e7-22992

[Federal Register: November 27, 2007 (Volume 72, Number 227)]

[Proposed Rules]

[Page 66097-66103]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr27no07-41]

=============================================================

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

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 150

RIN 3038-AC40

Risk Management Exemption From Federal Speculative Position

Limits

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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

SUMMARY: Section 150.2 of the Commodity Futures Trading Commission's

(``Commission'') regulations imposes limits on the size of speculative

positions that traders may hold or control in futures and futures

equivalent option contracts on certain designated agricultural

commodities named therein. Section 150.3 lists certain types of

positions that may be exempted from these Federal speculative position

limits. The Commission is proposing to provide an additional exemption

for ``risk management positions.'' A risk management position would be

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 upon either: A fiduciary

obligation to match or track the results of a broadly diversified index

that includes the same commodity markets in fundamentally the same

proportions as the futures or futures equivalent position; or a

portfolio diversification plan that has, among other substantial asset

classes, an exposure to a broadly diversified index that includes the

same commodity markets in fundamentally the same proportions as the

futures or futures equivalent position. The exemption would be subject

to conditions, including that the positions must be passively managed,

must be unleveraged, and may not be carried into the spot month.

DATES: Comments must be received on or before January 28, 2008.

ADDRESSES: Comments should be submitted to David Stawick, Secretary,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

Street, NW., Washington, DC 20581. Comments also may be sent by

facsimile to (202) 418-5521, or by electronic mail to

[email protected] Reference should be made to ``Proposed Risk

Management Exemption from Federal Speculative Position Limits.''

Comments may also be submitted by connecting to the Federal eRulemaking

Portal at http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.regulations.gov and following comment submission

instructions.

FOR FURTHER INFORMATION CONTACT: Donald Heitman, Senior Special

Counsel, Division of Market Oversight, Commodity Futures Trading

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

DC 20581, telephone (202) 418-5041, facsimile number (202) 418-5507,

electronic mail [email protected]; or John Fenton, Director of

Surveillance, Division of Market Oversight, telephone (202) 418-5298,

facsimile number (202) 418-5507, electronic mail [email protected]

SUPPLEMENTARY INFORMATION:

[[Page 66098]]

I. Background

A. Statutory Framework

Speculative position limits have been a tool for the regulation of

the U.S. futures markets since the adoption of the Commodity Exchange

Act of 1936. Section 4a(a) of the Commodity Exchange Act (``Act''), 7

U.S.C. 6a(a), states that:

Excessive 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 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.

Accordingly, section 4a(a) of the Act provides the Commission with

the authority to:

Fix such limits on the amounts of trading which may be done or

positions which may be held by any person under contracts of sale of

such commodity for future delivery on or subject to the rules of any

contract market or derivatives transaction execution facility as the

Commission finds are necessary to diminish, eliminate, or prevent

such burden.

This longstanding statutory framework providing for Federal

speculative position limits was supplemented with the passage of the

Futures Trading Act of 1982, which acknowledged the role of exchanges

in setting their own speculative position limits. The 1982 legislation

also provided, under section 4a(e) of the Act, that limits set by

exchanges and approved by the Commission were subject to Commission

enforcement.

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

established designation criteria and core principles with which a

designated contract market (``DCM'') must comply to receive and

maintain designation. Among these, Core Principle 5 in section 5(d) of

the Act states:

Position Limitations or Accountability--To reduce the potential

threat of market manipulation or congestion, especially during

trading in the delivery month, the board of trade shall adopt

position limitations or position accountability for speculators,

where necessary and appropriate.

B. Regulatory Framework

The regulatory structure based upon these statutory provisions

consists of three elements, the levels of the speculative position

limits, certain exemptions from the limits (for hedging, spreading/

arbitrage, and other positions), and the policy on aggregating commonly

owned or controlled accounts for purposes of applying the limits. This

regulatory structure is administered under a two-pronged framework.

Under the first prong, the Commission establishes and enforces

speculative position limits for futures contracts on a limited group of

agricultural commodities. These Federal limits are enumerated in

Commission regulation 150.2, and apply to the following futures and

option markets: Chicago Board of Trade (``CBOT'') corn, oats, soybeans,

wheat, soybean oil, and soybean meal; Minneapolis Grain Exchange

(``MGE'') hard red spring wheat and white wheat; ICE Futures U.S.

