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2013-27200

  • Federal Register, Volume 78 Issue 239 (Thursday, December 12, 2013)[Federal Register Volume 78, Number 239 (Thursday, December 12, 2013)]

    [Proposed Rules]

    [Pages 75679-75842]

    From the Federal Register Online via the Government Printing Office [www.gpo.gov]

    [FR Doc No: 2013-27200]

    [[Page 75679]]

    Vol. 78

    Thursday,

    No. 239

    December 12, 2013

    Part II

    Commodity Futures Trading Commission

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    17 CFR Parts 1, 15, 17, et al.

    Position Limits for Derivatives; Proposed Rule

    Federal Register / Vol. 78 , No. 239 / Thursday, December 12, 2013 /

    Proposed Rules

    [[Page 75680]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 1, 15, 17, 19, 32, 37, 38, 140, and 150

    RIN 3038-AD99

    Position Limits for Derivatives

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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    SUMMARY: The Commission proposes to amend regulations concerning

    speculative position limits to conform to the Wall Street Transparency

    and Accountability Act of 2010 (``Dodd-Frank Act'') amendments to the

    Commodity Exchange Act (``CEA'' or ``Act''). The Commission proposes to

    establish speculative position limits for 28 exempt and agricultural

    commodity futures and option contracts, and physical commodity swaps

    that are ``economically equivalent'' to such contracts. In connection

    with establishing these limits, the Commission proposes to update some

    relevant definitions; revise the exemptions from speculative position

    limits, including for bona fide hedging; and extend and update

    reporting requirements for persons claiming exemption from these

    limits. The Commission proposes appendices that would provide guidance

    on risk management exemptions for commodity derivative contracts in

    excluded commodities permitted under the proposed definition of bona

    fide hedging position; list core referenced futures contracts and

    commodities that would be substantially the same as a commodity

    underlying a core referenced futures contract for purposes of the

    proposed definition of basis contract; describe and analyze fourteen

    fact patterns that would satisfy the proposed definition of bona fide

    hedging position; and present the proposed speculative position limit

    levels in tabular form. In addition, the Commission proposes to update

    certain of its rules, guidance and acceptable practices for compliance

    with Designated Contract Market (``DCM'') core principle 5 and Swap

    Execution Facility (``SEF'') core principle 6 in respect of exchange-

    set speculative position limits and position accountability levels.

    DATES: Comments must be received on or before February 10, 2014.

    ADDRESSES: You may submit comments, identified by RIN number 3038-AD99

    by any of the following methods:

    Agency Web site: http://comments.cftc.gov.

    Mail: Secretary of the Commission, Commodity Futures

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

    Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

    Federal eRulemaking Portal: http://www.regulations.gov.

    Follow instructions for submitting comments.

    All comments must be submitted in English, or if not, accompanied

    by an English translation. Comments will be posted as received to

    www.cftc.gov. You should submit only information that you wish to make

    available publicly. If you wish the Commission to consider information

    that is exempt from disclosure under the Freedom of Information Act, a

    petition for confidential treatment of the exempt information may be

    submitted according to the procedure established in Sec. 145.9 of the

    Commission's regulations (17 CFR 145.9).

    The Commission reserves the right, but shall have no obligation, to

    review, pre-screen, filter, redact, refuse, or remove any or all of

    your submission from http://www.cftc.gov that it may deem to be

    inappropriate for publication, such as obscene language. All

    submissions that have been redacted or removed that contain comments on

    the merits of the rulemaking will be retained in the public comment

    file and will be considered as required under the Administrative

    Procedure Act and other applicable laws, and may be accessible under

    the Freedom of Information Act.

    FOR FURTHER INFORMATION CONTACT: Stephen Sherrod, Senior Economist,

    Division of Market Oversight, at (202) 418-5452, ssherrod@cftc.gov;

    Riva Spear Adriance, Senior Special Counsel, Division of Market

    Oversight, at (202) 418-5494, radriance@cftc.gov; David N. Pepper,

    Attorney-Advisor, Division of Market Oversight, at (202) 418-5565,

    dpepper@cftc.gov, Commodity Futures Trading Commission, Three Lafayette

    Centre, 1155 21st Street NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    Table of Contents

    I. Position Limits for Physical Commodity Futures and Swaps

    A. Background

    1. CEA Section 4a

    2. The Commission Construes CEA Section 4a(a) To Mandate That

    the Commission Impose Position Limits

    3. Necessity Finding

    B. Proposed Rules

    1. Section 150.1--Definitions

    i. Various Definitions Found in Sec. 150.1

    ii. Bona Fide Hedging Definition

    2. Section 150.2--Position Limits

    i. Current Sec. 150.2

    ii. Proposed Sec. 150.2

    3. Section 150.3--Exemptions

    i. Current Sec. 150.3

    ii. Proposed Sec. 150.3

    4. Part 19--Reports by Persons Holding Bona Fide Hedge Positions

    Pursuant to Sec. 150.1 of This Chapter and by Merchants and Dealers

    in Cotton

    i. Current Part 19

    ii. Proposed Amendments to Part 19

    5. Sec. 150.7--Reporting Requirements for Anticipatory Hedging

    Positions

    i. Current Sec. 1.48

    ii. Proposed Sec. 150.7

    6. Miscellaneous Regulatory Amendments

    i. Proposed Sec. 150.6--Ongoing Responsibility of DCMs and SEFs

    ii. Proposed Sec. 150.8--Severability

    iii. Part 15--Reports--General Provisions

    iv. Part 17--Reports by Reporting Markets, Futures Commission

    Merchants, Clearing Members, and Foreign Brokers

    II. Revision of Rules, Guidance, and Acceptable Practices Applicable

    to Exchange-Set Speculative Position Limits--Sec. 150.5

    A. Background

    B. The Current Regulatory Framework for Exchange-Set Position

    Limits

    1. Section 150.5

    2. The Commodity Futures Modernization Act of 2000 Caused

    Commission Sec. 150.5 To Become Guidance on and Acceptable

    Practices for Compliance with DCM Core Principle 5

    3. The CFTC Reauthorization Act of 2008

    4. The Dodd-Frank Act Amendments to CEA Section 5

    i. The Dodd-Frank Act Added Provisions That Permit the

    Commission To Override the Discretion of DCMs in Determining How To

    Comply With the Core Principles

    ii. The Dodd-Frank Act Established a Comprehensive New Statutory

    Framework for Swaps

    iii. The Dodd-Frank Act Added the Regulation of Swaps, Added

    Core Principles for SEFs, Including SEF Core Principle 6, and

    Amended DCM Core Principle 5

    5. Dodd-Frank Rulemaking

    i. Amended Part 38

    ii. Amended Part 37

    iii. Vacated Part 151

    C. Proposed Amendments to Sec. 150.5

    1. Proposed Amendments to Sec. 150.5 To Add References to Swaps

    and Swap Execution Facilities

    2. Proposed Sec. 150.5(a)--Requirements and Acceptable

    Practices for Commodity Derivative Contracts That Are Subject to

    Federal Position Limits

    3. Proposed Sec. 150.5(b)--Requirements and Acceptable

    Practices for Commodity Derivative Contracts That Are Not Subject to

    Federal Position Limits

    III. Related Matters

    A. Considerations of Costs and Benefits

    1. Background

    i. Statutory Mandate To Consider Costs and Benefits

    2. Section 150.1--Definitions

    i. Bona Fide Hedging

    ii. Rule Summary

    iii. Benefits and Costs

    [[Page 75681]]

    3. Section 150.2--Limits

    i. Rule Summary

    ii. Benefits

    iii. Costs

    iv. Consideration of Alternatives

    4. Section 150.3--Exemptions

    i. Rule Summary

    ii. Benefits

    iii. Costs

    iv. Consideration of Alternatives

    5. Section 150.5--Exchange-Set Speculative Position Limits

    i. Rule Summary

    ii. Benefits

    iii. Costs

    iv. Consideration of Alternatives

    6. Section 150.7--Reporting Requirements for Anticipatory

    Hedging Positions

    i. Benefits and Costs

    7. Part 19--Reports

    i. Rule Summary

    ii. Benefits

    iii. Costs

    iv. Consideration of Alternatives

    8. CEA Section 15(a)

    i. Protection of Market Participants and the Public

    ii. Efficiency, Competitiveness, and Financial Integrity of

    Markets

    iii. Price Discovery

    iv. Sound Risk Management

    v. Other Public Interest Considerations

    B. Paperwork Reduction Act

    1. Overview

    2. Methodology and Assumptions

    3. Information Provided by Reporting Entities/Persons and

    Recordkeeping Duties

    4. Comments on Information Collection

    C. Regulatory Flexibility Act

    IV. Appendices

    A. Appendix A--Studies Relating to Position Limits Reviewed and

    Evaluated by the Commission

    I. Position Limits for Physical Commodity Futures and Swaps

    A. Background

    1. CEA Section 4a

    Speculative position limits have been used as a tool to regulate

    futures markets for over seventy years. Since the Commodity Exchange

    Act of 1936,\1\ Congress has repeatedly expressed confidence in the use

    of speculative position limits as an effective means of preventing

    unreasonable and unwarranted price fluctuations.\2\

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    \1\ 7 U.S.C. 1 et seq.

    \2\ See, e.g., H.R. Rep. No. 421, 74th Cong., 1st Sess. 1

    (1935); H.R. Rep. No. 624, 99th Cong., 2d Sess. 44 (1986).

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    CEA section 4a, as amended by the Dodd-Frank Act, provides the

    Commission with broad authority to set position limits. When Congress

    created the Commission in 1974, it reiterated that the purpose of the

    CEA was to prevent fraud and manipulation and to control speculation.

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

    provided a statutory basis for exchanges to use pre-existing position

    accountability levels as an alternative means to limit the burdens of

    excessive speculative positions. Nevertheless, the CFMA did not weaken

    the Commission's authority in CEA section 4a to establish position

    limits to prevent such undue burdens on interstate commerce.\3\ More

    recently, in the CFTC Reauthorization Act of 2008, Congress gave the

    Commission expanded authority to set position limits for significant

    price discovery contracts on exempt commercial markets.\4\

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    \3\ See Commodity Futures Modernization Act of 2000, Public Law

    106-554, 114 Stat. 2763 (Dec. 21, 2000).

    \4\ See Food, Conservation and Energy Act of 2008, Public Law

    110-246, 122 Stat. 1624 (June 18, 2008).

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    In 2010, the Dodd-Frank Act expanded the Commission's authority to

    set position limits by amending CEA section 4a(a)(1) to authorize the

    Commission to establish position limits not just for futures and option

    contracts, but also for swaps that are economically equivalent to

    covered futures and options contracts,\5\ swaps traded on a DCM or SEF,

    swaps that are traded on or subject to the rules of a DCM or SEF, and

    swaps not traded on a DCM or SEF that perform or affect a significant

    price discovery function with respect to regulated entities (``SPDF

    Swaps'').\6\ CEA section 4a(a)(1) further declares the Congressional

    determination that: ``[e]xcessive speculation in any commodity under

    contracts of sale of such commodity for future delivery made on or

    subject to the rules of contract markets or derivatives transaction

    execution facilities, or swaps that perform or affect a significant

    price discovery function with respect to registered entities 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.'' \7\

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    \5\ See infra discussion of economically equivalent.

    \6\ CEA section 4a(a)(1) (as amended 2010) ; 7 U.S.C. 6a(a)(1).

    \7\ Id.

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    As described below, amended CEA section 4a(a)(2), Congress

    directed, i.e., mandated, that the Commission ``shall'' establish

    limits on the amount of positions, as appropriate, that may be held by

    any person in agricultural and exempt commodity futures and options

    contracts traded on a DCM.\8\ Similarly, as described below, in amended

    CEA section 4a(a)(5),\9\ Congress mandated that the Commission impose

    position limits on swaps that are economically equivalent to the

    agricultural and exempt commodity derivatives for which it mandated

    position limits in CEA section 4a(a)(2).

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    \8\ CEA section 4a(a)(2); 7 U.S.C. 6a(a)(2).

    \9\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5).

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    With respect to the position limits that the Commission is required

    to set, CEA section 4a(a)(3) guides the Commission in setting the level

    of those limits by providing several criteria for the Commission to

    address, namely: (i) To diminish, eliminate, or prevent excessive

    speculation as described under this section; (ii) to deter and prevent

    market manipulation, squeezes, and corners; (iii) to ensure sufficient

    market liquidity for bona fide hedgers; and (iv) to ensure that the

    price discovery function of the underlying market is not disrupted.\10\

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    \10\ CEA section 4a(a)(3); 7 U.S.C. 6a(a)(3).

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    CEA section 4a(a)(5) requires the Commission to establish, at an

    appropriate level, position limits for swaps that are economically

    equivalent to those futures and options that are subject to mandatory

    position limits pursuant to CEA section 4a(a)(2).\11\ CEA section

    4a(a)(5) also requires that the position limits on economically

    equivalent swaps be imposed at the same time as mandatory limits are

    imposed on futures and options.\12\

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    \11\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5).

    \12\ See id.

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    CEA section 4a(a)(6) requires the Commission to apply position

    limits on an aggregate basis to contracts based on the same underlying

    commodity across: (1) Contracts listed by DCMs; (2) with respect to

    foreign boards of trade (``FBOTs''), contracts that are price-linked to

    a contract listed for trading on a registered entity and made available

    from within the United States via direct access; and (3) SPDF

    Swaps.\13\

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    \13\ CEA section 4a(a)(6); 7 U.S.C. 6a(a)(6).

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    Furthermore, under new CEA section 4a(a)(7), Congress gave the

    Commission authority to exempt persons or transactions from any

    position limits it establishes.\14\

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    \14\ CEA section 4a(a)(7); 7 U.S.C. 6a(a)(7).

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    2. The Commission Construes CEA Section 4a(a) To Mandate That the

    Commission Impose Position Limits

    The Commission concludes that, based on its experience and

    expertise, when section 4a(a) of the Act is considered as an integrated

    whole, it is reasonable to construe that section to mandate that the

    Commission impose position limits. This mandate requires the Commission

    to impose limits on futures contracts, options, and certain swaps for

    agricultural and exempt commodities. The Commission also

    [[Page 75682]]

    concludes that the mandate requires it to impose such limits without

    first finding that any such limit is necessary to prevent excessive

    speculation in a particular market.

    In ISDA v. CFTC,\15\ the district court concluded that section

    4a(a)(1) of the Act ``unambiguously requires that, prior to imposing

    position limits, the Commission find that position limits are necessary

    to `diminish, eliminate, or prevent' the burden described in [section

    4a(a)(1) of the Act].'' \16\ But the court further concluded that, even

    if CEA section 4a(a)(1) standing alone required the Commission to make

    a necessity determination as a prerequisite to imposing position

    limits, it was plausible to conclude that sections 4a(a)(2), (3), and

    (5) of the Act, which were added by Dodd-Frank, constituted a mandate,

    requiring the Commission to impose position limits without making any

    findings of necessity. The court ultimately determined that the Dodd-

    Frank amendments, and their relationship to section 4a(a)(1) of the

    Act, are ``ambiguous and lend themselves to more than one plausible

    interpretation.'' \17\ Thus, the court rejected the Commission's

    contention that section 4a(a) of the Act unambiguously mandated the

    imposition of position limits without any finding of necessity.

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    \15\ International Swaps and Derivatives Association v. United

    States Commodity Futures Trading Commission, 887 F. Supp. 2d 259

    (D.D.C. 2012).

    \16\ Id. at 270.

    \17\ Id. at 281.

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    Having concluded that section 4a(a) of the Act is ambiguous, the

    court could not rely on the Commission's interpretation to resolve the

    section's ambiguity. As the court observed, the D.C. Circuit has held

    that `` `deference to an agency's interpretation of a statute is not

    appropriate when the agency wrongly believes that interpretation is

    compelled by Congress.' '' \18\ The court further held that, pursuant

    to the law of the D.C. Circuit, it was required to remand the matter to

    the Commission so that it could ``fill in the gaps and resolve the

    ambiguities.'' \19\ The court cautioned the Commission that, in

    resolving the ambiguity of section 4a(a) of the Act, `` `it is

    incumbent upon the agency not to rest simply on its parsing of the

    statutory language.' '' \20\

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    \18\ Id. at 280-82, quoting Peter Pan Bus Lines, Inc. v. Fed.

    Motor Carrier Safety Admin., 471 F.3d 1350, 1354 (D.C. Cir. 2006).

    \19\ 887 F. Supp. 2d at 282.

    \20\ Id. at n.7, quoting PDK Labs. Inc. v. DEA, 362 F.3d 786,

    797 (D.C. Cir. 2004).

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    The Commission now undertakes the task assigned by the court: using

    its experience and expertise to resolve the ambiguity the district

    court perceived in section 4a(a) of the Act. The most important

    guidepost for the Commission in resolving the ambiguity is section

    4a(a)(2) of the Act. That section, which is captioned ``Establishment

    of Limitations,'' includes two sections that are critical to

    understanding congressional intent. Subsection 4a(a)(2)(A) provides

    that the Commission, in accordance with the standards set forth in

    section 4a(a)(1) of the Act, shall establish limits on the amount of

    positions, as appropriate, other than bona fide hedge positions that

    may be held by any person with respect to physical commodities other

    than excluded commodities.\21\ Subsection 4a(a)(2)(B) provides that for

    exempt commodities, the limits ``required'' under subsection

    4a(a)(2)(A) be established within 180 days of the enactment of section

    4a(a)(2)(B) and that for agricultural commodities, the limits

    ``required'' under subsection 4a(a)(2)(A) be established within 270

    days of the enactment of section 4a(a)(2)(B).\22\

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    \21\ CEA section 4a(a)(2)(A); 7 U.S.C. 6a(a)(2)(A).

    \22\ CEA section 4a(a)(2)(B); 7 U.S.C. 6a(a)(2)(B).

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

    The court concluded that this section was ambiguous as to whether

    the Commission had a mandate to impose position limits. The court

    focused on the opening phrase of subsection (A)--``[i]n accordance with

    the standards set forth in [section 4a(a)(1) of the Act].'' The court

    held that the term ``standards'' in section 4a(a)(2) of the Act was

    ambiguous and could refer to the requirement in section 4a(a)(1) of the

    Act that the Commission impose position limits ``as [it] finds are

    necessary to diminish, eliminate, or prevent'' an unnecessary burden on

    interstate commerce.\23\ Thus, the court held that it was plausible

    that section 4a(a)(2) of the Act required the Commission to make a

    finding of necessity as a precondition to imposing any position limit.

    But the court held that it was also plausible that the reference to

    ``standards'' did not incorporate such a requirement.

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    \23\ 887 F. Supp. 2d at 274-76.

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    The Commission believes that it is reasonable to conclude from the

    Dodd-Frank amendments that Congress mandated limits and did not intend

    for the Commission to make a necessity finding as a prerequisite to the

    imposition of limits. The Commission's interpretation of its mandate is

    also based on congressional concerns that arose, and congressional

    actions taken, before the passage of the Dodd-Frank amendments. During

    the years leading up to the enactment, Congress conducted several

    investigations that concluded that excessive speculation accounted for

    significant volatility and price increases in physical commodity

    markets. A congressional investigation determined that prices of crude

    oil had risen precipitously and that ``[t]he traditional forces of

    supply and demand cannot fully account for these increases.'' \24\ The

    investigation found evidence suggesting that speculation was

    responsible for an increase of as much as $20-25 per barrel of crude

    oil, which was then at $70.\25\ Subsequently, Congress found similar

    price volatility stemming from excessive speculation in the natural gas

    market.\26\ Thus, these investigations had already gathered evidence

    regarding the impact of excessive speculation, and had concluded that

    such speculation imposed an undue burden on the economy. In light of

    these investigations and conclusions, it is reasonable for the

    Commission to conclude that Congress did not intend for it to duplicate

    investigations Congress had already conducted, and did not intend to

    leave it up to the Commission whether there should be federal limits.

    Instead, Congress set short deadlines for the limits it ``required,''

    and directed the Commission to conduct a study of the limits after

    their imposition and to report to Congress promptly on their effects.

    Accordingly, the Commission believes that the better reading of the

    Dodd-Frank amendments, in light of the congressional investigations and

    findings made, is the Dodd-Frank amendments require the Commission to

    impose position limits on physical commodity derivatives as opposed to

    merely reaffirming the preexisting, discretionary authority the

    Commission has long had to impose limits as it finds necessary.

    Congress made the decision to impose limits, and it is for the

    Commission to carry that decision out, subject to close congressional

    oversight.

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    \24\ ``The Role of Market Speculation in Rising Oil and Gas

    Prices: A Need to Put the Cop Back on the Beat,'' Staff Report,

    Permanent Subcommittee on Investigations of the Senate Committee on

    Homeland Security and Governmental Affairs, U.S. Senate, S. Prt. No.

    109-65 at 1 (June 27, 2006).

    \25\ Id. at 12; see also ``Excessive Speculation in the Natural

    Gas Market,'' Staff Report, Permanent Subcommittee on Investigations

    of the Senate Committee on Homeland Security and Governmental

    Affairs, U.S. Senate at 1 (June 25, 2007) available at http://www.levin.senate.gov/imo/media/doc/supporting/2007/PSI.Amaranth.062507.pdf (last visited Mar. 18, 2013) (``Gas

    Report'').

    \26\ Gas Report at 1-2.

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

    Based on its experience, the Commission concludes that Congress

    could not have contemplated that, as a prerequisite to imposing limits,

    the Commission would first make the sort of

    [[Page 75683]]

    necessity determination that the plaintiffs in ISDA v. CFTC argue

    section 4a(a)(2) of the Act requires--i.e., a finding that, before

    imposing any limit in any particular market, there is a reasonable

    likelihood that excessive speculation will pose a problem in that

    market, and that position limits are likely to curtail that excessive

    speculation without imposing undue costs.\27\ As the district court

    noted, for 45 years after passage of the CEA, the Commission's

    predecessor agency made findings of necessity in its rulemakings

    establishing position limits.\28\ During that period, the Commission

    had jurisdiction over only a limited number of agricultural

    commodities. The court cited several orders issued by the Commodity

    Exchange Commission (``CEC'') between 1940 and 1956 establishing

    position limits, and in each of those orders, the CEC stated that the

    limits it was imposing were necessary. Each of those orders involved no

    more than a small number of commodities. But it took the CEC many

    months to make those findings. For example, in 1938, the CEC imposed

    position limits on six grain products.\29\ Proceedings leading up to

    the establishment of the limits commenced more than 13 months earlier,

    when the CEC issued a notice of hearings regarding the limits.\30\

    Similarly, in September 1939, the CEC issued a Notice of Hearing with

    respect to position limits for cotton, but it was not until August 1940

    that the CEC finally promulgated such limits.\31\ And the CEC began the

    process of imposing limits on soybeans and eggs in January 1951, but

    did not complete the process until more than seven months later.\32\

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

    \27\ See 887 F. Supp. 2d at 273.

    \28\ Id. at 269.

    \29\ See 3 FR 3145, Dec. 24, 1938.

    \30\ See 2 FR 2460, Nov. 12, 1937.

    \31\ See 4 FR 3903, Sep. 14, 1939; 5 FR 3198, Aug. 28, 1940.

    \32\ See 16 FR 321, Jan. 12, 1951; 16 FR 8106, Aug. 16, 1951;

    see also 17 FR 6055, Jul. 4, 1952 (notice of hearing regarding

    proposed position limits for cottonseed oil, soybean oil, and lard);

    18 FR 443, Jan. 22, 1953 (orders setting limits for cottonseed oil,

    soybean oil, and lard); 21 FR 1838, Mar. 24, 1956 (notice of hearing

    regarding proposed position limits for onions), 21 FR 5575, Jul. 25,

    1956 (order setting position limits for onions).

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

    In the Commission's experience (i.e., in the experience of its

    predecessor agency), it took at least four months to make a necessity

    finding with respect to one commodity. The process of making the sort

    of necessity findings that plaintiffs urged upon the court with respect

    to all agricultural commodities and all exempt commodities would be far

    more lengthy than the time allowed by section 4a(a)(3) of the Act,

    i.e., 180 or 270 days.

    Dodd-Frank requires the Commission to impose position limits on all

    exempt commodities within 180 days after enactment, and on all

    agricultural commodities within 270 days.\33\ Because of these

    stringent time limits, the Commission concludes that Congress did not

    intend for the Commission to delay the imposition of limits until it

    has first made antecedent, contract-by-contract necessity findings.\34\

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

    \33\ Although the Commission did not meet these deadlines in its

    first position limits rulemaking, it completed the task (in which

    the Commission received and addressed more than 15,000 comments) as

    expeditiously as possible under the circumstances.

    \34\ Even if there were no mandate, the Commission would not

    need to make the sort of particularized necessity findings advocated

    by the plaintiffs in ISDA v. CFTC, and discussed by the district

    court. When the Commission imposed limits pre-Dodd-Frank, it only

    had to determine that excessive speculation is harmful to the market

    and that limits on speculative positions are a reasonable means of

    preventing price disruptions in the marketplace that place an undue

    burden on interstate commerce. That is the determination that the

    Commission made in 1981 when it required the exchanges to establish

    position limits on all futures contracts, regardless of the

    characteristics of a particular contract market. See 46 FR 50940

    (``[I]t is the Commission's view that this objective [``the

    prevention of large and/or abrupt price movements which are

    attributable to extraordinarily large speculative positions''] is

    enhanced by speculative position limits since it appears 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 immediate wake of that

    decision, Congress enacted legislation to give the Commission the

    specific authority to enforce those omnibus limits. See CEA section

    4a(e); 7 U.S.C. 6a(e).

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

    Additional experience of the Commission confirms this

    interpretation. The Commission has found, historically, that

    speculative position limits are a beneficial tool to prevent, among

    other things, manipulation of prices. Limits do so by restricting the

    size of positions held by noncommercial entities that do not have

    hedging needs in the underlying physical markets. In other words,

    markets that have underlying physical commodities with finite supplies

    benefit from the protections offered by position limits. This will be

    discussed further, below.

    For example, in 1981, the Commission, acting expressly pursuant to,

    inter alia, what was then CEA Section 4a(1) (predecessor to CEA section

    4a(a)(1)), adopted what was then Sec. 1.61.\35\ This rule required

    speculative position limits for ``for each separate type of contract

    for which delivery months are listed to trade'' on any DCM, including

    ``contracts for future delivery of any commodity subject to the rules

    of such contract market.'' \36\ The Commission explained that this

    action was necessary in order to ``close the existing regulatory gap

    whereby some but not all contract markets [we]re subject to a specified

    speculative position limit.'' \37\ Like the Dodd-Frank Act, the 1981

    final rule established (and the rule release described) that such

    limits ``shall'' be established according to what the Commission termed

    ``standards.'' \38\ As used in the 1981 final rule and release,

    ``standards'' meant the criteria for determining how the required

    limits would be set.\39\ ``Standards'' did not include the antecedent

    judgment of whether to order limits at all. The Commission had already

    made the antecedent judgment in the rule that ``speculative limits are

    appropriate for all contract markets irrespective of the

    characteristics of the underlying market.'' \40\ It further concluded

    that, with respect to any particular market, the ``existence of

    historical trading data'' showing excessive speculation or other

    burdens on that market is not ``an essential prerequisite to the

    establishment of a speculative limit.'' \41\ The Commission thus

    directed the exchanges to set limits for all futures contracts

    ``pursuant to the . . . standards of rule 1.61[.]'' \42\ And Sec. 1.61

    incorporated the standards from then-CEA-section 4a(1)--an

    ``Aggregation Standard'' (46 FR at 50943) for applying the limits to

    positions both held and controlled by a trader and a flexibility

    standard, allowing the exchanges to set ``different and separate

    position limits for different types of futures contracts, or for

    different delivery months, or from exempting positions which are

    normally known in the trade as `spreads, straddles or arbitrage' or

    from fixing limits which apply to such positions which are different

    from limits fixed for other positions.'' \43\

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

    \35\ 46 FR 50938, 50944-45, Oct. 16, 1981. The rule adopted in

    1981 tracked, in significant part, the language of Section 4a(1).

    Compare 17 CFR 1.61(a)(1) (1982) with 7 U.S.C. 6a(1) (1976).

    \36\ 46 FR 50945.

    \37\ Id. 50939; see also id. 50938 (``to ensure that each

    futures and options contract traded on a designated contract market

    will be subject to speculative position limits'').

    \38\ Compare id. at 50941-42, 50945 with 7 U.S.C. 6a(a)(2)(A).

    \39\ 46 FR 50941-42, 50945.

    \40\ Id. at 50941.

    \42\ Id. at 50942.

    \43\ Id. at 50945 (Sec. 1.61(a)). Compare 7 U.S.C. 6a(1)

    (1976).

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

    The language that ultimately became section 737 of the Dodd-Frank

    Act, amending CEA section 4a(a), originated in substantially final form

    in H.R. 977, introduced by Representative Peterson,

    [[Page 75684]]

    who was then Chairman of the House Agriculture Committee and who would

    ultimately be a member of the Dodd-Frank conference committee.\44\ H.R.

    977 appears influenced by the Commission's 1981 rulemaking,

    establishing that there ``shall'' be position limits in accordance with

    the ``standards'' identified in CEA section 4a(a).\45\ Like the 1981

    rule, H.R. 977 established (and the Dodd-Frank Act ultimately adopted)

    a ``good faith'' exception for positions acquired prior to the

    effective date of the mandated limits.\46\ The committee report

    accompanying H.R. 977 described it as ``Mandat[ing] the CFTC to set

    speculative position limits'' and the section-by-section analysis

    stated that the legislation ``requires the CFTC to set appropriate

    position limits for all physical commodities other than excluded

    commodities.'' \47\ This closely resembles the omnibus prophylactic

    approach the Commission took in 1981, when the Commission required the

    establishment of position limits on all futures contracts according to

    ``standards'' it borrowed from CEA section 4a(1), and the Commission

    finds the history and interplay of the 1981 rule and Dodd-Frank section

    737 to be further evidence that Congress intended to follow much the

    same approach as the Commission did in 1981, mandating position limits

    as to all physical commodities.\48\

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

    \44\ H.R. 977, 11th Cong. (2009).

    \45\ 7 U.S.C. 6.

    \46\ Compare H.R. 977, 11th Cong. (2009) with 46 FR 50944.

    \47\ H.Rept. 111-385, at 15, 19 (Dec. 19, 2009).

    \48\ See Union Carbide Corp. & Subsidiaries v. Comm'r of

    Internal Revenue, 697 F.3d 104, (2d Cir. 2012) (explaining that when

    an agency must resolve a statutory ambiguity, to do so `` `with the

    aid of reliable legislative history is rational and prudent' ''

    (quoting Robert A. Katzman, Madison Lecture: Statutes, 87 N.Y.U. L.

    Rev. 637, 659 (2012)).

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

    Consistent with this interpretation, which is based on the

    Commission's experience, CEA section 4a(a)(2)(A)'s phrase ``[i]n

    accordance with the standards set forth in [CEA section 4a(a)(1)]''

    does not require a finding of necessity as a prerequisite to the

    imposition of position limits, but rather has a different meaning.

    Section 4a(a)(1) of the Act lists ``standards'' that the Commission

    must consider, and has historically considered, when it imposes

    position limits. It contains an aggregation standard, which provides

    that, if one person controls the positions of another, or if those

    persons coordinate their trading, then those positions must be

    aggregated. And it contains a flexibility standard, providing the

    Commission with the flexibility to impose different position limits for

    different commodities, markets, delivery months, etc.\49\ Because the

    Commission concludes that, when Congress amended section 4a(a) of the

    Act and directed the Commission to establish the ``required'' limits,

    it did not want, much less require the Commission to make an antecedent

    finding of necessity for every position limit it imposes, the

    ``standards'' the Commission must apply in imposing the limits required

    by section 4a(a)(2) of the Act consist of the aggregation standard and

    the flexibility standard of CEA section 4a(a)(1), the same standards

    the Commission required the exchanges to apply the last time there was

    a mandatory, prophylactic position limits regime.\50\

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

    \49\ In its 1981 rulemaking in which the Commission required

    exchanges to impose position limits, the Commission interpreted the

    term ``standards,'' to not require exchanges to make any finding of

    necessity with respect to imposing position limits. See 46 FR.

    50941-42 (preamble), 50945 (text of Sec. 1.61(a)(2)).

    \50\ The District Court expressed concern that, unless CEA

    section 4a(a)(2) incorporated a necessity finding, then the language

    referring to such a finding in CEA section 4a(a)(1) might be

    rendered surplusage. 887 F. Supp. 2d at 274-75. That is, the court

    believed that, unless a necessity finding were incorporated into any

    limits required by CEA section 4a(a)(2), then the ``finds as

    necessary'' language would serve no purpose in the CEA. But there is

    no surplusage because CEA section 4a(a) only mandates position

    limits with respect to physical commodity derivatives (i.e.,

    agricultural commodities and exempt commodities). The mandate does

    not apply to excluded commodities (i.e., intangible commodities such

    as interest rates, exchange rates, or indexes, see CEA section

    1a(19) (defining the term ``excluded commodity''). As a result,

    although a necessity finding does not apply with respect to physical

    commodities as to which the Dodd-Frank Congress mandated position

    limits, it still applies to any limits the Commission may choose to

    impose with respect to excluded commodities. Thus, the mandate of

    CEA section 4a(a) does not render the necessity language surplusage.

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

    In addition, section 719 of the Dodd-Frank Act (codified at 15

    U.S.C. 8307) provides that the Commission ``shall conduct a study of

    the effects (if any) of the position limits imposed'' pursuant to CEA

    section 4a(a)(2), that ``[w]ithin 12 months after the imposition of

    position limits,'' the Commission ``shall'' submit a report of the

    results of that study to Congress, and that, within 30 days of the

    receipt of that report, Congress ``shall'' hold hearings regarding the

    findings of that report. As explained above, if, as a precondition to

    imposing position limits, the Commission were required to make the sort

    of necessity determinations apparently contemplated by the district

    court, the Commission would have to conduct time-consuming studies and

    then determine as a matter of discretion whether a limit was necessary.

    The Commission believes that, to comply with section 719 of the Dodd-

    Frank Act, the Commission would then, within one year, have to conduct

    another round of studies with respect to each contract as to which it

    had imposed limits. The Commission does not believe that Congress would

    have imposed such burdensome and duplicative requirements on the

    Commission. Moreover, Congress would not have required the Commission

    to conduct a study of the effects, ``if any,'' of position limits, and

    would not have imposed a hearing requirement on itself, if the

    Commission had the discretion to not impose any position limits at

    all.\51\

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

    \51\ When Congress requires an agency to promulgate a rule, it

    frequently requires the agency to provide it with a report regarding

    the impact of that rule. See, e.g., 15 U.S.C. 6502, 6506 (provisions

    of the Children's Online Privacy Protection Act, requiring the FTC

    to promulgate implementing rules, and to report as to the impact

    thereof); 47 U.S.C. 227(b), (h) (requiring the FCC to implement

    rules restricting unsolicited fax advertising, and to report on

    enforcement); 15 U.S.C. 78m(p) (requiring the SEC to issue rules

    requiring disclosures regarding the use of certain ``conflict

    minerals'' obtained from the Democratic Republic of Congo), and

    section 1502(d) of the Dodd-Frank Act (requiring the Comptroller

    General to report regarding the effectiveness of the conflict

    minerals rule).

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

    Further, Congress was careful to make clear that its mandate only

    extends to agricultural and exempt commodities. If there were no

    mandate, then the same standards that apply to position limits for

    excluded commodities would also apply to agricultural and exempt

    commodities and, basically, the Commission would have only permissive

    authority to promulgate position limits for any commodity--the same

    permissive authority that existed prior to the Dodd-Frank Act. Finding

    that a mandate exists is the only way to give effect to the distinction

    that Congress drew.

    The legislative history of the Dodd-Frank amendments to CEA section

    4a(a) confirms that Congress intended to make position limits mandatory

    for agricultural and exempt commodities. As initially introduced, the

    House version of the bill that became Dodd-Frank provided the

    Commission with discretionary authority to issue position limits by

    stating that the Commission ``may'' impose them.\52\ However, by the

    time the bill passed the House, it dispensed with the permissive

    approach in favor of a mandate, stating that the Commission ``shall''

    impose limits, and

    [[Page 75685]]

    in addition, the House added two new subsections, mandating the

    imposition of limits for agricultural and exempt commodities with the

    tight deadlines described above.\53\ Similarly, it was only after the

    initial bill was amended to make position limits mandatory that the

    House bill referred to the limits for agricultural and exempt

    commodities as ``required'' in one instance.\54\ Furthermore, Congress

    decided to include the requirement that the Commission conduct studies

    on the ``effects (if any) of position limits imposed'' \55\ to

    determine if the required position limits were harming US markets only

    after position limits went from discretionary to mandatory.\56\ To

    remove all doubt, the House Report accompanying the House Bill also

    made clear that the House amendments to the position limits bill

    ``required'' the Commission to impose limits.\57\ The Conference

    Committee adopted the provisions of the House bill with regard to

    position limits and then strengthened them by referring to the position

    limits as ``required'' an additional three times so that CEA section

    4a(a), as enacted referred, to position limits as ``required'' a total

    of four times.\58\

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

    \52\ Initially, the House used the word ``may'' to permit the

    Commission to impose aggregate positions on contracts based upon the

    same underlying commodity. See H.R. 4173, 11th Cong. section

    3113(a)(2) (as introduced in the House, Dec. 2, 2009) (``Introduced

    Bill''); see also Brief of Senator Levin et al as Amicus Curiae at

    10-11, ISDA v. CFTC, no. 12-5362 (D.C. Cir. Apr. 22, 2013), Document

    No. 1432046 (hereafter ``Levin Br.'').

    \53\ Levin Br. at 11 (citing H.R. 4173, 111th Cong. section

    3113(a)(5)(2), (7) (as passed by the House Dec. 11, 2009)

    (``Engrossed Bill'')).

    \54\ Id. at 12. (citing Engrossed Bill at section

    3113(a)(5)(3)).

    \55\ 15 U.S.C. 8307.

    \56\ See Levin Br. at 13-17; see also DVD: October 21, 2009

    Business Meeting (House Agriculture Committee 2009), ISDA v. CFTC,

    Dkt. 37-2 Exh. B (Apr. 13, 2012) at 59:55-1:02:18.

    \57\ Levin Br. at 23 (citing H.R. Rep. No. 111-373 at 11

    (2009)).

    \58\ Levin Br. at 17-18.

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

    Considering the text, purpose and legislative history of section

    4a(a) as a whole, along with its own experience and expertise, the

    Commission believes that it is reasonable to conclude that Congress--

    notwithstanding the ambiguity the district court found to arise from

    some of the words in the statute--decided that position limits were

    necessary with respect to physical commodities, mandated the Commission

    to impose them on physical commodities, and required that the

    Commission do so expeditiously.\59\

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

    \59\ The district court noted that CEA sections 4a(a)(2), (3),

    and (5)(A) contain the words ``as appropriate.'' The court held that

    it was ambiguous whether those words referred to the Commission's

    obligation to impose limits (i.e., the Commission shall, ``as

    appropriate,'' impose limits), or to the level of the limits the

    Commission is to impose. Because, as explained above, the Commission

    believes it is reasonable to interpret CEA section 4a(a) to mandate

    the imposition of limits, the words ``as appropriate'' must refer to

    the level of limits, i.e., the Commission must set limits at an

    appropriate level. Thus, while Congress made the threshold decision

    to impose position limits on physical commodity futures and options

    and economically equivalent swaps, Congress at the same time

    delegated to the Commission the task of setting the limits at levels

    that would maximize Congress' objectives. See CEA sections

    4a(a)(3)(A)-(B).

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

    3. Necessity Finding

    As explained above, the Commission concludes that the CEA mandates

    the imposition of speculative position limits. Because of this mandate,

    the Commission need not make a prerequisite finding that such limits

    are necessary ``to diminish, eliminate or prevent excessive speculation

    causing sudden or unreasonable fluctuations or unwarranted changes in

    the prices of'' commodities under pre-Dodd-Frank CEA section 4a(a)(1).

    Nonetheless, out of an abundance of caution in light of the district

    court decision in ISDA v. CFTC, and without prejudice to any argument

    the Commission may advance in any forum, the Commission proposes, as a

    separate and independent basis for the proposed Rule, a preliminary

    finding herein that such limits are necessary to achieve their

    statutory purposes.\60\

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

    \60\ The CEA does not define ``excessive speculation.'' But the

    Commission has historically associated it with extraordinarily large

    speculative positions. 76 FR at 71629 (referring to

    ``extraordinarily large speculative positions'').

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

    Historically, speculative position limits have been one of the

    tools used by the Commission to prevent, among other things,

    manipulation of prices. Limits do so by restricting the size of

    positions held by noncommercial entities that do not have hedging needs

    in the underlying physical markets. By capping the size of speculative

    positions, limits lessen the likelihood that a trader can obtain a

    large enough position to potentially manipulate prices, engage in

    corners or squeezes or other forms of price manipulation. The position

    limits in this proposal are necessary as a prophylactic measure to

    lessen the likelihood that a trader will accumulate excessively large

    speculative positions that can result in corners, squeezes, or other

    forms of manipulation that cause unwarranted or unreasonable price

    fluctuations. In the Commission's experience, position limits are also

    necessary as a prophylactic measure because excessively large

    speculative positions may cause sudden or unreasonable price

    fluctuations even if not accompanied by manipulative conduct. Two

    examples that inform the Commission's determinations are the silver

    crisis of 1979-80 and events in the natural gas markets in 2006.\61\

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

    \61\ Since the 1920's, Congressional and other official

    governmental investigations and reports have identified other

    instances of sudden or unreasonable fluctuations or unwarranted

    changes in the price of commodities. See discussion below.

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

    Position limits would help to deter and prevent manipulative

    corners and squeezes, such as the silver price spike caused by the Hunt

    brothers and their cohorts in 1979-80.

    A market is ``cornered'' when an individual or group of individuals

    acting in concert acquire a controlling or ownership interest in a

    commodity that is so dominant that the individual or group of

    individuals can set or manipulate the price of that commodity.\62\ In a

    short squeeze, an excess of demand for a commodity together with a lack

    of supply for that commodity forces the price of that commodity upward.

    During a short squeeze, individuals holding short positions, i.e.,

    sales for future delivery of a commodity,\63\ are typically forced to

    purchase that commodity in situations where the price increases

    rapidly, in order to exit their short position and/or cover,\64\ i.e.,

    be able to deliver the commodity in accordance with the terms of the

    sale.\65\

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

    \62\ See CFTC Glossary, A Guide to the Language of the Futures

    Industry (``CFTC Glossary''), available at http://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/glossary, which

    defines a corner as ``(1) [s]ecuring such relative control of a

    commodity that its price can be manipulated, that is, can be

    controlled by the creator of the corner; or (2) in the extreme

    situation, obtaining contracts requiring the delivery of more

    commodities than are available for delivery.''

    \63\ See CFTC Glossary, which defines a ``short'' as ``(1) [t]he

    selling side of an open futures contract; (2) a trader whose net

    position in the futures market shows an excess of open sales over

    open purchases.''

    \64\ See CFTC Glossary, which defines ``cover'' as ``(1)

    [p]urchasing futures to offset a short position (same as Short

    Covering); . . . (2) to have in hand the physical commodity when a

    short futures sale is made, or to acquire the commodity that might

    be deliverable on a short sale'' and offset as ``[l]iquidating a

    purchase of futures contracts through the sale of an equal number of

    contracts of the same delivery month, or liquidating a short sale of

    futures through the purchase of an equal number of contracts of the

    same delivery month.''

    \65\ See CFTC Glossary, which defines a ``squeeze'' as ``[a]

    market situation in which the lack of supplies tends to force shorts

    to cover their positions by offset at higher prices.''

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

    A rapid rise and subsequent sharp decline in silver prices occurred

    from the second half of 1979 to the first half of 1980 when the Hunt

    brothers \66\ and colluding syndicates \67\ attempted to corner the

    silver market by hoarding silver and executing a short squeeze. Prices

    deflated only after the Commodity Exchange, Inc. (``COMEX'')

    [[Page 75686]]

    and the Chicago Board of Trade (``CBOT'') imposed a series of emergency

    rules imposing at various times position limits, increased margin

    requirements, and trading for liquidation only on U.S. silver futures.

    It was the consensus view of staffs of the Commission, the Board of

    Governors of the Federal Reserve System, the Department of the Treasury

    and the Securities and Exchange Commission articulated in an

    interagency task force study of events in the silver market during that

    period that ``[r]easonable speculative position limits, if they had

    been in place before the buildup of large positions occurred, would

    have helped prevent the accumulation of such large positions and the

    resultant dislocations created when the holders of those positions

    stood for delivery.'' \68\ That is, speculative position limits would

    have helped to prevent the buildup of the silver price spike of 1979-

    80. The Commission believes that this conclusion remains correct.

    ``Moreover, by limiting the ability of one person or group to obtain

    extraordinarily large positions, speculative limits diminish the

    possibility of accentuating price swings if large positions must be

    liquidated abruptly in the face of adverse price movements or for other

    reasons.'' \69\

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

    \66\ The primary silver traders in the Hunt family were Nelson

    Bunker Hunt, William Herbert Hunt, and Lamar Hunt.

    \67\ A group of individuals and firms trading through

    ContiCommodity Services, Inc. and ACLI International Commodity

    Services, Inc., both of which were FCMs.

    \68\ Commodity Futures Trading Commission, Report To The

    Congress In Response To Section 21 Of The Commodity Exchange Act,

    May 29, 1981, Part Two, A Study of the Silver Market, at 173

    (``Interagency Silver Study'').

    \69\ Speculative Position Limits, 45 FR 79831, 79833, Dec. 2,

    1980.

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

    The Hunt brothers were speculators \70\ who neither produced,

    distributed, processed nor consumed silver. The corner began in early

    1979, when the Hunt brothers accumulated large physical holdings of

    silver by purchasing silver futures and taking physical delivery of

    silver.\71\ By the fall of 1979, they had accumulated over 43 million

    ounces of physical silver.\72\ In addition to their physical holdings,

    in the fall of 1979 the Hunts and their cohorts held over 12 thousand

    contracts for March delivery, representing a potential future delivery

    to the hoard of another 60 million ounces of silver.\73\ In general,

    the larger a position held by a trader, the greater is the potential

    that the position may affect the price of the contract. Throughout late

    1979, the Hunts continued to stand for delivery and took care to ensure

    that their own holdings were not re-delivered back to them when

    outstanding futures contracts settled.\74\ Thus, through this period,

    silver prices climbed as the Hunts accumulated more financial and

    physical positions and the available supply of silver decreased. As the

    interagency working group observed, ``[t]he biggest single source of

    the change in demand for silver bullion during the last half of 1979

    and the first quarter of 1980 came from the silver acquisitions of Hunt

    family members and other large traders.'' \75\

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

    \70\ Speculators seek to profit by anticipating the price

    movement of a commodity in which a futures position has been

    established. See CFTC Glossary, which defines a speculator as,

    ``[i]n commodity futures, a trader who does not hedge, but who

    trades with the objective of achieving profits through the

    successful anticipation of price movements.'' In contrast, a hedger

    is ``[a] trader who enters into positions in a futures market

    opposite to positions held in the cash market to minimize the risk

    of financial loss from an adverse price change; or who purchases or

    sells futures as a temporary substitute for a cash transaction that

    will occur later. One can hedge either a long cash market position

    (e.g., one owns the cash commodity) or a short cash market position

    (e.g., one plans on buying the cash commodity in the future).'' The

    Hunts had no apparent industrial use for silver, although some

    attribute their early activities in the silver market to an attempt

    to hedge against Carter-era inflation and a defense against

    potential confiscation of precious metals in the event of a national

    crisis.

    \71\ Typically, delivery occurs in only a small percentage of

    futures transactions. The vast majority of contracts are liquidated

    by offsetting transactions.

    \72\ See, e.g., Matonis, Jon, Hunt Brothers Demanded Physical

    Silver Delivery Too, available at http://www.rapidtrends.com/hunt-brothers-demanded-physical-silver-delivery-too/. To provide context,

    at this time COMEX and CBOT warehouses held 120 million ounces of

    silver.

    \73\ Interagency Silver Study at 18.

    \74\ It has been reported that they moved vast quantities of

    silver to warehouses in Switzerland to prevent this possibility.

    \75\ Interagency Silver Study at 77.

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

    The exchanges and regulators were slow to react to events in the

    silver market. However, to correct by then evident market imbalances,

    in late 1979 the CBOT introduced position limits of 3 million ounces of

    silver (i.e., 600 contracts) per trader and raised margin requirements.

    Contracts over 3 million ounces were to be liquidated by February of

    1980. On January 7, 1980, the larger COMEX instituted position limits

    of 10 million ounces of silver (i.e., 2,000 contracts) per trader, with

    contracts over that amount to be liquidated by February 18. Then, on

    January 21, COMEX suspended trading in silver and announced that it

    would only accept liquidation orders. The price of silver began to

    decline. When the price of a commodity starts to move against the

    cornerer, attempts by the cornerer to sell would tend to fuel a further

    price move against the cornerer resulting in a vicious cycle of price

    decline. The Hunts were eventually unable to meet their margin calls

    and took a huge loss on their positions. The interagency working group

    concluded that the data relating to the episode ``support the

    hypothesis that the deliveries and potential deliveries to large long

    participants in the silver futures markets contributed to the rise and

    fall in silver prices in both the cash and futures markets. The rise

    appears to have been caused in part by the conversion of silver futures

    contracts to actual physical silver. The subsequent fall in prices was

    then exacerbated by the anticipated selling of some of the Hunt's

    physical silver by FCMs as well as the liquidation of Hunt group and

    possibly . . . [other large traders'] futures positions.'' \76\

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

    \76\ Interagency Silver Study at 133.

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

    Figure 1 illustrates the rapid rise and sharp decline in the price

    of silver during the period in question.\77\ In January of 1979, the

    settlement price of silver was approximately $6.00 per troy ounce. By

    August, the price had risen to over $9.00, an increase of over 50

    percent. Through most of October and November 1979, silver traded

    within a range of $15.00-$17.50 per troy ounce. On November 28, the

    closing price rose above $18.00. In December of 1979, the price rose

    above $30.00 and continued to climb until mid-January. On January 17,

    1980, the closing price of silver reached its apex at $48.70 per troy

    ounce, more than five times the August price. On January 21, the price

    declined to $44.00; on January 22 the closing price slid to $34.00 per

    troy ounce. Through March 7, 1980, silver traded in an approximate

    range of $30.00-$40.00 per troy ounce. On March 10, silver closed below

    $30.00. On March 17 and 18, silver closed below $20.00. After a brief

    rebound above $22.00, by March 26 the price dropped to $15.80. On March

    27, the price of silver hit a low of $10.80 per troy ounce, less than a

    quarter of the high of $48.70 two months earlier. ``After March 28,

    silver prices stabilized for a while in the $12-$15 range. . . . During

    April through December 1980, silver prices moved generally in a range

    between $12 and $20 per ounce.'' \78\

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

    \77\ See CFTC Glossary, which defines ``spot price'' as ``[t]he

    price at which a physical commodity for immediate delivery is

    selling at a given time and place.'' The prompt month is the nearest

    month to the expiration date of a futures contract.

    \78\ Interagency Silver Study at 35-36.

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

    [[Page 75687]]

    [GRAPHIC] [TIFF OMITTED] TP12DE13.000

    Figure 2 shows the distortion in the price of silver futures

    contracts due to the short squeeze during the run-up to the January 17

    high and the effect of ``burying the corpse'' after the squeeze ended.

    In January 1980, due to the hoarding of the Hunts and their cohorts,

    physical supplies of silver were tight and the physical commodity was

    expensive to deliver. Scarcity in the physical market for silver

    distorted prices in the silver futures markets. The degree to which the

    value of the front month contract exceeded the value of other contracts

    was exaggerated. By April of 1980, because the Hunts and their cohorts

    were forced to sell, physical supply had increased and silver was

    comparatively cheaper to deliver. The front month contract was then

    worth substantially less than other contracts. In contrast, assuming

    equilibrium in production, use, and storage of silver, one would expect

    the charted price spreads to look comparatively much flatter. That is,

    there should not be that much difference between the price of the front

    month contract and other contracts because silver should not be subject

    to seasonality such as would affect crops. Moreover, because silver is

    relatively cheap to store, the difference in the price of the front

    month and other contracts should also be less sensitive to the cost of

    carry.

    [[Page 75688]]

    [GRAPHIC] [TIFF OMITTED] TP12DE13.001

    In section 4a(a)(1) of the Act, Congress identifies ``sudden or

    unreasonable fluctuations or unwarranted changes in the price of such

    commodity'' \79\ as an indication that excessive speculation may be

    present in a market for a commodity. The rapid rise and sharp decline

    in the price of silver that commenced in August 1979 and was spent by

    the end of March 1980 certainly fits the description advanced by

    Congress. Nevertheless, the Commission, based on its experience and

    expertise, does not believe that the burdens on interstate commerce are

    limited solely to the temporary and unwarranted changes in price such

    as those exhibited during the silver price spike that resulted, at

    least in part, from the deliberate behavior of the Hunt brothers and

    their cohorts.\80\ Indirect burdens on interstate commerce may arise as

    a result of unwarranted changes in price such as occurred in this case.

    Such burdens arise due to manipulation or attempted manipulation, or

    they may result from the excessive size and disorderly trading of a

    speculative, i.e., non-hedging, position.

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

    \79\ 7 U.S.C. 6a(a)(1).

    \80\ The Interagency Silver Study identified three main factors

    contributing to the price increases in silver at the time.

    First, the state of the economy during the period in question

    affected all precious metals including silver. . . .

    Second, changes in the supply and demand of physical silver

    affected the price of silver. . . .

    Third, the accumulation of large amounts of both physical silver

    and silver futures by individuals such as the Hunt family of Dallas,

    Texas, had an effect on the price of silver directly and on the

    expectations of others who became aware of these actions.

    Interagency Silver Study at 2.

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

    Sudden or unreasonable fluctuations or unwarranted changes in the

    price of a commodity derivative contract may be caused by a trader

    establishing, maintaining or liquidating an extraordinarily large

    position whether in a physical-delivery or cash-settled contract.

    Prices for commodity derivative contracts reflect expectations about

    the price of the underlying commodity at a future date and, thus,

    reflect expectations about supply and demand for that underlying

    commodity. In contrast, the supply of a commodity derivative contract

    itself is not limited to the supply of the underlying commodity.

    Rather, the supply of a commodity derivative contract is a function of

    the ability of a trader to induce a counterparty to take the opposite

    side of the transaction.\81\ Thus, the capacity of the market (i.e.,

    all participants) to absorb purchase or sale orders for commodity

    derivative contracts is limited by the number of participants that are

    willing to provide liquidity, i.e., take the other side of the order at

    a given price. For example, a trader that demands immediacy in

    establishing a long position larger than the amount of pending offers

    to sell by market participants may cause the commodity derivative

    contract price to increase, as market participants may demand a higher

    price when entering new offers to sell. It follows that an

    extraordinarily large position, relative to the size of other

    participants' positions, may cause an unwarranted price fluctuation.

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

    \81\ In a commodity derivative contract, the two parties to the

    contract have opposite positions. That is, for every long position

    in a commodity derivative contract held by one trader, there is a

    short position that another trader must hold.

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

    In the spot month for a physical-delivery commodity derivative

    contract, concerns regarding sudden or unreasonable fluctuations or

    unwarranted changes in the price of that contract are heighted because

    open positions in such a contract either: Must be satisfied by delivery

    of the underlying commodity (which is of limited supply and, thus,

    susceptible to corners or squeezes); or must be offset before delivery

    obligations attach (that requires trading with another participant to

    offset the open position).\82\ For example, a trader

    [[Page 75689]]

    holding an extraordinarily large long position, absent position limits,

    could maintain a long position (requiring delivery beyond the limited

    supply of the physical commodity) deep into the spot month. By

    maintaining such an extraordinarily large position, such a trader may

    cause an unwarranted increase in the price of the commodity derivative

    contract, as holders of short positions attempt to induce a

    counterparty to offset their position.

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

    \82\ Regarding cash-settled commodity derivative contracts,

    there are a variety of methods for determining the final cash

    settlement price, such as by reference to (i) a survey price of cash

    market transactions, or (ii) the final (or daily) settlement price

    of a physical-delivery futures contract. For example, in the case of

    a trader who holds an extraordinarily large position in a cash-

    settled contract based on a survey of prices of cash market

    transactions, where the price of the spot month cash-settled

    contract is used by cash market participants in determining or

    setting their cash market transaction prices, then an unwarranted

    price fluctuation in that cash-settled commodity derivative contract

    could result in distorted prices in cash market transactions and,

    thus, an artificial final cash settlement price from a survey of

    such distorted cash market transaction prices. Alternatively, for

    example, in the case of a trader who holds an extraordinarily large

    position in a cash-settled contract based on the final settlement

    price of a physical-delivery futures contract, then a trader has an

    incentive to mark the close of that physical-delivery futures

    contract to benefit her position in the cash-settled contract.

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

    Prices that deviate from the natural forces of supply and demand,

    i.e., artificial prices, may occur when there is hoarding of a physical

    commodity in an attempted or perfected manipulative activity (such as a

    corner). If a price of a commodity is artificial, resources will be

    inefficiently allocated during the time that the artificial price

    exists. Similarly, prices that are unduly influenced by the size of a

    very large speculative position, or trading that increases or reduces

    the size of such very large speculative position, may lead to an

    inefficient allocation of resources to the extent that such prices do

    not allocate resources to their highest and best use. These burdens

    were present during the Hunt brothers episode. The Interagency Silver

    Study concluded that ``the volatile conditions in silver markets and

    the much higher price levels . . . affected the industrial and

    commercial sectors of the economy to a greater extent than would have

    been the case if silver price changes had been less turbulent.'' \83\

    The Interagency Silver Study described several negative consequences of

    resource misallocations that occurred during the silver price spike.

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

    \83\ Id. at 150.

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

    Significant changes took place in the use of silver as an

    industrial input during silver's price oscillation in 1979-80. In the

    photography industry, the consumption of silver from the first quarter

    of 1979 to the first quarter of 1980 fell by nearly one third.

    Similarly, the use of silver in the production of silverware declined

    by over one half in this period. In addition, numerous other uses of

    silver exhibited sharp usage declines equivalent to or in excess of

    these examples. These sharp reductions in silver use are indicative of

    the general disruption caused by the sharp rise in silver prices. Since

    the demand for silver in many of these uses is relatively price

    inelastic, the substantial decline registered in the use of silver for

    industrial purposes underscores the sizable magnitude of silver price

    increases and the consequent disruption experienced by the industry.

    Individual commercial operations using silver were also disrupted.

    To illustrate, a major producer of X-ray film discontinued production

    purportedly as a result of the sharply increased and erratic behavior

    of the price of silver. In addition, there were reports that trading

    firms failed financially in early 1980 due to losses incurred in silver

    markets. Finally, the financial condition of small firms dependent on

    silver products (hearing aid batteries, printing supplies, etc.)

    deteriorated as a result of high silver prices and limited

    supplies.\84\

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

    \84\ Id. (footnotes omitted). James M. Stone, formerly Chairman

    of the Commission, maintained that the negative effects of the price

    spike on commercials were borne out in employment figures: ``In the

    case of silver, the employment impacts fell hardest upon the makers

    of consumer products. According to the Department of Labor's Bureau

    of Labor Statistics some 6000 jobs in the jewelry, silverware and

    plateware industries were lost between November of 1979 and February

    of 1980.'' Additional Comments on the Interagency Silver Study at 9

    (``Stone Comments'').

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

    Moreover, after the settlement price of silver peaked in mid-

    January 1980, the ensuing ``rapid decline of silver prices subjected

    several FCMs and their parent companies to considerable financial

    stress.'' \85\ In the view of the Commission and other regulators,

    ``[w]hile all FCMs carrying silver positions appear to have remained

    solvent during the period in question, the potential for insolvency was

    significant.'' \86\ The Interagency Silver Study described a cascade of

    undesirable events;

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

    \85\ Id. at 135.

    \86\ Id. at 140.

    Falling prices reduced the equity in the accounts of some large,

    net long silver futures positions, necessitating margin calls.

    Responsibility for the financial obligations of some of these

    positions had to be assumed by FCMs when large margin calls went

    unmet. A significant proportion of the loans to major silver longs,

    collateralized by silver, had been made by some FCMs acting for

    their parent companies. A major portion of this collateral was

    rehypothecated for bank loans by these companies. The FCMs and their

    parent companies were thus exposed to two related problems that

    threatened them with insolvency--the losses on customer accounts and

    the possibility that silver prices would fall to a point which would

    cause the banks to demand payment on the hypothecated loans. . . .

    The FCM was not only vulnerable because of its customers' losses on

    the futures contracts, but also because of the potential for a

    decline in the value of loan collateral.\87\

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

    \87\ Id. at 135-6 (footnote omitted).

    The failure of an FCM with large silver exposures could have

    adversely affected clients without positions in silver and potentially

    other participants in the futures markets. The failure of a large FCM

    could have negatively affected the various exchanges and potentially

    the clearinghouses.\88\ The solvency of FCMs and other Commission

    registrants crucial to properly functioning futures markets is clearly

    within the Commission's regulatory ambit. The failure of a commission

    registrant in the context of unwarranted price spikes would be a burden

    on interstate commerce.

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

    \88\ See id. at 140-41. ``Although the clearinghouses have

    contingency plans to deal with insolvent members, to date these

    plans have covered only the collapse of small FCMs. Conceivably, a

    major default could result in assessments of members that might, in

    turn, result in the insolvency of some members and the collapse of

    the exchange.''

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

    Fallout from the silver price spike in late 1979-early 1980

    extended beyond the silver markets. ``Banks, by extending credit for

    futures market activity while accepting silver as collateral, exposed

    themselves to higher than normal risks.'' \89\ Unusual activity was

    also observed in other futures markets, such as precious metals and

    commodities other than silver in which the Hunts were thought to have

    had positions.\90\ ``On March 27, 1980, the date on which the price of

    silver dropped to its lowest point, $10.80 an ounce, a combination of

    factors, including news of the Hunts' problems in meeting margin calls,

    the efforts of the Hunts to sell positions in various exchange-listed

    securities in order to meet those calls, and the actions of the SEC in

    suspending trading in Bache Group stock, appeared to have a direct

    impact on the securities markets.'' \91\ Commenters noted the marked

    changes in the rate of inflation concomitant with the rapid rise and

    fall of the price of silver.\92\ Potential bank

    [[Page 75690]]

    failures, disruptions in other futures markets, disruptions in the

    securities markets and volatile inflation rates would be additional

    burdens on interstate commerce. In highlighting the ability of market

    participants to accumulate extraordinarily large speculative positions,

    thereby demoralizing the silver markets to the injury of producers and

    consumers, the entirety of the Hunt brothers silver episode called into

    question the adequacy of futures regulation generally and the integrity

    of the futures markets.

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

    \89\ Interagency Silver Study at 145. ``Bank loans to major

    silver traders were made both directly and indirectly through FCMs.

    . . . Default on a major portion of these loans could have had a

    significant effect on the overall banking industry, but particularly

    on those banks where the loan concentration was the greatest.''

    Testimony of Philip McBride Johnson, Chairman, Commodity Futures

    Trading Commission, Before the Subcommittee on Conservation, Credit

    and Rural Development, Committee on Agriculture, U.S. House of

    Representatives, Oct. 1, 1981, at 19 (``Johnson Testimony'').

    \90\ See Interagency Silver Study at 147-8. See also Johnson

    Testimony at 18-21.

    \91\ Interagency Silver Study at 148.

    \92\ See Stone Comments at 9; Johnson Testimony at 20. Contra

    Philip Cagan, ``Financial Futures Markets: Is More Regulation

    Needed?,'' I J. Futures Markets 169, 181-82 (1981).

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

    The Commission believes that if Federal speculative position limits

    had been in effect that correspond to the limits that the Commission

    proposes now, across markets now subject to Commission jurisdiction,

    such limits would have prevented the Hunt brothers and their cohorts

    from accumulating such large futures positions.\93\ Such large

    positions were associated with the sudden fluctuations in price shown

    in Figures 1 and 2. These unwarranted changes in price imposed an undue

    and unnecessary burden on interstate commerce, as described in greater

    detail on the preceding pages. If the Hunt brothers had been prevented

    from accumulating such large futures positions, they would not have

    been able to demand delivery on such large futures positions. The Hunts

    therefore would have been unable to hoard as much physical silver. The

    Commission's belief is based on the following assessment:

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

    \93\ See also Speculative Position Limits, 45 FR 79831, 79833,

    Dec. 2, 1980 (``Had limits on the amount of total open commitments

    which any trader or group can own been in effect, such occurrences

    may have been prevented.'').

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

    In order to approximate a single-month and all-months-combined

    limit calculated using a methodology similar to that proposed in this

    release \94\ for silver during this time period, the Commission used

    data regarding month-end open contracts from the Interagency Silver

    Study.\95\ These month-end open interest reports are for all silver

    futures combined for the Chicago Board of Trade and the Commodity

    Exchange in New York.\96\ Table 1 shows the month-end open interest for

    all silver futures combined from August 1979 to April 1980. Using these

    numbers, the average month-end open interest for this period is 190,545

    contracts, and applying the 10, 2.5 percent formula to this average

    would result in single-month and all-months-combined limits of 6,700

    contracts. The Hunts would have exceeded this single-month limit in the

    fall of 1979 when they and their cohorts held over 12,000 contracts for

    March delivery.\97\ In addition, the Hunts and their cohorts held net

    positions in silver futures on COMEX and CBOT that exceeded the

    calculated all-months-combined limits on multiple occasions between

    September 1975 and February 1980 as is shown in Table 2. Hence, if the

    proposed rule had been in place, it could have limited the size of the

    positions held by the Hunts and their cohorts as early as the autumn of

    1975.

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

    \94\ 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 level will be set 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. The 10, 2.5 percent formula

    is identified in 17 CFR 150.5(c)(2).

    \95\ Interagency Silver Study at 117.

    \96\ During the time of the events discussed, silver bullion

    futures contracts traded in the United States on the COMEX in New

    York, the CBOT in Chicago, and the MidAmerica Commodity Exchange

    (``MCE'') in Chicago. At this time, the COMEX and CBOT contracts

    were each 5,000 troy ounces of silver, and MCE's contract was 1,000

    troy ounces. Month-end open interest numbers were not available for

    MCE.

    \97\ See discussion below.

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

    There are two limitations to the data used in this analysis. First,

    the month-end open interest data do not include open interest from the

    MidAmerica Commodity Exchange. Second, the month-end open interest

    numbers are for a short time-period starting at the end of August 1979.

    If the proposed rule had been in place at the time of the Hunt brothers

    price spike, the limits would have been calculated using data from two

    years and would likely have used data from an earlier period which

    could have caused the limit levels to be different. However, the

    Commission believes that the calculated limits are a fair approximation

    of the limits that would have applied during this time period.

    Moreover, for speculative position limits not to have constrained the

    Hunts at the end of 1975 when their net position was reported as 15,876

    contracts, the average total open interest for the time period would

    have had to be over 500,000 contracts (of 5,000 troy ounces). Moreover,

    the average total open interest would have had to be over 900,000

    contracts (of 5,000 troy ounces) before the all-months-combined limit

    would have exceeded the maximum net position reported by the

    Interagency Silver Study (24,722 for September 30, 1979). According to

    the Interagency Silver Study, it was at this point that the Hunts began

    acquiring large quantities of physical silver.\98\

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

    \98\ Interagency Silver Study at 104.

    Table 1--Month-End Open Interest for Chicago Board of Trade (CBOT) and the Commodity Exchange (COMEX), August

    1979 Through April 1980, All Silver Futures Combined \99\

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

    CBOT open COMEX open Total open

    Date interest interest interest

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

    8/31/1979....................................................... 185,031 157,952 342,983

    9/30/1979....................................................... 161,154 167,723 328,877

    10/31/1979...................................................... 105,709 145,611 251,320

    11/30/1979...................................................... 98,009 134,207 232,216

    12/31/1979...................................................... 93,748 127,225 220,973

    1/31/1980....................................................... 49,675 77,778 127,453

    2/29/1980....................................................... 28,211 63,672 91,884

    3/31/1980....................................................... 24,336 48,688 73,024

    4/30/1980....................................................... 19,008 27,166 46,174

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

    [[Page 75691]]

    Table 2--Estimated Ownership of Silver by Hunt Related Accounts

    [Contracts of 5,000 troy ounces] \100\

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

    Net futures Net futures Futures total

    Date COMEX CBOT (from table)

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

    9/30/1975....................................................... 6,917 4,560 11,077

    12/31/1975...................................................... 6,865 9,011 15,876

    3/31/1976....................................................... 6,092 5,324 11,416

    6/30/1976....................................................... 4,061 (920) 3,141

    9/30/1976....................................................... 3,890 578 4,468

    12/31/1976...................................................... 3,910 571 4,481

    3/31/1977....................................................... 3,288 259 3,547

    6/30/1977....................................................... 4,540 816 5,356

    9/30/1977....................................................... 5,277 1,518 6,795

    12/31/1977...................................................... 5,826 2,016 7,344

    3/31/1978....................................................... 6,459 2,224 8,683

    6/30/1978....................................................... 4,200 2,451 6,651

    9/30/1978....................................................... 2,481 3,047 5,528

    12/31/1978...................................................... 4,076 1,317 5,393

    3/31/1979....................................................... 6,655 1,699 8,354

    5/31/1979....................................................... 8,712 4,765 13,477

    6/30/1979....................................................... 9,442 3,846 13,288

    7/31/1979....................................................... 10,407 4,336 14,743

    8/31/1979....................................................... 14,941 8,700 23,641

    9/30/1979....................................................... 15,392 9,330 24,722

    10/31/1979...................................................... 11,395 7,444 18,839

    11/30/1979...................................................... 12,379 5,693 18,072

    12/31/1979...................................................... 13,806 5,921 19,727

    1/31/1980....................................................... 7,432 1,344 8,776

    2/29/1980....................................................... 6,993 789 7,782

    4/2/1980........................................................ 1,056 388 1,444

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

    The Commission finds that if the position limits suggested by this data

    were applied as early as 1975, the Hunts would not have been able to

    accumulate or hold their excessively large futures positions and

    thereby the limits would have restricted their ability to cause the

    price fluctuations and other harms described above.

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

    \99\ Id. at 117.

    \100\ Id. at 103.

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

    Position limits would help to diminish or prevent unreasonable

    fluctuations or unwarranted changes in the price of a commodity, such

    as the extreme price volatility in the 2006 natural gas markets.\101\

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

    \101\ For purposes of discussion, the following section recounts

    certain findings about the 2006 natural gas markets by the staff of

    the Permanent Subcommittee on Investigations of the United States

    Senate (the ``Permanent Subcommittee''). See generally Excessive

    Speculation in the Natural Gas Market, Staff Report with Additional

    Minority Staff Views, Permanent Subcommittee on Investigations,

    United States Senate, Released in Conjunction with the Permanent

    Subcommittee on Investigations, June 25 & July 9, 2007 Hearings

    (``Subcommittee Report''). Separately, the Commission, on July 25,

    2007, charged Amaranth Advisors LLC, Amaranth Advisors (Calgary) ULC

    and its former head energy trader, Brian Hunter, with attempted

    manipulation in violation of the Commodity Exchange Act. The charges

    against the Amaranth entities were later settled, with a fine of

    $7.5 million levied against them in August of 2009. See U.S.

    Commodity Futures Trading Commission Charges Hedge Fund Amaranth and

    its Former Head Energy Trader, Brian Hunter, with Attempted

    Manipulation of the Price of Natural Gas Futures, July 25, 2007,

    available at http://www.cftc.gov/PressRoom/PressReleases/pr5359-07;

    Amaranth Entities Ordered to Pay a $7.5 Million Civil Fine in CFTC

    Action Alleging Attempted Manipulation of Natural Gas Futures

    Prices, August 12, 2009, available at http://www.cftc.gov/PressRoom/PressReleases/pr5692-09. The Commission enforcement action is still

    pending against Brian Hunter. The discussion herein of the natural

    gas events and Subcommittee Report shall not be construed to alter

    any statements by or positions of the Commission and its staff in

    the pending enforcement matter.

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

    Amaranth Advisors L.L.C. (``Amaranth'') was a hedge fund that,

    until its spectacular collapse in September 2006, held ``by far the

    largest positions of any single trader in the 2006 U.S. natural gas

    financial markets.'' \102\ Amaranth's activities are a classic example

    of the market power that often typifies excessive speculation. ``Market

    power'' in this context means the ability to move prices by exerting

    outsize influence on expectations of supply and/or demand for a

    commodity. Amaranth accumulated such large speculative natural gas

    futures positions that it affected expectations of demand for physical

    natural gas and prices rose to levels not warranted by the otherwise

    natural forces of supply and demand for the commodity.\103\

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

    \102\ Subcommittee Report at 67.

    \103\ Amaranth was a pure speculator that, for example, could

    neither make nor take delivery of physical natural gas.

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

    ``Prior to its collapse, Amaranth dominated trading in the U.S.

    natural gas market. . . . All but a few of the largest energy companies

    and hedge funds consider trades of a few hundred contracts to be large

    trades. Amaranth held as many as 100,000 natural gas futures contracts

    at once, representing one trillion cubic feet of natural gas, or 5% of

    the natural gas used in the United States in a year. At times, Amaranth

    controlled up to 40% of all of the open interest on NYMEX for the

    winter months (October 2006 through March 2007). Amaranth accumulated

    such large positions and traded such large volumes of natural gas

    futures that it distorted market prices, widened price spreads, and

    increased price volatility.'' \104\

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

    \104\ Subcommittee Report at 51-52.

    \105\ Subcommittee Report at 17.

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

    Natural gas is one of the main sources of energy for the United

    States. The price of natural gas has a pervasive effect throughout the

    U.S. economy. In general, ``[b]ecause one of the major uses of natural

    gas is for home heating, natural gas demand peaks in the winter month

    and ebbs during the summer months.'' \105\ During the summer months,

    when demand for physical natural gas falls, the spot price of natural

    gas tends to fall, with the excess physical supply being placed into

    underground storage reservoirs for future use. During the winter, when

    demand for natural gas exceeds production and the spot price tends to

    increase, natural gas is removed from

    [[Page 75692]]

    underground storage and is consumed.\106\

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

    \106\ See id.

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

    Amaranth believed that winter natural gas prices would be much

    higher than summer natural gas prices, notwithstanding an abundant

    supply of natural gas in 2006. Seeking to profit from this view,

    Amaranth engaged in spread trading: it bought contracts for future

    delivery of natural gas in months where it thought prices would be

    relatively higher and sold contracts for future delivery of natural gas

    in months were it thought prices would be relatively lower.\107\

    Amaranth primarily traded the January/November spread and the March/

    April spread, although it took positions in other near months. When

    Amaranth bet that the spread between the two contracts would increase,

    it would make money by selling out of the position or the equivalent

    underlying legs at a higher price than it paid. Amaranth's positions

    were extremely large.\108\ The Permanent Subcommittee found that

    ``Amaranth's large positions and trades caused significant price

    movements in key natural gas futures prices and price relationships.''

    \109\ The Permanent Subcommittee also found that ``Amaranth's trades

    were not the sole cause of the increasing price spreads between the

    summer and winter contracts; rather they were the predominant cause.''

    \110\

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

    \107\ Amaranth sought to benefit from changes in the price

    relationship between two linked contracts. For instance, if a trader

    is long the front month at 10 and short the back month at 8, the

    spread is 2. If the price of the front month contract rises to 11,

    the spread is 3 and the position has a gain. If the price of the

    back month contract declines to 7, the spread is 3 and the position

    has a gain. If the price of the front month contract rises to 11 and

    the price of the back month contract declines to 7, the spread is 4

    and the position has a gain. But if the front month contract falls

    to 8 and the back month contract falls to 6, the spread does not

    change.

    \108\ ``Amaranth also held large positions in other winter and

    summer months spanning the five-year period from 2006-2010. In

    aggregate, Amaranth amassed an extraordinarily large share of the

    total open interest on NYMEX. During the spring and summer of 2006,

    Amaranth controlled between 25 and 48% of the outstanding contracts

    (open interest) in all NYMEX natural gas futures contracts for 2006;

    about 30% of the outstanding contracts (open interest) in all NYMEX

    natural gas futures contracts for 2007; between 25 and 40% of the

    outstanding contracts (open interest) in all NYMEX natural gas

    futures contracts for 2008; between 20 and 40% of the outstanding

    contracts (open interest) in all NYMEX natural gas futures contracts

    for 2009; and about 60% of the outstanding contracts (open interest)

    in all NYMEX natural gas futures contracts for 2010.'' Subcommittee

    Report at 52.

    \109\ Subcommittee Report at 2.

    \110\ Id. at 68 (emphasis in original).

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

    Events in the 2006 natural gas markets demonstrate the burdens on

    interstate commerce of extreme price volatility.

    In section 4a(a)(1) of the CEA Congress causally links excessive

    speculative positions with ``sudden or unreasonable fluctuations or

    unwarranted changes in the price of'' such commodities. The precipitous

    decline in natural gas prices from late-August 2006 until Amaranth's

    collapse in September 2006 demonstrates that link. The Permanent

    Subcommittee found that ``[p]urchasers of natural gas during the summer

    of 2006 for delivery in the following winter months paid inflated

    prices due to Amaranth's speculative trading'' and that ``[m]any of

    these inflated costs were passed on to consumers, including residential

    users who paid higher home heating bills.'' \111\ Such inflated costs

    are clearly a burden on interstate commerce. In the words of the

    Permanent Subcommittee, ``[t]he Amaranth experience demonstrates how

    excessive speculation can distort prices of futures contracts that are

    many months from expiration, with serious consequences for other market

    participants.'' \112\ The Permanent Subcommittee findings support the

    imposition of speculative position limits outside the spot month.

    Commercial participants in the 2006 natural gas markets were reluctant

    or unable to hedge.\113\ Speculators withdrew liquidity from a market

    viewed as artificially expensive.\114\ To relieve the burdens on

    interstate commerce posed by positions as large as Amaranth's, Congress

    directed the Commission to set position limits to, among other things,

    ensure sufficient market liquidity for bona fide hedgers.\115\

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

    \111\ Id. at 6.

    \112\ Id. at 4.

    \113\ See id. at 114.

    \114\ See id. at 71-77.

    \115\ 7 U.S.C. 6a(a)(3)(B)(iv).

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

    ``Amaranth held as many as 100,000 natural gas contracts in a

    single month, representing 1 trillion cubic feet of natural gas, or 5%

    of the natural gas in the entire United States in a year. At times

    Amaranth controlled 40% of all of the outstanding contracts on NYMEX

    for natural gas in the winter season (October 2006 through March 2007),

    including as much as 75% of the outstanding contracts to deliver

    natural gas in November 2008.'' \116\ Position limits that would

    prevent the accumulation of such overly large speculative positions in

    deferred commodity contracts would help to prevent unreasonable

    fluctuations or unwarranted changes in the price of a commodity that

    may occur when a speculator must substantially reduce its position

    within a short period of time to the extent the price of such commodity

    during the unwind period does not reflect fundamental values.\117\

    Moreover, position limits would help to prevent disruptions to market

    integrity caused by the corrosive perception that a market is unfair or

    prices in a market do not reflect the fundamental forces of supply and

    demand as occurred during 2006 in the natural gas markets. Commodity

    markets where artificial volatility discourages participation are less

    likely to produce ``a market consensus on correct pricing.'' \118\

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

    \116\ Subcommittee Report at 2.

    \117\ This is because, among other things, the speculator's

    influence on expectations of demand is reduced as the speculator is

    no longer willing and able to hold such a large net position in

    futures contracts.

    \118\ Subcommittee Report at 119.

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

    Based on certain assumptions described below, the Commission

    believes that if Federal speculative position limits had been in effect

    that correspond to the limits that the Commission proposes now, across

    markets now subject to Commission jurisdiction, such limits would have

    prevented Amaranth from accumulating such large futures positions and

    thereby restrict its ability to cause unwarranted price effects. Using

    non-public data reported to the Commission under Part 16 of the

    Commission's regulations for open interest \119\ for natural gas

    contracts, the Commission calculated the single-month and all-months-

    combined limits using the same methodology as proposed in this release

    for the period January 1, 2004 to December 31, 2005. The results of

    this analysis are presented in Table 3 below, which shows that the

    resulting single-month and all-months combined limits would have each

    been 40,900 contracts.

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

    \119\ See 17 CFR 16.01.

    [[Page 75693]]

    Table 3--Open Interest and Calculated Limits for NYMEX Natural Gas January 1, 2004, to December 31, 2005

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

    Open interest

    Core referenced futures contract Year (daily Open interest Limit (daily Limit (month Limit

    average) (month end) average) end)

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

    NYMEX Natural Gas....................................... 2004 851,763 839,330 23,200 22,900 40,900

    2005 1,559,335 1,529,252 40,900 40,200 ..............

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

    Using non-public data reported to the Commission under Part 17 of

    the Commission's regulation for large trader positions,\120\ the

    Commission also calculated Amaranth's positions \121\ as they would be

    calculated under the proposed rule for the period January 1, 2005 to

    September 30, 2006. During this time, Amaranth's net position would

    have exceeded the limits for the single month and for all-months-

    combined on multiple days, starting as early as June 2006. It is

    important to note that ICE did not report market open interest for its

    swap contracts or for large traders to the Commission during this time

    period, so the Commission cannot exactly replicate the calculations in

    the proposed rule. However, even if ICE had the same amount of open

    interest in futures-equivalent terms as all of the NYMEX natural gas

    contracts listed in 2005,\122\ the calculated limit would be 79,900

    contracts. According to the Subcommittee Report, Amaranth would have

    exceeded this limit at the end of July 2006 with its holding of 80,000

    long contracts in the January 2007 delivery month.\123\ Moreover, the

    Subcommittee Report also shows that Amaranth tended to trade in the

    same direction for the same delivery month on ICE and NYMEX. Hence, the

    Commission believes that had the proposed rule been in effect in 2006,

    Amaranth would not have been able to build such large positions in

    natural gas futures and swaps and thereby limits would have restricted

    Amaranth's ability to cause harmful price effects that limits are

    intended to prevent.\124\

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

    \120\ See 17 CFR 17.00.

