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, [email protected];

Riva Spear Adriance, Senior Special Counsel, Division of Market

Oversight, at (202) 418-5494, [email protected]; David N. Pepper,

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

[email protected], 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).

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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.

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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\

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\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).

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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\

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\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).

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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\

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\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).

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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\

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\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)).

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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\

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\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.

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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\

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\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).

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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\

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\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.

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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\

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\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).

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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\

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\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'').

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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\

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\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.

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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\

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\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.''

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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\

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\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.

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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\

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\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.

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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\

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\76\ Interagency Silver Study at 133.

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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\

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\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.

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[[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.

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\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.

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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.

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\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.

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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.

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\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'').

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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.''

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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.

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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\

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\126\ 46 FR 50938, 50939, Oct. 16, 1981.

\127\ 75 FR 4144, 4145-46, Jan. 26, 2010.

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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\

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\128\ Futures Trading Act of 1982: Hearings on S. 2109 before

the S. Subcomm. on Agricultural Research, 97th Cong. 44 (1982).

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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\

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\129\ S. Rep. 97-384 at 45 (1982).

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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.

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\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).

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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.

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\133\ 76 FR at 71663.

\134\ Id. at 71664.

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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\

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\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.'').

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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\

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\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.

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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\

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\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.'').

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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\

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\150\ 7 U.S.C. 6a(a)(1)-(2).

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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.

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\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.

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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.

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\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.

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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\

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\156\ 76 FR 71626, 71631 (n. 49), Nov. 18, 2011.

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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.

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\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).

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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\

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\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.

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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\

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\159\ 76 FR at 71685.

\160\ See id.

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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\

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\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.

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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\

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\164\ See discussion below.

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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.

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\165\ 76 FR at 71632.

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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\

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\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.

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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\

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\167\ The selection of the core referenced futures contracts is

explained in the discussion of proposed Sec. 150.2. See discussion

below.

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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\

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\168\ See proposed Sec. 150.1.

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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\

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\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.

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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.

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\171\ CEA section 1a(38); 7 U.S.C. 1a(38).

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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\

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\172\ CEA section 4a(2)(A); 7 U.S.C. 6a(2)(A).

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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\

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\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).

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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.

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\175\ See 76 FR at 71685.

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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.

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\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).

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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.

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\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.'').

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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.

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\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.

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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\

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\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).

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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.

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\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).

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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\

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\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.''

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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\

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\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.

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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\

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\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.

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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\

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\193\ Id.

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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.

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\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.

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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\

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\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.'').

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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\

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\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.

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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\

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\203\ See supra discussion of the proposed definition of

``speculative position limit.''

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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\

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\204\ Vacated Sec. 151.1.

\205\ See supra discussion of proposed Sec. 150.1 ``referenced

contract'' definition.

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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\

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\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.

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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).

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\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.

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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.

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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.

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\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.

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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\

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\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.

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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\

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\216\ 42 FR 14832, Mar. 16, 1977.

\217\ Id.

\218\ 42 FR 42748, Aug. 24, 1977.

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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\

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\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\

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\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.

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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.

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\227\ 44 FR 7124, Feb. 6, 1979.

\228\ Id. at 7125.

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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.

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\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\

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\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.

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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\

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\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.

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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\

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\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\

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\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\

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\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.

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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\

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\249\ 72 FR 66097, Nov. 27, 2007.

\250\ 73 FR 32261, Jun. 6, 2008.

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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\

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\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.

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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.

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\254\ 75 FR 4144, Jan. 26, 2010 (withdrawn 75 FR 50950, Aug. 18,

2010).

\255\ 75 FR at 4152.

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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\

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\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).

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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\

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\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).

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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\

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\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).

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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\

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\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).

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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\

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\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.

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\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.

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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.

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\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\

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\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).

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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.

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\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).

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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\

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\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).

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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).

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\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.

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\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).

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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.

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\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/idc/groups/public/@lrfederalregister/documents/file/2013-12365a.pdf).

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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\

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\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).

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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.

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\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).

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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.

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\286\ 52 FR 34633, Sep. 14, 1987.

\287\ Id. at 34626.

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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\

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\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).

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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\

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\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).

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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.

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\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.)

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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\

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\294\ 52 FR 38914, 38920, Oct. 20, 1987.

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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.

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\295\ 42 FR 14832, 14834, Mar. 16, 1977.

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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.

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\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).

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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\

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\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.

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[[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.

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\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.

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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).

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\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).

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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.

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\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.

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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.

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\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.

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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\

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\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?

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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\

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\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.

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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\

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\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).

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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?

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\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).

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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.

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\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.

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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.

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\319\ 7 U.S.C. 7(d)(5).

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(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\

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\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.

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\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.''

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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\

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\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.

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[[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.

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\326\ Id.

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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\

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\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\

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\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.

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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.