(formerly the New York Board of Trade) cotton No. 2; and Kansas City

Board of Trade (``KCBOT'') hard winter wheat. Under the second prong,

individual DCMs establish and enforce their own speculative position

limits or position accountability provisions (including exemption and

aggregation rules), subject to Commission oversight and separate

authority to enforce exchange-set speculative position limits approved

by the Commission. Thus, responsibility for enforcement of speculative

position limits is shared by the Commission and the DCMs.\1\

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

\1\ Provisions regarding the establishment of exchange-set

speculative position limits were originally set forth in CFTC

regulation 1.61. In 1999, the Commission simplified and reorganized

its rules by relocating the substance of regulation 1.61's

requirements to part 150 of the Commission's rules, thereby

incorporating within part 150 provisions for both Federal

speculative position limits and exchange-set speculative position

limits (see 64 FR 24038, May 5, 1999). 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, August 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. Section 4a(e) provides that a violation of a

speculative position limit set 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.

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

Commission regulation 150.3, ``Exemptions,'' lists certain types of

positions that may be exempted from (and thus may exceed) the Federal

speculative position limits. For example, under Sec. 150.3(a)(1), bona

fide hedging transactions, as defined in Sec. 1.3(z) of the

Commission's regulations, may exceed the limits. The Commission has

periodically amended the exemptive rules applicable to Federal

speculative position limits in response to changing conditions and

practices in futures markets. These amendments have included an

exemption from speculative position limits for the positions of multi-

advisor commodity pools and other similar entities that use independent

account controllers,\2\ and an amendment to extend the exemption for

positions that have a common owner but are independently controlled to

include certain commodity trading advisors.\3\ In 1987, the Commission

also issued an agency interpretation clarifying certain aspects of the

hedging definition.\4\ The Commission has also issued guidance with

respect to exchange speculative limits, including guidelines regarding

the exemption of risk-management positions from exchange-set

speculative position limits in financial futures contracts.\5\ However,

the last significant amendment to the Commission's exemptive rules was

implemented in 1991.

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

\2\ 53 FR 41563 (October 24, 1988).

\3\ 56 FR 14308 (April 9, 1991).

\4\ 52 FR 27195 (July 20, 1987).

\5\ 52 FR 34633 (September 14, 1987).

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

C. Changes in Trading Practices

The intervening 16 years have seen significant changes in trading

patterns and practices in derivatives markets, thus prompting the

Commission to reassess its policies regarding exemptions from the

Federal speculative position limits. These changes primarily involve

trading strategies and programs based on commodity indexes. In

particular, pension funds and other investors (including individual

investors participating in commodity index-based funds or trading

programs) have become interested in taking on commodity price exposure

as a way of diversifying portfolios that might otherwise be limited to

stocks and interest rate instruments. Financial research has shown that

the risk/return performance of a portfolio is improved by acquiring

uncorrelated or negatively correlated assets, and commodities

(including agricultural commodities) generally perform that role in a

portfolio of other financial assets.\6\

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

\6\ The argument has also been made that commodities act as a

general hedge of liability obligations that are linked to inflation.

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

The components of a commodity index-based investment might include

energy commodities, metals (both precious metals and industrial

metals), agricultural commodities that are subject to exchange limits

(including coffee, sugar, cocoa, and orange juice, as well as livestock

and meat), and those agricultural commodities named above that are

subject to Federal speculative position limits (grains, the soybean

complex and cotton). With respect to agricultural commodities subject

to Federal limits, the Commission has responded to various instances

where

[[Page 66099]]

index-based positions in such commodities exceed (or might grow to

exceed) the Federal speculative position limits. In certain cases, the

Commission has granted exemptive or no-action relief from Federal

speculative position limits. In granting such relief, the Commission

has included conditions to protect the market from the potential for

the sudden or unreasonable fluctuations or unwarranted changes in

prices that speculative limits are designed to prevent.

