 a.m. on the third business day after a position has
exceeded the level in a Referenced Contract for the first time and not
later than the third business day following each calendar month in
which the person exceeded such levels;
(3) The filing is submitted pursuant to Sec. 151.6, then the 401
or 404, or their respective alternatives as provided for under Sec.
151.6(d), shall be submitted within ten business days following the
quarter in which the person holds a position in excess in the
visibility levels provided in Sec. 151.6(a); or
(4) A notice of disaggregation is filed pursuant to Sec. 151.7(h),
in which case the notice shall be submitted within five business days
of when the person claims a disaggregation exemption.
[[Page 71694]]
(e) When the reporting entity discovers errors or omissions to past
reports, the entity so notifies the Commission and files corrected
information in a form and manner and at a time as may be instructed by
the Commission or its designee.
Sec. 151.11 Designated contract market and swap execution facility
position limits and accountability rules.
(a) Spot-month limits. (1) For all Referenced Contracts executed
pursuant to their rules, swap execution facilities that are trading
facilities and designated contract markets shall adopt, enforce, and,
establish rules and procedures for monitoring and enforcing spot-month
position limits set at levels no greater than those established by the
Commission under Sec. 151.4.
(2) For all agreements, contracts, or transactions executed
pursuant to their rules that are not subject to the limits set forth in
paragraph (a)(1) of this section, it shall be an acceptable practice
for swap execution facilities that are trading facilities and
designated contract markets to adopt, enforce, and establish rules and
procedures for monitoring and enforcing spot-month position limits set
at levels no greater than 25 percent of estimated deliverable supply,
consistent with Commission guidance set forth in this title.
(b) Non-spot-month limits. (1) Referenced Contracts. For Referenced
Contracts executed pursuant to their rules, swap execution facilities
that are trading facilities and designated contract markets shall adopt
enforce, and establish rules and procedures for monitoring and
enforcing single month and all-months limits at levels no greater than
the position limits established by the Commission under Sec.
151.4(d)(3) or (4).
(2) Non-referenced contracts. For all other agreements, contracts,
or transactions executed pursuant to their rules that are not subject
to the limits set forth in Sec. 151.4, except as provided in Sec.
151.11(b)(3) and (c), it shall be an acceptable practice for swap
execution facilities that are trading facilities and designated
contract markets to adopt, enforce, and establish rules and procedures
for monitoring and enforcing single-month and all-months-combined
position limits at levels no greater than ten percent of the average
delta-adjusted futures, swaps, and options month-end all months open
interest in the same contract or economically equivalent contracts
executed pursuant to the rules of the designated contract market or
swap execution facility that is a trading facility for the greater of
the most recent one or two calendar years up to 25,000 contracts with a
marginal increase of 2.5 percent thereafter.
(3) Levels at designation or initial listing. Other than in
Referenced Contracts, at the time of its initial designation or upon
offering a new contract, agreement, or transaction to be executed
pursuant to its rules, it shall be an acceptable practice for a
designated contract market or swap execution facility that is a trading
facility to provide for speculative limits for an individual single-
month or in all-months-combined at no greater than 1,000 contracts for
physical commodities other than energy commodities and 5,000 contracts
for other commodities, provided that the notional quantity for such
contracts, agreements, or transactions, corresponds to a notional
quantity per contract that is no larger than a typical cash market
transaction in the underlying commodity.
(4) For purposes of this paragraph, it shall be an acceptable
practice for open interest to be calculated by combining the all months
month-end open interest in the same contract or economically equivalent
contracts executed pursuant to the rules of the designated contract
market or swap execution facility that is a trading facility (on a
delta-adjusted basis, as appropriate) for all months listed during the
most recent one or two calendar years.
(c) Alternatives. In lieu of the limits provided for under Sec.
151.11(a)(2) or (b)(2), it shall be an acceptable practice for swap
execution facilities that are trading facilities and designated
contract markets to adopt, enforce, and establish rules and procedures
for monitoring and enforcing position accountability rules with respect
to any agreement, contract, or transaction executed pursuant to their
rules requiring traders to provide information about their position
upon request by the exchange and to consent to halt increasing further
a trader's position upon request by the exchange as follows:
(1) On an agricultural or exempt commodity that is not subject to
the limits set forth in Sec. 151.4, having an average month-end open
interest of 50,000 contracts and an average daily volume of 5,000
contracts and a liquid cash market, provided, however, such swap
execution facilities that are trading facilities and designated
contract markets are not exempt from the requirement set forth in
paragraph (a)(2) that they adopt a spot-month position limit with a
level no greater than 25 percent of estimated deliverable supply; or
(2) On a major foreign currency, for which there is no legal
impediment to delivery and for which there exists a highly liquid cash
market; or
(3) On an excluded commodity that is an index or measure of
inflation, or other macroeconomic index or measure; or
(4) On an excluded commodity that meets the definition of section
1a(19)(ii), (iii), or (iv) of the Act.
(d) Securities futures products. Position limits for securities
futures products are specified in 17 CFR part 41.
(e) Aggregation. Position limits or accountability rules
established under this section shall be subject to the aggregation
standards of Sec. 151.7.
(f) Exemptions. (1) Hedge exemptions. (i) For purposes of exempt
and agricultural commodities, no designated contract market or swap
execution facility that is a trading facility bylaw, rule, regulation,
or resolution adopted pursuant to this section shall apply to any
position that would otherwise be exempt from the applicable Federal
speculative position limits as determined by Sec. 151.5; provided,
however, that the designated contract market or swap execution facility
that is a trading facility may limit bona fide hedging positions or any
other positions which have been exempted pursuant to Sec. 151.5 which
it determines are not in accord with sound commercial practices or
exceed an amount which may be established and liquidated in an orderly
fashion.
(ii) For purposes of excluded commodities, no designated contract
market or swap execution facility that is a trading facility by law,
rule, regulation, or resolution adopted pursuant to this section shall
apply to any transaction or position defined under Sec. 1.3(z) of this
chapter; provided, however, that the designated contract market or swap
execution facility that is a trading facility may limit bona fide
hedging positions that it determines are not in accord with sound
commercial practices or exceed an amount which may be established and
liquidated in an orderly fashion.
(2) Procedure. Persons seeking to establish eligibility for an
exemption must comply with the procedures of the designated contract
market or swap execution facility that is a trading facility for
granting exemptions from its speculative position limit rules. In
considering whether to permit or grant an exemption, a designated
contract market or swap execution facility that is a trading facility
must take into account sound commercial practices and
[[Page 71695]]
paragraph (d)(1) of this section and apply principles consistent with
Sec. 151.5.
(g) Other exemptions. Speculative position limits adopted pursuant
to this section shall not apply to:
(1) Any position acquired in good faith prior to the effective date
of any bylaw, rule, regulation, or resolution which specifies such
limit;
(2) Spread or arbitrage positions either in positions in related
Referenced Contracts or, for contracts that are not Referenced
Contracts, economically equivalent contracts provided that such
positions are outside of the spot month for physical-delivery
contracts; or
(3) Any person that is registered as a futures commission merchant
or floor broker under authority of the Act, except to the extent that
transactions made by such person are made on behalf of or for the
account or benefit of such person.
(h) Ongoing responsibilities. Nothing in this part shall be
construed to affect any provisions of the Act relating to manipulation
or corners or to relieve any designated contract market, swap execution
facility that is a trading facility, or governing board of a designated
contract market or swap execution facility that is a trading facility
from its responsibility under other provisions of the Act and
regulations.
(i) Compliance date. The compliance date of this section shall be
60 days after the term ``swap'' is further defined under the Wall
Street Transparency and Accountability Act of 2010. A document will be
published in the Federal Register establishing the compliance date.
(j) Notwithstanding paragraph (i) of this section, the compliance
date of provisions of paragraph (b)(1) of this section as it applies to
non-legacy Referenced Contracts shall be upon the establishment of any
non-spot-month position limits pursuant to Sec. 151.4(d)(3). In the
period prior to the establishment of any non-spot-month position limits
pursuant to Sec. 151.4(d)(3) it shall be an acceptable practice for a
designated contract market or swap execution facility to either:
(1) Retain existing non-spot-month position limits or
accountability rules; or
(2) Establish non-spot-month position limits or accountability
levels pursuant to the acceptable practice described in Sec.
151.11(b)(2) and (c)(1) based on open interest in the same contract or
economically equivalent contracts executed pursuant to the rules of the
designated contract market or swap execution facility that is a trading
facility.
Sec. 151.12 Delegation of authority to the Director of the Division
of Market Oversight.
(a) The Commission hereby delegates, until it orders otherwise, to
the Director of the Division of Market Oversight or such other employee
or employees as the Director may designate from time to time, the
authority:
(1) In Sec. 151.4(b) for determining levels of open interest, in
Sec. 151.4(d)(2)(ii) to estimate deliverable supply, in Sec.
151.4(d)(3)(ii) to fix non-spot-month limits, and in Sec. 151.4(e) to
publish position limit levels.
(2) In Sec. 151.5 requesting additional information or determining
whether a filing should not be considered as bona fide hedging;
(3) In Sec. 151.6 for accepting alternative position visibility
filings under paragraphs (c)(2) and (d) therein;
(4) In Sec. 151.7(h)(2) to call for additional information from a
trader claiming an aggregation exemption;
(5) In Sec. 151.10 for providing instructions or determining the
format, coding structure, and electronic data transmission procedures
for submitting data records and any other information required under
this part.
(b) The Director of the Division of Market Oversight may submit to
the Commission for its consideration any matter which has been
delegated in this section.
(c) Nothing in this section prohibits the Commission, at its
election, from exercising the authority delegated in this section.
Sec. 151.13 Severability.
If any provision of this part, or the application thereof to any
person or circumstances, is held invalid, such invalidity shall not
affect other provisions or application of such provision to other
persons or circumstances which can be given effect without the invalid
provision or application.
Appendix A to Part 151--Spot-Month Position Limits
------------------------------------------------------------------------
Referenced
Contract contract spot-
month limit
------------------------------------------------------------------------
Agricultural Referenced Contracts
------------------------------------------------------------------------
ICE Futures U.S. Cocoa............................... 1,000
ICE Futures U.S. Coffee C............................ 500
Chicago Board of Trade Corn.......................... 600
ICE Futures U.S. Cotton No. 2........................ 300
ICE Futures U.S. FCOJ-A.............................. 300
Chicago Mercantile Exchange Class III Milk........... 1,500
Chicago Mercantile Exchange Feeder Cattle............ 300
Chicago Mercantile Exchange Lean Hog................. 950
Chicago Mercantile Exchange Live Cattle.............. 450
Chicago Board of Trade Oats.......................... 600
Chicago Board of Trade Rough Rice.................... 600
Chicago Board of Trade Soybeans...................... 600
Chicago Board of Trade Soybean Meal.................. 720
Chicago Board of Trade Soybean Oil................... 540
ICE Futures U.S. Sugar No. 11........................ 5,000
ICE Futures U.S. Sugar No. 16........................ 1,000
Chicago Board of Trade Wheat......................... 600
Minneapolis Grain Exchange Hard Red Spring Wheat..... 600
Kansas City Board of Trade Hard Winter Wheat......... 600
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Metal Referenced Contracts
------------------------------------------------------------------------
Commodity Exchange, Inc. Copper...................... 1,200
New York Mercantile Exchange Palladium............... 650
[[Page 71696]]
New York Mercantile Exchange Platinum................ 500
Commodity Exchange, Inc. Gold........................ 3,000
Commodity Exchange, Inc. Silver...................... 1,500
------------------------------------------------------------------------
Energy Referenced Contracts
------------------------------------------------------------------------
New York Mercantile Exchange Light Sweet Crude Oil... 3,000
New York Mercantile Exchange New York Harbor Gasoline 1,000
Blendstock..........................................
