2020-02320
Federal Register, Volume 85 Issue 39 (Thursday, February 27, 2020)
[Federal Register Volume 85, Number 39 (Thursday, February 27, 2020)]
[Proposed Rules]
[Pages 11596-11744]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-02320]
[[Page 11595]]
Vol. 85
Thursday,
No. 39
February 27, 2020
Part III
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. 85 , No. 39 / Thursday, February 27, 2020 /
Proposed Rules
[[Page 11596]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 15, 17, 19, 40, 140, 150, and 151
RIN 3038-AD99
Position Limits for Derivatives
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing amendments to 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''). Among other amendments,
the Commission proposes new and amended federal spot month limits for
25 physical commodity derivatives; amended single month and all-months-
combined limits for most of the agricultural contracts currently
subject to federal limits; new and amended definitions for use
throughout the position limits regulations, including a revised
definition of ``bona fide hedging transactions or positions'' and a new
definition of ``economically equivalent swaps''; amended rules
governing exchange-set limit levels and grants of exemptions therefrom;
a new streamlined process for bona fide hedging recognitions for
purposes of federal limits; new enumerated hedges; and amendments to
certain regulatory provisions that would eliminate Form 204, enabling
the Commission to leverage cash-market reporting submitted directly to
the exchanges.
DATES: Comments must be received on or before April 29, 2020.
ADDRESSES: You may submit comments, identified by ``Position Limits for
Derivatives'' and RIN 3038-AD99, by any of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, be
accompanied by an English translation. Comments will be posted as
received to https://comments.cftc.gov. You should submit only
information that you wish to make available publicly. If you wish the
Commission to consider information that you believe is exempt from
disclosure under the Freedom of Information Act (``FOIA''), a petition
for confidential treatment of the exempt information may be submitted
according to the procedures established in Sec. 145.9 of the
Commission's regulations.\1\
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\1\ 17 CFR 145.9.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse, or remove any or all
submissions from https://comments.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
FOIA.
FOR FURTHER INFORMATION CONTACT: Aaron Brodsky, Senior Special Counsel,
(202) 418-5349, [email protected]; Steven Benton, Industry Economist,
(202) 418-5617, [email protected]; Jeanette Curtis, Special Counsel,
(202) 418-5669, [email protected]; Steven Haidar, Special Counsel, (202)
418-5611, [email protected]; Harold Hild, Policy Advisor, 202-418-5376,
[email protected]; or Lillian Cardona, Special Counsel, (202) 418-5012,
[email protected]; Division of Market Oversight, in each case at the
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Introduction
B. Executive Summary
C. Summary of Proposed Amendments
D. The Commission Preliminarily Construes CEA Section 4a(a) To
Require the Commission To Make a Necessity Finding Before
Establishing Position Limits for Physical Commodities Other Than
Excluded Commodities
II. Proposed Rules
A. Sec. 150.1--Definitions
B. Sec. 150.2--Federal Limit Levels
C. Sec. 150.3--Exemptions From Federal Position Limits
D. Sec. 150.5--Exchange-Set Position Limits and Exemptions
Therefrom
E. Sec. 150.6--Scope
F. Sec. 150.8--Severability
G. Sec. 150.9--Process for Recognizing Non-Enumerated Bona Fide
Hedging Transactions or Positions With Respect to Federal
Speculative Position Limits
H. Part 19 and Related Provisions--Reporting of Cash-Market
Positions
I. Removal of Part 151
III. Legal Matters
A. Introduction
B. Key Statutory Provisions
C. Ambiguity of Section 4a With Respect to Necessity Finding
D. Resolution of Ambiguity
E. Evaluation of Considerations Relied Upon by the Commission in
Previous Interpretation of Paragraph 4a(a)(2)
F. Necessity Finding
G. Request for Comment
IV. Related Matters
A. Cost-Benefit Considerations
B. Paperwork Reduction Act
C. Regulatory Flexibility Act
D. Antitrust Considerations
I. Background
A. Introduction
The Commission has long established and enforced speculative
position limits for futures and options on futures contracts on various
agricultural commodities as authorized by the CEA.\2\ The existing part
150 position limits regulations \3\ include three components: (1) The
level of the limits, which currently apply to nine agricultural
commodity derivatives contracts and set a maximum that restricts the
number of speculative positions that a person may hold in the spot
month, individual month, and all-months-combined; \4\ (2) exemptions
for positions that constitute bona fide hedges and for certain other
types of transactions; \5\ and (3) regulations to determine which
accounts and positions a person must aggregate for the purpose of
determining compliance with the position limit levels.\6\ The existing
federal speculative position limits function in parallel to exchange-
set limits required by
[[Page 11597]]
designated contract market (``DCM'') Core Principle 5.\7\ Certain
contracts are thus subject to both federal and DCM-set limits, whereas
others are subject only to DCM-set limits and/or position
accountability.
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\2\ 7 U.S.C. 1 et seq.
\3\ 17 CFR part 150. Part 150 of the Commission's regulations
establishes federal position limits (that is, position limits
established by the Commission, as opposed to exchange-set limits) on
nine agricultural contracts. Agricultural contracts refers 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
currently includes nine contracts: CBOT Corn (and Mini-Corn) (C),
CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT Wheat
(and Mini-Wheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal (SM),
MGEX Hard Red Spring Wheat (MWE), CBOT KC Hard Red Winter Wheat
(KW), and ICE Cotton No. 2 (CT). See 17 CFR 150.2. The position
limits on these agricultural contracts are referred to as ``legacy''
limits because these contracts have been subject to federal position
limits for decades.
\4\ See 17 CFR 150.2.
\5\ See 17 CFR 150.3.
\6\ See 17 CFR 150.4.
\7\ 7 U.S.C. 7(d)(5); 17 CFR 38.300.
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As part of the Dodd-Frank Act, Congress amended the CEA's position
limits provisions, which, since 1936, have authorized the Commission
(and its predecessor) to impose limits on speculative positions to
prevent the harms caused by excessive speculation. As discussed below,
the Commission interprets these amendments as, among other things,
tasking the Commission with establishing such position limits as it
finds are ``necessary'' for the purpose of ``diminishing, eliminating,
or preventing'' ``[e]xcessive speculation . . . causing sudden or
unreasonable fluctuations or unwarranted changes in . . . price . . .''
\8\ The Commission also interprets these amendments as tasking the
Commission with establishing position limits on any ``economically
equivalent'' swaps.\9\
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\8\ 7 U.S.C. 6a(a)(1); see infra Section III.F. (discussion of
the necessity finding).
\9\ 7 U.S.C. 6a(a)(5).
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The Commission previously issued proposed and final rules in 2011
to implement the provisions of the Dodd-Frank Act regarding position
limits and the bona fide hedge definition.\10\ A September 28, 2012
order of the U.S. District Court for the District of Columbia vacated
the 2011 Final Rulemaking, with the exception of the rule's amendments
to 17 CFR 150.2.\11\
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\10\ Position Limits for Derivatives, 76 FR 4752 (Jan. 26,
2011); Position Limits for Futures and Swaps, 76 FR 71626 (Nov. 18,
2011) (``2011 Final Rulemaking'').
\11\ Int'l Swaps & Derivatives Ass'n v. U.S. Commodity Futures
Trading Comm'n, 887 F. Supp. 2d 259 (D.D.C. 2012) (``ISDA'').
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Subsequently, the Commission proposed position limits regulations
in 2013 (``2013 Proposal''), June of 2016 (``2016 Supplemental
Proposal''), and again in December of 2016 (``2016 Reproposal'').\12\
The 2016 Reproposal would have amended part 150 to, among other things:
establish federal position limits for 25 physical commodity futures
contracts and for ``economically equivalent'' futures, options on
futures, and swaps; revise the existing exemptions from such limits,
including for bona fide hedges; and establish a framework for exchanges
\13\ to recognize certain positions as bona fide hedges, and thus
exempt from position limits.
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\12\ Position Limits for Derivatives, 78 FR 75680 (Dec. 12,
2013) (2013 Proposal); Position Limits for Derivatives: Certain
Exemptions and Guidance, 81 FR 38458 (June 13, 2016) (2016
Supplemental Proposal); and Position Limits for Derivatives, 81 FR
96704 (Dec. 30, 2016) (2016 Reproposal).
\13\ Unless indicated otherwise, the use of the term
``exchanges'' throughout this proposal refers to DCMs and Swap
Execution Facilities.
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To date, the Commission has not issued any final rulemaking based
on the 2013 Proposal, 2016 Supplemental Proposal, or 2016 Reproposal.
The 2016 Reproposal generally addressed comments received in response
to those prior rulemakings. In a companion proposed rulemaking, the
CFTC also proposed, and later adopted in 2016, amendments to rules
governing aggregation of positions for purposes of compliance with
federal position limits.\14\ These aggregation rules currently apply
only to the nine agricultural contracts subject to existing federal
limits, and going forward would apply to the commodities that would be
subject to federal limits under this release.
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\14\ Aggregation of Positions, 81 FR 91454 (Dec. 16, 2016)
(``Final Aggregation Rulemaking''); see 17 CFR 150.4. Under the
Final Aggregation Rulemaking, unless an exemption applies, a
person's positions must be aggregated with positions for which the
person controls trading or for which the person holds a 10 percent
or greater ownership interest. The Division of Market Oversight has
issued time-limited no-action relief from some of the aggregation
requirements contained in that rulemaking. See CFTC Letter No. 19-19
(July 31, 2019), available at https://www.cftc.gov/csl/19-19/download.
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After reconsidering the prior proposals, including reviewing the
comments responding thereto, the Commission is withdrawing from further
consideration the 2013 Proposal, the 2016 Supplemental Proposal, and
the 2016 Reproposal.\15\
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\15\ Because the earlier proposals are withdrawn, comments on
them will not be part of the administrative record with respect to
the current proposal, except where expressly referenced herein.
Commenters should resubmit comments relevant to the subject
proposal; commenters who wish to reference prior comment letters
should cite those prior comment letters as specifically as possible.
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Instead, the Commission is now issuing a new proposal (``2020
Proposal''). The 2020 Proposal is intended to (1) recognize differences
across commodities and contracts, including differences in commercial
hedging and cash-market reporting practices; (2) focus on derivatives
contracts that are critical to price discovery and distribution of the
underlying commodity such that the burden of excessive speculation in
the derivatives contract may have a particularly acute impact on
interstate commerce for that commodity; and (3) reduce duplication and
inefficiency by leveraging existing expertise and processes at DCMs.
For these general reasons, discussed in turn below, the Commission
proposes new regulations, rather than finalizing the 2016
Reproposal.\16\
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\16\ The specific proposed new regulations are discussed in
detail later in this release.
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First, the Commission preliminarily believes that any position
limits regime must take into account differences across commodity and
contract types. The existing federal position limits regulations apply
only to nine contracts, all of which are physically-settled futures on
agricultural commodities. Limits on these commodities have been in
place for decades, as have the federal program for exemptions from
these limits and the federal rules governing DCM-set limits on such
commodities. The existing framework is largely a historical remnant of
an approach that predates cash-settled futures contracts, let alone
swaps, institutional-investor interest in commodity indexes, and highly
liquid energy markets. Congress has tasked the Commission with:
Establishing such limits as it finds are ``necessary'' for the purpose
of preventing the burdens associated with excessive speculation causing
sudden or unreasonable fluctuations or unwarranted changes in price;
and establishing limits on swaps that are ``economically equivalent''
to certain futures contracts. The Commission has preliminarily
determined that an approach that is flexible enough to accommodate
potential future, unpredictable developments in commercial hedging
practices would be well-suited for the current derivatives markets by
accommodating differences in commodity types, contract specifications,
hedging practices, cash-market trading practices, organizational
structures of hedging participants, and liquidity profiles of
individual markets.
The Commission proposes to build this flexibility into several
parts of the proposed regulations, including: Exchange-set limits and/
or accountability, rather than federal limits, outside of the spot
month for referenced contracts based on commodities other than the nine
legacy agricultural commodities; the ability for exchanges to use more
than one formula when setting their own limit levels; an updated
formula for federal non-spot month levels on the nine legacy
agricultural contracts that is calibrated to recently observed trading
activity; a bona fide hedging definition that is broad enough to
accommodate common commercial hedging practices, including anticipatory
hedging practices such as anticipatory merchandising; a broader range
of exchange-granted recognitions for purposes of federal and
[[Page 11598]]
exchange-set limits that are in line with common commercial hedging
practices; the elimination of a restriction for purposes of federal
limits on holding positions during the last trading days of the spot
month; and broader discretion for market participants to measure risk
in the manner most suitable for their business.
Second, the proposal establishes limits on a limited set of
commodities for which the Commission preliminarily finds that
speculative position limits are necessary.\17\ As described below, this
necessity finding is based on a combination of factors including: The
particular importance of these contracts in the price discovery process
for their respective underlying commodities, the fact that they require
physical delivery of the underlying commodity, and, in some cases, the
commodities' particular importance to the national economy and
especially acute economic burdens on interstate commerce that would
arise from excessive speculation causing sudden or unreasonable
fluctuations or unwarranted changes in the price of the commodities
underlying these contracts.\18\
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\17\ See infra Section III.F.
\18\ See infra Section III.F.1.
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Third, the Commission preliminarily believes that there is an
opportunity for greater collaboration between the Commission and the
exchanges within the statutorily created parallel federal and exchange-
set position limit regimes. Given the exchanges' self-regulatory
responsibilities, resources, deep knowledge of their markets and
trading practices, close interactions with market participants,
existing programs for addressing exemption requests, and ability to
generally act more quickly than the Commission, the Commission
preliminarily believes that cooperation between the Commission and the
exchanges on position limits should not only be continued, but
enhanced. For example, exchanges are particularly well-positioned to
provide the Commission with estimates of deliverable supply, to
recommend limit levels for the Commission's consideration, and to help
administer the program for recognizing bona fide hedges. Further, given
that the Commission is proposing to require exchanges to collect, and
provide to the Commission upon request, cash-market information from
market participants requesting bona fide hedges, the Commission also
proposes to eliminate Form 204, which market participants with bona
fide hedging positions in excess of limits currently file each month
with the Commission to demonstrate cash-market positions justifying
such overages. The Commission preliminarily believes that enhanced
collaboration will maintain the Commission's access to information and
result in a more efficient administrative process, in part by reducing
duplication of efforts. The Commission invites comments on all aspects
of this rulemaking.
B. Executive Summary
This executive summary provides an overview of the key components
of this proposal. The summary only highlights certain aspects of the
proposed regulations and generally uses shorthand to summarize complex
topics. The executive summary is neither intended to be a comprehensive
recitation of the proposal nor intended to supplement, modify, or
replace any interpretive or other language contained herein. Section II
of this release includes a more detailed and comprehensive discussion
of all of the proposed regulations, and Section V includes the actual
regulations.
1. Contracts Subject to Federal Speculative Position Limits
Federal speculative position limits would apply to ``referenced
contracts,'' which include: (a) 25 ``core referenced futures
contracts;'' (b) futures and options directly or indirectly linked to a
core referenced futures contract; and (c) ``economically equivalent
swaps.''
a. Core Referenced Futures Contracts
Federal speculative position limits would apply to the following 25
physically-settled core referenced futures contracts:
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\19\ While the Commission is proposing federal non-spot month
limits only for the nine legacy agricultural core referenced futures
contracts, exchanges would be required to establish, consistent with
Commission standards set forth in this proposal, exchange-set
position limits and/or position accountability levels in the non-
spot months for the non-legacy agricultural, metals, and energy core
referenced futures contracts.
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Non-legacy
Legacy agricultural (federal agricultural Metals (federal
limits during and outside (federal limits only limits only during
the spot month) during the spot the spot month)
month) 19
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CBOT Corn (C)............... CBOT Rough Rice (RR) COMEX Gold (GC).
CBOT Oats (O)............... ICE Cocoa (CC)...... COMEX Silver (SI)
CBOT Soybeans (S)........... ICE Coffee C (KC)... COMEX Copper (HG).
CBOT Wheat (W).............. ICE FCOJ-A (OJ)..... NYMEX Platinum (PL).
CBOT Soybean Oil (SO)....... ICE U.S. Sugar No. NYMEX Palladium
11 (SB). (PA).
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CBOT Soybean Meal (SM)...... ICE U.S. Sugar No. Energy
16 (SF). (federal limits only
during the spot
month)
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MGEX Hard Red Spring Wheat CME Live Cattle (LC) NYMEX Henry Hub
(MWE). Natural Gas (NG).
ICE Cotton No. 2 (CT)....... NYMEX Light Sweet
Crude Oil (CL).
CBOT KC Hard Red Winter NYMEX New York
Wheat (KW). Harbor ULSD Heating
Oil (HO).
NYMEX New York
Harbor RBOB
Gasoline (RB).
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b. Futures and Options on Futures Linked to a Core Referenced Futures
Contract
Referenced contracts would also include futures and options on
futures that are directly or indirectly linked to the price of a core
referenced futures contract or to the same commodity underlying the
applicable core referenced futures contract for delivery at the same
location as specified in that core referenced futures contract.
Referenced contracts, however, would not include location basis
contracts, commodity index contracts, swap guarantees, and trade
options that meet certain requirements.
[[Page 11599]]
c. Economically Equivalent Swaps
Referenced contracts would also include economically equivalent
swaps, which would be defined as swaps with ``identical material''
contractual specifications, terms, and conditions to a referenced
contract. Swaps in commodities other than natural gas that have
identical material specifications, terms, and conditions to a
referenced contract, but differences in lot size specifications,
notional amounts, or delivery dates diverging by less than one calendar
day, would still be deemed economically equivalent swaps. Natural gas
swaps that have identical material specifications, terms, and
conditions to a referenced contract, but differences in lot size
specifications, notional amounts, or delivery dates diverging by less
than two calendar days, would still be deemed economically equivalent
swaps.
2. Federal Limit Levels During the Spot Month
Federal spot month limits would apply to referenced contracts on
all 25 core referenced futures contracts. The following proposed spot
month limit levels, summarized in the table below, are set at or below
25 percent of deliverable supply, as estimated using recent data
provided by the DCM listing the core referenced futures contract, and
verified by the Commission. The proposed spot month limits would apply
on a futures-equivalent basis based on the size of the unit of trading
of the relevant core referenced futures contract, and would apply
``separately'' to physically-settled and cash-settled referenced
contracts. Therefore, a market participant could net positions across
physically-settled referenced contracts, and separately could net
positions across cash-settled referenced contracts, but would not be
permitted to net cash-settled referenced contracts with physically-
settled referenced contracts.
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\20\ The proposed federal spot month limit for Live Cattle would
feature a step-down limit similar to the CME's existing Live Cattle
step-down exchange set limit. The proposed federal spot month step-
down limit is: (1) 600 at the close of trading on the first business
day following the first Friday of the contract month; (2) 300 at the
close of trading on the business day prior to the last five trading
days of the contract month; and (3) 200 at the close of trading on
the business day prior to the last two trading days of the contract
month.
\21\ The proposed federal spot month limit for Light Sweet Crude
Oil would feature the following step-down limit: (1) 6,000 contracts
as of the close of trading three business days prior to the last
trading day of the contract; (2) 5,000 contracts as of the close of
trading two business days prior to the last trading day of the
contract; and (3) 4,000 contracts as of the close of trading one
business day prior to the last trading day of the contract.
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Existing exchange-
Core referenced futures contract 2020 Proposed spot Existing federal set spot month
month limit spot month limit limit
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Legacy Agricultural Contracts
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CBOT Corn (C).................................... 1,200 600 600
CBOT Oats (O).................................... 600 600 600
CBOT Soybeans (S)................................ 1,200 600 600
CBOT Soybean Meal (SM)........................... 1,500 720 720
CBOT Soybean Oil (SO)............................ 1,100 540 540
CBOT Wheat (W)................................... 1,200 600 600/500/400/300/220
CBOT KC Hard Red Winter Wheat (KW)............... 1,200 600 600
MGEX Hard Red Spring Wheat (MWE)................. 1,200 600 600
ICE Cotton No. 2 (CT)............................ 1,800 300 300
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Other Agricultural Contracts
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CME Live Cattle (LC)............................. 20 600/300/200 n/a 450/300/200
CBOT Rough Rice (RR)............................. 800 n/a 600/200/250
ICE Cocoa (CC)................................... 4,900 n/a 1,000
ICE Coffee C (KC)................................ 1,700 n/a 500
ICE FCOJ-A (OJ).................................. 2,200 n/a 300
ICE U.S. Sugar No. 11 (SB)....................... 25,800 n/a 5,000
ICE U.S. Sugar No. 16 (SF)....................... 6,400 n/a n/a
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Metals Contracts
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COMEX Gold (GC).................................. 6,000 n/a 3,000
COMEX Silver (SI)................................ 3,000 n/a 1,500
COMEX Copper (HG)................................ 1,000 n/a 1,500
NYMEX Platinum (PL).............................. 500 n/a 500
NYMEX Palladium (PA)............................. 50 n/a 50
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Energy Contracts
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NYMEX Henry Hub Natural Gas (NG)................. 2,000 n/a 1,000
NYMEX Light Sweet Crude Oil (CL)................. 21 6,000/5,000/ n/a 3,000
4,000
NYMEX New York Harbor ULSD Heating Oil (HO)...... 2,000 n/a 1,000
NYMEX New York Harbor RBOB Gasoline (RB)......... 2,000 n/a 1,000
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3. Federal Limit Levels Outside of the Spot Month
Federal limits outside of the spot month would apply only to
referenced contracts based on the nine legacy agricultural commodities
subject to existing federal limits. All other referenced contracts
subject to federal limits would be subject to federal limits only
during the spot month, as specified above, and otherwise would only be
subject to exchange-set limits and/or position accountability levels
outside of the spot month.
[[Page 11600]]
The following proposed non-spot month limit levels, summarized in
the table below, are set at 10 percent of open interest for the first
50,000 contracts, with an incremental increase of 2.5 percent of open
interest thereafter, and would apply on a futures-equivalent basis
based on the size of the unit of trading of the relevant core
referenced futures contract:
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2020 Proposed Existing federal Existing exchange-
single month and single month and set single month
Core referenced futures contract all-months all-months- and all-months-
combined limit combined limit combined limit
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CBOT Corn (C).......................................... 57,800 33,000 33,000
CBOT Oats (O).......................................... 2,000 2,000 2,000
CBOT Soybean (S)....................................... 27,300 15,000 15,000
CBOT Soybean Meal (SM)................................. 16,900 6,500 6,500
CBOT Soybean Oil (SO).................................. 17,400 8,000 8,000
CBOT Wheat (W)......................................... 19,300 12,000 12,000
CBOT KC HRW Wheat (KW)................................. 12,000 12,000 12,000
MGEX HRS Wheat (MWE)................................... 12,000 12,000 12,000
ICE Cotton No. 2 (CT).................................. 11,900 5,000 5,000
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4. Exchange-Set Limits and Exemptions Therefrom
a. Contracts Subject to Federal Limits
An exchange that lists a contract subject to federal limits, as
specified above, would be required to set its own limits for such
contracts at a level that is no higher than the federal level.
Exchanges would be allowed to grant exemptions from their own limits,
provided the exemption does not subvert the federal limits
framework.\22\
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\22\ In addition, as explained further below, exchanges may
choose to participate in the Commission's new proposed streamlined
process for reviewing bona fide hedge exemption applications for
purposes of federal limits.
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b. Physical Commodity Contracts Not Subject to Federal Limits
For physical commodity contracts not subject to federal limits, an
exchange would generally be required to set spot month limits no
greater than 25 percent of deliverable supply, but would have
flexibility to submit other approaches for review by the Commission,
provided the approach results in spot month levels that are ``necessary
and appropriate to reduce the potential threat of market manipulation
or price distortion of the contract's or the underlying commodity's
price or index'' and complies with all other applicable regulations.
Outside of the spot month, such an exchange would have additional
flexibility to set either position limits or position accountability
levels, provided the levels are ``necessary and appropriate to reduce
the potential threat of market manipulation or price distortion of the
contract's or the underlying commodity's price or index.'' Non-
exclusive Acceptable Practices would provide several examples of
formulas that the Commission has determined would meet this standard,
but an exchange would have the flexibility to develop other approaches.
Exchanges would be provided flexibility to grant a variety of
exemption types, provided that the exchange must take into account
whether the exemption would result in a position that would not be in
accord with ``sound commercial practices'' in the market for which the
exchange is considering the application, and/or would ``exceed an
amount that may be established and liquidated in an orderly fashion in
that market.''
5. Limits on ``Pre-Existing Positions''
Certain ``Pre-Existing Positions'' that were entered into prior to
the effective date of final position limits rules would not be subject
to federal limits. Both ``Pre-Enactment Swaps,'' which are swaps
entered into prior to the Dodd-Frank Act whose terms have not expired,
and ``Transition Period Swaps,'' which are swaps entered into between
July 22, 2010 and 60 days after the publication of final position
limits rules, would not be subject to federal limits. All other ``Pre-
Existing Positions'' that are acquired in good faith prior to the
effective date of final position limits rules would be subject to
federal limits during, but not outside, the spot month.
6. Substantive Standards for Exemptions From Federal Limits
a. Bona Fide Hedge Recognition
Hedging transactions or positions may continue to exceed federal
limits if they satisfy all three elements of the ``general'' bona fide
hedging definition: (1) The hedge represents a substitute for
transactions or positions made at a later time in a physical marketing
channel (``temporary substitute test''); (2) the hedge is economically
appropriate to the reduction of risks in the conduct and management of
a commercial enterprise (``economically appropriate test''); and (3)
the hedge arises from the potential change in value of actual or
anticipated assets, liabilities, or services (``change in value
requirement''). The Commission proposes several changes to the existing
bona fide hedging definition, including those described immediately
below, and also proposes a streamlined process for granting bona fide
hedge recognitions, described further below.
First, for referenced contracts based on the 25 core referenced
futures contracts listed in Sec. 150.2(d), the Commission would expand
the current list of enumerated bona fide hedges to cover additional
hedging practices included in the 2016 Reproposal, as well as hedges of
anticipated merchandising.\23\ Persons who hold a bona fide hedging
transaction or position in accordance with Sec. 150.1 in referenced
contracts based on one of the 25 core referenced futures contracts and
whose hedging practice is included in the list of enumerated hedges in
Appendix A of part 150 would not be required to request prior approval
from
[[Page 11601]]
the Commission to hold such bona fide hedge position. That is, such
exemptions would be self-effectuating for purposes of federal
speculative position limits, so a person would only be required to
request the bona fide hedge exemption from the relevant exchange for
purposes of exchange-set limits. Transactions or positions that do not
fit within one of the enumerated hedges could still be recognized as a
bona fide hedge, provided the Commission, or an exchange subject to
Commission oversight, recognizes the position as such using one of the
processes described below. The Commission would be open to adopting
additional enumerated hedges as it becomes more comfortable with
evolving hedging practices, particularly in the energy space, and
provided the practices comply with the general bona fide hedging
definition.
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\23\ The existing definition of ``bona fide hedging transactions
and positions'' enumerates the following hedging transactions: (1)
Hedges of inventory and cash commodity fixed-price purchase
contracts under 1.3(z)(2)(i)(A); (2) hedges of unsold anticipated
production under 1.3(z)(2)(i)(B); (3) hedges of cash commodity
fixed-price sales contracts under 1.3(z)(2)(ii)(A); (4) certain
cross-commodity hedges under 1.3(z)(2)(ii)(B); (5) hedges of
unfilled anticipated requirements under 1.3(z)(2)(ii)(C) and (6)
hedges of offsetting unfixed price cash commodity sales and
purchases under 1.3(z)(2)(iii). The following additional hedging
practices are not enumerated in the existing regulation, but are
included as enumerated hedges in the 2020 Proposal: (1) Hedges by
agents; (2) hedges of anticipated royalties; (3) hedges of services;
(4) offsets of commodity trade options; and (5) hedges of
anticipated merchandising.
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Second, the Commission is clarifying its position on whether and
when market participants may measure risk on a gross basis rather than
on a net basis in order to provide market participants with greater
flexibility. Instead of only being permitted to hedge on a ``net
basis'' except in a narrow set of circumstances, market participants
would also now be able to hedge positions on a ``gross basis'' in
certain circumstances, provided that the participant has done so over
time in a consistent manner and is not doing so to evade the federal
limits.
Third, market participants would have additional leeway to hold
bona fide hedging positions in excess of limits during the last five
days of the spot period (or during the time period for the spot month
if less than five days). The proposal would not include such a
restriction for purposes of federal limits, and would make clear that
exchanges continue to have the discretion to adopt such restrictions
for purposes of exchange-set limits. The proposal would also include
flexible guidance on the circumstances under which exchanges may waive
any such limitation for purposes of their own limits.
Finally, the proposal would modify the ``temporary substitute
test'' to require that a bona fide hedging transaction or position in a
physical commodity must always, and not just normally, be connected to
the production, sale, or use of a physical cash-market commodity.
Therefore, a market participant would generally no longer be allowed to
treat positions entered into for ``risk management purposes'' \24\ as a
bona fide hedge, unless the position qualifies as either (i) an offset
of a pass-through swap, where the offset reduces price risk attendant
to a pass-through swap executed opposite a counterparty for whom the
swap qualifies as a bona fide hedge; or (ii) a ``swap offset,'' where
the offset is used by a counterparty to reduce price risk attendant to
a swap that qualifies as a bona fide hedge and that was previously
entered into by that counterparty.
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\24\ The phrase ``risk management'' as used in this instance
refers to derivatives positions, typically held by a swap dealer,
used to offset a swap position, such as a commodity index swap, with
another entity for which that swap is not a bona fide hedge.
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b. Spread Exemption
Transactions or positions may also continue to exceed federal
limits if they qualify as a ``spread transaction,'' which includes the
following common types of spreads: Calendar spreads, inter-commodity
spreads, quality differential spreads, processing spreads (such as
energy ``crack'' or soybean ``crush'' spreads), product or by-product
differential spreads, or futures-option spreads. Spread exemptions may
be granted using the process described below.
c. Financial Distress Exemption
This exemption would allow a market participant to exceed federal
limits if necessary to take on the positions and associated risk of
another market participant during a potential default or bankruptcy
situation. This exemption would be available on a case-by-case basis,
depending on the facts and circumstances involved.
d. Conditional Spot Month Limit Exemption in Natural Gas
The rules would allow market participants with cash-settled
positions in natural gas to exceed the proposed 2,000 contract spot
month limit, provided that the participant exits its spot month
positions in the New York Mercantile Exchange (``NYMEX'') Henry Hub
(NG) physically-settled natural gas contracts, and provided further
that the participant's position in cash-settled natural gas contracts
does not exceed 10,000 NYMEX Henry Hub Natural Gas (NG) equivalent-size
natural gas contracts per DCM that lists a natural gas referenced
contract. Such market participants would be permitted to hold an
additional 10,000 contracts in cash-settled natural gas economically
equivalent swaps.
7. Process for Requesting Bona Fide Hedge Recognitions and Spread
Exemptions
a. Self-Effectuating Enumerated Bona Fide Hedges
For referenced contracts based on any core referenced futures
contract listed in Sec. 150.2(d), bona fide hedge recognitions for
positions that fall within one of the proposed enumerated hedges,
including the proposed anticipatory enumerated hedges, would be self-
effectuating for purposes of federal limits, provided the market
participant separately applies to the relevant exchange for an
exemption from exchange-set limits. Such market participants would no
longer be required to file Form 204/304 with the Commission on a
monthly basis to demonstrate cash-market positions justifying position
limit overages. Instead, the Commission would have access to cash-
market information such market participants submit as part of their
application to an exchange for an exemption from exchanges-set limits,
typically filed on an annual basis.
b. Bona Fide Hedges That Are Not Self-Effectuating
The Commission will consider adding to the proposed list of
enumerated hedges at a later time once the Commission becomes more
familiar with common commercial hedging practices for referenced
contracts subject to federal position limits. Until that time, all bona
fide hedging recognitions that are not enumerated in Appendix A of part
150 would be granted pursuant to one of the proposed processes for
requesting a non-enumerated bona fide hedge recognition, as explained
below.
A market participant seeking to exceed federal limits for a non-
enumerated bona fide hedging transaction or position would be able to
choose whether to apply directly to the Commission or, alternatively,
apply to the applicable exchange using a new proposed streamlined
process. If applying directly to the Commission, the market participant
would also have to separately apply to the relevant exchange for relief
from exchange-set position limits. If applying to an exchange using the
new proposed streamlined process, a market participant would be able to
file an application with an exchange, generally at least annually,
which would be valid both for purposes of federal and exchange-set
limits. Under this streamlined process, if the exchange determines to
grant a non-enumerated bona fide hedge recognition for purposes of its
exchange-set limits, the
[[Page 11602]]
exchange must notify the Commission and the applicant simultaneously.
Then, 10 business days (or two business days in the case of sudden or
unforeseen bona fide hedging needs) after the exchange issues such a
determination, the market participant could rely on the exchange's
determination for purposes of federal limits unless the Commission (and
not staff) notifies the market participant otherwise. After the 10
business days expire, the bona fide hedge exemption would be valid both
for purposes of federal and exchange position limits and the market
participant would be able to take on a position that exceeds federal
position limits. Under this streamlined process, during the 10 business
day review period, any rejection of an exchange determination would
require Commission action. Further, if, for purposes of federal
position limits, the Commission determines to reject an application for
exemption, the applicant would not be subject to any position limits
violation during the period of the Commission's review nor once the
Commission has issued its rejection, provided the person reduces the
position within a commercially reasonable amount of time, as
applicable.
Under the proposal, positions that do not fall within one of the
enumerated hedges could thus still be recognized as bona fide hedges,
provided the exchange deems the position to comply with the general
bona fide hedging definition, and provided that the Commission does not
object to such a hedge within the ten-day (or two-day, as appropriate)
window.
Requests and approvals to exceed limits would generally have to be
obtained in advance of taking on the position, but the proposed rule
would allow market participants with sudden or unforeseen hedging needs
to file a request for a bona fide hedge exemption within five business
days of exceeding the limit. If the Commission rejects the application,
the market participant would not be subject to a position limit
violation, provided the participant reduces its position within a
commercially reasonable amount of time.
Among other changes, market participants would also no longer be
required to file Form 204/304 with the Commission on a monthly basis to
demonstrate cash-market positions justifying position limit overages.
c. Spread Exemptions
For referenced contracts on any commodity, spread exemptions would
be self-effectuating for purposes of federal limits, provided that the
position: Falls within one of the categories set forth in the proposed
``spread transaction'' definition,\25\ and provided further that the
market participant separately applies to the applicable exchange for an
exemption from exchange-set limits.
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\25\ The categories are: Calendar spreads, inter-commodity
spreads, quality differential spreads, processing spreads (such as
energy ``crack'' or soybean ``crush'' spreads), product or by-
product differential spreads, and futures-option spreads.
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Market participants with a spread position that does not fit within
the ``spread transaction'' definition with respect to any of the
commodities subject to the proposed federal limits may apply directly
to the Commission, and must also separately apply to the applicable
exchange.
8. Comment Period and Compliance Date
The public may comment on these rules during a 90-day period that
starts after this proposal has been approved by the Commission. Market
participants and exchanges would be required to comply with any
position limit rules finalized from herein no later than 365 days after
publication in the Federal Register.
C. Summary of Proposed Amendments
The Commission is proposing revisions to Sec. Sec. 150.1, 150.2,
150.3, 150.5, and 150.6 and to parts 1, 15, 17, 19, 40, and 140, as
well as the addition of Sec. Sec. 150.8, 150.9, and Appendices A-F to
part 150.\26\ Most noteworthy, the Commission proposes the following
amendments to the foregoing rule sections, each of which, along with
all other proposed changes, is discussed in greater detail in Section
II of this release. The following summary is not intended to provide a
substantive overview of this proposal, but rather is intended to
provide a guide to the rule sections that address each topic. Please
see the executive summary above for an overview of this proposal
organized by topic, rather than by section number.
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\26\ This 2020 Proposal does not propose to amend current Sec.
150.4 dealing with aggregation of positions for purposes of
compliance with federal position limits. Section 150.4 was amended
in 2016 in a prior rulemaking. See Final Aggregation Rulemaking, 81
FR at 91454.
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The Commission preliminarily finds that federal
speculative position limits are necessary for 25 core referenced
futures contracts and proposes federal limits on physically-settled and
linked cash-settled futures, options on futures, and ``economically
equivalent'' swaps for such commodities. The 25 core referenced futures
contracts would include the nine ``legacy'' agricultural contracts
currently subject to federal limits and 16 additional non-legacy
contracts, which would include: seven additional agricultural
contracts, four energy contracts, and five metals contracts.\27\
Federal spot and non-spot month limits would apply to the nine
``legacy'' agricultural contracts currently subject to federal
limits,\28\ and only federal spot month limits would apply to the
additional 16 non-legacy contracts. Outside of the spot month, these 16
non-legacy contracts would be subject to exchange-set limits and/or
accountability levels if listed on an exchange.
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\27\ The seven additional agricultural contracts that would be
subject to federal spot month limits are CME Live Cattle (LC), CBOT
Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ-A (OJ),
ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF). The four
energy contracts that would be subject to federal spot month limits
are: NYMEX Light Sweet Crude Oil (CL), NYMEX New York Harbor ULSD
Heating Oil (HO), NYMEX New York Harbor RBOB Gasoline (RB), and
NYMEX Henry Hub Natural Gas (NG). The five metals contracts that
would be subject to federal spot month limits are: COMEX Gold (GC),
COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium (PA), and
NYMEX Platinum (PL). As discussed below, any contracts for which the
Commission is proposing federal limits only during the spot month
would be subject to exchange-set limits and/or accountability
outside of the spot month.
\28\ The Commission currently sets and enforces speculative
position limits with respect to certain enumerated agricultural
products. 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. These agricultural products consist of the
following nine currently traded contracts: CBOT Corn (and Mini-Corn)
(C), CBOT Oats (O), CBOT Soybeans (and Mini-Soybeans) (S), CBOT
Wheat (and Mini-Wheat) (W), CBOT Soybean Oil (SO), CBOT Soybean Meal
(SM), MGEX HRS Wheat (MWE), CBOT KC HRW Wheat (KW), and ICE Cotton
No. 2 (CT). See 17 CFR 150.2.
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Amendments to Sec. 150.1 would add or revise several
definitions for use throughout part 150, including: new definitions of
the terms ``core referenced futures contract'' (pertaining to the 25
physically-settled futures contracts explicitly listed in the
regulations) and ``referenced contract'' (pertaining to contracts that
have certain direct and/or indirect linkages to the core referenced
futures contracts, and to ``economically equivalent swaps'') to be used
as shorthand to refer to contracts subject to federal limits; a
``spread transaction'' definition; and a definition of ``bona fide
hedging transactions or positions'' that is broad enough to accommodate
hedging practices in a variety of contract types, including hedging
practices that may develop over time.
Amendments to Sec. 150.2 would list the 25 core
referenced futures contracts which, along with any associated
referenced contracts, would be subject
[[Page 11603]]
to federal limits; and specify the proposed federal spot and non-spot
month limit levels. Federal spot month limit levels would be set at or
below 25 percent of deliverable supply, whereas federal non-spot month
limit levels would be set at 10 percent of open interest for the first
50,000 contracts of open interest, with an incremental increase of 2.5
percent of open interest thereafter.
Amendments to Sec. 150.3 would specify the types of
positions for which exemptions from federal position limit requirements
may be granted, and would set forth and/or reference the processes for
requesting such exemptions, including recognitions of bona fide hedges
and exemptions for spread positions, financial distress positions,
certain natural gas positions held during the spot month, and pre-
enactment and transition period swaps. For all contracts subject to
federal limits, bona fide hedge exemptions listed in Appendix A to part
150 as an enumerated bona fide hedge would be self-effectuating for
purposes of federal limits. For non-enumerated hedges, market
participants must request approval in advance of taking a position that
exceeds the federal position limit, except in the case of sudden or
unforeseen hedging needs.
Amendments to Sec. 150.5 would refine the process, and
establish non-exclusive methodologies, by which exchanges may set
exchange-level limits and grant exemptions therefrom with respect to
futures and options on futures, including separate methodologies for
contracts subject to federal limits and physical commodity derivatives
not subject to federal limits.\29\ While the Commission will oversee
compliance with federal position limits on swaps, amended Sec. 150.5
would not apply to exchanges with respect to swaps until a later time
once exchanges have access to sufficient data to monitor compliance
with limits on swaps across exchanges.
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\29\ Proposed Sec. 150.5 addresses exchange-set position limits
and exemptions therefrom, whereas proposed Sec. 150.3 addresses
exemptions from federal limits, and proposed Sec. 150.9 addresses
federal limits and acceptance of exchange-granted bona fide hedging
recognitions for purposes of federal limits. Exchange rules
typically refer to ``exemptions'' in connection with bona fide
hedging and spread positions, whereas the Commission uses the
nomenclature ``recognition'' with respect to bona fide hedges, and
``exemption'' with respect to spreads.
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New Sec. 150.9 would establish a streamlined process for
addressing requests for bona fide hedging recognitions for purposes of
federal limits, leveraging off exchange expertise and resources while
affording the Commission an opportunity to intervene as-needed. This
process would be used by market participants with non-enumerated
positions. Under the proposed rule, market participants could provide
one application for a bona fide hedge to a designated contract market
or swap execution facility, as applicable, and receive approval of such
request for purposes of both exchange-set limits and federal limits.
New Appendix A to part 150 would contain enumerated
hedges, some of which appear in the definition of bona fide hedging
transactions and positions in current Sec. 1.3, which would be
examples of positions that would comply with the proposed bona fide
hedging definition. As the enumerated hedges would be examples of bona
fide hedging positions, positions that do not fall within any of the
enumerated hedges could still potentially be recognized as bona fide
hedging positions, provided the position otherwise complies with the
proposed bona fide hedging definition and all other applicable
requirements.
Amendments to part 19 and related provisions would
eliminate Form 204, enabling the Commission to leverage cash-market
reporting submitted directly to the exchanges under Sec. Sec. 150.5
and 150.9.
D. The Commission Preliminarily Construes CEA Section 4a(a) To Require
the Commission To Make a Necessity Finding Before Establishing Position
Limits for Physical Commodities Other Than Excluded Commodities
The Commission is required by ISDA to determine whether CEA section
4a(a)(2)(A) requires the Commission to find, before establishing a
position limit, that such limit is ``necessary.'' \30\ The provision
states in relevant part that ``the Commission shall'' establish
position limits ``as appropriate'' for contracts in physical
commodities other than excluded commodities ``[i]n accordance with the
standards set forth in'' the preexisting section 4a(a)(1).\31\ That
preexisting provision requires the Commission to establish position
limits as it ``finds are necessary to diminish, eliminate, or prevent''
certain enumerated burdens on interstate commerce.\32\ In the 2011
Final Rulemaking, the Commission interpreted this language as an
unambiguous mandate to establish position limits without first finding
that such limits are necessary, but with discretion to determine the
``appropriate'' levels for each.\33\ In ISDA, the U.S. District Court
for the District of Columbia disagreed and held that section
4a(a)(2)(A) is ambiguous as to whether the ``standards set forth in
paragraph (1)'' include the requirement of an antecedent finding that a
position limit is necessary.\34\ The court vacated the 2011 Final
Rulemaking and directed the Commission to apply its experience and
expertise to resolve that ambiguity.\35\ The Commission has done so and
preliminarily determines that section 4a(a)(2)(A) should be interpreted
to require that before establishing position limits, the Commission
must determine that limits are necessary.\36\ A full legal analysis is
set forth infra at Section III.F.
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\30\ ISDA, 887 F.Supp.2d at 259, 281.
\31\ 7 U.S.C. 6a(a)(2)(A).
\32\ 7 U.S.C. 6a(a)(1).
\33\ 2011 Final Rulemaking, 76 FR at 71626, 71627.
\34\ ISDA, 887 F.Supp.2d at 279-280.
\35\ Id. at 281.
\36\ See infra Section III.F.
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The Commission preliminarily finds that position limits are
necessary for the 25 core referenced futures contracts, and any
associated referenced contracts. This preliminary finding is based on a
combination of factors including: The particular importance of these
contracts in the price discovery process for their respective
underlying commodities, the fact that they require physical delivery of
the underlying commodity, and, in some cases, the commodities'
particular importance to the national economy and especially acute
economic burdens that would arise from excessive speculation causing
sudden or unreasonable fluctuations or unwarranted changes in the price
of the commodities underlying these contracts.
II. Proposed Rules
A. Sec. 150.1--Definitions
Definitions relevant to the existing position limits regime
currently appear in both Sec. Sec. 1.3 and 150.1 of the Commission's
regulations.\37\ The Commission proposes to update and supplement the
definitions in Sec. 150.1, including by moving a revised definition of
``bona fide hedging transactions and positions'' from Sec. 1.3 into
Sec. 150.1. The proposed changes are intended, among other things, to
conform the definitions to the Dodd-Frank Act amendments to the
CEA.\38\
[[Page 11604]]
Each proposed defined term is discussed in alphabetical order below.
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\37\ 17 CFR 1.3 and 150.1, respectively.
\38\ In addition to the amendments described below, the
Commission proposes to re-order the defined terms so that they
appear in alphabetical order, rather than in a lettered list, so
that terms can be more quickly located. Moving forward, any new
defined terms would be inserted in alphabetical order, as
recommended by the Office of the Federal Register. See Document
Drafting Handbook, Office of the Federal Register, National Archives
and Records Administration, 2-31 (Revision 5, Oct. 2, 2017)
(stating, ``[i]n sections or paragraphs containing only definitions,
we recommend that you do not use paragraph designations if you list
the terms in alphabetical order. Begin the definition paragraph with
the term that you are defining.'').
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1. ``Bona Fide Hedging Transactions or Positions''
a. Background
Under CEA section 4a(c)(1), position limits shall not apply to
transactions or positions that are ``shown to be bona fide hedging
transactions or positions, as such terms shall be defined by the
Commission . . . .'' \39\ The Dodd-Frank Act directed the Commission,
for purposes of implementing CEA section 4a(a)(2), to adopt a
definition consistent with CEA section 4a(c)(2).\40\ The current
definition of ``bona fide hedging transactions and positions,'' which
first appeared in Sec. 1.3 of the Commission's regulations in the
1970s,\41\ is inconsistent, in certain ways described below, with the
revised statutory definition in CEA section 4a(c)(2).
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\39\ 7 U.S.C. 6a(c)(1). While portions of the CEA and proposed
Sec. 150.1 respectively refer, and would refer, to the phrase
``bona fide hedging transactions or positions,'' the Commission may
use the phrases ``bona fide hedging position,'' ``bona fide hedging
definition,'' and ``bona fide hedge'' throughout this section of the
release as shorthand to refer to the same.
\40\ 7 U.S.C. 6a(c)(2).
\41\ See, e.g., Definition of Bona Fide Hedging and Related
Reporting Requirements, 42 FR 42748 (Aug. 24, 1977). Previously, the
Secretary of Agriculture, pursuant to section 404 of the Commodity
Futures Trading Commission Act of 1974 (Pub. L. 93-463), promulgated
a definition of bona fide hedging transactions and positions.
Hedging Definition, Reports, and Conforming Amendments, 40 FR 11560
(Mar. 12, 1975). That definition, largely reflecting the statutory
definition previously in effect, remained in effect until the newly-
established Commission defined that term. Id.
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Accordingly, and for the reasons outlined below, the Commission
proposes to remove the current bona fide hedging definition from Sec.
1.3 and replace it with an updated bona fide hedging definition that
would appear alongside all of the other position limits related
definitions in proposed Sec. 150.1.\42\ This definition would be
applied in determining whether a position is a bona fide hedge that may
exceed the proposed federal limits set forth in Sec. 150.2. The
Commission's current bona fide hedging definition is described
immediately below, followed by a discussion of the proposed new
definition. This section of the release describes the substantive
standards for bona fide hedges. The process for granting bona fide
hedge recognitions is discussed later in this release in connection
with proposed Sec. Sec. 150.3 and 150.9.\43\
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\42\ In a 2018 rulemaking, the Commission amended Sec. 1.3 to
replace the sub-paragraphs that had for years been identified with
an alphabetic designation for each defined term with an alphabetized
list. See Definitions, 83 FR 7979 (Feb. 23, 2018). The bona fide
hedging definition, therefore, is now a paragraph, located in
alphabetical order, in Sec. 1.3, rather than in Sec. 1.3(z).
Accordingly, for purposes of clarity and ease of discussion, when
discussing the Commission's current version of the bona fide hedging
definition, this release will refer to the bona fide hedging
definition in Sec. 1.3.
Further, the version of Sec. 1.3 that appears in the Code of
Federal Regulations applies only to excluded commodities and is not
the version of the bona fide hedging definition currently in effect.
The version currently in effect, the substance of which remains as
it was amended in 1987, applies to all commodities, not just to
excluded commodities. See Revision of Federal Speculative Position
Limits, 52 FR 38914 (Oct. 20, 1987). While the 2011 Final Rulemaking
amended the Sec. 1.3 bona fide hedging definition to apply only to
excluded commodities, that rulemaking was vacated, as noted
previously, by a September 28, 2012 order of the U.S. District Court
for the District of Columbia, with the exception of the rule's
amendments to 17 CFR 150.2. Although the 2011 Final Rulemaking was
vacated, the 2011 version of the bona fide hedging definition in
Sec. 1.3, which applied only to excluded commodities, has not yet
been formally removed from the Code of Federal Regulations. The
currently-in-effect version of the Commission's bona fide hedging
definition thus does not currently appear in the Code of Federal
Regulations. The closest to a ``current'' version of the definition
is the 2010 version of Sec. 1.3, which, while substantively
current, still includes the ``(z)'' denomination that was removed in
2018. The Commission proposes to address the need to formally remove
the incorrect version of the bona fide hedging definition as part of
this rulemaking.
\43\ See infra Section II.C.2. (discussion of proposed Sec.
150.3) and Section II.G.3. (discussion of proposed Sec. 150.9).
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b. The Commission's Existing Bona Fide Hedging Definition in Sec. 1.3
Paragraph (1) of the current bona fide hedging definition in Sec.
1.3 contains what is currently labeled the ``general'' bona fide
hedging definition, which has five key elements and requires that the
position must: (1) ``normally'' represent a substitute for transactions
or positions made at a later time in a physical marketing channel
(``temporary substitute test''); (2) be economically appropriate to the
reduction of risks in the conduct and management of a commercial
enterprise (``economically appropriate test''); (3) arise from the
potential change in value of actual or anticipated assets, liabilities,
or services (``change in value requirement''); (4) have a purpose to
offset price risks incidental to commercial cash or spot operations
(``incidental test''); and (5) be established and liquidated in an
orderly manner (``orderly trading requirement'').\44\
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\44\ 17 CFR 1.3.
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Additionally, paragraph (2) currently sets forth a non-exclusive
list of four categories of ``enumerated'' hedging transactions that are
included in the general bona fide hedging definition in paragraph (1).
Market participants thus need not seek recognition from the Commission
of such positions as bona fide hedges prior to exceeding limits for
such positions; rather, market participants must simply report any such
positions on the monthly Form 204, as required by part 19 of the
Commission's regulations.\45\ The four existing categories of
enumerated hedges are: (1) Hedges of ownership or fixed-price cash
commodity purchases and hedges of unsold anticipated production; (2)
hedges of fixed-price cash commodity sales and hedges of unfilled
anticipated requirements; (3) hedges of offsetting unfixed-price cash
commodity sales and purchases; and (4) cross-commodity hedges.\46\
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\45\ 17 CFR part 19.
\46\ 17 CFR 1.3.
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Paragraph (3) of the current bona fide hedging definition states
that the Commission may recognize non-enumerated bona fide hedging
transactions and positions pursuant to a specific request by a market
participant using the process described in Sec. 1.47 of the
Commission's regulations.\47\
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\47\ Id.
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c. Proposed Replacement of the Bona Fide Hedging Definition in Sec.
1.3 With a New Bona Fide Hedging Definition in Sec. 150.1
i. Background
The list of enumerated hedges found in paragraph (2) of the current
bona fide hedging definition in Sec. 1.3 was developed at a time when
only agricultural commodities were subject to federal limits, has not
been updated since 1987,\48\ and is likely too narrow to reflect common
commercial hedging practices, including for metal and energy contracts.
Numerous market and regulatory developments have taken place since
then, including, among other things, increased futures trading in the
metals and energy markets, the development of the swaps markets, and
the shift in trading from pits to electronic platforms. In addition,
the CFMA \49\ and Dodd-Frank Act introduced various regulatory reforms,
including the enactment of position limits core principles.\50\ The
Commission is thus proposing to update its bona fide hedging definition
to better conform to the current state of the law
[[Page 11605]]
and to better reflect market developments over time.
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\48\ See Revision of Federal Speculative Position Limits, 52 FR
38914 (Oct. 20, 1987).
\49\ Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (Dec. 21, 2000).
\50\ See 7 U.S.C. 7(d)(5) and 7 U.S.C. 7b-3(f)(6).
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While one option for doing so could be to expand the list of
enumerated hedges to encompass a larger array of hedging strategies,
the Commission does not view this alone to be a practical solution. It
would be difficult to maintain a list that captures all hedging
activity across commodity types, and any list would inherently fail to
take into account future changes in industry practices and other
developments. The Commission proposes to create a new bona fide hedging
definition in proposed Sec. 150.1 that would work in connection with
limits on a variety of commodity types and accommodate changing hedging
practices over time. The Commission proposes to couple this updated
definition with an expanded list of enumerated hedges. While positions
that fall within the proposed enumerated hedges, discussed below, would
be examples of positions that comply with the bona fide hedging
definition, they would certainly not be the only types of positions
that could be bona fide hedges. The proposed enumerated hedges are
intended to ensure that the framework proposed herein does not reduce
any clarity inherent in the existing framework; the proposed enumerated
hedges are in no way intended to limit the universe of hedging
practices that could otherwise be recognized as bona fide.
The Commission anticipates these proposed modifications would
provide a significant degree of flexibility to market participants in
terms of how they hedge, and to exchanges in terms of how they evaluate
transactions and positions for purposes of their position limit
programs, without sacrificing any of the clarity provided by the
existing bona fide hedging definition. Further, as described in detail
in connection with the discussion of proposed Sec. 150.9 later in this
release, the Commission anticipates that allowing the exchanges to
process applications for bona fide hedges for purposes of federal
limits would be significantly more efficient than the existing
processes for exchanges and the Commission.\51\ The Commission
discusses each element of the proposed bona fide hedging definition
below, followed by a discussion of the proposed enumerated hedges. The
Commission's intent with this proposal is to acknowledge to the
greatest extent possible, consistent with the statutory language,
existing bona fide hedging exemptions provided by exchanges.
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\51\ In this rulemaking, the Commission proposes to allow
qualifying exchanges to process requests for non-enumerated bona
fide hedge recognitions for purposes of federal limits. See infra
Section II.G.3. (discussion of proposed Sec. 150.9).
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ii. Proposed Bona Fide Hedging Definition for Physical Commodities
The Commission proposes to maintain the general elements currently
found in the bona fide hedging definition in Sec. 1.3 that conform to
the revised statutory bona fide hedging definition in CEA section
4a(c)(2), and proposes to eliminate the elements that do not. In
particular, the Commission proposes to include the updated versions of
the temporary substitute test, economically appropriate test, and
change in value requirements that are described below, and eliminate
the incidental test and orderly trading requirement, which are not
included in the revised statutory text. Each of these proposed changes
is described below.\52\
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\52\ Bona fide hedge recognition is determined based on the
particular circumstances of a position or transaction and is not
conferred on the basis of the involved market participant alone.
Accordingly, while a particular position may qualify as a bona fide
hedge for a given market participant, another position held by that
same participant may not. Similarly, if a participant holds
positions that are recognized as bona fide hedges, and holds other
positions that are speculative, only the speculative positions would
be subject to position limits.
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(1) Temporary Substitute Test
The language of the temporary substitute test that appears in the
Commission's existing bona fide hedging definition is inconsistent in
some ways with the language of the temporary substitute test that
currently appears in the statute. In particular, the bona fide hedging
definition in section 4a(c)(2)(A)(i) of the CEA currently provides,
among other things, that a bona fide hedging position ``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.'' \53\ The
Commission's definition currently provides that a bona fide hedging
position ``normally represent[s] a substitute for transactions to be
made or positions to be taken at a later time in a physical marketing
channel'' (emphasis added).\54\ The Dodd-Frank Act amended the
temporary substitute language that previously appeared in the statute
by removing the word ``normally'' from the phrase ``normally 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. . . .''
\55\ The Commission preliminarily interprets this change as reflecting
Congressional direction that a bona fide hedging position in physical
commodities must always (and not just ``normally'') be in connection
with the production, sale, or use of a physical cash-market
commodity.\56\
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\53\ 7 U.S.C. 6a(c)(2)(A)(i).
\54\ 17 CFR 1.3.
\55\ 7 U.S.C. 6a(c)(2)(A)(i).
\56\ Previously, the Commission stated that, among other things,
the inclusion of the word ``normally'' in connection with the pre-
Dodd-Frank Act version of the temporary substitute language
indicated that the bona fide hedging definition should not be
construed to apply only to firms using futures to reduce their
exposures to risks in the cash market, and that to qualify as a bona
fide hedge, a transaction in the futures market did not necessarily
need to be a temporary substitute for a later transaction in the
cash market. See Clarification of Certain Aspects of the Hedging
Definition, 52 FR 27195, 27196 (July 20, 1987). In other words, that
1987 interpretation took the view that a futures position could
still qualify as a bona fide hedging position even if it was not in
connection with the production, sale, or use of a physical
commodity.
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Accordingly, the Commission preliminarily interprets this change to
signal that the Commission should cease to recognize ``risk
management'' positions as bona fide hedges for physical commodities,
unless the position satisfies the pass-through swap/swap offset
requirements in section 4a(c)(2)(B) of the CEA, discussed further
below.\57\ In order to implement that statutory change, the Commission
proposes a narrower bona fide hedging definition for physical
commodities in proposed Sec. 150.1 that does not include the word
``normally'' currently found in the temporary substitute language in
paragraph (1) of the existing Sec. 1.3 bona fide hedging definition.
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\57\ 7 U.S.C. 6a(c)(2)(B). In connection with physical
commodities, the phrase ``risk management exemption'' has
historically been used by Commission staff to refer to non-
enumerated bona fide hedge recognitions granted under Sec. 1.47 to
allow swap dealers and others to hold agricultural futures positions
outside of the spot month in excess of federal limits in order to
offset commodity index swap or related exposure, typically opposite
an institutional investor for which the swap was not a bona fide
hedge. As described below, due to differences in statutory language,
the phrase ``risk management exemption'' often has a broader meaning
in connection with excluded commodities than with physical
commodities. See infra Section II.A.1.c.v. (discussion of proposed
pass-through language).
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The practical effect of conforming the temporary substitute test in
the regulation to the amended statutory provision would be to prevent
market participants from treating positions entered into for risk
management purposes as bona fide hedges for contracts subject to
federal limits, unless the position qualifies under the pass-through
swap provision in CEA section 4a(c)(2)(B).\58\ As noted above,
[[Page 11606]]
the Commission previously viewed positions in physical commodities,
entered into for risk management purposes to offset the risk of swaps
and other financial instruments and not as substitutes for transactions
or positions to be taken in a physical marketing channel, as bona fide
hedges. However, given the statutory change, positions that reduce the
risk of such swaps and financial instruments would no longer meet the
requirements for a bona fide hedging position under CEA section
4a(c)(2) and under proposed Sec. 150.1. As discussed below, any such
previously-granted risk management exemptions would generally no longer
apply after the effective date of the speculative position limits
proposed herein.\59\ Further, retaining such exemptions for swap
intermediaries, without regard to the purpose of their counterparty's
swap, would be inconsistent with the statutory restrictions on pass-
through swap offsets, which require that the swap position being offset
qualify as a bona fide hedging position.\60\ Aside from this change,
the Commission is not proposing any other modifications to its existing
temporary substitute test.
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\58\ 7 U.S.C. 6a(c)(2)(B). See infra Section II.A.1.c.v.
(discussion of proposed pass-through language). Excluded
commodities, as described in further detail below, are not subject
to the statutory bona fide hedging definition. Accordingly, the
statutory restrictions on risk management exemptions that apply to
physical commodities subject to federal limits do not apply to
excluded commodities.
\59\ See infra Section II.C.2.g. (discussion of revoking
existing risk management exemptions).
\60\ See 7 U.S.C. 6a(c)(2)(B)(i). The pass-through swap offset
language in the proposed bona fide hedging definition is discussed
in greater detail below.
---------------------------------------------------------------------------
While the Commission preliminarily interprets the Dodd-Frank
amendments to the CEA as constraining the Commission from recognizing
as bona fide hedges risk management positions involving physical
commodities, the Commission has in part addressed the hedging needs of
persons seeking to offset the risk from swap books by proposing the
pass-through swap and pass-through swap offset provisions discussed
below.
The Commission observes that while ``risk management'' positions
would not qualify as bona fide hedges, some other provisions in this
proposal may provide flexibility for existing and prospective risk
management exemption holders in a manner that comports with the
statute. In particular, the Commission anticipates that the proposal to
limit the applicability of federal non-spot month limits to the nine
legacy agricultural contracts,\61\ coupled with the proposed adjustment
to non-spot limit levels based on updated open interest numbers for the
nine legacy agricultural contracts currently subject to federal
limits,\62\ may accommodate risk management activity that remains below
the proposed levels in a manner that comports with the CEA. Further, to
the extent that such activity would be opposite a counterparty for whom
the swap is a bona fide hedge, the Commission would encourage
intermediaries to consider whether they would qualify under the bona
fide hedging position definition for the proposed pass-through swap
treatment, which is explicitly authorized by the CEA and discussed in
greater detail below.\63\ Moreover, while positions entered into for
risk management purposes may no longer qualify as bona fide hedges,
some may satisfy the proposed requirements for spread exemptions.
Finally, consistent with existing industry practice, exchanges may
continue to recognize risk management positions for contracts that are
not subject to federal limits, including for excluded commodities.
---------------------------------------------------------------------------
\61\ See infra Section II.B.2.d. (discussion of non-spot month
limit levels).
\62\ The proposed non-spot month levels for the nine legacy
agricultural contracts were calculated using a methodology that,
with the exception of CBOT Oats (O), CBOT KC HRW Wheat (KW), and
MGEX HRS Wheat (MWE), would result in higher levels than under
existing rules and prior proposals. See infra Section II.B.2.d
(discussion of proposed non-spot month limit levels).
\63\ See infra Section II.A.1.c.v. (discussion of proposed pass-
through language).
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(2) Economically Appropriate Test
The bona fide hedging definitions in section 4a(c)(2)(A)(ii) of the
CEA and in existing Sec. 1.3 of the Commission's regulations both
provide that a bona fide hedging position must be ``economically
appropriate to the reduction of risks in the conduct and management of
a commercial enterprise.'' \64\ The Commission proposes to replicate
this standard in the new definition in Sec. 150.1, with one
clarification: Consistent with the Commission's longstanding practice
regarding what types of risk may be offset by bona fide hedging
positions in excess of federal limits,\65\ the Commission proposes to
make explicit that the word ``risks'' refers to, and is limited to,
``price risk.'' This proposed clarification does not reflect any change
in policy, as the Commission has, when defining bona fide hedging,
historically focused on transactions that offset price risk.\66\
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\64\ 7 U.S.C. 6a(c)(2)(A)(ii) and 17 CFR 1.3.
\65\ See, e.g., 2013 Proposal, 78 FR at 75709, 75710.
\66\ For example, in promulgating existing Sec. 1.3, the
Commission explained that a bona fide hedging position must, among
other things, ``be economically appropriate to risk reduction, such
risks must arise from operation of a commercial enterprise, and the
price fluctuations of the futures contracts used in the transaction
must be substantially related to fluctuations of the cash market
value of the assets, liabilities or services being hedged.'' Bona
Fide Hedging Transactions or Positions, 42 FR 14832, 14833 (Mar. 16,
1977). ``Value'' is generally understood to mean price times
quantity. Dodd-Frank added CEA section 4a(c)(2), which copied the
economically appropriate test from the Commission's definition in
Sec. 1.3. See also 2013 Proposal, 78 FR at 75702, 75703 (stating
that 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'').
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Commenters have previously requested flexibility for hedges of non-
price risk.\67\ However, re-interpreting ``risk'' to mean something
other than ``price risk'' would make determining whether a particular
position is economically appropriate to the reduction of risk too
subjective to effectively evaluate. While the Commission or an
exchange's staff can objectively evaluate whether a particular
derivatives position is an economically appropriate hedge of a price
risk arising from an underlying cash-market transaction, including by
assessing the correlations between the risk and the derivatives
position, it would be more difficult, if not impossible, to objectively
determine whether an offset of non-price risk is economically
appropriate for the underlying risk. For example, for any given non-
price risk, such as political risk, there could be multiple
commodities, directions, and contract months which a particular market
participant may view as an economically appropriate offset for that
risk, and multiple market participants might take different views on
which offset is the most effective. Re-interpreting ``risk'' to mean
something other than ``price risk'' would introduce an element of
subjectivity that would make a federal position limit framework
difficult, if not impossible, to administer.
---------------------------------------------------------------------------
\67\ See, e.g., 2016 Reproposal, 81 FR at 96847.
---------------------------------------------------------------------------
The Commission remains open to receiving new product submissions,
and should those submissions include contracts or strategies that are
used to hedge something other than price risk, the Commission could at
that point evaluate whether to propose regulations that would recognize
hedges of risks other than price risk as bona fide hedges.
(3) Change in Value Requirement
The Commission proposes to retain the substance of the change in
value requirement in existing Sec. 1.3, with some non-substantive
technical modifications, including modifications to correct a
typographical error.\68\ Aside
[[Page 11607]]
from the typographical error, the proposed Sec. 150.1 change in value
requirement mirrors the Dodd-Frank Act's change in value requirement in
CEA section 4a(c)(2)(A)(iii).\69\
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\68\ The Commission proposes to replace the phrase ``liabilities
which a person owns,'' which appears in the statute erroneously,
with ``liabilities which a person owes,'' which the Commission
believes was the intended wording. The Commission interprets the
word ``owns'' to be a typographical error. A person may owe on a
liability, and may anticipate incurring a liability. If a person
``owns'' a liability, such as a debt instrument issued by another,
then such person owns an asset. The fact that assets are included in
CEA section 4a(c)(2)(A)(iii)(I) further reinforces the Commission's
interpretation that the reference to ``owns'' means ``owes.'' The
Commission also proposes several other non-substantive modifications
in sentence structure to improve clarity.
\69\ 7 U.S.C. 6a(c)(2)(A)(iii).
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(4) Incidental Test and Orderly Trading Requirement
While the Commission proposes to maintain the substance of the
three core elements of the existing bona fide hedging definition
described above, with some modifications, the Commission also proposes
to eliminate two elements contained in the existing Sec. 1.3
definition: The incidental test and orderly trading requirement that
currently appear in paragraph (1)(iii) of the Sec. 1.3 bona fide
hedging definition.\70\
---------------------------------------------------------------------------
\70\ 17 CFR 1.3.
---------------------------------------------------------------------------
Notably, Congress eliminated the incidental test from the statutory
bona fide hedging definition in CEA section 4a(c)(2).\71\ Further, the
Commission views the incidental test as redundant because the
Commission is proposing to maintain the change in value requirement
(value is generally understood to mean price per unit times quantity of
units), and the economically appropriate test, which includes the
concept of the offset of price risks in the conduct and management of
(i.e., incidental to) a commercial enterprise.
---------------------------------------------------------------------------
\71\ 7 U.S.C. 6a(c)(2).
---------------------------------------------------------------------------
The Commission does not view the proposed elimination of the
incidental test in the definition that appears in the regulations as a
change in policy. The proposed elimination would not result in any
changes to the Commission's interpretation of the bona fide hedging
definition for physical commodities.
The Commission also preliminarily believes that the orderly trading
requirement should be deleted from the definition in the Commission's
regulations because the statutory bona fide hedging definition does not
include an orderly trading requirement,\72\ and because the meaning of
``orderly trading'' is unclear in the context of the over-the counter
(``OTC'') swap market and in the context of permitted off-exchange
transactions, such as exchange for physicals. The proposed elimination
of the orderly trading requirement would also have no bearing on an
exchange's ability to impose its own orderly trading requirement.
Further, in proposing to eliminate the orderly trading requirement from
the definition in the regulations, the Commission is not proposing any
amendments or modified interpretations to any other related
requirements, including to any of the anti-disruptive trading
prohibitions in CEA section 4c(a)(5),\73\ or to any other statutory or
regulatory provisions.
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\72\ The orderly trading requirement has been a part of the
regulatory definition of bona fide hedging since 1975; see Hedging
Definition, Reports, and Conforming Amendments, 40 FR 11560 (Mar.
12, 1975). Prior to 1974, the orderly trading requirement was found
in the statutory definition of bona fide hedging position; changes
to the CEA in 1974 removed the statutory definition from CEA section
4a(3).
\73\ 7 U.S.C. 6c(a)(5).
---------------------------------------------------------------------------
Taken together, the proposed retention of the updated temporary
substitute test, economically appropriate test, and change in value
requirement, coupled with the proposed elimination of the incidental
test and orderly trading requirement, should reduce uncertainty by
eliminating provisions that do not appear in the statute, and by
clarifying the language of the remaining provisions. By reducing
uncertainty surrounding some parts of the bona fide hedging definition
for physical commodities, the Commission anticipates that, as described
in greater detail elsewhere in this release, it would be easier going
forward for the Commission, exchanges, and market participants to
address whether novel trading practices or strategies may qualify as
bona fide hedges.
iii. Proposed Enumerated Bona Fide Hedges for Physical Commodities
Federal position limits currently only apply to referenced
contracts based on nine legacy agricultural commodities, and, as
mentioned above, the bona fide hedging definition in existing Sec. 1.3
includes a list of four categories of enumerated hedges that may be
exempt from federal position limits.\74\ So as not to reduce any of the
clarity provided by the current list of enumerated hedges, the
Commission proposes to maintain the existing enumerated hedges, some
with modification, and, for the reasons described below, to expand this
list. Such enumerated bona fide hedges would be self-effectuating for
purposes of federal limits.\75\ The Commission also proposes to move
the expanded list to proposed Appendix A to part 150 of the
Commission's regulations. The Commission preliminarily believes that
the list of enumerated hedges should appear in an appendix, rather than
be included in the definition, because each enumerated hedge represents
just one way, but not the only way, to satisfy the proposed bona fide
hedging definition and Sec. 150.3(a)(1).\76\ In some places, as
described below, the Commission proposes to modify and/or re-organize
the language of the current enumerated hedges; such proposed changes
are intended only to provide clarifications, and, unless indicated
otherwise, are not intended to substantively modify the types of
practices currently listed as enumerated hedges. In other places,
however, the Commission proposes substantive changes to the existing
enumerated hedges, including the elimination of the five-day rule for
purposes of federal limits, while allowing exchanges to impose a five-
day rule, or similar restrictions, for purposes of exchange-set limits.