For example, in 1991, the Commission received a request from a

large commodity merchandising firm that engaged in commodity related

swaps \7\ as a part of a commercial line of business. The firm, through

an affiliate, wished to enter into an OTC swap transaction with a

qualified counterparty (a large pension fund) involving an index based

on the returns afforded by investments in exchange-traded futures

contracts on certain non-financial commodities meeting specified

criteria. The commodities making up the index included wheat, corn and

soybeans, all of which were (and still are) subject to Federal

speculative position limits. As a result of the swap, the swap dealing

firm would, in effect, be going short the index. In other words, it

would be required to make payments to the pension fund counterparty if

the value of the index was higher at the end of the swap payment period

than at the beginning. In order to hedge itself against this risk, the

swap dealer planned to establish a portfolio of long futures positions

in the commodities making up the index, in such amounts as would

replicate its exposure under the swap transaction. By design, the index

did not include contract months that had entered the delivery period

and the swap dealer, in replicating the index, stated that it would not

maintain futures positions based on index-related swap activity into

the spot month (when physical commodity markets are most vulnerable to

manipulation and attendant unreasonable price fluctuations). The result

of the hedge was that the composite return on the futures portfolio

would offset the net payments the swap dealer would be required to make

to the pension fund counterparty.

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

\7\ A swap is a privately negotiated exchange of one asset or

cash flow for another asset or cash flow. In a commodity swap, at

least one of the assets or cash flows is related to the price of one

or more commodities.

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

Because the futures positions the swap dealer would have to

establish to hedge its exposure on the swap transaction would be in

excess of the speculative position limits on wheat, corn and soybeans,

it requested, and was granted, a hedge exemption for those positions.

The swap transaction allowed the pension fund to add commodities

exposure to its portfolio indirectly, through the OTC trade with the

swap dealer--something it could have done directly, but only in a

limited fashion.\8\

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

\8\ The pension fund would have been limited in its ability to

take on this commodities exposure directly, by putting on the long

futures position itself, because the pension fund--having no

offsetting price risk incidental to commercial cash or spot

operations--would not have qualified for a hedge exemption with

respect to the position. (See Sec. 1.3(z) of the Commission's

regulations.)

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

Similar hedge exemptions were subsequently granted in other cases

where the futures positions clearly offset risks related to swaps or

similar OTC positions involving both individual commodities and

commodity indexes. These non-traditional hedges were all subject to

specific limitations to protect the marketplace from potential ill

effects. The limitations included: (1) The futures positions must

offset specific price risk; (2) the dollar value of the futures

positions would be no greater than the dollar value of the underlying

risk; and (3) the futures positions would not be carried into the spot

month.

The Commission's Division of Market Oversight (``Division'' or

``DMO'') has also recently issued two no-action letters involving

another type of index-based trading.\9\ Both cases involved trading

that offered investors the opportunity to participate in a broadly

diversified commodity index-based fund or program (``index fund''). The

futures positions of these index funds differed from the futures

positions taken by the swap dealers described above. The swap dealer

positions were taken to offset OTC swaps exposure that was directly

linked to the price of an index. For that reason, the Division granted

hedge exemptions to these swap dealer positions. On the other hand, in

the index fund positions described in the no-action letters, the price

exposure results from a promise or obligation to track an index, rather

than from holding an OTC swap position whose value is directly linked

to the price of the index. The Division believed that this difference

was significant enough that the index fund positions would not qualify

for a hedge exemption. Nevertheless, because the index fund positions

represented a legitimate and potentially useful investment strategy,

the Division granted the index funds no-action relief, subject to

certain conditions, described below, that were intended to protect the

futures markets from potential ill effects.

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

\9\ CFTC Letter 06-09 (April 19, 2006); CFTC Letter 06-19

(September 6, 2006).

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

II. Proposed Amendment

A. Introduction

In light of the changing trading practices and conditions described

above, the Commission is now considering whether to amend its Part 150

regulations to create a new exemption from Federal speculative position

limits. In addition to the above-described policy of granting index-

based hedge exemptions to swap dealers, which policy would remain in

effect, the proposal would create an additional risk management

exemption. That exemption would apply to positions held by: (1)

Intermediaries, such as index funds, who pass price risks on to their

customers; and (2) pension funds and other institutional investors

seeking to diversify risks in portfolios by including an allocation to

commodity exposure. As noted above, pension funds can already benefit

from a hedge exemption indirectly, by entering into an OTC position

with a swap dealer who, in turn, puts on an offsetting futures position

in reliance on the existing hedge exemption policy. The proposed rules

would allow a pension fund to receive an exemption directly, by putting

on a futures position itself pursuant to the new risk management

exemption provision.