New York Mercantile Exchange Henry Hub Natural Gas... 1,000
New York Mercantile Exchange New York Harbor Heating 1,000
Oil.................................................
------------------------------------------------------------------------
Appendix B to Part 151--Examples of Bona Fide Hedging Transactions and
Positions
A non-exhaustive list of examples of bona fide hedging
transactions or positions under Sec. 151.5 is presented below. A
transaction or position qualifies as a bona fide hedging transaction
or position when it meets the requirements under Sec. 151.5(a)(1)
and one of the enumerated provisions under Sec. 151.5(a)(2). With
respect to a transaction or position that does not fall within an
example in this Appendix, a person seeking to rely on a bona fide
hedging exemption under Sec. 151.5 may seek guidance from the
Division of Market Oversight.
1. Royalty Payments
a. Fact Pattern: In order to develop an oil field, Company A
approaches Bank B for financing. To facilitate the loan, Bank B
first establishes an independent legal entity commonly known as a
special purpose vehicle (SPV). Bank B then provides a loan to the
SPV. Payments of principal and interest from the SPV to the Bank are
based on a fixed price for crude oil. The SPV in turn makes a
production loan to Company A. The terms of the production loan
require Company A to provide the SPV with volumetric production
payments (VPPs) based on the SPV's share of the production and the
prevailing price of crude oil. Because the price of crude may fall,
the SPV reduces that risk by entering into a NYMEX Light Sweet Crude
Oil crude oil swap with Swap Dealer C. The swap requires the SPV to
pay Swap Dealer C the floating price of crude oil and for Swap
Dealer C to pay a fixed price. The notional quantity for the swap is
equal to the expected production underlying the VPPs to the SPV.
Analysis: The swap between Swap Dealer C and the SPV meets the
general requirements for bona fide hedging transactions (Sec.
151.5(a)(1)(i)-(iii)) and the specific requirements for royalty
payments (Sec. 151.5(a)(2)(vi)). The VPPs that the SPV receives
represent anticipated royalty payments from the oil field's
production. The swap represents a substitute for transactions to be
made in the physical marketing channel. The SPV's swap position
qualifies as a hedge because it is economically appropriate to the
reduction of risk. The SPV is reasonably certain that the notional
quantity of the swap is equal to the expected production underlying
the VPPs. The swap reduces the risk associated with a change in
value of a royalty asset. The fluctuations in value of the SPV's
anticipated royalties are substantially related to the fluctuations
in value of the NYMEX Light Sweet Crude Oil Referenced Contract swap
with Swap Dealer C. The risk-reducing position will not qualify as a
bona fide hedge in a physical-delivery Referenced Contract during
the spot month.
b. Continuation of Fact Pattern: Swap Dealer C offsets the risk
associated with the swap to the SPV by selling Referenced Contracts.
The notional quantity of the Referenced Contracts sold by Swap
Dealer C exactly matches the notional quantity of the swap with the
SPV.
Analysis: Because the SPV enters the swap as a bona fide hedger
under Sec. 151.5(a)(2)(vi), the offset of the risk of the swap in a
Referenced Contract by Swap Dealer C qualifies as a bona fide
hedging transaction under Sec. 151.5(a)(3). As provided in Sec.
151.5(a)(3), the risk reducing position of Swap Dealer C does not
qualify as a bona fide hedge in a physical-delivery Referenced
Contract during the spot month.
2. Sovereigns
a. Fact Pattern: A Sovereign induces a farmer to sell his
anticipated production of 100,000 bushels of corn forward to User A
at a fixed price for delivery during the expected harvest. In return
for the farmer entering into the fixed-price forward sale, the
Sovereign agrees to pay the farmer the difference between the market
price at the time of harvest and the price of the fixed-price
forward, in the event that the market price is above the price of
the forward. The fixed-price forward sale of 100,000 bushels of corn
reduces the farmer's downside price risk associated with his
anticipated agricultural production. The Sovereign faces commodity
price risk as it stands ready to pay the farmer the difference
between the market price and the price of the fixed-price contract.
To reduce that risk, the Sovereign purchases 100,000 bushels of
Chicago Board of Trade (``CBOT'') Corn Referenced Contract call
options.
Analysis: Because the Sovereign and the farmer are acting
together pursuant to an express agreement, the aggregation
provisions of Sec. 151.7 and Sec. 151.5(b) apply and they are
treated as a single person. Taking the positions of the Sovereign
and farmer jointly, the risk profile of the combination of the
forward sale and the long call is approximately equivalent to the
risk profile of a synthetic long put.\521\ A synthetic long put may
be a bona fide hedge for anticipated production. Thus, that single
person satisfies the general requirements for bona fide hedging
transactions (Sec. 151.5(a)(1)(i)-(iii)) and specific requirements
for anticipated agricultural production (Sec. 151.5(a)(2)(i)(B)).
The synthetic long put is a substitute for transactions that the
farmer will make at a later time in the physical marketing channel
after the crop is harvested. The synthetic long put reduces the
price risk associated with anticipated agricultural production. The
size of the hedge is equivalent to the size of the Sovereign's risk
exposure. As provided under Sec. 151.5(a)(2)(i)(B), the Sovereign's
risk-reducing position will not qualify as a bona fide hedge in a
physical-delivery Referenced Contract during the last five trading
days.
---------------------------------------------------------------------------
\521\ Put-call parity describes the mathematical relationship
between price of a put and call with identical strike prices and
expiry.
---------------------------------------------------------------------------
3. Services
a. Fact Pattern: Company A enters into a risk service agreement
to drill an oil well with Company B. The risk service agreement
provides that a portion of the revenue receipts to Company A depends
on the value of the oil produced. Company A is concerned that the
price of oil may fall resulting in lower anticipated revenues from
the risk service agreement. To reduce that risk, Company A sells
5,000 NYMEX Light Sweet Crude Oil Referenced Contracts, which is
equivalent to the firm's anticipated share of the oil produced.
Analysis: Company A's hedge of a portion of its revenue stream
from the risk service agreement meets the general requirements for
bona fide hedging (Sec. 151.5(a)(1)(i)-(iii)) and the specific
provisions for services (Sec. 151.5(a)(2)(vii)). Selling NYMEX
Light Sweet Crude Oil Referenced Contracts is a substitute for
transactions to be taken at a later time in the physical marketing
channel once the oil is produced. The Referenced Contracts sold by
Company A are economically appropriate to the reduction of risk
because the total notional quantity of the Referenced Contracts sold
by Company A equals its share of the expected quantity of future
production under the risk service agreement. Because the price of
oil may fall, the transactions in Referenced Contracts arise from a
potential reduction in the value of the service that Company A is
providing to Company B. The contract for services
[[Page 71697]]
involves the production of a commodity underlying the NYMEX Exchange
Light Sweet Crude Oil Referenced Contract. As provided under Sec.
151.5(a)(2)(vii), the risk reducing position will not qualify as a
bona fide hedge during the spot month of the physical-delivery
Referenced Contract.
b. Fact Pattern: A City contracts with Firm A to provide waste
management services. The contract requires that the trucks used to
transport the solid waste use natural gas as a power source.
According to the contract, the City will pay for the cost of the
natural gas used to transport the solid waste by Firm A. In the
event that natural gas prices rise, the City's waste transport
expenses rise. To mitigate this risk, the City establishes a long
position in NYMEX Natural Gas Referenced Contracts that is
equivalent to the expected use of natural gas over the life of the
service contract.
Analysis: This transaction meets the general requirements for
bona fide hedging transaction (Sec. 151.5(a)(1)(i)-(iii)) and the
specific provisions for services (Sec. 151.5(a)(2)(vii)). Because
the City is responsible for paying the cash price for the natural
gas used to power the trucks that transport the solid waste under
the services agreement, the long hedge is a substitute for
transactions to be taken at a later time in the physical marketing
channel. The transaction is economically appropriate to the
reduction of risk because the total notional quantity of the
positions Referenced Contracts purchased equals the expected use of
natural gas over the life of the contract. The positions in
Referenced Contracts reduce the risk associated with an increase in
anticipated liabilities that the City may incur in the event that
the price of natural gas increases. The service contract involves
the use of a commodity underlying a Referenced Contract. As provided
under Sec. 151.5(a)(2)(vii), the risk reducing position will not
qualify as a bona fide hedge during the spot month of the physical-
delivery Referenced Contract.
c. Fact Pattern: Natural Gas Producer A induces Pipeline
Operator B to build a pipeline between Producer A's natural gas
wells and the Henry Hub pipeline interconnection by entering into a
fixed-price contract for natural gas transportation that guarantees
a specified quantity of gas to be transported over the pipeline.
With the construction of the new pipeline, Producer A plans to
deliver natural gas to Henry Hub at a price differential between his
gas wells and Henry Hub that is higher than its transportation cost.
Producer A is concerned, however, that the price differential may
decline. To lock in the price differential, Producer A decides to
sell outright NYMEX Henry Hub Natural Gas Referenced Contract cash-
settled futures contracts and buy an outright swap that NYMEX Henry
Hub Natural Gas at his gas wells.
Analysis: This transaction satisfies the general requirements
for a bona fide hedge exemption (Sec. Sec. 151.5(a)(1)(i)-(iii))
and specific provisions for services (Sec. 151.5(a)(2)(vii)).\522\
The hedge represents a substitute for transactions to be taken in
the future (e.g., selling natural gas at Henry Hub). The hedge is
economically appropriate to the reduction of risk that the location
differential will decline, provided the hedge is not larger than the
quantity equivalent of the cash market commodity to be produced and
transported. As provided under Sec. 151.5(a)(2)(vii), the risk
reducing position will not qualify as a bona fide hedge during the
spot month of the physical-delivery Referenced Contract.
---------------------------------------------------------------------------
\522\ Note that in addition to the use of Referenced Contracts,
Producer A could have hedged this risk by using a basis contract,
which is excluded from the definition of Referenced Contracts.
---------------------------------------------------------------------------
4. Lending a Commodity
a. Fact Pattern: Bank B lends 1,000 ounces of gold to Jewelry
Fabricator J at LIBOR plus a differential. Under the terms of the
loan, Jewelry Fabricator J may later purchase the gold at a
differential to the prevailing price of Commodity Exchange, Inc.
(``COMEX'') Gold (i.e., an open-price purchase agreement embedded in
the terms of the loan). Jewelry Fabricator J intends to use the gold
to make jewelry and reimburse Bank B for the loan using the proceeds
from jewelry sales. Because Bank B is concerned about its potential
loss if the price of gold drops, it reduces the risk of a potential
loss in the value of the gold by selling COMEX Gold Referenced
Contracts with an equivalent notional quantity of 1,000 ounces of
gold.
Analysis: This transaction meets the general bona fide hedge
exemption requirements (Sec. Sec. 151.5(a)(1)(i)-(iii)) and the
specific requirements associated with owing a cash commodity (Sec.
151.5(a)(2)(i)). Bank B's short hedge of the gold represents a
substitute for a transaction to be made in the physical marketing
channel. Because the total notional quantity of the amount of gold
contracts sold is equal to the amount of gold that Bank B owns, the
hedge is economically appropriate to the reduction of risk. Finally,
the transactions in Referenced Contracts arise from a potential
change in the value of the gold owned by Bank B.
b. Fact Pattern: Silver Processor A agrees to purchase scrap
metal from a Scrap Yard that will be processed into 5,000 ounces of
silver. To finance the purchase, Silver Processor A borrows 5,000
ounces of silver from Bank B and sells the silver in the cash
market. Using the proceeds from the sale of silver in the cash
market, Silver Processor A pays the Scrap Yard for the scrap metal
containing 5,000 ounces of silver at a negotiated discount from the
current spot price. To repay Bank B, Silver Processor A may either:
Provide Bank B with 5,000 ounces of silver and an interest payment
based on a differential to LIBOR; or repay the Bank at the current
COMEX Silver settlement price plus an interest payment based on a
differential to LIBOR (i.e., an open-price purchase agreement).