With the exception of risk management positions previously recognized
as bona fide hedges, and assuming all regulatory requirements continue
to be satisfied, bona fide hedging recognitions that are currently in
effect under the Commission's existing rules, either by virtue of Sec.
1.47 or one of the enumerated hedges currently listed in Sec. 1.3,
would be grandfathered once the rules proposed herein are adopted.
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\74\ 17 CFR 1.3.
\75\ See infra Section II.C.2. (discussion of proposed Sec.
150.3) and Section II.G.3. (discussion of proposed Sec. 150.9).
\76\ As discussed below, proposed Sec. 150.3(a)(1) would allow
a person to exceed position limits for bona fide hedging
transactions or positions, as defined in proposed Sec. 150.1.
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When first proposed, the Commission viewed the enumerated bona fide
hedges as conforming to the general definition of bona fide hedging
``without further consideration as to the particulars of the case.''
\77\ Similarly, the proposed enumerated hedges would reflect fact
patterns for which the Commission has preliminarily determined, based
on experience over time, that no case-by-case determination, or review
of additional details, by the Commission is needed to determine that
the position or transaction is a bona fide hedge. This proposal would
in no way foreclose the recognition of other hedging practices as bona
fide hedges.
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\77\ Bona Fide Hedging Transactions or Positions, 42 FR 14832
(Mar. 16, 1977).
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The Commission would be open, on a case-by-case basis, to
recognizing as bona fide hedges positions or transactions that may fall
outside the bounds of these enumerated hedges, but that nevertheless
satisfy the proposed
[[Page 11608]]
bona fide hedging definition and section 4a(c)(2) of the CEA.\78\
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\78\ See infra Section II.G.3. (discussion of proposed Sec.
150.9).
---------------------------------------------------------------------------
The Commission does not anticipate that moving the list of
enumerated hedges from the bona fide hedging definition to an appendix
per se would have a substantial impact on market participants who seek
clarity regarding bona fide hedges. However, the Commission is open to
feedback on this point.
Positions in referenced contracts subject to position limits that
meet any of the proposed enumerated hedges would, for purposes of
federal limits, meet the bona fide hedging definition in CEA section
4a(c)(2)(A), as well as the Commission's proposed bona fide hedging
definition in Sec. 150.1. Any such recognitions would be self-
effectuating for purposes of federal limits, provided the market
participant separately requests an exemption from the applicable
exchange-set limit established pursuant to proposed Sec. 150.5(a). The
proposed enumerated hedges are each described below, followed by a
discussion of the proposal's treatment of the five-day rule.
(1) Hedges of Unsold Anticipated Production
This hedge is currently enumerated in paragraph (2)(i)(B) of the
bona fide hedging definition in Sec. 1.3, and is subject to the five-
day rule. The Commission proposes to maintain it as an enumerated
hedge, with the modification described below. This enumerated hedge
would allow a market participant who anticipates production, but who
has not yet produced anything, to enter into a short derivatives
position in excess of limits to hedge the anticipated production.
While existing paragraph (2)(i)(B) limits this enumerated hedge to
twelve-months' unsold anticipated production, the Commission proposes
to remove the twelve-month limitation. The twelve-month limitation may
be unsuitable in connection with additional contracts based on
agricultural and energy commodities covered by this release, which may
have longer growth and/or production cycles than the nine legacy
agricultural commodities. Commenters have also previously recommended
removing the twelve-month limitation on agricultural production,
stating that it is unnecessarily short in comparison to the expected
life of investment in production facilities.\79\ The Commission
preliminarily agrees.
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\79\ See, e.g., 2016 Reproposal, 81 FR at 96752.
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(2) Hedges of Offsetting Unfixed Price Cash Commodity Sales and
Purchases
This hedge is currently enumerated in paragraph (2)(iii) of the
bona fide hedging definition in Sec. 1.3 and is subject to the five-
day rule. The Commission proposes to maintain it as an enumerated
hedge, with one proposed modification described below. This enumerated
hedge allows a market participant to use commodity derivatives in
excess of limits to offset an unfixed price cash commodity purchase
coupled with an unfixed price cash commodity sale.
Currently, under paragraph (2)(iii), the cash commodity must be
bought and sold at unfixed prices at a basis to different delivery
months, meaning the offsetting derivatives transaction would be used to
reduce the risk arising from a time differential in the unfixed-price
purchase and sale contracts.\80\ The Commission proposes to expand this
provision to also permit the cash commodity to be bought and sold at
unfixed prices at a basis to different commodity derivative contracts
in the same commodity, even if the commodity derivative contracts are
in the same calendar month. The Commission is proposing this change to
allow a commercial enterprise to enter into the described derivatives
transactions to reduce the risk arising from either (or both) a
location differential \81\ or a time differential in unfixed-price
purchase and sale contracts in the same cash commodity.
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\80\ The Commission stated when it proposed this enumerated
hedge, ``[i]n 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.''
Revision of Federal Speculative Position Limits, 51 FR 31648, 31650
(Sept. 4, 1986).
\81\ 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, a
position in a basis contract would not be subject to position
limits, as discussed in connection with paragraph (3) of the
proposed definition of ``referenced contract.''
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Both an unfixed-price cash commodity purchase and an offsetting
unfixed-price cash commodity sale must be in hand in order to be
eligible for this enumerated hedge, because having both the unfixed-
price sale and purchase in hand would allow for an objective evaluation
of the hedge.\82\ Absent either the unfixed-price purchase or the
unfixed-price sale (or absent both), it would be less clear how the
transaction could be classified as a bona fide hedge, that is, a
transaction that reduces price risk.\83\
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\82\ For example, in the case of a calendar spread, having both
the unfixed-price sale and purchase in hand would set the timeframe
for the calendar month spread being used as the hedge.
\83\ In 2013, the Commission provided an example regarding this
enumerated hedge: ``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.'' 2013 Proposal,
78 FR at 75715.
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This is not to say that an unfixed-price cash commodity purchase
alone, or an unfixed-price cash commodity sale alone, could never be
recognized as a bona fide hedge. Rather, an additional facts and
circumstances analysis would be warranted in such cases.
Further, 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. 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, but the short derivative leg of the spread
would no longer qualify as a bona fide hedging position. Commercial
entities in these circumstances thus may have to consider reducing
certain positions in order to comply with the regulations proposed
herein.
(3) Short Hedges of Anticipated Mineral Royalties
The Commission is proposing a new acceptable practice that is not
currently enumerated in Sec. 1.3 for short hedges of anticipated
mineral royalties. The Commission previously adopted a similar
provision as an enumerated hedge in part 151 in response to a request
from commenters.\84\ The proposed provision would permit an owner of
rights to a future royalty to lock in the price of anticipated mineral
production by entering into a short position in excess of limits in a
commodity derivative contract to offset the anticipated change in value
of mineral royalty rights that are owned by that person and arise out
of the production of a mineral commodity
[[Page 11609]]
(e.g., oil and gas).\85\ The Commission preliminarily believes that
this remains a common hedging practice, and that positions that satisfy
the requirements of this acceptable practice would conform to the
general definition of bona fide hedging without further consideration
as to the particulars of the case.
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\84\ See 2011 Final Rulemaking, 76 FR at 71646. As noted above,
part 151 was subsequently vacated.
\85\ 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. A person who has issued a royalty, in
contrast, 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. The issuer of a
royalty, therefore, does not have price risk arising from that
royalty agreement.
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The Commission proposes to limit this acceptable practice to
mineral royalties; the Commission preliminarily believes that while
royalties have been paid for use of land in agricultural production,
the Commission has not received any evidence of a need for a bona fide
hedge recognition from owners of agricultural production royalties. The
Commission requests comment on whether and why such an exemption might
be needed for owners of agricultural production or other royalties.
(4) Hedges of Anticipated Services
The Commission is proposing a new enumerated hedge that is not
currently enumerated in the Sec. 1.3 bona fide hedging definition for
hedges of anticipated services. The Commission previously adopted a
similar provision as an enumerated hedge in part 151 in response to a
request from commenters.\86\ This enumerated hedge would recognize as a
bona fide hedge a long or short derivatives position used to hedge the
anticipated change in value of receipts or payments due or expected to
be due under an executed contract for services arising out of the
production, manufacturing, processing, use, or transportation of the
commodity underlying the commodity derivative contract.\87\ The
Commission preliminarily believes that this remains a common hedging
practice, and that positions that satisfy the requirements of this
acceptable practice would conform to the general definition of bona
fide hedging without further consideration as to the particulars of the
case.
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\86\ See 2011 Final Rulemaking, 76 FR at 71646. As noted above,
part 151 was subsequently vacated.
\87\ As the Commission previously stated, regarding a proposed
hedge for services, ``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].'' 2013 Proposal, 78 FR at 75716.
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(5) Cross-Commodity Hedges
Paragraph (2)(iv) of the existing Sec. 1.3 bona fide hedge
definition enumerates the offset of cash purchases, sales, or purchases
and sales with a commodity derivative other than the commodity that
comprised the cash position(s).\88\ The Commission proposes to include
this hedge in the enumerated hedges and expand its application such
that cross-commodity hedges could be used to establish compliance with:
Each of the proposed enumerated hedges listed in Appendix A to part
150; \89\ and hedges in the proposed pass-through provisions under
paragraph (2) of the proposed bona fide hedging definition discussed
further below; provided, in each case, that the position satisfies each
element of the relevant acceptable practice.\90\
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\88\ For example, existing paragraph (2)(iv) of the bona fide
hedging definition recognizes as an enumerated hedge the offset of a
cash-market position in one commodity, such as soybeans, through a
derivatives position in a different commodity, such as soybean oil
or soybean meal.
\89\ Specifically, for: (i) Hedges of unsold anticipated
production, (ii) hedges of offsetting unfixed-price cash commodity
sales and purchases, (iii) hedges of anticipated mineral royalties,
(iv) hedges of anticipated services, (v) hedges of inventory and
cash commodity fixed-price purchase contracts, (vi) hedges of cash
commodity fixed-price sales contracts, (vii) hedges by agents, and
(viii) offsets of commodity trade options, a cross-commodity hedge
could be used to offset risks arising from a commodity other than
the cash commodity underlying the commodity derivatives contract.
\90\ For example, an airline that wishes to hedge the price of
jet fuel may enter into a swap with a swap dealer. In order to
remain flat, the swap dealer may offset that swap with a futures
position, for example, in ULSD. Subsequently, the airline may also
offset the swap exposure using ULSD futures. In this example, under
the pass-through swap language of proposed Sec. 150.1, the airline
would be acting as a bona fide hedging swap counterparty and the
swap dealer would be acting as a pass-through swap counterparty. In
this example, provided each element of the enumerated hedge in
paragraph (a)(5) of Appendix A, the pass-through swap provision in
Sec. 150.1, and all other regulatory requirements are satisfied,
the airline and swap dealer could each exceed limits in ULSD futures
to offset their respective swap exposures to jet fuel. See infra
Section II.A.1.c.v. (discussion of proposed pass-through language).
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This enumerated hedge is conditioned on the fluctuations in value
of the position in the commodity derivative contract or of the
underlying cash commodity being ``substantially related'' \91\ to the
fluctuations in value of the actual or anticipated cash position or
pass-through swap. To be ``substantially related,'' the derivative and
cash market position, which may be in different commodities, should
have a reasonable commercial relationship.\92\ For example, there is a
reasonable commercial relationship between grain sorghum, used as a
food grain for humans or as animal feedstock, with corn underlying a
derivative. There currently is not a futures contract for grain sorghum
grown in the United States listed on a U.S. DCM, so corn represents a
substantially related commodity to grain sorghum in the United
States.\93\ In contrast, there does not appear to be a reasonable
commercial relationship between a physical commodity, say copper, and a
broad-based stock price index, such as the S&P 500 Index, because these
commodities are not reasonable substitutes for each other in that they
have very different pricing drivers. That is, the price of a physical
commodity is based on supply and demand, whereas the stock price index
is based on various individual stock prices for different companies.
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\91\ See proposed Appendix A to part 150.
\92\ Id.
\93\ Grain sorghum was previously listed for trading on the
Kansas City Board of Trade and Chicago Mercantile Exchange, but
because of liquidity issues, grain buyers continued to use the more
liquid corn futures contract, which suggests that the basis risk
between corn futures and cash sorghum could be successfully managed
with the corn futures contract.
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(6) Hedges of Inventory and Cash Commodity Fixed-Price Purchase
Contracts
Hedges of inventory and cash-commodity fixed-price purchase
contracts are included in paragraph (2)(i)(A) of the existing Sec. 1.3
bona fide hedge definition, and the Commission proposes to include them
as an enumerated hedge with minor modifications. This proposed
enumerated hedge acknowledges that a commercial enterprise is exposed
to price risk (e.g., that the market price of the inventory could
decrease) if it has obtained inventory in the normal course of business
or has entered into a fixed-price spot or forward purchase contract
calling for delivery in the physical marketing channel of a cash-market
commodity (or a combination of the two), and has not offset that price
risk. Any such inventory, or a fixed-price purchase contract, must be
on hand, as opposed to a non-fixed purchase contract or an anticipated
purchase. To satisfy the requirements of this particular enumerated
hedge, a bona fide hedge would be to establish a short position in a
commodity derivative contract to offset such price risk. An exchange
may require such short position holders to demonstrate the ability to
deliver against the short
[[Page 11610]]
position in order to demonstrate a legitimate purpose for holding a
position deep into the spot month.\94\
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\94\ 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.
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(7) Hedges of Cash Commodity Fixed-Price Sales Contracts
This hedge is enumerated in paragraphs (2)(ii)(A) and (B) of the
existing Sec. 1.3 bona fide hedge definition, and the Commission
proposes to maintain it as an enumerated hedge. This enumerated hedge
acknowledges that a commercial enterprise is exposed to price risk
(i.e., that the market price of a commodity might be higher than the
price of a fixed-price sales contract for that commodity) if it has
entered into a spot or forward fixed-price sales contract calling for
delivery in the physical marketing channel of a cash-market commodity,
and has not offset that price risk. To satisfy the requirements of this
particular enumerated hedge, a bona fide hedge would be to establish a
long position in a commodity derivative contract to offset such price
risk.
(8) Hedges by Agents
This proposed enumerated hedge is included in paragraph (3) of the
existing Sec. 1.3 bona fide hedge definition as an example of a
potential non-enumerated bona fide hedge. The Commission proposes to
include this example as an enumerated hedge, with non-substantive
modifications,\95\ because the Commission preliminarily believes that
this is a common hedging practice, and that positions which satisfy the
requirements of this enumerated hedge would conform to the general
definition of bona fide hedging without further consideration as to the
particulars of the case. This proposed provision would allow an agent
who has the responsibility to trade cash commodities on behalf of
another entity for which such positions would qualify as bona fide
hedging positions to hedge those cash positions on a long or short
basis. For example, an agent may trade on behalf of a farmer or a
producer, or a government may wish to contract with a commercial firm
to manage the government's cash wheat inventory; in such circumstances,
the agent or the commercial firm would not take ownership of the
commodity it trades on behalf of the farmer, producer, or government,
but would be an agent eligible for an exemption to hedge the risks
associated with such cash positions.
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\95\ For example, the Commission proposes to replace the phrase
``offsetting cash commodity'' with ``contract's underlying cash
commodity'' to use language that is consistent with the other
proposed enumerated hedges.
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(9) Offsets of Commodity Trade Options
The Commission is proposing a new enumerated hedge to recognize
certain offsets of commodity trade options as a bona fide hedge. Under
this proposed enumerated hedge, a commodity trade option meeting the
requirements of Sec. 32.3 \96\ of the Commission's regulations \97\
may be deemed a cash commodity fixed-price purchase or cash commodity
fixed-price sales contract, as the case may be, provided that such
option is adjusted on a futures-equivalent basis.\98\ Because the
Commission proposes to include hedges of cash commodity fixed-price
purchase contracts and hedges of cash commodity fixed-price sales
contracts as enumerated hedges, the Commission also proposes to include
hedges of commodity trade options as an enumerated hedge.
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\96\ 17 CFR 32.3. In order to qualify for the trade option
exemption, Sec. 32.3 requires, among other things, that: (1) The
offeror is either (i) an eligible contract participant, as defined
in section 1a(18) of the Act, or (ii) offering or entering into the
commodity trade option solely for purposes related to its business
as a ``producer, processor, or commercial user of, or a merchant
handling the commodity that is the subject of the'' trade option;
and (2) the offeree is offered or entering into the commodity trade
option solely for purposes related to its business as ``a producer,
processor, or commercial user of, or a merchant handling the
commodity that is the subject'' of the commodity trade option.
\97\ 17 CFR 32.3.
\98\ It may not be possible to compute a futures-equivalent
basis for a trade option that does not have a fixed strike price.
Thus, under this enumerated hedge, a market participant may not use
a trade option as a basis for a bona fide hedging position until a
fixed strike price reasonably may be determined. For example, a
commodity trade option with a fixed strike price may be converted to
a futures-equivalent basis, and, on that futures-equivalent basis,
deemed a cash commodity sale contract, in the case of a short call
option or long put option, or a cash commodity purchase contract, in
the case of a long call option or short put option.
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(10) Hedges of Unfilled Anticipated Requirements
This proposed enumerated hedge appears in paragraph (2)(ii)(C) of
the existing Sec. 1.3 bona fide hedge definition. The Commission
proposes to include it as an enumerated hedge, with modification. To
satisfy the requirements of this particular enumerated hedge, a bona
fide hedge would be to establish a long position in a commodity
derivative contract to offset the expected price risks associated with
the anticipated future purchase of the cash-market commodity underlying
the commodity derivative contract. Such unfilled anticipated
requirements could include requirements for processing, manufacturing,
use by that person, or resale by a utility to its customers.\99\
Consistent with the existing provision, for purposes of exchange-set
limits, exchanges may wish to consider adopting rules providing that
during the lesser of the last five days of trading (or such time period
for the spot month), such positions must not exceed the person's
unfilled anticipated requirements of the underlying cash commodity for
that month and for the next succeeding month.\100\ Any such quantity
limitation may help prevent the use of long futures to source large
quantities of the underlying cash commodity. The Commission
preliminarily believes that the two-month limitation would allow for an
amount of activity that is in line with common commercial hedging
practices, without jeopardizing any statutory objectives.
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\99\ The proposed inclusion of unfilled anticipated requirements
for resale by a utility to its customers does not appear in the
existing Sec. 1.3 bona fide hedging definition. This provision is
analogous to the unfilled anticipated requirements provision of
existing paragraph (2)(ii)(C) of the existing bona fide hedging
definition, 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. This would recognize a bona fide hedging
position where a utility is required or encouraged by its public
utility commission to hedge.
\100\ This is essentially a less-restrictive version of the
five-day rule, allowing a participant to hold a position during the
end of the spot period if economically appropriate, but only up to
two months' worth of anticipated requirements. The two-month
quantity limitation has long-appeared in existing Sec. 1.3 as a
measure to prevent the sourcing of massive quantities of the
underlying in a short time period. 17 CFR 1.3.
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Although existing paragraph (2)(ii)(C) limits this enumerated hedge
to twelve-months' unfilled anticipated requirements outside of the spot
period, the Commission proposes to remove the twelve-month limitation
because commenters have previously stated, and the Commission
preliminarily believes, that there is a commercial need to hedge
unfilled anticipated requirements for a time period longer than twelve
months.\101\
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\101\ See, e.g., 2016 Reproposal, 81 FR at 96751.
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(11) Hedges of Anticipated Merchandising
The Commission is proposing a new enumerated hedge to recognize
certain offsets of anticipated purchases or sales as a bona fide hedge.
Under this proposed enumerated hedge, a merchant may establish a long
or short position in
[[Page 11611]]
a commodity derivative contract to offset the anticipated change in
value of the underlying commodity that the merchant anticipates
purchasing or selling in the future. To safeguard against misuse, the
enumerated hedge would be subject to certain conditions. First, the
commodity derivative position must not exceed in quantity twelve
months' of purchase or sale requirements of the same commodity that is
anticipated to be merchandised. This requirement is intended to ensure
that merchants are hedging their anticipated merchandising exposure to
the value change of the underlying commodity, while calibrating the
anticipated need within a reasonable timeframe and the limitations in
physical commodity markets, such as annual production or processing
capacity. Unlike in the enumerated hedge for unsold anticipated
production, where the Commission is proposing to eliminate the twelve-
month limitation, the Commission has preliminarily determined that a
twelve-month limitation for anticipatory merchandising is suitable in
connection with contracts that are based on anticipated activity on
yet-to-be established cash positions due to the uncertainty of
forecasting such activity and, all else being equal, the increased risk
of excessive speculation on the price of a commodity the longer the
time period before the actual need arises.
Second, the Commission is proposing to limit this enumerated hedge
to merchants who are in the business of purchasing and selling the
underlying commodity that is anticipated to be merchandised, and who
can demonstrate that it is their historical practice to do so. Such
demonstrated history should include a history of making and taking
delivery of the underlying commodity, and a demonstration of an ability
to store and move the underlying commodity. The Commission has a
longstanding practice of providing exemptive relief to commercial
market participants to enable physical commodity markets to continue to
be well-functioning markets. The proposed anticipatory merchandising
hedge requires that the person be a merchant handling the underlying
commodity that is subject to the anticipatory merchandising hedge and
that such merchant is entering into the anticipatory merchandising
hedge solely for purposes related to its merchandising business. A
merchandiser that lacks the requisite history of anticipatory
merchandising activity could still potentially receive bona fide hedge
recognition under the proposed non-enumerated process, so long as the
merchandiser can otherwise show activities in the physical marketing
channel, including, for example, arrangements to take or make delivery
of the underlying commodity.
The Commission preliminarily believes that anticipated
merchandising is a hedging practice commonly used by some commodity
market participants, and that merchandisers play an important role in
the physical supply chain. Positions which satisfy the requirements of
this acceptable practice would thus conform to the general definition
of bona fide hedging.
While each of the proposed enumerated hedges described above would
be self-effectuating for purposes of federal limits, the Commission and
the exchanges would continue to exercise close oversight over such
positions to confirm that market participants' claimed exemptions are
consistent with their cash-market activity. In particular, because all
contracts subject to federal limits would also be subject to exchange-
set limits, all traders seeking to exceed federal position limits would
have to request an exemption from the relevant exchange for purposes of
the exchange limit, regardless of whether the position falls within one
of the enumerated hedges. In other words, enumerated bona fide hedge
recognitions that are self-effectuating for purposes of federal limits
would not be self-effectuating for purposes of exchange limits.
Exchanges have well-established programs for granting exemptions,
including, in some cases, experience granting exemptions for
anticipatory merchandising for certain traders in markets not currently
subject to federal limits. As discussed in greater detail below,
proposed Sec. 150.5 \102\ would ensure that such programs require,
among other things, that: Exemption applications filed with an exchange
include sufficient information to enable the exchange to determine, and
the Commission to verify, whether the exchange may grant the exemption,
including an indication of whether the position qualifies as an
enumerated hedge for purposes of federal limits and a description of
the applicant's activity in the underlying cash markets; and that the
exchange provides the Commission with a monthly report showing the
disposition of all exemption applications, including cash market
information justifying the exemption. The Commission expects exchanges
will be thoughtful and deliberate in granting exemptions, including
anticipatory exemptions.
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\102\ See infra Section II.D.4. (discussion of proposed Sec.
150.5).
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The Commission and the exchanges also have a variety of other tools
designed to help prevent misuse of self-effectuating exemptions. For
example, market participants who submit an application to an exchange
as required under Sec. 150.5 would be subject to the Commission's
false statements authority that carries with it substantial penalties
under both the CEA and federal criminal statutes.\103\ Similarly, the
Commission can use surveillance tools, special call authority, rule
enforcement reviews, and other formal and informal avenues for
obtaining additional information from exchanges and market participants
in order to distinguish between true hedging needs and speculative
trading masquerading as a bona fide hedge.
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\103\ CEA section 6(c)(2), 7 U.S.C. 9(2); CEA section 9(a)(3), 7
U.S.C. 13(a)(3); CEA section 9(a)(4), 7 U.S.C. 13(a)(4); 18 U.S.C.
1001.
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In the 2013 Proposal, the Commission previously addressed a
petition for exemptive relief for 10 transactions described as bona
fide hedging transactions by the Working Group of Commercial Energy
Firms (which has since reconstituted itself as the ``Commercial Energy
Working Group'') (``BFH Petition'').\104\ In the 2013 Proposal, the
Commission included examples Nos. 1, 2, 6, 7 (scenario 1), and 8 as
being permitted under the proposed definition of bona fide hedging.
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\104\ The Working Group BFH Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/wgbfhpetition012012.pdf.
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With respect to the rules proposed herein, the Commission has
preliminarily determined that example #4 (binding, irrevocable bids or
offers) and #5 (timing of hedging physical transactions) from the BFH
Petition potentially fit within the proposed Appendix A paragraph
(a)(11) enumerated hedge of anticipatory merchandising, so long as the
transaction complies with each condition of that proposed enumerated
hedge.
In addition, as discussed further below, because the Commission is
also proposing to eliminate the five-day rule from the enumerated
hedges to which the five-day rule currently applies, the Commission has
preliminarily determined that example #9 (holding a cross-commodity
hedge using a physical delivery contract into the spot month) and #10
(holding a cross-commodity hedge using a physical delivery contract to
meet unfilled anticipated
[[Page 11612]]
requirements) from the BFH Petition potentially fit within the proposed
Appendix A paragraph (a)(5) enumerated hedge, so long as the
transaction otherwise complies with the additional conditions of all
applicable enumerated hedges and other requirements.
Regarding examples #3 (unpriced physical purchase or sale
commitments) and #7 (scenario 2) (use of physical delivery referenced
contracts to hedge physical transactions using calendar month average
pricing), while the Commission has preliminarily determined that the
positions described within those examples do not fit within any of the
proposed enumerated hedges, market participants seeking bona fide hedge
recognition for such positions may apply for a non-enumerated
recognition under proposed Sec. Sec. 150.3 or 150.9, and a facts and
circumstances decision would be made.\105\ As included in the request
for comment on this section, the Commission requests additional
information on the scenarios listed above, particularly for the
positions that the Commission preliminarily views as falling outside
the proposed list of enumerated hedges.
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\105\ Similarly, other examples of anticipatory merchandising
that have been described to the Commission in response to request
for comment on proposed rulemakings on position limits (i.e., the
storage hedge and hedges of assets owned or anticipated to be owned)
would be the type of transactions that market participants may seek
through one of the proposed processes for requesting a non-
enumerated bona fide hedge recognition.
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iv. Elimination of a Federal Five Day Rule
Under the existing bona fide hedging definition in Sec. 1.3, to
help protect orderly trading and the integrity of the physical-delivery
process, certain enumerated hedging positions in physical-delivery
contracts are not recognized as bona fide hedges that may exceed limits
when the position is held during the last five days of trading during
the spot month. The goal of the five-day rule is to help ensure that
only those participants who actually intend to make or take delivery
maintain positions toward the end of the spot period.\106\ When the
Commission adopted the five-day rule, it believed that, as a general
matter, there is little commercial need to maintain such positions in
the last five days.\107\ However, persons wishing to exceed position
limits during the five last trading days could submit materials
supporting a classification of the position as a bona fide hedge, based
on the particular facts and circumstances.\108\
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\106\ Paragraphs (2)(i)(B), (ii)(C), (iii), and (iv) of the
existing Sec. 1.3 bona fide hedging definition are subject to some
form of the five-day rule.
\107\ Definition of Bona Fide Hedging and Related Reporting
Requirements, 42 FR 42748, 42750 (Aug. 24, 1977).
\108\ Id.
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The Commission has viewed the five-day rule as an important way to
help ensure that futures and cash-market prices converge and to prevent
excessive speculation as a physical-delivery contract nears expiration,
thereby protecting the integrity of the delivery process and the price
discovery function of the market, and deterring or preventing types of
market manipulations such as corners and squeezes. The enumerated
hedges currently subject to the five-day rule are either: (i)
Anticipatory in nature; or (ii) involve a situation where there is no
need to make or take delivery. The Commission has historically
questioned the need for such positions in excess of limits to be held
into the spot period if the participant has no immediate plans and/or
need to make or take delivery in the few remaining days of the spot
period.\109\
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\109\ See, e.g., 42 FR at 42749.
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While the Commission continues to believe that the justifications
described above for the existing five-day rule remain valid, the
Commission has preliminarily determined that for contracts subject to
federal limits, the exchanges, subject to Commission oversight, are
better positioned to decide whether to apply the five-day rule in
connection with their own exchange-set limits, or whether to apply
other tools that may be equally effective. Accordingly, consistent with
this proposal's focus on leveraging existing exchange practices and
expertise when appropriate, the Commission proposes to eliminate the
five-day rule from the enumerated hedges to which the five-day rule
currently applies, and instead to afford exchanges with the discretion
to apply, and when appropriate, waive the five-day rule (or similar
restrictions) for purposes of their own limits.
Allowing for such discretion will afford exchanges flexibility to
quickly impose, modify, or waive any such limitation as circumstances
dictate. While a strict five day rule may be inappropriate in certain
circumstances, including when applied to energy contracts that
typically have a shorter spot period than agricultural contracts,\110\
the flexible approach allowed for herein may allow for the development
and implementation of additional solutions other than a five-day rule
that protect convergence while minimizing the impact on market
participants. The proposed approach would allow exchanges to design and
tailor a variety of limitations to protect convergence during the spot
period. For example, in certain circumstances, a smaller quantity
restriction, rather than a complete restriction on holding positions in
excess of limits during the spot period, may be effective at protecting
convergence. Similarly, exchanges currently utilize other tools to
achieve similar policy goals, such as by requiring market participants
to ``step down'' the levels of their exemptions as they approach the
spot period, or by establishing exchange-set speculative position
limits that include a similar step down feature. As proposed Sec.
150.5(a) would require that any exchange-set limits for contracts
subject to federal limits must be less than or equal to the federal
limit, any exchange application of the five day rule, or a similar
restriction, would have the same effect as if administered by the
Commission for purposes of federal speculative position limits.
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\110\ Energy contracts typically have a three-day spot period,
whereas the spot period for agricultural contracts is typically two
weeks.
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The Commission expects that exchanges would closely scrutinize any
participant who requests a recognition during the last five days of the
spot period or in the time period for the spot month.
To assist exchanges that wish to establish a five-day rule, or a
similar provision, the Commission proposes guidance in paragraph (b) of
Appendix B that would set forth circumstances when a position held
during the spot period may still qualify as a bona fide hedge. The
guidance would provide that a position held during the spot period may
still qualify as a bona fide hedging position, provided that, among
other things: (1) The position complies with the bona fide hedging
definition; and (2) there is an economically appropriate need to
maintain such position in excess of federal speculative position limits
during the spot period, and that need relates to the purchase or sale
of a cash commodity.\111\
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\111\ For example, an economically appropriate need for soybeans
would mean obtaining soybeans from a reasonable source (considering
the marketplace) that is the least expensive, at or near the
location required for the purchaser, and that such sourcing does not
cause market disruptions or prices to spike.
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In addition, the guidance would provide that the person wishing to
exceed federal position limits during the spot period: (1) Intends to
make or take delivery during that period; (2) provides materials to the
exchange supporting the waiver of the five-day rule; (3)
[[Page 11613]]
demonstrates supporting cash-market exposure in-hand that is verified
by the exchange; (4) demonstrates that, for short positions, the
delivery is feasible, meaning that the person has the ability to
deliver against the short position; \112\ and (5) demonstrates that,
for long positions, the delivery is feasible, meaning that the person
has the ability to take delivery at levels that are economically
appropriate.\113\ This proposed guidance is intended to include a non-
exclusive list of considerations for determining whether to waive a
five-day rule established at the discretion of an exchange.
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\112\ That is, the person has inventory on-hand in a deliverable
location and in a condition in which the commodity can be used upon
delivery.
\113\ That is, the delivery comports with the person's
demonstrated need for the commodity, and the contract is the
cheapest source for that commodity.
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v. Guidance on Measuring Risk
In prior proposals involving position limits, the Commission
discussed the issue of whether the Commission may recognize as bona
fide both ``gross hedging'' and ``net hedging.'' \114\ Such attempts
reflected the Commission's longstanding preference for net hedging,
which, although not stated explicitly in prior releases, has been
underpinned by a concern that unfettered recognition of gross hedging
could potentially allow for the cherry picking of positions in a manner
that subverts the position limits rules.\115\
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\114\ Id. at 96747.
\115\ For example, using gross hedging, a market participant
could potentially point to a large long cash position as
justification for a bona fide hedge, even though the participant, or
an entity with which the participant is required to aggregate, has
an equally large short cash position that would result in the
participant having no net price risk to hedge as the participant had
no price risk exposure to the commodity prior to establishing such
derivative position. Instead, the participant created price risk
exposure to the commodity by establishing the derivative position.
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In an effort to clarify its current view on this issue, the
Commission proposes guidance in paragraph (a) to Appendix B. The
Commission is of the preliminary view that there are myriad ways in
which organizations are structured and engage in commercial hedging
practices, including the use of multi-line business strategies in
certain industries that would be subject to federal limits for the
first time under this proposal. Accordingly, the Commission does not
propose a one-size-fits-all approach to the manner in which risk is
measured across an organization.
The proposed guidance reflects the Commission's historical practice
of recognizing positions hedged on a net basis as bona fide; \116\
however, as the Commission has also previously allowed, the proposed
guidance also may in certain circumstances allow for the recognition of
gross hedging as bona fide, provided that: (1) The manner in which the
person measures risk is consistent over time and follows a person's
regular, historical practice \117\ (meaning the person is not switching
between net hedging and gross hedging on a selective basis simply to
justify an increase in the size of his/her derivatives positions); (2)
the person is not measuring risk on a gross basis to evade the limits
set forth in proposed Sec. 150.2 and/or the aggregation rules
currently set forth in Sec. 150.4; (3) the person is able to
demonstrate (1) and (2) to the Commission and/or an exchange upon
request; and (4) an exchange that recognizes a particular gross hedging
position as a bona fide hedge pursuant to proposed Sec. 150.9
documents the justifications for doing so and maintains records of such
justifications in accordance with proposed Sec. 150.9(d).
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\116\ See 2016 Reproposal, 81 FR at 96747 (stating that gross
hedging was economically appropriate in circumstances where ``net
cash positions do not necessarily measure total risk exposure due to
differences in the timing of cash commitments, the location of
stocks, and differences in grades or the types of cash commodity.'')
See also Bona Fide Hedging Transactions or Positions, 42 FR at
14832, 14834 (Mar. 16, 1977) and Definition of Bona Fide Hedging and
Related Reporting Requirements, 42 FR 42748, 42750 (Aug. 24, 1977).
\117\ This proposed guidance on measuring risk is consistent in
many ways with the manner in which the exchanges require their
participants to measure and report risk, which is consistent with
the Commission's requirements with respect to the reporting of risk.
For example, under Sec. 17.00(d), futures commission merchants
(``FCMs''), clearing members, and foreign brokers are required to
report certain reportable net positions, while under Sec. 17.00(e),
such entities may report gross positions in certain circumstances,
including if the positions are reported to an exchange or the
clearinghouse on a gross basis. 17 CFR 17.00. The Commission's
understanding is that certain exchanges generally prefer, but do not
require, their participants to report positions on a net basis. For
those participants that elect to report positions on a gross basis,
such exchanges require such participants to continue reporting that
way, particularly through the spot period. The Commission
preliminarily believes that such consistency is a strong indicator
that the participant is not measuring risk on a gross basis simply
to evade regulatory requirements.
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The Commission continues to believe that a gross hedge may be a
bona fide hedge in circumstances where net cash positions do not
necessarily 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.\118\ However, the Commission
clarifies that these may not be the only circumstances in which gross
hedging may be recognized as bona fide. Like the analysis of whether a
particular position satisfies the proposed bona fide hedge definition,
the analysis of whether gross hedging may be utilized would involve a
case-by-case determination made by the Commission and/or by an exchange
using its expertise and knowledge of its participants as it considers
applications under Sec. 150.9, subject to Commission review and
oversight.
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\118\ See, e.g., Bona Fide Hedging Transactions or Positions, 42
FR at 14834.
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The Commission believes that permitting market participants with
bona fide hedges to use either or both gross or net hedging will help
ensure that market participants are able to hedge efficiently. Large,
complex entities may have hedging needs that cannot be efficiently and
effectively met with either gross or net hedging. For instance, some
firms may hedge on a global basis while others may hedge by trading
desk or business line. Some risks that appear offsetting may in fact
need to be treated separately where a difference in delivery location
or date makes net hedging of those positions inappropriate.
To prevent ``cherry-picking'' when determining whether to gross or
net hedge certain risks, hedging entities should have policies and
procedures setting out when gross and net hedging is appropriate.
Consistent usage of appropriate gross and/or net hedging in line with
such policies and procedures can demonstrate compliance with the
Commission's regulations. On the other hand, usage of gross or net
hedging that is inconsistent with an entity's policies or a change from
gross to net hedging (or vice versa) could be an indication that an
entity is seeking to evade position limits regulations.
vi. Pass-Through Provisions
As the Commission has noted above, CEA section 4a(c)(2)(B) \119\
further contemplates bona fide hedges that by themselves do not meet
the criteria of CEA section 4a(c)(2)(A), but that are executed by a
pass-through swap counterparty opposite a bona fide hedging swap
counterparty, or used by a bona fide hedging swap counterparty to
offset its swap exposure that does satisfy CEA section
4a(c)(2)(A).\120\ The
[[Page 11614]]
Commission preliminarily believes that, in affording bona fide hedging
recognition to positions used to offset exposure opposite a bona fide
hedging swap counterparty, Congress in CEA section 4a(c)(2)(B)
intended: (1) To encourage the provision of liquidity to commercial
entities that are hedging physical commodity price risk in a manner
consistent with the bona fide hedging definition; but also (2) to
prohibit risk management positions that are not opposite a bona fide
hedging swap counterparty from being recognized as bona fide
hedges.\121\
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\119\ 7 U.S.C. 6a(c)(2)(B).
\120\ CEA section 4a(c)(2)(B)(i) recognizes as a bona fide
hedging position a position that reduces risk attendant to a
position resulting from a swap that was executed opposite a
counterparty for which the transaction would qualify as a bona fide
hedging transaction pursuant to 4a(c)(2)(A). 7 U.S.C.
6a(c)(2)(B)(i). CEA section 4a(c)(2)(B)(ii) further recognizes as
bona fide positions that reduce risks attendant to a position
resulting from a swap that meets the requirements of 4a(c)(2)(A). 7
U.S.C. 6a(c)(2)(B)(ii).
\121\ As described above, the Commission has preliminarily
interpreted the revised statutory temporary substitute test as
limiting its authority to recognize risk management positions as
bona fide hedges unless the position is used to offset exposure
opposite a bona fide hedging swap counterparty.
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The Commission proposes to implement this pass-through swap
language in paragraph (2) of the bona fide hedging definition for
physical commodities in proposed Sec. 150.1. Each component of the
proposed pass-through swap provision is described in turn below.
Proposed paragraph (2)(i) of the bona fide hedging definition would
address a situation where a particular swap qualifies as a bona fide
hedge by satisfying the temporary substitute test, economically
appropriate test, and change in value requirement under proposed
paragraph (1) for one of the counterparties (the ``bona fide hedging
swap counterparty''), but not for the other counterparty, and where
those bona fides ``pass through'' from the bona fide hedging swap
counterparty to the other counterparty (the ``pass-through swap
counterparty''). The pass-through swap counterparty could be an entity
such as a swap dealer, for example, that provides liquidity to the bona
fide hedging swap counterparty.
Under the proposed rule, the pass-through of the bona fides from
the bona fide hedging swap counterparty to the pass-through swap
counterparty would be contingent on: (1) The pass-through swap
counterparty's ability to demonstrate that the pass-through swap is a
bona fide hedge upon request from the Commission and/or from an
exchange; \122\ and (2) the pass-through swap counterparty entering
into a futures, option on a futures, or swap position in the same
physical commodity as the pass-through swap to offset and reduce the
price risk attendant to the pass-through swap.
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\122\ While proposed paragraph (2)(i) of the bona fide hedging
definition in Sec. 150.1 would require the pass-through swap
counterparty to be able to demonstrate the bona fides of the pass-
through swap upon request, the proposed rule would not prescribe the
manner by which the pass-through swap counterparty obtains the
information needed to support such a demonstration. The pass-through
swap counterparty could base such a demonstration on a
representation made by the bona fide hedging swap counterparty, and
such determination may be made at the time when the parties enter
into the swap, or at some later point. For the bona fides to pass-
through as described above, the swap position need only qualify as a
bona fide hedging position at the time the swap was entered into.
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If the two conditions above are satisfied, then the bona fides of
the bona fide hedging swap counterparty ``pass through'' to the pass-
through swap counterparty for purposes of recognizing as a bona fide
hedge any futures, options on futures, or swap position entered into by
the pass-through swap counterparty to offset the pass-through swap
(i.e. to offset the swap opposite the bona fide hedging swap
counterparty). The pass-through swap counterparty could thus exceed
federal limits for the bona fide hedge swap opposite the bona fide
hedging swap counterparty and for any offsetting futures, options on
futures, or swap position in the same physical commodity, even though
any such position on its own would not qualify as a bona fide hedge for
the pass-through swap counterparty under proposed paragraph (1).
Proposed paragraph (2)(ii) of the bona fide hedging definition
would address a situation where a participant who qualifies as a bona
fide hedging swap counterparty (i.e., a counterparty with a position in
a previously-entered into swap that qualified, at the time the swap was
entered into, as a bona fide hedge under paragraph (1)) seeks, at some
later time, to offset that bona fide hedge swap position using futures,
options on futures, or swaps in excess of limits. Such step might be
taken, for example, to respond to a change in the bona fide hedging
swap counterparty's risk exposure in the underlying commodity.\123\
Proposed paragraph (2)(ii) would allow such a bona fide hedging swap
counterparty to use futures, options on futures, or swaps in excess of
federal limits to offset the price risk of the previously-entered into
swap, even though the offsetting position itself does not qualify for
that participant as a bona fide hedge under paragraph (1).
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\123\ Examples of a change in the bona fide hedging swap
counterparty's cash market price risk could include a change in the
amount of the commodity that the hedger will be able to deliver due
to drought, or conversely, higher than expected yield due to growing
conditions.
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The proposed pass-through exemption under paragraph (2) would only
apply to the pass-through swap counterparty's offset of the bona fide
hedging swap, and/or to the bona fide hedging swap counterparty's
offset of its bona fide hedging swap. Any further offsets would not be
eligible for a pass-through exemption under (2) unless the offsets
themselves meet the bona fide hedging definition. For instance, if
Producer A enters into an OTC swap with Swap Dealer B, and the OTC swap
qualifies as a bona fide hedge for Producer A, then Swap Dealer B could
be eligible for a pass-through exemption to offset that swap in the
futures market. However, if Swap Dealer B offsets its swap opposite
Producer A using an OTC swap with Swap Dealer C, Swap Dealer C would
not be eligible for a pass-through exemption.
As discussed more fully above, the pass-through swap provision may
help mitigate some of the potential impact resulting from the removal
of the ``risk management'' exemptions that are currently in
effect.\124\
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\124\ See supra Section II.A.1.c.ii.(1) (discussion of the
temporary substitute test).
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2. ``Commodity Derivative Contract''
The Commission proposes to create the defined term ``commodity
derivative contract'' for use throughout part 150 of the Commission's
regulations as shorthand for any futures contract, option on a futures
contract, or swap in a commodity (other than a security futures product
as defined in CEA section 1a(45)).
3. ``Core Referenced Futures Contract''
The Commission proposes to provide a list of 25 futures contracts
in proposed Sec. 150.2(d) to which proposed position limit rules would
apply. The Commission proposes the term ``core referenced futures
contract'' as a short-hand phrase to denote such contracts.\125\ As per
the ``referenced contract'' definition described below, position limits
would also apply to any contract that is directly/indirectly linked to,
or that has certain pricing relationships with, a core referenced
futures contract.
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\125\ The selection of the proposed core referenced futures
contracts is explained below in the discussion of proposed Sec.
150.2.
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4. ``Economically Equivalent Swap''
CEA section 4a(a)(5) requires that when the Commission imposes
limits on futures and options on futures pursuant to CEA section
4a(a)(2), the Commission also establish limits simultaneously for
``economically equivalent'' swaps ``as appropriate.'' \126\
[[Page 11615]]
As the statute does not define the term ``economically equivalent,''
the Commission must apply its expertise in construing such term, and,
as discussed further below, must do so consistent with the policy goals
articulated by Congress, including in CEA sections 4a(a)(2)(C) and
4a(a)(3).
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\126\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). In addition, CEA
section 4a(a)(4) separately authorizes, but does not require, the
Commission to impose federal limits on swaps that meet certain
statutory criteria qualifying them as ``significant price discovery
function'' swaps. 7 U.S.C. 6a(a)(4). The Commission reiterates, for
the avoidance of doubt, that the definitions of ``economically
equivalent'' in CEA section 4a(a)(5) and ``significant price
discovery function'' in CEA section 4a(a)(4) are separate concepts
and that contracts can be economically equivalent without serving a
significant price discovery function. See 2016 Reproposal, 81 FR at
96736 (the Commission noting that certain commenters may have been
confusing the two definitions).
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Under the Commission's proposed definition of an ``economically
equivalent swap,'' a swap on any referenced contract (including core
referenced futures contracts), except for natural gas referenced
contracts, would qualify as ``economically equivalent'' with respect to
that referenced contract so long as the swap shares identical
``material'' contractual specifications, terms, and conditions with the
referenced contract, disregarding any differences with respect to: (i)
Lot size or notional amount, (ii) delivery dates diverging by less than
one calendar day (if the swap and referenced contract are physically-
settled), or (iii) post-trade risk management arrangements.\127\ For
reasons described further below, natural gas swaps would qualify as
economically equivalent with respect to a particular referenced
contract under the same circumstances, except that physically-settled
swaps with delivery dates diverging by less than two calendar days,
rather than one calendar day, could qualify as economically equivalent.
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\127\ The proposed ``economically equivalent'' language is
distinct from the terms ``futures equivalent,'' ``economically
appropriate,'' and other similar terms used in the Commission's
regulations. For the avoidance of doubt, the Commission's proposed
definition of ``economically equivalent swap'' for the purposes of
CEA section 4a(a)(5) does not impact the application of any such
other terms as they appear in part 20 of the Commission's
regulations, in the Commission's proposed bona fide hedge
definition, or elsewhere.
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In promulgating the position limits framework, Congress instructed
the Commission to consider several factors: First, CEA section 4a(a)(3)
requires the Commission when establishing federal limits, to the
maximum extent practicable, in its discretion, to (i) diminish,
eliminate, or prevent excessive speculation; (ii) deter and prevent
market manipulation, squeezes, and corners; (iii) ensure sufficient
market liquidity for bona fide hedgers; and (iv) ensure that the price
discovery function of the underlying market is not disrupted. Second,
CEA section 4a(a)(2)(C) requires the Commission to strive to ensure
that any limits imposed by the Commission will not cause price
discovery in a commodity subject to federal limits to shift to trading
on a foreign exchange.
Accordingly, any definition of ``economically equivalent swap''
must consider these statutory objectives. The Commission also
recognizes that physical commodity swaps are largely bilaterally
negotiated, traded off-exchange (i.e., OTC), and potentially include
customized (i.e., ``bespoke'') terms, while futures contracts are
exchange traded with standardized terms. As explained further below,
due to these differences between swaps and exchange-traded futures and
options, the Commission has preliminarily determined that Congress's
underlying policy goals in CEA section 4a(a)(2)(C) and (3) are best
achieved by proposing a narrow definition of ``economically equivalent
swaps,'' compared to the broader definition of ``referenced contract''
the Commission is proposing to apply to look-alike futures and related
options.\128\
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\128\ The proposed definition of ``referenced contract'' would
incorporate cash-settled look-alike futures contracts and related
options that are either (i) 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 (ii) 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. See infra Section II.A.16. (definition
of ``referenced contract''). The proposed definition of
``economically equivalent swap'' would be included as a type of
``referenced contract,'' but, as discussed herein, would include a
relatively narrower class of swaps compared to look-alike futures
and options contracts, for the reasons discussed below.
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The Commission's proposed ``referenced contract'' definition in
Sec. 150.1 would include ``economically equivalent swaps,'' meaning
any economically equivalent swap would be subject to federal limits,
and thus would be required to be added to, and could be netted against,
as applicable, other referenced contracts in the same commodity for the
purpose of determining one's aggregate positions for federal position
limit levels.\129\ Any swap that is not deemed economically equivalent
would not be a referenced contract, and thus could not be netted with
referenced contracts nor would be required to be aggregated with any
referenced contract for federal position limits purposes. The proposed
definition is based on a number of considerations.
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\129\ See infra Section II.B.2.k. (discussion of netting).
---------------------------------------------------------------------------
First, the proposed definition would support the statutory
objectives in CEA section 4a(a)(3)(i) and (ii) by helping to prevent
excessive speculation and market manipulation, including corners and
squeezes, by: (1) Focusing on swaps that are the most economically
equivalent in every significant way to futures or options on futures
for which the Commission deems position limits to be necessary; \130\
and (2) simultaneously limiting the ability of speculators to obtain
excessive positions through netting. Any swap that meets the proposed
definition would offer identical risk sensitivity to its associated
referenced futures or options on futures contract with respect to the
underlying commodity, and thus could be used to effect a manipulation,
benefit from a manipulation, or otherwise potentially distort prices in
the same or similar manner as the associated futures or options on
futures contract.
---------------------------------------------------------------------------
\130\ See infra Section III.F. (necessity finding).
---------------------------------------------------------------------------
Because OTC swaps are bilaterally negotiated and customizable, the
Commission has preliminarily determined not to propose a more inclusive
``economically equivalent swap'' definition that would encompass
additional swaps because such definition could make it easier for
market participants to inappropriately net down against their core
referenced futures contracts by allowing market participants to
structure swaps that do not necessarily offer identical risk or
economic exposure or sensitivity. In contrast, the Commission
preliminarily believes that this is less of a concern with exchange-
traded futures and related options since these instruments have
standardized terms and are subject to exchange rules and oversight. As
a result, the proposal would generally allow market participants to net
certain positions in referenced contracts in the same commodity across
economically equivalent swaps, futures, and options on futures, but the
proposed economically equivalent swap definition would focus on swaps
with identical material terms and conditions in order to reduce the
ability of market participants to accumulate large, speculative
positions in excess of federal limits by using tangentially-related
(i.e., non-identical) swaps to net down such positions.
Second, the proposed definition would address statutory objectives
by focusing federal limits on those swaps that pose the greatest threat
for facilitating corners and squeezes--that is, those swaps with
similar delivery
[[Page 11616]]
dates and identical material economic terms to futures and options on
futures subject to federal limits--while also minimizing market impact
and liquidity for bona fide hedgers by not unnecessarily subjecting
other swaps to the new federal framework. For example, if the
Commission were to adopt an alternative definition of economically
equivalent swap that encompassed a broader range of swaps by including
delivery dates that diverge by one or more calendar days--perhaps by
several days or weeks--a speculator with a large portfolio of swaps may
be more likely to be constrained by the applicable position limits and
therefore may have an incentive either to minimize its swaps activity,
or move its swaps activity to foreign jurisdictions. If there were many
similarly situated speculators, the market for such swaps could become
less liquid, which in turn could harm liquidity for bona fide hedgers.
As a result, the Commission has preliminarily determined that the
proposed definition's relatively narrow scope of swaps reasonably
balances the factors in CEA section 4a(a)(3)(B)(ii) and (iii) by
decreasing the possibility of illiquid markets for bona fide hedgers on
the one hand while, on the other hand, focusing on the prevention of
market manipulation during the most sensitive period of the spot month
as discussed above.
Third, the proposed definition would help prevent regulatory
arbitrage and would strengthen international comity. If the Commission
proposed a definition that captured a broader range of swaps, U.S.-
based swaps activity could potentially migrate to other jurisdictions
with a narrower definition, such as the European Union (``EU''). In
this regard, the proposed definition is similar in certain ways to the
EU definition for OTC contracts that are ``economically equivalent'' to
commodity derivatives traded on an EU trading venue.\131\ The proposed
definition of economically equivalent swaps thus furthers statutory
goals, including those set forth in CEA section 4a(a)(2)(C), which
requires the Commission to strive to ensure that any federal position
limits are ``comparable'' to foreign exchanges and will not cause
``price discovery . . . to shift to trading'' on foreign
exchanges.\132\ Further, market participants trading in both U.S. and
EU markets should find the proposed definition to be familiar, which
may help reduce compliance costs for those market participants that
already have systems and personnel in place to identify and monitor
such swaps.
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\131\ See EU Commission Delegated Regulation (EU) 2017/591, 2017
O.J. (L 87). The applicable European regulations define an OTC
derivative to be ``economically equivalent'' when it has ``identical
contractual specifications, terms and conditions, excluding
different lot size specifications, delivery dates diverging by less
than one calendar day and different post trade risk management
arrangements.'' While the Commission's proposed definition is
similar, the Commission's proposed definition requires ``identical
material'' terms rather than ``identical'' terms. Further, the
Commission's proposed definition excludes different ``lot size
specifications or notional amounts'' rather than referencing only
``lot size'' since swaps terminology usually refers to ``notional
amounts'' rather than to ``lot sizes.''
Both the Commission's definition and the applicable EU
regulation are intended to prevent harmful netting. See European
Securities and Markets Authority, Draft Regulatory Technical
Standards on Methodology for Calculation and the Application of
Position Limits for Commodity Derivatives Traded on Trading Venues
and Economically Equivalent OTC Contracts, ESMA/2016/668 at 10 (May
2, 2016), available at https://www.esma.europa.eu/sites/default/files/library/2016-668_opinion_on_draft_rts_21.pdf (``[D]rafting the
[economically equivalent OTC swap] definition in too wide a fashion
carries an even higher risk of enabling circumvention of position
limits by creating an ability to net off positions taken in on-venue
contracts against only roughly similar OTC positions.'').
The applicable EU regulator, the European Securities and Markets
Authority (``ESMA''), recently released a ``consultation paper''
discussing the status of the existing EU position limits regime and
specific comments received from market participants. According to
ESMA, no commenter, with one exception, supported changing the
definition of an economically equivalent swap (referred to as an
``economically equivalent OTC contract'' or ``EEOTC''). ESMA further
noted that for some respondents, ``the mere fact that very few EEOTC
contracts have been identified is no evidence that the regime is
overly restrictive.'' See European Securities and Markets Authority,
Consultation Paper MiFID Review Report on Position Limits and
Position Management Draft Technical Advice on Weekly Position
Reports, ESMA70-156-1484 at 46, Question 15 (Nov. 5, 2019),
available at https://www.esma.europa.eu/document/consultation-paper-position-limits.
\132\ 7 U.S.C. 6a(a)(2)(C).
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Each element of the proposed definition, as well as the proposed
exclusions from the definition, is described below.
a. Scope of Identical Material Terms
Only ``material'' contractual specifications, terms, and conditions
would be relevant to the analysis of whether a particular swap would
qualify as an economically equivalent swap. The proposed definition
would thus not require that a swap be identical in all respects to a
referenced contract in order to be deemed ``economically equivalent.''
``Material'' specifications, terms, and conditions would be limited to
those provisions that drive the economic value of a swap, including
with respect to pricing and risk. Examples of ``material'' provisions
would include, for example: The underlying commodity, including
commodity reference price and grade differentials; maturity or
termination dates; settlement type (e.g., cash- versus physically-
settled); and, as applicable for physically-delivered swaps, delivery
specifications, including commodity quality standards or delivery
locations.\133\ Because settlement type would be considered to be a
material ``contractual specification, term, or condition,'' a cash-
settled swap could only be deemed economically equivalent to a cash-
settled referenced contract, and a physically-settled swap could only
be deemed economically equivalent to a physically-settled referenced
contract; however, a cash-settled swap that initially did not qualify
as ``economically equivalent'' due to no corresponding cash-settled
referenced contract (i.e., no cash-settled look-alike futures
contract), could subsequently become an ``economically equivalent
swap'' if a cash-settled futures contract market were to develop. In
addition, a swap that either references another referenced contract, or
incorporates its terms by reference, would be deemed to share identical
terms with the referenced contract and therefore would qualify as an
economically equivalent swap.\134\ Any change in the material terms of
such a swap, however, would render the swap no longer economically
equivalent for position limits purposes.\135\
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\133\ When developing its definition of an ``economically
equivalent swap,'' the Commission, based on its experience,
preliminarily has determined that for a swap to be ``economically
equivalent'' to a futures contract, the material contractual
specifications, terms, and conditions would need to be identical. In
making this determination, the Commission took into account, in
regards to the economics of swaps, how a swap and a corresponding
futures contract or option on a futures contract react to certain
market factors and movements, the pricing variables used in
calculating each instrument, the sensitivities of those variables,
the ability of a market participant to gain the same type of
exposures, and how the exposures move to changes in market
conditions.
\134\ For example, a cash-settled swap that either settles to
the pricing of a corresponding cash-settled referenced contract, or
incorporates by reference the terms of such referenced contract,
could be deemed to be economically equivalent to the referenced
contract.
\135\ The Commission preliminarily recognizes that the material
swap terms noted above are essential to determining the pricing and
risk profile for swaps. However, there may be other contractual
terms that also may be important for the counterparties but not
necessarily ``material'' for purposes of position limits. For
example, as discussed below, certain other terms, such as clearing
arrangements or governing law, may not be material for the purpose
of determining economic equivalence for federal position limits, but
may nonetheless affect pricing and risk or otherwise be important to
the counterparties.
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In contrast, the Commission generally would consider those swap
contractual terms, provisions, or terminology (e.g., ISDA terms and
definitions) that are unique to swaps (whether standardized
[[Page 11617]]
or bespoke) not to be material for purposes of determining whether a
swap is economically equivalent to a particular referenced contract.
For example, swap provisions or terms designating business day or
holiday conventions, day count (e.g., 360 or actual), calculation
agent, dispute resolution mechanisms, choice of law, or representations
and warranties are generally unique to swaps and/or otherwise not
material, and therefore would not be dispositive for determining
whether a swap is economically equivalent.\136\
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\136\ Commodity swaps, which generally are traded OTC, are less
standardized compared to exchange-traded futures and therefore must
include these provisions in an ISDA master agreement between
counterparties. While certain provisions, for example choice of law,
dispute resolution mechanisms, or the general representations made
in an ISDA master agreement, may be important considerations for the
counterparties, the Commission would not deem such provisions
material for purposes of determining economic equivalence under the
federal position limits framework for the same reason the Commission
would not deem a core referenced futures contract and a look-alike
referenced contract to be economically different, even though the
look-alike contract may be traded on a different exchange with
different contractual representations, governing law, holidays,
dispute resolution processes, or other provisions unique to the
exchanges. Similarly, with respect to day counts, a swap could
designate a day count that is different than the day count used in a
referenced contract but adjust relevant swap economic terms (e.g.,
relevant rates or payments, fees, basis, etc.) to achieve the same
economic exposure as the referenced contract. In such a case, the
Commission may not find such differences to be material for purposes
of determining the swap to be economically equivalent for federal
position limits purposes.
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The Commission is unable to publish a list of swaps it would deem
to be economically equivalent swaps because any such determination
would involve a facts and circumstances analysis, and because most
commodity swaps are created bilaterally between counterparties and
traded OTC. Absent a requirement that market participants identify
their economically equivalent swaps to the Commission on a regular
basis, the Commission preliminarily believes that market participants
are best positioned to determine whether particular swaps share
identical material terms with referenced contracts and would therefore
qualify as ``economically equivalent'' for purposes of federal position
limits. However, the Commission understands that for certain bespoke
swaps it may be unclear whether the facts and circumstances would
demonstrate whether the swap qualifies as ``economically equivalent''
with respect to a referenced contract.
The Commission emphasizes that under this proposal, market
participants would have the discretion to make such determination as
long as they make a reasonable, good faith effort in reaching their
determination, and that the Commission would not bring any enforcement
action for violating the Commission's speculative position limits
against such market participants as long as the market participant
performed the necessary due diligence and is able to provide sufficient
evidence, if requested, to support its reasonable, good faith
effort.\137\ Because market participants would be provided with
discretion in making any ``economically equivalent'' swap
determination, the Commission preliminarily anticipates that this
flexibility should provide a greater level of certainty to market
participants in contrast to the alternative in which market
participants would be required to first submit swaps to the Commission
staff and wait for feedback.\138\
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\137\ As noted below, the Commission reserves the authority
under this proposal to determine that a particular swap or class of
swaps either is or is not ``economically equivalent'' regardless of
a market participant's determination. See infra Section II.A.4.d.
(discussion of commission determination of economic equivalence). As
long as the market participant made its determination, prior to such
Commission determination, using reasonable, good faith efforts, the
Commission would not take any enforcement action for violating the
Commission's position limits regulations if the Commission's
determination differs from the market participant's.
\138\ As discussed under Section II.A.16. (definition of
``referenced contract''), the Commission proposes to include a list
of futures and related options that qualify as referenced contracts
because such contracts are standardized and published by exchanges.
In contrast, since swaps are largely bilaterally negotiated and OTC
traded, a swap could have multiple permutations and any published
list of economically equivalent swaps would be unhelpful or
incomplete.
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b. Exclusions From the Definition of ``Economically Equivalent Swap''
As noted above, the Commission's proposed definition would
expressly provide that differences in lot size or notional amount,
delivery dates diverging by less than one calendar day (or less than
two calendar days for natural gas), or post-trade risk management
arrangements would not disqualify a swap from being deemed to be
``economically equivalent'' to a particular referenced contract.
i. Delivery Dates Diverging by Less Than One Calendar Day
The proposed definition as it applies to commodities other than
natural gas would encompass swaps with delivery dates that diverge by
less than one calendar day from that of a referenced contract.\139\ As
a result, a swap with a delivery date that differs from that of a
referenced contract by one calendar day or more would not be deemed to
be economically equivalent under the Commission proposal, and such
swaps would not be required to be added to, nor permitted to be netted
against, any referenced contract when calculating one's compliance with
federal position limit levels.\140\ The Commission recognizes that
while a penultimate contract may be significantly correlated to its
corresponding spot-month contract, it does not necessarily offer
identical economic or risk exposure to the spot-month contract, and
depending on the underlying commodity and market conditions, a market
participant may open itself up to material basis risk by moving from
the spot-month contract to a penultimate contract. Accordingly, the
Commission has preliminarily determined that it would not be
appropriate to permit market participants to net such penultimate
positions against their core referenced futures contract positions
since such positions do not necessarily reflect equivalent economic or
risk exposure.
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\139\ This aspect of the proposed definition would be irrelevant
for cash-settled swaps since ``delivery date'' applies only to
physically-settled swaps.
\140\ A swap as so described that is not ``economically
equivalent'' would not be subject to a federal speculative position
limit under this proposal.
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ii. Post-Trade Risk Management
The Commission is specifically excluding differences in post-trade
risk management arrangements, such as clearing or margin, in
determining whether a swap is economically equivalent. As noted above,
many commodity swaps are traded OTC and may be uncleared or cleared at
a different clearing house than the corresponding referenced
contract.\141\ Moreover, since the core referenced futures contracts,
along with futures contracts and options on futures in general, are
traded on DCMs with vertically integrated clearing houses, as a
practical matter, it is impossible for OTC commodity swaps, which
historically have been uncleared, to share identical post-trade
clearing house or other post-trade risk management arrangements with
their associated core referenced futures contracts.
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\141\ Similar to the Commission's understanding of ``material''
terms, the Commission construes ``post-trade risk management
arrangements'' to include various provisions included in standard
swap agreements, including, for example: Margin or collateral
requirements, including with respect to initial or variation margin;
whether a swap is cleared, uncleared, or cleared at a different
clearing house than the applicable referenced contract; close-out,
netting, and related provisions; and different default or
termination events and conditions.
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Therefore, if differences in post-trade risk management
arrangements were sufficient to exclude a swap from economic
equivalence to a core
[[Page 11618]]
referenced futures contract, then such an exclusion could otherwise
render ineffective the Commission's statutory directive under CEA
section 4a(a)(5) to include economically equivalent swaps within the
federal position limits framework. Accordingly, the Commission has
preliminarily determined that differences in post-trade risk management
arrangements should not prevent a swap from qualifying as economically
equivalent with an otherwise materially identical referenced contract.
iii. Lot Size or Notional Amount
The last exclusion would clarify that differences in lot size or
notional amount would not prevent a swap from being deemed to be
economically equivalent to its corresponding referenced contract. The
Commission's use of ``lot size'' and ``notional amount'' refer to the
same general concept--while futures terminology usually employs ``lot
size,'' swap terminology usually employs ``notional amount.''
Accordingly, the Commission proposes to use both terms to convey the
same general meaning, and in this context does not mean to suggest a
substantive difference between the two terms.
c. Economically Equivalent Natural Gas Swaps
Market dynamics in natural gas are unique in several respects
including, among other things, that ICE and NYMEX both list high volume
contracts, whereas liquidity in other commodities tends to pool at a
single DCM. As expiration approaches for natural gas contracts, volume
tends to shift from the NYMEX core referenced futures contract
(``NG''), which is physically settled, to an ICE contract, which is
cash settled. This trend reflects certain market participants' desire
for exposure to natural gas prices without having to make or take
delivery.\142\ NYMEX and ICE also list several ``penultimate'' cash-
settled referenced contracts that use the price of the physically-
settled NYMEX contract as a reference price for cash settlement on the
day before trading in the physically-settled NYMEX contract
terminates.\143\ In order to recognize the existing natural gas
markets, which include active and vibrant markets in penultimate
natural gas contracts, the Commission thus proposes a slightly broader
economically equivalent swap definition for natural gas so that swaps
with delivery dates that diverge by less than two calendar days from an
associated referenced contract could still be deemed economically
equivalent and would be subject to federal limits. The Commission
intends for this change to prevent and disincentivize manipulation and
regulatory arbitrage and to prevent volume from shifting away from NG
to penultimate natural gas contract futures and/or penultimate swap
markets in order to avoid federal position limits.\144\
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\142\ In part to address historical concerns over the potential
for manipulation of physically-settled natural gas contracts during
the spot month in order to benefit positions in cash-settled natural
gas contracts, the Commission proposes later in this release to
allow for a higher ``conditional'' spot month limit in cash-settled
natural gas referenced contracts under the condition that market
participants seeking to utilize such conditional limit exit any
positions in physically-settled natural gas referenced contracts.
See infra Section II.C.2.e. (proposed conditional spot month limit
exemption for natural gas).
\143\ Such penultimate contracts include: ICE's Henry Financial
Penultimate Fixed Price Futures (PHH) and options on Henry
Penultimate Fixed Price (PHE), and NYMEX's Henry Hub Natural Gas
Penultimate Financial Futures (NPG).
\144\ As noted above, the Commission is proposing a relatively
narrow ``economically equivalent swap'' definition in order to
prevent market participants from inappropriately netting positions
in core referenced futures contracts against swap positions further
out on the curve. The Commission preliminarily acknowledges that
liquidity could shift to penultimate swaps as a result but believes
that, with the exception of natural gas, this concern is mitigated
since certain constraints exist that militate against this
occurring. First, there may be basis risk between the penultimate
swap and the core referenced futures contract. Second, compared to
most other contracts, the Commission believes that natural gas has a
relatively liquid penultimate futures market that enables a market
participant to hedge or set-off its penultimate swap position. Since
the constraints described above do not necessarily apply to the
natural gas futures markets, the Commission preliminarily believes
that liquidity may be incentivized to shift from NG to penultimate
natural gas swaps in order to avoid federal position limits in the
absence of the Commission's proposed exception for natural gas in
the ``economically equivalent swap'' definition.
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d. Commission Determination of Economic Equivalence
While the Commission would primarily rely on market participants to
determine whether their swaps meet the proposed ``economically
equivalent swap'' definition, the Commission is proposing paragraph (3)
to the definition to clarify that the Commission may determine on its
own initiative that any swap or class of swaps satisfies, or does not
satisfy, the economically equivalent definition with respect to any
referenced contract or class of referenced contracts. The Commission
believes that this provision may provide the ability to offer clarity
to the marketplace in cases where uncertainty exists as to whether
certain swaps would qualify (or would not qualify) as ``economically
equivalent,'' and therefore would be (or would not be) subject to the
proposed federal position limits framework. Similarly, where market
participants hold divergent views as to whether certain swaps qualify
as ``economically equivalent,'' the Commission can ensure that all
market participants treat OTC swaps with identical material terms
similarly, and also would be able to serve as a backstop in case market
participants fail to properly treat economically equivalent swaps as
such. As noted above, the Commission would not take any enforcement
action with respect to violating the Commission's position limits
regulations if the Commission disagrees with a market participant's
determination as long as the market participant is able to provide
sufficient support to show that it made a reasonable, good faith effort
in applying its discretion.\145\
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\145\ See supra II.A.4.a. (discussing market participants'
discretion in determining whether a swap is economically
equivalent).