In determining whether the new risk management exemption proposed

herein is appropriate, it is important to recall that the purpose of

position limits, as specified in Section 4a(a) of the Act, is to

diminish, eliminate, or prevent sudden or unreasonable fluctuations or

unwarranted changes in the prices of commodities. Within this

constraint, it is appropriate that the Commission (and the exchanges)

not unduly restrict trading activity. A position limit is a means to an

end, not an end in itself. Accordingly, to the extent that a type of

trading activity can be identified that is unlikely to cause sudden or

unreasonable fluctuations or unwarranted changes in prices, it is a

good candidate to qualify for an exemption from position limits.

Commodity index-based trading has characteristics that recommend it on

that score: (1) It is generally passively managed, so that positions

tend not to be changed based on market news or short-term price

volatility; (2) it is generally unleveraged, so that financial

considerations should not cause rapid liquidation of positions; and (3)

it is inherently diversified, in that futures positions are normally

held in many

[[Page 66100]]

different markets, and its purpose typically is to diversify a

portfolio containing assets with different risk profiles.

B. Conditions for the Exemption

To be eligible for an exemption as a ``risk management position''

under the proposed amendments to Part 150, a futures position would

need to comply with several conditions designed to protect the futures

markets from sudden or unreasonable fluctuations or unwarranted changes

in prices. First, Sec. 150.3(a) would be amended to add a requirement

that all positions subject to the exemptive provisions must be

``established and liquidated in an orderly manner.'' This requirement

already applies to the positions referred to in Sec. 150.3(a)(1),

which exempts bona fide hedging transactions, by virtue of similar

language appearing in the bona fide hedging definition (see Sec.

1.3(z)(1)). However, the proposed amendment would clarify that the same

requirement would apply not only to the risk management positions to be

exempted under proposed new Sec. 150.3(a)(2), but also to the spread

or arbitrage positions already exempted under current Sec. 150.3(a)(3)

and the positions carried in the separate account of an independent

account controller already exempted under current Sec. 150.3(a)(4).

Second, the proposed rules would define a ``risk management

position'' as a futures or futures equivalent position, held as part of

a broadly diversified portfolio of long-only or short-only \10\ futures

or futures equivalent \11\ positions, that is based upon either: (1) A

fiduciary obligation to match or track the results of a broadly

diversified index that includes the same commodity markets in

fundamentally the same proportions as the futures or futures equivalent

position; or (2) a portfolio diversification plan that has, among other

substantial asset classes, an exposure to a broadly diversified index

that includes the same commodity markets in fundamentally the same

proportions as the futures or futures equivalent position. The first of

these alternatives covers positions held by index funds, such as those

that were the subject of the Commission No-action letters discussed

above. The second alternative covers positions held directly by pension

funds and other institutional investors.

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

\10\ The long-only or short-only qualification would limit risk

management positions to positions offsetting either a long index or

portfolio or a short index or portfolio, and thus would not allow

for spread or straddle positions. With respect to short-only

positions, it should be noted that all the applications for index-

based trading relief received by the Commission to date, whether for

hedge exemptions or no-action relief, have involved long-only

futures positions. However, the proposed rules would also provide

for an entity that might offer investors a ``bear market index.''

Such an index would require the offeror to be long opposite its

customers. It would, therefore, need to offset that exposure with

short futures positions.

\11\ For example, a long call option combined with a short put

option is equivalent to a long futures contract.

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

A ``broadly diversified index'' would be defined to limit the

weighting of certain agricultural commodities in the index so that

commodities subject to Federal speculative position limits would not

comprise a disproportionate share of the index. Thus, a ``broadly

diversified index'' would mean an index based on physical commodities

in which: (1) not more than 15% of the index is composed of any single

agricultural commodity named in Sec. 150.2 (for which purposes, wheat

shall be regarded as a single commodity, so that positions in all

varieties of wheat, on all exchanges, combined, may not exceed 15% of

the index, and the soybean complex shall likewise be regarded as a

single commodity, so that positions in soybeans, soybean oil and

soybean meal, on all exchanges combined, may not exceed 15% of the

index); and (2) not more than 50% of the index as a whole is composed

of agricultural commodities named in Sec. 150.2. The Commission

believes that a narrowly based index could be used to evade speculative

position limits. For example, the grains all tend to have similar risk

profiles--i.e, they tend to respond similarly to common market factors,

such as weather. Therefore, the Commission is concerned that an index

composed, for example, of 25% each of corn, wheat, oats and soybeans--

rather than constituting a means of portfolio diversification--could

operate as a mechanism for evading speculative position limits in one

or more of those commodities.