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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.

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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.

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\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\

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\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.

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\343\ 76 FR at 71654.

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(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\

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\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.

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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.

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\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.

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\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.

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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.

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\353\ A generator must also be able to satisfy any operating

constraints, including minimum production runs.

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(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.''

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\354\ 76 FR at 71646.

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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.

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\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.

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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\

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\357\ See current Sec. 1.3(z)(2)(i)(B) and (C).

\358\ See current Sec. 1.48.

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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.

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\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.

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\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.

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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\

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\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.

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\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.

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\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.

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\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.

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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\

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\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.

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\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.

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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.

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\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.

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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\

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\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).

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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.

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\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).

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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:

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\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\

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\375\ Id. at 4152-54.

The Commission withdrew the 2010 Energy Proposal when the Dodd-Frank

Act became law.\376\

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\376\ 75 FR 50950, Aug. 18, 2010.

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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\

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\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.

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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\

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\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.

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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:

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\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\

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\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\

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\386\ See generally 76 FR 71626, Nov. 18, 2011.

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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.

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\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.

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\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\

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\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\

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\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.

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[[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).

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\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.

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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.

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\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.

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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\

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\400\ 17 CFR 150.2.

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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.

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\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.

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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.

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\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.

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\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.

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\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.

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\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).

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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.

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\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.

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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.

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\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.

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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.

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\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.

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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\

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\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.

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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\

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\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.''

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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\

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\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.

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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.

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\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.

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\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.

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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.

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\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.

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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?

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\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.

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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.

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\464\ See infra discussion of proposed revisions of part 19.

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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.

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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.

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\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.

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(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.

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\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.

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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\

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\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).

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(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\

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\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).

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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.

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\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.

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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.

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\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/idc/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.

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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.

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\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.

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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\

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\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).

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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\

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\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.

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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\

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\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/idc/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/idc/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.

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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.

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\496\ See discussion above.

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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.

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\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.

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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\

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\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.

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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\

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\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.

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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.)

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\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.

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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\

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\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.

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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.

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\512\ See 76 FR at 71692.

\513\ See discussion below.

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(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\

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\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.

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[[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.

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\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).

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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.

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\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.

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(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.

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\518\ Additionally, data under this provision may be required by

way of special call, in addition to special commodity reporting.

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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\

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\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.

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(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.

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\521\ See supra discussion of the proposed definition of bona

fide hedging position.

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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\

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\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).

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[[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.

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\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.

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(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.

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\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.

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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\

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\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.

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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\

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\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.

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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.

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\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.' '').

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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.

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\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.

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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.

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\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.

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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.

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\543\ The Commission notes that amended Sec. 150.6 matches

vacated Sec. 151.11(h).

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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.

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\544\ The Commission notes that proposed Sec. 150.8 matches

vacated Sec. 151.13.

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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\

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\545\ See discussion of new and amended series '04 reports

above.

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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\

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\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).

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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\

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\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.

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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\

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\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.

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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.

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\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.

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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\

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\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.

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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\

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\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.

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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\

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\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).

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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\

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\565\ 46 FR 50938, 50939-40, Oct. 16, 1981.

\566\ Id. at 50940.

\567\ Id. at 50945.

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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:

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\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\

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\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\

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\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.

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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\

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\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).

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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\

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\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.

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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\

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\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.

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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\

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\581\ 17 CFR 150.5(a).

\582\ Id.

\583\ Id.

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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\

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\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).

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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\

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\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.

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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\

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\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.

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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\

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\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).

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Lastly, the Commission codified its aggregation policy relating to

exchange-set position limits in Sec. 150.5(g).\602\

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\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).

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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.

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\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.

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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\

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\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.

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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\

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\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\

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\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\

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\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.

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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.

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\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.

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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\

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\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.

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\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\

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\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.

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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\

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\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.

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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.

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\644\ See 887 F. Supp. 2d 259 (D.D.C. 2012).

\645\ See id generally.

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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.

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\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).

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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.

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\648\ Appendix B to Part 37--Guidance on, and Acceptable

Practices in, Compliance with Core Principles.

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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.

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\649\ See 887 F. Supp. 2d 259 (D.D.C. 2012).

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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\

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\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.

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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\

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\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.

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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.

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\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).

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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.

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\659\ See id.

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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.

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\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.

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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\

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\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?

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\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.

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\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.

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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.

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\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\

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\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.

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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\

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\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.

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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\

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\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.

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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\

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\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.

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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\

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\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.

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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\

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\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).

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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.

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\684\ See supra discussion of pre-enactment and transition

period swap positions.

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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.

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\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.

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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\

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\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)).

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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\

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\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.

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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.

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\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).

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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\

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\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.

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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.

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\693\ Compare 17 CFR 150.5(e)(2)-(3).

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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\

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\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).

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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.

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\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.