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5. ``Eligible Affiliate''
The Commission proposes to create the new defined term ``eligible
affiliate,'' which would be used in proposed Sec. 150.2(k), discussed
in connection with proposed Sec. 150.2 below. As discussed further in
that section of the release, an entity that qualifies as an ``eligible
affiliate'' would be permitted to voluntarily aggregate its positions,
even though it is eligible for an exemption from aggregation under
Sec. 150.4(b).
6. ``Eligible Entity''
The Commission adopted a revised ``eligible entity'' definition in
the 2016 Final Aggregation Rulemaking.\146\ The Commission is not
proposing any further amendments to this definition, but is including
that revised definition in this document so that all defined terms are
included. As noted above, the Commission is also proposing a non-
substantive change to remove the lettering from this and other
definitions that appear lettered in existing Sec. 150.1, and to list
the definitions in alphabetical order.
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\146\ See 17 CFR 150.1(d).
---------------------------------------------------------------------------
7. ``Entity''
The Commission proposes defining ``entity'' to mean ``a `person' as
defined in section 1a of the Act.'' \147\ The term, not defined in
existing Sec. 150.1, is used throughout proposed part 150 of the
Commission's regulations.
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\147\ 7 U.S.C. 1a(38).
---------------------------------------------------------------------------
8. ``Excluded Commodity''
The phrase ``excluded commodity'' is defined in CEA section 1a(19),
but is not defined or used in existing part 150 of the Commission's
regulations. The
[[Page 11619]]
Commission proposes including a definition of ``excluded commodity'' in
part 150 that references that term as defined in CEA section
1a(19).\148\
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\148\ 7 U.S.C. 1a(19).
---------------------------------------------------------------------------
9. ``Futures-Equivalent''
This phrase is currently defined in existing Sec. 150.1(f) and is
used throughout existing part 150 of the Commission's regulations to
describe the method for converting a position in an option on a futures
contract to an economically equivalent amount in a futures contract.
The Dodd-Frank Act amendments to CEA section 4a,\149\ in part, direct
the Commission to apply aggregate federal position limits to physical
commodity futures contracts and to swap contracts that are economically
equivalent to such physical commodity futures on which the Commission
has established limits. In order to aggregate positions in futures,
options on futures, and swaps, it is necessary to adjust the position
sizes, since such contracts may have varying units of trading (e.g.,
the amount of a commodity underlying a particular swap contract could
be larger than the amount of a commodity underlying a core referenced
futures contract). The Commission thus proposes to adjust position
sizes to an equivalent position based on the size of the unit of
trading of the core referenced futures contract. The phrase ``futures-
equivalent'' is used for that purpose throughout the proposed rules,
including in connection with the ``referenced contract'' definition in
proposed Sec. 150.1. The Commission also proposes broadening this
definition to include references to the proposed term ``core referenced
futures contracts.''
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\149\ Under 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 options on
futures contracts. 7 U.S.C. 6a(a)(2) and (5).
---------------------------------------------------------------------------
10. ``Independent Account Controller''
The Commission adopted a revised ``independent account controller''
definition in the 2016 Final Aggregation Rule.\150\ The Commission is
not proposing any further amendments to this definition, but is
including that revised definition in this document so that all defined
terms appear together.
---------------------------------------------------------------------------
\150\ See 17 CFR 150.1(e).
---------------------------------------------------------------------------
11. ``Long Position''
The phrase ``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.'' The Commission proposes to update this definition
to apply to swaps and to clarify that such positions would be on a
futures-equivalent basis. This provision would thus be applicable to
options on futures and swaps such that a long position would also
include a long futures-equivalent option on futures and a long futures-
equivalent swap.
12. ``Physical Commodity''
The Commission proposes to define 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.'' \151\ The proposed definition of ``physical commodity''
thus would include both exempt and agricultural commodities, but not
excluded commodities.
---------------------------------------------------------------------------
\151\ 7 U.S.C. 6a(a)(2)(A) and (B).
---------------------------------------------------------------------------
13. ``Position Accountability''
Existing Sec. 150.5 permits position accountability in lieu of
position limits in certain cases, but does not define the term
``position accountability.'' The proposed amendments to Sec. 150.5
would allow exchanges, in some cases, to adopt position accountability
levels in lieu of, or in addition to, position limits. The Commission
proposes a definition of ``position accountability'' for use throughout
proposed Sec. 150.5 as discussed in greater detail in connection with
proposed Sec. 150.5 below.
14. ``Pre-Enactment Swap''
The Commission proposes to create the defined term ``pre-enactment
swap'' to mean any swap entered into prior to enactment of the Dodd-
Frank Act of 2010 (July 21, 2010), the terms of which have not expired
as of the date of enactment of that Act. As discussed in connection
with proposed Sec. 150.3 later in this release, if acquired in good
faith, such swaps would be exempt from federal speculative position
limits, although such swaps could not be netted with post-effective
date swaps for purposes of complying with spot month speculative
position limits.
15. ``Pre-Existing Position''
The Commission proposes to create the defined term ``pre-existing
position'' to reference any position in a commodity derivative contract
acquired in good faith prior to the effective date of a final federal
position limit rulemaking. Proposed Sec. 150.2(g) would set forth the
circumstances under which position limits would apply to such
positions.
16. ``Referenced Contract''
The nine contracts currently subject to federal limits, which are
all physically-settled futures, are all listed in existing Sec.
150.2.\152\ As the Commission is proposing to expand the position
limits framework to cover certain cash-settled futures and options on
futures contracts and certain economically equivalent swaps, the
Commission proposes a new defined term, ``referenced contract,'' for
use throughout proposed part 150 to refer to contracts that would be
subject to federal limits.
---------------------------------------------------------------------------
\152\ 17 CFR 150.2.
---------------------------------------------------------------------------
The referenced contract definition would thus include: (1) Any core
referenced futures contract listed in proposed Sec. 150.2(d); (2) any
other contract (futures or option on futures), on a futures-equivalent
basis with respect to a particular core referenced futures contract,
that is directly or indirectly linked to the price of a core referenced
futures contract, or that is directly or indirectly linked to the price
of the same commodity underlying a core referenced futures contract
(for delivery at the same location(s)); and (3) any economically
equivalent swap, on a futures-equivalent basis.
The proposed referenced contract definition would include look-
alike futures and options on futures contracts (as well as options or
economically equivalent swaps with respect to such look-alike
contracts) and contracts of the same commodity but different sizes
(e.g., mini contracts). Positions in referenced contracts may in
certain circumstances be netted with positions in other referenced
contracts. However, to avoid evasion and undermining of the position
limits framework, non-referenced contracts on the same commodity could
not be used to net down positions in referenced contracts.\153\
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\153\ A more detailed discussion of when netting is permitted
appears below. See infra Section II.B.2.k. (discussion of netting).
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a. Cash-Settled Referenced Contracts
Under these proposed provisions, federal limits would apply to all
cash-settled futures and options on futures contracts on physical
commodities that are linked in some manner, whether directly or
indirectly, to physically-settled contracts subject to federal limits,
and to any cash settled swaps that are deemed ``economically equivalent
swaps'' with respect to a particular cash-settled referenced
contract.\154\ While the Commission
[[Page 11620]]
acknowledges previous comments to the effect that cash-settled
contracts are less susceptible to manipulation and thus should not be
subject to federal limits, the Commission is of the view that generally
speaking, linked cash-settled and physically-settled contracts form one
market, and thus should be subject to federal limits. This view is
informed by the Commission's experience overseeing derivatives markets,
where it has observed that it is common for the same market participant
to arbitrage linked cash- and physically-settled contracts, and where
it has also observed instances where linked cash-settled and
physically-settled contracts have been used together as part of a
manipulation.\155\ In the Commission's view, cash-settled contracts are
generally economically equivalent to physical-delivery contracts in the
same commodity. In the absence of position limits, a trader with
positions in both the physically-delivered and cash-settled contracts
may have increased ability and incentive to manipulate one contract to
benefit positions in the other.
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\154\ For example, ICE's Henry Penultimate Fixed Price Future,
which cash-settles directly to NYMEX's Henry Hub Natural Gas core
referenced futures contract, would be considered a referenced
contract under the rules proposed herein.
\155\ The Commission has previously found that traders with
positions in look-alike cash-settled contracts may have an incentive
to manipulate and undermine price discovery in the physical-delivery
contracts to which the cash-settled contract is linked. The practice
known as ``banging the close'' or ``marking the close'' is one such
manipulative practice that the Commission prosecutes and that this
proposal seeks to prevent.
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The proposal to include futures contracts and options on futures
that are ``indirectly linked'' to the core referenced futures contract
under the definition of ``referenced contract'' is intended to prevent
the evasion of position limits through the creation of an economically
equivalent futures contract or option on a future, as applicable, that
does not directly reference the price of the core referenced futures
contract. Such contracts that settle to the price of a referenced
contract but not to the price of a core referenced futures contract,
for example, would be indirectly linked to the core referenced futures
contract.\156\
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\156\ As discussed above, the Commission is proposing a
definition of ``economically equivalent swap'' that is narrower than
the class of futures and options on futures that would be included
as referenced contracts. See supra Section II.A.4. (discussion of
economically equivalent swaps).
---------------------------------------------------------------------------
On the other hand, an outright derivative contract whose settlement
price is based on an index published by a price reporting agency that
surveys cash market transaction prices (even if the cash market
practice is to price at a differential to a futures contract) would not
be directly or indirectly linked to the core referenced futures
contract. Similarly, a physical-delivery derivative contract whose
settlement price was based on the same underlying commodity at a
different delivery location (e.g., a hypothetical physical-delivery
futures contract on ultra-low sulfur diesel delivered at L.A. Harbor
instead of the NYMEX ultra-low sulfur diesel futures contract delivered
in New York Harbor core referenced futures contract) would not be
linked, directly or indirectly, to the core referenced futures contract
because the price of the physically-delivered L.A. Harbor contract
would reflect the L.A. Harbor market price for ultra-low sulfur diesel.
b. Exclusions From the Referenced Contract Definition
While the proposed referenced contract definition would include
linked contracts, it would also explicitly exclude certain other types
of contracts. Paragraph (3) of the proposed referenced contract
definition would explicitly exclude from that definition a location
basis contract, a commodity index contract, a swap guarantee, or a
trade option that meets the requirements of Sec. 32.3 of this chapter.
First, failing to exclude location basis contracts from the
referenced contract definition could enable speculators to net portions
of the location basis contract with outright positions in one of the
locations comprising the basis contract, which would permit
extraordinarily large speculative positions in the outright
contract.\157\ For example, under the proposed rules, a large outright
position in Henry Hub Natural Gas futures could not be netted down
against a location basis contract that cash-settles to the difference
in price between Gulf Coast Natural Gas and Henry Hub Natural Gas.
Absent the proposed exclusion, a market participant could otherwise
increase its exposure in the outright contract by using the location
basis contract to net down, and then increase further, an outright
contract position that would otherwise be restricted by position
limits.\158\ Further, excluding location basis contracts from the
referenced contract definition may allow commercial end-users to more
efficiently hedge the cost of commodities at their preferred location.
---------------------------------------------------------------------------
\157\ See infra Section II.B.2.k. (discussion of netting).
\158\ While excluding location basis contracts from the
referenced contract definition would prevent the circumstance
described above, it would also mean that location basis contracts
would not be subject to federal limits. The Commission would be
comfortable with this outcome because location basis contracts
generally demonstrate minimal volatility and are typically
significantly less liquid than the core referenced futures
contracts, meaning they would be more costly to try to use in a
manipulation.
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Similarly, the proposed exclusion of commodity index contracts from
the referenced contract definition would help ensure that market
participants could not use a position in a commodity index contract to
net down an outright position that was a component of the commodity
index contract. If the Commission did not exclude commodity index
contracts, then speculators would be allowed to take on massive
outright positions in referenced contracts, which could lead to
excessive speculation.
As noted above, it is common for swap dealers to enter into
commodity index contracts with participants for which the contract
would not qualify as a bona fide hedging position (e.g., with a pension
fund). Failing to exclude commodity index contracts from the referenced
contract definition could enable a swap dealer to use positions in
commodity index contracts to net down offsetting outright futures
positions in the components of the index. This would have the effect of
subverting the statutory pass-through swap language in CEA section
4a(c)(2)(B), which is intended to foreclose the recognition of
positions entered into for risk management purposes as bona fide hedges
unless the swap dealer is entering into positions opposite a
counterparty for which the swap position is a bona fide hedge.\159\
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\159\ 7 U.S.C. 6a(c)(2)(B). While excluding commodity index
contracts from the referenced contract definition would prevent the
potentially risky netting circumstance described above, it would
also mean that commodity index contracts would not be subject to
federal limits. The Commission would be comfortable with this
outcome because the commodities comprising the index would
themselves be subject to limits, and because commodity index
contracts generally tend to exhibit low volatility since they are
diversified across many different commodities.
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In order to clarify the types of contracts that would qualify as
location basis contracts and commodity index contracts, and thus would
be excluded from the referenced contract definition, the Commission
proposes guidance in Appendix C to part 150 of the Commission's
regulations. The proposed guidance would include information which
would help define the parameters of the terms ``location basis
contract'' and ``commodity index contract.'' To the extent a particular
contract fits within the proposed guidance, such contract would not be
a referenced contract, would not be subject to federal limits, and
could not
[[Page 11621]]
be used to net down positions in referenced contracts.\160\
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\160\ See infra Section II.B.2.k. (discussion of netting).
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Second, swap guarantees are explicitly excluded from the proposed
referenced contract definition. In connection with further defining the
term ``swap'' jointly with the Securities and Exchange Commission in
connection with the ``Product Definition Adopting Release,'' \161\ 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.\162\ 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. The Commission understands that
swap guarantees generally serve as insurance, and in many cases swap
guarantors guarantee the performance of an affiliate in order to entice
a counterparty to enter into a swap with such guarantor's affiliate. As
a result, the Commission preliminarily believes that swap guarantees
neither contribute to excessive speculation, market manipulation,
squeezes, or corners nor were contemplated by Congress when Congress
articulated its policy goals in CEA sections 4a(a)(1)-(3).\163\
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\161\ See generally Further Definition of ``Swap,'' ``Security-
Based Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, 77 FR 48207 (Aug. 13,
2012) (``Product Definitions Adopting Release'').
\162\ See id. at 48226.
\163\ To the extent that swap guarantees may lower costs for
uncleared OTC swaps in particular by incentivizing counterparties to
agree to the swap, excluding swap guarantees arguably may improve
market liquidity, which is consistent with the CEA's statutory goals
in CEA section 4a(a)(3)(B) to ensure sufficient liquidity for bona
fide hedgers when establishing its position limit framework.
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Third, trade options that meet the requirements of Sec. 32.3 would
also be excluded from the proposed referenced contract definition. The
Commission has traditionally exempted trade options from a number of
Commission requirements because they are typically used by end-users to
hedge physical risk and thus do not contribute to excessive
speculation. Trade options are not subject to position limits under
current regulations, and the proposed exclusion of trade options from
the referenced contract definition would simply codify existing
practice.\164\
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\164\ In the trade options final rule, the Commission stated its
belief that federal limits should not apply to trade options, and
expressed an intention to address trade options in the context of
any final rulemaking on position limits. See Trade Options, 81 FR at
14966, 14971 (Mar. 21, 2016).
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c. List of Referenced Contracts
In an effort to provide clarity to market participants regarding
which exchange-traded contracts are subject to federal limits, the
Commission anticipates publishing, and regularly updating, a list of
such contracts on its website.\165\ The Commission thus proposes to
publish a CFTC Staff Workbook of Commodity Derivative Contracts under
the Regulations Regarding Position Limits for Derivatives along with
this release, which would provide a non-exhaustive list of referenced
contracts and may be helpful to market participants in determining
categories of contracts that would fit within the referenced contract
definition. As always, market participants may request clarification
from the Commission.
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\165\ As discussed above, the Commission will provide market
participants with reasonable, good-faith discretion to determine
whether a swap would qualify as economically equivalent for federal
position limit purposes. See supra Section II.A.4. (discussion of
economically equivalent swaps).
---------------------------------------------------------------------------
In order to ensure that the list remains up-to-date and accurate,
the Commission is proposing changes to certain provisions of part 40 of
its regulations which pertain to the collection of position limits
information through the filing of product terms and conditions
submissions. In particular, under existing rules, including Sec. Sec.
40.2, 40.3, and 40.4, DCMs and SEFs are required to comply with certain
submission requirements related to the listing of certain products.
Many of the required submissions must include the product's ``terms and
conditions,'' which is defined in Sec. 40.1(j) and which includes,
under Sec. 40.1(j)(1)(vii), ``Position limits, position accountability
standards, and position reporting requirements.'' The Commission
proposes to expand Sec. 40.1(j)(1)(vii), which addresses futures and
options on futures, to also include an indication as to whether the
contract meets the definition of a referenced contract as defined in
Sec. 150.1, and, if so, the name of the core referenced futures
contract on which the referenced contract is based. The Commission
proposes to also expand Sec. 40.1(j)(2)(vii), which addresses swaps,
to include an indication as to whether the contract meets the
definition of economically equivalent swap as defined in Sec. 150.1 of
this chapter, and, if so, the name of the referenced contract to which
the swap is economically equivalent. This information would enable the
Commission to maintain on its website, www.cftc.gov, an up-to-date list
of DCM and SEF contracts subject to federal limits.
17. ``Short Position''
The Commission proposes to expand the existing definition of
``short position,'' currently defined in Sec. 150.1(h), to include
swaps and to clarify that any such positions would be measured on a
futures-equivalent basis.
18. ``Speculative Position Limit''
The Commission proposes to define the term ``speculative position
limit'' for use throughout part 150 of the Commission's regulations to
refer to federal or exchange-set limits, net long or net short,
including single month, spot month, and all-months-combined limits.
This proposed definition is not intended to limit the authority of
exchanges to adopt other types of limits that do not meet the
``speculative position limit definition,'' such as a limit on gross
long or gross short positions, or a limit on holding or controlling
delivery instruments.
19. ``Spot Month,'' ``Single Month,'' and ``All-Months''
The Commission proposes to expand the existing definition of ``spot
month'' to account for the fact that the proposed limits would apply to
both physically-settled and certain cash-settled contracts, to clarify
that the spot month for referenced contracts would be the same period
as that of the relevant core referenced futures contract, and to
account for variations in spot month conventions that differ by
commodity. In particular, for the ICE U.S. Sugar No. 11 (SB) core
referenced futures contract, the spot month would mean the period of
time beginning at the opening of trading on the second business day
following the expiration of the regular option contract traded on the
expiring futures contract until the contract expires. For the ICE U.S.
Sugar No. 16 (SF) core referenced futures contract, the spot month
would mean the period of time beginning on the third-to-last trading
day of the contract month until the contract expires. For the CME Live
Cattle (LC) core referenced futures contract, the spot month would mean
the period of time beginning at the close of trading on the fifth
business day of the contract month until the contract expires.
The Commission also proposes to eliminate the existing definitions
of ``single month'' and ``all-months'' because the definitions for
those terms would be built into the proposed definition of
``speculative position limits'' described above.
[[Page 11622]]
20. ``Spread Transaction''
The Commission proposes to incorporate a definition for
transactions normally known to the trade as ``spreads,'' which would
list the types of transactions that could qualify for spread exemptions
for purposes of federal position limits. The proposed list would cover
common types of inter-commodity and intra-commodity spreads such as:
Calendar spreads; quality differential spreads; processing spreads
(such as energy ``crack'' or soybean ``crush'' spreads); product or by-
product differential spreads; and futures-options spreads.\166\
Separately, under proposed Sec. 150.3(a)(2)(ii), the Commission could
determine to exempt any other spread transaction that is not included
in the spread transaction definition, but that the Commission has
determined is consistent with CEA section 4a(a)(3)(B),\167\ and
exempted, pursuant to proposed Sec. 150.3(b).
---------------------------------------------------------------------------
\166\ For example, trading activity in many commodity derivative
markets is concentrated in the nearby contract month, but a hedger
may need to offset risk in deferred months where derivative trading
activity may be less active. A calendar spread trader could provide
liquidity without exposing himself or herself to the price risk
inherent in an outright position in a deferred month. Processing
spreads can serve a similar function. For example, a soybean
processor may seek to hedge his or her processing costs by entering
into a ``crush'' spread, i.e., going long soybeans and short soybean
meal and oil. A speculator could facilitate the hedger's ability to
do such a transaction by entering into a ``reverse crush'' spread
(i.e., going short soybeans and long soybean meal and oil). Quality
differential spreads, and product or by-product differential
spreads, may serve similar liquidity-enhancing functions when
spreading a position in an actively traded commodity derivatives
market such as CBOT Wheat (W) against a position in another actively
traded market, such as MGEX Wheat.
\167\ As noted above, CEA section 4a(a)(3)(B) provides that the
Commission shall set limits ``to the maximum extent practicable, in
its discretion--(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.''
---------------------------------------------------------------------------
21. ``Swap'' and ``Swap Dealer''
The Commission proposes to incorporate the definitions of ``swap''
and ``swap dealer'' as they are defined in section 1a of the Act and
Sec. 1.3 of this chapter.\168\
---------------------------------------------------------------------------
\168\ 7 U.S.C. 1a(47) and 1a(49); 17 CFR 1.3.
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22. ``Transition Period Swap''
The Commission proposes to create the defined term ``transition
period swap'' to mean any swap entered into during the period
commencing July 22, 2010 and ending 60 days after the publication of a
final federal position limits rulemaking in the Federal Register, the
terms of which have not expired as of that date. As discussed in
connection with proposed Sec. 150.3 later in this release, if acquired
in good faith, such swaps would be exempt from federal speculative
position limits, although such swaps could not be netted with post-
effective date swaps for purposes of complying with spot month
speculative position limits.
Finally, the Commission proposes to eliminate existing Sec.
150.1(i), which includes a chart specifying the ``first delivery month
of the crop year'' for certain commodities. The crop year definition
had been pertinent for purposes of the spread exemption to the
individual month limit in current Sec. 150.3(a)(3), which limits
spreads to those between individual months in the same crop year and to
a level no more than that of the all-months limit. This provision was
pertinent at a time when the single month and all months combined
limits were different. Now that the current and proposed single month
and all months combined limits are the same, and now that the
Commission is proposing a new process for granting spread exemptions in
Sec. 150.3, this provision is no longer needed.
23. Request for Comment
The Commission requests comment on all aspects of the proposed
amendments and additions to the definitions in Sec. 150.1. The
Commission also invites comments on the following:
(1) Should the Commission include the enumerated hedges in
regulations, rather than in an appendix of acceptable practices? Why or
why not?
(2) Should the Commission list any additional common commercial
hedging practices as enumerated hedges?
(3) The Commission proposes to eliminate the five day rule on
federal position limits, instead allowing exchanges discretion on
whether to apply or waive any five day rule or equivalent on their
exchange position limits. The Commission believes that the five day
rule can be an important way to help ensure that futures and cash
market prices converge. As such, should the Commission require that
exchanges apply the five day rule to some or all bona fide hedging
positions and/or spread exemptions? If so, to which bona fide hedging
positions? Should the exchanges retain the ability to waive such five
day rule?
(4) The Commission requests comment on the nature of anticipated
merchandising exemptions that have been granted by DCMs in connection
with the 16 non-legacy commodities or in connection with exemptions
from exchange limits in 9 legacy commodities.
(5) To what extent do the enumerated hedges proposed in this
release encompass the types of positions discussed in the BFH Petition?
Should additional types of positions identified in the BFH Petition,
including examples nos. 3 (unpriced physical purchase and sale
commitments) and 7 (scenario 2) (use of physical delivery referenced
contracts to hedge physical transactions using calendar month averaging
pricing), be enumerated as bona fide hedges, after notice and comment?
(6) The Commission requests comment as to whether price risk is
attributable to a variety of factors, including political and weather
risk, and could therefore allow hedging political, weather, or other
risks, or whether price risk is something narrower in the application
of bona fide hedging.
(7) While an ``economically equivalent swap'' qualifies as a
referenced contract under paragraph (2) of the ``referenced contract''
definition, paragraph (1) of the ``referenced contract'' definition
applies a broader test to determine whether futures contracts or
options on a futures contract would qualify as a referenced contract.
Instead of a separate definition for ``economically equivalent swaps,''
should the same test (e.g., paragraph (1) of the ``referenced
contract'' definition) that applies to futures and options on futures
for determining status as ``referenced contracts'' also apply to
determine whether a swap is an ``economically equivalent swap,'' and
therefore a ``referenced contract''? Why or why not?
(8) The Commission is proposing to define ``economically equivalent
swap'' in a manner that is generally consistent with the EU's
definition, with the exception that a swap must have ``identical
material'' terms, disregarding differences in lot size or notional
amount, delivery dates diverging by less than one calendar day (or for
natural gas, by less than two calendar days), or post-trade risk
management arrangements. Is this approach either too narrow or too
broad? Why or why not?
(9) The Commission requests comment how a market participant
subject to both the CFTC's and EU's position limits regimes expects to
comply with both regimes for contracts subject to both regimes.
(10) With respect to economically equivalent swaps, the Commission
proposes an exception that would capture penultimate swaps only for
natural gas contracts, including
[[Page 11623]]
penultimate swaps on the NYMEX NG core referenced futures contract. Is
this exception for such penultimate natural gas swaps appropriate, or
should economically equivalent natural gas swaps be treated the same as
other economically equivalent swaps? Why or why not?
(11) Should the Commission broaden the definition of ``economically
equivalent swap'' to include penultimate referenced contracts for all
(or at least a subset of) commodities subject to federal position
limits? Why or why not?
(12) The Commission is proposing that a physically-settled swap may
qualify as economically equivalent even if its delivery date diverges
by less than one calendar day from its corresponding physically-settled
referenced contract. Should the Commission include a similar provision
for cash-settled swaps where cash-settled swaps could qualify as
economically equivalent if their cash settlement price determination
diverged from their corresponding cash-settled referenced contract by
less than one calendar day?
(13) Under the proposed definition of ``economically equivalent
swaps,'' a cash-settled swap that otherwise shares identical material
terms with a physically-settled referenced contract (and vice-versa)
would not be deemed to be economically equivalent due to the difference
in settlement type. Should the Commission consider treating swaps that
share identical material terms, other than settlement type (i.e., cash-
settled versus physically-settled swaps), to be economically
equivalent? Why or why not?
(14) Consistent with the 2016 Reproposal, the Commission is
proposing to explicitly exclude swap guarantees from the referenced
contract definition.\169\ Should the Commission again propose to
exclude swap guarantees from the referenced contract definition? Why or
why not? If the Commission does exclude swap guarantees, should such
exclusion be limited to guarantees for affiliated entities only? Why or
why not?
---------------------------------------------------------------------------
\169\ See 2016 Reproposal, 81 FR at 96966.
---------------------------------------------------------------------------
(15) Please indicate if any updates or other modifications are
needed to: (1) The proposed list of referenced contracts that would
appear in the CFTC Staff Workbook of Commodity Derivative Contracts
Under the Regulations Regarding Position Limits for Derivatives posted
on the Commission's website; \170\ or (2) the proposed Appendix D to
part 150 list of commodities deemed ``substantially the same'' for
purposes of the term ``location basis contract'' as used in the
proposed ``referenced contract'' definition.
---------------------------------------------------------------------------
\170\ Position Limits for Derivatives, U.S. Commodity Futures
Trading Commission website, available at https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/PositionLimitsforDerivatives/index.htm.
---------------------------------------------------------------------------
(16) Should the Commission require exchanges to maintain a list of
referenced contracts and location basis contracts listed on their
platforms?
(17) The Commission has previously requested, and commenters have
previously provided, a list of risks other than price risk for which
commercial enterprises commonly need to hedge.\171\ Please explain
which hedges of non-price risks could be objectively and systematically
verified as bona fide hedges by the Commission, and how the Commission
would verify that such positions are bona fide hedges, including how
the Commission would consistently and definitively quantify and assess
whether any such hedges of non-price risks are bona fide hedges that
comply with the proposed bona fide hedging definition.
---------------------------------------------------------------------------
\171\ See, e.g., National Gas Supply Association Comment Letter
at 4 (Feb. 28, 2017) in response to 2016 Reproposal (listing
operational risk, liquidity risk, credit risk, locational risk, and
seasonal risk).
---------------------------------------------------------------------------
(18) The Commission proposes to define spread transactions to
include: Either a calendar spread, intercommodity spread, quality
differential spread, processing spread (such as energy ``crack'' or
soybean ``crush'' spreads), product or by-product differential spread,
or futures-option spread. Are there other types of transactions
commonly known to the trade as ``spreads'' that the Commission should
include in its spread transaction definition? Please provide any
examples or descriptions that will help the Commission determine
whether such transactions would be consistent with CEA section
4a(a)(3)(B) and should be included in the definition of spread
transaction.
(19) Should the Commission require market participants that trade
economically equivalent swaps OTC, rather than on a SEF or DCM, to
self-identify and report to the Commission that in their view, such
swaps meet the Commission's proposed economically equivalent swap
definition?
B. Sec. 150.2--Federal Limit Levels
1. Existing Sec. 150.2
Federal spot month, single month, and all-months-combined position
limits currently apply to nine physically-settled futures contracts on
agricultural commodities listed in existing Sec. 150.2, and, on a
futures-equivalent basis, to options contracts thereon. Existing
federal limit levels set forth in Sec. 150.2 \172\ apply net long or
net short and are as follows:
---------------------------------------------------------------------------
\172\ 17 CFR 150.2.
Existing Legacy Agricultural Contract Federal Spot Month, Single Month,
and All-Months-Combined Limit Levels
------------------------------------------------------------------------
Single month and
Contract Spot month limit all-months-
combined limit
------------------------------------------------------------------------
Chicago Board of Trade (``CBOT'') 600 33,000
Corn (C).........................
CBOT Oats (O)..................... 600 2,000
CBOT Soybeans (S)................. 600 15,000
CBOT Soybean Meal (SM)............ 720 6,500
CBOT Soybean Oil (SO)............. 540 8,000
CBOT Kansas City Hard Red Winter 600 12,000
Wheat (KW).......................
CBOT Wheat (W).................... 600 12,000
ICE Futures U.S. (``ICE'') Cotton 300 5,000
No. 2 (CT).......................
Minneapolis Grain Exchange 600 12,000
(``MGEX'') Hard Red Spring Wheat
(MWE)............................
------------------------------------------------------------------------
[[Page 11624]]
While not explicit in Sec. 150.2, the Commission's practice has
been to set spot month limit levels at or below 25 percent of
deliverable supply based on DCM estimates of deliverable supply
verified by the Commission, and to set limit levels outside of the spot
month at 10 percent of open interest for the first 25,000 contracts of
open interest, with a marginal increase of 2.5 percent of open interest
thereafter.
2. Proposed Sec. 150.2 \173\
---------------------------------------------------------------------------
\173\ This portion of the release is organized by subject
matter, rather than by lettered provision, and will proceed in the
following order: (1) Contracts subject to federal limits; (2)
proposed spot month limit levels; (3) proposed methodology for
setting spot month limit levels; (4) proposed non-spot month limit
levels; (5) proposed methodology for setting non-spot month limit
levels; (6) subsequent levels; (7) relevant contract month for
purposes of referenced contracts; (8) limits on pre-existing
positions; (9) limits for positions on foreign boards of trade; (10)
anti-evasion provision; (11) netting of positions; (12) eligible
affiliates and aggregation; and (13) request for comment.
---------------------------------------------------------------------------
a. Contracts Subject to Federal Limits
The Commission proposes to establish federal limits on the 25 core
referenced futures contracts listed in proposed Sec. 150.2(d),\174\
and on their associated referenced contracts, which would include swaps
that qualify as ``economically equivalent swaps.'' \175\ The Commission
proposes to establish position limits on futures and options on these
25 commodities on the basis that position limits on such contracts are
``necessary.'' A discussion of the necessity finding and the
characteristics of the 25 core referenced futures contracts is in
Section III.F.
---------------------------------------------------------------------------
\174\ Proposed Sec. 150.2(d) provides that each core referenced
futures contract includes any ``successor'' contracts. An example of
a successor contract would be the RBOB Gasoline contract that was
listed due to a change in gasoline specifications and that
ultimately replaced the Unleaded Gasoline contract. For some time,
both contracts were listed for trading to allow open interest to
migrate to the new RBOB contract; once trading migrated, the
Unleaded Gasoline contract was delisted.
\175\ As described above, the proposed term ``referenced
contract'' includes: (1) Futures and options on futures contracts
that, with respect to a particular core referenced futures contract,
are directly or indirectly linked to the price of that core
referenced futures contract, or directly or indirectly linked to the
price of the same commodity underlying the core referenced futures
contract for delivery at the same location; and (2) ``economically
equivalent swaps.'' See proposed ``referenced contract'' and
``economically equivalent swap'' definitions in 150.1.
---------------------------------------------------------------------------
In order to comply with CEA section 4a(a)(5), the Commission also
proposes to establish limits on swaps that are ``economically
equivalent'' to the above.\176\ As discussed above, under the
Commission's proposed definition of ``economically equivalent swap''
set forth in Sec. 150.1, a swap would generally qualify as
economically equivalent with respect to a particular referenced
contract so long as the swap shares identical material contract
specifications, terms, and conditions with the referenced contract,
disregarding any differences with respect to lot size or notional
amount, delivery dates diverging by less than one calendar day, (or for
natural gas, by less than two calendar days) or post-trade risk-
management arrangements.\177\
---------------------------------------------------------------------------
\176\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5).
\177\ See infra Section II.A.4. (definition of ``economically
equivalent swap'').
---------------------------------------------------------------------------
As described in greater detail below, the proposed federal limits
would apply during all contract months for the nine legacy agricultural
commodity contracts and only during the spot month for the 16 other
commodity contracts.
Proposed Sec. 150.2(e) would provide that the levels set forth
below for the 25 contracts are listed in Appendix E to part 150 of the
Commission's regulations and would set the compliance date for such
levels at 365 days after publication of final position limits
regulations in the Federal Register.
b. Proposed Federal Spot Month Limit Levels
Under the rules proposed herein, federal spot month limit levels
would apply to all 25 core referenced futures contracts, and any
associated referenced contracts.\178\ Federal spot month limits for
referenced contracts on all 25 commodities are essential for deterring
and preventing excessive speculation, manipulation, corners and
squeezes.\179\ Proposed Sec. 150.2(e) provides that federal spot month
levels are set forth in proposed Appendix E to part 150 and are as
follows:
---------------------------------------------------------------------------
\178\ As described below, federal non-spot month limit levels
would only apply to the nine legacy agricultural commodities. The 16
non-legacy commodities would be subject to federal limits during the
spot month, and exchange-set limits and/or accountability outside of
the spot month. See infra Section II.B.2.d. (discussion of proposed
non-spot month limit levels).
\179\ See infra Section III. (Legal Matters).
\180\ CBOT's existing exchange-set limit for Wheat (W) is 600
contracts. However, for its May contract month, CBOT has a variable
spot limit that is dependent upon the deliverable supply that it
publishes from the CBOT's Stocks and Grain report on the Friday
preceding the first notice day for the May contract month. In the
last five trading days of the expiring futures month in May, the
speculative position limit is: (1) 600 contracts if deliverable
supplies are at or above 2,400 contracts; (2) 500 contracts if
deliverable supplies are between 2,000 and 2,399 contracts; (3) 400
contracts if deliverable supplies are between 1,600 and 1,999
contracts; (4) 300 contracts if deliverable supplies are between
1,200 and 1,599 contracts; and (5) 220 contracts if deliverable
supplies are below 1,200 contracts.
\181\ The proposed federal spot month limit for CME Live Cattle
(LC) would feature a step-down limit similar to the CME's existing
Live Cattle (LC) step-down exchange set limit. The proposed federal
spot month step down limit is: (1) 600 at the close of trading on
the first business day following the first Friday of the contract
month; (2) 300 at the close of trading on the business day prior to
the last five trading days of the contract month; and (3) 200 at the
close of trading on the business day prior to the last two trading
days of the contract month.
\182\ CME's existing exchange-set limit for Live Cattle (LC) has
a step-down spot month limit: (1) 450 at the close of trading on the
first business day following the first Friday of the contract month;
(2) 300 at the close of trading on the business day prior to the
last five trading days of the contract month; and (3) 200 at the
close of trading on the business day prior to the last two trading
days of the contract month.
\183\ CBOT's existing exchange-set spot month limit for Rough
Rice (RR) is 600 contracts for all contract months. However, for
July and September, there is a step-down limit from 600 contracts.
In the last five trading days of the expiring futures month, the
speculative position limit for the July futures month steps down to
200 contracts from 600 contracts and the speculative position limit
for the September futures month steps down to 250 contracts from 600
contracts.
\184\ NYMEX recommends implementing a step-down federal spot
position limit for its Light Sweet Crude Oil (CL) futures contract:
(1) 6,000 contracts as of the close of trading three business days
prior to the last trading day of the contract; (2) 5,000 contracts
as of the close of trading two business days prior to the last
trading day of the contract; and (3) 4,000 contracts as of the close
of trading one business day prior to the last trading day of the
contract.
----------------------------------------------------------------------------------------------------------------
2020 Proposed spot Existing federal spot Existing exchange-set
Core referenced futures contract month limit month limit spot month limit
----------------------------------------------------------------------------------------------------------------
Legacy Agricultural Contracts
----------------------------------------------------------------------------------------------------------------
CBOT Corn (C)........................ 1,200 600 600
CBOT Oats (O)........................ 600 600 600
CBOT Soybeans (S).................... 1,200 600 600
CBOT Soybean Meal (SM)............... 1,500 720 720
CBOT Soybean Oil (SO)................ 1,100 540 540
CBOT Wheat (W)....................... 1,200 600 \180\ 600/500/400/300/
220
CBOT KC HRW Wheat (KW)............... 1,200 600 600
[[Page 11625]]
MGEX HRS Wheat (MWE)................. 1,200 600 600
ICE Cotton No. 2 (CT)................ 1,800 300 300
----------------------------------------------------------------------------------------------------------------
Other Agricultural Contracts
----------------------------------------------------------------------------------------------------------------
CME Live Cattle (LC)................. \181\ 600/300/200 n/a \182\ 450/300/200
CBOT Rough Rice (RR)................. 800 n/a \183\ 600/200/250
ICE Cocoa (CC)....................... 4,900 n/a 1,000
ICE Coffee C (KC).................... 1,700 n/a 500
ICE FCOJ-A (OJ)...................... 2,200 n/a 300
ICE U.S. Sugar No. 11 (SB)........... 25,800 n/a 5,000
ICE U.S. Sugar No. 16 (SF)........... 6,400 n/a n/a
----------------------------------------------------------------------------------------------------------------
Metals Contracts
----------------------------------------------------------------------------------------------------------------
COMEX Gold (GC)...................... 6,000 n/a 3,000
COMEX Silver (SI).................... 3,000 n/a 1,500
COMEX Copper (HG).................... 1,000 n/a 1,500
NYMEX Platinum (PL).................. 500 n/a 500
NYMEX Palladium (PA)................. 50 n/a 50
----------------------------------------------------------------------------------------------------------------
Energy Contracts
----------------------------------------------------------------------------------------------------------------
NYMEX Light Sweet Crude Oil (CL)..... \184\ 6,000/5,000/4,000 n/a 3,000
NYMEX NYH ULSD Heating Oil (HO)...... 2,000 n/a 1,000
NYMEX NYH RBOB Gasoline (RB)......... 2,000 n/a 1,000
NYMEX Henry Hub Natural Gas (NG)..... 2,000 n/a 1,000
----------------------------------------------------------------------------------------------------------------
Limits for any contract with a proposed limit above 100 contracts
would be rounded up to the nearest 100 contracts from the exchange-
recommended level and/or from 25 percent of deliverable supply.
c. Process for Calculating Federal Spot Month Limit Levels
The existing federal spot month limit levels on the nine legacy
agricultural contracts have remained constant for decades, yet the
markets have changed significantly during that time period, including
the advent of electronic trading and the implementation of extended
trading hours. Further, open interest and trading volume have since
reached record levels, and some of the deliverable supply estimates on
which the existing federal spot month limits were originally based are
now decades out of date. In light of these and other factors, CME
Group, ICE, and MGEX recommended federal spot month limit levels for
each of their respective core referenced futures contracts, including
contracts that would be subject to federal limits for the first time
under this proposal.\185\ Commission staff reviewed these
recommendations and conducted its own analysis of them, including by
requesting additional information and by independently assessing the
recommended levels using its own experience, observations, and
knowledge. The Commission proposes to adopt each of the exchange-
recommended levels as federal spot month limit levels.
---------------------------------------------------------------------------
\185\ See ICE Comment Letter at 8 (May 14, 2019); MGEX Comment
Letter at 2, 4-8 (Aug. 31, 2018); and Summary DSE Proposed Limits,
CME Group Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038-AD99).
---------------------------------------------------------------------------
In setting federal limits, the Commission considers the four policy
objectives in CEA section 4a(a)(3)(B). That is, to set limits, to the
maximum extent practicable, in its discretion, 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.\186\ In
setting federal position limit levels, the Commission endeavors to
maximize these objectives by setting limits that are low enough to
prevent excessive speculation, manipulation, squeezes, and corners that
could disrupt price discovery, but high enough so as not to restrict
liquidity for bona fide hedgers.
---------------------------------------------------------------------------
\186\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------
Based on the Commission's experience overseeing federal position
limits for decades, and overseeing exchange-set position limits
submitted to the Commission pursuant to part 40 of its regulations, the
Commission has analyzed and evaluated the information provided by CME
Group, ICE, and MGEX, and preliminarily finds that none of the
recommended levels considered in preparing this release appear
improperly calibrated such that they might hinder liquidity for bona
fide hedgers, or invite excessive speculation, manipulation, corners,
or squeezes, including activity that could impact price discovery. For
these reasons, discussed in turn below, the Commission preliminarily
believes that the DCMs' recommended spot month limit levels all further
the statutory objectives set forth in CEA section 4a(a)(3)(B).\187\
---------------------------------------------------------------------------
\187\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------
i. The Proposed Spot Month Limit Levels Are Low Enough To Prevent
Excessive Speculation and Protect Price Discovery
All 25 of the exchange-recommended levels are at or below 25
percent of deliverable supply.\188\ The Commission has long used
deliverable supply as the basis for spot month position limits due to
concerns regarding corners, squeezes, and other settlement-period
manipulative activity.\189\ It would be difficult, in the absence of
other factors, for a participant to corner or squeeze a market if the
participant holds less than or equal to 25 percent of deliverable
supply because, among other things, any
[[Page 11626]]
potential economic gains resulting from the manipulation may be
insufficient to justify the potential costs, including the costs of
acquiring, and ultimately offloading, the positions used to effectuate
the manipulation.
---------------------------------------------------------------------------
\188\ The recommended levels range from approximately 7 percent
of deliverable supply to 25 percent of deliverable supply.
\189\ See, e.g., Revision of Federal Speculative Position Limits
and Associated Rules, 64 FR 24038 (May 5, 1999).
---------------------------------------------------------------------------
By restricting positions to a proportion of the deliverable supply
of the commodity, the spot month position limits require that no one
speculator can hold a position larger than 25 percent of deliverable
supply, reducing the possibility that a market participant can use
derivatives, including referenced contracts, to affect the price of the
cash commodity (and vice versa). Limiting a speculative position based
on a percentage of deliverable supply also restricts a speculative
trader's ability to establish a leveraged position in cash-settled
derivative contracts, reducing that trader's incentive to manipulate
the cash settlement price.\190\ Further, by proposing levels that are
sufficiently low to prevent market manipulation, including corners and
squeezes, the proposed levels also help ensure that the price discovery
function of the underlying market is not disrupted because markets that
are free from corners, squeezes, and other manipulative activity
reflect fundamentals of supply and demand rather than artificial
pressures.
---------------------------------------------------------------------------
\190\ Id.
---------------------------------------------------------------------------
Each of the exchange-recommended levels is based on a percentage of
deliverable supply estimated by the relevant exchange and submitted to
the Commission for review.\191\ The Commission has closely assessed the
estimates, which CME Group, ICE, and MGEX updated with recent data
using the methodologies they used during the 2016 Reproposal.\192\ The
Commission hereby verifies that the estimates submitted by the
exchanges are reasonable.
---------------------------------------------------------------------------
\191\ See ICE Comment Letter at 8 (May 14, 2019); MGEX Comment
Letter at 2, 4-8 (Aug. 31, 2018); and Summary DSE Proposed Limits,
CME Group Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038-AD99).CME Group
submitted updated estimates of deliverable supply and recommended
federal spot month limit levels for CBOT Corn (C), CBOT Oats (O),
CBOT Rough Rice (RR), CBOT Soybeans (S), CBOT Soybean Meal (SM),
CBOT Soybean Oil (SO), CBOT Wheat (W), and CBOT KC HRW Wheat (KW);
COMEX Gold (GC), COMEX Silver (SI), NYMEX Platinum (PL), NYMEX
Palladium (PA), and COMEX Copper (HG); and NYMEX Henry Hub Natural
Gas (NG), NYMEX Light Sweet Crude Oil (CL), NYMEX NY Harbor ULSD
Heating Oil (HO), and NYMEX NY Harbor RBOB Gasoline (RB). ICE
submitted updated estimates of deliverable supply and recommended
federal spot month limit levels for ICE Cocoa (CC), ICE Coffee C
(KC), ICE Cotton No. 2 (CT), ICE FCOJ-A (OJ), ICE U.S. Sugar No. 11
(SB), and ICE U.S. Sugar No. 16 (SF). MGEX submitted an updated
deliverable supply estimate and indicated that if the Commission
adopted a specific spot month position limit, MGEX believes the
federal spot month limit level for MGEX Hard Red Spring Wheat (MWE)
should be no less than 1,000 contracts. Commission staff reviewed
the exchange submissions and conducted its own research. Commission
staff reviewed the data submitted, confirmed that the data submitted
accurately reflected the source data, and considered whether the
data sources were authoritative. Commission staff considered whether
the assumptions made by the exchanges in the submissions were
acceptable, or whether alternative assumptions would lead to similar
results. In some cases, Commission staff conducted trade source
interviews. Commission staff replicated the calculations included in
the submissions.
\192\ See CME Group Comment Letter (Apr. 15, 2016); CME Group
Comment Letter (addressing natural gas) (Sept. 15, 2016); CME Group
Comment Letter (addressing ULSD) (Sept. 15, 2016); ICE Comment
Letter (Apr. 20, 2016); and MGEX Comment Letter (Jul. 13, 2016),
available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1772&ctl00_ctl00_cphContentMain_MainContent_gvCommentListChangePage=8_50. At that time, the Commission reviewed the
methodologies that the DCMs used to prepare the estimates, among
other things, and verified the deliverable supply estimates as
reasonable. See 2016 Reproposal, 81 FR at 96754.
---------------------------------------------------------------------------
In verifying the DCMs' estimates of deliverable supply, the
Commission is not endorsing any particular methodology for estimating
deliverable supply beyond what is already set forth in Appendix C to
part 38 of the Commission's regulations.\193\ As circumstances change
over time, such DCMs may need to adjust the methodology, assumptions,
and allowances that they use to estimate deliverable supply to reflect
then current market conditions and other relevant factors.
---------------------------------------------------------------------------
\193\ 17 CFR part 38, Appendix C.
---------------------------------------------------------------------------
ii. The Proposed Spot Month Limit Levels are High Enough To Ensure
Sufficient Market Liquidity for Bona Fide Hedgers
Section 4a(a)(1) of the CEA addresses ``excessive speculation. .
.causing sudden or unreasonable fluctuations or unwarranted [price]
changes . . .'' \194\ Speculative activity that is not ``excessive'' in
this manner is not a focus of section 4a(a)(1). Rather, speculative
activity may generate liquidity by enabling market participants with
bona fide hedging positions to trade more efficiently. Setting position
limits too low could result in reduced liquidity, including for bona
fide hedgers. The Commission has not observed, or received any
complaints about, a lack of liquidity for bona fide hedgers in the
markets for the 25 core referenced futures contracts. In fact, as
described later in this release, the 25 core referenced futures
contracts represent some of the most liquid markets overseen by the
Commission.\195\ Market developments that have taken place since
federal spot month limits were last amended decades ago, such as
electronic trading and expanded trading hours, have likely only
contributed to these already liquid markets.\196\ Market participants
have more opportunities than ever to enter, trade, or exit a position.
By proposing to generally increase the existing federal spot month
limit levels, and by proposing federal spot month limit levels that are
generally equal to or higher than existing exchange-set levels,\197\
yet in all cases still low enough to prevent excessive speculation,
manipulation, corners and squeezes, the Commission does not expect the
proposed limits to result in a reduction in liquidity for bona fide
hedgers.
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\194\ CEA section 4a(a)(1); 7 U.S.C. 6a(a)(1).
\195\ See infra Section III.F.
\196\ With the exception of CBOT Oats (O), open interest for the
legacy agricultural commodities has increased dramatically over the
past several decades, some by a factor of four.
\197\ While the proposed spot month limit levels are generally
higher than the existing federal or exchange-set levels, the
proposed federal level for COMEX Copper (HG) is below the existing
exchange-set level, the proposed federal level for CBOT Oats (O) is
the same as the existing federal and exchange-set level, and the
proposed federal levels for NYMEX Platinum (PL) and NYMEX Palladium
(PA) are the same as the existing exchange-set levels.
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iii. The Proposed Spot Month Limit Levels Fall Within a Range of
Acceptable Levels
ICE and MGEX recommended federal spot month limit levels at 25
percent of deliverable supply, while CME Group generally recommended
levels below 25 percent of deliverable supply.\198\ These
[[Page 11627]]
distinctions reflect philosophical and other differences among the
exchanges and differences between the core referenced futures contracts
and their underlying commodities, including a preference on the part of
CME Group not to increase existing limit levels applicable to its core
referenced futures contracts too drastically.\199\ The Commission has
previously stated that ``there is a range of acceptable limit levels,''
\200\ and continues to believe this is true, both for spot and non-spot
month limits. There is no single ``correct'' spot month limit level for
a given contract, and it is likely that a number of limit levels within
a certain range could effectively address the 4a(a)(3) factors. While
the CME Group, ICE, and MGEX recommended levels all fall at different
ends of the deliverable supply range, the levels all fall at or below
25 percent of deliverable supply, which is critical for protecting the
spot month from excessive speculation, manipulation, corners and
squeezes.
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\198\ For the following core referenced futures contracts, CME
Group recommended spot month levels below 25 percent of deliverable
supply: CBOT Corn (C) (9.22% of deliverable supply), CBOT Oats (O)
(19.29%), CBOT Soybeans (S) (15.86%), CBOT Soybean Meal (SM)
(16.77%), Soybean Oil (SO) (8.31%), CBOT Wheat (W) (9.24%), CBOT KC
HRW Wheat (KW) (9.24%), CME Live Cattle (LC) (step-down limits
15.86%-7.93%-5.29%), CBOT Rough Rice (RR) (8.94%), COMEX Gold (GC)
(12.72%), COMEX Silver (SI) (12.62%), COMEX Copper (HG) (9.66%),
NYMEX Platinum (PL) (13.60%), NYMEX Palladium (PA) (17.18%), NYMEX
Light Sweet Crude Oil (CL) (step-down limits 11.16%-9.30%-7.44%),
NYMEX NYH ULSD Heating Oil (HO) (10.85%), and NYMEX NYH RBOB
Gasoline (RB) (7.41%). CME Group recommended spot month levels at 25
percent of estimated deliverable supply for NYMEX Henry Hub Natural
Gas (NG). ICE and MGEX recommended limit levels at 25 percent of
estimated deliverable supply for each of their core referenced
futures contracts: Cocoa (CC), Coffee C (KC), FCOJ-A (OJ), Cotton
No. 2 (CT), U.S. Sugar No. 11 (SB), and U.S. Sugar No. 16 (SF) on
ICE, and Hard Red Spring Wheat (MWE) on MGEX. See ICE Comment Letter
at 1-7 (May 14, 2019); MGEX Comment Letter at 2, 4-8 (Aug. 31,
2018); and Summary DSE Proposed Limits, CME Group Comment Letter
(Nov. 26, 2019), available at https://comments.cftc.gov (comment
file for RIN 3038-AD99).
\199\ CME Group has indicated that for its own exchange-set
limits, it historically has not typically set the limit at the full
25 percent of deliverable supply when launching a new product,
regardless of asset class or commodity. CME Group's recommended spot
month limit levels are based on observations regarding the
orderliness of liquidations and monitoring for appropriate price
convergence. CME Group indicated that the recommended levels reflect
a measured approach calibrated to avoid the risk of disruption to
its markets, and stated that upon analyzing a reasonable body of
data relating to the expirations with the recommended spot month
limit levels, CME Group would consider in the future making any
recommendations for increases in limits if any additional increases
were appropriate. Summary DSE Proposed Limits, CME Group Comment
Letter (Nov. 26, 2019), available at https://comments.cftc.gov
(comment file for RIN 3038-AD99).
\200\ See, e.g., Revision of Federal Speculative Position
Limits, 57 FR at 12766, 12770 (Apr. 13, 1992).
---------------------------------------------------------------------------
iv. The Proposed Spot Month Limit Levels Account for Differences
Between Markets
In addition to being high enough to ensure sufficient liquidity,
and low enough to prevent excessive speculation and manipulation, the
proposed spot month limit levels are also calibrated to further address
CEA section 4a(a)(3) by accounting for differences between markets for
the core referenced futures contracts and for their underlying
commodities.\201\
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\201\ Commenters, including those responding to the 2016
Reproposal, have previously requested that limit levels should be
set on a commodity-by-commodity basis to recognize differences among
commodities, including differences in liquidity, seasonality, and
other economic factors. See, e.g., AQR Capital Management Comment
Letter at 12 (Feb. 28, 2017); Copperwood Asset Management Comment
Letter at 3 (Feb. 28, 2017); Managed Funds Association, Asset
Management Group of the Securities Industry and Financial Markets
Association, and the Alternative Investment Management Association
Comment Letter at 9-12 (Feb. 28, 2017); and National Grain and Feed
Association Comment Letter at 2 (Feb. 28, 2017).
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For the agricultural commodities, the Commission considered a
variety of factors in evaluating the exchange-recommended spot month
levels, including concentration and composition of market participants,
the historical price volatility of the commodity, convergence between
the futures and cash market prices at the expiration of the contract,
and the Commission's experience observing how the supplies of
agricultural commodities are affected by weather (drought, flooding, or
optimal growing conditions), storage costs, and delivery mechanisms. In
the Commission's view, the exchanges' recommended spot month levels for
each of the agricultural contracts would allow for speculators to be
present in the market while preventing speculative positions from being
so large as to harm convergence and otherwise hinder statutory
objectives.
The Commission also considered the delivery mechanisms for the
agricultural commodities in assessing the exchange-recommended spot
month levels. For example, for the CME Live Cattle (LC) contract, the
Commission considered the physical limitation that exists on how many
cattle can be processed (inspected, graded, and weighed) at the
delivery facilities. CME Group currently has an exchange-set step-down
spot month limit, and recommended a federal step-down limit for CME
Live Cattle (LC) of 600/300/200 contracts in order to avoid congestion
and to foster convergence by gradually reducing the limit levels in a
manner that meets the processing capacity of the delivery facilities.
The Commission proposes to adopt this step-down limit due to the unique
attributes of the CME Live Cattle (LC) contract.
For the metals contracts, which are all listed on NYMEX, the
Commission took delivery mechanisms, among other factors, into account
in assessing the recommended spot month limit levels. Upon expiration,
the long for each metals contract receives the ownership certificate
(warrant) for the metal already in the warehouse/depository and can
continue to store the metal where it is, load-out the metal, or short a
futures contract to sell the ownership certificate. This delivery
mechanism, which allows for the resale of the warrant while the metal
remains in the warehouse, provides for relatively inexpensive and
simple delivery when compared to the delivery mechanisms for other
commodity types. Further, metals tend not to spoil and are cheap to
store on a per dollar basis compared to other commodities. As metals
are generally easier to obtain, store, and sell than other commodity
types, it is also potentially cheaper to accomplish a corner or squeeze
in metals than in other commodity types. The Commission has previously
observed manipulative activity in metals as evidenced by the Hunt
Brother silver and Sumitomo copper events. The Commission kept this
history in mind in accepting CME Group's recommendation to take a
fairly cautious approach with respect to the recommended levels for
each metal contract, which are each well below 25 percent of
deliverable supply.\202\ Commission staff has, however, reviewed each
of the metals contracts previously and confirms that these contracts
satisfy all regulatory requirements, including the DCM Core Principle 3
requirement that the contracts are not readily susceptible to
manipulation.
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\202\ As noted above, CME Group's recommended federal level of
1,000 for COMEX Copper (HG) is below the existing exchange-set level
of 1,500, and CME Group's recommended federal levels for NYMEX
Platinum (PL) and NYMEX Palladium (PA) are equal to the existing
exchange-set levels of 500 and 50, respectively. CME Group
recommended federal levels of 6,000 for COMEX Gold (GC) and 3,000
for COMEX Silver (SI), which would represent an increase over the
existing exchange-set levels of 3,000 and 1,500, respectively. While
CME Group's recommended federal COMEX Gold (GC) and COMEX Silver
(SI) levels are higher than the existing exchange-set levels, the
recommended levels still represent only approximately 13 percent of
deliverable supply each. Summary DSE Proposed Limits, CME Group
Comment Letter (Nov. 26, 2019), available at https://comments.cftc.gov (comment file for RIN 3038-AD99).
---------------------------------------------------------------------------
Additionally, the Commission considered the volatility in the
estimated deliverable supply for metals. For the COMEX Copper (HG)
contract, the estimated deliverable supply for copper (measured by
copper stocks in COMEX-approved warehouses) has experienced
considerable volatility during the past decade, resulting in COMEX
amending its exchange-set spot month position limit multiple times,
decreasing or increasing the limit level to reflect the amount of
copper in its approved warehouses.\203\ Similarly, volatility in
deliverable supplies has been observed for the NYMEX Palladium (PA)
contract, where production of palladium from major producers has been
declining while demand for palladium by the auto
[[Page 11628]]
industry for catalytic converters has increased. This trend in
palladium stocks in exchange-approved depositories has been observed
since 2014. In a series of amendments, NYMEX reduced its exchange-set
spot month limit from 650 contracts to below 200 contracts over
time.\204\
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\203\ The volatility was based on factors such as the bust in
the housing market in 2008, the severe recession in the United
States in 2009, and high demand for copper exports to China, which
has grown continually over the past 20 years.
\204\ See, e.g., NYMEX Submissions Nos. 14-463 (Oct. 31, 2014),
15-145 (Apr. 14, 2015), and 15-377 (Aug. 27, 2015).
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The Commission has not observed similar volatility in the
deliverable supply estimates for agricultural or energy commodities.
Given this history of volatility in deliverable supply estimates for
metals, if the Commission were to set limit levels at, rather than
below, 25 percent of deliverable supply, and if deliverable supply were
to subsequently change drastically, the spot month limit level could
end up being well above (or below) 25 percent of deliverable supply,
and thus potentially too high (or too low) to further statutory
objectives.
For the energy complex, the Commission considered factors such as
the underlying infrastructure and connectivity. For example, as of
2017, generally, out of commodities underlying the core referenced
futures contracts in energy, natural gas had the most robust
infrastructure for moving the commodity, with over 1,600,000 miles of
pipeline (including distribution mains, transmission pipelines, and
gathering lines) in the United States, compared to only 215,000 miles
of pipeline for oil (including crude and product lines).\205\ The
robust infrastructure for moving natural gas supports CME Group's
recommended spot month limit level at 25 percent of estimated
deliverable supply for the NYMEX Henry Hub Natural Gas (NG) contract,
while comparatively smaller crude oil and crude product pipeline
infrastructure support CME Group's recommended spot month limit levels
below 25 percent of estimated deliverable supply for the NYMEX Light
Sweet Crude Oil (CL) and NYMEX NYH RBOB Gasoline (RB) contracts.
---------------------------------------------------------------------------
\205\ See U.S. Oil and Gas Pipeline Mileage, Bureau of
Transportation Statistics website, available at www.bts.gov/content/us-oil-and-gas-pipeline-mileage.
---------------------------------------------------------------------------
The Commission also considered factors such as the large amounts of
liquidity in the cash-settled natural gas referenced contracts relative
to the physically settled NYMEX Henry Hub Natural Gas (NG) core
referenced futures contract. For that contract, CME Group recommended
setting the spot month limit at 25 percent of estimated deliverable
supply (2,000 contract spot month limit) with a conditional limit
exemption of 10,000 contracts net long or net short conditioned on the
participant not holding or controlling any positions during the spot
month in the physically-settled NYMEX Henry Hub Natural Gas (NG) core
referenced futures contract. Speculators who desire price exposure to
natural gas will likely trade in the cash-settled contracts because,
generally, they do not have the ability to make or take delivery;
trading in the cash-settled contract removes the chance that they may
be unable to exit the physically-settled NYMEX Henry Hub Natural Gas
(NG) contract and be selected to make or take delivery of natural gas.
Thus, speculators are likely to remain out of the NYMEX Henry Hub
Natural Gas (NG) contract during the spot month. Since corners and
squeezes cannot be effected using cash settled contracts, the
Commission proposes a spot month limit set at 25 percent of deliverable
supply for the NYMEX Henry Hub Natural Gas (NG) core referenced futures
contract.
Further, for certain energy commodities, CME Group recommended
step-down limits, including for commodities where delivery constraints
could hinder convergence or where market participants otherwise
provided feedback that such limits would help maintain orderly markets.
In the case of NYMEX Light Sweet Crude Oil (CL), CME Group currently
has a single spot-month limit of 3,000 contracts, but is recommending a
step down limit that would end at 4,000 contracts (step-down limits of
6,000/5,000/4,000). Historically, as liquidity decreases in the
contract, the exchange would have a step down mechanism in its
exemptions that it had granted to force market participants to lower
their positions to the current 3,000 contract spot month limit. Given
the recommended increase to a final step-down limit of 4,000 contracts,
the exchange, through feedback from market participants, recommended a
step-down spot month limit that would in effect provide the same
diminishing effect on positions.
d. Proposed Federal Single Month and All-Months Combined (``Non-Spot
Month'') Limit Levels
Under the rules proposed herein, federal non-spot month limits
would only apply to the nine agricultural commodities currently subject
to federal limits. The 16 additional contracts covered by this proposal
would be subject to federal limits only during the spot month, and
exchange-set limits and/or accountability requirements outside of the
spot month.\206\
---------------------------------------------------------------------------
\206\ Market Resources, ICE Futures website, available at
https://www.theice.com/futures-us/market-resources (ICE exchange-set
position limits); Position Limits, CME Group website, available at
https://www.cmegroup.com/market-regulation/position-limits.html;
Rules and Regulations of the Minneapolis Grain Exchange, Inc., MGEX,
available at http://www.mgex.com/documents/Rulebook_051.pdf (MGEX
exchange-set position limits).
---------------------------------------------------------------------------
The Commission proposes to maintain federal non-spot month limits
for the nine legacy agricultural contracts, with the modifications set
forth below, because the Commission has observed no reason to eliminate
them. These non-spot month limits have been in place for decades, and
while the Commission is proposing to modify the limit levels,\207\
removing the levels entirely could potentially result in market
disruption. In fact, commercial market participants trading the nine
legacy agricultural contracts have requested that the Commission
maintain federal limits outside the spot month in order to promote
market integrity. For the following reasons, however, the Commission is
not proposing limits outside the spot month for the other 16 contracts.
---------------------------------------------------------------------------
\207\ See infra Section II.B.2.e.
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[[Page 11629]]
First, corners and squeezes cannot occur outside the spot month
when there is no threat of delivery, and there are tools other than
federal position limits for deterring and preventing manipulation
outside of the spot month.\208\ Surveillance at both the exchange and
federal level, coupled with exchange-set limits and/or accountability,
would continue to offer strong deterrence and protection against
manipulation outside of the spot month. In particular, under this
proposal, for the 16 contracts that would be subject to federal limits
only during the spot month, exchanges would be required to establish
either position limit levels or position accountability levels outside
of the spot month.\209\ Any such accountability and limit levels would
be subject to standards established by the Commission including, among
other things, that any such levels be ``necessary and appropriate to
reduce the potential threat of market manipulation or price distortion
of the contract's or the underlying commodity's price or index.'' \210\
Exchanges would also be required to submit any rules adopting or
modifying such position limit and/or accountability levels to the
Commission pursuant to part 40 of the Commission's regulations.\211\
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\208\ In the case of certain commodities where open interest in
the deferred month contracts may be much larger, it may become
difficult to exert market power via concentrated futures positions.
For example, a participant with a large cash-market position and a
large deferred futures position may attempt to move cash markets in
order to benefit that deferred futures position. Any attempt to do
so could become muted due to general futures market resistance from
multiple vested interests present in that deferred futures month
(i.e., the overall size of the deferred contracts may be too large
for one individual to influence via cash market activity). However,
if a large position accumulated over time in a particular deferred
month is held into the spot month, it is possible that such
positions could form the groundwork for an attempted corner or
squeeze in the spot month.
\209\ See infra Section II.D.4. (discussion of proposed Sec.
150.5).
\210\ Id.
\211\ Under the proposed ``position accountability'' definition
in Sec. 150.1, DCM accountability rules would have to require a
trader whose position exceeds the accountability level to consent
to: (1) Provide information about its position to the DCM; and (2)
halt increasing further its position or reduce its position in an
orderly manner, in each case as requested by the DCM.
---------------------------------------------------------------------------
Exchange position accountability establishes a level at which an
exchange will ask traders additional questions, including regarding the
trader's purpose for the position, and will evaluate existing market
conditions. If the position does not raise any concerns, the exchange
will allow the trader to exceed the accountability level. If the
position raises concerns, the exchange has the authority to instruct
the trader not to increase the position further, or to reduce the
position. Accountability is a particularly flexible and effective tool
because it provides the exchanges with an opportunity to intervene once
a position hits a relatively low level, while still affording market
participants with the flexibility to establish a large position when
warranted by the nature of the position and the condition of the
market.
The Commission has decades of experience overseeing accountability
levels implemented by exchanges,\212\ including for all 16 contracts
that would not be subject to federal limits outside of the spot month
under this proposal. Such accountability levels apply to all
participants on the exchange, whether commercial or non-commercial, and
regardless of whether the participant would qualify for an exemption.
In the Commission's experience, these levels have functioned as-
intended, and the Commission views exchange accountability outside of
the spot month as an equally robust, yet more flexible, alternative to
federal non-spot month speculative position limits.
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\212\ See, e.g., 56 FR 51687 (Oct. 15, 1991) (permitting CME to
establish position accountability for certain financial contracts
traded on CME), Speculative Position Limits--Exemptions from
Commission Rule 1.61, 57 FR 29064 (June 30, 1992) (permitting the
use of accountability for trading in energy commodity contracts),
and 17 CFR 150.5(e) (2009) (formally recognizing the practice of
accountability for contracts that met specified standards).
---------------------------------------------------------------------------
Second, applying federal limits during the spot month to referenced
contracts based on all 25 core referenced futures contracts, and
outside of the spot month only to referenced contracts based on the
nine legacy agricultural commodities, furthers statutory goals while
minimizing the impact on existing industry practice and leveraging
existing exchange-set limits and accountability levels that appear to
have functioned well. The Commission thus endeavors to minimize market
disruption that could result from eliminating existing federal non-spot
month limits on certain agricultural commodities and from adding new
non-spot limits on certain metals and energy commodities that have
never been subject to federal limits. Layering federal non-spot month
limits for the 16 additional contracts on top of existing exchange-set
limit/accountability levels may only provide minimal benefits, if any,
and would forego the benefits associated with flexible accountability
levels, which provide many of the same protections as hard limits but
with significantly more flexibility for market participants to exceed
the accountability level in cases where the position would not harm the
market.
As set forth in proposed Sec. 150.2(e), proposed federal non-spot
month levels applicable to referenced contracts based on the nine
legacy agricultural contracts are listed in proposed Appendix E and are
as follows:
----------------------------------------------------------------------------------------------------------------
2020 Proposed
single month
and all-months Existing Existing
combined federal exchange-set
Core referenced futures contract limit based single month single month
on new 10/2.5 and all- and all-
formula for months- months-
first 50,000 combined limit combined limit
OI
----------------------------------------------------------------------------------------------------------------
CBOT Corn (C)................................................... 57,800 33,000 33,000
CBOT Oats (O)................................................... 2,000 2,000 2,000
CBOT Soybeans (S)............................................... 27,300 15,000 15,000
CBOT Soybean Meal (SM).......................................... 16,900 6,500 6,500
CBOT Soybean Oil (SO)........................................... 17,400 8,000 8,000
CBOT Wheat (W).................................................. 19,300 12,000 12,000
KC HRW Wheat (KW)............................................... 12,000 12,000 12,000
MGEX HRS Wheat (MWE)............................................ 12,000 12,000 12,000
ICE Cotton No. 2 (CT)........................................... 11,900 5,000 5,000
----------------------------------------------------------------------------------------------------------------
[[Page 11630]]
e. Methodology for Setting Proposed Non-Spot Month Limit Levels
The Commission's practice has been to set non-spot month limit
levels for the nine legacy agricultural contracts at 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'').\213\ The
existing non-spot month limit levels have not been updated to reflect
changes in open interest data in over a decade, and the 10, 2.5 percent
formula has been used since the 1990s, and was based on the
Commission's experience up until that time.\214\ The Commission's
adoption of the 10, 2.5 percent formula was based on two primary
factors: growth in open interest and the size of large traders'
positions.\215\
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\213\ For example, assume a commodity contract has an aggregate
open interest of 200,000 contracts over the past 12 month period.
Applying the 10, 2.5 percent formula to an aggregate open interest
of 200,000 contracts would yield a non-spot month limit of 6,875
contracts. That is, 10 percent of the first 25,000 contracts would
equal 2,500 contracts (25,000 contracts x 0.10 = 2,500 contracts).
Then add 2.5 percent of the remaining 175,000 of aggregate open
interest or 4,375 contracts (175,000 contracts x 0.025 = 4,375
contracts) for a total non-spot month limit of 6,875 contracts
(2,500 contracts + 4,375 contracts = 6,875 contracts).