Silver Processor A processes and refines the scrap to repay Bank B.
Although Bank B has lent the silver, it is still exposed to a
reduction in value if the price of silver falls. Bank B reduces the
risk of a possible decline in the value of their silver asset over
the loan period by selling COMEX Silver Referenced Contracts with a
total notional quantity equal to 5,000 ounces.
Analysis: This transaction meets the general requirements for a
bona fide hedging transaction (Sec. Sec. 151.5(a)(1)(i)-(iii)) and
specific provisions for owning a commodity (Sec. 151.5(a)(2)(i)).
Bank B's hedge of the silver that it owns represents a substitute
for a transaction in the physical marketing channel. The hedge is
economically appropriate to the reduction of risk because the bank
owns 5,000 ounces of silver. The hedge reduces the risk of a
potential change in the value of the silver that it owns.
5. Processor Margins
a. Fact Pattern: Soybean Processor A has a total throughput
capacity of 100 million tons of soybeans per year. Soybean Processor
A ``crushes'' soybeans into products (soybean oil and meal). It
currently has 20 million tons of soybeans in storage and has offset
that risk through fixed-price forward sales of the amount of
products expected to be produced from crushing 20 million tons of
soybeans, thus locking in the crushing margin on 20 million tons of
soybeans. Because it has consistently operated its plant at full
capacity over the last three years, it anticipates purchasing
another 80 million tons of soybeans over the next year. It has not
sold the crushed products forward. Processor A faces the risk that
the difference in price between soybeans and the crushed products
could change such that crush products (i.e., the crush spread) will
be insufficient to cover its operating margins. To lock in the crush
spread, Processor A purchases 80 million tons of CBOT Soybean
Referenced Contracts and sells CBOT Soybean Meal and Soybean Oil
Referenced Contracts, such that the total notional quantity of
soybean meal and oil Referenced Contracts equals the expected
production from crushing soybeans into soybean meal and oil
respectively.
Analysis: These hedging transactions meet the general
requirements for bona fide hedging transactions (Sec. Sec.
151.5(a)(1)(i)-(iii)) and the specific provisions for unfilled
anticipated requirements and unsold anticipated agricultural
production (Sec. Sec. 151.5(a)(2)(i)-(ii)). Purchases of soybean
Referenced Contracts qualify as bona fide hedging transaction
provided they do not exceed the unfilled anticipated requirements of
the cash commodity for one year (in this case 80 million tons). Such
transactions are a substitute for purchases to be made at a later
time in the physical marketing channel and are economically
appropriate to the reduction of risk. The transactions in Referenced
Contracts arise from a potential change in the value of soybeans
that the processor anticipates owning. The size of the permissible
hedge position in soybeans must be reduced by any inventories and
fixed-price purchases because they are no longer unfilled
requirements. As provided under Sec. 151.5(a)(2)(ii)(C), the risk
reduction position that is not in excess of the anticipated
requirements for soybeans for that month and the next succeeding
month qualifies as a bona fide hedge during the last five trading
days provided it is not in a physical-delivery Referenced Contract.
Given that Soybean Processor A has purchased 80 million tons
worth of CBOT Soybean Referenced Contracts, it can reduce
[[Page 71698]]
its processing risk by selling soybean meal and oil Referenced
Contracts equivalent to the expected production. The sale of CBOT
Soybean, Soybean Meal, and Soybean Oil contracts represents a
substitute for transactions to be taken at a later time in the
physical marketing channel by the soybean processor. Because the
amount of soybean meal and oil Referenced Contracts sold forward by
the soybean processor corresponds to expected production from 80
million tons of soybeans, the hedging transactions are economically
appropriate to the reduction of risk in the conduct and management
of the commercial enterprise. These transactions arise from a
potential change in the value of soybean meal and oil that is
expected to be produced. The size of the permissible hedge position
in the products must be reduced by any fixed-price sales because
they are no longer unsold production. As provided under Sec.
151.5(a)(2)(i)(B), the risk reducing position does not qualify as a
bona fide hedge in a physical-delivery Referenced Contract during
the last five trading days in the event the anticipated crushed
products have not been produced.
6. Portfolio Hedging
a. Fact Pattern: It is currently January and Participant A owns
five million bushels of corn located in its warehouses. Participant
A has entered into fixed-price forward sale contracts with several
processors for a total of five million bushels of corn that will be
delivered in May of this year. Participant A has separately entered
into fixed-price purchase contracts with several merchandisers for a
total of two million bushels of corn to be delivered in March of
this year. Participant A's gross long cash position is equal to
seven million bushels of corn. Because Participant A has sold
forward five million bushels of corn, its net cash position is equal
to long two million bushels of corn. To reduce its price risk,
Participant A chooses to sell the quantity equivalent of two million
bushels of CBOT Corn Referenced Contracts.
Analysis: The cash position and the fixed-price forward sale and
purchases are all in the same crop year. Participant A currently
owns five million bushels of corn and has effectively sold that
amount forward. The firm is concerned that the remaining amount--two
million bushels worth of fixed-price purchase contracts--will fall
in value. Because the firm's net cash position is equal to long two
million bushels of corn, the firm is exposed to price risk. Selling
the quantity equivalent of two million bushels of CBOT Corn
Referenced Contracts satisfies the general requirements for bona
fide hedging transactions (Sec. Sec. 151.5(a)(1)(i)-(iii)) and the
specific provisions associated with owning a commodity (Sec.
151.5(a)(2)(i)).\523\ Participant A's hedge of the two million
bushels represents a substitute to a fixed-price forward sale at a
later time in the physical marketing channel. The transaction is
economically appropriate to the reduction of risk because the amount
of Referenced Contracts sold does not exceed the quantity equivalent
risk exposure (on a net basis) in the cash commodity in the current
crop year. Lastly, the hedge arises from a potential change in the
value of corn owned by Participant A.
---------------------------------------------------------------------------
\523\ Participant A could also choose to hedge on a gross basis.
In that event, Participant A would sell the quantity equivalent of
seven million bushels of March Chicago Board of Trade Corn
Referenced Contracts, and separately purchase the quantity
equivalent of five million bushels of May Chicago Board of Trade
Corn Referenced Contracts.
---------------------------------------------------------------------------
7. Anticipated Merchandising
a. Fact Pattern: Elevator A, a grain merchandiser, owns a 31
million bushel storage facility. The facility currently has 1
million bushels of corn in storage. Based upon its historical
purchasing and selling patterns for the last three years, Elevator A
expects that in September it will enter into fixed-price forward
purchase contracts for 30 million bushels of corn that it expects to
sell in December. Currently the December corn futures price is
substantially higher than the September corn futures price. In order
to reduce the risk that its unfilled storage capacity will not be
utilized over this period and in turn reduce Elevator A's
profitability, Elevator A purchases the quantity equivalent of 30
million bushels of September CBOT Corn Referenced Contracts and
sells 30 million bushels of December CBOT Corn Referenced Contracts.
Analysis: This hedging transaction meets the general
requirements for bona fide hedging transactions (Sec. Sec.
151.5(a)(1)(i)-(iii)) and specific provisions associated with
anticipated merchandising (Sec. 151.5(a)(2)(v)). The hedging
transaction is a substitute for transactions to be taken at a later
time in the physical marketing channel. The hedge is economically
appropriate to the reduction of risk associated with the firm's
unfilled storage capacity because: (1) The December CBOT Corn
futures price is substantially above the September CBOT Corn futures
price; and (2) Elevator A reasonably expects to engage in the
anticipated merchandising activity based on a review of its
historical purchasing and selling patterns at that time of the year.
The risk arises from a change in the value of an asset that the firm
owns. As provided by Sec. 151.5(a)(2)(v), the size of the hedge is
equal to the firm's unfilled storage capacity relating to its
anticipated merchandising activity. The purchase and sale of
offsetting Referenced Contracts are in different months, which
settle in not more than twelve months. As provided under Sec.
151.5(a)(2)(v), the risk reducing position will not qualify as a
bona fide hedge in a physical-delivery Referenced Contract during
the last 5 trading days of the September contract.
8. Aggregation of Persons
a. Fact Pattern: Company A owns 100 percent of Company B.
Company B buys and sells a variety of agricultural products, such as
wheat and cotton. Company B currently owns 1 million bushels of
wheat. To reduce some of its price risk, Company B decides to sell
the quantity equivalent of 600,000 bushels of CBOT Wheat Referenced
Contracts. After communicating with Company B, Company A decides to
sell the quantity equivalent of 400,000 bushels of CBOT Wheat
Referenced Contracts.
Analysis: Because Company A owns more than 10 percent of Company
B, Company A and B are aggregated together as one person under Sec.
151.7. Under Sec. 151.5(b), entities required to aggregate accounts
or positions under Sec. 151.7 shall be considered the same person
for the purpose of determining whether a person or persons are
eligible for a bona fide hedge exemption under paragraph Sec.
151.5(a). The sale of wheat Referenced Contracts by Company A and B
meets the general requirements for bona fide hedging transactions
(Sec. Sec. 151.5(a)(1)(i)-(iii)) and the specific provisions for
owning a cash commodity (Sec. 151.5(a)(2)(i)). The transactions in
Referenced Contracts by Company A and B represent a substitute for
transactions to be taken at a later time in the physical marketing
channel. The transactions in Referenced Contracts by Company A and B
are economically appropriate to the reduction of risk because the
combined total of 1,000,000 bushels of CBOT Wheat Referenced
Contracts sold by Company A and Company B does not exceed the
1,000,000 bushels of wheat that is owned by Company A. The risk
exposure for Company A and B results from a potential change in the
value of wheat.
9. Repurchase Agreements
a. Fact Pattern: When Elevator A purchased 500,000 bushels of
wheat in April it decided to reduce its price risk by selling the
quantity equivalent of 500,000 bushels of CBOT Wheat Referenced
Contracts. Because the price of wheat has steadily risen since
April, Elevator A has had to make substantial maintenance margin
payments. To alleviate its concern about further margin payments,
Elevator A decides to enter into a repurchase agreement with Bank B.
The repurchase agreement involves two separate contracts: A fixed-
price sale from Elevator A to Bank B at today's spot price; and an
open-priced purchase agreement that will allow Elevator A to
repurchase the wheat from Bank B at the prevailing spot price three
months from now. Because Bank B obtains title to the wheat under the
fixed-price purchase agreement, it is exposed to price risk should
the price of wheat drop. It therefore decides to sell the quantity
equivalent of 500,000 bushels of CBOT Wheat Referenced Contracts.
Analysis: Bank B's hedging transaction meets the general
requirements for bona fide hedging transactions (Sec. Sec.
151.5(a)(1)(i)-(iii)) and the specific provisions for owning the
cash commodity (Sec. 151.5(a)(2)(i)). The sale of Referenced
Contracts by Bank B is a substitute for a transaction to be taken at
a later time in the physical marketing channel either to Elevator A
or to another commercial party. The transaction is economically
appropriate to the reduction of risk in the conduct and management
of the commercial enterprise of Bank B because the notional quantity
of Referenced Contracts sold by Bank B is not larger than the
quantity of cash wheat purchased by Bank B. Finally, the purchase of
CBOT Wheat Referenced Contracts reduces the risk associated with
owning cash wheat.