Third, the positions subject to the exemption must be passively

managed. The proposed rules would define a ``passively managed

position'' as a futures or futures equivalent position that is part of

a portfolio that tracks a broadly diversified index, which index is

calculated, adjusted, and re-weighted pursuant to an objective,

predetermined mathematical formula the application of which allows only

limited discretion with respect to trading decisions. This definition

contemplates a certain limited amount of discretion in the manner in

which the futures position tracks the underlying index. For example,

index funds generally provide rules or standards for periodically re-

weighting the index to account for price changes in the commodities

that make up the index, or readjusting the composition of the index to

account for changing economic or market factors. Such discretion would

be permissible. However, the definition contemplates that the position

holder's discretion would not extend to frequently or arbitrarily

changing the composition of the index or the weighting of the

commodities in the index. Such actions would indicate that the position

was being actively managed with a view to taking advantage of short-

term market trends. The definition also contemplates that the position

holder could exercise some discretion as to when to roll futures

positions forward into the next delivery month without violating the

``passively managed'' requirement (provided no positions were carried

into the spot month). The Commission believes that limited discretion

as to when a position must be rolled forward can mitigate the market

impact that might otherwise result from large positions being rolled

forward on a pre-determined date and, consequently, help to avoid

liquidity problems.

Fourth, the futures trading undertaken pursuant to the exemption

must be unleveraged. An unleveraged position would be defined as a

futures or futures equivalent position that is part of a portfolio of

futures or futures equivalent positions directly relating to an

underlying broadly diversified index, the notional value of which

positions does not exceed the sum of the value of: (1) Cash set aside

in an identifiable manner, or unencumbered short-term U.S. Treasury

obligations so set aside, plus any funds deposited as margin on such

position; and (2) accrued profits on such position held at the futures

commission merchant. Because the futures positions would be fully

offset by cash or profits on such positions, financial considerations

(e.g., significant price changes) should not cause rapid liquidation of

positions, which can cause sudden or unreasonable fluctuations or

unwarranted changes in prices.

Finally, positions may not be carried into the spot month, a period

during which physical commodity markets are particularly vulnerable to

manipulations, squeezes and sudden or unreasonable fluctuations or

unwarranted changes in prices.

Entities intending to hold risk management positions pursuant to

the exemption in Sec. 150.3(a)(2) would be required to apply to the

Commission and receive Commission approval in order to receive an

exemption. The applicant would be required to provide the following

information:

[[Page 66101]]

Application for a Risk Management Exemption as Defined in Sec.

150.1(j)

1. Initial application materials:

A. For an exemption related to a ``fiduciary obligation''.

A description of the underlying index or group of

commodities, including the commodities, the weightings, the method and

timing of re-weightings, the selection of futures months, and the

timing and criteria for rolling from one futures month to another;

A description of the ``fiduciary obligation;''

The actual or anticipated value of the underlying funds to

be invested in commodities within the next fiscal or calendar year and

the method for calculating that value, as well as the equivalent

numbers of futures contracts in each of the Sec. 150.2 markets for

which the exemption is sought;

A description of the manner in which the funds to be

invested in commodities will be set aside;

A statement certifying that the requirements of this

exemption are met and will be observed at all times going forward and

that the Commission will be notified promptly of any material changes

in this information; and

Such other information as the Commission may request.

B. For an exemption based upon a ``portfolio diversification

plan''.

A description of the investment index or group of

commodities, including the commodities, the weightings, the method and

timing of re-weightings, the selection of futures months, and the

timing and criteria for rolling from one futures month to another;

A description of the entire portfolio, including the total

size of the assets, the asset classes making up the portfolio, and a

description of the allocation among the asset classes;

The actual or anticipated value of the underlying funds to

be invested in commodities and the method for calculating that value,

as well as the equivalent numbers of futures contracts in each of the

Sec. 150.2 markets for which the exemption is sought;

A description of the manner in which the funds to be

invested in commodities will be set aside;

A statement certifying that the requirements of this

exemption are met and will be observed at all times going forward and

that the Commission will be notified promptly of any material changes

in this information; and

Such other information as the Commission may request.