\214\ See, e.g., Revision of Federal Speculative Position Limits
and Associated Rules, 64 FR at 24038 (May 5, 1999) (increasing
deferred-month limit levels based on 10 percent of open interest up
to an open interest of 25,000 contracts, with a marginal increase of
2.5 percent thereafter). Prior to 1999, the Commission had given
little weight to the size of open interest in the contract in
determining the position limit level--instead, the Commission's
traditional standard was to set limit levels based on the
distribution of speculative traders in the market. See, e.g., 64 FR
at 24039; Revision of Federal Speculative Position Limits and
Associated Rules, 63 FR at 38525, 38527 (July 17, 1998).
\215\ See 64 FR at 24038. See also 63 FR at 38525, 38527 (The
1998 proposed revisions to non-spot month levels, which were
eventually adopted in 1999, were based upon two criteria: ``(1) the
distribution of speculative traders in the markets; and (2) the size
of open interest.'').
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The Commission proposes to maintain the 10, 2.5 percent formula for
non-spot limits, with the limited change that the 2.5 percent
calculation will be applied to open interest above 50,000 contracts
rather than to the current level of 25,000 contracts. The Commission
believes that this change is warranted due to the significant overall
increase in open interest in these markets, which has roughly doubled
since federal limits were set on these markets. The Commission would
apply the modified formula to recent open interest data for the periods
from July 2017-June 2018 and July 2018-June 2019 of the applicable
futures and delta adjusted futures options. The resulting proposed
limit levels, set forth in the second column in the table above, would
generally be higher than existing limit levels, with the exception of
CBOT Oats (O), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), where
proposed levels would remain at the existing levels.
The Commission continues to believe that a formula based on a
percentage of open interest is an appropriate tool for establishing
limits outside the spot month. As the Commission stated when it
initially proposed to use an open interest formula, taking open
interest into account ``will permit speculative position limits to
reflect better the changing needs and composition of the futures
markets . . .'' \216\ Open interest is a measure of market activity
that reflects the number of contracts that are ``open'' or live, where
each contract of open interest represents both a long and a short
position. Relative to contracts with smaller open interest, contracts
with larger open interest may be better able to mitigate the disruptive
impact of excessive speculation because there may be more activity to
oppose, diffuse, or otherwise counter a potential pricing disruption.
Limiting positions to a percentage of open interest: (1) Helps ensure
that positions are not so large relative to observed market activity
that they risk disrupting the market; (2) allows speculators to hold
sufficient contracts to provide a healthy level of liquidity for
hedgers; and (3) allows for increases in position limits and position
sizes as markets expand and become more active.
---------------------------------------------------------------------------
\216\ Revision of Federal Speculative Position Limits, 57 FR
12766, 12770 (Apr. 13, 1992). The Commission also stated that
providing for a marginal increase was ``based upon the universal
observation that the size of the largest individual positions in a
market do not continue to grow in proportion with increases in the
overall open interest of the market.'' Id.
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While the Commission continues to prefer a formula based on a
percentage of open interest, market and potential regulatory changes
counsel in favor of proposing a slight modification to the existing
formula. In particular, as discussed in detail below, open interest has
grown, and market composition has changed, significantly since the
1990s. The proposed increase in the open interest portion of the non-
spot month limit formula from 25,000 to 50,000 contracts would provide
a modest increase in the non-spot month limit of 1,875 contracts (over
what the limit would be if the 10, 2.5 percent formula were applied at
25,000 contracts), assuming the underlying commodity futures market has
open interest of at least 50,000 contracts. The Commission believes
that the amended non-spot month formula would provide a conservative
increase in the non-spot month limits for most contracts to better
reflect the general increase observed in open interest across futures
markets since the late 1990s, as discussed below.
i. Increases in Open Interest
The table below provides data that describes the market environment
during the period prior to, and subsequent to, the adoption of the 10,
2.5 percent formula by the Commission in 1999. The data includes
futures contracts and the delta-adjusted options on futures open
interest.\217\ The first column of the table provides the maximum open
interest in the nine legacy agricultural contracts over the five year
period ending in 1999. The CBOT Corn (C) contract had maximum open
interest of approximately 463,000 contracts, and the CBOT Soybeans (S)
contract had maximum open interest of approximately 227,000 contracts.
The other seven contracts had maximum open interest figures that ranged
from less than 20,000 contracts for CBOT Oats (O) to approximately
172,000 for CBOT Soybean Oil (SO). Hence, when adopting the 10, 2.5
percent formula in 1999, the Commission's experience in these markets
was of aggregate futures and options on futures open interest well
below 500,000 contracts.
---------------------------------------------------------------------------
\217\ Delta is a ratio comparing the change in the price of an
asset (a futures contract) to the corresponding change in the price
of its derivative (an option on that futures contract) and has a
value that ranges between zero and one. In-the-money call options
get closer to 1 as their expiration approaches. At-the-money call
options typically have a delta of 0.5, and the delta of out-of-the-
money call options approaches 0 as expiration nears. The deeper in-
the-money the call option, the closer the delta will be to 1, and
the more the option will behave like the underlying asset. Thus,
delta-adjusted options on futures will represent the total position
of those options as if they were converted to futures.
Table--Maximum Futures and Options on Futures Open Interest, 1994-2018
----------------------------------------------------------------------------------------------------------------
1994-1999 2000-2004 2005-2009 2010-2014 2015-2018
----------------------------------------------------------------------------------------------------------------
CBOT Corn (C)................... 463,386 828,176 1,897,484 2,052,678 2,201,990
ICE Cotton No. 2 (CT)........... 122,989 140,240 388,336 296,596 344,302
[[Page 11631]]
CBOT Oats (O)................... 18,879 17,939 16,860 15,375 11,313
CBOT Soybeans (S)............... 227,379 327,276 672,061 991,258 997,881
CBOT Soybean Meal (SM).......... 155,658 183,255 241,917 392,265 544,363
CBOT Soybean Oil (SO)........... 172,424 191,337 328,050 395,743 547,784
CBOT Wheat (W).................. 163,193 187,181 507,401 576,333 621,750
CBOT Wheat: Kansas City Hard Red 76,435 87,611 159,332 189,972 311,592
Winter (KW)....................
MGEX Wheat: Minneapolis Hard Red 24,999 36,155 57,765 68,409 80,635
Spring (MWE)...................
----------------------------------------------------------------------------------------------------------------
The table also displays the maximum open interest figures for
subsequent periods up to, and including, 2018. The maximum open
interest for all of these contracts, except for oats, generally
increased over the period.\218\ By the 2015-2018 period covered in the
last column of the table, five of the contracts had maximum open
interest greater than 500,000 contracts. The contracts for CBOT Corn
(C), CBOT Soybeans (S), and CBOT Hard Red Winter Wheat (KW) saw maximum
open interest increase by a factor of four to five times the maximum
open interest during the 1994-1999 period leading up to the
Commission's adoption of the 10, 2.5 percent formula in 1999.
---------------------------------------------------------------------------
\218\ See infra Section II.B.2.e.iii. (discussion of proposed
non-spot month limit level for CBOT Oats (O)).
---------------------------------------------------------------------------
ii. Changes in Market Composition
As open interest has increased, the current non-spot limits have
become significantly more restrictive over time. In particular, because
the 2.5 percent incremental increase applies after the first 25,000
contracts of open interest, limits on commodities with open interest
above 25,000 contracts (i.e., all commodities other than oats) continue
to increase at a much slower rate of 2.5 percent rather than 10
percent, as for the first 25,000 contracts. This gradual increase was
less of a problem in the latter part of the 1990s, for example, when
open interest in each of the nine legacy agricultural contracts was
below 500,000, and in many cases below 200,000. More recently, however,
open interest has grown above 500,000 for a majority of the legacy
contracts. The 10, 2.5 percent formula has thus become more restrictive
for market participants, including those entities with positions that
may not be eligible for a bona fide hedging exemption, but who might
otherwise provide valuable liquidity to commercial firms.
This problem has become worse over time because dealers play a much
more significant role in the market today than at the time the
Commission adopted the 10, 2.5 percent formula. Prior to 1999, the
Commission regulated physical commodity markets where the largest
participants were often large commercial interests who held short
positions. The offsetting positions were often held by small,
individual traders, who tended to be long.\219\ Several years after the
Commission adopted the 10, 2.5 percent formula, the composition of
futures market participants changed, as dealers began to enter the
physical commodity futures market in larger size. The table below
presents data from the Commission's publicly available ``Bank
Participation Report'' (``BPR''), as of the December report for 2002-
2018.\220\ The table displays the number of banks holding reportable
positions for the seven futures contracts for which federal limits
apply and that were reported in the BPR.\221\ The report presents data
for every market where five or more banks hold reportable positions.
The BPR is based on the same large-trader reporting system database
used to generate the Commission's Commitments of Traders (``COT'')
report.\222\
---------------------------------------------------------------------------
\219\ Stewart, Blair, An Analysis of Speculative Trading in
Grain Futures, Technical Bulletin No. 1001, U.S. Department of
Agriculture (Oct. 1949).
\220\ Bank Participation Reports, U.S. Commodity Futures Trading
Commission website, available at https://www.cftc.gov/MarketReports/BankParticipationReports/index.htm .
\221\ The term ``reportable position'' is defined in Sec.
15.00(p) of the Commission's regulations. 17 CFR 15.00(p).
\222\ Commitments of Traders, U.S. Commodity Futures Trading
Commission website, available at www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm. There are generally still as many
large commercial traders in the markets today as there were in the
1990s.
---------------------------------------------------------------------------
No data was reported for the seven futures contracts in December
2002, indicating that fewer than five banks held reportable positions
at the time of the report. The December 2003 report shows that five or
more banks held reportable positions in four of the commodity futures.
The number of banks with reportable positions generally increased in
the early to mid-2000s. As described in the Commission's 2008 Staff
Report on Commodity Swap Dealers & Index Traders, major changes in the
composition of futures markets developed over the 20 years prior to
2008, including an influx of swap dealers (``SDs''), affiliated with
banks or other large financial institutions, acting as aggregators or
market makers and providing swaps to commercial hedgers and to other
market participants.\223\ The dealers functioned in the swaps market
and also used the futures markets to hedge their exposures. When the
Commission adopted the 10, 2.5 percent formula in 1999, it had limited
experience with physical commodity derivatives markets in which such
banks were significant participants.
---------------------------------------------------------------------------
\223\ Staff Report on Commodity Swap Dealers & Index Traders
with Commission Recommendations, U.S. Commodity Futures Trading
Commission (Sept. 2008), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/cftcstaffreportonswapdealers09.pdf.
Table--Number of Reporting Commercial Banks With Long Futures Positions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year Corn Cotton Soybeans Soybean meal Soybean oil Wheat Wheat KCBT
--------------------------------------------------------------------------------------------------------------------------------------------------------
2002.................................... NR NR NR NR NR NR NR
2003.................................... 5 6 7 NR NR 5 NR
2004.................................... 5 10 7 NR NR 7 NR
2005.................................... 10 8 6 NR 5 9 9
2006.................................... 11 11 9 NR 7 14 7
2007.................................... 13 8 12 NR 6 14 6
2008.................................... 17 13 16 NR 6 14 9
[[Page 11632]]
2009.................................... 8 8 8 NR NR 13 NR
2010.................................... 7 7 7 NR NR 11 NR
2011.................................... 10 11 9 5 5 10 NR
2012.................................... 8 10 11 6 6 13 5
2013.................................... 11 11 13 10 6 11 5
2014.................................... 15 12 15 10 9 15 6
2015.................................... 12 13 13 12 9 16 9
2016.................................... 15 14 15 12 10 15 6
2017.................................... 16 13 12 11 9 16 8
2018.................................... 16 15 18 15 13 18 12
--------------------------------------------------------------------------------------------------------------------------------------------------------
NR = ``Not Reported''.
For 2003, the first year in the report with reported data on the
futures for these physical commodities, the BPR showed, as displayed in
the table below, that the reporting banks held modest positions,
totaling 3.4 percent of futures long open interest for wheat and
smaller positions in other futures. The positions displayed in the
table below increased over the next several years, generally peaking
around 2005/2006 as a fraction of the long open interest.
Table--Percent of Futures Long Open Interest Held by Commercial Banks
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year (Dec.) Corn Cotton Soybeans Soybean meal Soybean oil Wheat Wheat KCBT
--------------------------------------------------------------------------------------------------------------------------------------------------------
2002.................................... NR NR NR NR NR NR NR
2003.................................... 1.5% 1.4% 0.8% NR NR 3.4% NR
2004.................................... 7.0 6.5 3.6 NR NR 14.5 NR
2005.................................... 12.5 13.8 8.3 NR 6.8 20.2 5.2
2006.................................... 9.4 14.2 7.7 NR 6.7 17.0 6.9
2007.................................... 9.2 9.7 6.7 NR 6.5 13.5 5.5
2008.................................... 8.9 18.2 10.0 NR 6.4 18.7 7.1
2009.................................... 4.3 6.5 3.6 NR NR 9.3 NR
2010.................................... 3.7 2.5 4.7 NR NR 6.9 NR
2011.................................... 4.1 3.3 4.9 1.9 4.4 7.7 NR
2012.................................... 4.7 9.9 3.7 5.8 5.5 7.4 3.5
2013.................................... 5.3 9.1 4.4 7.0 4.1 6.2 6.4
2014.................................... 9.7 10.0 6.3 6.7 6.5 7.7 10.1
2015.................................... 8.1 10.1 5.0 5.9 6.4 7.8 4.3
2016.................................... 8.1 8.5 7.1 10.7 6.6 7.3 5.2
2017.................................... 5.5 9.5 4.3 9.1 7.3 7.7 4.8
2018.................................... 5.8 8.3 5.9 9.2 7.6 10.2 7.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
NR = ``Not Reported''.
iii. Proposed Non-Spot Month Limits for Hard Red Wheat and Oats
The Commission proposes partial wheat parity outside of the spot
month: limits for CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) would
be set at 12,000 contracts, while limits for CBOT Wheat (W) would be
set at 19,300 contracts. Based on the Commission's experience since
2011 with non-spot month speculative position limit levels at 12,000
for the CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) core referenced
futures contracts, the Commission is proposing to maintain the current
non-spot month limit levels for those two contracts, rather than
reducing the existing levels to the lower levels that would result from
applying the proposed modified 10, 2.5 percent formula.\224\ The
current 12,000 contract level appears to have functioned well for these
contracts, and the Commission sees no market-based reason to reduce the
levels.
---------------------------------------------------------------------------
\224\ Applying the proposed modified 10, 2.5 percent formula to
recent open interest data for these two contracts would result in
limit levels of 11,900 and 5,700, respectively.
---------------------------------------------------------------------------
CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) are both hard red
wheats representing about 60 percent of the wheat grown in the United
States \225\ and about 80 percent of the wheat grown in Canada.\226\
Although the CBOT Wheat (W) contract allows for delivery of hard red
wheat, it typically sees deliveries of soft white wheat varieties,
which comprises a smaller percentage of the wheat grown in North
America. Even though the CBOT Wheat (W) contract has the majority of
liquidity among the three wheat contracts as measured by open interest
and trading volume, it is the hard red wheats that make up the bulk of
wheat crops in North America. Thus, the Commission proposes to maintain
the non-spot month limit for the CBOT KC HRW Wheat (KW) contract and
MGEX HRS Wheat (MWE) contract at the 12,000 contract level even though
both contracts would have a lower non-spot month limit based solely on
the open interest formula. The Commission preliminarily believes that
maintaining partial parity and the existing non-spot month limits in
this manner will benefit the MWE and KW markets since the two species
of wheat are similar (i.e., hard red wheat) to one another relative to
CBOT Wheat (W), which is soft white
[[Page 11633]]
wheat; and as a result, the Commission has preliminarily determined
that decreasing the non-spot month levels for MWE could impose
liquidity costs on the MWE market and harm bona fide hedgers, which
could further harm liquidity for bona fide hedgers in the related KW
market.
---------------------------------------------------------------------------
\225\ Wheat Sector at a Glance, USDA Economic Research Service,
available at https://www.ers.usda.gov/topics/crops/wheat/wheat-sector-at-a-glance.
\226\ Estimated Areas, Yield, Production, Average Farm Price and
Total Farm Value of Principal Field Crops, In Metric and Imperial
Units, Statistics Canada website, available at https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=3210035901.
---------------------------------------------------------------------------
However, the Commission has determined not to raise the proposed
limit levels for CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE) to the
proposed 19,300 contract limit level for CBOT Wheat (W) because 19,300
contracts appears to be extraordinarily large in comparison to open
interest in the CBOT KC HRW Wheat (KW) and MGEX HRS Wheat (MWE)
markets, and the limit levels for both contracts are already larger
than a limit level based on the 10, 2.5 percent formula. The Commission
is concerned that substantially raising non-spot limits on the KW or
MWE contracts could create a greater likelihood of excessive
speculation given their smaller overall trading relative to the CBOT
Wheat (W) contract. In response to prior proposals, which would have
resulted in lower non-spot limits for MWE, MGEX had requested parity
among all wheat contracts. In part, MGEX reasoned that intermarket
spread trading among the three contracts is vital to their price
discovery function.\227\ The Commission notes that intermarket
spreading is permitted under this proposal.\228\ The intermarket spread
exemption should address any concerns over the loss of liquidity in
spread trades among the three wheat contracts.
---------------------------------------------------------------------------
\227\ See Statement of Layne Carlson, CFTC Agricultural Advisory
Committee meeting, Sept. 22, 2015, at 38-44.
\228\ See supra Section II.A.20. (definition of spread
transaction).
---------------------------------------------------------------------------
Likewise, based on the Commission's experience since 2011 with the
current non-spot month speculative position limit of 2,000 contracts
for CBOT Oats (O), the Commission is proposing to maintain the current
2,000 contract level rather than reducing it to the lower levels that
would result from applying the updated 10, 2.5 formula.\229\ The
existing 2,000 contract limit for CBOT Oats (O) appears to have
functioned well, and the Commission sees no reason to reduce it.
---------------------------------------------------------------------------
\229\ Applying the proposed modified 10, 2.5 percent formula to
recent open interest data for oats would result in a 700 contract
limit level.
---------------------------------------------------------------------------
While retaining the existing non-spot month limits for the MWE and
KW contracts and for CBOT Oats (O) does break with the proposed non-
spot month formula, the Commission has confidence that the existing
contract limits should continue to be appropriate for these contracts.
Furthermore, even when relying on a single criterion, such as
percentage of open interest, the Commission has historically recognized
that there can ``result . . . a range of acceptable position limit
levels.'' \230\
---------------------------------------------------------------------------
\230\ Revision of Speculative Position Limits, 57 FR 12770,
12766 (Apr. 13, 1992). See also Revision of Speculative Position
Limits and Associated Rules, 63 FR at 38525, 38527 (July 17, 1998).
Cf. 2013 Proposal, 78 FR at 75729 (there may be range of spot month
limits that maximize policy objectives).
---------------------------------------------------------------------------
For all of the core referenced contracts, based on decades of
experience overseeing exchange-set position limits and administering
its own federal position limits regime, the Commission is of the view
that the proposed non-spot month limit levels are also low enough to
diminish, eliminate, or prevent excessive speculation, and to deter and
prevent market manipulation, squeezes, and corners. The Commission has
previously studied prior increases in federal non-spot month limits and
concluded that the overall impact was modest, and that any changes in
market performance were most likely attributable to factors other than
changes in the federal position limit rules.\231\ The Commission has
since gained further experience which supports that conclusion,
including by monitoring amendments to position limit levels by
exchanges. Further, given the significant increases in open interest
and changes in market composition that have occurred since the 1990s,
the Commission is comfortable that the proposal to amend the 10, 2.5
percent formula will adequately address each of the policy objectives
set forth in CEA section 4a(a)(3).\232\
---------------------------------------------------------------------------
\231\ 64 FR 24038, 24039 (May 5, 1999).
\232\ 7 U.S.C. 6a(a)(3)(B).
---------------------------------------------------------------------------
iv. Conclusion
With the exception of the CBOT KC HRW Wheat (KW), MGEX HRS Wheat
(MWE), and CBOT Oats (O) contracts, as noted above, the proposed
formula would result in higher non-spot month limit levels than those
currently in place. Furthermore, as noted above, under the rules
proposed herein, the nine legacy agricultural contracts would be the
only contracts subject to limits outside of the spot month. Aside from
the CBOT Oats (O) contract, these contracts all have high open
interest, and thus their pricing may be less likely to be affected by
the trading of large position holders in non-spot months. Further,
consistent with the approach proposed herein to leverage existing
exchange-level programs and expertise, the proposed federal non-spot
month limit levels would serve simply as ceilings--exchanges would
remain free to set exchange levels below the federal limit. The
exchanges currently have systems and processes in place to monitor and
surveil their markets in real time, and have the ability, and
regulatory responsibility, to act quickly in the event of a
disturbance.\233\
---------------------------------------------------------------------------
\233\ For example, under DCM Core Principle 4, DCMs are required
to ``have the capacity and responsibility to prevent manipulation,
price distortion, and disruptions of the delivery or cash-settlement
process through market surveillance, compliance, and enforcement
practices and procedures,'' including ``methods for conducting real-
time monitoring of trading'' and ``comprehensive and accurate trade
reconstructions.'' 7 U.S.C. 7(d)(4).
---------------------------------------------------------------------------
Additionally, exchanges have tools other than position limits for
protecting markets. For instance, exchanges can establish position
accountability levels well below a position limit level, and can impose
liquidity and concentration surcharges to initial margin if they are
vertically integrated with a derivatives clearing organization. One
reason that the Commission is proposing to update the formula for
calculating non-spot month limit levels is that the exchanges may be
able in certain circumstances to act much more quickly than the
Commission, including quickly altering their own limits and
accountability levels based on changing market conditions. Any decrease
in an exchange-set limit would effectively lower the federal limit for
that contract, as market participants would be required to comply with
both federal and exchange-set limits, and as the Commission has the
authority to enforce violations of both federal and exchange-set
limits.\234\
---------------------------------------------------------------------------
\234\ See infra Section II.D.4.g. (discussion of Commission
enforcement of exchange-set limits).
---------------------------------------------------------------------------
f. Subsequent Spot and Non-Spot Month Limit Levels
Prior to amending any of the proposed spot or non-spot month
levels, if adopted, the Commission would provide for public notice and
comment by publishing the proposed levels in the Federal Register.
Under proposed Sec. 150.2(f), should the Commission wish to rely on
exchange estimates of deliverable supply to update spot month
speculative limit levels, DCMs would be required to supply to the
Commission deliverable supply estimates upon request. Proposed Sec.
150.2(j) would delegate the authority to make such requests to the
Director of the Division of Market Oversight.
Recognizing that estimating deliverable supply can be a time and
resource consuming process for DCMs and for the Commission, the
Commission is not proposing to require
[[Page 11634]]
DCMs to submit such estimates on a regular basis; instead, DCMs would
be required to submit estimates of deliverable supply if requested by
the Commission.\235\ DCMs would also have the option of submitting
estimates of deliverable supply and/or recommended speculative position
limit levels if they wanted the Commission to consider them when
setting/adjusting federal limit levels. Any such information would be
included in a Commission action proposing changes to the levels. The
Commission encourages exchanges to submit such estimates and
recommendations voluntarily, as the exchanges are uniquely situated to
recommend updated levels due to their knowledge of individual contract
markets. When submitting estimates, DCMs would be required under
proposed Sec. 150.2(f) to provide a description of the methodology
used to derive the estimate, as well as any statistical data supporting
the estimate, so that the Commission can verify that the estimate is
reasonable. DCMs should consult the guidance regarding estimating
deliverable supply set forth in Appendix C to part 38.\236\
---------------------------------------------------------------------------
\235\ For example, if a contract has problems with pricing
convergence between the futures and the cash market, it could be a
symptom of a deliverable supply issue in the market. In such a
situation, the Commission may request an updated deliverable supply
estimate from the relevant DCM to help identify the possible cause
of the pricing anomaly.
\236\ 17 CFR part 38, Appendix C.
---------------------------------------------------------------------------
g. Relevant Contract Month
Proposed Sec. 150.2(c) clarifies that the spot month and single
month for any given referenced contract is determined by the spot month
and single month of the core referenced futures contract to which that
referenced contract is linked. This requires that referenced contracts
be linked to the core referenced futures contract in order to be netted
for position limit purposes. For example, for the NYMEX NY Harbor ULSD
Heating Oil (HO) futures core referenced futures contract, the spot
month period starts at the close of trading three business days prior
to the last trading day of the contract. The spot month period for the
NYMEX NY Harbor ULSD Financial (MPX) futures referenced contract would
thus start at the same time--the close of trading three business days
prior to the last trading day of the core referenced futures contract.
h. Limits on ``Pre-Existing Positions''
Under proposed Sec. 150.2(g)(1), other than pre-enactment swaps
and transition period swaps as defined in proposed Sec. 150.1, ``pre-
existing positions,'' defined in proposed Sec. 150.1 as positions
established in good faith prior to the effective date of a final
federal position limits rulemaking, would be subject to federal spot
month limit levels. This clarification is intended to avoid rendering
spot month limits ineffective--failing to apply spot month limits to
such pre-existing positions could result in a large, pre-existing
position either intentionally or unintentionally causing a disruption
to the price discovery function of the core referenced futures contract
as positions are rolled into the spot month. The Commission is
particularly concerned about protecting the spot month in physical-
delivery futures from price distortions or manipulation that would
disrupt the hedging and price discovery utility of the futures
contract.
Proposed Sec. 150.2(g)(2) would provide that the proposed non-spot
month limit levels would not apply to positions acquired in good faith
prior to the effective date of such limit, recognizing that pre-
existing large positions may have a relatively less disruptive effect
outside of the spot month than during the spot month given that
physical delivery occurs only during the spot month. However, other
than pre-enactment swaps and transition period swaps, any pre-existing
positions held outside the spot month would be attributed to such
person if the person's position is increased after the effective date
of a final federal position limits rulemaking.
i. Positions on Foreign Boards of Trade
CEA section 4a(a)(6) directs the Commission to, among other things,
establish limits on the aggregate number of positions in contracts
based upon the same underlying commodity that may be held by any person
across contracts listed by DCMs, certain contracts traded on a foreign
board of trade (``FBOT'') with linkages to a contract traded on a
registered entity, and swap contracts that perform or affect a
significant price discovery function with respect to regulated
entities.\237\ Pursuant to that directive, proposed Sec. 150.2(h)
would apply the proposed limits to a market participant's aggregate
positions in referenced contracts executed on a DCM and on, or pursuant
to the rules of, an FBOT, provided that the referenced contracts settle
against a price of a contract listed for trading on a DCM or SEF, and
that the FBOT makes such contract available in the United States
through ``direct access.'' \238\ In other words, a market participant's
positions in referenced contracts listed on a DCM and on an FBOT
registered to provide direct access would collectively have to stay
below the federal limit level for the relevant core referenced futures
contract. The Commission preliminarily believes that, as proposed,
Sec. 150.2(h) would lessen regulatory arbitrage by eliminating a
potential loophole whereby a market participant could accumulate
positions on certain FBOTs in excess of limits in referenced
contracts.\239\
---------------------------------------------------------------------------
\237\ 7 U.S.C. 6a(a)(6).
\238\ Commission regulation Sec. 48.2(c) defines ``direct
access'' to mean an explicit grant of authority by a foreign board
of trade to an identified member or other participant located in the
United States to enter trades directly into the trade matching
system of the foreign board of trade. 17 CFR 48.2(c).
\239\ In addition, CEA section 4(b)(1)(B) prohibits the
Commission from permitting an FBOT to provide direct access to its
trading system to its participants located in the United States
unless the Commission determines, in regards to any FBOT contract
that settles against any price of one or more contracts listed for
trading on a registered entity, that the FBOT (or its foreign
futures authority) adopts position limits that are comparable to the
position limits adopted by the registered entity. 7 U.S.C.
6(b)(1)(B). CEA section 4(b)(1)(B) provides that the Commission may
not permit a foreign board of trade to provide to the members of the
foreign board of trade or other participants located in the United
States direct access to the electronic trading and order-matching
system of the foreign board of trade with respect to an agreement,
contract, or transaction that settles against any price (including
the daily or final settlement price) of 1 or more contracts listed
for trading on a registered entity, unless the Commission determines
that the foreign board of trade (or the foreign futures authority
that oversees the foreign board of trade) adopts position limits
(including related hedge exemption provisions) for the agreement,
contract, or transaction that are comparable to the position limits
(including related hedge exemption provisions) adopted by the
registered entity for the 1 or more contracts against which the
agreement, contract, or transaction traded on the foreign board of
trade settles.
---------------------------------------------------------------------------
j. Anti-Evasion
Pursuant to the Commission's rulemaking authority in section 8a(5)
of the CEA,\240\ the Commission proposes Sec. 150.2(i), which is
intended to deter and prevent a number of potential methods of evading
the position limits proposed herein. The proposed anti-evasion
provision is not intended to capture a trading strategy merely because
it may result in smaller position size for purposes of position limits,
but rather is intended to deter and prevent cases of willful evasion of
federal position limits, the specifics of which the Commission may be
unable to anticipate. The proposed federal position limit requirements
would apply during the spot month for all referenced contracts subject
to federal limits and non-spot position limit requirements would only
apply for the nine legacy agricultural contracts.
[[Page 11635]]
Under this proposed framework, and because the threat of corners and
squeezes is the greatest in the spot month, the Commission
preliminarily anticipates that it may focus its attention on anti-
evasion activity during the spot month.
---------------------------------------------------------------------------
\240\ 7 U.S.C. 12a(5).
---------------------------------------------------------------------------
First, the proposed rule would consider a commodity index contract
and/or location basis contract used to willfully circumvent position
limits to be a referenced contract subject to federal limits. Because
commodity index contracts and location basis contracts are excluded
from the proposed ``referenced contract'' definition and thus not
subject to federal limits,\241\ the Commission intends that proposed
Sec. 150.2(i) would close a potential loophole whereby a market
participant who has reached its limits could purchase a commodity index
contract in a manner that allowed the participant to exceed limits when
taking into account the weighting in the component commodities of the
index contract. The proposed rule would close a similar potential
loophole with respect to location basis contracts.
---------------------------------------------------------------------------
\241\ See supra Section II.A.16.b. (explanation of proposed
exclusions from the ``referenced contract'' definition).
---------------------------------------------------------------------------
Second, proposed Sec. 150.2(i) would provide that a bona fide
hedge recognition or spread exemption would no longer apply if used to
willfully circumvent speculative position limits. This provision is
intended to help ensure that bona fide hedge recognitions and spread
exemptions are granted and utilized in a manner that comports with the
CEA and Commission regulations, and that the ability to obtain a bona
fide hedge recognition or spread exemption does not become an avenue
for market participants to inappropriately exceed speculative position
limits.
Third, a swap contract used to willfully circumvent speculative
position limits would be deemed an economically equivalent swap, and
thus a referenced contract, even if the swap does not meet the
economically equivalent swap definition set forth in proposed Sec.
150.1. This provision is intended to deter and prevent the structuring
of a swap in order to willfully evade speculative position limits.
The determination of whether particular conduct is intended to
circumvent or evade requires a facts and circumstances analysis. In
preliminarily interpreting these anti-evasion rules, the Commission is
guided by its interpretations of anti-evasion provisions appearing
elsewhere in the Commission's regulations, including the interpretation
of the anti-evasion rules that the Commission adopted in its
rulemakings to further define the term ``swap'' and to establish a
clearing requirement under section 2(h)(1)(A) of the CEA.\242\
---------------------------------------------------------------------------
\242\ See Further Definition of ``Swap,'' ``Security-Based
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, 77 FR 48207, 48297-
48303 (Aug. 13, 2012); Clearing Requirement Determination Under
Section 2(h) of the CEA, 77 FR 74284, 74317-74319 (Dec. 13, 2012).
---------------------------------------------------------------------------
Generally, consistent with those interpretations, in evaluating
whether conduct constitutes evasion, the Commission would consider,
among other things, the extent to which the person lacked a legitimate
business purpose for structuring the transaction in that particular
manner. For example, an analysis of how a swap was structured could
reveal that persons crafted derivatives transactions, structured
entities, or conducted themselves in a manner without a legitimate
business purpose and with the intent to willfully evade position limits
by structuring a swap such that it would not meet the proposed
``economically equivalent swap'' definition. As stated in a prior
rulemaking, a person's specific consideration of, for example, costs or
regulatory burdens, including the avoidance thereof, is not, in and of
itself, dispositive that the person is acting without a legitimate
business purpose in a particular case.\243\ The Commission will view
legitimate business purpose considerations on a case-by-case basis in
conjunction with all other relevant facts and circumstances.
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\243\ See Clearing Requirements Determination Under Section 2(h)
of the CEA, 77 FR at 74319.
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Further, as part of its facts and circumstances analysis, the
Commission would look at factors such as the historical practices
behind the market participant and transaction in question. For example,
with respect to Sec. 150.2(i)(3), the Commission would consider
whether a market participant has a history of structuring its swaps one
way, but then starts structuring its swaps a different way around the
time the participant risked exceeding a speculative position limit as a
result of its swap position, such as by modifying the delivery date or
other material terms and conditions such that the swap no longer meets
the definition of an ``economically equivalent swap.''
Consistent with interpretive language in prior rulemakings
addressing evasion,\244\ when determining whether a particular activity
constitutes willful evasion, the Commission will consider the extent to
which the activity involves deceit, deception, or other unlawful or
illegitimate activity. Although it is likely that fraud, deceit, or
unlawful activity will be present where willful evasion has occurred,
the Commission does not believe that these factors are a prerequisite
to an evasion finding because a position that does not involve fraud,
deceit, or unlawful activity could still lack a legitimate business
purpose or involve other indicia of evasive activity. The presence or
absence of fraud, deceit, or unlawful activity is one fact the
Commission will consider when evaluating a person's activity. That
said, the proposed anti-evasion provision does require willfulness,
i.e. ``scienter.'' The Commission will interpret ``willful'' consistent
with how the Commission has in the past, that acting either
intentionally or with reckless disregard constitutes acting
``willfully.'' \245\
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\244\ See Further Definition of ``Swap,'' ``Security-Based
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, 77 FR 48207, 48297-
48303 and Clearing Requirement Determination Under Section 2(h) of
the CEA, 77 FR 74284, 74317-74319.
\245\ See In re Squadrito, [1990-1992 Transfer Binder] Comm.
Fut. L. Rep. (CCH) ] 25,262 (CFTC Mar. 27, 1992) (adopting
definition of ``willful'' in McLaughlin v. Richland Shoe Co., 486
U.S. 128 (1987)).
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In determining whether a transaction has been entered into or
structured willfully to evade position limits, the Commission will not
consider the form, label, or written documentation as dispositive. The
Commission also is not requiring a pattern of evasive transactions as a
prerequisite to prove evasion, although such a pattern may be one
factor in analyzing whether evasion has occurred. In instances where
one party willfully structures a transaction to evade but the other
counterparty does not, proposed Sec. 150.2(i) would apply to the party
who willfully structured the transaction to evade.
Finally, entering into transactions that qualify for the forward
exclusion from the swap definition shall not be considered evasive.
However, in circumstances where a transaction does not, in fact,
qualify for the forward exclusion, the transaction may or may not be
evasive depending on an analysis of all relevant facts and
circumstances.
k. Netting
For the reasons discussed above, the referenced contract definition
in proposed Sec. 150.1 includes, among other things, cash-settled
contracts that are linked, either directly or indirectly, to a core
referenced futures contract; and any ``economically equivalent
[[Page 11636]]
swaps.'' \246\ Under proposed Sec. 150.2(a), federal spot month limits
would apply to physical-delivery referenced contracts separately from
federal spot month limits applied to cash-settled referenced contracts,
meaning that during the spot month, positions in physically-settled
contracts may not be netted with positions in linked cash-settled
contracts. Specifically, all of a trader's positions (long or short) in
a given physically-settled referenced contract (across all exchanges
and OTC as applicable) \247\ are netted and subject to the spot month
limit for the relevant commodity, and all of such trader's positions in
any cash-settled referenced contracts (across all exchanges and OTC as
applicable) linked to such physically-settled core referenced futures
contract are netted and independently (rather than collectively along
with the physically-settled positions) subject to the federal spot
month limit for that commodity.\248\ A position in a commodity contract
that is not a referenced contract is therefore not subject to federal
limits, and, as a consequence, cannot be netted with positions in
referenced contracts for purposes of federal limits.\249\ For example,
a swap that is not a referenced contract because it does not meet the
economically equivalent swap definition could not be netted with
positions in a referenced contract.
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\246\ See supra Section II.A.16. (discussion of the proposed
referenced contract definition).
\247\ In practice, the only physically-settled referenced
contracts under this proposal would be the 25 core referenced
futures contracts, none of which are listed on multiple DCMs,
although there could potentially be physically-settled OTC swaps
that would satisfy the ``economically equivalent swap'' definition
and therefore would also qualify as referenced contracts.
\248\ Consistent with CEA section 4a(a)(6), this would include
positions across exchanges.
\249\ Proposed Appendix C to part 150 provides guidance
regarding the referenced contract definition, including that the
following types of contracts are not deemed referenced contracts,
meaning such contracts are not subject to federal limits and cannot
be netted with positions in referenced contracts for purposes of
federal limits: Location basis contracts; commodity index contracts;
and trade options that meet the requirements of 17 CFR 32.3.
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Allowing the netting of linked physically-settled and cash-settled
contracts during the spot month could lead to disruptions in the price
discovery function of the core referenced futures contract or allow a
market participant to manipulate the price of the core referenced
futures contract. Absent separate spot month limits for physically-
settled and cash-settled contracts, the spot month limit would be
rendered ineffective, as a participant could maintain large positions
in excess of limits in both the physically-settled contract and the
linked cash-settled contract, enabling the participant to disrupt the
price discovery function as the contracts go to expiration by taking
large opposite positions in the physically-settled core referenced
futures and cash-settled referenced contracts, or potentially allowing
a participant to effect a corner or squeeze.\250\
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\250\ For example, 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.
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Proposed Sec. 150.2(b), which would establish limits outside the
spot month, does not use the ``separately'' language. Accordingly,
outside of the spot month, participants may net positions in linked
physically-settled and cash-settled referenced contracts, because there
is no immediate threat of delivery.
Finally, proposed Sec. 150.2(a) and (b) also provide that spot and
non-spot limits apply ``net long or net short.'' Consistent with
existing Sec. 150.2, this language requires that, both during and
outside the spot month, and subject to the provisions governing netting
described above, a given participant's long positions in a particular
contract be aggregated (including across exchanges and OTC as
applicable), and a participant's short positions be aggregated
(including across exchanges and OTC as applicable), and those aggregate
long and short positons be netted--in other words, it is the net value
that is subject to federal limits.
Consistent with current and historical practice, the speculative
position limits proposed herein would apply to positions throughout
each trading session, including as of the close of each trading
session.\251\
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\251\ See, e.g., Elimination of Daily Speculative Trading
Limits, 44 FR 7124, 7125 (Feb. 6, 1979).
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l. ``Eligible Affiliates'' and Aggregation
Proposed Sec. 150.2(k) addresses entities that qualify as an
``eligible affiliate'' as defined in proposed Sec. 150.1. Under the
proposed definition, an ``eligible affiliate'' includes certain
entities that, among other things, are required to aggregate their
positions under Sec. 150.4 and that do not claim an exemption from
aggregation. There may be certain entities that are eligible for an
exemption from aggregation but that prefer to aggregate rather than
disaggregate their positions; for example, when aggregation would
result in advantageous netting of positions with affiliated entities.
Proposed Sec. 150.2(k) is intended to address such a circumstance by
making clear that an ``eligible affiliate'' may opt to aggregate its
positions even though it is eligible to disaggregate.
m. Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.2. The Commission also invites comments on the following:
(20) Are there legitimate strategies on which the Commission should
offer guidance with respect to the anti-evasion provision?
(21) Should the Commission list by regulation specific factors/
circumstances in which it may set spot month limits with other than the
at or below 25 percent of deliverable supply formula, and non-spot
month limits with other than the modified 10, 2.5 percent formula
proposed herein? If so, please provide examples of any such factors,
including an explanation of whether and why different formulas make
sense for different commodities.
(22) Is the proposed compliance date of twelve months after
publication of a final federal position limits rulemaking in the
Federal Register an appropriate amount of time for compliance? If not,
please provide reasons supporting a different timeline. Do market
participants support delaying compliance until one year after a DCM has
had its new Sec. 150.9 rules approved by the Commission under Sec.
40.5?
(23) The Commission understands that it may be possible for a
market participant trading options to start a trading day below the
delta-adjusted federal speculative position limit for that option, but
end up above such limit as the option becomes in-the-money during the
spot month. Should the Commission allow for a one-day grace period with
respect to federal position limits for market participants who have
exercised options that were out-of-the money on the previous trading
day but that become in-the-money during the trading day in the spot
month?
(24) Given that the contracts in corn and soybean complex are more
liquid than CBOT Oats (O) and the MGEX HRS (MWE) wheat contract, should
the Commission employ a higher open interest formula for corn and the
soybean complex?
(25) Should the Commission phase-in the proposed increased federal
non-spot month limits incrementally over a period of time, rather than
implementing the entire increase upon the effective date? Please
explain why or why not. If so, please comment on an appropriate phase-
in schedule, including whether different
[[Page 11637]]
commodities should be subject to different schedules.
(26) The Commission is aware that the non-spot month open interest
is skewed to the first new crop (usually December or November) for the
nine legacy agricultural contracts. The Commission understands that
cotton may be unique because it has an extended harvest period starting
in July in the south and working its way north until November. There
may be some concern with positions being rolled from the prompt month
into deferred contract months causing disruption to the price discovery
function of the Cotton futures. Should the Commission consider lowering
the single month limit to a percentage of the all months limits for
Cotton? If so, what percentage of the all month limit should be used
for the single month limit? Please provide a rationale for your
percentage.
(27) Should the Commission allow market participants who qualify
for the conditional spot month limit in natural gas to net cash-settled
natural gas referenced contracts across DCMs? Why or why not?
C. Sec. 150.3--Exemptions From Federal Position Limits
1. Existing Sec. Sec. 150.3, 1.47, and 1.48
Existing Sec. 150.3(a), which pre-dates the Dodd-Frank Act, lists
positions that may, under certain circumstances, exceed federal limits:
(1) Bona fide hedging transactions, as defined in the current bona fide
hedging definition in Sec. 1.3; and (2) certain spread or arbitrage
positions.\252\ So that the Commission can effectively oversee the use
of such exemptions, existing Sec. 150.3(b) provides that the
Commission or certain Commission staff may make special calls to demand
certain information from exemption holders, including information
regarding positions owned or controlled by that person, trading done
pursuant to that exemption, and positions that support the claimed
exemption.\253\ Existing Sec. 150.3(a) allows for bona fide hedging
transactions to exceed federal limits, and the current process for a
person to request such recognitions for non-enumerated hedges appears
in Sec. 1.47.\254\ Under that provision, persons seeking recognition
by the Commission of a non-enumerated bona fide hedging transaction or
position must file statements with the Commission.\255\ Initial
statements must be filed with the Commission at least 30 days in
advance of exceeding the limit. \256\ Similarly, existing Sec. 1.48
sets forth the process for market participants to file an application
with the Commission to recognize certain enumerated anticipatory
positions as bona fide hedging positions.\257\ Under that provision,
such recognitions must be requested 10 days in advance of exceeding the
limit.\258\
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\252\ 17 CFR 150.3(a).
\253\ 17 CFR 150.3(b).
\254\ 17 CFR 1.47.
\255\ 17 CFR 1.47(a).
\256\ 17 CFR 1.47(b).
\257\ 17 CFR 1.48.
\258\ Id.
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Further, the Commission provides self-effectuating spread
exemptions for the nine legacy agricultural contracts currently subject
to federal limits, but does not specify a formal process for granting
such spread exemptions.\259\ The Commission's authority and existing
regulation for exempting certain spread positions can be found in
section 4a(a)(1) of the Act and existing Sec. 150.3(a)(3) of the
Commission's regulations, respectively.\260\ In particular, CEA section
4a(a)(1) provides the Commission with authority to exempt from position
limits transactions ``normally known to the trade as `spreads' or
`straddles' or `arbitrage.' ''
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\259\ Since 1938, the Commission (known as the Commodity
Exchange Commission in 1938) has recognized the use of spread
positions to facilitate liquidity and hedging. Notice of Proposed
Order in the Matter of Limits on Position and Daily Trading in Grain
for Future Delivery, 3 FR 1408 (June 14, 1938).
\260\ See 7 U.S.C. 6a(a)(1) and 17 CFR 150.3(a)(3) (providing
that the position limits set in Sec. 150.2 may be exceeded to the
extent such positions are: Spread 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.). Although
existing Sec. 150.3(a)(3) does not specify a formal process for
granting spread exemptions, the Commission is able to monitor
traders' gross and net positions using part 17 data, the monthly
Form 204, and information from the applicable DCMs to identify any
such spread positions.
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2. Proposed Sec. 150.3
As described elsewhere in this release, the Commission is proposing
a new bona fide hedging definition in Sec. 150.1 (described above) and
a new streamlined process in proposed Sec. 150.9 for recognizing non-
enumerated bona fide hedging positions (described further below). The
Commission thus proposes to update Sec. 150.3 to conform to those new
proposed provisions. Proposed Sec. 150.3 also includes new exemption
types not explicitly listed in existing Sec. 150.3, including: (i)
Exemptions for financial distress situations; (ii) conditional
exemptions for certain spot month positions in cash-settled natural gas
contracts; and (iii) exemptions for pre-enactment swaps and transition
period swaps.\261\ Proposed Sec. 150.3(b)-(g) respectively address:
Requests for relief from position limits submitted directly to the
Commission or Commission staff (rather than to an exchange under
proposed Sec. 150.9, as discussed further below); previously-granted
risk management exemptions to position limits; exemption-related
recordkeeping and special-call requirements; the aggregation of
accounts; and the delegation of certain authorities to the Director of
the Division of Market Oversight.
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\261\ The Commission revised Sec. 150.3(a) in 2016, relocating
the independent account controller aggregation exemption from Sec.
150.3(a)(4) in order to consolidate it with the Commission's
aggregation requirements in Sec. 150.4(b)(4). See Final Aggregation
Rulemaking, 81 FR at 91489-90.
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a. Bona Fide Hedging Positions and Spread Exemptions
The Commission has years of experience granting and monitoring
spread exemptions, and enumerated and non-enumerated bona fide hedges,
as well as overseeing exchange processes for administering exemptions
from exchange-set limits on such contracts. As a result of this
experience, the Commission has determined to continue to allow self-
effectuating enumerated bona fide hedges and certain spread exemptions
for all contracts that would be subject to federal position limits, as
explained further below.
i. Bona Fide Hedging Positions
First, under proposed Sec. 150.3(a)(1)(i), bona fide hedge
recognitions for positions in referenced contracts that fall within one
of the proposed enumerated hedges set forth in proposed Appendix A to
part 150, discussed above, would be self-effectuating for purposes of
federal position limits. Market participants would thus not be required
to request Commission approval prior to exceeding federal position
limits in such cases, but would be required to request a bona fide
hedge exemption from the relevant exchange for purposes of exchange-set
limits established pursuant to proposed Sec. 150.5(a), and submit
required cash-market information to the exchange as part of such
request.\262\ The Commission has also determined to allow the proposed
enumerated anticipatory bona fide hedges (some of which are not
currently self-effectuating and thus are required to be approved by the
Commission under existing Sec. 1.48) to be self-effectuating for
purposes of federal limits (and thus would not require prior
[[Page 11638]]
Commission approval for such enumerated anticipatory hedges). The
Commission may consider expanding the proposed list of enumerated
hedges at a later time, after notice and comment, as it gains
experience with the new federal position limits framework proposed
herein.
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\262\ See infra Section II.D.4.a. See also proposed Sec.
150.5(a)(2)(ii)(A)(1).
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Second, under proposed Sec. 150.3(a)(1)(ii), for positions in
referenced contracts that do not fit within one of the proposed
enumerated hedges in Appendix A, (i.e., non-enumerated bona fide
hedges), market participants must request approval from the Commission,
or from an exchange, prior to exceeding federal limits. Such exemptions
thus would not be self-effectuating and market participants in such
cases would have two options for requesting such a non-enumerated bona
fide hedge recognition: (1) Apply directly to the Commission in
accordance with proposed Sec. 150.3(b) (described below), and
separately also apply to an exchange pursuant to exchange rules
established under proposed Sec. 150.5(a); \263\ or, alternatively (2)
apply to an exchange pursuant to proposed Sec. 150.9 for a non-
enumerated bona fide hedge recognition that could be valid both for
purposes of federal and exchange-set position limit requirements,
unless the Commission (and not staff) objects to the exchange's
determination within a limited period of time.\264\ As discussed
elsewhere in this release, market participants relying on enumerated or
non-enumerated bona fide hedge recognitions would no longer have to
file the monthly Form 204/304 with supporting cash market
information.\265\
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\263\ See infra Section II.D.4. (discussion of proposed Sec.
150.5).
\264\ See infra Section II.G.3. (discussion of proposed Sec.
150.9).
\265\ See infra Section II.H.2. (discussion of the proposed
elimination of Form 204).
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ii. Spread Exemptions
Under proposed Sec. 150.3(a)(2)(i), spread exemptions for
positions in referenced contracts would be self-effectuating, provided
that the position fits within one of the types of spreads listed in the
spread transaction definition in proposed Sec. 150.1,\266\ and
provided further that the market participant separately requests a
spread exemption from the relevant exchange's limits established
pursuant to proposed Sec. 150.5(a).
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\266\ See supra Section II.A.20. (proposed definition of
``spread transaction'' in Sec. 150.1, which would cover: Calendar
spreads; quality differential spreads; processing spreads (such as
energy ``crack'' or soybean ``crush'' spreads); product or by-
product differential spreads; and futures-options spreads.)
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The Commission anticipates that such spread exemptions might
include spreads that are ``legged in,'' that is, carried out in two
steps, or alternatively are ``combination trades,'' that is, all
components of the spread are executed simultaneously or near
simultaneously. The list of spread transactions in proposed Sec. 150.1
reflects the most common types of spread strategies for which the
Commission and/or exchanges have previously granted spread exemptions.
Under proposed Sec. 150.3(a)(2)(ii), for all contracts subject to
federal limits, if the spread position does not fit within one of the
spreads listed in the spread transaction definition in proposed Sec.
150.1, market participants must apply for the spread exemption relief
directly from the Commission in accordance with proposed Sec.
150.3(b). The market participant must receive notification of the
approved spread exemption under proposed Sec. 150.3(b)(4) before
exceeding the federal speculative position limits for that spread
position. The Commission may consider expanding the proposed spread
transactions definition at a later time, after notice and comment, as
it gains experience with the new federal position limits framework
proposed herein.
iii. Removal of Existing Sec. Sec. 1.47, 1.48, and 140.97
Given the proposal set forth in Sec. 150.9, as described in detail
below, to allow for a streamlined process for recognizing bona fide
hedges for purposes of federal limits,\267\ the Commission also
proposes to delete existing Sec. Sec. 1.47 and 1.48. The Commission
preliminarily believes that overall, the proposed approach would lead
to a more efficient bona fide hedge recognition process. As the
Commission proposes to delete Sec. Sec. 1.47 and 1.48, the Commission
also proposes to delete existing Sec. 140.97, which delegates to the
Director of the Division of Enforcement or his designee authority
regarding requests for classification of positions as bona fide hedges
under existing Sec. Sec. 1.47 and 1.48.\268\
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\267\ Id.
\268\ 17 CFR 140.97.
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The Commission does not intend the proposed replacement of
Sec. Sec. 1.47 and 1.48 to have any bearing on bona fide hedges
previously recognized under those provisions. With the exception of
certain recognitions for risk management positions discussed below,
positions that were previously recognized as bona fide hedges under
Sec. Sec. 1.47 or 1.48 would continue to be recognized, provided they
continue to meet the statutory bona fide hedging definition and all
other existing and proposed requirements.
b. Process for Requesting Commission-Provided Relief for Non-Enumerated
Bona Fide Hedges and Spread Exemptions
Under the proposed rules, non-enumerated bona fide hedging
recognitions may only be granted by the Commission as proposed in Sec.
150.3(b), or under the streamlined process proposed in Sec. 150.9.
Further, spread exemptions that do not meet the proposed spread
transaction definition may only be granted by the Commission as
proposed in Sec. 150.3(b). Under the Commission process in Sec.
150.3(b), a person seeking a bona fide hedge recognition or spread
exemption may submit a request to the Commission.
With respect to bona fide hedge recognitions, such request must
include: (i) A description of the position in the commodity derivative
contract for which the application is submitted, including the name of
the underlying commodity and the position size; (ii) information to
demonstrate why the position satisfies section 4a(c)(2) of the Act and
the definition of bona fide hedging transaction or position in proposed
Sec. 150.1, including factual and legal analysis; (iii) a statement
concerning the maximum size of all gross positions in derivative
contracts for which the application is submitted (in order to provide a
view of the true footprint of the position in the market); (iv)
information regarding the applicant's activity in the cash markets and
the swaps markets for the commodity underlying the position for which
the application is submitted; \269\ and (v) any other information that
may help the Commission determine whether the position meets the
requirements of section 4a(c)(2) of the Act and the definition of bona
fide hedging transaction or position in Sec. 150.1.\270\
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\269\ The Commission would expect that applicants would provide
cash market data for at least the prior year.
\270\ For example, the Commission may, in its discretion,
request a description of any positions in other commodity derivative
contracts in the same commodity underlying the commodity derivative
contract for which the application is submitted. Other commodity
derivatives contracts could include other futures, options, and
swaps (including over-the-counter swaps) positions held by the
applicant.
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With respect to spread exemptions, such request must include: (i) A
description of the spread transaction for which the exemption
application is
[[Page 11639]]
submitted; \271\ (ii) a statement concerning the maximum size of all
gross positions in derivative contracts for which the application is
submitted; and (iii) any other information that may help the Commission
determine whether the position is consistent with section 4a(a)(3)(B)
of the Act.
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\271\ The nature of such description would depend on the facts
and circumstances, and different details may be required depending
on the particular spread.
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Under proposed Sec. 150.3(b)(2), the Commission, or Commission
staff pursuant to delegated authority proposed in Sec. 150.3(g), may
request additional information from the requestor and must provide the
requestor with ten business days to respond. Under proposed Sec.
150.3(b)(3) and (4), the requestor, however, may not exceed federal
position limits unless it receives a notice of approval from the
Commission or from Commission staff pursuant to delegated authority
proposed in Sec. 150.3(g); provided however, that, due to demonstrated
sudden or unforeseen increases in its bona fide hedging needs, a person
may request a recognition of a bona fide hedging transaction or
position within five business days after the person established the
position that exceeded the federal speculative position limit.\272\
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\272\ Where a person requests a bona fide hedge recognition
within five business days after they exceed federal position limits,
such person would be required to demonstrate that they encountered
sudden or unforeseen circumstances that required them to exceed
federal position limits before submitting and receiving approval of
their bona fide hedge application. These applications submitted
after a person has exceeded federal position limits should not be
habitual and will be reviewed closely. If the Commission reviews
such application and finds that the position does not qualify as a
bona fide hedge, then the applicant would be required to bring their
position into compliance within a commercially reasonable time, as
determined by the Commission in consultation with the applicant and
the applicable DCM or SEF. If the applicant brings the position into
compliance within a commercially reasonable time, then the applicant
will not be considered to have violated the position limits rules.
Further, any intentional misstatements to the Commission, including
statements to demonstrate why the bona fide hedging needs were
sudden and unforeseen, would be a violation of sections 6(c)(2) and
9(a)(2) of the Act.
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Under this proposed process, market participants would be
encouraged to submit their requests for bona fide hedge recognitions
and spread exemptions as early as possible since proposed Sec.
150.3(b) would not set a specific timeframe within which the Commission
must make a determination for such requests.
Further, all approved bona fide hedge recognitions and spread
exemptions must be renewed if there are any changes to the information
submitted as part of the request, or upon request by the Commission or
Commission staff.\273\ Finally, the Commission (and not staff) may
revoke or modify any bona fide hedge recognition or spread exemption at
any time if the Commission determines that the bona fide hedge
recognition or spread exemption, or portions thereof, are no longer
consistent with the applicable statutory and regulatory
requirements.\274\
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\273\ See proposed Sec. 150.3(b)(5). Currently, the Commission
does not require automatic updates to bona fide hedge applications,
and does not require applications or updates thereto for spread
exemptions, which are self-effectuating. Consistent with current
practices, under proposed Sec. 150.3(b)(5), the Commission would
not require automatic annual updates to bona fide hedge and spread
exemption applications; rather, updated applications would only be
required if there are changes to information the requestor initially
submitted or upon Commission request. This approach is different
than the proposed streamlined process in Sec. 150.9, which would
require automatic annual updates to such applications, which is more
consistent with current exchange practices. See, e.g., CME Rule 559.
\274\ This proposed authority to revoke or modify a bona fide
hedge recognition or spread exemption would not be delegated to
Commission staff.
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The Commission anticipates that most market participants would
utilize the streamlined process set forth in proposed Sec. 150.9 and
described below, rather than the process as proposed in Sec. 150.3(b),
because exchanges would generally be able to make such determinations
more efficiently than Commission staff, and because market participants
are likely already familiar with the proposed processes set forth in
Sec. 150.9, which is intended to leverage the processes currently in
place at the exchanges for addressing requests for exemptions from
exchange-set limits. Nevertheless, proposed Sec. 150.3(a)(1) and (2)
clarify that market participants may seek relief from federal position
limits for non-enumerated bona fide hedges and spread transactions that
do not meet the proposed spread transactions definition directly from
the Commission. After receiving any approval of a bona fide hedge or
spread exemption from the Commission, the market participant would
still be required to request a bona fide hedge recognition or spread
exemption from the relevant exchange for purposes of exchange-set
limits established pursuant to proposed Sec. 150.5(a).
c. Request for Comment
The Commission requests comments on all aspects of proposed Sec.
150.3(a)(1) and (2). The Commission also invites comment on the
following:
(28) Out of concern that large demand for delivery against long
nearby futures positions may outpace demand on spot cash values, the
Commission has previously discussed allowing cash and carry exemptions
as spreads on the condition that the exchange ensures that exit points
in cash and carry spread exemptions would facilitate an orderly
liquidation.\275\ Should the Commission allow the granting of cash and
carry exemptions under such conditions? If so, please explain why,
including how such exemptions would be consistent with the Act and the
Commission's regulations. If not, please explain why not, and if other
circumstances would be better, including better for preserving
convergence, which is essential to properly functioning markets and
price discovery. If cash and carry exemptions were allowed, how could
an exchange ensure that exit points in cash and carry exemptions
facilitate convergence of cash and futures?
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\275\ See, e.g., 2016 Reproposal, 81 FR 96704 at 96833.
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d. Financial Distress Exemptions
Proposed Sec. 150.3(a)(3) would allow for a financial distress
exemption in certain situations, including the potential default or
bankruptcy of a customer or a potential acquisition target. For
example, in periods of financial distress, such as a customer default
at an FCM or a potential bankruptcy of a market participant, it may be
beneficial for a financially-sound market participant to take on the
positions and corresponding risk of a less stable market participant,
and in doing so, exceed federal speculative position limits. Pursuant
to authority delegated under Sec. Sec. 140.97 and 140.99, Commission
staff previously granted exemptions in these types of situations to
avoid sudden liquidations required to comply with a position
limit.\276\ Such sudden liquidations could otherwise potentially hinder
statutory objectives, including by reducing liquidity, disrupting price
discovery, and/or increasing systemic risk.\277\
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\276\ See, e.g., CFTC Press Release No. 5551-08, CFTC Update on
Efforts Underway to Oversee Markets, (Sept. 19, 2008), available at
http://www.cftc.gov/PressRoom/PressReleases/pr5551-08.
\277\ See 7 U.S.C. 6a(a)(3).
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The proposed exemption would be available to positions of ``a
person, or related persons,'' meaning that a financial distress
exemption request should be specific to the circumstances of a
particular person, or to persons related to that person, and not a more
general request by a large group of unrelated people whose financial
distress circumstances may differ from one another. The proposed
exemption would be granted on a case by case basis in response to a
request submitted pursuant to Sec. 140.99, and would be
[[Page 11640]]
evaluated based on the specific facts and circumstances of a particular
person or related persons. Any such financial distress position would
not be a bona fide hedging transaction or position unless it otherwise
met the substantive and procedural requirements set forth in proposed
Sec. Sec. 150.1, 150.3, and 150.9, as applicable.
e. Conditional Spot Month Exemption in Natural Gas
Certain natural gas contracts are currently subject to exchange-set
limits, but not federal limits.\278\ This proposal would apply federal
limits to certain natural gas contracts for the first time by including
the physically-settled NYMEX Henry Hub Natural Gas (``NYMEX NG'')
contract as a core referenced futures contract listed in proposed Sec.
150.2(d). As set forth in proposed Appendix E to part 150, that
physically-settled contract, as well as any cash-settled natural gas
contract that qualifies as a referenced contract,\279\ would be
separately subject to a federal spot month limit, net long or net
short, of 2,000 NYMEX NG equivalent-size contracts.
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\278\ Some examples include natural gas contracts that use the
NYMEX NG futures contract as a reference price, such as ICE's Henry
Financial Penultimate Fixed Price Futures (PHH), options on Henry
Penultimate Fixed Price (PHE), Henry Basis Futures (HEN) and Henry
Swing Futures (HHD); NYMEX's E-mini Natural Gas Futures (QG), Henry
Hub Natural Gas Last Day Financial Futures (HH), and Henry Hub
Natural Gas Financial Calendar Spread (3 Month) Option (G3); and
Nasdaq Futures, Inc.'s (``NFX'') Henry Hub Natural Gas Financial
Futures (HHQ), and Henry Hub Natural Gas Penultimate Financial
Futures (NPQ).
\279\ Under the referenced contract definition proposed in Sec.
150.1, cash-settled natural gas referenced contracts are those
futures or options contracts, including spreads, that are:
(1) Directly or indirectly linked, including being partially or
fully settled on, or priced at a fixed differential to, the price of
the physically-settled NYMEX NG 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 the physically-settled NYMEX NG core
referenced futures contract for delivery at the same location or
locations as specified in the NYMEX NG core referenced futures
contract. As proposed, the referenced contract definition does not
include a location basis contract, a commodity index contract, or a
trade option that meets the requirements of Sec. 32.3 of this
chapter. See proposed Sec. 150.1.
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Under the referenced contract definition in proposed Sec. 150.1,
ICE's cash-settled Henry Hub LD1 contract, ICE's Henry Financial
Penultimate Fixed Price Futures, NYMEX's cash-settled Henry Hub Natural
Gas Last Day Financial Futures contract, Nodal Exchange's (``Nodal'')
cash-settled Henry Hub Monthly Natural Gas contract, and NFX cash-
settled Henry Hub Natural Gas Financial Futures contract, for example,
would each qualify as a referenced contract subject to federal limits
by virtue of being cash-settled to the physically-settled NYMEX NG core
referenced futures contract.\280\ Any other cash-settled contract that
meets the referenced contract definition would also be subject to
federal limits, as would an ``economically equivalent swap,'' as
defined in proposed Sec. 150.1, with respect to any natural gas
referenced contract.
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\280\ On November 12, 2019, Nodal announced that it had reached
an agreement to acquire the core assets of NFX. See Nodal Exchange
Acquires U.S. Commodities Business of Nasdaq Futures, Inc. (NFX),
Nodal Exchange website (Nov. 12, 2019), available at https://www.nodalexchange.com/wp-content/uploads/20191112-Nodal-NFX-release-Final.pdf (press release). The acquisition includes all of NFX's
energy complex of futures and options contracts, including NFX's
Henry Hub Natural Gas Financial Futures contract. Because that
contract will become part of Nodal's offerings, that contract, as
well as Nodal's existing Henry Hub Monthly Natural Gas contract,
would continue to qualify as referenced contracts under the proposed
definition herein, and thus would be subject to federal limits by
virtue of being cash-settled to the physically-settled NYMEX NG core
referenced futures contract. According to the November 12, 2019
press release, ``Nodal Exchange and Nodal Clear plan to complete the
integration of U.S. Power contracts by December 2019. U.S. Natural
Gas, Crude Oil and Ferrous Metals contracts could transfer to Nodal
as soon as spring 2020.'' Id.
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Proposed Sec. 150.3(a)(4) would permit a new federal conditional
spot month limit exemption for certain cash-settled natural gas
referenced contracts. Under proposed Sec. 150.3(a)(4), market
participants seeking to exceed the proposed 2,000 NYMEX NG equivalent-
size contract spot month limit for a cash-settled natural gas
referenced contract listed on any DCM could receive an exemption that
would be capped at 10,000 NYMEX NG equivalent-size contracts net long
or net short per DCM, plus an additional 10,000 NYMEX NG futures
equivalent size contracts in economically equivalent swaps. A grant of
such an exemption would be conditioned on the participant not holding
or controlling any positions during the spot month in the physically-
settled NYMEX NG core referenced futures contract.\281\
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\281\ While the NYMEX NG is the only natural gas contract
included as a core referenced futures contract in this release, the
conditional spot month exemption proposed herein would also apply to
any other physically-settled natural gas contract that the
Commission may in the future designate as a core referenced futures
contract, as well as to any physically-delivered contract that is
substantially identical to the NYMEX NG and that qualifies as a
referenced contract, or that qualifies as an economically equivalent
swap.
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This proposed conditional exemption level of 10,000 contracts per
DCM in natural gas would codify into federal regulations the industry
practice of an exchange-set conditional limit that is five times the
size of the spot month limit that has developed over time, and which
the Commission preliminarily believes has functioned well. The practice
balances the needs of certain market participants, who may currently
hold or control 5,000 contracts in each DCM's cash-settled natural gas
futures contracts and prefer a sizeable position in a cash-settled
contract in order to obtain the desired exposure without needing to
make or take delivery of natural gas, with the policy objectives of the
Commission, which has historically had concerns about the possibility
of traders attempting to manipulate the physically-settled NYMEX NG
contract (i.e., mark-the close) in order to benefit from a larger
position in the cash-settled ICE LD1 Natural Gas Swap and/or NYMEX
Henry Hub Natural Gas Last Day Financial Futures contract during the
spot month as these contracts expired.\282\
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\282\ As noted above, current exchange rules establish a spot
month limit of 1,000 NYMEX equivalent sized contracts. The
Commission proposes a federal spot month limit of 2,000 NYMEX
equivalent sized contracts based on updated deliverable supply
estimates. See supra Section II.B.2.b. (2020 proposed spot month
limit chart). The proposed conditional spot month limit exemption of
10,000 contracts per exchange is thus five times the proposed
federal spot month limit.
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NYMEX, ICE, NFX, and Nodal currently have rules in place
establishing a conditional spot month limit exemption equivalent to up
to 5,000 contracts (in NYMEX-equivalent size) for their respective
cash-settled natural gas contracts, provided that the trader does not
maintain a position in the physically-settled NYMEX NG contract during
the spot month.\283\ Together, the ICE, NYMEX, NFX, and Nodal rules
allow a trader to hold up to 20,000 (NYMEX-equivalent size) contracts
during the spot month combined across ICE, NYMEX, NFX, and Nodal cash-
settled natural gas contracts, provided the trader does not hold
positions in excess of 5,000
[[Page 11641]]
contracts on any one DCM, and provided further that the trader does not
hold any positions in the physically-settled NYMEX NG contract during
the spot month.\284\
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\283\ See ICE Rule 6.20(c), NYMEX Rule 559.F, NFX Rule Chapter
V, Section 13(a), and Nodal Rule 6.5.2. The spot month for such
contracts is three days. See also Position Limits, CMG Group
website, available at https://www.cmegroup.com/market-regulation/position-limits.html (NYMEX position limits spreadsheet); Market
Resources, ICE Futures website, available at https://www.theice.com/futures-us/market-resources (ICE position limits spreadsheet). NYMEX
rules establish an exchange-set spot month limit of 1,000 contracts
for its physically-settled NYMEX NG Futures contract and a separate
spot month limit of 1,000 contracts for its cash-settled Henry Hub
Natural Gas Last Day Financial Futures contract. As the ICE natural
gas contract is one quarter the size of the NYMEX contract, ICE's
exchange-set natural gas limits are shown in NYMEX equivalents
throughout this section of the release. ICE thus has rules in place
establishing an exchange-set spot month limit of 4,000 contracts
(equivalent to 1,000 NYMEX contracts) for its cash-settled Henry Hub
LD1 Fixed Price Futures contract.
\284\ In practice, a majority of the trading in such contracts
is on ICE and NYMEX. As noted above, Nodal is acquiring NFX,
including its Henry Hub Natural Gas Financial Futures contract.
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The DCMs originally adopted these rules, in consultation with
Commission staff, in large part to address historical concerns over the
potential for manipulation of physically-settled natural gas contracts
during the spot month in order to benefit positions in cash-settled
natural gas contracts, and to accommodate certain trading dynamics
unique to the natural gas contracts. In particular, in natural gas,
open interest tends to decline in the NYMEX NG contract approaching
expiration and tends to increase rapidly in the ICE cash-settled Henry
Hub LD1 contract. These dynamics suggest that cash-settled natural gas
contracts serve an important function for hedgers and speculators who
wish to recreate and/or hedge the physically-settled NYMEX NG contract
price without being required to make or take delivery.
The condition in proposed Sec. 150.3(a)(4), however, should remove
the potential to manipulate the physically-settled natural gas contract
in order to benefit a sizeable position in the cash-settled contract.
To qualify for the exemption, market participants would not be
permitted to hold any spot month positions in the physically-settled
contract. This proposed conditional exemption would prevent
manipulation by traders with leveraged positions in the cash-settled
contracts (in comparison to the level of the limit in the physical-
delivery contract) who might otherwise attempt to mark the close or
distort physical-delivery prices in the physically-settled contract to
benefit their leveraged cash-settled positions. Thus, the exemption
would establish a higher conditional limit for the cash-settled
contract than for the physical-delivery contract, so long as the cash-
settled positions are decoupled from spot-month positions in physical-
delivery contracts which set or affect the value of such cash-settled
positions.