10. Inventory
a. Fact Pattern: Copper Wire Fabricator A is concerned about
possible reductions in the
[[Page 71699]]
price of copper. Currently it is November and it owns inventory of
100,000 pounds of copper and 50,000 pounds of finished copper wire.
Currently, deferred futures prices are lower than the nearby futures
price. Copper Wire Fabricator A expects to sell 150,000 pounds of
finished copper wire in February. To reduce its price risk, Copper
Wire Fabricator A sells 150,000 pounds of February COMEX Copper
Referenced Contracts.
Analysis: The Copper Wire Fabricator A's hedging transaction
meets the general requirements for bona fide hedging transactions
(Sec. Sec. 151.5(a)(1)(i)-(iii)) and the provisions for owning a
commodity (Sec. 151.5(a)(2)(i)(A)). The sale of Referenced
Contracts represents a substitute for transactions to be taken at a
later time. The transactions are economically appropriate to the
reduction of risk in the conduct and management of the commercial
enterprise because the price of copper could drop further. The
transactions in Referenced Contracts arise from a possible reduction
in the value of the inventory that it owns.
Issued by the Commission this 18th day of October 2011, in
Washington, DC.
David Stawick,
Secretary of the Commission.
Appendices to Position Limits for Futures and Swaps--Commission Voting
Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn and
Chilton voted in the affirmative; Commissioners Sommers and O'Malia
voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the final rulemaking to establish position limits for
physical commodity derivatives. The CFTC does not set or regulate
prices. Rather, the Commission is charged with a significant
responsibility to ensure the fair, open and efficient functioning of
derivatives markets. Our duty is to protect both market participants
and the American public from fraud, manipulation and other abuses.
Position limits have served since the Commodity Exchange Act
passed in 1936 as a tool to curb or prevent excessive speculation
that may burden interstate commerce. When the CFTC set position
limits in the past, the agency sought to ensure that the markets
were made up of a broad group of market participants with no one
speculator having an outsize position. At the core of our
obligations is promoting market integrity, which the agency has
historically interpreted to include ensuring that markets do not
become too concentrated. Position limits help to protect the markets
both in times of clear skies and when there is a storm on the
horizon. In 1981, the Commission said that ``the capacity of any
contract market to absorb the establishment and liquidation of large
speculative positions in an orderly manner is related to the
relative size of such positions, i.e., the capacity of the market is
not unlimited.''
In the Dodd-Frank Act, Congress mandated that the CFTC set
aggregate position limits for certain physical commodity
derivatives. The Dodd-Frank Act broadened the CFTC's position limits
authority to include aggregate position limits on certain swaps and
certain linked contracts traded on foreign boards of trade in
addition to U.S. futures and options on futures. Congress also
narrowed the exemptions traditionally available from position limits
by modifying the definition of bona fide hedge transaction, which
particularly would affect swap dealers.
Today's final rule implements these important new provisions.
The final rule fulfills the Congressional mandate that we set
aggregate position limits that, for the first time, apply to both
futures and economically equivalent swaps, as well as linked
contracts on foreign boards of trade. The final rule establishes
federal position limits in 28 referenced commodities in
agricultural, energy and metals markets.
Per Congress's direction, the rule implements one position
limits regime for the spot month and another for single-month and
all-months combined limits. It implements spot-month limits, which
are currently set in agriculture, energy and metals markets, sooner
than the single-month or all-months-combined limits. Spot-month
limits are set for futures contracts that can by physically settled
as well as those swaps and futures that can only be cash-settled. We
are seeking additional comment as part of an interim final rule on
these spot month limits with regard to cash-settled contracts.
Single-month and all-months-combined limits, which currently are
only set for certain agricultural contracts, will be re-established
in the energy and metals markets and be extended to certain swaps.
These limits will be set using a formula that is consistent with
that which the CFTC has used to set position limits for decades. The
limits will be set by a Commission order based upon data on the
total size of the swaps and futures market collected through the
position reporting rule the Commission finalized in July. It is only
with the passage and implementation of the Dodd-Frank Act that the
Commission now has broad authority to collect data in the swaps
market.
The final rule also implements Congress's direction to narrow
exemptions while also ensuring that bona fide hedge exemptions are
available for producers and merchants. The final position limits
rulemaking builds on more than two years of significant public
input. The Commission benefited from more than 15,100 comments
received in response to the January 2011proposal. We first held
three public meetings on this issue in the summer of 2009 and got a
great deal of input from market participants and the broader public.
We also benefited from the more than 8,200 comments we received in
response to the January 2010 proposed rulemaking to re-establish
position limits in the energy markets. We further benefited from
input received from the public after a March 2010 meeting on the
metals markets.
Appendix 3--Statement of Commissioner Jill Sommers
I respectfully dissent from the action taken today by the
Commission to issue final rules establishing position limits for
futures and swaps.
It has been nearly two years since the Commission issued its
January 2010 proposal to impose position limits on a small group of
energy contracts. Since then, Commission staff and the Commission
have spent an enormous amount of time and energy on the issue of
imposing speculative position limits, time that could have been much
better spent implementing the specific Dodd-Frank regulatory reforms
that will actually reduce systemic risk and prevent another
financial crisis.
This vote today on position limits is no doubt the single most
significant vote I have taken since becoming a Commissioner. It is
not because imposing position limits will fundamentally change the
way the U.S. markets operate, but because I believe this agency is
setting itself up for an enormous failure.
As I have said in the past, position limits can be an important
tool for regulators. I have been clear that I am not philosophically
opposed to limits. After all, this agency has set limits in certain
markets for many years. However, I have had concerns all along about
the particular application of the limits in this rule, compounded by
the unnecessary narrowing of the bona-fide hedging exemptions,
beyond what was required by the Dodd-Frank Act.
Over the last four years, many have argued for position limits
with such fervor and zeal, believing them to be a panacea for
everything. Just this past week, the Commission has been bombarded
by a letter-writing campaign suggesting that the five of us have the
power to end world hunger by imposing position limits on
agricultural commodities. This latest campaign exemplifies my
ongoing concern and may result in damaging the credibility of this
agency. I do not believe position limits will control prices or
market volatility, and I fear that this Commission will be blamed
when this final rule does not lower food and energy costs. I am
disappointed at this unfortunate circumstance because, while the
Commission's mission is to protect market users and the public from
fraud, manipulation, abusive practices and systemic risk related to
derivatives that are subject to the Commodity Exchange Act, and to
foster open, competitive, and financially sound markets, nowhere in
our mission is the responsibility or mandate to control prices.
When analyzing the potential impact this final rule will have on
market participants, I am most concerned that rules designed to
``reign in speculators'' have the real potential to inflict the
greatest harm on bona fide hedgers--that is, the producers,
processers, manufacturers, handlers and users of physical
commodities. This rule will make hedging more difficult, more
costly, and less efficient, all of which, ironically, can result in
increased food and energy costs for consumers.
[[Page 71700]]
Currently, the Commission sets and administers position limits
and exemptions for contracts on nine agricultural commodities. For
contracts of the remaining commodities, the exchanges set and
administer position limits and exemptions. Pursuant to the final
rule the Commission issued today, the Commission will set and
administer position limits and exemptions for 28 reference
contracts. This will amount to a substantial transfer of
responsibility from the exchanges to the Commission. As a result of
taking on this responsibility for 19 new reference contracts, the
Commission is significantly increasing its front-line oversight of
the granting and monitoring of bona-fide hedging exemptions for the
transactions of massive, global corporate conglomerates that on a
daily basis produce, process, handle, store, transport, and use
physical commodities in their extremely complex logistical
operations.
At the very time the Commission is taking on this new
responsibility, the Commission is eliminating a valuable source of
flexibility that has been a part of regulation 1.3(z) for decades--
that is, the ability to recognize non-enumerated hedge transactions
and positions. This final rule abandons important and long-standing
Commission precedent without justification or reasoned explanation,
by merely stating ``the Commission has * * * expanded the list of
enumerated hedges.'' The Commission also seems to be saying that we
no longer need the flexibility to allow for non-enumerated hedge
transactions and positions because one can seek interpretative
guidance pursuant to Commission Regulation 140.99 on whether a
transaction or class of transactions qualifies as a bona-fide hedge,
or can petition the Commission to amend the list of enumerated
transactions. The Commission also recognizes that CEA Section
4a(a)(7) grants it the broad exemptive authority is issue an order,
rule, or regulation, but offers no guidance on when it may do so,
and what factors it may consider or criteria it may use to make a
determination.
These processes are cold comfort. There is no way to tell how
long interpretative guidance or a Commission Order will take.
Moreover, if a market participant petitions the Commission to amend
the list of enumerated transactions, if the Commission chooses to do
so, it must formally propose the amendment pursuant to APA notice
and comment. As we know all too well, issuing new rules and
regulations is a time consuming process fraught with delay and
uncertainty. In the end, none of these processes is flexible or
useful to the needs of hedgers in a complex global marketplace.
When the Commission first recognized the need to allow for non-
enumerated hedges in 1977, the Commission stated ``The purpose of
the proposed provision was to provide flexibility in application of
the general definition and to avoid an extensive specialized listing
of enumerated bona fide hedging transactions and positions. * * *''
Today the global marketplace and commercial firms' hedging
strategies are much more complex than in 1977. Yet, we are content
to abandon decades of precedent that provided flexibility in favor
of specifying a specialized list of enumerated bona fide hedging
transactions and positions. I am not comfortable with notion that a
list of eight bona-fide hedging transactions in this rule is
sufficiently extensive and specialized to cover the complex needs of
today's bona-fide hedgers. Repealing the ability to recognize non-
enumerated hedge transactions and positions is a mistake and the
statute does not require it. The Commission should have remained
true to its precedent and utilized the broad authority contained in
CEA Section 4a(a)(7) to include within Regulation 151.5(a)(2) a
ninth enumerated hedging transaction and position, with the same
conditions as the previous eight, as follows: ``Other risk-reducing
practices commonly used in the market that are not enumerated above,
upon specific request made in accordance with Regulation section
1.47.''
In addition to abandoning decades of flexibility to recognize
non-enumerated hedging transactions and positions, the final rules
today do not fully effect the authority the Commission has had for
decades to define bona-fide hedging transactions and positions ``to
permit producers, purchasers, sellers, middlemen, and users of a
commodity or a product derived therefrom to hedge their legitimate
anticipated business needs. * * *'' This authority is found in CEA
Section 4a(c)(1). In addition, Section 4a(c)(2) clearly recognizes
the need for anticipatory hedging by using the word ``anticipates''
in three places. Nonetheless, without defining what constitutes
``merchandising'' the Commission has limited ``Anticipated
Merchandising Hedging'' in Regulation 151.5(a)(2)(v) to transactions
not larger than ``current or anticipated unfilled storage
capacity.'' It appears then that merchandising does not include the
varying activities of ``producers, purchasers, sellers, middlemen,
and users of a commodity'' as contemplated by Section 4a(c)(1), but
merely consists of storing a commodity. This limited approach is
needlessly at odds with the statute and with the legitimate needs of
hedgers.
I have always believed that there was a right way and a wrong
way for us to move forward on position limits. Unfortunately I
believe we have chosen to go way beyond what is in the statute and
have created a very complicated regulation that has the potential to
irreparably harm these vital markets.
Appendix 4--Statement of Commissioner Scott O'Malia
I respectfully dissent from the action taken today by the
Commission to issue final rules relating to position limits for
futures and swaps. While I have a number of serious concerns with
this final rule, my principal disagreement is with the Commission's
restrictive interpretation of the statutory mandate under Section 4a
of the Commodity Exchange Act (``CEA'' or ``Act'') to establish
position limits without making a determination that such limits are
necessary and effective in relation to the identifiable burdens of
excessive speculation on interstate commerce.