    \121\ Because the Commission's calculations are based on non-

    public information, the results of this analysis may be different

    from calculations based on publicly available information, including

    information contained in the Subcommittee Report.

    \122\ Since the main natural gas swap contracts on ICE are one

    quarter of the size of the NYMEX Henry Hub Natural Gas Futures

    contract, this would mean that the open interest for natural gas

    contracts on ICE would have to be four times the open interest for

    natural gas contracts on NYMEX.

    \123\ See Subcommittee Report at 79.

    \124\ According to the Subcommittee Report, Amaranth reduced its

    positions on NYMEX as directed by NYMEX in August 2006, and at the

    same time, increased its corresponding positions on ICE. See

    Subcommittee Report at 97-98.

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

    Position limits would prevent the accumulation of extraordinarily

    large positions that could potentially cause unreasonable price

    fluctuations even in the absence of manipulative conduct.

    As the above examples illustrate, position limits are vital tools

    to prevent the accumulation of speculative positions that can enable

    market manipulation. But these examples also show that limits are

    necessary to achieve a broader statutory purpose -- to prevent price

    distortions that can potentially occur due to excessively large

    speculative positions even in the absence of manipulative conduct.

    The text of section 4a(a)(1) of the Act itself establishes its

    broader purpose: It authorizes limits as the Commission finds are

    necessary to prevent price distortions that can potentially occur due

    to excessive speculation (i.e. excessively large speculative

    positions), without regard to whether it is manipulative.\125\ The

    Commission has long interpreted the provision as authorizing limits to

    achieve this broader purpose and it has long found that limits are

    necessary to do so.

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

    \125\ See 7 U.S.C. 6a(a)(1).

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

    For example, in the 1981 Rule requiring exchanges to set limits for

    all commodities, noted above, the Commission found that ``historical

    and current reason for imposing position limits on individual contracts

    is to prevent unreasonable fluctuations or unwarranted changes in the

    price of a commodity which may occur by allowing any one trader or

    group of traders acting in concert to hold extraordinarily large

    futures positions.'' \126\ In a 2010 rulemaking, the Commission stated

    that ``[f]rom the earliest days of federal regulation of the futures

    markets, Congress made it clear that unchecked speculative positions,

    even without intent to manipulate the market, can cause price

    disturbances. To protect markets from the adverse consequences

    associated with large speculative positions, Congress expressly

    authorized the [Commission] to impose speculative position limits

    prophylactically.'' \127\

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

    \126\ 46 FR 50938, 50939, Oct. 16, 1981.

    \127\ 75 FR 4144, 4145-46, Jan. 26, 2010.

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

    The Commission reiterated this view before Congress in 1982 in

    opposing industry amendments to the CEA that would have required that

    limits are necessary to prevent manipulation, corners or squeezes.

    Former Commission Chair Philip McBride Johnson told Congress that

    position limits were ``predicated on several different sections of the

    Commodity Exchange Act which pertain to orderly markets and the terms

    `manipulation, corners or squeezes' refer to only one class of market

    disruption which the limits established under this rule are intended to

    diminish or prevent. For instance, CEA section 4a contains the

    Congressional finding that excessive speculation in the futures markets

    can cause sudden or unreasonable fluctuations or unwarranted changes in

    the price of commodities. Accordingly, a requirement that the

    Commission make the suggested finding concerning `manipulation,

    corners, or squeezes' prior to requiring a contract market to establish

    speculative limits could significantly restrict the application of the

    current rule and undermine its more comprehensive regulatory purpose of

    preventing excessive speculation which arises from extraordinarily

    large positions.'' \128\

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

    \128\ Futures Trading Act of 1982: Hearings on S. 2109 before

    the S. Subcomm. on Agricultural Research, 97th Cong. 44 (1982).

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

    Congress effectively ratified the Commission's interpretation in

    1982. As it explained: ``the Senate Committee decided to retain [CEA

    section] 4a language concerning the burden which excess speculation

    places on interstate commerce. This was due to the Committee's belief

    that speculative limits, in addition to their role in preventing

    manipulations, corners, or squeezes, are also important regulatory

    tools for preventing unreasonable fluctuations or unwarranted changes

    in commodity prices that may arise even in the absence of

    manipulation.'' \129\

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

    \129\ S. Rep. 97-384 at 45 (1982).

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

    The Commission has long found and again finds, based on its

    experience, that unchecked speculative positions can potentially

    disrupt markets. In general, the larger a position held by a trader,

    the greater is the potential that the position may affect the price of

    the contract. The Commission reaffirms that, ``the capacity of any

    contract to absorb the

    [[Page 75694]]

    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.'' \130\ When positions

    exceed the capacity of markets to absorb and liquidate them,

    unreasonable price fluctuations and volatility can potentially occur.

    ``[B]y limiting the ability of one person or group to obtain

    extraordinarily large positions, speculative limits diminish the

    possibility of accentuating price swings if large positions must be

    liquidated abruptly in the face of adverse price movements or for other

    reasons.'' \131\ As former Commission Chair McBride Johnson explained

    to Congress regarding the silver crisis: ``It seems clear from the

    silver crisis that the orderly imposition of speculative limits before

    a crisis develops is one of the more promising means of solving such

    difficulties in the future . . . .'' \132\ This statement is equally

    true of the natural gas events of 2006. Had the Hunt brothers and

    Amaranth been prevented from amassing extraordinarily large speculative

    positions in the first place, their ability to cause unwarranted price

    fluctuations and volatility and other harmful market effects

    attributable to such positions would have been restricted.

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

    \130\ 46 FR 50938, Oct. 16, 1981 (adopting then Sec. 1.61 (now

    part of Sec. 150.5)).

    \131\ 45 FR at 79833.

    \132\ Futures Trading Act of 1982: Hearings on S. 2109 before

    the S. Subcomm. on Agricultural Research, 97th Cong. 44 (1982).

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

    The Commission requests comment on all aspects of this section.

    Studies and Reports

    In addition to those cited previously, the Commission has reviewed

    and evaluated additional studies and reports (collectively,

    ``studies'') about various issues relating to position limits. A list

    of studies that the Commission has reviewed is in appendix A to this

    preamble.

    Some studies discuss whether or not excessive speculation exists,

    the definition of excessive speculation, and/or whether excessive

    speculation has a negative impact on derivatives markets.\133\ Those

    studies that do generally discuss the impact of position limits do not

    address or provide analysis of how the Commission should specifically

    implement position limits under section 4a of the CEA.\134\ Some

    studies may be read to support the imposition of Federal speculative

    position limits; others suggest that speculative position limits will

    be ineffective; still others assert that imposing speculative position

    limits will be harmful. There is a demonstrable lack of consensus in

    the studies.

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

    \133\ 76 FR at 71663.

    \134\ Id. at 71664.

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

    Many of the studies were focused on the impact of speculative

    activity in futures markets, e.g., how the behavior of non-commercial

    traders affected price levels. Such studies did not provide a view on

    position limits in general or on the Commission's implementation of

    position limits in particular. Some studies have found little or no

    evidence of excessive speculation unduly moving prices,\135\ while

    others conclude there is significant evidence of the impact of

    speculation in commodity markets.\136\ Even studies that questioned

    whether speculation affects prices were often equivocal.\137\ Still

    other studies have determined that while speculation may not cause a

    price movement, such activity may increase price pressures, thereby

    exacerbating the price movement.\138\

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

    \135\ See, e.g., Harris, Jeffrey and Buyuksahin, Bahattin, ``The

    Role of Speculators in the Crude Oil Futures Market,'' June 16,

    2009, at 2, 19 (``We find that the changing net positions of no

    specific trader groups lead to price changes . . . .'' and ``we fail

    to find the causality from these [speculative] traders' positions to

    prices.''); Byun, Sungje, ``Speculation in Commodity Futures Market,

    Inventories and the Price of Crude Oil,'' January 17, 2013, at 3, 33

    (noting that `` . . . evidence among researchers is inconsistent''

    but that ``we conclude there does not exist sufficient evidence on

    the potential contribution of financial investors in the crude oil

    market.''); Irwin, Scott H.; Sanders, Dwight R.; and Merrin, Robert

    P., ``Devil or Angel: The Role of Speculation in the Recent

    Commodity Price Boom,'' August 1, 2009, at 17 (``There is little

    evidence that the recent boom and bust in commodity prices was

    driven by a speculative bubble . . . Economic fundamentals, as

    usual, provide a better explanation for the movements in commodity

    prices.'').

    \136\ See, e.g., Singleton, Kenneth J., ``Investor Flows and the

    2008 Boom/Bust in Oil Prices,'' March 23, 2011, at 2-3 (Singleton

    presents `` . . . new evidence that . . . there were economically

    and statistically significant effects of investor flows on futures

    prices.''); Tang, Ke and Xiong, Wei, ``Index Investment and

    Financialization of Commodities,'' November 1, 2012, at 72 (``As a

    result of the financialization process, the price of an individual

    commodity is no longer determined solely by its supply and demand.

    Instead, prices are also determined by the aggregate risk appetite

    for financial assets and the investment behavior of diversified

    commodity index investors.''); Manera, Matteo, Nicolini, Marcella,

    and Vignati, Ilaria, ``Futures Price Volatility in Commodities

    Markets: The Role of Short-Term vs Long-Term Speculation,'' April 1,

    2013, at 15 (``We find that speculation significantly affects the

    volatility of returns, although in contrasting ways. The scalping

    index has a positive and significant coefficient in the variance

    equation, suggesting that short term speculation has a positive

    impact on volatility.'').

    \137\ Compare Technical Committee of the International

    Organization of Securities Commissions, Task for on Commodity

    Futures Markets Final Report, March 1, 2009, at 3 (``economic

    fundamentals, rather than speculative activity, are a plausible

    explanation for recent price changes in commodities'') with id. at 8

    (``short term expectations can be influenced by sentiment and

    investor behavior, which can amplify short-term price fluctuations,

    as in other asset markets''). Another study opining that speculative

    activity in general may reduce volatility nevertheless conceded that

    the authors could not rule out the possibility that a single trader

    might implement strategies that move prices and increase volatility.

    Brunetti, Celso and Buyuksahin, Bahattin, ``Is Speculation

    Destabilizing?,'' April 22, 2009, at 4, 22-23; see also Irwin, et

    al., ``The Performance of CBOT Corn, Soybean, and Wheat Futures

    Contracts after Recent Changes in Speculative Limits,'' July 29,

    2007, at 1, 6 (concluding that there was ``no large change in''

    price volatility after speculative limits were increased, but

    cautioning that ``[w]ith limited observations available for the

    period following the change in speculative limits . . . ,

    conclusions about the impact on volatility are tentative. Additional

    observations will be required across varying scenarios of supply,

    demand, and price level, to have full confidence in the

    conclusions.'') (emphasis added); Parsons, John E., ``Black Gold &

    Fool's Gold: Speculation in the Oil Futures Market,'' September 1,

    2009, at 108 (position limits will not prevent asset bubbles from

    forming, but they are ``necessary to insure the integrity of the

    market'').

    \138\ See, e.g., Hamilton, James D., ``Causes and Consequences

    of the Oil Shock of 2007-08,'' April 1, 2009, at 258 (Hamilton

    raises ``the possibility that miscalculation of the long-run price

    elasticity of oil demand . . . was one factor in the oil shock of

    2007-2008, and that speculative investing in oil futures may have

    contributed to that miscalculation.''); Juvenal, Luciana and

    Petrella, Ivan, ``Speculation in the Oil Market,'' June 1, 2012,

    (``While global demand shocks account for the largest share of oil

    price fluctuations, speculative shocks are the second most important

    driver.'').

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

    Several studies did generally address the concept of position

    limits as part of their discussion of speculative activity. The authors

    of some of these works expressed views that speculative position limits

    were an important regulatory tool and that the CFTC should implement

    limits to control excessive speculation.\139\ For example,

    [[Page 75695]]

    one author opined that `` . . . strict position limits should be placed

    on individual holdings, such that they are not manipulative.'' \140\

    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.'' \141\ The authors of one study claimed that ``[r]ules 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.'' \142\

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

    \139\ See, e.g., Greenberger, Michael, ``The Relationship of

    Unregulated Excessive Speculation to Oil Market Price Volatility,''

    January 1, 2010, at 11 (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., ``The 2008 Oil

    Price ``Bubble'','' August 2009, at 8 (``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,''

    June 2009, at 12 (``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,'' June 25, 2007, at 8 (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.''); United

    Nations Conference on Trade and Development, ``The Global Economic

    Crisis: Systemic Failures and Multilateral Remedies,'' March 1,

    2009, at 14, (The UNCTAD recommends that `` . . . regulators should

    be enabled to intervene when swap dealer positions exceed

    speculative position limits and may represent `excessive

    speculation'.); United Nations Conference on Trade and Development,

    ``The Financialization of Commodity Markets,'' July 1, 2009, at 26

    (The report recommends tighter restrictions, notably closing

    loopholes that allow potentially harmful speculative activity to

    surpass position limits.).

    \140\ de Schutter, Olivier, ``Food Commodities Speculation and

    Food Price Crises,'' September 1, 2010, United Nations Special

    Report on the Right to Food, at 8.

    \141\ Masters, Michael and White, Adam, ``The Accidental Hunt

    Brothers: How Institutional Investors are Driving up Food and Energy

    Prices,'' July 31, 2008, at 3.

    \142\ Medlock, Kenneth and Myers Jaffe, Amy, ``Who is In the Oil

    Futures Market and How Has It Changed?,'' August 26, 2009, Baker

    Institute for Public Policy, at 8.

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

    Not all of the reviewed studies viewed position limits in a

    positive light. One study claimed that position limits will not

    restrain manipulation,\143\ while another argued that position limits

    in the agricultural commodities have not significantly affected

    volatility.\144\ 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.\145\ A 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.\146\ Another 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.\147\ Another study suggested

    eliminating position limits, arguing that increasing ex-post penalties

    for manipulation would be more effective at deterring manipulative

    behavior.\148\ One study noted the similar efforts under discussion in

    European markets.\149\

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

    \143\ Ebrahim, Muhammed and Rhys ap Gwilym, ``Can Position

    Limits Restrain Rogue Traders?,'' March 1, 2013, Journal of Banking

    & Finance, at 27 (``. . . 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.'').

    \144\ Irwin, Scott H.; Garcia, Philip; and Good, Darrel L.,

    ``The Performance of CBOT Corn, Soybean, and Wheat Futures Contracts

    after Recent Changes in Speculative Limits,'' July 29, 2007, at 16

    (``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.'').

    \145\ Parsons, John E., ``Black Gold & Fool's Gold: Speculation

    in the Oil Futures Market,'' September 1, 2009, at 30 (``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.'').

    \146\ Wray, Randall, ``The Commodities Market Bubble: Money

    Manager Capitalism and the Financialization of Commodities,''

    October 1, 2008, at 41, 43 (``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.'').

    \147\ CME Group, Inc., ``Excessive Speculation and Position

    Limits in Energy Derivatives Markets,'' CME Group White Paper, 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.'') (available at http://www.cmegroup.com/company/files/PositionLimitsWhitePaper.pdf).

    \148\ Pirrong, Craig, ``Squeezes, Corpses, and the Anti-

    Manipulation Provisions of the Commodity Exchange Act,'' October 1,

    1994, at 2 (``The efficiency of futures markets would be improved,

    and perhaps substantially so, by eliminating position limits . . .

    and relying upon revitalized, harm-based sanctions to deter market

    manipulation.'').

    \149\ European Commission, ``Review of the Markets in Financial

    Instruments Directive,'' December 1, 2010, at 82 note 282

    (``European Parliament . . . 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.'').

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

    Studies that militate against imposing any speculative position

    limits appear to conflict with the Congressional mandate (discussed

    above) that the Commission impose limits on futures contracts, options,

    and certain swaps for agricultural and exempt commodities. Such studies

    also appear to conflict with Congress' determination, codified in CEA

    section 4a(a)(1), that position limits are an effective tool to address

    excessive speculation as a cause of sudden or unreasonable fluctuations

    or unwarranted changes in the price of such commodities.\150\

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

    \150\ 7 U.S.C. 6a(a)(1)-(2).

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

    In any case, these studies overall show a lack of consensus

    regarding the impact of speculation on commodity markets and the

    effectiveness of position limits. While there is not a consensus, the

    fact that there are studies on both sides, in the Commission's view,

    warrants erring on the side of caution. In light of the Commission's

    experience with position limits, and its interpretation of

    congressional intent, it is the Commission's judgment that position

    limits should be implemented as a prophylactic measure, to protect

    against the potential for undue price fluctuations and other burdens on

    commerce that in some cases have been at least in part attributable to

    excessive speculation.

    In this regard, the Commission has found two studies of actual

    market events to be helpful and persuasive in making its alternative

    necessity finding.\151\ The first is the inter-agency report on the

    silver crisis.\152\ This report, by a joint task force of the staffs of

    the Commission, the Board of Governors of the Federal Reserve System,

    the Department of the Treasury and the Securities and Exchange

    Commission, provides an in-depth description and analysis of the silver

    crisis, the Hunt brothers' build-up of massive positions, the

    manipulative

    [[Page 75696]]

    conduct that those massive positions enabled, the resulting extreme

    price volatility, and consequent harms to the economy. The second is

    the PSI Report on Excessive Speculation in the Natural Gas market.\153\

    As a Congressional report issued following hearings, it is more helpful

    and persuasive than academic and other studies in indicating how

    Congress views limits as necessary to prevent the adverse effects of

    excessively large speculative positions. The PSI Report is also more

    helpful because it thoroughly studied actual market events involving a

    vital energy commodity, natural gas, examined how Amaranth's buildup of

    massive speculative positions by itself created a risk of market harms,

    documented how Amaranth sought to avoid existing limits, and analyzed

    how its ability to do so was a cause of the attendant extreme price

    volatility documented in the report.

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

    \151\ Another study of actual market events analyzed position

    limits in the context of the ``Flash Crash'' of May 6, 2010. While

    this study concluded that position limits would not have prevented

    the crash, and that price limits were more effective, it measured

    the impacts of potential limits on certain financial contracts not

    implicated in the instant rulemaking. Lee, Bernard; Cheng, Shih-Fen;

    and Koh, Annie, ``Would Position Limits Have Made any Difference to

    the 'Flash Crash' on May 6, 2010,'' November 1, 2010, at 37.

    \152\ U.S Commodity Futures Trading Commission, ``Part Two, A

    Study of the Silver Market,'' May 29, 1981, Report to The Congress

    in Response to Section 21 of The Commodity Exchange Act.

    \153\ U.S. Senate Permanent Subcommittee on Investigations,

    ``Excessive Speculation in the Natural Gas Market,'' June 25, 2007.

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

    The Commission requests comment on its discussion of studies and

    reports. It also invites commenters to advise the Commission of any

    additional studies that the Commission should consider, and why.

    B. Proposed Rules

    1. Section 150.1--Definitions

    i. Various Definitions Found in Sec. 150.1

    The Commission proposes to amend the definitions of ``futures-

    equivalent,'' ``independent account controller,'' ``long position,''

    ``short position,'' and ``spot month'' found in Sec. 150.1 of its

    regulations to conform them to the concepts and terminology of the CEA,

    as amended by the Dodd-Frank Act.\154\ The Commission also is proposing

    to add to Sec. 150.1, definitions for ``basis contract,'' ``calendar

    spread contract,'' ``commodity derivative contract,'' ``commodity index

    contract,'' ``core referenced futures contract,'' ``eligible

    affiliate,'' ``entity,'' ``excluded commodity,'' ``intercommodity

    spread contract,'' ``intermarket spread positions,'' ``intramarket

    spread positions,'' ``physical commodity,'' ``pre-enactment swap,''

    ``pre-existing position,'' ``referenced contract,'' ``spread

    contract,'' ``speculative position limit,'' ``swap,'' ``swap dealer''

    and ``transition period swap.'' In addition, the Commission is

    proposing to move the definition of bona fide hedging from Sec. 1.3(z)

    into part 150, and to amend and update it. Moreover, the Commission

    proposes to delete the definition for ``the first delivery month of the

    `crop year.' '' The Commission notes that several terms that are not

    currently in part 150 are not included in the current rulemaking

    proposal even though definitions for those terms were adopted in

    vacated part 151. The Commission does not view definition of these

    terms as necessary for clarity in light of other revisions proposed

    herein. The terms not currently proposed include ``swaption'' and

    ``trader.'' \155\ Separately, the Commission is making a non-

    substantive change to list the definitions in alphabetical order rather

    than by use of assigned letters. This last change will be helpful when

    looking for a particular definition, both in the near future, in light

    of the additional definitions proposed to be adopted, and in the

    expectation that future rulemakings may adopt additional definitions.

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

    \154\ In a separate proposal approved on the same date as this

    proposal, the Commission is proposing amendments to Sec. 150.4--

    aggregation of positions (``Aggregation NPRM'') (Nov. 5, 2013),

    including amendments to the definitions of ``eligible entity'' and

    ``independent account controller.''

    \155\ ``Swaption'' was defined in vacated part 151 to mean ``an

    option to enter into a swap or a physical commodity option.''

    ``Trader'' was defined in vacated part 151 to mean ``a person that,

    for its own account or for an account that it controls, makes

    transactions in Referenced Contracts or has such transactions

    made.'' The Commission notes that while vacated part 151 and several

    places in current part 150 use the term ``trader,'' the term

    ``person'' is currently used in both Sec. 1.3(z) and in other

    places in part 150. The amendments in both the Aggregation NPRM and

    this NPRM use the term ``person'' in a manner consistent with its

    current use in part 150.

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

    a. Basis Contract

    While the term ``basis contract'' is not defined in current Sec.

    150.1, a definition was adopted in vacated Sec. 151.1. The definition

    adopted in Sec. 151.1 defined basis contract as ``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.'' When it adopted part 151, the

    Commission noted that a swap based on the difference in price of a

    commodity (or substantially the same commodity) at different delivery

    locations was a ``basis contract and therefore not subject to the

    limits adopted therein.\156\

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

    \156\ 76 FR 71626, 71631 (n. 49), Nov. 18, 2011.

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

    Under the proposal, the definition for ``basis contract'' adopted

    in Sec. 150.1 would expand upon the definition of basis contract

    adopted in vacated part 151, by defining basis contract to mean ``a

    commodity derivative contract that is cash-settled based on the

    difference in: (1) The price, directly or indirectly, of: (a) A

    particular core referenced futures contract; or (b) a commodity

    deliverable on a particular core referenced futures contract, whether

    at par, a fixed discount to par, or a premium to par; and (2) the

    price, at a different delivery location or pricing point than that of

    the same particular core referenced futures contract, directly or

    indirectly, of: (a) A commodity deliverable on the same particular core

    referenced futures contract, whether at par, a fixed discount to par,

    or a premium to par; or (b) a commodity that is listed in appendix B to

    this part as substantially the same as a commodity underlying the same

    core referenced futures contract.''

    The Commission notes that the proposal excludes intercommodity

    spread contracts, calendar spread contracts, and basis contracts from

    the definition of ``commodity index contract.''

    The Commission is proposing appendix B to this part, Commodities

    Listed as Substantially the Same for Purposes of the Definition of

    Basis Contract. The Commission proposes to expand the definition of

    basis contract to include contracts cash-settled on the difference in

    prices of two different, but economically closely related commodities.

    The basis contract definition in vacated part 151 targeted the location

    differential. Now the Commission is proposing a basis contract

    definition that would expand to include certain quality differentials

    (e.g., RBOB vs. 87 unleaded).\157\ The intent of the expanded

    definition is to reduce the potential for excessive speculation in

    referenced contracts where, for example, a speculator establishes a

    large outright directional position in referenced contracts and nets

    down that directional position with a contract based on the difference

    in price of the commodity underlying the referenced contracts and a

    close economic substitute that was not deliverable on the core

    referenced futures contract. In the absence of this expanded

    definition, the speculator could then increase further the large

    position in the referenced contracts. By way of comparison, the

    Commission preliminarily believes there is greater concern that (i)

    someone may manipulate the markets by disguise of a directional

    exposure through netting down the directional exposure using one of the

    legs of a quality differential (if that quality differential contract

    were not exempted) than (ii) that someone may use certain quality

    differential contracts that were exempted from position limits to

    manipulate the

    [[Page 75697]]

    outright price of a referenced contract. Historically, manipulation has

    occurred though use of outright positions (as in the case of the Hunt

    brothers) or time spreads (Amaranth, for example, used calendar month

    spreads), rather than quality or locational differentials.

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

    \157\ The expanded basis contract definition is not intended to

    include significant time differentials in prices of the two

    commodities (e.g., the expanded basis contract definition would not

    include calendar spreads for nearby vs. deferred contracts).

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

    The Commission seeks comment on alternatives to the specification

    of quality standards for substantially the same commodity, such as a

    methodology to identify and define which differential contracts should

    be excluded from position limits. (i) Should the Commission expand the

    definition of basis contract to include any commodity priced at a

    differential to any of its products and by-products? For example,

    should a basis contract include a soybean crush spread contract or a

    crude oil crack spread contract, regardless of the number of

    components? (ii) Should the Commission expand the definition of basis

    contract to include a product or by-product of a particular commodity,

    priced at a differential to another product or by-product of that same

    commodity? For example, should the basis contract definition include a

    contract based on jet fuel priced at a differential to heating oil? Jet

    fuel and heating oil are both products of the same commodity, namely

    crude oil. (iii) Should the Commission expand the definition of basis

    contract for a particular commodity to include other similar

    commodities? For example, should the basis contract definition include

    a contract based on the difference in prices of light sweet crude oil

    and a sour crude oil that is not deliverable on the WTI contract?

    b. Commodity Derivative Contract

    The Commission proposes in Sec. 150.1(l) to define the term

    ``commodity derivative contract'' for position limits purposes as

    shorthand for any futures, option, or swap contract in a commodity

    (other than a security futures product as defined in CEA section

    1a(45)). Part 150 refers only to futures and options, while vacated

    part 151 was drafted without the use of any similar concise phrase. It

    was determined during the process of updating part 150 that the use of

    such a generic term would be a useful way to streamline and simplify

    references in part 150 to the various kinds of contracts to which the

    position limits regime applies. As such, this new definition can be

    found frequently throughout the Commission's proposed amendments to

    part 150.\158\

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

    \158\ See, e.g., proposed amendments to Sec. 150.1 (the

    definitions of: ``basis contract,'' the definition of ``bona fide

    hedging position,'' ``inter-market spread position,'' ``intra-market

    spread position,'' ``pre-existing position,'' ``speculative position

    limits,'' and ``spot month''), Sec. Sec. 150.2(f)(2), 150.3(d),

    150.3(h), 150.5(a), 150.5(b), 150.5(e), 150.7(d), 150.7(f), appendix

    A to part 150, and appendix C to part 150.

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

    c. Commodity Index Contract

    The term ``commodity index contract'' is not currently defined in

    Sec. 150.1; a definition for the term was adopted in vacated part

    151.\159\ Under the definition adopted in Sec. 151.1, 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.'' \160\

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

    \159\ 76 FR at 71685.

    \160\ See id.

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

    The Commission noted in the vacated part 151 final rulemaking that

    the definition of ``Referenced Contract'' in Sec. 151.1 expressly

    excluded commodity index contracts.\161\ The Commission also noted that

    ``if a swap is based on prices of multiple different commodities

    comprising an index, it is a `commodity index contract.' '' \162\ As

    the preamble pointed out, it would not, therefore, be subject to

    position limits.\163\

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

    \161\ Id. at 71656.

    \162\ Id. at 71631 n.49.

    \163\ Id. The Commission clarifies here, that, as was noted in

    the vacated part 151 Rulemaking, 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. 150.2. The

    Commission further clarifies that, again as was noted in the vacated

    part 151 Rulemaking, 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. 150.2. See id.

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

    The Commission proposes in the current rulemaking to add into Sec.

    150.1 substantially the same definition for ``commodity index

    contract'' as was adopted in vacated Sec. 151.1, with one change. The

    proviso included in Sec. 151.1, which required treatment of a position

    in a commodity index contract as a Referenced Contract if the contract

    was used to circumvent speculative position limits, acted in the Sec.

    151.1 definition as an anti-evasion provision, a substantive regulatory

    requirement. Consequently, to provide greater clarity as to the effect

    of the provision, the definition of ``commodity index contract''

    proposed in 150.1 mirrors that of the definition in 151.1, but with no

    anti-evasion proviso. Instead, an anti-evasion provision, while similar

    to that contained in Sec. 151.1, is included in proposed Sec.

    150.2(h).\164\

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

    \164\ See discussion below.

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

    As in vacated part 151, and as noted above, the definition of

    ``referenced contract'' proposed in the current rulemaking also

    expressly excludes commodity index contracts. However, as the

    Commission noted in the final part 151 Rulemaking, part 20 of the

    Commission's regulations requires reporting entities to report

    commodity reference price data sufficient to distinguish between

    commodity index contract and non-commodity index contract positions in

    covered contracts.\165\ Therefore, for commodity index contracts, the

    Commission intends to rely on the data elements in Sec. 20.4(b) to

    distinguish data records subject to Sec. 150.2 position limits from

    those contracts that are excluded from Sec. 150.2. This will enable

    the Commission to set position limits using the narrower data set

    (i.e., referenced contracts subject to Sec. 150.2 position limits) as

    well as conduct surveillance using the broader data set.

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

    \165\ 76 FR at 71632.

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

    d. Core Referenced Futures Contract

    While current part 150 does not contain a definition of the term

    ``core referenced futures contracts,'' a definition for the term was

    adopted in vacated Sec. 151.1 as a simple short-hand phrase to denote

    certain futures contracts, regarding which several position limit rules

    were then applied. The definition adopted in Sec. 151.1 provided that

    a core referenced futures contract was ``a futures contract defined in

    Sec. 151.2''; section 151.2 provided a list of 28 physical commodity

    futures and option contracts.\166\

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

    \166\ The Commission clarified in adopting Sec. 151.2, that

    core referenced futures contracts included options that expire into

    outright positions in such contracts. See 76 FR at 71631.

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

    The Commission proposes to include in Sec. 150.1 the same

    definition as was adopted in vacated Sec. 151.1--such that the

    definition would cite to futures contracts listed in Sec. 151.2.\167\

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

    \167\ The selection of the core referenced futures contracts is

    explained in the discussion of proposed Sec. 150.2. See discussion

    below.

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

    e. Eligible Affiliate

    The term ``eligible affiliate,'' used in proposed Sec.

    150.2(c)(2), is not defined in current Sec. 150.1. The Commission

    proposes to amend Sec. 150.1 to define an

    [[Page 75698]]

    ``eligible affiliate'' as ``an entity with respect to which another

    person: (1) Directly or indirectly holds either: (i) A majority of the

    equity securities of such entity, or (ii) the right to receive upon

    dissolution of, or the contribution of, a majority of the capital of

    such entity; (2) reports its financial statements on a consolidated

    basis under Generally Accepted Accounting Principles or International

    Financial Reporting Standards, and such consolidated financial

    statements include the financial results of such entity; and (3) is

    required to aggregate the positions of such entity under Sec. 150.4

    and does not claim an exemption from aggregation for such entity.''

    \168\

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

    \168\ See proposed Sec. 150.1.

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

    The definition of ``eligible affiliate'' proposed in the current

    NPRM qualifies persons as eligible affiliates based on requirements

    similar to those recently adopted by the Commission in a separate

    rulemaking. On April 1, 2013, the Commission provided relief from the

    mandatory clearing requirement of section 2(h)(1)(A) of the Act for

    certain affiliated persons if the affiliated persons (``eligible

    affiliate counterparties'') meet requirements contained in Sec.

    50.52.\169\ Under both Sec. 50.52 and the current proposed definition,

    a person is an eligible affiliate if the person, directly or

    indirectly, holds a majority ownership interest in the other

    counterparty (a majority of the equity securities of such entity, or

    the right to receive upon dissolution of, or the contribution of, a

    majority of the capital of such entity), reports its financial

    statements on a consolidated basis under Generally Accepted Accounting

    Principles or International Financial Reporting Standards, and such

    consolidated financial statements include the financial results of such

    entity. In addition, for purposes of the position limits regime, an

    eligible affiliate, as proposed in Sec. 150.1, must be required to

    aggregate the positions of such entity under Sec. 150.4 and does not

    claim an exemption from aggregation for such entity.\170\

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

    \169\ See Clearing Exemption for Swaps Between Certain

    Affiliated Entities, 78 FR 21749, 21783, Apr. 11, 2013. Section

    50.52(a) addresses eligible affiliate counterparty status, allowing

    a person not to clear a swap subject to the clearing requirement of

    section 2(h)(1)(A) of the Act and part 50 if the person meets the

    requirements of the conditions contained in paragraphs (a) and (b)

    of Sec. 50.52. The conditions in paragraph (a) of Sec. 50.52

    specify either one counterparty holds a majority ownership interest

    in, and reports its financial statements on a consolidated basis

    with, the other counterparty, or both counterparties are majority

    owned by a third party who reports its financial statements on a

    consolidated basis with the counterparties.

    The conditions in paragraph (b) of Sec. 50.52 address factors

    such as the decision of the parties not to clear, the associated

    documentation, audit, and recordkeeping requirements, the policies

    and procedures that must be established, maintained, and followed by

    a dealer and major swap participant, and the requirement to have an

    appropriate centralized risk management program, rather than the

    nature of the affiliation. As such, those conditions are less

    pertinent to the definition of eligible affiliate.

    \170\ See proposed amendments to the definition of ``eligible

    affiliate'' in proposed Sec. 150.1.

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

    The Commission requests comment on the proposed definition. Is the

    definition an appropriate one for purposes of the position limits

    regime? Should the Commission consider adopting a definition that more

    closely tracks the ``eligible affiliate counterparties'' definition

    adopted in Sec. 50.52 or is the difference appropriate in light of the

    differing regulatory purposes of the two regulations?

    f. Entity

    The current proposal defines ``entity'' to mean ``a `person' as

    defined in section 1a of the Act.'' \171\ The term is not defined in

    either current Sec. 150.1, but was defined in vacated Sec. 151.1; the

    language proposed here tracks that adopted in Sec. 151.1. The term

    ``entity,'' like that of ``person,'' is used in a number of contexts,

    and in various definitions. Defining the term, therefore, provides a

    clear and unambiguous meaning, and prevents confusion.

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

    \171\ CEA section 1a(38); 7 U.S.C. 1a(38).

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

    g. Excluded Commodity

    The phrase ``excluded commodity'' was added into the CEA in the

    CFMA, but was not defined or used in part 150. CEA section 4a(a)(2)(A),

    as amended by the Dodd-Frank Act, utilizes the phrase ``excluded

    commodity'' when it provides a timeline under which the Commission is

    charged with setting limits for futures and option contracts other than

    on excluded commodities.\172\

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

    \172\ CEA section 4a(2)(A); 7 U.S.C. 6a(2)(A).

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

    Part 151 included in the definition section of vacated Sec. 151.1,

    a definition which simply incorporated into part 151 the statutory

    meaning, as a useful term for purposes of a number of the changes made

    by part 151 to the position limits regime. For example, the phrase was

    used in vacated Sec. 151.11, in the provision of acceptable practices

    for DCMs and SEFs in their adoption of rules and procedures for

    monitoring and enforcing position accountability provisions; it was

    also used in the amendments to the definition of bona fide

    hedging.\173\ Similarly, the Commission believes that the adoption into

    part 150 of the excluded commodity definition will be a useful tool in

    addressing the same provisions, and so proposes to adopt into Sec.

    150.1 the definition used in Sec. 151.1.\174\

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

    \173\ See 17 CFR 1.3(z) as amended by the vacated part 151

    Rulemaking.

    \174\ See e.g., proposed Sec. 150.1 definitions for bona fide

    hedging and proposed amendments to Sec. 150.5(b).

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

    h. First Delivery Month of the Crop Year

    The term ``first delivery month of the crop year'' is currently

    defined in Sec. 150.1(c), with a table of the first delivery month of

    the crop year for the commodities for which position limits are

    currently provided in Sec. 150.2. The crop year definition has been

    pertinent for purposes of the spread exemption to the single month

    limit in current Sec. 150.3(a)(3), which limits spread positions in a

    single month to a level no more than that of the all-months limit. The

    Commission did not adopt this definition in vacated part 151.\175\ In

    the current proposal, the Commission proposes to amend Sec. 150.1 to

    delete the definition of ``crop year.'' The elimination of the

    definition reflects the fact that the definition is no longer needed,

    since the current proposal, like the approach adopted in part 151,

    would raise the level of individual month limits to the level of the

    all-month limits.

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

    \175\ See 76 FR at 71685.

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

    i. Futures Equivalent

    The term ``futures-equivalent'' is currently defined in Sec.

    150.1(f) to mean ``an option contract which has been adjusted by the

    previous day's risk factor, or delta coefficient, for that option which

    has been calculated at the close of trading and published by the

    applicable exchange under Sec. 16.01 of this chapter.'' \176\ The

    Commission proposes to retain the definition currently found in Sec.

    150.1(f), while broadening it in light of the Dodd-Frank Act amendments

    to CEA section 4a.\177\ The proposed amendments would also delete, as

    unnecessary, the reference to Sec. 16.01 found in the current

    definition.

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

    \176\ 17 CFR 150.1(f).

    \177\ Amendments to CEA section 4a(1) authorize the Commission

    to extend position limits beyond futures and option contracts to

    swaps traded on a DCM or SEF and swaps not traded on a DCM or SEF

    that perform or affect a significant price discovery function with

    respect to regulated entities (``SPDF swaps''). 7 U.S.C. 6a(a)(1).

    In addition, under new CEA sections 4a(a)(2) and 4a(a)(5),

    speculative position limits apply to agricultural and exempt

    commodity swaps that are ``economically equivalent'' to DCM futures

    and option contracts. 7 U.S.C. 6a(a)(2) and (5).

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

    As proposed, ``futures equivalent'' would be defined in Sec. 150.1

    as ``(1) An option contract, whether an option on a future or an option

    that is a swap, which has been adjusted by an economically reasonable

    and analytically supported risk factor, or delta coefficient, for that

    [[Page 75699]]

    option computed as of the previous day's close or the current day's

    close or contemporaneously during the trading day, and; (2) A swap

    which has been converted to an economically equivalent amount of an

    open position in a core referenced futures contract.''

    Vacated Sec. 151.1 did not retain a definition for ``futures-

    equivalent;'' instead final part 151 referred to guidance on futures

    equivalency provided in appendix A to part 20.\178\ The Commission

    notes that while the part 20 ``futures equivalent'' definition is

    consistent with the ``futures-equivalent'' definition proposed herein,

    it addresses only swaps, and cites to, and relies on, the guidance

    provided in appendix A to part 20.\179\ The definition proposed herein

    addresses both options on futures and options that are swaps; it also

    includes and expands upon clarifications that are incorporated into the

    current definition regarding the computation time and the adjustment by

    an economically reasonable and analytically supported risk factor, or

    delta coefficient.

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

    \178\ 76 FR at 71633 (n. 67) (stating that ``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 also 76 FR 43851, 43865, Jul.

    22, 2011.

    \179\ See 17 CFR 20.1 (``Futures equivalent means an

    economically equivalent amount of one or more futures contracts that

    represents a position or transaction in one or more paired swaps or

    swaptions consistent with the conversion guidelines in appendix A of

    this part.'').

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

    As noted above, the current Sec. 150.1(f) definition of ``futures-

    equivalent'' is narrowly defined to mean ``an option contract,'' and

    nothing else. Although certain contracts, from a practical standpoint,

    may be economically equivalent to futures contracts, as that terms is

    defined in Sec. 150.1, such products are not ``futures-equivalent''

    under the narrow definition of current Sec. 150.1(f) unless they are

    options on those actual futures. Therefore, current Sec. 150.1(f) is

    narrowly tailored to target only specifically enumerated futures

    contracts on ``legacy'' agricultural commodities and their equivalent

    options.

    The current rulemaking, like vacated part 151, establishes federal

    position limits and limit formulas for 28 physical commodity futures

    and option contracts, or ``core referenced futures contracts,'' and

    applies these limits to all derivatives that are directly or indirectly

    linked to the price of a core referenced futures contracts, or based on

    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, and defines such derivative products, collectively, as

    ``referenced contracts.'' Therefore, the position limits amendments

    proposed in this current rulemaking, similar to the position limits

    regime established in vacated part 151, apply across different trading

    venues to economically equivalent contracts, as that term is defined in

    Sec. 150.1, that are based on the same underlying commodity. As

    discussed supra, however, current part 150 defines ``futures-

    equivalent'' narrowly to mean ``an option contract,'' and makes no

    mention of broadly defined ``referenced contracts.'' Consequently, as

    noted above, and consistent with these changes to the position limits

    regime, including the applicability of aggregate position limits to

    economically equivalent ``referenced contracts'' across different

    trading venues, the Commission proposes to expand the strict ``futures-

    equivalent'' standard set forth in current part 150.

    j. Intercommodity Spread Contract

    Current part 150 does not include a definition of the term

    ``intercommodity spread contract,'' which was introduced and adopted in

    vacated part 151. The Commission proposes to add into Sec. 150.1 the

    definition adopted in Sec. 151.1,\180\ such that an ``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.'' The

    Commission determined, however, to adopt the term ``intercommodity

    spread contract'' as part of the definition of reference contract

    rather than as a separate term, since the phrase ``intercommodity

    spread contract'' is used solely for purposes of defining the term

    ``referenced contract.'' The inclusion of the term as part of the

    definition of referenced contract is intended to simplify the

    definition section and make it easier to understand.

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

    \180\ In vacated part 151, ``intercommodity spread contract''

    was defined to mean ``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.'' See vacated Sec. 151.1.

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

    k. Intermarket Spread Position

    The term ``intermarket spread position'' is not defined in current

    part 150, and was not adopted in part 151. But in conjunction with the

    amendments to part 150 to address the changes to CEA section 4a made by

    the Dodd-Frank Act,\181\ the Commission proposes to add into Sec.

    150.1 a definition for ``intermarket spread position'' to mean ``a long

    position in a commodity derivative contract in a particular commodity

    at a particular designated contract market or swap execution facility

    and a short position in another commodity derivative contract in that

    same commodity away from that particular designated contract market or

    swap execution facility.'' Among the changes to CEA section 4a, new

    section 4a(a)(6) of the Act requires the Commission to apply position

    limits on an aggregate basis to contracts based on the same underlying

    commodity across certain markets.\182\ The Commission believes that the

    term ``intermarket spread position'' simplifies the proposed changes to

    Sec. 150.5, which provide acceptable exemptions DCMs and SEFs may

    choose to grant from speculative position limits.\183\

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

    \181\ See e.g., discussions of Dodd-Frank changes to CEA section

    4a above and below.

    \182\ CEA section 4a(a)(6) requires the Commission to apply

    position limits on an aggregate basis to (1) contracts based on the

    same underlying commodity across DCMs; (2) with respect to foreign

    boards of trade (``FBOTs''), contracts that are price-linked to a

    DCM or SEF contract and made available from within the United States

    via direct access; and (3) SPDF swaps. 7 U.S.C. 6a(a)(6). See also,

    consideration of proposed changes to Sec. 150.2 for further

    discussion.

    \183\ See e.g., Sec. 150.5(a)(2)(B)(ii); see also

    150.5(b)(5)(b)(iv).

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

    l. Intramarket Spread Position

    Neither current part 150, nor vacated part 151, includes a

    definition of the term ``intramarket spread contract.'' The Commission

    now proposes to add into Sec. 150.1 the definition, such that

    ``intramarket spread position'' means ``a long position in a commodity

    derivative contract in a particular commodity and a short position in

    another commodity derivative contract in the same commodity on the same

    designated contract market or swap execution facility.''

    Current part 150 includes exemptions for certain spread positions.

    For example, current Sec. 150.3(a)(3) provides an exemption for spread

    (or arbitrage) positions, but this exemption is limited to those

    between single months for futures contracts and/or, options thereon, if

    outside of the spot month, and only if in the same crop year. While

    current Sec. 150.3(a)(3) limits the spread

    [[Page 75700]]

    exemption provided thereunder, the exemption under current Sec.

    150.5(a) is not so limited. Instead, under current Sec. 150.5(a),

    exchanges may exempt from position limits ``positions which are

    normally known in the trade as ``spreads, straddles, or arbitrage. . .

    .'' \184\ The Commission notes that the definition it now proposes for

    ``intramarket spread position'' is a generic term, and not limited only

    to futures and/or options thereon.\185\ In a similar manner to adoption

    of the term ``intermarket spread position,'' the term ``intramarket

    spread position,'' therefore, simplifies the Commissions amendments to

    exemptions for spread positions, including proposed changes to Sec.

    150.5, which, as noted above, provide acceptable exemptions DCMs and

    SEFs may choose to grant from speculative position limits.

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

    \184\ The Commission notes that the exemption provided in Sec.

    150.5(a) for ``positions which are normally known in the trade as

    `spreads, straddles, or arbitrage,' '' tracks CEA section 4a(a)(1).

    7 U.S.C. 6a(a)(1). Also, various DCMs currently have rules in place

    that provide exemptions for such as ``spreads, straddles, or

    arbitrage'' positions. See, e.g., ICE Futures U.S. rule 6.27 and CME

    rule 559.C.

    \185\ For further discussion regarding the exemptions for

    intramarket spread positions, see infra, discussion regarding Sec.

    150.5(a)(2) and (b)(5).

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

    m. Long Position

    The term ``long position'' is currently defined in Sec. 150.1(g)

    to mean ``a long call option, a short put option or a long underlying

    futures contract,'' but the phrase was not retained in vacated Sec.

    151.1. The Commission proposes to retain the definition, but to update

    it to make it also applicable to swaps such that a long position would

    include a long futures-equivalent swap.

    n. Physical Commodity

    The Commission proposes to amend Sec. 150.1 by adding in a

    definition of the term ``physical commodity'' for position limits

    purposes. Congress used the term ``physical commodity'' in CEA sections

    4a(a)(2)(A) and 4a(a)(2)(B) to mean commodities ``other than excluded

    commodities as defined by the Commission.'' Therefore, the Commission

    interprets ``physical commodities'' to include both exempt and

    agricultural commodities, but not excluded commodities, and proposes to

    define the term as such.\186\

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

    \186\ For position limits purposes, proposed Sec. 150.1 would

    define ``physical commodity'' to mean ``any agricultural commodity

    as that term is defined in Sec. 1.3 of this chapter or any exempt

    commodity as that term is defined in section 1a(20) of the Act.''

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

    o. Referenced Contracts

    Part 150 currently does not include a definition of the phrase

    ``Referenced Contract,'' which was introduced and adopted in vacated

    part 151.\187\ As was noted when part 151 was adopted, the Commission

    identified 28 core referenced futures contracts and proposed to apply

    aggregate limits on a futures equivalent basis across all derivatives

    that [met the definition of Referenced Contracts'].'' \188\

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

    \187\ Vacated Sec. 151.1 defined ``Referenced Contract'' to

    mean ``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 contract on a commodity

    index 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.''

    \188\ 76 FR at 71629.

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

    The vacated Sec. 151.1 definition of Referenced Contracts

    included: (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; and (4) intercommodity spreads with

    two components, one or both of which are Referenced Contracts.

    According to the Commission, these criteria captured contracts with

    prices that are or should be closely correlated to the prices of the

    Core Referenced Futures Contract, as defined in vacated Sec.

    151.1.\189\ In addition, the definition included categories of

    Referenced Contract based on objective criteria and readily available

    data (i.e., derivatives that are directly or indirectly linked to or

    based on the same commodity for delivery at the same delivery location

    as a Core Referenced Futures Contract).\190\ At that time, the

    Commission clarified that a swap contract using as its sole floating

    reference price the prices generated directly or indirectly from the

    price of a single Core Referenced Futures Contract or a swap priced

    based on a fixed differential to a Core Referenced Futures Contract,

    were look-alike Referenced Contracts, and subject to the limits adopted

    in vacated part 151.\191\ In addition, the definition included options

    that expire into outright positions in such contracts.\192\

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

    \189\ Id. at 71630.

    \190\ Id. at 71630-31.

    \191\ Id. at 71631 n.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).'').

    \192\ Id. at 71631.

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

    In response to comments that the Commission should broaden the

    scope of Referenced Contracts, the Commission noted that expanding the

    scope of position limits based, for example, on cross-hedging

    relationships or other historical price analysis would be problematic

    as historical relationships may change over time and, additionally,

    would require individualized determinations. In light of these

    circumstances, the Commission determined that it was not necessary to

    expand the scope of position limits beyond what was adopted. The

    Commission also noted 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, further

    noting that it would consider amending the scope of economically

    equivalent contracts (and the relevant identifying criteria) as it

    gained experience in this area.\193\

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

    \193\ Id.

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

    The definition for ``referenced contract'' proposed in Sec. 150.1

    mirrors the definition proposed in Sec. 151.1, with the delineation of

    several related terms incorporated into the definition.\194\ The

    [[Page 75701]]

    beginning of the current definition parallels the definition in vacated

    Sec. 151.1, differing only with the addition of a clarification that

    the definition of ``referenced contract'' does not include guarantees

    of a swap. This clarification is added into the list of products that

    are not included in the definition.\195\ In the proposed definition,

    ``referenced contract'' would not include ``a guarantee of a swap, a

    basis contract, or a commodity index contract.'' \196\ In addition, for

    the sake of clarify, the proposal incorporates into the definition of

    ``referenced contract'' several related terms. Consequently, the

    definition for ``referenced contract'' delineates the meaning of

    ``calendar spread contract,'' ``commodity index contract,'' ``spread

    contract,'' and ``intercommodity spread contract.'' \197\ The

    incorporation of these terms into the definition of ``referenced

    contract'' is intended to retain in one place the various parts and

    meanings of the definition, thereby facilitating comprehension of the

    definition.

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

    \194\ In the current rulemaking, the term ``referenced

    contract'' is defined in Sec. 150.1 to mean, on a futures-

    equivalent basis with respect to a particular core referenced

    futures contract, ``a core referenced futures contract listed in

    Sec. 151.2(d) of this part, or a futures contract, options

    contract, or swap, other than a guarantee of a swap, a basis

    contract, or a commodity index contract: (1) That is: (a) 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 (b) 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; and (2) Where: (a) 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; (b) 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; (c)

    Spread contract means either a calendar spread contract or an

    intercommodity spread contract; and (d) 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.''

    \195\ As defined in vacated Sec. 151.1, ``Referenced Contract''

    excludes ``a basis contract or contract on a commodity index.'' See

    vacated Sec. 151.1.

    \196\ The Commission proposes to exclude a guarantee of a swap

    from the definition of a referenced contract due to regulatory

    developments that occurred after the vacated part 151 Rulemaking. In

    connection with further defining the term ``swap'' jointly with the

    Securities and Exchange Commission, (see generally Further

    Definition of ``Swap,'' ``Security-Based Swap,'' and ``Security-

    Based Swap Agreement''; Mixed Swaps; Security-Based Swap Agreement

    Recordkeeping, 77 FR 48208, Aug. 13, 2012 (``Product Definitions

    Adopting Release'')), the Commission interpreted the term ``swap''

    (that is not a ``security-based swap'' or ``mixed swap'') to include

    a guarantee of such swap, to the extent that a counterparty to a

    swap position would have recourse to the guarantor in connection

    with the position. See id. at 48226. Excluding guarantees of swaps

    from the definition of referenced contract should help avoid any

    potential confusion regarding the application of position limits to

    guarantees of swaps, which could impede the Commission's efforts to

    monitor compliance with the requirements of the CEA. In addition, if

    the rules proposed in the Aggregation NPRM are adopted, it would

    obviate the need to include guarantees of swaps in the definition of

    referenced contracts.

    \197\ Compare vacated Sec. 151.1 with proposed Sec. 150.1.

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

    p. Short Position

    The term ``short position'' is currently defined in Sec. 150.1(c)

    to mean ``a short call option, a long put option, or a short underlying

    futures contract.'' Vacated part 151 did not retain this definition.

    The current proposal would amend the definition to state that a short

    position means ``a short call option, a long put option or a short

    underlying futures contract, or a short futures-equivalent swap.'' This

    revised definition reflects the fact that under the Dodd-Frank Act, the

    Commission is charged with applying the position limits regime to

    swaps.

    q. Speculative Position Limit

    The term ``speculative position limit'' is currently not defined in

    Sec. 150.1 and was not defined in vacated part 151. The Commission now

    proposes to define the term ``speculative position limit'' to mean

    ``the maximum position, either net long or net short, in a commodity

    derivatives contract that may be held or controlled by one person,

    absent an exemption, such as an exemption for a bona fide hedging

    position. This limit may apply to a person's combined position in all

    commodity derivative contracts in a particular commodity (all-months-

    combined), a person's position in a single month of commodity

    derivative contracts in a particular commodity, or a person's position

    in the spot month of commodity derivative contacts in a particular

    commodity. Such a limit may be established under federal regulations or

    rules of a designated contract market or swap execution facility. An

    exchange may also apply other limits, such as a limit on gross long or

    gross short positions, or a limit on holding or controlling delivery

    instruments.''

    This proposed definition is similar to definitions for position

    limits used by the Commission for many years; the various regulations

    and defined terms included use of maximum amounts ``net long or net

    short,'' which limited what any one person could ``hold or control,''

    ``one grain on any one contract market'' (or in ``in one commodity'' or

    ``a particular commodity''), and ``in any one future or in all futures

    combined.'' For example, in 1936, Congress enacted the CEA, which

    authorized the CFTC's predecessor, the CEC, to establish limits on

    speculative trading. Congress empowered the CEC to ``fix such limits on

    the amount of trading . . . as the [CEC] finds is necessary to

    diminish, eliminate, or prevent such burden.'' \198\ The first

    speculative position limits were issued by the CEC in December

    1938.\199\ Those first speculative position limits rules provided in

    Sec. 150.1 for limits on position and daily trading in grain for

    future delivery, adopting a maximum amount ``net long or net short

    position which any one person may hold or control in any one grain on

    any one contract market'' as 2,000,000 bushels ``in any one future or

    in all futures combined.'' \200\

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

    \198\ CEA section 6a(1) (Supp. II 1936).

    \199\ 3 FR 3145, Dec. 24, 1938.

    \200\ 17 CFR 150.1 (1938) (Part 150--Orders of The Commodity

    Exchange Commission)(``Limits on position and daily trading in grain

    for future delivery. The following limits on the amount of trading

    under contracts of sale of grain for future delivery on or subject

    to the rules of contract markets which may be done by any person are

    hereby proclaimed and fixed, to be in full force and effect on and

    after December 31, 1938: (a) Position limits. (1) The limit on the

    maximum net long or net short position which any one person may hold

    or control in any one grain on any one contract market, except as

    specifically authorized by paragraph (a) (2), is: 2,000,000 bushels

    in any one future or in all futures combined. (2) To the extent that

    the net position held or controlled by any one person in all futures

    combined in any one grain on any one contract market is shown to

    represent spreading in the same grain between markets, the limit on

    net position in all futures combined set forth in paragraph (a)(1)

    may be exceeded on such contract market, but in no case shall the

    excess result in a net position of more than 3,000,000.'').

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

    Another example is found in the glossaries published by the

    Commission for many years. Various Commission documents over the years

    have included a glossary. For example, the Commission's annual report

    for 1983 includes in its glossary ``Position Limit The maximum

    position, either net long or net short, in one commodity future

    combined which may be held or controlled by one person as prescribed by

    any exchange or by the CFTC.'' The version of the staff glossary

    currently posted on the CFTC Web site defines speculative position

    limit as ``[t]he maximum position, either net long or net short, in one

    commodity future (or option) or in all futures (or options) of one

    commodity combined that may be held or controlled by one person (other

    than a person eligible for a hedge exemption) as prescribed by an

    exchange and/or by the CFTC.''

    r. Spot Month

    Vacated part 151 adopted an amended definition for ``spot month''

    that replaced the definition for spot month currently found in Sec.

    150.1 by citing to the definition provided in Sec. 151.3. Vacated

    Sec. 151.3 provided detailed lists of spot months separately for

    agricultural, metals and energy commodities.

    The Commission proposes to adopt a simplified update to the

    definition of ``spot month'' by expanding upon the current Sec. 150.1

    definition. The definition, as expanded, would specifically address

    both physical-delivery contracts and cash-settled contracts, and

    clarify the duration of ``spot month.'' Under the proposed changes, the

    term ``spot month'' does not refer to a month of time. Rather, the

    definition clarifies that the ``spot

    [[Page 75702]]

    month'' is the trading period immediately preceding the delivery period

    for a physical-delivery futures contract as well as for any cash-

    settled swaps and futures contracts that are linked to the physical-

    delivery contract. The definition continues to define the spot month as

    the period of time beginning at of the close of trading on the trading

    day preceding the first day on which delivery notices can be issued to

    the clearing organization of a contract market, while adding in a

    clarification that this definition applies only to physical-delivery

    commodity derivatives contracts. For physical-delivery contracts with

    delivery beginning after the last trading day, the proposal defines the

    spot month as the close of trading on the trading day preceding the

    third-to-last trading day, until the contract is no longer listed for

    trading (or available for transfer, such as through exchange for

    physical transactions). This definition is consistent with the current

    spot month for each of the 28 core referenced futures contracts. The

    definition proposes similar, but slightly different language for cash-

    settled contracts, providing that the spot month begins at the earlier

    of the start of the period in which the underlying cash-settlement

    price is calculated or the close of trading on the trading day

    preceding the third-to-last trading day and continues until the

    contract cash-settlement price is determined.\201\ In addition, the

    definition includes a proviso that, if the cash-settlement price is

    determined based on prices of a core referenced futures contract during

    the spot month period for that core referenced futures contract, then

    the spot month for that cash-settled contract is the same as the spot

    month for that core referenced futures contract.\202\

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

    \201\ For example, a ``look-alike'' contract that references a

    calendar-month average of settlement prices would have the same

    spot-month limit as the core referenced futures contract (CRFC) but

    the limit would be in effect beginning with the first calendar day

    of the cash-settlement period; a ``look-alike'' contract that

    references a single day's settlement price in the spot-month of the

    CRFC would have a spot-month limit at the same level as the CRFC but

    the limit would be in effect only during the spot month of the CRFC.

    \202\ For example, the physical-delivery NYMEX Henry Hub Natural

    Gas futures contract would have, as is currently the case for the

    exchange spot month limit, a spot period beginning on close of

    trading three business days prior to the last trading day of that

    core referenced futures contract. The NYMEX Henry Hub Natural Gas

    Penultimate Financial futures contract (which is cash-settled based

    on the NYMEX Henry Hub Natural Gas Futures contract settlement price

    on the business day preceding the last trading day for that

    physical-delivery contract, and is currently subject to position

    accountability effective on the last three trading days of the

    futures contract), would have a spot month period that is the same

    as that of the physical-delivery NYMEX Henry Hub Natural Gas futures

    contract.

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

    s. Spot-Month, Single-Month, and All-Months-Combined Position Limits

    In addition to a definition for ``spot month,'' current part 150

    includes definitions for ``single month,'' and for ``all-months'' where

    ``single month'' is defined as ``each separate futures trading month,

    other than the spot month future,'' and ``all-months'' is defined as

    ``the sum of all futures trading months including the spot month

    future.''

    Vacated part 151 retained only the definition for spot month, and,

    instead, adopted a definition for ``spot-month, single-month, and all-

    months-combined position limits.'' The definition provided that, for

    Referenced Contracts based on a commodity identified in Sec. 151.2,

    the maximum number of contracts a trader may hold was as provided in

    Sec. 151.4.

    In the current rulemaking proposal, as noted above, the Commission

    proposes to amend Sec. 150.1 by deleting the definitions for ``single

    month,'' and for ``all-months.'' Unlike the vacated part 151

    Rulemaking, the current proposal does not include a definition for

    ``spot-month, single-month, and all-months-combined position limits.''

    Instead, the current rulemaking proposes to adopt a definition for

    ``speculative position limits'' that should obviate the need for these

    definitions.\203\

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

    \203\ See supra discussion of the proposed definition of

    ``speculative position limit.''

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

    t. Spread Contract

    Spread contract was defined in vacated part 151 as ``either a

    calendar spread contract or an intercommodity spread contract.'' \204\

    The Commission proposes to add the same definition into Sec. 150.1 in

    conjunction with the proposal to define ``referenced contract.'' \205\

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

    \204\ Vacated Sec. 151.1.

    \205\ See supra discussion of proposed Sec. 150.1 ``referenced

    contract'' definition.

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

    The Commission also notes that while the proposed definition of

    ``referenced contract'' specifically excludes guarantees of a swap,

    basis contracts and commodity index contracts, spread contracts are not

    excluded from the proposed definition of ``referenced contract.'' \206\

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

    \206\ The Commission notes that this is consistent with vacated

    part 151. See, e.g., the final part 151 Rulemaking, which noted that

    commodity index contracts, which by the definition in vacated Sec.

    151.1 were expressly excluded from the definition of ``Referenced

    Contract,'' were not spread contracts. 76 FR at 71656. See also, the

    definition of ``commodity index contract,'' which 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.''

    Vacated Sec. 151.1.

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

    u. Swap

    The definitions of several terms adopted in vacated part 151 relied

    on the statutory definition in some cases in conjunction with a further

    definition adopted by the Commission in other rulemakings.\207\ Other

    defined terms that rely on the statutory definition in included:

    ``entity,'' ``excluded commodity,'' and ``swap dealer.'' Since the

    adoption of part 151, the Commission, in a joint rulemaking with the

    Securities and Exchange Commission, adopted a further definition for

    ``swap'' in Sec. 1.3(xxx).\208\ Consequently, the definition of

    ``swap'' proposed in the current rulemaking, while paralleling that of

    the definition included in vacated Sec. 151.1, and while substantially

    the same, additionally cites to the definition of ``swap'' found in

    Sec. 1.3(xxx).

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

    \207\ Under vacated Sec. 151.1, the term ``[s]wap means `swap'

    as defined in section 1a of the Act and as further defined by the

    Commission.''

    \208\ See 77 FR 48208, 48349, Aug. 13, 2012.

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

    v. Swap Dealer

    The term ``swap dealer'' is not currently defined in Sec. 150.1,

    but was defined in vacated 151.1 to mean `` `swap dealer' as that term

    is defined in section 1a of the Act and as further defined by the

    Commission.'' \209\ Similar to the definition of ``swap,'' the

    Commission adopted a definition for ``swap dealer'' since part 151 was

    finalized.\210\ Under the current proposal, Sec. 150.1 would be amend

    to define ``swap dealer'' to mean `` `swap dealer' as that term is

    defined in section 1a of the Act and as further defined in section 1.3

    of this chapter.'' This revised definition reflects the fact that the

    definition of ``swap dealer,'' while paralleling that of the definition

    included in Sec. 151.1, and while substantially the same, additionally

    cites to the definition of ``swap dealer'' found in Sec. 1.3(ggg).

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

    \209\ See vacated Sec. 151.1.

    \210\ 77 FR 30596, May 23, 2012.

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

    ii. Bona Fide Hedging Definition

    The core of the Commission's approach to defining bona fide hedging

    over the years has focused on transactions that offset a recognized

    physical price risk.\211\ Once a bona fide

    [[Page 75703]]

    hedge is implemented, the hedged entity should be price insensitive

    because any change in the value of the underlying physical commodity is

    offset by the change in value of the entity's physical commodity

    derivative position.

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

    \211\ For an historical perspective on the bona fide hedging

    provision prior to the Dodd-Frank amendments, see Testimony of

    General Counsel Dan M. Berkovitz, Commodity Futures Trading

    Commission, ``Position Limits and the Hedge Exemption, Brief

    Legislative History,'' July 28, 2009, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement072809.

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

    Because a firm that has hedged its price exposure is price neutral

    in its overall physical commodity position, the hedged entity should

    have little incentive to manipulate or engage in other abusive market

    practices to affect prices. By contrast, a party that maintains a

    derivative position that leaves them with exposure to price changes is

    not neutral as to price and, therefore, may have an incentive to affect

    prices. Further, the intention of a hedge exemption is to enable a

    commercial entity to offset its price risk; it was never intended to

    facilitate taking on additional price risk.

    The Commission recognizes there are complexities to analyzing the

    various commercial price risks applicable to particular commercial

    circumstances in order to determine whether a hedge exemption is

    warranted. These complexities have led the Commission, from time to

    time, to issue rule changes, interpretations, and exemptions. Congress,

    too, has periodically revised the Federal statutes applicable to bona

    fide hedging, most recently in the Dodd-Frank Act. These complexities

    will be further explored below.

    a. Bona Fide Hedging History

    Prior to 1974, the term bona fide hedging transactions or positions

    was defined in section 4a(3) of the Act. That definition only applied

    to agricultural commodities. When the Commission was created in 1974,

    the Act's definition of commodity was expanded. At that time, Congress

    was concerned that the limited hedging definition, even if applied to

    newly regulated commodity futures, would fail to accommodate the

    commercial risk management needs of market participants that could

    emerge over time. Accordingly, Congress, in section 404 of the

    Commodity Futures Trading Commission Act of 1974, repealed the

    statutory definition and gave the Commission the authority to define

    bona fide hedging.\212\ In response to the 1974 legislation, the

    Commission's predecessor adopted in 1975 a bona fide hedging definition

    in Sec. 1.3(z) of its regulations stating, among other requirements,

    that transactions or positions would not be classified as hedging

    unless their bona fide purpose was to offset price risks incidental to

    commercial cash or spot operations, and such positions were established

    and liquidated in an orderly manner and in accordance with sound

    commercial practices.\213\ Shortly thereafter, the newly formed

    Commission sought comment on amending that definition.\214\ Given the

    large number of issues raised in comment letters, the Commission

    adopted the predecessor's definition with minor changes as an interim

    definition of bona fide hedging transactions or positions, effective

    October 18, 1975.\215\

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

    \212\ Section 404 of Public Law 93-463, October 23, 1974, (CFTC

    Act), amended section 4a(3) of the Act, deleting the statutory

    definition of bona fide hedging position or transaction and

    directing the newly-established Commission to issue a rule defining

    that term.

    \213\ Pending promulgation of a definition by the Commission,

    the Secretary of Agriculture promulgated Sec. 1.3(z) pursuant to

    section 404 of the CFTC Act. 40 FR 11560, Mar. 12, 1975. This

    definition of bona fide hedging in new Sec. 1.3(z) deviated in only

    minor ways from the hedging definition contained in section 4a(3) of

    the Act. The Commodity Exchange Commission subsequently issued

    conforming amendments to various rules. 40 FR 15086, Apr. 4, 1975.

    \214\ 40 FR 34627, Aug. 18, 1975. The Commission sought comment

    on many issues, including whether to include in the definition of

    bona fide hedging transactions and positions ``the practice of many

    traders which results in hedging of gross cash positions rather than

    a net cash position--so-called `double hedging.' '' Id. at 34628.

    The Commission later noted ``that net cash positions do not

    necessarily measure total risk exposure and in such cases the

    hedging of gross cash positions does not constitute `double

    hedging.' '' 42 FR 42748, 42750, Aug. 24, 1977.

    \215\ 40 FR 48688, Oct. 17, 1975. The Commission re-issued all

    regulations, with rule 1.3(z) essentially unchanged, in 1976. 41 FR

    3192, 3195, Jan. 21, 1976.

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

    In 1977, the Commission proposed a revised definition of bona fide

    hedging that largely forms the basis of the current definition of bona

    fide hedging.\216\ The 1977 proposed definition set forth: (i) A

    general definition of bona fide hedging positions under economically

    appropriate circumstances and subject to other conditions (noted

    below); (ii) an enumerated list of specific positions that conform to

    the general definition; and (iii) a procedure to consider non-

    enumerated cases.\217\ The 1977 proposal, as adopted, established the

    concept of portfolio hedging and recognized cross-commodity hedges and

    hedges of anticipated production or unfilled anticipated requirements,

    provided such hedges were not recognized in the five last days of

    trading in any particular futures contract (the ``five-day rule'' in

    current Sec. 1.3(z)(2)).\218\

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

    \216\ 42 FR 14832, Mar. 16, 1977.

    \217\ Id.

    \218\ 42 FR 42748, Aug. 24, 1977.

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

    The general definition of bona fide hedging in current Sec.

    1.3(z), as was the case when adopted in 1977, advises that a position

    should ``normally represent a substitute for . . . positions to be

    taken at a later time in a physical marketing channel,'' and requires

    such position to be ``economically appropriate to the reduction of

    risks in the conduct of a commercial enterprise,'' and where the risks

    arise from the potential change in value of assets, liabilities or

    services.\219\ Such bona fide hedges also must have a purpose ``to

    offset price risks incidental to commercial cash or spot operations''

    and must be ``established and liquidated in an orderly manner in

    accordance with sound commercial practices.'' Thus a bona fide hedge

    exemption was appropriate where there was a demonstrated physical price

    risk that had been recognized. This also applies, for example, to bona

    fide hedge exemptions for unfilled anticipated requirements, where

    processors or manufacturers are exposed to price risk on such unfilled

    anticipated requirements necessary for their manufacturing or

    processing.\220\

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

    \219\ 17 CFR 1.3(z)(1) (2010). The Commission cautions that the

    e-CFR version of Sec. 1.3(z) reflects changes made by the vacated

    2011 final rule.

    \220\ The Commission notes that the definition of bona fide

    hedging transactions or positions historically included an exemption

    for unfilled anticipated requirements. As the Commission stated in

    1974, in its proposal to adopt Sec. 1.3(z), the regulation on the

    hedging definition proposed by the Secretary of Agriculture was

    intended to comply with the intent of section 404 of Public Law 93-

    463, enacted October 23, 1974, as stated in the Conference Report

    accompanying HR. 13113, pp. 40-1. The Commission noted in its

    proposal that the new statutory language was intended to allow

    processors and manufacturers to hedge unfilled annual requirements.

    39 FR 39731, Nov. 11, 1974.

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

    The 1977 proposed definition did not include the modifying adverb

    ``normally'' to the verb ``represent.'' \221\ The Commission explained

    in the 1977 preamble it intended to recognize bona fide hedging

    positions ``on the basis of net risk related to changes in the values

    reflected on balance sheets.'' \222\ The Commission introduced the

    adverb normally in the 1977 final rulemaking in order to make clear it

    would recognize as bona fide such balance sheet hedging and ``other [at

    the time] relatively infrequent but potentially important examples of

    risk reducing futures transactions'' that would otherwise not have met

    the general definition of bona fide hedging.\223\ The Commission noted:

    ``One form of balance sheet hedging would involve offsetting net

    exposure to changes in currency exchange rates for the purpose of

    stabilizing the domestic dollar accounting value of assets which are

    held abroad. In the case of depreciable capital assets, such hedging

    transactions

    [[Page 75704]]

    might not represent a substitute for subsequent transactions in a

    physical marketing channel.'' \224\

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

    \221\ See 42 FR 42748, Aug. 24, 1977.

    \222\ Id.

    \223\ 42 FR at 42749.

    \224\ Id. at 42749 (n. 1).

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

    With respect to the five-day rule in current Sec. 1.3(z)(2) for

    anticipatory hedges of unfilled anticipated requirements, the

    Commission observed that historically there was a low utilization of

    this provision in terms of actual positions acquired in the futures

    market.\225\ For cross commodity and short anticipatory hedge

    positions, the Commission did ``not believe that persons who do not

    possess or do not have a commercial need for the commodity for future

    delivery will normally wish to participate in the delivery process.''

    \226\

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

    \225\ Id. at 42749. The five-day rule in current Sec. 1.3(z)(2)

    for anticipatory hedges permits an exception for a person with a

    long anticipatory hedging need, for up to two months unfilled

    anticipated requirements.

    \226\ Id.

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

    In 1979, the Commission eliminated daily speculative trading volume

    limits and concluded such daily trading limits were ``not necessary to

    diminish, eliminate or prevent excessive speculation.'' \227\ The

    Commission noted eliminating daily trading limits had no effect on the

    limits on the size of speculative positions which any one person may

    hold or control on a single contract market. The Commission also noted

    the speculative position limits apply to positions throughout the day

    as well as to positions at the close of the trading session.\228\ The

    Commission continues to apply position limits throughout the day and

    will continue under this proposal.

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

    \227\ 44 FR 7124, Feb. 6, 1979.

    \228\ Id. at 7125.

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

    In the aftermath of the silver futures market crisis during late

    1979 to early 1980,\229\ in 1981 the Commission adopted Sec. 1.61,

    subsequently incorporated into Sec. 150.5, requiring DCMs to adopt

    speculative position limits and providing an exemption for ``bona fide

    hedging positions as defined by a contract market in accordance with

    Sec. 1.3(z)(1) of the Commission's regulations.'' \230\ That rule

    permits DCMs to limit bona fide hedging positions which it determines

    are not in accord with sound commercial practices or exceed an amount

    which the exchange determines may be established or liquidated in an

    orderly fashion.

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

    \229\ See, In re Nelson Bunker Hunt et al., CFTC Docket No. 85-

    12.

    \230\ 46 FR 50938, 50945, Oct. 16, 1981. With the passage of the

    Commodity Futures Modernization Act in 2000 and the Commission's

    subsequent adoption of the part 38 regulations covering DCMs in 2001

    (66 FR 42256, Aug. 10, 2001), part 150's approach to exchange-set

    speculative position limits was incorporated as an acceptable

    practice under DCM Core Principle 5--Position Limitations and

    Accountability. 72 FR 66097, 66098 n.1, Nov. 27, 2007.

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

    In 1986, in response to concerns raised in testimony regarding the

    constraints on investment decisions imposed by position limits, the

    House Committee on Agriculture, in its report accompanying the

    Commission's 1986 reauthorization legislation, instructed the

    Commission to reexamine its approach to speculative position limits and

    its definition of hedging.\231\ Specifically, the Committee Report

    ``strongly urge[d] the Commission to undertake a review of its hedging

    definition . . . and to consider giving certain concepts, uses, and

    strategies `non-speculative' treatment . . . whether under the hedging

    definition or, if appropriate, as a separate category similar to the

    treatment given certain spread, straddle or arbitrage positions . . .

    '' \232\ The Committee Report singled out four categories of trading

    and positions that the Commission should consider recognizing as non-

    speculative: (i) ``Risk management'' trading by portfolio managers as

    an alternative to the concept of ``risk reduction;'' (ii) futures

    positions taken as alternatives to, rather than as temporary

    substitutes for, cash market positions; (iii) other positions acquired

    to implement strategies involving the use of financial futures

    including, but not limited to, asset allocation (altering portfolio

    exposure in certain areas such as equity and debt), portfolio

    immunization (curing mismatches between the duration and sensitivity of

    assets and liabilities to ensure that portfolio assets will be

    sufficient to fund the payment of liabilities), and portfolio duration

    (altering the average maturity of a portfolio's assets); and (iv)

    certain options trading, in particular the writing of covered puts and

    calls.\233\

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

    \231\ House Committee on Agriculture, Futures Trading Act of

    1986, H.R. Rep. No. 624, 99th Cong., 2d Sess. 44-46 (1986).

    \232\ Id. at 46.

    \233\ Id.

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

    The Senate Committee on Agriculture, Nutrition and Forestry, in its

    report on the 1986 CFTC reauthorization legislation, also directed the

    Commission to reassess its interpretation of bona fide hedging.\234\

    Specifically, the Senate Committee directed the Commission to consider

    ``whether the concept of prudent risk management [should] be

    incorporated in the general definition of hedging as an alternative to

    this risk reduction standard.'' \235\

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

    \234\ Senate Committee on Agriculture, Nutrition and Forestry,

    Futures Trading Act of 1986, S. Rep. No. 291, 99th Cong., 2d Sess.

    at 21-22 (1986).

    \235\ Id. at 22.

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

    The Commission heeded Congress's recommendation, and the Commission

    issued two 1987 interpretive statements regarding the definition of

    bona fide hedging. The first 1987 interpretative statement clarified

    the meaning of current Sec. 1.3(z)(1).\236\ The Commission interpreted

    the regulatory ``temporary substitute'' criterion \237\ not to be a

    necessary condition for classification of positions as hedging. The

    Commission interpreted the ``incidental test'' \238\ to be a

    ``requirement that the risks that are offset by a futures or option

    hedge must arise from commercial cash market activities.'' The

    Commission also noted bona fide hedges could include balance sheet and

    other trading strategies that are risk reducing, such as ``strategies

    that provide protection equivalent to a put option for an existing

    portfolio of securities.'' \239\

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

    \236\ See, Clarification of Certain Aspect of the Hedging

    Definition, 52 FR 27195, Jul. 20, 1987 (July 1987 Interpretative

    Statement).

    \237\ In current Sec. 1.3(z)(1), the phrase ``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'' has been termed the ``temporary

    substitute criterion.'' (Emphasis added.)

    \238\ In current Sec. 1.3(z)(1), the phrase ``price risks

    incidental to commercial cash or spot operations'' has been termed

    the ``incidental test.''

    \239\ 52 FR at 27197.

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

    The second 1987 interpretative statement provides assistance to an

    exchange who may wish to recognize risk management exemptions from

    exchange speculative position limit rules.\240\ ``The Commission

    note[d] that providing risk management exemptions to commercial

    entities who are typically engaged in buying, selling or holding cash

    market instruments is similar to a provision in the Commission's

    hedging definition, [namely], the risks to be hedged arise in the

    management and conduct of a commercial enterprise.'' \241\ The

    Commission believed that it would be consistent with the objectives of

    section 4a of the Act and Sec. 1.61 [now incorporated as Sec. 150.5]

    for exchange rules to exempt from speculative limits a number of risk

    management positions in debt-based, equity-based and foreign currency

    futures and options.\242\ Those positions included: Unleveraged long

    positions (covered by cash set aside); short calls on securities or

    currencies owned (i.e., covered calls); and long positions in asset

    allocation strategies

    [[Page 75705]]

    covered by hedged debt securities or currencies owned.\243\

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

    \240\ See, Risk Management Exemptions from Speculative Position

    Limits Approved under Commission Regulation 1.61, 52 FR 34633, Sep.

    14, 1987.

    \241\ Id. at 34637.

    \242\ Id. at 34636.

    \243\ Id.

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

    In 1987, the Commission also added an enumerated hedging position

    for spread positions which offset unfixed-price cash sales and unfixed-

    price cash purchases that are priced basis different delivery months in

    a futures contract (that is, floating-price cash purchases coupled with

    floating-price cash sales).\244\ In this regard, the Commission

    extended the cross-commodity hedging provisions to offsets of such

    coupled floating-price cash contracts that were not cash market

    transactions in the same commodity underlying the futures

    contract.\245\

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

    \244\ 52 FR 38914, 38919, Oct. 20, 1987.

    \245\ Id. at 38922.

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

    The Commission adopted federal limits on soybean meal and soybean

    oil futures contracts in 1987, in response to a petition by the Chicago

    Board of Trade.\246\ In the final rule, the Commission noted: ``Crush

    positions allow the processor to determine or fix his processing margin

    in advance and are included within the exemptions permitted for

    anticipatory hedging under Commission Rule 1.3(z)(2).'' \247\

    Specifically, the Commission noted for a crush position established by

    a soybean processor, the short positions in soybean oil and soybean

    meal futures would be permitted to the extent of twelve months unsold

    anticipated production; and the long positions in soybean futures would

    be permitted to the extent of twelve months unfilled anticipated

    requirements. The Commission declined to adopt an exemption for a

    reverse crush position. The Commission stated its belief, based upon

    comments received and its own analysis, ``that there are important

    differences between the crush and reverse crush positions from the

    standpoint of bona fide hedging by soybean processors.'' The results of

    a crush position, plus or minus basis variation, are known once the

    position is established. In contrast, the Commission noted with a

    reverse crush spread position, ``the intended results transpire only

    if, and when, the futures markets reflect the expected or anticipated

    more favorable crushing margin and the position can be lifted.''

    Accordingly, the Commission noted it did not appear appropriate to

    recognize the reverse crush spread position as an enumerated category

    of bona fide hedging.\248\

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

    \246\ Petition for rulemaking of the CBOT, dated July 24, 1986,

    cited in 52 FR 6814, Mar. 5, 1987.

    \247\ 52 FR 38914, 38920, Oct. 20, 1987.

    \248\ Id. The Commission noted at that time that the

    determination of whether a reverse crush position is bona fide

    hedging should be made on a case-by-case basis under Sec. 1.47.

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

    In 2007, the Commission proposed a risk management exemption to

    federal position limits, in addition to the bona fide hedging

    exemption.\249\ A risk management position would have been defined as a

    futures or futures equivalent position held as part of a broadly

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

    equivalent positions, that is based on either tracking a broadly

    diversified index for clients or a portfolio diversification plan that

    included an exposure to a broadly diversified index. In either case,

    the exemption would have been conditioned on the futures positions

    being passively managed, unleveraged, and outside of the spot month.

    The Commission withdrew that proposal in 2008, citing a lack of

    consensus.\250\

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

    \249\ 72 FR 66097, Nov. 27, 2007.

    \250\ 73 FR 32261, Jun. 6, 2008.