While the Commission is unaware of any natural gas swaps that would
qualify as ``economically equivalent swaps,'' the Commission proposes
to apply the conditional exemption to swaps as well, provided that a
given market participant's positions in such cash-settled swaps do not
exceed 10,000 futures-equivalent contracts and provided that the
participant does not hold spot-month positions in physically settled
natural gas contracts. Because swaps may generally be fungible across
markets, that is, a position may be established on one SEF and offset
on another SEF or OTC, the Commission proposes that economically
equivalent swap contracts have a conditional spot month limit of 10,000
economically equivalent contracts in total across all SEFs and OTC.
A market participant that sought to hold positions in both the
NYMEX NG physically-settled contract and in any cash-settled natural
gas contract would not be eligible for the proposed conditional
exemption. Such a participant could only hold up to 2,000 contracts net
long or net short across exchanges/OTC in physically-settled natural
gas referenced contract(s), and another 2,000 contracts net long or net
short across exchanges/OTC in cash-settled natural gas contract
referenced contract(s).\285\
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\285\ See supra Section II.B.2.k. (discussion of netting).
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f. Exemption for Pre-Enactment Swaps and Transition Period Swaps
In order to promote a smooth transition to compliance for swaps not
previously subject to federal speculative position limits, proposed
Sec. 150.3(a)(5) would provide that federal speculative position
limits shall not apply to positions acquired in good faith in any pre-
enactment swap or in any transition period swap, in either case as
defined by Sec. 150.1.\286\ Any swap that meets the proposed
economically equivalent swap definition, but that otherwise qualifies
as a pre-enactment swap or transition period swap, would thus be exempt
from federal speculative position limits. This exemption would be self-
effectuating and would not require a market participant to request
relief.
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\286\ ``Pre-enactment swap'' would mean any swap entered into
prior to enactment of the Dodd-Frank Act of 2010 (July 21, 2010),
the terms of which have not expired as of the date of enactment of
that Act. ``Transition period swap'' would mean a swap entered into
during the period commencing after the enactment of the Dodd-Frank
Act of 2010 (July 21, 2010), and ending 60 days after the
publication in the Federal Register of final amendments to this part
implementing section 737 of the Dodd-Frank Act of 2010.
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In order to further lessen the impact of the proposed federal
limits on market participants, for purposes of complying with the
proposed federal non-spot month limits, the proposed rule would also
allow both pre-enactment swaps and transition period swaps to be netted
with commodity derivative contracts acquired more than 60 days after
publication of final rules in the Federal Register. Any such positions
would not be permitted to be netted during the spot month so as to
avoid rendering spot month limits ineffective--the Commission is
particularly concerned about protecting the spot month in physical-
delivery futures from price distortions or manipulation that would
disrupt the hedging and price discovery utility of the futures
contract.
g. Previously-Granted Risk Management Exemptions
As discussed elsewhere in this release, the Commission previously
recognized, as bona fide hedges under Sec. 1.47, certain risk-
management positions in physical commodity futures and/or options on
futures contracts thereon held outside of the spot month that were used
to offset the risk of commodity index swaps and other related exposure,
but that did not represent substitutes for transactions or positions to
be taken in a physical marketing channel. However, as noted earlier in
this release, the Commission interprets Dodd-Frank Act amendments to
the CEA as eliminating the Commission's authority to grant such relief
unless the position satisfies the pass-through provision in CEA section
4a(c)(2)(B).\287\ Accordingly, to ensure consistency with the Dodd-
Frank Act, the Commission will not recognize further risk management
positions as bona fide hedges, unless the position otherwise satisfies
the requirements of the pass-through provisions.\288\
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\287\ See supra Section II.A.1.c.ii.(1). (discussion of the
temporary substitute test and risk-management exemptions).
\288\ See supra Section II.A.1.c.vi. (discussion of proposed
pass-through language).
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In addition, the Commission proposes in Sec. 150.3(c) that such
previously-granted exemptions shall not apply after the effective date
of a final federal position limits rulemaking implementing the Dodd-
Frank Act. Proposed Sec. 150.3(c) uses the phrase ``positions in
financial instruments'' to refer to such commodity index swaps and
related exposure and would have the effect of revoking the ability to
use previously-granted risk management exemptions once the limits
proposed in Sec. 150.2 go into effect.
h. Recordkeeping
Proposed Sec. 150.3(d) establishes recordkeeping requirements for
persons who claim any exemptions or relief under proposed Sec. 150.3.
Proposed Sec. 150.3(d) should help to ensure that any person who
claims any exemption permitted under proposed Sec. 150.3 can
demonstrate compliance with the applicable requirements. Under proposed
Sec. 150.3(d)(1), any persons
[[Page 11642]]
claiming an exemption would be required to keep and maintain complete
books and records concerning all details of their related cash,
forward, futures, options on futures, and swap positions and
transactions, including anticipated requirements, production and
royalties, contracts for services, cash commodity products and by-
products, cross-commodity hedges, and records of bona fide hedging swap
counterparties.
Proposed Sec. 150.3(d)(2) addresses recordkeeping requirements
related to the pass-through swap provision in the proposed definition
of bona fide hedging transaction or position in proposed Sec.
150.1.\289\ Under proposed Sec. 150.3(d)(2), a pass-through swap
counterparty, as contemplated by proposed Sec. 150.1, that relies on a
representation received from a bona fide hedging swap counterparty that
a swap qualifies in good faith as a bona fide hedging position or
transaction under proposed Sec. 150.1, would be required to: (i)
Maintain any written representation for at least two years following
the expiration of the swap; and (ii) furnish the representation to the
Commission upon request.
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\289\ See supra Section II.A.1.c.vi. (discussion of proposed
pass-through language).
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i. Call for Information
The Commission proposes to move existing Sec. 150.3(b), which
currently allows the Commission or certain Commission staff to make
special calls to demand certain information regarding positions or
trading, to proposed Sec. 150.3(e), with some technical modifications.
Together with the recordkeeping provision of proposed Sec. 150.3(d),
proposed Sec. 150.3(e) should enable the Commission to monitor the use
of exemptions from speculative position limits and help to ensure that
any person who claims any exemption permitted by proposed Sec. 150.3
can demonstrate compliance with the applicable requirements.
j. Aggregation of Accounts
Proposed Sec. 150.3(f) would clarify that entities required to
aggregate under Sec. 150.4 would be considered the same person for
purposes of determining whether they are eligible for a bona fide hedge
recognition under Sec. 150.3(a)(1).
k. Delegation of Authority
Proposed Sec. 150.3(g) would delegate authority to the Director of
the Division of Market Oversight to: Grant financial distress
exemptions pursuant to proposed Sec. 150.3(a)(3); request additional
information with respect to an exemption request pursuant to proposed
Sec. 150.3(b)(2); determine, in consultation with the exchange and
applicant, a commercially reasonable amount of time required for a
person to bring its position within the federal position limits
pursuant to proposed Sec. 150.3(b)(3)(ii)(B); make a determination
whether to recognize a position as a bona fide hedging transaction or
to grant a spread exemption pursuant to proposed Sec. 150.3(b)(4); and
to request that a person submit updated materials or renew their
request pursuant to proposed Sec. 150.3(b)(2) or (5). This proposed
delegation would enable the Division of Market Oversight to act quickly
in the event of financial distress and in the other circumstances
described above.
l. Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.3. In addition, the Commission understands that there may be
certain not-for-profit electric and natural gas utilities that have
certain public service missions and that are prohibited, by their
governing body, risk management policies, or otherwise, from
speculating, and that would request relief from federal position limits
once federal limits on swaps are implemented. The Commission requests
comment on all aspects of the concept of an exemption from part 150 of
the Commission's regulations for certain not-for-profit electric and
natural gas utility entities that have unique public service missions
to provide reliable, affordable energy services to residential,
commercial, and industrial customers, and that are prohibited from
speculating. In addition, the Commission requests comment on whether
the definition of ``economically equivalent swap'' would cover the
types of hedging activities such utilities engage in with respect to
their OTC swap activity.
The Commission also invites comments on the following:
(29) What are the overarching issues or concerns the Commission
should consider regarding a potential exemption from position limits
for such not- for-profit electric and natural gas utilities?
(30) Are there certain provisions in part 150 of the Commission's
regulations that should apply to such not-for-profit electric and
natural gas utilities even if the Commission were to grant such
entities an exemption with respect to federal position limits?
(31) Are there other types of entities, similar to the not-for-
profit electric and natural gas utilities described above, for which
the Commission should also consider granting such exemptive relief by
rule, and why?
(32) What types of conditions, restrictions, or criteria should the
Commission consider applying with respect to such an exemption?
(33) Should higher position limits in cash-settled natural gas
futures be conditioned on the closing of any positions in the
physically delivered natural gas contract? Are there characteristics of
the natural gas futures markets that weigh in favor of or against the
higher conditional limits?
D. Sec. 150.5--Exchange-Set Position Limits and Exemptions Therefrom
1. Background
For the avoidance of confusion, the discussion of Sec. 150.5 that
follows addresses exchange-set limits and exemptions therefrom, not
federal limits. For a discussion of the proposed processes by which an
exemption may be recognized for purposes of federal limits, please see
the discussion of proposed Sec. 150.3 above and Sec. 150.9 below.
Under DCM Core Principle 5, DCMs shall adopt for each contract, as
is necessary and appropriate, position limitations or position
accountability for speculators, and, for any contract subject to a
federal position limit, DCMs must establish exchange-set limits for
that contract no higher than the federal limit level.\290\ Similarly,
under SEF Core Principle 6, SEFs that are trading facilities shall
adopt for each contract, as is necessary and appropriate, position
limitations or position accountability for speculators, and, for any
contract subject to a federal position limit, SEFs that are trading
facilities must establish exchange-set limits for that contract no
higher than the federal limit, and must monitor positions established
on or through the SEF for compliance with the limit set by the
Commission and the limit, if any, set by the SEF.\291\ Beyond these and
other statutory and Commission requirements, unless otherwise
determined by the Commission, DCM and SEF Core Principle 1 afford DCMs
and SEFs ``reasonable discretion'' in establishing the manner in which
they comply with the core principles.\292\
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\290\ See 7 U.S.C. 7(d)(5).
\291\ See 7 U.S.C. 7b-3(f)(6).
\292\ See 7 U.S.C. 7(d)(1) and 7 U.S.C. 7b-3(f)(1).
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The current regulatory provisions governing exchange-set position
limits and exemptions therefrom appear in Sec. 150.5.\293\ To align
Sec. 150.5 with Dodd-
[[Page 11643]]
Frank statutory changes \294\ and with other changes proposed
herein,\295\ the Commission proposes a new version of Sec. 150.5. This
new proposed Sec. 150.5 would generally afford exchanges the
discretion to decide for themselves how best to set limit levels and
grant exemptions from such limits in a manner that best reflects their
specific markets.
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\293\ 17 CFR 150.5.
\294\ While existing Sec. 150.5 on its face only applies to
contracts that are not subject to federal limits, DCM Core Principle
5, as amended by Dodd-Frank, and SEF Core Principle 6, establish
requirements both for contracts that are, and are not, subject to
federal limits. 7 U.S.C. 7(d)(5) and 7 U.S.C. 7b-3(f)(6).
\295\ Significant changes proposed herein include the process
set forth in proposed Sec. 150.9 and revisions to the bona fide
hedging definition proposed in Sec. 150.1.
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2. Implementation of Exchange-Set Limits on Swaps
With respect to the DCM Core Principle 5 and SEF Core Principle 6
requirements addressing exchange-set limits on swaps, the Commission is
preliminarily determining that it is reasonable to delay implementation
because requiring compliance would be impracticable, and in some cases
impossible, at this time.\296\
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\296\ The Commission has observed in prior releases that courts
have upheld relieving regulated entities of their statutory
obligations where compliance is impossible or impracticable. 2016
Supplemental Proposal, 81 FR at 38462.
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The Commission has previously explained why it has proposed to
temporarily delay imposition of exchange-set position limits on
swaps.\297\ The decision to delay imposing exchange-set position limits
on swaps is based largely on the lack of exchange access to sufficient
data regarding individual market participants' open swap positions,
which means that, without action to provide further access to swap data
to exchanges, the exchanges cannot effectively monitor swap position
limits.
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\297\ 2016 Supplemental Proposal, 81 FR at 38459-62; 2016
Reproposal, 81 FR at 96784-86.
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The Commission preliminarily believes that delayed implementation
of exchange-set speculative position limits on swaps at this time is
not inconsistent with the statutory objectives outlined in section
4a(a)(3) of the CEA: To diminish excessive speculation, to deter market
manipulation, to ensure sufficient liquidity for bona fide hedgers, and
to ensure that the price discovery function of the underlying market it
not disrupted.\298\
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\298\ 7 U.S.C. 6a(a)(3).
---------------------------------------------------------------------------
Accordingly, while proposed Sec. 150.5 will apply to DCMs and
SEFs, the requirements associated with swaps would be enforced at a
later time. In other words, exchanges must comply with proposed Sec.
150.5 only with respect to futures and options on futures traded on
DCMs, and with respect to swaps at a later time as determined by the
Commission.
3. Existing Sec. 150.5
As noted above, existing Sec. 150.5 pre-dates the Dodd-Frank Act
and addresses the establishment of DCM-set position limits for all
contracts not subject to federal limits under existing Sec. 150.2
(aside from certain major foreign currencies).\299\ Existing Sec.
150.5(a) authorizes DCMs to set different limits for different
contracts and contract months, and permits DCMs to grant exemptions
from DCM-set limits for spreads, straddles, or arbitrage trades.
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\299\ Existing Sec. 150.5(a) states that the requirement to set
position limits shall not apply to futures or option contract
markets on major foreign currencies, for which there is no legal
impediment to delivery and for which there exists a highly liquid
cash market. 17 CFR 150.5(a).
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Existing Sec. 150.5(b) provides a limited set of methodologies for
DCMs to use in establishing initial limit levels, including separate
maximum limit levels for spot month limits in physical-delivery
contracts, spot month limits in cash-settled contracts, non-spot month
limits for tangible commodities other than energy, and non-spot month
limits for energy products and non-tangible commodities, including
financials.\300\ Existing Sec. 150.5(c) provides that DCMs may adjust
their speculative initial levels as follows: (i) No greater than 25
percent of deliverable supply for adjusted spot month levels in
physically-delivered contracts; (ii) ``no greater than necessary to
minimize the potential for manipulation or distortion of the contract's
or the underlying commodity's price'' for adjusted spot month levels in
cash-settled contracts; and (iii) for adjusted non-spot month limit
levels, either no greater than 10 percent of open interest, up to
25,000 contracts, with a marginal increase of 2.5 percent thereafter,
or based on position sizes customarily held by speculative traders on
the DCM.
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\300\ See 17 CFR 150.5(b)(1)-(3) (no greater than one-quarter of
the estimated spot month deliverable supply for physical delivery
contracts during the spot month; no greater than necessary to
minimize the potential for manipulation or distortion of the
contract's or the underlying commodity's price for cash-settled
contracts during the spot month; no greater than 1,000 contracts for
tangible commodities other than energy outside the spot month; and
no greater than 5,000 contracts for energy products and nontangible
commodities, including financials outside the spot month).
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Existing Sec. 150.5(d) addresses bona fide hedging exemptions from
DCM-set limits, including an exemption application process, providing
that exchange-set speculative position limits shall not apply to bona
fide hedging positions as defined by a DCM in accordance with the
definition of bona fide hedging transactions and positions for excluded
commodities in Sec. 1.3. Existing Sec. 150.5(d) also addresses
factors for consideration by DCMs in recognizing bona fide hedging
exemptions (or position accountability), including whether such
positions ``are not in accord with sound commercial practices or exceed
an amount which may be established and liquidated in an orderly
fashion.'' \301\
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\301\ See 17 CFR 150.5(d)(1).
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Existing Sec. 150.5(e) permits DCMs in certain circumstances to
submit for Commission approval, as a substitute for the position limits
required under Sec. 150.5(a), (b), and (c), a DCM rule requiring
traders ``to be accountable for large positions,'' meaning that under
certain circumstances, traders must provide information about their
position upon request to the exchange, and/or consent to halt
increasing further a position if so ordered by the exchange.\302\ Among
other things, this provision includes open interest and volume-based
parameters for determining when DCMs may do so.\303\
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\302\ 17 CFR 150.5(e).
\303\ 17 CFR 150.5(e)(1)-(4).
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Existing Sec. 150.5(f) provides that DCM speculative position
limits adopted pursuant to Sec. 150.5 shall not apply to certain
positions acquired in good faith prior to the effective date of such
limits or to a person that is registered as an FCM or as a floor broker
under authority of the CEA except to the extent that transactions made
by such person are made on behalf of or for the account or benefit of
such person.\304\ This provision also provides that in addition to the
express exemptions specified in Sec. 150.5, a DCM may propose such
other exemptions from the requirements of Sec. 150.5 as are consistent
with the purposes of Sec. 150.5, and provides procedures for doing
so.\305\ Finally, existing Sec. 150.5(g) addresses aggregation of
positions for which a person directly or indirectly controls trading.
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\304\ 17 CFR 150.5(f).
\305\ Id.
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4. Proposed Sec. 150.5
Pursuant to CEA sections 5(d)(1) and 5h(f)(1), the Commission
proposes a new version of Sec. 150.5.\306\ Proposed Sec. 150.5 is
intended to provide the ability for DCMs and SEFs to set limit levels
[[Page 11644]]
and grant exemptions in a manner that best accommodates activity
particular to their markets, while promoting compliance with DCM Core
Principle 5 and SEF Core Principle 6 and ensuring consistency with
other changes proposed herein, including the process for exchanges to
administer applications for non-enumerated bona fide hedge exemptions
for purposes of federal limits proposed in Sec. 150.9.\307\
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\306\ As mentioned above, while proposed Sec. 150.5 will
include references to swaps and SEFs, the proposed rule would
initially only apply to DCMs, as requirements relating to exchange-
set limits on swaps would be phased in at a later time.
\307\ To avoid confusion created by the parallel federal and
exchange-set position limit frameworks, the Commission clarifies
that proposed Sec. 150.5 deals solely with exchange-set position
limits and exemptions therefrom, whereas proposed Sec. 150.9 deals
solely with federal limits and recognition of exchange-granted
exemptions and bona fide hedging determinations for purposes of
federal limits.
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Proposed Sec. 150.5 contains two main sub-sections, with each sub-
section addressing a different category of contract: (i) Proposed Sec.
150.5(a) would include rules governing exchange-set limits for
contracts subject to federal limits; and (ii) proposed Sec. 150.5(b)
would include rules governing exchange-set limits for physical
commodity contracts that are not subject to federal limits.
As described in further detail below, the proposed provisions
addressing exchange-set limits on contracts that are not subject to
federal limits reflect a principles-based approach and include
acceptable practices that provide for non-exclusive methods of
compliance with the principles-based regulations. The Commission would
therefore provide exchanges with the ability to set limits and grant
exemptions in the manner that most suits their unique markets. Each
proposed provision of Sec. 150.5 is described in detail below.
a. Proposed Sec. 150.5(a)--Requirements for Exchange-Set Limits on
Commodity Derivative Contracts Subject to Federal Limits Set Forth in
Sec. 150.2
Proposed Sec. 150.5(a) would apply to all contracts subject to the
federal limits proposed in Sec. 150.2 and, among other things, is
intended to help ensure that exchange-set limits do not undermine the
federal limits framework. Under proposed Sec. 150.5(a)(1), for any
contract subject to a federal limit, DCMs and, ultimately, SEFs, would
be required to establish exchange-set limits for such contracts.
Consistent with DCM Core Principle 5 and SEF Core Principle 6, the
exchange-set limit levels on such contracts, whether cash-settled or
physically-settled, and whether during or outside the spot month, would
have to be no higher than the level specified for the applicable
referenced contract in proposed Sec. 150.2. Exchanges would be free to
set position limits that are more stringent than the federal limit for
a particular contract, and would also be permitted to adopt position
accountability at a level lower than the federal limit, in addition to
an exchange-set position limit that is equal to or less than the
federal limit.
Proposed Sec. 150.5(a)(2) would permit exchanges to grant
exemptions from exchange-set limits established under proposed Sec.
150.5(a)(1) as follows:
First, if such exemptions from exchange-set limits conform to the
types of exemptions that may be granted for purposes of federal limits
under proposed Sec. Sec. 150.3(a)(1)(i), 150.3(a)(2)(i), and
150.3(a)(4)-(5) (enumerated bona fide hedge recognitions and spread
exemptions that are listed in the spread transaction definition in
proposed Sec. 150.1, as well as exempt conditional spot month
positions in natural gas and pre-enactment and transition period
swaps), then the level of the exemption may exceed the applicable
federal position limit under proposed Sec. 150.2. Since the proposed
exemptions listed above are self-effectuating for purposes of federal
position limit levels, exchanges may grant such exemptions pursuant to
proposed Sec. 150.5(a)(2)(i).
Second, if such exemptions from exchange-set limits conform to the
exemptions from federal limits that may be granted under proposed
Sec. Sec. 150.3(a)(1)(ii) and 150.3(a)(2)(ii) (respectively, non-
enumerated bona fide hedges and spread transactions that are not
currently listed in the spread transaction definition in proposed Sec.
150.1), then the level of the exemption may exceed the applicable
federal position limit under proposed Sec. 150.2, provided that the
exemption for purposes of federal limits is first approved in
accordance with proposed Sec. 150.3(b) or Sec. 150.9, as applicable.
Third, if such exemptions conform to the exemptions from federal
limits that may be granted under proposed Sec. 150.3(a)(3) (financial
distress positions), then the level of the exemption may exceed the
applicable federal position limit under proposed Sec. 150.2, provided
that the Commission has first issued a letter approving such exemption
pursuant to a request submitted under Sec. 140.99.\308\
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\308\ Under the proposal, requests for exemptions for financial
distress positions would be submitted directly to the Commission (or
delegated staff) for consideration, and any approval of such
exemption would be issued in the form of an exemption letter from
the Commission (or delegated staff) pursuant to Sec. 140.99.
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Finally, for purposes of exchange-set limits only, exchanges may
grant exemption types that are not listed in Sec. 150.3(a). However,
in such cases, the exemption level would have to be capped at the level
of the applicable federal position limit, so as not to undermine the
federal limit framework, unless the Commission has first approved such
exemption for purposes of federal limits pursuant to Sec. 150.3(b).
Exchanges that wish to offer exemptions from their own limits other
than the types listed in proposed Sec. 150.3(a) could also submit
rules to the Commission allowing for such exemptions pursuant to part
40. The Commission would carefully review any such exemption types for
compliance with applicable standards, including any statutory
requirements \309\ and Commission-set standards.\310\
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\309\ For example, an exchange would not be permitted to adopt
rules allowing for risk management exemptions in physical
commodities because the Commission interprets Dodd-Frank amendments
to CEA section 4a(c)(2) as prohibiting risk management exemptions in
such commodities. See supra Section II.A.1.c.ii.(1). (discussion of
the temporary substitute test and risk-management exemptions).
\310\ For example, as discussed below, proposed Sec.
150.5(a)(2)(ii)(C) would require that exchanges take into account
whether the requested exemption would result in positions that are
not in accord with sound commercial practices in the relevant
commodity derivative market and/or would not exceed an amount that
may be established and liquidated in an orderly fashion in that
market.
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Under proposed Sec. 150.5(a)(2)(ii)(A), exchanges that wish to
grant exemptions from their own limits would have to require traders to
file an application. Aside from the requirements discussed below,
including the requirement that the exchange collect cash-market and
swaps market information from the applicant, exchanges would have
flexibility to establish the application process as they see fit,
including adopting protocols to reduce burdens by leveraging existing
processes with which their participants are already familiar. For all
exemption types, exchanges would have to generally require that such
applications be filed in advance of the date such position would be in
excess of the limits, but exchanges would be given the discretion to
adopt rules allowing traders to file applications within five business
days after a trader established such position. Exchanges wishing to
grant such retroactive exemptions would have to require market
participants to demonstrate circumstances warranting a sudden and
unforeseen hedging need.
Proposed Sec. 150.5(a)(2)(ii)(B) would provide that exchanges must
require that a trader reapply for the exemption granted under proposed
Sec. 150.5(a)(2) at least annually so that the exchange and the
Commission can closely monitor exemptions for contracts subject to
[[Page 11645]]
federal speculative position limits, and to help ensure that the
exchange and the Commission remain aware of the trader's activities.
Proposed Sec. 150.5(a)(2)(ii)(C) would authorize exchanges to deny,
limit, condition, or revoke any exemption request in accordance with
exchange rules,\311\ and would set forth a principles-based standard
for the granting of exemptions that do not conform to the type that the
Commission may grant under proposed Sec. 150.3(a). Specifically,
exchanges would be required to take into account: (i) Whether the
requested exemption from its limits would result in a position that is
``not in accord with sound commercial practices'' in the market in
which the DCM is granting the exemption; and (ii) whether the requested
exemption would result in a position that would ``exceed an amount that
may be established or liquidated in an orderly fashion in that
market.'' Exchanges' evaluation of exemption requests against these
standards would be a facts and circumstances determination.
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\311\ Currently, DCMs review and set exemption levels annually
based on the facts and circumstances of a particular exemption and
the market conditions at that time. As such, a DCM may decide to
deny, limit, condition, or revoke a particular exemption, typically,
if the DCM determines that certain conditions have changed and
warrant such action. This may happen if, for example, there are
droughts, floods, embargoes, trade disputes, or other events that
cause shocks to the supply or demand of a particular commodity and
thus impact the DCM's disposition of a particular exemption.
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Activity may reflect ``sound commercial practice'' for a particular
market or market participant but not for another. Similarly, activity
may reflect ``sound commercial practice'' outside the spot month but
not in the spot month. Further, activity with manipulative intent or
effect, or that has the potential or effect of causing price distortion
or disruption, would be inconsistent with ``sound commercial
practice,'' even if common practice among market participants. While an
exemption granted to an individual market participant may reflect
``sound commercial practice'' and may not ``exceed an amount that may
be established or liquidated in an orderly fashion in that market,''
the Commission expects exchanges to also evaluate whether the granting
of a particular exemption type to multiple participants could have a
collective impact on the market in a manner inconsistent with ``sound
commercial practice'' or in a manner that could result in a position
that would ``exceed an amount that may be established or liquidated in
an orderly fashion in that market.''
The Commission understands that the above-described parameters for
exemptions from exchange-set limits are generally consistent with
current industry practice among DCMs. Bearing in mind that proposed
Sec. 150.5(a) would apply to contracts subject to federal limits, the
Commission proposes codifying such parameters, as they would establish
important, minimum standards needed for exchanges to administer, and
the Commission to oversee, a robust program for granting exemptions
from exchange-set limits in a manner that does not undermine the
federal limits framework. Proposed Sec. 150.5(a) also would afford
exchanges the ability to generally oversee their programs for granting
exemptions from exchange limits as they see fit, including to establish
different application processes and requirements to accommodate the
unique characteristics of different contracts.
If adopted, changes proposed herein may result in certain ``pre-
existing positions'' being subject to speculative position limits even
though the position predated the adoption of such limits.\312\ So as
not to undermine the federal position limits framework during the spot
month, and to minimize disruption outside the spot month, the
Commission proposes Sec. 150.5(a)(3), which would require that during
the spot month, for contracts subject to federal limits, exchanges must
impose limits no larger than federal levels on ``pre-existing
positions,'' other than for pre-enactment swaps and transition period
swaps.
However, outside the spot month, exchanges would not be required to
impose limits on such positions, provided the position is acquired in
good faith consistent with the ``pre-existing position'' definition of
proposed Sec. 150.1, and provided further that if the person's
position is increased after the effective date of the limit, such pre-
existing position, other than pre-enactment swaps and transition period
swaps, along with the position increased after the effective date,
would be attributed to the person. This provision is consistent with
the proposed treatment of pre-existing positions for purposes of
federal limits set forth in proposed Sec. 150.2(g) and is intended to
prevent spot month limits from being rendered ineffective.
Not subjecting pre-existing positions to spot month limits could
result in a large, pre-existing position either intentionally or
unintentionally causing a disruption as it is rolled into the spot
month, and the Commission is particularly concerned about protecting
the spot month in physical-delivery futures from corners and squeezes.
Outside of the spot month, however, concerns over corners and squeezes
may be less acute.\313\
Finally, the Commission seeks a balance between having sufficient
information to oversee the exchange-granted exemptions, and not
burdening exchanges with excessive periodic reporting requirements. The
Commission thus proposes under Sec. 150.5(a)(4) to require one monthly
report by each exchange. Certain exchanges already voluntarily file
these types of monthly reports with the Commission, and proposed Sec.
150.5(a)(4) would standardize such reports for all exchanges that
process applications for bona fide hedges, spread exemptions, and other
exemptions for contracts that are subject to federal limits. The
proposed report would provide information regarding the disposition of
any application to recognize a position as a bona fide hedge (both
enumerated and non-enumerated) or to grant a spread or other exemption,
including any renewal, revocation of, or modification to the terms and
conditions of, a prior recognition or exemption.\314\
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\314\ In the monthly report, exchanges may elect to list new
recognitions or exemptions, and modifications to or revocations of
prior recognitions and exemptions each month; alternatively,
exchanges may submit cumulative monthly reports listing all active
recognitions and exemptions (i.e., including exemptions that are not
new or have not changed).
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As specified under proposed Sec. 150.5(a)(4), the report would
provide certain details regarding the bona fide hedging position or
spread exemption, including: The effective date and expiration date of
any recognition or exemption; any unique identifier assigned to track
the application or position; identifying information about the
applicant; the derivative contract or positions to which the
application pertains; the maximum size of the commodity derivative
position that is recognized or exempted by the exchange (including any
``walk-down'' requirements); \315\ any size limitations the exchange
sets for the position; and a brief narrative summarizing the
applicant's relevant cash market activity.
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\315\ An exchange could determine to recognize as a bona fide
hedge or spread exemption all, or a portion, of the commodity
derivative position for which an application has been submitted,
provided that such determination is made in accordance with the
requirements of proposed Sec. 150.5 and is consistent with the Act
and the Commission's regulations. In addition, an exchange could
require that a bona fide hedging positon or spread position be
subject to ``walk-down'' provisions that require the trader to scale
down its positions in the spot month in order to reduce market
congestion as needed based on the facts and circumstances.
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[[Page 11646]]
With respect to any unique identifiers to be included in the
proposed monthly report, the exchange's assignment of a unique
identifier would assist the Commission's tracking process. The unique
identifier could apply to each of the bona fide hedge or spread
exemption applications that the exchange receives, and, separately,
each type of commodity derivative position that the exchange wishes to
recognize as a bona fide hedge or spread exemption. Accordingly, the
Commission suggests that, as a ``best practice,'' the exchange's
procedures for processing bona fide hedging position and spread
exemption applications contemplate the assignment of such unique
identifiers.
The proposed report would also be required to specify the maximum
size and/or size limitations by contract month and/or type of limit
(e.g., spot month, single month, or all-months-combined), as
applicable.
The proposed monthly report would be a critical element of the
Commission's surveillance program by facilitating its ability to track
bona fide hedging positions and spread exemptions approved by
exchanges. The proposed monthly report would also keep the Commission
informed as to the manner in which an exchange is administering its
application procedures, the exchange's rationale for permitting large
positions, and relevant cash market activity. The Commission expects
that exchanges would be able to leverage their current exemption
processes and recordkeeping procedures to generate such reports.
In certain instances, information included in the proposed monthly
report may prompt the Commission to request records required to be
maintained by an exchange. For example, the Commission proposes that,
for each derivative position that an exchange wishes to recognize as a
bona fide hedge, or any revocation or modification of such recognition
or exemption, the report would include a concise summary of the
applicant's activity in the cash markets and swaps markets for the
commodity underlying the position. The Commission expects that this
summary would focus on the facts and circumstances upon which an
exchange based its determination to recognize a bona fide hedge, to
grant a spread exemption, or to revoke or modify such recognition or
exemption. In light of the information provided in the summary, or any
other information included in the proposed monthly report regarding the
position, the Commission may request the exchange's complete record of
the application. The Commission expects that it would only need to
request such complete records in the event that it noticed an issue
that could cause market disruptions.
Proposed Sec. 150.5(a)(4) would require an exchange, unless
instructed otherwise by the Commission, to submit such monthly reports
according to the form and manner requirements the Commission specifies.
In order to facilitate the processing of such reports, and the analysis
of the information contained therein, the Commission would establish
reporting and transmission standards. The proposal would also require
that such reports be submitted to the Commission using an electronic
data format, coding structure, and electronic data transmission
procedures approved in writing by the Commission, as specified on its
website.\316\
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\316\ The Commission would provide such form and manner
instructions on the Forms and Submissions page at www.cftc.gov. Such
instructions would likely be published in the form of a technical
guidebook.
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.5(a). The Commission also invites comments on the following:
(34) The Commission has proposed that exchanges submit monthly
reports under Sec. 150.5(a)(4). Do exchanges prefer that the
Commission specify a particular day each month as a deadline for
submitting such monthly reports or do exchanges prefer to have
discretion in determining which day to submit such reports?
b. Proposed Sec. 150.5(b)--Requirements and Acceptable Practices for
Exchange-Set Limits on Commodity Derivative Contracts in a Physical
Commodity That Are Not Subject to the Limits Set Forth in Sec. 150.2
As described elsewhere in this release, the Commission is proposing
federal speculative limits on 25 core referenced futures contracts and
their respective referenced contracts.\317\ DCMs, and, ultimately,
SEFs, listing physical commodity contracts for which federal limits do
not apply would have to comply with proposed Sec. 150.5(b), which
includes a combination of rules and references to acceptable practices.
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\317\ See infra Section III.F.
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Under proposed Sec. 150.5(b), for physical commodity derivatives
that are not subject to federal limits, whether cash-settled or
physically-settled, exchanges would be subject to flexible standards
during the product's spot month and non-spot month. During the spot
month, under proposed Sec. 150.5(b)(1)(i), exchanges would be required
to establish position limits, and such limits would have to be set at a
level that is no greater than 25 percent of deliverable supply. As
described in detail in connection with the proposed federal spot month
limits described above, it would be difficult, in the absence of other
factors, for a participant to corner or squeeze a market if the
participant holds less than or equal to 25 percent of deliverable
supply, and the Commission has long used deliverable supply as the
basis for spot month position limits due to concerns regarding corners,
squeezes, and other settlement-period manipulative activity.\318\
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\318\ See supra Section II.B.2. (discussion of proposed Sec.
150.2).
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The Commission recognizes, however, that there may be circumstances
where an exchange may not wish to use the 25 percent formula,
including, for example, if the contract is cash-settled, does not have
a measurable deliverable supply, or if the exchange can demonstrate
that a different parameter is better suited for a particular contract
or market.\319\ Accordingly, the proposal would afford exchanges the
ability to submit to the Commission alternative potential methodologies
for calculating spot month limit levels required by proposed Sec.
150.5(b)(1), provided that the limits are set at a level that is
``necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract's or the underlying
commodity's price or index.'' This standard has appeared in existing
Sec. 150.5 since its adoption in connection with spot month limits on
cash-settled contracts. As noted above, existing Sec. 150.5 includes
separate parameters for spot month limits in physical-delivery
contracts and for cash-settled contracts, but does not include
flexibility for exchanges to consider alternative parameters. In an
effort to both simplify the regulation and provide the ability for
exchanges to consider multiple parameters that may be better suited for
certain products, the Commission proposes the above standard as a
principles-based requirement for both cash-settled and physically-
settled contracts subject to proposed Sec. 150.5(b).
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\319\ Guidance for calculating deliverable supply can be found
in Appendix C to part 38. 17 CFR part 38, Appendix C.
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Outside of the spot month, where, historically, attempts at certain
types of market manipulation are generally less of a concern, proposed
Sec. 150.5(b)(2)(i) would allow exchanges to choose between position
limits or position accountability for physical commodity
[[Page 11647]]
contracts that are not subject to federal limits. While exchanges would
be provided the ability to decide whether to use limit levels or
accountability levels for any such contract, under either approach, the
exchange would have to set a level that is ``necessary and appropriate
to reduce the potential threat of market manipulation or price
distortion of the contract's or the underlying commodity's price or
index.''
To help exchanges efficiently demonstrate compliance with this
standard for physical commodity contracts outside of the spot month,
the Commission proposes separate acceptable practices for exchanges
that wish to adopt non-spot month position limits and exchanges that
wish to adopt non-spot month accountability.\320\ For exchanges that
choose to adopt non-spot month position limits, rather than position
accountability, proposed paragraph (a)(1) to Appendix F of part 150
would set forth non-exclusive acceptable practices. Under that
provision, exchanges would be deemed in compliance with proposed Sec.
150.5(b)(2)(i) if they set non-spot limit levels for each contract
subject to Sec. 150.5(b) at a level no greater than: (1) The average
of historical position sizes held by speculative traders in the
contract as a percentage of the contract's open interest; \321\ (2) the
spot month limit level for the contract; (3) 5,000 contracts (scaled up
proportionally to the ratio of the notional quantity per contract to
the typical cash market transaction if the notional quantity per
contract is smaller than the typical cash market transaction, or scaled
down proportionally if the notional quantity per contract is larger
than the typical cash market transaction); \322\ or (4) 10 percent of
open interest in that contract for the most recent calendar year up to
50,000 contracts, with a marginal increase of 2.5 percent of open
interest thereafter.\323\ When evaluating average position sizes held
by speculative traders, the Commission expects exchanges: (i) To be
cognizant of speculative positions that are extraordinarily large
relative to other speculative positions, and (ii) to not consider any
such outliers in their calculations.
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\320\ The acceptable practices proposed in Appendix F to part
150 herein reflect non-exclusive methods of compliance. Accordingly,
the language of this proposed acceptable practice, along with the
other acceptable practices proposed herein, uses the word ``shall''
not to indicate that the acceptable practice is a required method of
compliance, but rather to indicate that in order to satisfy the
acceptable practice, a market participant must (i.e., shall)
establish compliance with that particular acceptable practice.
\321\ For example, if speculative traders in a particular
contract typically make up 12 percent of open interest in that
contract, the exchange could set limit levels no greater than 12
percent of open interest.
\322\ For exchanges that choose to adopt a non-spot month limit
level of 5,000 contracts, this level assumes that the notional
quantity per contract is set at a level that reflects the size of a
typical cash market transaction in the underlying commodity.
However, if the notional quantity of the contract is larger/smaller
than the typical cash market transaction in the underlying
commodity, then the DCM must reduce/increase the 5,000 contract non-
spot month limit until it is proportional to the notional quantity
of the contract relative to the typical cash market transaction.
These required adjustments to the 5,000 contract metric are intended
to avoid a circumstance where an exchange could allow excessive
speculation by setting excessively large notional quantities
relative to typical cash-market transaction sizes. For example, if
the notional quantity per contract is set at 30,000 units, and the
typical observed cash market transaction is 2,500 units, the
notional quantity per contract would be 12 times larger than the
typical cash market transaction. In that case, the non-spot month
limit would need to be 12 times smaller than 5,000 (i.e., at 417
contracts.). Similarly, if the notional quantity per contract is
1,000 contracts, and the typical observed cash market transaction is
2,500 units, the notional quantity per contract would be 2.5 times
smaller than the typical cash market transaction. In that case, the
non-spot month limit would need to be 2.5 times larger than 5,000,
and would need to be set at 12,500 contracts.
\323\ In connection with the proposed Appendix F to part 150
acceptable practices, open interest should be calculated by
averaging the month-end open positions in a futures contract and its
related option contract, on a delta-adjusted basis, for all months
listed during the most recent calendar year.
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These proposed parameters have largely appeared in existing Sec.
150.5 for many years in connection with non-spot month limits, either
for initial or subsequent levels.\324\ The Commission is of the view
that these parameters would be useful, flexible standards to carry
forward as acceptable practices. For example, the Commission expects
that the 5,000-contract acceptable practice would be a useful benchmark
for exchanges because it would allow them to establish limits and
demonstrate compliance with Commission regulations in a relatively
efficient manner, particularly for new contracts that have yet to
establish open interest. Similarly, for purposes of exchange-set limits
on physical commodity contracts that are not subject to federal limits,
the Commission proposes to maintain the baseline 10, 2.5 percent
formula as an acceptable practice. Because these parameters are simply
acceptable practices, exchanges may, after evaluation, propose higher
non-spot month limits or accountability levels.
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\324\ 17 CFR 150.5(b) and (c). Proposed Sec. 150.5(b) would
address physical commodity contracts that are not subject to federal
limits.
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Along those lines, the Commission recognizes that other parameters
may be preferable and/or just as effective, and would be open to
considering alternative parameters submitted pursuant to part 40 of the
Commission's regulations, provided, at a minimum, that the parameter
complies with Sec. 150.5(b)(2)(i). The Commission encourages exchanges
to submit potential new parameters to Commission staff in draft form
prior to submitting them under part 40.
For exchanges that choose to adopt position accountability, rather
than limits, outside of the spot month, proposed paragraph (a)(2) of
Appendix F to part 150 would set forth a non-exclusive acceptable
practice that would permit exchanges to comply with proposed Sec.
150.5(b)(2)(i) by adopting rules establishing ``position
accountability'' as defined in proposed Sec. 150.1. ``Position
accountability'' would mean rules, submitted to the Commission pursuant
to part 40, that require traders to, upon request by the exchange,
consent to: (i) Provide information to the exchange about their
position, including, but not limited to, information about the nature
of the their positions, trading strategies, and hedging information;
and (ii) halt further increases to their position or to reduce their
position in an orderly manner.\325\
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\325\ While existing Sec. 150.5(e) includes open-interest and
volume-based limitations on the use of accountability, the
Commission opts not to include such limitations in this proposal.
Under the rules proposed herein, if an exchange submitted a part 40
filing seeking to adopt position accountability, the Commission
would determine on a case-by-case basis whether such rules are
consistent with the Act and the Commission's regulations. The
Commission does not want to use one-size-fits-all volume-based
limitations for making such determinations.
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Proposed Sec. 150.5(b)(3) addresses a circumstance where multiple
exchanges list contracts that are substantially the same, including
physically-settled contracts that have the same underlying commodity
and delivery location, or cash-settled contracts that are directly or
indirectly linked to a physically-settled contract. Under proposed
Sec. 150.5(b)(3), exchanges listing contracts that are substantially
the same in this manner must either adopt ``comparable'' limits for
such contracts, or demonstrate to the Commission how the non-comparable
levels comply with the standards set forth in proposed Sec.
150.5(b)(1) and (2). Such a determination also must address how the
levels are necessary and appropriate to reduce the potential threat of
market manipulation or price distortion of the contract's or the
underlying commodity's price or index. Proposed Sec. 150.5(b)(3) would
apply equally to cash-settled and physically-settled contracts, and to
limits during and outside of the spot month, as
[[Page 11648]]
applicable.\326\ Proposed Sec. 150.5(b)(3) is intended to help ensure
that position limits established on one exchange would not jeopardize
market integrity or otherwise harm other markets. Further, proposed
Sec. 150.5(b)(3) would be consistent with the Commission's proposal to
generally apply equivalent federal limits to linked contracts,
including linked contracts listed on multiple exchanges.\327\
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\326\ For reasons discussed elsewhere in this release, this
provision would not apply to natural gas contracts. See supra
Section II.C.2.e. (discussion of proposed conditional spot month
exemption in natural gas).
\327\ See supra Section II.A.16. (discussion of the proposed
referenced contract definition and linked contracts).
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Finally, under proposed Sec. 150.5(b)(4), exchanges would be
permitted to grant exemptions from any limits established under
proposed Sec. 150.5(b). As noted, proposed Sec. 150.5(b) would apply
to physical commodity contracts not subject to federal limits; thus,
exchanges would be given flexibility to grant exemptions in such
contracts, including exemptions for both intramarket and intermarket
spread positions,\328\ as well as other exemption types not explicitly
listed in proposed Sec. 150.3.\329\ However, such exchanges must
require that traders apply for the exemption. In considering any such
application, the exchanges would be required to take into account
whether the exemption would result in a position that would not be in
accord with ``sound commercial practices'' in the market for which the
exchange is considering the application, and/or would ``exceed an
amount that may be established and liquidated in an orderly fashion in
that market.''
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\328\ The Commission understands an intramarket spread position
to be a long position in one or more commodity derivative contracts
in a particular commodity, or its products or its by-products, and a
short position in one or more commodity derivative contracts in the
same, or similar, commodity, or its products or by-products, on the
same DCM. The Commission understands an intermarket spread position
to be a long (or short) position in one or more commodity derivative
contracts in a particular commodity, or its products or its by-
products, at a particular DCM and a short (or long) position in one
or more commodity derivative contracts in that same, or similar,
commodity, or its products or its by-products, away from that
particular DCM. For instance, the Commission would consider a spread
between CBOT Wheat (W) futures and MGEX HRS Wheat (MWE) futures to
be an intermarket spread based on the similarity of the commodities.
\329\ As noted above, proposed Sec. 150.3 would allow for
several exemption types, including: Bona fide hedging positions;
certain spreads; financial distress positions; and conditional spot
month limit exemption positions in natural gas.
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While exchanges would be subject to the requirements of Sec.
150.5(a) and (b) described above, such proposed requirements are not
intended to limit the discretion of exchanges to utilize other tools to
protect their markets. Among other things, an exchange would have the
discretion to: impose additional restrictions on a person with a long
position in the spot month of a physical-delivery contract who stands
for delivery, takes that delivery, then re-establishes a long position;
establish limits on the amount of delivery instruments that a person
may hold in a physical-delivery contract; and impose such other
restrictions as it deems necessary to reduce the potential threat of
market manipulation or congestion, to maintain orderly execution of
transactions, or for such other purposes consistent with its
responsibilities.
c. Proposed Sec. 150.5(c)--Requirements for Security Futures Products
As the Commission has previously noted, security futures products
and security options may serve economically equivalent or similar
functions to one another.\330\ Therefore, when the Commission
originally adopted position limits regulations for security futures
products in part 41, it set levels that were generally comparable to,
although not identical with, the limits that applied to options on
individual securities.\331\ The Commission has pointed out that
security futures products may be at a competitive disadvantage if
position limits for security futures products vary too much from those
of security options.\332\ As a result, the Commission in 2019 adopted
amendments to the position limitations and accountability requirements
for security futures products, noting that one goal was to provide a
level regulatory playing field with security options.\333\ Proposed
Sec. 150.5(c), therefore, would include a cross-reference clarifying
that for security futures products, position limitations and
accountability requirements for exchanges are specified in Sec.
41.25.\334\ This would allow the Commission to take into account the
position limits regime that applies to security options when
considering position limits regulations for security futures products.
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\330\ See Position Limits and Position Accountability for
Security Futures Products, 83 FR at 36799, 36802 (July 31, 2018).
\331\ Id. See also Listing Standards and Conditions for Trading
Security Futures Products, 66 FR at 55078, 55082 (Nov. 1, 2001)
(explaining the Commission's adoption of position limits for
security futures products).
\332\ See 83 FR at 36799, 36802 (July 31, 2018).
\333\ See Position Limits and Position Accountability for
Security Futures Products, 84 FR at 51005, 51009 (Sept. 27, 2019).
\334\ See 17 CFR 41.25. Rule Sec. 41.25 establishes conditions
for the trading of security futures products.
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d. Proposed Sec. 150.5(d)--Rules on Aggregation
As noted earlier in this release, the Commission adopted in 2016
final aggregation rules under Sec. 150.4 that apply to all contracts
subject to federal limits. The Commission recognizes that with respect
to contracts not subject to federal limits, market participants may
find it burdensome if different exchanges adopt different aggregation
standards. Accordingly, under proposed Sec. 150.5(d), all DCMs, and,
ultimately, SEFs, that list any physical commodity derivatives,
regardless of whether the contract is subject to federal limits, would
be required to adopt aggregation rules for such contracts that conform
to Sec. 150.4.\335\ Exchanges that list excluded commodities would be
encouraged to also adopt aggregation rules that conform to Sec. 150.4.
Aggregation policies that otherwise 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.
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\335\ Under Sec. 150.4, unless an exemption applies, a person's
positions must be aggregated with positions for which the person
controls trading or for which the person holds a 10 percent or
greater ownership interest. Commission Regulation Sec. 150.4(b)
sets forth several permissible exemptions from aggregation. See
Final Aggregation Rulemaking, 81 FR at 91454. The Division of Market
Oversight has issued time-limited no-action relief from some of the
aggregation requirements contained in that rulemaking. See CFTC
Letter No. 19-19 (July 31, 2019), available at https://www.cftc.gov/csl/19-19/download.
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e. Proposed Sec. 150.5(e)--Requirements for Submissions to the
Commission
Proposed Sec. 150.5(e) reflects that, consistent with the
definition of ``rule'' in existing Sec. 40.1, any exchange action
establishing or modifying exchange-set position limits or exemptions
therefrom, or position accountability, in any case pursuant to proposed
Sec. 150.5(a), (b), (c), or Appendix F to part 150, would qualify as a
``rule'' and must be submitted to the Commission as such pursuant to
part 40 of the Commission's regulations. Such rules would also include,
among other things, parameters used for determining position limit
levels, and policies and related processes setting forth parameters
addressing, among other things, which types of exemptions are
permitted, the parameters for the granting of such exemptions, and any
exemption application requirements.
[[Page 11649]]
Proposed Sec. 150.5(e) further provides that exchanges would be
required to review regularly \336\ any position limit levels
established under proposed Sec. 150.5 to ensure the level continues to
comply with the requirements of those sections. For example, in the
case of Sec. 150.5(b), exchanges would be expected to ensure the
limits comply with the requirement that limits be set ``at a level that
is necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract's or the underlying
commodity's price or index.'' Exchanges would also be required to
update such levels as needed, including if the levels no longer comply
with the proposed rules.
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\336\ An acceptable, regular review regime would consist of both
a periodic review and an event-specific review (e.g., in the event
of supply and demand shocks such as unanticipated shocks to supply
and demand of the underlying commodity, geo-political shocks, and
other events that may result in congestion and/or other
disruptions). The Commission also expects that exchanges would re-
evaluate such levels in the event of unanticipated shocks to the
supply or demand of the underlying commodity.
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f. Delegation of Authority to the Director of the Division of Market
Oversight
The Commission proposes to delegate its authority, pursuant to
proposed Sec. 150.5(a)(4)(ii), to the Director of the Commission's
Division of Market Oversight, or such other employee(s) that the
Director may designate from time to time, to provide instructions
regarding the submission of information required to be reported by
exchanges to the Commission on a monthly basis, and to determine the
manner, format, coding structure, and electronic data transmission
procedures for submitting such information.
g. Commission Enforcement of Exchange-Set Limits
As discussed throughout this release, the framework for exchange-
set limits operates in conjunction with the federal position limits
framework. The Futures Trading Act of 1982 gave the Commission, under
CEA section 4a(5) (since re-designated as section 4a(e)), the authority
to directly enforce violations of exchange-set, Commission-approved
speculative position limits in addition to position limits established
directly by the Commission.\337\ Since 2008, it has also been a
violation of the Act for any person to violate an exchange position
limit rule certified to the Commission by such exchange pursuant to CEA
section 5c(c)(1).\338\ Thus, under CEA section 4a(e), it is a violation
of the Act for any person to violate an exchange position limit rule
certified to or approved by the Commission, including to violate any
subsequent amendments thereto, and the Commission has the authority to
enforce those violations.
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\337\ See Futures Trading Act of 1982, Public Law 97-444, 96
Stat. 2299-30 (1983).
\338\ See CFTC Reauthorization Act of 2008, Food, Conservation
and Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18,
2008) (also known as the ``Farm Bill'') (amending CEA section 4a(e),
among other things, to assure that a violation of position limits,
regardless of whether such position limits have been approved by or
certified to the Commission, would constitute a violation of the Act
that the Commission could independently enforce). See also Federal
Speculative Position Limits for Referenced Energy Contracts and
Associated Regulations, 75 FR at 4144, 4145 (Jan. 26, 2010)
(summarizing the history of the Commission's authority to directly
enforce violations of exchange-set speculative position limits).
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h. Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.5.
E. Sec. 150.6--Scope
Existing Sec. 150.6 provides that nothing in this part shall be
construed to affect any provisions of the Act relating to manipulation
or corners nor to relieve any contract market or its governing board
from responsibility under section 5(4) of the Act to prevent
manipulation and corners.\339\
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\339\ 17 CFR 150.6.
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Position limits are meant to diminish, eliminate, or prevent
excessive speculation and deter and prevent market manipulation,
squeezes, and corners. The Commission stresses that nothing in the
proposed revisions to part 150 would impact the anti-disruptive, anti-
cornering, and anti-manipulation provisions of the Act and Commission
regulations, including but not limited to CEA sections 6(c) or 9(a)(2)
regarding manipulation, section 4c(a)(5) regarding disruptive practices
including spoofing, or sections 180.1 and 180.2 of the Commission's
regulations regarding manipulative and deceptive practices. It may be
possible for a trader to manipulate or attempt to manipulate the prices
of futures contracts or the underlying commodity with a position that
is within the federal position limits. It may also be possible for a
trader holding a bona fide hedge recognition from the Commission or an
exchange to manipulate or attempt to manipulate the markets. The
Commission would not consider it a defense to a charge under the anti-
manipulation provisions of the Act or the regulations that a trader's
position was within position limits.
Like existing Sec. 150.6, proposed Sec. 150.6 is intended to make
clear that fulfillment of specific part 150 requirements alone does not
necessarily satisfy other obligations of an exchange. Proposed Sec.
150.6 would provide that part 150 of the Commission's regulations shall
only be construed as having an effect on position limits set by the
Commission or an exchange including any associated recordkeeping and
reporting requirements. Proposed Sec. 150.6 would provide further that
nothing in part 150 shall affect any other provisions of the Act or
Commission regulations including those relating to actual or attempted
manipulation, corners, squeezes, fraudulent or deceptive conduct, or to
prohibited transactions. For example, proposed Sec. 150.5 would
require DCMs, and, ultimately, SEFs, to impose and enforce exchange-set
speculative position limits. The fulfillment of the requirements of
Sec. 150.5 alone would not satisfy any other legal obligations under
the Act or Commission regulations applicable to exchanges to prevent
manipulation and corners. Likewise, a market participant's compliance
with position limits or an exemption thereto does not confer any type
of safe harbor or good faith defense to a claim that the participant
had engaged in an attempted or perfected manipulation.
Further, the proposed amendments are intended to help clarify that
Sec. 150.6 applies to: Regulations related to position limits found
outside of part 150 of the Commission's regulations (e.g., relevant
sections of part 1 and part 19); and recordkeeping and reporting
regulations associated with speculative position limits.
F. Sec. 150.8--Severability
The Commission proposes to add new Sec. 150.8 to provide for 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 would provide 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.
G. Sec. 150.9--Process for Recognizing Non-Enumerated Bona Fide
Hedging Transactions or Positions With Respect to Federal Speculative
Position Limits
1. Background and Overview
For the nine legacy agricultural contracts currently subject to
federal position limits, the Commission's current processes for
recognizing non-enumerated bona fide hedge positions and certain
enumerated anticipatory bona fide hedge positions exist in
[[Page 11650]]
parallel with exchange processes for granting exemptions from exchange-
set limits, as described below. The exchange processes for granting
exemptions vary by exchange, and generally do not mirror the
Commission's processes. Thus, when requesting certain bona fide hedging
position recognitions that are not self-effectuating, market
participants must currently comply with the exchanges' processes for
exchange-set limits and the Commission's processes for federal limits.
Although this disparity is currently only an issue for the nine
agricultural futures contracts subject to both federal and exchange-set
limits, the parallel approaches may become more inefficient and
burdensome once the Commission adopts limits on additional commodities.
Accordingly, the Commission is proposing Sec. 150.9 to establish a
separate framework, applicable to proposed referenced contracts in all
commodities, whereby a market participant who is seeking a bona fide
hedge recognition that is not enumerated in proposed Appendix A can
file one application with an exchange to receive a bona fide hedging
recognition for purposes of both exchange-set limits and for federal
limits.\340\ Given the proposal to significantly expand the list of
enumerated hedges, the Commission expects the use of the proposed Sec.
150.9 non-enumerated process described below would be rare and
exceptional. This separate framework would be independent of, and serve
as an alternative to, the Commission's process for reviewing exemption
requests under proposed Sec. 150.3. Among other things, proposed Sec.
150.9 would help to streamline the process by which non-enumerated bona
fide hedge recognition requests are addressed, minimize disruptions by
leveraging existing exchange-level processes with which many market
participants are already familiar,\341\ and reduce inefficiencies
created when market participants are required to comply with different
federal and exchange-level processes.
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\340\ Alternatively, under the proposed framework, a trader
could submit a request directly to the Commission pursuant to
proposed Sec. 150.3(b). A trader that submitted such a request
directly to the Commission for purposes of federal limits would have
to separately request an exemption from the applicable exchange for
purposes of exchange-set limits. As discussed earlier in this
release, the Commission proposes to separately allow for enumerated
hedges and spreads that meet the ``spread transaction'' definition
to be self-effectuating. See supra Section II.C.2. (discussion of
proposed Sec. 150.3).
\341\ In particular, the Commission recognizes that, in the
energy and metals spaces, market participants are familiar with
exchange application processes and are not familiar with the
Commission's processes since, currently, there are no federal
position limits for those commodities.
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For instance, currently, market participants seeking recognitions
of non-enumerated bona fide hedges for the nine legacy agricultural
commodities must request recognitions from both the Commission under
existing Sec. 1.47, and from the relevant exchange. If the recognition
is for an ``enumerated'' hedge under existing Sec. 1.3 (other than
anticipatory enumerated hedges), the market participant would not need
to file an application with the Commission (as the enumerated hedge has
a self-effectuating recognition for purposes of federal limits).
If the exemption is for a ``non-enumerated'' hedge or certain
enumerated anticipatory hedges under existing Sec. 1.3, the market
participant would need to file an application with the Commission
pursuant to Sec. Sec. 1.47 or 1.48, respectively. In either case, the
market participant would also still need to seek an exchange exemption
and file a Form 204/304 on a monthly basis with the Commission. As
discussed more fully in this section, with respect to bona fide hedges
that are not self-effectuating for purposes of federal limits, proposed
Sec. 150.9 would permit such a market participant to file a single
application with the exchange and relieve the market participant from
having to separately file an application and/or monthly cash-market
reporting information with the Commission.
The existing Commission and exchange level approaches are described
in more detail below, followed by a more detailed discussion of
proposed Sec. 150.9.
2. Existing Approaches for Recognizing Bona Fide Hedges
The Commission's authority and existing processes for recognizing
bona fide hedges can be found in section 4a(c) of the Act, and
Sec. Sec. 1.3, 1.47, and 1.48 of the Commission's regulations.\342\ In
particular, CEA section 4a(c)(1) provides that no CFTC rule issued
under CEA section 4a(a) applies to ``transactions or positions which
are shown to be bona fide hedging transactions or positions.'' \343\
Further, under the existing definition of ``bona fide hedging
transactions and positions'' in Sec. 1.3,\344\ paragraph (1) provides
the Commission's general definition of bona fide hedging transactions
or positions; paragraph (2) provides a list of enumerated bona fide
hedging positions that, generally, are self-effectuating, and must be
reported (along with supporting cash-market information) to the
Commission monthly on Form 204 after the positions are taken; \345\ and
paragraph (3) provides a procedure for market participants to seek
recognition from the Commission for non-enumerated bona fide hedging
positions. Under paragraph (3), any person that seeks Commission
recognition of a position as a non-enumerated bona fide hedge must
submit an application to the Commission in advance of taking on the
position, and pursuant to the processes found in Sec. 1.47 (30 days in
advance for non-enumerated bona fide hedges) or Sec. 1.48 (10 days in
advance for enumerated anticipatory hedges), as applicable.
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\342\ See 7 U.S.C. 6a(c) and 17 CFR 1.3, 1.47, and 1.48.
\343\ 7 U.S.C. 6a(c)(1).
\344\ As described above, the Commission proposes to move an
amended version of the bona fide hedging definition from Sec. 1.3
to Sec. 150.1. See supra Section II.A. (discussion of proposed
Sec. 150.1).
\345\ As described below, the Commission proposes to eliminate
Form 204 and to rely instead on the cash-market information
submitted to exchanges pursuant to proposed Sec. Sec. 150.5 and
150.9. See infra Section II.H.3. (discussion of proposed amendments
to part 19).
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b. Exchanges' Existing Approach for Granting Bona Fide Hedge Exemptions
\346\ With Respect to Exchange-Set Limits
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\346\ Exchange rules typically refer to ``exemptions'' in
connection with bona fide hedging and spread positions, whereas the
Commission uses the nomenclature ``recognition'' with respect to
bona fide hedges, and ``exemption'' with respect to spreads.
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Under DCM Core Principle 5,\347\ DCMs have, for some time,
established exchange-set limits for futures contracts that are subject
to federal limits, as well as for contracts that are not. In addition,
under existing Sec. 150.5(d), DCMs may grant exemptions to exchange-
set position limits for positions that meet the Commission's general
definition of bona fide hedging transactions or positions as defined in
paragraph (1) of Sec. 1.3.\348\ As such, with respect to exchange-set
limits, exchanges have adopted processes for handling trader requests
for bona fide hedging exemptions, and generally have granted such
requests pursuant to exchange rules that incorporate the Commission's
existing general definition of bona fide hedging transactions or
positions in paragraph (1) of Sec. 1.3.\349\ Accordingly, DCMs
currently have rules and application forms in place to process
applications to exempt bona fide
[[Page 11651]]
hedging positions with respect to exchange-set position limits.\350\
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\347\ 7 U.S.C. 7(d)(5).
\348\ 17 CFR 150.5(d).
\349\ See, e.g., CME Rule 559 and ICE Rule 6.29 (addressing
position limits and exemptions).
\350\ Id.
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Separately, under SEF Core Principle 6, currently SEFs are required
to adopt, as is necessary and appropriate, position limits or position
accountability levels for each swap contract to reduce the potential
threat of market manipulation or congestion.\351\ For contracts that
are subject to a federal position limit, the SEF must set its position
limits at a level that is no higher than the federal limit, and must
monitor positions established on or through the SEF for compliance with
both the Commission's federal limit and the exchange-set limit.\352\
Section 37.601 further implements SEF Core Principle 6 and specifies
that until such time that SEFs are required to comply with the
Commission's position limits regulations, a SEF may refer to the
associated guidance and/or acceptable practices set forth in Appendix B
to part 37 of the Commission's regulations.\353\ Currently, in
practice, there are no federal position limits on swaps for which SEFs
would be required to establish exchange-set limits.
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\351\ 7 U.S.C. 7b-3(f)(6). The Commission codified Core
Principle 6 under Sec. 37.600. 17 CFR 37.600.
\352\ Id.
\353\ 17 CFR 37.601. Under Appendix B to part 37, for Required
Transactions, as defined in Sec. 37.9, SEFs may demonstrate
compliance with SEF Core Principle 6 by setting and enforcing
position limits or position accountability levels only with respect
to trading on the SEF's own market. For Permitted Transactions, as
defined in Sec. 37.9, SEFs may demonstrate compliance with SEF Core
Principle 6 by setting and enforcing position accountability levels
or by sending the Commission a list of Permitted Transactions traded
on the SEF.
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As noted above, the application processes currently used by
exchanges are different than the Commission's processes. In particular,
exchanges typically use one application process to grant all exemption
types, whereas the Commission has different processes for different
exemptions, as explained below. Also, exchanges generally do not
require the submission of monthly cash-market information, whereas the
Commission has various monthly reporting requirements under Form 204
and part 17 of the Commission's regulations. Finally, exchanges
generally require exemption applications to include cash-market
information supporting positions that exceed the limits, to be filed
annually prior to exceeding a position limit, and to be updated on an
annual basis.\354\
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\354\ Id.
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The Commission, on the other hand, currently has different
processes for permitting enumerated bona fide hedges and for
recognizing positions as non-enumerated bona fide hedges. Generally,
for bona fide hedges enumerated in paragraph (2) of the bona fide hedge
definition in Sec. 1.3, no formal process is required by the
Commission. Instead, such enumerated bona fide hedge recognitions are
self-effectuating and Commission staff reviews monthly reporting of
cash-market positions on existing Form 204 and part 17 position data to
monitor such positions. Recognition requests for non-enumerated bona
fide hedging positions and for certain enumerated anticipatory bona
fide hedge positions, as explained above, must be submitted to the
Commission pursuant to the processes in existing Sec. Sec. 1.47 and
1.48 of the regulations, as applicable.
3. Proposed Sec. 150.9
Under the proposed procedural framework, an exchange's
determination to recognize a non-enumerated bona fide hedge in
accordance with proposed Sec. 150.9 with respect to exchange-set
limits would serve to inform the Commission's own decision as to
whether to recognize the exchange's determination for purposes of
federal speculative position limits set forth in proposed Sec. 150.2.
Among other conditions, the exchange would be required to base its
determination on standards that conform to the Commission's own
standards for recognizing bona fide hedges for purposes of federal
position limits. Further, the exchange's determination with respect to
its own position limits and application process would be subject to
Commission review and oversight. These requirements would facilitate
Commission review and determinations by ensuring that any bona fide
hedge recognized by an exchange for purposes of exchange-set limits and
in accordance with proposed Sec. 150.9 conforms to the Commission's
standards.
For a given referenced contract, proposed Sec. 150.9 would
potentially allow a person to exceed federal position limits if the
exchange listing the contract has recognized the position as a bona
fide hedge with respect to exchange-set limits. Under this framework,
the exchange would make such determination with respect to its own
speculative position limits, set in accordance with proposed Sec.
150.5(a), and, unless the Commission denies or stays the application
within ten business days (or two business days for applications,
including retroactive applications, filed due to sudden or unforeseen
circumstances), the exemption would be deemed approved for purposes of
federal positions limits.
The exchange's exemption would be valid only if the exchange meets
the following additional conditions, each described in greater detail
below: (1) The exchange maintains rules, approved by the Commission
pursuant to Sec. 40.5, that establish application processes for
recognizing bona fide hedges in accordance with Sec. 150.9; (2) the
exchange meets specified prerequisites for granting such recognitions;
(3) the exchange satisfies specified recordkeeping requirements; and
(4) the exchange notifies the Commission and the applicant upon
determining to recognize a bona fide hedging transaction or position. A
person may exceed the applicable federal position limit ten business
days (for new and annually renewed exemptions) or two business days
(for applications, including retroactive applications, submitted due to
sudden and unforeseen circumstances) after the exchange makes its
determination, unless the Commission notifies the exchange and the
applicant otherwise.
The above-described elements of the proposed approach differ from
the regulations proposed in the 2016 Reproposal, which did not require
a 10-day Commission review period. The 2016 Reproposal allowed DCMs and
SEFs to recognize non-enumerated bona fide hedges for purposes of
federal position limits.\355\ However, the 2016 Reproposal may not have
conformed to the legal limits on what an agency may delegate to persons
outside the agency.\356\ The 2016 Reproposal
[[Page 11652]]
delegated to the DCMs and SEFs a significant component of the
Commission's authority to recognize bona fide hedges for purposes of
federal position limits. Under that proposal, the Commission did not
have a substantial role in reviewing the DCMs' or SEFs' recognitions of
non-enumerated bona fide hedges for purposes of federal position
limits. Upon further reflection, the Commission believes that the 2016
Reproposal may not have retained enough authority with the Commission
under case law on sub-delegation of agency decision making authority.
Under the new proposed model, the Commission would be informed by the
exchanges' determinations to make the Commission's own determination
for purposes of federal position limits within a 10-day review period.
Accordingly, the Commission would retain its decision-making authority
with respect to the federal position limits and provide legal certainty
to market participants of their determinations.
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\355\ Proposed Sec. 150.9(a)(5) of the 2016 Reproposal provided
that an applicant's derivatives position shall be deemed to be
recognized as a non-enumerated bona fide hedging position exempt
from federal position limits at the time that a designated contract
market or swap execution facility notifies an applicant that such
designated contract market or swap execution facility will recognize
such position as a non-enumerated bona fide hedging position.
\356\ In U.S. Telecom Ass'n v. FCC, the D.C. Circuit held
``that, while federal agency officials may subdelegate their
decision-making authority to subordinates absent evidence of
contrary congressional intent, they may not subdelegate to outside
entities--private or sovereign--absent affirmative evidence of
authority to do so.'' U.S. Telecom Ass'n v. FCC, 359 F.3d 554, 565-
68 (D.C. Cir. 2004) (citing Shook v. District of Columbia Fin.
Responsibility & Mgmt. Assistance Auth., 132 F.3d 775, 783-84 & n. 6
(D.C. Cir.1998); Nat'l Ass'n of Reg. Util. Comm'rs (``NARUC'') v.
FCC, 737 F.2d 1095, 1143-44 & n. 41 (D.C. Cir.1984); Nat'l Park and
Conservation Ass'n v. Stanton, 54 F.Supp.2d 7, 18-20 (D.D.C.1999).
Nevertheless, the D.C. Circuit recognized three circumstances that
the agency may ``delegate'' its authority to an outside party
because they do not involve subdelegation of decision-making
authority: (1) Establishing a reasonable condition for granting
federal approval; (2) fact gathering; and (3) advice giving. The
first instance involves conditioning of obtaining a permit on the
approval by an outside entity as an element of its decision process.
The second provides the agency with nondiscretionary information
gathering. The third allows a federal agency to turn to an outside
entity for advice and policy recommendations, provided the agency
makes the final decisions itself. Id. at 568. ``An agency may not,
however, merely `rubber-stamp' decisions made by others under the
guise of seeking their `advice,' [ ], nor will vague or inadequate
assertions of final reviewing authority save an unlawful
subdelegation, [ ].'' Id.