While I agree that the Commission has been directed to establish
position limits applicable to futures, options, and swaps that are
economically equivalent to such futures and options (for exempt and
agricultural commodities as defined by the Act), I disagree that our
mandate provides for so little discretion in the manner of its
execution. Throughout the preamble, the Commission uses, ``Congress
did not give the Commission a choice'' \524\ as a rationale in
adopting burdensome and unmanageable rules of questionable
effectiveness. This statement, in all of its iterations in this
rule, is nothing more than hyperbole used tactfully to support a
politically-driven overstatement as to the threat of ``excessive
speculation'' in our commodity markets. In aggrandizing a market
condition that it has never defined through quantitative or
qualitative criteria in order to justify draconian rules, the
Commission not only fails to comply with Congressional intent, but
misses an opportunity to determine and define the type and extent of
speculation that is likely to cause sudden, unreasonable and/or
unwarranted commodity price movements so that it can respond with
rules that are reasonable and appropriate.
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\524\ Position Limits for Futures and Swaps (to be codified at
17 CFR pts. 1, 150 and 151) at 11, available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister101811c.pdf (hereafter, ``Position Limits for Futures
and Swaps'').
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In relevant part, section 4a(a)(1) of the Act states:
``Excessive speculation in any commodity under contracts of sale of
such commodity for future delivery * * * or swaps * * * 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.'' Section 4a(a)(1) further
defines the Commission's duties with regard to preventing such price
fluctuations through position limits, clearly stating: ``For the
purpose of diminishing, eliminating, or preventing such burden, the
Commission shall, from time to time, after due notice and
opportunity for hearing, by rule, regulation, or order, proclaim and
fix such limits * * * as the Commission finds are necessary to
diminish, eliminate, or prevent such burden.'' Congress could not be
more clear in its directive to the Commission to utilize not only
its expertise, but the public rulemaking process, each and every
time it determines to establish position limits to ensure that such
limits are essential and suitable to combat the actual or potential
threats to commodity prices due to excessive speculation.
An Ambiguously Worded Mandate Does Not Relieve the Commission of Its
Duties Under the Act
Historically, the Commission has taken a much more disciplined
and fact-based approach in considering the question of position
limits; a process that is lacking from the current proposal. The
general authority for the Commission to establish ``limits on the
amounts of trading which may be done or positions which may be held
* * * as the Commission finds are necessary to diminish, eliminate,
or prevent'' the ``undue burdens'' associated with excessive
speculation found in section 4a of the Act has remained unchanged
since its original enactment in 1936 and through subsequent
amendments,
[[Page 71701]]
including the Dodd-Frank Act.\525\ Over thirty years ago, on
December 2, 1980, the Commission, pursuant in part to its authority
under section 4a (1) of the Act, issued a proposal to implement
rules requiring exchanges to impose position limits on contracts
that were not currently subject to Commission imposed limits.\526\
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\525\ Position Limits for Futures and Swaps, supra note 1, at 5.
\526\ Speculative Position Limits, 45 FR 79831 (proposed Dec. 2,
1980) (to be codified at 17 CFR pt. 1).
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In support of its proposal, the Commission relied on a June 1977
report on speculative limits prepared by the Office of the Chief
Economist (the ``Staff Report''). The Staff Report addressed three
major policy questions: (1) whether there should be limits and for
what groups of commodities; (2) what guidelines are appropriate in
setting the level of limits; and (3) whether the Commission or the
exchange should set the limits.527 528 In considering
these questions, the Staff Report noted, ``Although the Commission
is authorized to establish speculative limits, it is not required to
do so.'' \529\ In its Interpretation of the above language in
section 4a, the Staff Report at the outset provided the legal
context for its study as follows:
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\527\ Id. at 79832; Speculative Limits: a staff paper prepared
for Commission discussion by the Office of the Chief Economist at 1,
June 24, 1977.
\528\ The Staff Report ultimately made four general
recommendations. First, the Commission ought to adopt a policy of
establishing speculative limits only in those markets where the
characteristics of the commodity, its marketing system, and the
contract lend themselves to undue influence from large scale
speculative positions. Second, that in markets where limits are
deemed to be necessary, such limits should only be established to
curtail extraordinary speculative positions which are not offset by
comparable commercial positions. Third, there ought to be no limits
on daily trading except to the extent that the limits would prevent
the accumulation of large intraday positions. Fourth, in markets
where limits are deemed necessary, the exchange should set and
review the limits subject to Commission approval. Office of Chief
Economist, supra note 4, at 5-6.
\529\ Office of Chief Economist, supra note 4, at 7.
[T]he Commission need not establish speculative limits if it
does not find that excessive speculation exists in the trading of a
particular commodity. Furthermore, apparently, the Commission does
not have to establish limits if it finds that such limits will not
effectively curb excessive speculation.\530\
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\530\ Id. at 7-8.
While not directly linked to the statutory language of section
4a or an interpretation of such language, the Staff Report utilized
its findings to formulate a policy for the Commission to move
forward, which, based on comments to the Commission's January 2011
proposal,\531\ is clearly embodied in the purpose and spirit of the
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Act:
\531\ See, e.g., Comment letter from Futures Industry
Association on Position Limits for Derivatives (RIN 2028-AD15 and
3038-AD16) at 6-7 (Mar. 25, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=34054&SearchText=futures%20industry%20association
; Comment letter from CME Group on Position Limits for Derivatives
at 1-7 (Mar. 28, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=33920&SearchText=cme; and Comment
Letter of International Swaps and Derivatives Association, Inc. and
Securities Industry and Financial Markets Association on Notice of
Proposed Rulemaking--Position Limits for Derivatives (RIN 3038-AD15
and 3038-AD16) at 3-6 (Mar. 28, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=33568&SearchText=isda.
Perhaps the most important feature brought out in the study is that,
prior to the adoption of speculative position limits for any
commodity in which limits are not now imposed by CFTC, the
Commission should carefully consider the need for and effectiveness
of such limits for that commodity and the resources necessary to
enforce such limits.\532\
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\532\ Office of Chief Economist, supra note 7, at 5.
In its final rule, published in the Federal Register on October
16, 1981--almost exactly thirty years ago today--the Commission
chose to base its determination on Congressional findings embodied
in section 4a(1) of the Act that excessive speculation is harmful to
the market, and a finding that speculative limits are an effective
prophylactic measure. The Commission did not do so because it found
that more specific determinations regarding the necessity and
effectiveness of position limits were not required. Rather, the
Commission was fashioning a rule ``to assure that the exchanges
would have an opportunity to employ their knowledge of their
individual contract markets to propose the position limits they
believe most appropriate.'' \533\ Moreover, none of the commenters
opposing the adoption of limits for all markets demonstrated to the
Commission that its findings as to the prophylactic nature of the
proposal before them were unsubstantiated.\534\ Therefore, the
Commission did not eschew a requirement to demonstrate whether
position limits were necessary and would be effective--it delegated
these determinations to the exchanges.
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\533\ 46 FR at 50938, 50940.
\534\ Id.
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Today, the Commission reaffirms its proposed interpretation of
amended section 4a that in setting position limits pursuant to
directives in sections 4a(a)(2)(A), 4a(a)(3) and 4a(a)(5), it need
not first determine that position limits are necessary before
imposing them or that it may set limits only after conducting a
complete study of the swaps market.\535\ Relying on the various
directives following ``shall,'' the Commission has bluntly stated
that ``Congress did not give the Commission a choice.'' \536\ This
interpretation ignores the plain language in the statute that the
``shalls'' in sections 4a(a)(2)(A), 4a(a)(3) and 4a(a)(5) are
connected to the modifying phrase, ``as appropriate.'' Although the
Commission correctly construes the ``as appropriate'' language in
the context of the provisions as a whole to direct the Commission to
exercise its discretion in determining the extent of the limits that
Congress ``required'' it to impose, the Commission ignores the fact
that in the context of the Act, such discretion is broad enough to
permit the Commission to not impose limits if they are not
appropriate. Though a permissible interpretation, the Commission's
narrow view of its authority permeates the final rules today and
provides a convenient rationale for many otherwise unsustainable
conclusions, especially with regard to the cost-benefit analysis of
the rule.
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\535\ Position Limits for Futures and Swaps, supra note 1, at
10-11.
\536\ Id.
---------------------------------------------------------------------------
Section 4a(a)(2)(A), in relevant part, states that the
Commission ``shall by rule, regulation, or order establish limits on
the amount of positions, as appropriate'' that may be held by any
person in physical commodity futures and options contracts traded on
a designated contract market (DCM). In section 4a(a)(5), Congress
directed that the Commission ``shall establish limits on the amount
of positions, including aggregate position limits, as appropriate''
that may be held by any person with respect to swaps. Section
4a(a)(3) qualifies the Commission's authority by directing it so set
such limits ``required'' by section 4a(a)(2), ``as appropriate * * *
[and] to the maximum extent practicable, in its discretion'' (1) to
diminish, eliminate, or prevent excessive speculation as described
under this section (section 4a of the Act), (2) to deter and prevent
market manipulation, squeezes, and corners, (3) to ensure sufficient
market liquidity for bona fide hedgers, and (4) to ensure that the
price discovery function of the underlying market is not
disrupted.\537\
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\537\ See section 4a(a)(3)(B) of the CEA.
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Congress, in repeatedly qualifying its mandates with the phrase
``as appropriate'' and by specifically referring back to the
Commission's authority to set position limits as proscribed in
section 4a(a)(1), clearly did not relieve the Commission of any
requirement to exercise its expertise and set position limits only
to the extent that it can provide factual support that such limits
will diminish, eliminate or prevent excessive speculation.\538\
Instead, by directing the Commission to establish limits ``as
appropriate,'' \539\ Congress intended to
[[Page 71702]]
provide the Commission with the discretion necessary to establish a
position limit regime in a manner that will not only protect the
markets from undue burdens due to excessive speculation and
manipulation, but that will also provide for market liquidity and
price discovery in a level playing field while preventing regulatory
arbitrage.\540\
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\538\ See, e.g., Comment letter from BG Americas & Global LNG on
Proposed Rule Regarding Position Limits for Derivatives (RIN 2028-
AD15 and 3038-AD16) at 4 (Mar. 28, 2011), available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=965
(``Notwithstanding the Commission's argument that it has authority
to use position limits absent a specific finding that an undue
burden on interstate commerce had actually resulted, the language
and intent of CEA Section 4a(a)(1) remains unchanged by the Dodd-
Frank Act. As a consequence, the Commission has not been relieved of
the obligation under Section 4a(a)(1) to show that the proposed
position limits for the Referenced Contracts are necessary to
prevent excessive speculation.'').
\539\ See La Union Del Pueblo Entero v. FEMA, No. B-08-487, slip
op., 2009 WL 1346030 at *4 (S.D. Tex. May 13, 2009) (``[W]hen
`shall' is modified by a discretionary phrase such as `as may be
necessary' or `as appropriate' an agency has some discretion when
complying with the mandate.'' (citing Consumer Fed'n of America v.
U.S. Dep't of Health and Human Servs., 83 F.3d 1497, 1503 (DC Cir.
1996) (indicating that where Congress in mandating administrative
action modifies the word ``shall'' with the phrase ``as
appropriate'' an agency has discretion to evaluate the circumstances
and determine when and how to act)).
\540\ Section 4a(a)(6) mandates through an unqualified
``shall,'' that the Commission set aggregate limits across trading
venues including foreign boards of trade.