2. Supplemental Material: Whenever the purchases or sales that a

person wishes to qualify under this risk management exemption shall

exceed the amount provided in the person's most recent filing pursuant

to this section, or the amount previously specified by the Commission

pursuant to this section, such person shall file with the Commission a

statement that updates the information provided in the person's most

recent filing and provides the reasons for this change. Such statement

shall be filed at least ten business days in advance of the date that

such person wishes to exceed those amounts and if the notice filer is

not notified otherwise by the Commission within the 10-day period, the

exemption will continue to be effective. The Commission may, upon call,

obtain such additional materials from the applicant or person availing

themselves of this exemption as the Commission deems necessary to

exercise due diligence with respect to granting and monitoring this

exemption.

Entities holding risk management positions pursuant to the

exemption in Sec. 150.3(a)(2) would also be required to immediately

report to the Commission in the event they know, or have reason to

know,\12\ that any person holds a greater than 25% interest in such

position. The reason for this requirement is to alert the Commission to

the possibility that an individual might be attempting to use the

exemption as a means of avoiding otherwise applicable speculative

position limits.

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

\12\ The Commission understands that not every entity that might

qualify for this exemption would necessarily know the identities of

all of the participants in the position. For example, a fund based

on a commodity index may qualify for the exemption but the entity

operating the fund may not know the identities of the owners of

outstanding shares and, therefore, may not know when any given

person had acquired a 25% or more interest in the position held by

the fund.

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

C. Questions

The Commission would welcome public comments on any aspect of the

proposed risk management exemption from Federal speculative position

limits. However, the Commission is particularly interested in the views

of commenters on the following specific questions:

(1) Are any of the proposed conditions for receiving a risk

management exemption unnecessary and, if so, why? Alternatively, should

any of the proposed conditions be modified and, if so, why?

(2) Should any other conditions, in addition to those set out in

these proposed rules, be imposed as a prerequisite for receiving a risk

management exemption? If so, what is the rationale for such additional

conditions (i.e., what potential harm would they address)?

(3) Is there any type of index-based trading that should be covered

by the proposed rules, but is not? If so, how should the proposed rules

be revised to apply to such trading?

(4) The proposed rules would allow for a risk management exemption

in the case of short-only futures or futures equivalent positions used

to manage risks in connection with a ``bear market index.'' Would any

of the exemptive rules, as proposed, create potential problems as

applied to such an index? For example, in applying the definition of

``unleveraged position,'' would problems be encountered in comparing

the notional value of an unleveraged short futures position to the

value of the cash, margins and accrued profits on such position?

(5) Should the proposed rules impose any restrictions or conditions

regarding how broad- or narrow-based an index should be if a position

based on the index is to qualify for an exemption? For example, with

respect to narrow-based indices reflecting specific industry or

commodity sectors, should the Commission be concerned that a narrow-

based index composed entirely of agricultural commodities--for example,

25% each of corn, wheat, oats and soybeans--could operate as a

mechanism for evading speculative position limits in one or more of

those commodities?

(6) The proposed rules list the information that must be provided

in an application for a risk management exemption. Are the requirements

set out in the proposed rules appropriate? Should the requirements be

revised and, if so, how?

III. Related Matters

A. Cost Benefit Analysis

Section 15(a) of the Act requires the Commission to consider the

costs and benefits of its action before issuing a new regulation under

the Act. By its terms, section 15(a) does not require the Commission to

quantify the costs and benefits of a new regulation or to determine

whether the benefits of the proposed regulation outweigh its costs.

Rather, section 15(a) requires the Commission to ``consider the costs

and benefits'' of the subject rule.

Section 15(a) further specifies that the costs and benefits of the

proposed rule 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;

[[Page 66102]]

(4) sound risk management practices; and (5) other public interest

considerations. The Commission may, in its discretion, give greater

weight to any one of the five enumerated areas of concern and may, in

its discretion, determine that, notwithstanding its costs, a particular

rule is necessary or appropriate to protect the public interest or to

effectuate any of the provisions or to accomplish any of the purposes

of the Act.

The proposed rules would provide for a risk management exemption

from the Federal speculative position limits applicable to certain

agricultural commodities, thus giving entities such as index funds and

pension funds an opportunity to more effectively manage risks for their

investors through greater diversification of their portfolios. The

rules would seek to protect the futures markets from potential ill

effects of such risk management positions by imposing conditions on the

exemption and creating an application process (including a requirement

to file updates as necessary) to assure those conditions are met. The

Commission, in proposing these rules, has endeavored to impose the

minimum requirements necessary consistent with its mandate to protect

the markets and the public from ill effects.