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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\

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\696\ See supra discussion of what is meant by ``substantially

the same'' in this context.

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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\

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\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.

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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\

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\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).

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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\

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\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).

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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.

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\706\ See CEA section 4a(c)(1); 7 U.S.C. 6a(c)(1).

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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.

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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)).

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\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.

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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\

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\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.

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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\

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\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).

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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).

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\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.

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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.

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\722\ See supra discussion of proposed amendments to Sec.

150.1.

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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\

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\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.

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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.''

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\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.

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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\

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\726\ See supra for additional explanation of these terms.

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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.

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\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'').

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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.

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\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.

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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\

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\731\ See discussion above.

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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.

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\732\ 7 U.S.C. 6a(c)(1).

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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\

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\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.

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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\

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\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.

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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).

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\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.

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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\

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\736\ A detailed description of each enumerated position can be

found supra.

\737\ See discussion above.

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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.

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\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.

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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\

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\739\ See discussion above.

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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).

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\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).

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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?

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\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).

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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.

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\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.

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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\

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\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.

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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.

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\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.

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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.

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\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.

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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\

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\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.

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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\

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\753\ As discussed above, the definition of referenced contract

excludes any guarantee of a swap, basis contracts, and commodity

index contracts.

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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.

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\754\ 17 CFR 150.2.

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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.

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\755\ See discussion above.

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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.

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\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.

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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\

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\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.

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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.

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\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\

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\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.

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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\

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\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.

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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.

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\761\ 7 U.S.C. 6a(a)(3)(A).

\762\ See discussion above.

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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.

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\763\ 7 U.S.C. 6a(a)(3)(A).

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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\

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\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.

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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.

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\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).

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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.

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\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.

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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.

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\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.

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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.

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\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.

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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\

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\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.

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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).

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\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.

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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.

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\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.

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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.

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\779\ See discussion above.

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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.

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\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.

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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.

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\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.

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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\

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\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).

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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).

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\787\ 77 FR 66288, Nov. 2, 2012.

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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.

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\788\ See supra considerations of costs and benefits of the

proposed amendments to part 19 and the Paperwork Reduction Act.

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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.

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\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 .

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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.

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\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.

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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.

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\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.

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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\

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\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).

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[[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.

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\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.

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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.

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\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.

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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.

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\800\ See Aggregation NPRM.

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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.

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\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.

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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.

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\802\ The terms ``inter-market spread'' and ``intra-market

spread'' are defined in proposed Sec. 150.1.

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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.

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\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.

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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\

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\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.

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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\

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\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.

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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.

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\809\ These amendments are non-substantive conforming amendments

and should not have implications for the Commission's consideration

of costs and benefits.

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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\

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\810\ See supra discussion of proposed amendments to part 19.

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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.

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\811\ Furthermore, anyone exceeding the federal limits who has

received a special call must file a series '04 form.

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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.

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\812\ 17 CFR 15.02.

\813\ See supra discussion of series '04 forms.

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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\

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\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.

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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.

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\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.

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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.

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\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).

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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.

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\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.

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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.

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\819\ See supra discussion of definition of bona fide hedging

position in proposed Sec. 150.1.

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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\

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\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).

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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.

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\821\ See supra discussion of proposed Sec. 150.2.

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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

[[Page 75780]]

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 response for a total per-

entity hour burden of approximately 180 hours, which computes to a

total annual burden of 7,200 hours for all affected entities. Using an

estimated hourly wage of $120 per hour,\825\ the Commission estimates

an annual per-entity cost of approximately $10,800 and a total annual

cost of $864,000 for all affected entities.

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\825\ Id.

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For the new Form 604, the Commission anticipates that approximately

200 market participants will file an average of 10 reports annually at

an estimated labor burden of 30 hours per response for a total per-

entity hour burden of approximately 300 hours, which computes to a

total annual burden of 60,000 hours for all affected entities. Using an

estimated hourly wage of $120 per hour,\826\ the Commission estimates

an annual per-entity cost of approximately $36,000 and a total annual

cost of $7,200,000 for all affected entities.

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\826\ Id.

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Finally, for the new Form 704, the Commission anticipates that

approximately 200 market participants will file an average of 10

reports annually at an estimated labor burden of 20 hours per response

for a total per-entity hour burden of approximately 200 hours, which

computes to a total annual burden of 40,000 hours for all affected

entities. Using an estimated hourly wage of $120 per hour,\827\ the

Commission estimates an annual per-entity cost of approximately $24,000

and a total annual cost of $4,800,000 for all affected entities.

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\827\ Id.

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The Commission requests comment regarding its consideration of

costs pertaining to the amendments to part 19. Has the Commission

accurately described the ways that market participants may incur costs?