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I agree with commenters who argued that the Commission is
directed under its new authority to set position limits ``as
appropriate,'' or in other words meaning that whatever limits the
Commission sets are supported by empirical evidence demonstrating
that those would diminish, eliminate, or prevent excessive
speculation.\541\ In the absence of such evidence, I also agree with
commenters that we are unable, at this time, to fulfill the mandate
and assure Congress and market participants that any such limits we
do establish will comply with the statutory objectives of section
4a(a)(3). And, to be clear, without empirical data, we cannot assure
Congress that the limits we set will not adversely affect the
liquidity and price discovery functions of affected markets. The
Commission will have significant additional data about the over-the-
counter (OTC) swaps markets in the next year, and at a minimum, I
believe it would be appropriate for the Commission to defer any
decisions about the nature and extent of position limits for months
outside of the spot-month, including any determinations as to
appropriate formulas, until such time as we have had a meaningful
opportunity to review and assess the new data and its relevance to
any determinations regarding excessive speculation. At a future
date, when the Commission applies the second phase of the position
limits regime and sets the non-spot-month limits (single and all-
months combined limits), I will work to ensure that the position
formulas and applicable limits are validated by Commission data to
be both appropriate and effective so that those limits truly
``diminish, eliminate, or prevent excessive speculation.''
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\541\ See, e.g., Comment letter from Futures Industry
Association on Position Limits for Derivatives (RIN 2028-AD15 and
3038-AD16) at 6-8; Comment Letter of International Swaps and
Derivatives Association, Inc. and Securities Industry and Financial
Markets Association on Notice of Proposed Rulemaking--Position
Limits for Derivatives (RIN 3038-AD15 and 3038-AD16) at 3-4.
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An Absence of Justification
Today the Commission voted to move forward on a rule that (1)
establishes hard federal position limits and position limit formulas
for 28 physical commodity futures and options contracts and physical
commodity swaps that are economically equivalent to such contracts
in the spot-month, for single months, and for all-months combined;
(2) establishes aggregate position limits that apply across
different trading venues to contracts based on the same underlying
commodity; (3) implements a new, more limited statutory definition
of bona fide hedging transactions; (4) revises account aggregation
standards; (5) establishes federal position visibility reporting
requirements; and (6) establishes standards for position limits and
position accountability rules for registered entities. The
Commission voted on this multifaceted rule package without the
benefit of performing an objective factual analysis based on the
necessary data to determine whether these particular limits and
limit formulas will effectively prevent or deter excessive
speculation. The Commission did not even provide for public comment
a determination as to what criteria it utilized to determine whether
or not excessive speculation is present or will potentially threaten
prices in any of the commodity markets affected by the new position
limits.
Moreover, while it engaged in a public rulemaking, the
Commission's Notice of Proposed Rulemaking,\542\ in its complexity
and lack of empirical data and legal rationale for several new
mandates and changes to existing policies--in spite of the fact that
we largely rely on our historical experiences in setting such
limits--tainted the entire process. By failing to put forward data
evidencing that commodity prices are threatened by the negative
influence of a defined level of speculation that we can define as
``excessive speculation,'' and that today's measures are appropriate
(i.e. necessary and effective) in light of such findings, I believe
that we have failed under the Administrative Procedure Act to
provide a meaningful and informed opportunity for public
comment.\543\
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\542\ Position Limits for Derivatives, 76 FR 4752 (proposed Jan.
26, 2011) (to be codified at 17 CFR pts. 1, 150 and 151).
\543\ See Am. Med. Ass'n v. Reno, 57 F.3d 1129, 1132-3 (DC Cir.
1995) (``Notice of a proposed rule must include sufficient detail on
its content and basis in law and evidence to allow for meaningful
and informed comment: `the Administrative Procedure Act requires the
agency to make available to the public in a form that allows for
meaningful comment, the data the agency used to develop the proposed
rule.''') (quoting Engine Mfrs. Ass'n v. EPA, 20 F.3d 1177, 1181 (DC
Cir. 1994)).
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Substantive comment letters, of which there were approximately
100,\544\ devoted at times substantial text to expressions of
confusion and requests for clarification of vague descriptions and
processes. In more than one instance, preamble text did not reflect
proposed rule text and vice versa.\545\ Indeed, the entire
rulemaking process has been plagued by internal and public debates
as to what the Commission's motives are and to what extent they are
based on empirical evidence, in policy, or are simply without
reason.
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\544\ Position Limits for Futures and Swaps, supra note 1, at 4.
\545\ See, e.g., 76 FR at 4752, 4763 and 4775 (In its discussion
of registered entity position limits, the preamble makes no mention
of proposed Sec. 151.11(a)(2) which would remove a registered
entity's discretion under CEA Sec. 5(d)(5)(A) for designated
contract markets (DCMs) and under CEA Sec. 5h(f)(6)(A) for swap
execution facilities (SEFs) that are trading facilities to set
position accountability in lieu of position limits for physical
commodity contracts for which the Commission has not set Federal
limits.).
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Implementing an Appropriate Program for Position Management
This rule, like several proposed before it, fails to make a
compelling argument that the proposed position limits, which only
target large concentrated positions,\546\ will dampen price
distortions or curb excessive speculation--especially when those
position limits are identified by the overall participation of
speculators as an increased percentage of the market. What the rule
argues is that there is a Congressional mandate to set position
limits, and therefore, there is no duty on the Commission to
determine that excessive speculation exists (and is causing price
distortions), or to ``prove that position limits are an effective
regulatory tool.'' \547\ This argument is incredibly convenient
given that the proposed position limits are modeled on the
agricultural commodities position limits, and despite those federal
position limits, contracts such as wheat, corn, soybeans, and cotton
contracts were not spared record-setting price increases in 2007 and
2008. Indeed, the cotton No. 2 futures contract has hit sixteen
``record-setting'' prices since December 1, 2010. The most recent
high was set on March 4, 2011 when the March 2011 future traded at a
price of $215.15.
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\546\ Today's final rule does not hide the fact that the
position limits regime is aimed at ``prevent[ing] a large trader
from acquiring excessively large positions and thereby would help
prevent excessive speculation and deter and prevent market
manipulations, squeezes, and corners.'' See Position Limits for
Futures and Swaps, supra note 1, at 47. See also Comment letter from
Better Markets on Position Limits for Derivatives (RIN 2028-AD15 and
3038-AD16) at 62 (Mar. 28, 2011) available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=34010&SearchText=better%20markets (``[T]here are
critical differences between a commodities market position limit
regime focused just on manipulation, and one focusing on a very
different concept of excessive speculation.'').
\547\ Position Limits for Futures and Swaps, supra note 1, at
137 (``In light of the congressional mandate to impose position
limits, the Commission disagrees with comments asserting that the
Commission must first determine that excessive speculation exists or
prove that position limits are an effective tool.'').
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To be clear, I am not opposed to position or other trading
limits in all circumstances. I remain convinced that position
limits, whether enforced at the exchange level or by the Commission,
are effective only to the extent that they mitigate potential
congestion during delivery periods and trigger reporting obligations
that provide regulators with the complete picture of an entity's
trading. I therefore believe that accountability levels and
visibility levels provide a more refined regulatory tool to
identify, deter, and respond in advance to threats of manipulation
and other non-legitimate price movements and distortions. I would
have supported a rule that would impose position limits in the spot-
month for physical commodities, i.e. the referenced contracts,\548\
and would establish an accountability level. The Commission's
ability to monitor such accountability levels
[[Page 71703]]
would rely on a technology based, real-time surveillance program
that the Commission must be committed to deploying if it is to take
its market oversight mission seriously.
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\548\ As defined in new Sec. 151.1.
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And to be absolutely clear, ``speculation'' in the world of
commodities is a technical term ascribed to any trading that does
not qualify as ``bona fide hedging.'' Congress has not outlawed
speculation, even when that speculation reaches some unspecified
tipping point where it becomes ``excessive.'' What Congress has
stated, for over seventy years until the passage of the Dodd-Frank
Act, is that excessive speculation that causes sudden or
unreasonable fluctuations or unwarranted changes in the price of a
commodity is a burden on interstate commerce, and the Commission has
authority to utilize its expertise to establish limits on trading or
positions that will be effective in diminishing, eliminating, or
preventing such burden.\549\ The Commission, however, is not, and
has never been, without other tools to detect and deter those who
engage in abusive practices.\550\ What the Dodd-Frank Act did do is
direct the Commission to exercise its authority at a time when there
is simply a lack of empirical data to support doing so, in a
universe of legal uncertainty. However, the Dodd-Frank Act did not
leave us without a choice, as contended by today's rule. Rather,
against the current backdrop of market uncertainty, and Congress's
longstanding deference to the expertise of the Commission, the most
reasonable interpretation of Dodd-Frank's mandate is that while we
must take action and establish position limits, we must only do so
to the extent they are appropriate.
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\549\ See section 4a(a)(1) of the CEA.
\550\ See Establishment of Speculative Position Limits, 46 FR
50938, 50939 (Oct. 16, 1981) (to be codified at 17 CFR pt. 1) (``The
Commission wishes to emphasize, that while Congress gave the
Commission discretionary authority to impose federal speculative
limits in section 4a(1), the development of an alternate procedure
was not foreclosed, and section 4a(1) should not be read in a
vacuum.'').
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Today I write to not only reiterate my concerns with regard to
the effectiveness of position limits generally, but to highlight
some of the regulatory provisions that I believe pose the greatest
fundamental problems and/or challenges to the implementation of the
rule passed today. In addition to disagreeing with the Commission's
interpretation of its statutory mandate, I believe the Commission
has so severely restricted the permitted activities allowed under
the bona fide hedging rules that the pursuit by industry of
legitimate and appropriate risk management is now made unduly
onerous. These limitations, including a veritable ban on
anticipatory hedging for merchandisers, are inconsistent with the
statutory directive and the very purpose of the markets to, among
other things, provide for a means for managing and assuming price
risks. I also believe that the rules put into place overly broad
aggregation standards, fail to substantiate claims that they
adequately protect against international regulatory arbitrage, and
do not include an adequate cost-benefit analysis.
Bona Fide Hedging: Guilty Until Proven Innocent
The Commission's regulatory definition of bona fide hedging
transactions in Sec. 151.5 of the rules, as directed by new section
4a(c)(1) of the Act, generally restricts bona fide hedge exemptions
from the application of federally-set position limits to those
transactions or positions which represent a substitute for an actual
cash market transaction taken or to be taken later, or those trading
as the counterparty to an entity that it engaged in such
transaction. This definition is narrower than current Commission
regulation 1.3(z)(1), which allows for an exemption for transactions
or positions that normally represent a substitute for a physical
market transaction.
When combined with the remaining provisions of Sec. 151.5,
which provide for a closed universe of enumerated hedges and
ultimately re-characterize longstanding acceptable bona fide hedging
practices as speculative, it is evident that the Commission has used
its authority to further narrow the availability of bona fide
hedging transactions in a manner that will negatively impact the
cash commodity markets and the physical commodity marketplace by
eliminating certain legitimate derivatives risk management
strategies, most notably anticipatory hedging. Among other things, I
believe the Commission should have defined bona fide hedging
transactions and positions more broadly so that they encompass long-
standing risk management practices and should have preserved a
process by which bona fide hedgers could expeditiously seek
exemptions for non-enumerated hedging transactions.