The Commission specifically invites public comment on its

application of the cost benefits criteria of the Act. Commenters are

also invited to submit any quantifiable data that they may have

concerning the costs and benefits of the proposed rules with their

comment letter.

B. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,

requires Federal agencies, in proposing rules, to consider the impact

of those rules on small businesses. The Commission believes that the

proposed rule amendments to implement a new exemption from Federal

speculative position limits would only affect large traders. The

Commission has previously determined that large traders are not small

entities for the purposes of the RFA.\13\ Therefore, the Chairman, on

behalf of the Commission, hereby certifies, pursuant to 5 U.S.C.

605(b), that the action taken herein will not have a significant

economic impact on a substantial number of small entities.

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

\13\ 47 FR 18618 (April 30, 1982).

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

C. Paperwork Reduction Act

When publishing proposed rules, the Paperwork Reduction Act of 1995

(44 U.S.C. 3507(d)) imposes certain requirements on Federal agencies

(including the Commission) in connection with their conducting or

sponsoring any collection of information as defined by the Paperwork

Reduction Act. In compliance with the Act, the Commission, through this

rule proposal, solicits comment to: (1) Evaluate whether the proposed

collection of information is necessary for the proper performance of

the functions of the agency, including the validity of the methodology

and assumptions used; (2) evaluate the accuracy of the agency's

estimate of the burden of the proposed collection of information

including the validity of the methodology and assumptions used; (3)

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

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

information on those who are to respond through the use of appropriate

automated, electronic, mechanical, or other technological collection

techniques or other forms of information technology, e.g., permitting

electronic submission of responses.

The Commission has submitted the proposed rule and its associated

information collection requirements to the Office of Management and

Budget (``OMB'') for its review.

Collection of Information: Rules Establishing Risk Management

Exemption From Federal Speculative Position Limits, OMB Control Number.

The estimated burden was calculated as follows:

Estimated number of respondents: 6.

Annual responses by each respondent: 1.

Total annual responses: 6.

Estimated average hours per response: 10.

Annual reporting burden: 60 hours.

List of Subjects in 17 CFR Part 150

Agricultural commodities, Bona fide hedge positions, Position

limits, Spread exemptions.

In consideration of the foregoing, pursuant to the authority

contained in the Commodity Exchange Act, the Commission hereby proposes

to amend part 150 of chapter I of title 17 of the Code of Federal

Regulations as follows:

PART 150--LIMITS ON POSITIONS

1. The authority citation for part 150 is revised to read as

follows:

Authority: 7 U.S.C. 6a, 6c, and 12a(5), as amended by the

Commodity Futures Modernization Act of 2000, Appendix E of Pub. L.

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

2. Section 150.1 is amended by adding new paragraphs (j) through

(m) to read as follows:

Sec. 150.1 Definitions.

* * * * *

(j) Risk management position, for the purposes of an exemption

under Sec. 150.3(a)(2), means 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

upon either:

(1) A fiduciary obligation to match or track the results of a

broadly diversified index that includes the same commodity markets in

fundamentally the same proportions as the futures or futures equivalent

position; or

(2) A portfolio diversification plan that has, among other

substantial asset classes, an exposure to a broadly diversified index

that includes the same commodity markets in fundamentally the same

proportions as the futures or futures equivalent position.

(k) Broadly diversified index means an index based on physical

commodities in which:

(1) Not more than 15% of the index is composed of any single

agricultural commodity named in Sec. 150.2 (for which purposes, wheat

shall be regarded as a single commodity, so that positions in all

varieties of wheat, on all exchanges combined, may not exceed 15% of

the index, and the soybean complex shall be regarded as a single

commodity, so that positions in soybeans, soybean oil and soybean meal,

on all exchanges combined, may not exceed 15% of the index); and

(2) Not more than 50% of the index as a whole is composed of

agricultural commodities named in Sec. 150.2.

(l) Passively managed position means a futures or futures

equivalent position that is part of a portfolio that tracks a broadly

diversified index, which index is calculated, adjusted, and re-weighted

pursuant to an objective, predetermined mathematical formula the

application of which allows only limited discretion with respect to

trading decisions.