Are there other costs, direct or indirect, that the Commission should

consider regarding the proposed part 19? How does the introduction of

the new series '04 reports affect the likelihood that a trader may seek

an exemption? What other burdens may arise from the filing of these

reports? Are the Commission's burden estimates under the PRA

reasonable? Why or why not? Commenters are encouraged to submit their

own estimates of costs, including labor burdens and wage estimates, for

the Commission's consideration.

iv. Consideration of Alternatives

The Commission also recognizes that alternatives may exist to

discretionary elements of the part 19 reporting amendments 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.

8. CEA Section 15(a)

As described above, the Commission interprets the revised CEA

section 4a as requiring the imposition of speculative position limits

during the spot-month, any single month, and all-months-combined on all

commodity derivative contracts, including swaps, that reference the

same underlying physical commodity on an aggregated basis across

trading venues. Section 15(a) of the Act requires the Commission to

evaluate the costs and benefits of its discretionary actions in light

of five enumerated factors that represent broad areas of market and

public concern. The Commission welcomes comment on its evaluation under

CEA section 15(a).

i. Protection of Market Participants and the Public

Broadly speaking, the Commission's expansion of the federal

speculative position limits regime to include an additional 19 core-

referenced futures contracts (and the associated referenced contracts)

will extend protections afforded to the existing legacy contracts.

Namely, the limits are intended as a measure to prophylactically deter

manipulation and to diminish, eliminate, or prevent excessive

speculation in significant price discovery contracts. The proposed

limits in Sec. 150.2, the methodology used for determining limits at

the spot, single and all-months combined levels and the determination

of distinct levels in physically-delivered and cash-settled contracts

all support the Commission's mission to prevent undue or unnecessary

burdens on interstate commerce resulting from excess speculation such

as the sudden or unreasonable fluctuations or unwarranted changes in

commodity prices. Further, by requiring that market participants who

avail themselves of the exemptions offered under Sec. 150.3 document

their exemption eligibility and make such records available on request

and through regular reporting to the Commission, the Commission is

protecting market participants--hedgers and speculators alike--from

another party abusing the exemptions reserved for eligible entities.

The Commission anticipates that market participants engaged in

speculative trading will incur costs to monitor their positions vis-a-

vis limit levels. The Commission expects that market participants will

need to invest 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.

ii. Efficiency, Competitiveness, and Financial Integrity of Markets

Position limits help to prevent market manipulation or excessive

speculation that may unduly influence prices at the expense of the

efficiency and integrity of markets. The expansion of the federal

position limits regime to 28 core referenced futures contracts enhances

the buffer against excessive speculation historically afforded to the

nine legacy contracts exclusively, improving the financial integrity of

those markets. Moreover, the proposed limits in Sec. 150.2 promote

market competitiveness by preventing a trader from gaining too much

market power.

The stringently defined exemptions in Sec. 150.3 and the reporting

requirements assigned to those availing themselves of the exemptions

provided are the Commission's first line of defense in ensuring that

participants transacting in the Commission's jurisdictional markets are

doing so in a competitive and efficient environment.

In codifying the Commission's historical practice of temporarily

lifting position limit restrictions, the proposed

[[Page 75781]]

Sec. 150.3(b) financial distress exemption 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. In addition, it provides market

participants with a degree of confidence which contributes to the

overall efficiency and financial integrity of markets.

iii. Price Discovery

Market manipulation or excessive speculation may result in

artificial prices. So, in this sense, position limits might also help

to prevent the price discovery function of the underlying commodity

markets from being disrupted. On the other hand, imposing position

limits raises the concerns that liquidity and price discovery may be

diminished, because certain market segments, i.e., speculative traders,

are restricted. However, the Commission has mitigated some of these

concerns by proposing various exemptions to positions limits. In

addition, applying current DCM-set limits as federal limits means that

even though additional contract markets will be brought into the

federal position limits regime, the activity of speculative traders, at

least initially, will be no less restricted than under the current

regime.

iv. Sound Risk Management

Proposed exemptions for bona fide hedgers help to ensure that

market participants with positions that are hedging legitimate

commercial needs are properly recognized as hedgers under the

Commission's speculative position limits regime. This promotes sound

risk management practices. In addition, the Commission has crafted the

proposed rules to ensure sufficient market liquidity for bona fide

hedgers to the maximum extent practicable, e.g., through the

conditional spot month limit exemption.

To the extent that monitoring for position limits requires market

participants to create internal risk limits and evaluate position size

in relation to the market, position limits may also provide an

incentive for market participants to engage in sound risk management

practices.

v. Other Public Interest Considerations

The regulations proposed under Sec. 150.5 require that exchange-

set limits employ policies that conform to the Commission's general

policy both for contracts that are subject to federal limits under

Sec. 150.2 and those that are not, thus harmonizing rules for all

federal and exchange-set speculative position limits.