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Both DCMs and SEFs would be eligible to allow traders to utilize
the processes set forth under proposed Sec. 150.9. However, as a
practical matter, the Commission expects that upon implementation of
Sec. 150.9, the process proposed therein will likely be used primarily
by DCMs, rather than by SEFs, given that most economically equivalent
swaps that would be subject to federal position limits are expected to
be traded OTC and not executed on SEFs.
The Commission emphasizes that proposed Sec. 150.9 is intended to
serve as a separate, self-contained process that is related to, but
independent of, the proposed regulations governing: (1) The process in
proposed Sec. 150.3 for traders to apply directly to the Commission
for a bona fide hedge recognition; and (2) exchange processes for
establishing exchange-set limits and granting exemptions therefrom in
proposed Sec. 150.5. Proposed Sec. 150.9 is intended to serve as a
voluntary process exchanges can implement to provide additional
flexibility for their market participants seeking non-enumerated bona
fide hedges to file one application with an exchange to receive a
recognition or exemption for purposes of both exchange-set limits and
for federal limits. Proposed Sec. 150.9 is discussed in greater detail
below.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.9. The Commission also invites comments on the following:
(35) Considering that the Commission's proposed position limits
would apply to OTC economically equivalent swaps, should the Commission
develop a mechanism for exchanges to be involved in the review of non-
enumerated bona fide hedge applications for OTC economically equivalent
swaps?
(36) If so, what, if any, role should exchanges play in the review
of non- enumerated bona fide hedge applications for OTC economically
equivalent swaps?
a. Proposed Sec. 150.9(a)--Approval of Rules
Under proposed Sec. 150.9(a), the exchange must have rules,
adopted pursuant to the rule approval process in Sec. 40.5 of the
Commission's regulations, establishing processes and standards in
accordance with proposed Sec. 150.9, described below. The Commission
would review such rules to ensure that the exchange's standards and
processes for recognizing bona fide hedges from its own exchange-set
limits conform to the Commission's standards and processes for
recognizing bona fide hedges from the federal limits.
b. Proposed Sec. 150.9(b)--Prerequisites for an Exchange To Recognize
Non-Enumerated Bona Fide Hedges in Accordance With This Section
This section sets forth conditions that would require an exchange-
recognized bona fide hedge to conform to the corresponding definitions
or standards the Commission uses in proposed Sec. Sec. 150.1 and 150.3
for purposes of the federal position limits regime.
An exchange would be required to meet the following prerequisites
with respect to recognizing bona fide hedging positions under proposed
Sec. 150.9(b): (i) The exchange lists the applicable referenced
contract for trading; (ii) the position is consistent with both the
definition of bona fide hedging transaction or position in proposed
Sec. 150.1 and section 4a(c)(2) of the Act; and (iii) the exchange
does not recognize as bona fide hedges any positions that include
commodity index contracts and one or more referenced contracts, nor
does the exchange grant risk management exemptions for such
contracts.\357\
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\357\ The Commission finds that 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 would be inconsistent with the definition of bona
fide hedging transactions or positions for physical commodities in
proposed Sec. 150.1. See supra Section II.A.1.c.ii.(1) (discussion
of the temporary substitute test and risk-management exemptions).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.9. The Commission also invites comments on the following:
(37) Does the proposed compliance date of twelve-months after
publication of a final federal position limits rulemaking in the
Federal Register provide a sufficient amount of time for exchanges to
update their exemption application procedures, as needed, and begin
reviewing exemption applications in accordance with proposed Sec.
150.9? If not, please provide an alternative longer timeline and
reasons supporting a longer timeline.
c. Proposed Sec. 150.9(c)--Application Process
Proposed Sec. 150.9(c) sets forth the information and
representations that the exchange, at a minimum, would be required to
obtain from applicants as part of the application process for granting
bona fide hedges. In this connection, exchanges may rely upon their
existing application forms and processes in making such determinations,
provided they collect the information outlined below. The Commission
believes the information set forth below is sufficient for the exchange
to determine, and the Commission to verify, whether a particular
transaction or position satisfies the federal definition of bona fide
hedging transaction for purposes of federal position limits.
i. Proposed Sec. 150.9(c)(1)--Required Information for Bona Fide
Hedging Positions
With respect to bona fide hedging positions in referenced
contracts, proposed Sec. 150.9(c)(1) would require that any
application include: (i) A description of the position in the commodity
derivative contract for which the application is submitted (which would
include the name of the underlying commodity and the position size);
(ii) information to demonstrate why the position satisfies section
4a(c)(2) of the Act and the definition of bona fide hedging transaction
or position in proposed Sec. 150.1, including factual and legal
analysis; (iii) a
[[Page 11653]]
statement concerning the maximum size of all gross positions in
derivative contracts for which the application is submitted (in order
to provide a view of the true footprint of the position in the market);
(iv) information regarding the applicant's activity in the cash markets
for the commodity underlying the position for which the application is
submitted; \358\ and (v) any other information the exchange requires,
in its discretion, to enable the exchange to determine, and the
Commission to verify, whether such position should be recognized as a
bona fide hedge.\359\ These proposed application requirements are
similar to current requirements for recognizing a bona fide hedging
position under existing Sec. Sec. 1.47 and 1.48.
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\358\ The Commission would expect that exchanges would require
applicants to provide cash market data for at least the prior year.
\359\ Under proposed Sec. 150.9(c)(1)(iv) and (v), exchanges,
in their discretion, could request additional information as
necessary, including information for cash market data similar to
what is required in the Commission's existing Form 204. See infra
Section II.H.3. (discussion of Form 204 and proposed amendments to
part 19). Exchanges could also request a description of any
positions in other commodity derivative contracts in the same
commodity underlying the commodity derivative contract for which the
application is submitted. Other commodity derivatives contracts
could include other futures, options, and swaps (including OTC
swaps) positions held by the applicant.
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Market participants have raised concerns that such requirements,
even if administered by the exchanges, would require hedging entities
to change internal books and records to track which category of bona
fide hedge a position would fall under. The Commission notes that, as
part of this current proposal, exchanges would not need to require the
identification of a hedging need against a particular identified
category. So long as the requesting party satisfies all applicable
requirements in proposed Sec. 150.9, including demonstrating with a
factual and legal analysis that a position would fit within the bona
fide hedge definition, the Commission is not intending to require the
hedging party's books and records to identify the particular type of
hedge being applied.
ii. Proposed Sec. 150.9(c)(2)--Timing of Application
The Commission does not propose to prescribe timelines (e.g., a
specified number of days) for exchanges to review applications because
the Commission believes that exchanges are in the best position to
determine how to best accommodate the needs of their market
participants. Rather, under proposed Sec. 150.9(c)(2), the exchange
must separately require that applicants submit their application in
advance of exceeding the applicable federal position limit for any
given referenced contract. However, an exchange may adopt rules that
allow a person to submit a bona fide hedge application within five days
after the person has exceeded federal speculative limits if such person
exceeds the limits due to sudden or unforeseen increases in its bona
fide hedging needs. Where an applicant claims a sudden or unforeseen
increase in its bona fide hedging needs, the proposed rules would
require exchanges to require that the person provide materials
demonstrating that the person exceeded the federal speculative limit
due to sudden or unforeseen circumstances. Further, the Commission
would caution exchanges that applications submitted after a person has
exceeded federal position limits should not be habitual and should be
reviewed closely. Finally, if the Commission finds that the position
does not qualify as a bona fide hedge, then the applicant would be
required to bring its position into compliance, and could face a
position limits violation if it does not reduce the position within a
commercially reasonable time.
iii. Proposed Sec. 150.9(c)(3)--Renewal of Applications
Under proposed Sec. 150.9(c)(3), the exchange must require that
persons with bona fide hedging recognitions in referenced contracts
granted pursuant to proposed Sec. 150.9 reapply at least on an annual
basis by updating their original application, and receive a notice of
approval from the exchange prior to exceeding the applicable position
limit.
iv. Proposed Sec. 150.9(c)(4)--Exchange Revocation Authority
Under proposed Sec. 150.9(c)(4), the exchange retains its
authority to limit, condition, or revoke, at any time, any recognition
previously issued pursuant to proposed Sec. 150.9, for any reason,
including if the exchange determines that the recognition is no longer
consistent with the bona fide hedge definition in proposed Sec. 150.1
or section 4a(c)(2) of the Act.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.9. The Commission also invites comments on the following:
(38) As described above, the Commission does not propose to
prescribe timelines for exchanges to review applications. Please
comment on what, if any, timing requirements the Commission should
prescribe for exchanges' review of applications pursuant to proposed
Sec. 150.9.
(39) Currently, certain exchanges allow for the submission of
exemption requests up to five business days after the trader
established the position that exceeded the exchange-set limit. Under
proposed Sec. 150.9, should exchanges continue to be permitted to
recognize bona fide hedges and grant spread exemptions retroactively--
up to five days after a trader has established a position that exceeds
federal position limits?
d. Proposed Sec. 150.9(d)--Recordkeeping
Proposed Sec. 150.9(d) would set forth recordkeeping requirements
for purposes of Sec. 150.9. The required records would form a critical
element of the Commission's oversight of the exchanges' application
process and such records could be requested by the Commission as
needed. Under proposed Sec. 150.9(d), exchanges must maintain complete
books and records of all activities relating to the processing and
disposition of applications in a manner consistent with the
Commission's existing general regulations regarding recordkeeping.\360\
Such records must include all information and documents submitted by an
applicant in connection with its application; records of oral and
written communications between the exchange and the applicant in
connection with the application; and information and documents in
connection with the exchange's analysis of and action on such
application.\361\ Exchanges would also be required to maintain any
documentation submitted by an applicant after the disposition of an
application, including, for example, any reports or updates the
applicant filed with the exchange.
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\360\ Requirements regarding the keeping and inspection of all
books and records required to be kept by the Act or the Commission's
regulations are found at Sec. 1.31, 17 CFR 1.31. DCMs are already
required to maintain records of their business activities in
accordance with the requirements of Sec. 1.31 of Sec. 38.951, 17
CFR 38.951.
\361\ The Commission does not intend, in proposed Sec.
150.9(d), to create any new obligation for an exchange to record
conversations with applicants or their representatives; however, the
Commission does expect that an exchange would preserve any written
or electronic notes of verbal interactions with such parties.
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Exchanges would be required to store and produce records pursuant
to existing Sec. 1.31,\362\ and would be subject
[[Page 11654]]
to requests for information pursuant to other applicable Commission
regulations, including, for example, existing Sec. 38.5.\363\
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\362\ Consistent with existing Sec. 1.31, the Commission
expects that these records would be readily available during the
first two years of the required five year recordkeeping period for
paper records, and readily accessible for the entire five-year
recordkeeping period for electronic records. In addition, the
Commission expects that records required to be maintained by an
exchange pursuant to this section would be readily accessible during
the pendency of any application, and for two years following any
disposition that did not recognize a derivative position as a bona
fide hedge.
\363\ See 17 CFR 38.5 (requiring, in general, that upon request
by the Commission, a DCM must file responsive information with the
Commission, such as information related to its business, or a
written demonstration of the DCM's compliance with one or more core
principles).
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Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.9. The Commission also invites comments on the following:
(40) Do the proposed recordkeeping requirements set forth in Sec.
150.9 comport with existing practice? Are there any ways in which the
Commission could streamline the proposed recordkeeping requirements
while still maintaining access to sufficient information to carry out
its statutory responsibilities?
e. Proposed Sec. 150.9(e)--Process for a Person To Exceed Federal
Position Limits
Under proposed Sec. 150.9(e), once an exchange recognizes a bona
fide hedge with respect to its own speculative position limits
established pursuant to Sec. 150.5(a), a person could rely on such
determination for purposes of exceeding federal position limits
provided that specified conditions are met, including that the exchange
provide the Commission with notice of any approved application as well
as a copy of the application and any supporting materials, and the
Commission does not object to the exchange's determination. The
exchange is only required to provide this notice to the Commission with
respect to its initial (and not renewal) determinations for a
particular application. Under proposed Sec. 150.9(e), the exchange
must provide such notice to the Commission concurrent with the notice
provided to the applicant, and, except as provided below, a trader can
exceed federal position limits ten business days after the exchange
issues the required notification, provided the Commission does not
notify the exchange or applicant otherwise.
However, for a person with sudden or unforeseen bona fide hedging
needs that has filed an application, pursuant to proposed Sec.
150.9(c)(2)(ii), after they already exceeded federal speculative
position limits, the exchange's retroactive approval of such
application would be deemed approved by the Commission two business
days after the exchange issues the required notification, provided the
Commission does not notify the exchange or applicant otherwise. That
is, the bona fide hedge recognition would be deemed approved by the
Commission two business days after the exchange issues the required
notification, unless the Commission notifies the exchange and the
applicant otherwise during this two business day timeframe.
Once those ten (or two) business days have passed, the person could
rely on the bona fide hedge recognition both for purposes of exchange-
set and federal limits, with the certainty that the Commission (and not
Commission staff) would only revoke that determination in the limited
circumstances set forth in proposed Sec. 150.9(f)(1) and (2) described
further below.
However, under proposed Sec. 150.9(e)(5), if, during the ten (or
two) business day timeframe, the Commission notifies the exchange and
applicant that the Commission (and not staff) has determined to stay
the application, the person would not be able to rely on the exchange's
approval of the application for purposes of exceeding federal position
limits, unless the Commission approves the application after further
review.
Separately, under proposed Sec. 150.9(e)(5), the Commission (or
Commission staff) may request additional information from the exchange
or applicant in order to evaluate the application, and the exchange and
applicant would have an opportunity to provide the Commission with any
supplemental information requested to continue the application process.
Any such request for additional information by the Commission (or
staff), however, would not stay or toll the ten (or two) business day
application review period.
Further, under proposed Sec. 150.9(e)(6), the applicant would not
be subject to any finding of a position limits violation during the
Commission's review of the application. Or, if the Commission
determines (in the case of retroactive applications) that the bona fide
hedge is not approved for purposes of federal limits after a person has
already exceeded federal position limits, the Commission would not find
that the person has committed a position limits violation so long as
the person brings the position into compliance within a commercially
reasonable time.
The Commission believes that the ten (or two) business day period
to review exchange determinations under proposed Sec. 150.9 would
allow the Commission enough time to identify applications that may not
comply with the proposed bona fide hedging position definition, while
still providing a mechanism whereby market participants may exceed
federal position limits pursuant to Commission determinations.
Request for Comment
The Commission requests comment on all aspects of proposed Sec.
150.9. The Commission also invites comments on the following:
(41) The Commission has proposed, in Sec. 150.9(e)(3), a ten
business day period for the Commission to review an exchange's
determination to recognize a bona fide hedge for purposes of the
Commission approving such determination for federal position limits.
Please comment on whether the review period is adequate, and if not,
please comment on what would be an appropriate amount of time to allow
the Commission to review exchange determinations while also providing a
timely determination for the applicant.
(42) The Commission has proposed a two business day review period
for retroactive applications submitted to exchanges after a person has
already exceeded federal position limits. Please comment on whether
this time period properly balances the need for the Commission to
oversee the administration of federal position limits with the need of
hedging parties to have certainty regarding their positions that are
already in excess of the federal position limits.
(43) With respect to the Commission's review authority in Sec.
150.9(e)(5), if the Commission stays an application during the ten (or
two) business-day review period, the Commission's review, as would be
the case for an exchange, would not be bound by any time limitation.
Please comment on what, if any, timing requirements the Commission
should prescribe for its review of applications pursuant to proposed
Sec. 150.9(e)(5).
(44) Please comment on whether the Commission should permit a
person to exceed federal position limits during the ten business day
period for the Commission's review of an exchange-granted exemption.
(45) Under proposed Sec. 150.9(e), an exchange is only required to
notify the Commission of its initial approval of an exemption
application (and not any renewal approvals). Should the Commission
require that exchanges submit approved renewals of applications to the
Commission for review and approval if there are material changes to the
facts and circumstances underlying the renewal application?
[[Page 11655]]
f. Proposed Sec. 150.9(f)--Commission Revocation of an Approved
Application
Proposed Sec. 150.9(f) sets forth the limited circumstances under
which the Commission would revoke a bona fide hedge recognition granted
pursuant to proposed Sec. 150.9. The Commission expects such
revocation to be rare, and this authority would not be delegated to
Commission staff. First, under proposed Sec. 150.9(f)(1), if an
exchange revokes its recognition of a bona fide hedge, then such bona
fide hedge would also be deemed revoked for purposes of federal limits.
Second, under proposed Sec. 150.9(f)(2), if the Commission
determines that an application that has been approved or deemed
approved by the Commission is no longer consistent with the applicable
sections of the Act and the Commission's regulations, the Commission
shall notify the person and exchange, and, after an opportunity to
respond, the Commission can require the person to reduce the
derivatives position within a commercially reasonable time, or
otherwise come into compliance. In determining a commercially
reasonable amount of time, the Commission must consult with the
applicable exchange and applicant, and may consider factors including,
among others, current market conditions and the protection of price
discovery in the market.
The Commission expects that it would only exercise its revocation
authority under circumstances where the disposition of an application
has resulted, or is likely to result, in price anomalies, threatened
manipulation, actual manipulation, market disruptions, or disorderly
markets. In addition, the Commission's authority to require a market
participant to reduce certain positions in proposed Sec. 150.9(f)(2)
would not be subject to the requirements of CEA section 8a(9), that is,
the Commission would not be compelled to find that a CEA section 8a(9)
emergency condition exists prior to requiring that a market participant
reduce certain positions pursuant to proposed Sec. 150.9(f)(2).
If the Commission determines that a person must reduce its position
or otherwise bring it into compliance, the Commission would not find
that the person has committed a position limit violation so long as the
person comes into compliance within the commercially reasonable time
identified by the Commission in consultation with the applicable
exchange and applicant. The Commission intends for persons to be able
to rely on recognitions and exemptions granted pursuant to Sec. 150.9
with the certainty that the exchange decision would only be reversed in
very limited circumstances. Any action compelling a market participant
to reduce its position pursuant to Sec. 150.9(f)(2) would be a
Commission action, and would not be delegated to Commission staff.
\364\
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\364\ None of the provisions in proposed Sec. 150.9 would
compromise the Commission's emergency authorities under CEA section
8a(9), including the Commission's authority to fix ``limits that may
apply to a market position acquired in good faith prior to the
effective date of the Commission's action.'' CEA section 8a(9). 7
U.S.C. 12a(9).
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g. Proposed Sec. 150.9(g)--Delegation of Authority to the Director of
the Division of Market Oversight
The Commission proposes to delegate certain of its authorities
under proposed Sec. 150.9 to the Director of the Commission's Division
of Market Oversight, or such other employee(s) that the Director may
designate from time to time. Proposed Sec. 150.9(g)(1) would delegate
the Commission's authority, in Sec. 150.9(e)(5), to request additional
information from the exchange and applicant.
The Commission does not propose, however, to delegate its
authority, in proposed Sec. 150.9(e)(5) and (6) to stay or reject such
application, nor proposed Sec. 150.9(f)(2), to revoke a bona fide
hedge recognition granted pursuant to Sec. 150.9 or to require an
applicant to reduce its positions or otherwise come into compliance.
The Commission believes that if an exchange's disposition of an
application raises concerns regarding consistency with the Act,
presents novel or complex issues, or requires remediation, then the
Commission, and not Commission staff, should make the final
determination, after taking into consideration any supplemental
information provided by the exchange or the applicant.
As with all authorities delegated by the Commission to staff, the
Commission would maintain the authority to consider any matter which
has been delegated, including the proposed delegations in Sec. Sec.
150.3 and 150.9 described above. The Commission will closely monitor
staff administration of the proposed processes for granting bona fide
hedge recognitions.
H. Part 19 and Related Provisions--Reporting of Cash-Market Positions
1. Background
Key reports currently used for purposes of monitoring compliance
with federal position limits include Form 204 \365\ and Form 304,\366\
known collectively as the ``series `04'' reports. Under existing Sec.
19.01, market participants that hold bona fide hedging positions in
excess of limits for the nine commodities currently subject to federal
limits must justify such overages by filing the applicable report each
month: Form 304 for cotton, and Form 204 for the other
commodities.\367\ These reports are generally filed after exceeding the
limit, show a snapshot of such traders' cash positions on one given day
each month, and are used by the Commission to determine whether a
trader has sufficient cash positions that justify futures and options
on futures positions above the speculative limits.
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\365\ CFTC Form 204: Statement of Cash Positions in Grains,
Soybeans, Soybean Oil, and Soybean Meal, U.S. Commodity Futures
Trading Commission website, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@forms/documents/file/cftcform204.pdf (existing Form 204).
\366\ CFTC Form 304: Statement of Cash Positions in Cotton, U.S.
Commodity Futures Trading Commission website, available at http://www.cftc.gov/ucm/groups/public/@forms/documents/file/cftcform304.pdf
(existing Form 204). Parts I and II of Form 304 address fixed-price
cash positions used to justify cotton positions in excess of federal
limits. As described below, Part III of Form 304 addresses unfixed-
price cotton ``on-call'' information, which is not used to justify
cotton positions in excess of limits, but rather to allow the
Commission to prepare its weekly cotton on-call report.
\367\ 17 CFR 19.01.
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2. Proposed Elimination of Form 204 and Cash-Reporting Elements of Form
304
For the reasons set forth below, the Commission proposes to
eliminate Form 204 and Parts I and II of existing Form 304, which
requests information on cash-market positions for cotton akin to the
information requested in Form 204.\368\
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\368\ Proposed amendments to Part III of the Form 304, which
addresses cotton on-call, are discussed below.
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First, the Commission would no longer need the cash-market
information currently reported on Forms 204 and 304 because the
exchanges would collect, and make available to the Commission, cash-
market information needed to assess whether any such position is a bona
fide hedge.\369\ Further, the Commission would continue to have access
to information, including cash-market information, by issuing special
calls relating to positions exceeding limits.
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\369\ The cash-market reporting regime discussed in this section
of the release only pertains to bona fide hedges, not to spread
exemptions, because the Commission has not traditionally relied on
cash-market information when reviewing requests for spread
exemptions.
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Second, Form 204 as currently constituted would be inadequate for
the
[[Page 11656]]
reporting of cash-market positions relating to certain energy contracts
which would be subject to federal limits for the first time under this
proposal. For example, when compared to agricultural contracts, energy
contracts generally expire more frequently, have a shorter delivery
cycle, and have significantly more product grades. The information
required by Form 204, as well as the timing and procedures for its
filing, reflects the way agricultural contracts trade, but is
inadequate for purposes of reporting cash-market information involving
energy contracts.
While the Commission considered proposing to modify Form 204 to
cover energy and metal contracts, the Commission has opted instead to
propose a more streamlined approach to cash-market reporting that
reduces duplication between the Commission and the exchanges. In
particular, to obtain information with respect to cash market
positions, the Commission proposes to leverage the cash-market
information reported to the exchanges, with some modifications. When
granting exemptions from their own limits, exchanges do not use a
monthly cash-market reporting framework akin to Form 204. Instead,
exchanges generally require market participants who wish to exceed
exchange-set limits, including for bona fide hedging positions, to
submit an annual exemption application form in advance of exceeding the
limit.\370\ Such applications are typically updated annually and
generally include a month-by-month breakdown of cash-market positions
for the previous year supporting any position-limits overages during
that period.\371\
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\370\ See, e.g., ICE Rule 6.29 and CME Rule 559.
\371\ For certain physically-delivered agricultural contracts,
some exchanges may require that spot month exemption applications be
renewed several times a year for each spot month, rather than
annually.
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To ensure that the Commission continues to have access to the same
information on cash-market positions that is already provided to
exchanges, the Commission proposes several reporting and recordkeeping
requirements in Sec. Sec. 150.3, 150.5, and 150.9, as discussed
above.\372\ First, exchanges would be required to collect applications,
updated at least on an annual basis, for purposes of granting bona fide
hedge recognitions from exchange-set limits for contracts subject to
federal limits,\373\ and for recognizing bona fide hedging positions
for purposes of federal limits.\374\ Among other things, such
applications would be required to include: (1) Information regarding
the applicant's activity in the cash markets for the underlying
commodity; and (2) any other information to enable the exchange to
determine, and the Commission to verify, whether the exchange may
recognize such position as a bona fide hedge.\375\ Second, consistent
with existing industry practice for certain exchanges, exchanges would
be required to file monthly reports to the Commission showing, among
other things, for all bona fide hedges (whether enumerated or non-
enumerated), a concise summary of the applicant's activity in the cash
markets.\376\
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\372\ As discussed earlier in this release, proposed Sec. 150.9
also includes reporting and recordkeeping requirements pertaining to
spread exemptions. Those requirements will not be discussed again in
this section of the release, which addresses cash-market reporting
in connection with bona fide hedges. This section of the release
focuses on the cash-market reporting requirements in Sec. 150.9
that pertain to bona fide hedges.
\373\ See proposed Sec. 150.5(a)(2)(ii)(A)(1).
\374\ As discussed above in connection with proposed Sec.
150.9, market participants who wish to request a bona fide hedge
recognition under Sec. 150.9 would not be required to file such
applications with both the exchange and the Commission. They would
only file the applications with the exchange, which would then be
subject to recordkeeping requirements in proposed Sec. 150.9(d), as
well as proposed Sec. Sec. 150.5 and 150.9 requirements to provide
certain information to the Commission on a monthly basis and upon
demand.
\375\ See proposed Sec. 150.9(c)(1)(iv)-(v).
\376\ See proposed Sec. 150.5(a)(4).
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Collectively, these proposed Sec. Sec. 150.5 and 150.9 rules would
provide the Commission with monthly information about all recognitions
and exemptions granted for purposes of contracts subject to federal
limits, including cash-market information supporting the applications,
and annual information regarding all month-by-month cash-market
positions used to support a bona fide hedging recognition. These
reports would help the Commission verify that any person who claims a
bona fide hedging position can demonstrate satisfaction of the relevant
requirements. This information would also help the Commission perform
market surveillance in order to detect and deter manipulation and
abusive trading practices in physical commodity markets.
While the Commission would no longer receive the monthly snapshot
data currently included on Form 204, the Commission would have broad
access, at any time, to the cash-market information described above, as
well as any other data or information exchanges collect as part of
their application processes.\377\ This would include any updated
application forms and periodic reports that exchanges may require
applicants to file regarding their positions. To the extent that the
Commission observes market activity or positions that warrant further
investigation, Sec. 150.9 would also provide the Commission with
access to any supporting or related records the exchanges would be
required to maintain.\378\
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\377\ See, e.g., proposed Sec. 150.9(d) (requiring that all
such records, including cash-market information submitted to the
exchange, be kept in accordance with the requirements of Sec. 1.31)
and proposed Sec. 19.00(b) (requiring, among other things, all
persons exceeding speculative limits who have received a special
call to file any pertinent information as specified in the call).
\378\ See proposed Sec. 150.9(d).
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Furthermore, the proposed changes would not impact the Commission's
existing provisions for gathering information through special calls
relating to positions exceeding limits and/or to reportable positions.
Accordingly, as discussed further below, the Commission proposes that
all persons exceeding the proposed limits set forth in Sec. 150.2, as
well as all persons holding or controlling reportable positions
pursuant to Sec. 15.00(p)(1), must file any pertinent information as
instructed in a special call.\379\
---------------------------------------------------------------------------
\379\ See proposed Sec. 19.00(b).
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Finally, the Commission understands that the exchanges maintain
regular dialogue with their participants regarding cash-market
positions, and that it is common for exchange surveillance staff to
make informal inquiries of market participants, including if the
exchange has questions about market events or a participant's use of an
exemption. The Commission encourages exchanges to continue this
practice. Similarly, the Commission anticipates that its own staff
would engage in dialogue with market participants, either through the
use of informal conversations or, in limited circumstances, via special
call authority.
For market participants who are accustomed to filing Form 204s with
information supporting classification as a federally enumerated hedging
position, the proposed elimination of Form 204 would result in a slight
change in practice. Under the proposed rules, such participants' bona
fide hedge recognitions could still be self-effectuating for purposes
of federal limits, provided the market participant also separately
applies for a bona fide hedge exemption from exchange-set limits
established pursuant to proposed Sec. 150.5(a), and provided further
that the participant submits the requisite cash-market information to
the exchange as required by proposed Sec. 150.5(a)(2)(ii)(A)(1).
[[Page 11657]]
3. Proposed Changes to Parts 15 and 19 To Implement the Proposed
Elimination of Form 204 and Portions of Form 304
The market and large-trader reporting rules are contained in parts
15 through 21 of the Commission's regulations. Collectively, these
reporting rules effectuate the Commission's market and financial
surveillance programs by enabling the Commission to gather information
concerning the size and composition of the commodity derivative markets
and to monitor and enforce any established speculative position limits,
among other regulatory goals.
To effectuate the proposed elimination of Form 204 and the cash-
market reporting components of Form 304, the Commission proposes
corresponding amendments to certain provisions in parts 15 and 19.
These amendments would eliminate: (i) Existing Sec. 19.00(a)(1), which
requires persons holding reportable positions which constitute bona
fide hedging positions to file a Form 204; and (ii) existing Sec.
19.01, which, among other things, sets forth the cash-market
information required on Forms 204 and 304.\380\ Based on the proposed
elimination of existing Sec. 19.00(a)(1) and Form 204, the Commission
also proposes to remove related provisions from: (i) The ``reportable
position'' definition in Sec. 15.00(p); (ii) the list of ``persons
required to report'' in Sec. 15.01; and (iii) the list of reporting
forms in Sec. 15.02.
---------------------------------------------------------------------------
\380\ 17 CFR 19.01.
---------------------------------------------------------------------------
4. Special Calls
Notwithstanding the proposed elimination of Form 204, the
Commission does not propose to make any significant substantive changes
to information requirements relating to positions exceeding limits and/
or to reportable positions. Accordingly, in proposed Sec. 19.00(b),
the Commission proposes that all persons exceeding the proposed limits
set forth in Sec. 150.2, as well as all persons holding or controlling
reportable positions pursuant to Sec. 15.00(p)(1), must file any
pertinent information as instructed in a special call. This proposed
provision is similar to existing Sec. 19.00(a)(3), but would require
any such person to file the information as instructed in the special
call, rather than to file a series '04 report.\381\
---------------------------------------------------------------------------
\381\ 17 CFR 19.00(a)(3).
---------------------------------------------------------------------------
The Commission also proposes to add language to existing Sec.
15.01(d) to clarify that persons who have received a special call are
deemed ``persons required to report'' as defined in Sec. 15.01.\382\
The Commission proposes this change to clarify an existing requirement
found in Sec. 19.00(a)(3), which requires persons holding or
controlling positions that are reportable pursuant to Sec. 15.00(p)(1)
who have received a special call to respond.\383\ The proposed changes
to part 19 operate in tandem with the proposed additional language for
Sec. 15.01(d) to reiterate the Commission's existing special call
authority without creating any new substantive reporting obligations.
Finally, proposed Sec. 19.03 would delegate authority to issue such
special calls to the Director of the Division of Enforcement, and
proposed Sec. 19.03(b) would delegate to the Director of the Division
of Enforcement the authority in proposed Sec. 19.00(b) to provide
instructions or to determine the format, coding structure, and
electronic data transmission procedures for submitting data records and
any other information required under part 19.
---------------------------------------------------------------------------
\382\ 17 CFR 15.01.
\383\ 17 CFR 19.00(a)(3).
---------------------------------------------------------------------------
5. Form 304 Cotton On-Call Reporting
With the proposed elimination of the cash-market reporting elements
of Form 304 as described above, Form 304 would be used exclusively to
collect the information needed to publish the Commission's weekly
cotton on call report, which shows the quantity of unfixed-price cash
cotton purchases and sales that are outstanding against each cotton
futures month.\384\ The requirements pertaining to that report would
remain in proposed Sec. Sec. 19.00(a) and 19.02, with minor
modifications to existing provisions. The Commission proposes to update
cross references (including to renumber Sec. 19.00(a)(2) as Sec.
19.00(a)) and to clarify and update the procedures and timing for the
submission of Form 304. In particular, proposed Sec. 19.02(b) would
require that each Form 304 report be made weekly, dated as of the close
of business on Friday, and filed not later than 9 a.m. Eastern Time on
the third business day following that Friday using the format, coding
structure, and electronic data transmission procedures approved in
writing by the Commission. The Commission also proposes some
modifications to the Form 304 itself, including conforming and
technical changes to the organization, instructions, and required
identifying information.\385\
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\384\ Cotton On-Call, U.S. Commodity Futures Trading Commission
website, available at https://www.cftc.gov/MarketReports/CottonOnCall/index.htm (weekly report).
\385\ Among other things, the proposed changes to the
instructions would clarify that traders must identify themselves on
Form 304 using their Public Trader Identification Number, in lieu of
the CFTC Code Number required on previous versions of Form 304. This
proposed change would help Commission staff to connect the various
reports filed by the same market participants. This release includes
a representation of the proposed Form 304, which would be submitted
in an electronic format published pursuant to the proposed rules,
either via the Commission's web portal or via XML-based, secure FTP
transmission.
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Request for Comment
The Commission requests comment on all aspects of the proposed
amendments to Part 19 and related provisions. The Commission also
invites comments on the following:
(46) To what extent, and for what purpose, do market participants
and others rely on the information contained in the Commission's weekly
cotton on-call report?
(47) Does publication of the cotton on-call report create any
informational advantages or disadvantages, and/or otherwise impact
competition in any way?
(48) Should the Commission stop publishing the cotton on-call
report, but continue to collect, for internal use only, the information
required in Part III of Form 304 (Unfixed-Price Cotton ``On Call'')?
(49) Alternatively, should the Commission stop publishing the
cotton on-call report and also eliminate the Form 304 altogether,
including Part III?
6. Proposed Technical Changes to Part 17
Part 17 of the Commission's regulations addresses reports by
reporting markets, FCMs, clearing members, and foreign brokers.\386\
The Commission proposes to amend existing Sec. 17.00(b), which
addresses information to be furnished by FCMs, clearing members, and
foreign brokers, to delete certain provisions related to aggregation,
because those provisions have become duplicative of aggregation
provisions that were adopted in Sec. 150.4 in the 2016 Final
Aggregation Rulemaking.\387\ The Commission also proposes to add a new
provision, Sec. 17.03(i), which delegates certain authority under
Sec. 17.00(b) to the Director of the Office of Data and
Technology.\388\
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\386\ 17 CFR part 17.
\387\ See Final Aggregation Rulemaking. Specifically, the
Commission proposes to delete paragraphs (1), (2), and (3) from
Sec. 17.00(b). 17 CFR 17.00(b).
\388\ Under Sec. 150.4(e)(2), which was adopted in the 2016
Final Aggregation Rulemaking, the Director of the Division of Market
Oversight is delegated authority to, among other things, provide
instructions relating to the format, coding structure, and
electronic data transmission procedures for submitting certain data
records. 17 CFR 150.4(e)(2). A subsequent rulemaking changed this
delegation of authority from the Director of the Division of Market
Oversight to the Director of the Office of Data and Technology, with
the concurrence of the Director of the Division of Enforcement. See
82 FR at 28763 (June 26, 2017). The proposed addition of Sec.
17.03(i) would conform Sec. 17.03 to that change in delegation.
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[[Page 11658]]
I. Removal of Part 151
Finally, the Commission is proposing to remove and reserve part 151
in response to its vacatur by the U.S. District Court for the District
of Columbia,\389\ as well as in light of the proposed revisions to part
150 that conform part 150 to the amendments made to the CEA section 4a
by the Dodd-Frank Act.
---------------------------------------------------------------------------
\389\ See supra note 11 and accompanying discussion.
---------------------------------------------------------------------------
III. Legal Matters
A. Introduction
Section 737 (a)(4) of the Dodd-Frank Act,\390\ codified as section
4a(a)(2)(A) of the Commodity Exchange Act,\391\ states in relevant part
that ``the Commission shall'' establish position limits for contracts
in physical commodities other than excluded commodities ``[i]n
accordance with the standards set forth in'' section 4a(a)(1), which
primarily contains the Commission's preexisting authority to establish
such position limits as it ``finds are necessary.'' \392\ In connection
with the 2011 Final Rulemaking, the Commission determined that section
4a(a)(2)(A) is an unambiguous mandate to establish position limits for
all physical commodities. In ISDA,\393\ however, the U.S. District
Court for the District of Columbia held that the term ``standards set
forth in paragraph (1)'' is ambiguous as to whether it includes the
requirement under section 4a(a)(1) that before the Commission
establishes a position limit, it must first find it ``necessary'' to do
so. The court therefore vacated the 2011 Final Rulemaking and directed
the Commission to determine, in light of the Commission's ``experience
and expertise'' '' and the ``competing interests at stake,'' whether
section 4a(a)(2)(A) requires the Commission to make a necessity finding
before establishing the relevant limits, or if section 4a(a)(2)(A) is a
mandate from Congress to do so without that antecedent finding.
---------------------------------------------------------------------------
\390\ Dodd-Frank Wall Street Reform and Consumer Protection Act
of 2010, Sec. 737(a)(4), Public Law 111-203, 124 Stat. 1376, 1723
(July 21, 2010).
\391\ 7 U.S.C. 6a(a)(2)(A).
\392\ 7 U.S.C. 6a(a)(1).
\393\ 887 F. Supp.2d 259.
---------------------------------------------------------------------------
Following the court's order, the Commission subsequently determined
that the ``standards set forth in paragraph (1)'' do not include the
requirement in that paragraph that the Commission find position limits
``necessary.'' \394\ Rather, the Commission determined, ``the standards
set forth in paragraph (1)'' refer only to what the Commission called
the ``aggregation standard'' and the ``flexibility standard.'' \395\
The ``aggregation standard'' referred to directions under section
4a(a)(1)(A) that in determining whether any person has exceeded an
applicable position limit, the Commission must aggregate the positions
a party controls directly or indirectly, or held by two persons acting
in concert ``the same as if the positions were held by, or the trading
were done by, a single person.'' \396\ The ``flexibility standard''
referred to the statement in section 4a(a)(1)(A) that ``[n]othing in
this section shall be construed to prohibit'' the Commission from
fixing different limits for different commodities, markets, futures,
delivery months, numbers of days remaining on the contract, or for
buying and selling operations.\397\
---------------------------------------------------------------------------
\394\ See, e.g., 2013 Proposal, 78 FR at 75680, 75684.
\395\ See, e.g., id.
\396\ 7 U.S.C. 6a(a)(1).
\397\ Id.
---------------------------------------------------------------------------
The Commission here preliminarily reaches a different conclusion.
In light of its experience with and expertise in position limits and
the competing interests at stake, the Commission now determines that it
should interpret ``the standards set forth in paragraph (1)'' to
include the traditional necessity and aggregation standards. The
Commission also preliminarily determines that the ``flexibility
standard'' is not an accurate way of describing the statute's lack of a
prohibition on differential limits, and therefore is not included in
``the standards set forth in paragraph (1)'' with which position limits
must accord. However, even if that were not so, the Commission would
still preliminarily determine that ``the standards set forth in
paragraph (1)'' should be interpreted to include necessity.
B. Key Statutory Provisions
The Commission's authority to establish position limits dates back
to the Commodity Exchange Act of 1936.\398\ The relevant CEA language,
now codified in its present form as section 4a(a)(1), states, among
other things that the Commission ``shall, from time to time . . .
proclaim and fix such limits on the amounts of trading which may be
done or positions which may be held by any person under such
contracts'' as the Commission ``finds are necessary to diminish,
eliminate, or prevent such burden.'' Thus, the Commission's original
authority to establish a position limit required it first to find that
it was necessary to do so. Section 4a(a)(1) also includes what the
Commission has referred to as the aggregation and flexibility
standards.
---------------------------------------------------------------------------
\398\ Public Law 74-675 Sec. 5, 49 Stat. 1491, 1492 (June 15,
1936).
---------------------------------------------------------------------------
Section 4a(a)(2)(A) provides, in relevant part, that ``[i]n
accordance with the standards set forth in paragraph (1) of this
subsection,'' i.e., paragraph 4a(a)(1) discussed above, the Commission
shall, by rule, regulation, or order 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 contracts of sale for future
delivery or with respect to options on the contracts or commodities
traded on or subject to the rules of a DCM. This direction applies only
to physical commodities other than excluded commodities. Paragraph
4a(a)(2)(B) states that the limits for exempt physical commodities
``required'' under subparagraph (A) ``shall'' be established within 180
days, and for agricultural commodities the limits ``required'' under
subparagraph (A) ``shall'' be established within 270 days. Paragraph
4a(a)(2)(C) establishes as a ``goal'' that 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 by the Commission not cause price discovery to shift to foreign
boards of trade.
Next, paragraph 4a(a)(3) establishes certain requirements for
position limits set pursuant to paragraph 4a(a)(2). It directs that
when the Commission establishes ``the limits required in paragraph
(2),'' it shall, ``as appropriate,'' set limits on the number of
positions that may be held in the spot month, each other month, and the
aggregate number of positions that may be held by any person for all
months; and ``to the extent practicable, in its discretion'' the
Commission shall fashion the limits to (i) ``diminish, eliminate, or
prevent excessive speculation as described under this section;'' (ii)
``deter and prevent market manipulation, squeezes, and corners;'' (iii)
``ensure sufficient market liquidity for bona fide hedgers;'' and (iv)
``ensure that the price discovery function of the underlying market is
not disrupted.''
Paragraph 4a(a)(5) adds a further requirement that when the
Commission establishes limits under paragraph 4a(a)(2), the Commission
must establish limits on the amount of positions, ``as appropriate,''
on swaps that are ``economically equivalent'' to futures
[[Page 11659]]
and options contracts subject to paragraph 4a(a)(2).
C. Ambiguity of Section 4a With Respect to Necessity Finding
The district court held that section 4a(a)(2) is ambiguous as to
whether, before the Commission establishes a position limit, it must
first find that a limit is ``necessary.'' The court found the phrase
``[i]n accordance with the standards set forth in paragraph (1) of this
subsection'' unclear as to whether it includes the proviso in paragraph
(1) that position limits be established only ``as the Commission finds
are necessary.'' \399\ The court noted that, by some definitions of
``standard,'' a requirement that position limits be ``necessary'' could
qualify.\400\
---------------------------------------------------------------------------
\399\ ISDA, 887 F.Supp.2d at 274.
\400\ Id.
---------------------------------------------------------------------------
The district court found the ambiguity compounded by the phrase
``as appropriate'' in sections 4a(a)(2)(A), 4a(a)(3), and
4a(a)(5).\401\ It was unclear to the court whether this phrase gives
the Commission discretion not to impose position limits at all if it
finds them not appropriate, or if the discretion extends only to
determining ``appropriate'' levels at which to set the limits.\402\
Neither the grammar of the relevant provisions nor the available
legislative history resolved these issues to the court's
satisfaction.\403\ In sum, ``the Dodd-Frank amendments do not
constitute a clear and unambiguous mandate to set position limits.''
\404\ The court therefore directed the Commission to resolve the
ambiguity, not by ``rest[ing] simply on its parsing of the statutory
language,'' but by ``bring[ing] its experience and expertise to bear in
light of the competing interests at stake.'' \405\
---------------------------------------------------------------------------
\401\ Id. at 276-278.
\402\ Id.
\403\ Id.
\404\ Id. at 280.
\405\ Id. at 281.
---------------------------------------------------------------------------
D. Resolution of Ambiguity
The Commission has applied its experience and expertise in light of
the competing interests at stake and preliminarily determined that
paragraph 4a(a)(2) should be interpreted as incorporating the
requirement of paragraph 4a(a)(1) that position limits be established
only ``as the Commission finds are necessary.'' This is based on a
number of considerations.
First, while the Commission has previously taken the position that
necessity does not fall within the definition of the word ``standard,''
that view relied on only one of the many dictionary definitions of
``standard,'' \406\ and the Commission now believes it was an overly
narrow interpretation. The word ``standard'' is used in different ways
in different contexts, and many reasonable definitions would encompass
``necessity.'' \407\ In legal contexts, ``necessity'' is routinely
called a ``standard.'' \408\ The Commission preliminarily believes that
the more natural reading of ``standard'' in section 4a(a)(2)(A) does
include the requirement of a necessity finding.
---------------------------------------------------------------------------
\406\ ISDA, Defendant Commodity Futures Trading Commission's
Cross-Motion for Summary Judgment at 24-25, (quoting definition of
``standard'' as ``something set up and established by authority as a
rule for the measure of quantity, weight, extent, value, or
quality'' from Merriam-Webster's Collegiate Dictionary 1216 (11th
ed. 2011)).
\407\ Black's Law Dictionary 1624 (10th ed. 2014) (``A criterion
for measuring acceptability, quality, or accuracy.''); The American
Heritage Dictionary of the English Language (5th ed. 2011) (``A
degree or level of requirement, excellence, or attainment.''); New
Oxford American Dictionary 1699 (3rd ed. 2010) (``an idea or thing
used as a measure, norm, or model in comparative evaluations''); The
Random House Unabridged Dictionary 1857 (2d ed. 1993) (``rule or
principle that is used as a basis for judgment''); XVI The Oxford
English Dictionary 505 (2d ed. 1989) (``A rule, principle, or means
of judgment or estimation; a criterion, measure.'').
\408\ Home Buyers Warranty Corp. v. Hanna, 750 F.3d 427, 435
(4th Cir. 2014) (applying a `` `necessity' standard'' under Fed. R.
Civ. P. 19(a)(1)(A)); United States v. Cartagena, 593 F.3d 104, 111
n.4 (1st Cir. 2010) (discussing a ``necessity standard'' under the
Omnibus Crime Control and Safe Streets Act of 1968); Fones4All Corp.
v. F.C.C., 550 F.3d 811, 820 (9th Cir. 2008) (applying a ``necessity
standard'' under the Telecommunications Act of 1996); Swonger v.
Surface Transp. Bd., 265 F.3d 1135, 1141-42 (10th Cir. 2001)
(applying a ``necessity standard'' under transportation law); see
also Minnesota v. Mille Lacs Band of Chippewa Indians, 526 U.S. 172,
205 (1999) (``conservation necessity standard''); Int'l Union,
United Auto., Aerospace & Agr. Implement Workers of Am., UAW v.
Johnson Controls, Inc., 499 U.S. 187, 198 (1991) (``business
necessity standard'').
---------------------------------------------------------------------------
Second, and relatedly, the Commission believes the term
``standard'' is a less natural fit for the language in subparagraph
4a(a)(1) that the Commission has previously called the ``flexibility
standard.'' The sentence provides that ``[n]othing in this section
shall be construed to prohibit the Commission from fixing different
trading or position limits for different'' contracts or
situations.\409\ Typically a legal standard constrains an agency's
discretion.\410\ But nothing in the so-called ``flexibility'' language
constrains the Commission at all. In other words, the express lack of
any prohibition of differential limits under section 4a(a)(1) is better
understood as the absence of any standard.\411\ And if flexibility is
not a standard, then necessity must be, because section 4a(a)(2)(A)
refers to ``standards,'' plural.
---------------------------------------------------------------------------
\409\ 7 U.S.C. 6a(a)(1)(A).
\410\ See, e.g., OSU Student Alliance v. Ray, 699 F.3d 1053,
1064 (9th Cir. 2012) (holding that the First Amendment was violated
by enforcement of a rule that ``created no standards to cabin
discretion''); Lenis v. U.S. Attorney General, 525 F.3d 1291, 1294
(11th Cir. 2008) (dismissing petition for review where agency
procedural regulation ``specifie[d] no standards for a court to use
to cabin'' the agency's discretion); Tamenut v. Mukasey, 521 F.3d
1000, 1004 (8th Cir. 2008); Drake v. FAA, 291 F.3d 59, 71 (D.C. Cir.
2002) (similar).
\411\ Tamenut v. Mukasey, 521 F.3d 1000, 1004 (8th Cir. 2008)
(explaining that a statute placing ``no constraints on the
[agency's] discretion . . . specifie[d] no standards''); United
States v. Gonzalez-Aparicio, 663 F.3d 419, 435 (9th Cir. 2011)
(Tashima, J., dissenting) (``If we can pick whatever standard suits
us, free from the direction of binding principles, then there is no
standard at all.''); Downs v. Am. Emp. Ins. Co., 423 F.2d 1160, 1163
(5th Cir. 1970) (``best judgment is no standard at all'').
---------------------------------------------------------------------------
Third, the requirement that position limits be ``appropriate'' is
an additional ground to interpret the statute as lacking an across-the
board-mandate. In the past, the Commission has taken the view that the
word ``appropriate'' as used in section 4a(a)(2)(A)--and in sections
4a(a)(3) and 4a(a)(5) in connection with position limits established
pursuant to section 4a(a)(2)(A)--refers to position limit levels but
not to the determination of whether to establish a limit.\412\ However,
the Supreme Court has opined in the context of the Clean Air Act that
``[n]o regulation is `appropriate' if it does significantly more harm
than good.'' \413\ That was not a CEA case, but the Commission finds
the Court's reasoning persuasive in this context.
---------------------------------------------------------------------------
\412\ E.g., ISDA, Commission Appellate Brief at 37-38.
\413\ Michigan v. EPA, 135 S.Ct. 2699, 2707 (2015). Because
Michigan was not a CEA case, the Commission does not mean to imply
that Michigan would be controlling or compels any particular result
in determining when a position limit is appropriate. To the
contrary, the court in ISDA held that the CEA is ambiguous in that
regard. The Commission merely finds the Supreme Court's discussion
in Michigan useful in reasonably resolving that ambiguity.
---------------------------------------------------------------------------
It is reasonable to interpret the direction to set a position limit
``as appropriate'' to mean that in a given context, it may be that no
position limit is justified. Under an across-the-board mandate,
however, the Commission would be compelled to impose some limit even if
any level of position limit would do significantly more harm than good,
including with respect to the public interests Congress set forth in
section 4a(a)(1) itself and elsewhere in section 4a and the CEA
generally.\414\ The Commission does not believe that is the best
reading of section 4a(a)(2)(A). Rather, Congress's use of
``appropriate'' in that section and elsewhere in the Dodd-Frank
amendments is more consistent with a directive that the
[[Page 11660]]
Commission consider all relevant factors and, on that basis, set an
appropriate limit level--or no limit at all, if to establish one would
contravene the public interests Congress articulated in section
4a(a)(1) and the CEA generally. That is also better policy. To be
clear, this does not mean the Commission must conduct a formal cost-
benefit analysis in which each advantage and disadvantage is assigned a
monetary value. To the contrary, the Commission retains broad
discretion to decide how to determine whether a position limit is
appropriate.\415\
---------------------------------------------------------------------------
\414\ 7 U.S.C. 5, 6a(a)(2)(C) and (a)(3)(B).
\415\ 135 S.Ct. at 2707, 2711.
---------------------------------------------------------------------------
Fourth, mandatory federal position limits for all physical
commodities would be a sea change in derivatives regulation, and the
Commission does not believe it should infer that Congress would have
acted so dramatically without speaking clearly and unequivocally.\416\
It is important to understand the reach of the proposition that the
Commission must impose position limits for every physical commodity.
The Commission estimates, based on information from the Commission's
surveillance system, that currently there are over 1,200 contracts on
physical commodities listed on DCMs. Some of these contracts have
little or no active trading.\417\ Absent clearer statutory language
than is present in the statute, the Commission does not believe it
should interpret the statute as though Congress had concerns about or
even considered each and every one of the similar number of contracts
listed at the time of Dodd-Frank. In a similar vein, the Commission
previously has cited Senate Subcommittee's staff studies of potential
excessive speculation that preceded the enactment of section
4a(a)(2).\418\ But those studies covered only a few commodities--oil,
natural gas, and wheat.\419\ While these studies demonstrate that
Senate subcommittee's concern with potential excessive speculation, the
Commission does not believe it should interpret a statute by
extrapolating from one Senate subcommittee's interest in three specific
commodities to a requirement to impose limits on all of the many
hundreds of physical futures contracts listed on exchanges, where
Congress as a whole has not said so unambiguously.
---------------------------------------------------------------------------
\416\ E.g., Whiteman v. American Trucking Assns., Inc., 531 U.S.
457, 468 (2000) (Congress . . . does not alter the fundamental
details of a regulatory scheme in vague terms. . . .''); EEOC v.
Staten Island Sav. Bank, 207 F.3d 144, (2d Cir. 2000) (``we are
reluctant to infer . . . a mandate for radical change absent a
clearer legislative command''); Canup v. Chipman-Union, Inc., 123
F.3d 1440, (11th Cir. 1997) (``We would expect Congress to speak
more clearly if it intended such a radical change. . . .'').
\417\ See, e.g., Daily Agricultural Volume and Open Interest,
CME Group website, available at https://www.cmegroup.com/market-data/volume-open-interest/agriculture-commodities-volume.html
(tables of daily trading volume and open interest for CME futures
contracts).
\418\ E.g., 2013 Proposal, 78 FR at 75787 nn.122-124; ISDA,
Brief for Appellant Commodity Futures Trading Commission at 14-15.
\419\ Id.
---------------------------------------------------------------------------
DCMs also regularly create new contracts. If Congress intended
federal position limits to apply to all physical commodity contracts,
the Commission would expect there to be a provision directing it to
establish position limits on a continuous basis. There is no such
provision--and Congress directed the Commission to complete its
position-limits rulemaking within 270 days.\420\ The only other
relevant provision is the preexisting and broadly discretionary
requirement that the Commission make an assessment ``from time to
time.'' That structure is inconsistent, both as a statutory and policy
matter, with an across-the-board mandate.
---------------------------------------------------------------------------
\420\ 7 U.S.C. 6a(a)(2)(B).
---------------------------------------------------------------------------
Fifth, the Commission believes as a matter of policy judgment that
requiring a necessity finding better carries out the purposes of
section 4a. As Congress presumably was aware, position limits create
costs as well as potential benefits.
The Commission has recognized, and Congress also presumably
understood, that there are costs even for well-crafted position limits.
As discussed below in the Commission's consideration of costs and
benefits, market participants must monitor their positions and have
safeguards in place to ensure compliance with limits. In addition to
compliance costs, position limits may constrain some economically
beneficial uses of derivatives, because a limit calculated to prevent
excessive speculation or to restrict opportunities for manipulation
may, in some circumstances, affect speculation that is desirable. While
the Commission has designed limits to avoid interference with normal
trading, certain negative effects cannot be ruled out.
For example, to interpret section 4a(a)(2) as a mandate even where
unnecessary could pose risks to liquidity and hedging. Well-calibrated
position limits can protect liquidity by checking excessive
speculation, but unnecessary limits can have the opposite effect by
drawing capital out of markets. Indeed, the liquidity of a futures
contract, upon which hedging depends, is directly related to the amount
of speculation that takes place. Speculators contribute valuable
liquidity to commodity markets, and section 4a(a)(1) identified
``excessive speculation''--not all speculation--as ``an undue burden on
interstate commerce.'' To needlessly reduce liquidity, impair price
discovery, and make hedging more difficult for commodity end-users
without sufficient beneficial effects on interstate commerce is unsound
policy, as Congress has defined the policy. If Congress had drafted the
statute unambiguously to reflect the judgment that these costs of
position limits are justified in all instances, the Commission of
course would follow it. Without such clarity, the Commission does not
believe it should interpret the statute to impose those costs
regardless of whether and to what extent doing so advances Congress'
stated goals.
Sixth, while Congress has deemed position limits an effective tool,
it is sound regulatory policy for the Commission to apply its
experience and expertise to determine whether economic conditions with
respect to a given commodity at a given point in time render it likely
that position limits will achieve positive outcomes. A mandate without
the requirement of a necessity finding would eliminate the Commission's
expertise and experience from the process and could lead to position
limits that do not have significantly positive effects, or even
position limits that are counterproductive. Necessity findings may also
enhance public confidence that position limits in place are necessary
to their statutory purposes, potentially improving public confidence in
the markets themselves. It is therefore sound policy to construe the
statute in a way that requires the Commission to make a necessity
finding before establishing position limits.\421\
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\421\ The Commission also does not believe that establishing and
enforcing position limits for all contracts on physical commodities,
regardless of their importance to the price or delivery process of
the underlying commodities or to the economy more broadly, would be
a productive use of the public resources Congress has appropriated
to the Commission.
---------------------------------------------------------------------------
Finally, also as a matter of policy, the Commission's approach will
prevent market participants from suffering the costs of statutory
ambiguity. Mandating position limits across all products would
automatically impose costs on market participants regardless of whether
doing so fulfills the purpose of section 4a. The associated compliance
costs remain as long as those limits are in place. Reading a mandate
into section 4a would exchange regulatory convenience, with or without
any public benefit, for long-term burdens on market participants. The
Commission does not believe that ambiguity should
[[Page 11661]]
be resolved reflexively in a manner that shifts costs to market
participants. Rather, the Commission believes that where an agency has
discretion to choose from among reasonable alternative interpretations,
it should not impose costs without a strong justification, which in
this context would be lacking without a necessity finding.
E. Evaluation of Considerations Relied Upon by the Commission in
Previous Interpretation of Paragraph 4a(a)(2)
As noted above, the Commission previously has identified a number
of considerations it believed supported interpreting paragraph 4a(a)(2)
to mandate position limits for all physical commodities other than
excluded commodities, without the need for a necessity finding.
Although the Administrative Procedure Act does not require the
Commission to rebut those previous points, the Commission believes it
is useful to discuss them. While certain of these considerations could
support such an interpretation, the Commission is no longer persuaded
that, on balance, they support interpreting paragraph 4a(a)(2) as an
across-the-board mandate. Considerations on which the Commission
previously relied include the following:
1. When Congress enacted paragraph 4a(a)(2), the text of what
previously was paragraph 4a(a),\422\ already provided that the
Commission ``shall . . . proclaim and fix'' position limits ``as the
Commission finds are necessary'' to diminish, eliminate, or prevent the
burdens on commerce associated with excessive speculation. This
directive applied--and still applies--to all exchange-traded
commodities, including the physical commodities that are the subject of
paragraph 4a(a)(2). The Commission has previously reasoned that if
paragraph 4a(a)(2) were not a mandate to establish position limits
without such a necessity finding, it would be a nullity.\423\ That is,
the Commission already had the authority to issue position limits, so
4a(a)(2) would add nothing were it not a mandate. The Commission is no
longer convinced that is correct.
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\422\ 7 U.S.C. 6a(a).
\423\ E.g., 2016 Reproposal, 81 FR at 96715, 96716 (discussing
comments on past releases); 2013 Proposal, 78 FR at 75684.
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Whereas the Commission's preexisting authority under the
predecessor to paragraph 4a(a)(1) directed the Commission to establish
position limits ``from time to time,'' new paragraph 4a(a)(2) directed
the Commission to consider position limits promptly within two
specified time limits after Congress passed the Dodd-Frank Act. That is
a new directive, and it is consistent with maintaining the requirement
for, and preserving the benefits of, a necessity finding. This
interpretation is also consistent with the Commission's belief that
Congress would not have intended a drastic mandate without a clear
statement to that effect. This interpretation is likewise consistent
with Congress' addition of swaps to the Commission's jurisdiction--it
makes sense to direct the Commission to give prompt consideration to
whether position limits are necessary at the same time Congress was
expanding the Commission's oversight responsibilities to new markets,
and the Commission believes that is sound policy to ensure that the
regime works well as a whole. Rather than leave it to the Commission's
preexisting discretion to set limits ``from time to time,'' it is
reasonable to believe that Congress found it important for the
Commission to focus on this issue at a time certain.
In addition, paragraph 4a(a)(2) triggers other requirements added
to section 4a(a) by Dodd-Frank and not included in paragraph 4a(a)(1).
For example, as described above, paragraph 4a(a)(3)(B) identifies
objectives the Commission is required to pursue in establishing
position limits, including three, set forth in subparagraphs
4a(a)(3)(B)(ii)-(iv), that are not explicitly mentioned in paragraph
4a(a)(1). The Commission previously opined that paragraph 4a(a)(5),
which directs the Commission to establish, position limits on swaps
``economically equivalent'' to futures subject to new position limits,
would add nothing to paragraph 4a(a)(1), because if there were no
mandate. The Commission no longer finds that reasoning persuasive.
Paragraph 4a(a)(5) goes beyond paragraph 4a(a)(1), because it
separately requires that when the Commission imposes limits on futures
pursuant to paragraph 4a(a)(2), it also does so on economically
equivalent swaps. Without that text, the Commission would have no such
obligation to issue both types of limits at the same time.
2. The Commission has also previously been influenced by the
requirements of paragraph 4a(a)(3), which directs the Commission, ``as
appropriate'' when setting limits, to establish them for the spot
month, each other month, and all months; and sets forth four policy
objectives the Commission must pursue ``to the maximum extent
practicable.'' \424\ The Commission described these as ``constraints''
and found it ``unlikely'' that Congress intended to place new
constraints on the Commission's preexisting authority to establish
position limits, given the background of the amendments and in
particular the studies that preceded their enactment.\425\ However, on
further consideration of this statutory language, the Commission does
not interpret that language as a set of constraints in the sense of
directing the Commission to make less use of limits or to impose higher
limits than in the past. Rather, it focuses the Commission's decision
process by identifying relevant objectives and directing the Commission
to achieve them to the maximum extent practicable. Requiring the
Commission to prioritize, to the extent practicable, preventing
excessive speculation and manipulation, ensuring liquidity, and
avoiding disruption of price discovery is reasonable regardless of
whether there is an across-the-board mandate.
---------------------------------------------------------------------------
\424\ 7 U.S.C. 6a(a)(3).
\425\ E.g., 2016 Reproposal, 81 FR at 96716 (discussing comments
on earlier releases).
---------------------------------------------------------------------------
In past releases the Commission has also suggested that it is
unclear why Congress would have imposed the decisional ``constraints''
of paragraph 4a(a)(3) ``with respect to physical commodities but not
excluded commodities or others'' unless this provision was enacted as
part of a mandate to impose limits without a necessity finding.\426\
However, all of these relevant amendments pertain only to physical
commodities other than excluded commodities. The Congressional studies
that preceded the enactment of paragraph 4a(a)(2) demonstrated concern
specifically with problems in markets for physical commodities such as
oil and natural gas.\427\ It therefore is not surprising that Congress
enacted provisions specifically addressing limits for physical
commodities and not others, whether or not Congress intended a
necessity finding. Those physical commodities were the focus of
Congress' concern.
---------------------------------------------------------------------------
\426\ Id.
\427\ See, e.g., 2013 Proposal, 78 FR at 75682 and nn.24-26
(describing Congressional studies).
---------------------------------------------------------------------------
3. The Commission has previously stated that the time requirements
for establishing limits set forth in subparagraph 4a(a)(2)(B) are
inconsistent with a necessity finding because, based on past
experience, necessity findings for individual commodity markets cannot
be made
[[Page 11662]]
within the specified time periods.\428\ However, the fact that many
decades ago a number of months may have elapsed between proposals and
final position limits does not mean that much time was necessary then
or is necessary now. There are a number of possible reasons, such as
limits on agency resources and why the agency took that amount of time.
It is not a like-to-like comparison, because the agencies acting many
decades ago were not acting pursuant to a mandate. The speed with which
an agency could or would enact discretionary position limits is not
necessarily a good proxy for how long would be required under a
mandate.\429\ There is accordingly no inconsistency, and thus the
deadlines do not necessarily imply that Congress intended to eliminate
a necessity finding for limits under paragraph 4a(a)(2).
---------------------------------------------------------------------------
\428\ E.g., 2016 Reproposal, 81 FR at 96708; 2013 Proposal, 78
FR at 75682, 75683.
\429\ The Commission's reasoning in this respect has also
assumed that a necessity finding means a granular market-by-market
study of whether position limits will be useful for a given
contract. As explained below, however, the Commission here
preliminarily determines that such an analysis is not required.
Under the Commission's current preliminary interpretation of the
necessity finding requirement, it would have been plausible to
complete the required findings under the deadlines Congress
established.
---------------------------------------------------------------------------
4. The Commission previously has stated that Congress appears to
have modeled the text of paragraph 4a(a)(2) on the text of the
Commission's 1981 rule requiring exchanges to set speculative position
limits for all contracts.\430\ The Commission has further stated that
the 1981 rule treated aggregation and flexibility as ``standards,'' and
Congress therefore likely did the same in paragraph 4a(a)(2).\431\ The
Commission no longer agrees with that description or that reasoning.
---------------------------------------------------------------------------
\430\ E.g., 2013 Proposal, 78 FR at 75683, 75684.
\431\ Id.
---------------------------------------------------------------------------
Under the 1981 rule, former section 1.61(a) of the Commission's
regulations required exchanges to adopt position limits for all
contracts listed to trade.\432\ The rule also established requirements
similar to the current statutory aggregation requirements: Section
1.61(a) required that limits apply to positions a person may either
``hold'' or ``control,'' \433\ section 1.61(g) established more
detailed aggregation requirements.\434\ Section 1.61(a)(1) contained
language the Commission has called the ``flexibility standard,'' i.e.,
that ``nothing'' in section 1.61 ``shall be construed to prohibit a
contract market from fixing different and separate position limits for
different types of futures contracts based on the same commodity,
different position limits for different futures, 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.'' \435\ Section 1.61(d)(1) of the rule required every
exchange to submit information to the Commission demonstrating that it
had ``complied with the purpose and standards set forth in paragraph
(a).'' \436\ In the 2013 and 2016 proposals, the Commission concluded
that the cross-reference to the ``standards set forth in paragraph
(a)'' meant both the aggregation and flexibility language, because both
of those sets of language appear in paragraph (a). By contrast,
paragraph (a) did not include a requirement for a necessity finding,
since the 1981 rule required position limits on all actively traded
contracts.\437\
---------------------------------------------------------------------------
\432\ Establishment of Speculative Position Limits, 46 FR at
50945 (Oct. 16, 1981).
\433\ Id.
\434\ Id. at 50946.
\435\ Id. at 50945.
\436\ Id.
\437\ Id.
---------------------------------------------------------------------------
On further review, the Commission does not find this reasoning
persuasive. The ``flexibility'' language gave the exchange unfettered
discretion to set different limits for different kinds of positions--
there was expressly ``nothing'' in that language to limit the
exchange's discretion.\438\ In other words, there is nothing in that
flexibility text with which to ``comply,'' so it cannot be part of what
section 1.61(d)(1) referenced as a ``standard'' for which compliance
must be demonstrated.
---------------------------------------------------------------------------
\438\ 46 FR at 50945 (section 1.61(a)(1)).
---------------------------------------------------------------------------
As discussed above, ``standard'' is an ill-fitting label for this
lack of a prohibition. Indeed, the 1981 release and associated 1980
NPRM did use the word ``standard'' to refer to certain language
directing and constraining the discretion of the exchanges, a much more
natural use of that word. For example, the preambles to both releases
called requirements to aggregate certain holdings ``aggregation
standards.'' \439\ And, in both the 1980 NPRM (in the preamble) and the
1981 Final Rule (in rule text), the Commission used the word
``standard'' to describe factors, such as position sizes customarily
held by speculative traders, that exchanges were required to consider
in setting the level of position limits.\440\
---------------------------------------------------------------------------
\439\ Id. at 50943; Speculative Position Limits, 45 FR at 79834.
\440\ 46 FR at 50945 (in section 1.61(a)(2)); 45 FR at 79833,
79834.
---------------------------------------------------------------------------
Although the wording of the 1981 rule and paragraph 4a(a)(2) have
similarities, there are also differences. These differences weaken the
inference that Congress intended the statute to hew closely to the
rule. There is no legislative history articulating any relationship
between the two. And even if Congress in Dodd-Frank did borrow concepts
from the 1981 rule, there is little reason to infer that Congress was
borrowing the precise meaning of any individual word--much less that
the use of ``standards'' includes what ``nothing in this section shall
be construed to prohibit . . . .''
5. In past releases the Commission has also observed that, in 1983,
as part of the Futures Trading Act of 1982, Public Law 96-444, 96 Stat.
2294 (1983), Congress added a provision to the CEA making it a
violation of the Act to violate exchange-set position limits, thus, in
effect, ratifying the Commission's 1981 rule.\441\ The Commission
reasoned that this history supports the possibility that Congress could
reasonably have followed an across-the-board approach here.\442\ But
while that may be so, the Commission today does not find that mere
possibility helpful in interpreting the ambiguous term ``standards,''
because there is no evidence that Congress in 1982 considered the lack
of a prohibition on different position limit levels in the rule to be a
``standard.'' By extension, the Futures Trading Act does not bear on
the Commission's preliminary interpretation of ``standards'' in section
4a(a)(2)(A) today.
---------------------------------------------------------------------------
\441\ See, e.g., 2016 Reproposal, 81 FR at 96709, 96710.
\442\ Id. at 96710.
---------------------------------------------------------------------------
6. In briefs in the ISDA case, the Commission pointed out that CEA
paragraphs 4a(a)(2)(B) and 4a(a)(3) repeatedly use the word
``required'' in connection with position limits established pursuant to
paragraph 4a(a)(2), implying that the Commission is required to
establish those limits regardless of whether it finds them to be
necessary.\443\ But that is not the only way to interpret the word
``required.'' Position limits are required under certain circumstances
even if there is no across-the-board mandate--i.e., when the Commission
finds that they are ``necessary.'' Under the Commission's current
preliminary interpretation, the Commission was required to assess
within a specified timeframe if position limits were ``necessary'' and,
if so, section 4a(a)(2) states that the Commission ``shall'' establish
them.
[[Page 11663]]
Thus, the word ``required'' in paragraphs 4a(a)(2)(B) and 4a(a)(3)
leaves open the question of whether paragraph 4a(a)(2) itself requires
position limits for all physical commodity contracts or, on the other
hand, only requires them where the Commission finds them necessary
under the standards of paragraph 4a(a)(1). The use of the word
``required'' in paragraphs 4a(a)(2)(B) and 4a(a)(3) therefore does not
resolve the ambiguity in the statute. For the same reason, the
evolution of the statutory language during the legislative process,
during which the word ``may'' was changed to ``shall'' in a number of
places, also does not resolve the ambiguity.\444\
---------------------------------------------------------------------------
\443\ E.g., ISDA, Brief for Appellant Commodity Futures Trading
Commission at 26-27.
\444\ See, e.g., 2013 Proposal, 78 FR at 75684, 75685
(discussing evolution of statutory language as supporting mandate).