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

    In March of 2009, the Commission issued a concept release on

    whether to eliminate the bona fide hedge exemption for certain swap

    dealers and create a new limited risk management exemption from

    speculative position limits.\251\ The Commission explained that,

    beginning in 1991, the Commission had granted bona fide hedge

    exemptions under Sec. 1.47 to a number of swap intermediaries who were

    seeking to manage price risk on their books as a result of their

    serving as counterparties to their swap clients in commodity index swap

    contracts or commodity swap contracts.\252\ The swap clients included

    pension funds and other passive investors who were not using swaps to

    offset risks in the physical marketing channel. In order to protect

    itself from the risks of such swaps, the swap intermediary would

    establish a portfolio of long futures positions in the commodities

    making up the index or the commodity underlying the swap, in such

    amounts as would offset its exposure under the swap transaction. By

    design, the commodity index did not include contract months in the spot

    month. The exemptions did not cover positions carried into the spot

    month. The comments on the March 2009 concept release were about

    equally divided between those who favored eliminating the bona fide

    hedge exemption for swap dealers (or restricting the exemption to

    positions offsetting swap dealers' exposure to traditional commercial

    market users) and those who favored retaining the swap dealer hedge

    exemption in its current form, or some variation thereof.\253\

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

    \251\ 74 FR 12282, Mar. 24, 2009.

    \252\ Id. at 12284.

    \253\ The comments are available for review on the Commission's

    Web site at http://www.cftc.gov/LawRegulation/PublicComments/09-004.

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

    In January of 2010, the Commission proposed an integrated

    speculative position framework for the major energy contracts listed on

    DCMs.\254\ The proposed rules would not have recognized futures and

    option transactions offsetting exposure acquired pursuant to swap

    dealing activity as bona fide hedges. Instead, upon compliance with

    several conditions including reporting and disclosure obligations, the

    proposed regulations would have allowed swap dealers to seek a limited

    exemption from the proposed speculative position limits for the major

    energy contracts.\255\ The proposed framework was withdrawn after

    enactment of the Dodd-Frank Act, which the Commission interprets as

    expanding the range of derivative contracts, beyond contracts listed on

    DCMs, on which the Commission must impose position limits.

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

    \254\ 75 FR 4144, Jan. 26, 2010 (withdrawn 75 FR 50950, Aug. 18,

    2010).

    \255\ 75 FR at 4152.

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

    Since 1974, the Commission has had authority under the Act to

    define the term bona fide hedging position. With the enactment on July

    21, 2010 of the Dodd-Frank Act, section 4a(c)(1) of the Act,\256\

    continues to provide that position limits do not apply to positions

    shown to be bona fide hedging positions as defined by the

    Commission.\257\

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

    \256\ 7 U.S.C. 6a(c)(1).

    \257\ Id. The Dodd-Frank Act did not change the language found

    in prior 7 U.S.C. 6a(c) (2010).

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

    However, Dodd-Frank added section 4a(c)(2) of the Act, which the

    Commission interprets as directing the Commission to narrow the bona

    fide hedging position definition for physical commodities from the

    definition found in current Sec. 1.3(z)(1), as discussed further

    below.\258\ Separately, Dodd-Frank added section 4a(a)(7) of the Act to

    give the Commission plenary authority to grant general exemptive relief

    from the position limit rules.\259\

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

    \258\ See infra discussion of ``temporary substitute test.''

    \259\ Section 4a(a)(7) of the Act provides: ``The Commission, by

    rule, regulation, or order, may exempt, conditionally or

    unconditionally, any person or class of persons, any swap or class

    of swaps, any contract of sale of a commodity for future delivery or

    class of such contracts, any option or class of options, or any

    transaction or class of transactions from any requirement it may

    establish under this section with respect to position limits.'' 7

    U.S.C. 6a(a)(7).

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

    On November 18, 2011, the Commission adopted part 151 to establish

    a position limits regime for

    [[Page 75706]]

    twenty-eight exempt and agricultural commodity futures and options

    contracts and the physical commodity swaps that are economically

    equivalent to such contracts.\260\ In connection with issuing the part

    151 limits, the Commission defined bona fide hedging transactions or

    positions in Sec. 151.5(a) and enumerated eight transactions or

    positions that would constitute bona fide hedging transactions or

    positions and, thus, would be exempt from the part 151 limits.\261\

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

    \260\ See generally 76 FR 71626, Nov. 18, 2011.

    \261\ See 17 CFR 151.5(a)(2)(i)-(viii). The Commission also

    recognized pass-through swaps and pass-through swap offsets as bona

    fide hedging transactions. 17 CFR 151.5(a)(3)-(4).

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

    In addition to the exemptions enumerated in Sec. 151.5(a)(2) and

    (5) provided that, ``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 \262\ or the

    Commission under section 4a(a)(7) of the Act concerning the

    applicability of the bona fide hedging transaction exemption.'' \263\

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

    \262\ Section 140.99 sets out general procedures and

    requirements for requests to Commission staff for exemptive, no-

    action and interpretative letters.

    \263\ 17 CFR Sec. 151.5(a)(5).

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

    On January 20, 2012, the Working Group of Commercial Energy Firms

    (the ``Working Group'') filed a petition pursuant to both section

    4a(a)(7) of the Act and Sec. 151.5(a)(5) (the ``Working Group

    Petition'') \264\ requesting that the Commission ``grant exemptive

    relief for [ten] classes of risk-reducing transactions described [in

    the petition] to the extent that such transactions are not covered by

    [Sec. Sec. ] 151.5(a)(1) or (2) of the Position Limit Rules or, in the

    alternative, clarify that such classes of transactions qualify as `bona

    fide hedging transactions or positions' within the meaning of

    [Sec. Sec. ] 151.5(a)(1) and (2); [(``Requests One-Ten'')] and provide

    exemptive relief regarding the definition of (a) ``spot month'' set

    forth in [Sec. ] 151.3(c) of the Position Limit Rules, and (b)

    ``swaption'' set forth in [Sec. ] 151.1 of the Position Limit Rules

    [(`Other Requests)].'' \265\ In connection with any relief ultimately

    granted as a result of the Petition, the Working Group also requested

    that the Commission ``confirm that any relief granted is generally

    applicable to the entire market.'' \266\

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

    \264\ The Working Group Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/wgbfhpetition012012.pdf. The Working Group supplemented the

    petition in a letter dated April 17, 2012, available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/workinggroupltr041712.pdf. As noted in their submission, the

    Working Group is a diverse group of commercial firms in the energy

    industry whose primary business activity is the physical delivery of

    one or more energy commodities to, among others, industrial,

    commercial and residential consumers. Members of the Working Group

    and their affiliates actively trade futures and swaps and they

    assert that they would be materially impacted by position limit

    rules under part 151.

    \265\ See Working Group Petition at 1.

    \266\ See Working Group Petition at 3. In letters dated March

    1,2012, and March 26, 2012, respectively, a group of three energy

    trade associations (Edison Electric Institute, American Gas

    Association, and Electric Power Supply Association), and the Futures

    Industry Association submitted comments in support of the Working

    Group Petition, available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/eei-aga-epsa_comments.pdf

    and http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/fialtr032612.pdf.

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

    In addition to the Working Group Petition, on March 13, 2012, the

    American Petroleum Institute (``API'') also filed a petition pursuant

    to both section 4a(a)(7) of the Act and Sec. 151.5(a)(5) (the ``API

    Petition'').\267\ The API Petition generally endorsed the Working Group

    petition and requested that the Commission recognize as bona fide

    hedging transactions certain routine energy market transactions that

    are priced at monthly average index prices.\268\ The request in the API

    Petition is essentially a restatement of Requests One through Three of

    the Working Group Petition. The API Petition also requested relief for

    pass-through swaps.

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

    \267\ The API Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/apiltr031312.pdf. As noted in their submission, API is a national

    trade association representing more than 450 oil and natural gas

    companies. Its members transact in physical and financial, exchange-

    traded, and over-the-counter markets primarily to hedge or mitigate

    commercial risks associated with their core business of delivering

    energy to wholesale and retail customers.

    \268\ See API Petition at 1.

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

    Further, the CME Group, on April 26, 2012, filed a petition

    pursuant to section 4a(a)(7) of the Act and Sec. 151.5(a)(5) (the

    ``CME Petition'').\269\ The CME Petition generally requested that the

    Commission recognize as bona fide hedging transactions certain

    purchases by persons engaged in processing, manufacturing or feeding

    that were permitted under Sec. 1.3(z)(2)(ii)(C) during the last five

    trading days in physical-delivery contracts, not to exceed anticipated

    requirements for that month and the next succeeding month. The request

    in the CME Petition is substantively similar to Request Eight of the

    Working Group Petition.

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

    \269\ The CME Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/cmeltr042612.pdf.

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

    With the court's September 28, 2012, order vacating part 151, the

    Commission now re-proposes a definition of bona fide hedging position.

    b. Proposed Definition of Bona Fide Hedging Position

    The Commission proposes to delete Sec. 1.3(z), the current

    definition of ``bona fide hedging transactions or positions,'' and

    replace it with a new definition of ``bona fide hedging position'' in

    Sec. 150.1.\270\ Section 4a(c)(1) of the Act, as added by the Dodd-

    Frank Act, authorizes the Commission to define bona fide hedging

    positions ``consistent with the purposes of this Act.'' \271\ The

    proposed definition of bona fide hedging position builds on the

    Commission's history, both in administering a regulatory exemption to

    federal limits and in providing guidance to exchanges in establishing

    exchange limits, and is grounded for physical commodities on the new

    requirements in section 4a(c)(2) of the Act, as amended by section 737

    of the Dodd-Frank Act in July 2010.\272\

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

    \270\ The proposed definition does not reference

    ``transactions'' because the Commission has not had trading volume

    limits on transactions since 1979. See generally Elimination of

    Daily Speculative trading Limits, 44 FR 7124, Feb. 6, 1979.

    \271\ 7 U.S.C. 6a(c)(1).

    \272\ 7 U.S.C. 6a(c)(2).

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

    Organization. The proposed definition of bona fide hedging position

    is organized into six sections: an opening paragraph with two general

    requirements for all hedges; and five numbered paragraphs (paragraphs

    (1)-(5)). Paragraph (1) of the proposed definition sets forth

    requirements for hedges of an excluded commodity, and incorporates

    guidance on risk management exemptions that may be adopted by an

    exchange.\273\ Paragraph (2) lists requirements for hedges of a

    physical commodity. Paragraphs (3) and (4) list enumerated exemptions.

    Paragraph (5) specifies the requirements for cross-commodity hedges.

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

    \273\ Regarding the definition of bona fide hedging positions in

    excluded commodities, the Commission notes this proposed definition

    also would provide flexibility to exchanges adopting exemptions for

    securities futures contracts consistent with Sec. 41.25(a)(3)(iii).

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

    c. General Requirements for All Bona Fide Hedges--Opening Paragraph

    The opening paragraph of the proposed definition sets forth two

    general requirements for any legitimate hedging position: (i) The

    purpose of the position must be to offset price risks incidental to

    commercial cash operations (the ``incidental test''); and

    [[Page 75707]]

    (ii) the position must be established and liquidated in an orderly

    manner in accordance with sound commercial practices (the ``orderly

    trading requirement''). These general requirements are found in current

    Sec. 1.3(z)(1).\274\

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

    \274\ In relevant part, current Sec. 1.3(z)(1) provides:

    ``Notwithstanding the foregoing, no transaction or position shall be

    classified as bona fide hedging for purposes of section 4a of the

    Act unless their purpose is to offset price risks incidental to

    commercial cash or spot operations and such position are established

    and liquidated in an orderly manner in accordance with sound

    commercial practices and [unless other] provisions [of this

    definition] have been satisfied.'' 17 CFR 1.3(z)(1). The second

    characteristic was contained in vacated Sec. 151.5(a)(1)(v).

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

    Incidental test. Consistent with its prior interpretation of the

    incidental test under Sec. 1.3(z)(1), discussed above, the Commission

    intends the proposed incidental test to be a requirement that the risks

    offset by a commodity derivative contract hedging position must arise

    from commercial cash market activities.\275\ The Commission believes

    this requirement is consistent with the statutory guidance to define

    bona fide hedging positions to permit hedging ``legitimate anticipated

    business needs.'' \276\ In the absence of a requirement for a

    legitimate business need, the Commission believes it would be difficult

    to distinguish between hedging and speculative activities. The

    Commission believes the concept of commercial cash market activities is

    also embodied in the economically appropriate test for physical

    commodities in section 4a(c)(2) of the Act, discussed below. The

    proposed incidental test amends the incidental test in current Sec.

    1.3(z)(1) by clarifying that forward commercial operations may also

    serve as the basis for a bona fide hedging position.\277\ This is

    consistent with the Commission's long-standing recognition of fixed-

    price purchase and fixed-price sales contracts (which may specify

    forward delivery dates) as the basis of certain enumerated hedges in

    current Sec. 1.3(z)(2).

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

    \275\ See, Clarification of Certain Aspect of the Hedging

    Definition, 52 FR 27195, Jul. 20, 1987 (July 1987 interpretative

    statement).

    \276\ 7 U.S.C. 6a(c)(1).

    \277\ The incidental test was not contained in vacated Sec.

    151.5(a)(1). This omission was not discussed in the preambles to the

    proposed or final rule. However, the incidental test was retained in

    amended Sec. 1.3(z)(1) for excluded commodities. 76 FR at 71683.

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

    Orderly trading requirement. The proposed orderly trading

    requirement is intended to impose on bona fide hedgers a duty of

    ordinary care when entering, maintaining and exiting the market in the

    ordinary course of business and in order to avoid as practicable the

    potential for significant market impact in establishing, maintaining or

    liquidating a position in excess of position limitations.\278\ The

    Commission believes the proposed orderly trading requirement is

    consistent with the policy objectives of position limits to diminish,

    eliminate or prevent excessive speculation and to ensure that the price

    discovery function of the underlying market is not disrupted.\279\ The

    Commission believes the orderly trading requirement is particularly

    important since the Commission intends to set the initial levels of

    position limits at the outer bound of the range of levels of position

    limits that may serve to maximize the statutory policy objectives.

    Thus, bona fide hedgers likely would only need an exemption for

    extraordinarily large positions.

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

    \278\ Compare, section 4c(a)(5)(B) of the Act, which makes it

    unlawful for any person to engage in any trading, practice, or

    conduct on or subject to the rules of a registered entity that, for

    example, demonstrates intentional or reckless disregard for the

    orderly execution of transactions during the closing period. 7

    U.S.C. 6c(a)(5)(B). Section 4c(a)(6) of the Act authorizes the

    Commission to promulgate such ``rules and regulations as, in the

    judgment of the Commission, are reasonable necessary to prohibit . .

    . any other trading practice that is disruptive of fair and

    equitable trading.'' 7 U.S.C. 6c(a)(6).

    \279\ See sections 4a(3)(B)(i) and (iv) of the Act. 7 U.S.C.

    6a(3)(B)(i) and (iv).

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

    The Commission believes that negligent trading, practices, or

    conduct should be a sufficient basis for the Commission to disallow a

    bona fide hedging exemption. The Commission believes that an evaluation

    of ``orderly trading'' should be based on the totality of the facts and

    circumstances as of the time the person engaged in the relevant

    trading, practices, or conduct--i.e., the Commission intends to

    consider whether the person knew or should have known, based on the

    information available at the time, he or she was engaging in the

    conduct at issue.

    The Commission proposes to apply its policy regarding orderly

    markets for purposes of the disruptive trading practice prohibitions,

    to its orderly trading requirement for purposes of position limits.

    ``The Commission's policy is that an orderly market may be

    characterized by, among other things, parameters such as a rational

    relationship between consecutive prices, a strong correlation between

    price changes and the volume of trades, levels of volatility that do

    not dramatically reduce liquidity, accurate relationships between the

    price of a derivative and the underlying such as a physical commodity

    or financial instrument, and reasonable spreads between contracts for

    near months and for remote months.'' \280\ Further, in fulfilling their

    duty of ordinary care when entering, maintaining and exiting a

    position, market participants should assess market conditions and

    consider how their trading practices and conduct affect the orderly

    execution of transactions when establishing, maintaining or liquidating

    a position in excess of a speculative position limit.

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

    \280\ See Interpretive Guidance and Policy Statement on

    Antidisruptive Practices Authority, 78 FR 31890, 31895-96 (May 28,

    2013) (available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2013-12365a.pdf).

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

    d. Requirements and Guidance for Hedges in an Excluded Commodity--

    Paragraph (1)

    The proposed definition of bona fide hedging position for contracts

    in an excluded commodity \281\ includes the general requirements in the

    opening paragraph and would require that the position is economically

    appropriate to the reduction of risks in the conduct and management of

    a commercial enterprise (the ``economically appropriate'' test) and is

    either (i) specifically enumerated in paragraphs (3)-(5) of the

    definition of bona fide hedging position; or (ii) recognized as a bona

    fide hedging position by a DCM or SEF consistent with the guidance on

    risk management exemptions in proposed appendix A to part 150.\282\

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

    \281\ ``Excluded commodity'' is defined in section 1a(19) of the

    Act. 7 U.S.C. 1a(19).

    \282\ See the discussion below of proposed Sec. 150.5(b)(5),

    requiring exchange hedge exemptions to exchange limits on contracts

    in an excluded commodity to conform to the definition of bona fide

    hedging position in Sec. 150.1. The Dodd-Frank Act expanded the

    authority of the Commission with respect to core principles

    applicable to exchange traded contracts in an excluded commodity,

    but did not address directly the definition of bona fide hedging

    positions for excluded commodities. The Dodd-Frank Act amended the

    core principles for DCMs and established core principles for SEFs,

    authorizing the Commission, by rule or regulation, to restrict the

    reasonable discretion of the exchange in complying with core

    principles. 7 U.S.C. 7(d)(1)(B) and 7b-3(f)(1)(B).

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

    The economically appropriate test in section 4a(c)(2) of the Act,

    applicable to physical commodities, also should apply to excluded

    commodities because it has long been a fundamental requirement of a

    bona fide hedging position.\283\ Current Sec. 1.3(z)(1) contains the

    economically appropriate test.\284\

    [[Page 75708]]

    The Commission notes that the concept of the reduction of risk was long

    embodied in the statutory concept of ``offset'' prior to 1974.\285\ The

    economically appropriate test is discussed further, below.

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

    \283\ See, e.g., the definition of bona fide hedging promulgated

    by the Commission's predecessor in Sec. 1.3(z) of its regulations

    in 1975. 40 FR 11560, 11561, Mar. 12, 1975 (``Bona fide hedging

    transactions or positions . . . shall mean sales of or short

    positions in any commodity for future delivery . . . ,'' (emphasis

    added)).

    \284\ The Commission adopted this requirement in Sec. 1.3(z)(1)

    in 1977. 42 FR 42748, 42751, Aug. 24, 1977. Prior to that time, the

    concept of economically appropriate to the reduction of risk in the

    operation of a commercial enterprise was not separately articulated,

    but was reflected in the incidental test (``unless their bona fide

    purpose is to offset price risks incidental to commercial cash or

    spot operations'') in Sec. 1.3(z)(1) as amended in 1975. 40 FR

    11560, 11561, Mar. 12, 1975. Current Sec. 150.5(d) provides

    guidance to DCMs that exchange regulations for bona fide hedging

    position exemptions (including exemptions for excluded commodity

    contracts) should be granted in accordance with current Sec.

    1.3(z)(1). 17 CFR 150.5(d) See, for example, Chicago Mercantile

    Exchange Rule 559.A., Bona Fide Hedging Positions, available at

    http://www.cmegroup.com/rulebook/CME/I/5/5.pdf, that provides: ``The

    Market Regulation Department may grant exemptions from position

    limits for bona fide hedge positions as defined by CFTC Regulation

    Sec. 1.3(z)(1). Approved bona fide hedgers may be exempted from

    emergency orders that reduce position limits or restrict trading.''

    \285\ Prior to 1974, section 4a of the Act defined bona fide

    hedging transactions as: ``For the purposes of this paragraph, bona

    fide hedging transactions shall mean sales of any commodity for

    future delivery on or subject to the rules of any board of trade to

    the extent that such sales are offset in quantity by the ownership

    or purchase of the same cash commodity or, conversely, purchases of

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

    board of trade to the extent that such purchases are offset by sales

    of the same cash commodity.'' 7 U.S.C. 6a (1940).

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

    Under the proposed definition, an exchange would be permitted to

    grant an exemption based on its rules that were consistent with the

    enumerated exemptions in paragraphs (3)-(5) of the proposed definition

    of bona fide hedging position. Current Sec. 1.3(z)(1) also requires a

    bona fide hedging position to be either (i) an enumerated exemption in

    current Sec. 1.3(z)(2) or (ii) a non-enumerated exemption under

    current Sec. 1.3(z)(3) (a non-enumerated exemption may be granted

    under current Sec. 1.47 as a risk management exemption). The

    enumerated exemptions in paragraphs (3)-(5) of the proposed definition

    of bona fide hedging position contain all of the enumerated exemptions

    in current Sec. 1.3(z)(2). The specifically enumerated exemptions also

    are discussed separately, below.

    The Commission is proposing to incorporate as guidance in appendix

    A to part 150 the concepts in the 1987 risk management exemptions

    interpretative statement.\286\ The Commission believes that it would be

    consistent with the objectives of section 4a of the Act for exchange

    rules to exempt from speculative limits a number of risk management

    positions in commodity derivative contracts in an excluded commodity.

    Such risk management exemption positions would include, but not be

    limited to, three types of exemptions for: (i) Unleveraged long

    positions (covered by cash set aside); (ii) short calls on securities

    or currencies owned (i.e., covered calls); and (iii) long positions in

    asset allocation strategies covered by hedged debt securities or

    currencies owned (i.e., unleveraged synthetic positions).\287\ The

    Commission is proposing to withdraw the 1987 risk management exemption

    interpretative statement in light of incorporating its concepts in

    proposed appendix A to part 150, thus rendering that interpretative

    statement redundant. The Commission requests comment on all aspects of

    proposed appendix A to part 150.

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

    \286\ 52 FR 34633, Sep. 14, 1987.

    \287\ Id. at 34626.

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

    In addition, under the proposed guidance for excluded commodities

    and as is currently the case, there need not be any temporary

    substitute test for a bona fide hedging position in an excluded

    commodity. This is consistent with the Commission's July 1987

    interpretative statement that the temporary substitute component need

    not apply to a bona fide hedging position in an excluded

    commodity.\288\

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

    \288\ 52 FR 27195, Jul. 20, 1987 (July 1987 Interpretative

    Statement). See also House of Representatives Committee Report

    quoted at 52 FR 34633, 34634, September 14, 1987, regarding

    ``futures positions taken as alternatives rather than temporary

    substitutes for cash market positions.'' H.R. Rep No. 624, 99th

    Cong., 2d Sess. 1, 45-46 (1986). However, the Commission is

    proposing to withdraw the July 1987 Interpretative Statement, since

    the temporary substitute test was added by the Dodd-Frank Act as a

    statutory requirement for a bona fide hedging position in a physical

    commodity. 7 U.S.C. 4a(c)(2)(A)(i).

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

    e. Requirements for Hedges in a Physical Commodity--Paragraph (2)

    The Commission is proposing to implement the statutory directive of

    section 4a(c)(2) of the Act in paragraph (2) of the proposed definition

    of bona fide hedging position under Sec. 150.1. The proposed

    definition for physical commodities would also include the general

    requirements of the opening paragraph, as is the case under current

    Sec. 1.3(z)(1) and as discussed above.

    Section 4a(c)(2) of the Act directs the Commission to define what

    constitutes a bona fide hedging position for futures and option

    contracts on physical commodities listed by DCMs.\289\ The Commission

    proposes to apply the same definition to (i) swaps that are

    economically equivalent to futures contracts and (ii) direct-access

    linked FBOT futures contracts that are economically equivalent to

    futures contracts listed by DCMs.\290\ Applying the same definition to

    economically equivalent contracts would promote administrative

    efficiency. Applying the same definition to economically equivalent

    contracts also is consistent with congressional intent as embodied in

    the expansion of the Commission's authority to apply position limits to

    swaps (i.e., those that are economically equivalent to futures and

    swaps that serve a significant price discovery function) and to direct-

    access linked FBOT contracts.\291\

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

    \289\ 7 U.S.C. 6a(c)(2).

    \290\ This is consistent with the approach the Commission took

    in vacated Sec. 151.5. 76 FR 71643 n.168.

    \291\ 7 U.S.C. 6a(a)(5)-(6).

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

    Paragraph (2)(i) of the proposed definition would recognize as bona

    fide a position in a commodity derivative contract that (i) represents

    a substitute for positions taken or to be taken at a later time in the

    physical marketing channel (i.e., the ``temporary substitute'' test);

    (ii) is economically appropriate to the reduction of risks (i.e., the

    ``economically appropriate'' test); and (iii) arises from the potential

    change in value of assets, liabilities or services (i.e., the ``change

    in value'' requirement), provided the position is enumerated in

    paragraphs (3) through (5) of the definition, as discussed below. This

    subparagraph would incorporate the provisions of section 4a(c)(2)(A) of

    the Act for futures and option contracts and also would include the

    provisions of section 4a(c)(2)(B)(ii) of the Act, regarding swaps, by

    using the term commodity derivative contracts, which includes swaps,

    futures and futures option contracts.

    Temporary substitute test. The temporary substitute test requires

    that a bona fide hedging position must represent ``a substitute for . .

    . positions taken or to be taken at a later time in a physical

    marketing channel.'' \292\ Paragraph (2)(i) of the proposed definition

    incorporates the temporary substitute test of section 4a(c)(2)(A)(i) of

    the Act. The express language of section 4a(c)(2)(A)(i) of the Act

    requires the temporary substitute test to be a necessary condition for

    classification of positions in physical commodities as bona fide

    hedging positions. Section 4a(c)(2)(A) of the Act incorporates many

    aspects of the general definition of bona fide hedging in current Sec.

    1.3(z)(1). However, there are significant differences. Section

    4a(c)(2)(A)(i) of the Act does not include the adverb ``normally'' to

    modify the verb ``represents'' in the phrase ``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

    [[Page 75709]]

    channel.'' \293\ In addition, Congress provided explicit requirements

    for recognizing swaps as bona fide hedging positions in section

    4a(c)(2)(B), recognizing positions that reduce either the risk of swaps

    that meet the requirements of section 4a(c)(2)(A) of the Act or swaps

    that are executed opposite a counterparty whose transaction would

    qualify as bona fide under section 4a(c)(2)(A) of the Act. The

    statutory requirements are more stringent than the conditions for swap

    risk management exemptions the Commission previously granted under

    Sec. 1.3(z)(3) and Sec. 1.47. As discussed above, the Commission

    granted risk management exemptions for persons to offset the risk of

    swaps that did not represent substitutes for transactions or positions

    in a physical marketing channel, neither by the intermediary nor the

    counterparty. Thus, positions that reduce the risk of such speculative

    swaps would no longer meet the requirements for a bona fide hedging

    transaction or position under the new statutory criteria.

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

    \292\ 7 U.S.C. 6a(c)(2)(A)(i).

    \293\ In contrast and as noted above, in current Sec.

    1.3(z)(1), the phrase ``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'' has been termed the ``temporary substitute'' criterion.

    (Emphasis added.)

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

    Economically appropriate test. Paragraph (2)(A)(ii) of the proposed

    definition incorporates the economically appropriate test of section

    4a(c)(2)(A)(ii) of the Act. This statutory provision mirrors the

    provisions in current Sec. 1.3(z)(1). The Commission has provided

    interpretations and guidance over the years as to the meaning of

    ``economically appropriate'' in current Sec. 1.3(z)(1). For example,

    the Commission has indicated that hedges of processing margins by a

    processor, such as a soybean processor that establishes long positions

    in the soybean contract and short positions in the soybean meal contact

    and the soybean oil contract, may be economically appropriate.\294\

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

    \294\ 52 FR 38914, 38920, Oct. 20, 1987.

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

    By way of example, a manufacturer may anticipate using a commodity

    that it does not own as an input to its manufacturing process; however,

    the manufacturer expects to change output prices to offset

    substantially a change in price of the input commodity. For example,

    processing by a soybean crush operation or a fuel blending operation

    may add relatively little value to the price of the input commodity. In

    such circumstances, it would be economically appropriate for the

    processor to offset the price risks of both the unfilled anticipated

    requirement for the input commodity and the unsold anticipated

    production; such a hedge would, for example, fully lock in the value of

    soybean crush processing. Alternatively, a processor may wish to

    establish a calendar month hedge solely in terms of the input

    commodity, to offset the price risk of the anticipated input commodity

    and to cross-commodity hedge the unsold anticipated production. In such

    an alternative, a processor has hedged the commercial enterprise's

    exposure to the value of the input commodity at the expected time of

    acquisition and to the input commodity's value component of the

    processed commodity at the expected later time of production and sale.

    Unfilled anticipated requirements, unsold anticipated production and

    cross-commodity hedging are also discussed as enumerated hedges, below.

    The Commission affirms that gross hedging may be appropriate under

    certain circumstances, when net cash positions do not measure total

    risk exposure due to differences in the timing of cash commitments, the

    location of stocks, and differences in grades or types of the cash

    commodity being hedged.\295\ By way of example, a merchant may have

    sold a certain quantity of a commodity for deferred delivery in the

    current year (i.e., a fixed-price cash sales contract) and purchased

    that same quantity of that same commodity for deferred receipt in the

    next year (i.e., a fixed-price cash purchase contract). Such a merchant

    would be exposed to value risks in the two cash contracts arising from

    different delivery periods (that is, from a timing difference). Thus,

    although the merchant has bought and sold the same quantity of the same

    commodity, the merchant may elect to offset the price risk arising from

    the cash purchase contract separately from the price risk arising from

    the cash sales contract, with each offsetting commodity derivative

    contract regarded as a bona fide hedging position. However, if such a

    merchant were to offset only the cash purchase contract, but not the

    cash sales contract (or vice versa), then it reasonably would appear

    the offsetting commodity derivative contract would result in an

    increased value exposure of the enterprise (that is, the risk of

    changes in the value of the cash commodity contract that was not offset

    is likely to be higher than the risk of changes in the value of the

    calendar spread difference between the nearby and deferred delivery

    period) and, so, the commodity derivative contract would not qualify as

    a bona fide hedging position.

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

    \295\ 42 FR 14832, 14834, Mar. 16, 1977.

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

    In order for a position to be economically appropriate to the

    reduction of risks in the conduct and management of a commercial

    enterprise, the enterprise generally should take into account all

    inventory or products that the enterprise owns or controls, or has

    contracted for purchase or sale at a fixed price. For purposes of

    reporting cash market positions under current part 19, the Commission

    historically has allowed a reporting trader to ``exclude certain

    products or byproducts in determining his cash positions for bona fide

    hedging'' if it is ``the regular business practice of the reporting

    trader'' to do so.\296\ The Commission has determined to clarify the

    meaning of ``economically appropriate'' in light of this reporting

    exclusion of certain cash positions.

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

    \296\ See current Sec. 19.00(b)(1) (providing that ``[i]f the

    regular business practice of the reporting trader is to exclude

    certain products or byproducts in determining his cash position for

    bona fide hedging . . . , the same shall be excluded in the

    report''). 17 CFR 19.00(b)(1).

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

    Originally, the Commission intended for the optional part 19

    reporting exclusion to cover only cash positions that were not capable

    of being delivered under the terms of any derivative contract.\297\ The

    Commission differentiated between ``products and byproducts'' of a

    commodity and the underlying commodity itself, the former capable of

    exclusion from part 19 reporting under normal business practices due to

    the absence of any derivative contract in such product or

    byproduct.\298\ This intention ultimately evolved to allow cross-

    commodity hedging of products and byproducts of a commodity that were

    not necessarily deliverable under the terms of any derivative

    contract.\299\

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

    \297\ 43 FR 45825, 45827, Oct. 4, 1978 (explaining that the

    allowance for eggs not kept in cold storage to be excluded from

    reporting a cash position in eggs under part 19 ``was appropriate

    when the only futures contract being traded in fresh shell eggs

    required delivery from cold storage warehouses.'').

    \298\ See id. Prior to the Commission's revision of the part 19

    reporting exclusion for eggs, the exclusion allowed ``eggs not in

    cold storage or certain egg products'' not to be reported as a cash

    position. 26 FR 2971, Apr. 7, 1961 (emphasis added). Additionally,

    the title to the revised exclusion read, ``Excluding products or

    byproducts of the cash commodity hedged.'' See 43 FR 45825, 45828

    (Oct. 4, 1978). So, in addition to a commodity itself that was not

    deliverable under any derivative contract, the Commission also

    recognized a separate class of ``products and byproducts'' that

    resulted from the processing of a commodity that it did not believe

    at the time were capable of being hedged by any derivative contract

    for purposes of a bona fide hedge.

    \299\ See 42 FR 42748, Aug. 24, 1977. Cross-commodity hedging is

    discussed as an enumerated hedge, below.

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

    [[Page 75710]]

    The instructions to current Form 204 go a step further than current

    Sec. 19.00(b)(1) by allowing for a reporting trader to exclude

    ``certain source commodities, products, or byproducts in determining [

    ] cash positions for bona fide hedging.'' (Emphasis added.) In line

    with its historical approach to the reporting exclusion, the Commission

    does not believe that it would be economically appropriate to exclude

    large quantities of a source commodity held in inventory when an

    enterprise is calculating its value at risk to a source commodity and

    it intends to establish a long derivatives position as a hedge of

    unfilled anticipated requirements. As explained in the revisions to

    part 19, discussed below, a source commodity itself can only be

    excluded from a calculation of a cash position if the amount is de

    minimis, impractical to account for, and/or on the opposite side of the

    market from the market participant's hedging position.

    Change in value requirement. Paragraph (2)(A)(iii) of the proposed

    definition incorporates the potential change in value requirement of

    section 4a(c)(2)(A)(iii) of the Act. This statutory provision largely

    mirrors the provisions in current Sec. 1.3(z)(1).\300\ The Commission

    notes that it uses the term ``price risk'' to mean a ``potential change

    in value.'' To satisfy the change in value requirement, the purpose of

    a bona fide hedge must be to offset price risks incidental to a

    commercial enterprise's cash operations. The change in value

    requirement is embedded in the concept of offset of price risks.

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

    \300\ Compare 7 U.S.C. 6a(c)(2)(A)(iii) and 17 CFR 1.3(z)(1).

    Note that Sec. 1.3(z)(1)(ii) uses the phrase ``liabilities which a

    person owes or anticipate incurring,'' while section

    4a(c)(2)(A)(iii)(II) uses the phrase ``liabilities that a person

    owns or anticipates incurring.'' (Emphasis added.) The Commission

    interprets the word ``owns'' to be an error and the word ``owes'' to

    be correct.

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

    Pass-through Swaps and Offsets. Subparagraph (2)(B) of the proposed

    definition would recognize as bona fide a commodity derivative contract

    that reduces the risk of a position resulting from a swap executed

    opposite a counterparty for which the position at the time of the

    transaction would qualify as a bona fide hedging position under

    subparagraph (2)(A). This provision generally mirrors the provisions of

    section 4a(c)(2)(B)(i) of the Act,\301\ and clarifies that the swap

    itself is also a bona fide hedging position to the extent it is offset.

    However, the Commission is proposing that it will not recognize as bona

    fide hedges the offset of such swaps with physical-delivery contracts

    during the lesser of the last five days of trading or the time period

    for the spot month in such physical-delivery commodity derivative

    contract (the ``five-day'' rule).

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

    \301\ The Commission interprets the statutory provision that

    requires that ``the transaction would qualify as a bona fide hedging

    transaction'' to mean the swap position at the time of the

    transaction would qualify as a bona fide hedging position. 7 U.S.C.

    6a(c)(2)(B)(i).

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

    The Commission is proposing to use its exemptive authority under

    section 4a(a)(7) of the Act to net positions in futures, futures

    options, economically equivalent swaps and direct-access linked FBOT

    contracts in the same referenced contract for purposes of single month

    and all-months-combined limits under proposed Sec. 150.2, discussed

    below.\302\ Thus, a pass-through swap exemption would not be necessary

    for a swap portfolio in referenced contracts that would automatically

    be netted with futures and futures options in the same referenced

    contract outside of the spot month under the proposed rules. The

    Commission historically has permitted non-enumerated risk management

    positions under Sec. 1.3(z)(3) and Sec. 1.47. Almost all exemptions

    historically requested and granted under these provisions were for risk

    management of swap positions related to the agricultural commodities

    subject to federal position limits under part 150.

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

    \302\ This is consistent with netting permitted in vacated Sec.

    151.4(b) of swaps with futures for purposes of single-month and all-

    months-combined limits. The Commission noted in that final

    rulemaking that it did ``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.'' 76 FR at 71644.

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

    As noted above, the proposed rule would impose a five-day rule

    during the spot-month. In the risk management exemptions for swaps

    issued to date by the Commission under current Sec. 1.3(z)(3) and

    Sec. 1.47, the exemptions for swap offsets did not run to the spot

    month. As discussed above, the Commission has long imposed a five-day

    rule in current Sec. 1.3(z)(2) for other exemptions. For example, for

    hedges of unfilled anticipated requirements, the Commission observed

    that historically there was a low utilization of this provision in

    terms of actual positions acquired in the futures market.\303\ For

    cross-commodity and short anticipatory hedge positions, the Commission

    did not believe that persons who do not possess or do not have a

    commercial need for the commodity for future delivery will normally

    wish to participate in the delivery process.\304\ In the instant cases

    of swaps, the Commission has observed generally low usage among all

    traders of the physical-delivery futures contract during the spot

    month, relative to the existing exchange spot-month position

    limits.\305\ The Commission invites comments as to the extent to which

    traders actually have offset the risk of swaps during the spot month in

    a physical-delivery futures contract with a position in excess of an

    exchange's spot-month position limit.

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

    \303\ 42 FR 42748, Aug. 24, 1977.

    \304\ Id. 42749.

    \305\ Compare 76 FR at 71690. Vacated Sec. 151.5(a)(2)(3)

    recognized a pass-through swap offset during the spot period as an

    exception to the five-day rule if the ``pass-through swap position

    continues to offset the cash market commodity price risk of the bona

    fide hedging counterparty.'' Based on a review of open positions in

    physical-delivery futures contracts, the Commission no longer

    believes it necessary to recognize offsets of swaps in the last few

    days of the expiring physical-delivery contract and has not provided

    this additional provision in the current proposal. Rather, the

    Commission has decided to forego this exception to the five-day rule

    in the interest of ensuring that the price discovery function of the

    underlying market is not disrupted during the last few days of the

    spot period. Further, the Commission believes it would have been

    administratively burdensome for a trader to demonstrate that its

    counterparty continued to have a bona fide hedging need through the

    spot period.

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

    The Commission has reviewed its historical policy position

    regarding the five-day rule for speculative limits in the spot month in

    light of position information, including positions in physical-delivery

    energy futures contracts.\306\ For example, the Commission reviewed

    three years of confidential large trader data in cash-settled and

    physical-delivery energy contracts. The review covered actual positions

    held in the physical-delivery energy futures markets during the three-

    day spot period, among all traders (including those who had received

    hedge exemptions from their DCM). It showed that, historically, there

    have been relatively few positions held in excess (and those few not

    greatly in excess) of the spot month limits. Accordingly, the

    Commission generally is not inclined to change its long-held policy

    views regarding physical-

    [[Page 75711]]

    delivery futures contracts at this time.\307\

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

    \306\ The Commission also relies upon the congressional shift

    evidenced in the Dodd-Frank Act amendments to the CEA, that directed

    the Commission, to the maximum extent practicable, in its

    discretion, (i) to diminish, eliminate, or prevent excessive

    speculation, (ii) to deter and prevent market manipulation,

    squeezes, and corners, (iii) to ensure sufficient market liquidity

    for bona fide hedgers, and (iv) to ensure that the price discovery

    function of the underlying market is not disrupted. 7 U.S.C.

    6a(a)(3)(B). The five-day rule would serve to prevent excessive

    speculation as a physical-delivery contract nears expiration,

    thereby deterring or preventing types of market manipulations such

    as squeezes and corners and protecting the price discovery function

    of the market. The restriction of the five-day rule does not appear

    to deprive the market of sufficient liquidity for bona fide hedgers.

    \307\ Nevertheless, the Commission requests comment on whether

    the five-day rule should be waived for pass-through swaps and

    offsets in the event a position of the bona fide counterparty in the

    physical-delivery futures contract would have been recognized as a

    bona fide hedging position. If so, should a person be required to

    document the continuing bona fides of the counterparty to such swaps

    through the spot period, that is, in addition to the time of the

    transaction? Further, should a person also be required to have an

    unfixed-price forward contract with the bona fide counterparty, so

    that a person would have a bona fide need and ability to make or

    take delivery on the physical-delivery futures contract, analogous

    to the agent provisions in proposed paragraph (3)(iv) of the

    definition of bona fide hedging position?

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

    The Commission typically does not publish ``general statistical

    information'' \308\ regarding large trader positions in the expiring

    physical-delivery energy futures contracts because of concerns that

    such data may reveal information about the amount of market power a

    person may need to ``mark the close'' \309\ or otherwise manipulate the

    price of an expiring contract.\310\

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

    \308\ As authorized by CEA section 8(a)(1). 7 U.S.C. 12(a)(1).

    \309\ Marking the close refers to, among other things, the

    practice of acquiring a substantial position leading up to the

    closing period of trading in a futures contract, followed by

    offsetting the position before the end of the close of trading, in

    an attempt to manipulate prices in the closing period.

    \310\ The Commission gathers large trader position reports on

    reportable traders in futures under part 17 of the Commission's

    rules. That data has historically remained confidential pursuant to

    CEA section 8. The Commission does, however, publish summary

    statistics for all-months-combined in its Commitments of Traders

    Report, available on http://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm.

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

    f. Trade Option Exemption

    The Commission previously amended part 32 of its regulations to

    allow commodity options to trade subject to the same rules applicable

    to any other swap, unless the commodity option qualifies under the new

    Sec. 32.3 trade option exemption.\311\ In order to qualify for the

    trade option exemption, (i) both offeror and offeree must be a

    producer, processor, or commercial user of, or merchant handling the

    commodity that is the subject of the commodity option transaction, or

    the products or byproducts thereof, and both offeror and offeree must

    be offering or entering into the commodity option transaction solely

    for purposes related to their business as such,\312\ and (ii) the

    option is intended to be physically settled such that, if exercised,

    the commodity option would result in the sale of an exempt or

    agricultural commodity for immediate or deferred shipment or

    delivery.\313\ Qualifying trade options are exempt from all

    requirements of the CEA and Commission's regulations, except for

    certain enumerated provisions, including position limits.\314\

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

    \311\ See 17 CFR 32.2; Commodity Options, 77 FR 25320 (Apr. 27,

    2012).

    \312\ Additionally, the offeror can be an eligible contract

    participant (``ECP'') as defined in CEA section 1a(18).

    \313\ The Commission noted in the preamble to the trade option

    exemption that in determining delivery intent, market participants

    could refer to the guidance provided for the forward contract

    exclusion in the Product Definition rulemaking. See 77 FR at 25326.

    This guidance conveyed that the Commission's ``Brent

    Interpretation'' is equally applicable to the forward exclusion from

    the swap definition as it was to the forward exclusion from the

    ``future delivery'' definition, which allows for subsequently,

    separately negotiated book-out transactions to qualify for the

    forward contract exclusion. See 77 FR 48208, 48228, Aug. 13, 2012

    (citing Statutory Interpretation Concerning Forward Transactions, 55

    FR 39188, Sep. 25, 1990).

    \314\ See 17 CFR 32.3(b)-(d).

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

    The Commission is making conforming changes to the trade option

    exemption requirement that position limits still apply. Under Sec.

    32.3(c)(2), ``Part 151 (Position Limits)'' of the Commission's

    regulations applies to every counterparty to a trade option ``to the

    same extent that [part 151] would apply to such person in connection

    with any other swap.'' The Commission is replacing the reference to

    ``Part 151,'' now vacated, with ``Part 150'' to clarify that the

    position limit requirements proposed herein still would be applicable

    to trade options qualifying under the exemption.

    The Commission also is requesting comment as to whether the

    Commission should use its exemptive authority under CEA section

    4a(a)(7) \315\ to provide that the offeree of a commodity option

    qualifying for the trade option exemption would be presumed to be a

    ``pass-through swap counterparty'' for purposes of the offeror of the

    trade option qualifying for the pass-through swap offset.\316\ Although

    the Commission is proposing generally to net futures and swaps in

    reference contracts in the same commodity under proposed Sec. 150.2,

    as discussed below, the Commission notes that cross-commodity offsets

    of pass-through swaps would not be recognized unless the counterparty

    to the swap is a bona fide hedger. Would this presumption help offerors

    determine the appropriateness of carrying out cross-commodity hedge

    transactions?

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

    \315\ 7 U.S.C. 6a(a)(7).

    \316\ See the proposed Sec. 150.1 definition of ``bona fide

    hedge exemption'' at paragraph (2)(ii).

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

    In addition, the Commission requests comments on whether adopting

    such a presumption might allow use of the exemption to evade Commission

    rules pertaining to swap transactions. Should the Commission adopt an

    anti-evasion provision to address this concern? Furthermore, might some

    additional safeguards be included to allow the Commission to provide

    administrative simplicity through use of the presumption, while also

    limiting use of the presumption to evade other regulations?

    Further, the Commission requests comment on whether it would be

    appropriate to exclude trade options from the definition of referenced

    contracts and, thus, to exempt trade options from the proposed position

    limits. If trade options were excluded from the definition of reference

    contracts, then commodity derivative contracts that offset the risk of

    trade options would not automatically be netted with such trade options

    for purposes of non-spot month position limits. The Commission notes

    that forward contracts are not subject to the proposed position limits;

    however, certain forward contracts may serve as the basis of a bona

    fide hedging position exemption, e.g., an enumerated bona fide hedging

    position exemption is available for the offset of the risk of a fixed

    price forward contract with a short futures position. Should the

    Commission include trade options as one of the enumerated exemptions

    (e.g., proposed paragraphs (3)(ii) and (iii) of the definition of bona

    fide hedging position under proposed Sec. 150.1)? As an alternative to

    excluding trade options from the definition of referenced contract,

    should the Commission provide an exemption under CEA section 4a(a)(7)

    that permits the offeree or offeror to submit a notice filing to

    exclude their trade options from position limits? If so, why and under

    what circumstances? Are there any other characteristics of trade

    options or the parties to trade options that the Commission should

    consider? Would any of these alternatives permit commodity options that

    should be regulated as swaps to circumvent the protections established

    in the Dodd-Frank Act for the forward contract exclusion for non-

    financial commodities?

    g. Enumerated Hedges--Paragraphs (3)-(5).

    Proposed paragraph (1)(i) would require a bona fide hedging

    position in an excluded commodity to be enumerated under paragraphs

    (3), (4), or (5) of the definition or to be granted an exemption under

    exchange rules consistent with the risk management guidance of appendix

    A to part 150. Proposed paragraph (2)(i)(D) would require a bona fide

    hedging position in

    [[Page 75712]]

    a physical commodity to be enumerated under paragraphs (3), (4), or (5)

    of the definition. The Commission has historically enumerated

    acceptable bona fide hedging positions in Sec. 1.3(z)(2) for physical

    commodities. Each of the enumerated provisions is discussed below. For

    convenience, the Commission is providing a summary comparison of the

    various provisions of the proposed rule, vacated part 151, and current

    rules, in Table 4 below.

    Table 4--Proposed, Current, and Vacated Enumerated Bona Fide Hedges

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

    Paragraph in proposed

    definition of bona fide

    Cash position underlying bona hedging position under Current Sec. 1.3(z) Vacated part 151

    fide hedging position Sec. 150.1 and related and related provisions definition

    provisions

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

    Inventory and fixed-price cash (3)(i)................... 1.3(z)(2)(i)(A)......... 151.5(a)(2)(i)(A).

    commodity purchase contracts.

    Fixed-price cash commodity sales (3)(ii).................. 1.3(z)(2)(ii)(A) and (B) 151.5(a)(2)(ii)(A) and

    contracts. (B).

    Unfilled anticipated requirements (3)(C)(i)................ 1.3(z)(2)(ii)(C)........ 151.5(a)(2)(ii)(C).

    for same cash commodity.

    Unfilled anticipated requirements (3)(C)(ii)............... N/A..................... N/A.

    for resale by a utility.

    Hedges by agents................. (3)(iv).................. 1.3(z)(3)............... 151.5(a)(2)(iv).

    Discussed as example of

    non-enumerated hedge.

    Unsold anticipated production.... (4)(i)................... 1.3(z)(2)(i)(B)......... 151.5(a)(2)(i)(B).

    Offsetting unfixed-price cash (4)(ii).................. 1.3(z)(2)(iii).......... 151.5(a)(2)(iii).

    commodity sales and purchases. Scope expanded in

    comparison to part 151.

    Anticipated royalties............ (4)(iii)................. N/A..................... 151.5(a)(2)(vi).

    Scope reduced in

    comparison to part 151

    to ownership of

    royalties.

    Services......................... (4)(iv).................. N/A..................... 151.5(a)(2)(vii).

    Cross-commodity hedges........... (5)...................... 1.3(z)(2)(iv)........... 151.5(a)(2)(viii).

    Scope expanded to permit

    cross-hedge of pass-

    through swap in

    comparison to part 151.

    Pass-through swap offset......... (2)(ii)(A)............... 1.3(z)(3) and 1.47...... 151.5(a)(3).

    Non-enumerated exemption

    for futures used in

    risk management of

    swaps.

    Pass-through swap................ (2)(ii)(B)............... N/A, as not subject to 151.5(a)(4).

    current federal limits.

    Non-enumerated hedges............ 150.3(e)................. 1.3(z)(3) and 1.47...... 151.5(a)(5).

    Filing for anticipatory hedges... 150.7.................... 1.3(z) and 1.48......... 151.5(d).

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

    N/A denotes not applicable.

    For clarity, the proposed definition uses the terms long positions

    and short positions in commodity derivative contracts as those terms

    are proposed to be defined, rather than the terms purchases or sales of

    any commodity for future delivery, used in current Sec. 1.3(z)(2).

    These clarifications are for two reasons. First, the proposed

    definition only addresses bona fide hedging positions, and does not

    address bona fide hedging transactions. Although the language of

    current Sec. 1.3(z)(2) was written to address purchase or sales

    transactions, the Commission eliminated daily speculative trading

    volume limits in 1979, as noted above.\317\ The Commission and its

    predecessor has long interpreted the terms sales or purchases of

    futures contracts in Sec. 1.3(z)(2) to mean short or long positions in

    futures contracts in the context of position limits.\318\ Second, the

    proposed definition would be applicable to positions in commodity

    derivative contracts (i.e., futures, options thereon, swaps and direct-

    access linked FBOT contracts) rather than only to futures and options

    contracts. As noted above, the Commission preliminarily believes it

    appropriate to apply the same definition of bona fide hedging positions

    to all physical commodity derivative contracts subject to federal

    limits.

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

    \317\ 44 FR 7124, Feb. 6, 1979.

    \318\ The statutory definition of bona fide hedging in section

    4a(3) of the Act (prior to the CFTC Act of 1974) used the terms

    ``sales of any commodity for future delivery . . . to the extent

    that such sales are offset in quantity by the ownership or purchase

    of the same cash commodity'' and ``purchases of any commodity for

    future delivery . . . to the extent that such purchases are offset

    by sales of the same cash commodity.'' 7 U.S.C. 6a(3) (1940).

    Following enactment of the CFTC Act, the Secretary of Agriculture's

    initial proposed definition of bona fide hedging transactions or

    positions makes clear this understanding, as that definition

    provided, in relevant part, for ``sales of, or short positions in

    any commodity for future delivery . . . to the extent that such

    sales or short positions are offset in quantity by the ownership or

    fixed-price purchase of the same cash commodity'' and for

    ``purchases of, or long positions in, any commodity for future

    delivery . . . to the extent that such purchases or long positions

    are offset by fixed-price sales of the same cash commodity. . . .''

    39 FR 39731, Nov. 11, 1974. The Commission adopted that same

    language in its initial definition of bona fide hedging transactions

    or positions. 40 FR 48688, 48689, Oct. 17, 1975. In both the

    proposed and final rules in 1977, the Commission was silent as to

    why it omitted the clarifying phrases ``long positions'' and ``short

    positions.'' Proposed Rule, 42 FR 14832, Mar. 16, 1977; Final Rule,

    42 FR 42748, Aug. 24, 1977.

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

    The Commission notes that DCMs and SEFs may impose additional

    conditions on holders of positions in commodity derivative contracts,

    particularly in the spot month. The Commission has long relied on the

    DCMs to protect the integrity of the exchange's delivery process in

    physical-delivery contracts. Congress recognizes this obligation,

    including in core principle 5, which

    [[Page 75713]]

    requires DCMs to consider position limitations or position

    accountability for speculators to reduce the potential threat of market

    manipulation or congestion, especially during trading in the delivery

    month.\319\ Exchanges will typically impose on large short position

    holders in a physical-delivery contract a continuing obligation to

    compare cash market and futures market prices in the spot month and to

    liquidate the derivative position (i.e., buy back the short position)

    if the commodity may be sold at a more favorable (higher) price in the

    cash market. Further, exchanges will typically impose on large long

    position holders in a physical-delivery contract a continuing

    obligation to compare cash market and futures market prices in the spot

    month and to liquidate the derivative position (i.e., sell the long

    position) if the commodity may be purchased at a more favorable (lower)

    price in the cash market. Exchanges can continue these practices under

    the proposed rule.

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

    \319\ 7 U.S.C. 7(d)(5).

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

    (1) Exemption-by-Exemption Discussion

    Inventory and cash commodity purchase contracts--paragraph (3)(A).

    Inventory and fixed-price cash commodity purchase contracts have long

    served as the basis of a bona fide hedging position.\320\ This

    provision is in current Sec. 1.3(z)(2)(i)(A). A commercial enterprise

    is exposed to price risk if it has (i) obtained inventory in the normal

    course of business or (ii) entered into a fixed-price purchase

    contract, whether spot or forward, calling for delivery in the physical

    marketing channel of a commodity; and has not offset that price risk.

    For example, an enterprise may offset such price risk in the cash

    market by entry into fixed-price sales contracts. An appropriate hedge

    of inventory or a fixed-price purchase contract would be to establish a

    short position in a commodity derivative contract to offset the risk of

    such position. Such short position may be held into the spot month in a

    physical-delivery contract if economically appropriate.\321\

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

    \320\ See, e.g., 7 U.S.C 6a(3) (1970). That statutory definition

    of bona fide hedging included ``sales of, or short positions in, any

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

    contract market made or held by such person to the extent that such

    sales or short positions are offset in quantity by the ownership or

    purchase of the same cash commodity by the same person.''

    \321\ For example, it would not appear to be economically

    appropriate to hold a short position in the spot month of a

    commodity derivative contract against fixed-price purchase contracts

    that provide for deferred delivery in comparison to the delivery

    period for the spot month commodity derivative contract. This is

    because the commodity under the cash contract would not be available

    for delivery on the commodity derivative contract.

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

    A person can use a commodity derivative contract to hedge

    inventories of a cash commodity that is deliverable on that physical-

    delivery contract. Such a deliverable cash commodity inventory need not

    be in a delivery location. However, the Commission notes that a DCM or

    SEF may prudentially require such short positions holders to

    demonstrate the ability to move the commodity into a deliverable

    location, particularly during the spot month.\322\

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

    \322\ Further, the Commission notes an exchange, pursuant to its

    position accountability rules, may at any time direct a trader that

    is in excess of accountability levels to reduce a position in a

    contract traded on that exchange.

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

    Once inventory has been sold, a person is permitted a commercially

    reasonable time period, as necessary to exit the market in an orderly

    manner, to liquidate a position in commodity derivative contracts in

    excess of a position limit. Generally, the Commission believes such

    time period would be less than one business day.

    Cash commodity sales contracts--paragraph (3)(B). Fixed-price cash

    commodity sales have long served as the basis of a bona fide hedging

    position.\323\ This provision is in current Sec. 1.3(z)(2)(ii)(A) and

    (B). A commercial enterprise is exposed to price risk if it has entered

    into a fixed-price sales contract, whether spot or forward, calling for

    delivery in the physical marketing channel of a commodity and has not

    offset that price risk, for example, by entering into a fixed-price

    purchase contract. An appropriate hedge of a fixed-price sales contract

    would be to establish a long position in a commodity derivative

    contract to offset the risk of such cash market contact. Such long

    position may be held into the spot month in a physical-delivery

    contract if economically appropriate.

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

    \323\ See, e.g., 7 U.S.C. 6a(3)(1970). That statutory definition

    of bona fide hedging included ``purchases of, or long positions in,

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

    contract market made or held by such person to the extent that such

    purchases or long positions are offset by sales of the same cash

    commodity by the same person.''

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

    Unfilled anticipated requirements--paragraph (3)(C)(i). Unfilled

    anticipated requirements for the same cash commodity have long served

    as the basis of a bona fide hedging position.\324\ This provision

    mirrors the requirement of current Sec. 1.3(z)(2)(ii)(C). An

    appropriate hedge of unfilled anticipated requirements would be to

    establish a long position in a commodity derivative contract to offset

    the risk of such unfilled anticipated requirements.

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

    \324\ See, e.g., 7 U.S.C. 6a(3)(C) (1970). That statutory

    definition of bona fide hedging included ``an amount of such

    commodity the purchase of which for future delivery shall not exceed

    such person's unfilled anticipated requirements for processing or

    manufacturing during a specified operating period not in excess of

    one year: Provided, That such purchase is made and liquidated in an

    orderly manner and in accordance with sound commercial practice in

    conformity with such regulations as the Secretary of Agriculture may

    prescribe.''

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

    Under the proposal, such long positions may not be held into the

    lesser of the last five days of trading or the time period for the spot

    month in a physical-delivery commodity derivative contract (the five-

    day rule), with the exception that a person may hold long positions

    that do not exceed the person's unfilled anticipate requirements of the

    same cash commodity for the next two months. As noted above, the CME

    Group and the Working Group pointed out that previously, persons

    engaged in purchases of futures contracts have been permitted to hold

    up to 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 one futures do not exceed the person's unfilled anticipated

    requirements of the same cash commodity for that month and for the next

    succeeding month.

    Utility hedging unfilled anticipated requirements of customers--

    paragraph (3)(iii)(B). The Commission is proposing a new exemption for

    unfilled anticipated requirements for resale by a utility. This

    provision is analogous to the unfilled anticipated requirements

    provision of paragraph (3)(iii)(A), except the commodity is not for use

    by the same person--that is, the utility--but rather for anticipated

    use by the utility's customers. The proposed new exemption would

    recognize a bona fide hedging position where a utility is required or

    encouraged to hedge by its public utility commission (``PUC'').

    Request Six of the Working Group petition asked the Commission to

    grant relief with respect to a long position in a commodity derivative

    contract that arises from natural gas utilities' desire to hedge the

    price of gas that they expect to purchase and supply to their retail

    customers. In support of its petition, the Working Group provided

    evidence that hedging natural gas price risk, which includes some

    combination of fixed-price supply contracts, storage and derivatives,

    is a prudent risk management practice that limits volatility in the

    prices ultimately paid by consumers.\325\

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

    \325\ See, e.g., ``Use of Hedging by Local Gas Distribution

    Companies: Basic Considerations and Regulatory Issues,'' K. Costello

    and J. Cita, The National Regulatory Research Institute at the Ohio

    State University (May 2001). All supporting materials provided by

    the Working Group are available at http://sirt.cftc.gov/sirt/sirt.aspx?Topic=CommissionOrdersandOtherActionsAD&Key=23082.

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

    [[Page 75714]]

    Materials submitted in support of the Working Group petition \326\

    make it clear that the risk management transactions--fixed-price

    contracts, storage, and derivatives--engaged in by a typical natural

    gas utility to reduce risk associated with anticipated requirements of

    natural gas are used to fulfill its obligation to serve retail

    customers and are typically considered by the state PUC as prudent. The

    PUC may indeed obligate the natural gas utility to hedge some portion

    of the supply of natural gas needed to meet the needs of its customers

    and may take regulatory action if the utility fails to do so. As a

    result, in order to mitigate the impact of natural gas price volatility

    on the cost of natural gas acquired to serve its regulated retail

    natural gas customers, a utility may enter into long positions in

    commodity derivative contracts to hedge a specified percentage of such

    customers' anticipated natural gas requirements over a multi-year

    horizon. The utility's PUC considers such hedging practices to be

    prudent and has allowed gains and losses related to such hedging

    activities to be retained by its regulated retail natural gas

    customers.

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

    \326\ Id.

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

    The Commission recognizes the highly regulated nature of the

    natural gas market, where state-regulated public utilities may have

    rules or guidance concerning locking in the costs of anticipated

    requirements for retail customers through a number of means, including

    fixed-price purchase contracts, storage, and commodity derivative

    contracts. Moreover, since the public utility typically does not

    directly profit from the results of its hedging activity (because most

    or all of the gains derived from hedging are passed on to customers,

    e.g., through the price charged for natural gas), the utility has no

    incentive to speculate.

    The Commission invites comments on all aspects of this new

    enumerated bona fide hedging exemption.

    Hedges by agents--paragraph (3)(iv). The Commission is proposing an

    enumerated exemption for hedges 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 merchandising the

    cash positions that are being offset in commodity derivative contracts

    and the agent has a contractual arrangement with the person who owns

    the commodity or holds the cash market commitment being offset. 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.\327\

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

    \327\ This provision is included in current Sec. 1.3(z)(3) as

    an example of a potential non-enumerated case. 17 CFR 1.3(z)(3).

    Compare vacated Sec. 151.5(a)(2)(iv).

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

    Other enumerated hedging positions--paragraph (4). Each of the

    other enumerated hedging positions would be subject to the five-day

    rule for physical-delivery contracts. The Commission reiterates the

    intent of the five-day rule is to protect the integrity of the delivery

    process in physical-delivery contracts. The reorganization into new

    paragraph (4) of existing provisions in 1.3(z) subject to the five-day

    rule is intended for administrative ease.

    Unsold anticipated production--paragraph (4)(i). Unsold anticipated

    production has long served as the basis of a bona fide hedging

    position.\328\ This provision is in current Sec. 1.3(z)(2)(i)(B). The

    Commission historically has recognized twelve months of unsold

    anticipated production in an agricultural commodity as the basis of a

    bona fide hedging position. Under the proposal, this twelve-month

    restriction would not apply to physical-delivery contracts that were

    not in an agricultural commodity.

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

    \328\ See 7 U.S.C 6a(3)(A) (1940). That statutory definition of

    bona fide hedging, enacted in 1936, included ``the amount of such

    commodity such person is raising, or in good faith intends or

    expects to raise, within the next twelve months, on land (in the

    United States or its Territories) which such person owns or

    leases.''

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

    The Commission is considering relaxing the five-day rule to permit

    a person to hold a position in a physical-delivery commodity derivative

    contract, other than in an agricultural commodity, through the close of

    the spot month that does not exceed in quantity the reasonably

    anticipated unsold forward production that would be available for

    delivery under the terms of a physical-delivery commodity derivative

    contract. For example, a person with a significant number of producing

    natural gas wells may be highly certain that she can be a position to

    deliver natural gas on the physical-delivery natural gas futures

    contract.\329\ The Commission is considering permitting the exchange

    listing the physical-delivery commodity derivative contract to

    administer exemptions to the five-day rule upon application to such

    exchange specifying the unsold forward production that could be moved

    into delivery position. The Commission requests comment on this

    alternative.

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

    \329\ In contrast, prior to harvest, a farmer must plant and

    manage a crop until it is ripe. Anticipated agricultural production

    may not be available timely at a delivery location for a futures

    contract. Thus, historically, only inventories of agricultural

    commodities, rather than anticipated production, have been

    recognized as a basis for a bona fide hedging position under the

    five-day rule.

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

    Offsetting unfixed-price cash commodity sales and purchases--

    paragraph (4)(ii). Offsetting unfixed-price cash commodity sales and

    purchases basis different delivery months in the same commodity

    derivative contract have long served as the basis of a bona fide

    hedging position. \330\ This provision is in current Sec.

    1.3(z)(2)(iii). The Commission explained a major rationale for this

    exemption for spread positions was to facilitate commercial risk

    shifting positions which may not have otherwise conformed to the

    definition of bona fide hedging.\331\

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

    \330\ The Commission added this enumerated exemption to the

    definition of bona fide hedging in 1987. 52 FR 38914, Oct. 20, 1987.

    \331\ 51 FR 31648, 31650, September 4, 1986. ``In particular, a

    cotton merchant may contract to purchase and sell cotton in the cash

    market in relation to the futures price in different delivery months

    for cotton, i.e., a basis purchase and a basis sale. Prior to the

    time when the price is fixed for each leg of such a cash position,

    the merchant is subject to a variation in the two futures contracts

    utilized for price basing. This variation can be offset by

    purchasing the future on which the sales were based [and] selling

    the future on which [the] purchases were based.'' Id. (n. 3).

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

    The proposed enumerated provision would be expanded from current

    Sec. 1.3(z)(2)(iii) to include unfixed-price cash contracts basis

    different commodity derivative contracts in the same commodity,

    regardless of whether the commodity derivative contracts are in the

    same calendar month.\332\ The Commission notes a commercial enterprise

    may enter into the described transactions to reduce the risk arising

    from either (or both) a location differential or a time differential in

    unfixed price purchase and sale contracts in the same cash

    commodity.\333\ The contemplated derivative transactions represent a

    substitute for two transactions to be made at a later time in a

    physical marketing channel: a fixed-price purchase and a fixed-price

    sale of the

    [[Page 75715]]

    same cash commodity. The commercial enterprise intends to later take

    delivery on one unfixed-price cash contract and to re-deliver the same

    cash commodity on another unfixed-price cash contract. There may be no

    substantive difference in time between taking and making delivery in

    the physical marketing channel, but the derivative contracts do not

    offset each other because they are in two different contracts (e.g.,

    the NYMEX Light Sweet Crude Oil futures contract versus the ICE Europe

    Brent crude futures) or two different instruments (e.g., swaps versus

    futures). The contemplated derivative positions will offset the risk

    that the difference in the expected delivery prices of the two unfixed-

    price cash contracts in the same commodity will change between the time

    the hedging transaction is entered and the time of fixing of the prices

    on the purchase and sales cash contracts. Therefore, the contemplated

    derivative positions are economically appropriate to the reduction of

    risk.

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

    \332\ The Working Group requested this expansion in Requests One

    and Two.

    \333\ A location differential is the difference in price between

    two derivative contracts in the same commodity (or substantially the

    same commodity) at two different delivery locations on the same (or

    similar) delivery dates. A location differential also may underlie a

    single derivative contract that is called a basis contract.

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

    In the case of reducing the risk of a location differential, and

    where each of the underlying transactions in separate derivative

    contracts may be in the same contract month, the Commission notes that

    a position in a basis contract would not be subject to position limits,

    as discussed in the proposed definition of referenced contract.

    The Commission notes that upon fixing the price of, or taking

    delivery on, the purchase contract, the owner of the cash commodity may

    hold the short derivative leg of the spread as a hedge against a fixed-

    price purchase or inventory.\334\ However, the long derivative leg of

    the spread would no longer qualify as a bona fide hedging position

    since the commercial entity has fixed the price or taken delivery on

    the purchase contract. Similarly, if the commercial entity first fixed

    the price of the sales contract, the long derivative leg of the spread

    may be held as a hedge against a fixed-price sale,\335\ but the short

    derivative leg of the spread would no longer qualify as a bona fide

    hedging position.

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

    \334\ See proposed paragraph (3)(i) of the definition of bona

    fide hedging position under Sec. 150.1.

    \335\ See proposed paragraph (3)(ii) of the definition of bona

    fide hedging position under Sec. 150.1.

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

    Anticipated royalties--paragraph (4)(iii). The new enumerated

    exemption would permit an owner of a royalty to lock in the price of

    anticipated mineral production. The Commission initially recognized the

    hedging of anticipated royalties in vacated Sec. 151.5(a)(2)(vi).\336\

    That provision would have recognized ``sales or purchases'' in

    commodity derivative contracts that would be ``offset by the

    anticipated change in value of royalty rights that are owned by the

    same person . . . [and] arise out of the production, manufacturing,

    processing, use, or transportation of the commodity underlying the

    [commodity derivative contract], which may not exceed one year for

    agricultural'' commodity derivative contracts; such positions would be

    subject to the five-day rule.

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

    \336\ 76 FR at 71689.

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

    The Commission has reconsidered that exemption in vacated Sec.

    151.5(a)(2)(vi) and now re-proposes it as an enumerated exemption for

    short positions in commodity derivative contracts offset by the

    anticipated change in value of mineral royalty rights that are owned by

    the same person and arise out of the production of a mineral commodity

    (e.g., oil and gas); such positions would be subject to the five-day

    rule. This proposed exemption differs from the exemption in vacated

    Sec. 151.5(a)(2)(vi) because it applies only to: (i) Short positions;

    (ii) arising from production; and (iii) in the context of mineral

    extraction.

    A royalty arises as ``compensation for the use of property . . .

    [such as] natural resources, expressed as a percentage of receipts from

    using the property or as an account per unit produced.'' \337\ A short

    position is the proper offset of a yet-to-be received payment based on

    a percentage of receipts per unit produced for a royalty that is owned.

    This is because a short position fixes the price of the anticipated

    receipts, removing exposure to change in value of the person's share of

    the production revenue.\338\ In contrast, a person who has issued a

    royalty has, by definition, agreed to make a payment in exchange for

    value received or to be received (e.g., the right to extract a

    mineral). Upon extraction of a mineral and sale at the prevailing cash

    market price, the issuer of a royalty remits part of the proceeds in

    satisfaction of the royalty agreement. Thus, the issuer of a royalty

    does not have price risk arising from that royalty agreement.

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

    \337\ Black's Law Dictionary, 6th Ed.

    \338\ A short position fixes the price at the entry price to the

    commodity derivative contract. For any decrease (increase) in price

    of the commodity produced, the expected royalty would decline

    (increase) in value, but the commodity derivative contract would

    increase (decrease) in value, offsetting the price risk in the

    royalty.

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

    The Commission preliminarily believes that ``manufacturing,

    processing, use, or transportation'' of a commodity does not conform to

    the meaning of the term royalty. Further, while the Commission

    recognizes that, historically, royalties have been paid for use of land

    in agricultural production,\339\ the Commission has not received any

    evidence of a need for a bona fide hedging exemption from owners of

    agricultural production royalties. The Commission nonetheless invites

    comment on all aspects of this new royalty exemption.

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

    \339\ For example, corn ``rents'' were cited in An Inquiry into

    the Nature and Causes of the Wealth of Nations, Smith, Adam, 1776,

    at cp. 5, available at: http://www.gutenberg.org/files/3300/3300-h/3300-h.htm. This eBook is for the use of anyone anywhere at no cost

    and with almost no restrictions whatsoever. You may copy it, give it

    away, or re-use it under the terms of the Project Gutenberg License

    included with this eBook or online at www.gutenberg.org.

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

    Services--paragraph (4)(iv). The Commission is proposing the

    hedging of services as a new enumerated hedge in subparagraph (4)(iv)

    of the proposed definition. This new exemption is not without

    Commission precedent. For example, in 1977, the Commission noted that

    the existence of futures markets for both source and product

    commodities, such as soybeans and soybean oil and meal, afford business

    firms increased opportunities to hedge the value of services.\340\ The

    Commission's current proposal is similar to vacated Sec.

    151.5(a)(2)(vii).\341\ That provision would have recognized ``sales or

    purchases'' in commodity derivative contracts that would be ``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 . . . [and] the contract for services arises out of the

    production, manufacturing, processing, use, or transportation of the

    commodity underlying the [commodity derivative contract], which may not

    exceed one year for agricultural'' commodity derivative contracts; such

    positions would be subject to the five-day rule. That provision also

    made such positions subject to a provision for cross-commodity hedging,

    namely that, ``The fluctuations in the value of the position in

    [commodity derivative contracts] are substantially related to the

    fluctuations in value of receipts or payments due or expected to be due

    under a contract for services.'' \342\

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

    \340\ 42 FR 14832, 14833, Mar. 16, 1977.

    \341\ 76 FR at 71689.

    \342\ Vacated Sec. 151.5(a)(2)(vii)(B).

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

    The Commission has reconsidered its proposed exemption in vacated

    Sec. 151.5(a)(2)(vii) and now re-proposes an enumerated exemption that

    is largely the same, save for deleting the cross-commodity hedging

    provision in this enumerated exemption, as that provision is included

    under the cross-

    [[Page 75716]]

    commodity hedging exemption, discussed below. Thus, the proposed

    exemption would recognize ``sales or purchases'' in commodity

    derivative contracts that are ``offset by the anticipated change in

    value of receipts or payments due or expected to be due under an

    executed contract for services by the same person . . . [and] the

    contract for services arises out of the production, manufacturing,

    processing, use, or transportation of the commodity which may not

    exceed one year for agricultural'' commodity derivative contracts; such

    positions would be subject to the five-day rule.

    As the Commission previously noted and under this proposed

    exemption, ``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 [commodity derivative

    contract].'' \343\ The Commission invites comment on all aspects of

    this new services exemption.

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

    \343\ 76 FR at 71654.

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

    (2) Cross-Commodity Hedges--Paragraph (5)

    The proposed cross-commodity hedging provision would apply to all

    enumerated hedges in paragraphs (3) and (4) of the definition of bona

    fide hedging position, as well as to pass-through swaps under paragraph

    (2).\344\ The Commission has long recognized cross-commodity hedging,

    noting in 1977 that sales for future delivery of any product or

    byproduct which is offset by the ownership of fixed-price purchase of

    the source commodity would be covered by the general provisions for

    cross-commodity hedging in Sec. 1.3(z)(2).\345\

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

    \344\ Compare with vacated Sec. 151.5(a)(2)(viii), which

    provided for cross-commodity hedges in enumerated positions but not

    for pass-through swaps.

    \345\ 42 FR 14832, 14834, Mar. 16, 1977. The Commission noted

    its belief that there is little commercial need to maintain cross-

    hedge positions during the last five trading days of any expiring

    contract. It believed the five-day restriction was necessary to

    guarantee the integrity of the markets. The Commission considered

    there was little commercial utility of such positions during the

    last five days of trading to offset anticipated production, which at

    that time was limited to agricultural commodities. The Commission

    considered its responsibility for orderly markets and concluded not

    to propose an enumerated exemption in the last five days of trading

    for anticipatory production. See also 7 U.S.C. 6a(3)(B) (1970). That

    statutory definition of bona fide hedging included ``an amount of

    such commodity the sale of which for future delivery would be a

    reasonable hedge against the products or byproducts of such

    commodity owned or purchased by such person, or the purchase of

    which for future delivery would be a reasonable hedge against the

    sale of any product or byproduct of such commodity by such person.''

    Id.

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

    Under the proposed enumerated exemption, cross-commodity hedging

    would be conditioned on: (i) The fluctuations in value of the position

    in the commodity derivative contract (or the commodity underlying the

    commodity derivative contract) are substantially related to the

    fluctuations in value of the actual or anticipated cash position or

    pass-through swap (the ``substantially related'' test); and (ii) the

    five-day rule being applied to positions in any physical-delivery

    commodity derivative contract.\346\ As discussed above, the five-day

    rule would not restrict positions in cash-settled contracts, but would

    restrict only positions in physical-delivery commodity derivative

    contracts. Thus, the Commission is protecting the integrity of the

    delivery process in the physical-delivery contract. Further, as noted

    above, few traders typically hold a position in excess of the position

    limits during the last few days of the spot month. Hence, a cross-

    commodity hedger who held a position deep into the spot month in excess

    of the spot position limit likely would be large relative to all

    traders. Such large positions may interfere with convergence of the

    commodity derivative contract with the cash market price, since the

    supply and demand expectations for cross-commodity hedgers may differ

    from those of persons hedging price risks of the commodity underlying

    the physical-delivery derivative.

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

    \346\ Compare with current Sec. 1.3(z)(2)(iv), which requires

    compliance with the substantially related test and with the five-day

    rule, and does not provide an exception to the five-day rule for

    cash-settled contracts.

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

    Substantially related test. The Commission is proposing guidance on

    the meaning of the substantially related test. The Commission is

    proposing a non-exclusive safe harbor for cross-commodity hedges.\347\

    The safe harbor would have two factors: (i) Qualitative; and (ii)

    quantitative.

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

    \347\ The Commission understands that cross-commodity hedges in

    physical commodities are not generally recognized by accountants as

    eligible for hedge accounting treatment.

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

    Qualitative factor: As a first factor in assessing whether a cross-

    commodity hedge is bona fide, the target commodity should have a

    reasonable commercial relationship to the commodity underlying the

    commodity derivative contract. For example, there is a reasonable

    commercial relationship between grain sorghum (commonly called milo),

    used as a food grain for humans or as animal feedstock, with corn

    underlying a commodity derivative contract.\348\

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

    \348\ See, e.g., ``The Alternative Field Crops Manual,''

    University of Minnesota, November 1989, available at http://www.hort.purdue.edu/newcrop/afcm/sorghum.html.

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

    In contrast, there does not appear to be a reasonable commercial

    relationship between a physical commodity and a stock price index;

    while long-term price series of such commodities may be statistically

    related by either inflation or measures of economic activity, such

    disparate commodities do not appear to have the requisite commercial

    relationship. Such correlation appears for this purpose to be spurious.

    [[Page 75717]]

    Quantitative factor: The target commodity should also be offset by

    a position in a commodity derivative contract that provides a

    reasonable quantitative correlation and in light of available liquid

    commodity derivative contracts. The Commission will presume an

    appropriate quantitative relationship exists when the correlation (R),

    between first differences or returns in daily spot price series for the

    target commodity and the price series for the commodity underlying the

    derivative contract (or the price series for the derivative contract

    used to offset risk), is at least 0.80 for a time period of at least 36

    months.\349\ When less granular price series than daily are used, R

    typically will be higher. Thus, price series data of at least daily

    frequency should be used, if available.

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

    \349\ By way of comparison, accounting practice may look to

    goodness of fit (R\2\) to be at least 0.80. The proposed correlation

    (R) of 0.80 corresponds to an R\2\ of 0.64, substantially less than

    accounting practice. Further, accounting practice may look to the

    coefficient (hedge ratio) from a regression analysis to be in the

    range of negative 0.80 to 1.25. The Commission notes that the size

    of this coefficient is dependent upon the unit of trading for the

    hedging instrument and the unit of trading for the target of the

    hedge. To the extent both may be expressed in similar terms, the

    coefficient may fall within the range suggested by accounting

    practice. However, given standardized hedging instruments such as

    futures are fixed in terms of a particular price quote for a

    commodity (such as in dollars per bushel) and the target of a cross-

    commodity hedge may not have units fixed in the same terms (such as

    in dollars per hundred weight), the hedge ratio will depend on a

    fairly arbitrary choice of units to express the price series of the

    target of the hedge. Thus, the Commission is not proposing any

    particular safe harbor or requirement for a hedge ratio.

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

    The Commission will presume that positions in a commodity

    derivative contract that does not meet the safe harbor are not bona

    fide cross-commodity hedging positions. However, a person may rebut

    this presumption upon presentation of facts and circumstances

    demonstrating a reasonable relationship between the spot price series

    for the commodity to be hedged and either the spot price series for the

    commodity underlying the commodity derivative contract or the price

    series for the commodity derivative contract to be used for hedging. A

    person should consider whether there is an actively traded commodity

    derivative contract that would meet the safe harbor, in light of

    liquidity considerations. A person may seek interpretative relief under

    Sec. 140.99 for recognition of such a position as a bona fide hedging

    position.

    Generally, a regression or time series analysis of prices should be

    performed to determine an appropriate hedge ratio.\350\ Many price

    series are non-stationary because the prices increase with time and,

    thus, do not revert to a mean (i.e., stationary) price level. A

    regression on non-stationary data can give rise to spurious values for

    the ``goodness of fit'' and other statistics.\351\ Thus, a quantitative

    analysis should be performed using first differences or returns

    (percentage price changes) so as to render the time series

    stationary.\352\ However, the Commission is not proposing to condition

    the substantially related test on any particular hedge ratio

    methodology.

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

    \350\ The Commission notes this safe harbor is intentionally

    written in general terms. Appropriate hedge ratios may be determined

    using an appropriate model, including but not limited to ordinary

    lease squares (OLS), autoregressive conditional heteroscedasticity

    (ARCH), generalized autoregressive conditional heteroscedasticity

    (GARCH), or an error-correction model (ECM).

    \351\ ``Goodness of fit'' is defined as: ``A general term

    describing the extent to which an econometrically estimated equation

    fits the data. There are various ways of summarizing this concept,

    including the coefficient of determination and adjusted R\2\.''

    ``The MIT Dictionary of Modern Economics,'' 4th Ed. (1996).

    \352\ See, e.g., ``A Guide to Econometrics,'' 5th Ed., The MIT

    Press (2003), at p.319.

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

    By way of example, the Commission believes that fluctuations in the

    value of electricity contracts typically will not be substantially

    related to fluctuations in value of natural gas. There may not be a

    substantial relation, for example, because the marginal pricing in a

    spot market may be driven by the price of something other than natural

    gas, such as nuclear, coal, transmission, outages, or water/

    hydroelectric power generation. Table 5 below shows illustrative simple

    correlations, both in terms of levels and returns, between spot

    electricity prices and natural gas (both spot Henry Hub prices and the

    nearby NYMEX Henry Hub Natural Gas futures prices, assuming a roll to

    the next deferred futures contract on the eleventh calendar day of each

    month). These correlations are much lower than the proposed safe harbor

    level of 0.80.