(m) Unleveraged position means:

(1) A futures or futures equivalent position that is part of a

portfolio of futures or futures equivalent positions directly relating

to an underlying broadly diversified index, the notional value of which

positions does not exceed the sum of the value of:

(i) Cash set aside in an identifiable manner, or unencumbered

short-term U.S. Treasury obligations so set aside, plus any funds

deposited as margin on such position; and

[[Page 66103]]

(ii) Accrued profits on such position held at the futures

commission merchant.

(2) [Reserved]

3. Section 150.3 is amended by revising paragraph (a) introductory

text, adding a new paragraph (a)(2), and adding a new paragraph (c) to

read as follows:

Sec. 150.3 Exemptions.

(a) Positions which may exceed limits. The position limits set

forth in Sec. 150.2 of this part may be exceeded to the extent such

positions are established and liquidated in an orderly manner and are:

* * * * *

(2) Risk management positions, as defined in Sec. 150.1(j), that

fulfill the following requirements:

(i) Such risk management positions must comply with the following

conditions:

(A) The positions must be passively managed;

(B) The positions must be unleveraged; and

(C) The positions must not be carried into the spot month.

(ii) Entities intending to hold risk management positions pursuant

to the exemption in Sec. 150.3(a)(2) must apply to the Commission and

receive Commission approval. Such applications must include the

following information:

(A) In the case of an exemption based on a fiduciary obligation, as

described in Sec. 150.1(j)(1), an application must include:

(1) A description of the underlying index or group of commodities,

including the commodities, the weightings, the method and timing of re-

weightings, the selection of futures months, and the timing and

criteria for rolling from one futures month to another;

(2) A description of the ``fiduciary obligation;''

(3) The actual or anticipated value of the underlying funds to be

invested in commodities within the next fiscal or calendar year and the

method for calculating that value, as well as the equivalent numbers of

futures contracts in each of the Sec. 150.2 markets for which the

exemption is sought;

(4) A description of the manner in which the funds to be invested

in commodities will be set aside;

(5) A statement certifying that the requirements of this exemption

are met and will be observed at all times going forward and that the

Commission will be notified promptly of any material changes in this

information; and

(6) Such other information as the Commission may request.

(B) In the case of an exemption based on a portfolio

diversification plan, as described in Sec. 150.1(j)(2), an application

must include:

(1) A description of the investment index or group of commodities,

including the commodities, the weightings, the method and timing of re-

weightings, the selection of futures months, and the timing and

criteria for rolling from one futures month to another;

(2) A description of the entire portfolio, including the total size

of the assets, the asset classes making up the portfolio, and a

description of the allocation among the asset classes;

(3) The actual or anticipated value of the underlying funds to be

invested in commodities and the method for calculating that value, as

well as the equivalent numbers of futures contracts in each of the

Sec. 150.2 markets for which the exemption is sought;

(4) A description of the manner in which the funds to be invested

in commodities will be set aside;

(5) A statement certifying that the requirements of this exemption

are met and will be observed at all times going forward and that the

Commission will be notified promptly of any material changes in this

information; and

(6) Such other information as the Commission may request.

(iii) Whenever the purchases or sales that a person wishes to

qualify under this risk management exemption shall exceed the amount

provided in the person's most recent filing pursuant to this section,

or the amount previously specified by the Commission pursuant to this

section, such person shall file with the Commission a statement that

updates the information provided in the person's most recent filing and

provides the reasons for this change. Such statement shall be filed at

least ten business days in advance of the date that such person wishes

to exceed those amounts and if the notice filer is not notified

otherwise by the Commission within the 10-day period, the exemption

will continue to be effective. The Commission may, upon call, obtain

such additional materials from the applicant or person availing

themselves of this exemption as the Commission deems necessary to

exercise due diligence with respect to granting and monitoring this

exemption.

(iv) Entities holding risk management positions pursuant to the

exemption in Sec. 150.3(a)(2) shall immediately report to the

Commission in the event that they know, or have reason to know, that

any person holds a greater than 25% interest in such position.

* * * * *

(c) The Commission hereby delegates, until such time as the

Commission orders otherwise, to the Director of the Division of Market

Oversight, or the Director's designee, the functions reserved to the

Commission in Sec. 150.3(a)(2) of this chapter.

Issued by the Commission this 20th day of November, 2007, in

Washington, DC.

David Stawick,

Secretary of the Commission.

[FR Doc. E7-22992 Filed 11-26-07; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: November 27, 2007