B. Paperwork Reduction Act

1. Overview

The PRA \828\ imposes certain requirements on Federal agencies in

connection with their conducting or sponsoring any collection of

information as defined by the PRA. Certain provisions of the

regulations proposed herein will result in amendments to approved

collection of information requirements within the meaning of the PRA.

An agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information unless it displays a currently

valid control number issued by the Office of Management and Budget

(``OMB''). Therefore, the Commission is submitting this proposal to OMB

for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The

information collection requirements proposed in this proposal would

amend previously-approved collections associated with OMB control

numbers 3038-0009 and 3038-0013.

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\828\ 44 U.S.C. 3501 et seq.

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If adopted, responses to these collections of information would be

mandatory. Several of the reporting requirements are mandatory in order

to obtain exemptive relief, and are thus mandatory under the PRA to the

extent a market participant elects to seek such relief. The Commission

will protect proprietary information according to the Freedom of

Information Act and 17 CFR part 145, headed ``Commission Records and

Information.'' In addition, the Commission emphasizes that section

8(a)(1) of the Act strictly prohibits the Commission, unless

specifically authorized by the Act, from making public ``data and

information that would separately disclose the business transactions or

market positions of any person and trade secrets or names of

customers.'' \829\ The Commission also is required to protect certain

information contained in a government system of records pursuant to the

Privacy Act of 1974.\830\

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\829\ 7 U.S.C. 12(a)(1).

\830\ 5 U.S.C. 552a.

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Under the proposed regulations, market participants with positions

in a ``referenced contract,'' as defined in proposed Sec. 150.1, would

be subject to the position limit framework established under the

proposed revisions to parts 19 and 150. Proposed part 19 prescribes new

forms and reporting requirements for persons claiming a conditional

spot month limit exemption (proposed Form 504),\831\ a pass-through

swap exemption (proposed Form 604),\832\ or an anticipatory exemption

(proposed Form 704).\833\ The proposed amendments to part 19 also

update and change reporting obligations and required information for

Form 204 and Form 304.\834\ Proposed part 150 prescribes reporting

requirements for DCMs listing a core referenced futures contract \835\

and traders who wish to apply for an exemption from DCM- or SEF-

established positions limits in non-referenced contracts,\836\ as well

as recordkeeping requirements for persons who claim exemptions from

position limits or are counterparties to a person claiming a pass-

through swap offset.\837\

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\831\ See proposed Sec. Sec. 19.00(a)(1)(i) and 19.01(a)(1).

\832\ See proposed Sec. Sec. 19.00(a)(1)(ii) and 19.01(a)(2).

\833\ The requirement of filing a Form 704 in order to claim an

anticipatory exemption is stipulated in proposed Sec. 150.7(a) in

addition to its inclusion in proposed amendments to part 19. See

proposed Sec. Sec. 19.00(a)(1)(iv), 19.01(a)(4) and 150.7(a).

\834\ See proposed Sec. 19.01(a)(3).

\835\ See proposed Sec. 150.2(e)(3)(ii).

\836\ See proposed Sec. 150.5(b)(5)(C).

\837\ See proposed Sec. 150.3(g).

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2. Methodology and Assumptions

It is not possible at this time to precisely determine the number

of respondents affected by the proposed rules. Many of the regulations

that impose PRA burdens are exemptions that a market participant may

elect to take advantage of, meaning that without intimate knowledge of

the day-to-day business decisions of all its market participants, the

Commission could not know which participants, or how many, may elect to

obtain such an exemption. Further, the Commission is unsure of how many

participants not currently in the market may be required to or may

elect to incur the estimated burdens in the future. Finally, many of

the regulations proposed herein are applying to participants in swaps

markets for the first time, and, as explained supra, the Commission's

lack of experience with such markets and with many of the participants

therein hinders its ability to determine with precision the number of

affected entities.

These limitations notwithstanding, the Commission has made best-

effort estimations regarding the likely number of affected entities for

the purposes of calculating burdens under the PRA. The Commission used

its proprietary data, collected from market participants, to estimate

the number of respondents for each of the proposed obligations subject

to the PRA. As discussed supra,\838\ the

[[Page 75782]]

Commission analyzed data covering the two year period 2011-2012 to

determine how many participants would be over 60, 80, or 100 percent of

the proposed limit levels in each of the 28 core referenced futures

contracts, were such limit levels to be adopted as proposed.

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\838\ See supra discussion of number of traders over the limits.

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

For purposes of the PRA, Commission staff determined the number of

unique traders over the proposed spot-month position limit level for

all of the 28 core referenced futures contracts combined. The

Commission also determined the number of traders over the non-spot-

month position limit level for all of the 28 core referenced futures

contracts combined. Staff then added those two figures and rounded it

up to the nearest hundred to arrive at an approximation of 400

persons.\839\ This base figure was then scaled to estimate, based on

the Commission's expertise and experience in the administration of

position limits, how many participants may be affected by each specific

provision. The analysis reviewed by the Commission does not account for

hedging and other exemptions from position limits, which leads the

Commission to believe that the approximate number of traders in excess

of the limits is a very conservative estimate. The Commission welcomes

comment on its estimates, the methodology described above, and its

conclusion regarding the conservativeness of its estimates.