    [[Page 75718]]

    Table 5--Correlations--Spot Electricity Prices and Natural Gas (spot and futures) Prices January 2, 2009 to May

    14, 2013

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

    Price series: Correlations using: Henry Hub spot Henry Hub futures

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

    Houston electricity................. Levels.................. 0.1333 0.0630

    Returns................. 0.1264 0.0488

    PJM electricity..................... Levels.................. 0.4415 0.2724

    Returns................. 0.0987 0.0153

    New England electricity............. Levels.................. 0.3450 0.2422

    Returns................. 0.1808 0.0121

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

    Data sources: Henry Hub Gulf Coast Natural Gas Spot Price ($ per mmBTUs) and Natural Gas Futures Contracts ($

    per mmBTU), source: US Energy Information Administration, available at http://www.eia.gov/dnav/ng/ng_pri_fut_s1_d.htm; Wholesale Day Ahead Prices at Selected Hubs, Peak (5/16/2013), source: US Energy Information

    Administration, republished from the Intercontinental Exchange (ICE), available at http://www.eia.gov/electricity/wholesale/ electricity/wholesale/.

    Alternatively, a generator of electricity that owns or leases a

    natural gas generator may qualify for an unfilled anticipated

    requirements bona fide hedge to meet a fixed price power commitment

    (sale of electricity). The position that is hedged is the quantity

    equivalent of natural gas through the generator to meet the contracted

    fixed price power commitment.\353\ A natural gas hedge exemption can

    also be applied to operating characteristics of the plant and sources

    of revenue such as ancillary services.

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

    \353\ A generator must also be able to satisfy any operating

    constraints, including minimum production runs.

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

    (3) Examples of Bona Fide Hedging Positions in Appendix B

    The Commission is providing examples to illustrate enumerated bona

    fide hedging positions. The Commission invites comment on all aspects

    of the examples.

    h. Non-Enumerated Hedging Exemptions

    The Commission proposes to replace the existing procedures for

    persons seeking non-enumerated hedging exemptions under current Sec.

    1.3(z)(3) and Sec. 1.47 with proposed Sec. 150.3(e), discussed

    further below, that would provide guidance for persons seeking non-

    enumerated hedging exemptions through filing of a petition under

    section 4a(a)(7) of the Act. As noted above, practically all non-

    enumerated hedging exemption requests were from persons seeking to

    offset the risk arising from swap books, which the Commission has

    addressed in the proposed pass-through swaps and pass-through swap

    offsets, and in the proposal to net positions in futures and swap

    reference contracts for purposes of single-month and all-months-

    combined position limits.

    The Commission requests comment on industry practices involving the

    hedging of risks of cash market activities in a physical commodity that

    are not specifically enumerated in paragraphs (3), (4), and (5) of the

    proposed definition of bona fide hedging position, the extent to which

    such hedging practices reflect industry standards or best practices and

    the particular sources of changes in value that such hedging positions

    offset.

    Under the proposal for hedges of physical commodities, additional

    enumerated hedges could only be added to the proposed definition of

    bona fide hedging position by way of notice and comment rulemaking.

    Should the Commission adopt, as an alternative, an administrative

    procedure that would allow the Commission to add additional enumerated

    bona fide hedges without requiring notice and comment rulemaking? If

    so, what procedures should be used? Is current Sec. 1.47 an

    appropriate process? And what standards, in addition to the statutory

    standards of CEA section 4a(c)(2), should be applicable to any such

    administrative procedure? The Commission is particularly concerned

    about the absence of standards in current Sec. 1.47. If the Commission

    were to adopt such an administrative procedure, how should the

    Commission address the factors in CEA section 4a(a)(3)(B) in such an

    administrative procedure?

    No Proposal of Unfilled Storage Capacity as an Anticipated

    Merchandizing Hedge. The Commission is not re-proposing a hedge for

    unfilled storage capacity that was in vacated Sec. 151.5(a)(2)(v).

    That exemption would have permitted a person to establish as a bona

    fide hedge offsetting sales and purchases of commodity derivative

    contracts that did not exceed in quantity the amount of the same cash

    commodity that was anticipated to be merchandized. That exemption was

    limited to the current or anticipated amount of unfilled storage

    capacity that the person owned or leased.

    The Commission previously noted it had not recognized anticipated

    merchandising transactions as bona fide hedges due to its historic view

    that merchandizing transactions generally fail to meet the economically

    appropriate test.\354\ The Commission explained, ``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 [commodity derivative contracts]

    could not reduce this yet-to-be-assumed risk.'' In response to

    comments, the Commission opined 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

    transaction in question may meet the statutory definition of a bona

    fide hedging transaction.''

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

    \354\ 76 FR at 71646.

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

    With the benefit of further review, the Commission now sees a

    strong basis to doubt that such a position generally will meet the

    economically appropriate test. This is because the value fluctuations

    in a calendar month spread in a commodity derivative contract will

    likely have at best a low correlation with value fluctuations in

    expected returns (e.g., rents) on unfilled storage capacity. There are

    at least two factors that contribute to the size of a calendar month

    spread.\355\ One factor is the cost of carry, comprised of the

    anticipated storage cost plus the interest paid to finance purchase of

    the physical

    [[Page 75719]]

    commodity over the time period of the calendar month spread.\356\ A

    second factor, and likely the factor that most contributes to value

    fluctuations in the calendar month spread, is the difference in the

    anticipated supply and demand of a commodity on the different dates of

    the calendar month spread. In this context, a calendar month spread

    position would likely increase, rather than decrease, risk in the

    operation of a commercial enterprise. Accordingly, for these reasons,

    the Commission is not re-proposing to recognize a bona fide hedging

    position based on an unfilled storage bin and any of a number of

    commodities that a merchant might store in such bin.

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

    \355\ A calendar month spread generally means the purchase of

    one delivery month of a given futures contract and simultaneous sale

    of a different delivery month of the same futures contract. See CFTC

    Glossary, available at http://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/index.htm.

    \356\ For a brief discussion of cost of carry, see, e.g.,

    ``Options, Futures, and Other Derivatives,'' 3rd Ed., Hull, (1997)

    at p. 67.

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

    For example, the Commission recognizes there is commercial risk in

    operating off-farm storage, including the risk that total grain

    production may not be sufficient to ensure capacity utilization of such

    storage. Business costs of providing off-farm storage include the fixed

    cost of the storage facility and the variable costs for labor and fuel,

    in addition to other costs such as insurance. However, as the

    Commission noted above, based on its experience, the value fluctuations

    in a calendar month spread in a commodity derivative contract will

    likely have at best a low correlation with value fluctuations in

    expected returns (e.g., rents) on unfilled storage capacity. Therefore,

    the Commission requests comment on what positions in commodity

    derivative contracts, if any, would offset the value changes in the

    commercial risks (e.g., changes in anticipated rental income or changes

    in other revenue streams) arising from a commodity storage business.

    And for those positions that would offset value changes in the

    commercial risks, what data should the Commission obtain to verify such

    claims? By way of comparison, the Commission has recognized unsold

    anticipated production and unfilled anticipated requirements for

    processing, manufacturing or feeding, as the basis of a bona fide

    hedging position.\357\ The Commission has required persons seeking to

    claim such production or requirements exemptions to file statements

    showing historical production or usage and anticipated production or

    usage.\358\

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

    \357\ See current Sec. 1.3(z)(2)(i)(B) and (C).

    \358\ See current Sec. 1.48.

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

    The Commission invites commenters to provide specific, empirical

    analysis and data that would demonstrate how particular types of

    transactions could reduce the value at risk of unfilled storage space

    that could support such an exemption.

    i. Summary of Disposition of Working Group Petition Requests

    As noted above, the Working Group made ten requests for exemptions

    under vacated part 151.\359\ The Commission summarizes and addresses in

    a brief statement each request, below.

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

    \359\ The Working Group Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/wgbfhpetition012012.pdf.

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

    Request One. Unfixed Price Transactions Involving a Non-Referenced

    Contract: In a hedge of an unfixed price purchase and unfixed price

    sale of a physical commodity in which one leg of the hedge is a

    referenced contract and the other leg is a non-referenced contract, the

    Working Group requests that the referenced contract leg of the hedge be

    treated as a bona fide hedging position.

    The proposed definition of bona fide hedging position would permit

    Request One under proposed paragraphs (4)(ii)(B) and (5), discussed

    above.

    Request Two. Offsetting Unfixed Price Transactions Hedged with

    Derivatives in the Same Calendar Month: The Working Group requests that

    hedges of an unfixed price purchase and an unfixed price sale of a

    physical commodity in which the separate legs of the hedge are in the

    same calendar month, but which do not offset each other, because they

    are in different contracts or for any other reason, be treated as bona

    fide hedging positions.

    The proposed definition of bona fide hedging position would permit

    Request Two under proposed paragraphs (4)(ii)(B) and (5), discussed

    above.

    Request Three. Unpriced Physical Purchase or Sale Commitments: The

    Working Group requests that referenced contracts used to lock in a

    price differential where one leg of the underlying transaction is an

    unpriced commitment to buy or sell a physical energy commodity, and the

    offsetting sale or purchase has not been completed, be treated as bona

    fide hedging transactions or positions.

    This request would not be permitted under the proposed definition

    of bona fide hedging position. The transaction described in Request

    Three concerns a commercial entity that has entered into either an

    unfixed-price sale or an unfixed-price purchase, but has not entered

    into an offsetting purchase or sale contract. This differs from the

    proposed enumerated bona fide hedge exemption provided in paragraph

    (4)(ii) because both sides of the cash transactions have not been

    contracted.

    Locking in the spread for the same commodity between two markets is

    prudent risk management when a commercial trader has a contractual

    commitment both to buy and sell the physical commodity at unfixed

    prices in the same two markets. A commercial merchant may expect to

    match an unfixed-price purchase with an unfixed-price sale, regardless

    of which came first, and at that point, will qualify for a hedge

    exemption for the basis risk, under paragraphs (4)(ii) and (5), as

    discussed in Requests One and Two, above.

    However, a trader has not established a definite exposure to a

    value change when that trader has established only an unfixed price

    purchase or sales contract. This cash position fails the change in

    value requirement. Considering the anticipated merchandizing

    transaction, a merchant may assert her intention, but merchandizing

    intentions alone are not sufficient to recognize a price risk (that is,

    the yet-to-be established pair of unfixed-price cash purchase and sales

    contracts). The Commission is concerned that exempting such a yet-to-be

    established cash position would make it difficult or impossible for the

    Commission to distinguish hedging from speculation. For example, a

    trader could maintain a derivatives position, exempt from position

    limits, until that trader enters into a subsequent cash market

    transaction that results in a book-out of the first unfixed-price cash

    market transaction. The trader could assert that changed conditions

    resulted in a change in intentions. Since market prices are continually

    changing to reflect new information and, thus, changing conditions, the

    Commission believes an exemption standard based on merchandizing

    intentions alone would be no standard at all.

    The Commission recognizes there can be a gradation of probabilities

    that an anticipated transaction will occur. However, the example above

    offers no context in which to evaluate the nature or probability of an

    anticipated merchandising transaction, and such context is essential to

    determining the nature of any price risk that has been realized and

    could support the existence of a bona fide hedge. The Commission notes

    that in such cases, the only way to evaluate the nature of any price

    risk would be for the Commission to be provided with particulars of the

    transaction. This can be done, under the current proposal, either by

    requesting a staff interpretive letter under Sec. 140.99 or seeking

    CEA section 4a(a)(7) exemptive

    [[Page 75720]]

    relief. Furthermore, in instances where an entity can establish that

    the nature of their commercial operation is such that they have

    committed physical or financial resources towards the anticipated

    transaction, they should consider whether they can avail themselves of

    the exemption for unsold anticipated production or unfilled anticipated

    requirements exemptions.

    Request Four. Binding, Irrevocable Bids or Offers: The Working

    Group requests that referenced contracts used to hedge exposure to

    market price volatility associated with binding and irrevocable fixed-

    price bids or offers be treated as bona fide hedging positions.

    The contemplated transactions are not consistent with the

    enumerated hedges in proposed paragraphs (3)(i), as a hedge of a

    purchase contract, or (3)(ii), as a hedge of a sales contract, because

    the cash transaction is tentative and, therefore, neither a sale nor a

    purchase agreement.

    In the Commission's view, a binding bid or offer by itself is too

    tenuous to serve as the basis for an exemption from speculative

    position limits, since it is an uncompleted merchandising transaction

    that, historically, has not been recognized as the basis for a bona

    fide hedging transaction under Sec. 1.3(z)(2). Any related derivative

    would cover a conditional price risk for a bid or offer that would

    depend on that bid or offer being accepted and, therefore, would not be

    economically appropriate to the reduction of risk. The commercial

    entity submitting a binding, fixed-price bid or offer is essentially

    subject to a contingent price risk.\360\ The Commission also

    understands that some commercial entities submit bids or offers merely

    to obtain information about the request for proposal, without an

    intention of submitting a quote that is likely to be accepted.

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

    \360\ For example, if the entity submits a fixed-price bid, it

    runs the risk that either (a) it did not enter into a derivative

    hedge position that would cover an accepted bid, and before its bid

    was accepted, the cash market price decreased (so that it ends up

    paying an above-market price); or (b) it did enter into a

    derivatives position (a short position) that would cover an accepted

    bid, and before its bid was rejected, the derivative price increased

    so that the entity loses money when it lifts the short position.

    Either outcome would create a loss for the commercial entity.

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

    Moreover, the Working Group's suggestion that the Commission

    condition its relief on a good-faith showing and immediate

    reclassification of the portion of the position not awarded against the

    bid or offer does not protect the market against the prospect that

    multiple participants may hold such a good-faith belief and may also

    hold a position in the same direction as the cover transaction. If the

    Commission were to grant relief with respect to such positions, then

    all persons who made good-faith bids or offers on a particular cash

    market solicitation would be eligible to enter into derivatives to

    cover their potential exposure, in addition to holding speculative

    positions on the same side of the market at the limit. Under such

    relief, such persons, in the aggregate, could hold derivatives as cover

    in an amount several times larger than the total amount to be awarded

    under the solicitation. Undue volatility could result when the winning

    bid is accepted and all the losing bidders simultaneously reduce their

    total positions to get below the speculative position limit level.

    In contrast, under the Commission's proposed rules a commercial

    entity may cover the risk of a yet to be accepted bid or offer,

    provided its total position does not exceed the Commission's

    speculative position limits. Thus, when such person's bid or offer is

    not accepted and that person's speculative position is appropriately

    limited, that person need not liquidate any of its position to come

    into compliance with limits. As discussed further below, the Commission

    proposes to set speculative limits at relatively high levels. Thus, a

    commercial entity is not likely to be constrained in covering bids or

    offers unless it also has a relatively large speculative position on

    the same side of the market.

    Request Five. Timing of Hedging Physical Transactions: The Working

    Group requests that referenced contracts used to hedge a physical

    transaction that is subject to ongoing, good-faith negotiations, and

    that the hedging party reasonably expects to conclude, be treated as

    bona fide hedging transactions or positions.

    As with Request Four, the contemplated transactions are not

    consistent with the enumerated hedges in proposed paragraphs (3)(i), as

    a hedge of a purchase contract, or (3)(ii), as a hedge of a sales

    contract, because the cash transaction is tentative (here, subject to

    negotiation) and, therefore, neither a sale nor a purchase agreement.

    The Commission is concerned that a trader has not established a

    definite exposure to a value change when that trader has only entered

    into negotiations for a fixed-price purchase or sales contract. This

    tentative cash position thus fails the change in value requirement.

    Further, a trader could assert that changed conditions resulted in

    a change in intentions and a failure to complete negotiations. Since

    market prices are continually changing to reflect new information and,

    thus, changing conditions, the Commission believes an exemption

    standard based on merchandizing intentions alone (even if the merchant

    were engaged in good faith negotiations) would be no standard at all.

    In the case where the anticipated merchandizing transaction is

    ``naked,'' or not backed by any existing physical exposure, the

    Commission is not aware of a methodology for distinguishing naked

    merchandizing from speculation. In the case of a firm bid or offer not

    offset by existing physical exposure, an entity can, at the time the

    bid or offer is accepted, enter into a corresponding hedge transaction

    or, in the alternative, an entity can enter into a corresponding hedge

    transaction at the time the bid or offer is made provided the entity

    remains within the speculative position limits. The Commission invites

    comment on why hedging in this manner is insufficient to offset

    physical risks. The Commission asks that parties submitting comments

    detail the nature of their merchandizing operations and how they

    realize and account for physical risks related to anticipatory

    merchandizing transactions not offset by anticipated production or

    processing requirements. In particular, the Commission requests comment

    on appropriate measures to address the risks for contingent bids or

    offers. Under what circumstances should the Commission recognize

    contingent bids or offers as the basis of a bona fide hedging position?

    If the Commission were to do so, should only the expected value of the

    risk of such position be recognized? And what would be an appropriate

    methodology for distinguishing naked merchandizing from speculation?

    How should the Commission address the varying ex ante subjective

    probability of completion of such bids or offers? For example, is an ex

    post measure of completion, e.g., the ratio of completed transactions

    to bids or offers, an acceptable proxy to impute the probability of

    acceptance for purposes of determining an ex ante hedge ratio,

    regardless of the expected probability of completion on a particular

    bid or offer? Should the Commission require a person, seeking to claim

    an exemption based on contingent bids or offers, keep complete records

    of all such cash market bids or offers? If so, what record format and

    specific data elements should be kept?

    Request Six. Local Natural Gas Utility Hedging of Customer

    Requirements: The Working Group requests that long positions in

    referenced contracts purchased by a state-regulated public

    [[Page 75721]]

    utility to hedge the anticipated natural gas requirements of its retail

    customers be treated as bona fide hedging transactions or positions.

    The proposed definition of bona fide hedging position would permit

    Request Six under proposed paragraph (3)(iii)(B), discussed above.

    Request Seven. Use of Physical-Delivery Referenced Contracts to

    Hedge Physical Transactions Using Calendar Month Average Pricing: The

    Working Group argues that referenced contracts used to hedge in

    connection with calendar month average (``CMA'') pricing are not

    speculative in nature and should be exempt from speculative position

    limits. The Working Group requests that firms engaged in CMA-priced

    transactions involving physical-delivery referenced contracts be

    permitted to hold those positions through the spot month as bona fide

    hedging positions.

    The discussion below summarizes and addresses the petitioner's

    scenarios under Request Seven and notes the proposed exemptions that

    would be applicable or the reasons for denial.

    Summary of Scenario 1: Refinery hedging unfilled anticipatory

    requirements for crude oil on a calendar month average basis and cross-

    hedging the sale of anticipated processed distillate products \361\

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

    \361\ The petitioner separately requested relief for a seller of

    crude oil on a CMA basis that had contracted to deliver crude oil

    ratably to a refiner during a month at the daily average spot price.

    That is, the seller entered into an unfixed price forward sales

    contract to the refiner. Such a transaction would be covered by the

    existing bona fide hedging rules. Such an unfixed price sales

    contract would become partially fixed as each day in the month

    locked in the daily spot price that would be used to fix the price

    of deliveries in the forward delivery period. Thus, to the extent

    the price of the forward contract was partially fixed, a seller

    could use long positions in commodity derivative contracts to offset

    the risk of the partially-fixed-price sales contract under the

    provisions of proposed paragraph (3)(i).

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

    The Working Group noted that a refinery may buy crude oil on a CMA

    basis. The petitioner describes a three-step program whereby a refinery

    might buy crude oil on a CMA basis and subsequently sell distillate

    products on a CMA basis. First, on each trading day over approximately

    a one month period prior to expiration of the nearby NYMEX light sweet

    crude oil (WTI) futures contract, the refinery purchases futures

    contracts in the nearby contract month and sells an equivalent amount

    of futures in the next two deferred contract months in that same

    futures contract. The resulting positions are calendar month spreads in

    WTI futures contracts that are acquired at an average price over the

    one-month period. Second, following the establishment of the spread

    positions in WTI futures contracts, the refinery engages in exchange of

    futures for physical commodity (EFP) transactions, obtaining a short

    nearby WTI futures position in exchange for entering into cash market

    contracts for purchase of crude oil at a fixed price over the following

    calendar month.\362\ These nearby short WTI futures positions offset

    the nearby long WTI futures positions of the calendar month spread.

    Alternatively, the refinery stands for delivery on the nearby long WTI

    futures positions. As a result, the refinery holds only short deferred

    month WTI futures positions. Third, as the refinery takes deliveries of

    crude oil over the following calendar month on the cash market

    contracts (or alternatively under the physical delivery provisions of

    the futures contracts), the refinery processes the crude oil then sells

    the distillate products on the spot market. As the sales of distillate

    products occur, the refinery buys back the short WTI futures positions

    in the next two contract months.

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

    \362\ Under NYMEX rules regarding EFP transactions in WTI

    futures, the buyer and seller of futures must be the seller and

    buyer of an approximately equivalent quantity of the physical

    product underlying the futures. See NYMEX rule 200.20 (available at

    http://www.cmegroup.com/rulebook/NYMEX/2/200.pdf), and NYMEX rule

    538 (available at http://www.cmegroup.com/rulebook/NYMEX/1/5.pdf).

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

    The contemplated long positions are consistent with proposed

    paragraph (3)(iii) to the extent a refinery does not establish a long

    position in excess of that refinery's unfilled anticipated requirements

    for crude oil for the next two months. Further, in the case of a

    refinery, the Commission notes that, unless the refinery has fixed

    price sales \363\ or offsetting short positions of the expected

    processed cash products, such contemplated long positions in WTI

    futures alone may not be economically appropriate to the reduction of

    risk in the conduct and management of a commercial enterprise; hence,

    the Commission also views the short positions in WTI futures to be an

    integral component of the contemplated calendar spreads.

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

    \363\ A refinery with fixed price sales contracts may, as

    appropriate, enter into a long position in commodity derivative

    contracts as a bona fide hedging position or cross-commodity hedging

    position under proposed paragraphs (3)(ii) and (5).

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

    Regarding the short positions, the Commission considers the

    economic consequences of the positions over two time periods: (1) the

    period of time the refinery holds a calendar spread position (long

    nearby and short deferred WTI contract months); and (2) the subsequent

    period of time when the refinery holds only a short position in WTI

    futures \364\ and has a fixed price purchase contract on which it

    receives crude oil that it processes into distillate products.

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

    \364\ The refinery's long position in WTI futures would be

    liquidated as a result of the EFP transaction that established the

    fixed price purchase contract.

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

    Regarding the first time period, when considered as a whole with

    the long positions covering the unfilled anticipated requirements, the

    refinery's short positions would be risk reducing transactions, and

    therefore would qualify under proposed paragraphs (4)(i) and (5), so

    long as the long futures positions (meeting the unfilled anticipated

    requirements of paragraph (3)(iii)) fix the input price and the short

    futures positions fix a significant portion of the price of the

    expected output of petroleum distillate products that are not yet sold

    at a fixed price. The refinery's short position in referenced contracts

    would be an economically appropriate cross-commodity hedge, as

    contemplated by paragraph (5), to the extent the fluctuations in value

    of the anticipated processed cash commodities (that is, the petroleum

    distillates) are substantially related to fluctuations in value of the

    referenced contracts in crude oil.\365\

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

    \365\ Regarding the first time period, there is another

    enumerated bona fide hedging exemption involving offsetting

    commodity derivative contracts. Offsetting sales and purchases of

    commodity derivative contracts would be recognized as bona fide

    hedging positions to reduce the risk of unfixed price purchase and

    sales contracts of the cash commodity (paragraph (4)(ii)). This

    provision does not recognize positions as bona fide hedges under the

    five-day rule (i.e., during the lesser of the last five days of

    trading or the spot month for physical-delivery commodity derivative

    contracts). The refinery short positions are not similar to

    positions established to offset the risk of unfixed price sales and

    purchases, in that the refinery has not entered into open price

    purchase and sales contracts.

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

    During the second time period, the refinery, for example, contracts

    for the purchase of crude oil at a fixed price (as a result of the EFP

    transaction) or subsequently holds crude oil in inventory (e.g.,

    through taking delivery on the WTI futures contracts). Thus, the

    refinery in the second time period initially holds a bona fide hedging

    position under paragraph (3)(A). Once the crude oil is processed, the

    refinery also may continue to hold short crude oil futures contracts as

    a cross-hedge of distillate products under paragraph (5). Proposed

    paragraph (5) permits a cross-commodity hedge when the fluctuations in

    value of the position in the commodity derivative contract are

    substantially related to the fluctuations in value of the actual or

    anticipated cash

    [[Page 75722]]

    position. In this example, the aggregate price fluctuations of all of

    the distillate products of crude oil are substantially related to the

    price fluctuations of crude oil, with such prices expected to differ by

    refining costs and an expected processing margin. Thus, the refinery in

    the second time period holds a short futures position that is a bona

    fide inventory hedge or a bona fide cross-commodity hedge permitted

    under existing and proposed rules.

    Summary of Scenario 2: Merchant short hedge of CMA price purchase

    of crude oil from producer, and long position to cover anticipated re-

    sale of crude oil at CMA.

    In its January 20, 2012, petition, the Working Group gives the

    example of a producer that sells oil at the price at which it was

    valued (basis WTI futures) on each day it was extracted from the earth.

    The buyer is an aggregator that pays each producer for crude oil on a

    CMA basis for the production of the prior month. The aggregator seeks

    to ensure the CMA selling price for the oil purchased from the

    producers.

    The aggregator sells the nearby WTI futures each trading day over a

    one month period and buys an equivalent quantity of WTI futures

    contracts in the subsequent two deferred WTI contract months.

    Subsequently, the aggregator intends, in an EFP transaction, to

    exchange long futures in the nearby contract month, for a sales

    contract to be delivered ratably over the delivery period of that

    nearby contract month. (The long futures from the EFP transaction would

    offset the short WTI futures in the nearby contract month.) The

    aggregator would sell the long futures contracts each day as oil is

    delivered ratably during the month. By ratably selling the long futures

    as the physical barrels are delivered, the aggregator effectively

    realizes the price of the prompt barrel on that trading day.

    Alternatively, in its April 17, 2012 supplement, the Working Group

    argues that it should be sufficient that an aggregator wants to lock in

    CMA pricing for a sales commitment by entering into the spread position

    described above, regardless of the facts relating to the purchase side

    of the transaction.

    Because the aggregator is selling futures daily as the price on the

    aggregator's contractual purchase commitment is being fixed for each

    day's production, the aggregator builds a short futures position to

    offset the crude oil it will eventually purchase from the producer

    under the CMA cash contract at a price that is partially fixed each day

    the short position is acquired. Once the aggregator is committed at a

    fixed price to take delivery of the oil, the aggregator holds a bona

    fide hedging position under paragraph (3)(A), which continues to be a

    bona fide hedging position under that rule after the aggregator takes

    delivery of the oil.

    The Commission has not recognized as bona fide hedging a long

    futures position (as a synthetic sales price for the same commodity),

    when a person holds either inventory or a fixed-price purchase

    contract, the price risk of which has been offset using a short futures

    position. From the scenario and alternative presented, it is not clear

    that there is a price risk that is being reduced. Rather, the

    aggregator appears to seek to establish a sales price, without a

    corresponding uncovered price risk in either inventory or fixed-price

    sales or fixed-price purchase contracts. Thus, the transactions do not

    satisfy the requirements of the proposed definition of bona fide

    hedging position.

    In considering the petition, the Commission reviewed its historical

    policy position with respect to bona fide hedges in light of position

    information regarding physical-delivery energy futures contracts. The

    Commission reviewed three years of confidential large trader data in

    cash-settled and physical-delivery energy contracts.\366\ The review

    covered actual positions held in the physical-delivery energy futures

    markets during the three-day spot period, among all traders (including

    those who had received hedge exemptions from their D.C.M). It showed

    that, historically, there have been relatively few positions held in

    excess (and those few not greatly in excess) of the spot month limits.

    Accordingly, the Commission does not propose to grant the Working

    Group's requests regarding Scenario 2.

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

    \366\ The Commission typically does not publish ``general

    statistical information'' as authorized by CEA section 8(a)(1)

    regarding large trader positions in the expiring physical-delivery

    energy futures contracts because of concerns that such data may

    reveal information about the amount of market power a person may

    need to ``mark the close'' or otherwise manipulate the price of an

    expiring contract. Marking the close refers to, among other things,

    the practice of acquiring a substantial position leading up to the

    closing period of trading in a futures contract, followed by

    offsetting the position before the end of the close of trading, in

    an attempt to manipulate prices in the closing period. The

    Commission gathers large trader position reports on reportable

    traders in futures under part 17 of the Commission's rules. That

    data generally is confidential pursuant to section 8 of the Act. The

    Commission does, however, publish summary statistics for all-months-

    combined in its Commitments of Traders Report, available at http://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm.

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

    Nonetheless, the Commission notes that a person desiring to

    establish a synthetic sales price may hold a position subject to the

    spot month limit, but cautions that such person should trade so as not

    to disrupt the settlement price of the physical-delivery contract.

    Working Group Petition Requests Eight, Nine, and Ten

    Request Eight. Holding a Hedge Using a Physical-Delivery Contract

    into the Spot Month; Generally: The Working Group requests that firms

    that use physical-delivery referenced contracts (in commodities other

    than metals or agriculture) as bona fide hedging transactions or

    positions be permitted to hold these hedges into the spot month.

    Request Nine. Holding a Cross-Commodity Hedge Using a Physical

    Delivery Contract into the Spot Month: The Working Group requests that

    firms that use physical-delivery referenced contracts as a cross-

    commodity hedge be permitted to hold these hedges into the spot month.

    Request Ten. Holding a Cross-Commodity Hedge Using a Physical-

    Delivery Contract to Meet Unfilled Anticipated Requirements: \367\ The

    Working Group argued that the Commission should ``reinstate'' Sec.

    1.3(z)(2)(ii)(C) \368\ to permit firms to hold cross-commodity hedges

    involving physical-delivery referenced contracts into the spot month in

    order to meet their unfilled anticipated requirements.

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

    \367\ Request Ten is similar to Request Eight, which also deals

    with unfilled anticipated requirements. However, Request Eight deals

    with requirements for the same commodity, whereas Request Ten

    involves cross-hedging in a different commodity.

    \368\ Prior to the court's order vacating part 151, Sec. 1.3(z)

    was amended to in November 2011 to apply only to excluded (i.e.,

    financial, not physical) commodities. Therefore, by requesting that

    this particular section of Sec. 1.3(z) be ``reinstated,''

    petitioner is asking that it be applied once again to physical

    delivery (exempt and agricultural) commodities. However, Sec.

    1.3(z)(2)(iv) has never permitted a cross-commodity hedge under

    Sec. 1.3(z)(2)(ii)(C) to be held into the five last trading days.

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

    The proposed definition of bona fide hedging position would permit

    Request Eight under proposed paragraphs (3)(C), discussed above, for

    hedges of unfilled anticipated requirements.\369\

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

    \369\ The CME Petition also requested that the Commission

    recognize as bona fide hedges positions held into the five last

    trading days in physical-delivery referenced contracts that reduce

    the risk of two months unfilled anticipated requirements in the same

    cash commodity, as provided in Sec. 1.3(z)(2)(ii)(C).

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

    However, the proposed definition does not recognize the other

    requests as bona fide hedging positions. As discussed above, the

    Commission continues to believe that, as a physical-delivery commodity

    derivative contract approaches expiration, it is necessary to protect

    orderly trading and the integrity of the markets. A person holding a

    large physical-delivery futures position who

    [[Page 75723]]

    has no intention to make or take delivery may cause an unwarranted

    price fluctuation by demanding to liquidate such position deep into the

    delivery period in a physical-delivery agricultural contract or a metal

    futures contract or during the three-day spot period in a physical-

    delivery energy futures contract. Further, as noted above, a review of

    large trader positions in physical-delivery energy futures contracts

    does not show a current practice of traders holding large positions in

    the spot period of the physical-delivery energy referenced contracts

    relative to the exchange spot month limits.

    The Commission invites comments on all aspects of the Working

    Group's petition and the Commission review.

    2. Section 150.2--Position limits

    i. Current Sec. 150.2

    The Commission currently sets and enforces speculative position

    limits with respect to certain enumerated agricultural products.\370\

    Current Sec. 150.2 provides in its entirety that ``[n]o 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

    [enumerated levels].'' \371\ As such, the speculative position limits

    set forth in current Sec. 150.2 apply only to specific futures

    contracts traded on specific exchanges and, on a futures-equivalent

    basis, to specific option contracts thereon.\372\ ``Futures-

    equivalent'' is defined in current Sec. 150.1(f) as ``an option

    contract,'' and nothing else.\373\ Accordingly, current Sec. 150.2

    establishes federal position limits only for specifically enumerated

    futures contracts on ``legacy'' agricultural commodities and options on

    those futures contracts.

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

    \370\ The ``enumerated'' agricultural products refer to the list

    of commodities contained in the definition of ``commodity'' in CEA

    section 1a; 7 U.S.C. 1a. This list of agricultural contracts

    includes nine currently traded contracts: Corn (and Mini-Corn),

    Oats, Soybeans (and Mini-Soybeans), Wheat (and Mini-wheat), Soybean

    Oil, Soybean Meal, Hard Red Spring Wheat, Hard Winter Wheat, and

    Cotton No. 2. See 17 CFR 150.2. The position limits on these

    agricultural contracts are referred to as ``legacy'' limits because

    these contracts on agricultural commodities have been subject to

    federal positions limits for decades.

    \371\ 17 CFR 150.2. Footnote 1 to Sec. 150.2 adds, ``for

    purposes of compliance with these limits, positions in the regular

    sized and mini-sized contracts shall be aggregated.'' Id.

    \372\ See id.

    \373\ See 17 CFR 150.1(f).

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

    In 2010, the Commission proposed to implement additional

    speculative position limits for futures and option contracts in certain

    energy commodities (``2010 Energy Proposal'').\374\ In the 2010 Energy

    Proposal, the Commission included a discussion of past and present

    position limits for certain agricultural contracts under part 150

    stating that current Sec. 150.2 applies only to specific agricultural

    futures and options contracts:

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

    \374\ 75 FR 4142, Jan. 26, 2010.

    [t]he current Federal speculative position limits of regulation

    150.2 apply only to specific futures contracts [and] (on a futures-

    equivalent basis) specific option contracts. Historically, all

    trading volume in a specific contract tended to migrate to a single

    [futures] contract on a single exchange. Consequently, speculative

    position limits that applied to a single [futures] contract and

    options thereon effectively applied to a single market. The current

    speculative position limits of regulation 150.2 for certain

    agricultural contracts follow this approach.\375\

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

    \375\ Id. at 4152-54.

    The Commission withdrew the 2010 Energy Proposal when the Dodd-Frank

    Act became law.\376\

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

    \376\ 75 FR 50950, Aug. 18, 2010.

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

    The limited scope and applicability of the speculative position

    limits in current Sec. 150.2, as well as in the 2010 Energy Proposal,

    are inconsistent with the congressional shift evidenced in the Dodd-

    Frank Act amendments to section 4a of the Act, upon which the

    Commission relies in this release. Amended CEA section 4a(a)(1)

    authorizes the Commission to extend position limits beyond futures and

    option contracts to swaps traded on a DCM or SEF and swaps not traded

    on a DCM or SEF that perform or affect a significant price discovery

    function with respect to regulated entities (``SPDF swaps'').\377\

    Further, new CEA section 4a(a)(5) requires that speculative position

    limits apply to swaps that are ``economically equivalent'' \378\ to DCM

    futures and option contracts for agricultural and exempt commodities

    under new CEA section 4a(a)(2).\379\ Similarly, new CEA section

    4a(a)(6) requires the Commission to apply position limits on an

    aggregate basis to contracts based on the same underlying commodity

    across: (1) DCMs; (2) with respect to foreign boards of trade

    (``FBOTs''), contracts that are price-linked to a DCM or SEF contract

    and made available from within the United States via direct access; and

    (3) SPDF swaps.\380\

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

    \377\ 7 U.S.C. 6a(a)(1).

    \378\ Section 4a(a)(5) of the Act requires the Commission to

    impose the same limits on ``swaps'' that are ``economically

    equivalent'' to futures and options contracts. The statute does not

    define the term. But the Commission construes it, consistent with

    the policy objectives of the Dodd-Frank amendments, to require the

    Commission to expeditiously impose limits on physical commodity

    swaps that are price-linked to futures contracts, or to satisfy

    other defined equivalence criteria. The Commission accordingly

    construes the term ``economically equivalent'' to require swaps to

    satisfy the definition of ``referenced'' contract in proposed Sec.

    150.1. It requires that a swap be, among other things, ``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 . . . 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 . . .'' Other similarities or

    differences that exist between futures and swaps are not material to

    the Commission's interpretation of economic equivalence under 7

    U.S.C. 6a(a)(5).

    \379\ 7 U.S.C. 6a(a)(2), (5).

    \380\ 7 U.S.C. 6a(a)(6). The Commission refers to this

    requirement in section 4a(a)(6) of the Act as a requirement for

    position aggregation.

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

    In 2011, the Commission proposed and, after comment, adopted rules

    to establish an expanded position limits regime pursuant to the mandate

    contained in the Dodd-Frank Act amendments to CEA section 4a.\381\

    However, in an Order dated September 28, 2012, the U.S. District Court

    for the District of Columbia vacated the 2011 Position Limits

    Rulemaking, with the exception of the revised position limit levels in

    amended Sec. 150.2.\382\ Therefore, part 150 continues to apply, as

    amended, as if part 151 had not been finally adopted by the

    Commission.\383\

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

    \381\ The Commission instructed market participants to continue

    to comply with the existing position limit regime contained in part

    150 and any applicable DCM position limits or accountability levels

    until the compliance date for the position limits rules in new part

    151. After such date, part 150 would have been revoked and

    compliance with part 151 would have been required. 76 FR 71632.

    \382\ See 887 F. Supp. 2d 259 (D.D.C. 2012).

    \383\ The District Court's order vacated the final rule and the

    interim final rule promulgated in the 2011 Position Limits

    Rulemaking, with the exception of the rule's amendments to 17 CFR

    150.2.

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

    Vacated part 151 would have established federal position limits and

    limit formulas for 28 physical commodity futures and option contracts,

    or ``Core Referenced Futures Contracts,'' and would have applied these

    limits to all derivatives that are directly or indirectly linked to the

    price of a Core Referenced Futures Contract (collectively, ``Referenced

    Contracts'').\384\ Therefore, the position limits in vacated part 151

    would have applied across different trading venues to economically

    equivalent Referenced Contracts (as specifically defined in part 151)

    that are based on the same underlying commodity, a concept known as

    aggregate limits. Vacated

    [[Page 75724]]

    Sec. 151.1 defined ``Referenced Contract'' to mean:

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

    \384\ 76 FR at 71629.

    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.\385\

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

    \385\ Id. at 71685.

    In addition to establishing federal position limits for all

    Referenced Contracts, vacated part 151 would have, among other things,

    implemented a new statutory definition of bona fide hedging

    transactions, revised the standards for position aggregation, and

    established position visibility reporting requirements.\386\

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

    \386\ See generally 76 FR 71626, Nov. 18, 2011.

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

    ii. Proposed Sec. 150.2

    Proposed Sec. 150.2 would list spot month, single month, and all-

    months-combined position limits for 28 core referenced futures

    contracts. Consistent with section 4a(a)(5) of the Act, proposed Sec.

    150.2 would apply such position limits to all referenced contracts (as

    that term is defined in the proposed amendments to Sec. 150.1) \387\

    including economically equivalent swaps.\388\ Consistent with section

    4a(a)(6) of the Act, proposed Sec. 150.2 would apply position limits

    across all trading venues subject to the Commission's jurisdiction.

    Proposed Sec. 150.2 would also specify Commission procedures for

    computing position limits levels.

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

    \387\ See discussion of proposed Sec. 150.1 above.

    \388\ Section 4a(a)(5) of the Act requires the Commission to

    impose the same limits on ``swaps'' that are ``economically

    equivalent'' to futures and options contracts. The statute does not

    define the term. But the Commission construes it, consistent with

    the policy objectives of the Dodd-Frank amendments, to require the

    Commission to expeditiously impose limits on physical commodity

    swaps that are price-linked to futures contracts, or to satisfy

    other defined equivalence criteria. The Commission accordingly

    construes the term ``economically equivalent'' to require swaps to

    satisfy the definition of ``referenced'' contract in proposed Sec.

    150.1. It requires that a swap be, among other things, ``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 . . . 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. . . .'' Other similarities or

    differences that exist between futures and swaps are not material to

    the Commission's interpretation of economic equivalence under 7

    U.S.C. 6a(a)(5).

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

    a. Spot Month Limits

    Proposed Sec. 150.2(a) provides that no person may hold or control

    positions in referenced contracts in the spot month, net long or net

    short, in excess of the level specified by the Commission for physical-

    delivery referenced contracts and, specified separately, for cash-

    settled referenced contracts.\389\ Proposed Sec. 150.2(a) requires

    that a trader's positions in the physical-delivery referenced contract

    and cash-settled referenced contract are to be calculated separately

    under the separate spot month position limits fixed by the Commission.

    Therefore, 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. 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. The Commission will closely monitor the effects of

    its spot-month position limits.

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

    \389\ The Commission proposes to adopt an amended definition of

    spot month in proposed Sec. 150.1 (as discussed above), simplified

    from the spot-month definitions listed in vacated Sec. 151.3. The

    term ``spot month'' does not refer to a month of time.

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

    b. Single-Month and All-Months-Combined Limits

    Proposed Sec. 150.2(b) provides that no person may hold or control

    positions, net long or net short, in referenced contracts in a single-

    month or in all-months-combined in excess of the levels specified by

    the Commission. Proposed Sec. 150.2(b) permits traders to net all

    positions in referenced contracts (regardless of whether such

    referenced contracts are physical-delivery or cash-settled) when

    calculating the trader's positions for purposes of the proposed single-

    month or all-months-combined position limits.\390\

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

    \390\ The Commission would allow traders to net positions in

    physical-delivery and cash-settled contracts outside the spot month

    because the Commission is less concerned about corners and squeezes

    outside the spot month. Permitting such netting will significantly

    reduce the number of traders with positions over the levels of non-

    spot month limits. The Commission discusses how many traders

    historically held positions over the levels of non-spot month limits

    below.

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

    The Commission also proposes to amend Sec. 150.2 by deleting the

    potentially ambiguous phrase ``separately or in combination.'' The

    Commission first proposed adding the phrase ``separately or in

    combination'' to Sec. 150.2 in 1992.\391\ While the text of current

    Sec. 150.2 could be read in context to apply limits to futures or

    option positions, separately or in combination, the preamble to that

    rulemaking proposal stated otherwise, indicating the Commission was

    proposing a ``unified approach'' to limits on futures and options

    positions combined.\392\ When considering at that time whether to

    extend the existing federal position limits on futures contracts also

    to option contracts (on a futures equivalent basis), the Commission

    explained that a unified futures and options level limit was ``more

    appropriate for several reasons'' than position limits on futures that

    are separate from position limits on options.\393\ Further, the

    Commission noted in the 1992 preamble that ``proposed Rule 150.2

    provides that `[n]o person may hold or control net long or net short

    positions in excess of the stated limits.'' \394\ Although the 1992

    preamble stated the limit rule was to apply on a net basis to futures

    and options combined, the regulatory text could be read to suggest a

    different approach, i.e., applying to futures or options on both a

    separate basis and a combined basis. The phrase ``separately or in

    combination'' was not discussed in any subsequent Federal Register

    notice.\395\

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

    \391\ See Revision of Federal Speculative Position Limits,

    Proposed Rules, 57 FR 12766, Apr. 13, 1992.

    \392\ Id. at 12768.

    \393\ Id. at 12769.

    \394\ Id. at 12770.

    \395\ Indeed, the Commission noted in 1993 when it adopted an

    interim final rule that ``as proposed, speculative position limits

    for both futures and options thereon are being combined into a

    single limit.'' See interim final rule at 58 FR 17973, Apr. 7, 1993.

    The Commission noted it ``proposed to unify speculative position

    limits for both futures and options thereon, reasoning that, because

    price movements in the two markets are highly related, the unified

    system more readily reflects the economic reality of a position in

    its totality. Moreover, unified speculative limits provide the

    trader with greater flexibility. Further, traders should find such a

    unified speculative position limit easier to use and to understand.

    Finally, as a consequence of the simpler structure, unified

    speculative position limits would be easier to administer, resulting

    in more accurate and timely market surveillance.'' Id. at 17974.

    In discussing comments on the 1992 proposed rule, the Commission

    noted an objection by a DCM to the proposed unified futures and

    options limits, preferring the DCM's proposed separate futures and

    options limits. Id. at 17976. The Commission discussed views of

    other commenters regarding the proposed ``unified limits.'' Id. at

    17977. The Commission concluded that it would adopt the unified

    limits, noting it ``will combine futures and option limits.'' The

    preamble also made clear the limits would not apply separately,

    noting further that ``because such positions would be netted

    automatically under a unified speculative position limit, the

    Commission is removing and reserving Sec. 150.3(a)(2) which exempts

    from Federal speculative position limits positions in option

    contracts which offset the futures positions.'' Id. at 17978-79.

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

    [[Page 75725]]

    c. Selection of Initial Commodity Derivative Contracts in Physical

    Commodities

    As discussed above, the Commission interprets the CEA to mandate

    position limits for futures contracts in physical commodities other

    than excluded commodities (i.e., position limits are required for

    futures contracts in agricultural and exempt commodities).

    The Commission is proposing a phased approach to implement the

    statutory mandate. The Commission is proposing in this release to

    establish speculative position limits on 28 core referenced futures

    contracts in physical commodities.\396\ The Commission anticipates that

    it will, in subsequent releases, propose to expand the list of core

    referenced futures contracts in physical commodities. The Commission

    believes that a phased approach will (i) reduce the potential

    administrative burden by not immediately imposing position limits on

    all commodity derivative contracts in physical commodities at once, and

    (ii) facilitate adoption of monitoring policies, procedures and systems

    by persons not currently subject to positions limits (such as traders

    in swaps that are not significant price discovery contracts).

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

    \396\ The 28 core referenced futures contracts are: Chicago

    Board of Trade Corn, Oats, Rough Rice, Soybeans, Soybean Meal,

    Soybean Oil and Wheat; Chicago Mercantile Exchange Feeder Cattle,

    Lean Hog, 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 Hard Winter Wheat (on September 6, 2013, CBOT and the Kansas

    City Board of Trade (``KCBT'') requested that the Commission permit

    the transfer to CBOT, effective December 9, of all contracts listed

    on the KCBT, and all associated open interest); Minneapolis Grain

    Exchange Hard Red Spring Wheat; and New York Mercantile Exchange

    Palladium, Platinum, Light Sweet Crude Oil, NY Harbor ULSD, RBOB

    Gasoline and Henry Hub Natural Gas.

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

    The Commission proposes, initially, to establish position limits on

    these 28 core referenced futures contracts, and related swap and

    futures contracts, on the basis that such contracts (i) have high

    levels of open interest \397\ and significant notional value of open

    interest \398\ or (ii) serve as a reference price for a significant

    number of cash market transactions.\399\ Thus, in the first phase, the

    Commission generally is proposing limits on those contracts that it

    believes are likely to play a larger role in interstate commerce than

    that played by other physical commodity derivative contracts.

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

    \397\ Open interest for this purpose is the sum of open

    contracts, as defined in Sec. 1.3(t), in futures contracts and in

    futures option contracts converted to a futures-equivalent amount,

    as defined in Sec. 150.1(f), and open swaps, as defined in Sec.

    20.1, on a future equivalent basis, as defined in Sec. 20.1, where

    such swaps are significant price discovery contracts as determined

    by the Commission under Sec. 36.3(d).

    \398\ Notional value of open interest for this purpose is open

    interest times the unit of trading for the relevant futures contract

    times the price of that futures contract.

    \399\ The Commission, in the vacated part 151 Rulemaking,

    selected for what was also intended as a first phase, the same 28

    core referenced futures contracts on the same basis. 76 FR at 71629.

    As was noted when part 151 was adopted, the 28 core referenced

    futures contracts were selected on the basis that such contracts:

    (1) had high levels of open interest and significant notional value;

    or (2) served as a reference price for a significant number of cash

    market transactions. Id.

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

    In selecting the list of 28 core referenced futures contracts in

    proposed Sec. 150.2(d), the Commission calculated the open interest

    and notional value of open interest for all futures, futures options,

    and significant price discovery contracts as of December 31, 2012 in

    all agricultural and exempt commodities. The Commission identified

    those commodities with the largest notional value of open interest and

    open interest for agricultural commodities, energy commodities, and

    metals commodities. The Commission then selected 16 agricultural

    commodities, 4 energy commodities, and 5 metals commodities. Once these

    commodities were selected, the Commission determined the most important

    futures contract, or contracts, within each commodity, generally by

    selecting the physical-delivery contracts with the highest levels of

    open interest, and deemed these as the core referenced futures

    contracts for which position limits would be established in this

    release. As such, the Commission proposes in this release to set

    position limits in 19 core referenced futures contracts for

    agricultural commodities, 4 core referenced futures contracts for

    energy commodities, and 5 core referenced futures contracts for metals

    commodities. The Commission currently sets limits for 9 legacy

    agricultural contracts under part 150.\400\

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

    \400\ 17 CFR 150.2.

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

    In selecting the 16 agricultural commodities, the Commission used

    oats as its baseline since oats has the lowest notional value of open

    interest and the lowest open interest among the 9 legacy agricultural

    contracts. Hence, the Commission selected all agricultural commodities

    that have notional value of open interest and open interest that exceed

    that of oats.\401\ The Commission has determined to defer consideration

    of speculative position limits on contracts in other agricultural

    commodities because the Commission must marshal its resources. The

    Commission anticipates that it will consider speculative position

    limits on contracts in other agricultural commodities in a subsequent

    rulemaking.

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

    \401\ While cheese has a notional value of open interest that is

    higher than oats, it has an open interest that is lower than that of

    oats (the open interest of the cheese contract was less than 10,000

    contracts as of year-end 2012). Furthermore, all futures and options

    contracts in cheese are on the same DCM (which currently has a

    single month position limit set at 1,000 contracts) and had no Large

    Trader Reporting for physical commodity swaps as reported under part

    20 during January 2013. The Commission intends to address cheese

    when it proposes, in subsequent releases, expansions to the list of

    referenced contracts in physical commodities.

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

    Table 6 below provides the notional value of open interest and open

    interest for agricultural contracts by type of commodity contract

    reported under the Commission's reporting rules.\402\ With respect to

    the type of commodity, it should be noted, for example, that ``wheat''

    refers to the general type of physical commodity, and includes

    contracts listed on three different DCMs.

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

    \402\ 17 CFR Part 16. Commission staff computed notional values

    of open interest from data reported under Sec. 16.01. Data reported

    under Sec. 16.01 includes significant price discovery contracts in

    compliance with core principle VI for exempt commercial markets,

    app. B to part 36.

    [[Page 75726]]

    Table 6--Largest Agricultural Commodities Ranked by Notional Value of Open Interest in Futures, Futures Options,

    and Significant Price Discovery Contracts, as of December 31, 2012

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

    Type and rank within type by Number of Notional value of

    notion value of open interest Commodity contracts open interest Open interest

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

    Agricultural:

    1............................. Soybeans............. 6 $54.07 billion....... 765,030

    2............................. Corn................. 6 $51.54 billion....... 1,545,135

    3............................. Wheat................ 10 $41.06 billion....... 767,006

    4............................. Sugar................ 5 $39.06 billion....... 896,082

    5............................. Live Cattle.......... 2 $19.91 billion....... 394,385

    6............................. Coffee............... 3 $13.89 billion....... 211,147

    7............................. Soybean Oil.......... 4 $11.01 billion....... 344,412

    8............................. Soybean Meal......... 2 $10.46 billion....... 253,361

    9............................. Cotton............... 3 $9.75 billion........ 234,367

    10............................ Lean Hogs............ 1 $9.68 billion........ 280,451

    11............................ Cocoa................ 1 $5.13 billion........ 218,224

    12............................ Feeder Cattle........ 1 $2.64 billion........ 34,816

    13............................ Milk................. 3 $1.45 billion........ 40,690

    14............................ Frozen Orange Juice.. 1 $609 million......... 29,652

    15............................ Rice................. 1 $445 million......... 14,783

    16............................ Cheese............... 2 $282 million......... 8,601

    17............................ Oats................. 1 $187 million......... 10,755

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

    For exempt commodity contracts, the Commission proposes to

    initially select the commodities in the energy and metals markets that

    have the largest open interest and notional value of interest. For

    metals, the Commission proposes to initially target the 5 largest

    commodities in terms of notional value of open interest, as listed in

    Table 7 below, and selected 1 core referenced futures contract for each

    of the 5 metals. In selecting these 5 core referenced futures

    contracts, the Commission would establish federal position limits on

    ninety-eight percent of the open interest in U.S. metals markets.

    The next largest commodity in metals after palladium in terms of

    notional value is iron ore, which has open interest that is about one-

    quarter that of palladium.\403\ Furthermore, there are less than 50

    reportable traders \404\ in iron ore, while in the 5 selected metals,

    each has more than 200 reportable traders. The Commission has

    determined to defer consideration of speculative position limits on

    contracts in iron ore and other metal commodities because the

    Commission must marshal its resources. The Commission anticipates that

    it will consider speculative position limits on contracts in iron ore

    and other metal commodities in a subsequent rulemaking.

    Table 7--Largest Metals Commodities by Notional Value of Open Interest in Futures, Futures Options, and

    Significant Price Discovery Contracts, as of December 31, 2012

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

    Type and rank within type by Number of Notional value of

    notion value of open interest Commodity contracts open interest Open interest

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

    Metals:

    1............................. Gold................. 6 $100.41 billion...... 604,853

    2............................. Silver............... 5 $27.77 billion....... 180,576

    3............................. Copper............... 3 $13.28 billion....... 146,865

    4............................. Platinum............. 1 $4.78 billion........ 61,467

    5............................. Palladium............ 1 $2.08 billion........ 32,293

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

    For energy commodities, the Commission similarly proposes to select

    the 4 largest commodities for this first phase of the expansion of

    speculative position limits and selected 1 core referenced futures

    contract in each of these 4 commodities. Each of these commodities has

    a notional value of open interest in excess of $40 billion.

    The fifth largest commodity in energy is electricity, and the

    Commission has determined to defer consideration of speculative

    position limits on contracts in electricity and other energy

    commodities because the Commission must marshal its resources. The

    Commission anticipates that it will consider speculative position

    limits on contracts in electricity and other energy commodities in a

    subsequent rulemaking.

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

    \403\ The open interest in iron ore futures, futures options,

    and significant price discovery contracts as of December 31, 2012,

    was 8,195 contracts and the notional value of open interest was

    $236.63 million.

    \404\ A reportable trader is a trader with a reportable position

    as defined in Sec. 15.00(p).

    [[Page 75727]]

    Table 8--Largest Energy Commodities by Notional Value of Open Interest in Futures, Futures Options, and

    Significant Price Discovery Contracts, as of December 31, 2012

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

    Type and rank within type by Number of Notional value of

    notion value of open interest Commodity contracts open interest Open interest

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

    Energy:

    1............................. Crude Oil............ 76 $516.42 billion...... 6,188,201

    2............................. Heating Oil/Diesel... 89 $470.69 billion...... 1,192,036

    3............................. Natural Gas.......... 216 $225.74 billion...... 21,335,777

    4............................. Gasoline............. 54 $46.13 billion....... 402,369

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

    d. Setting Levels of Spot-Month Limits

    Proposed Sec. 150.2(e)(1) establishes the initial levels of

    speculative position limits for each referenced contract at the levels

    listed in appendix D to this part. These levels would become effective

    60 days after publication in the Federal Register of a final rule

    adopted by the Commission. The Commission proposes to set the initial

    spot month position limit levels for referenced contracts at the

    existing DCM-set levels for the core referenced futures contracts

    because the Commission believes this approach is consistent with the

    regulatory objectives of the Dodd-Frank Act amendments to the CEA and

    many market participants are already used to these levels.\405\

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

    \405\ DCMs currently set spot-month position limits based on

    their own estimates of deliverable supply. Federal spot-month limits

    can, therefore, be implemented by the Commission relatively

    expeditiously.

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

    As an alternative to the initial spot month limits in proposed

    appendix D to part 150, the Commission is considering setting the

    initial spot month limits based on estimated deliverable supplies

    submitted by the CME Group in correspondence dated July 1, 2013.\406\

    Under this alternative, the Commission would use the exchange's

    estimated deliverable supplies and apply the 25 percent formula to set

    the level of the spot month limits in a final rule if the Commission

    verifies the exchange's estimated deliverable supplies are reasonable.

    For purposes of setting initial spot month limits in a final rule, in

    the event the Commission is not able to verify an exchange's estimated

    deliverable supply for any commodity as reasonable, then the Commission

    may determine to adopt the initial spot month limits in proposed

    appendix D for such commodity, or such higher level based on the

    Commission's estimated deliverable supply for such commodity, but not

    greater than would result from the exchange's estimated deliverable

    supply. The Commission requests comment on whether the initial spot

    month limits should be based on the exchange's July 1, 2013,

    estimations of deliverable supplies, once verified. The spot month

    limits that would result from the CME's estimated deliverable supplies

    are show in Table 9 below.

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

    \406\ Letter from Terrance A. Duffy, Executive Chairman and

    President, CME Group, to CFTC Chairman Gensler, Commissioner

    Chilton, Commissioner Sommers, Commissioner O'Malia, Commissioner

    Wetjen, and Division of Market Oversight Director Richard Shilts,

    dated July 1, 2013 (available at www.cftc.gov). The Commission notes

    the CME Group did not propose to set the level of spot month limits

    using the 25 percent formula in this letter.

    Table 9--Alternative Proposed Initial Spot Month Limit Levels for Certain Core Referenced Futures Contracts

    (Based on CME Group Estimates of Deliverable Supply Submitted to the Commission on July 1, 2013)

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

    Alternative

    proposed spot-

    month limit CME Group

    Current spot- (25% of CME Group deliverable deliverable

    Contract month limit deliverable supply estimate supply

    supply rounded estimate in

    up to the next contracts

    100 contracts)

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

    Legacy Agricultural

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

    Chicago Board of Trade Corn (C)....... 600 1,000 19,590,000 bushels...... 3,918

    Chicago Board of Trade Oats (O)....... 600 1,500 29,470,000 bushels...... 5,894

    Chicago Board of Trade Soybeans (S)... 600 1,200 23,900,000 bushels...... 4,780

    Chicago Board of Trade Soybean Meal 720 4,400 1,753,047 tons.......... 17,531

    (SM).

    Chicago Board of Trade Soybean Oil 540 5,300 1,253,000 lbs........... 20,883

    (SO).

    Chicago Board of Trade Wheat (W)...... 600 3,700 73,790,000 bushels...... 14,757

    Kansas City Board of Trade Hard Winter 600 4,100 81,710,000 bushels...... 16,342

    Wheat (KW).

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

    Other Agricultural

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

    Chicago Board of Trade Rough Rice (RR) 600 1,800 14,100,000 cwt.......... 7,050

    Chicago Mercantile Exchange Class III 1500 5,300 4,170,000,000 lbs....... 20,850

    Milk (DA).

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

    Energy

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

    New York Mercantile Exchange Henry Hub 1,000 3,900 154,200,000 mmBtu....... 15,420

    Natural Gas (NG).

    [[Page 75728]]

    New York Mercantile Exchange Light 3,000 12,100 48,100,000 barrels...... 48,100

    Sweet Crude Oil (CL).

    New York Mercantile Exchange NY Harbor 1,000 5,500 20,000,000 barrels...... 22,000

    ULSD (HO).

    New York Mercantile Exchange RBOB 1,000 7,300 29,000,000 barrels...... 29,000

    Gasoline (RB).

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

    Metal

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

    Commodity Exchange, Inc. Copper (HG).. 1,200 1,700 161,850,000 lbs......... 6,474

    Commodity Exchange, Inc. Gold (GC).... 3,000 27,300 10,911,100 troy ounces.. 109,111

    Commodity Exchange, Inc. Silver (SI).. 1,500 5,700 113,375,000 troy ounces. 22,675

    New York Mercantile Exchange Palladium 650 1,500 578,900 troy ounces..... 5,789

    (PA).

    New York Mercantile Exchange Platinum 500 800 152,150 troy ounces..... 3,043

    (PL).

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

    The Commission is considering a further alternative to setting the

    spot month limit at a level based on 25 percent of estimated

    deliverable supply. This alternative would permit the Commission, in

    its discretion, both for setting an initial spot month limit and

    subsequent resets, to use the recommended level, if any, of the spot

    month limit as submitted by each DCM listing a CRFC (if lower than 25

    percent of estimated deliverable supply). Under this alternative, the

    Commission would have discretion to set the level of any spot month

    limit to the DCM's recommended level, a level corresponding to 25

    percent of estimated deliverable supply, or a level in proposed

    appendix D. The Commission requests comment on all aspects of this

    alternative. Specifically, is the Commission's discretion in

    administering levels of spot month limits appropriately constrained by

    the choice, in its discretion, of the DCM's recommended level or the

    level corresponding to 25 percent of deliverable supply or a level in

    proposed appendix D?

    Proposed Sec. 150.2(e)(3) explains how the Commission will

    calculate spot month position limit levels. The Commission proposes to

    fix the levels of the spot-month limits for referenced contracts based

    on one-quarter of the estimated spot-month deliverable supply in the

    relevant core referenced futures contract, no less frequently than

    every two calendar years.\407\ Under the proposal, each DCM listing a

    core referenced futures contract would be required to report to the

    Commission an estimate of spot-month deliverable supply, accompanied by

    a description of the methodology used to derive the estimate and any

    statistical data supporting the estimate.\408\ Proposed Sec.

    150.2(e)(3) provides a cross-reference to appendix C to part 38 for

    guidance on how to estimate deliverable supply.\409\ The Commission

    proposes to utilize the estimated spot-month deliverable supply

    provided by a DCM unless the Commission decides to rely on its own

    estimate of deliverable supply.

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

    \407\ Federal spot month limits have historically been set at

    one-quarter of estimated deliverable supply. See, e.g., 64 FR 24038,

    24041, May 5, 1999. Further, current guidance on complying with DCM

    core principle 5 calls for spot month levels to be set at ``no

    greater than one-quarter of the estimated spot month deliverable

    supply. . . .'' 17 CFR 150.5(c)(1).

    \408\ The timing for submission of such reports varies by

    commodity type--see proposed Sec. 150.2(e)(ii)(A)-(D).

    \409\ See 17 CFR part 38, appendix C, at section (b)(1)(i).

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

    The Commission proposes to update spot-month limits every two years

    for each of the 28 referenced contracts, and to stagger the dates on

    which DCMs must submit estimates of deliverable supply. The Commission

    has re-evaluated data on the frequency with which DCMs historically

    have changed the levels of spot month limits in the 28 physical-

    delivery core referenced futures contracts. Given the low frequency of

    changes to DCM spot month limits, the Commission has reconsidered

    requiring annual updates for referenced contracts in agricultural

    commodities.\410\ When compared with annual updates to the spot month

    position limits, biennial updates would reduce the burden on market

    participants in updating speculative position limit monitoring

    systems.\411\

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

    \410\ In any event, core principle 5 in section 5(d)(5) of the

    Act imposes a continuing obligation on a DCM, where the DCM has set

    a position limit as necessary and appropriate, to ensure levels of

    position limits are set to reduce the potential threat of market

    manipulation or congestion (especially during the spot month). 7

    U.S.C. 7(d)(5). Thus, a DCM appropriately would reduce the level of

    its exchange-set spot month limit if the level of deliverable supply

    declined significantly. Core principle 6 in section 5h(f)(6) of the

    Act imposes a similar obligation on a SEF that is a trading

    facility. 7 U.S.C. 7b-3(f)(6).

    \411\ Proposed Sec. 150.2(e)(3) also provides the Commission

    with flexibility to reset spot month position limits more frequently

    than every two years, but the proposed rule would require DCMs to

    submit estimated deliverable supplies only every two years. This

    means, for example, that a DCM may with discretion provide the

    Commission with updated estimated deliverable supplies and petition

    the Commission to reset spot month limits more frequently than every

    two years. Similarly, proposed Sec. 150.2(e)(4) provides the

    Commission with flexibility to change non-spot month position limits

    more frequently than every two years. This means, for example, that

    a DCM may petition the Commission to reset non-spot month position

    limits based on the most recent calendar-year's open interest.

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

    The term ``estimated deliverable supply'' means the amount of a

    commodity that can reasonably be expected to be readily available to

    short traders to make delivery at the

    [[Page 75729]]

    expiration of a futures contract.\412\ The use of estimated deliverable

    supply to set spot-month limits is wholly consistent with DCM core

    principles 3 and 5.\413\ Currently, in determining whether a physical-

    delivery contract complies with core principle 3, the Commission

    considers whether the specified contract terms and conditions may

    result in an estimated deliverable supply that is sufficient to ensure

    that the contract is not readily susceptible to price manipulation or

    distortion. The Commission has previously indicated that it would be an

    acceptable practice for a DCM to set spot-month limits pursuant to core

    principle 5 based on an analysis of estimated deliverable

    supplies.\414\ Accordingly, the Commission is adopting estimated

    deliverable supply as the basis of setting spot-month limits.

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

    \412\ As part of its recently published guidance for complying

    with DCM core principle 3, the Commission provided guidance on how

    to calculate deliverable supplies in appendix C to part 38 (at

    paragraph (b)(1)(i)). 77 FR 36612, 36722, Jun. 19, 2012. Typically,

    deliverable supply reflects the quantity of the commodity that

    potentially could be made available for sale on a spot basis at

    current prices at the contract's delivery points. For a physical-

    delivery commodity contract, this estimate might represent product

    which is in storage at the delivery point(s) specified in the

    futures contract or can be moved economically into or through such

    points consistent with the delivery procedures set forth in the

    contract and which is available for sale on a spot basis within the

    marketing channels that normally are tributary to the delivery

    point(s).

    \413\ DCM core principle 3 specifies that a board of trade shall

    list only contracts that are not readily susceptible to

    manipulation. See CEA section 5(d)(3); 7 U.S.C. 7(d)(3). DCM core

    principle 5 (discussed in detail below) requires 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.''

    CEA section 5(d)(5); 7 USC 7(d)(5). See also guidance and discussion

    of estimated deliverable supply in Core Principles and Other

    Requirements for Designated Contract Markets, Final Rule, 77 FR

    36612, 36722, Jun. 19, 2012.

    \414\ See 17 CFR 150.5(b).

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

    The Commission proposes to adopt the 25 percent level of estimated

    deliverable supply for setting spot-month limits because, based on the

    Commission's surveillance and enforcement experience, this formula

    narrowly targets the trading that may be most susceptible to, or likely

    to facilitate, price disruptions. The Commission believes this spot

    month limit formula best maximizes the statutory objectives expressed

    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. This formula is consistent

    with the longstanding acceptable practices for DCM core principle 5

    which provide that, for physical-delivery contracts, the spot-month

    limit should not exceed 25 percent of the estimated deliverable

    supply.\415\ The Commission believes, based on its experience and

    expertise, that the formula would be an effective prophylactic tool to

    reduce the threat of corners and squeezes, and promote convergence

    without compromising market liquidity.\416\

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

    \415\ Id.

    \416\ The Commission also has established requirements for a DCM

    to monitor a physical-delivery contract's terms and conditions as

    they relate to the convergence between the futures contract price

    and the cash price of the underlying commodity. 17 CFR 38.252. See

    the preamble discussion of Sec. 38.252 in the final part 38

    rulemaking. 77 FR 36612, 36635, June 19, 2012. The spot month limits

    will be set at levels that target only extraordinarily large

    traders. For example, the spot month limit for CBOT Wheat will be

    set at 600 contracts. The contract size for CBOT Wheat is 5,000

    bushels (~136 metric tons). The current price of a bushel of wheat

    is approximately $7 per bushel. Therefore, a speculative trader

    would be permitted to carry a ~$21 million position in wheat into

    the spot month under the proposed position limits regime.

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

    Furthermore, the Commission has observed generally low usage among

    all traders of the physical-delivery futures contract during the spot

    month, relative to the existing exchange spot-month position limits.

    Thus, the Commission infers that few, if any, traders offset the risk

    of swaps in physical-delivery futures contracts during the spot month

    with positions in excess of the exchange's current spot month

    limits.\417\ The Commission invites comments as to the extent to which

    traders actually have offset the risk of swaps during the spot month in

    a physical-delivery futures contract with a position in excess of an

    exchange's spot-month position limit.

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

    \417\ See 76 FR at 71635 (n. 100-01) (discussing data in CME

    natural gas contract).

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

    Additionally, the Commission imposes spot-month limits using the

    same formula to restrict the size of positions in cash-settled

    contracts that would potentially benefit from a trader's distortion of

    the price of the underlying referenced contract (or other cash price

    series) that serves as the basis of cash settlement.\418\ The

    Commission has found that traders with positions in look-alike cash-

    settled contracts have an incentive to manipulate and undermine price

    discovery in the physical-delivery contract to which the cash-settled

    contract is linked by price. This practice is known as ``banging'' or

    ``marking the close,'' \419\ a manipulative practice that the

    Commission prosecutes and that this proposal seeks to prevent.\420\

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

    \418\ The Commission also has established requirements for DCMs

    to monitor the pricing of cash-settled contracts. 17 CFR 38.253.

    \419\ Section 4c(a)(5) of the Act lists certain unlawful

    disruptive trading practices, including ``any trading, practice, or

    conduct on or subject to the rules of a registered entity that . . .

    demonstrates intentional or reckless disregard for the orderly

    execution of transactions during the closing period.'' 7 U.S.C.

    6c(a)(5)(B). ``Banging'' or ``marking the close'' is discussed in

    the Commission's Antidisruptive Practices Authority, Interpretive

    guidance and policy statement, 78 FR 31890, 31894-96, May 28, 2013.

    \420\ See, e.g., DiPlacido v. CFTC, 364 Fed. Appx. 657 (2d Cir.

    2009) (upholding Commission finding that DiPlacido manipulated the

    market where DiPlacido's closing trades accounted for 14% of the

    market).

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

    In the final part 38 rulemaking, the Commission instructed DCMs,

    when estimating deliverable supplies, to take into consideration the

    individual characteristics of the underlying commodity's supply and the

    specific delivery features of the futures contract.\421\ In this

    regard, the Commission notes that DCMs historically have set or

    maintained exchange spot month limits at levels below 25 percent of

    deliverable supply. Setting such a lower level of a spot month limit

    may also serve the objectives of preventing excessive speculation,

    manipulation, squeezes and corners, while ensuring sufficient market

    liquidity for bona fide hedgers in the view of the listing DCM and

    ensuring the price discovery function of the market is not disrupted.

    Hence, the Commission observes that there may be a range of spot month

    limits, including limits set at levels below 25 percent of deliverable

    supply, which may serve as practicable to maximize these policy

    objectives.

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

    \421\ See 77 FR 36611, 36723, Jun. 12, 2012. DCM estimates of

    deliverable supplies (and the supporting data and analysis) will

    continue to be subject to Commission review.

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

    e. Setting Levels of Single-Month and All-Months-Combined Limits

    Proposed Sec. 150.2(e)(4) explains how the Commission would

    calculate non-spot-month position limit levels, which the Commission

    proposes to fix no less frequently than every two calendar years. In

    contrast to spot month position limits which are set as a function of

    estimated deliverable supply, 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 level will be set

    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.\422\

    The Commission has used the 10, 2.5 percent formula in administering

    the level of the legacy all-

    [[Page 75730]]

    months position limits since 1999.\423\ The Commission believes the

    non-spot month position limits would restrict the market power of a

    speculator that could otherwise be used to cause unwarranted price

    movements. The Commission solicits comment on its single-month and all-

    months-combined limits, including whether the proposed formula has

    effectively addressed and will continue to address the Sec. 4a(a)(3)

    regulatory objectives.

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

    \422\ The Commission proposes to use the futures position limits

    formula (the 10, 2.5 percent formula) to determine non-spot-month

    position limits for referenced contracts. The 10, 2.5 percent

    formula is identified in 17 CFR 150.5(c)(2).

    \423\ See 64 FR 24038, 24039, May 5, 1999. The Commission

    applies the open interest criterion by using a formula that

    specifies appropriate increases to the limit level as a percentage

    of open interest. As the total open interest of a futures market

    increases, speculative position limit levels can be raised. The

    Commission proposed using the 10, 2.5 percent formula in 1992. See

    Revision of Federal Speculative Position Limits, Proposed Rules, 57

    FR 12766, 12770, Apr. 13, 1992. The Commission implemented the 10,

    2.5 percent formula in two steps, the first step in 1993 and the

    second step in 1999. See Revision of Federal Speculative Limits,

    Interim Final Rules, 58 FR 17973, 17978, Apr. 7, 1993. See also

    Establishment of Speculative Position Limits, 46 FR 50938, Oct. 16,

    1981 (``[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.'').

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

    The Commission also proposes to estimate average open interest in

    referenced contracts based on the largest annual average open interest

    computed for each of the past two calendar years, using either month-

    end open contracts or open contracts for each business day in the time

    period, as the Commission finds in its discretion to be reliable.

    (1) Initial Levels

    For setting the levels of initial non-spot month limits, the

    Commission proposes to use open interest for calendar years 2011 and

    2012 in futures contracts, options thereon, and in swaps that are

    significant price discovery contracts that are traded on exempt

    commercial markets.

    Table 10--Open Interest and Calculated Limits by Core Futures Referenced Contract, January 1, 2011, to December 31, 2012

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

    Open

    Core referenced futures interest Open Limit Limit

    Commodity type contract Year (daily interest (daily (month end) Limit

    average) (month end) average)

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

    Legacy Agricultural.................. CBOT Corn (C)........... 2011 2,063,231 1,987,152 53,500 51,600 53,500

    ........................ 2012 1,773,525 1,726,096 46,300 45,100

    CBOT Oats (O)........... 2011 15,375 15,149 1,600 1,600 1,600

    ........................ 2012 12,291 11,982 1,300 1,200

    CBOT Soybeans (S)....... 2011 822,046 798,417 22,500 21,900 26,900

    ........................ 2012 997,736 973,672 26,900 26,300

    CBOT Soybean Meal (SM).. 2011 237,753 235,945 7,900 7,800 9,000

    ........................ 2012 283,304 281,480 9,000 9,000

    CBOT Soybean Oil (SO)... 2011 392,658 382,100 11,700 11,500 11,900

    ........................ 2012 397,549 388,417 11,900 11,600

    CBOT Wheat (W).......... 2011 565,459 550,251 16,100 15,700 16,200

    ........................ 2012 572,068 565,490 16,200 16,100

    ICE Cotton No. 2 (CT)... 2011 275,799 272,613 8,800 8,700 8,800

    ........................ 2012 259,608 261,789 8,400 8,500

    KCBT Hard Winter Wheat 2011 183,400 177,998 6,500 6,400 6,500

    (KW).

    ........................ 2012 155,540 155,074 5,800 5,800

    MGEX Hard Red Spring 2011 55,938 54,546 3,300 3,300 3,300

    Wheat (MWE).

    ........................ 2012 40,577 40,314 2,900 2,900

    Other Agricultural................... CBOT Rough Rice (RR).... 2011 21,788 21,606 2,200 2,200 2,200

    ........................ 2012 15,262 14,964 1,600 1,500

    CME Milk Class III (DA). 2011 55,567 57,490 3,300 3,400 3,400

    ........................ 2012 47,378 47,064 3,100 3,100

    CME Feeder Cattle (FC).. 2011 44,611 43,730 3,000 3,000 3,000

    ........................ 2012 44,984 43,651 3,000 3,000

    CME Lean Hog (LH)....... 2011 284,211 288,281 9,000 9,100 9,400

    ........................ 2012 296,822 297,882 9,300 9,400

    CME Live Cattle (LC).... 2011 433,581 440,229 12,800 12,900 12,900

    ........................ 2012 409,501 417,037 12,200 12,400

    ICUS Cocoa (CC)......... 2011 191,801 198,290 6,700 6,900 7,100

    ........................ 2012 202,886 206,808 7,000 7,100

    ICE Coffee C (KC)....... 2011 174,845 176,079 6,300 6,300 7,100

    ........................ 2012 204,268 207,403 7,000 7,100

    ICE FCOJ-A (OJ)......... 2011 37,347 36,813 2,900 2,800 2,900

    ........................ 2012 30,788 29,867 2,700 2,700

    ICE Sugar No. 11 (SB)... 2011 814,234 806,887 22,300 22,100 23,500

    ........................ 2012 855,375 862,446 23,300 23,500

    ICE Sugar No. 16 (SF)... 2011 11,532 11,662 1,200 1,200 1,200

    ........................ 2012 10,485 10,530 1,100 1,100

    Energy............................... NYMEX Henry Hub Natural 2011 4,831,973 4,821,859 122,700 122,500 149,600

    Gas (NG).

    ........................ 2012 5,905,137 5,866,365 149,600 148,600

    NYMEX Light Sweet Crude 2011 4,214,770 4,291,662 107,300 109,200 109,200

    Oil (CL).

    ........................ 2012 3,720,590 3,804,287 94,900 97,000

    NYMEX NY Harbor ULSD 2011 559,280 566,600 15,900 16,100 16,100

    (HO).

    ........................ 2012 473,004 485,468 13,800 14,100

    [[Page 75731]]

    NYMEX RBOB Gasoline (RB) 2011 362,349 370,207 11,000 11,200 11,800

    ........................ 2012 388,479 393,219 11,600 11,800

    Metals............................... COMEX Copper (HG)....... 2011 134,097 131,688 5,300 5,200 5,600

    ........................ 2012 148,767 147,187 5,600 5,600

    COMEX Gold (GC)......... 2011 782,793 746,904 21,500 20,600 21,500

    ........................ 2012 685,618 668,751 19,100 18,600

    COMEX Silver (SI)....... 2011 179,393 172,567 6,400 6,200 6,400

    ........................ 2012 165,670 164,064 6,100 6,000

    NYMEX Palladium (PA).... 2011 22,327 22,244 2,300 2,300 5,000

    ........................ 2012 23,869 24,265 2,400 2,500

    NYMEX Platinum (PL)..... 2011 40,988 40,750 2,900 2,900 5,000

    ........................ 2012 54,838 54,849 3,300 3,300

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

    Given the levels of open interest for the calendar years of 2011

    and 2012 for futures contracts and for swaps that are significant price

    discovery contracts traded on exempt commercial markets, this formula

    would result in levels for non-spot month position limits that are high

    in comparison to the size of positions typically held in futures

    contracts.\424\ Few persons held positions over the levels of the

    proposed position limits in the past two calendar years, as illustrated

    in Table 11 below. To provide the public with additional information

    regarding the number of large position holders in the past two calendar

    years, the table also provides counts of persons over 60, 80, 100, and

    500 percent of the levels of the proposed position limits. Note that

    the 500 percent line is omitted from Table 11 where no person held a

    position over that level.

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

    \424\ A review of preliminary swap open interest reported under

    part 20 indicates that open interest in swap referenced contracts is

    low, in comparison to futures open interest. Any open interest in

    swap referenced contracts would serve to increase the levels of the

    positions limits.

    Table 11--Unique Persons Over Percentages of Proposed Position Limit Levels, January 1, 2011, to December 31,

    2012

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

    Unique persons over level

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

    Commodity type/core referenced Percent of Spot month

    futures contract level (physical- Spot month Single month All months

    delivery) (cash-settled)

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

    Legacy Agricultural

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

    CBOT Corn (C)................... 60 243 4 9 16

    80 167 * 6 8

    100 53 * * 5

    500 7 .............. .............. ..............

    CBOT Oats (O)................... 60 5 .............. 15 15

    80 4 .............. 8 9

    100 * .............. 6 8

    CBOT Soybeans (S)............... 60 119 .............. 14 17

    80 88 .............. 9 12

    100 27 .............. 6 8

    500 9 .............. .............. ..............

    CBOT Soybean Meal (SM).......... 60 52 * 20 35

    80 32 * 9 16

    100 12 * 6 9

    CBOT Soybean Oil (SO)........... 60 114 .............. 31 37

    80 70 .............. 15 20

    100 20 .............. 10 12

    500 * .............. .............. ..............

    CBOT Wheat (W).................. 60 46 .............. 22 32

    80 31 .............. 14 16

    100 14 .............. 9 12

    500 * .............. .............. ..............

    ICE Cotton No. 2 (CT)........... 60 12 .............. 16 19

    80 7 .............. 11 14

    100 6 .............. 9 11

    500 * .............. .............. ..............

    KCBT Hard Winter Wheat (KW)..... 60 33 .............. 36 40

    80 18 .............. 13 21

    100 14 .............. 9 13

    500 * .............. .............. ..............

    MGEX Hard Red Spring Wheat (MWE) 60 11 .............. 17 24

    80 10 .............. 11 15

    100 6 .............. 9 9

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

    [[Page 75732]]

    Other Agricultural

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

    CBOT Rough Rice (RR)............ 60 9 .............. 7 9

    80 6 .............. 5 5

    100 .............. .............. * *

    CME Milk Class III (DA)......... 60 NA 6 * 19

    80 NA 4 .............. 14

    100 NA * .............. 7

    CME Feeder Cattle (FC).......... 60 NA 76 4 13

    80 NA 55 * 7

    100 NA 16 * *

    CME Lean Hog (LH)............... 60 NA 52 20 30

    80 NA 41 11 18

    100 NA 28 7 13

    500 NA * .............. ..............

    CME Live Cattle (LC)............ 60 37 .............. 13 27

    80 * .............. 7 17

    100 * .............. 4 12

    ICUS Cocoa (CC)................. 60 * .............. 24 29

    80 * .............. 14 18

    100 * .............. 10 12

    ICE Coffee C (KC)............... 60 14 .............. 19 24

    80 13 .............. 8 14

    100 8 .............. 5 6

    500 2 .............. .............. ..............

    ICE FCOJ-A (OJ)................. 60 8 .............. 13 16

    80 7 .............. 9 9

    100 6 .............. 6 7

    ICE Sugar No. 11 (SB)........... 60 33 .............. 28 31

    80 23 .............. 20 24

    100 15 .............. 12 18

    500 * .............. .............. ..............