In this instance, Congress was particularly clear in its mandate
under section 4a(c)(2) that the Commission must limit the definition
of bona fide hedging transactions/positions to those that represent
actual substitutes for cash market transactions, but Congress did
not so limit the Commission in any other manner with regard to the
new regulatory provisions addressing anticipatory hedging and the
availability of non-enumerated hedges.\551\ Moreover, inasmuch as
the bona fide hedging definition is restrictive, section 4a(a)(7)
provides the Commission broad exemptive authority which it could
have utilized to create a process for expeditious adjudication of
petitions from entities relying on a broader set of legitimate
trading strategies than those that fit the confines of section
4a(c)(1). In addition, given the complex, multi-faceted nature of
hedging for commodity-related risks, the Commission could have, as
suggested by one commenter, engaged in a separate and distinct
informal rulemaking process to develop a workable, commercially
practicable definition of bona fide hedging.\552\ Given the
commercial interests at stake, this would have been a welcome
approach. Instead, the Commission chose form over function so that
it could ``check the box'' on its mandate.
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\551\ To the contrary, Congress specifically indicated that in
defining bona fide hedging transactions or positions, the Commission
may do so in such a manner as ``to permit producers, sellers,
middlemen, and users of a commodity or a product derived therefrom
to hedge their legitimate anticipated business needs for that period
of time into the future for which an appropriate futures contract is
open and available on an exchange.'' See section 4a(c)(1) of the
CEA.
\552\ See, e.g., Comment letter from BG Americas & Global LNG on
Proposed Rule Regarding Position Limits for Derivatives (RIN 2028-
AD15 and 3038-AD16) at 13.
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In order to qualify as a bona fide hedging transaction or
position, a transaction must meet both the requirements under Sec.
151.5(a)(1) and qualify as one of eight specific and enumerated
hedging transactions described in Sec. 151.5(a)(2). While the list
of enumerated hedging transactions is an improvement from the
proposed rules, and responds to several comments, especially with
regard to the addition of an Appendix B to the final rule describing
examples of bona fide hedging transactions, it remains inflexible.
In response to commenters, the Commission has decided--at the last
minute--to permit entities engaging in practices that reduce risk
but that may not qualify as one of the enumerated hedging
transactions under Sec. 151.5(a)(2) to seek relief from Commission
staff under Sec. 140.99 or the Commission under section 4a(a)(7) of
the CEA. Whereas this change to the preamble and the rule text is
helpful, neither of these alternatives provides for an expeditious
determination, nor do they provide for a predictable or certain
outcome. In its refusal to accommodate traders seeking legitimate
bona fide hedging exemptions in compliance with the Act with an
expeditious and straightforward process, the Commission is being
short-sighted in light of the dynamic (and in the case of the OTC
markets, uncertain) nature of the commodity markets and with respect
to the appropriate use of Commission resources.
One particularly glaring example of the Commission's decision to
pursue form over function is found in the enumerated exemption for
anticipated merchandising found at Sec. 151.5(2)(v). The new
statutory provision in section 4a(c)(d)(A)(ii) is included to
assuage unsubstantiated concerns about unintended consequences such
as creating a potential loophole for clearly speculative
activity.\553\ The Commission has so narrowly defined the
anticipated merchandising that only the most elementary operations
will be able to utilize it.
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\553\ Position Limits for Futures and Swaps, supra note 1, at
75.
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For example, in order to qualify an anticipatory merchandising
transaction as a bona fide hedge, a hedger must (i) own or lease
storage capacity and demonstrate that the hedge is no greater than
the amount of current or anticipated unfilled storage capacity owned
or leased by the same person during the period of anticipated
merchandising activity, which may not exceed one year, (ii) execute
the hedge in the form of a calendar spread that meets the
``appropriateness'' test found in Sec. 151.5(a)(1), and (iii) exit
the position prior to the last five days of trading if the Core
Referenced Futures Contract is for agricultural or metal contracts
or the spot month for other physical-delivery commodities. In
addition,
[[Page 71704]]
(iv) an anticipatory merchandiser must meet specific filing
requirements under Sec. 151.5(d), which among other things, (v)
requires that the person who intends on exceeding position limits
complete the filing at least ten days prior to the date of expected
overage.
Putting the burdens associated with the Sec. 151.5(d) filings
aside, the anticipatory merchandising exemption and its limitations
on capacity, the requirement to ``own or lease'' such capacity, and
one-year limitation for agricultural commodities does not comport
with the economic realities of commercial operations. In recent
testimony, Todd Thul, Risk Manager for Cargill AgHorizons, commented
on its understanding of this provision. He said that by limiting the
exemption to unfilled storage capacities through calendar spread
positions for one year, the CFTC will reduce the industry's ability
to continue offering the same suite of marketing tools to farmers
that they are accustomed to using.\554\ Mr. Thul offered a more
reasonable and appropriate limitation on anticipatory hedging based
on annual throughput actually handled on a historic basis by the
company in question. It is unclear from today's rule as to whether
the Commission considered such an alternative, but according to Mr.
Thul, by going forward with the exemption as-is, we will ``severely
limit the ability of grain handlers to participate in the market and
impede the ability to offer competitive bids to farmers, manage
risk, provide liquidity and move agriculture products from origin to
destination.'' 555 556 Limiting commercial participation,
Mr. Thul points out, increases volatility--and that is clearly not
what Congress intended. I agree. I cannot help but think that the
Commission is waging war on commercial hedging by employing a
``government knows best'' mandate to direct companies to employ only
those hedging strategies that we give our blessing to and can
conceive of at this point in time. Imagine the absurdity that we
could prevent a company such as a cotton merchandiser from hedging
forward a portion of his expected cotton purchase. Or, if they meet
the complicated prerequisites, the commercial firm must get approval
from the Commission before deploying a legitimate commercial
strategy that exchanges have allowed for years.
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\554\ Testimony of Todd Thul, Risk Manager, Cargill AgHorizons
before the House Committee on Agriculture, Oct. 12, 2011, available
at http://agriculture.house.gov/pdf/hearings/Thul111012.pdf.
\555\ Id.
\556\ Though I rely upon the example of agricultural operations
to illustrate my point, the limitations on the anticipated
merchandising hedge are equally harmful to other industries that
operate in relatively volatile environments that are subject to
unpredictable supply and demand swings due to economic factors, most
notably energy. See, e.g., Comment letter from ISDA on Notice of
Proposed Rulemaking--Position Limits for Derivatives at 3-5 (Oct. 3,
2011).
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Aggregation Disparity
In another attack on commercial hedging the Commission has
developed a flawed aggregation rule that singles out owned-non
financial firms for unique and unfair treatment under the rule.
These commercial firms, which, among others, could be energy
producers or merchandisers, are not provided the same protections
under the independent controller rules as financial entities such as
hedge funds or index funds. I believe that the aggregation
provisions of the final rule would have benefited from a more
thorough consideration of additional options and possible re-
proposal of at least two provisions: the general aggregation
provision found in Sec. 151.7(b) and the proposed aggregation for
exemption found in Sec. 151.7(f) of the proposed rule,\557\ now
commonly referred to at the Commission as the owned non-financial
exemption or ``ONF.''
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\557\ See 76 FR at 4752, 4762 and 4774.
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Under Sec. 151.7(b), absent the applicability of a specific
exemption found elsewhere in Sec. 151.7, a direct or indirect
ownership interest of ten percent or greater by any entity in
another entity triggers a 100% aggregation of the ``owned'' entity's
positions with that of the owner. While commenters agreed that an
ownership interest of ten percent or greater has been the historical
basis for requiring aggregation of positions under Commission
regulation Sec. 150.5(b), absent applicable exemptions,
historically, aggregation has not been required in the absence of
indicia of control over the ``owned'' entity's trading activities,
consistent with the independent account controller exemption (the
``IAC'') under Commission regulation Sec. 150.3(a)(4). While the
final rule preserves the IAC exemption, it only does so in response
to overwhelming comments arguing against its proposed elimination,
which was without any legal rationale.\558\ And, to be clear, the
IAC is only available to ``eligible entities'' defined in Sec.
151.1, namely financial entities, and only with respect to client
positions.
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\558\ See 76 FR at 4752, 4762.
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The practical effect of this requirement is that non-eligible
entities, such as holding companies who do not meet any of the other
limited specified exemptions will be forced to aggregate on a 100%
basis the positions of any operating company in which it holds a ten
percent or greater equity interest in order to determine compliance
with position limits. While the Commission concedes that the holding
company could conceivably enter into bona fide hedging transactions
relating to the operating company's cash market activities, provided
that the operating company itself has not entered into such
hedges,\559\ this is an inadequate, operationally-impracticable
solution to the problem of imparting ownership absent control.
Moreover, by requiring 100% aggregation based on a ten percent
ownership interest, the Commission has determined that it would
prefer to risk double-counting of positions over a rational
disaggregation provision based on a concept of ownership that does
not clearly attach to actual control of trading of the positions in
question.
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\559\ Position Limits for Futures and Swaps, supra note 1, at
83-84.
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Exemptions like those found in Sec. Sec. 151.7(g) and (i) that
provide for disaggregation when ownership above the ten percent
threshold is specifically associated with the underwriting of
securities or where aggregation across commonly-owned affiliates
would require information sharing that would result in a violation
of federal law, are useful and no doubt appreciated. However, the
Commission has failed to apply a consistent standard supporting the
principles of ownership and control across all entities in this
rulemaking.
Tiered Aggregation--A Viable and Fair Solution
Also, the Commission did not address in the final rules a
proposal put forth by Barclays Capital for the Commission to clarify
that when aggregation is triggered, and no exemption is available,
only an entity's pro rata share of the position that is actually
controlled by it, or in which it has an ownership interest will be
aggregated. This proposal included a suggestion that the Commission
consider positions in tiers of ownership, attributing a percentage
of the positions to each tier. While Barclays acknowledged that the
monitoring would still be imperfect, the measures would be more
accurate than an attribution of a full 100% ownership and would
decrease the percentage of duplicative counting of positions.\560\
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\560\ Comment letter from Barclays Capital on Position Limits
for Derivatives (RIN 3038-AD15 and 3038-AD16) at 3 (Mar. 28, 2011),
available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=965.
---------------------------------------------------------------------------
I believe that a tiered approach to aggregation should have been
considered in these rules, and not be entirely removed from
consideration as we move forward with these final rules. Barclays
(and perhaps others) has made a compelling case and staff has not
persuaded me that there is any legal rationale for not further
exploring this option. While I understand that it may be more
administratively burdensome for the Commission to monitor tiered
aggregation, I would presume that we could engage in a cost-benefit
analysis to more fully explore such burdens in light of the
potential costs to industry associated with the implementation of
100% aggregation.
Owned Non-Financial--No Justification
The best example of the Commission's imbalanced treatment of
market participants is manifest in the aggregation rules applied to
owned non-financial firms. The Commission has shifted its
aggregation proposal from the draft proposal to this final version.
The final rule does not ultimately adopt the proposed owned-non-
financial entity exemption which was proposed in lieu of the IAC to
allow disaggregation primarily in the case of a conglomerate or
holding company that ``merely has a passive ownership interest in
one or more non-financial companies.'' \561\ The rationale was that,
in such cases, operating companies would likely have complete
trading and management independence and operate at such a distance
that is would simply be inappropriate to aggregate positions.\562\
While several commenters argued that the ONF was too narrow and
discriminated against financial entities without a proper basis, the
Commission provided no
[[Page 71705]]
substantive rationale for its decision to fully drop the ONF
exemption from consideration. Instead, the Commission relied upon
its determination to retain the IAC exemption and add the additional
exemptions under Sec. Sec. 151.7(g) and (i) described above to find
that it ``may not be appropriate, at this time, to expand further
the scope of disaggregation exemptions to owned-non financial
entities.''
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\561\ 76 FR at 4752, 4762.