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\839\ Staff believes that such rounding preserves the

reasonability of the estimate without creating a false impression of

precision.

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The Commission's estimates concerning 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 a figure of $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. This figure was

then multiplied by 1.33 to account for benefits \840\ and further by

1.5 to account for overhead and administrative expenses.\841\ 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 (average of senior and 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 Commission

welcomes public comment on its assumptions regarding its estimated

hourly wage.

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\840\ The Bureau of Labor Statistics reports that an average of

32.8% of all compensation in the financial services industry is

related to benefits. This figure may be obtained on the Bureau of

Labor Statistics Web site, at http://www.bls.gov/news.release/ecec.t06.htm. The Commission rounded this number to 33% to use in

its calculations.

\841\ Other estimates of this figure have varied dramatically

depending on the categorization of the expense and the type of

industry classification used (see, e.g., BizStats at http://www.bizstats.com/corporation-industry-financials/finance-insurance-52/securities-commodity-contracts-other-financial-investments-523/commodity-contracts-dealing-and-brokerage-523135/show and Damodaran

Online at http://pages.stern.nyu.edu/~adamodar/pc/datasets/

uValuedata.xls) The Commission has chosen to use a figure of 50% for

overhead and administrative expenses to attempt to conservatively

estimate the average for the industry.

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3. Information Provided by Reporting Entities/Persons and Recordkeeping

Duties

For purposes of assisting the Commission in setting spot-month

limits no less frequently than every two years, proposed Sec.

150.2(e)(3)(ii) adds an additional burden cost to information

collection 3038-0013 by requiring DCMs to supply the Commission with an

estimated spot-month deliverable supply for each core referenced

futures contract listed. The estimate must include documentation as to

the methodology used in deriving the estimate, including a description

and any statistical data employed. The Commission estimates that 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, 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. The Commission welcomes comment regarding the

estimated burden on DCMs that will result from proposed Sec. 150.2(e).

Proposed Sec. 150.3(g)(1) adds an additional burden cost to

information collection 3038-0013 by requiring any person claiming an

exemption from federal position limits under part 150 to keep and

maintain books and records concerning all details of their related

cash, forward, futures, options and swap positions and transactions to

serve as a reasonable basis to demonstrate reduction of risk on each

day that the exemption was claimed. These records must be

comprehensive, in that they must cover anticipated requirements,

production and royalties, contracts for services, cash commodity

products and by-products, and cross-commodity hedges. Proposed Sec.

150.3(g)(2) requires any person claiming a pass-through swap offset

hedging exemption to obtain a representation that the swap qualifies as

a pass-through swap for purposes of a bona fide hedging position.

Additionally, proposed Sec. 150.3(g)(3) requires any person

representing to another person that a swap qualifies as a pass-through

swap for purposes of a bona fide hedging position, to keep and make

available to the Commission upon request all relevant books and records

supporting such a representation for at least two years following the

expiration of the swap.

The Commission estimates that approximately 400 traders will claim

an average of 50 exemptions each per year that fall within the scope of

the recordkeeping requirements of proposed Sec. 150.3(g). At

approximately one hour per exemption claimed to keep and maintain the

required books and records, the Commission estimates that industry will

incur a total of 20,000 annual labor hours amounting to $2,400,000 in

additional labor costs. The Commission requests public comment

regarding the burden associated with the recordkeeping requirements of

proposed Sec. 150.3(g) and its estimates thereto.

Proposed Sec. 150.5(b)(5)(iii) adds an additional burden cost to

information collection 3038-0013 by requiring traders who wish to avail

themselves of any exemption from a DCM or SEF's speculative position

limit rules that is allowed for under Sec. 150.5(b)(5)(A)-(B) to

submit an application to the DCM or SEF explaining how the exemption

would be in accord with sound commercial practices and would allow for

a position that could be liquidated in an orderly fashion. As noted

supra, the Commission understands that requiring traders to apply for

exemptive relief comports with existing DCM practice; thus, the

Commission anticipates that the codification of this requirement will

have the practical effect of incrementally increasing, rather than

creating, the burden of applying for such exemptive relief. The

Commission estimates that approximately 400 traders will claim

exemptions from DCM or

[[Page 75783]]

SEF-established speculative position limits each year, with each trader

on average making 100 related submissions to the DCM or SEF each year.

Each submission is estimated to take 2 hours to complete and file,

meaning that these traders would incur a total burden of 80,000 labor

hours per year for an industry-wide additional labor cost of

$9,600,000. The Commission welcomes all comment regarding the estimated

burden on market participants wishing to avail themselves of a DCM or

SEF exemption.