    ICE Sugar No. 16 (SF)........... 60 6 .............. 10 16

    80 5 .............. 7 14

    100 5 .............. 7 13

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

    Energy

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

    NYMEX Henry Hub Natural Gas (NG) 60 177 221 * 5

    80 131 183 .............. ..............

    100 61 148 .............. ..............

    500 .............. 35 .............. ..............

    NYMEX Light Sweet Crude Oil (CL) 60 98 89 .............. 4

    80 72 62 .............. *

    100 39 33 .............. *

    500 .............. .............. .............. ..............

    NYMEX NY Harbor ULSD (HO)....... 60 76 45 9 18

    80 53 35 6 15

    100 33 24 5 8

    500 .............. * .............. ..............

    NYMEX RBOB Gasoline (RB)........ 60 71 45 21 30

    80 48 32 12 16

    100 30 22 7 11

    500 .............. * .............. ..............

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

    Metals

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

    COMEX Copper (HG)............... 60 14 .............. 29 28

    80 13 .............. 21 22

    100 * .............. 16 16

    COMEX Gold (GC)................. 60 13 .............. 24 21

    80 9 .............. 19 19

    100 5 .............. 12 12

    COMEX Silver (SI)............... 60 5 .............. 25 21

    80 * .............. 15 13

    100 * .............. 10 9

    NYMEX Palladium (PA)............ 60 6 .............. 5 5

    80 * .............. * *

    [[Page 75733]]

    100 * .............. * *

    NYMEX Platinum (PL)............. 60 11 .............. 15 18

    80 5 .............. 11 12

    100 * .............. 9 10

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

    Legend:

    * means fewer than 4 unique owners exceeded the level.

    -- means no unique owners exceeded the level.

    NA means not applicable.\425\

    The Commission has also reviewed preliminary data submitted to it

    under part 20. The Commission preliminarily has decided not to use the

    data currently reported under part 20 for purposes of setting the

    initial levels of the proposed single month and all-months-combined

    positions limits. Instead, the Commission is proposing to set initial

    levels based on open interest in futures, options on futures, and SPDC

    swaps. Thus, the proposed initial levels represent lower bounds for the

    initial levels the Commission may establish in final rules. The

    Commission is providing the public with average open positions reported

    under part 20 for the month of January 2013, in the table below. As

    discussed below, the data reported during the month of January 2013,

    reflected improved data reporting quality. However, the Commission is

    concerned that the longer time series of this data has been less

    reliable and thus has not used it for purposes of setting proposed

    initial position limit levels.

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

    \425\ Table notes: (1) Aggregation exemptions were not used in

    computing the counts of unique persons; (2) the position data was

    for futures, futures options and swaps that are significant price

    discovery contracts (SPDCs).

    Table 12--Swaps Reported Under Part 20--Average Daily Open Positions,

    Futures Equivalent, January 2013

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

    Uncleared

    Covered swap contract swaps Cleared swaps

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

    Chicago Board of Trade (``CBOT'') Corn.. 110,533 3,060

    CBOT Ethanol............................ * 15,905

    CBOT Oats............................... .............. ..............

    CBOT Rough Rice......................... .............. ..............

    CBOT Soybean Meal....................... 20,594 ..............

    CBOT Soybean Oil........................ 35,760 ..............

    CBOT Soybeans........................... 39,883 1,306

    CBOT Wheat.............................. 64,805 2,856

    Chicago Mercantile Exchange (``CME'') .............. ..............

    Butter.................................

    CME Cheese.............................. .............. ..............

    CME Dry Whey............................ .............. ..............

    CME Feeder Cattle....................... * ..............

    CME Hardwood Pulp....................... .............. ..............

    CME Lean Hog............................ 12,809 ..............

    CME Live Cattle......................... 17,617 ..............

    CME Milk Class III...................... .............. ..............

    CME Non Fat Dry Milk.................... .............. ..............

    CME Random Length Lumbar................ .............. ..............

    CME Softwood Pulp....................... .............. ..............

    Commodity Exchange, Inc. (``COMEX'') 9,259 ..............

    Copper Grade No. 1.....................

    COMEX Gold.............................. 38,295 ..............

    COMEX Silver............................ 5,753 ..............

    ICE Futures U.S. (``ICE'') Cocoa........ 8,933 ..............

    ICE Coffee C............................ 3,465 ..............

    ICE Cotton No. 2........................ 14,627 ..............

    ICE Frozen Concentrated Orange Juice.... * ..............

    ICE Sugar No. 11........................ 287,434 ..............

    ICE Sugar No. 16........................ .............. ..............

    Kansas City Board of Trade (``KCBT'') 2,565 ..............

    Wheat..................................

    Minneapolis Grain Exchange (``MGEX'') 2,419 ..............

    Wheat..................................

    NYSE LIFFE (``NYL'') Gold, 100 Troy Oz.. .............. ..............

    NYL Silver, 5000 Troy Oz................ .............. ..............

    New York Mercantile Exchange (``NYMEX'') .............. ..............

    Cocoa..................................

    NYMEX Brent Financial................... 93,825 ..............

    NYMEX Central Appalachian Coal.......... .............. ..............

    NYMEX Coffee............................ 2,320 ..............

    NYMEX Cotton............................ 8,315 ..............

    [[Page 75734]]

    NYMEX Crude Oil, Light Sweet............ 507,710 ..............

    NYMEX Gasoline Blendstock (RBOB)........ 10,110 ..............

    NYMEX Hot Rolled Coil Steel............. * ..............

    NYMEX Natural Gas....................... 1,060,468 96,057

    NYMEX No. 2 Heating Oil, New York Harbor 35,126 ..............

    NYMEX Palladium......................... * ..............

    NYMEX Platinum.......................... * ..............

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

    Legend:

    * means fewer than 1,000 futures equivalent contracts reported in the

    category.

    Leaders mean no contracts reported.

    The part 20 data are comprised of positions resulting from cleared

    and uncleared swaps, which are reported by different reporting

    entities. Clearing members of derivative clearing organizations

    (``DCOs'') have reported paired swap positions in cleared swaps since

    November 11, 2011, and paired swap positions in uncleared swaps since

    January 20, 2012. DCOs have also reported aggregate positions of each

    clearing member's house and customer accounts for each paired swap

    since November 11, 2011. Data reports submitted by clearing members

    have had various errors (e.g., duplicate records, inconsistent

    reporting of data fields)--Commission staff continues to work with

    these reporting entities to improve data reporting.

    Beginning March 1, 2013, swap dealers that were not clearing

    members were required to submit data reports under Sec. 20.4(c).

    Additionally, some swap dealers began reporting such data voluntarily

    prior to March 1, 2013.\426\ As these new reporters submitted position

    data reports, the Commission observed a substantial increase in open

    interest for uncleared swaps that appeared unreasonable; it became

    apparent that part of this increase was caused by data reporting

    errors.\427\ The Commission believes it would be difficult to

    distinguish the true level of open interest because some reporting

    errors may cause open interest to be underestimated while others may

    cause open interest to be overestimated.

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

    \426\ Further, other firms have begun to report under part 20

    after March 1, 2013, following registration as swap dealers.

    \427\ For example, reported total open interest in swaps, both

    cleared and uncleared, linked to or based on NYMEX Natural Gas

    futures contracts averaged approximately 1.2 million contracts

    between January 1, 2013 and March 1, 2013 and approximately 97

    million contracts between March 1 and May 31, 2013 (with a peak

    value close to 300 million contracts).

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

    Alternatively, the Commission is considering using part 20 data,

    should it determine such data to be reliable, in order to establish

    higher initial levels in a final rule.\428\ Further, the Commission is

    considering using data from swaps data repositories, as practicable. In

    either case, the Commission is considering excluding inter-affiliate

    swaps, since such swaps would tend to inflate open interest.

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

    \428\ Several reporting entities have submitted data that

    contained stark errors. For example, certain reporting entities

    submitted position sizes that the Commission determined to be 1000

    times, or even 10,000 times, too large.

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

    Based on the forgoing, the Commission believes the initial levels

    proposed herein should ensure adequate liquidity for hedges yet

    nevertheless prevent a speculative trader from acquiring excessively

    large positions above the limits, and thereby help to prevent excessive

    speculation and to deter and prevent market manipulation.

    (2) Subsequent Levels

    For setting subsequent levels of non-spot month limits, the

    Commission proposes to estimate average open interest in referenced

    contracts using data reported by DCMs and SEFs pursuant to parts 16,

    20, and/or 45.\429\ While the Commission does not currently possess all

    data needed to fully enforce the position limits proposed herein, the

    Commission believes that it should have adequate data to reset the

    overall concentration-based percentages for the position limits two

    years after initial levels are set.\430\ The Commission intends to use

    comprehensive positional data on physical commodity swaps once such

    data is collected by swap data repositories under part 45, and would

    convert such data to futures-equivalent open positions in order to fix

    numerical position limits through the application of the proposed open-

    interest-based position limit formula. The resultant limits are

    purposely designed to be high enough to ensure sufficient liquidity for

    bona fide hedgers and to avoid disrupting the price discovery process

    given the limited information the Commission has with respect to the

    size of the physical commodity swap markets, including preliminary data

    collected under part 20 as of January 2013. The Commission further

    proposes to publish on the Commission's Web page such estimates of

    average open interest in referenced contracts on a monthly basis to

    make it easier for market participants to estimate changes in levels of

    position limits.

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

    \429\ Options listed on DCMs would be adjusted using an option

    delta reported to the Commission pursuant to 17 CFR part 16; swaps

    would be counted on a futures equivalent basis, equal to the

    economically equivalent amount of core referenced futures contracts

    reported pursuant to 17 CFR part 20 or as calculated by the

    Commission using swap data collected pursuant to17 CFR part 45.

    \430\ While the Commission has access to some data on physical-

    commodity swaps from swaps data repositories, the Commission

    continues to work with SDRs and other market participants to fully

    implement the swaps data reporting regime.

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

    f. Grandfather of Pre-Existing Positions

    The Commission proposes in new Sec. 150.2(f)(2) to conditionally

    exempt from federal non-spot-month speculative position limits any

    referenced contract position acquired by a person in good faith prior

    to the effective date of such limit, provided that such pre-existing

    referenced contract position is attributed to the person if such

    person's position is increased after the effective date of such

    limit.\431\ This conditional exemption for pre-existing positions is

    consistent with the provisions of CEA section 4a(b)(2) in

    [[Page 75735]]

    that it is designed to phase in position limits without significant

    market disruption, while attributing such pre-existing positions to the

    person if such person's position is increased after the effective date

    of a position limit is consistent with the provisions of CEA section

    22(a)(5)(B). Notwithstanding this exemption for pre-existing positions

    in non-spot months, proposed Sec. 150.2(f)(1) would require a person

    holding a pre-existing referenced contract position (in a commodity

    derivative contract other than a pre-enactment and transition period

    swaps as defined in proposed Sec. 150.1) to comply with spot month

    speculative position limits.\432\ The Commission remains particularly

    concerned about protecting the spot month in physical-delivery futures

    contracts from squeezes and corners.

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

    \431\ Such pre-existing positions 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 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. 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.

    \432\ Nothing in proposed Sec. 150.2(f) would override the

    exemption set forth in proposed Sec. 150.3(d) for pre-enactment and

    transition period swaps from speculative position limits. See

    discussion of proposed Sec. 150.3(d) below.

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

    Proposed Sec. 150.2(g) would apply position limits to foreign

    board of trade (``FBOT'') contracts that are both: (1) Linked

    contracts, that is, a contract that settles against the price

    (including the daily or final settlement price) of one or more

    contracts listed for trading on a DCM or SEF; and (2) direct-access

    contracts, that is, the FBOT makes the contract available in the United

    States through direct access to its electronic trading and order

    matching system through registration as an FBOT or via a staff no

    action letter.\433\ Proposed Sec. 150.2(g) is consistent with CEA

    section 4a(a)(6)(B), which directs the Commission to apply aggregate

    position limits to FBOT linked, direct-access contracts.\434\

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

    \433\ Proposed Sec. 150.2(g) is identical in substance to

    vacated Sec. 151.8. Compare 76 FR 71693.

    \434\ See supra discussion of CEA section 4a(a)(6) concerning

    aggregate position limits and the treatment of FBOT contracts.

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

    3. Section 150.3--Exemptions

    i. Current Sec. 150.3

    CEA section 4a(c)(1) exempts bona fide hedging transactions or

    positions, which terms are to be defined by the Commission, from any

    rule promulgated by the Commission under CEA section 4a concerning

    speculative position limits.\435\ Current Sec. 150.3, adopted by the

    Commission before the Dodd-Frank Act was enacted, contains an exemption

    from federal position limits for bona fide hedging transactions.\436\

    Additionally, Dodd-Frank added section 4a(a)(7) to the CEA, which gives

    the Commission authority to provide exemptions from any requirement the

    Commission establishes under section 4a with respect to speculative

    position limits.\437\

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

    \435\ 7 U.S.C. 6a(c)(1).

    \436\ Bona fide hedging transactions and positions for excluded

    commodities are currently defined at 17 CFR Sec. 1.3(z). As

    discussed above, the Commission has proposed a new comprehensive

    definition of bona fide hedging positions in proposed Sec. 150.1.

    \437\ 7 U.S.C. 6a(a)(7). Section 4a(a)(7) of the CEA provides

    the Commission plenary authority to grant exemptive relief from

    position limits. Specifically, under Section 4a(a)(7), the

    Commission ``by rule, regulation, or order, may exempt,

    conditionally or unconditionally, any person, or class of persons,

    any swap or class of swaps, any contract of sale of a commodity for

    future delivery or class of such contracts, any option or class of

    options, or any transaction or class of transactions from any

    requirement it may establish . . . with respect to position

    limits.''

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

    The existing exemptions promulgated under pre-Dodd-Frank CEA

    section 4a and set forth in current Sec. 150.3 are fundamental to the

    Commission's regulatory framework for speculative position limits.

    Current Sec. 150.3 specifies the types of positions that may be

    exempted from, and thus may exceed, the federal speculative position

    limits. First, the exemption for bona fide hedging transactions and

    positions as defined in current Sec. 1.3(z) permits a commercial

    enterprise to exceed positions limits to the extent the positions are

    reducing price risks incidental to commercial operations.\438\ Second,

    the exemption for spread or arbitrage positions between single months

    of a futures contract (and/or, on a futures-equivalent basis, options)

    outside of the spot month, permits any trader's spread position to

    exceed the single month limit.\439\ Third, positions carried for an

    eligible entity \440\ in the separate account of an independent account

    controller (``IAC'') \441\ that manages customer positions need not be

    aggregated with the other positions owned or controlled by that

    eligible entity (the ``IAC exemption'').\442\

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

    \438\ 17 CFR 150.3(a)(1). The current definition of bona fide

    hedging transactions and positions in 1.3(z) is discussed above.

    \439\ The Commission clarifies that a spread or arbitrage

    position in this context means a short position in a single month of

    a futures contract and a long position in another contract month of

    that same futures contract, outside of the spot month, in the same

    crop year. The short and/or long positions may also be in options on

    that same futures contract, on a futures equivalent basis. Such

    spread or arbitrage positions, when combined with any other net

    positions in the single month, must not exceed the all-months limit

    set forth in current Sec. 150.2, and must be in the same crop year.

    17 CFR 150.3(a)(3).

    \440\ ``Eligible entity'' is defined in current 17 CFR 150.1(d).

    \441\ ``Independent account controller'' is defined in 17 CFR

    150.1(e).

    \442\ See 17 CFR 150.3(a)(4). See also discussion of the IAC

    exemption in the Aggregation NPRM.

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

    ii. Proposed Sec. 150.3

    In this release, the Commission proposes organizational and

    substantive amendments to Sec. 150.3, generally resulting in an

    increase in the number of exemptions to speculative position limits.

    First, the Commission proposes to amend the three exemptions from

    federal speculative limits currently contained in Sec. 150.3. These

    amendments would update cross references, relocate the IAC exemption

    and consolidate it with the Commission's separate proposal to amend the

    aggregation requirements of Sec. 150.4,\443\ and delete the calendar

    month spread provision which is unnecessary under proposed changes to

    Sec. 150.2 that would increase the level of the single month position

    limits. Second, the Commission proposes to add exemptions from the

    federal speculative position limits for financial distress situations,

    certain spot-month positions in cash-settled referenced contracts, and

    grandfathered pre-Dodd-Frank and transition period swaps. Third, the

    Commission proposes to revise recordkeeping and reporting requirements

    for traders claiming any exemption from the federal speculative

    position limits.

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

    \443\ See Aggregation NPRM.

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

    a. Proposed Amendments to Existing Exemptions

    (1) New Cross-References

    Because the Commission proposes to replace the definition of bona

    fide hedging in 1.3(z) with the definition in proposed Sec. 150.1,

    proposed Sec. 150.3(a)(1)(i) updates the cross-references to reflect

    this change.\444\ Proposed Sec. 150.3(a)(3) would add a new cross-

    reference to the reporting requirements proposed to be amended in part

    19.\445\ As is currently the case for bona fide hedgers, persons who

    wish to claim any exemption from federal position limits, including

    hedgers, would need to satisfy the reporting requirements in part

    19.\446\ As discussed elsewhere in this release, the Commission is

    proposing amendments to update part 19 reporting.\447\ For purposes of

    simplicity, the Commission is retaining the current placement of many

    reporting requirements, including those related to claimed exemptions

    from the federal position limits, within

    [[Page 75736]]

    parts 15-21 of the Commission's regulations.\448\ Lastly, proposed

    Sec. 150.3(i) would add a cross-reference to the updated aggregation

    rules in proposed Sec. 150.4.\449\ The Commission proposes to retain

    the current practice of considering entities required to aggregate

    accounts or positions under proposed Sec. 150.4 to be the same person

    when determining whether they are eligible for a bona fide hedging

    position exemption.\450\

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

    \444\ See supra discussion of the Commission's revised

    definition of bona fide hedging position in proposed Sec. 150.1.

    \445\ See infra discussion of proposed revisions of 17 CFR part

    19.

    \446\ See 17 CFR part 19.

    \447\ See infra discussion of proposed revisions of 17 CFR part

    19.

    \448\ The Commission notes this is a change from the

    organization of vacated Sec. 151.5, that included both exemptions

    and related reporting requirements in a single section.

    \449\ See Aggregation NPRM.

    \450\ See Aggregation NPRM. The Commission clarifies that

    whether it is economically appropriate for one entity to offset the

    cash market risk of an affiliate depends, in part, upon that

    entity's ownership interest in the affiliate. It would not be

    economically appropriate for an entity to offset all the risk of an

    affiliate's cash market exposure unless that entity held a 100

    percent ownership interest in the affiliate. For less than a 100

    percent ownership interest, it would be economically appropriate for

    an entity to offset no more than a pro rata amount of any cash

    market risk of an affiliate, consistent with the entity's ownership

    interest in the affiliate.

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

    (2) Deleting Exemption for Calendar Spread or Arbitrage Positions

    The Commission proposes to delete the exemption in current Sec.

    150.3(a)(3) for spread or arbitrage positions between single months of

    a futures contract or options thereon, outside the spot month.\451\ The

    Commission has proposed to maintain the current practice in Sec.

    150.2, which the district court did not vacate, of setting single-month

    limits at the same levels as all-months limits, rendering the

    ``spread'' exemption unnecessary. The spread exemption set forth in

    current Sec. 150.3(a)(3) permits a spread trader to exceed single

    month limits only to the extent of the all months limit.\452\ Since

    proposed Sec. 150.2 sets single month limits at the same level as all

    months limits, the spread exemption no longer provides useful relief.

    Furthermore, as discussed below in this release, the Commission would

    codify guidance in proposed Sec. 150.5(a)(2)(B) that would allow a DCM

    or SEF to grant exemptions for intramarket and intermarket spread

    positions (as those terms are defined in proposed Sec. 150.1)

    involving commodity derivative contracts subject to the federal

    limits.\453\

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

    \451\ In its entirety, 17 CFR 150.3(a)(3) sets forth an

    exemption from federal position limits for [s]pread or arbitrage

    positions between single months of a futures contract and/or, on a

    futures-equivalent basis, options thereon, outside of the spot

    month, in the same crop year; provided however, that such spread or

    arbitrage positions, when combined with any other net positions in

    the single month, do not exceed the all-months limit set forth in

    Sec. 150.2.

    \452\ See id.

    \453\ As discussed above.

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

    (3) Relocating Independent Account Controller (``IAC'') Exemption to

    proposed Sec. 150.4

    In a separate rulemaking, the Commission has proposed Sec.

    150.4(b)(5) to replace the existing IAC exemption in current Sec.

    150.3(a)(4).\454\ Proposed Sec. 150.4(b)(5) sets forth an exemption

    for accounts carried by an IAC that is substantially similar to current

    Sec. 150.3(a)(4). Thus, the Commission is proposing to delete the IAC

    exemption in current Sec. 150.3(a)(4) because it is duplicative.

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

    \454\ For purposes of simplicity, the IAC exemption would be

    placed within the regulatory section providing for aggregation of

    positions. See Aggregation NPRM.

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

    b. Proposed Additional Exemptions From Position Limits

    As discussed above, 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 that the Commission

    may establish under section 4a of the Act. Pursuant to this authority,

    the Commission proposes to add new exemptions in Sec. 150.3 for

    financial distress situations and qualifying positions in cash-settled

    referenced contracts. The Commission also proposes to add guidance to

    persons seeking exemptive relief for certain qualifying non-enumerated

    risk-reducing transactions. Additionally, the Commission proposes to

    grandfather pre-Dodd-Frank enactment swaps and transition swaps entered

    into before from position limits.

    (1) Financial Distress Exemption

    The Commission proposes to add an exemption from position limits

    for certain market participants in certain financial distress scenarios

    to Sec. 150.3(b). During periods of financial distress, it may be

    beneficial for a financially sound entity to take on the positions (and

    corresponding risk) of a less stable market participant. The Commission

    historically has provided for an exemption from position limits in

    these types of situations, to avoid sudden liquidations that could

    potentially reduce liquidity, disrupt price discovery, and/or increase

    systemic risk.\455\ Therefore, the Commission now proposes to codify in

    regulation its prior exemptive practices to accommodate situations

    involving, for example, a customer default at a FCM, or in the context

    of potential bankruptcy. The Commission historically has not granted

    such an exemption by Commission Order due to concerns regarding

    timeliness and flexibility. Furthermore, the Commission clarifies that

    this exemption for financial distress situations is not a hedging

    exemption.

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

    \455\ See Release 5551-08, ``CFTC Update on Efforts Underway to

    Oversee Markets,'' September 19, 2008 (available at http://www.cftc.gov/PressRoom/PressReleases/pr5551-08).

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

    (2) Conditional Spot-Month Limit Exemption

    Proposed Sec. 150.3(c) would provide a conditional spot-month

    limit exemption that permits traders to acquire positions up to five

    times the spot-month limit if such positions are exclusively in cash-

    settled contracts. This conditional exemption would only be available

    to traders who do not hold or control positions in the spot-month

    physical-delivery referenced contract. Historically, the Commission and

    Congress have been particularly concerned about protecting the spot

    month in physical-delivery futures contracts.\456\ For example, new CEA

    section 4c(a)(5)(B) makes it unlawful for any person to engage in any

    trading, practice, or conduct on or subject to the rules of a

    registered entity that demonstrates intentional or reckless disregard

    for the orderly execution of transactions during the closing period.

    The Commission interprets the closing period to be defined generally as

    the period in the contract or trade when the settlement price is

    determined under the rules of a trading facility such as a DCM or SEF,

    and may include the time period in which a daily settlement price is

    determined and the expiration day for a futures contract.\457\

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

    \456\ See, for example, the guidance for DCMs to establish a

    spot month limit in physical-delivery futures contracts that is no

    greater than 25 percent of estimated deliverable supply in 17 CFR

    150.5(b).

    \457\ See Antidisruptive Practices Authority, Interpretive

    guidance and policy statement, 78 FR 31890, 31894, May 28, 2013. See

    also the discussion above of ``banging the close'' and the DiPlacido

    case.

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

    This proposed conditional exemption for cash-settled contracts

    generally tracks exchange-set position limits currently implemented for

    certain cash-settled energy futures and swaps.\458\ The

    [[Page 75737]]

    Commission has examined market data on the effectiveness of conditional

    spot-month limits for cash-settled energy futures swaps, including the

    data submitted as part of the prior position limits rulemaking,\459\

    and preliminarily believes that the conditional approach effectively

    addresses the Sec. 4a(a)(3) regulatory objectives. Since spot-month

    limit levels for cash-settled referenced contracts will be set at no

    more than 25% of the estimated spot-month deliverable supply in the

    relevant core referenced futures contract, the proposed conditional

    exemption would therefore permit a speculator to own positions in cash-

    settled referenced contracts equivalent to no more than 125% of the

    estimated deliverable supply.

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

    \458\ For example, this is the same methodology for spot-month

    speculative position limits that applies to cash-settled Henry Hub

    natural gas contracts on NYMEX and ICE, beginning with the February

    2010 contract months (with the exception of the exchange-set

    requirement that a trader not hold large cash commodity positions).

    In response to concerns regarding increasing trading volumes in

    standardized swaps, in 2008 Congress amended section 2(h) of the Act

    to establish core principles for exempt commercial markets

    (``ECMs'') trading swap contracts that the Commission determined to

    be significant price discovery contracts (``SPDCs''). 7 U.S.C.

    2(h)(7) (2009). See also section 13201 of the Food, Conservation and

    Energy Act of 2008, H.R. 2419 (May 22, 2008). Core principle (IV)

    directed ECMs to ``adopt, where necessary and appropriate, position

    limitations or position accountability for speculators . . . to

    reduce the potential threat of market manipulation or congestion,

    especially during trading in the delivery month.'' 7 U.S.C.

    2(h)(7)(C)(ii)(IV)(2009). Under the Commission's rules for ECMs

    trading SPDCs, the Commission provided an acceptable practice that

    an ECM trading a SPDC that is economically-equivalent to a contract

    traded on a DCM should set the spot-month limit at the same level as

    that specified for the economically-equivalent DCM contract. 17 CFR

    part 36 (2010). In practice, for example, ICE complied with this

    requirement by establishing a spot month limit for its natural gas

    SPDC at the same level as the spot month limit in the economically-

    equivalent NYMEX Henry Hub Natural Gas futures contract. Both ICE

    and NYMEX established conditional spot month limits in their cash-

    settled natural gas contracts at a level five times the level of the

    spot month limit in the physical-delivery futures contract.

    \459\ See 76 FR 71635 (n. 100-01)(discussing data for the CME

    natural gas contract).

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

    As proposed, this broad conditional spot month limit exemption for

    cash-settled contracts would be similar to the conditional spot month

    limit for cash-settled contracts in proposed Sec. 151.4.\460\ However,

    unlike proposed Sec. 151.4, proposed Sec. 150.3(c) would not require

    a trader to hold physical commodity inventory of less than or equal to

    25 percent of the estimated deliverable supply in order to qualify for

    the conditional spot month limit exemption. Rather, the Commission

    proposes to require enhanced reporting of cash market holdings of

    traders availing themselves of the conditional spot month limit

    exemption, as discussed in the proposed changes to part 19, below.\461\

    The Commission preliminarily believes that an enhanced reporting regime

    may serve to provide sufficient information to conduct an adequate

    surveillance program to detect and potentially deter excessively large

    positions or manipulative schemes involving the cash market.

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

    \460\ 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. See Proposed Rule, 76

    FR 4752, 4758, Jan. 26, 2011.

    \461\ See infra discussion of proposed revisions to part 19.

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

    The Commission notes that the proposed conditional spot month limit

    is a change of course from the expanded spot month limit that was only

    for natural gas referenced contracts in vacated Sec. 151.4.\462\ In

    proposing to expand the scope of derivatives contracts for which the

    conditional spot month limit is available, the Commission has

    reconsidered the risks to the market of permitting a speculative trader

    to hold an expanded position in a cash-settled contract when that

    speculative trader also is active in the underlying physical-delivery

    contract. The Commission preliminarily believes the conditional natural

    gas spot month limits of the exchanges generally have served to further

    the purposes Congress articulated for positions limits in sections

    4a(a)(3)(B) and 4c(a)(5)(B) of the Act, such as deterring market

    manipulation, ensuring the price discovery function of the underlying

    market is not disrupted, and deterring disruptive trading during the

    closing period. The Commission notes those exchange-set conditional

    limits, as is the case for the proposed rule, prohibit a speculative

    trader who is holding an expanded position in a cash-settled contract

    from also holding any position in the physical-delivery contract.

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

    \462\ Under vacated Sec. 151.4, the Commission would have

    applied spot-month position limits for cash-settled contracts using

    the same methodology as applied to the physical-delivery core

    referenced futures contracts, with the exception of natural gas

    contracts, which would have a class limit and aggregate limit of

    five times the level of the limit for the physical-delivery Core

    Referenced Futures Contract. 76 FR 71635.

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

    The proposed conditional exemption would satisfy the goals set

    forth in CEA section 4a(a)(3)(B) by: Eliminating all speculation in a

    physical-delivery contract during the spot period by a trader availing

    herself of the conditional spot month limit exemption; ensuring

    sufficient market liquidity in the cash-settled contract for bona fide

    hedgers, in light of the typically rapidly decreasing levels of open

    interest in the physical-delivery contract during the spot month as

    hedgers exit the physical-delivery contract; and protecting the price

    discovery process in the physical-delivery contract from the risk that

    traders with leveraged positions in cash-settled contracts (in

    comparison to the level of the limit in the physical-delivery contract)

    would otherwise attempt to mark the close or distort physical-delivery

    prices to benefit their leveraged cash-settled positions. Thus, the

    exemption would establish a higher conditional limit for cash-settled

    contracts than for physical delivery contracts, so long as such

    positions are decoupled from positions in physical delivery contracts

    which set or affect the value of such cash-settled positions.

    The Commission preliminarily believes this proposed exemption would

    not encourage price discovery to migrate to the cash-settled contracts

    in a way that would make the physical-delivery contract more

    susceptible to sudden price movements near expiration. The Commission

    has observed, repeatedly, that open interest in physical-delivery

    contracts typically declines markedly in the period immediately

    preceding the spot month. Open interest typically declines to minimal

    levels prior to the close of trading in physical-delivery contracts.

    The Commission notes a hedger with a long position need not stand for

    delivery when the price of a physical-delivery contract has adequately

    converged to the underlying cash market price; rather, such long

    position holder may offset and purchase needed commodities in the cash

    market at a comparable price that meets the hedger's specific location

    and quality needs. Similarly, the Commission notes a hedger with a

    short position need not give notice of intention to deliver and deliver

    when the price of a physical-delivery contract has adequately converged

    to the underlying cash market price; rather, such short position holder

    may offset and sell commodities held in inventory or current production

    in the cash market at a comparable price that is consistent with the

    hedger's specific storage location and quality of inventory or

    production.\463\ Concerns regarding corners and squeezes are most acute

    in the markets for physical contracts in the spot month, which is why

    speculative limits in physical delivery markets are generally set at

    levels that are stricter during the spot month. The Commission seeks

    comment on whether a conditional spot-month

    [[Page 75738]]

    limit exemption adequately protects the price discovery function of the

    underlying physical-delivery market. Further, the Commission solicits

    comment on its conditional spot month limit, including whether it is

    advisable to expand this conditional limit to all contracts.

    Additionally, the Commission solicits comment on whether the

    conditional spot-month limit has effectively addressed and will

    continue to address the CEA section 4a(a)(3) regulatory objectives. Are

    there other concerns or issues regarding the proposed conditional spot

    month limit exemption that the Commission has not addressed?

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

    \463\ Once the price of a physical-delivery contract has

    converged adequately to cash market prices, long and short position

    holders typically offset physical-delivery contracts. Prior to such

    adequate convergence, the Commission has observed when a physical-

    delivery contract is trading at a price above prevailing cash market

    prices, commercials with inventory tend to sell contracts with the

    intent of making delivery, causing physical-delivery prices to

    converge to cash market prices. Similarly, the Commission has

    observed when a physical-delivery contract is trading at a price

    below prevailing cash market prices, commercials with a need for the

    commodity or merchants active in the cash market tend to buy the

    contract with the intent of taking delivery, causing physical-

    delivery prices to converge to cash market prices.

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

    While traders who avail themselves of a conditional spot month

    limit exemption could not directly influence particular settlement

    prices by trading in the physical-delivery referenced contract, the

    Commission remains concerned about such traders' activities in the

    underlying cash commodity. Accordingly, the Commission proposes new

    reporting requirements in part 19, as discussed below.\464\ The

    Commission invites comment and empirical analysis as to whether these

    reporting requirements adequately address concerns regarding: (1)

    Protecting the price discovery function of the physical-delivery

    market, including deterring attempts to mark the close in the physical-

    delivery contract; and (2) providing adequate liquidity for bona fide

    hedgers in the physical-delivery contracts. In light of these two

    concerns, the Commission is also proposing alternatives to the

    conditional spot-month limit exemption, as discussed below, including

    the possibility that it would not adopt the proposed conditional spot-

    month limit exemption.

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

    \464\ See infra discussion of proposed revisions of part 19.

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

    As one alternative to the proposed conditional spot month limit,

    the Commission is considering whether to restrict a trader claiming the

    conditional spot-month limit exemption to positions in cash-settled

    contracts that settle to an index based on cash-market transactions

    prices. This would prohibit traders from claiming a conditional

    exemption if the trader held positions in the spot-month of cash-

    settled contracts that settle to prices based on the underlying

    physical-delivery futures contract. If the Commission adopted this

    alternative instead of the proposal, would the physical-delivery

    futures contract market be better protected? Why or why not?

    The Commission is also considering a second alternative to the

    proposed conditional spot month limit: Setting an expanded spot-month

    limit for cash-settled contracts at five times the level of the limit

    for the physical-delivery core referenced futures contract, regardless

    of positions in the underlying physical-delivery contract. This

    alternative would not prohibit a trader from carrying a position in the

    spot-month of the physical-delivery contract. Consequently, this

    alternative would give more weight to protecting liquidity for bona

    fide hedgers in the physical-delivery contract in the spot month, and

    less weight to protecting the price discovery function of the

    underlying physical-delivery contract in the spot month.\465\ Given

    Congressional concerns regarding disruptive trading practices in the

    closing period, as discussed above, would this second alternative

    adequately address the policy factors in CEA section 4a(a)(3)(B)?

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

    \465\ This second alternative would effectively adopt for all

    commodity derivative contract limits certain provisions of vacated

    Sec. 151.4 (that would have been applicable only to contracts in

    natural gas). As noted above, under vacated Sec. 151.4, the

    Commission would have applied a spot-month position limit for cash-

    settled contracts in natural gas at a level of five times the level

    of the limit for the physical-delivery Core Referenced Futures

    Contract in natural gas. Id.

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

    The Commission is also considering a third alternative: Limiting

    application of an expanded spot-month limit to a trader holding

    positions in cash-settled contracts that settle to an index based on

    cash-market transactions prices. Under this third alternative, cash-

    settled contracts that settle to the underlying physical-delivery

    contract would be restricted by a spot-month limit set at the same

    level as that of the underlying physical-delivery contract. The

    Commission is considering an aggregate spot-month limit on all types of

    cash-settled contracts set at five times the level of the limit of the

    underlying physical-delivery contract for this alternative to the

    proposed conditional spot month limit. Would this third alternative

    adequately address the policy factors in CEA section 4a(a)(3)(B)? Would

    this third alternative better address such policy factors than the

    second alternative?

    The Commission requests comment on all aspects of the proposed

    conditional spot limit and the three alternatives discussed above,

    including whether conditional spot month limit exemptions should vary

    based on the underlying commodity. Should the Commission consider any

    other alternatives? If yes, please describe any alternative in detail.

    Would any of the proposed conditional spot month limit or the

    alternatives be more or less likely to increase or decrease liquidity

    in particular products? Would anti-competitive behavior be more or less

    likely to result from any of the proposed conditional spot month limit

    or the alternatives? Does any of the proposed conditional spot month

    limit or the alternatives increase the potential for manipulation? If

    yes, please provide detailed arguments and analyses.

    (3) Exemption for Pre-Dodd-Frank Enactment Swaps and Transition Period

    Swaps

    Proposed Sec. 150.3(d) would provide an exemption from federal

    position limits for (1) swaps entered into prior to July 21, 2010 (the

    date of the enactment of the Dodd-Frank Act of 2010), the terms of

    which have not expired as of that date, and (2) swaps entered into

    during the period commencing July 22, 2010, the terms of which have not

    expired as of that date, and ending 60 days after the publication of

    final Sec. 150.3 in the Federal Register.\466\ However, the Commission

    would allow both pre-enactment and transition swaps to be netted with

    commodity derivative contracts acquired more than 60 after publication

    of final Sec. 150.3 in the Federal Register for the purpose of

    complying with any non-spot-month position limit.

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

    \466\ This exemption is consistent with CEA section 4a(b)(2).

    The time period for transition swaps for purposes of position limits

    differs from the time period for transition swaps for purposes of

    swap data recordkeeping and reporting requirements. In both cases,

    the time periods for transition swaps begins on the date of

    enactment of the Dodd-Frank Act. However, the time periods for

    transition swaps end prior to the compliance date for each relevant

    rule. Swap data recordkeeping and reporting requirements for pre-

    enactment and transition period swaps are listed in 17 CFR part 46.

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

    (4) Other Exemptions for Non-Enumerated Risk-Reducing Practices

    The Commission notes that the enumerated list of bona fide hedging

    positions as set forth in proposed Sec. 150.1 represents an expanded

    list of exemptions that has evolved over many years of the Commission's

    experience in administering speculative position limits. The Commission

    has carefully expanded the list of exemptions in light of the statutory

    directive to define a bona fide hedging position in section 4a(c)(2) of

    the Act.

    The Commission previously permitted a person to file an application

    seeking approval for a non-enumerated position to be recognized as a

    bona fide hedging position under Sec. 1.47. The Commission proposes to

    delete Sec. 1.47 for several reasons. First, Sec. 1.47 did not

    provide guidance as to the standards the Commission would use to

    determine whether a position was a bona fide

    [[Page 75739]]

    hedging position. Second, in the Commission's experience, the

    overwhelming number of applications filed under Sec. 1.47 were from

    swap intermediaries seeking to offset the risk of swaps. Section

    4a(c)(2) of the Act addresses the application of the bona fide hedging

    definition to certain positions that reduce risks attendant to a

    position resulting from certain swaps. As discussed in the definitions

    section above, those statutory provisions have been incorporated into

    the proposed definition of a bona fide hedging position under Sec.

    150.1; further, as discussed in the position limits section above, the

    provisions of proposed Sec. 150.2 include relief outside of the spot

    month to permit automatic netting of swaps that are referenced

    contracts with futures contracts that are referenced contracts and,

    where appropriate, to recognize as a bona fide hedging position the

    offset of certain non-referenced contract swaps with futures that are

    referenced contracts.\467\ Third, Sec. 1.47 provided specific, limited

    timeframes (of 30 days or 10 days) for the Commission to determine

    whether the position may be classified as bona fide hedging. The

    Commission preliminarily believes it should not constrain itself to

    such limited timeframes for review of potentially complex and novel

    risk-reducing transactions.

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

    \467\ All the exemptions granted by the Commission pursuant to

    Sec. 1.47 involving swaps were restricted to recognition of the

    futures offset as a bona fide hedging position only outside of the

    spot month.

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

    Nevertheless, the Commission proposes in Sec. 150.3(e) to provide

    guidance to persons seeking exemptive relief. A person that engages in

    risk-reducing practices commonly used in the market that the person

    believes may not be included in the list of enumerated bona fide

    hedging transactions may apply to the Commission for an exemption from

    position limits. As proposed, market participants would be guided in

    Sec. 150.3(e) first to consult proposed appendix C to part 150 to see

    whether their practices fall within a non-exhaustive list of examples

    of bona fide hedging positions as defined under proposed Sec. 150.1.

    A person engaged in risk-reducing practices that are not enumerated

    in the revised definition of bona fide hedging in proposed Sec. 150.1

    may use two different avenues to apply to the Commission for relief

    from federal position limits: The person may request an interpretative

    letter from Commission staff pursuant to Sec. 140.99 \468\ concerning

    the applicability of the bona fide hedging position exemption, or the

    person may seek exemptive relief from the Commission under section

    4a(a)(7) of the Act.\469\

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

    \468\ 17 CFR 140.99 defines three types of staff letters--

    exemptive letters, no-action letters, and interpretative letters--

    that differ in scope and effect. An interpretative letter is written

    advice or guidance by the staff of a division of the Commission or

    its Office of the General Counsel. It binds only the staff of the

    division that issued it (or the Office of the General Counsel, as

    the case may be), and third-parties may rely upon it as the

    interpretation of that staff. See description of CFTC Staff Letters,

    available at http://www.cftc.gov/lawregulation/cftcstaffletters/index.htm.

    \469\ See supra discussion of CEA section 4a(a)(7).

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

    (5) Previously Granted Risk Management Exemptions

    Until about mid-2008, the Commission accepted and approved filings

    pursuant to Sec. 1.3(z) and Sec. 1.47 for recognition of transactions

    and positions described in such filings as bona fide hedging for

    purposes of compliance with Federal position limits. Since then, the

    Division of Market Oversight (the ``Division''), on behalf of the

    Commission, has only considered revisions to previously recognized

    filings.\470\ Prior to the Dodd-Frank Act and pursuant to authority

    delegated to it under Sec. 140.97,\471\ the Division recognized a

    broad range of transactions and positions as bona fide hedges based on

    facts and representations contained in such filings.\472\ In seeking

    these determinations and exemptions from Federal position limits,

    filers would furnish information to demonstrate, among other things,

    that the described transactions and positions were economically

    appropriate to the reduction of risk exposure attendant to the conduct

    and management of a commercial enterprise.\473\ On this basis, the

    Division provided relief to dealers, market makers and ``risk

    intermediaries'' facing not only producers and consumers of commodities

    but hedge funds, pension funds and other financial institutions who

    lacked the capacity to make or take delivery of, or otherwise handle, a

    physical commodity.\474\ The exemptions granted by the Division were

    not limited to futures to offset price risks associated with commodity

    index swaps that could be hedged in the component futures contracts.

    Filers obtained exemptions for futures transactions used to hedge price

    risks from transactions involving options, warrants, certificates of

    deposit, structured notes and various other structured products and

    hybrid instruments referencing commodities or embedding transactions

    linked to the payout or performance of a commodity or basket of

    commodities (collectively, ``financial products''). In sum, the

    Division provided relief to ``persons using the futures markets to

    manage risks associated with financial investment portfolios'' and

    granted exemptions from speculative position limits to a broad range of

    ``trading strategies to reduce financial risks, regardless of whether a

    matching transaction ever took place in a cash market for a physical

    commodity.'' \475\ In

    [[Page 75740]]

    recognizing such trading strategies as bona fide hedges, the Commission

    was responding to Congressional direction\476\ to update its approach

    at a time when many sought to encourage what was then thought to be

    benign or beneficial financial innovation. In hindsight, the sum of

    these determinations may have exceeded what would be appropriate ``to

    permit producers, purchasers, sellers, middlemen, and users of a

    commodity or product derived therefrom to hedge their legitimate

    anticipated business needs'' and adequate ``to prevent unwarranted

    price pressures by large hedgers.'' \477\

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

    \470\ On May 29, 2008, the Commission announced a number of

    initiatives to increase transparency of the energy futures markets.

    In particular, the Commission would review the trading practices of

    index traders in the futures markets. CFTC Press Release 5503-08,

    May 29, 2008, available at http://www.cftc.gov/PressRoom/PressReleases/pr5503-08. On June 3, 2008, the Commission announced

    policy initiatives aimed at addressing concerns raised at an April

    22, 2008 roundtable regarding events affecting the agricultural

    futures markets. Among other things, the Commission withdrew

    proposed rulemakings that would have increased the Federal

    speculative position limits on certain agricultural futures

    contracts and created a risk-management hedge exemption from the

    Federal speculative position limits for agricultural futures and

    options contracts. At the time, Acting Chairman Lukken and

    Commissioners Dunn, Sommers and Chilton said, ``. . . the Commission

    will be cautious and guarded before granting additional exemptions

    in this area.'' CFTC Press Release 5504-08, June 3, 2008, available

    at http://www.cftc.gov/PressRoom/PressReleases/pr5504-08.

    \471\ 17 CFR 140.97.

    \472\ Almost all requests pursuant to Sec. 1.47 have been for

    ``risk-management'' exemptions. See generally Risk Management

    Exemptions from Speculative Position Limits Approved under

    Commission Regulation 1.61, 52 FR 34633, Sep. 14, 1987;

    Clarification of Certain Aspects of the Hedging Definition, 52 FR

    27195, Jul. 20, 1987. The Commission first approved a request for a

    risk-management exemption in 1991. The Commission has also approved

    a request by a foreign government to recognize certain positions

    associated with a governmental agricultural support program that

    would be consistent with the examples of bona fide hedging positions

    in proposed appendix B to part 150.

    \473\ Section 1.3(z)(1) includes the language, ``economically

    appropriate to the reduction of risks in the conduct and management

    of a commercial enterprise.'' 17 CFR 1.3(z)(1). Section 1.47(b)(2)

    includes the language, ``economically appropriate to the reduction

    of risk exposure attendant to the conduct and management of a

    commercial enterprise.'' 17 CFR 1.47(b)(2).

    \474\ The Commission notes that both the filings received by the

    Commission requesting such exemptions and the responding exemption

    letters issued by the Division are confidential in light of section

    8 of the Act since, as noted above, the filings included information

    that described transactions and positions in order to demonstrate,

    among other things, that the transactions and positions were

    economically appropriate to the reduction of risk exposure attendant

    to the conduct and management of a commercial enterprise, while the

    Division's responding letters included information regarding the

    nature of the price risks that the transactions would entail.

    \475\ Staff Report, S. Permanent Subcomm. on Investigations,

    ``Excessive Speculation in the Wheat Market,'' S. Hrg. 111-155 (Jul.

    21, 2009) at 13 (``Wheat Report''). The Wheat Report was issued

    before the Dodd-Frank Act became law.

    \476\ See generally CFTC Staff Report on Commodity Swap Dealers

    & Index Traders with Commission Recommendations (Sep. 2008) at 13-15

    (``Index Trading Report'').

    \477\ 7 U.S.C. 6a(c)(1).

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

    The Commission now proposes a definition of bona fide hedging

    position that would apply to all referenced contracts, and proposes to

    remove Sec. 1.47.\478\ The Commission is also proposing in Sec.

    150.3(f) that risk-management exemptions granted by the Commission

    under Sec. 1.47 shall not apply to swap positions entered into after

    the effective date of a final position limits rulemaking, i.e.,

    revoking the exemptions for new swap positions.\479\ This means that

    certain transactions and positions (and, by extension, persons party to

    such transactions or holding such positions) heretofore exempt from

    Federal position limits may be subject to Federal position limits. This

    is because some transactions and positions previously characterized as

    ``risk-management'' and recognized as bona fide hedges are inconsistent

    with the revised definition of bona fide hedging positions proposed in

    this release and the purposes of the Dodd-Frank Act amendments to the

    CEA.\480\ As noted above, some pre-Dodd-Frank Act exemptions recognized

    offsets of risks from financial products. But the Commission now

    proposes to incorporate the ``temporary substitute'' test of section

    4a(c)(2)(A)(i) of the Act in paragraph (2)(i) of the proposed

    definition of bona fide hedging position.\481\ Financial products are

    not substitutes for positions taken or to be taken in a physical

    marketing channel. Thus, the offset of financial risks arising from

    financial products is inconsistent with the proposed definition of bona

    fide hedging for physical commodities. Moreover, the Commission

    interprets CEA section 4a(c)(2)(B) as a direction from Congress to

    narrow the scope of what constitutes a bona fide hedge.\482\ Other

    things being equal, a narrower definition of bona fide hedging would

    logically subject more speculative positions to Federal limits.

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

    \478\ Section 1.3(z), the definition of bona fide hedging

    transactions and positions for excluded commodities, was revised

    (but retained as amended) by the vacated part 151 Rulemaking.

    Section 1.47 of the Commission's regulations was removed and

    reserved by the vacated part 151 Rulemaking. On September 28, 2012,

    the District Court for the District of Columbia vacated the part 151

    Rulemaking with the exception of the amendments to Sec. 150.2. 887

    F. Supp. 2d 259 (D.D.C. 2012). Vacating the part 151 Rulemaking,

    with the exception of the amendments to Sec. 150.2, means that as

    things stand now, it is as if the Commission had never adopted any

    part of the part 151 Rulemaking other than the amendments to Sec.

    150.2. That is, the definition of bona fide hedging transactions and

    positions in Sec. 1.3(z) remains unchanged, and Sec. 1.47 is still

    in effect. As discussed above, the new definition of bona fide

    hedging positions in proposed Sec. 150.1 is different from the

    changes to Sec. 1.3(z) adopted by the Commission in the vacated

    part 151 Rulemaking. See 76 FR 71683-84. The Commission proposes to

    delete Sec. 1.47 for several reasons, as discussed above. Proposed

    Sec. 150.3(e) would provide guidance for persons seeking non-

    enumerated hedging exemptions through filing of a petition under

    section 4a(a)(7) of the Act, 7 U.S.C. 6a(a)(7), replacing the

    current process, as discussed above, under Sec. 1.3(z)(3) and Sec.

    1.47 of the Commission's regulations.

    \479\ This approach is consistent with the limited exemption to

    provide for transition into position limits for persons with

    existing Sec. 1.47 exemptions under vacated Sec. 151.9(d) adopted

    in the vacated part 151 Rulemaking. See 76 FR 71655-56. This limited

    grandfather is similarly designed to limit market disruption.

    \480\ 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.'' 7 U.S.C. 6a(c)(1).

    \481\ Section 4a(c)(2)(A)(i) of the Act provides that the

    Commission shall define what constitutes a bona fide hedging

    position as a position that 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. 7 U.S.C. 6a(c)(2)(A)(i). The

    proposed definition of bona fide hedging position requires that, for

    a position in a commodity derivative contracts in a physical

    contract to be a bona fide hedging position, such position must

    represent 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. See supra discussion of the temporary substitute

    test.

    \482\ See discussion above.

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

    Many of the Commission's bona fide hedging exemptions prior to the

    Dodd-Frank Act provided relief from Federal speculative position limits

    for persons acting as intermediaries in connection with index trading

    activities.\483\ For example, a pension fund enters into a swap to

    receive the rate of return on a particular commodity index (such as the

    Standard & Poor's-Goldman Sachs Commodity Index or the Dow Jones-UBS

    Commodity Index) with a swap dealer. The pension fund thus has a

    synthetic long position in the index. The swap dealer, in turn, must

    pay the rate of return on the index to the pension fund, and purchases

    commodity futures contracts to hedge its short exposure to the index.

    Prior to the Dodd-Frank Act, the swap dealer might have obtained a bona

    fide hedge exemption for its position. This would no longer be the

    case.

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

    \483\ Index trading activities have emerged as an area of

    special concern to both Congress and the Commission. See generally

    the Wheat Report and the Index Trading Report. The Commission

    continues to consider the concerns of commenters who argue that some

    transactions and positions recognized before the Dodd-Frank Act as

    bona fide hedging may, in fact, facilitate excessive speculation.

    See, e.g., Testimony of Michael W. Masters before the Commodity

    Futures Trading Commission, Aug. 5, 2009, available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/hearing080509_masters.pdf; Comment Letter from Better Markets,

    Inc., Mar. 28, 2013, available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=34010&SearchText=Better%20Markets. The

    speculative position limits that the Commission now proposes do not

    directly address these concerns as they relate to commodity index

    funds, commodity index speculation and passive investment in the

    commodity derivatives markets. The speculative position limits that

    the Commission proposes apply only to transactions involving one

    commodity or the spread between two commodities (e.g., the purchase

    of one delivery month of one commodity against the sale of that same

    delivery month of a different commodity). They do not apply to

    diversified commodity index contracts involving more than two

    commodities. This means that index speculators remain unconstrained

    on the size of positions in diversified commodity index contracts

    that they can accumulate so long as they can find someone with the

    capacity to take the other side of their trades. These commenters

    assert that such contracts, which this proposal does not address,

    consume liquidity and damage the price discovery function of the

    market. Contra Bessembinder et al., ``Predatory or Sunshine Trading?

    Evidence from Crude Oil Rolls'' (working paper, 2012) available at

    http://business.nd.edu/uploadedFiles/Faculty_and_Research/Finance/Finance_Seminar_Series/2012%20Fall%20Finance%20Seminar%20Series%20-%20Hank%20Bessembinder%20Paper.pdf.

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

    The effect of revoking these exemptions for intermediaries may be

    mitigated in part by the absence of class limits in the proposed

    rules.\484\ The

    [[Page 75741]]

    absence of class limits means that market participants will be able to

    net economically equivalent derivatives contracts that are referenced

    contracts, i.e., futures against swaps, outside of the spot month,

    which would have the effect of reducing the size of a net position,

    perhaps below applicable speculative limits, in the case of an

    intermediary who enters into multiple swap positions in individual

    commodities to replicate a desired commodity index exposure in lieu of

    executing a swap on the commodity index.\485\ Netting would also permit

    larger speculative positions in futures alone outside of the spot month

    for traders who did not previously have a bona fide hedge exemption,

    but who have positions in swaps in the same commodity that would be

    netted against futures in the same commodity.\486\ Declining to impose

    class limits might seem to be at cross-purposes with narrowing the

    scope of the bona fide hedging definition. However, the Commission is

    concerned that class limits could impair liquidity in futures or swaps,

    as the case may be. For example, a speculator with a large portfolio of

    swaps near a particular class limit would be assumed to have a strong

    preference for executing futures transactions in order to maintain a

    swaps position below the class limit. If there were many similarly

    situated speculators, the market for such swaps could become less

    liquid. The absence of class limits should decrease the possibility of

    illiquid markets for contracts subject to Federal speculative position

    limits. Economically equivalent swaps and futures contracts outside of

    the spot month are close substitutes for each other. The absence of

    class limits should allow greater integration between the swaps and

    futures markets for contracts subject to Federal speculative position

    limits, and should also provide market participants with more

    flexibility when both hedging and speculating.

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

    \484\ In the vacated part 151 Rulemaking Proposal, 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 part 151 rule would have applied single-month

    and all-months-combined position limits to each class separately.

    The aggregate position limits across contract classes would have

    been in addition to the position limits within each contract class.

    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 swap from establishing extraordinarily large

    offsetting positions. 76 FR at 71642. In response to comments

    received on the proposed part 151 rule, the Commission determined to

    eliminate class limits from the final rule. This is because the

    Commission believed that comments regarding the ability of market

    participants to net swaps and futures positions that are

    economically equivalent had merit. The Commission believed that

    concerns regarding the potential for market abuses through the use

    of futures and swaps positions could be addressed adequately, for

    the time being, by the Commission's large trader surveillance

    program. The Commission stated in the vacated part 151 Rulemaking

    that it would closely monitor speculative positions in Referenced

    Contracts and may revisit this issue as appropriate. 76 FR 71643.

    The Commission has determined to omit class limits from the rules

    proposed in this release for the same reasons that it eliminated

    class limits in the vacated part 151 Rulemaking.

    \485\ Netting of commodity index contracts with referenced

    contracts would not be permitted because a commodity index contract

    is not a substitute for a position taken or to be taken in a

    physical marketing channel.

    \486\ For example, a swap intermediary seeking to manage price

    risk on its books from serving as a counterparty to swap clients in

    commodity index swap contracts or commodity swap contracts could

    establish a portfolio of long futures positions in the commodities

    in the index or the commodity underlying the swap above applicable

    speculative limits if it had obtained a risk-management exemption.

    If the Commission adopts this proposal, the intermediary would not

    be able to hedge above the limits pursuant to the exemption, but

    could net economically equivalent contracts, which would have the

    effect of reducing the size of the position below applicable

    speculative limits.

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

    c. Proposed Recordkeeping Requirements

    Proposed Sec. 150.3(g) specifies recordkeeping requirements for

    persons who claim any exemption set forth in proposed Sec. 150.3.

    Persons claiming exemptions under proposed Sec. 150.3 must maintain

    complete books and records concerning all details of their related

    cash, forward, futures, options and swap positions and

    transactions.\487\ Furthermore, such persons must make such books and

    records available to the Commission upon request under proposed Sec.

    150.3(h), which would preserve the ``special call'' rule set forth in

    current Sec. 150.3(e). This ``special call'' rule sets forth that any

    person claiming an exemption under Sec. 150.3 must, upon request,

    provide to the Commission such information as specified in the call

    relating to the positions owned or controlled by that person; trading

    done pursuant to the claimed exemption; the commodity derivative

    contracts or cash market positions which support the claim of

    exemption; and the relevant business relationships supporting a claim

    of exemption.\488\

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

    \487\ Such positions and transactions include anticipated

    requirements, production and royalties, contracts for services, cash

    commodity products and by-products, and cross-commodity hedges.

    \488\ In order to capture information relating to swaps

    positions, the term ``futures, options'' in 17 CFR 150.3(e) would be

    replaced in proposed Sec. 150.3(g) with the broader term

    ``commodity derivative contracts'' (defined in proposed Sec.

    150.1).

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

    The proposed rules concerning detailed recordkeeping and special

    calls would help to ensure that any person who claims any exemption set

    forth in Sec. 150.3 can demonstrate a legitimate purpose for doing so.

    4. Part 19--Reports by Persons Holding Bona Fide Hedge Positions

    Pursuant to Sec. 150.1 of This Chapter and by Merchants and Dealers in

    Cotton

    i. Current Part 19

    The market and large trader reporting rules are contained in parts

    15 through 21 of the Commission's regulations.\489\ Collectively, these

    reporting rules effectuate the Commission's market and financial

    surveillance programs by providing information concerning the size and

    composition of the commodity futures, options, and swaps markets,

    thereby permitting the Commission to monitor and enforce the

    speculative position limits that have been established, among other

    regulatory goals. The Commission's reporting rules are implemented

    pursuant to the authority of CEA sections 4g and 4i, among other CEA

    sections. Section 4g of the Act imposes reporting and recordkeeping

    obligations on registered entities, and obligates FCMs, introducing

    brokers, floor brokers, and floor traders to file such reports as the

    Commission may require on proprietary and customer positions executed

    on any board of trade.\490\ Section 4i of the Act requires the filing

    of such reports as the Commission may require when positions equal or

    exceed Commission-set levels.\491\

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

    \489\ 17 CFR parts 15-21.

    \490\ See CEA section 4g(a); 7 U.S.C. 6g(a).

    \491\ See CEA section 4i; 7 U.S.C. 6i.

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

    Current part 19 of the Commission's regulations sets forth

    reporting requirements for persons holding or controlling reportable

    futures and option positions which constitute bona fide hedge positions

    as defined in Sec. 1.3(z) and for merchants and dealers in cotton

    holding or controlling reportable positions for future delivery in

    cotton.\492\ In the several markets with federal speculative position

    limits--namely those for grains, the soy complex, and cotton--hedgers

    that hold positions in excess of those limits must file a monthly

    report pursuant to part 19 on CFTC Form 204: Statement of Cash

    Positions in Grains,\493\ which includes the soy complex, and CFTC Form

    304 Report: Statement of Cash Positions in Cotton.\494\ These monthly

    reports, collectively referred to as the Commission's ``series '04

    reports,'' must show the trader's positions in the cash market and are

    used by the Commission to determine whether a trader has sufficient

    cash positions that justify futures and option positions above the

    speculative limits.\495\

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

    \492\ See 17 CFR part 19. Current part 19 cross-references a

    provision of the definition of reportable position in 17 CFR

    15.00(p)(2). As discussed below, that provision would be

    incorporated into proposed Sec. 19.00(a).

    \493\ Current CFTC Form 204: Statement of Cash Positions in

    Grains is available at http://www.cftc.gov/ucm/groups/public/@forms/documents/file/cftcform204.pdf.

    \494\ Current CFTC Form 304 Report: Statement of Cash Positions

    in Cotton is available at http://www.cftc.gov/ucm/groups/public/@forms/documents/file/cftcform304.pdf.

    \495\ In addition, in the cotton market, merchants and dealers

    file a weekly CFTC Form 304 Report of their unfixed-price cash

    positions, which is used to publish a weekly Cotton On-call report,

    a service to the cotton industry. The Cotton On-Call Report shows

    how many unfixed-price cash cotton purchases and sales are

    outstanding against each cotton futures month.

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

    ii. Proposed Amendments to Part 19

    The Commission proposes to amend part 19 so that it conforms with

    the Commission's proposed changes to part

    [[Page 75742]]

    150. First, the Commission proposes to amend part 19 by adding new and

    modified cross-references to proposed part 150, including the new

    definition of bona fide hedging position in proposed Sec. 150.1.

    Second, the Commission proposes to amend Sec. 19.00(a) by extending

    reporting requirements to any person claiming any exemption from

    federal position limits pursuant to proposed Sec. 150.3. The

    Commission proposes to add three new series '04 reporting forms to

    effectuate these additional reporting requirements. Third, the

    Commission proposes to update the manner of part 19 reporting. Lastly,

    the Commission proposes to update both the type of data that would be

    required in series '04 reports, as well as the time allotted for filing

    such reports.

    For purposes of clarity and simplicity, the Commission seeks to

    retain the current organization of grouping many reporting

    requirements, including those related to claimed exemptions from the

    federal position limits, within parts 15-21 of the Commission's

    regulations. The Commission notes this is a change from the

    organization of vacated Sec. 151.5, which included both exemptions and

    related reporting requirements within a single section.

    a. Amended Cross-References

    As discussed above, the Commission has proposed to replace the

    definition of bona fide hedging transaction found in Sec. 1.3(z) with

    a new proposed definition of bona fide hedging position in proposed

    Sec. 150.1. Therefore, proposed part 19 would replace cross-references

    to Sec. 1.3(z) with cross-references to the new definition of bona

    fide hedging positions in proposed Sec. 150.1.

    Proposed part 19 will be expanded to include reporting requirements

    for positions in swaps, in addition to futures and options positions,

    for any part of which a person relies on an exemption. Therefore,

    positions in ``commodity derivative contracts,'' as defined in proposed

    Sec. 150.1, would replace ``futures and option positions'' throughout

    amended part 19 as shorthand for any futures, option, or swap contract

    in a commodity (other than a security futures product as defined in CEA

    section 1a(45)).\496\ This amendment would harmonize the reporting

    requirements of part 19 with proposed amendments to part 150 that

    encompass swap transactions.

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

    \496\ See discussion above.

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

    Proposed Sec. 19.00(a) would eliminate the cross-reference to the

    definition of reportable position in Sec. 15.00(p)(2). In this regard,

    the current reportable position definition essentially identifies

    futures and option positions in excess of speculative position limits.

    Proposed Sec. 19.00(a) simply makes clear that the reporting

    requirement applies to commodity derivative contract positions

    (including swaps) that exceed speculative position limits, as discussed

    below.

    b. List of Persons Who Must File Series '04 Reports Extended To Include

    Any Person Claiming an Exemption Under Proposed Sec. 150.3

    The reporting requirements of current part 19 apply only to persons

    holding bona fide hedge positions and merchants and dealers in cotton

    holding or controlling reportable positions for future delivery in

    cotton.\497\ The Commission proposes to extend the reach of part 19 by

    requiring all persons who wish to avail themselves of any exemption

    from federal position limits under proposed Sec. 150.3 to file

    applicable series '04 reports.\498\ Collection of this information

    would facilitate the Commission's surveillance program with respect to

    detecting and deterring trading activity that may tend to cause sudden

    or unreasonable fluctuations or unwarranted changes in the prices of

    the referenced contracts and their underlying commodities. By

    broadening the scope of persons who must file series '04 reports, the

    Commission seeks to ensure that any person who claims any exemption

    from federal speculative position limits can demonstrate a legitimate

    purpose for doing so. The list of positions set forth in proposed Sec.

    150.3 that are eligible for exemption from the federal position

    includes, but is not limited to, bona fide hedging positions (including

    pass-through swaps and anticipatory bona fide hedge positions),

    qualifying spot month positions in cash-settled referenced contracts,

    and qualifying non-enumerated risk-reducing transactions.

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

    \497\ See 17 CFR part 19. Current part 19 cross-references the

    definition of reportable position in 17 CFR 15.00(p).

    \498\ Furthermore, anyone exceeding the federal limits who has

    received a special call must file a series '04 form.

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

    Series '04 reports currently refers to Form 204 and Form 304, which

    are listed in current Sec. 15.02.\499\ The Commission proposes to add

    three new series '04 reporting forms to effectuate the expanded

    reporting requirements of part 19. The Commission will avoid using any

    form numbers with ``404'' to avoid confusion with the part 151

    Rulemaking.\500\ Proposed Form 504 would be added for use by persons

    claiming the conditional spot month limit exemption pursuant to

    proposed Sec. 150.3(c).\501\ Proposed Form 604 would be added for use

    by persons claiming a bona fide hedge exemption for either of two

    specific pass-through swap position types, as discussed further

    below.\502\ Proposed Form 704 would be added for use by persons

    claiming a bona fide hedge exemption for certain anticipatory bona fide

    hedging positions.\503\

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

    \499\ 17 CFR 15.02.

    \500\ Forms 404, 404A and 404S were required under provisions of

    vacated part 151.

    \501\ See supra discussion of proposed Sec. 150.3(c).

    \502\ Proposed Form 604 would replace Form 404S (as contemplated

    in vacated part 151).

    \503\ The updated definition of bona fide hedging in proposed

    Sec. 150.1 incorporates several specific types of anticipatory

    transactions: unfilled anticipated requirements, unsold anticipated

    production, anticipated royalties, anticipated services contract

    payments or receipts, and anticipatory cross-commodity hedges. See,

    paragraphs (3)(iii), (4)(i), (iii), and (iv), and (5), respectively,

    of the Commission's amended definition of bona fide hedging

    transactions in proposed Sec. 150.1 as discussed above.

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

    c. Manner of Reporting

    (1) Excluding Certain Source Commodities, Products or Byproducts of the

    Cash Commodity Hedged

    For purposes of reporting cash market positions under current part

    19, the Commission historically has allowed a reporting trader to

    ``exclude certain products or byproducts in determining his cash

    positions for bona fide hedging'' if it is ``the regular business

    practice of the reporting trader'' to do so.\504\ The Commission has

    determined to clarify the meaning of ``economically appropriate'' in

    light of this reporting exclusion of certain cash positions.\505\ In

    order for a position to be economically appropriate to the reduction of

    risks in the conduct and management of a commercial enterprise, the

    enterprise generally should take into account all inventory or products

    that the enterprise owns or controls, or has contracted for purchase or

    sale at a fixed price. For example, in line with its historical

    approach to the reporting exclusion, the Commission does not believe

    that it would be economically appropriate to exclude large quantities

    of a source commodity held in inventory when an enterprise is

    calculating its value at risk to a source commodity and it intends to

    establish a long derivatives position as

    [[Page 75743]]

    a hedge of unfilled anticipated requirements. Therefore, under proposed

    Sec. 19.00(b)(1), a source commodity itself can only be excluded from

    a calculation of a cash position if the amount is de minimis,

    impractical to account for, and/or on the opposite side of the market

    from the market participant's hedging position.\506\

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

    \504\ See 17 CFR 19.00(b)(1) (providing that ``[i]f the regular

    business practice of the reporting trader is to exclude certain

    products or byproducts in determining his cash position for bona

    fide hedging . . ., the same shall be excluded in the report'').

    \505\ See supra discussion of the ``economically appropriate

    test'' as it relates to the definition of bona fide hedging

    position.

    \506\ Proposed Sec. 19.00(b)(1) adds a caveat to the

    alternative manner of reporting: when reporting for the cash

    commodity of soybeans, soybean oil, or soybean meal, the reporting

    person shall show the cash positions of soybeans, soybean oil and

    soybean meal. This proposed provision for the soybean complex is

    included in the current instructions for preparing Form 204.

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

    Originally, the Commission intended for the optional part 19

    reporting exclusion to cover only cash positions that were not capable

    of being delivered under the terms of any derivative contract.\507\ The

    Commission differentiated between ``products and byproducts'' of a

    commodity and the underlying commodity itself, the former capable of

    exclusion from part 19 reporting under normal business practices due to

    the absence of any derivative contract in such product or

    byproduct.\508\ This intention ultimately evolved to allow cross-

    commodity hedging of products and byproducts of a commodity that were

    not necessarily deliverable under the terms of any derivative

    contract.\509\ The instructions to current Form 204 go a step further

    than current Sec. 19.00(b)(1) by allowing for a reporting trader to

    exclude ``certain source commodities, products, or byproducts in

    determining [ ] cash positions for bona fide hedging.'' (Emphasis

    added.)

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

    \507\ 43 FR 45825, 45827, Oct. 4, 1978 (explaining that the

    allowance for eggs not kept in cold storage to be excluded from

    reporting a cash position in eggs under part 19 ``was appropriate

    when the only futures contract being traded in fresh shell eggs

    required delivery from cold storage warehouses.'').

    \508\ Prior to the Commission revising the part 19 reporting

    exclusion for eggs, see id., the exclusion allowed ``eggs not in

    cold storage or certain egg products'' not to be reported as a cash

    position. 26 FR 2971, Apr. 7, 1961 (emphasis added). Additionally,

    the title to the revised exclusion reads: ``Excluding products or

    byproducts of the cash commodity hedged.'' See 43 FR 45825, 45828,

    Oct. 4, 1978. So, in addition to a commodity itself that was not

    deliverable under any derivative contract, the Commission also

    recognized a separate class of ``products and byproducts'' that

    resulted from the processing of a commodity that it did not believe

    at the time was capable of being hedged by any derivative contract

    for purposes of a bona fide hedge.

    \509\ See 42 FR 42748, Aug. 24, 1977. Cross-commodity hedging is

    discussed as an enumerated hedge, below.

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

    The Commission's proposed clarification of the Sec. 19.00(b)(1)

    reporting exclusion would prevent the definition of bona fide hedging

    positions in proposed Sec. 150.1 from being swallowed by this

    reporting rule. For it would not be economically appropriate behavior

    for a person who is, for example, long derivative contracts to exclude

    inventory when calculating unfilled anticipated requirements. Such

    behavior would call into question whether an offset to unfilled

    anticipated requirements is, in fact, a bona fide hedging position,

    since such inventory would fill the requirement. As such, a trader can

    only underreport cash market activities on the opposite side of the

    market from her hedging position as a regular business practice, unless

    the unreported inventory position is de minimis or impractical to

    account for. By way of example, the alternative manner of reporting in

    proposed Sec. 19.00(b)(1) would permit a person who has a cash

    inventory of 5 million bushels of wheat, and is short 5 million bushels

    worth of commodity derivative contracts, to underreport additional cash

    inventories held in small silos in disparate locations that are

    administratively difficult to count. This person could instead opt to

    calculate and report these hard-to-count inventories and establish

    additional short positions in commodity derivative contracts as a bona

    fide hedge against such additional inventories.

    (2) Cross-Commodity Hedges

    Proposed Sec. 19.00(b)(2) sets forth instructions, which are

    consistent with the provisions in the current section, for reporting a

    cash position in a commodity that is different from the commodity

    underlying the futures contract used for hedging.\510\ A person who is

    unsure of whether a commodity may serve as the basis of a cross-

    commodity hedge should refer to the deliverable commodities listed by

    the relevant DCM under the terms of a particular core referenced

    futures contract. Persons who wish to avail themselves of cross-

    commodity hedges are required to file an appropriate series '04

    form.\511\

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

    \510\ Proposed Sec. 19.00(b)(2) would add the term commodity

    derivative contracts (as defined in proposed Sec. 150.1). The

    proposed definition of cross-commodity hedge in proposed Sec. 150.1

    is discussed above.

    \511\ Vacated Sec. 151.5(g) would have required the filing of a

    Form 404, 404A, or 404S by persons availing themselves of cross-

    commodity hedges.

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

    Under vacated Sec. 151.5(g), traders engaged in hedging commercial

    activity (or hedging swaps that in turn hedge commercial activity) that

    did not involve the same quantity or commodity as the quantity or

    commodity associated with positions in referenced contracts that are

    used to hedge would have been obligated to submit a description of the

    conversion methodology each time they cross-hedged.\512\ In lieu of

    that, the Commission proposes to instead maintain the special call

    status concerning such information as set forth in current Sec.

    19.00(b)(3).\513\ Furthermore, since proposed Sec. 19.00(b)(3) would

    maintain the requirement that cross-hedged positions be shown both in

    terms of the equivalent amount of the commodity underlying the

    commodity derivative contract used for hedging and in terms of the

    actual cash commodity (as provided for on the appropriate series '04

    form), the Commission will be able to determine the hedge ratio used

    merely by comparing the reported positions. Thus, the Commission will

    be positioned to review whether a hedge ratio appears reasonable in

    comparison to, for example, other similarly situated traders, without

    requiring reporting of the conversion methodology.

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

    \512\ See 76 FR at 71692.

    \513\ See discussion below.

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

    (3) Standards and Conversion Factors

    Proposed Sec. 19.00(b)(3) maintains the requirement that standards

    and conversion factors used in computing cash positions for reporting

    purposes must be made available to the Commission upon request.

    Proposed Sec. 19.00(b)(3) would clarify that such information would

    include hedge ratios used to convert the actual cash commodity to the

    equivalent amount of the commodity underlying the commodity derivative

    contract used for hedging, and an explanation of the methodology used

    for determining the hedge ratio.

    (4) Examples of Completed '04 Forms

    To assist filers in completing Forms 204, 304, 504, 604 and 704,

    illustrative examples are provided in appendix A to part 19, adjacent

    to the blank forms and instructions. Once finalized, filers would be

    able to contact Commission staff in the Office of Data and Technology

    (ODT) and/or surveillance staff in the Division of Market Oversight for

    additional guidance.

    d. Information Required and Timing

    Proposed Sec. 19.01(b)(3) would require series `04 reports to be

    transmitted using the format, coding structure, and electronic data

    transmission procedures approved in writing by the Commission or its

    designee.\514\

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

    \514\ For example, the Commission is considering requiring that

    series '04 reports should be sent to the Commission via FTP, unless

    otherwise specifically authorized by the Commission or its designee.

    Prior to submitting series '04 reports, persons would contact the

    CFTC at (312) 596-0700 to obtain the CFTC trader identification code

    required by such reports. Further instructions on submitting '04

    reports may be found at http://www.cftc.gov/Forms/index.htm. If

    submission through FTP is impractical, the reporting trader would

    contact the Commission at (312) 596-0700 for further instruction.

    CFTC Form 204 reports with respect to transactions in wheat,

    corn, oats, soybeans, soybean meal and soybean oil would no longer

    be sent to the Commission's office in Chicago, IL.

    Similarly, CFTC Form 304 reports with respect to transactions in

    cotton would no longer be sent to the Commission's office in New

    York, NY.

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

    [[Page 75744]]

    (1) Bona Fide Hedgers and Cotton Merchants and Dealers

    Current Sec. 19.01(a) sets forth the data that must be provided by

    bona fide hedgers (on Form 204) and by merchants and dealers in cotton

    (on Form 304).\515\ The Commission proposes to continue using Forms 204

    and 304, which will feature only minor changes to the types of data to

    be reported.\516\ To accommodate open price pairs, proposed Sec.

    19.01(a)(3) would remove the modifier ``fixed price'' from ``fixed

    price cash position'' and would add a specific request for data

    concerning open price contracts. The Commission would maintain

    additional reporting requirements for cotton but will incorporate the

    monthly reporting, including the granularity of equity, certificated

    and non-certificated cotton stocks, on Form 204. Weekly reporting for

    cotton will be retained as a separate report made on Form 304 for the

    collection of data required by the Commission to publish its weekly

    public cotton ``on call'' report on www.cftc.gov.

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

    \515\ Vacated Sec. 151.5 would have set 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.

    Under vacated Sec. 151.5, had a bona fide hedger sought to claim an

    exemption from position limits because of cash market activities,

    then the hedger would have submitted a Form 404 filing pursuant to

    vacated Sec. 151.5(b). The Form 404 filing would have been

    submitted when the bona fide hedger exceeded the applicable position

    limit and claimed an exemption or when its hedging needs increased.

    Similarly, parties to bona fide hedging swap transactions would have

    been required to submit a Form 404S filing to qualify for a hedging

    exemption, which would also have been submitted when the bona fide

    hedger exceeded the applicable position limit and claimed an

    exemption or when its hedging needs increased.

    \516\ The list of data required for persons filing on Forms 204

    and 304 would be relocated from current Sec. 19.01(a) to proposed

    Sec. 19.01(a)(3).

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

    Proposed Sec. 19.01(b) would maintain the requirement that reports

    on Form 204 be submitted to the Commission on a monthly basis, as of

    the close of business on the last Friday of the month.\517\

    Accordingly, commercial firms would measure their respective cash

    positions on one day a month, as they currently do for Form 204, and

    submit a monthly report, as currently provided in Sec. 19.01. Proposed

    Sec. 19.02 provides that Form 304, but not Form 204, must be filed

    weekly to provide data for the Commission's weekly cotton ``on call''

    report. The Commission would continue to utilize its special call

    authority in addition to the regular reporting on '04 forms to ensure

    that it has sufficient information.

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

    \517\ Compare proposed Sec. 19.01(b) with 17 CFR 19.01(b).

    Additionally, compare proposed Sec. 19.01(b) with vacated Sec.

    151.5(c) which would have required that any person holding a

    derivatives position in excess of a position limit record and

    ultimately report information about such person's cash positions in

    the relevant commodity for each day that its derivatives position

    exceeds the applicable position limit.

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

    (2) Conditional Spot-Month Limit Exemption

    Proposed Sec. 19.01(a)(1) would require persons availing

    themselves of the conditional spot month limit exemption (pursuant to

    proposed Sec. 150.3(c)) to report certain detailed information

    concerning their cash market activities for any commodity specially

    designated by the Commission for reporting under Sec. 19.03 of this

    part. While traders who avail themselves of this exemption could not

    directly influence particular settlement prices by trading in the

    physical-delivery referenced contract, the Commission remains concerned

    about such traders' activities in the underlying cash commodity.

    Accordingly, proposed Sec. 19.01(b) would require that persons

    claiming a conditional spot month limit exemption must report on new

    Form 504 daily, by 9 a.m. Eastern Time on the next business day, for

    each day that a person is over the spot month limit in certain special

    commodity contracts specified by the Commission.\518\ The scope of

    reporting--purchase and sales contracts through the delivery area for

    the core referenced futures contract and inventory in the delivery

    area--differs from the scope of reporting for bona fide hedgers, since

    the person relying on the conditional spot month limit exemption may

    not be hedging any position.

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

    \518\ Additionally, data under this provision may be required by

    way of special call, in addition to special commodity reporting.

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

    Initially, the Commission would require reporting on new Form 504

    for conditional spot month limit exemptions in the natural gas

    commodity derivative contracts only. Based on its experience in

    surveillance of natural gas commodity derivative contracts, the

    Commission believes that enhanced reporting is warranted.\519\ The

    Commission would wait to impose similar reporting requirements for

    persons claiming conditional spot month limit exemptions in other

    commodity derivative contracts until the Commission gains additional

    experience with the limits in proposed Sec. 150.2. In this regard, the

    Commission will closely monitor the reporting associated with

    conditional spot month limit exemptions in natural gas and may require

    reporting on Form 504 for other commodity derivative contracts in the

    future in response to market developments and to facilitate

    surveillance.\520\

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

    \519\ The Commission has observed dramatic instances of

    disruptive trading practices in the natural gas markets. See United

    States CFTC v. Amaranth Advisors, LLC, 2009 U.S. Dist. LEXIS 101406

    (S.D.N.Y. Aug. 12, 2009). The Commission endeavors to balance the

    cost of similar enhanced reporting for the other 27 commodities

    against its experience with observing disruptive trading practices.

    \520\ See proposed Sec. 19.03.

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

    (3) Pass-Through Swap Exemption

    Under the definition of bona fide hedging position in proposed

    Sec. 150.1, a person who uses a swap to reduce risks attendant to a

    position that qualifies as a bona fide hedging position may pass-

    through those bona fides to the counterparty, even if the person's swap

    position is not in excess of a position limit.\521\ As such, positions

    in commodity derivative contracts that reduce the risk of pass-through

    swaps would qualify as bona fide hedging positions.

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

    \521\ See supra discussion of the proposed definition of bona

    fide hedging position.

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

    Proposed Sec. 19.01(a)(2) would require a person relying on the

    pass-through swap exemption who holds either of two position types to

    file a report with the Commission on new Form 604. The first type of

    position is a swap executed opposite a bona fide hedger that is not a

    referenced contract and for which the risk is offset with referenced

    contracts. The second type of position is a cash-settled swap executed

    opposite a bona fide hedger that is offset with physical-delivery

    referenced contracts held into a spot month, or, vice versa, a

    physical-delivery swap executed opposite a bona fide hedger that is

    offset with cash-settled referenced contracts held into a spot month.

    These reports on Form 604 would explain hedgers' needs for large

    referenced contract positions and would give the Commission the ability

    to verify the positions were a bona fide hedge, with heightened daily

    surveillance of spot month offsets. Persons holding any type of pass-

    through swap position other than the two described above would report

    on Form 204.\522\

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

    \522\ Persons holding pass-through swap positions that are

    offset with referenced contracts outside the spot month (whether

    such contracts are for physical delivery or are cash-settled) need

    not report on Form 604 because swap positions will be netted with

    referenced contract positions outside the spot month pursuant to

    proposed Sec. 150.2(b).