\562\ Id.
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In failing to articulate a basis for its decision to drop
outright from consideration the ONF exemption, the Commission places
itself in the same improvident position it was in when it proposed
eliminating the IAC exemption, and now has given no reasoned
explanation for discriminating against non-financial entities. This
is especially disconcerting since at least one commenter has pointed
out that baseless decision-making of this kind creates a risk that a
court will strike down our action as arbitrary and capricious.\563\
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\563\ See Comment letter from CME Group on Position Limits for
Derivatives at 16 (Mar. 28, 2011), available at http://
comments.cftc.gov/PublicComments/
ViewComment.aspx?id=33920&SearchText=CME (``Where agencies do not
articulate a basis for treating similarly situated entities
differently, as the Commission fails to do here, courts will strike
down their actions as arbitrary and capricious. See, e.g., Indep.
Petroleum Ass'n of America v. Babbitt, 92 F.3d 1248 (D.D. Cir. 1996)
(``An Agency must treat similar cases in a similar manner unless it
can provide a legitimate reason for failing to do so.'' (citing
Nat'l Ass'n of Broadcasters v. FCC, 740 F.2d 1190, 1201 (DC Cir.
1984))).
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Since I first learned of the Commission's change of course, I
have requested that the Commission re-propose the ONF exemption in a
manner that establishes an appropriate legal basis and provides for
additional public comment pursuant to the Administrative Procedure
Act. The Commission has outright refused to entertain my request to
even include in the preamble of the final rules a commitment to
further consider a version of the ONF exemption that would be more
appropriate in terms of its breadth. The Commission's decision puts
the rule at risk of being overturned by the courts and exemplifies
the pains at which this rule has been drafted to put form over
function.
The Great Unknown: International Regulatory Arbitrage
In addressing concerns relating to the opportunities for
regulatory arbitrage that may arise as a result of the Commission
imposing these position limits, the Commission points out that is
has worked to achieve the goal of avoiding such regulatory arbitrage
through participation in the International Organization of
Securities Commissions (``IOSCO'') and summarily rejects commenters
who believe it is a foregone conclusion that the existence of
international differences in position limit policies will result in
such arbitrage in reliance on prior experience. While I don't
disagree that the Commission's work within IOSCO is beneficial in
that it increases the likelihood that we will reach international
consensus with regard to the use of position limits, the Commission
ought to be more forthcoming as to principles as a whole.
In particular, while the IOSCO Final Report on Principles for
the Regulation and Supervision of Commodity Derivatives Markets
\564\ does, for the first time, call on market authorities to make
use of intervention powers, including the power to set ex-ante
position limits, this is only one of many such recommendations that
international market authorities are not required to implement. The
IOSCO Report includes the power to set position limits, including
less restrictive measures under the more general term ``position
management.'' Position Management encompasses the retention of
various discretionary powers to respond to identified large
concentrations. It would have been preferable for the Commission to
have explored some of these other discretionary powers as options in
this rulemaking, thereby putting us in the right place to put our
findings into more of a practice.
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\564\ Principles for Regulation and Supervision of Commodity
Derivatives Markets, IOSCO Technical Committee (Sept. 2011),
available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD358.pdf.
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As to the Commission's stance that today's rules will not, by
their very passage, drive trading abroad, I am concerned that the
Commission's prior experience in determining the competitive effects
of regulatory policies is inadequate. Today's rules by far represent
the most expansive exercise of the Commission's authority both with
regard to the setting of position limits and with regard to its
jurisdiction in the OTC markets. The Commission's past studies
regarding the effects of having a different regulatory regime than
our international counterparts, conducted in 1994 and 1999, cannot
possibly provide even a baseline comparison. Since 2000, the volume
of actively traded futures and option contracts on U.S. exchanges
alone has increased almost tenfold. Electronic trading now
represents 83% of that volume, and it is not too difficult to
imagine how easy it would be to take that volume global.
I recognize that we cannot dictate how our fellow market
authorities choose to structure their rules and that in any action
we take, we must do so with the knowledge that as with any rules, we
risk triggering a regulatory race to the bottom. However, I believe
that we ought not to deliver to Congress, or the public, an
unsubstantiated sense of security in these rules.
Cost-Benefit Analysis: Hedgers Bear the Brunt of an Undue and Unknown
Burden
With every final rule, the Commission has attempted to conduct a
more rigorous cost-benefit analysis. There is most certainly an
uncertainty as to what the Commission must do in order to justify
proposals aimed at regulating the heretofore unregulated. These
analyses demonstrate that the Commission is taking great pains to
provide quantifiable justifications for its actions, but only when
reasonably feasible. The baseline for reasonability was especially
low in this case because, in spite of the availability of enough
data to determine that this rule will have an annual effect on the
economy of more than $100 million, and the citation of at least
fifty-two empirical studies in the official comment record debating
all sides of the excessive speculation debate, the Commission is not
convinced that it must ``determine that excessive speculation exists
or prove that position limits are an effective regulatory tool.''
\565\ I suppose this also means that the Commission did not have to
consider the costs of alternative means by which it could have
complied with the statutory mandates. It is utterly astounding that
the Commission has designed a rule to combat the unknown threat of
``excessive speculation'' that will likely cost market participants
$100 million dollars annually and yet, ``[T]he Commission need not
prove that such limits will in fact prevent such burdens.'' \566\ A
flip remark such as this undermines the entire rule, and invites
legal challenge.
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\565\ Position Limits for Futures and Swaps, supra note 1, at
137.
\566\ Id.
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I respect that the Commission has been forthcoming in that the
overall costs of this final rule will be widespread throughout the
markets and that swap dealers and traditional hedgers alike will be
forced to change their trading strategies in order to comply with
the position limits. However, I am unimpressed by the Commission's
glib rationale for not fully quantifying them. The Commission does
not believe it is reasonably feasible to quantify or even estimate
the costs from changes in trading strategies because doing so would
necessitate having access to and an understanding of entities'
business models, operating models, hedging strategies, and
evaluations of potential alternative hedging or business strategies
that would be adopted in light of such position limits.\567\ The
Commission believed it impractical to develop a generic or
representative calculation of the economic consequences of a firm
altering its trading strategies.\568\ It seems that the numerous
swap dealers and commercial entities who provided comments as to
what kind of choices they would be forced to make if they were to
find themselves faced with hard position limits, the loss of
exchange-granted bona fide hedge exemptions for risk management and
anticipatory hedging, and forced aggregation of trading accounts
over which they may not even have current access to trading
strategies or position information, more likely than not thought
they were being pretty clear as to the economic costs.
---------------------------------------------------------------------------
\567\ Id. at 144.
\568\ Id.
---------------------------------------------------------------------------
In choosing to make hardline judgments with regard to setting
position limits, limiting bona fide hedging, and picking clear
winners and losers with regard to account aggregation, the
Commission was perhaps attempting to limit the universe of trading
strategies. Indeed, as one runs through the examples in the preamble
and the new Appendix B to the final rules, one cannot help but
conclude that how you choose to get your exposure will affect the
application of position limits. And the Commission will help you
make that choice even if you aren't asking for it.
I have numerous lingering questions and concerns with the cost-
benefit analysis, but I will focus on the impact of these rules on
the costs of claiming a bona fide hedge exemption.
[[Page 71706]]
In addition to incorporating the new, narrower statutory
definition of bona fide hedging for futures contracts into the final
rules, the Commission also extended the definition of bona fide
hedging transactions to swaps and established a reporting and
recordkeeping regime for bona fide hedging exemptions. In the
section of the cost-benefit analysis dedicated to a discussion of
the bona fide hedging exemptions, the Commission ``estimates that
there may be significant costs (or foregone benefits)'' and that
firms ``may need to adjust their trading and hedging strategies''
(emphasis added).\569\ Based on the comments of record and public
contention over these rules, that may be the understatement of the
year. To be clear, however, there is no quantification or even
qualification of this potentially tectonic shift in how commercial
firms and liquidity providers conduct their business because the
Commission is unable to estimate these kinds of costs, and the
commenters did not provide any quantitative data for them to work
with.\570\ I think this part of the cost-benefit analysis may be
susceptible to legal challenge.
---------------------------------------------------------------------------
\569\ Position Limits for Futures and Swaps, supra note 1, at
166.
\570\ Id. at 171.
---------------------------------------------------------------------------
The Commission does attempt a strong comeback in estimating the
costs of bona fide hedging-related reporting requirements. The
Commission estimates that these requirements, even after all of the
commenter-friendly changes to the final rule, will affect
approximately 200 entities annually and result in a total burden of
approximately $29.8 million. These costs, it argues, are necessary
in that they provide the benefit of ensuring that the Commission has
access to information to determine whether positions in excess of a
position limit relate to bona fide hedging or speculative
activity.\571\ This $29.8 million represents almost thirty percent
of the overall estimated costs at this time, and it only covers
reporting for entities seeking to hedge their legitimate commercial
risk. I find it difficult to believe that the Commission cannot come
up with a more cost-effective and less burdensome alternative,
especially in light of the current reporting regimes and development
of universal entity, commodity, and transaction identifiers. I was
not presented with any other options. I will, however, continue to
encourage the rulemaking teams to communicate with one another in
regard to progress in these areas and ensure that the Commission's
new Office of Data and Technology is tasked with the permanent
objective of exploring better, less burdensome, and more cost-
efficient ways of ensuring that the Commission receives the data it
needs.
---------------------------------------------------------------------------
\571\ Id.
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We Have Done What Congress Asked--But, What Have We Actually Done?
The consequence is that in its final iteration, the position
limits rule represents the Commission's desire to ``check the box''
as to position limits. Unfortunately, in its exuberance and attempt
to justify doing so, the Commission has overreached in interpreting
its statutory mandate to set position limits. While I do not
disagree that the Commission has been directed to impose position
limits, as appropriate, this rule fails to provide a legally sound,
comprehensible rationale based on empirical evidence. I cannot
support passing our responsibilities on to the judicial system to
pick apart this rule in a multitude of legal challenges, especially
when our action could negatively affect the liquidity and price
discovery function of our markets, or cause them to shift to foreign
markets. I also have serious reservations regarding the excessive
regulatory burden imposed on commercial firms seeking completely
legitimate and historically provided relief under the bona fide
hedge exemption. These firms will spend excessive amounts to remain
within the strict limitations set by this rule. Congress clearly
conceived of a much more workable and flexible solution that this
Commission has ignored.
In its comment letter of March 25, 2011, the Futures Industry
Association (FIA) stated, ``The price discovery and risk-shifting
functions of the U.S. derivatives markets are too important to U.S.
and international commerce to be the subject of a position limits
experiment based on unsupported claims about price volatility caused
by excessive speculative positions.'' \572\ Their summation of our
proposal as an experiment is apt. Today's final rule is based on a
hypothesis that historical practice and approach, which has not been
proven effective in recognized markets, will be appropriate for this
new integrated futures and swaps market that is facing uncertainty
from all directions largely due to the other rules we are in the
process of promulgating. I do not believe the Commission has done
its research and assessed the impacts of testing this hypothesis,
and that is why I cannot support the rule. As the Commission begins
to analyze the results of its experiment, it remains my sincerest
hope that our miscalculations ultimately do not lead to more harm
than good. I will take no comfort if being proven correct means that
the agency has failed in its mission.
---------------------------------------------------------------------------
\572\ Comment letter from Futures Industry Association on
Position Limits for Derivatives (RIN 2028-AD15 and 3038-AD16) at 3
(Mar. 25, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=34054&SearchText=futures%20industry%20association
.
[FR Doc. 2011-28809 Filed 11-10-11; 11:15 am]
BILLING CODE P