January 12, 2016
Thank you for that warm welcome. Given the cold, it’s a real pleasure to be inside here today with you.
I’ve been an attorney for decades. And like you, I take great pride in that role. I started my legal career in 1982, as an associate at Davis Polk & Wardwell. In the summer of 1988, I joined Latham & Watkins as a senior corporate associate, and became a partner a couple of years later.
Though I did not expect it, I stayed at Latham until I retired to become a Commissioner of the Commodity Futures Trading Commissions (CFTC). My practice included corporate, finance and securities transactions for large global corporations and financial institutions, including mergers and acquisitions, private equity, securities offerings, strategic alliances, corporate restructurings, leveraged finance, securitizations, distressed debt and asset acquisitions and venture capital financings. And, I was fortunate that Latham was doing cutting-edge work. I saw, firsthand, the evolution of the financial industry beginning in the 1980s.
In February 2010, I was appointed by President Obama and confirmed by the Senate to serve as Vice Chair, of the Securities Investor Protection Corporation (SIPC). Later, I became the Acting Chair. These very different roles – advising industry for 33 years – and then at SIPC, overseeing the liquidation of bankrupt broker-dealers, were a great preparation for my current role as Commissioner, in which I help enhance regulations on behalf of the general public to provide for the safety and stability of the futures and swaps markets. So it’s great to be here today with so many other lawyers working in this vibrant world of derivatives law.
But, here I am today to talk about what might be called the eternal rulemaking – position limits. I know that this issue has been hashed out so many times that it’s hard to imagine a CFTC Commissioner still wants to talk about it. After all, as I’ve said before, we all know everyone’s positions on position limits by now. I cannot even imagine how many hundreds of thousands of billable hours have been spent by law firms working on new versions of the same letters they have written the CFTC numerous times before on this issue. Yet, the rule remains unfinished and I have hope that, at last, this will be the year that it will be finalized, and we can begin the process of implementation.
As always, the views that I express today are my own, and do not represent those of my fellow Commissioners or the CFTC’s Staff.
The conversation on position limits began in the U.S. in the 1930s and it continues today. It has become a part of global market reform efforts. Despite many rounds of comments and debate through the decades, the conversation really has not changed all that much over time. There simply is no easy way to address the concerns that drive the position limit discussion. Because of the difficulty, each proposal on position limits has typically taken many iterations, and over a period of not months, but years. We obviously are not breaking that trend. Yet, I believe we are close now. I think the rule can be finalized this year, and we will all begin the process of implementing it.
Amongst the mountain of comments, meeting transcripts, and federal register releases generated by this effort, it is easy to lose sight of what really lays at the heart of this effort: Public confidence in our markets. By most measures, the economy has improved since the 2008 crisis – unemployment is returning to normal historical levels. Based on current estimates, GDP looks like it has been above 2% for the last two years. Consumer spending is growing. But questions over the structure and functioning of our markets remain at the heart of our debates about financial reform. Understandably, public trust recovers slowly; it has to be earned.
I see two clear themes in the history of position limits. One is a blend of economics and policy. The idea that we can prevent or mitigate the negative effects of excessive speculation by limiting the size of any one market participant.
The second is about public confidence, or rather the lack of it. Under this second theme, one reason position limits are necessary is because, left to their own devices, people will try and game the system, and use market power to their own advantage, harming markets, other investors, and consumers, and reducing confidence in the markets. Not just the events of 2008, but simply the history of markets, shows this is, actually, a pretty reasonable concern. The astonishing growth of our financial and commodity markets, has led to fundamental changes in market structure. New classes of investors, strategies, and technologies, have reshaped our markets in ways we are still trying to understand.
So, if many of us are still trying to figure position limits out, think of the challenge for the general public, or even the smaller trader seeking to implement a hedging strategy for a rural utility. Faced with a history of severe market abuses in unregulated markets, including energy markets, is it any wonder that the debate over position limits continues today?
Some have said that position limits are a prescription looking for a problem; that there is no proof they are necessary at this time. This argument misses the point. Anyone with a basic understanding of statistics and knowledge of the data that exists for commodity markets will come to much the same conclusion our own economists have come to. The data does not exist to identify the impact of speculation in our markets with any kind of statistical certainty. Too much of the commodity markets is still dark to us. Too many sovereign entities can influence prices.
However, while we may not be able to quantify speculative impacts on prices, neither can we show there is no impact. Like much of financial regulation, the answer is found not in quantitative studies, but within the public policy process. The position limit provisions of Dodd Frank were passed because Members of Congress were concerned about the impact of excessive speculation on commodity prices. Section 737 of the Act, the section that is most focused on position limits, orders the Commission to establish limits for futures and option contracts and economically equivalent swaps to protect against excessive speculation.
Given the data and structural challenges in quantifying speculation, it is impossible to construct a “test” for what is excessive speculation. But, we can try and limit the damage that excessive speculation could cause, by limiting the size of the positions any one market participant can hold. That is the essence of position limits.