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

    [[Page 75745]]

    (A) Non-Referenced Contract Swap Offset

    Proposed Sec. 19.01(a)(2)(i) lists the types of data that a person

    who executes a pass-through swap that is not a referenced contract and

    for which the risk is offset with referenced contracts must report on

    new Form 604. Such data requirements include details concerning the

    non-referenced contract in terms of commodity reference price,\523\

    notional quantity, gross long or short position in terms of futures-

    equivalents in the core referenced futures contract, and gross long or

    short position in the referenced contract used to offset risk.\524\

    Under proposed Sec. 19.01(b), persons holding a non-referenced

    contract swap offset would submit reports to the Commission on a

    monthly basis, as of the close of business of the last Friday of the

    month. This data collection would permit staff to identify offsets of

    non-referenced-contract pass-through swaps on an ongoing basis for

    further analysis. The Commission believes collection of this data will

    be less burdensome on reporting entities than complying with special

    calls.

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

    \523\ As defined in 17 CFR 20.1, a commodity reference price is

    the price series used by the parties to a swap or swaption to

    determine payments made, exchanged, or accrued under the terms of

    that swap or swaption.''

    \524\ In contrast to vacated Sec. 151.5(f) and (g), proposed

    Sec. 19.01(a)(2)(i) would not require the person to submit a

    description of the conversion methodology each time he or she cross-

    hedged.

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

    (B) Spot Month Swap Offset

    Under proposed Sec. 150.2(a), a trader in the spot month may not

    net across physical-delivery and cash-settled contracts for the purpose

    of complying with federal position limits.\525\ If a person executes a

    cash-settled pass-through swap that is offset with physical-delivery

    contracts held into a spot month (or vice versa), then, pursuant to

    proposed Sec. 19.01(a)(2)(ii), that person must report additional

    information concerning the swap and offsetting referenced contract

    position on new Form 604. A person need not file a Form 604 if he or

    she executes a cash-settled pass-through swap that is offset with cash-

    settled referenced contracts, or, vice versa, a physical delivery pass-

    through swap offset with physical delivery referenced contracts.\526\

    Pursuant to proposed Sec. 19.01(b), a person holding a spot month swap

    offset would need to file on Form 604 as of the close of business on

    each day during a spot month, and not later than 9 a.m. Eastern Time on

    the next business day following the date of the report. The Commission

    notes that pass-through swap offsets would not be permitted during the

    lesser of the last five days of trading or the time period for the spot

    month. However, the Commission remains concerned that a trader could

    hold an extraordinarily large position early in the spot month in the

    physical-delivery contract along with an offsetting short position in a

    cash-settled contract, which may disrupt the price discovery function

    of the underlying physical delivery core referenced futures contract.

    Hence, the Commission proposes to introduce this new daily reporting

    requirement within the spot month to identify and monitor such

    offsetting positions.

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

    \525\ See supra discussion of proposed Sec. 150.2(a).

    \526\ To provide clarity in filings, a person may report cash-

    settled referenced contracts used for bona fide hedging in a

    separate filing from physical-delivery referenced contracts used for

    bona fide hedging.

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

    5. Section 150.7--Reporting Requirements for Anticipatory Hedging

    Positions

    For reasons discussed above, the revised definition of bona fide

    hedging in proposed Sec. 150.1 incorporates hedges of five specific

    types of anticipated transactions: unfilled anticipated requirements,

    unsold anticipated production, anticipated royalties, anticipated

    services contract payments or receipts, and anticipatory cross-

    hedges.\527\ The Commission proposes reporting requirements in new

    Sec. 150.7 for traders seeking an exemption from position limits for

    any of these five enumerated anticipated hedging transactions. Proposed

    Sec. 150.7 would build on, and replace, the special reporting

    requirements for hedging of unsold anticipated production and unfilled

    anticipated requirements in current Sec. 1.48.\528\

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

    \527\ See paragraphs (3)(iii), (4)(i), (iii), and (iv), and (5),

    respectively, of the Commission's amended definition of bona fide

    hedging transactions in proposed Sec. 150.1 as discussed above.

    \528\ See 17 CFR 1.48. See also definition of bona fide hedging

    transactions in current 17 CFR 1.3(z)(2)(i)(B) and (ii)(C),

    respectively.

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

    i. Current Sec. 1.48

    Current Sec. 1.48 provides a procedure for persons to file for

    bona fide hedging exemptions for anticipated production or unfilled

    requirements when that person has not covered the anticipatory need

    with fixed-price commitments to sell a commodity, or inventory or

    fixed-price commitments to purchase a commodity. The Commission has

    long been concerned that distinguishing between what is the reduction

    of risk arising from anticipatory needs, and what is speculation, may

    be exceedingly difficult if anticipatory transactions are not well

    defined. Therefore, for more than fifty years, the position limit rules

    have set discrete reporting requirements in Sec. 1.48 for persons

    wishing to avail themselves of certain anticipatory bona fide hedging

    position exemptions.\529\ When first promulgated in 1956, Sec. 1.48

    set forth reporting requirements for persons hedging anticipated

    requirements for processing or manufacturing.\530\ In 1977, Sec. 1.48

    was amended to include similar reporting requirements for a second type

    of anticipatory hedge transaction: unsold anticipated production.\531\

    Thereafter, the Commission did not substantively amend Sec. 1.48 until

    it adopted a new position limits regime in 2011.\532\

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

    \529\ See Hedging Anticipated Requirements for Processing or

    Manufacturing under Section 4a(3) of the Commodity Exchange Act, 21

    FR 6913, Sep. 12, 1956.

    \530\ Id. The statutory definition also provided an anticipatory

    production hedge for twelve months agricultural production. 7 U.S.C.

    6a(3)(A) (1940) (1970). The statutory definition was deleted in

    1974, as discussed above in the definition of bona fide hedging

    position.

    \531\ See Definition of Bona Fide Hedging Requirements and

    Related Reporting Requirements, 42 FR 42748, Aug. 24, 1977. The

    Commission stated at that time that this amended reporting

    requirement was intended to conform Sec. 1.48 to the updated

    definition of bona fide hedging in Sec. 1.3(z), and to limit the

    potential for market disruption. Id. at 42750.

    \532\ See generally 76 FR 71626, November 18, 2011. Prior to

    compliance dates, the rule was vacated, as discussed below.

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

    In January 2011, the Commission published a notice of proposed

    rulemaking to replace existing part 150, in its entirety, with a new

    federal position limits rules regime in the form of new part 151.\533\

    Proposed Sec. 151.5 would have established exemptions from position

    limits for bona fide hedging transactions or positions in exempt and

    agricultural commodities.\534\ The referenced contracts subject to the

    proposed position limit framework would have been subject to the bona

    fide hedge provisions of proposed Sec. 151.5 and would have no longer

    been subject to the definition of bona fide hedging transactions in

    Sec. 1.3(z), which would have been retained only for excluded

    commodities.\535\ Proposed Sec. 151.5(c) specified reporting and

    approval requirements for traders seeking an anticipatory hedge

    exemption, incorporating the current requirements of Sec. 1.48 (and

    thereby rendering Sec. 1.48

    [[Page 75746]]

    duplicative).\536\ However, in an Order dated September 28, 2012, the

    United States District Court for the District of Columbia vacated part

    151.\537\ The District Court decision had the effect of reinstating

    Sec. Sec. 1.3(z) and 1.48.\538\ Therefore, Sec. Sec. 1.3(z) and 1.48

    continue to apply as if part 151 had not been finally adopted by the

    Commission.

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

    \533\ Proposed Rule, 76 FR 4752, Jan. 26, 2011. The final

    rulemaking for new Part 151 required DCMs to comply with Part 150

    until such time that the Commission replaces Part 150 with the new

    Part 151. See 76 FR 71632.

    \534\ 76 FR 71643.

    \535\ 76 FR 71644.

    \536\ Id. This rulemaking would have removed and reserved Sec.

    1.48.

    \537\ See 887 F. Supp. 2d 259 (D.D.C. 2012).

    \538\ See Georgetown Univ. Hosp. v. Bowen, 821 F.2d 750, 757

    (D.C. Cir. 1987) (``This circuit has previously held that the effect

    of invalidating an agency rule is to `reinstate the rules previously

    in force.' '').

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

    ii. Proposed Sec. 150.7

    a. Reporting Requirements for Anticipatory Hedging Positions

    The Commission's revised definition of bona fide hedging in

    proposed Sec. 150.1 would enumerate two new types of anticipatory bona

    hedging positions. Two existing types of anticipatory hedges would be

    carried forward from the existing definition of bona fide hedging in

    current Sec. 1.3(z): hedges of unfilled anticipated requirements and

    hedges of unsold anticipated production, as well as anticipatory cross-

    commodity hedges of such requirements or production.\539\ Proposed

    Sec. 150.1 would expand the list of enumerated anticipatory bona fide

    hedging positions to include hedges of anticipated royalties and hedges

    of anticipated services contract payments or receipts, as well as

    anticipatory cross-commodity hedges of such contracts.\540\ As

    discussed above, Sec. 1.48 has long required special reporting for

    hedges of unfilled anticipated requirements and hedges of unsold

    anticipated production because the Commission remains concerned about

    distinguishing between anticipatory reduction of risk and speculation.

    Such concerns apply equally to any position undertaken to reduce the

    risk of anticipated transactions. Hence, the Commission proposes to

    extend the special reporting requirements in proposed Sec. 150.7 for

    all types of enumerated anticipatory hedges that appear in the

    definition of bona fide hedging positions in proposed Sec. 150.1.

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

    \539\ See current definition of bona fide hedging transactions

    at 17 CFR 1.3(z)(2)(i)(B) and (ii)(C), respectively. Cross-commodity

    hedges are permitted under 17 CFR 1.3(z)(2)(iv). Compare with

    paragraphs (3)(iii) and (4)(i), respectively, of the definition of

    bona fide hedging positions in proposed Sec. 150.1, discussed

    above.

    \540\ See sections (4)(iii) and (iv) and (5), respectively, of

    the definition of bona fide hedging positions in proposed Sec.

    150.1, discussed above.

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

    For purposes of simplicity, the proposed special reporting

    requirements for anticipatory hedges would be placed within the

    Commission's position limits regime in part 150, and alongside the

    Commission's updated definition of bona fide hedging positions in

    proposed Sec. 150.1. Thus, the Commission is proposing to delete the

    reporting requirements for anticipatory hedges in current Sec. 1.48

    because that section is duplicative.

    b. New Form 704

    The Commission proposes to add a new series '04 reporting form,

    Form 704, to effectuate these additional and updated reporting

    requirements for anticipatory hedges. Persons wishing to avail

    themselves of an exemption for any of the anticipatory hedging

    transactions enumerated in the updated definition of bona fide hedging

    in proposed Sec. 150.1 would be required to file an initial statement

    on Form 704 with the Commission at least ten days in advance of the

    date that such positions would be in excess of limits established in

    proposed Sec. 150.2. Advance notice of a trader's intended maximum

    position in commodity derivative contracts to offset anticipatory risks

    would allow the Commission to review a proposed position before a

    trader exceeds the position limits and, thereby, would allow the

    Commission to prevent excessive speculation in the event that a trader

    were to misconstrue the purpose of these limited exemptions.\541\ The

    trader's initial statement on Form 704 would provide a detailed

    description of the person's anticipated activity (i.e., unfilled

    anticipated requirements, unsold anticipated production, etc.).\542\

    Under proposed Sec. 150.7(b), the Commission may reject all or a

    portion of the position as not meeting the requirements for bona fide

    hedging positions under proposed Sec. 150.1. To support this

    determination, proposed Sec. 150.7(c) would allow the Commission to

    request additional specific information concerning the anticipated

    transaction to be hedged. Otherwise, Form 704 filings that conform to

    the requirements set forth in proposed Sec. 150.7 would become

    effective ten days after submission. Proposed Sec. 150.7(e) would

    require an anticipatory hedger to file a supplemental report on Form

    704 whenever the anticipatory hedging needs increase beyond that in its

    most recent filing.

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

    \541\ Further, advance filing may serve to reduce the burden on

    a person who exceeds position limits and who may then otherwise be

    issued a special call to determine whether the underlying

    requirements for the exemption have been met. If the Commission were

    to reject such an exemption, such a person would have already

    violated position limits.

    \542\ Proposed 150.7(d)(2) would require additional information

    for cross hedges, for reasons discussed above.

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

    c. Annual and Monthly Reporting Requirements

    Proposed Sec. 150.7(f) would add a requirement for any person who

    files an initial statement on Form 704 to provide annual updates that

    detail the person's actual cash market activities related to the

    anticipated exemption. With an eye towards distinguishing bona fide

    hedging of anticipatory risks from speculation, annual reporting of

    actual cash market activities and estimates of remaining unused

    anticipated exemptions beyond the past year would enable the Commission

    to verify whether the person's anticipated cash market transactions

    closely track that person's real cash market activities. Proposed Sec.

    150.7(g) would similarly enable the Commission to review and compare

    the actual cash activities and the remaining unused anticipated hedge

    transactions by requiring monthly reporting on Form 204. Absent monthly

    filing, the Commission would need to issue a special call to determine

    why a person's commodity derivative contract position is, for example,

    larger than the pro rata balance of her annually reported anticipated

    production.

    As is the case under current Sec. 1.48, proposed Sec. 150.7(h)

    requires that a trader's maximum sales and purchases must not exceed

    the lesser of the approved exemption amount or the trader's current

    actual anticipated transaction.

    d. Delegation

    The Commission is proposing to delete current Sec. 140.97, which

    delegates to the Director of the Division of Market Oversight or his

    designee authority regarding requests for classification of positions

    as bona fide hedging under current Sec. Sec. 1.47 and 1.48. For

    purposes of simplicity, this delegation of authority would be placed in

    proposed Sec. 150.7(j), within the Commission's position limits regime

    in part 150.

    6. Miscellaneous Regulatory Amendments

    i. Proposed Sec. 150.6--Ongoing Application of the Act and Commission

    Regulations

    The Commission is proposing to amend existing Sec. 150.6 to

    conform the provision with the general applicability of part 150 to

    SEFs that are trading facilities, and concurrently making non-

    substantive changes to clarify the provision. The provision, as amended

    and clarified, provides this part shall only be construed as having an

    effect on

    [[Page 75747]]

    position limits and that nothing in part 150 shall affect any provision

    promulgated under the Act or Commission regulations including but not

    limited to those relating to manipulation, attempted manipulation,

    corners, squeezes, fraudulent or deceptive conduct, or prohibited

    transactions.\543\ For example, by requiring DCMs and SEFs that are

    trading facilities to impose and enforce exchange-set speculative

    position limits, the Commission does not intend for the fulfillment of

    such requirements alone to satisfy any other legal obligations under

    the Act and Commission regulations of DCMs and SEFs that are trading

    facilities to detect and deter market manipulation and corners. In

    another example, a market participant's compliance with position limits

    or an exemption does not confer any type of safe harbor or good faith

    defense to a claim that he had engaged in an attempted manipulation, a

    perfected manipulation or deceptive conduct.

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

    \543\ The Commission notes that amended Sec. 150.6 matches

    vacated Sec. 151.11(h).

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

    ii. Proposed Sec. 150.8--Severability

    The Commission is proposing to add Sec. 150.8 to address the

    severability of individual provisions of part 150. Should any

    provision(s) of part 150 be declared invalid, including the application

    thereof to any person or circumstance, Sec. 150.8 provides that all

    remaining provisions of part 150 shall not be affected to the extent

    that such remaining provisions, or the application thereof, can be

    given effect without the invalid provisions.\544\ The Commission

    believes it is prudent to include a severability clause to avoid any

    further delay, as practicable, in carrying out Congress' mandate to

    impose position limits in a timely manner.

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

    \544\ The Commission notes that proposed Sec. 150.8 matches

    vacated Sec. 151.13.

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

    iii. Part 15--Reports--General Provisions

    The Commission is proposing to amend the definition of the term

    ``reportable position'' in current Sec. 15.00(p)(2) by clarifying

    that: (1) Such positions include swaps; (2) issued and stopped

    positions are not included in open interest against a position limit;

    and (3) special calls may be made for any day a person exceeds a limit.

    Additionally, the Commission is proposing to amend Sec. 15.01(d) by

    adding language to reference swaps positions. Lastly, the Commission is

    proposing to amend the list of reporting forms in current Sec. 15.02

    to account for new and updated series '04 reporting forms, as discussed

    above.\545\

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

    \545\ See discussion of new and amended series '04 reports

    above.

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

    iv. Part 17--Reports by Reporting Markets, Futures Commission

    Merchants, Clearing Members, and Foreign Brokers

    The Commission is proposing to amend current Sec. 17.00(b) to

    delete aggregation provisions, since those provisions are duplicative

    of aggregation provisions in Sec. 150.4.\546\ Proposed Sec. 17.00(b)

    would provide that ``[e]xcept as otherwise instructed by the Commission

    or its designee and as specifically provided in Sec. 150.4 of this

    chapter, if any person holds or has a financial interest in or controls

    more than one account, all such accounts shall be considered by the

    futures commission merchant, clearing member or foreign broker as a

    single account for the purpose of determining special account status

    and for reporting purposes.'' In addition, proposed Sec. 17.03(h)

    would delegate to the Director of the Division of Market Oversight or

    his designee the authority to instruct persons pursuant to proposed

    Sec. 17.03.\547\

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

    \546\ In a separate proposal approved on the same date as this

    proposal, the Commission is proposing amendments to Sec. 150.4--

    aggregation of positions. See Aggregation NPRM (Nov. 5, 2013).

    \547\ In a separate final rulemaking (Oct. 30, 2013), the

    Commission adopted amendments to Sec. 17.03; the current proposal

    would amend Sec. 17.03 further by adding proposed Sec. 17.03(h).

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

    II. Revision of Rules, Guidance, and Acceptable Practices Applicable to

    Exchange-Set Speculative Position Limits--Sec. 150.5

    A. Background

    Pursuant to 17 CFR part 150, the Commission administers speculative

    position limits on futures contracts for certain agricultural

    commodities.\548\ Prior to the CEA's amendment in 1974, which expanded

    its jurisdiction to all ``services, rights and interests'' in which

    futures contracts are traded, only certain designated agricultural

    commodities could be regulated. Both prior to and after the 1974

    amendments to the Act, futures markets that traded commodities not so

    enumerated applied speculative position limits by exchange rule, if at

    all. In 1981, the Commission promulgated Sec. 1.61, which required

    that, absent an exemption, exchanges must adopt and enforce speculative

    position limits for all contracts that are not subject to the

    Commission-set limits.\549\ The Commission has periodically reviewed

    and updated its policies and rules pertaining to each of the three

    basic elements of the regulatory framework for speculative position

    limits, namely, the levels of the limits, the exemptions from them (in

    particular, for hedgers), and the policy on aggregating accounts.\550\

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

    \548\ See 17 CFR Part 150.

    \549\ See Establishment of Speculative Position Limits, 46 FR

    50938, Oct. 16, 1981, and 17 CFR 1.61 (removed and reserved May 5,

    1999). Section 1.61 permitted exchanges to adopt and enforce their

    own speculative position limits for those contracts that were

    covered by Commission-set speculative position limits, as long as

    the exchange limits were not higher than those set by the

    Commission. Furthermore, CEA section 4a(e) provides that a violation

    of a speculative position limit established by a Commission-approved

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

    can enforce directly violations of exchange-set speculative position

    limits as well as those provided under Commission rules.

    \550\ Initially, for example, the Commission redefined

    ``hedging'' (see 42 FR 42748, Aug. 24, 1977), and raised speculative

    position limits in wheat (see 41 FR 35060, Aug. 19, 1976).

    Subsequently, for example, the Commission solicited public comment

    on, and subsequently approved, exchange requests for exemptions for

    futures and option contracts on certain financial instruments from

    the requirement specified by former Sec. 1.61 that speculative

    position limits be specified for all contracts. See 56 FR 51687,

    Oct. 15, 1991.

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

    In 1999, the Commission relocated several of the rules and policies

    concerning exchange-set-position limits from Sec. 1.61 to current

    Sec. 150.5, thereby incorporating within part 150 most Commission

    rules relating to speculative position limits. The Commission codified

    as rules within Sec. 150.5 various staff policies and administrative

    practices that had developed over time. These policies and practices

    related to the speculative position limit levels that the staff had

    routinely recommended for approval by the Commission for newly

    designated futures and option contracts, as well as the magnitude of

    increases to the limit levels that it would approve for already-traded

    contracts. The Commission also codified within Sec. 150.5 various

    exemptions from the general requirement that exchanges must set

    speculative position limits for all contracts. The exemptions included

    permitting exchanges to substitute position accountability rules for

    position limits for physical commodity derivatives outside the spot

    month in high volume and liquid markets.\551\

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

    \551\ See 17 CFR 150.5. See also Revision of Federal Speculative

    Position Limits and Associated Rules, Final Rules, 64 FR 24038,

    24040-42, May 5, 1999. As noted in the notice of proposed rulemaking

    for Sec. 150.5, promulgating these policies within a single section

    of the Commission's rules would increase significantly their

    accessibility and clarify their terms. See 63 FR 38537, Jul. 17,

    1998.

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

    Less than two years after the Commission promulgated Sec. 150.5,

    the Commodity Futures Modernization Act

    [[Page 75748]]

    of 2000 (``CFMA'') \552\ amended the CEA to include a set of core

    principles that DCMs must comply with at the time of application, and

    on an ongoing basis after designation,\553\ including DCM core

    principle 5, which requires exchanges to adopt position limits or

    position accountability levels where necessary and appropriate to

    reduce the threat of market manipulation or congestion.\554\ The CFMA

    further amended the CEA to provide DCMs with ``reasonable discretion''

    in determining how to comply with each core principle, including core

    principle 5 regarding exchange-set position limits.\555\ Since 2000,

    the Commission has continued to maintain Sec. 150.5, but only as

    guidance on, and acceptable practices for, compliance with DCM core

    principle 5. The Commission did not amend Sec. 150.5 following passage

    of the CFMA.

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

    \552\ Commodity Futures Modernization Act of 2000, Public Law

    106-554, 114 Stat. 2763 (Dec. 21, 2000). By enacting the CFMA,

    Congress intended ``[t]o reauthorize and amend the Commodity

    Exchange Act to promote legal certainty, enhance competition, and

    reduce systemic risk in markets for futures and over-the-counter

    derivatives . . . .'' Id.

    \553\ See CEA section 5(d); 7 U.S.C. 7(d). The CEA, as amended

    by the CFMA, required a DCM applicant to demonstrate its ability to

    comply with 18 core principles.

    \554\ CEA section 5(d)(5); 7 U.S.C. 7(d)(5).

    \555\ DCM core principle 1 states, among other things, that

    boards of trade ``shall have reasonable discretion in establishing

    the manner in which they comply with the core principles.'' This

    ``reasonable discretion'' provision underpinned the Commission's use

    of core principle guidance and acceptable practices. See former CEA

    section 5(d)(1)(amended in 2010); U.S.C. 7(d)(1). As discussed

    above, the Dodd-Frank Act subsequently amended DCM core principle 1

    to specifically provide the Commission with discretion to determine,

    by rule or regulation, the manner in which boards of trade comply

    with the core principles.

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

    In 2010, the Dodd-Frank Act amended the CEA to explicitly provide

    that the Commission may mandate the manner in which DCMs must comply

    with the core principles.\556\ Specifically, the Dodd-Frank Act amended

    DCM core principle 1 to include the condition that ``[u]nless otherwise

    determined by the Commission by rule or regulation,'' boards of trade

    shall have reasonable discretion in establishing the manner in which

    they comply with the core principles.\557\

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

    \556\ See CEA section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B).

    \557\ See id. Congress limited the exercise of reasonable

    discretion by DCMs only where the Commission has acted by

    regulation.

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

    Additionally, the Dodd-Frank Act amended DCM core principle 5 to

    require that, for any contract that is subject to a position limitation

    established by the Commission pursuant to CEA section 4a(a), the DCM

    ``shall set the position limitation of the board of trade at a level

    not higher than the position limitation established by the

    Commission.'' \558\ Furthermore, the Dodd-Frank Act added CEA section

    5h to provide a regulatory framework for Commission oversight of

    SEFs.\559\ Under SEF core principle 6, which parallels DCM core

    principle 5, Congress required that SEFs adopt for each swap, as is

    necessary and appropriate, position limits or position

    accountability.\560\ In addition, Congress required that, for any

    contract that is subject to a Federal position limit under CEA Section

    4a(a), the SEF shall set its position limits at a level no higher than

    the position limitation established by the Commission.\561\

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

    \558\ See CEA section 5(d)(5)(B) (amended 2010); 7 U.S.C.

    7(d)(5)(B).

    \559\ See CEA section 5h; 7 U.S.C. 7b-3.

    \560\ CEA section 5h(f)(6); 7 U.S.C. 7b-3(f)(6).

    \561\ Id.

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

    In view of these Dodd-Frank Act amendments, the Commission proposes

    several amendments to update and streamline the part 150 regulations.

    First, the Commission proposes new and amended clarifying definitions

    in Sec. 150.1 that relate particularly to position limits. Second, the

    Commission proposes to amend Sec. 150.5 to include SEFs and swaps.

    Third, the Commission proposes to codify rules and acceptable practices

    for compliance with DCM core principle 5 and SEF core principle 6

    within amended Sec. 150.5(a) for commodity derivative contracts that

    are subject to the federal position limits set forth in Sec. 150.2.

    Lastly, the Commission proposes to codify rules and revise guidance and

    acceptable practices for compliance with DCM core principle 5 and SEF

    core principle 6 within amended Sec. 150.5(b) for commodity derivative

    contracts that are not subject to the Federal position limits set forth

    in Sec. 150.2.

    B. The Current Regulatory Framework for Exchange-Set Position Limits

    1. Section 150.5

    The Commission currently sets and enforces position limits pursuant

    to its broad authority under CEA section 4a \562\ and does so only with

    respect to certain enumerated agricultural products.\563\ In 1981, the

    Commission promulgated what was then 17 CFR 1.61 (re-codified in 1999

    as 17 CFR 150.5), which required that, absent an exemption, exchanges

    must adopt and enforce speculative position limits for all futures

    contracts that were not subject to Commission-set limits.\564\

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

    \562\ CEA section 4a, as amended by the Dodd-Frank Act, provides

    the Commission with broad authority to set position limits. 7 U.S.C.

    6a. See supra discussion of CEA section 4a.

    \563\ The position limits on these agricultural contracts are

    referred to as ``legacy'' limits, and the listed commodities are

    referred to as the ``enumerated'' agricultural commodities. This

    list of agricultural contracts includes Corn (and Mini-Corn), Oats,

    Soybeans (and Mini-Soybeans), Wheat (and Mini-wheat), Soybean Oil,

    Soybean Meal, Hard Red Spring Wheat, Hard Winter Wheat, and Cotton

    No. 2. See 17 CFR 150.2.

    \564\ 46 FR 50938, Oct. 16, 1981. The Commission stated the

    purpose of such limits was to prevent ``excessive speculation . . .

    arising from those extraordinarily large positions which may cause

    sudden or unreasonable fluctuations or unwarranted changes in the

    price'' of commodity futures. Id. at 50945. Former Sec. 1.61(a)(2)

    specified that limits shall be based on ``such factors that will

    accomplish the purposes of this section. As appropriate, these

    factors shall include position sizes customarily held by speculative

    traders in the market . . . , which shall not be extraordinarily

    large relative to total open positions in the contract market . . .

    [or] breadth and liquidity of the cash market underlying each

    delivery month and the opportunity for arbitrage between the futures

    market and cash market in the commodity underlying the futures

    contract.'' 17 CFR 1.61 (removed and reserved on May 5, 1999).

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

    The Commission's 1981 rule requiring that exchanges set position

    limits was a watershed in its approach to position limits. The

    Commission first concluded that multiple provisions of the CEA vested

    it with authority to direct that exchanges impose position limits.\565\

    The Commission explained that section 4a ``represents an express

    Congressional finding that excessive speculation is harmful to the

    market, and a finding that speculative limits are an effective

    prophylactic measure.'' \566\ Relying on those Congressional findings,

    the Commission directed exchanges to impose speculative position limits

    on all futures contracts subject to their jurisdiction.\567\

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

    \565\ 46 FR 50938, 50939-40, Oct. 16, 1981.

    \566\ Id. at 50940.

    \567\ Id. at 50945.

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

    In adopting this prophylactic approach, the Commission explained

    that comments it had received during the rulemaking that questioned

    ``the general desirability of [position] limits [were] contrary to

    Congressional findings in sections 3 and 4a of the Act and considerable

    years of Federal and contract market regulatory experience.'' \568\ The

    Commission also explained that:

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

    \568\ Id. at 50940.

    the prevention of large and/or abrupt price movements which are

    attributable to extraordinarily large speculative positions is a

    Congressionally endorsed regulatory objective of the Commission.

    Further . . . this objective is enhanced by speculative position

    limits since it appears 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

    the positions,

    [[Page 75749]]

    i.e., the capacity of the market is not unlimited.\569\

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

    \569\ Id.

    Citing the recent disruption in the silver market, the Commission

    insisted that position limits be imposed prophylactically for all

    futures and options contracts, irrespective of the unique features of

    the cash market underlying a particular derivative.\570\ Thus, the

    Commission concluded that ``speculative limits are appropriate for all

    contract markets,'' \571\ and directed exchanges to impose them on an

    ``omnibus basis,'' \572\ that is, on all futures contracts.\573\

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

    \570\ Id. at 50940-41. The Commission stated it would consider

    the particular characteristics of the cash markets in setting limit

    levels, but required that all futures contracts have position

    limits. Id. at 50941.

    \571\ Id. at 50941.

    \572\ Id. at 50939.

    \573\ See 17 CFR 1.61(a)(1) (1982). In addition, Sec. 1.61

    permitted exchanges to adopt and enforce their own speculative

    position limits for those contracts that have federal speculative

    position limits, as long as the exchange limits were not higher than

    those set by the Commission.

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

    Congress ratified the Commission's construction of section 4a and

    its promulgation of Sec. 1.61 in the Futures Trading Act of 1982 \574\

    when it enacted section 4a(e) of the Act, which provides that limits

    set by exchanges and approved by the Commission are subject to

    Commission enforcement.\575\

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

    \574\ The Futures Trading Act of 1982, Public Law 97-444, 96

    Stat. 2294 (1983).

    \575\ See id; see also 7 U.S.C. 6a(e).

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

    During the 1990s, the Commission allowed exchanges to replace

    position limits with position accountability levels with respect to

    certain derivatives outside the spot month.\576\ Position

    accountability levels are not fixed limits, but rather position sizes

    that trigger an exchange review of a trader's position and at which an

    exchange may remediate perceived problems, such as preventing a trader

    from increasing his position or forcing a reduction in a position. In

    January 1992, the Commission approved the CME's request for an

    exemption from the position limits requirements and permitted the CME

    to establish position accountability for a variety of financial

    contracts. Initially, the Commission limited its approval of position

    accountability to financial instruments (i.e., excluded commodities)

    that had a high degree of liquidity. Six months later, the Commission

    determined it would also allow position accountability to be used for

    highly liquid energy and metals contracts.\577\

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

    \576\ See Speculative Position Limits--Exemptions from

    Commission Rule 1.61, 56 FR 51687, Oct. 15, 1991; and Speculative

    Position Limits--Exemptions from Commission Rule 1.61, 57 FR 29064,

    Jun. 30, 1992.

    \577\ See 57 FR 29064, Jun. 30, 1992.

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

    In 1999, the Commission simplified and reorganized its rules

    relating to speculative position limits by removing and reserving Sec.

    1.61 and relocating several of its rules and policies concerning

    exchange-set-position limits to new Sec. 150.5, thereby incorporating

    within part 150 most Commission rules relating to speculative position

    limits.\578\ The Commission codified within Sec. 150.5 various staff

    policies and administrative practices that had developed over time

    relating to: (1) The speculative position limit levels that the staff

    routinely had recommended for approval by the Commission for newly

    designated futures and option contracts; (2) the magnitude of increases

    to the limit levels that it would approve for traded contracts; and (3)

    various exemptions from the general requirement that exchanges set

    speculative position limits for all contracts, such as permitting

    exchanges to substitute position accountability rules for position

    limits for high volume and liquid markets.\579\ The Commission

    explained that codifying the prior administrative practices as part of

    new Sec. 150.5 would make the applicable standard for exchange-set

    position limits more transparent and thereby make compliance easier for

    exchanges to achieve.\580\

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

    \578\ 64 FR 24038, 24040, May 5, 1999. As noted in the notice of

    proposed rulemaking for Sec. 150.5, promulgating these policies

    within a single section of the Commission's rules would increase

    significantly their accessibility and clarify their terms. See

    Revision of Federal Speculative Position Limits and Associated

    Rules, Proposed Rules, 63 FR 38537, Jul. 17, 1998.

    \579\ 64 FR at 24040-42. As the Commission explained, the open-

    interest criterion and numeric formula used by the Commission in its

    1991 proposed amendment of Commission-set speculative position

    limits provided the most definitive guidance by the Commission on

    acceptable levels for speculative position limits for tangible

    commodities and, along with several other commonly accepted

    measures, had been widely followed as a matter of administrative

    practice when reviewing proposed exchange speculative position

    limits under Commission rule 1.61. Id. at 24040. Additionally, in

    reviewing new contracts for tangible commodities, the staff had

    relied upon the Commission's formulation providing for a minimum

    level of 1,000 contracts for non-spot month speculative position

    limits. Id. Moreover, the Commission had routinely approved a level

    of 5,000 contracts in non-spot months for designation of financial

    futures and energy contracts, and that level had become a rule of

    thumb as a matter of administrative practice. Id.

    \580\ Id.

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

    Under Sec. 150.5(a), the Commission required each exchange to

    ``limit the maximum number of contracts a person may hold or control,

    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.'' \581\ The Commission noted that this

    provision does not apply to contracts for which position limits are set

    forth in Sec. 150.2 or to a futures or option contract on a major

    foreign currency.\582\ Furthermore, nothing in Sec. 150.5(a) was to be

    construed to prohibit an exchange from setting different limits for

    different futures contracts or delivery months, or from exempting

    positions normally known in the trade as spreads, straddles, or

    arbitrage.\583\

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

    \581\ 17 CFR 150.5(a).

    \582\ Id.

    \583\ Id.

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

    In Sec. 150.5(b), the Commission presented explicit numeric

    formulas and descriptive standards for the speculative position limit

    levels that it found to be appropriate for new contracts.\584\ For

    physical delivery contracts, the spot month limit level must be no

    greater than one-quarter of the estimated spot month deliverable

    supply, calculated separately for each month to be listed.\585\ For

    cash-settled contracts, the Commission presented a descriptive

    standard: ``the spot month limit level must be no greater than

    necessary to minimize the potential for manipulation or distortion of

    the contract's or the underlying commodity's price.'' \586\ Individual

    non-spot-month or all-months-combined levels for such newly-designated

    contracts must be no greater than 1,000 contracts for tangible

    commodities other than energy products,\587\ and no greater than 5,000

    contracts for energy products and non-tangible commodities, including

    contracts on financial products.\588\ In Sec. 150.5(c), the Commission

    codified mandatory numeric formulas and descriptive standards for

    subsequent adjustments to spot, individual and all-months-combined

    position limit levels.\589\

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

    \584\ See 17 CFR 150.5(b). The Commission explained that the

    proposed limit levels for new contracts, which were based upon the

    formula and associated minimum levels used by the Commission in its

    1992 proposed rulemaking, had long been used as a matter of informal

    administrative practice. 64 FR 24040.

    \585\ 17 CFR 150.5(b)(1).

    \586\ Id.

    \587\ 17 CFR 150.5(b)(2).

    \588\ 17 CFR 150.5(b)(3).

    \589\ 17 CFR 150.5(c).

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

    The Commission explained that these explicit numeric formulas grew

    from administrative practices that had long required a deliverable

    supply of at least four times the spot month speculative position

    limit.\590\ The Commission

    [[Page 75750]]

    further explained that the descriptive standards for exchange-set

    limits in Sec. 150.5 grew from staff experience that had demonstrated

    that many commodities, particularly intangible commodities, have

    sufficiently large deliverable supplies to meet this standard without

    requiring a spot month level that is lower than the individual month

    level.\591\

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

    \590\ 64 FR at 24041 (citing 62 FR 60831, 60838, Nov. 13, 1997).

    A spot month speculative position limit that exceeds this amount

    enhances the susceptibility of the contract to market manipulation,

    price distortion or congestion. Except for cash-settled contracts,

    Commission staff had used this standard to review every new

    contract, or proposals to increase existing exchange speculative

    position limits, since 1981, when Sec. 1.61 was issued. Id.

    \591\ 64 FR at 24041. For other commodities, however, especially

    commodities having strong seasonal characteristics, spot month

    speculative position limits are required to be set at a level lower

    than the individual month limit for all or some trading months. Id.

    Accordingly, codification of the standard only made explicit the

    standard which, since 1981, had been applied to, and met by, every

    physical delivery futures contract at the time of initial review and

    upon subsequent increases to the spot month speculative position

    limit. Id.

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

    In Sec. 150.5(d), the Commission explicitly precluded exchanges

    from applying exchange-set speculative position limits rules to bona

    fide hedging positions as defined by an exchange in accordance with

    Sec. 1.3(z)(1).\592\ However, that section also provided an exchange

    with the discretion to limit bona fide hedging positions that it

    determines are ``not in accord with sound commercial practices or

    [that] exceed an amount which may be established and liquidated in an

    orderly fashion.'' \593\ Under Sec. 150.5(d)(2), the Commission

    explicitly required traders to apply to the exchange for any exemption

    from its speculative position limit rules.\594\ Furthermore, under

    Sec. 150.5(f), an exchange is compelled to grant additional exemptions

    to positions acquired in good faith prior to the effective date of any

    exchange position limits rule.\595\ In addition to the express

    exemptions specified in Sec. 150.5, Sec. 150.5(f) permitted an

    exchange to propose other exemptions consistent with the purposes of

    Sec. 150.5.\596\

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

    \592\ 17 CFR 150.5(d)(1); 17 CFR 1.3(z).

    \593\ 17 CFR 150.5(d)(1).

    \594\ 17 CFR 150.5(d)(2). In considering whether to grant such

    an application for exemption, exchanges must take into account

    whether the hedging position is not in accord with sound commercial

    practices or exceeds an amount which may be established and

    liquidated in an orderly fashion. See id.

    \595\ 17 CFR 150.5(f). This exemption also applies to positions

    acquired in good faith prior to the effective date of any exchange

    position limits rule by a person that is registered as a futures

    commission merchant or as a floor broker under authority of the Act

    except to the extent that transactions made by such person are made

    for or on behalf of the account or benefit of such person.

    \596\ Id.

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

    In Sec. 150.5(e), the Commission codified its existing policies

    concerning the classes of contracts for which an exchange could replace

    the required speculative position limit with a position accountability

    rule.\597\ Under Sec. 150.5(e), at least twelve months after a

    contract's initial listing for trading, an exchange could apply to the

    Commission to substitute for the position limits required under part

    150 an exchange rule requiring traders to be accountable for large

    positions.\598\ The Commission explained that the type of position

    accountability rule that applies to a particular contract under Sec.

    150.5(e) is determined by the liquidity of the futures market, the

    liquidity of the cash market and the Commission's oversight

    experience.\599\ The Commission further explained that it used Sec.

    150.5(e) to restate these criteria with greater clarity and precision,

    particularly in measuring the necessary levels of liquidity of the

    futures and option markets.\600\ Furthermore, for purposes of Sec.

    150.5(e), trading volume and open interest must be calculated by

    combining the month-end futures and its related option contract, on a

    delta-adjusted basis, for all months listed during the most recent

    calendar year.\601\

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

    \597\ 17 CFR 150.5(e). Position accountability rules impose a

    level that triggers distinct reporting responsibilities by a trader

    at the request of the applicable exchange.

    \598\ Id. The Commission explained that a trading history of at

    least 12 months must first be established before a futures contract

    can meet the proposed rule's liquidity requirements. See Proposed

    Rule, 63 FR 38525, 38529, Jul. 17, 1998.

    \599\ Revision of Federal Position Limits and Associated Rules,

    Proposed Rule, 63 FR 38525, 38530, Jul. 17, 1998. The Commission

    explained that a liquid market is one which has sufficient trading

    activity to enable individual trades coming to a market to be

    transacted without significantly affecting the price. Id. A high

    degree of liquidity in the futures and option markets better enables

    traders to arbitrage these markets with the underlying cash markets.

    Id. Where the underlying cash markets in turn are very liquid and

    have extremely large deliverable supplies, the threat of market

    manipulation or distortions caused by large speculative positions is

    lessened. Id.

    \600\ See 17 CFR 150.5(e)(1)-(3); see also Proposed Rule, 63 FR

    38525, 38530, Jul. 17, 1998.

    \601\ 17 CFR 150.5(e)(4).

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

    Lastly, the Commission codified its aggregation policy relating to

    exchange-set position limits in Sec. 150.5(g).\602\

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

    \602\ To determine whether any person has exceeded the limits

    established under this section, all positions in accounts for which

    such person by power of attorney or otherwise directly or indirectly

    controls trading shall be included with the positions held by such

    person; such limits upon positions shall apply to positions held by

    two or more person acting pursuant to an express or implied

    agreement or understanding, the same as if the positions were held

    by a single person. 17 CFR 150.5(g).

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

    2. The Commodity Futures Modernization Act of 2000 Caused Commission

    Sec. 150.5 To Become Guidance on and Acceptable Practices for

    Compliance With DCM Core Principle 5

    Just over a year after the Commission promulgated Sec. 150.5, the

    Commodity Futures Modernization Act of 2000 \603\ amended the CEA to

    establish DCMs as a registration category and create a set of 18 core

    principles with which DCMs must comply.\604\ DCM core principle 5

    requires exchanges to adopt position limits or position accountability

    levels ``where necessary and appropriate to reduce the threat of market

    manipulation or congestion.'' \605\ Under the CFMA, DCM core principle

    1 gave DCMs ``reasonable discretion'' in determining how to comply with

    the core principles.\606\ The CFMA, however, did not change the

    treatment of the enumerated agricultural commodities, which remain

    subject to Federal speculative position limits. Moreover, the CFMA did

    not alter the Commission's authority in CEA section 4a to establish

    position limits. The core principles regime set forth in the CFMA had

    the effect of undercutting the prescriptive rules of Sec. 150.5

    because DCMs were afforded ``reasonable discretion'' in determining how

    to comply with the position limits or accountability requirements of

    core principle 5. Nevertheless, the Commission has retained current

    Sec. 150.5 as guidance on, and acceptable practices for, compliance

    with DCM

    [[Page 75751]]

    core principle 5.\607\ The Commission did not amend Sec. 150.5

    following passage of CFMA.

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

    \603\ CFMA, Public Law 106-554, 114 Stat. 2763. By enacting the

    CFMA, Congress intended ``[t]o reauthorize and amend the Commodity

    Exchange Act to promote legal certainty, enhance competition, and

    reduce systemic risk in markets for futures and over-the-counter

    derivatives, and for other purposes.'' Id.

    \604\ See CEA section 5(d); 7 U.S.C. 7(d). DCMs were first

    established under the CFMA as one of two forms of Commission-

    regulated markets for the trading of contracts for sale of a

    commodity for future delivery or commodity options (the other being

    registered DTEFs). In addition, the CFMA provided for two markets

    exempt from regulation: Exempt boards of trade (``EBOTs'') and

    exempt commercial markets (``ECMs''). See A New Regulatory Framework

    for Trading Facilities, Intermediaries and Clearing Organizations,

    Notice of Proposed Rulemaking, 66 FR 14262, Mar. 9, 2001; Final

    Rulemaking, 66 FR 42256, Aug. 10, 2001.

    \605\ CEA sections 5(d)(1), (5); 7 U.S.C. 7(d)(1), (5).

    \606\ CEA section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B). The

    Commission also undertakes due diligence reviews of each exchange's

    compliance with the core principles during rule and product

    certification reviews and periodic examinations of DCMs' compliance

    with the core principles under Rule Enforcement Reviews. As

    discussed above, DCM core principle 1 was amended by the Dodd-Frank

    Act to give the Commission authority to determine, by rule or

    regulation, the manner in which boards of trade must comply with the

    core principles.

    \607\ Guidance provides DCMs and DCM applicants with contextual

    information regarding the core principles, including important

    concerns which the Commission believes should be taken into account

    in complying with specific core principles. In contrast, the

    acceptable practices are more specific than guidance and provide

    examples of how DCMs may satisfy particular requirements of the core

    principles; they do not, however, establish mandatory means of

    compliance. Acceptable practices are intended to assist DCMs by

    establishing non-exclusive safe harbors. The safe harbors apply only

    to compliance with specific aspects of the core principle, and do

    not protect the exchange with respect to charges of violations of

    other sections of the CEA or other aspects of the core principle. In

    applying Sec. 150.5 as guidance and acceptable practices, most

    exchanges, in exercising their ``reasonable discretion,'' have

    continued to impose strict position limits in the spot month and to

    apply position accountability standards in non-spot months.

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

    In August 2001, the Commission adopted part 38 to govern trading on

    DCMs post-CFMA. Under Sec. 38.2, DCMs operating under part 38 were

    ``exempt from all Commission rules not specifically reserved'' \608\

    and Sec. 38.2 did not reserve Sec. 150.5.\609\ Accordingly, DCMs

    operating under part 38 in the post-CFMA environment have not been

    required to comply with Sec. 150.5. In this same rulemaking, the

    Commission adopted appendix B to part 38 as guidance on and acceptable

    practices for compliance with the DCM core principles, including core

    principle 5.\610\ Within appendix B to part 38, the Commission advised

    DCMs to, among other things, adopt spot-month limits for markets based

    on commodities having more limited deliverable supplies, or where

    otherwise necessary to minimize the susceptibility of the market to

    manipulation or price distortions.\611\ The Commission also advised

    DCMs on how they should set spot-moth limit levels and instructed DCMs

    that they could elect not to adopt all-months-combined and non-spot

    month limits.\612\ Appendix B to part 38 was subsequently amended in

    June 2012 to delete the guidance and acceptable practices section

    relevant to compliance with DCM core principle 5 in deference to parts

    150 and 151.\613\

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

    \608\ 17 CFR 38.2 (amended June 19, 2012); see also A New

    Regulatory Framework for Trading Facilities, Intermediaries and

    Clearing Organizations, Final Rules, 66 FR 42256, 42257, Aug. 10,

    2001.

    \609\ See id.

    \610\ 17 CFR part 38 app. B (2002); see also 66 FR 42256, Aug.

    10, 2001.

    \611\ Id.

    \612\ Id.

    \613\ See Core Principles and Other Requirements for Designated

    Contract Markets, Final Rule, 77 FR 36611, 36639, Jun. 19, 2012. The

    Commission published the final rules for Position Limits for Futures

    and Swaps on November 18, 2011, which required DCMs to comply with

    part 150 (Limits on Positions) until such time that the Commission

    replaces part 150 with the new part 151 (Limits on Positions). Id.

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

    3. The CFTC Reauthorization Act of 2008

    In the CFTC Reauthorization Act of 2008, Congress, among other

    things, expanded the Commission's authority to set position limits to

    include significant price discovery contracts (``SPDCs'') on exempt

    commercial markets (``ECMs'').\614\ The Reauthorization Act's

    provisions regarding ECMs were based largely on the Commission's

    recommendations for improving oversight of ECMs whose contracts perform

    or affect a significant price discovery function. The legislation

    significantly expanded the Commission's regulatory authority over ECMs

    by adding section 2(h)(7) \615\ to the CEA, establishing criteria for

    the Commission to consider in determining whether a particular ECM

    contract performs a significant price discovery function, and providing

    for greater regulation of SPDCs traded on ECMs. The Reauthorization Act

    also required ECMs to adopt position limit and accountability level

    provisions for SPDCs, authorized the Commission to require the

    reporting of large trader positions in SPDCs, and established core

    principles governing ECMs with SPDCs. The core principles applicable to

    ECMs with SPDCs were largely derived from selected DCM core principles

    and designation criteria set forth in CEA section 5, and Congress

    intended that they be construed in a like manner.\616\

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

    \614\ CFTC Reauthorization Act of 2008, incorporated as Title

    XIII of the Food, Conservation and Energy Act of 2008, Public Law

    110-246, 122 Stat. 1651 (June 18, 2008).

    \615\ CEA sections 2(h)(3)-(7) were deleted by the Dodd-Frank

    Act on July 15, 2011, thus eliminating the ECM category.

    \616\ See Joint Explanatory Statement of the Committee of

    Conference, H.R. Rep. No. 110-627, 110 Cong., 2d Sess. at 985

    (2008). Section 723 of the Dodd-Frank Act subsequently repealed the

    ECM SPDC provisions. See Section 723 of the Dodd-Frank Act, Pub. L.

    111-203, 124 Stat. 1376 (2010).

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

    Much like DCM core principle 5, ECM core principle IV of CEA

    section 2(h)(7)(C) required electronic trading facilities to adopt

    where necessary and appropriate, position limits or position

    accountability provisions, especially during trading in the delivery

    month, and taking into account fungible positions at a derivative

    clearing organization.\617\

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

    \617\ CEA section 2(h)(7)(C) (amended 2010).

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

    In a Notice of Final Rulemaking in March 2009, the Commission

    adopted Appendix B to Part 36 as guidance on and acceptable practices

    for compliance with ECM core principles.\618\ The guidance on and

    acceptable practices for compliance with ECM core principle IV

    generally tracked those for DCM core principle 5 as listed in Sec.

    150.5.\619\ Furthermore, the Commission indicated within this Notice of

    Final Rulemaking that Sec. 150.5 was not binding on DCMs once part 38

    was finalized.\620\ The Commission rejected a commenter's suggestion

    that a proposed ECM-SPDCs core principle for position limits and

    accountability should adopt the existing standards in CEA section

    4a(b)(2) (barring trading or positions in excess of federal limits)

    and, especially, incorporate a broader good faith exemption in Sec.

    150.5(f).\621\ The Commission responded that section 4a(b)(2) applies

    to federal limits, not exchange-set limits.\622\ The Commission further

    explained that Sec. 150.5(f) ``no longer has direct application to

    DCM-set limits'' because ``the statutory authority governing [those]

    limits is found in CEA section 5(d)(5)--DCM core principle 5.'' \623\

    That core principle does not, the Commission explained, contain any of

    the exemptive language found in CEA section 4a or Sec. 150.5(f).\624\

    The Commission observed that the part 38 rules specifically exempt DCMs

    and DCM-traded contracts from all rules other than those specifically

    reserved in Sec. 38.2, and Sec. 38.2 did not retain

    [[Page 75752]]

    Sec. 150.5(f).\625\ Accordingly, the Commission explained, ``the part

    150 rules essentially constitute guidance for DCMs administering

    position limit regimes, [and] Commission staff in overseeing such

    regimes has not required that position limits include an exemption for

    positions acquired in good faith.'' \626\

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

    \618\ Significant Price Discovery Contracts on Exempt Commercial

    Markets, Final Rulemaking, 74 FR 12178, Mar. 23, 2009; See also 17

    CFR part 36 app. B (2009).

    \619\ For example, ECMs were advised to adopt spot-month limits

    for SPDCs. If there was an economically-equivalent SPDC, or a

    contract on a DCM, then the spot-month limit should be set at the

    same level as that specified for such other contract. If there was

    not an economically-equivalent SPDC or contract traded on a DCM,

    then in the case of a physical delivery contact, the spot-month

    limit should be set based upon an analysis of deliverable supplies

    and the history of spot-month liquidations and at no more than 25

    percent of the estimated deliverable supply or, in the case of a

    cash settlement provision, the spot month limit should be set at a

    level that minimizes the potential for price manipulation or

    distortion in the significant price discovery contract itself; in

    related futures and options contracts traded on a DCM or DTEF; in

    other significant price discovery contracts; in other fungible

    agreements, contracts and transactions; and in the underlying

    commodity. ECMs were also advised to adopt position accountability

    provisions for non-spot month and all-months combined or, in lieu of

    position accountability, an ECM could establish non-spot individual

    month position limits and all-months-combined position limits for

    its SPDC. See 17 CFR part 36 app. B (2009).

    \620\ See 74 FR 12178, 12183, Mar. 23, 2009.

    \621\ See id.

    \622\ See id.

    \623\ See id.

    \624\ See id; see also CEA Section 4a and 17 CFR 150.5(f).

    \625\ See 74 FR 12178, 12183, Mar. 23, 2009; see also 17 CFR

    Part 38. The Commission acknowledged that the acceptable practices

    in former appendix B to part 38 incorporate many provisions of Sec.

    150.5, but not Sec. 150.5(f).

    \626\ 74 FR 12183. In a 2010 notice of proposed rulemaking, the

    Commission similarly noted that former appendix B to part 38

    ``specifically reference[d] part 150'' in order to provide

    ``guidance'' to DCMs on how to comply with the core principle on

    position limits/accountability. 75 FR 4144, 4147, Jan. 26, 2010.

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

    4. The Dodd-Frank Act Amendments to CEA Section 5

    On July 21, 2010, President Obama signed The Dodd-Frank Wall Street

    Reform and Consumer Protection Act.\627\ The legislation was enacted to

    reduce risk, increase transparency, and promote market integrity within

    the financial system by, among other things, enhancing the Commission's

    rulemaking and enforcement authorities with respect to all registered

    entities and intermediaries subject to the Commission's oversight.\628\

    The Dodd-Frank Act repealed certain sections of the CEA, amended

    others, and added many new provisions and vastly expanded the

    Commission's jurisdiction. The Commission has finalized 65 rules,

    orders, and guidance to implement sweeping changes to the regulatory

    framework established by the Dodd-Frank Act.\629\ This proposed

    rulemaking would make several conforming amendments to part 150 of the

    Commission's regulations, most prominently to Sec. 150.5, in order to

    integrate that section more fully within the statutory framework

    created by the Dodd-Frank Act.

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

    \627\ See generally the Dodd-Frank Wall Street Reform and

    Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

    \628\ Furthermore, the Dodd-Frank Act amended the DCM core

    principles by: (1) Eliminating the eight criteria for designation as

    a contract market; (2) amending most of the core principles,

    including incorporating the substantive requirements of the

    designation criteria; and (3) adding five new core principles.

    Accordingly, all DCMs and DCM applicants must comply with a total of

    23 core principles as a condition of obtaining and maintaining

    designation as a contract market.

    \629\ 77 FR 66288, Nov. 2, 2012. See also amendments to CEA

    section 4a, discussed above.

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

    i. The Dodd-Frank Act Added Provisions That Permit the Commission To

    Override the Discretion of DCMs in Determining How To Comply With the

    Core Principles

    As discussed above, DCM core principle 1, set out in CEA section

    5(d)(1), states that boards of trade ``shall have reasonable discretion

    in establishing the manner in which they comply with the core

    principles.'' \630\ However, section 735 of the Dodd-Frank Act amended

    section 5(d)(1) of the CEA to include the proviso that ``[u]nless

    otherwise determined by the Commission by rule or regulation . . . ,''

    boards of trade shall have reasonable discretion in establishing the

    manner in which they comply with the core principles.\631\ In view of

    amended CEA section 5(d)(1), which gives the Commission authority to

    determine, by rule or regulation, the manner in which boards of trade

    must comply with the core principles, the Commission has proposed a

    number of new and revised rules, guidance, and acceptable practices to

    implement the new and revised Dodd-Frank Act core principles.

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

    \630\ CEA section 5(d)(1); 7 U.S.C. 7(d)(1).

    \631\ See CEA section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B).

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

    ii. The Dodd-Frank Act Established a Comprehensive New Statutory

    Framework for Swaps

    The Dodd-Frank Act tasked the Commission with overseeing the U.S.

    market for swaps (except for security-based swaps). Title VII of the

    Dodd-Frank Act amended the CEA to establish a comprehensive new

    regulatory framework for swaps, including requirements for SEFs.\632\

    This new regulatory framework includes: (1) Registration, operation,

    and compliance requirements for SEFs; and (2) fifteen core principles

    with which SEFs must comply. As a condition of obtaining and

    maintaining their registration as a SEF, applicants and registered SEFs

    are required to comply with the SEF core principles and with any

    requirement that the Commission may impose by rule or regulation.\633\

    The Dodd-Frank Act also amended the CEA to provide that, under new

    section 5h, the Commission may determine, by rule or regulation, the

    manner in which SEFs comply with the core principles.\634\

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

    \632\ The SEF definition is added in section 721 of the Dodd-

    Frank Act, amending CEA section 1a. 7 U.S.C. 1a(50).

    \633\ See CEA section 5h, as enacted by section 733 of the Dodd-

    Frank Act; 7 U.S.C. 7b-3.

    \634\ See id.; see also SEF core principle 1 at CEA section

    5h(f)(1)(B); 7 U.S.C. 7b-3(f)(1)(B).

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

    iii. The Dodd-Frank Act Added the Regulation of Swaps, Added Core

    Principles for SEFs, Including SEF Core Principle 6, and Amended DCM

    Core Principle 5

    The Dodd-Frank Act added a core principle concerning position

    limitations or accountability for SEFs, SEF core principle 6, which

    parallels DCM core principle 5.\635\ SEF core principle 6 requires SEFs

    that are trading facilities to set, ``as is necessary and appropriate,

    position limitations or position accountability for speculators'' \636\

    for each contract executed pursuant to their rules. Furthermore, for

    contracts subject to Federal position limits imposed by the Commission

    under CEA section 4a(a), CEA section 5h(f)(6)(B) \637\ requires SEFs

    that are trading facilities to set and enforce speculative position

    limits at a level no higher than those established by the Commission.

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

    \635\ Compare CEA section 5h(f)(6); 7 U.S.C. 7b-3(f)(6) with CEA

    section 5(d)(5); 7 U.S.C. 7(d)(5).

    \636\ CEA section 5h(f)(6)(A); 7 U.S.C. 7b-3(f)(6).

    \637\ 7 U.S.C. 7b-3(f)(6) as added by the Dodd-Frank Act.

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

    The Dodd-Frank Act similarly amended DCM core principle 5 by adding

    that for any contract that is subject to a position limit established

    by the Commission pursuant to CEA section 4a(a), the DCM shall set the

    position limit of the board of trade at a level not higher than the

    position limitation established by the Commission.\638\

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

    \638\ See CEA section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B). DCM core

    principle 5 under CEA section 5(d)(5) requires that DCMs adopt for

    each contract, as is necessary and appropriate, position limitations

    or position accountability.

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

    5. Dodd-Frank Rulemaking

    To implement section 735 of the Dodd-Frank Act, the Commission has

    proposed a number of new and revised rules, guidance, and acceptable

    practices to implement the new and revised DCM core principles. In

    doing so, the Commission has evaluated the preexisting regulatory

    framework for overseeing DCMs, which consisted largely of guidance and

    acceptable practices, in order to update those provisions and to

    determine which core principles would benefit from having new or

    revised derivative regulations. Based on that review, and in view of

    the Dodd-Frank Act's amendment to section 5(d)(1) of the CEA, which

    grants the Commission authority to determine, by rule or regulation,

    the manner in which boards of trade comply with the core principles,

    the Commission has proposed revised guidance and acceptable practices

    for some core

    [[Page 75753]]

    principles and, for other core principles, has proposed to codify rules

    in lieu of guidance and acceptable practices.

    i. Amended Part 38

    In January 2011, the Commission published a notice of proposed

    rulemaking to replace existing part 150, in its entirety, with a new

    federal position limits rules regime in the form of new part 151.\639\

    Just one month prior to this publication, the Commission published a

    notice of proposed rulemaking to amend part 38 to establish regulatory

    obligations that each DCM must meet in order to comply with section 5

    of the CEA, as amended by the Dodd-Frank Act. Accordingly, the

    Commission proposed Sec. 38.301 to require that each DCM must comply

    with the requirements of part 151 as a condition of its compliance with

    DCM core principle 5.\640\ The Commission later adopted a revised

    version of Sec. 38.301 with an additional clause that requires DCMs to

    continue to meet the requirements of part 150 of the Commission's

    regulations--the current position limit regulations--until such time

    that compliance would be required under part 151.\641\ The Commission

    explained that this clarification would ensure that DCMs are in

    compliance with the Commission's regulations under part 150 during the

    interim period until the compliance date for the new position limits

    regulations of part 151 would take effect.\642\ The Commission further

    explained that new Sec. 38.301 was based on the Dodd-Frank amendments

    to the DCM core principles regime, which collectively provide that DCM

    discretion in setting position limits or position accountability levels

    is limited by Commission regulations setting limits.\643\

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

    \639\ Position Limits for Derivatives, Proposed Rule, 76 FR

    4752, Jan. 26, 2011. The final rulemaking for vacated part 151

    required DCMs to comply with part 150 until such time that the

    Commission replaces part 150 with the new part 151. See 76 FR at

    71632.

    \640\ 75 FR 80571, 80585, Dec. 22, 2010.

    \641\ 77 FR 36611, 36639, Jun. 19, 2012. The Commission mandated

    in final Sec. 38.301 that, in order to comply with DCM core

    principle 5, a DCM must ``meet the requirements of parts 150 and 151

    of this chapter, as applicable.'' See also 17 CFR 38.301.

    \642\ 77 FR at 36639.

    \643\ Id. See also CEA sections 5(d)(1) and 5(d)(5) (amended

    2010), and discussion supra of Dodd-Frank amendments to the DCM core

    principles.

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

    However, in an Order dated September 28, 2012, the United States

    District Court for the District of Columbia vacated part 151.\644\ The

    District Court's decision did not affect the applicability of part

    150.\645\ Therefore, part 150 continues to apply as if part 151 had not

    been finally adopted by the Commission, and Sec. 150.5 continues to

    apply as non-exclusive guidance and acceptable practices for compliance

    with DCM core principle 5. In light of the foregoing, the Commission

    could not, without notice, interpret Sec. 150.5 as a pre-requisite for

    compliance with core principle 5. Additionally, the Commission is

    proposing to amend Sec. 38.301 by deleting the reference to vacated

    part 151. Proposed Sec. 38.301 would maintain the requirement that

    DCMs meet the requirements of part 150, as applicable.

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

    \644\ See 887 F. Supp. 2d 259 (D.D.C. 2012).

    \645\ See id generally.

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

    ii. Amended Part 37

    Similarly, in the Commission's proposal to adopt a regulatory

    scheme applicable to SEFs, under proposed Sec. 37.601,\646\ the

    Commission proposed to require that SEFs establish position limits in

    accordance with the requirements set forth in part 151 of the

    Commission's regulations.\647\ In the SEF final rulemaking, the

    Commission revised Sec. 37.601 to state that until such time that

    compliance is required under part 151, a SEF may refer to the guidance

    and/or acceptable practices in appendix B of part 37 to demonstrate to

    the Commission compliance with the requirements of core principle 6.

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

    \646\ Current Sec. 37.601 provides requirements for SEFs that

    are trading facilities to comply with SEF core principle 6 (Position

    Limits or Accountability).

    \647\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR 1214 (proposed Jan. 7, 2011).

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

    In light of the District Court vacatur of part 151, the Commission

    proposes to amend Sec. 37.601 to delete the reference to vacated part

    151. Instead, this rulemaking proposes to require that SEFs that are

    trading facilities meet the requirements of part 150, which are

    comparable to the DCM's requirement, since, as proposed, Sec. 150.5

    would apply to commodity derivative contracts, whether listed on a DCM

    or on a SEF that is a trading facility. In addition, the Commission

    proposes to amend appendix B to part 37, which provides guidance on

    complying with core principles, both initially and on an ongoing basis,

    to maintain SEF registration.\648\ Since this rulemaking proposes to

    require that SEFs that are trading facilities meet the requirements of

    part 150, the proposed amendments to the guidance regarding SEF core

    principle 6 would reiterate that requirement. For SEFs that are not

    trading facilities, to whom core principle 6 is not applicable under

    the statutory language, the proposal would provide that part 150 should

    be considered as guidance.

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

    \648\ Appendix B to Part 37--Guidance on, and Acceptable

    Practices in, Compliance with Core Principles.

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

    iii. Vacated Part 151

    As discussed above, the United States District Court for the

    District of Columbia vacated part 151 of the Commission's

    regulations.\649\ Because the District Court's decision did not affect

    the applicability of part 150, current Sec. 150.5 remains as guidance

    and acceptable practices for compliance with DCM core principle 5 and

    SEF core principle 6. The Commission continues to rigorously enforce

    compliance with these core principles.

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

    \649\ See 887 F. Supp. 2d 259 (D.D.C. 2012).

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

    Vacated Sec. 151.11 would have required DCMs and SEFs to adopt

    position limits for Referenced Contracts, and would have established

    acceptable practices for establishing position limits and position

    accountability for certain non-referenced contracts and excluded

    commodities.\650\ Specifically, vacated Sec. 151.11(a) would have

    required DCMs and SEFs to set spot month limits, with exceptions for

    securities futures and some excluded commodities.\651\ Under vacated

    Sec. 151.11(a)(1), the Commission would have required DCMs and SEFs to

    establish spot-month limits for Referenced Contracts at levels no

    greater than the federal position limits (established pursuant to

    vacated Sec. 151.4).\652\ For contracts other than Referenced

    Contracts (including other physical commodity contracts), it would be

    acceptable practice under vacated Sec. 151.11(a)(2) for DCMs and SEFs

    to set position limits at levels no greater than 25 percent of

    estimated deliverable supply.\653\ Additionally, under vacated Sec.

    151.11(c), DCMs and SEFs would have had discretion to establish

    position accountability levels in lieu of position

    [[Page 75754]]

    limits for excluded commodities under certain circumstances.\654\

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

    \650\ See 76 FR at 71659-61.

    \651\ 76 FR at 71659.

    \652\ 76 FR at 71659-60. For Referenced Contracts, DCMs and SEFs

    would have been similarly required under vacated Sec. 151.11(b) to

    set single non-spot-month and all-months limits for Referenced

    Contracts at levels no higher than the federal position limits

    (established pursuant to vacated Sec. 151.4). Id. For non-

    referenced contracts, it would be acceptable practice under vacated

    Sec. 151.11(b)(2) for DCMs and SEFs to impose limits based on ten

    percent of the average combined futures, swaps 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. 76

    FR 71661.

    \653\ 76 FR at 71660. Furthermore, for non-referenced contracts,

    vacated Sec. 151.11(b)(3) would have allowed as an acceptable

    practice the provision of 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. Id.

    \654\ Id. Position accountability levels could be used in lieu

    of position limits only if the contract involves either a major

    currency or certain excluded commodities (such as measures of

    inflation, or other macroeconomic measures) 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. Id. Compare

    this vacated provision with current 17 CFR 150.5(e). As for physical

    commodities, under vacated Sec. 151.11(c), the Commission would

    have allowed a DCM or SEF to establish position accountability rules

    as 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. Id.

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

    Vacated Sec. Sec. 151.11(e) and 151.11(f) would have required DCMs

    and SEFs to follow the same account aggregation and bona fide exemption

    standards set forth by vacated Sec. Sec. 151.5 and 151.7 with respect

    to exempt and agricultural commodities.\655\ 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.\656\ Accordingly, the Commission had required under this

    vacated rulemaking that DCMs and SEFs create rules and procedures to

    allow traders to claim a bona fide hedge exemption, consistent with

    vacated Sec. 151.5 for physical commodity derivatives and Sec.

    1.3(z), as was amended in the vacated rulemaking, for excluded

    commodities.\657\

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

    \655\ Id. Furthermore, under vacated Sec. 151, the Commission

    would have removed the procedure to apply to the Commission for bona

    fide hedge exemptions for non-enumerated transactions or positions

    under Sec. 1.3(z)(3). Id. DCMs and SEFs would have been able to

    recognize non-enumerated hedge transactions subject to Commission

    review. Id. Additionally, DCMs and SEFs could continue to provide

    exemptions for ``risk-reducing'' and ``risk-management''

    transactions or positions consistent with existing Commission

    guidelines. Id. (citing 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, Sep. 14, 1987). Vacated

    Sec. 151.11(f)(2) would have required traders seeking a hedge

    exemption to comply with the procedures of the DCM or SEF for

    granting exemptions from its speculative position limit rules. 76 FR

    71660-61.

    \656\ 76 FR at 71661.

    \657\ Id. Vacated Sec. 151.11 contemplated that DCMs and SEFs

    would administer their own bona fide hedge exemption regime in

    parallel to the Commission's regime.

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

    C. Proposed Amendments to Sec. 150.5

    To implement section 735 of the Dodd-Frank Act regarding DCMs, the

    Commission continues to adopt new and revised rules, guidance, and

    acceptable practices to implement the DCM core principles added and

    revised by the Dodd-Frank Act. The Commission continues to evaluate its

    pre-Dodd-Frank Act regulations and approach to oversight of DCMs, which

    had consisted largely of published guidance and acceptable practices,

    with the aim of updating them to conform to the new Dodd-Frank Act

    regulatory framework. Based on that review, and pursuant to the

    authority given to the Commission in amended sections 5(d)(1) and

    5h(f)(1) of the CEA, which permit the Commission to determine, by rule

    or regulation, the manner in which boards of trade and SEFs,

    respectively, must comply with the core principles,\658\ the Commission

    is proposing several updates to Sec. 150.5 to promote compliance with

    DCM core principle 5 and SEF core principle 6.

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

    \658\ See CEA sections 5(d)(1)(B) and 5h(f)(1)(B); 7 U.S.C.

    7(d)(1)(B) and 7b-3(f)(1)(B).

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

    First, the Commission proposes amendments to the provisions of

    Sec. 150.5 to include SEFs and swaps. Second, the Commission proposes

    to codify rules and revise acceptable practices for compliance with DCM

    core principle 5 and SEF core principle 6 within amended Sec. 150.5(a)

    for contracts subject to the federal position limits set forth in Sec.

    150.2. Lastly, the Commission proposes to codify rules and revise

    guidance and acceptable practices for compliance with DCM core

    principle 5 and SEF core principle 6 within amended Sec. 150.5(b) for

    contracts not subject to the federal position limits set forth in Sec.

    150.2.

    As noted above, the CFMA core principles regime concerning position

    limitations or accountability for exchanges had the effect of

    undercutting the mandatory rules promulgated by the Commission in Sec.

    150.5. Since the CFMA amended the CEA in 2000, the Commission has

    retained Sec. 150.5, but only as guidance on, and acceptable practice

    for, compliance with DCM core principle 5.\659\ However, the Commission

    did not amend the text of Sec. 150.5 following passage of CFMA,

    leaving language in place that could suggest that the rules originally

    codified within Sec. 150.5 remain mandatory for exchanges. To correct

    this potential misimpression, the Commission now proposes several

    amendments to Sec. 150.5 to clarify that certain provisions of Sec.

    150.5 are non-exclusive guidance on, and acceptable practice for,

    compliance with DCM core principle 5.

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

    \659\ See id.

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

    Additionally, the Commission is proposing several conforming

    amendments to Sec. 150.5 in order to integrate that section more fully

    with the statutory framework created by the Dodd-Frank Act. The

    Commission, pursuant to the factors enumerated in section 4a(a)(3) of

    the Act, has endeavored to maximize the objectives of preventing

    excessive speculation, deterring and preventing market manipulation,

    ensuring that markets remain sufficiently liquid so as to afford end

    users and producers of commodities the ability to hedge commercial

    risks, and promoting efficient price discovery. These proposed

    clarifying revisions to Sec. 150.5 should also provide exchanges with

    sufficient flexibility to address the divergent and changing conditions

    in their respective markets.

    Within amended Sec. 150.5(a), the Commission proposes to codify a

    set of rules and revise acceptable practices for compliance with DCM

    core principle 5 and SEF core principle 6 for contracts that are

    subject to the federal position limits set forth in Sec. 150.2. Within

    amended Sec. 150.5(b), the Commission proposes to codify rules and

    revise guidance and acceptable practices for compliance with DCM core

    principle 5 and SEF core principle 6 for contracts that are not subject

    to the federal position limits set forth in Sec. 150.2.

    Unlike current Sec. 150.5, which contains only non-exclusive

    guidance on and acceptable practices for compliance with DCM core

    principle 5 (despite the presence of language that connotes mandatory

    rules), proposed Sec. 150.5 contains a mix of rules that would be

    mandatory for compliance with DCM core principle 5 and SEF core

    principle 6, coupled with guidance and acceptable practices for

    compliance with those core principles. Accordingly, the Commission

    urges the reader to pay special attention to the language in proposed

    Sec. 150.5 that distinguishes mandatory rules (indicated by terms such

    as ``must'' and ``shall'') from guidance and acceptable practices

    (indicated by terms such as ``should'' or ``may'').

    Additionally, the Commission proposes to amend Sec. 150.5 to

    implement uniform requirements for DCMs and SEFs relating to hedging

    exemptions across all types of contracts, including those that are

    subject to federal limits. The Commission also proposes to require DCMs

    and SEFs to have aggregation policies that mirror the federal

    aggregation provisions.\660\ Hedging exemptions and position

    aggregation exemptions, if not uniform with the Commission's

    requirements,

    [[Page 75755]]

    may serve to permit a person to obtain a larger position on a

    particular DCM or SEF than would be permitted under the federal limits.

    For example, if an exchange were to grant an aggregation position to a

    corporate person with aggregate positions above federal limits, that

    exchange may permit such person to be treated as two or more persons.

    The person would avoid violating exchange limits, but may be in

    violation of the federal limits. The Commission believes that a DCM or

    SEF, consistent with its responsibilities under applicable core

    principles, may serve an important role in ensuring compliance with

    federal positions limits and thereby protect the price discovery

    function of its market and guard against excessive speculation or

    manipulation. In the absence of uniform hedging and position

    aggregation exemptions, DCMs or SEFs may not serve that role. The

    Commission notes that hedging exemptions and aggregation policies that

    vary from exchange to exchange would increase the administrative burden

    on a trader active on multiple exchanges, as well as increase the

    administrative burden on the Commission in enforcing exchange-set

    position limits.

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

    \660\ Aggregation exemptions are, in effect, a way for a trader

    to acquire a larger speculative position. The Commission believes

    that it is important that the aggregation rules set out, to the

    extent feasible, ``bright line'' standards that are capable of easy

    application by a wide variety of market participants while not being

    susceptible to circumvention.

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

    The essential features of the proposed amendments to Sec. 150.5

    are summarized below.

    1. Proposed Amendments to Sec. 150.5 To Add References to Swaps and

    Swap Execution Facilities

    As discussed above, the Dodd-Frank Act created a new type of

    regulated marketplace, SEFs, for which it established a comprehensive

    regulatory framework. A SEF must comply with fifteen enumerated core

    principles and any requirement that the Commission may impose by rule

    or regulation.\661\ The Dodd-Frank Act provides that the Commission

    may, in its discretion, determine by rule or regulation the manner in

    which SEFs comply with the core principles.\662\

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

    \661\ See supra discussion of SEF core principles.

    \662\ See CEA section 5h(f)(1)(B); 7 U.S.C. 7b-3(f)(1)(B).

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

    For contracts that are subject to federal position limits imposed

    under CEA section 4a(a), new CEA section 5h(f)(6)(A) \663\ requires

    that SEFs set ``as is necessary and appropriate, position limitations

    or position accountability for speculators'' for each contract executed

    pursuant to their rules.\664\ New CEA section 5h(f)(6)(B),\665\

    requires SEFs that are trading facilities to set and enforce

    speculative position limits at a level no higher than those established

    by the Commission.\666\ The Commission recognizes that SEFs may need to

    contract with derivative clearing organizations in order to comply with

    SEF core principle 6. The Commission invites comments on the

    practicability and effectiveness of such arrangements. In addition, the

    Commission invites comment as to whether the Commission should use its

    exemptive authority under CEA section 4a(a)(7) to exempt SEFs from the

    requirements of CEA section 5h(f)(6)(B). If so, why and to what extent?

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

    \663\ As added by section 723 of the Dodd-Frank Act.

    \664\ A similar duty is imposed on DCMs under CEA section

    5(d)(5)(A); 7 U.S.C. 7(d)(5)(A).

    \665\ As added by section 723 of the Dodd-Frank Act.

    \666\ This requirement for SEFs parallels that for DCMs as

    listed in the CEA section 5(d)(5)(B); 7 U.S.C. 7(d)(5)(B).

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

    The Commission carefully considered both the novel nature of SEFs

    and its experience in overseeing DCMs' compliance with core principles

    when determining which SEF core principles to address with rules that

    would provide more certainty to the marketplace, and which core

    principles to address with guidance or acceptable practices that might

    provide more flexibility. The Commission has determined that the policy

    purposes effectuated by establishing uniform requirements for

    aggregation and bona fide hedging exemptions for DCM contracts are

    equally present in SEF markets.\667\ Accordingly, the Commission has

    determined to amend Sec. 150.5 to present essentially identical

    standards for establishing rules and acceptable practices relating to

    position limits (and accountability levels) for DCMs and SEFs.

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

    \667\ See core principle 6 for SEFs, CEA section 5h(f)(6)(A); 7

    U.S.C. 7b-3(f)(6)(A). The Commission notes that section 4a(a)(2) of

    the CEA requires the Commission to establish speculative position

    limits on physical commodity DCM contracts as appropriate, but did

    not extend this requirement to SEF contracts. See discussion above.

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

    2. Proposed Sec. 150.5(a)--Requirements and Acceptable Practices for

    Commodity Derivative Contracts That Are Subject to Federal Position

    Limits

    Proposed Sec. 150.5(a) adds several requirements that a DCM or SEF

    must adhere to when setting position limits for contracts that are

    subject to the federal position limits listed in Sec. 150.2.\668\

    Proposed Sec. 150.5(a)(1) specifies that a DCM or SEF that lists a

    contract on a commodity that is subject to federal position limits must

    adopt position limits for that contract at a level that is no higher

    than the federal position limit.\669\ Exchanges with cash-settled

    contracts price-linked to contracts subject to federal limits must also

    adopt those limit levels.

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

    \668\ As discussed above, 17 CFR 150.2 provides limits for

    specified agricultural contracts in the spot month, individual non-

    spot months, and all-months-combined.

    \669\ Proposed Sec. 150.5(a)(1) is in keeping with the mandate

    in core principle 5 as amended by the Dodd-Frank Act. See CEA

    section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B). SEF core principle 6

    parallels DCM core principle 5. Compare CEA section 5h(f)(5); 7

    U.S.C. 7b-3(f)(5) with CEA section 5(d)(5); 7 U.S.C. 7(d)(5).

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

    Proposed Sec. 150.5(a)(2) prescribes the manner in which a DCM or

    SEF that lists a contract on a commodity that is subject to federal

    position limits must adopt hedge exemption rules. Proposed Sec.

    150.5(a)(2)(i) cross-references the definition of bona fide hedging, as

    proposed in amended Sec. 150.1, as the regulation governing bona fide

    hedging positions.\670\ Proposed Sec. 150.5(a)(2)(ii) clarifies the

    types of spread positions for which a DCM or SEF may grant exemptions

    from the federal limits by cross-referencing the definitions of

    intermarket and intramarket spread positions in proposed Sec.

    150.1.\671\ To be eligible for exemption under proposed Sec.

    150.5(a)(2)(ii), intermarket and intramarket spread positions must be

    outside of the spot month for physical delivery contracts, and

    intramarket spread positions must not exceed the federal all-months

    limit when combined with any other net positions in the single month.

    Proposed Sec. 150.5(a)(2)(iii) would require traders to apply to the

    DCM or SEF for any exemption from its speculative position limit

    rules.\672\ Proposed Sec. 150.5(a)(2)(iii) also preserves the

    exchange's ability to limit bona fide hedging positions which it

    determines are not in accord with sound commercial practices, or which

    exceed

    [[Page 75756]]

    an amount that may be established and liquidated in an orderly

    fashion.\673\

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

    \670\ Compare 17 CFR 150.5(d) which explicitly precludes

    exchanges from applying exchange-set speculative position limits

    rules to bona fide hedging positions as defined by the exchange in

    accordance with Sec. 1.3(z)(1).

    \671\ The Commission has proposed to maintain the current

    practice in 17 CFR 150.2 of setting single-month limits at the same

    levels as all-months limits, rendering the ``spread'' exemption in

    17 CFR 150.3 unnecessary. However, since DCM core principle 5 allows

    exchanges to set more restrictive limits than the federal limits, a

    DCM or SEF may set the single month limit at a level lower than that

    of the all-month limit, an exemption for intramarket spread position

    may be useful. See CEA section 5(d)(5); 7 U.S.C. 7(d)(5). An

    exemption for intramarket spread positions would be unnecessary if

    the DCM or SEF sets the single month limit at the same level as the

    all-months limit.

    Additionally, the duplicative term ``arbitrage'' would be

    removed because CEA section 4a(a)(1) explains that ``the word

    `arbitrage' in domestic markets shall be defined to mean the same as

    `spread' or `straddle.' '' 7 U.S.C. 6a(a)(1).

    \672\ Hence, proposed Sec. 150.5(a)(2)(C) would codify as a

    requirement for DCMs and SEFs the acceptable practice concerning

    application for exemption listed in 17 CFR 150.5(d)(2).

    \673\ Proposed Sec. 150.5(a)(2)(C) presents guidance that

    largely mirrors the guidance provided in the second half of 17 CFR

    150.5(d), with edits to specify DCMs and SEFs.

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

    Proposed Sec. 150.5(a)(3)(i) requires a DCM or SEF to exempt from

    speculative position limits established under Sec. 150.2 a swap

    position acquired in good faith prior to the effective date of such

    limits.\674\ However, proposed Sec. 150.5(a)(3)(i) would allow a

    person to net such a pre-existing swap with post-effective date

    commodity derivative contracts for the purpose of complying with any

    non-spot-month speculative position limit. Furthermore, proposed Sec.