Proposed Sec. 19.01(a)(1) adds an additional burden cost to

information collection 3038-0009 for persons claiming a conditional

spot month limit exemption pursuant to Sec. 150.3(c), by requiring the

filing of Form 504 for special commodities so designated by the

Commission under Sec. 19.03. A Form 504 filing shows the composition

of the cash position of each commodity underlying a referenced contract

that is held or controlled for which the exemption is claimed,\842\

including the ``as of'' date, the quantity of stocks owned of such

commodity, the quantity of fixed-price purchase commitments open

providing for receipt of such cash commodity, the quantity of fixed-

price sale commitments open providing for delivery of such cash

commodity, the quantity of unfixed-price purchase commitments open

providing for receipt of such cash commodity, and the quantity of

unfixed-price sale commitments open providing for delivery of such cash

commodity. The Commission estimates that approximately 40 traders will

claim a conditional spot month limit 12 times per year, and each

corresponding submission will take 15 labor hours to complete and file.

Therefore, the Commission estimates that the Form 504 reporting

requirement will result in approximately 7,200 total annual labor hours

for an additional industry-wide labor cost of $864,000. The Commission

requests comment on its estimates regarding new Form 504. In

particular, the Commission welcomes comment regarding the number of

entities who may partake of the conditional limit in natural gas and

would thus be required to file Form 504.

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\842\ The Commission proposes that initially only the natural

gas commodity derivative contracts would be designated under Sec.

19.03 for Form 504 reporting. As such, the Commission's estimates

reflect only the burden for traders in that commodity. The

Commission is not able to estimate the expanded cost of any future

Commission determination to designate another commodity under Sec.

19.03 as a special commodity for which Form 504 filings would be

required. See supra discussion regarding the proposed conditional

spot month limit.

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Proposed Sec. 19.01(a)(2) adds an additional burden cost to

information collection 3038-0009 by requiring persons claiming a pass-

through swap exemption pursuant to Sec. 150.3(a)(1)(i) to file Form

604 showing various data depending on whether the offset is for non-

referenced contract swaps or spot-month swaps including, at a minimum,

the underlying commodity or commodity reference price, the applicable

clearing identifiers, the notional quantity, the gross long or short

position in terms of futures-equivalents in the core referenced futures

contracts, and the gross long or short positions in the referenced

contract for the offsetting risk position. The Commission estimates

that approximately 200 traders will claim a pass-through swap exemption

an average of ten times per year each. At approximately 30 labor hours

to complete each corresponding submission for a total burden to traders

of 60,000 annual labor hours, compliance with the Form 604 filing

requirements industry-wide will impose an additional $7,200,000 in

labor costs. The Commission requests comment on its estimates regarding

new Form 604. In particular, the Commission welcomes comment regarding

the number of entities who may utilize the pass-through swap exemption

and the burden incurred to file Form 604.

Proposed Sec. 19.01(a)(3) increases existing burden costs

previously approved under information collection 3038-0009 by expanding

the number of cash commodities that existing Form 204 covers.

Additionally, proposed Sec. 19.01(a)(3) requires additional data to be

reported on Form 204 and proposed Sec. 19.02 requires additional data

to be reported on existing Form 304 (call cotton). Both forms are

required to be filed when a trader accumulates a net long or short

commodity derivative position in a core referenced futures contract

that exceeds a federal limit, and inform the Commission of the trader's

cash positions underlying those commodity derivative contracts for

purposes of claiming bona fide hedging exemptions.

The Commission estimates that approximately 400 traders will be

required to file Form 204 12 times per year each. At an estimated two

labor hours to complete and file each Form 204 report for a total

annual burden to industry of 9,600 labor hours, the Form 204 reporting

requirement will cost industry $1,200,000 in labor costs. The

Commission also estimates that approximately 400 traders will be

required to make a Form 304 submission for call cotton 52 times per

year each. At one hour to complete each submission (representing a net

increase of a half hour from the previous estimate) for a total annual

burden to industry of 20,800 labor hours, the Form 304 reporting

requirement will impose upon industry $2,500,000 in labor costs.

Previously, the Commission estimated the combined annual labor hours

for both forms to be 1,350 hours, which amounted to a total labor cost

to industry of $68,850 per annum.\843\ Therefore, the Commission is

increasing its net estimate of labor hours and costs associated with

existing Form 204 and Form 304 for collection 3038-0009 by 30,400 hours

and $3,700,000.\844\ The Commission requests comment with respect to

its estimates regarding the increased number of entities and additional

information required to file Forms 204 and 304.

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\843\ This estimate was based upon an average wage rate of $51

per hour. Adjusted to the hourly wage rate used for purposes of this

PRA estimate, the previous total labor cost would have been

$202,500.