Some observers have estimated that 15 percent of the run-up in oil prices last decade was due to speculation.1 Multiply that by the billions of barrels of oil sold every day, week, month, and year, and it is easy to understand the public’s concern. Given the overall fragility of the economy in 2008, the spring and summer 2008 spike in oil prices2 almost certainly did not help the then-already weak U.S. economy, which had already entered a recession in December 2007.3
Position limits are not new. The Commission and exchanges have long established and enforced speculative position limits for futures and options on various agricultural commodities.4 Commodity prices today are substantially down from their peaks. But, in time, they will inevitably go up, and questions will again be raised about the role of speculation. This is likely, a la the film “Groundhog Day,” a situation that that has no end but merely repeats endlessly.
To use an analogy that is more accessible that financial history, but perhaps not as accessible as a Bill Murray movie, position limits are something like seat belts. They won’t be needed every day, but when you are driving a car and have an accident, they can mitigate your injuries.
Past instances of excessive speculation or attempted market manipulation might have been mitigated, if position limits had been in place. With position limits for precious metals in the 1980s, the Hunt Brothers might not have been able to corner the silver market. With position limits for electricity in the early 2000s, maybe Enron’s impact would have been lessened.
Clearly, position limits are a necessity. Congress mandated it, good sense endorses it, and our markets require it.
None of us can predict the future. All we can do is put in place appropriate protections so that we are ready for both the foreseen and unforeseen.
Of course, in the debate over whether we need position limits, some of the ancillary benefits of position limits have gotten lost. I think two benefits of position limits that are underestimated are the greater recordkeeping and data requirements of the rule. Through these, the Commission will have a better view of market structure for commodity markets; in effect, they will help us cut through the darkness and improve our market data.
While I support the position limits rule, I do not believe our current proposal is perfect. In fact, I think it can and should be improved. For instance, I think we can provide more clarity and ease of operation for commercial end users. And I want a rule that is workable. I am committed to getting this rule right.
In my time as a Commissioner, I have spoken with farmers, processors, and others involved in producing the food we eat and the plant-based products we use. Their job is tough. Given the sizeable capital investments needed and their frequently unpredictable incomes, they need access to cost-effective hedging to finance their businesses. They need to be able to protect against anticipated risks.
I am confident we can meet their needs, while maintaining the protections for investors, consumers, and the broader financial system that Congress envisioned. For example, I believe, the Commission will soon consider a supplemental rule proposal for position limits. This proposal should enhance the rule’s approach to anticipatory hedging and risk management, providing a role for the exchanges to work with commercial participants to manage their anticipated commercial risks.
This new proposal would be the second change the current Commission has made to our position limits proposal. Last year, we issued a new proposal for the aggregation of commodity positions.5 It provided more flexibility to market participants to disaggregate positions, where they can show that controls are in place to ensure trading decisions are done independently amongst entities.
I began this speech by talking about public confidence. We have to do our best to make sure the public better understands that, speculation, for lack of a better word, is good. Speculation works. It is necessary for commercial companies to hedge their risks in the marketplace.
But, the need for speculation cannot be infinite. You need a certain amount of water in the creek to swim. At a certain point, though, more water does not make swimming any easier.
At a high enough level, it threatens to wash you away. To drown you.
And, in our commodity markets, we have no easy way to tell when liquidity becomes a flood.
Position limits have been the traditional solution to guard against this. Perhaps there are more targeted or more efficient measures. I think we should keep looking for them. With our increasingly dynamic global market, we are under more pressure than ever not to drop the ball.
Forthcoming rules must draw from the lessons learned from pre-crisis behavior, as well as account for future challenges. I believe we will have an improved position limits rule, one that helps prevent the negative impacts of excessive speculation while allowing commercial end-users to manage their risks, that addresses many of the concerns that have been raised, and that gives the public confidence that we have fulfilled Congress’ mandate.
This rule will certainly not be the last conversation on position limits. In the future,
the Commission may consider whether limits are needed on additional products, such as on carbon emissions or renewable energy credit derivatives. Existing limits may need to be changed. I am always eager to hear first-hand how are rules can be improved.
So, please, bring me your thoughts and ideas, and thank you for inviting me here today.
1 Luciana Juvenal & Ivan Petrella, “Speculation in the Oil Market,” Federal Reserve Bank of St. Louis, March 13, 2012, available at https://research.stlouisfed.org/publications/es/12/ES_2012-03-12.pdf.
2 See Graph of West Texas Intermediate Crude Oil Prices, Federal Reserve Bank of St. Louis, available at https://research.stlouisfed.org/fred2/graph/?g=33PV.
3 National Bureau of Economic Research, “US Business Cycle Expansions and Contractions,” April 23, 2012, available at http://www.nber.org/cycles/US_Business_Cycle_Expansions_and_Contractions_20120423.pdf.
4 See Testimony of Dan M. Berkovitz, CFTC General Counsel, Hearing on Speculative Position Limits in Energy Futures Markets, July 28, 2009, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement072809.
5 Aggregation of Positions, 80 Fed. Reg. 58365, September 29, 2015, available at http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2015-24596a.pdf.
Last Updated: January 12, 2016