    150.5(a)(3)(ii) requires a DCM or SEF to exempt from non-spot-month

    speculative position limits established under Sec. 150.2 any commodity

    derivative contract acquired in good faith prior to the effective date

    of such limit. However, such a pre-existing commodity derivative

    contract position must be attributed to the person if the person's

    position is increased after the effective date of such limit.\675\

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

    \674\ The Commission is exercising its authority under CEA

    section 4a(a)(7) to exempt pre-Dodd-Frank and transition period

    swaps from speculative position limits (unless the trader elects to

    include such a position to net with post-effective date commodity

    derivative contracts). Such a pre-existing swap position will be

    exempt from initial spot month speculative position limits.

    \675\ Notwithstanding any pre-existing exemption adopted by a

    DCM or SEF that applies to speculative position limits in non-spot

    months, a person holding pre-existing commodity derivative contracts

    (except for pre-existing swaps as described above) must comply with

    spot month speculative position limits. However, nothing in proposed

    Sec. 150.5(a)(3)(B) would override the exclusion of pre-Dodd-Frank

    and transition period swaps from speculative position limits.

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

    The Commission proposes to require DCMs and SEFs to have

    aggregation polices that mirror the federal aggregation

    provisions.\676\ Therefore, proposed Sec. 150.5(a)(4) requires DCMs

    and SEFs to have aggregation rules that conform to the uniform

    standards listed in Sec. 150.4.\677\

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

    \676\ See supra discussion concerning aggregation.

    \677\ Proposed Sec. 150.5(a)(4) references 17 CFR 150.4 as the

    regulation governing aggregation for contracts subject to federal

    position limits and would replace 17 CFR 150.5(g). See supra the

    Commission's explanation for implementing uniform aggregation

    standards across DCMs and SEFs.

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

    A DCM or SEF would continue to be free to enforce position limits

    that are more stringent that the federal limits. The Commission

    clarifies that federal spot month position limits do not to apply to

    physical-delivery contracts after delivery obligations are

    established.\678\ Exchanges generally prohibit transfer or offset of

    positions once long and short position holders have been assigned

    delivery obligations. Proposed Sec. 150.5(a)(6) would clarify

    acceptable practices for a DCM or SEF to enforce spot month limits

    against the combination of, for example, long positions that have not

    been stopped, stopped positions, and deliveries taken in the current

    spot month.\679\

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

    \678\ Therefore, federal spot month position limits do not apply

    to positions in physical-delivery contracts on which notices of

    intention to deliver have been issued, stopped long positions,

    delivery obligations established by the clearing organization, or

    deliveries taken.

    \679\ For example, an exchange may restrict a speculative long

    position holder that otherwise would obtain a large long position,

    take delivery, and seek to re-establish a large long position in an

    attempt to corner a significant portion of the deliverable supply or

    to squeeze shorts. Proposed Sec. 150.5(b)(9) would set forth the

    same acceptable practices for contracts not subject to federal

    limits.

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

    3. Proposed Sec. 150.5(b)--Requirements and Acceptable Practices for

    Commodity Derivative Contracts That Are Not Subject to Federal Position

    Limits

    The Commission sets forth in proposed Sec. 150.5(b) requirements

    and acceptable practices applicable to DCM- and SEF-set speculative

    position limits for any contract that is not subject to federal

    position limits, including physical and excluded commodities.\680\

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

    \680\ For position limits purposes, proposed Sec. 150.1(k)

    would define ``physical commodity'' to mean any agricultural

    commodity, as defined in 17 CFR 1.3, or any exempt commodity, as

    defined in section 1a(20) of the Act. Excluded commodity is defined

    in section 1a(19) of the Act.

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

    As discussed above, the Commission proposes to revise Sec. 150.5

    to implement uniform requirements for DCMs and SEFs relating to hedging

    exemptions across all types of commodity derivative contracts,

    including those that are not subject to federal position limits. The

    Commission further proposes to require DCMs and SEFs to have uniform

    aggregation polices that mirror the federal aggregation provisions for

    all types of commodity derivative contracts, including for contracts

    that are not subject to federal position limits. As explained above,

    hedging exemptions and aggregation policies that vary from exchange to

    exchange would increase the administrative burden on a trader active on

    multiple exchanges, as well as increase the administrative burden on

    the Commission in monitoring and enforcing exchange-set position

    limits.

    Therefore, proposed Sec. 150.5(b)(5)(i) would require any hedge

    exemption rules adopted by a designated contract market or a swap

    execution facility that is a trading facility to conform to the

    definition of bona fide hedging position in proposed Sec. 150.1. In

    addition to this affirmative rule, proposed Sec. 150.5(b)(5) would set

    forth acceptable practices for DCMs and SEFs to grant exemptions from

    position limits for positions, other than bona fide hedging positions,

    in contracts not subject to federal limits. Such exemptions generally

    track the exemptions set forth in proposed Sec. 150.3, and are

    suggested as acceptable practices based on the same logic that

    underpins the proposed Sec. 150.3 exemptions.\681\ It would be

    acceptable practice for a DCM or SEF to grant exemptions under certain

    circumstances for financial distress, intramarket and intermarket

    spreads, and qualifying cash-settled contract positions in the spot

    month.\682\ Additionally, proposed Sec. 150.5(b)(5)(ii) would set

    forth an acceptable practice for a DCF or SEF to grant a limited risk

    management exemption for contracts on excluded commodities pursuant to

    rules submitted to the Commission, and consistent with the guidance in

    new appendix A to part 150.\683\

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

    \681\ See supra discussion of the Sec. 150.3 exemptions.

    \682\ See id.

    \683\ New appendix A to part 150 is intended to capture the

    essence of the Commission's 1987 interpretation of its definition of

    bona fide hedge transactions to permit exchanges to grant hedge

    exemptions for various risk management transactions. See Risk

    Management Exemptions From Speculative Position Limits Approved

    Under Commission Regulation 1.61, 52 FR 34633, Sep. 14, 1987. The

    Commission specified that such exemptions be granted on a case-by-

    case basis, subject to a demonstrated need for the exemption. It

    also required that applicants for these exemptions be typically

    engaged in the buying, selling, or holding of cash market

    instruments. See id. Additionally, the Commission required the

    exchanges to monitor the exemptions they granted to ensure that any

    positions held under the exemption did not result in any large

    positions that could disrupt the market. See id. The term ``excluded

    commodity'' is defined in CEA section 1(a)(19).

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

    Proposed Sec. 150.5(b)(6) and (7) set forth acceptable practices

    relating to pre-enactment and transition period swap positions (as

    those terms are defined in proposed Sec. 150.1),\684\ and to commodity

    derivative contract positions acquired in good faith prior to the

    effective date of mandatory federal speculative position limits.

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

    \684\ See supra discussion of pre-enactment and transition

    period swap positions.

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

    Additionally, for any contract that is not subject to federal

    position limits, proposed Sec. 150.5(b)(8) requires the DCM or SEF to

    conform to the uniform federal aggregation provisions.\685\ This

    proposed requirement generally mirrors the requirement in proposed

    Sec. 150.5(a)(4) for contracts that are subject to federal position

    limits by requiring the DCM or SEF to have

    [[Page 75757]]

    aggregation rules that conform to Sec. 150.4.

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

    \685\ Proposed Sec. 150.5(b)(7) would replace 17 CFR 150.5(g)

    as it relates to contracts that are not subject to federal position

    limits.

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

    The Commission proposes in Sec. 150.5(b) to generally update and

    reorganize the set of acceptable practices listed in current Sec.

    150.5 as it relates to contracts that are not subject to the federal

    position limits. For existing and newly established DCMs and newly

    established SEFs, these acceptable practices generally concern how to:

    (1) Set spot-month position limits; (2) set individual non-spot month

    and all-months-combined position limits; (3) set position limits for

    cash-settled contracts that use a reference contract as a price source;

    (4) adjust position limit levels after a contract has been listed for

    trading; and (5) adopt position accountability in lieu of speculative

    position limits.

    For a derivative contract that is based on a commodity with a

    measurable deliverable supply, proposed Sec. 150.5(b)(1)(i)(A) updates

    the acceptable practice in current Sec. 150.5(b)(1) whereby spot month

    position limits should be set at a level no greater than one-quarter of

    the estimated deliverable supply of the underlying commodity.\686\

    Proposed Sec. 150.5(b)(1)(i)(A) clarifies that this acceptable

    practice for setting spot month position limits would apply to any

    commodity derivative contract, whether physical-delivery or cash-

    settled, that has a measurable deliverable supply.\687\

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

    \686\ Proposed Sec. 150.5(b)(1)(i)(A) is consistent with the

    Commission's longstanding policy regarding the appropriate level of

    spot-month limits for physical delivery contracts. These position

    limits would be set at a level no greater than 25 percent of

    estimated deliverable supply. The spot-month limits would be

    reviewed at least every 24 months thereafter. The proposed

    deliverable supply formula narrowly targets the trading that may be

    most susceptible to, or likely to facilitate, price disruptions. The

    formula seeks to minimize the potential for corners and squeezes by

    facilitating the orderly liquidation of positions as the market

    approaches the end of trading and by restricting swap positions that

    may be used to influence the price of referenced contracts that are

    executed centrally.

    \687\ In general, the term ``deliverable supply'' 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 to 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. Proposed Sec.

    150.1 would define commodity derivative contract to mean any

    futures, option, or swap contract in a commodity (other than a

    security futures product as defined in CEA section 1a(45)).

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

    For a derivative contract that is based on a commodity without a

    measurable deliverable supply, proposed Sec. 150.5(b)(1)(i)(B) would

    codify as guidance that the spot month limit level should be no greater

    than necessary and appropriate to reduce the potential threat of market

    manipulation or price distortion of the contract's or the underlying

    commodity's price.\688\

    Proposed Sec. 150.5(b)(1)(ii)(A) preserves the existing acceptable

    practice in current Sec. 150.5(b)(2) whereby individual non-spot or

    all-months-combined levels for agricultural commodity derivative

    contracts that are not subject to the federal limits should be no

    greater than 1,000 contracts at initial listing. The proposed rule

    would also codify as guidance that the 1,000 contract limit should be

    taken into account when the notional quantity per contract is no larger

    than a typical cash market transaction in the underlying commodity, or

    reduced if the notional quantity per contract is larger than a typical

    cash market transaction.\689\ Additionally, proposed Sec.

    150.5(b)(1)(ii)(A) would codify that if the commodity derivative

    contract is substantially the same as a pre-existing DCM or SEF

    commodity derivative contract, then it would be an acceptable practice

    for the DCM or SEF to adopt the same limit as applies to that pre-

    existing commodity derivative contract.\690\

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

    \688\ This descriptive standard is largely based on the language

    of DCM core principle 5 and SEF core principle 6. The Commission

    does not suggest that an excluded commodity derivative contract that

    is based on a commodity without a measurable supply should adhere to

    a numeric formula in setting spot month position limits.

    \689\ The Commission explained what it considers to be a

    ``typical cash market transaction'' in the preamble for final part

    151 (subsequently vacated): ``[f]or 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.'' See 76 FR 71660.

    \690\ In this context, ``substantially the same'' means a close

    economic substitute. For example, a position in Eurodollar futures

    can be a close economic substitute for a fixed-for-floating interest

    rate swap.

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

    Proposed Sec. 150.5(b)(1)(ii)(B) preserves the existing acceptable

    practice, set forth in current Sec. 150.5(b)(3), for DCMs to set

    individual non-spot or all-months-combined limits at levels no greater

    than 5,000 contracts at initial listing, but would apply this

    acceptable practice on a wider scale to both exempt and excluded

    commodity derivative contracts.\691\ Proposed Sec. 150.5(b)(1)(ii)(B)

    would codify as guidance for exempt and excluded commodity derivative

    contracts that the 5,000 contract limit should be applicable when the

    notional quantity per contract is no larger than a typical cash market

    transaction in the underlying commodity, or should be reduced if the

    notional quantity per contract is larger than a typical cash market

    transaction. Additionally, proposed Sec. 150.5(b)(1)(B)(ii) would

    codify a new acceptable practice for a DCM or SEF to adopt the same

    limit as applies to the pre-existing contract if the new commodity

    contract is substantially the same as an existing contract.

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

    \691\ In contrast, 17 CFR 150.5(b)(3) lists this as an

    acceptable practice for contracts for energy products and non-

    tangible commodities. Excluded commodity is defined in CEA section

    1a(19), and exempt commodity is defined CEA section 1a(20).

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

    Proposed Sec. 150.5(b)(1)(iii) sets forth that if a commodity

    derivative contract is cash-settled by referencing a daily settlement

    price of an existing contract listed on a DCM or SEF, then it would be

    an acceptable practice for a DCM or SEF to adopt the same position

    limits as the original referenced contract, assuming the contract sizes

    are the same. Based on its enforcement experience, the Commission

    believes that limiting a trader's position in cash-settled contracts in

    this way diminishes the incentive to exert market power to manipulate

    the cash-settlement price or index to advantage a trader's position in

    the cash-settled contract.\692\

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

    \692\ With respect to cash-settled contracts where the

    underlying product is a physical commodity with limited supplies,

    enabling a trader to exert market power (including agricultural and

    exempt commodities), the Commission has viewed the specification of

    speculative position limits to be an essential term and condition of

    such contracts in order to ensure that they are not readily

    susceptible to manipulation, which is the DCM core principle 3

    requirement.

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

    Proposed Sec. 150.5(b)(2)(i) updates the acceptable practices in

    current Sec. 150.5(c) for adjusting limit levels for the spot month.

    For a derivative contract that is based on a commodity with a

    measurable deliverable supply, proposed Sec. 150.5(b)(2)(i) maintains

    the acceptable practice in current Sec. 150.5(c) to adjust spot month

    position limits to a level no greater than one-quarter of the estimated

    deliverable supply of the underlying commodity, but would apply this

    acceptable practice to any commodity derivative contract, whether

    physical-delivery or cash-settled, that has a measurable deliverable

    supply. For a derivative contract that is based on a commodity without

    a measurable deliverable supply, proposed Sec. 150.5(b)(1)(i)(B) would

    codify as

    [[Page 75758]]

    guidance that the spot month limit level should not be adjusted to

    levels greater than necessary and appropriate to reduce the potential

    threat of market manipulation or price distortion of the contract's or

    the underlying commodity's price. Proposed Sec. 150.5(b)(2)(i) would

    codify as a new acceptable practice that spot month limit levels be

    reviewed no less than once every two years.

    Proposed Sec. 150.5(b)(2)(ii) maintains as an acceptable practice

    the basic formula set forth in current Sec. 150.5(c)(2) for adjusting

    non-spot-month limits at levels of no more than 10% of the average

    combined futures and delta-adjusted option month-end open interest for

    the most recent calendar year up to 25,000 contracts, with a marginal

    increase of 2.5% of the remaining open interest thereafter. Proposed

    Sec. 150.5(b)(2)(ii) would also maintain as an alternative acceptable

    practice the adjustment of non-spot-month limits to levels based on

    position sizes customarily held by speculative traders in the contract.

    Proposed Sec. 150.5(b)(3) generally updates and reorganizes the

    existing acceptable practices in current Sec. 150.5(e) for a DCM or

    SEF to adopt position accountability rules in lieu of position limits,

    under certain circumstances, for contracts that are not subject to

    federal position limits. This proposed section reiterates the DCM's

    authority, with conforming changes for SEFs, to require traders to

    provide information regarding their position when requested by the

    exchange.\693\ Proposed Sec. 150.5(b)(3) would codify a new acceptable

    practice for a DCM or SEF to require traders to consent to halt from

    increasing their position in a contract if so ordered. Proposed Sec.

    150.5(b)(3) would also codify a new acceptable practice for a DCM or

    SEF to require traders to reduce their position in an orderly manner.

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

    \693\ Compare 17 CFR 150.5(e)(2)-(3).

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

    Proposed Sec. 150.5(b)(3)(i) would maintain the acceptable

    practice for a DCM or SEF to adopt position accountability rules

    outside the spot month, in lieu of position limits, for an agricultural

    or exempt commodity derivative contract that: (1) has an average month-

    end open interest of 50,000 contracts and an average daily volume of

    5,000 or more contracts during the most recent calendar year; (2) has a

    liquid cash market; and (3) is not subject to federal limits in Sec.

    150.2--provided, however, that such DCM or SEF should adopt a spot

    month speculative position limit with a level no greater than one-

    quarter of the estimated spot month deliverable supply.\694\

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

    \694\ 17 CFR 150.5(e)(3) applies this acceptable practice to a

    ``tangible commodity, including, but not limited to metals, energy

    products, or international soft agricultural products.'' Also,

    compare the ``minimum open interest and volume test'' in proposed

    Sec. 150.5(b)(3)(i) with that in current Sec. 150.5(e)(3).

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

    For an excluded commodity derivative contract that has a highly

    liquid cash market and no legal impediment to delivery, proposed Sec.

    150.5(b)(3)(ii)(A) would maintain the acceptable practice for a DCM or

    SEF to adopt position accountability rules in the spot month in lieu of

    position limits. For an excluded commodity derivative contract without

    a measurable deliverable supply, proposed Sec. 150.5(b)(3)(ii)(A)

    would codify an acceptable practice for a DCM or SEF to adopt position

    accountability rules in the spot month in lieu of position limits

    because there is not a deliverable supply that is subject to

    manipulation. However, for an excluded commodity derivative contract

    that has a measurable deliverable supply, but that may not be highly

    liquid and/or is subject to some legal impediment to delivery, proposed

    Sec. 150.5(b)(3)(ii)(A) sets forth an acceptable practice for a DCM or

    SEF to adopt a spot-month position limit equal to no more than one-

    quarter of the estimated deliverable supply for that commodity, because

    the estimated deliverable supply may be susceptible to manipulation.

    Furthermore, proposed Sec. 150.5(b)(3)(ii) would remove the ``minimum

    open interest and volume'' test for excluded commodity derivative

    contracts generally.\695\ Proposed Sec. 150.5(b)(3)(ii)(B) would

    codify an acceptable practice for a DCM or SEF to adopt position

    accountability levels for an excluded commodity derivative contract in

    lieu of position limits in the individual non-spot month or all-months-

    combined.

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

    \695\ The ``minimum open interest and volume'' test, as

    presented in 17 CFR 150.5(e)(1)-(2), need not be used to determine

    whether an excluded commodity derivative contract should be eligible

    for position accountability rules in lieu of position limits in the

    spot month.

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

    Proposed Sec. 150.5(b)(3)(iii) adds a new acceptable practice for

    an exchange to list a new contract with position accountability levels

    in lieu of position limits if that new contract is substantially the

    same as an existing contract that is currently listed for trading on an

    exchange that has already adopted position accountability levels in

    lieu of position limits.\696\

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

    \696\ See supra discussion of what is meant by ``substantially

    the same'' in this context.

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

    Proposed Sec. 150.5(b)(4) maintains the acceptable practice that

    for contracts not subject to federal position limits, DCMs and SEFs

    should calculate trading volume and open interest as established in

    current Sec. 150.5(e)(4).\697\ Proposed Sec. 150.5(b)(4) would build

    upon these standards by accounting for swaps in reference contracts on

    a futures-equivalent basis.\698\

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

    \697\ For SEFs, trading volume and open interest for swaptions

    should be calculated on a delta-adjusted basis.

    \698\ ``Futures-equivalent'' is a defined term in proposed Sec.

    150.1 that accounts for swaps in referenced contracts.

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

    III. Related Matters

    A. Considerations of Costs and Benefits

    1. Background

    Generally, speculative position limits cap the size of positions

    that a person may hold or control in commodity derivative contracts for

    speculative purposes.\699\ First authorized in 1936,\700\ position

    limits are not a new regulatory tool for containing speculative market

    activity. The Commission and its predecessors have directly set limits

    for futures and options contracts on certain agricultural commodities

    since 1938. Additionally, for approximately 20 years from 1981 until

    the Commodity Futures Modernization Act (``CFMA'') \701\ amended the

    CEA to substitute a core-principles-based, self-regulatory model for

    futures exchanges, Commission rules required exchanges to set position

    limits (or, in certain

    [[Page 75759]]

    specified cases, position accountability levels) for futures and

    options contracts not subject to Commission-imposed limits.\702\

    Through amendments to the CEA over more than 75 years and a number of

    legislative reauthorizations, the Commission's basic authority to

    establish speculative position limits, now codified in CEA section

    4a(a), has remained constant.\703\

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

    \699\ Derivative contracts--i.e., futures, options and swaps--

    may not transfer any ownership interest in the underlying commodity,

    but their prices are substantially derived from the value of the

    underlying commodity. Those who purchase or sell derivatives do so

    either to hedge or speculate. Generally, hedging is the use of

    derivatives markets by commodity producers, merchants or end-users

    to manage their exposure to fluctuation in the price of a commodity

    that a producer or user intends to use or produce; speculation, in

    contrast, is the use of derivative markets to profit from price

    appreciation or depreciation in the underlying commodity. Because

    the limits only restrict positions obtained for speculative

    purposes, this discussion refers interchangeably to ``position

    limits,'' ``speculative position limits,'' or ``speculative

    limits.''

    \700\ Congress first granted the CEC, a Commodity Futures

    Trading Commission predecessor, authority to set speculative

    position limits as part of the New Deal reforms enacted in the

    Commodity Exchange Act of 1936. Public Law 74-765, 49 Stat. 1491,

    1492 (codified at 7 U.S.C. 6a(1) (1940)). Specifically, Congress

    authorized the CEC to ``fix such limits on the amount of trading . .

    . which may be done by any person as the [CEC] finds is necessary to

    diminish, eliminate, or prevent such burden.'' Congress exempted

    positions attributable to bona fide hedging. Unless otherwise

    indicated, references in this discussion to the ``Commission'' mean

    the Commodity Futures Trading Commission as well as its predecessor

    agencies, including the CEC.

    \701\ Commodity Futures Modernization Act of 2000, Public Law

    106-554, 114 Stat. 2763 (Dec. 21, 2000).

    \702\ See, e.g., 46 FR 50938, 50940, Oct. 16, 1981. As discussed

    above, following enactment of the CFMA, which among other things

    afforded DCMs discretion to set appropriate position limits under

    DCM core principle 5, these rules, then contained in Sec. 150.5,

    became ineffective as requirements; they were retained, however, as

    guidance and acceptable practices for DCMs to use in meeting their

    core principle 5 compliance obligations. 74 FR 12178, 12183, Mar.

    23, 2009.

    \703\ One of these amendments, the Commodity Futures Trading Act

    of 1974, created the CFTC and granted it expanded jurisdiction

    beyond the certain enumerated agricultural products of its

    predecessor to all ``services, rights, and interests'' in which

    futures contracts are traded. Public Law 93-463, 88 Stat. 1389

    (1974).

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

    The backdrop for this basic authority is a public record replete

    with Congressional and other official governmental investigations and

    reports--issued over more than 80 years--critical of the harm

    attributed to ``excess speculation'' in derivative markets. From the

    1920s through 2009, a litany of official government investigations,

    hearings and reports document disruptive speculative behavior; \704\

    several of the earliest link the behavior to artificial price effects

    and impaired commodity distribution efficiency, and recommend mandatory

    position limits as a tool to curb speculative abuses and their ill-

    effects. The statute reflects and responds to the centerpiece concern

    of these hearings and reports. Indeed, CEA section 4a(a)(1) states

    Congress's express determination that excessive commodity speculation

    causing sudden or unreasonable price fluctuations or unwarranted

    changes in commodity prices is an undue and unnecessary burden on

    interstate commerce, and mandates that the Commission set position

    limits, including prophylactic limits, to diminish, eliminate, or

    prevent this burden.\705\

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

    \704\ See, e.g., Federal Trade Commission, ``Report of the

    Federal Trade Commission on the Grain Trade,'' vol. VI, at 60-62

    (1924)(documenting a number of ``violent fluctuations of price''

    over the preceding 30 years evidencing ``the close connection

    between extreme fluctuations in annual average prices of cash grain

    and unusual speculative activity in the futures market''); id. vol.

    VII, at 293-294 (1926)(recommending limitation on individual open

    interest because the ``very large trader . . . [w]hether he is more

    often right than wrong . . . and whether influenced by a desire to

    manipulate or not . . . can cause disturbances in the market which

    impair its proper functioning and are harmful to producers and

    consumers''); Grain Futures Administration, ``Fluctuations in Wheat

    Futures,'' S. Doc. No. 69-135, at 1,6 (1926) (investigation of

    ``wide and erratic [1925 wheat futures] price fluctuations . . .

    were largely artificial[,] were caused primarily . . . by heavy

    trading on the part of a limited number of professional speculators

    [that] completely disrupted the market and resulted in abnormal

    fluctuations . . . felt in every other large grain market in the

    world;'' concludes that limitations on the extent of daily trading

    by speculators are ``inevitable . . . if there is to be eliminated

    from the market those hazards which are so unmistakably reflected as

    existing whenever excessively large lines are held by

    individuals''); 1932 Annual Report of the Chief of the Grain Futures

    Admin., at 4, 8 (describing the 16 percent drop in May wheat prices

    during a 21-day period as illustrative of the price impact of

    ``short selling by a few large traders;'' again stresses the need

    for legislation authorizing limitations to eliminate ``the economic

    evils incident to market domination by a few powerful operators

    trading for speculative account''); 1950 Annual Report of the

    Administrator of the Commodity Exchange Authority, at 14-15

    (speculative operations by a small number of traders holding a large

    proportion of long contracts ``distorted egg future prices in

    October 1949 and disrupted orderly marketing of the commodity

    causing financial losses;'' notes that enforcement of speculative

    limits is a ``strong deterrent to excessive speculation by large

    traders''); Commodity Futures Trading Commission, Report To The

    Congress In Response To Section 21 Of The Commodity Exchange Act,

    May 29, 1981, Part Two, A Study of the Silver Market (addressing

    silver market corner discussed above); ``The Role of Market

    Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back

    on the Beat,'' Staff Report, Permanent Subcommittee on

    Investigations of the Senate Committee on Homeland Security and

    Governmental Affairs, U.S. Senate, S. Rpt. No. 109-65 at 1 (June 27,

    2006) (addressing speculation and price increases in oil and gas

    markets) [hereinafter ``Oil & Gas Report'']; ``Excessive Speculation

    in the Natural Gas Market, Staff Report,'' Permanent Subcommittee on

    Investigations of the Senate Committee on Homeland Security and

    Governmental Affairs, U.S. Senate, at 1 (June 25, 2007) (addressing

    speculation, price increases and market distortion in natural gas

    markets discussed above) [hereinafter ``Gas Report'']; ``Excessive

    Speculation in the Wheat Market;'' Staff Report, Permanent

    Subcommittee on Investigations of the Senate Committee on Homeland

    Security and Governmental Affairs, U.S. Senate, at 2 (June 24, 2009)

    (addressing excessive speculation in wheat futures contracts by

    commodity index traders) [hereinafter ``Wheat Report'']; see also

    Jerry W. Markham, ``The History of Commodity Futures Trading and its

    Regulation,'' at 3-47 (1987) (summarizes numerous incidents of large

    speculative trader abuse in an array of commodities from the

    emergence of futures exchanges in the mid-1800s through the 1970s).

    \705\ The roots of this statutory determination date back to

    1922, when Congress found ``sudden or unreasonable fluctuations in

    the prices'' of certain commodity futures transactions ``frequently

    occur as a result of [ ] speculation, manipulation or control'' and

    that ``such fluctuations in prices are an obstruction to and a

    burden upon'' interstate commerce. Grain Futures Act of 1922, ch.

    369 at section 3, 342 Stat. 998, 999 (1922), codified at 7 U.S.C. 5

    (1925-26).

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

    The longstanding statutory approach to position limit regulation

    reflects two important concepts with direct bearing on the benefits and

    costs involved in this rulemaking. First is the distinction between

    speculative trading, for which limits are statutorily authorized, and,

    as to derivatives for physical commodities, mandated, and bona fide

    hedging, for which they are not.\706\ This distinction is important

    because a chief purpose of position limits is to preserve the integrity

    of derivative markets for the benefit of producers that use them to

    hedge risk and consumers that consume the underlying commodities.

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

    \706\ See CEA section 4a(c)(1); 7 U.S.C. 6a(c)(1).

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

    Second is the distinction between speculation generally and

    excessive speculation as addressed in CEA section 4a(a)(1). While, as

    noted above, numerous government inquires have linked speculation at

    excessive levels to abuses and burdens on commerce, below excessive

    levels, speculation provides needed liquidity to derivative

    markets.\707\

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    \707\ Hedgers do not always trade simultaneously in the same

    quantities in opposing directions. That is, long and short hedgers

    may trade at different times and with different quantities, often

    making transactions between only hedgers unfeasible. Speculative

    traders thus provide a trading partner for hedgers for whom there is

    no feasible hedger counterparty. In so doing, speculators provide

    valuable liquidity to the market.

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

    In 2010 the Dodd-Frank Act \708\ amended CEA section 4a(a). These

    amendments responded to the 2008 financial crisis and came in the wake

    of three Congressional reports within a three-year span finding

    increased and/or ``excessive'' derivative market speculation linked to

    increased and distorted prices. These reports recommended increased

    statutory authority to, in the parlance of two of the reports, put the

    Commission ``back on the beat.'' \709\ Among other things, the Dodd-

    Frank Act \710\ expanded the Commission's speculative position limit

    authority under CEA section 4a to

    [[Page 75760]]

    mandate that the Commission: (i) establish limits on the amount of

    positions, as appropriate, that may be held by any person in

    agricultural and exempt commodity \711\ futures and options contracts

    traded on a DCM (CEA section 4a(a)(2));* * * \712\ (ii) establish at an

    appropriate level position limits for swaps that are economically

    equivalent to those futures and options that are subject to mandatory

    position limits pursuant to CEA section 4a(a)(2), and do so at the same

    time as the CEA section 4a(a)(2) limits are established (CEA section

    4a(a)(5)); and (iii) apply position limits on an aggregate basis to

    contracts based on the same underlying commodity across enumerated

    trading venues \713\ (CEA section 4a(a)(6)).

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

    \708\ Public Law 111-203, 124 Stat. 1376 (2010).

    \709\ See, e.g., Wheat Report, at 15-16 (excessive speculation

    in wheat futures contracts by commodity index traders contributed to

    ``unreasonable fluctuations or unwarranted changes'' in wheat

    futures prices, resulting in an abnormally large and persistent gap

    between wheat futures and cash prices (the basis);'' commerce was

    unduly burdened; stiffened position limit regulation for index

    traders recommended); Gas Report, at 3-7 (``[t]he current regulatory

    system was unable to prevent [the hedge fund] Amaranth's excessive

    speculation in the 2006 natural gas market;'' the experience

    demonstrated ``how excessive speculation can distort prices'' and

    have ``serious consequences for other market participants;'' and the

    Commission should be put ``back on the beat''); Oil & Gas Report, at

    6-7 (heavy speculation in commodity energy markets contributed to

    rising U.S. energy prices, distorting the historical relationship

    between price and inventory; recommends putting the CFTC ``back on

    the beat'' to police these markets by eliminating the ``Enron''

    loophole that limited it from doing so). In the interval between the

    two reports addressed to energy market speculation and the Dodd-

    Frank Act amendments, Congress also expanded the Commission's

    authority to set position limits for significant price discovery

    contracts on exempt commercial markets. See Food, Conservation and

    Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (2008).

    \710\ Dodd-Frank Act section 737(a).

    \711\ As defined in CEA section 1a(20), ``exempt commodity''

    means a commodity that is neither an agricultural commodity nor an

    ``excluded commodity.'' Excluded commodities, in turn, are defined

    in CEA section 1a(19) to encompass specified groups of financial and

    occurrence-based commodities. Accordingly, exempt commodities

    include energy products and metals. The Dodd-Frank mandate in CEA

    section 4a(a)(2) to impose limits applies to all agricultural and

    exempt commodities (collectively, physical commodities). This

    mandate does not apply to excluded commodities, which are primarily

    intangible commodities, like financial products.

    \712\ The Commission's statutory interpretation of its mandate

    under CEA section 4a(a)(2) is discussed in detail above. A separate

    provision added by the Dodd-Frank Act directs the Commission with

    respect to factors to consider in establishing the levels of

    speculative position limits that are mandated by CEA section

    4a(a)(2). See CEA section 4a(a)(3); 7 U.S.C. 6a(a)(3).

    \713\ Specifically, as enumerated these are: (1) contracts

    listed by DCMs; (2) with respect to FBOTs, contracts that are price-

    linked to a contract listed for trading on a registered entity and

    made available from within the United States via direct access; and

    (3) SPDF Swaps.

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

    Additionally, the Dodd-Frank Act requires DCMs and SEFs to set

    position limits for any contract subject to a Commission-imposed limit

    at a level not higher than the Commission's limit.\714\ Finally, the

    Dodd-Frank Act, through new CEA section 4a(c)(2), requires that the

    Commission define bona fide hedging positions pursuant to an express

    framework for purposes of exclusion from position limits. The

    Commission's approach, historically, to exercising its statutory

    position limits authority has been to set or order limits

    prophylactically to deter all forms of manipulation and to diminish,

    eliminate, or prevent excessive speculation.\715\ It has done so

    through regulations comprised of three primary components: (1) The

    level of the limits, which set a threshold that restricts the number of

    speculative positions that a person may hold in the spot-month, in any

    individual month, and in all months combined; (2) the standards for

    what constitute bona fide hedging versus speculative transactions, as

    well as other exemptions; and (3) the accounts and positions a person

    must aggregate for the purpose of determining compliance with the

    position limit levels. These rules now reside in part 150 of the

    Commission's regulations.\716\ The rules proposed herein would amend

    part 150 and make certain conforming amendments to related reporting

    requirements in parts 15, 17 and 19. They would do so in a manner that

    represents an extension of the Commission's historical approach towards

    the first two components: limit levels and exemptions. The third

    component, aggregation, is addressed in a separate Commission

    rulemaking.\717\

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

    \714\ See Dodd-Frank Act sections 735(b) (amending CEA section

    5(d)(5)) and 733 (adding CEA section 5h, subsection (f)(6) of which

    specifies SEF's core principle obligation with respect to position

    limitations or accountability).

    \715\ See, e.g., 46 FR 50938, 50940, Oct. 16, 1981. In this

    release adopting Sec. 1.61, the Commission articulated its

    interpretation that the CEA authorized prophylactic speculative

    position limits. One year later, Congress enacted the Futures

    Trading Act of 1982, Public Law 97-444, 96 Stat. 2294, 2299-

    2300(1982), which, inter alia, amended the CEA to ``clarify and

    strengthen the Commission's'' position limits authority. S. Rep. 97-

    384, at 44 (1982). Congress enacted this strengthening amendment

    with awareness of the Commission's prophylactic interpretation and

    approach, and after rejecting amendments that would have

    circumscribed the Commission's authority. See, e.g., Futures Trading

    Act of 1982: Hearings on S. 2109 before the S. Subcomm. on

    Agricultural Research, 97th Cong. 28, 29, 44-45, 337, 340-45 (1982)

    (oral and written statements of Commission Chair Phillip McBride

    Johnson and Commodity Exchange Executive Vice Chair Lee Berendt

    concerning, inter alia, the Commission's omnibus approach to

    position limits); S. Rep. 97-384, at 44-45, 79 (discussing rejected

    amendments).

    \716\ As discussed above, the District Court for the District of

    Columbia vacated part 151 of the Commission's regulations, which

    would have replaced part 150. As a result, part 150 remains in

    effect.

    \717\ See Aggregation NPRM.

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

    i. Statutory Mandate To Consider Costs and Benefits

    CEA section 15(a) \718\ requires the Commission to consider the

    costs and benefits of its actions before promulgating a regulation

    under the CEA or issuing certain orders. CEA section 15(a) further

    specifies that the costs and benefits shall be evaluated in light of

    five broad areas of market and public concern: (1) Protection of market

    participants and the public; (2) efficiency, competitiveness, and

    financial integrity of futures markets; (3) price discovery; (4) sound

    risk management practices; and (5) other public interest

    considerations.\719\

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

    \718\ 7 U.S.C. 19(a).

    \719\ In ICI v. CFTC, 2013 WL 3185090, at *8 (D.C. Cir. 2013),

    the United States Court of Appeals for the D.C. Circuit held that

    CEA section 15(a) imposes no duty on the Commission to conduct a

    quantitative economic analysis: ``Where Congress has required

    ```rigorous, quantitative economic analysis,''' it has made that

    requirement clear in the agency's statute, but it imposed no such

    requirement here [in the CEA].'' Id. (citation omitted).

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

    The Commission considers the costs and benefits resulting from its

    discretionary determinations with respect to the CEA section 15(a)

    factors.

    Accordingly, the discussion that follows identifies, and considers

    against the five CEA section 15(a) factors, benefits and costs to

    market participants and the public that the Commission expects to flow

    from these proposed rules relative to the statutory requirements of the

    CEA and the Commission's regulations now in effect. The Commission has

    attempted to quantify the costs and benefits of these regulations where

    feasible. Where quantification is not feasible the Commission

    identifies and considers costs and benefits qualitatively.

    Beyond specific questions interspersed throughout its discussion,

    the Commission generally requests comment on all aspects of its

    consideration of costs and benefits, including: identification and

    assessment of any costs and benefits not discussed therein; data and

    any other information to assist or otherwise inform the Commission's

    ability to quantify or qualify the benefits and costs of the proposed

    rules; and, substantiating data, statistics, and any other information

    to support positions posited by commenters with respect to the

    Commission's consideration of costs and benefits.

    The following consideration of benefits and costs is generally

    organized according to the following rules proposed in this release:

    definitions (Sec. 150.1),\720\ federal position limits (Sec. 150.2),

    exemptions to limits (Sec. 150.3), position limits set by DCMs and

    SEFs (Sec. 150.5), anticipatory hedging requirements (Sec. 150.7),

    and reporting requirements (Sec. 19.00). For each rule, the Commission

    summarizes the proposed rule and considers the benefits and costs

    expected to result from it.\721\ The Commission then considers the

    benefits and costs of the proposed rules collectively in light of the

    five public

    [[Page 75761]]

    interest considerations of CEA section 15(a).

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

    \720\ Many of the revised or new definitions do not

    substantively affect the Commission's considerations of costs and

    benefits on their own merit, but are considered in conjunction with

    the sections of the rule that implement them.

    \721\ The proposed rules also include amendments to 17 CFR parts

    15 and 17, as discussed supra. The Commission preliminarily believes

    these amendments are not substantive in nature and do not have cost

    or benefit implications. The Commission welcomes comment on any

    potential costs or benefits of the changes to parts 15 and 17.

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

    2. Section 150.1--Definitions

    Currently, Sec. 150.1 defines terms for operation within the

    various rules that comprise part 150. As described above, the

    Commission proposes formatting, organizational, and other non-

    substantive amendments to these definitional provisions that, subject

    to consideration of any relevant comments, it does not view as having

    benefit or cost implications.\722\ But, with respect to a number of

    definitions, the Commission proposes substantive amendments and

    additions. With the exception of the term ``bona fide hedging

    position,'' for which the benefits and costs of the proposed Sec.

    150.1 definition are considered in the subsection directly below, any

    benefits and costs attributable to substantive definitional changes and

    additions proposed in Sec. 150.1 are considered in the discussion of

    the rule in which such new or amended terms would be operational.

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

    \722\ See supra discussion of proposed amendments to Sec.

    150.1.

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

    i. Bona Fide Hedging

    Proposed Sec. 150.1 would include a definition of the term ``bona

    fide hedging positions''--which operates to distinguish hedging

    positions from those that are speculative and thus subject to position

    limits, both federal and exchange-set, unless otherwise exempted by the

    Commission. Hedgers present a lesser risk of burdening interstate

    commerce as described in CEA section 4a because their positions are

    offset in the physical market. CEA section 4a(c) has long directed that

    no Commission rule, regulation or order establishing position limits

    under CEA section 4a(a) apply to bona fide hedging as defined by the

    Commission.\723\ The proposed definition would replace the definition

    now contained in Sec. 1.3(z) to implement that statutory

    directive.\724\

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

    \723\ CEA section 4a(c)(1); 7 U.S.C. 6a(c)(1).

    \724\ Currently, 17 CFR 1.3(z), defines the term ``bona fide

    hedging transactions and positions.'' Originally adopted by the

    newly formed Commission in 1975, a revised version of Sec. 1.3(z)

    took effect two years later. This 1977 revision largely forms the

    basis of the current definition of bona fide hedging. A history of

    the definition of bona fide hedging is presented above. With the

    adoption of the proposed definition of ``bona fide hedging

    positions'' in Sec. 150.1, Sec. 1.3(z) would be deleted.

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

    Generally, the current definition of bona fide hedging in Sec.

    1.3(z) advises that a position should ``normally represent a substitute

    for . . . positions to be taken at a later time in a physical marketing

    channel'' and requires such position to be ``economically appropriate

    to the reduction of risks in the conduct of a commercial enterprise''

    where the risks arise from the potential change in value of assets,

    liabilities, or services.\725\ Such bona fide hedges must have a

    purpose ``to offset price risks incidental to commercial cash or spot

    operations'' and must be ``established and liquidated in an orderly

    manner in accordance with sound commercial practices.''

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

    \725\ 17 CFR 1.3(z)(1). The Commission cautions that the e-CFR

    2012 version of this provision reflects changes made by the now-

    vacated Part 151 rule.

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

    This general definition thus provides general components of the

    type of position that constitute a bona fide hedge position. The

    criterion that such a position should ``normally represent a substitute

    for . . . positions to be taken at a later time in a physical marketing

    channel'' has been deemed the ``temporary substitute'' criterion. The

    requirement that such position be ``economically appropriate to the

    reduction of risks in the conduct of a commercial enterprise'' is

    referred to as the ``economically appropriate'' test. The criterion

    that hedged risks arise from the potential change in value of assets,

    liabilities, or services is commonly known as the ``change in value''

    requirement or test. The phrase ``price risks incidental to commercial

    cash or spot operations'' has been termed the ``incidental test.'' The

    criterion that hedges must be ``established and liquidated in an

    orderly manner'' is known as the ``orderly trading requirement.'' \726\

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

    \726\ See supra for additional explanation of these terms.

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

    The current definition also describes a non-exclusive list of

    transactions that satisfy the definitional criteria and therefore

    qualify as bona fide hedges; these ``enumerated hedging transactions''

    are located in Sec. 1.3(z)(2). For those transactions that may fit the

    definition but are not listed in Sec. 1.3(z)(2), current Sec.

    1.3(z)(3) provides a means of requesting relief from the Commission.

    The Dodd-Frank Act amended the CEA in ways that require the

    Commission to adjust its current bona fide hedging definition.

    Specifically, the Dodd-Frank Act added section 4a(c)(2) of the Act,

    which the Commission interprets as directing the Commission to narrow

    the bona fide hedging position definition for physical commodities from

    the definition found in current Sec. 1.3(z)(1).\727\

    Dodd-Frank also provided direction regarding the bona fide hedging

    criteria for swaps contracts newly under the Commission's jurisdiction.

    Specifically, new CEA sections 4a(a)(5) and (6) require the Commission

    to impose limits on an aggregate basis across all economically

    equivalent contracts, excepting in both cases bona fide hedging

    positions. CEA section 4a(c)(2)(B) describes which swap offset

    positions may qualify as bona fide hedges. Finally, new CEA section

    4a(a)(7) provides the Commission with authority to grant exemptive

    relief from position limits. The Commission proposes to amend its

    definition of bona fide hedging under the authority and direction of

    amended CEA section 4a(c) and the other provisions added by the Dodd-

    Frank Act. To the extent a change in the definition represents a

    statutory requirement, it is not discretionary and thus not subject to

    CEA section 15(a).

    ii. Rule Summary

    Like current Sec. 1.3(z), the proposed Sec. 150.1 bona fide

    hedging definition employs a basic organizational model of stating

    general, broadly applicable requirements for a hedge to qualify as bona

    fide,\728\ and then specifying certain particular (``enumerated'')

    hedges that are deemed to meet the general requirements.\729\

    Generally, the proposed definition is built around the same criteria as

    are currently found in Sec. 1.3(z), including the temporary substitute

    and economically appropriate criteria. Thus, the proposed definition is

    substantially similar to the current definition, with limited changes

    to accommodate altered statutory requirements regarding bona fide

    hedging as well as accomplish discretionary improvements. The proposed

    definition also reflects organizational changes to better accommodate

    the extension of speculative position limits to all economically

    equivalent contracts across all trading venues. To the extent the

    proposed definition carries over requirements currently resident in the

    Sec. 1.3(z) definition, it does not represent a change from current

    practice and therefore should not pose incremental benefits or costs.

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

    \728\ Compare 17 CFR 1.3(z)(1) (``General Definition'') with the

    proposed Sec. 150.1 definition of bona fide hedging opening

    sentence and paragraphs (1) and (2) (respectively, ``Hedges of an

    excluded commodity'' and ``Hedges of a physical commodity'').

    \729\ Compare 17 CFR 1.3(z)(2)(``Enumerated Hedging

    Transactions'') with the proposed Sec. 150.1 definition of bona

    fide hedging paragraphs (3) and (4) (respectively, ``Enumerated

    hedging positions'' and ``Other enumerated hedging positions'').

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

    The proposed definition has been relocated from Sec. 1.3(z) to

    Sec. 150.1 in order to facilitate reference between sections of part

    150. The proposed

    [[Page 75762]]

    definition of bona fide hedging position is also re-organized into six

    sections, starting with an opening paragraph describing the general

    requirements for all hedges followed by five numbered paragraphs.

    Paragraph (1) of the proposed definition describes requirements for

    hedges of an excluded commodity,\730\ including guidance on risk

    management exemptions that may be adopted by an exchange. Paragraph (2)

    describes requirements for hedges of a physical commodity. Paragraphs

    (3) and (4) describe enumerated exemptions. Paragraph (5) describes

    cross-commodity hedges.

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

    \730\ An ``excluded commodity'' is defined in CEA section

    1a(19). The definition includes financial products such as interest

    rates, exchange rates, currencies, securities, credit risks, and

    debt instruments as well as financial events or occurrences.

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

    The following discussion is meant to highlight the essential

    components of each section of the proposed definition. A full

    discussion of the history and policy rationale of each section may be

    found supra.\731\

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

    \731\ See discussion above.

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

    a. Opening Paragraph

    The opening paragraph of the proposed definition incorporates the

    incidental test and the orderly trading requirement, both found in the

    current Sec. 1.3(z)(1). The Commission intends the proposed incidental

    test to be a requirement that the risks offset by a commodity

    derivative contract hedging position must arise from commercial cash

    market activities. The Commission believes this requirement is

    consistent with the statutory guidance to define bona fide hedging

    positions to permit the hedging of ``legitimate anticipated business

    needs.'' \732\ The incidental test allows the Commission to distinguish

    between hedging and speculate activities by defining the former as

    requiring a legitimate business need.

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

    \732\ 7 U.S.C. 6a(c)(1).

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

    The proposed orderly trading requirement is intended to impose on

    bona fide hedgers the duty to enter and exit the market carefully in

    the ordinary course of business. The requirement is also intended to

    avoid to the extent possible the potential for significant market

    impact in establishing or liquidating a position in excess of position

    limits. This requirement is particularly important because, as

    discussed below, the Commission proposes to set the initial levels of

    position limits at the outer bound of the range of levels of limits

    that may serve to balance the statutory policy objectives in CEA

    section 4a(a)(3) for limit levels. As such, bona fide hedgers likely

    would only need an exemption for very large positions. The orderly

    trading requirement is intended to prevent disorderly trading,

    practices, or conduct from bona fide hedgers by encouraging market

    participants to assess market conditions and consider how the trading

    practices and conduct affect the orderly execution of transactions when

    establishing or liquidating a position greater than the applicable

    position limit.\733\

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

    \733\ As discussed supra, the Commission believes that negligent

    trading, practices, or conduct should be a sufficient basis for the

    Commission to deny or revoke a bona fide hedging exemption.

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

    b. Paragraph (1) Hedges of an Excluded Commodity

    The first paragraph in the proposed definition addresses hedging of

    an excluded commodity; it emanates from the Commission's discretionary

    authority to impose limits on intangible commodities. In general, in

    addition to the requirements in the opening paragraph, proposed

    paragraph (1) requires the position meet the economically appropriate

    test and is either enumerated in paragraphs (3), (4), or (5) of the

    proposed definition or is recognized by a DCM or SEF as a bona fide

    hedge pursuant to exchange rules. The temporary substitute and change

    in value criteria are not included in the proposed paragraph (1), as

    these requirements are inappropriate in the context of certain excluded

    commodities that lack a physical marketing channel.\734\

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

    \734\ The Commission notes that DCMs currently incorporate the

    temporary substitute and change in value criteria when the

    contract's underlying market has physical delivery obligations. The

    proposal would not limit their ability to continue to do so when

    appropriate.

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

    Exclusively addressed to excluded commodity hedging, paragraph (1)

    is relevant only for the purposes of exchange-set limits under Sec.

    150.5 as proposed for amendment. As the Commission has determined to

    focus the application of federal speculative position limits on 28

    physical commodities and their related physical-delivery and cash-

    settled referenced contracts, this paragraph does not affect the

    imposition of federal speculative position limits and exemptions

    thereto.

    c. Paragraph (2) Hedges of a Physical Commodity

    Proposed paragraph (2) of the definition enumerates what

    constitutes a hedge for physical commodities, including physical

    agricultural and exempt commodities both subject and not subject to

    federal speculative position limits. In addition to the requirements in

    the opening paragraph, proposed paragraph (2) requires that the

    position satisfy the temporary substitute test, the economically

    appropriate test, and the change-in-value test. These tests have been

    incorporated into the revised statutory definition in CEA section

    4a(c)(2) and essentially mirror the current definition in Sec.

    1.3(z).\735\ The proposed paragraph (2) also requires the position

    either be enumerated in proposed paragraphs (3), (4), or (5) or be a

    pass-through swap offset or pass-through swap position as defined in

    paragraph (2)(ii).

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

    \735\ With respect to the temporary substitute test, the word

    ``normally'' has been removed in the proposed definition in order to

    conform with the stricter statutory standard in new CEA section

    4a(c)(2). See discussion above.

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

    Proposed paragraph (2) of the definition applies generally to

    derivative positions that hedge a physical commodity and as such

    includes swaps. Thus, the paragraph responds to the statutory

    requirement in CEA section 4a(a)(5) that the Commission establish

    limits on economically equivalent contracts, including swaps, excluding

    bona fide hedging positions. The definition of a pass-through swap

    offset position incorporates the definition in new CEA section

    4a(c)(2)(B)(i), with the inclusion of the requirement that such

    position not be maintained during the lesser of the last five days of

    trading or the time period for the spot month for the physical-delivery

    contract.

    d. Paragraphs (3) and (4) Enumerated Hedging Positions

    Proposed paragraph (3) lists specific positions that would fit

    under the definition of a bona fide hedging position, including hedges

    of inventory, cash commodity purchase and sales contracts, unfilled

    anticipated requirements, and hedges by agents.\736\ Each of these

    positions was described in Sec. 1.3(z), with the exception of

    paragraph (iii)(B), which was added in response to the petition

    submitted to the Commission by the Working Group of Commercial Energy

    Firms.\737\

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

    \736\ A detailed description of each enumerated position can be

    found supra.

    \737\ See discussion above.

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

    Proposed paragraph (4) provides other enumerated hedging

    exemptions, including hedges of unanticipated production, offsetting

    unfixed price cash commodity sales and purchases, anticipated

    royalties, and services, all of which are subject to the ``five-day

    rule.'' The ``five-day rule'' is a provision in many of the enumerated

    hedging positions that prohibits a trader from maintaining the

    positions in any physical-delivery commodity derivative

    [[Page 75763]]

    contract during the lesser of the last five days of trading or the time

    period for the spot month in such physical-delivery contract.\738\

    Because each exemption shares this provision, the Commission is

    proposing to reorganize such exemptions into proposed paragraph (4) for

    administrative efficiency.

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

    \738\ As discussed above, the purpose of the five-day rule is to

    protect the integrity of the delivery and settlement processes in

    physical-delivery contracts. Without this rule, high concentrations

    of exempted positions can distort the markets, impairing price

    discovery while potentially having an adverse impact on efforts to

    deter all forms of market manipulation and diminish excessive

    speculation.

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

    Of the enumerated hedges in proposed paragraphs (4)(i) and (ii) are

    currently in Sec. 1.3(z) and paragraph (4)(iv) codifies a hedge that

    has historically been recognized by the Commission. Paragraph (4)(iii)

    proposes a royalties exemption not now specified in Sec. 1.3(z).

    e. Paragraph (5) cross-commodity hedges

    Proposed paragraph (5) describes positions that would qualify as

    cross-commodity bona fide hedges. The Commission has long recognized

    cross-commodity hedging, stating in 1977 that such positions would be

    covered under the general provisions of Sec. 1.3(z)(2).

    The definition in proposed paragraph (5) would condition cross-

    commodity hedging on: (i) whether the fluctuations in value of the

    position in the commodity derivative contract are ``substantially

    related'' to the fluctuations in value of the actual or anticipated

    cash position or pass-through swap; and (ii) the five-day rule being

    applied to positions in any physical-delivery commodity derivative

    contract. The second condition, i.e. the application of the five-day

    rule, would help to protect the integrity of the delivery process in

    the physical-delivery contract but would not apply to cash-settled

    contract positions.\739\

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

    \739\ See discussion above.

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

    iii. Benefits and Costs

    Elements of the proposed definition that represent discretionary,

    substantive modifications to the required manner in which bona fide

    hedging have been defined under Sec. 1.3(z) include the following:

    \740\ (i) Proposing requirements for hedges in an excluded commodity in

    proposed paragraph (1); (ii) adding the five-day rule into the

    statutory definition of pass-through swap as described in paragraph

    (2)(ii)(A); (iii) applying the definition in proposed paragraph (2) to

    positions in economically equivalent contracts in a physical commodity;

    \741\ (iv) expanding paragraph (3)(III)(b) to incorporate hedges

    encouraged by a public utility commission; (v) expanding paragraph

    (4)(ii) to include offsetting unfixed-price cash commodity sales and

    purchases that are basis different contracts in the same commodity,

    regardless of whether the contracts are in the same calendar month;

    (vi) adding paragraph (iii) to proposed paragraph (4) to enumerate

    anticipated royalty hedges; and (vii) enumerating cross-commodity

    hedges as a standalone provision in paragraph (5).

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

    \740\ The Commission notes that the relocation of the definition

    from Sec. 1.3(z) to part 150 is also discretionary. As noted above,

    the placement is intended to facilitate compliance with the other

    sections of part 150; the Commission does not believe, however, that

    this action has substantive cost or benefit implications. Also, the

    proposed definition incorporates and references elements of non-

    binding guidance not encompassed by CEA section 15(a).

    \741\ As discussed supra, CEA section 4a(a)(5) requires that the

    Commission set speculative limits on the amount of positions,

    ``other than bona fide hedging positions . . . held by any person

    with respects to swaps that are economically equivalent'' to futures

    and options. 7 U.S.C. 6a(a)(5). Subject to CEA section 4a(a)(2), the

    Commission is exercising its discretion in defining bona fide

    hedging in economically equivalent contracts in the same manner as

    for futures and options in physical commodities. 7 U.S.C. 6a(a)(2).

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

    a. Benefits

    The Commission proposes the definition for excluded commodities in

    paragraph (1) in order to provide a consistent definition of bona fide

    hedging--i.e., a definition that incorporates the economically

    appropriate test--for all commodities under the Commission's

    jurisdiction. The addition of paragraph (1) would provide exchanges

    with a definition for bona fide hedging designed to provide a level of

    assurance that the Commission's policy objectives regarding bona fide

    hedging are met at the exchange level as well as at the federal level,

    and for excluded commodities as well as agricultural and exempt

    commodities.

    The Commission believes that the additions to the definition of

    bona fide hedging proposed in this release provide additional necessary

    relief to bona fide hedgers. This relief, in turn, will help to ensure

    that market participants with positions hedging legitimate business

    needs are properly recognized as hedgers under the Commission's

    speculative position limits regime. Thus, the Commission anticipates

    that the addition of the enumerated position for anticipated royalties

    and the expansion of the enumerated unfilled anticipated requirements

    position provide additional means for obtaining a hedge exemption by

    recognizing the legitimate business need in each position. The safe

    harbor proposed in paragraph (5) is expected to provide clarity and

    promote regulatory certainty for entities that use cross-commodity

    hedging strategies. Further, the addition of the five-day rule to the

    hedging definition for pass-through swaps helps the Commission to

    ensure the integrity of the delivery process in the physical-delivery

    contract and as a result to accomplish to the maximum extent

    practicable the factors in CEA section 4a(a)(3). Finally, the

    Commission believes using the same bona fide hedging exemptions in

    economically equivalent contracts may facilitate administrative

    efficiency by avoiding the need for market participants to manage and

    apply different definitional criteria across multiple products and

    trading venues.\742\ The Commission requests comment on its

    consideration of the benefits of the proposed definition of bona fide

    hedging. Has the Commission misidentified any of the benefits of the

    proposed rule? Are there additional benefits the Commission ought to

    consider regarding the proposed definition of bona fide hedging? Why or

    why not?

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

    \742\ Further, using the same exemptions in economically

    equivalent contracts is consistent with the approach of the Dodd-

    Frank Act section 737(a) amendment requiring that the Commission

    establish limits for economically equivalent swap positions and

    across trading venues, including direct-access linked FBOT

    contracts. See 7 U.S.C. 6a(a)(5)-(6).

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

    b. Costs

    The Commission anticipates that there will be some small additional

    costs associated with the proposed definition.

    Entities may incur costs to the extent the proposed definition of a

    bona fide hedging position in an excluded commodity requires an

    exchange to adjust its policies for bona fide hedging exemptions or a

    market participant to adjust its trading strategies for what is and is

    not a bona fide hedge in an excluded commodity. The Commission expects

    such costs to be negligible, as the definition is substantially the

    same as the current definition under Sec. 1.3(z). Costs for exchanges

    are also considered in the section of this release that discusses the

    proposed amendments to Sec. 150.5.

    In general, under other aspects of the Commission's proposed

    definition, market participants may incur costs to determine whether

    their positions fall under one of the new or expanded enumerated

    positions. In the event a position does not fit under any of the

    enumerated positions, market

    [[Page 75764]]

    participants may incur costs associated with filing for exemptive

    relief as described in the section discussing the costs of proposed

    Sec. 150.3 or in altering speculative trading strategies as discussed

    above. As trading strategies are proprietary, and the determinations

    made by individual entities present a burden that is highly

    idiosyncratic, it is not reasonably feasible for the Commission to

    estimate the value of the burden imposed.

    c. Request for Comment

    The Commission requests comment on its consideration of the costs

    of the proposed definition of bona fide hedging position. Are there

    additional costs related to the Commission's discretionary actions that

    the Commission should consider? Has the Commission misidentified any

    costs? Commenters are encouraged to submit any data that the Commission

    should consider in evaluating the costs of the proposed definition.

    d. Consideration of Alternatives

    The Commission recognizes that alternatives exist to discretionary

    elements of the definition of bona fide hedging positions proposed

    herein. The Commission requests comments on whether an alternative to

    what is proposed would result in a superior benefit-cost profile, with

    support for any such position provided.

    3. Section 150.2--Limits

    i. Rule Summary

    As previously discussed, the Commission interprets CEA section

    4a(a)(2) to mandate that it establish speculative position limits for

    all agricultural and exempt physical commodity derivative

    contracts.\743\ The Commission currently sets and enforces speculative

    position limits for futures and futures-equivalent options contracts on

    nine agricultural products. Specifically, current Sec. 150.2 provides

    ``[n]o 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'' enumerated spot, single-month, and all-

    month levels for nine specified contracts.\744\ These proposed

    amendments to Sec. 150.2 would expand the scope of federal position

    limits regulation in three chief ways: (1) specify limits on 19

    contracts in addition to the nine existing legacy contracts (i.e., a

    total of 28); (2) extend the application of these limits beyond futures

    and futures-equivalent options to all commodity derivative interests,

    including swaps; and (3) extend the application of these limits across

    trading venues to all economically equivalent contracts that are based

    on the same underlying commodity. In addition, the proposed rule would

    provide a methodology and procedures for implementing and applying the

    expanded limits.

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

    \743\ See supra discussion of the Commission's interpretation of

    this mandate.

    \744\ These contracts are Chicago Board of Trade corn and mini-

    corn, oats, soybeans and mini-soybeans, wheat and mini-wheat,

    soybean oil, and soybean meal; Minneapolis Grain Exchange hard red

    spring wheat; ICE Futures U.S. cotton No. 2; and Kansas City Board

    of Trade hard winter wheat.

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

    The Commission proposes to amend Sec. 150.2 to impose speculative

    position limits as mandated by Congress in accordance with the

    statutory bounds that define its discretion in doing so. First,

    pursuant to CEA section 4a(a)(5) the Commission must concurrently

    impose position limits on swaps that are economically equivalent to the

    agricultural and exempt commodity derivatives for which position limits

    are mandated in section 4a(a)(2). Second, CEA section 4a(a)(3) requires

    that the Commission appropriately set limit levels mandated under

    section 4a(a)(2) that ``to the maximum extent practicable, in its

    discretion,'' accomplish four specific objectives.\745\ Third, CEA

    section 4a(a)(2)(C) requires that in setting limits mandated under

    section 4a(a)(2)(A), the ``Commission shall strive to ensure that

    trading on foreign boards of trade in the same commodity will be

    subject to comparable limits and that any limits . . . imposed . . .

    will not cause price discovery in the commodity to shift to trading on

    the foreign boards of trade.'' Key elements of the proposed rule are

    summarized below.\746\

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

    \745\ These objectives are to: (1) ``diminish, eliminate, or

    prevent excessive speculation;'' (2) ``deter and prevent market

    manipulation, squeezes, and corners;'' (3) ``ensure sufficient

    market liquidity for bona fide hedgers;'' and (4) ``ensure that the

    price discovery function of the underlying market is not

    disrupted.'' 7 U.S.C. 6a(a)(3).

    \746\ For a more detailed description, see discussion above.

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

    Generally, proposed Sec. 150.2 would limit the size of speculative

    positions,\747\ i.e., prohibit any person from holding or controlling

    net long/short positions above certain specified spot month, single

    month, and all-months-combined position limits. These position limits

    would reach: (1) 28 ``core referenced futures contracts,'' \748\

    representing an expansion of 19 contracts beyond the 9 legacy

    agricultural contracts identified currently in Sec. 150.2; \749\ (2) a

    newly defined category of ``referenced contracts'' (as defined in

    proposed Sec. 150.1); \750\ and (3) across all trading venues to all

    economically equivalent contracts that are based on the same underlying

    commodity.

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

    \747\ Proposed Sec. 150.1 would include a consistent definition

    of the term ``speculative position limits.''

    \748\ Proposed Sec. 150.1 also would define the term ``core

    referenced futures contract'' by reference to ``a futures contract

    that is listed in Sec. 150.2(d).''

    \749\ Specifically, in addition to the existing 9 legacy

    agricultural contracts now within Sec. 150.2--i.e., Chicago Board

    of Trade corn, oats, soybeans, soybean oil, soybean meal, and wheat;

    Minneapolis Grain Exchange hard red spring wheat; ICE Futures U.S.

    cotton No. 2; and Kansas City Board of Trade hard winterwheat--

    proposed Sec. 150.2 would expand the list of core referenced

    futures contracts to capture the following additional agricultural,

    energy, and metal contracts: Chicago Board of Trade Rough Rice; ICE

    Futures U.S. Cocoa, Coffee C, FCOJ-A, Sugar No. 11 and Sugar No. 16;

    Chicago Mercantile Exchange Feeder Cattle, Lean Hog, Live Cattle and

    Class III Milk; Commodity Exchange, Inc., Gold, Silver and Copper;

    and New York Mercantile Exchange Palladium, Platinum, Light Sweet

    Crude Oil, NY Harbor ULSD, RBOB Gasoline and Henry Hub Natural Gas.

    \750\ This would result in the application of prescribed

    position limits to a number of contract types with prices that are

    or should be closely correlated to the prices of the 28 core

    referenced futures contracts--i.e., economically equivalent

    contracts--including: (1) ``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); (2) contracts based on an

    index comprised of one or more prices for the same delivery location

    and in the same or substantially the same commodity underlying a

    core referenced futures contract; and (3) inter-commodity spreads

    with two components, one or both of which are referenced contracts.

    The proposed ``reference contract'' definition would exclude,

    however, a guarantee of a swap.

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

    a. Sec. 150.2(a) Spot-Month Speculative Position Limits

    In order to implement the statutory directive in CEA section

    4a(a)(3)(A), proposed Sec. 150.2(a) would prohibit any person from

    holding or controlling positions in referenced contracts in the spot

    month in excess of the level specified by the Commission for referenced

    contracts.\751\ Proposed Sec. 150.2(a) would require, in the

    Commission's discretion, that a trader's positions, net long or net

    short, in the physical-delivery referenced contract and cash-settled

    referenced contract be

    [[Page 75765]]

    calculated separately under the spot month position limits fixed by the

    Commission for each. As a result, a trader could hold positions up to

    the applicable 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 would not be able

    to net across physical-delivery and cash-settled contracts in the spot

    month.

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

    \751\ As discussed supra, the Commission proposes to adopt a

    streamlined, amended definition of ``spot month'' in proposed Sec.

    150.1. The term would be defined as the trading period immediately

    preceding the delivery period for a physical-delivery futures

    contract and cash-settled swaps and futures contracts that are

    linked to the physical-delivery contract. The definition proposes

    similar but slightly different language for cash-settled contracts,

    providing for the spot month to be the earlier of the period in

    which the underlying cash-settlement price is calculated or the

    close of trading on the trading day preceding the third-to-last

    trading day, until the contract cash-settlement price is determined.

    For more details, see discussion above.

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

    b. Sec. 150.2(b) Single-Month and All-Months-Combined Speculative

    Position Limits

    Proposed Sec. 150.2(b) would provide that no person may hold or

    control positions, net long or net short, in referenced contracts in a

    single-month or in all-months-combined in excess of the levels

    specified by the Commission. Proposed Sec. 150.2(b) would require

    netting all positions in referenced contracts (regardless of whether

    such referenced contracts are physical-delivery or cash-settled) when

    calculating a trader's positions for purposes of the proposed single-

    month or all-months-combined position limits (collectively ``non-spot-

    month'' limits).\752\

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

    \752\ The Commission proposes to use the same level for single-

    month and all-months-combined limits, and refers to those limits as

    the ``non-spot-month limits.'' The spot month and any single month

    refer to those periods of the core referenced futures contract.

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

    c. Sec. 150.2(d) Core Referenced Futures Contracts

    To be clear, the statutory mandate in Dodd-Frank section 4a(a)(2)

    applies on its face to all physical commodity contracts. The Commission

    is nevertheless proposing, initially, to apply speculative position

    limits to referenced contracts that are based on 28 core referenced

    futures contract listed in proposed Sec. 150.2(d). As defined in

    proposed Sec. 150.1, referenced contracts are futures, options, or

    swaps contracts that are directly or indirectly linked to a core

    referenced futures contract or the commodity underlying a core

    referenced futures contract.\753\

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

    \753\ As discussed above, the definition of referenced contract

    excludes any guarantee of a swap, basis contracts, and commodity

    index contracts.

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

    Proposed Sec. 150.2(d) lists the 28 core referenced futures

    contracts on which the Commission is initially proposing to establish

    federal speculative position limits. The list represents a significant

    expansion of federal speculative position limits from the current list

    of nine agricultural contracts under current part 150.\754\ The

    Commission has selected these important food, energy, and metals

    contracts on the basis that such contracts (i) have high levels of open

    interest and significant notional value and/or (ii) serve as a

    reference price for a significant number of cash market transactions.

    Thus, the Commission is proposing limits to commence the expansion of

    its federal position limit regime with those commodity derivative

    contracts that it believes are likely to have the greatest impact on

    interstate commerce. Because the mandate applies to all physical

    commodity contracts, the Commission intends through supplemental

    rulemaking to establish limits for all other physical commodity

    contracts. Given limited Commission resources, it cannot do so in this

    initial rulemaking.

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

    \754\ 17 CFR 150.2.

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

    As discussed above,\755\ the Commission calculated the notional

    value of open interest (delta-adjusted) and open interest (delta-

    adjusted) for all futures, futures options, and significant price

    discovery contracts as of December 31, 2012 in all agricultural and

    exempt commodities in order to select the list of 28 core referenced

    futures contracts in proposed Sec. 150.2(d). The Commission selected

    commodities in which the derivative contracts had largest notional

    value of open interest and open interest for three categories:

    agricultural, energy, and metals. The Commission then designated the

    benchmark futures contracts for each commodity as the core referenced

    futures contracts for which position limits would be established.

    Proposed Sec. 150.2(d) lists 19 core referenced futures contracts for

    agricultural commodities, four core referenced futures contracts for

    energy commodities, and five core referenced futures contracts for

    metals commodities.

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

    \755\ See discussion above.

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

    d. Sec. 150.2(e) Levels of Speculative Position Limits

    The Commission proposes setting initial spot month position limit

    levels for referenced contracts at the existing DCM-set levels for the

    core referenced futures contracts. Thereafter, proposed Sec.

    150.2(e)(3) would task the Commission with recalibrating spot month

    position limit levels no less frequently than every two calendar years.

    The Commission's proposed recalibration would result in limits no

    greater than one-quarter (25 percent) of the estimated spot-month

    deliverable supply \756\ in the relevant core referenced futures

    contract. This formula is consistent with the acceptable practices in

    current Sec. 150.5, as well as the Commission's longstanding practice

    of using this measure of deliverable supply to evaluate whether DCM-set

    spot-month limits are in compliance with DCM core principles 3 and 5.

    The proposed rules separately restrict the size of positions in cash-

    settled referenced contracts that would potentially benefit from a

    trader's potential distortion of the price of the underlying core

    referenced futures contract.

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

    \756\ The guidance for meeting DCM core principle 3 (as listed

    in 17 CFR part 38 app. C) specifies that, ``[t]he specified terms

    and conditions [of a futures contract], considered as a whole,

    should result in a `deliverable supply' that is sufficient to ensure

    that the contract is not susceptible to price manipulation or

    distortion. In general, the term `deliverable supply' means the

    quantity of the commodity meeting the contract's delivery

    specifications that reasonably can be expected to be readily

    available to short traders and salable by long traders at its market

    value in normal cash marketing channels . . .'' See 77 FR 36612,

    36722, Jun. 19, 2012.

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

    As proposed, each DCM would be required to supply the Commission

    with an estimated spot-month deliverable supply figure that the

    Commission would use to recalibrate spot-month position limits unless

    it decides to rely on its own estimate of deliverable supply

    instead.\757\

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

    \757\ Proposed Sec. 150.2(e)(3)(ii) would require DCMs to

    submit estimates of deliverable supply. DCM estimates of deliverable

    supplies (and the supporting data and analysis) would continue to be

    subject to Commission review.

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

    In contrast to spot-month limits, which would be set as a function

    of deliverable supply, the proposed formula for the non-spot-month

    position limits is based on total open interest for all referenced

    contracts that are aggregated with a particular core referenced

    contract. Proposed Sec. 150.2(e)(4) explains that the Commission would

    calculate non-spot-month position limit levels based on the following

    formula: 10 percent of the largest annual average open interest for the

    first 25,000 contracts and 2.5 percent of the open interest

    thereafter.\758\ As is the case with spot month limits, the Commission

    proposes to adjust single month and all-months-combined limits no less

    frequently than every two calendar years.

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

    \758\ Since 1999, the same 10 percent/2.5 percent methodology,

    now incorporated in current Sec. 150.5(c)(2), has been used to

    determine futures all-months position limits for referenced

    contracts.

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

    The Commission's proposed average open interest calculation would

    be computed for each of the past two calendar years, using either

    month-end open contracts or open contracts for each business day in the

    time period, as practical and in the Commission's discretion.

    Initially, the Commission proposes to set the levels of initial non-

    spot-month limits using open interest

    [[Page 75766]]

    for calendar years 2011 and 2012 in futures contracts, options thereon,

    and in swaps that are significant price discovery contracts and are

    traded on exempt commercial markets. Using the 2011/2012 combined

    levels of open interest for futures contracts and for swaps that are

    significant price discovery contracts and are traded on exempt

    commercial markets will result in non-spot month position limit levels

    that are not overly restrictive at the outset; this is intended to

    facilitate the transition to the new position limits regime without

    disrupting liquidity. For example, the Commission is proposing a non-

    spot-month limit for CBOT Wheat that represents the harvest from around

    2 million acres (3,125 square miles) of wheat, or 81 million bushels.

    The proposed non-spot-month limit for NYMEX WTI Light Sweet Crude Oil

    represents 109.2 million barrels of oil. The Commission believes these

    levels to be sufficiently high as to restrict excessive speculation

    without restricting the benefits of speculative activity, including

    liquidity provision for bona fide hedgers.

    After the initial non-spot-month limits are set, the Commission

    proposes subsequently to use the data reported by DCMs and SEFs

    pursuant to parts 16, 20, and/or 45 to estimate average open interest

    in referenced contracts.\759\

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

    \759\ Options listed on DCMs would be adjusted using an option

    delta reported to the Commission pursuant to 17 CFR part 16; swaps

    would be counted on a futures equivalent basis, equal to the

    economically equivalent amount of core referenced futures contracts

    reported pursuant to 17 CFR part 20 or as calculated by the

    Commission using swap data collected pursuant to 17 CFR part 45.

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

    e. Sec. 150.2(f)-(g) Pre-Existing Positions and Positions on Foreign

    Boards of Trade

    The Commission proposes in new Sec. 150.2(f)(2) to exempt from

    federal non-spot-month speculative position limits any referenced

    contract position acquired by a person in good faith prior to the

    effective date of such limit, provided that the pre-existing position

    is attributed to the person if such person's position is increased

    after the effective date of such limit.\760\

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

    \760\ See also the definition of the term ``Pre-existing

    position'' incorporated in proposed Sec. 150.1 herein. Such pre-

    existing positions 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 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. 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

    total size of the pre-existing and new positions may not exceed the

    applicable limit.

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

    Finally, proposed Sec. 150.2(g) would apply position limits to

    positions on foreign boards of trade (``FBOT''s) provided that

    positions are held in referenced contracts that settle to a referenced

    contract and that the FBOT allows direct access to its trading system

    for participants located in the United States.

    ii. Benefits

    The criteria set out in CEA section 4a(a)(3)(B)--namely, that

    position limit levels (1) ``diminish, eliminate, or prevent excessive

    speculation;'' (2) ``deter and prevent market manipulation, squeezes,

    and corners;'' (3) ``ensure sufficient market liquidity for bona fide

    hedgers;'' and (4) ``ensure that the price discovery function of the

    underlying market is not disrupted''--clearly articulate objectives

    that Congress intended the Commission to accomplish, to the maximum

    extent practicable, in setting limit levels in accordance with the

    mandate to impose limits. The Commission is proposing to expand its

    speculative position limits regime to include all commodity derivative

    interests, including swaps; to impose federal limits on 19 additional

    contract markets; and to apply limits across trading venues to all

    economically equivalent contracts that are based on the same underlying

    commodity.

    In so doing, the proposed rules generally would expand the

    prophylactic protections of federal position limits to additional

    contract markets. Proposed Sec. 150.2(f) and (g) implement statutory

    directives in CEA section 4a(b)(2) and CEA section 4a(a)(6)(B),

    respectively, and are not acts of the Commission's discretion. Thus,

    the Commission is not required to consider costs and benefits of these

    provisions under CEA section 15(a). Specific discussion of the benefits

    of the other components of proposed Sec. 150.2 is below.

    a. Sec. 150.2(a) Spot-Month Speculative Position Limits

    As discussed above, CEA section 4a(a)(3)(A) now directs the

    Commission to set limits on speculative positions during the spot-

    month.\761\ It is during the spot-month period that concerns regarding

    certain manipulative behaviors, such as corners and squeezes, become

    most urgent.\762\ Spot-month position limits cap speculative traders'

    positions, and therefore restrict their ability to amass market power.

    In so doing, spot-month limits restrict the ability of speculators to

    engage in corners and squeezes and other forms of manipulation. They

    also prevent the potential adverse impacts of unduly large positions

    even in the absence of manipulation, thereby promoting a more orderly

    liquidation process for each contract.

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

    \761\ 7 U.S.C. 6a(a)(3)(A).

    \762\ See discussion above.

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

    The Commission has used its discretion in the manner in which it

    implements the statutorily-required spot-month position limits so as to

    achieve Congress's objectives in CEA section 4a(a)(3)(B)(ii) to prevent

    or deter market manipulation, including corners and squeezes. For

    example, the Commission has used its discretion under CEA section

    4a(a)(1) to set separate but equal limits in the spot-month for

    physical-delivery and cash-settled referenced contracts. By setting

    separate limits for physical-delivery and cash-settled referenced

    contracts, the proposed rule restricts the size of the position a

    trader may hold or control in cash-settled reference contracts, thus

    reducing the incentive of a trader to manipulate the settlement of the

    physical-delivery contract in order to benefit positions in the cash-

    settled reference contract. Thus, the separate limits further enhance

    the prevention of market manipulation provided by spot-month position

    limits by reducing the potential for adverse incentives to manifest in

    manipulative action.

    b. Sec. 150.2(b) Single-Month and All-Months-Combined Speculative

    Position Limits

    CEA section 4a(a)(3)(A) further directs the Commission to set

    limits on speculative positions for months other than the spot-

    month.\763\ While market disruptions arising from the concentration of

    positions remain a possibility outside the spot month, the above-

    mentioned concerns about corners and squeezes and other forms of

    manipulation are reduced because the potential for the same is reduced

    outside the spot-month. Accordingly, the Commission has proposed to use

    its discretion to require netting of physical-delivery and cash-settled

    referenced contracts for purposes of determining compliance with non-

    spot-month limits. The Commission deems it is appropriate to provide

    traders with additional flexibility in complying with the non-spot-

    months limits given their decreased risk of corners and squeezes.

    Because this additional flexibility means market participants are able

    to retain offsetting positions outside of the spot-month, liquidity

    should not be

    [[Page 75767]]

    impaired and price discovery should not be disrupted.

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

    \763\ 7 U.S.C. 6a(a)(3)(A).

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

    c. Sec. 150.2(e) Levels of Speculative Position Limits

    The proposed methodology for determining the levels at which the

    limits are set is consistent with the Commission's longstanding

    acceptable practices for DCM-set speculative position limits. Further,

    the Commission's proposal to set initial spot-month limits at the

    current federal or DCM-set levels for each core referenced futures

    contract means that any trading activity that is compliant with the

    current position limits regime generally will continue to be compliant

    under the first two years of the proposed rule.\764\

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

    \764\ The Commission notes that the CME Group submitted an

    estimate of deliverable supply that, if used by the Commission as a

    base for setting initial levels of spot month limits, would result

    in higher spot month limits than those currently proposed in

    appendix D. See discussion above for more information.

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

    The proposed rule is designed to result in speculative position

    limit levels that prevent excessive speculation and deter market

    manipulation without diminishing market liquidity. Specifically, levels

    that are too low may be binding and overly restrictive, but levels that

    are too high may not adequately protect against manipulation and

    excessive speculation. The Commission believes that both standards--

    i.e., spot month limits of not greater than 25 percent of deliverable

    supply and the 10 and 2.5 percent formula for non-spot-month limits--

    produce levels for speculative position limits that help to ensure that

    both policy objectives--to deter market manipulation and excessively

    large speculative positions and to maintain adequate market liquidity--

    are achieved to the maximum extent practicable.

    The Commission's review of the number of potentially affected

    traders indicates that the proposed rule will not significantly affect

    market liquidity. Over the last two full years (2011-2012), an average

    of fewer than 40 traders in any one of the 28 proposed markets exceeded

    just 60 percent of the level of the proposed spot-month position limit.

    An average of fewer than 10 of those traders exceeded 100 percent of

    the proposed level of the spot-month limit.\765\ In several months over

    the period, no trader exceeded the proposed level of the spot-month

    limits and some months saw a much larger number of traders with

    positions in excess of the proposed level of the spot-month limits.

    Smaller numbers were revealed when observing traders' positions in

    relation to proposed levels for non-spot-month position limits--an

    average of fewer than 10 traders exceeded 60 percent of the proposed

    all-months-combined limit. The analysis reviewed by the Commission does

    not account for hedging and other exemptions, which leads the

    Commission to believe that the number of speculative traders in excess

    of the proposed limit is even smaller. The relatively low number of

    traders that may exceed proposed limits in non-spot-months is

    indicative of the flexibility of the limit formula to account for

    changes in market participation.

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

    \765\ To put this figure in context, over the same period the

    number of unique owners over at least one of the proposed limit

    levels in the 28 proposed markets was 384, while 932 unique owners

    were over 60 percent of at least one of the proposed limit levels.

    In contrast, under the large trader reporting provisions of part 17,

    there are thousands of traders with reportable positions as defined

    in Sec. 15.00(p).

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

    d. Request for Comment

    The Commission welcomes comment on its considerations of the

    benefits of proposed Sec. 150.2. What other benefits of the provisions

    in Sec. 150.2 should the Commission consider? Has the Commission

    accurately identified the potential benefits of the proposed rules?

    iii. Costs

    The expansion of Sec. 150.2 will necessarily create some

    additional compliance costs for market participants. The Commission has

    attempted, where feasible, to reduce such burdens without compromising

    its policy objectives.

    a. Sec. 150.2(a)-(b) Spot-Month, Single-Months, and All-Months-

    Combined Speculative Position Limits; Other Considerations

    Notwithstanding the above analysis of potentially affected traders,

    the Commission anticipates that some market participants still may find

    it necessary to reassess and modify existing trading strategies in

    order to comply with spot- and non-spot-month position limits for the

    28 commodities with applicable federal limits, though the Commission

    believes much of these costs to be the direct result of the statutory

    mandate to impose limits. The Commission anticipates any such costs

    would be largely incurred by swaps-only entities, as futures and

    options market participants have experience with position limits,

    particularly in the spot-month, such that the costs of any strategic or

    trading changes that needed to be made may have already been incurred.

