I support the final rulemaking to establish position limits for physical commodity derivatives. The CFTC does not set or regulate prices. Rather, the Commission is charged with a significant responsibility to ensure the fair, open and efficient functioning of derivatives markets. Our duty is to protect both market participants and the American public from fraud, manipulation and other abuses.
Position limits have served since the Commodity Exchange Act passed in 1936 as a tool to curb or prevent excessive speculation that may burden interstate commerce.
When the CFTC set position limits in the past, the agency sought to ensure that the markets were made up of a broad group of market participants with no one speculator having an outsize position. At the core of our obligations is promoting market integrity, which the agency has historically interpreted to include ensuring that markets do not become too concentrated.
Position limits help to protect the markets both in times of clear skies and when there is a storm on the horizon. In 1981, the Commission said that “the capacity of any contract market to absorb the establishment and liquidation of large speculative positions in an orderly manner is related to the relative size of such positions, i.e., the capacity of the market is not unlimited.”
In the Dodd-Frank Act, Congress mandated that the CFTC set aggregate position limits for certain physical commodity derivatives. The Dodd-Frank Act broadened the CFTC’s position limits authority to include aggregate position limits on certain swaps and certain linked contracts traded on foreign boards of trade in addition to U.S. futures and options on futures. Congress also narrowed the exemptions traditionally available from position limits by modifying the definition of bona fide hedge transaction, which particularly would affect swap dealers.
Today’s final rule implements these important new provisions. The final rule fulfills the Congressional mandate that we set aggregate position limits that, for the first time, apply to both futures and economically equivalent swaps, as well as linked contracts on foreign boards of trade. The final rule establishes federal position limits in 28 referenced commodities in agricultural, energy and metals markets.
Per Congress’s direction, the rule implements one position limits regime for the spot month and another for single-month and all-months combined limits. It implements spot-month limits, which are currently set in agriculture, energy and metals markets, sooner than the single-month or all-months-combined limits. Spot-month limits are set for futures contracts that can by physically settled as well as those swaps and futures that can only be cash-settled. We are seeking additional comment as part of an interim final rule on these spot month limits with regard to cash-settled contracts.
Single-month and all-months-combined limits, which currently are only set for certain agricultural contracts, will be re-established in the energy and metals markets and be extended to certain swaps. These limits will be set using a formula that is consistent with that which the CFTC has used to set position limits for decades. The limits will be set by a Commission order based upon data on the total size of the swaps and futures market collected through the position reporting rule the Commission finalized in July. It is only with the passage and implementation of the Dodd-Frank Act that the Commission now has broad authority to collect data in the swaps market.
The final rule also implements Congress’s direction to narrow exemptions while also ensuring that bona fide hedge exemptions are available for producers and merchants.
The final position limits rulemaking builds on more than two years of significant public input. The Commission benefited from more than 15,100 comments received in response to the January 2011proposal. We first held three public meetings on this issue in the summer of 2009 and got a great deal of input from market participants and the broader public. We also benefited from the more than 8,200 comments we received in response to the January 2010 proposed rulemaking to re-establish position limits in the energy markets. We further benefited from input received from the public after a March 2010 meeting on the metals markets.
Clearinghouse Core Principles
I support the final rulemaking on core principles for derivatives clearing organizations (DCOs). Centralized clearing has been a feature of the U.S. futures markets since the late-19th century. Clearinghouses have functioned both in clear skies and during stormy times – through the Great Depression, numerous bank failures, two world wars, and the 2008 financial crisis – to lower risk to the economy. Importantly, centralized clearing protects banks and their customers from the risk of either party failing.
When customers don’t clear their transactions, they take on their dealer’s credit risk. We have seen over many decades, however, that banks do fail. Centralized clearing protects all market participants by requiring daily mark to market valuations and requiring collateral to be posted by both parties so that both the swap dealer and its customers are protected if either fails. It lowers the interconnectedness between financial entities that helped spread risk throughout the economy when banks began to fail in 2008.
Today’s rulemaking will establish certain regulatory requirements for DCOs to implement important core principles that were revised by the Dodd-Frank Act. We recognize the need for very robust risk management standards, particularly as more swaps are moved into central clearinghouses. We have incorporated the newest draft Committee on Payment and Settlement Systems (CPSS)-International Organization of Securities Commissions (IOSCO) standards for central counterparties into our final rules.
First, the financial resources and risk management requirements will strengthen financial integrity and enhance legal certainty for clearinghouses. We’re adopting a requirement that DCOs collect initial margin on a gross basis for its clearing member’s customer accounts For interest rates and financial index swaps, such as credit default swaps, we are maintaining, as proposed, a minimum margin for a five-day liquidation period. This is consistent with current market practice, and many commenters recommended this as a minimum. For the clearing of physical commodity swaps, such as on energy, metals and agricultural products, we are requiring margin that is risk-based but consistent with current market practice – a minimum of one day.
Maintaining a minimum five day liquidation period for interest rates and credit default swaps is appropriate not only as it is consistent with current market practice, but also as these markets are the most systemically relevant for the interconnected financial system. History shows that, in 2008, it took five days after the failure of Lehman Brothers for the clearinghouse to transfer Lehman’s interest rate swaps positions to other clearing members. These financial resource requirements, and particularly the margin requirements, are critical for safety and soundness as more swaps are moved into central clearing.
Second, the rulemaking implements the Dodd-Frank Act’s requirement for open access to DCOs. The participant eligibility requirements promote fair and open access to clearing. Importantly, the rule addresses how a futures commission merchant can become a member of a DCO. The rule promotes more inclusiveness while allowing DCO to scale a member’s participation and risk based upon its capital. This improves competition that will benefit end-users of swaps, while protecting DCOs’ ability manage risk.
Third, the reporting requirements will ensure that the Commission has the information it needs to monitor DCO compliance with the Commodity Exchange Act and Commission regulations.
Fourth, the rules formalize the DCO application procedures to bring about greater uniformity and transparency in the application process and facilitate greater efficiency and consistency in processing applications.
These reforms will both lower risk in the financial system and strengthen the market by making many of the processes more efficient and consistent.
Proposed Amendment to Dodd-Frank Rulemaking Effective Dates
I support the proposed amendment to the July 14th Exemptive Order regarding the effective dates of certain Dodd-Frank Act provisions.
The July 14th order provided relief until December 31, 2011, or when the definitional rulemakings become effective, whichever is sooner, from certain provisions that would otherwise apply to swaps or swap dealers on July 16. This includes provisions that do not directly rely on a rule to be promulgated, but do refer to terms that must be further defined by the CFTC and SEC, such as “swap” and “swap dealer.”
Commission staff is working very closely with Securities and Exchange Commission (SEC) staff on rules relating to entity and product definitions. Staff is making great progress, and we anticipate taking up the further definition of entities in the near term and product definitions shortly thereafter.
As these definitional rulemakings have yet to be finalized or become effective, today’s proposed amendment would provide relief through July 16, 2012, or when the definitional rulemakings become effective – whichever is sooner.
The order also provided relief through no later than December 31, 2011, from certain CEA requirements that may apply as the result of the repeal, effective on July 16, 2011, of CEA sections 2(d), 2(e), 2(g), 2(h) and 5d. The proposed amendment also extends this relief to July 16, 2012, or until a date the Commission may otherwise determine with respect to a particular requirement under the CEA.
In addition, today’s proposed amendment also tailors the July 14th relief in light of the Commission’s actions finalizing the agricultural swap rules.
Last Updated: October 18, 2011