\844\ The Commission notes that the burdens associated with

Forms 204 and 304 in collection 3038-0009 represent a fraction of

the total burden under that collection.

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Proposed Sec. 19.01(a)(4) adds an additional burden cost to

information collection 3038-0009 by requiring traders claiming

anticipatory exemptions to file Form 704 for the initial statement

pursuant to Sec. 150.7(d), the supplemental statement pursuant to

Sec. 150.7(e), and the annual update pursuant to Sec. 150.7(f), as

well as Form 204 monthly reporting the remaining unsold, unfilled and

other anticipated activity for the Specified Period in Form 704,

Section A. The Commission estimates that approximately 200 traders will

claim anticipatory exemptions every year an average of 10 times each.

At an estimated 20 labor hours to complete and file Form 704 for a

total annual burden to traders of 40,000 labor hours, the anticipatory

exemption filing requirement will cost industry an additional

$4,800,000 in labor costs. The Commission requests comment on its

estimates regarding new Form 704. In particular, the Commission

welcomes comment regarding the number of entities who may utilize the

anticipatory hedge exemption and the burden incurred to file Form 704.

4. Comments on Information Collection

The Commission invites the public and other federal agencies to

submit comments on any aspect of the reporting and recordkeeping

burdens discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the

Commission solicits comments in order to: (1) Evaluate

[[Page 75784]]

whether the proposed collections of information are necessary for the

proper performance of the functions of the Commission, including

whether the information will have practical utility; (2) evaluate the

accuracy of the Commission's estimate of the burden of the proposed

collections of information; (3) determine whether there are ways to

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

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

information on those who are to respond, including through the use of

automated collection techniques or other forms of information

technology. Comments may be submitted directly to the Office of

Information and Regulatory Affairs, by fax at (202) 395-6566 or by

email at [email protected] Please provide the Commission

with a copy of comments submitted so that all comments can be

summarized and addressed in the final rule preamble. Refer to the

Addresses section of this notice for comment submission instructions to

the Commission. A copy of the supporting statements for the collection

of information discussed above may be obtained by visiting RegInfo.gov.

OMB is required to make a decision concerning the collection of

information between 30 and 60 days after publication of this release.

Consequently, a comment to OMB is most assured of being fully

considered if received by OMB (and the Commission) within 30 days after

the publication of this notice of proposed rulemaking.

C. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') requires that Federal

agencies consider whether the rules they propose will have a

significant economic impact on a substantial number of small entities

and, if so, provide a regulatory flexibility analysis respecting the

impact.'' \845\ A regulatory flexibility analysis or certification

typically is required for ``any rule for which the agency publishes a

general notice of proposed rulemaking pursuant to'' the notice-and-

comment provisions of the Administrative Procedure Act, 5 U.S.C.

553(b).\846\ The requirements related to the proposed amendments fall

mainly on registered entities, exchanges, futures commission merchants,

swap dealers, clearing members, foreign brokers, and large traders.

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\845\ 5 U.S.C. 601 et seq.

\846\ 5 U.S.C. 601(2), 603-05.

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The Commission has previously determined that registered DCMs,

FCMs, SDs, MSPs, ECPs, SEFs, clearing members, foreign brokers and

large traders are not small entities for purposes of the RFA.\847\

While the requirements under the proposed rulemaking may impact non-

financial end users, the Commission notes that position limits levels

and filing requirements associated with bona fide hedging apply only to

large traders, while requirements to keep records supporting a

transaction's qualification for pass-through swap treatment incurs a

marginal burden that is mitigated through overlapping recordkeeping

requirements for reportable futures traders (current Sec. 18.05) and

reportable swap traders (current Sec. 20.6(b)); furthermore, these

records are ones that such entities maintain, as they would other

documents evidencing material financial relationships, in the ordinary

course of their businesses.

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\847\ See Policy Statement and Establishment of Definitions of

``Small Entities'' for Purposes of the Regulatory Flexibility Act,

47 FR 18618, 18619, Apr. 30, 1982 (DCMs, FCMs, and large traders)

(``RFA Small Entities Definitions''); Opting Out of Segregation, 66

FR 20740, 20743, Apr. 25, 2001 (ECPs); Position Limits for Futures

and Swaps; Final Rule and Interim Final Rule, 76 FR 71626, 71680,

Nov. 18, 2011 (clearing members); Core Principles and Other

Requirements for Swap Execution Facilities, 78 FR 33476, 33548, June

4, 2013 (SEFs); A New Regulatory Framework for Clearing

Organizations, 66 FR 45604, 45609, Aug. 29, 2001 (DCOs);

Registration of Swap Dealers and Major Swap Participants, 77 FR

2613, Jan. 19, 2012, (SDs and MSPs); and Special Calls, 72 FR 50209,

Aug. 31, 2007 (foreign brokers).

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Accord