    These costs are not reasonably quantifiable by the Commission, due to

    their highly variable and entity-specific nature, and because trading

    strategies are proprietary, but to the extent an expanded position

    limits regime alters the ways a trader conducts speculative trading

    activity, such costs may be incurred.

    Broadly speaking, imposing position limits raises the concerns that

    liquidity and price discovery may be diminished, because certain market

    segments, i.e., speculative traders, are restricted. The Commission has

    endeavored to mitigate concerns about liquidity and price discovery, as

    well as costs to market participants, by expanding limits to additional

    markets incrementally in order to facilitate the transition to the

    expanded position limits regime. For example, the Commission has

    proposed to adopt current spot-month limit levels as the initial levels

    in order to ensure traders know well in advance of the effective date

    of the rule what limits will be on that date. The Commission also

    expects a large number of swaps traders to avail themselves of the pre-

    existing position exemption as defined in proposed Sec. 150.3. 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, which allows the burden of altering

    strategies to happen incrementally over time. The preexisting position

    exemption applies to non-spot-month positions entered into in good

    faith prior to (i) the enactment of the Dodd-Frank Act or (ii) the

    effective date of this proposed rule.

    Implementing the statutory requirement of CEA section 4a(a)(6), the

    aggregate limits proposed in Sec. 150.2 would impact, as described

    above, market participants who are active across trading venues in

    economically equivalent contracts. Under current practice, speculative

    traders may hold positions up to the limit in each derivative product

    for which a limit exists. In contrast, aggregate limits cap all of a

    speculative market participant's positions in derivatives contracts for

    a particular commodity. In some circumstances, the aggregate limit will

    prevent traders from entering into positions that would have otherwise

    been permitted without aggregate limits.\766\ The proposed rule

    incorporates features that provide

    [[Page 75768]]

    counterbalancing opportunities for speculative trading.

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

    \766\ For example, a market participant has a position close to

    the spot-month limit in the NYMEX cash-settled crude oil contract is

    currently able to take the same size position in the ICE cash-

    settled crude oil contract. The proposed rule would, in accordance

    with the statutory requirement of CEA section 4a(a)(6), require that

    the positions on NYMEX and ICE be aggregated for the purposes of

    complying with the limit--effectively halving the limit.

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

    First, the limits apply separately to physical-delivery and cash-

    settled contracts in the spot-month. Physical-delivery core referenced

    futures contracts have one limit; cash-settled reference contracts

    traded on the same exchange, a different exchange, or over-the-counter

    have a separate, but equal, limit. Therefore, a speculative trader may

    hold positions up to the spot month limit in both the physical-delivery

    core referenced futures contract, and a cash-settled contract (i.e.,

    cash-settled future and/or swap).

    The second feature is the proposed conditional spot-month limit

    exemption. As discussed in a subsequent section of this release, the

    conditional spot-month limit exemption allows a speculative trader to

    hold a position in a cash-settled contract that is up to five times the

    spot-month limit of the core referenced futures contract, provided that

    trader does not hold any position in the physical-delivery core

    referenced futures contract.

    Finally, federal non-spot-month limits are calculated as a fixed

    ratio of total open interest in a particular commodity across all

    markets for referenced contracts. Because of this feature of the

    Commission's formula for calculating non-spot-month limit levels and of

    the proposed rule's application of non-spot-month limits on an

    aggregate basis across all markets, the imposition of the required

    aggregate limits should not unduly impact positions outside of the

    spot-month, as evidenced by the relatively few number of traders that

    would have been impacted historically, noted in table 11, supra.

    b. Sec. 150.2(e) Levels of Speculative Position Limits

    Market participants would incur costs to monitor positions to

    prevent a violation of the limit level. The Commission expects that

    large traders in the futures and options markets for the 28 core

    referenced futures contracts have already developed some system to

    control the size of their positions on an intraday basis, in compliance

    with the longstanding position limits regimes utilized by both the

    Commission on a federal level and DCMs on an exchange level and in

    light of industry practices to measure, monitor, and control the risk

    of positions. For these traders, the Commission anticipates a small

    incremental burden to accommodate any physical commodity swap positions

    that such traders may hold that would become subject to the position

    limits regime. The Commission, subject to evidence establishing the

    contrary, believes the burden will be minimal because futures and

    options market participants are currently monitoring trading to track,

    among other things, their positions vis-[agrave]-vis current limit

    levels. For those participating in the futures and options markets, the

    Commission estimates two to three labor weeks to adjust monitoring

    systems to track position limits for referenced contracts, including

    swaps and other economically equivalent contracts traded on other

    trading venues. Assuming an hourly wage of $120,\767\ multiplied by 120

    hours, this implementation cost would amount to approximately $14,000

    per entity.

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

    \767\ The Commission's estimates concerning the wage rates are

    based on 2011 salary information for the securities industry

    compiled by the Securities Industry and Financial Markets

    Association (``SIFMA''). The Commission is using $120 per hour,

    which is derived from a weighted average of salaries across

    different professions from the SIFMA Report on Management &

    Professional Earnings in the Securities Industry 2011, modified to

    account for an 1800-hour work-year, adjusted to account for the

    average rate of inflation in 2012, and multiplied by 1.33 to account

    for benefits and 1.5 to account for overhead and administrative

    expenses. The Commission anticipates that compliance with the

    provisions would require the work of an information technology

    professional; a compliance manager; an accounting professional; and

    an associate general counsel. Thus, the wage rate is a weighted

    national average of salary for professionals with the following

    titles (and their relative weight); ``programmer (senior)'' and

    ``programmer (non-senior)'' (15% weight), ``senior accountant''

    (15%) ``compliance manager'' (30%), and ``assistant/associate

    general counsel'' (40%). All monetary estimates have been rounded to

    the nearest hundred dollars.

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

    The incremental costs of compliance with the proposed rule would be

    higher for speculative traders who have until now traded only or

    primarily in swap contracts.\768\ Specifically, swaps-only traders may

    potentially incur larger start-up costs to develop a compliance system

    to monitor their positions in referenced contracts and to comply with

    an applicable position limit. Though swaps-only market participants

    have not historically been subject to position limits, swap dealers and

    major swap participants (as defined by the Commission pursuant to the

    Dodd-Frank Act) are required in Sec. 23.601 to implement systems to

    monitor position limits.\769\ In addition, many of these entities have

    already developed systems or business processes to monitor or control

    the size of swap positions for a variety of business reasons, including

    (i) managing counterparty credit risk exposure; and (ii) limiting and

    monitoring the risk exposure to such swap positions. Such existing

    systems would likely make compliance with position limits significantly

    less burdensome, as they may be able to leverage current monitoring

    procedures to comply with this rule. The Commission anticipates that a

    firm could select from a wide range of compliance systems to implement

    a monitoring regime. This flexibility allows the firm to tailor the

    system to suit its specific needs in a cost-effective manner.

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

    \768\ The Commission notes that costs associated with the

    inclusion of swaps contracts in the federal position limits regime

    are the direct result of changes made by the Dodd-Frank Act to

    section 4a of the Act. The Commission presents a discussion of these

    costs in order to be transparent regarding the effects of the

    proposed rules.

    \769\ See 17 CFR 23.601.

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

    In the release adopting now-vacated part 151, the Commission

    recognized the potentially firm-specific and highly variable nature of

    implementing monitoring systems. In particular, the Commission

    presented estimates of, on average, labor costs per entity ranging from

    40 to 1,000 hours, $5,000 to $100,000 in five-year annualized capital/

    start-up costs, and $1,000 to $20,000 in annual operating and

    maintenance costs.\770\ The Commission explained that costs would

    likely be lower for firms with positions far below the speculative

    limits, but higher for firms with large or complex positions as those

    firms may need comprehensive, real-time analysis.\771\ The Commission

    further explained that due to the variation in both number of positions

    held and degree of sophistication in existing risk management systems,

    it was not feasible for the Commission to provide a greater degree of

    specificity as to the particularized costs for swaps firms.\772\

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

    \770\ See 76 FR at 71667. The presentation of costs on a five-

    year annualized basis is consistent with requirements under the

    Paperwork Reduction Act (``PRA''). See OMB Form 83-I requiring the

    Commission's Paperwork Reduction Act analysis be submitted with

    ``annualized'' costs in all categories. Instructions for the form do

    not provide instructions for annualizing costs; the Commission chose

    to annualize over a five year period.

    \771\ Id. (n. 401).

    \772\ Id.

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

    At this time, the Commission remains in the early stages of

    implementing the suite of Dodd-Frank Act regulations addressing swap

    markets now under its jurisdiction. The Commission is registering swap

    dealers and major swaps participants for the first time. Much of the

    infrastructure, including execution facilities, of the new markets has

    only recently become operational, and the collection of comprehensive

    regulatory data on physical commodity swaps is in its infancy. Because

    of this, the Commission is unable to estimate with precision the likely

    number of impacted swaps-only traders who would be subject to position

    limits for the first time. However, the Commission

    [[Page 75769]]

    preliminarily believes that a relatively small number of swaps-only

    traders will be affected. The Commission anticipates that most of the

    traders in swaps markets that accumulate physical commodity swap

    positions of a sufficiently high volume to engender concern for

    crossing position limit thresholds either: Are required to register as

    swap dealers or major swaps participants and as such already have

    systems in place to monitor limits in accordance with Sec. 23.601; or,

    are also active in futures markets and as such have the ability to

    leverage existing strategies for monitoring limits.

    Accordingly, for purposes of proposing these amendments to Sec.

    150.2, the Commission again estimates that swaps entities will incur,

    on average, labor costs per entity ranging from 40 to 1,000 hours;

    between $25,000 and $500,000 in total (non-annualized) capital/start-up

    costs and $1,000 to $20,000 in annual operating and maintenance costs.

    These estimates provide a preliminary range of costs for monitoring

    positions that reflects, on average, costs that market participants may

    incur based on their specific, individualized needs.

    Finally, proposed Sec. 150.2(e)(3)(ii) requires DCMs that list a

    core referenced futures contract to supply to the Commission estimates

    of deliverable supply. The Commission proposes to require staggered

    submission of the deliverable supply estimates in order to spread out

    the administrative burden of the proposed rules. Further, for contracts

    with DCM-set limits, an exchange would have already estimated

    deliverable supply in order to set spot-month position limit or

    demonstrate continued compliance with core principles 3 and 5. Thus,

    the Commission does not anticipate a large burden to result from the

    proposed Sec. 150.2(e)(3)(ii). The Commission preliminarily believes

    that, as estimated in accordance with the Paperwork Reduction Act

    (``PRA''), the submission would require a labor burden of approximately

    20 hours per estimate. Thus, a DCM that submits one estimate may incur

    a burden of 20 hours for a cost, using the estimated hourly wage of

    $120,\773\ of approximately $2,400. DCMs that submit more than one

    estimate may multiply this per-estimate burden by the number of

    estimates submitted to obtain an approximate total burden for all

    submissions, subject to any efficiencies and economies of scale that

    may result from submitting multiple estimates.

    c. Request for Comment

    Do the estimates presented accurately reflect the expected costs of

    monitoring position limits under the proposed rule? Would the proposed

    rule engender material costs for monitoring positions addition to those

    the Commission has identified? Are the assumptions reflected in the

    Commission's consideration of the proposed rule's costs to monitor

    limits valid? If not, why and to what degree?

    Is the Commission's view that aggregate limits as proposed will not

    create overly restrictive limit levels valid? Would the aggregated,

    cross-exchange nature of the limits as proposed in Sec. 150.2 engender

    material costs that the Commission has not identified?

    Are there other cost factors related to operational changes that

    the Commission should consider? What other factors should the

    Commission consider?

    The Commission requests that commenters submit data or other

    information to assist it in quantifying anticipated costs of proposed

    Sec. 150.2 and to support their own assertions concerning costs

    associated with proposed Sec. 150.2.

    iv. Consideration of Alternatives

    The Commission recognizes there exist alternatives to its

    discretionary proposals herein. These include the alternative of

    setting initial levels for spot month speculative position limit based

    on estimates of deliverable supply, as provided by the CME Group,

    rather than at the levels proposed in appendix D. The Commission

    requests comment on whether an alternative to what is proposed,

    including setting initial limits based on a current estimate of

    deliverable supply, would result in a superior benefit-cost profile,

    with support for any such position provided.

    4. Section 150.3--Exemptions

    CEA section 4a(a)(7), added by the Dodd-Frank Act, authorizes the

    Commission to exempt, conditionally or unconditionally, any person,

    swap, futures contract, or option--as well as any class of the same--

    from the position limit requirements that the Commission establishes.

    Current Sec. 150.3 specifies three types of positions for exemption

    from calculation against the federal limits prescribed by the

    Commission under Sec. 150.2: (1) Bona fide hedges, (2) spreads or

    arbitrage between single months of a futures contract (and/or, on a

    futures-equivalent basis, options), and (3) those of an ``eligible

    entity'' as that term is defined in Sec. 150.1(d) \774\ carried in a

    separate account by an independent account controller (``IAC'') \775\

    when specific conditions are met. The Commission proposes to make

    organizational and conforming changes to Sec. 150.3 as well as several

    substantive changes. By exempting positions that pose less risk of

    unduly burdening interstate commerce from position limit regulation,

    these substantive revisions would further the Commission's mission

    specified in CEA section 4a(a)(3).

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

    \774\ For example, an operator of a commodity pool or certain

    other trading vehicle, a commodity trading advisor, or another

    specified financial entity such as a bank, trust company, savings

    association, or insurance company.

    \775\ IACs are defined currently in 17 CFR 150.1(e). Amendments

    to that definition are being proposed in a separate release. See

    Aggregation NPRM.

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

    The proposed organizational/conforming changes consist of updating

    cross references; \776\ relocating the IAC exemption to consolidate it

    with the Commission's separate proposal to amend the aggregation

    requirements of Sec. 150.4; \777\ and deleting the calendar month

    spread provision that, due to changes proposed under Sec. 150.2, would

    be rendered unnecessary.\778\ These amendments will facilitate reader

    ease-of-use and clarity. However, the Commission foresees little

    additional impact from these non-substantive proposed amendments.

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

    \776\ Specifically, as described above: a) proposed Sec.

    150.3(a)(1)(i) would update the cross-references to the bona fide

    hedging definition to reflect its proposed replacement in amended

    Sec. 150.1 from its current location in Sec. 1.3(z); b) proposed

    Sec. 150.3(a)(3) would add a new cross-reference to the reporting

    requirements proposed to be amended in part 19; and c) proposed

    Sec. 150.3(i) would add a cross-reference to the updated

    aggregation rules in proposed Sec. 150.4.

    \777\ See Aggregation NPRM. The exemption for accounts carried

    by an IAC is set out in proposed Sec. 150.4(b)(5); adoption of that

    proposal would render current Sec. 150.3(a)(4) duplicative.

    \778\ More specifically, as discussed supra, the Commission

    proposes to amend Sec. 150.2 to increase the level of single month

    position limits to the same level as all months limits. As a result,

    the spread exemption set forth in current Sec. 150.3(a)(3) that

    permits a spread trader to exceed single month limits only to the

    extent of the all months limit would no longer provide useful

    relief.

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

    The proposed substantive changes to Sec. 150.3 would revise an

    existing exemption, add three additional exemptions, and revise

    recordkeeping requirements. As summarized in the section below,

    proposed Sec. 150.3 would: (i) Codify in Commission regulation the

    statutory requirement of CEA section 4a(c)(1) that federal position

    limits not apply to bona fide hedging as defined by the Commission;

    (ii) add exemptions for financial distress situations, certain spot-

    month positions in cash-settled reference contracts, and pre-Dodd-Frank

    and transition period swaps; (iii) provide guidance for non-enumerated

    exemptions, including the deletion of Sec. 1.47; and (iv) revise

    recordkeeping

    [[Page 75770]]

    requirements for traders claiming any exemption from the federal

    speculative position limits.

    i. Rule Summary

    a. Section 150.3(a) Bona Fide Hedging Exemption

    As does current Sec. 150.3(a)(1), proposed Sec. 150.3(a)(1)(i)

    will codify the statutory requirement that bona fide hedging positions

    be exempt from federal position limits. To the extent that benefits and

    costs would derive from the Commission's proposed amendment in Sec.

    150.1 to the definition of ``bona fide hedging position'' that is

    discussed above. This proposed amendment would also require that the

    anticipatory hedging requirements proposed in Sec. 150.7, the

    recordkeeping requirements proposed in Sec. 150.3(g), and the

    reporting requirements in proposed part 19 are met in order to claim

    the exemption. Any benefits and costs attributable to these features of

    the rule are considered below in the respective discussions of proposed

    Sec. 150.7, Sec. 150.3(g) and Part 19.

    b. Section 150.3(b) Financial Distress Exemption

    Proposed Sec. 150.3(b) provides the means for market participants

    to request relief from applicable speculative position limits during

    times of market stress. The proposed rule allows for exemption under

    certain financial distress circumstances, including the default of a

    customer, affiliate, or acquisition target of the requesting entity,

    that may require an entity to assume in short order the positions of

    another entity.

    c. Section 150.3(c) Conditional Spot-Month Limit Exemption

    Proposed Sec. 150.3(c) would provide a conditional spot-month

    limit exemption that permits traders to acquire positions up to five

    times the spot month limit if such positions are exclusively in cash-

    settled contracts. The conditional exemption would not be available to

    traders who hold or control positions in the spot-month physical-

    delivery referenced contract in order to reduce the risk that traders

    with large positions in cash-settled contracts would attempt to distort

    the physical-delivery price to benefit such positions.

    The proposed conditional exemption is consistent with current

    exchange-set position limits on certain cash-settled natural gas

    futures and swaps.\779\ Both NYMEX and ICE have established conditional

    spot month limits in their cash-settled natural gas contracts at a

    level five times the level of the spot month limit in the physical-

    delivery futures contract. Since spot-month limit levels for referenced

    contracts will be set at no greater than 25 percent of the estimated

    deliverable supply in the relevant core referenced futures contract,

    the proposed exemption would allow a speculative trader to hold or

    control positions in cash-settled referenced contracts equal to no

    greater than 125 percent of the spot month limit.

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

    \779\ See discussion above.

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

    Historically, the Commission has been particularly concerned about

    protecting the spot month in physical-delivery futures contracts

    because they are most at risk for corners and squeezes. This acute risk

    is the reason that speculative limits in physical-delivery markets are

    generally set more restrictively during the spot month. The conditional

    exemption, as proposed, would constrain the potential for manipulative

    or disruptive activity in the physical-delivery contracts during the

    spot month by capping speculative trading in such contracts; however,

    in parallel cash-settled contracts, where the potential for

    manipulative or disruptive activity is much lower, the conditional

    exemption would broaden speculative trading opportunity, potentially

    providing additional liquidity for bona fide hedgers in cash-settled

    contracts.

    In proposing the conditional limit, the Commission has examined

    market data on the effectiveness of conditional spot-month limits in

    natural gas markets, including the data submitted as part of the

    rulemaking for now-vacated part 151.\780\ The Commission has also

    examined market data in other contracts, and has observed that open

    interest levels naturally decline in the physical-delivery contract

    leading up to and during the spot month, as the contract approaches

    expiration.\781\ Both hedgers and speculators exit the physical-

    delivery contract in order to, for example, roll their positions to the

    next contract month or avoid delivery obligations. Market participants

    in cash-settled contracts, however, tend to hold their positions

    through to expiration. This market behavior suggests that the

    conditional spot-month limit exemption should not affect liquidity in

    the spot month of the physical-delivery contract, as open interest is

    rapidly declining.\782\ The exemption, would, however, provide the

    opportunity for speculative trading to increase in the cash-settled

    contract. The Commission preliminarily believes that while this

    proposed exemption would remove certain constraints from speculative

    trading in cash-settled contracts, it would not damage liquidity in the

    aggregate, i.e., across physical-delivery and cash-settled contracts in

    the same commodity. On this basis, the Commission preliminarily

    believes a conditional limit in additional commodities is consistent

    with the statutory direction to deter manipulation while ensuring

    sufficient liquidity for bona fide hedgers without disrupting the price

    discovery process.

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

    \780\ See 76 FR at 71635 (n. 100-01).

    \781\ See discussion above.

    \782\ Traders participating in the physical-delivery contract in

    the spot month are understood to have a commercial reason or need to

    stay in the spot month; the Commission preliminarily believes at

    this time that it is unlikely that the factors keeping traders in

    the spot month physical-delivery contract will change due solely to

    the introduction of a higher cash-settled contract limit.

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

    The Commission's current proposal would not restrict a trader's

    cash commodity position. Instead, the Commission proposes to require

    enhanced reporting of cash market positions of traders availing

    themselves of the conditional spot-month limit. As discussed in the

    proposed changes to part 19, the Commission proposes to initially

    require this enhanced reporting only for the natural gas contract until

    it gains more experience administering the conditional spot month limit

    in the other referenced contracts. The Commission preliminarily

    believes that the proposed reporting regime in natural gas will provide

    useful information that can be deployed by surveillance staff to detect

    and potentially deter manipulative schemes involving the cash market.

    d. Section 150.3(d) Pre-Enactment and Transition Period Swaps Exemption

    To implement the statutory requirement of CEA section

    4a(b)(2),\783\ proposed Sec. 150.3(d) would provide an exemption from

    federal position limits for swaps entered into prior to July 21, 2010

    (the date of the enactment of the Dodd-Frank Act), the terms of which

    have not expired as of that date, and for swaps entered into during the

    period commencing July 22, 2010, the terms of which have not expired as

    of that date, and ending 60 days after the publication of final rule

    Sec. 150.3 in the Federal Register, i.e., its effective date. The

    Commission would allow both pre-enactment and transition swaps to be

    netted with commodity derivative contracts acquired more than 60 days

    after publication of final rule Sec. 150.3 in the Federal Register for

    the purpose of

    [[Page 75771]]

    complying with any non-spot-month position limit.\784\ This exemption

    facilitates the transition to full position limits compliance for

    previously unregulated swaps markets. Allowing netting with pre-

    enactment and transition swaps provides flexibility where possible in

    order to lessen the impact of the regime on entities that trade swaps.

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

    \783\ CEA section 4a(b)(2) states in part that ``any position

    limit fixed by the Commission . . . good faith prior to the

    effective date of such rule, regulation or order.'' 7 U.S.C.

    6a(b)(2).

    \784\ Because of concerns regarding manipulation during the

    delivery period of a referenced contract, the proposed rule would

    not allow pre- and post- enactment and transition swaps to be netted

    for the purpose of complying with any spot-month position limit.

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

    e. Section 150.3(e) and (f) Other Exemptions and Previously Granted

    Exemptions

    Proposed Sec. 150.3(e) and (f) provide information on other

    exemptive relief not specified by other sections of Sec. 150.3. The

    Commission previously permitted a person to file an application seeking

    approval for a non-enumerated position to be recognized as a bona fide

    hedging position under Sec. 1.47. Though the Commission is proposing

    to delete Sec. 1.47, the Commission believes it is appropriate to

    provide persons the opportunity to seek exemptive relief.

    Proposed Sec. 150.3(e) provides guidance to persons seeking

    exemptive relief. A person engaged in risk-reducing practices that are

    not enumerated in the revised definition of bona fide hedging in

    proposed Sec. 150.1 may use two different avenues to apply to the

    Commission for relief from federal position limits. The person may

    request an interpretative letter from Commission staff pursuant to

    Sec. 140.99 \785\ concerning the applicability of the bona fide

    hedging position exemption, or may seek exemptive relief from the

    Commission under section 4a(a)(7) of the Act.\786\

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

    \785\ 17 CFR 140.99 defines three types of staff letters--

    exemptive letters, no-action letters, and interpretative letters--

    that differ in terms of scope and effect. An interpretative letter

    is written advice or guidance by the staff of a division of the

    Commission or its Office of the General Counsel. It binds only the

    staff of the division that issued it (or the Office of the General

    Counsel, as the case may be), and third-parties may rely upon it as

    the interpretation of that staff.

    \786\ See supra discussion of CEA section 4a(a)(7).

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

    f. Section 150.3(g) and (h) Recordkeeping

    Proposed Sec. 150.3(g)(1) specifies recordkeeping requirements for

    persons who claim any exemption set forth in proposed Sec. 150.3.

    Persons claiming exemptions under Sec. 150.3 would need to maintain

    complete books and records concerning all details of their related

    cash, forward, futures, options and swap positions and transactions.

    Proposed Sec. 150.3(g)(1) is largely duplicative of other

    recordkeeping obligations imposed on market participants, including

    provisions in Sec. 1.35 and Sec. 18.05 as amended by the Commission

    to conform with the Dodd-Frank Act.\787\ Proposed Sec. 150.3(g)(2)

    require persons seeking to rely upon the pass-through swap offset

    exemption to obtain a representation from its counterparty that the

    swap qualifies as a bona fide hedging position and to retain this

    representation on file. Similarly, proposed Sec. 150.3(g)(3) requires

    a person who makes such a representation to maintain records supporting

    the representation. Under proposed Sec. 150.3(h), all persons would

    need to make such books and records available to the Commission upon

    request, which would preserve the ``call for information'' rule set

    forth in current Sec. 150.3(b).

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

    \787\ 77 FR 66288, Nov. 2, 2012.

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

    ii. Benefits

    In articulating exemptions from position limit requirements, Sec.

    150.3 works in concert with Sec. 150.2 as it pertains to Commission-

    specified federal limits and with certain requirements of Sec. 150.5

    pertaining to exchange-set position limits. Functioning as an

    integrated component within the broader position-limits regulatory

    regime, the Commission believes the proposed changes to Sec. 150.3

    accomplish, to the maximum extent practicable, the four objectives

    outlined in CEA section 4a(a)(3). As such, the Commission perceives

    these proposed amendments to offer significant benefits. These are

    explained more specifically below.

    a. Section 150.3(b) Financial Distress Exemption

    In codifying the Commission's historical practice of temporarily

    lifting position limit restrictions, the proposed rule further

    strengthens the benefits of accommodating transfers of positions from

    financially distressed firms to financially secure firms or

    facilitating other necessary remediation measures during times of

    market stress. More specifically, due to the improved facility and

    transparency with respect to the availability of this exemption, it

    becomes less likely that positions will be prematurely or unnecessarily

    liquidated. The disorderly liquidation of a position poses the threat

    of price impacts that may harm the efficiency as well as the price

    discovery function of markets. In addition, the availability of a

    financial distress exemption provides market participants with a degree

    of confidence that the Commission has the appropriate tools to

    facilitate the transfer of positions expeditiously in times of market

    uncertainty.

    b. Section 150.3(c) Conditional Spot-month Limit Exemption

    The conditional spot-month limit exemption provides speculators

    with an opportunity to maintain relatively large positions in cash-

    settled contracts up to but no greater than 125 percent of the spot-

    month limit. By prohibiting speculators using the exemption in the

    cash-settled contract from trading in the spot-month of the physical-

    delivery contract, the proposed rules should further protect the

    delivery and settlement process. In addition, the condition of the

    exemption--i.e., a trader availing himself of the exemption may not

    have any position in the physical-delivery contract--reduces the

    ability for a trader with a large cash-settled contract position to

    attempt to manipulate the physical-delivery contract price in order to

    benefit his position. As such, the conditional spot-month limit

    exemption would further three of the goals under CEA section 4a(a)(3)--

    deterring market manipulation, and ensuring sufficient market liquidity

    for bona fide hedgers, without disrupting the price discovery process.

    The proposed rules are specifically intended to provide an

    alternate structure to the one that is currently in place that also

    meets the objectives to deter and prevent manipulation and to ensure

    sufficient market liquidity. In this way, the conditional limit

    exemption provides flexibility for market participants and the

    Commission to meet the objectives outlined in CEA section 4a(a)(3). The

    Commission expects that market participants will respond to the

    flexibility afforded by the proposed exemption in order to fulfill

    their needs in a manner that is consistent with their business

    interests, although it cannot reasonably predict how markets, DCMs and

    market participants will adapt. Accordingly, the Commission requests

    comment on this exemption, its potential impacts on trading strategies,

    competition, and any other direct or indirect costs to markets or

    market participants and exchanges that could arise as a result of the

    conditional spot-month limit exemption.

    c. Section 150.3(d) Pre-Enactment and Transition Period Swaps Exemption

    The pre-existing swaps exemption in proposed Sec. 150.3(d) is

    consistent with CEA section 4a(b)(2). This exemption facilitates the

    transition to full position

    [[Page 75772]]

    limits compliance for previously unregulated swaps markets. Allowing

    netting with post-enactment swaps outside of the spot-month provides

    flexibility where possible in order to lessen the impact of the regime

    on entities that trade swaps.

    d. Section 150.3(e)-(f) Other Exemptions and Previously Granted

    Exemptions

    The proposed amendments to Sec. 150.3(e) and the replacement of

    existing Sec. 1.47 with new proposed Sec. 150.3(f) are essentially

    clarifying and organizational in nature. As such they will confer

    limited substantive benefits beyond providing market participants with

    clarity regarding the process for obtaining non-enumerated exemptive

    relief and promoting regulatory certainty for those granted exemptions

    pursuant to Sec. 1.47.

    e. Section 150.3(g) Recordkeeping

    By requiring that market participants who avail themselves of the

    exemptions offered under Sec. 150.3 maintain certain records to

    document their exemption eligibility and make such records available to

    the Commission on request, the rule reinforces proposed Sec. 150.2 and

    Sec. 150.3 and helps to accomplish, to the maximum extent practicable,

    the goals set out in CEA section 4a(a)(3)(B). Supporting books and

    records are critical to the Commission's ability to effectively monitor

    compliance with exemption eligibility standards each and every time an

    exemption is employed. Absent this ability, exemptions are more

    susceptible to abuse. This susceptibility increases the potential that

    position limits function in a diminished capacity than intended to

    prevent excessive speculation and/or market manipulation.

    f. Request for Comment

    The Commission requests comments on its considerations of the

    benefits associated with the proposed amendments to Sec. 150.3,

    including data or other information to assist the Commission in

    identifying the number and type of market participants that will

    realize, respectively, the benefits identified and/or to monetize such

    benefits. Has the Commission correctly identified market behavior and

    incentives that affect or would likely be affected by the conditional

    spot-month limit exemption? What other potential benefits could the

    conditional spot-month limit exemption have for markets and/or market

    participants? Will the exemptions proposed likely result in any

    benefits, direct or indirect, for markets and/or market participants in

    addition to those that the Commission has identified? If so, what, and

    why and how will they result? Has the Commission misidentified or

    overestimated any benefits likely to result from the proposed

    exemptions? If so, which and/or to what extent?

    iii. Costs

    In general, the exemptions proposed in Sec. 150.3 do not increase

    the costs of complying with position limits, and in fact may decrease

    these costs by providing for relief from speculative limits in certain

    situations. The exemptions are elective, so no entity is required to

    assert an exemption if it determines the costs of doing so do not

    justify the potential benefit resulting from the exemption. Thus, the

    Commission does not anticipate the costs of obtaining any of the

    exemptions to be overly burdensome. Nor does the Commission anticipate

    the costs would be so great as to discourage entities from utilizing

    available exemptions, as applicable.

    Potential costs attendant to the proposed amendments to Sec. 150.3

    are discussed specifically below.

    a. Section 150.3(b) Financial Distress Exemption

    The Commission anticipates the costs associated with the

    codification of the financial distress exemption to be minimal. Market

    participants who voluntarily employ these exemptions will incur costs

    stemming from the requisite filing and recordkeeping obligations that

    attend the exemptions.\788\ Along with performing its due diligence to

    acquire a distressed firm, or positions held or controlled by a

    distressed firm, an entity would have to update and submit to the

    Commission a request for the financial distress exemption. The

    Commission is unable at this time to accurately estimate how often this

    exemption may be invoked, as emergency or distressed market situations

    by nature are unpredictable and dependent on a variety of firm- and

    market-specific idiosyncratic factors as well as general macroeconomic

    indicators. Given the unusual and unpredictable nature of emergency or

    distressed market situations, the Commission anticipates that this

    exemption would be invoked infrequently, but is unable to provide a

    more precise estimate. The Commission also assumes that codifying the

    proposed rule and thus lending a level of transparency to the process

    will result in an administrative burden that is less onerous than the

    current regime. In addition, the Commission believes that in the case

    that one firm is assuming the positions of a financially distressed

    firm, the costs of claiming the exemption would be incidental to the

    costs of assuming the position.

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

    \788\ See supra considerations of costs and benefits of the

    proposed amendments to part 19 and the Paperwork Reduction Act.

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

    b. Section 150.3(c) Conditional Spot-month Limit Exemption

    A market participant that elects to exercise this exemption, one

    that is not available under current rules, will incur certain direct

    costs to do so. A person seeking to utilize this exemption for the

    natural gas market must file Form 504 in accordance with requirements

    listed in proposed Sec. 19.01.\789\ If that person currently has any

    position in the physical-delivery contract, such person may incur costs

    associated with liquidating that position in order to meet the

    conditions of the conditional spot-month limit exemption. As previously

    discussed, the conditional spot month limit is designed to deter market

    manipulation without disrupting the price discovery process. The

    Commission does not have reason to believe that liquidity, in the

    aggregate (across the core referenced and referenced contracts), will

    be adversely impacted. However, the proposed rules are specifically

    intended to provide an alternative to the position limit regime that is

    currently in place for the purpose of deterring and preventing

    manipulation and ensuring sufficient market liquidity; the Commission

    expects that market participants will respond to the flexibility

    afforded by the proposed exemption in order to fulfill their needs in a

    manner that is consistent with their business interests, although it

    cannot reasonably predict how markets, DCMs and market participants

    will adapt. Accordingly, the Commission requests comment on this

    exemption, its potential impacts on trading strategies, competition,

    and any other direct or indirect costs to markets or market

    participants and exchanges that could arise as a result of the

    conditional spot-month limit exemption.

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

    \789\ Specific costs associated with filing Form 504 are

    considered above in the sections that implement that form, namely

    the discussion of the costs and benefits of proposed amendments to

    part 19 and the Paperwork Reduction Act .

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

    c. Section 150.3(d) Pre-Enactment and Transition Period Swaps Exemption

    The exemption offered in proposed Sec. 150.3(d) is self-executing

    and would not require a market participant to file for relief. However,

    a firm may incur costs to identify positions eligible for

    [[Page 75773]]

    the exemption and to determine if that position is to be netted with

    post-enactment swaps for purposes of complying with a non-spot-month

    position limit. Such costs would be assumed voluntarily by a market

    participant in order to avail itself of the exemption, and the

    Commission does not anticipate these costs to be overly burdensome.

    d. Section 150.3(e)-(f) Other Exemptions and Previously Granted

    Exemptions

    Under the proposed Sec. 150.3(e), market participants electing to

    seek an exemption other than those specifically enumerated, will incur

    certain direct costs to do so. First, they will incur costs related to

    petitioning the Commission under Sec. 140.99 of the Commission's

    regulations or under CEA section 4a(a)(7). To the extent these costs

    may be marginally greater than a market participant would experience to

    seek an exemption under the process afforded under current Sec. 1.47--

    something the Commission cannot rule out at this time--the cost

    difference between the two is attributable to this rulemaking.\790\

    Further, market participants who had previously relied upon the

    exemptions granted under Sec. 1.47 would be able to continue to rely

    on such exemptions for existing positions. Going forward, market

    participants would need to enter into a new position that fits within

    applicable limits or are eligible for an alternate exemption, in which

    case the participants may incur costs associated with applying for such

    exemptions. The Commission is unable to ascertain at this time the

    number of participants affected by these proposed regulations. The

    Commission notes, however, that a decision to incur the costs inherent

    in seeking relief is voluntary.

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

    \790\ Alternatively, to the extent petitioning the Commission

    under Sec. 140.99 or under CEA section 4a(a)(7) results in lower

    costs relative to those necessary to utilize the current Sec. 1.47

    process, the cost difference is a benefit attributable to this

    rulemaking. The Commission requests comment concerning whether, and

    to what degree, requiring petitions for exemption under Sec. 140.99

    or under CEA section 4a(a)(7) in place of current Sec. 1.47 is

    likely to result in any material cost difference.

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

    e. Section 150.3(g) Recordkeeping

    Finally, any person that elects to exercise an exemption provided

    in proposed Sec. 150.3 would incur costs attributable to additional

    recordkeeping obligations under proposed Sec. 150.3(e)-(g). The

    Commission preliminarily believes that these costs will be minimal, as

    participants already maintain books and records under a variety of

    other Commission regulations and as the information required in these

    sections is likely already being maintained as part of prudent

    accounting and risk management policies and procedures. The Commission

    preliminarily believes that, as estimated in accordance with the PRA, a

    total of 400 entities will incur an annual labor burden of

    approximately 50 hours each, or 20,000 total hours for all affected

    entities, to comply with the additional recordkeeping obligations.

    Using an estimated hourly wage of $120 per hour,\791\ the Commission

    anticipates an annual burden of approximately $6,000 per entity and a

    total of $2,400,000 for all affected entities.

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

    \791\ The Commission's estimates concerning the wage rates are

    based on 2011 salary information for the securities industry

    compiled by the Securities Industry and Financial Markets

    Association (``SIFMA''). The Commission is using $120 per hour,

    which is derived from a weighted average of salaries across

    different professions from the SIFMA Report on Management &

    Professional Earnings in the Securities Industry 2011, modified to

    account for an 1800-hour work-year, adjusted to account for the

    average rate of inflation in 2012, and multiplied by 1.33 to account

    for benefits and 1.5 to account for overhead and administrative

    expenses. The Commission anticipates that compliance with the

    provisions would require the work of an information technology

    professional; a compliance manager; an accounting professional; and

    an associate general counsel. Thus, the wage rate is a weighted

    national average of salary for professionals with the following

    titles (and their relative weight); ``programmer (senior)'' and

    ``programmer (non-senior)'' (15% weight), ``senior accountant''

    (15%) ``compliance manager'' (30%), and ``assistant/associate

    general counsel'' (40%). All monetary estimates have been rounded to

    the nearest hundred dollars.

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

    f. Request for Comment

    The Commission requests comment on its considerations of the costs

    associated with the proposed changes to Sec. 150.3. Are there other

    costs associated with new exemptions that the Commission should

    consider? With respect to the proposed conditional spot-month limit

    exemption, specifically, the Commission welcomes comments regarding the

    potential cost impact on trading strategies, any other direct or

    indirect costs to markets or market participants that could arise as a

    result of it, and the estimated number of impacted entities.

    iv. Consideration of Alternatives

    The Commission recognizes that alternatives may exist to

    discretionary elements of Sec. 150.3 proposed herein. The Commission

    requests comment on whether an alternative to what is proposed would

    result in a superior benefit-cost profile, with support for any such

    position provided.

    5. Section 150.5--Exchange-Set Speculative Position Limits

    Current Sec. 150.5 addresses the requirements and acceptable

    practices for exchanges in setting speculative position limits or

    position accountability levels for futures and options contracts traded

    on each exchange. As further described above,\792\ the CFMA's

    amendments to the CEA in 2000 gave DCMs discretion to set those limits

    or levels within the statutory requirements of core principle 5.\793\

    With this grant of statutory discretion, Sec. 150.5 became non-binding

    guidance and accepted practice to assist the exchanges in meeting their

    statutory responsibilities under the core principles.\794\

    Subsequently, the Dodd-Frank Act scaled back the discretion afforded

    DCMs for establishing position limits under the earlier CFMA

    amendments. Specifically, among other things, the 2010 law: (1) amended

    core principle 1 to expressly subordinate DCMs' discretion in complying

    with statutory core principles to Commission rules and regulations; and

    (2) amended core principle 5 to additionally require that, with respect

    to contracts subject to a position limit set by the Commission under

    CEA section 4a, a DCM must set limits no higher than those prescribed

    by the Commission.\795\ The Dodd-Frank Act also added parallel core

    principle obligations on newly-authorized SEFs, including SEF core

    principle 6 regarding the establishment of position limits.\796\

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

    \792\ See discussion above.

    \793\ CEA section 5(d)(5) (specifying DCM core principle 5

    titled ``Position Limits or Accountability'').

    \794\ Specifically, in 2001, the Commission adopted in part 38

    app. B (Guidance on, and acceptable Practices in, Compliance with

    Core Principles), 66 FR 42256, 42280, Aug. 10, 2001, an acceptable

    practice for compliance with DCM core principle 5 that stated

    ``[p]rovisions concerning speculative position limits are set forth

    in part 150.'' Current Sec. 150.5 states that each DCM shall

    ``limit the maximum number of contracts a person may hold or

    control, separately or in combination, net long or net sort, for the

    purchase or sale of a commodity for future delivery or, on a

    futures-equivalent basis, options thereon,'' with certain

    exemptions. Exemptions from federal limits include major foreign

    currencies and ``spread, straddles or arbitrage'' exemptions.

    Current Sec. 150.5 expressly excludes bona fide hedging positions

    from limits, but acknowledges that exchanges may limit positions

    ``not in accord with sound commercial practices or exceed an amount

    which may be established and liquidated in an orderly fashion.''

    \795\ Dodd-Frank Act section 735(b). CEA section 4a(e),

    effective prior to, and not amended by, the Dodd-Frank Act, likewise

    provides that position limits fixed by a board of trade not exceed

    federal limits. 7 U.S.C. 6a(e).

    \796\ Dodd-Frank Act section 733 (adding CEA section 5h; 7

    U.S.C. 7b-3).

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

    [[Page 75774]]

    i. Rule Summary

    In light of these Dodd-Frank Act statutory amendments, the

    Commission proposes to amend Sec. 150.5 to specify certain binding

    requirements with which DCMs and SEFs must comply in establishing

    exchange-set limits. \797\ Specifically, proposed Sec. 150.5(a)(1)

    would require that DCMs and SEFs set limits for contracts listed in

    Sec. 150.2(d) at a level not higher than the levels specified in Sec.

    150.2. Proposed Sec. 150.5(a)(5) and (b)(8) would require that

    exchanges adopt aggregation rules that conform to proposed Sec. 150.4

    for all contracts, including those contracts subject to federal

    speculative limits. Proposed Sec. 150.5(a)(2)(i) and (b)(5)(i) would

    require that exchanges conform their bona fide hedging exemption rules

    to the proposed Sec. 150.1 definition of bona fide hedging for all

    contracts, including those contracts subject to federal speculative

    limits. Proposed Sec. 150.5(a)(2)(iii) and (b)(5)(iii) would require

    that exchanges condition any exemptive relief from federal or exchange-

    set position limits on an application from the trader.\798\ To the

    extent an exchange offers exemptive relief for intra- and inter-market

    spread positions for contracts subject to federal limits under proposed

    Sec. 150.2, proposed Sec. 150.5(a)(2)(i) and (ii) would require that

    the exchange provide such relief only outside of the spot month for

    physical-delivery contracts and, with respect to intra-market spread

    positions, on the condition that such positions do not exceed the all-

    months limit. Finally, proposed Sec. 150.5(a)(4) would further

    implement the statutory provision in CEA section 4a(b)(2) that exempts

    pre-existing positions, while Sec. 150.5(a)(3) would require exchanges

    to mirror the Commission's exemption in proposed Sec. 150.3 for pre-

    enactment and transition period swaps from exchange-set limits on

    contracts subject to limits under proposed Sec. 150.2. Proposed Sec.

    150.5(a)(3) would also require exchanges to allow the netting of pre-

    enactment and transition swaps with post-effective date commodity

    derivative contracts for the purpose of complying with any non-spot-

    month position limit.

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

    \797\ As discussed above, proposed Sec. 150.5 also would

    continue to incorporate non-exclusive guidance and acceptable

    practices for DCMs and SEFs with respect to setting limits with and

    without a measurable deliverable supply, adopting position

    accountability in lieu of a position limits scheme, and adjusting

    limit levels, among other things. As non-binding guidance and

    acceptable practices, these components of the rulemaking are not

    binding Commission regulations or orders subject to the requirement

    of CEA section 15(a).

    \798\ The Commission notes that for contracts subject to federal

    limits, exchange-granted exemptions would need to conform with the

    standards in proposed Sec. 150.5(a)(2)(i) for hedge exemptions and

    proposed Sec. 150.5(a)(2)(ii) for other exemptions.

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

    Two of these proposed requirements--i.e., that for contracts

    subject to limits specified in Sec. 150.2, DCMs and SEFs set limits no

    higher than those specified in Sec. 150.2, and that pre-existing

    positions must be exempted from exchange-set limits on contracts

    subject to Sec. 150.2--exclusively codify statutory requirements, and

    therefore reflect no exercise of Commission discretion subject to CEA

    section 15(a). The other-listed requirements, however, do involve

    Commission discretion, the costs and benefits of which are considered

    below.

    ii. Benefits

    Functioning as an integrated component within the broader position-

    limits regulatory regime, the Commission expects the proposed changes

    to Sec. 150.5 would further the four objectives outlined in CEA

    section 4a(a)(3).\799\ As explained more fully below, the Commission

    believes these proposed amendments offer significant benefits.

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

    \799\ CEA section 4a(a)(3)(B) applies for purposes of setting

    federal limit levels. 7 U.S.C. 6a(a)(3)(B). The Commission considers

    the four factors set out in the section relevant for purposes of

    considering the benefits and costs of these proposed amendments

    addressed to exchange-set position limits as well.

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

    a. Section 150.5(a)(5) and (b)(8) Aggregation

    CEA section 4a(a)(1) states that the Commission, ``[in] determining

    whether any person has exceeded such limits,'' must include ``the

    positions held and trading done by any persons directly or indirectly

    controlled'' by such person. Pursuant to this statutory direction, the

    Commission has proposed in a separate release amendments to its

    aggregation policy, located in Sec. 150.4.\800\ The regulations

    proposed in this release require that exchange-set limits employ

    aggregation policies that conform to the Commission's aggregation

    policy both for contracts that are subject to federal limits under

    Sec. 150.2 and those that are not, thus harmonizing aggregation rules

    for all federal and exchange-set speculative position limits.

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

    \800\ See Aggregation NPRM.

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

    For contracts subject to federal speculative position limits under

    proposed Sec. 150.2, the Commission anticipates that a harmonized

    approach to aggregation will prevent confusion that otherwise might

    result from allowing divergent standards between federal and exchange-

    set limits on the same contracts. Further, the proposed approach would

    prevent the kind of regulatory arbitrage that may impede the benefits

    of the federal speculative position limits regime. The harmonized

    approach to aggregation policies for limits on all levels eliminates

    the potential for exchanges to use permissiveness in aggregation

    policies as a competitive advantage and therefore prevents a ``race to

    the bottom,'' which would impair the effectiveness of the Commission's

    aggregation policy. In addition, DCMs and SEFs are required to set

    position limits at a level not higher than that set by the Commission.

    Differing aggregation standards may have the practical effect of

    lowering a DCM- or SEF-set limit to a level that is lower than that set

    by the Commission. Accordingly, harmonizing aggregation standards

    reinforces the efficacy and intended purpose of Sec. Sec.

    150.5(a)(2)(iii) and (b)(5)(iii) by foreclosing an avenue to circumvent

    applicable limits.

    Moreover, by extending this harmonized approach to contracts not

    included in proposed Sec. 150.2, the Commission is proposing a common

    standard for all federal and exchange-set limits. The proposed rule

    provides uniformity, consistency, and certainty for traders who are

    active on multiple trading venues, and thus should reduce the

    administrative burden on traders as well as the burden on the

    Commission in monitoring the markets under its jurisdiction.

    b. Section 150.5(a)(2)(i) and (b)(5)(i) Hedge Exemptions

    The proposed rules also promote a common standard for bona fide

    hedging exemptions by requiring such exemptions granted by an exchange

    to conform with the proposed definition of bona fide hedging in Sec.

    150.1. For contracts subject to federal limits under proposed Sec.

    150.2, the proposed rules under Sec. 150.5(a)(2)(i) prescribe a

    harmonized approach intended to prevent the confusion that may arise

    should the same contract have differing standards of bona fide hedging

    between the Commission's federal standard and the standard on any given

    exchange. As discussed above, the definition of bona fide hedging

    proposed by the Commission in this release allows only positions that

    represent legitimate commercial risk to be exempt from position limits.

    Deviation from this definition could impede the effectiveness of the

    Commission's position limit regime by potentially allowing positions to

    be improperly exempted from speculative limits.

    Proposed Sec. 150.5(b)(5)(i) would extend this common standard of

    bona fide hedging to contracts not subject to

    [[Page 75775]]

    federal speculative limits, thereby creating a single standard across

    all trading venues that would reduce the administrative burden on

    market participants trading on multiple trading venues and the burden

    on the Commission of monitoring the markets under its jurisdiction.

    c. Section 150.5(a)(2)(iii) and (b)(5)(iii) Application for Exemption

    Proposed Sec. 150.5 requires traders to apply to the exchange for

    any exemption from position limits. Requiring traders to apply to the

    exchange affirms the position of the DCM or SEF as the front-line

    regulator for position limits while providing the exchanges with

    information that can be used to ensure the legitimacy of a trader's

    position with regards to its eligibility for exemptive relief. By

    gathering information from traders' applications for exemption,

    exchanges will have a complete record of all exemptions requested,

    granted, and denied, as well as information about the commercial

    operations of traders who apply for exemptions. Because the Commission

    has not specified a format for such exemption applications, exchanges

    have flexibility to determine which information will best inform the

    exchange's self-regulatory operations and obligations.

    The Commission understands that many DCMs are already requiring

    applications for exemptive relief from speculative position

    limits,\801\ and that SEFs are likely to adopt this practice as a

    ``best practice'' for complying with core principles. As such, the

    proposed rules codify an industry ``best practice'' regarding position

    limits and promote the continuation of the benefits of that best

    practice across all trading venues and all commodity derivative

    contracts.

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

    \801\ See, e.g., CME Rule 559; NYMEX Rule 559; CBOT Rule 559;

    KCBT Rule 559; ICE Futures Rules 6.26, 6.27, and 6.29; and MGEX Rule

    1504.00.

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

    d. Section 150.5(a)(2)(ii) Other Exemptions

    As discussed above, the Commission is proposing to set single-month

    limits at the same levels as all-months limits, rendering the

    ``spread'' exemption in current Sec. 150.3 unnecessary. However, since

    DCM core principle 5 allows exchanges to set more restrictive levels

    than those set by the Commission, a DCM or SEF may set the single month

    limit at a lower level than that of the all-month limit. Further,

    because federal limits apply across trading venues, exchanges may grant

    spread exemptions for inter-market spreads across exchanges. As such,

    the Commission is proposing Sec. 150.5(a)(2)(ii) to clarify the types

    of spread positions for which a DCM or SEF may grant exemptions by

    cross-referencing the definitions proposed in Sec. 150.1 \802\ and to

    require that any such exemption be outside of the spot month for

    physical-delivery contracts.

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

    \802\ The terms ``inter-market spread'' and ``intra-market

    spread'' are defined in proposed Sec. 150.1.

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

    This exemption would provide exchanges with certainty regarding the

    application of spread exemptions for contracts subject to federal

    limits under proposed Sec. 150.2. Should an exchange decide to provide

    exemptive relief for spread positions, the exemption described in Sec.

    150.5(a)(2)(ii) promotes the intended goals of federal speculative

    limits, including protection of the spot period in the physical-

    delivery contract and exemption of positions as appropriate.

    e. Section 150.5(a)(3) Pre-Enactment and Transition Period Swaps

    Positions

    Proposed Sec. 150.5(a)(3) requires DCMs and SEFs to exempt pre-

    enactment and transition period swaps as defined in proposed Sec.

    150.1 from exchange-set limits on contracts subject to federal limits

    under proposed Sec. 150.2. This provision mirrors the exemption

    proposed in Sec. 150.3 and requires that exchanges provide the same

    relief as the Commission for pre-existing swaps positions.

    Further, requiring that DCMs and SEFs allow netting of pre-and-post

    enactment swaps outside of the spot month provides additional

    flexibility on an exchange level for market participants in

    transitioning to a position limits regime that includes swaps.

    f. Request for Comment

    The Commission requests comment on its consideration of the

    benefits of proposed Sec. 150.5. Are there additional benefits that

    the Commission should consider? Has the Commission misidentified any

    benefits?

    iii. Costs

    DCMs presently have considerable experience in setting and

    administering speculative position limits and hedge exemption programs

    in line with existing Commission guidance and acceptable practices that

    run parallel in most respects to the requirements that are incorporated

    in the proposed rule. Accordingly, as a general matter, the Commission

    anticipates minimal cost impact on DCMs from these proposed

    requirements; relative to DCMs, the cost impact for SEFs as newly-

    instituted entities may be somewhat greater.

    The Commission notes that recently adopted Sec. 37.204 of the

    Commission's regulations allows SEFs the flexibility to contract with a

    third-party regulatory service provider \803\ to fulfill certain

    regulatory obligations.\804\ The administration of position limits is

    within the range of obligations eligible for outsourcing to a third-

    party regulatory service provider. Presumably, a SEF will avail itself

    of this flexibility if doing so results in lower costs for the entity.

    In order to better inform itself with respect to the cost implications

    of this proposed rule for SEFs, the Commission requests comment on the

    likelihood of SEFs utilizing a third-party regulatory service provider

    to comply with its position limits obligations and the expected dollar

    costs of doing so. The Commission also requests comment on the expected

    dollar costs of meeting the proposed rule's requirement if a SEF

    undertakes to perform the proposed rule's obligations in-house rather

    than outsourcing them.

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

    \803\ Under Sec. 37.204, possible third-party regulatory

    service providers include registered futures associations (such as

    the National Futures Association (NFA)), registered entities (such

    as DCMs or SEFs), and the Financial Industry Regulatory Authority

    (FINRA).

    \804\ See 78 FR 33476, 33516, Jun. 4, 2013.

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

    The following discusses potential costs with respect to the

    specific discretionary aspects of the rule to which they are

    attributable.

    a. Section 150.5(a)(5) and (b)(8) Aggregation and Sec. 150.5(a)(2)(i)

    and (b)(5)(i) Hedge Exemptions

    DCMs may incur costs to amend their current aggregation and bona

    fide hedging policies to conform with proposed Sec. 150.4 and proposed

    Sec. 150.1 respectively. Such costs may include burdens associated

    with reviewing and evaluating current standards to assess differences

    that must be addressed, employing legal counsel to aid in ensuring

    conformity, and transitioning from an old standard to the new one.

    Because the burden associated with this rule is proportional to the

    divergence of a DCM's current standard from the Commission's proposed

    standard, costs are specific and proprietary to each affected entity;

    as such, the Commission is unable to estimate costs at this time within

    a range of reasonable accuracy. It requests comment to assist it in

    doing so.

    SEFs, as newly-instituted entities, will be required to incur costs

    to develop aggregation and bona fide hedging policies that conform to

    the appropriate provisions as required

    [[Page 75776]]

    under proposed Sec. 150.5. Such costs are likely to include legal

    counsel, as well as drafting and implementation of the new policy.

    Because these entities are new and have not previously been subject to

    the Commission's oversight in this capacity, the Commission requests

    comment regarding the costs associated with implementing the

    appropriate policies.

    b. Section 150.5(a)(2)(iii) and (b)(5)(iii) Application for Exemption

    The Commission anticipates that DCMs will incur minimal costs to

    administer the application process for exemption relief in accordance

    with standards set forth in the proposed rule. As described above, the

    Commission understands that requiring traders to apply for exemptive

    relief comports with existing DCM practice. Accordingly, by

    incorporating an application requirement that the Commission has reason

    to understand most if not all active DCMs already follow, the rule

    should have little cost impact for DCMs.

    For SEFs, the rules necessitate a compliant application regime,

    which will require an initial investment similar to that which DCMs

    have likely already made and need not duplicate. As noted above, the

    Commission considers it highly likely that, in accordance with industry

    best practices to comply with core principles and due to the utility of

    application information in demonstrating compliance with core

    principles, SEFs may incur such costs with or without the proposed

    rules. Again, due to the new existence of these entities, the

    Commission is unable to estimate what costs may be associated with the

    requirement to impose an application regime for exemptive relief on the

    exchange level. The Commission requests comment regarding the burden on

    a SEF to impose a compliant application regime.

    c. Section 150.5(a)(2)(ii) Other Exemptions

    Proposed Sec. 150.5(a)(2)(ii) provides clarity on the imposition

    of exemptions for spread positions on contracts subject to federal

    limits under proposed Sec. 150.2 in accordance with new definitions

    proposed in Sec. 150.1. The Commission notes again that the rules

    would apply if the single-month limit is at a lower level than the all-

    month limit, which would occur if a DCM or SEF determines to set more

    restrictive levels for a single-month limit that what has been set by

    the Commission, or if the exchange grants inter-market spread

    exemptions. Thus, the Commission anticipates that a DCM or SEF that has

    determined to set a more restrictive limit will have done so having

    taken into account any burden imposed by the proposed rule. Further,

    some trading venues already grant inter-market spread exemptions on

    certain commodities; such entities may be able to leverage current

    practices to extend such spread exemptions to other commodities as

    appropriate.

    The Commission expects small costs to be associated with

    communicating and monitoring the appropriate conditions for exemption

    as described in proposed Sec. 150.5(a)(2)(ii), namely that such

    position must be solely outside of the spot-month of the physical-

    delivery contract.

    d. Request for Comment

    The Commission requests comment on its considerations of the costs

    of proposed Sec. 150.5. Are there additional costs that the Commission

    should consider? Has the Commission misidentified any costs? What other

    relevant cost information or data, including alternative cost

    estimates, should the Commission consider and why?

    iv. Consideration of Alternatives

    The Commission recognizes that alternatives may exist to

    discretionary elements of Sec. 150.5 proposed herein. The Commission

    requests comment on whether an alternative to what is proposed would

    result in a superior benefit-cost profile, with support for any such

    position provided.

    6. Section 150.7--Reporting Requirements for Anticipatory Hedging

    Positions

    The revised definition of bona fide hedging in proposed Sec. 150.1

    incorporates hedges of five specific types of anticipated transactions:

    unfilled anticipated requirements, unsold anticipated production,

    anticipated royalties, anticipated services contract payments or

    receipts, and anticipatory cross-hedges.\805\ The Commission proposes

    reporting requirements in new Sec. 150.7 for traders seeking an

    exemption from position limits for any of these five enumerated

    anticipated hedging transactions. Proposed Sec. 150.7 would build on,

    and replace, the special reporting requirements for hedging of unsold

    anticipated production and unfilled anticipated requirements in current

    Sec. 1.48.\806\

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

    \805\ See, paragraphs (3)(iii), (4)(i), (iii), and (iv), and

    (5), respectively, of the Commission's amended definition of bona

    fide hedging transactions in proposed Sec. 150.1.

    \806\ See 17 CFR 1.48. See also definition of bona fide hedging

    transactions in current 17 CFR 1.3(z)(2)(i)(B) and (ii)(C),

    respectively.

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

    Current Sec. 1.48 provides a procedure for persons to file for

    bona fide hedging exemptions for anticipated production or unfilled

    requirements when that person has not covered the anticipatory need

    with fixed-price commitments to sell a commodity, or inventory or

    fixed-price commitments to purchase a commodity. It reflects a long-

    standing Commission concern for the difficulty of distinguishing

    between reduction of risk arising from anticipatory needs and that

    arising from speculation if anticipatory transactions are not well

    defined.\807\ These same concerns apply to any position undertaken to

    reduce the risk of anticipated transactions. To address them, the

    Commission proposes to extend the special reporting requirements in

    proposed Sec. 150.7 for all types of enumerated anticipatory hedges

    that appear in the definition of bona fide hedging positions in

    proposed Sec. 150.1.\808\

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

    \807\ See Hedging Anticipated Requirements for Processing or

    Manufacturing under Section 4a(3) of the Commodity Exchange Act, 21

    FR 6913, Sep. 12, 1956.

    \808\ For purposes of simplicity, the proposed special reporting

    requirements for anticipatory hedges would be placed within the

    Commission's position limits regime in part 150, and alongside the

    Commission's updated definition of bona fide hedging positions in

    proposed Sec. 150.1; rendered duplicative by these changes, current

    Sec. 1.48 would be deleted. In another non-substantive change,

    proposed Sec. 150.7(i) would replace current Sec. 140.97 which

    delegates to the Director of the Division of Market Oversight or his

    designee authority regarding requests for classification of

    positions as bona fide hedging under current Sec. Sec. 1.47 and

    1.48. For purposes of simplicity, this delegation of authority would

    be placed within the Commission's position limits regime in part

    150.

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

    The Commission proposes to add a new series '04 reporting form,

    Form 704, to effectuate these additional and updated reporting

    requirements for anticipatory hedges. Persons wishing to avail

    themselves of an exemption for any of the anticipatory hedging

    transactions enumerated in the updated definition of bona fide hedging

    in proposed Sec. 150.1 would be required to file an initial statement

    on Form 704 with the Commission at least ten days in advance of the

    date that such positions would be in excess of limits established in

    proposed Sec. 150.2.

    Proposed Sec. 150.7(f) would add a requirement for any person who

    files an initial statement on Form 704 to provide annual updates that

    detail the person's actual cash market activities related to the

    anticipated exemption. Proposed Sec. 150.7(g) would similarly enable

    the Commission to review and compare the

    [[Page 75777]]

    actual cash activities and the remaining unused anticipated hedge

    transactions by requiring monthly reporting on Form 204.

    As is the case under current Sec. 1.48, proposed Sec. 150.7(h)

    requires that a trader's maximum sales and purchases must not exceed

    the lesser of the approved exemption amount or the trader's current

    actual anticipated transaction.

    i. Benefits and Costs

    As noted above, the Commission remains concerned that

    distinguishing whether an over-the-limit position is entered into in

    order to reduce risk arising from anticipatory needs, or whether it is

    speculative, may be exceedingly difficult if anticipatory transactions

    are not well defined. The Commission proposes to add, in its

    discretion, proposed Sec. 150.7 to collect vital information to aid in

    this distinction. Advance notice of a trader's intended maximum

    position in commodity derivative contracts to offset anticipatory risks

    would identify--in advance--a position as a bona fide hedging position,

    avoiding unnecessary contact during the trading day with surveillance

    staff to verify whether a hedge exemption application is in process,

    the appropriate level for the exemption and whether the exemption is

    being used in a manner that is consistent with the requirements. Market

    participants can anticipate hedging needs well in advance of assuming

    positions in derivatives markets and in many cases need to supply the

    same information after the fact; in such cases, providing the

    information in advance allows the Commission to better direct its

    efforts towards deterring and detecting manipulation. The annual

    updates in proposed Sec. 150.7(f) similarly allow the Commission to

    verify on an ongoing basis that the person's anticipated cash market

    transactions closely track that person's real cash market activities.

    Absent monthly filing pursuant to proposed Sec. 150.7(g), the

    Commission would need to issue a special call to determine why a

    person's commodity derivative contract position is, for example, larger

    than the pro rata balance of her annually reported anticipated

    production.

    The Commission understands that there will be costs associated with

    proposed Sec. 150.7(f) in the filing of Form 704. Costs of filing that

    form are discussed in the context of the proposed part 19 requirements.

    The Commission requests comments on its consideration of the costs

    and benefits of proposed Sec. 150.7. Are there additional costs or

    benefits the Commission should consider? What costs may be incurred

    beyond those incurred to gather information and file Form 704? Should

    the Commission consider alternatives to its annual updating

    requirement? The Commission also recognizes that alternatives may exist

    to discretionary elements of Sec. 150.7 proposed herein. The

    Commission requests comments on whether an alternative to what is

    proposed would result in a superior benefit-cost profile, with support

    for any such position provided.

    7. Part 19--Reports

    CEA Section 4i authorizes the Commission to require the filing of

    reports, as described in CEA section 4g, when positions equal or exceed

    position limits. Current part 19 of the Commission's regulations sets

    forth these reporting requirements for persons holding or controlling

    reportable futures and option positions that constitute bona fide hedge

    positions as defined in Sec. 1.3(z) and in markets with federal

    speculative position limits--namely those for grains, the soy complex,

    and cotton. Since having a bona fide hedge exemption affords a

    commercial market participant the opportunity to hold positions that

    exceed a position limit level, it is important for the Commission to be

    able to verify that when an exemption is invoked that it is done so for

    legitimate purposes. As such, commercial entities that hold positions

    in excess of those limits must file information on a monthly basis

    pertaining to owned stocks and purchase and sales commitments for

    entities that claim a bona fide hedging exemption.

    In order to help ensure that the additional exemptions described in

    proposed Sec. 150.3 are used in accordance with the requirements of

    the exemption employed, as well as obtain information necessary to

    verify that any futures, options and swaps positions established in

    referenced contracts are justified, the Commission proposes to make

    conforming and substantive amendments to part 19. First, the Commission

    proposes to amend part 19 by adding new and modified cross-references

    to proposed part 150, including the new definition of bona fide hedging

    position in proposed Sec. 150.1.\809\ Second, the Commission proposes

    to amend Sec. 19.00(a) by extending reporting requirements to any

    person claiming any exemption from federal position limits pursuant to

    proposed Sec. 150.3. The Commission proposes to add three new series

    '04 reporting forms to effectuate these additional reporting

    requirements. Third, the Commission proposes to update the manner of

    part 19 reporting. Lastly, the Commission proposes to update both the

    type of data that would be required in series '04 reports, as well as

    the time allotted for filing such reports.

    ---------------------------------------------------------------------------

    \809\ These amendments are non-substantive conforming amendments

    and should not have implications for the Commission's consideration

    of costs and benefits.

    ---------------------------------------------------------------------------

    i. Rule Summary

    a. Extension of Reporting Requirements

    Proposed part 19 will be expanded to include reporting requirements

    for positions in swaps, in addition to futures and options positions,

    for any instance in which a person relies on an exemption. Therefore,

    positions in ``commodity derivative contracts,'' as defined in proposed

    Sec. 150.1, would replace ``futures and option positions'' throughout

    amended part 19 as shorthand for any futures, option, or swap contract

    in a commodity (other than a security futures product as defined in CEA

    section 1a(45)).\810\

    ---------------------------------------------------------------------------

    \810\ See supra discussion of proposed amendments to part 19.

    ---------------------------------------------------------------------------

    The Commission also proposes to extend the reach of part 19 by

    requiring all persons who avail themselves of any exemption from

    federal position limits under proposed Sec. 150.3 to file applicable

    series '04 reports.\811\ The list of positions set forth in proposed

    Sec. 150.3 that are eligible for exemption from the federal position

    includes, but is not limited to, bona fide hedging positions (including

    pass-through swaps and anticipatory bona fide hedge positions),

    qualifying spot month positions in cash-settled referenced contracts,

    and qualifying non-enumerated risk-reducing transactions.

    ---------------------------------------------------------------------------

    \811\ Furthermore, anyone exceeding the federal limits who has

    received a special call must file a series '04 form.

    ---------------------------------------------------------------------------

    The Commission currently requires two monthly reports, CFTC Forms

    204 and 304, which are listed in current Sec. 15.02.\812\ The reports,

    collectively referred to as the Commission's ``series '04 reports,''

    show a trader's positions in the cash market and are used by the

    Commission to determine whether a trader has sufficient cash positions

    that justify futures and option positions above the speculative limits.

    CFTC Form 204 is the Statement of Cash Positions in Grains, which

    includes the soy complex, and CFTC Form 304 Report is the Statement of

    Cash

    [[Page 75778]]

    Positions in Cotton.\813\ The Commission proposes to add three new

    series '04 reporting forms to effectuate the expanded reporting

    requirements of part 19. Proposed CFTC Form 504, Statement of Cash

    Positions for Conditional Spot Month Exemptions, would be added for use

    by persons claiming the conditional spot month limit exemption pursuant

    to proposed Sec. 150.3(c). Proposed CFTC Form 604, Statement of

    Counterparty Data for Pass-Through Swap Exemptions, would be added for

    use by persons claiming a bona fide hedge exemption for either of two

    specific pass-through swap position types, as discussed further below.

    Proposed CFTC Form 704, Statement of Anticipatory Bona Fide Hedge

    Exemptions, would be added for use by persons claiming a bona fide

    hedge exemption for certain anticipatory bona fide hedging positions.

    ---------------------------------------------------------------------------

    \812\ 17 CFR 15.02.

    \813\ See supra discussion of series '04 forms.

    ---------------------------------------------------------------------------

    b. Manner of Reporting

    For purposes of reporting cash market positions under current part

    19, the Commission historically has allowed a reporting trader to

    ``exclude certain products or byproducts in determining his cash

    positions for bona fide hedging'' if it is ``the regular business

    practice of the reporting trader'' to do so.\814\ Nevertheless, the

    Commission believes that an entity, when calculating the value that is

    subject to risks from a source commodity in order to establish a long

    derivatives position as a hedge for unfilled anticipated requirements,

    need take into account large quantities of a source commodity that it

    may hold in inventory. Under proposed Sec. 19.00(b)(1), a source

    commodity itself can only be excluded from a calculation of a cash

    position if the amount is de minimis, impractical to account for, and/

    or on the opposite side of the market from the market participant's

    hedging position.\815\

    ---------------------------------------------------------------------------

    \814\ See 17 CFR 19.00(b)(1) (providing that ``[i]f the regular

    business practice of the reporting trader is to exclude certain

    products or byproducts in determining his cash position for bona

    fide hedging . . . , the same shall be excluded in the report'').

    \815\ Proposed Sec. 19.00(b)(1) adds a caveat to the

    alternative manner of reporting: when reporting for the cash

    commodity of soybeans, soybean oil, or soybean meal, the reporting

    person shall show the cash positions of soybeans, soybean oil and

    soybean meal. This proposed provision for the soybean complex is

    included in the current instructions for preparing Form 204.

    ---------------------------------------------------------------------------

    Persons who wish to avail themselves of cross-commodity hedges are

    required to file an appropriate series '04 form. Proposed Sec.

    19.00(b)(2) sets forth instructions, which are consistent with the

    provisions in the current section, for reporting a cash position in a

    commodity that is different from the commodity underlying the futures

    contract used for hedging.\816\ Since proposed Sec. 19.00(b)(3) would

    maintain the requirement that cross-hedged positions be shown both in

    terms of the equivalent amount of the commodity underlying the

    commodity derivative contract used for hedging and in terms of the

    actual cash commodity (as provided for on the appropriate series '04

    form), the Commission will be able to determine the hedge ratio used

    merely by comparing the reported positions. Thus, the Commission will

    be positioned to review whether a hedge ratio appears reasonable in

    comparison to, for example, other similarly situated traders.

    ---------------------------------------------------------------------------

    \816\ Proposed Sec. 19.00(b)(2) would add the term commodity

    derivative contracts (as defined in proposed Sec. 150.1). The

    proposed definition of cross-commodity hedge in proposed Sec. 150.1

    is discussed above.

    ---------------------------------------------------------------------------

    Proposed Sec. 19.00(b)(3) maintains the requirement that standards

    and conversion factors used in computing cash positions for reporting

    purposes must be made available to the Commission upon request.

    Proposed Sec. 19.00(b)(3) would clarify that such information would

    include hedge ratios used to convert the actual cash commodity to the

    equivalent amount of the commodity underlying the commodity derivative

    contract used for hedging, and an explanation of the methodology used

    for determining the hedge ratio.

    c. Bona Fide Hedgers and Cotton Merchants and Dealers

    Current Sec. 19.01(a) sets forth the data that must be provided by

    bona fide hedgers (on Form 204) and by merchants and dealers in cotton

    (on Form 304). The Commission proposes to continue using Forms 204 and

    304, with minor changes to the types of data to be reported.\817\ Form

    204 will be expanded to incorporate, in addition to all other positions

    reportable under proposed Sec. 19.00(a)(1)(iii), monthly reporting for

    cotton, including the granularity of equity, certificated and non-

    certificated cotton stocks of cotton. Weekly reporting for cotton will

    be retained as a separate report made on Form 304 for the collection of

    data required by the Commission to publish its weekly public cotton

    ``on call'' report on www.cftc.gov.

    ---------------------------------------------------------------------------

    \817\ The list of data required for persons filing on Forms 204

    and 304 would be relocated from current Sec. 19.01(a) to proposed

    Sec. 19.01(a)(3).

    ---------------------------------------------------------------------------

    Proposed Sec. 19.01(b) would maintain the requirement that reports

    on Form 204 be submitted to the Commission on a monthly basis, as of

    the close of business on the last Friday of the month.

    d. Conditional Spot-Month Limit Exemption

    Proposed Sec. 19.01(a)(1) would require persons availing

    themselves of the conditional spot month limit exemption for natural

    gas (pursuant to proposed Sec. 150.3(c)) to report certain detailed

    information concerning their cash market activities. While traders

    could not directly influence the settlement price in the physical-

    delivery referenced contract due to the prohibition of holding

    physical-delivery contract positions when invoking the conditional spot

    month exemption, there is no similar restriction on holding the

    underlying cash commodity. While the Commission is concerned about

    traders' activities in the underlying cash market of any derivative

    contract, it is particularly concerned with respect to natural gas

    where there is an existing conditional spot-month limit exemption.

    Accordingly, proposed Sec. 19.01(b) would require that persons

    claiming a conditional spot month limit exemption must report on new

    Form 504 daily, by 9 a.m. Eastern Time on the next business day, for

    each day that a person is over the spot month limit in certain

    commodity contracts specified by the Commission. The scope of

    reporting--purchase and sales contracts through the delivery area for

    the core referenced futures contract and inventory in the delivery

    area--differs from the scope of reporting for bona fide hedgers, since

    the person relying on the conditional spot month limit exemption need

    not be hedging a position.

    Initially, the Commission would require reporting on new Form 504

    for exemptions in the natural gas commodity derivative contracts

    only.\818\ The Commission requests comment as to whether the costs and

    benefits of the enhanced reporting regime support imposing this

    requirement on additional commodity markets before gaining

    [[Page 75779]]

    additional experience with this exemption in other commodities.

    ---------------------------------------------------------------------------

    \818\ The Commission believes that enhanced reporting for

    natural gas contracts is warranted based on its experience in

    surveillance of natural gas commodity derivative contracts. Absent

    experiential evidence of current need beyond the natural gas realm,

    the Commission proposes to initially not impose reporting

    requirements for persons claiming conditional spot month limit

    exemptions in other commodity derivative contracts until the

    Commission gains additional experience with the limits in proposed

    Sec. 150.2. However, the Commission retains its authority to issue

    ``special calls'' under Sec. 18.05. The Commission will closely

    monitor the reporting associated with conditional spot-month limit

    exemptions in natural gas, as well as other information available to

    the Commission for other commodities, and may require reporting on

    Form 504 for other commodity derivative contracts in the future.

    ---------------------------------------------------------------------------

    e. Pass-Through Swap Exemption

    Under the definition of bona fide hedging position in proposed

    Sec. 150.1, 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.\819\ As such, positions

    in commodity derivative contracts that reduce the risk of pass-through

    swaps would qualify as bona fide hedging transactions.

    ---------------------------------------------------------------------------

    \819\ See supra discussion of definition of bona fide hedging

    position in proposed Sec. 150.1.

    ---------------------------------------------------------------------------

    Proposed Sec. 19.01(a)(2) would require a person relying on the

    pass-through swap exemption who holds either of two position types to

    file a report with the Commission on new form 604. The first type of

    position is a swap executed opposite a bona fide hedger that is not a

    referenced contract and for which the risk is offset with referenced

    contracts. The second type of position is a cash-settled swap executed

    opposite a bona fide hedger that is offset with physical-delivery

    referenced contracts held into a spot month, or, vice versa, a

    physical-delivery swap executed opposite a bona fide hedger that is

    offset with cash-settled referenced contracts held into a spot month.

    The information reported on Form 604 would explain hedgers' needs

    for large referenced contract positions and would give the Commission

    the ability to verify that the positions were a bona fide hedge, with

    heightened daily surveillance of spot month offsets. Persons holding

    any type of pass-through swap position other than the two described

    above would report on form 204.\820\

    ---------------------------------------------------------------------------

    \820\ Persons holding pass-through swap positions that are

    offset with referenced contracts outside the spot month (whether

    such contracts are for physical delivery or are cash-settled) need

    not report on Form 604 because swap positions will be netted with

    referenced contract positions outside the spot month pursuant to

    proposed Sec. 150.2(b).

    ---------------------------------------------------------------------------

    f. Swap Off-Sets

    Proposed Sec. 19.01(a)(2)(i) lists the types of data that a person

    who executes a pass-through swap that is not a referenced contract and

    for which the risk is offset with referenced contracts must report on

    new Form 604. Under proposed Sec. 19.01(b), persons holding non-

    referenced contract swap offset would submit reports to the Commission

    on a monthly basis, as of the close of business of the last Friday of

    the month. This data collection would permit staff to identify offsets

    of non-referenced-contract pass-through swaps on an ongoing basis for

    further analysis.

    Under proposed Sec. 150.2(a), a trader in the spot month may not

    net across physical-delivery and cash-settled contracts for the purpose

    of complying with federal position limits.\821\ If a person executes a

    cash-settled pass-through swap that is offset with physical-delivery

    contracts held into a spot month (or vice versa), then, pursuant to

    proposed Sec. 19.01(a)(2)(ii), that person must report additional

    information concerning the swap and offsetting referenced contract

    position on new Form 604. Pursuant to proposed Sec. 19.01(b), a person

    holding a spot month swap offset would need to file on form 604 as of

    the close of business on each day during a spot month, and not later

    than 9 a.m. Eastern Time on the next business day following the date of

    the report. The Commission notes that pass-through swap offsets would

    not be permitted during the lesser of the last five days of trading or

    the time period for the spot month. However, the Commission remains

    concerned that a trader could hold an extraordinarily large position

    early in the spot month in the physical-delivery contract along with an

    offsetting short position in a cash-settled contract. Hence, the

    Commission proposes to introduce this new daily reporting requirement

    within the spot month to identify and monitor such offsetting

    positions.

    ---------------------------------------------------------------------------

    \821\ See supra discussion of proposed Sec. 150.2.

    ---------------------------------------------------------------------------

    ii. Benefits

    The reporting requirements allow the Commission to obtain the

    information necessary to verify whether the relevant exemption

    requirements are fulfilled in a timely manner. This is needed for the

    Commission to help ensure that any person who claims any exemption from

    federal speculative position limits can demonstrate a legitimate

    purpose for doing so. In the absence of the reporting requirements

    detailed in proposed part 19, the Commission would lack critical tools

    to identify abuses related to the exemptions afforded in proposed Sec.

    150.3 in a timely manner and refer them to enforcement. As such, the

    reporting requirements are necessary for the Commission to be able to

    perform its essential surveillance functions. These reporting

    requirements therefore promote the Commission's ability to achieve, to

    the maximum extent practicable, the statutory factors outlined by

    Congress in CEA section 4a(a)(3).

    The Commission requests comment on its considerations of the

    benefits of reporting under part 19. Has the Commission accurately

    identified the benefits of collecting the reported information? Are

    there additional benefits the Commission should consider?

    iii. Costs

    The Commission recognizes there will be costs associated with the

    proposed changes and additions to the report filing requirements under

    part 19. Though the Commission anticipates that market participants

    should have ready access to much of the required information, the

    Commission expects that, at least initially, market participants will

    require additional time and effort to become familiar with new and

    amended series '04 forms, to gather the necessary information in the

    required format, and to file reports in the proposed timeframes. The

    Commission has attempted to mitigate the cost impacts of these reports.

    Actual costs incurred by market participants will vary depending on

    the diversity of their cash market positions, the experience that the

    participants currently have regarding filing Form 204 and Form 304 as

    well as a variety of other organizational factors. However, the

    Commission has estimated average incremental burdens associated with

    the proposed rules in order to fulfill its obligations under the

    PRA.\822\

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    \822\ See PRA section below for full details on the Commission's

    estimates.

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    For Form 204, the Commission estimates that approximately 400

    market participants will file an average of 12 reports annually at an

    estimated labor burden of 2 hours per response for a total per-entity

    hour burden of approximately 24 hours, which computes to a total annual

    burden of 9,600 hours for all affected entities. Using an estimated

    hourly wage of $120 per hour,\823\ the Commission estimates

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    an annual per-entity cost of approximately $2,900 and a total annual

    cost of $1,152,000 for all affected entities.

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    \823\ The Commission's estimates concerning the wage rates are

    based on 2011 salary information for the securities industry

    compiled by the Securities Industry and Financial Markets

    Association (``SIFMA''). The Commission is using $120 per hour,

    which is derived from a weighted average of salaries across

    different professions from the SIFMA Report on Management &

    Professional Earnings in the Securities Industry 2011, modified to

    account for an 1800-hour work-year, adjusted to account for the

    average rate of inflation in 2012, and multiplied by 1.33 to account

    for benefits and 1.5 to account for overhead and administrative

    expenses. The Commission anticipates that compliance with the

    provisions would require the work of an information technology

    professional; a compliance manager; an accounting professional; and

    an associate general counsel. Thus, the wage rate is a weighted

    national average of salary for professionals with the following

    titles (and their relative weight); ``programmer (senior)'' and

    ``programmer (non-senior)'' (15% weight), ``senior accountant''

    (15%) ``compliance manager'' (30%), and ``assistant/associate

    general counsel'' (40%). All monetary estimates have been rounded to

    the nearest hundred dollars.

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    For Form 304, the Commission estimates that approximately 400

    market participants will file an average of 52 reports annually at an

    estimated labor burden of 1 hours per response for a total per-entity

    hour burden of approximately 52 hours, which computes to a total annual

    burden of 20,800 hours for all affected entities. Using an estimated

    hourly wage of $120 per hour,\824\ the Commission estimates an annual

    per-entity cost of approximately $6,300 and a total annual cost of

    $2,500,000 for all affected entities.

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    \824\ Id.

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    For the new Form 504, the Commission anticipates that approximately

    40 market participants will file an average of 12 reports annually at

    an estimated labor burden of 15 hours per r