---------------------------------------------------------------------------
7. The Commission has pointed out that section 719 of the Dodd-
Frank Act required the Commission to ``conduct a study of the effects
(if any) of the position limits imposed'' pursuant to paragraph
4a(a)(2) and report the results to Congress within twelve months after
the imposition of limits.\445\ The Commission has suggested that
Congress would not have required such a study if paragraph 4a(a)(2)
left the Commission with discretion to find that limits were
unnecessary so that there would be nothing for the Commission to study
and report on to Congress.\446\ However, while the study requirement
implies that Congress perhaps anticipated that at least some limits
would be imposed pursuant to paragraph 4a(a)(2), it leaves open the
question of whether Congress mandated limits for every physical
commodity without the need for a necessity finding. In addition, the
phrase ``the effects (if any)'' language does not imply that Congress
expected position limits on all physical commodities. This language
simply recognizes that new position limits could be imposed, but have
no demonstrable effects.
---------------------------------------------------------------------------
\445\ See, e.g., id. at 75684.
\446\ See, e.g., id.
---------------------------------------------------------------------------
8. In past releases and court filings, the Commission has stated
that the legislative history of section 4a, as amended by the Dodd-
Frank Act, supports the conclusion that paragraph 4a(a)(2) requires the
establishment of position limits for all physical commodities whether
or not the Commission finds them necessary to achieve the objectives of
the statute.\447\ However, the most relevant legislative history, taken
as a whole, does not resolve the ambiguity in the statutory language or
compel the conclusion that Congress intended to drop the necessity
finding requirement when it enacted paragraph 4a(a)(2) as part of the
Dodd-Frank Act.
---------------------------------------------------------------------------
\447\ See, e.g., 2016 Reproposal, 81 FR at 96709.
---------------------------------------------------------------------------
The language of paragraph 4a(a)(2) derives from section 6(a) of a
bill, the Derivatives Markets Transparency and Accountability Act of
2009, H.R. 977 (111th Cong.), which was approved by the House Committee
on Agriculture in February of 2009.\448\ The committee report on this
bill included explanatory language stating that the relevant provision
required the Commission to set position limits ``for all physical
commodities other than excluded commodities.'' \449\ However, H.R. 977
was never approved by the full House of Representatives.\450\
---------------------------------------------------------------------------
\448\ See H.R. Rep. 111-385 part 1 at 4 (Dec. 19, 2009).
\449\ Id. at 19.
\450\ See Actions--H.R.977--111th Congress (2009-2010)
Derivatives Markets Transparency and Accountability Act of 2009,
Congress website, available at https://www.congress.gov/bill/111th-congress/house-bill/977/all-actions?overview=closed#tabs (bill
history).
---------------------------------------------------------------------------
The relevant language concerning position limits was incorporated
into the House of Representatives version of what became the Dodd-Frank
Act, H.R. 4173 (111th Cong.), as part of a floor amendment that was
introduced by the chairman of the Committee on Agriculture.\451\ In
explaining the amendment's language regarding position limits, the
chairman stated that it ``strengthens confidence in position limits on
physically deliverable commodities as a way to prevent excessive
speculation trading'' but did not specify that limits would be required
for all physical commodities without the need for a necessity
finding.\452\ The House of Representatives language regarding position
limits was ultimately incorporated into the Dodd-Frank Act by a
conference committee. However, the explanatory statement in the
Conference report states, with respect to position limits, only that
the act's ``regulatory framework outlines provisions for: . . .
[p]osition limits on swaps contracts that perform or affect a
significant price discovery function and requirements to aggregate
limits across markets.'' \453\
---------------------------------------------------------------------------
\451\ 155 Cong. Rec. H14682, H14692 (daily ed. Dec. 10, 2009).
\452\ Id. at H14705.
\453\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Conference Report to Accompany H.R. 4173 at 969 (H.R. Rep. 111-517
June 29, 2010).
---------------------------------------------------------------------------
In subsequent floor debate, the chairman of the House Agriculture
Committee alluded to position limits provisions deriving from earlier
bills reported by that committee, but did not describe them with
specificity.\454\ In the Senate, the chairman of the Senate Committee
on Agriculture, Nutrition, and Forestry stated that the conference bill
would ``grant broad authority to the Commodity Futures Trading
Commission to once and for all set aggregate position limits across all
markets on non-commercial market participants.'' \455\ The statement
that the bill would grant ``authority'' to set position limits implies
an exercise of judgement by the Commission in determining whether to
set particular limits.\456\ Thus, this legislative history is itself
ambiguous on the question of whether federal position limits are now
mandatory on all physical commodities in the absence of a finding of
necessity.
---------------------------------------------------------------------------
\454\ He stated, ``This conference report includes the tools we
authorized [in response to concerns about excessive speculation] and
the direction to the CFTC to mitigate outrageous price spikes we saw
2 years ago.'' 156 Cong. Rec. H5245 (daily ed. June 30, 2010).
\455\ 156 Cong. Rec. S5919 (daily ed. July 15, 2010).
\456\ In addition, the remainder of the Senate chairman's floor
statement with regard to position limits focused on volatility and
price discovery problems arising from the use of commodity swaps,
implying that her reference to setting position limits ``across all
markets'' refers to Dodd-Frank's extension of position limits
authority to swaps markets. 156 Cong. Rec. at S5919-20 (daily ed.
July 15, 2010).
---------------------------------------------------------------------------
Looking at legislative history in more general terms, the
Commission, in past releases, has pointed out that the enactment of
paragraph 4a(a)(2) followed congressional investigations in the late
1990s and early 2000s that concluded that excessive speculation
accounted for volatility and prices increases in the markets for a
number of commodities.\457\ However, while the history of congressional
investigations supports the conclusion that Congress intended the
Commission to take action with respect to position limits, it does not
resolve the specific interpretive issue of whether the ``[i]n
accordance with the standards set forth in paragraph (1)'' language
that was ultimately enacted by Congress incorporates a necessity
finding. As discussed above, the congressional investigations focused
on only a few commodities, which weakens the inference that Congress
considered the question of what speculative positions to limit a closed
question.
---------------------------------------------------------------------------
\457\ See, e.g., 2016 Reproposal, 81 FR at 96711-96713.
---------------------------------------------------------------------------
Overall, in past releases the Commission has expressed the view
that construing section 4a as an ``integrated whole'' leads to the
conclusion that paragraph 4a(a)(2) does not require a
[[Page 11664]]
necessity finding.\458\ However, for reasons explained above, the
Commission preliminarily believes that the better interpretation is
that prior to imposing position limits, it must make a finding that the
position limits are necessary.
---------------------------------------------------------------------------
\458\ See, e.g., 2016 Reproposal, 81 FR at 96713, 96714.
---------------------------------------------------------------------------
F. Necessity Finding
The Commission preliminarily finds that federal speculative
position limits are necessary for the 25 core referenced futures
contracts, and any associated referenced contracts. This preliminary
finding is based on a combination of factors including: The particular
importance of these contracts in the price discovery process for their
respective underlying commodities; the fact that they require physical
delivery of the underlying commodity; and, in some cases, the
especially acute economic burdens that would arise from excessive
speculation causing sudden or unreasonable fluctuations or unwarranted
changes in the price of the commodities underlying these contracts. The
Commission has preliminarily determined that the benefit of advancing
the statutory goal of preventing those undue burdens with respect to
these commodities in interstate commerce justifies the potential
burdens or negative consequences associated with establishing these
targeted position limits.\459\
---------------------------------------------------------------------------
\459\ As discussed, the Commission is not proposing non-spot-
month limits apart from the legacy agricultural contracts. Non-spot-
month prices serve as references for cash-market transactions much
less frequently than spot-month prices. Accordingly, the burdens of
excessive speculation in non-spot-months on commodities in
interstate commerce would be substantially less than the burdens of
excessive speculation in spot-months. It is also not possible to
execute a corner or squeeze in non-spot-months. And because there
generally are fewer market participants in non-spot-months, holders
of large speculative positions may play a more important role in
providing liquidity to bona fide hedgers.
---------------------------------------------------------------------------
1. Meaning of ``Necessary'' Under Section 4a(a)(1)
Section 4a(a)(1) of the Act contains a congressional finding that
``[e]xcessive speculation . . . causing sudden or unreasonable
fluctuations or unwarranted changes in . . . price . . . is an undue
and unnecessary burden on interstate commerce in such commodity.''
\460\ For the purpose of ``diminishing, eliminating, or preventing''
that burden, section 4a(a)(1) tasks the Commission with establishing
such position limits as it finds are ``necessary.'' \461\ The
Commission's analysis, therefore, proceeds on the basis of these
legislative findings that excessive speculation threatens negative
consequences for interstate commerce and the accompanying proposition
that position limits are an effective tool to diminish, eliminate, or
prevent the undue and unnecessary burdens Congress has targeted in the
statute.\462\ The Commission will therefore determine whether position
limits are necessary for a given contract, in light of those premises,
considering facts and circumstances and economic factors.
---------------------------------------------------------------------------
\460\ 7 U.S.C. 6a(a)(1).
\461\ 7 U.S.C. 6a(a)(1).
\462\ It is not the Commission's role to determine if these
findings are correct. See Public Citizen v. FTC, 869 F.2d 1541, 1557
(D.C. Cir. 1989) (``[A]gencies surely do not have inherent authority
to second-guess Congress' calculations.''); see also 46 FR at 50938,
50940 (``Section 4a(1) [now 4a(a)(1)] represents an express
Congressional finding that excessive speculation is harmful to the
market, and a finding that speculative limits are an effective
prophylactic measure.'').
---------------------------------------------------------------------------
The statute does not define ``necessary.'' In legal contexts, the
term can have ``a spectrum of meanings.'' \463\ ``At one end, it may
`import an absolute physical necessity, so strong, that one thing, to
which another may be termed necessary, cannot exist without that
other;' at the opposite, it may simply mean `no more than that one
thing is convenient, or useful, or essential to another.' '' \464\ The
Commission does not believe Congress intended either end of this
spectrum in section 4a(a)(1). On one hand, ``necessary'' in this
context cannot mean that position limits must be the only means capable
of addressing the burdens associated with excessive speculation. The
Act contains numerous provisions designed to prevent, diminish, or
eliminate price disruptions or distortions or unreasonable volatility.
For example, the Commission's anti-manipulation authority is designed
to stop, redress, and deter intentional acts that may give rise to
uneconomic prices or unreasonable volatility.\465\ Other examples
include prohibitions on disruptive trading practices,\466\ certain core
principles for contract markets,\467\ and the Commission's emergency
powers.\468\
---------------------------------------------------------------------------
\463\ Jewell v. Life Ins. Co. of N. Am., 508 F.3d 1303, 1310
(10th Cir. 2007).
\464\ Jewell v. Life Ins. Co. of N. Am., 508 F.3d 1303, 1310
(10th Cir. 2007); see also Black's Law Dictionary 1227 (3d ed. 1933)
(``As used in jurisprudence, the word `necessary' does not always
import an actual physical necessity, so strong that one thing, to
which another may be termed `necessary,' cannot exist without the
other. . . . To employ the means necessary to an end is generally
understood as employing any means calculated to produce the end, and
not as being confined to those single means without which the end
would be entirely unattainable.'' (citing McCullouch v. Maryland, 4
Wheat. 216, 4 L. Ed. 579 (1819)).
\465\ 7 U.S.C. 9(1), 9(3), 13(a)(2).
\466\ 7 U.S.C. 6c(a).
\467\ 7 U.S.C. 7(d).
\468\ 7 U.S.C. 12a(9).
---------------------------------------------------------------------------
Yet the Commission is directed by section 4a(a)(1) not only to
impose position limits to diminish or eliminate sudden and unwarranted
fluctuations in price caused by excessive speculation once those other
protections have failed, it is directed to establish position limits as
necessary to ``prevent'' those burdens on interstate commerce from
arising in the first place. It makes little sense to suppose that
Congress meant for the Commission to ``prevent'' unreasonable
fluctuations or unwarranted price changes caused by excessive
speculation only after they have already begun to occur, or when the
Commission can somehow predict with confidence that the Act's other
tools will be absolutely ineffective.\469\ The Act uses the word
``necessary'' in a number of places to authorize measures it is highly
unlikely Congress meant to apply only where the relevant policy goals
will otherwise certainly fail.\470\
---------------------------------------------------------------------------
\469\ See Nat. Res. Def. Council, Inc. v. Thomas, 838 F.2d 1224,
1236-37 (D.C. Cir. 1988) (``[A] measure may be 'necessary' even
though acceptable alternatives have not been exhausted.''); F.T.C.
v. Rockefeller, 591 F.2d 182, 188 (2d Cir. 1979) (rejecting ``the
notion that 'necessary' means that the [Federal Trade Commission]
must pursue all other `reasonably available alternatives''' before
undertaking the measure at issue). Indeed, where the Commission
considers setting such prophylactic limits, it is unlikely to be
knowable whether position limits will be the only effective tool.
The existence of other tools to prevent unwarranted volatility and
price changes may be relevant, but cannot be dispositive in all
cases.
\470\ See, e.g., 7 U.S.C. 2(h)(4)(A) (empowering the Commission
to prescribe rules ``as determined by the Commission to be necessary
to prevent evasions of the mandatory clearing requirements''); 7
U.S.C. 2(h)(4)(B)(iii) (requiring that the Commission ``shall'' take
such actions ``as the Commission determines to be necessary'' when
it finds that certain swaps subject to the clearing requirement are
not listed by any derivatives clearing organization); 7 U.S.C. 21(e)
(subjecting registered persons to such ``rules and regulations as
the Commission may find necessary to protect the public interest and
promote just and equitable principles of trade.'').
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On the other hand, the Commission also does not believe that
Congress intended position limits where they are merely ``useful'' or
``convenient.'' As explained above, Congress has already determined
that position limits are useful in preventing undue burdens on
interstate commerce associated with excessive speculation, but requires
the Commission to make the further finding that they are also
necessary. A ``convenience'' standard would be similarly toothless.
Rather than accepting either extreme, the Commission preliminarily
interprets that sections 4a(a)(1) and 4a(a)(2) direct the Commission to
establish position
[[Page 11665]]
limits where the Commission finds, based on the relevant facts and
circumstances, that position limits would be an efficient mechanism to
advance the congressional goal of preventing undue burdens on
interstate commerce in the given underlying commodity caused by
excessive speculation. For example, it may be that for a given
commodity, volatility in derivatives markets would be unlikely to cause
high levels of sudden or unreasonable fluctuations or unwarranted
changes in the price of the underlying commodity and would have little
overall impact on the national economy/interstate commerce. Under those
circumstances, the Commission may find that position limits are
unnecessary. There are, however, also contract markets in which
volatility would be highly likely to cause sudden or unreasonable
fluctuations or unwarranted changes in the price of the underlying
commodity or have significantly negative effects on the broader
economy. Even if such disruptions would be unlikely due to the
characteristics of an individual market, the Commission may
nevertheless determine that position limits are necessary as a
prophylactic measure given the potential magnitude or impact of the
event.\471\
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\471\ The Commission will also be mindful that the undue burdens
Congress tasked the Commission with diminishing, eliminating, or
preventing would not generally be borne exclusively by speculators
or other participants in futures and swaps markets, but instead the
public at large or a certain industry or sector of the economy. In a
given context, the Commission may find that this factor supports a
finding that position limits are necessary.
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Most commodities lie somewhere in between, with varying degrees of
linkage between derivative contracts and cash-market prices, and
differences in importance to the overall economy. There is no
mathematical formula to make this determination, though the Commission
will consider relevant data where it is available. The Commission must
instead exercise its judgment in light of facts and circumstances,
including its experience and expertise, to determine what limits are
economically justified.\472\ In all instances, the Commission will
consider the applicable costs and benefits as required under section
15(a) of the Act.\473\ With this interpretation of ``necessary'' in
mind, the Commission below explains its selection of the 25 core
referenced futures contracts, and any associated referenced contracts.
Going forward, the Commission will make this assessment ``from time to
time'' as required under section 4a(a)(1).
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\472\ The Commission is well positioned to select from among all
commodities within the scope of 4a(a)(1) and (2)(A), from its
ongoing regulatory activities, including but not limited to market
surveillance and product review.
\473\ 7 U.S.C. 19(a).
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The Commission recognizes that this approach differs from that
taken in earlier necessity findings. For example, when the Commission's
predecessor agency, the Commodity Exchange Commission (``CEC''),
established position limits, it would publish them in the Federal
Register along with necessity findings that were generally conclusory
recitations of the statutory language.\474\ The published basis would
be a recitation that trading of a given commodity for future delivery
by a person who holds or controls a net position in excess of a given
amount tends to cause sudden or unreasonable fluctuations or changes in
the price of that commodity, not warranted by changes in the conditions
of supply and demand.\475\ Apart from that, the CEC typically would
refer to a public hearing, but provide no specifics of the evidence
presented or what the CEC found persuasive.\476\ The CEC variously
imposed limits one commodity at a time, or for several commodities at
once.\477\
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\474\ See, e.g., Limits on Position and Daily Trading in
Soybeans for Future Delivery, 16 FR at 8107 (Aug. 16, 1951);
Findings of Fact, Conclusions, and Order in the Matter of Limits on
Position and Daily Trading in Cotton for Future Delivery, 5 FR at
3198 (Aug. 28, 1940); In re Limits on Position and Daily Trading in
Wheat, Corn, Oats, Barley, Rye, and Flaxseed, for Future Delivery, 3
FR at 3146, 3147 (Dec. 24, 1938).
\475\ See, e.g., Limits on Position and Daily Trading in
Soybeans for Future Delivery, 16 FR at 8107 (Aug. 16, 1951);
Findings of Fact, Conclusions, and Order in the Matter of Limits on
Position and Daily Trading in Cotton for Future Delivery, 5 FR at
3198 (Aug. 28, 1940); In re Limits on Position and Daily Trading in
Wheat, Corn, Oats, Barley, Rye, and Flaxseed, for Future Delivery, 3
FR at 3146, 3147 (Dec. 24, 1938).
\476\ The records available from the National Archives during
this period are sparse.
\477\ Compare 5 FR at 3198 (cotton) with 3 FR at 3146, 3147 (six
types of grain).
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In 1981, the Commission issued a rule directing all exchanges to
establish position limits for each contract not already subject to
federal limits, and for which delivery months were listed to
trade.\478\ There, as here, the Commission explained that section
4a(a)(1) represents an ``express Congressional finding that excessive
speculation is harmful to the market, and a finding that speculative
limits are an effective prophylactic measure.'' \479\ The Commission
observed that all futures markets share the salient characteristics
that make position limits a useful tool to prevent the potential
burdens of excessive speculation. Specifically, ``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.'' \480\
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\478\ 46 FR at 50945.
\479\ Id. at 50938, 50940. Section 4a(a)(1) was at the time
numbered 4a(1).
\480\ 46 FR at 50940 (Oct. 16, 1981). The Commission based this
finding in part upon then-recent events in the silver market, an
apparent reference to the corner and squeeze perpetrated by members
of the Hunt family in 1979 and 1980.
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In 2013, the Commission proposed a necessity finding applicable to
all physical commodities, and then reproposed it in 2016. In that
finding, the Commission discussed incidents in which the Hunt family in
1979 and 1980 accumulated unusually large silver positions, and in
which Amaranth Advisors L.L.C. in 2006 accumulated unusually large
natural gas positions.\481\ The Commission preliminarily determined
that the size of those positions contributed to unwarranted volatility
and price changes in those respective markets, which imposed undue
burdens on interstate commerce, and that position limits could have
prevented this.\482\ The Commission here preliminarily finds those
parts of the 2013 and 2016 proposed necessity finding to be beside the
point, because Congress has already determined that excessive
speculation can place undue burdens on interstate commerce in a
commodity, and that position limits can diminish, eliminate, or prevent
those burdens. In 2013 and 2016, the Commission also considered
numerous studies concerning position limits.\483\ To the extent that
those studies merely examined whether or not position limits are an
effective tool, the Commission here does not find them directly
relevant, again because Congress has already determined that position
limits can be effective to diminish, eliminate, or prevent sudden or
unreasonable fluctuations or unwarranted changes in commodity
prices.\484\
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\481\ 2013 Proposal, 78 FR at 75686, 75693.
\482\ Id. at 75691, 75193.
\483\ See 2016 Reproposal, 81 FR at 96894, 96924.
\484\ In any event, the Commission found those studies
inconclusive. 2016 Reproposal, 81 FR at 96723.
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In the 2013 and 2016 necessity findings, the Commission stated
again that ``all markets in physical commodities'' are susceptible to
the burdens of excessive speculation because all such markets have a
finite ability to absorb the establishment and liquidation of large
speculative positions in an orderly manner.\485\ The
[[Page 11666]]
Commission here, however, preliminarily determines that this
characteristic is not sufficient to support a finding that position
limits are ``necessary'' for all physical commodities, within the
meaning of section 4a(a)(1). Congress has already determined that
excessive speculation can give rise to unwarranted burdens on
interstate commerce and that position limits can be an effective tool
to eliminate, diminish, or prevent those burdens. Yet the statute
directs the Commission to establish position limits only when they are
``necessary.'' In that context, the Commission considers it unlikely
that Congress intended the Commission to find that position limits are
``necessary'' even where facts and circumstances show the significant
potential that they will cause disproportionate negative consequences
for markets, market participants, or the commodity end users they are
intended to protect. Similarly, because the Commission has
preliminarily determined that section 4a(a)(2) does not mandate federal
speculative position limits for all physical commodities,\486\ it
cannot be that federal position limits are ``necessary'' for all
physical commodities, within the meaning of section 4a(a)(1), on the
basis of a property shared by all of them, i.e., a limited capacity to
absorb the establishment and liquidation of large speculative positions
in an orderly fashion.
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\485\ 2016 Reproposal, 81 FR at 96722; see also Corn Products
Refining Co. v. Benson, 232 F.2d 554, 560 (1956) (finding it
``obvious that transactions in such vast amounts as those involved
here might cause `sudden or unreasonable fluctuations in the price'
of corn and hence be an undue and unnecessary burden on interstate
commerce'' (alteration omitted)).
\486\ See supra Section III.D.
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The Commission requests comments on all aspects of this
interpretation of the requirement in section 4a(a)(1) of a necessity
finding.
2. Necessity Findings as to the 25 Core Referenced Futures Contracts
As noted above, the proposed rule would impose federal position
limits on: 25 core referenced futures contracts, including 16
agricultural products, five metals products, and four energy products;
any futures or options on futures directly or indirectly linked to the
core referenced futures contracts; and any economically equivalent
swaps. As discussed above, the Commission's necessity analysis proceeds
on the basis of certain propositions reflected in the text of section
4a(a)(1): First, that excessive speculation in derivatives markets can
cause sudden or unreasonable fluctuations or unwarranted changes in the
price of an underlying commodity, i.e., fluctuations not attributable
to the forces of supply of and demand for that underlying commodity;
second, that such price fluctuations and changes are an undue and
unnecessary burden on interstate commerce in that commodity, and;
third, that position limits can diminish, eliminate, or prevent that
burden. With those propositions established by Congress, the
Commission's task is to make the further determination of whether it is
necessary to use position limits, Congress's prescribed tool to address
those burdens on interstate commerce, in light of the facts and
circumstances. Unlike prior preliminary necessity findings which
focused on evidence of excessive speculation in just wheat and natural
gas, this necessity finding addresses all 25 core referenced futures
contracts and focuses on two interrelated factors: (1) The importance
of the derivatives markets to the underlying cash markets, including
whether they call for physical delivery of the underlying commodity;
and (2) the importance of the cash markets underlying the referenced
futures contracts to the national economy. The Commission will apply
the relevant facts and circumstances holistically rather than
formulaically, in light of its experience and expertise.
With respect to the first factor, the markets for the 25 core
referenced futures contracts are large in terms of notional value and
open interest, and are critically important to the underlying cash
markets. These derivatives markets enable food processors, farmers,
mining operations, utilities, textile merchants, confectioners, and
others to hedge the risks associated with volatile changes in price
that are the hallmark of cash commodity markets.
Futures markets were established to allow industries that are vital
to the U.S. economy and critical to the American public to accurately
manage future receipts, expenses, and financial obligations with a high
level of certainty. In general, futures markets perform valuable
functions for society such as ``price discovery'' and by allowing
counterparties to transfer price risk to their counterparty. The risk
transfer function that the futures markets facilitate allows someone to
hedge against price movements by establishing a price for a commodity
for a time in the future. Prices in derivatives markets can inform the
cash market prices of, for example, energy used in homes, cars,
factories, and hospitals. More than 90 percent of Fortune 500 companies
use derivatives to manage risk, and over 50 percent of all companies
use derivatives in physical commodity markets such as the 25 core
referenced futures contracts.\487\
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\487\ ISDA Survey of the Derivatives Usage by the World's
Largest Companies 2009. It has also been estimated that the use of
commercial derivatives added 1.1 percent to the size of the U.S.
economy between 2003 and 2012. See Apanard Prabha et al., Deriving
the Economic Impact of Derivatives, (Mar. 2014), available at http://assets1b.milkeninstitute.org/assets/Publication/ResearchReport/PDF/Derivatives-Report.pdf.
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The 25 core referenced futures contracts are vital for establishing
reliable commodity prices and enabling the beneficial risk transfer
between buyers and sellers of commodities, allowing participants to
hedge risk and undertake planning with greater certainty. By providing
a highly efficient marketplace for participants to offset risks, the 25
core referenced futures contracts attract a broad range of
participants, including farmers, ranchers, producers, utilities,
retailers, investors, banking institutions, and others. These
participants hedge production costs and delivery prices so that, among
other things, consumers can always find plenty of food at reliable
prices on the grocery store shelves.
Futures prices are used for pricing of cash market transactions but
also serve as economic signals that help various members of society
plan. These signals help farmers decide which crops to plant as well as
assist producers to decide how to implement their production processes
given the anticipated costs of various inputs and the anticipated
prices of any anticipated finished products, and they serve similar
functions in other areas of the economy. For the commodities that are
the subject of this necessity finding, the Commission preliminarily has
determined that there is a significant amount of participation in these
commodity markets, both directly and indirectly, through price
discovery signals.\488\
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\488\ The Commission observes that there has been much written
in the academic literature about price discovery of the 25 core
referenced futures contracts. This demonstrates the importance of
the commodities underlying such contracts in our society. The
Commission's Office of the Chief Economist conducted a preliminary
search on the JSTOR and Science Direct academic research databases
for journal articles that contain the key words: Price Discovery
Futures. While the articles made varying
conclusions regarding aspects of the futures markets, and in some
cases position limits, almost all articles agreed that the futures
markets in general are important for facilitating price discovery
within their respective markets.
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Two key features of the 25 core referenced futures contracts are
the role they play in the price discovery process for their respective
underlying commodities and the fact that they
[[Page 11667]]
require physical delivery of the underlying commodity. Price discovery
is the process by which markets, through the interaction of buyers and
sellers, produce prices that are used to value underlying futures
contracts that allow society to infer the value of underlying physical
commodities. Adjustments in futures market requirements and valuations
by a diverse array of futures market participants, each with different
perspectives and access to supply and demand information, can result in
adjustments to the pricing of the commodities underlying the futures
contract. The futures markets are generally the first to react to such
price-moving information, and price movements in the futures markets
reflect a judgment of what is likely to happen in the future in the
underlying cash markets. The 25 core referenced futures contracts were
selected in part because they generally serve as reference prices for a
large number of cash-market transactions, and the Commission knows from
large trader reporting that there is a significant presence of
commercial traders in these contracts, many of whom may be using the
contracts for hedging and price discovery purposes.
For example, a grain elevator may use the futures markets as a
benchmark for the price it offers local farmers at harvest. In return,
farmers look to futures prices to determine for themselves whether they
are getting fair value for their crops. The physical delivery mechanism
further links the cash and futures markets, with cash and futures
prices expected to converge at settlement of the futures contract.\489\
In addition to facilitating price convergence, the physical delivery
mechanism allows the 25 core referenced futures contracts to be an
alternative means of obtaining or selling the underlying commodity for
market participants. While most physically-settled futures contracts
are rolled-over or unwound and are not ultimately settled using the
physical delivery mechanism, because the futures contracts have
standardized terms and conditions that reflect the cash market
commodity, participants can reasonably expect that the commodity sold
or purchased will meet their needs.\490\ This physical delivery and
price discovery process contributes to the complexity of the markets
for the 25 core referenced futures contracts. If these markets function
properly, American producers and consumers enjoy reliable commodity
prices. Excessive speculation causing sudden or unreasonable
fluctuations or unwarranted changes in the price of those commodities
could, in some cases, have far reaching consequences for the U.S.
economy by interfering with proper market functioning.
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\489\ Futures contracts are traded for settlement at a date in
the future. At a contract's delivery month and date, a commodity
cash market price and its futures price converge, allowing an
efficient transfer of physical commodities between buyers and
sellers of the futures contract.
\490\ Standardized terms and conditions for physically-settled
futures contracts typically include delivery quantities, qualities,
sizes, grades and locations for delivery that are commonly used in
the commodity cash market.
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The cash markets underlying the 25 core referenced futures
contracts are to varying degrees vitally important to the U.S. economy,
driving job growth, stimulating economic activity, and reducing trade
deficits while impacting everyone from consumers to automobile
manufacturers and farmers to financial institutions. These 25 cash
markets include some of the largest cash markets in the world,
contributing together, along with related industries, approximately 5
percent to the U.S. gross domestic product (``GDP'') directly and a
further 10 percent indirectly.\491\ As described in detail below, the
cash markets underlying the 25 core referenced futures contracts are
critical to consumers, producers, and, in some cases, the overall
economy.
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\491\ See The Bureau of Economic Analysis, U.S. Department of
Commerce, Interactive Access to Industry Economic Accounts Data: GDP
by Industry (Historical) that includes GDP contributions by U.S.
Farms, Oil & Gas extraction, pipeline transportation, petroleum and
coal products, utilities, mining and support activities, primary and
fabricated metal products and finance in securities, commodity
contracts and investments.
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By ``excessive speculation,'' the Commission here refers to the
accumulation of speculative positions of a size that threaten to cause
the ills Congress addressed in Section 4a--sudden or unreasonable
fluctuations or unwarranted changes in the price of the underlying
commodity. These potentially violent price moves in the futures markets
could impact producers such as utilities, farmers, ranchers, and other
hedging market participants. Such unwarranted volatility could result
in significant costs and price movements, compromising budgeting and
planning, making it difficult for producers to manage the costs of
farmlands and oil refineries, and impacting retailers' ability to
provide reliable prices to consumers for everything from cereal to
gasoline. To be clear, volatility is sometimes warranted in the sense
that it reflects legitimate forces of supply and demand, which can
sometimes change very quickly. The purpose of this proposed rule is not
to constrain those legitimate price movements. Instead, the
Commission's purpose is to prevent volatility caused by excessive
speculation, which Congress has deemed a potential burden on interstate
commerce.
Further, excessive speculation in the futures market could result
in price uncertainty in the cash market, which in turn could cause
periods of surplus or shortage that would not have occurred if prices
were more reliable. Properly functioning futures markets free from
excessive speculation are essential for hedging the volatility in cash
markets for these commodities that are the result of real supply and
demand. Specific attributes of the cash and derivatives markets for
these 25 commodities are discussed below.
3. Agricultural Commodities
Futures contracts on the 16 agricultural commodities are essential
tools for hedging against price moves of these widely grown crops, and
are key instruments in helping to smooth out volatility and to ensure
that prices remain reliable and that food remains on the shelves. These
agricultural futures contracts are used by grain elevators, farmers,
merchants, and others and are particularly important because prices in
the underlying cash markets swing regularly depending on factors such
as crop conditions, weather, shipping issues, and political events.
Settlement prices of futures contracts are made available to the
public by exchanges in a process known as ``price discovery.'' To be an
effective hedge for cash market prices, futures contracts should
converge to the spot price at expiration of the futures contract.
Otherwise, positions in a futures contract will be a less effective
tool to hedge price risk in the cash market since the futures positions
will less than perfectly offset cash market positions. Convergence is
so important for the 16 agricultural contracts that exchanges have
deliveries occurring during the spot month, unlike for the energy
commodities covered by this proposal.\492\ This delivery mechanism
helps to force convergence because shorts who can deliver cheaper than
the futures prices may do so, and longs can stand in for delivery if
it's cheaper to
[[Page 11668]]
obtain the underlying through the futures market than the cash market.
The Commission does not collect information on all cash market
transactions. Nevertheless, the Commission understands that futures
prices are often used by counterparties to settle many cash-market
transactions due to approximate convergence of the futures contract
price to the cash-market price at expiration.
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\492\ For energy contracts, physical delivery of the underlying
commodity does not occur during the spot month. This allows time to
schedule pipeline deliveries and so forth. Instead, a shipping
certificate (a financial instrument claim to the physical product),
not the underlying commodity, is the delivery instrument that is
exchanged at expiration of the futures contract.
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Agricultural futures markets are some of the most active, and open
interest on agricultural futures have some of the highest notional
value. The CBOT Corn (C) and CBOT Soybean (S) contracts, for example,
trade over 350,000 and 200,000 contracts respectively per day.\493\
Outstanding futures and options notional values range anywhere from
approximately $ 71 billion for CBOT Corn (C) to approximately $ 70
million for CBOT Oats (O), with the other core referenced futures
contracts on agricultural commodities all falling somewhere in
between.\494\
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\493\ CME Group website, available at https://www.cmegroup.com/trading/products/#pageNumber=1&sortAsc=false&sortField=oi.
\494\ Notional values here and throughout this section of the
release are derived from CFTC internal data obtained from the
Commitments of Traders Reports. Notional value means the U.S. dollar
value of both long and short contracts without adjusting for delta
in options. Data is as of June 30, 2019.
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The American agricultural market, including markets for the
commodities underlying the 16 agricultural core referenced contracts,
is foundational to the U.S. economy. Agricultural, food, and related
industries contributed $ 1.053 trillion to the U.S. economy in 2017,
representing 5.4 percent of U.S. GDP.\495\ In 2017, agriculture
provided 21.6 million full and part time jobs, or 11 percent of total
U.S. employment.\496\ Agriculture's contribution to international trade
is also sizeable. For fiscal year 2019, it was projected that
agricultural exports would exceed $ 137 billion, with imports at $ 129
billion for a net balance of trade of $ 8 billion.\497\ This balance of
trade is good for the nation and for American farmers. The U.S.
commodity futures markets have provided risk mitigation and pricing
that reflects the economic value of the underlying commodity to
farmers, ranchers, and producers.
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\495\ What is Agriculture's Share of the Overall U.S. Economy,
USDA Economic Research Services, available at https://www.ers.usda.gov/data-products/chart-gallery/gallery/chart-detail/?chartId=58270.
\496\ Ag and Food Sales and the Economy, USDA Economic Research
Services, available at https://www.ers.usda.gov/data-products/ag-and-food-statistics-charting-the-essentials/ag-and-food-sectors-and-the-economy.
\497\ Outlook for U.S. Agricultural Trade, USDA Economic
Research Services, available at https://www.ers.usda.gov/topics/international-markets-us-trade/us-agricultural-trade/outlook-for-us-agricultural-trade.
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The 16 agricultural core referenced futures contracts \498\ are key
drivers to the success of the American agricultural industry. The
commodities underlying these markets are used in a variety of consumer
products including: Ingredients in animal feeds for production of meat
and dairy (soybean meal and corn); margarine, shortening, paints,
adhesives, and fertilizer (soybean oil); home furnishings and apparel
(cotton); and food staples (corn, soybeans, wheat, oats, frozen orange
juice, cattle, rough rice, cocoa, coffee, and sugar).
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\498\ The 16 agricultural core referenced futures contracts are:
CBOT Corn (C), CBOT Oats (O), CBOT Soybeans (S), CBOT Soybean Meal
(SM), CBOT Soybean Oil (SO), CBOT Wheat (W), CBOT KC HRW Wheat (KW),
ICE Cotton No. 2 (CT), MGEX HRS Wheat (MWE), CBOT Rough Rice (RR),
CME Live Cattle (LC), ICE Cocoa (CC), ICE Coffee C (KC), ICE FCOJ-A
(OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S. Sugar No. 16 (SF).
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The cash markets underlying the 16 agricultural core referenced
futures contracts help create jobs and stimulate economic activity. The
soybean meal market alone has an implied value to the U.S. economy
through animal agriculture which contributed more than 1.8 million
American jobs,\499\ and wheat remains the largest produced food grain
in the United States, with planted acreage, production, and farm
receipts ranking third after corn and soybeans.\500\ The United States
is the world's largest producer of beef, and also produced 327,000
metric tons of frozen orange juice in 2018.\501\ Total economic
activity stimulated by the cotton crop is estimated at over $ 75
billion.\502\ Many of these markets are also significant export
commodities, helping to reduce the trade deficit. The United States
exports between 10 and 20 percent of its corn crop and 47 percent of
its soybean crop, generating tens of billions of dollars in annual
economic output.\503\
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\499\ Decision Innovation Solutions, 2018 Soybean Meal Demand
Assessment, United Soybean Board, available at https://www.unitedsoybean.org/wp-content/uploads/LOW-RES-FY2018-Soybean-Meal-Demand-Analysis-1.pdf.
\500\ Wheat Sector at a Glance, USDA Economic Research Service,
available at https://www.ers.usda.gov/topics/crops/wheat/wheat-sector-at-a-glance.
\501\ Cattle & Beef Sector at a Glance, USDA Economic Research
Service, available at https://www.ers.usda.gov/topics/animal-products/cattle-beef/sector-at-a-glance.
\502\ World of Cotton, National Cotton Council of America,
available at http://www.cotton.org/econ/world/index.cfm.
\503\ Feedgrains Sector at a Glance, USDA Economic Research
Service, available at https://www.ers.usda.gov/topics/crops/corn-and-other-feedgrains/feedgrains-sector-at-a-glance.
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Many of these agricultural commodities are also crucial to rural
areas. In Arkansas alone, which ranks first among rice-producing
states, the annual rice crop contributes $1.3 billion to the state's
economy and accounts for tens of thousands of jobs to an industry that
contributes more than $35 billion to the U.S. economy on an annual
basis.\504\ Similarly, the U.S. meat and poultry industry, which
includes cattle, accounts for $1.02 trillion in total economic output
equaling 5.6 percent of GDP, and is responsible for 5.4 million
jobs.\505\ Coffee-related economic activity comprises 1.6 percent of
total U.S. GDP,\506\ and U.S. sugar producers generate nearly $20
billion per year for the U.S. economy, supporting 142,000 jobs in 22
states.\507\ Even some of the smaller agricultural markets have a
noteworthy economic impact.\508\ For example, oats are planted on over
2.6 million acres in the United States, with the total U.S. supply in
the order of 182 million bushels,\509\ and in 2010 the United States
exported chocolate and chocolate-type confectionary products worth $799
million to more than 50 countries around the world. \510\
---------------------------------------------------------------------------
\504\ Where is Rice Grown, Think Rice website, available at
http://www.thinkrice.com/on-the-farm/where-is-rice-grown.
\505\ The United States Meat Industry at a Glance, North
American Meat Institute website, available at https://www.meatinstitute.org/index.php?ht=d/sp/i/47465/pid/47465.
\506\ The Economic Impact of the Coffee Industry, National
Coffee Association, available at http://www.ncausa.org/Industry-Resources/Economic-Impact.
\507\ U.S. Sugar Industry, The Sugar Association, available at
https://www.sugar.org/about/us-industry. While Sugar No. 11 (SB) is
primarily an international benchmark, the contract is still used for
price discovery and hedging within the United States and has
significantly more open interest and daily volume than the domestic
Sugar No. 16 (SF). As a pair, these two contracts are crucial tools
for risk management and for ensuring reliable pricing, with much of
the price discovery occurring in the higher-volume Sugar No. 11 (SB)
contract.
\508\ Although the macroeconomic impact of these markets is
smaller, the Commission reiterates that it has selected the 25 core
referenced futures contracts also based on the importance of
derivatives in these commodities to cash-market pricing.
\509\ Feed Outlook: May 2019, USDA Economic Research Service,
available at https://www.ers.usda.gov/publications/pub-details/?pubid=93094.
\510\ Economic Profile of the U.S. Chocolate Industry, World
Cocoa Foundation, available at https://www.worldcocoafoundation.org/wp-content/uploads/Economic_Profile_of_the_US_Chocolate_Industry_2011.pdf.
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4. Metal Commodities
The core referenced futures contracts on metal commodities play an
important role in the price discovery process and are some of the most
active and valuable in terms of notional value.
[[Page 11669]]
The Gold (GC) contract, for example, trades the equivalent of nearly 27
million ounces and 170,000 contracts daily. \511\ Outstanding futures
and options notional values range from approximately $234 billion in
the case of Gold (GC), to approximately $2.34 billion in the case of
Palladium (PA), with the other metals core referenced futures contracts
all falling somewhere in between.\512\ Metals futures are used by a
diverse array of commercial end-users to hedge their operations,
including mining companies, merchants and refiners.
---------------------------------------------------------------------------
\511\ Gold Futures Quotes, CME Group website, available at
https://www.cmegroup.com/trading/metals/precious/gold_quotes_globex.html.
\512\ Calculations based on data submitted to the Commission
pursuant to part 16 of the Commission's regulations.
---------------------------------------------------------------------------
The underlying commodities are also important to the U.S. economy.
In 2018, U.S. mines produced $82.2 billion of raw materials, including
the commodities underlying the five metals core referenced futures
contracts: COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX
Platinum (PL), and NYMEX Palladium (PA).\513\ U.S. mines produced 6.6
million ounces of gold in 2018 worth around $9.24 billion as of July 1,
2019, and the United States holds the largest official gold reserves of
any country, worth around $366 billion and representing 75 percent of
the value of total U.S. foreign reserves.\514\ U.S. silver refineries
produced around 52.5 million ounces of silver worth around $800 million
in 2018 at current prices.\515\
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\513\ Mineral Commodity Summaries 2019, U.S. Geological Survey,
available at http://prd-wret.s3-us-west-2.amazonaws.com/assets/palladium/production/atoms/files/mcs2019_all.pdf.
\514\ CPM Gold Yearbook 2019, CPM Group, available at https://www.cpmgroup.com/store/cpm-gold-yearbook-2019; Goldhub, World Gold
Council, available at https://www.gold.org/goldhub.
\515\ World Silver Survey 2019, The Silver Institute, available
at https://www.silverinstitute.org/wp-content/uploads/2019/04/WSS2019V3.pdf.
---------------------------------------------------------------------------
Major industries, including steel, aerospace, and electronics,
process and transform these materials, creating about $3.02 trillion in
value-added products.\516\ The five metals commodities are key
components of these products, including for use in: Batteries, solar
panels, water purification systems, electronics, and chemical refining
(silver); jewelry, electronics, and as a store of value (gold);
building construction, transportation equipment, and industrial
machinery (copper); automobile catalysts for diesel engines and in
chemical, electric, medical and biomedical applications, and petroleum
refining (platinum); and automobile catalysts for gasoline engines and
in dental and medical applications (palladium). A disruption in any of
these markets would impact highly important and sensitive industries,
including those critical to national security, and would also impact
the price of consumer products.
---------------------------------------------------------------------------
\516\ Id.
---------------------------------------------------------------------------
The underlying metals markets also create jobs and contribute to
GDP. Over 20,000 people were employed in U.S. gold and copper mines and
mills in 2017 and 2018, metal ore mining contributed $54.5 billion to
U.S. GDP in 2015, and the global copper mining industry drives more
than 45 percent of the world's GDP, either on a direct basis or through
the use of products that facilitate other industries.\517\
---------------------------------------------------------------------------
\517\ Creamer, Martin, Global Mining Derives 45%-Plus of World
GDP, Mining Weekly (July. 4, 2012), available at https://www.miningweekly.com/print-version/global-mining-drives-45-plus-of-world-gdp-cutifani-2012-07-04. Platinum and palladium mine
production in 2018 was less substantial, worth $114 million and $695
million, respectively (All such valuations throughout this release
are at current prices as of July 2, 2019.). See Bloxham, Lucy, et
al., Pgm Market Report May 2019, Johnson Matthey, available at
http://www.platinum.matthey.com/documents/new-item/pgm%20market%20reports/pgm_market_report_may_19.pdf. However,
derivatives contracts in those commodities do play a role in price
discovery.
---------------------------------------------------------------------------
The gold and silver markets are especially important because they
serve as financial assets and a store of value for individual and
institutional investors, including in times of economic or political
uncertainty. Several exchange-traded funds (``ETFs'') that are
important instruments for U.S. retail and institutional investors also
hold significant quantities of these metals to back their shares. A
disruption to any of these metals markets would thus not only impact
producers and retailers, but also potentially retail and institutional
investors. The iShares Silver Trust ETF, for example, holds around
323.3 million ounces of silver worth $4.93 billion, and the largest
U.S. listed gold-backed ETF holds around 25.5 million ounces to back
its shares worth around $35.7 billion.\518\ Platinum and palladium ETFs
are worth hundreds of millions of dollars as well.\519\
---------------------------------------------------------------------------
\518\ Historical Data, SPDR Gold Shares, available at http://www.spdrgoldshares.com/usa/historical-data. Data as of July 1, 2019.
\519\ iShares Silver Trust Fund, iShares, available at https://www.ishares.com/us/products/239855/ishares-silver-trust-fund/1521942788811.ajax?fileType=xls&fileName=iShares-Silver-Trust_fund&dataType=fund, https://www.aberdeenstandardetfs.us/institutional/us/en-us/products/product/etfs-physical-platinum-shares-pplt-arca#15.
---------------------------------------------------------------------------
5. Energy Commodities
The energy core referenced futures markets are crucial tools for
hedging price risk for commodities which can be highly volatile due to
changes in weather, economic health, demand-related price swings, and
pipeline and supply availability or disruptions. These futures
contracts are used by some of the largest refiners, exploration and
production companies, distributors, and by other key players in the
energy industry, and are some of the most widely traded and valuable
contracts in the world in terms of notional value. The NYMEX Light
Sweet Crude Oil (CL) contract, for example, is the world's most liquid
and actively traded crude oil contract, trading nearly 1.2 million
contracts a day, and the NYMEX Henry Hub Natural Gas (NG) contract
trades 400,000 contracts daily.\520\ Futures and option notional values
range from $ 53 billion in the case of NYMEX NY Harbor RBOB Gasoline
(RB) and NYMEX NY Harbor ULSD Heating Oil (HO), to $ 498 billion for
NYMEX Light Sweet Crude Oil (CL).\521\
---------------------------------------------------------------------------
\520\ Calculations based on data submitted to the Commission
pursuant to part 16 of the Commission's regulations.
\521\ Calculations based on data submitted to the Commission
pursuant to part 16 of the Commission's regulations.
---------------------------------------------------------------------------
Some of the energy core referenced futures contracts also serve as
key benchmarks for use in pricing cash-market and other transactions.
NYMEX NY Harbor RBOB Gasoline (RB) is the main benchmark used for
pricing gasoline in the U.S. petroleum products market, a huge physical
market with total U.S. refinery capacity of approximately 9.5 million
barrels per day of gasoline.\522\ Similarly, the NYMEX NY Harbor ULSD
Heating Oil (HO) contract is the main benchmark used for pricing the
distillate products market, which includes diesel fuel, heating oil,
and jet fuel. \523\
---------------------------------------------------------------------------
\522\ CME Comment letter dated April 24, 2015 at 79.
\523\ Id. at 136.
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The U.S. energy markets are some of the most important and complex
in the world, contributing over $ 1.3 trillion to the U.S.
economy.\524\ Crude oil, heating oil, gasoline, and natural gas, the
commodities underlying the four energy core reference futures
contracts,\525\ are key contributors to job growth and GDP. In 2015,
the natural gas and oil industries supported 10.3 million jobs directly
and indirectly, accounting for 5.6 percent of total U.S. employment,
and generating $ 714 billion in wages to
[[Page 11670]]
account for 6.7 percent of national income.\526\ Crude oil alone, which
is a key component in making gasoline, contributes 7.6 percent of total
U.S. GDP. RBOB gasoline, which is a byproduct of crude oil that is used
as fuel for vehicles and appliances, contributes $ 35.5 billion in
income and $57 billion in economic activity.\527\ ULSD comprises all
on-highway diesel fuel consumed in the United States, and is also
commonly used as heating oil.\528\
---------------------------------------------------------------------------
\524\ Natural Gas and Oil National Factsheet, API Energy,
available at https://www.api.org/~/media/Files/Policy/Jobs/National-
Factsheet.pdf.
\525\ The four energy core referenced futures contracts are:
NYMEX Light Sweet Crude Oil (CL), NYMEX NY Harbor ULSD Heating Oil
(HO), NYMEX NY Harbor RBOB Gasoline (RB), and NYMEX Henry Hub
Natural Gas (NG).
\526\ Natural Gas and Oil National Factsheet, API Energy,
available at https://www.api.org/~/media/Files/Policy/Jobs/National-
Factsheet.pdf; PricewaterhouseCoopers, Impacts of the Natural Gas
and Oil Industry on the US Economy in 2015, API Energy, available at
https://www.api.org/~/media/Files/Policy/Jobs/Oil-and-Gas-2015-
Economic-Impacts-Final-Cover-07-17-2017.pdf.
\527\ PricewaterhouseCoopers, Impacts of the Natural Gas and Oil
Industry on the US Economy in 2015, API Energy, at 12, available at
https://www.api.org/~/media/Files/Policy/Jobs/Oil-and-Gas-2015-
Economic-Impacts-Final-Cover-07-17-2017.pdf.
\528\ CME Comment Letter dated April 24, 2015 at 135.
---------------------------------------------------------------------------
Natural gas is similarly important, serving nearly 69 million
homes, 185,400 factories, and 5.5 million businesses such as hotels,
restaurants, hospitals, schools, and supermarkets. More than 2.5
million miles of pipeline transport natural gas to more than 178
million Americans.\529\ Natural gas is also a key input for electricity
generation and comprises more than one quarter of all primary energy
used in the United States. \530\ U.S. agricultural producers also rely
on an affordable, dependable supply of natural gas, as fertilizer used
to grow crops is composed almost entirely of natural gas components.
---------------------------------------------------------------------------
\529\ Natural Gas: The Facts, American Gas Association,
available at https://www.aga.org/globalassets/2019-natural-gas-factsts-updated.pdf.
\530\ Id.
---------------------------------------------------------------------------
6. Consistency With Commodity Indices
The criteria underlying the Commission's necessity finding is
consistent with the criteria used by several widely tracked third party
commodity index providers in determining the composition of their
indices. Bloomberg selects commodities for its Bloomberg Commodity
Index that in its view are ``sufficiently significant to the world
economy to merit consideration,'' that are ``tradeable through a
qualifying related futures contract'' and that generally are the
``subject of at least one futures contract that trades on a U.S.
exchange.'' \531\ Similarly, S&P's GSCI index is, among other things,
``designed to reflect the relative significance of each of the
constituent commodities to the world economy.'' \532\ Applying these
criteria, Bloomberg and S&P have deemed eligible for inclusion in their
indices lists of commodities that overlap significantly with the
Commission's proposed list of 25 core referenced futures contracts.
Independent index providers thus appear to have arrived at similar
conclusions to the Commission's preliminary necessity finding regarding
the relative importance of certain commodity markets.
---------------------------------------------------------------------------
\531\ The Bloomberg Commodity Index Methodology, Bloomberg, at
17 (Dec. 2018) available at https://data.bloomberglp.com/professional/sites/10/BCOM-Methodology-December-2019.pdf. The list
of commodities that Bloomberg deems eligible for inclusion in its
index overlaps significantly with the Commission's proposed list of
25 core referenced futures contracts.
\532\ S&P GSCI Methodology, S&P Dow Jones Indices, at 8 (Oct.
2019) available at https://us.spindices.com/documents/methodologies/methodology-sp-gsci.pdf?force_download=true.
---------------------------------------------------------------------------
7. Conclusion
This proposal only sets limits for referenced contracts for which a
DCM currently lists a physically-settled core referenced futures
contract. As discussed above, there are currently over 1,200 contracts
on physical commodities listed on DCMs, and there are physical
commodities other than those underlying the 25 core referenced futures
contracts that are important to the national economy, including, for
example, steel, butter, uranium, aluminum, lead, random length lumber,
and ethanol. However, unlike the 25 core referenced futures contracts,
the derivatives markets for those commodities are not as large as the
markets for the 25 core referenced futures contracts and/or play a less
significant role in the price discovery process.
For example, the futures contracts on steel, butter, and uranium
were not included as core referenced futures contracts because they are
cash-settled contracts that settle to a third party index. Among the
agricultural commodity futures listed on CME that are cash-settled only
to an index are: class III milk, feeder cattle, and lean hogs. All
three of these were included in the 2011 Final Rulemaking. Because
there are no physically-settled futures contracts on these commodities,
these cash-settled contracts would not qualify as referenced contracts
are would not be subject to the proposed rule. While the futures
contracts on aluminum, lead, random length lumber, and ethanol are
physically settled contracts, their open interest and trading volume is
lower than that of the CBOT Oats contract, which is the smallest market
included among the 25 core referenced futures contracts as measured by
open interest and volume. In that regard, based on FIA end of month
open interest data and 12-month total trading volume data for December
2019, CBOT Oats had end of month open interest of 4,720 contracts and
12-month total trading volume ending in December 2019 of 162,682 round
turn contracts.\533\ In comparison, the end of month December 2019 open
interest and 12-month total trading volume ending in December 2019 for
the other commodity futures contracts that were not selected to be
included as core referenced futures contracts were as follows: COMEX
Aluminum (267 OI/2,721 Vol), COMEX Lead (0 OI/0 Vol), CME Random Length
Lumber (3,275 OI/11,893 Vol), and CBOT Ethanol (708 OI/2,686 Vol.). It
would be impracticable for the Commission to analyze in comprehensive
fashion all contracts that have either feature, so the Commission has
chosen commodities for which the underlying and derivatives markets
both play important economic roles, including the potential for
especially acute burdens on a given commodity in interstate commerce
that would arise from excessive speculation in derivatives markets.
Line drawing of this nature is inherently inexact, and the Commission
will revisit these and other contracts ``from time to time'' as the
statute requires.\534\ Depending on facts and circumstances, including
the Commission's experience administering the proposed limits with
respect to the 25 core referenced futures contracts, the Commission may
determine that additional limits are necessary within the meaning of
section 4a(a)(1).
---------------------------------------------------------------------------
\533\ FIA notes that volume for exchange-traded futures is
measured by the number of contracts traded on a round-trip basis to
avoid double-counting. Furthermore, FIA notes that open interest for
exchange-traded futures is measured by the number of contracts
outstanding at the end of the month.
\534\ CEA section 4a(a)(1).
---------------------------------------------------------------------------
As discussed in the cost benefit consideration below, the
Commission's proposed limits are not without costs, and there are
potential burdens or negative consequences associated with establishing
the proposed limits.\535\ In particular, if the levels are set too
high, there is a greater risk of excessive speculation that could harm
market participants and the public. If the levels are set too low,
transaction costs may rise and liquidity could be reduced.\536\
Nevertheless, the Commission preliminarily believes that the specific
proposed limits applicable to the 25 core referenced futures contracts
would
[[Page 11671]]
limit such potential costs, and that the significant benefits
associated with advancing the statutory goal of preventing the undue
burdens associated with excessive speculation in these commodities
justify the potential costs associated with establishing the proposed
limits.
---------------------------------------------------------------------------
\535\ See infra Section IV.A. (discussion of cost-benefit
considerations for the proposed changes).
\536\ See infra Section IV.A.2.a. (cost-benefit discussion of
market liquidity and integrity).
---------------------------------------------------------------------------
G. Request for Comment
The Commission requests comment on all aspects of the proposed
necessity finding. The Commission also invites comments on the
following:
(50) Does the proposed necessity finding take into account the
relevant factors to ascertain whether position limits would be
necessary on a core referenced futures contract?
(51) Does the proposed necessity finding base its analysis on the
correct levels of trading volume and open interest? If not, what would
be a more appropriate minimum level of trading volume and/or open
interest upon which to evaluate whether federal position limits are
necessary to prevent excessive speculation?
(52) Are there particular attributes of any of the 25 proposed core
referenced futures contracts that the Commission should consider when
determining whether federal position limits are or are not necessary
for that particular product?
IV. Related Matters
A. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the Commodity Exchange Act (``CEA'' or ``Act'')
requires the Commodity Futures Trading Commission (``Commission'') to
consider the costs and benefits of its actions before promulgating a
regulation under the CEA.\537\ 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 (collectively,
the ``section 15(a) factors'').\538\
---------------------------------------------------------------------------
\537\ 7 U.S.C. 19(a).
\538\ Id.
---------------------------------------------------------------------------
The Commission interprets section 15(a) to require the Commission
to consider only those costs and benefits of its proposed changes that
are attributable to the Commission's discretionary determinations
(i.e., changes that are not otherwise required by statute) compared to
the existing status quo requirements. For this purpose, the status quo
requirements include the CEA's statutory requirements as well as any
applicable Commission regulations that are consistent with the
CEA.\539\ As a result, any proposed changes to the Commission's
regulations that are required by the CEA or other applicable statutes
would not be deemed to be a discretionary change for purposes of
discussing related costs and benefits.
---------------------------------------------------------------------------
\539\ This cost-benefit consideration section is divided into
seven parts, including this introductory section, each discussing
their respective baseline benchmarks with respect to any applicable
CEA or regulatory provisions.
---------------------------------------------------------------------------
The Commission anticipates that the proposed position limits
regulations will affect market participants differently depending on
their business model and scale of participation in the commodity
contracts that are covered by the proposal.\540\ The Commission also
anticipates that the proposal may result in ``programmatic'' costs to
some market participants. Generally, affected market participants may
incur increased costs associated with developing or revising,
implementing, and maintaining compliance functions and procedures. Such
costs might include those related to the monitoring of positions in the
relevant referenced contracts; related filing, reporting, and
recordkeeping requirements, and the costs of changes to information
technology systems.
---------------------------------------------------------------------------
\540\ For example, the proposal could result in increased costs
to market participants who may need to adjust their trading and
hedging strategies to ensure that their aggregate positions do not
exceed federal position limits, particularly those who will be
subject to federal position limits for the first time (i.e., those
who may trade contracts for which there are currently no federal
limits). On the other hand, existing costs could decrease for those
existing traders whose positions would fall below the new proposed
limits and therefore would not be forced to adjust their trading
strategies and/or apply for exemptions from the limits, particularly
if the Commission's proposal improves market liquidity or other
metrics of market health. Similarly, for those market participants
who would become subject to the federal position limits, general
costs would be lower to the extent such market participants can
leverage their existing compliance infrastructure in connection with
existing exchange position limit regimes relative to those market
participants that do not currently have such systems.
---------------------------------------------------------------------------
The Commission has preliminarily determined that it is not feasible
to quantify the costs or benefits with reasonable precision and instead
has identified and considered the costs and benefits
qualitatively.\541\ The Commission believes that for many of the costs
and benefits that quantification is not feasible with reasonable
precision because doing so would require understanding all market
participants' business models, operating models, cost structures, and
hedging strategies, including an evaluation of the potential
alternative hedging or business strategies that could be adopted under
the proposal. Further, while Congress has tasked the Commission with
establishing such position limits as the Commission finds are
``necessary,'' some of the benefits, such as mitigating or eliminating
manipulation or excessive speculation, may be very difficult or
infeasible to quantify. These benefits, moreover, would likely manifest
over time and be distributed over the entire market.
---------------------------------------------------------------------------
\541\ With respect to the Commission's analysis under its
discussion of its obligations under the Paperwork Reduction Act
(``PRA''), the Commission has endeavored to quantify certain costs
and other burdens imposed on market participants related to
collections of information as defined by the PRA. See generally
Section IV.B. (discussing the Commission's PRA determinations).
---------------------------------------------------------------------------
In light of these limitations, to inform its consideration of costs
and benefits of the proposed regulations, the Commission in its
discretion relies on: (1) Its experience and expertise in regulating
the derivatives markets; (2) information gathered through public
comment letters \542\ and meetings with a broad range of market
participants; and (3) certain Commission data, such as the Commission's
Large Trader Reporting System and data reported to swap data
repositories.
---------------------------------------------------------------------------
\542\ While the general themes contained in comments submitted
in response to prior proposals informed this rulemaking, the
Commission is withdrawing the 2013 Proposal, the 2016 Supplemental
Proposal, and the 2016 Reproposal. See supra Section I.A.
---------------------------------------------------------------------------
In addition to the specific questions included throughout the
discussion below, 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
herein; data and any other information to assist or otherwise inform
the Commission's ability to quantify or qualify the costs and benefits
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 Commission preliminarily considers the benefits and costs
discussed below in the context of international markets, because market
participants and exchanges subject to the Commission's jurisdiction for
purposes of position limits may be organized outside of the United
States; some industry leaders typically conduct operations both within
and outside the United States; and market participants may follow
substantially similar business practices wherever located.
[[Page 11672]]
Where the Commission does not specifically refer to matters of
location, the discussion of benefits and costs below refers to the
effects of this proposal on all activity subject to the proposed
regulations, whether by virtue of the activity's physical location in
the United States or by virtue of the activity's connection with or
effect on U.S. commerce under CEA section 2(i).\543\
---------------------------------------------------------------------------
\543\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------
The Commission will identify and discuss the costs and benefits
organized conceptually by topic, and certain topics may generally
correspond with a specific proposed regulatory section. The
Commission's discussion is organized as follows: (1) The scope of the
commodity derivative contracts that would be subject to the proposed
position limits framework, including with respect to the 25 proposed
core referenced futures contracts and the proposed definitions of
``referenced contract'' and ``economically equivalent swaps;'' (2) the
proposed federal position limit levels (proposed Sec. 150.2); (3) the
proposed federal bona fide hedging definition (proposed Sec. 150.1)
and other Commission exemptions from federal position limits (proposed
Sec. 150.3); (4) proposed streamlined process for the Commission and
exchanges to recognize bona fide hedges and to grant exemptions for
purposes of federal position limits (proposed Sec. Sec. 150.3 and
150.9) and related reporting changes to part 19 of the Commission's
regulations; (5) the proposed exchange-set position limits framework
and exchange-granted exemptions thereto (proposed Sec. 150.5); and (6)
the section 15(a) factors.
2. ``Necessity Finding'' and Scope of Referenced Futures Contracts
Subject to Proposed Federal Position Limit Levels
Federal spot and non-spot month limits currently apply to futures
and options on futures on the nine legacy agricultural
commodities.\544\ The Commission's proposal would expand the scope of
commodity derivative contracts currently subject to the Commission's
existing federal position limits framework \545\ so that federal spot-
month limits would apply to futures and options on futures on 16
additional physical commodities, for a total of 25 physical
commodities.\546\
---------------------------------------------------------------------------
\544\ The nine legacy agricultural contracts currently subject
to federal spot and non-spot month limits are: CBOT Corn (C), CBOT
Oats (O), CBOT Soybeans (S), CBOT Wheat (W), CBOT Soybean Oil (SO),
CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), ICE Cotton
No. 2 (CT), and CBOT KC Hard Red Winter Wheat (KW).
\545\ 17 CFR 150.2. Because the Commission has not yet
implemented the Dodd-Frank Act's amendments to the CEA regarding
position limits, except with respect to aggregation (see generally
Final Aggregation Rulemaking, 81 FR at 91454) and the vacated 2011
Position Limits Rulemaking's amendments to 17 CFR 150.2 (see
International Swaps and Derivatives Association v. United States
Commodity Futures Trading Commission, 887 F. Supp. 2d 259 (D.D.C.
2012)), the baseline or status quo consists of the provisions of the
CEA relating to position limits immediately prior to effectiveness
of the Dodd-Frank Act amendments to the CEA and the relevant
provisions of existing parts 1, 15, 17, 19, 37, 38, 140, and 150 of
the Commission's regulations, subject to the aforementioned
exceptions.
\546\ The 16 proposed new products that would be subject to
federal spot month limits would include seven agricultural (CME Live
Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C
(KC), ICE FCOJ-A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S.
Sugar No. 16 (SF)), four energy (NYMEX Light Sweet Crude Oil (CL),
NYMEX New York Harbor ULSD Heating Oil (HO), NYMEX New York Harbor
RBOB Gasoline (RB), NYMEX Henry Hub Natural Gas (NG)), and five
metals (COMEX Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX
Palladium (PA), and NYMEX Platinum (PL)) contracts.
---------------------------------------------------------------------------
The Commission has preliminarily interpreted CEA section 4a to
require that the Commission must make an antecedent ``necessity''
finding that establishing federal position limits is ``necessary'' to
diminish, eliminate, or prevent certain burdens on interstate commerce
with respect to the physical commodities in question.\547\ As the
statute does not define the term ``necessary,'' the Commission must
apply its expertise in construing such term, and, as discussed further
below, must do so consistent with the policy goals articulated by
Congress, including in CEA sections 4a(a)(2)(C) and 4a(a)(3), as noted
throughout this discussion of the Commission's cost-benefit
considerations.\548\ As discussed in greater detail in the preamble,
the Commission proposes to establish position limits on futures and
options on futures for these 25 commodities on the basis that position
limits on such contracts are ``necessary.'' In determining to include
the proposed 25 core referenced futures contracts within the proposed
federal position limit framework, the Commission considered the effects
that these contracts have on the underlying commodity, especially with
respect to price discovery; the fact that they require physical
delivery of the underlying commodity and therefore may be more affected
by manipulation such as corners and squeezes compared to cash-settled
contracts; and, in some cases, the especially acute economic burdens on
interstate commerce that could arise from excessive speculation in
these contracts causing sudden or unreasonable fluctuations or
unwarranted changes in the price of the commodities underlying these
contracts.\549\
---------------------------------------------------------------------------
\547\ See supra Section III.F. (discussion of the necessity
finding).
\548\ In promulgating the position limits framework, Congress
instructed the Commission to consider several factors: First, CEA
section 4a(a)(3) requires the Commission when establishing position
limits, to the maximum extent practicable, in its discretion, to (i)
diminish, eliminate, or prevent excessive speculation; (ii) deter
and prevent market manipulation, squeezes, and corners; (iii) ensure
sufficient market liquidity for bona fide hedgers; and (iv) ensure
that the price discovery function of the underlying market is not
disrupted. Second, CEA section 4a(a)(2)(C) requires the Commission
to strive to ensure that any limits imposed by the Commission will
not cause price discovery in a commodity subject to position limits
to shift to trading on a foreign exchange.
\549\ See supra Section III.F. (discussion of the necessity
finding).
---------------------------------------------------------------------------
More specifically, the 25 core referenced futures contracts were
selected because they: (i) Physically settle, (ii) have high levels of
open interest \550\ and significant notional value of open
interest,\551\ (iii) serve as a reference price for a significant
number of swaps and/or cash market transactions, and/or (iv) have, in
most cases, relatively higher average trading volumes.\552\ These
factors reflect the important and varying degrees of linkage between
the derivatives markets and the underlying cash markets. The Commission
preliminarily acknowledges that there is no mathematical formula that
would be dispositive, though the Commission has considered relevant
data where it is available.
---------------------------------------------------------------------------
\550\ Open interest for this purpose includes the sum of open
contracts, as defined in Sec. 1.3 of the Commission's regulations,
in futures contracts and in futures option contracts converted to a
futures-equivalent amount, as defined in current Sec. 150.1(f) of
the Commission's regulations. See 17 CFR 1.3 and 150.1(f).
\551\ Notional value of open interest for this purpose is open
interest multiplied by the unit of trading for the relevant futures
contract multiplied by the price of that futures contract.
\552\ A combination of higher average trading volumes and open
interest is an indicator of a contract's market liquidity. Higher
trading volumes make it more likely that the cost of transactions is
lower with narrower bid-ask spreads.
---------------------------------------------------------------------------
As a result, the Commission preliminarily has concluded that it
must exercise its judgment in light of facts and circumstances,
including its experience and expertise, to determine whether federal
position limit levels are economically justified. For example, based on
its general experience, the Commission preliminarily recognizes that
contracts that physically settle can, in certain circumstances during
the spot month, be at risk of corners and squeezes, which could distort
pricing and resource allocation, make it more costly to implement hedge
strategies, and harm the underlying cash market. Similarly, certain
contracts with higher
[[Page 11673]]
open interest and/or trading volume are more likely to serve as
benchmarks and/or references for pricing cash market and other
transactions, meaning a distortion of the price of any such contract
could potentially impact underlying cash markets that are important to
interstate commerce.\553\
---------------------------------------------------------------------------
\553\ See supra Section III.F. (discussion of the necessity
finding).
---------------------------------------------------------------------------
As discussed in more detail in connection with proposed Sec. 150.2
below, the Commission preliminarily believes that establishing federal
position limits at the proposed levels for the proposed 25 core
referenced futures contracts and related referenced contracts would
result in several benefits, including a reduction in the probability of
excessive speculation and market manipulation (e.g., squeezes and
corners) and the attendant harms to price discovery that may result.
The Commission acknowledges, in connection with establishing federal
position limit levels under proposed Sec. 150.2 (discussed below),
that position limits, especially if set too low, could adversely affect
market liquidity and increase transaction costs, especially for bona
fide hedgers, which ultimately might be passed on to the general
public. However, the Commission is also cognizant that setting position
limit levels too high may result in an increase in the possibility of
excessive speculation and the harms that may result, such as sudden or
unreasonable fluctuations or unwarranted changes in the price of the
commodities underlying these contracts.
For purposes of this discussion, rather than discussing the general
potential benefits and costs of the federal position limit framework,
the Commission will instead focus on the benefits and costs resulting
from the Commission's proposed necessity finding with respect to the 25
core referenced futures contracts.\554\ The Commission will address
potential benefits and costs of its approach with respect to: (1) The
liquidity and integrity of the futures and related options markets and
(2) market participants and exchanges.
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\554\ See supra Section III.F. (discussion of the necessity
finding).
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a. Potential Impact of the Scope of the Commission's Necessity Finding
on Market Liquidity and Integrity
The Commission has preliminarily determined that the 25 contracts
that the Commission proposes to include in its necessity finding are
among the most liquid physical commodity contracts, as measured by open
interest and/or trading volume, and therefore, imposing positions
limits on these contracts may impose costs on market participants by
constraining liquidity. However, the Commission believes that the
potential harmful effect on liquidity will be muted, as a result of the
generally high levels of open interest and trading volumes of the
respective 25 core referenced futures contracts.\555\
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\555\ The contracts that would be subject to the Commission's
proposal generally have higher trading volumes and open interest,
which tend to have greater liquidity, including relatively narrower
bid-ask spreads and relatively smaller price impacts from larger
transaction sizes. Further, all other factors being equal, markets
for contracts that are more illiquid tend to be more concentrated,
so that a position limit on such contracts might reduce open
interest on one side of the market, because a large trader would
face the potential of being capped out by a position limit. For this
reason, among others, the contracts to which the federal position
limits in existing Sec. 150.2 apply include some of the most liquid
physical-delivery futures contracts.
---------------------------------------------------------------------------
The Commission has preliminarily determined that, as a general
matter, focusing on the 25 proposed core referenced futures contracts
may benefit market integrity since these contracts generally are
amongst the largest physically-settled contracts with respect to
relative levels of open interest and/or trading volumes. As a result,
the Commission preliminarily believes that excessive speculation or
potential market manipulation in such contracts would be more likely to
affect more market participants and therefore potentially more likely
to cause an undue and unnecessary burden (e.g., potential harm to
market integrity or liquidity) on interstate commerce. Because each
proposed core referenced futures contract is physically-settled, as
opposed to cash-settled, the proposal focuses on preventing corners and
squeezes in those contracts where such market manipulation could cause
significant harm in the price discovery process for their respective
underlying commodities.\556\
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\556\ The Commission must also make this determination in light
of its limited available resources and responsibility to allocate
taxpayer resources in an efficient manner to meet the goals of
section 4a(a)(1), and the CEA generally.
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While the Commission recognizes that market participants may engage
in market manipulation through cash-settled futures and options on
futures, the Commission preliminarily has determined that focusing on
the physically-settled core referenced futures contracts will benefit
market integrity by reducing the risk of corners and squeezes in
particular. In addition, not imposing position limits on additional
commodities may foster non-excessive speculation, leading to better
prices and more efficient resource allocation in these commodities.
This may ultimately benefit commercial end users and possibly be passed
on to the general public in the form of better pricing. As noted above,
the scope of the Commission's necessity finding with respect to the 25
proposed core referenced futures contracts will allow the Commission to
focus on those contracts that, in general, the Commission preliminarily
recognizes as having particular importance in the price discovery
process for their respective underlying commodities as well as
potentially acute economic burdens that would arise from excessive
speculation causing sudden or unreasonable fluctuations or unwarranted
changes in the commodity prices underlying these contracts.
To the extent the Commission does not include additional
commodities in its necessity finding, the Commission's approach may
also introduce additional costs in the form of loss of certain benefits
associated with the proposed federal position limits framework, such as
stronger prevention of market manipulation, such as corners and
squeezes. Accordingly, the greater the potential benefits of the
proposed federal position limits framework in general, the greater the
potential cost in the reduction in market integrity in general from not
including other possible commodities within the federal position limits
framework (only to the extent any such additional commodities would be
found to be ``necessary'' for purposes of CEA section 4a). Nonetheless,
some of the potential harms to market integrity associated with not
including additional commodities within the federal position limits
framework could be mitigated to an extent by exchanges, which can use
tools other than position limits, such as margin requirements or
position accountability at lower levels than potential federal limits,
to defend against certain market behavior. Similarly, for those
contracts that would not be subject to the proposal, exchange-set
position limits alternatively may achieve the same benefits discussed
in connection with the proposed federal position limits.
b. Potential Impact of the Scope of the Commission's Necessity Finding
on Market Participants and Exchanges
The Commission acknowledges that the federal position limits
proposed herein could impose certain administrative, logistical,
technological, and financial burdens on exchanges and market
participants, especially with respect to developing or expanding
compliance systems and the adoption of monitoring policies. However,
the
[[Page 11674]]
Commission preliminarily believes that its approach to delaying the
effective date by 365 days from publication of any final rule in the
Federal Register should mitigate compliance costs by permitting the
update and build out of technological and compliance systems more
gradually. It may also reduce the burdens on market participants not
previously subject to position limits, who will have a longer period of
time to determine whether they may qualify for certain bona fide
hedging recognitions or other exemptions, and to possibly alter their
trading or hedging strategies.\557\ Further, the delayed effective date
will reduce the burdens on exchanges, market participants, and the
Commission by providing each with more time to resolve technological
and other challenges for compliance with the new regulations. In turn,
the Commission preliminarily anticipates that the extra time provided
by the delayed effective date will result in more robust systems for
market oversight, which should better facilitate the implementation of
the Commission's position limits framework and avoid unnecessary market
disruptions while exchanges and market participants prepare for its
implementation. However, the longer the proposed delay in the
proposal's effective date, the longer it will take to realize the
benefits identified above.
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\557\ Commenters on prior proposals have requested a sufficient
phase-in period. See, e.g., 2016 Reproposal, 81 FR at 96815
(implementation timeline).
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3. Federal Position Limit Levels (Proposed Sec. 150.2)
a. General Approach
Existing Sec. 150.2 establishes position limit levels that apply
net long or net short to futures and futures-equivalent options
contracts on nine legacy physically-settled agricultural
contracts.\558\ The Commission has previously set separate federal
position limits for: (i) The spot month, and (ii) the single month and
all-months combined limit levels (i.e., ``non-spot months'').\559\ For
the existing spot month federal limit levels, the contract levels are
based on 25 percent, or lower, of the estimated deliverable supply
(``EDS'').\560\ For the existing single month and all-months combined
limit levels, the levels are set at 10 percent of open interest for the
first 25,000 contracts of open interest, with a marginal increase of
2.5 percent of open interest thereafter (the ``10, 2.5 percent
formula'').
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\558\ The nine legacy agricultural contracts currently subject
to federal spot and non-spot month limits are: CBOT Corn (C), CBOT
Oats (O), CBOT Soybeans (S), CBOT Wheat (W), CBOT Soybean Oil (SO),
CBOT Soybean Meal (SM), MGEX Hard Red Spring Wheat (MWE), ICE Cotton
No. 2 (CT), and CBOT KC Hard Red Winter Wheat (KW).
\559\ For clarity, limits for single and all-months combined
apply separately. However, the Commission previously has applied the
same limit levels to the single month and all-months combined.
Accordingly, the Commission will discuss the single and all-months
limits, i.e., the non-spot month limits, together.
\560\ See supra Section II.B.1--Existing Sec. 150.2 (discussing
that establishing spot month levels at 25 percent or less of EDS is
consistent with past Commission practices).
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Proposed Sec. 150.2 would revise and expand the current federal
position limits framework as follows: First, for spot month levels,
proposed Sec. 150.2 would (i) cover 16 additional physically-settled
futures and related options contracts, based on the Commission's
existing approach of establishing limit levels at 25 percent or lower
of EDS, for a total of 25 core referenced futures contracts subject to
federal spot month limits (i.e., the nine legacy agricultural contracts
plus the proposed 16 additional contracts); \561\ and (ii) update the
existing spot month levels for the nine legacy agricultural contracts
based on revised EDS.\562\
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\561\ The 16 proposed new products that would be subject to
federal spot month limits would include seven agricultural (CME Live
Cattle (LC), CBOT Rough Rice (RR), ICE Cocoa (CC), ICE Coffee C
(KC), ICE FCOJ-A (OJ), ICE U.S. Sugar No. 11 (SB), and ICE U.S.
Sugar No. 16 (SF)), four energy (NYMEX Light Sweet Crude Oil (CL),
NYMEX NY Harbor ULSD Heating Oil (HO), NYMEX NY Harbor RBOB Gasoline
(RB), and NYMEX Henry Hub Natural Gas (NG)), and five metals (COMEX
Gold (GC), COMEX Silver (SI), COMEX Copper (HG), NYMEX Palladium
(PA), and NYMEX Platinum (PL)) contracts.
\562\ The proposal would maintain the current spot month limits
on CBOT Oats (O).
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Second, for non-spot month levels, proposed Sec. 150.2 would
revise the 10, 2.5 percent formula so that (i) the incremental 2.5
percent increase takes effect after 50,000 contracts of open interest,
rather than after 25,000 contracts under the existing rule (the
``marginal threshold level''), and (ii) the limit levels will be
calculated by applying the updated 10, 2.5 percent formula to open
interest data for the periods from July 2017-June 2018 and July 2018-
June 2019 of the applicable futures and delta adjusted futures
options.\563\
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\563\ As discussed below, for most of the legacy agricultural
commodities, this would result in a higher non-spot month limit.
However, the Commission is not proposing to change the non-spot
month limits for either CBOT Oats (O) or MGEX Hard Red Spring Wheat
(MWE) based on the revised open interest since this would result in
a reduction of non-spot month limits from 2,000 to 700 contracts for
CBOT Oats (O) and 12,000 to 5,700 contracts for MGEX HRS Wheat
(MWE). Similarly, the Commission also proposed to maintain the
current non-spot month limit for CBOT KC Hard Red Winter Wheat (KW).
---------------------------------------------------------------------------
Third, the proposed position limits framework would expand to cover
(i) any cash-settled futures and related options contracts directly or
indirectly linked to any of the 25 proposed physically-settled core
referenced futures contracts as well as (ii) any economically
equivalent swaps.
For spot month positions, the proposed position limits would apply
separately, net long or short, to cash-settled contracts and to
physically-settled contracts in the same commodity. This would result
in a separate net long/short position for each category so that cash-
settled contracts in a particular commodity would be netted with other
cash-settled contracts in that commodity, and physically-settled
contracts in a given commodity would be netted with other physically-
settled contracts in that commodity; a cash-settled contract and a
physically-settled contract would not net with one another. Outside the
spot month, cash and physically-settled contracts in the same commodity
would be netted together to determine a single net long/short position.
Fourth, proposed Sec. 150.2 would subject certain pre-existing
positions to federal position limits during the spot month but would
grandfather certain pre-existing positions outside the spot month.
In setting the federal position limit levels, the Commission seeks
to advance the enumerated statutory objectives with respect to position
limits in CEA section 4a(a)(3)(B).\564\ The Commission recognizes that
relatively high limit levels may be more likely to support some of the
statutory goals and less likely to advance others. For instance, a
relatively higher limit level may be more likely to benefit market
liquidity for hedgers or ensure that the price discovery of the
underlying market is not disrupted, but may be less likely to benefit
market integrity by being less effective at diminishing, eliminating,
or preventing excessive speculation or at deterring and preventing
market manipulation, corners, and squeezes. In particular, setting
relatively high federal position limit levels may result in excessively
large speculative positions and/or increased volatility, especially
during speculative showdowns, which may cause some market participants
to retreat from the commodities markets due to perceived decreases in
market integrity. In turn, fewer market participants may result in
lower liquidity levels for hedgers and harm to
[[Page 11675]]
the price discovery function in the underlying markets.
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\564\ See supra Section II.B.2.c. (for further discussion
regarding the CEA's statutory objectives for the federal position
limits framework).
---------------------------------------------------------------------------
Conversely, setting a relatively lower federal limit level may be
more likely to diminish, eliminate, or prevent excessive speculation,
but may also limit the availability of certain hedging strategies,
adversely affect levels of liquidity, and increase transaction
costs.\565\ Additionally, setting federal position limits too low may
cause non-excessive speculation to exit a market, which could reduce
liquidity, cause ``choppy'' \566\ prices and reduced market efficiency,
and increase option premia to compensate for the more volatile prices.
The Commission in its discretion has nevertheless endeavored to set
federal limit levels, to the maximum extent practicable, to benefit the
statutory goals identified by Congress.
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\565\ For example, relatively lower federal limits may adversely
affect potential hedgers by reducing liquidity. In the case of
reduced liquidity, a potential hedger may face unfavorable spreads
and prices, in which case the hedger must choose either to delay
implementing its hedging strategy and hope for more favorable
spreads in the near future or to choose immediate execution (to the
extent possible) at a less favorable price.
\566\ ``Choppy'' prices often refers to illiquidity in a market
where transacted prices bounce between the bid and the ask prices.
Market efficiency may be harmed in the sense that transacted prices
might need to be adjusted for the bid-ask bounce to determine the
fundamental value of the underlying contract.
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As discussed above, the contracts that would be subject to the
proposed federal limits are currently subject to either federal- or
exchange-set limits (or both). To the extent that the proposed federal
position limit levels are higher than the existing federal position
limit levels for either the spot or non-spot month, market participants
currently trading these contracts could engage in additional trading
under the proposed federal limits in proposed Sec. 150.2 that
otherwise would be prohibited under existing Sec. 150.2.\567\ On the
other hand, to the extent an exchange-set limit level would be lower
than its proposed corresponding federal limit, the proposed federal
limit would not affect market participants since market participants
would be required to comply with the lower exchange-set limit level (to
the extent that the exchanges maintain their current levels).\568\
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\567\ For the spot month, all the legacy agricultural contracts
other than CBOT Oats (O) would have higher federal levels. For the
non-spot months, all the legacy agricultural contracts other than
CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC HRW Wheat (KW),
would have higher federal levels.
\568\ While the Commission proposes to generally either increase
or maintain the federal position limits for both the spot-months and
non-spot months compared to existing federal limits, where
applicable, and exchange limits, the proposed federal level for
COMEX Copper (HG) would be below the existing exchange-set level.
Accordingly, market participants may have to change their trading
behavior with respect to COMEX Copper (HG), which could impose
compliance and transaction costs on these traders, to the extent
their existing trading would violate the proposed lower federal
limit levels.
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b. Spot Month Levels
The Commission proposes to maintain 25 percent of EDS as a ceiling
for federal limits. Based on the Commission's experience overseeing
federal position limits for decades and overseeing exchange-set
position limits submitted to the Commission pursuant to part 40 of the
Commission's regulations, none of the proposed levels listed in
Appendix E of part 150 of the Commission's regulations appears to be so
low as to reduce liquidity for bona fide hedgers or disrupt price
discovery function of the underlying market, or so high as to invite
excessive speculation, manipulation, corners, or squeezes because,
among other things, any potential economic gains resulting from the
manipulation may be insufficient to justify the potential costs,
including the costs of acquiring, and ultimately offloading, the
positions used to effect the manipulation.
c. Levels Outside of the Spot Month
i. The 10, 2.5 Percent Formula
The Commission preliminarily has determined that the existing 10,
2.5 percent formula generally has functioned well for the existing nine
legacy agricultural contracts and has successfully benefited the
markets by taking into account the competing goals of facilitating both
liquidity formation and price discovery while also protecting the
markets from harmful market manipulation and excessive speculation.
However, since the existing limit levels are based on open interest
levels from 2009 (except for CBOT Oats (O), CBOT Soybeans (S), and ICE
Cotton No. 2 (CT), for which existing levels are based on the
respective open interest from 1999), the Commission is proposing to
revise the levels based on the periods from July 2017-June 2018 and
July 2018-June 2019 to reflect the general increases in open interest
and trading volume that have occurred over time in the nine legacy
agricultural contracts (other than CBOT Oats (O), MGEX HRS Wheat (MWE),
and CBOT KC HRW Wheat (KW)).\569\ Since the proposed increase for most
of the federal non-spot position limits is predicated on the increase
in open interest and trading volume, as reflected in the revised data
reviewed by the Commission, the Commission preliminarily believes that
its proposal may enhance, or at least should maintain, general
liquidity, which the Commission preliminarily believes may benefit
those with bona fide hedging positions, and commercial end users in
general. On the other hand, the Commission understands that many market
participants, especially commercial end users, generally believe that
the existing non-spot month levels for the nine legacy agricultural
commodities function well, including promoting liquidity and
facilitating bona fide hedging in the respective markets. As a result,
the Commission's proposal may increase the risk of excessive
speculation without achieving any concomitant benefits of increased
liquidity for bona fide hedgers compared to the status quo.
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\569\ For most of the legacy agricultural commodities, this
would result in a higher non-spot month limit. However, the
Commission is not proposing to change the non-spot month limits for
either CBOT Oats (O) or MGEX HRS Wheat (MWE) based on the revised
open interest since this would result in a reduction of non-spot
month limits from 2,000 to 700 contracts for CBOT Oats (O) and
12,000 to 5,700 contracts for MGEX HRS Wheat (MWE). Similarly, the
Commission also proposed to maintain the current non-spot month
limit for CBOT KC HRW Wheat (KW). See supra Section II.B.2.e. --
Methodology for Setting Proposed Non-Spot Month Limit Levels for
further discussion.
---------------------------------------------------------------------------
The Commission also preliminarily recognizes that there could be
potential costs to keeping the existing 10, 2.5 percent formula (even
if revised to reflect current open interest levels) compared to
alternative formulae that would result in even higher federal position
limit levels. First, while the 10, 2.5 percent formula may have
reflected ``normal'' observed market activity through 1999 when the
Commission adopted it, it no longer reflects current open interest
figures. When adopting the 10, 2.5 percent formula in 1999, the
Commission's experience in these markets reflected aggregate futures
and options open interest well below 500,000 contracts, which no longer
reflects market reality.\570\ As the nine legacy agricultural contracts
(with the exception of CBOT Oats (O)) all have open interest well above
25,000
[[Page 11676]]
contracts, and in some cases above 500,000 contracts, the existing
formula may act as a negative constraint on liquidity formation
relative to the higher proposed formula. Further, if open interest
continues to increase over time, the Commission anticipates that the
existing 10, 2.5 percent formula could impose even greater marginal
costs on bona fide hedgers by potentially constraining liquidity
formation (i.e., as the open interest of a commodity contract increase,
a greater relative proportion of the commodity's open interest is
subject to the 2.5 percent limit level rather than the initial 10
percent limit). In turn, this may increase costs to commercial firms,
which may be passed to the public in the form of higher prices.
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\570\ See 64 FR at 24038, 24039 (May 5, 1999). As discussed in
the preamble, the data show that by the 2015-2018 period, five of
the nine legacy agricultural contracts had maximum open interest
greater than 500,000 contracts. The contracts for CBOT Corn (C),
CBOT Soybeans (S), and CBOT KC HRW Wheat (KW) saw increased maximum
open interest by a factor of four to five times the maximum open
interest during the years leading up to the Commission's adoption of
the 10, 2.5 percent formula in 1999. Similarly, the contracts for
CBOT Soybean Meal (SM), CBOT Soybean Oil (SO), CBOT Wheat (W), and
MGEX HRS Wheat (MWE) saw increased maximum open interest by a factor
of three to four times. See supra Section II.B.2.e. --Methodology
for Setting Proposed Non-Spot Month Limit Levels for further
discussion.
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Further, to the extent there may be certain liquidity constrains,
the Commission has determined that this potential concern could be
mitigated, at least in part, by the Commission's proposed change to
increase the marginal threshold level from 25,000 contracts to 50,000
contracts, which the Commission preliminarily believes should provide a
conservative increase in the non-spot month limits for most contracts
to better reflect the general increase observed in open interest across
futures markets. The Commission acknowledges that the marginal
threshold level could be increased above 50,000 contracts, but notes
that each increase of 25,000 contracts in the marginal threshold level
would only increase the permitted non-spot month level by 1,875
contracts (i.e., (10% of 25,000 contracts)--(2.5% of 25,000 contracts)
= 1,875 contracts). The Commission has observed based on current data
that this proposed change could benefit several market participants per
legacy agricultural commodity who otherwise would bump up against the
all-months and/or single month limits with based on the status quo
threshold of 25,000 contracts. As a result, the Commission
preliminarily has determined that changing the marginal threshold level
could result in marginal benefits and costs for many of the legacy
agricultural commodities, but the Commission acknowledges the proposed
change is relatively minor compared to revising the existing 10, 2.5
percent formula based on updated open interest data.
Second, the Commission preliminarily recognizes that an alternative
formula that allows for higher non-spot limits, compared to the
existing 10, 2.5 percent formula, could benefit liquidity and market
efficiency by creating a framework that is more conducive to the larger
liquidity providers that have entered the market over time.\571\
Compared to when the Commission first adopted the 10, 2.5 percent
formula, today there exist relatively more large non-commercial
traders, such as banks, managed money traders, and swap dealers, which
generally hold long positions and act as aggregators or market makers
that provide liquidity to short positions (e.g., commercial
hedgers).\572\ These dealers also function in the swaps market and use
the futures market to hedge their exposures. Accordingly, to the extent
that larger non-commercial market makers and liquidity providers have
entered the market--particularly to the extent they are able to take
offsetting positions to commercial short interests--a hypothetical
alternative formula that would permit higher non-spot month limits
might provide greater market liquidity, and possibly increased market
efficiency, by allowing for greater market-making activities.\573\
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\571\ See supra Section II.B.2.e.--Methodology for Setting
Proposed Non-Spot Month Limit Levels for further discussion.
\572\ Id.
\573\ For example, the Commission is aware of several market
makers that either have left particular commodity markets, or
reduced their market making activities. See, e.g., McFarlane, Sarah,
Major Oil Traders Don't See Banks Returning to the Commodity Markets
They Left, The Wall Street Journal (Mar. 28, 2017), available at
https://www.wsj.com/articles/major-oil-traders-dont-see-banks-returning-to-the-commodity-markets-they-left-1490715761?mg=prod/com-
wsj (describing how ``Morgan Stanley sold its oil trading and
storage business . . . and J.P. Morgan unloaded its physical
commodities business . . . .''); Decambre, Mark, Goldman Said to
Plan Cuts to Commodity Trading Desk: WSJ, MarketWatch website (Feb.
5, 2019), https://www.marketwatch.com/story/goldman-said-to-plan-cuts-to-commodity-trading-desk-wsj-2019-02-05 (describing how
Goldman Sachs ``plans on making cuts within its commodity trading
platform. . . .'').
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However, the Commission believes that any purported benefits
related to a hypothetical alternative formula that would allow for
higher non-spot limits would be minimal at best. Specifically, bona
fide hedgers and end users generally have not requested a revised
formula to allow for significantly higher non-spot limits. Similarly,
liquidity providers would still be able to maintain, and possibly
increase, market making activities under the Commission's proposal
since the non-spot month limits will generally still increase under the
existing 10, 2.5 percent formula to reflect the increase in open
interest. Further, to the extent that the Commission's proposal to
eliminate the risk management exemption could theoretically force
liquidity providers to reduce their trading activities, the Commission
preliminarily believes that certain liquidity-providing activity of the
existing risk management exemption holders may still be permitted under
the Commission's proposal, either as a result of the proposed swap
pass-through provision or because of the general increase in limits
based on the revised open interest levels.\574\ The Commission also
preliminarily recognizes an additional benefit to market integrity of
the current proposal compared to a hypothetical alternative formula:
While the Commission believes that the proposed pass-through swap
provision is narrowly-tailored to enable liquidity providers to
continue providing liquidity to bona fide hedgers, in contrast, an
alternative formula that would allow higher limit levels for all market
participants would also permit increased excessive speculation and
increase the probability of market manipulation or harm the underlying
price discovery function.
---------------------------------------------------------------------------
\574\ See supra Section II.A.1.c.v. (preamble discussion of
pass-through swap provision); see infra Section IV.A.4.b.i.(2).
---------------------------------------------------------------------------
Additionally, some have voiced general concern that permitting
increased federal non-spot month limits in the nine legacy agricultural
contracts (at any level), especially in connection with commodity
indices, could disrupt price discovery and result in a lack of
convergence between futures and cash prices, resulting in increased
costs to end users, which ultimately could be borne by the public. The
Commission has not seen data demonstrating this causal connection, but
acknowledges arguments to that effect.\575\
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\575\ As discussed in preamble Section II.B.2.e.--Methodology
for Setting Proposed Non-Spot Month Limit Levels, one of the
concerns that prompted the 2008 moratorium on granting risk
management exemptions was a lack of convergence between futures and
cash prices in wheat. Some at the time hypothesized that perhaps
commodity index trading was a contributing factor to the lack of
convergence, and, some have argued that this could harm price
discovery since traders holding these positions may not react to
market fundamentals, thereby exacerbating any problems with
convergence. However, the Commission has determined for various
reasons that risk management exemptions did not lead to the lack of
convergence since the Commission understands that many commodity
index traders vacate contracts before the spot month and therefore
would not influence converge between the spot and futures price at
expiration of the contract. Further, the risk-management exemptions
granted prior to 2008 remain in effect, yet the Commission is
unaware of any significant convergence problems relating to
commodity index traders at this time. Additionally, there did not
appear to be any convergence problems between the period when
Commission staff initially granted risk management exemptions and
2007. Instead, the Commission believes that the convergence issues
that started to occur around 2007 were due to the contract
specification underpricing the option to store wheat for the long
futures holder making the expiring futures price more valuable than
spot wheat.
---------------------------------------------------------------------------
Third, if the Commission's proposed non-spot position limits would
be too
[[Page 11677]]
high for a commodity, the proposal might be less effective in deterring
excessive speculation and market manipulation for that commodity's
market. Conversely, if the Commission's proposed position limit levels
would be too low for a commodity, the proposal could unduly constrain
liquidity for bona fide hedgers or result in a diminished price
discovery function for that commodity's underlying market. In either
case, the Commission would view these as costs imposed on market
participants. However, to the extent the Commission's proposed non-spot
limit levels could be too high, the Commission preliminarily believes
these costs could be mitigated because exchanges would be able to
establish lower non-spot month levels.\576\ Moreover, these concerns
may be mitigated further to the extent that exchanges use other tools
for protecting markets aside from position limits, such as establishing
accountability levels below federal position limit levels or imposing
liquidity and concentration surcharges to initial margin if vertically
integrated with a derivatives clearing organization. Further, as
discussed below, the Commission is proposing to maintain current non-
spot limit levels for CBOT Oats (O), MGEX HRS Wheat (MWE), and CBOT KC
HRW Wheat (KW), which otherwise would be lower based on current open
interest levels for these contracts.
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\576\ On the other hand, relying on exchanges may have potential
costs because exchanges may have conflicting interests and therefore
may not establish position limit (or accountability) levels lower
than the proposed federal limits. For example, exchanges may not be
incentivized to lower their limits due to competitive concerns with
another exchange, or due to influence from a large customer.
Conversely, exchange and Commission interests may be aligned to the
extent that exchanges do have a countervailing interest to protect
their markets from manipulation and price distortion: If market
participants lose confidence in the contract as a tool for hedging,
they will look for alternatives, possibly migrating to another
product on a different exchange. The Commission is aware of at least
one instance in which exchanges adopted spot-month position limits
and/or adopted a lower exchange-set limit for particular futures
contracts as a result of excessive manipulation and potential market
manipulation. Similarly, exchanges remain subject to their core
principle obligations to prevent manipulation, and the Commission
conducts general market oversight through its own surveillance
program. Accordingly, the Commission acknowledges such concerns
about conflicting exchange incentives, but preliminarily believes
that such concerns are mitigated for the foregoing reasons.
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ii. Exceptions to the Proposed 10, 2.5 Percent Formula for CBOT Oats
(O), MGEX Hard Red Spring Wheat (MWE), and CBOT Kansas City Hard Red
Winter Wheat (KW)
Based on the Commission's experience since 2011 with non-spot month
speculative position limit levels for MGEX HRS Wheat (``MWE'') and CBOT
KC HRW Wheat (``KW'') core referenced futures contracts, the Commission
is proposing to maintain the proposed limit levels for MWE and KW at
the existing level of 12,000 contracts rather than reducing them to the
lower level that would result from applying the proposed updated 10,
2.5 percent formula. Maintaining the status quo for the MWE and KW non-
spot month limit levels would result in partial wheat parity between
those two wheat contracts, but not with CBOT Wheat (``W''), which would
increase to 19,300 contracts. The Commission preliminarily believes
that this will benefit the MWE and KW markets since the two species of
wheat are similar to one another; accordingly, decreasing the non-spot
month levels for MWE could impose liquidity costs on the MWE market and
harm bona fide hedgers, which could further harm liquidity or bona fide
hedgers in the KW market. On the other hand, the Commission has
determined not to raise the proposed limit levels for either KW or MWE
to the limit level for W since the non-spot month level appears to be
extraordinarily large in comparison to open interest in KW and MWE
markets, and the limit level for the MWE contract is already larger
than the limit level would be based on the 10, 2.5 percent formula.
While W is a potential substitute for KW and MWE, it is not similar to
the same extent that MWE and KW are to one another, and so the
Commission has preliminarily determined that this is a reasonable
compromise to maintain liquidity and price discovery while not
unnecessarily inviting excessive speculation or potential market
manipulation in the MWE and KW markets.
Likewise, based on the Commission's experience since 2011 with the
non-spot month speculative position limit for CBOT Oats (O), the
Commission is proposing the limit level at the current 2,000 contract
level rather than reducing it to the lower level that would result from
applying the updated 10, 2.5 formula based on current open interest.
The Commission has preliminarily determined that there is no evidence
of potential market manipulation or excessive speculation, and so there
would be no perceived benefit to reducing the non-spot month limit for
the CBOT Oats (O) contract, while reducing the level could impose
liquidity costs.
d. Core Referenced Futures Contracts and Linked Referenced Contracts;
Netting
The definitions of the terms ``core referenced futures contract''
and ``referenced contract'' set the scope of contracts to which federal
position limits apply. As discussed below, by applying the federal
position limits to ``referenced contracts,'' the Commission's proposal
would expand the federal position limits beyond the proposed 25
physically-settled ``core referenced futures contracts'' listed in
proposed Appendix E to part 150 by also including any cash-settled
``referenced contracts'' linked thereto as well as swaps that meet the
proposed ``economically equivalent swap'' definition and thus qualify
as ``referenced contracts.'' \577\
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\577\ As discussed in the preamble, the proposed position limits
framework would also apply to physically-settled swaps that qualify
as economically equivalent swaps. However, the Commission
preliminarily believes that physically-settled economically
equivalent swaps would be few in number.
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i. Referenced Contracts
The Commission preliminarily has determined that including futures
contracts and options thereon that are ``directly'' or ``indirectly
linked'' to the core referenced contracts, including cash-settled
contracts, under the proposed definition of ``referenced contract''
would help prevent the evasion of federal position limits--especially
during the spot month--through the creation of a financially equivalent
contract that references the price of a core referenced futures
contract. The Commission preliminarily has determined that this will
benefit market integrity and potentially reduce costs to market
participants that otherwise could result from market manipulation.
The Commission also recognizes that including cash-settled
contracts within the proposed federal position limits framework may
impose additional compliance costs on market participants and
exchanges. Further, the proposed federal position limits--especially
outside the spot month--may not provide the benefits discussed above
with respect to market integrity and manipulation because there is no
physical delivery outside the spot month and therefore there is reduced
concern for corners and squeezes. However, to the extent that there is
manipulation of such non-spot, cash-settled contracts, the Commission's
authority to regulate and oversee futures and related options markets
(other than through establishing federal position
[[Page 11678]]
limits) may also be effective in uncovering or preventing manipulation,
especially in the non-spot cash markets, and may result in relatively
lower compliance costs incurred by market participants. Similarly, the
Commission preliminarily acknowledges that exchange oversight could
provide the same benefit to market oversight and prevention of market
manipulation, but with lower costs imposed on market participants--
given the exchanges' deep familiarity with their own markets and their
ability to tailor a response to a particular market disruption--
compared to federal position limits.
The proposed ``referenced contract'' definition would also include
``economically equivalent swaps,'' and for the reasons discussed below
would include a narrower set of swaps compared to the set of futures
and options thereon that would be, under the proposed ``referenced
contract'' definition, captured as either ``directly'' or ``indirectly
linked'' to a core referenced futures contract.\578\
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\578\ See infra Section IV.A.3.d.iv. (discussion of economically
equivalent swaps).
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ii. Netting
The Commission proposes to permit market participants to net
positions outside the spot month in linked physically-settled and cash-
settled referenced contracts, but during the spot month market
participants would not be able to net their positions in cash-settled
referenced contracts against their positions in physically-settled
referenced contracts. The Commission preliminarily believes that its
proposal would benefit liquidity formation and bona fide hedgers
outside the spot months since the proposed netting rules would
facilitate the management of risk on a portfolio basis for liquidity
providers and market makers. In turn, improved liquidity may benefit
bona fide hedgers and other end users by facilitating their hedging
strategies and reducing related transaction costs (e.g., improving
execution timing and reducing bid-ask spreads). On the other hand, the
Commission recognizes that allowing such netting could increase
transaction costs and harm market integrity by allowing for a greater
possibility of market manipulation since market participants and
speculators would be able to maintain larger gross positions outside
the spot month. However, the Commission preliminarily has determined
that such potential costs may be mitigated since concerns about corners
and squeezes generally are less acute outside the spot month given
there is no physical delivery involved, and because there are tools
other than federal position limits for preventing and deterring other
types of manipulation, including banging the close, such as exchange-
set limits and accountability and surveillance both at the exchange and
federal level. Moreover, prohibiting the netting of physical and cash
positions during the spot month should benefit bona fide hedgers as
well as price discovery of the underlying markets since market makers
and speculators would not be able to maintain a relatively large
position in the physical markets by netting it against its positions in
the cash markets.\579\ While this may increase compliance and
transaction costs for speculators, it might benefit some bona fide
hedgers and end users. It might also impose costs on exchanges,
including increased surveillance and compliance costs and lost fees
related to the trading that such market makers or speculators otherwise
might engage in absent federal position limits or with the ability to
their net physical and cash positions.
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\579\ Otherwise, a participant could maintain large, offsetting
positions in excess of limits in both the physically-settled and
cash-settled contract, which might harm market integrity and price
discovery and undermine the federal position limits framework. For
example, absent such a restriction in the spot month, a trader could
stand for over 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.
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iii. Exclusions From the ``Referenced Contract'' Definition
First, while the proposed ``referenced contract'' definition would
include linked contracts, it would explicitly exclude location basis
contracts, which are contracts that reflect the difference between two
delivery locations or quality grades of the same commodity.\580\ The
Commission preliminarily believes that excluding location basis
contracts from the ``referenced contract'' definition would benefit
market integrity by preventing a trader from obtaining an
extraordinarily large speculative position in the commodity underlying
the referenced contract. Otherwise, absent the proposed exclusion, a
market participant could increase its exposure in the commodity
underlying the referenced contract by using the location basis contract
to net down against its position in a referenced contract, and then
further increase its position in the referenced contract that would
otherwise by restricted by position limits. Similarly, the Commission
preliminarily believes that this would reduce hedging costs for hedgers
and commercial end-users, as they would be able to more efficiently
hedge the cost of commodities at their preferred location without the
risk of possibly hitting a position limits ceiling or incur compliance
costs related to applying for a bona fide hedge related to such
position.
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\580\ The term ``location basis contract'' generally means a
derivative that is cash-settled based on the difference in price,
directly or indirectly, of (1) a core referenced futures contract;
and (2) the same commodity underlying a particular core referenced
futures contract at a different delivery location than that of the
core referenced futures contract. For clarity, a core referenced
futures contract may have specifications that include multiple
delivery points or different grades (i.e., the delivery price may be
determined to be at par, a fixed discount to par, or a premium to
par, depending on the grade or quality). The above discussion
regarding location basis contracts is referring to delivery
locations or quality grades other than those contemplated by the
applicable core referenced futures contract.
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Excluding location basis contracts from the ``referenced contract''
definition also could impose costs for market participants that wish to
trade location basis contracts since, as noted, such contracts would
not be subject to federal limits and thus could be more easily subject
to manipulation by a market participant that obtained an excessively
large position. However, the Commission preliminarily believes such
costs are mitigated because location basis contracts generally
demonstrate less volatility and are less liquid than the core
referenced futures contracts, meaning the Commission believes that it
would be an inefficient method of manipulation (i.e., too costly to
implement and therefore, the Commission believes that the probability
of manipulation is low). Further, excluding location basis contracts
from the ``referenced contract'' definition is consistent with existing
market practice since the market treats a contract on one grade or
delivery location of a commodity as different from another grade or
delivery location. Accordingly, to the extent that the proposal is
consistent with current market practice, any benefits or costs already
may have been realized.
Second, the Commission preliminarily has concluded that excluding
commodity indices from the ``referenced contract'' definition would
benefit market integrity by preventing speculators from using a
commodity index contract to net down an outright position in a
referenced contract that is a component of the commodity index
contract, which would allow the speculator to take on large outright
positions in the referenced contracts and therefore result in increased
speculation, undermining the federal
[[Page 11679]]
position limits framework.\581\ However, the Commission preliminarily
believes that its proposed exclusion could impose costs on market
participants that trade commodity indices since, as noted, such
contracts would not be subject to federal limits and thus could be more
easily subject to manipulation by a market participant that obtained an
excessively large position. The Commission preliminarily believes such
costs would be mitigated because the commodities comprising the index
would themselves be subject to limits, and because commodity index
contracts generally tend to exhibit low volatility since they are
diversified across many different commodities. Further, the Commission
believes that it is possible that excluding commodity indices from the
definition of ``referenced contracts'' could result in some trading
shifting to commodity indices contracts, which may reduce liquidity in
exchange-listed core referenced futures contracts, harm pre-trade
transparency and the price discovery process in the futures markets,
and further depress open interest (as volumes shift to index positions,
which would not count toward open interest calculations). However, the
Commission believes that the probability of this occurring is low
because the Commission preliminarily believes that using indices is an
inefficient means of obtaining exposure to a certain commodity.
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\581\ Further, the Commission believes that prohibiting the
netting of a commodity index position with a referenced contract is
required by its interpretation of the Dodd-Frank Act's amendments to
the CEA's definition of ``bona fide hedging transaction or
position.'' The Commission interprets the amended CEA definition to
eliminate the Commission's ability to recognize risk management
positions as bona fide hedges or transactions. See infra Section
IV.A.4.--Bona Fide Hedging and Spread and Other Exemptions from
Federal Position Limits (proposed Sec. Sec. 150.1 and 150.3) for
further discussion. In this regard, the Commission has observed that
it is common for swap dealers to enter into commodity index
contracts with participants for which the contract would not qualify
as a bona fide hedging position (e.g., with a pension fund). Failing
to exclude commodity index contracts from the ``referenced
contract'' definition could enable a swap dealer to use positions in
commodity index contracts as a risk management hedge by netting down
its offsetting outright futures positions in the components of the
index. Permitting this type of risk management hedge would subvert
the statutory pass-through swap language in CEA section 4a(c)(2)(B),
which the Commission interprets as prohibiting the recognition of
positions entered into for risk management purposes as bona fide
hedges unless the swap dealer is entering into positions opposite a
counterparty for which the swap position is a bona fide hedge.
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Under certain circumstances, a participant that has reached the
applicable position limit could use a commodity index to purchase and
weight a commodity index contract, which is otherwise excluded from the
``referenced contract'' definition and therefore from federal position
limits, in a manner that would allow the participant to exceed limits
of the applicable referenced contract (i.e., the participant could be
long outright in a referenced contract, purchase a commodity index
contract that includes the applicable referenced contract as a
component, and short the remaining components of the index. The
Commission observes that these short positions would be subject to the
proposed federal limits, so there would be a ceiling on this strategy
and, in addition, it would be costly to potential manipulators because
margin would have to be posted and exchanged to retain the positions.
In this circumstance, excluding commodity indices from the ``referenced
contract'' definition could impose costs on market integrity. However,
the Commission preliminarily believes any related costs should be
mitigated because proposed Sec. 150.2 would include anti-evasion
language that would deem such commodity index contract to be a
referenced contract subject to federal limits. Also, analogous costs
could apply to the discussion above regarding location basis contracts
and such proposed anti-evasion provision would similarly cover location
basis contracts.\582\
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\582\ Similarly, the proposed anti-evasion provision would also
provide that a spread exemption would no longer apply.
---------------------------------------------------------------------------
iv. Economically Equivalent Swaps
The existing federal position limits framework does not include
limit levels on swaps. The Dodd-Frank Act added CEA section 4a(a)(5),
which requires that when the Commission imposes position limits on
futures and options on futures pursuant to CEA section 4a(a)(2), the
Commission also establish limits simultaneously for ``economically
equivalent'' swaps ``as appropriate.'' \583\ As the statute does not
define the term ``economically equivalent,'' the Commission will apply
its expertise in construing such term consistent with the policy goals
articulated by Congress, including in CEA sections 4a(a)(2)(C) and
4a(a)(3) as discussed below. Specifically, under the Commission's
proposed definition of ``economically equivalent swap'' set forth in
proposed Sec. 150.1, a swap would generally qualify as economically
equivalent with respect to a particular referenced contract so long as
the swap shares ``identical material'' contract specifications, terms,
and conditions with the referenced contract, disregarding any
differences with respect to lot size or notional amount, delivery dates
diverging by less than one calendar day (other than for natural gas
referenced contracts),\584\ or post-trade risk-management
arrangements.\585\ As discussed further below, the Commission explains
that the definition of ``economically equivalent swaps'' is relatively
narrow, especially compared to the definition of ``referenced
contract'' as applied to cash-settled look-alike contracts.
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\583\ CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5). In addition, CEA
section 4a(a)(4) separately authorizes, but does not require, the
Commission to impose federal limits on swaps that meet certain
statutory criteria qualifying them as ``significant price discovery
function'' swaps. 7 U.S.C. 6a(a)(4). The Commission reiterates, for
the avoidance of doubt, that the definitions of ``economically
equivalent'' in CEA section 4a(a)(5) and ``significant price
discovery function'' in CEA section 4a(a)(4) are separate concepts
and that contracts can be economically equivalent without serving a
significant price discovery function.
\584\ As discussed below, the proposed definition of
``economically equivalent swaps'' with respect to natural gas
referenced contracts would contain the same terms, except that it
would include delivery dates diverging by less than two calendar
days.
\585\ See supra Section II.A.4. (for further discussion
regarding the Commission's proposed definition of ``economically
equivalent swap'').
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The Commission preliminarily believes that the proposed definition
of ``economically equivalent swaps'' would benefit (1) market integrity
by protecting against excessive speculation and potential manipulation
and (2) market liquidity by not favoring OTC or foreign markets over
domestic markets. However, as discussed below, exchanges would be
subject to delayed compliance with respect to the proposed Sec. 150.5
requirements regarding exchange-set speculative position limits on
swaps until such time that exchanges have access to sufficient data to
monitor for limits on swaps across exchanges; as a result, exchange-set
limits would not need to include, nor would exchanges be required to
oversee, compliance with exchange-set position limits on swaps until
such time.
(1) Benefits and Costs Related to Market Integrity
The Commission preliminarily believes that the proposed definition
will benefit market integrity in two ways. First, the proposed
definition would protect against excessive speculation and potential
market manipulation by limiting the ability of speculators to obtain
excessive positions through netting. For example, a more inclusive
``economically equivalent'' definition that would encompass additional
swaps (e.g., swaps that may differ in their ``material'' terms or
physical swaps with delivery dates that
[[Page 11680]]
diverge by one day or more) could make it easier for market
participants to inappropriately net down against their referenced
contracts by allowing market participants to structure swaps that do
not necessarily offer identical risk or economic exposure or
sensitivity. In such a case, a market participant could enter into an
OTC swap with a maturity that differs by days or even weeks in order to
net down this position against its position in a referenced contract,
enabling it to hold an even greater position in the referenced
contract.
Similarly, requiring ``economically equivalent swaps'' to share all
material terms with their corresponding referenced contracts benefits
market integrity by preventing market participants from escaping the
position limits framework merely by altering non-material terms, such
as holiday conventions. On the other hand, the Commission recognizes
that such a narrow definition could impose costs on the marketplace by
possibly permitting excessive speculation since market participants
would not be subject to federal position limits if they were to enter
into swaps that may have different material terms (e.g., penultimate
swaps) \586\ but may nonetheless be sufficiently correlated to their
corresponding referenced contract. In this case, it is possible that
there may be potential for excessive speculation, market manipulation
such as squeezes and corners, insufficient market liquidity for bona
fide hedgers, or disruption to the price discovery function.
Nonetheless, to the extent that swaps currently are not subject to
federal position limit levels, such potential costs would remain
unchanged compared to the status quo.
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\586\ Or, in the case of natural gas referenced contracts, which
would potentially include penultimate swaps as economically
equivalent swaps, a swap with a maturity of less than one day away
from the penultimate swap. See infra Section IV.A.3.d.iv.(3)
(discussion of natural gas swaps).
---------------------------------------------------------------------------
Second, the relatively narrow proposed definition benefits market
integrity, and reduces associated compliance and implementation costs,
by permitting exchanges, market participants, and the Commission to
focus resources on those swaps that pose the greatest threat for
facilitating corners and squeezes--that is, those swaps with
substantially identical delivery dates and material economic terms to
futures and options on futures subject to federal position limits.
While swaps that have different material terms than their corresponding
referenced contracts, including different delivery dates, may
potentially be used for engaging in market manipulation, the proposed
definition would benefit market integrity by allowing exchanges and the
Commission to focus on the most sensitive period of the spot month,
including with respect to the Commission's and exchanges' various
surveillance and enforcement functions. To the extent market
participants would be able to use swaps that would not be covered by
the proposed definition to effect market manipulation, such potential
costs would not differ from the status quo since no swaps are currently
covered by federal position limits. The Commission however acknowledges
that its narrow definition may increase this cost, as fewer swaps will
be covered under the limits.
Further, the proposal to delay compliance with respect to exchange-
set limits on swaps will benefit exchanges by facilitating exchanges'
ability to establish surveillance and compliance systems. As noted
above, exchanges currently lack sufficient data regarding individual
market participants' open swap positions, which means that requiring
exchanges to establish oversight over participants' positions currently
could impose substantial costs and also may be impractical to achieve.
As a result, the Commission has preliminarily determined that allowing
exchanges delayed compliance with respect to swaps would reduce
unnecessary costs. Nonetheless, the Commission's preliminary
determination to permit exchanges to delay implementing federal
position limits on swaps could incentivize market participants to leave
the futures markets and instead transact in economically-equivalent
swaps, which could reduce liquidity in the futures and related options
markets, although the Commission recognizes that this concern should be
mitigated by the reality that the Commission would still oversee and
enforce federal position limits on economically equivalent swaps.
Additionally, while futures and related options are subject to
clearing and exchange oversight, economically equivalent swaps may be
transacted bilaterally off-exchange (i.e., OTC swaps). As a result, it
is relatively easy to create customized OTC swaps that may be highly
correlated to a referenced contract, which would allow the market
participant to create an exposure in the underlying commodity similar
to the referenced contract's exposure. Due to the relatively narrow
proposed ``economically equivalent swap'' definition, the Commission
preliminarily believes that it would not be difficult for market
participants to avoid federal position limits by entering into such OTC
swaps.\587\ While such swaps may not be perfectly correlated to their
corresponding referenced contracts, market participants may find this
risk acceptable in order to avoid federal position limits. An increase
in OTC swaps at the expense of futures and options contracts may impose
costs on market integrity due to lack of exchange oversight. If
liquidity were to move from futures exchanges to the OTC swaps markets,
non-dealer commercial entities may face increased transaction costs and
widening spreads, as swap dealers gain market power in the OTC market
relative to centralized exchange trading. The Commission is unable to
quantify the costs of these potential harms. However, while the
Commission acknowledges these potential costs, such costs to those
contracts that already have limits on them already may have been
realized in the marketplace because swaps are not subject to federal
position limits under the status quo.
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\587\ In contrast, since futures and options on futures
contracts are created by exchanges and submitted to the Commission
for either self-certification or approval under part 40 of the
Commission's regulations, a market participant would not be able to
customize an exchange-traded futures or options on futures contract.
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Lastly, under this proposal, market participants would be able to
determine whether a particular swap satisfies the definition of
``economically equivalent swap,'' as long as market participants make a
reasonable, good faith effort in reaching their determination and are
able to provide sufficient evidence, if requested, to support a
reasonable, good faith effort. The Commission preliminarily anticipates
that this flexibility will benefit market integrity by providing a
greater level of certainty to market participants in contrast to the
alternative in which market participants would be required to first
submit swaps to the Commission staff and wait for feedback or approval.
On the other hand, the Commission also recognizes that not having the
Commission explicitly opine on whether a swap would qualify as
economically equivalent could cause market participants to avoid
entering into such swaps. In turn, this could lead to less efficient
hedging strategies if the market participant is forced to turn to the
futures markets (e.g., a market participant may choose to transact in
the OTC swaps markets for various reasons, including liquidity, margin
requirements, or simply better familiarity with ISDA and swap processes
over exchange-traded futures). However, as noted below, the Commission
reserves the right to declare
[[Page 11681]]
whether a swap or class of swaps is or is not economically equivalent,
and a market participant could petition, or request informally, that
the Commission make such a determination, although the Commission
acknowledges that there could be costs associated with this, including
delayed timing and monetary costs.
Further, the Commission recognizes that requiring market
participants to conduct reasonable due diligence and maintain related
records also could impose new compliance costs. Additionally, the
Commission recognizes that certain market participants could assert
that an OTC swap is (or is not) ``economically equivalent'' depending
upon whether such determination benefits the market participant. In
such a case, market participants could theoretically subvert the intent
of the federal position limits framework, although the Commission
preliminarily believes that such potential costs would be mitigated due
to its surveillance functions and the proposal to reserve the authority
to declare that a particular swap or class of swaps either would or
would not qualify as economically equivalent.
(2) The Proposed Definition Could Increase Benefits or Costs Related to
Market Liquidity
First, the proposed definition could benefit market liquidity by
being, in general, less disruptive to the swaps markets, which in turn
may reduce the potential for disruption for the price discovery
function compared to an alternative in which the Commission would
proposed a broader definition. For example, if the Commission were to
adopt an alternative to its proposed ``economically equivalent swap''
definition that encompassed a broader range of swaps by including, for
example, delivery dates that diverge by one or more calendar days--
perhaps by several days or weeks--a speculator with a large portfolio
of swaps could more easily bump up against the applicable position
limits and therefore would have a strong incentive either to reduce its
swaps activity or move its swaps activity to foreign jurisdictions. If
there were many similarly situated speculators, the market for such
swaps could become less liquid, which in turn could harm liquidity for
bona fide hedgers as large liquidity providers could move to other
markets.
Second, the proposed definition could benefit market liquidity by
being sufficiently narrow to reduce incentives for liquidity providers
to move to foreign jurisdictions, such as the European Union
(``EU'').\588\ Additionally, the Commission preliminarily believes that
proposing a definition similar to that used by the EU will benefit
international comity.\589\ Further, since market participants trading
in both U.S. and EU markets would find the proposed definition to be
familiar, it may help reduce compliance costs for those market
participants that already have systems and personnel in place to
identify and monitor such swaps.
---------------------------------------------------------------------------
\588\ In this regard, the proposed definition is similar in
certain ways to the EU definition for OTC contracts that are
``economically equivalent'' to commodity derivatives traded on an EU
trading venue. The applicable European regulations define an OTC
derivative to be ``economically equivalent'' when it has ``identical
contractual specifications, terms and conditions, excluding
different lot size specifications, delivery dates diverging by less
than one calendar day and different post trade risk management
arrangements.'' While the Commission's proposed definition is
similar, the Commission's proposed definition requires ``identical
material'' terms rather than simply ``identical'' terms. Further,
the Commission's proposed definition excludes different ``lot size
specifications or notional amounts'' rather than referencing only
``lot size'' since swaps terminology usually refers to ``notional
amounts'' rather than to ``lot sizes.'' See EU Commission Delegated
Regulation (EU) 2017/591, 2017 O.J. (L 87).
\589\ Both the Commission's definition and the applicable EU
regulation are intended to prevent harmful netting. See European
Securities and Markets Authority, Draft Regulatory Technical
Standards on Methodology for Calculation and the Application of
Position Limits for Commodity Derivatives Traded on Trading Venues
and Economically Equivalent OTC Contracts, ESMA/2016/668 at 10 (May
2, 2016), available at https://www.esma.europa.eu/sites/default/files/library/2016-668_opinion_on_draft_rts_21.pdf (``[D]rafting the
[economically equivalent OTC swap] definition in too wide a fashion
carries an even higher risk of enabling circumvention of position
limits by creating an ability to net off positions taken in on-venue
contracts against only roughly similar OTC positions.'')
The applicable EU regulator, the European Securities and Markets
Authority (``ESMA''), recently released a ``consultation paper''
discussing the status of the existing EU position limits regime and
specific comments received from market participants. According to
ESMA, no commenter, with one exception, supported changing the
definition of an economically equivalent swap (referred to as an
``economically equivalent OTC contract'' or ``EEOTC''). ESMA further
noted that for some respondents, ``the mere fact that very few EEOTC
contracts have been identified is no evidence that the regime is
overly restrictive.'' See European Securities and Markets Authority,
Consultation Paper MiFID Review Report on Position Limits and
Position Management Draft Technical Advice on Weekly Position
Reports, ESMA70-156-1484 at 46, Question 15 (Nov. 5, 2019),
available at https://www.esma.europa.eu/document/consultation-paper-position-limits.
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(3) The Proposed Definition Could Create Benefits or Costs Related to
Market Liquidity for the Natural Gas Market
As discussed in greater detail in the preamble, the Commission
recognizes that the market dynamics in natural gas are unique in
several respects, including the fact that unlike with respect to other
core referenced futures contracts, for natural gas relatively liquid
spot-month and penultimate cash-settled futures exist. As a result, the
Commission believes that creating an exception to the proposed
``economically equivalent swap'' definition for natural gas would
benefit market liquidity by not unnecessarily favoring existing
penultimate contracts over spot contracts. The Commission is especially
sensitive to potential market manipulation in the natural gas markets
since market participants--to a significantly greater extent compared
to the other core referenced futures contracts that are included in the
proposal--regularly trade in both the physically-settled core
referenced futures contract and the cash-settled look-alike referenced
contracts. Accordingly, the Commission preliminarily has concluded that
a slightly broader definition of ``economically equivalent swap'' would
uniquely benefit the natural gas markets by helping to deter and
prevent manipulation of a physically-settled contract to benefit a
related cash-settled contract.
e. Pre-Existing Positions
Proposed Sec. 150.2(g) would impose federal limits on ``pre-
existing positions''--other than pre-enactment swaps and transition
period swaps--during the spot month, while non-spot month pre-existing
positions would not be subject to position limits as long as (i) the
position was acquired in good faith consistent with the ``pre-existing
position'' definition in proposed Sec. 150.1; \590\ and (ii) such
position would be attributed to the person if the position increases
after the limit's effective date.
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\590\ Proposed Sec. 150.1 would define ``pre-existing
position'' to mean ``any position in a commodity derivative contract
acquired in good faith prior to the effective date'' of any
applicable position limit.
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The Commission believes that this approach would benefit market
integrity since pre-existing positions (other than pre-enactment and
transition period swaps) that exceed spot-month limits could result in
market or price disruptions as positions are rolled into the spot
month.\591\ However, the Commission acknowledges that the proposed
``good-faith'' standard also could impose certain costs on market
integrity since an inherently subjective ``good faith'' standard could
result in disparate treatment of traders by a
[[Page 11682]]
particular exchange or across exchanges seeking a competitive advantage
with one another and could impose trading costs on those traders given
less advantageous treatment. For example, the Commission acknowledges
that since it has given discretion to an exchange in interpreting this
``good faith'' standard, an exchange may be more liberal with
concluding that a large trader or influential exchange member obtained
a position in ``good faith.'' As a result, the proposal could
potentially harm market integrity and/or increase transaction costs if
an exchange were to benefit certain market participants compared to
other market participants that receive relatively less advantageous
treatment. However, the Commission believes the risk of any
unscrupulous trader or exchange is mitigated since exchanges continue
to be subject to Commission oversight and to DCM Core Principles 4
(``prevention of market disruption'') and 12 (``protection of markets
and market participants''), among others, and since proposed Sec.
150.2(g)(2) also would require that exchanges must attribute the
position to the trader if its position increases after the position
limit's effective date.
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\591\ The Commission is particularly concerned about protecting
the spot month in physical-delivery futures from corners and
squeezes.
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4. Bona Fide Hedging and Spread and Other Exemptions From Federal
Position Limits (Proposed Sec. Sec. 150.1 and 150.3)
a. Background
The proposal provides for several exemptions that, subject to
certain conditions, would permit a trader to exceed the applicable
federal position limit set forth under proposed Sec. 150.2.
Specifically, proposed Sec. 150.3 would generally maintain, with
certain modifications discussed below, the two existing federal
exemptions for bona fide hedging positions and spread positions, and
would include new federal exemptions for certain conditional spot month
positions in natural gas, certain financial distress positions, and
pre-enactment and transition period swaps. Proposed Sec. 150.1 would
set forth the proposed definitions for ``bona fide hedging transactions
or positions'' and for ``spread transactions.'' \592\
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\592\ This discussion sometimes refers to the ``bona fide
hedging transactions or positions'' definition as ``bona fide
hedges,'' ``bona fide hedging,'' or ``bona fide hedge positions.''
For the purpose of this discussion, the terms have the same meaning.
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b. Bona Fide Hedging Definition; Enumerated Bona Fide Hedges; and
Guidance on Measuring Risk
The Commission is proposing several amendments related to bona fide
hedges. First, the Commission is proposing to include a revised
definition of ``bona fide hedging transactions or positions'' in Sec.
150.1 to conform to the statutory bona fide hedge definition in CEA
section 4a(c) as Congress amended it in the Dodd-Frank Act. As
discussed in greater detail in the preamble, the Commission proposes to
(1) revise the temporary substitute test, consistent with the
Commission's understanding of the Dodd-Frank Act's amendments to
section 4a of the CEA, to no longer recognize as bona fide hedges
certain risk management positions; (2) revise the economically
appropriate test to make explicit that the position must be
economically appropriate to the reduction of ``price risk''; and (3)
eliminate the incidental test and orderly trading requirement, which
Dodd-Frank removed from section 4a of the CEA. The Commission
preliminarily believes that these changes include non-discretionary
changes that are required by Congress's amendments to section 4a of the
CEA. The Commission also proposes to revise the bona fide hedge
definition to conform to the CEA's statutory definition, which permits
certain pass-through offsets.\593\
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\593\ As discussed in Section II.A.--Sec. 150.1--Definitions of
the preamble, the existing definition of ``bona fide hedging
transactions and positions'' currently appears in Sec. 1.3 of the
Commission's regulations; the proposal would move the revised
definition to proposed Sec. 150.1.
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Second, the Commission would maintain the distinction between
enumerated and non-enumerated bona fide hedges but would (1) move the
currently-enumerated hedges in the existing definition of ``bona fide
hedging transactions and positions'' currently found in Commission
regulation Sec. 1.3 to proposed Appendix A in part 150 that will serve
as examples of positions that would comply with the proposed bona fide
hedging definition; and (2) propose to make all existing enumerated
bona fide hedges as well as additional enumerated hedges to be self-
effectuating for federal position limit purposes, without the need for
prior Commission approval. In contrast, the existing enumerated
anticipatory bona fide hedges are not currently self-effectuating and
require market participants to apply to the Commission for recognition.
Third, the Commission is proposing guidance with respect to whether
an entity may measure risk on a net or gross basis for purposes of
determining its bona fide hedge positions.
The Commission expects these proposed modifications will provide
market participants with the ability to hedge, and exchanges with the
ability to recognize hedges, in a manner that is consistent with common
commercial hedging practices, reducing compliance costs and increase
the benefits associated with sound risk management practices.
i. Bona Fide Hedging Definition
(1) Elimination of Risk Management Exemptions; Addition of the Proposed
Pass-Through Swap Exemption
First, the Commission has preliminarily determined that eliminating
the risk-management exemption in physical commodity derivatives subject
to federal speculative position limits, unless the position satisfies
the pass-through/swap offset requirements in section 4a(c)(2)(B) of the
CEA discussed further below, is consistent with Congressional and
statutory intent, as evidenced by the Dodd-Frank Act's amendments to
the bona fide hedging definition in CEA section 4a(c)(2).\594\
Accordingly, once the proposed federal limit levels go into effect,
market participants with positions that do not otherwise satisfy
[[Page 11683]]
the proposed bona fide hedging definition or qualify for an exemption
would no longer be able to rely on recognition of such risk-reducing
techniques as bona fide hedges. Absent other factors, market
participants who have, or have requested, a risk management exemption
under the existing definition may resort to less effective hedging
strategies resulting in, for example, increased costs for liquidity
providers due to increased basis risk and/or decreased market
efficiency due to higher transaction (i.e., hedging) costs. Moreover,
absent other factors, by excluding risk management positions from the
bona fide hedge definition (other than those positions that would meet
the pass-through/swap offset requirement in the proposed bona fide
hedge definition, discussed further below), the proposed definition may
affect the overall level of liquidity in the market since dealers who
approach or exceed the federal position limit may decide to pull back
on providing liquidity, including to bona fide hedgers.
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\594\ See supra Section II.A.1.c.ii.(1). The existing bona fide
hedging definition in Sec. 1.3 requires that a position must
``normally'' represent a substitute for transactions or positions
made at a later time in a physical marketing channel (i.e., the
``temporary substitute test''). The Dodd-Frank Act amended the
temporary substitute language that previously appeared in the
statute by removing the word ``normally'' from the phrase normally
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). The Commission
preliminarily interprets this change as reflecting Congressional
direction that a bona fide hedging position in physical commodities
must always (and not just ``normally'') be in connection with the
production, sale, or use of a physical cash-market commodity.
Previously, the Commission stated that, among other things, the
inclusion of the word ``normally'' in connection with the pre-Dodd-
Frank version of the temporary substitute language indicated that
the bona fide hedging definition should not be construed to apply
only to firms using futures to reduce their exposures to risks in
the cash market, and that to qualify as a bona fide hedge, a
transaction in the futures market did not need to be a temporary
substitute for a later transaction in the cash market. See
Clarification of Certain Aspects of the Hedging Definition, 52 FR at
27195, 27196 (Jul. 20, 1987). In other words, that 1987
interpretation took the view that a futures position could still
qualify as a bona fide hedging position even if it was not in
connection with the production, sale, or use of a physical
commodity. Accordingly, based on the Commission's preliminary
interpretation of the revised statutory definition of bona fide
hedging in CEA section 4a(c)(2), risk-management hedges would not be
recognized under the Commission's proposed bona fide hedging
definition.
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On the other hand, the Commission believes that these potential
costs could be mitigated for several reasons. First, the proposed bona
fide hedging definition, consistent with the Dodd-Frank Act's changes
to CEA section 4a(c)(2), would permit the recognition as bona fide
hedges of futures and options on futures positions that offset pass-
through swaps entered into by dealers and other liquidity providers
(the ``pass-through swap counterparty'') \595\ opposite bona fide
hedging swap counterparties (the ``bona fide hedge counterparty''), as
long as: (1) The pass-through swap counterparty can demonstrate, upon
request from the Commission and/or from an exchange, that the pass-
through swap qualifies as a bona fide hedge for the bona fide hedge
counterparty; and (2) the pass-through swap counterparty enters into a
futures or option on a futures position or a swap position, in each
case in the same physical commodity as the pass-through swap to offset
and reduce the price risk attendant to the pass-through swap.\596\
Accordingly, a subset of risk management exemption holders could
continue to benefit from an exemption, and potential counterparties
could benefit from the liquidity they provide, as long as the position
being offset qualifies as a bona fide hedge for the counterparty.
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\595\ Such pass-through swap counterparties are typically swap
dealers providing liquidity to bona fide hedgers.
\596\ See paragraph (2)(i) of the proposed bona fide hedging
definition. Of course, if the pass-through swap qualifies as an
``economically appropriate swap,'' then the pass-through swap
counterparty would not need to rely on the proposed pass-through
swap provision since it may be able to offset its long (or short)
position in the economically equivalent swap with the corresponding
short (or long) position in the futures or option on futures
position or on the opposite side of another economically equivalent
swap.
---------------------------------------------------------------------------
The Commission preliminarily has determined that any resulting
costs or benefits related to the proposed pass-through swap exemption
are a result of Congress's amendments to CEA section 4a(c) rather than
the Commission's discretionary action. On the other hand, the
Commission's discretionary action to require the pass-through swap
counterparty to create and maintain records to demonstrate the bona
fides of the pass-through swap would cause the swap counterparty to
incur marginal recordkeeping costs.\597\
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\597\ To the extent that the pass-through swap counterparty is a
swap dealer or major swap participant, they already may be subject
to similar recordkeeping requirements under Sec. 1.31 and part 23
of the Commission's regulations. As a result, such costs may already
have been realized.
---------------------------------------------------------------------------
The proposed pass-through swap provision, consistent with the Dodd-
Frank Act's changes to CEA section 4a(c)(2), also would address a
situation where a participant who qualifies as a bona fide hedging swap
counterparty (i.e., a participant with a position in a previously-
entered into swap that qualified, at the time the swap was entered
into, as a bona fide hedging position under the proposed definition)
seeks, at some later time, to offset that swap position.\598\ Such step
might be taken, for example, to respond to a change in the
participant's risk exposure in the underlying commodity. As a result, a
participant could use futures or options on futures in excess of
federal position limits to offset the price risk of a previously-
entered into swap, which would allow the participant to exceed federal
limits using either new futures or options on futures or swap positions
that reduce the risk of the original swap.
---------------------------------------------------------------------------
\598\ See paragraph (2)(ii) of the proposed bona fide hedging
transactions or positions definition.
---------------------------------------------------------------------------
The Commission expects the pass-through swap provision to
facilitate dynamic hedging by market participants. The Commission
recognizes that a significant number of market participants use dynamic
hedging to more effectively manage their portfolio risks. Therefore,
this provision may increase operational efficiency. In addition, by
permitting dynamic hedging, a greater number of dealers should be
better able to provide liquidity to the market, as these dealers will
be able to more effectively manage their risks by entering into pass-
through swaps with bona fide hedgers as counterparties. Moreover,
market participants are not precluded from using swaps that are not
``economically equivalent swap'' for such risk management purposes
since swaps that are not deemed to be ``economically equivalent'' to a
referenced contract would not be subject to the Commission's proposed
position limits framework.
The Commission preliminarily observes that market participants may
not need to rely on the proposed pass-through swap provision to the
extent such parties employ swaps that qualify as ``economically
equivalent swaps,'' since such market participants may be able to net
such swaps against the corresponding futures or options on futures. As
a result, the Commission preliminarily anticipates that the proposed
pass-through swap provision would benefit those bona fide hedgers and
pass-through swap counterparties that use swaps that would not qualify
as economically equivalent under the Commission's proposal. To the
extent market participants use swaps that would qualify as economically
equivalent swaps, or could shift their trading strategies to use such
swaps without incurring additional costs, the Commission preliminarily
believes that the elimination of the risk management position would not
necessarily result in market participants incurring costs or limiting
their trading since they would be able to net the positions in
economically equivalent swaps with their futures and options on futures
positions, or with other economically equivalent swaps.
Second, for the nine legacy agricultural contracts, the proposal
would generally set federal non-spot month limit levels higher than
existing non-spot limits, which may enable additional dealer activity
described above.\599\ The remaining 16 core referenced futures
contracts would be subject to existing exchange-set limits or
accountability outside of the spot month, which does not represent a
change from the status quo under existing or proposed Sec. 150.5. The
proposed higher levels with respect to the nine legacy agricultural
contracts and the exchanges' flexible accountability regimes with
respect to the proposes new 16 core referenced futures contract should
mitigate at least some potential costs related to the
[[Page 11684]]
prohibition on recognizing risk management positions as bona fide
hedges.
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\599\ Proposed Sec. 150.2 generally would increase position
limits for non-spot months for contracts that currently are subject
to the federal position limits framework other than for CBOT Oats
(O), CBOT KC HRW Wheat (KW), and MGEX HRS Wheat (MWE), for which the
Commission would maintain existing levels.
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Third, the proposal may improve market competitiveness and reduce
transaction costs. As noted above, existing holders of the risk
management exemption, and the levels permitted thereunder, are
currently confidential, and the Commission is no longer granting new
risk management exemptions to potential new liquidity providers.
Accordingly, by eliminating the risk management exemption, the
Commission's proposal would benefit the public and strengthen market
integrity by improving market transparency since certain dealers would
no longer be able to maintain the grandfathered risk management
exemption while other dealer lack this ability under the status quo.
While the Commission believes that the risk management exemption may
allow dealers to more effectively provide market making activities,
which benefits market liquidity and ultimately leads to lower prices
for end-users, as noted above, the potential costs resulting from
removing the risk management exemption may be mitigated by the revised
position limit levels that reflect current EDS for spot month levels
and current open interest and trading volume for non-spot month levels.
Therefore, the Commission believes that existing risk management
exemption holders should be able to continue providing liquidity to
bona fide hedgers, but acknowledges that some may not to the same
degree as under the exemption; however, the Commission believes that
any potential harm to liquidity should be mitigated.
Further, the proposed spot month and non-spot month levels, which
generally will be higher than the status quo, together with the
elimination of the risk management exemptions that benefit only certain
dealers, might enable new liquidity providers to enter the markets on a
level playing field with the existing risk management exemption
holders. With the possibility of additional liquidity providers, the
proposed framework may strengthen market integrity by decreasing
concentration risk potentially posed by too few market makers. However,
the benefits to market liquidity the Commission describes above may be
muted since this analysis is predicated, in part, on the understanding
that dealers are the predominant large traders. Data in the
Commission's Supplementary COT and its underlying data indicate that
risk-management exemption holders are not the only large participants
in these markets--large commercial firms also hold large positions in
such commodities.
(2) Limiting ``Risk'' to ``Price'' Risk; Elimination of the Incidental
Test and Orderly Trading Requirement
As discussed in the preamble, the proposed bona fide hedging
definition's ``economically appropriate test'' would clarify that only
hedges that offset price risks could be recognized as bona fide hedging
transactions or positions. The Commission does not believe that this
clarification would impose any new costs or benefits, as it is
consistent with both the existing bona fide hedging definition \600\ as
well as the Commission's longstanding policy.\601\ Nonetheless, the
Commission realizes that hedging occurs for more types of risks than
price (e.g., volumetric hedging). Therefore, the Commission recognizes
that by expressly limiting the bona fide hedge exemption to hedging
only price risk, certain market participants may not be able to receive
a bona fide hedging recognition, and for certain dealers, this may
limit their ability to provide liquidity to the market because without
being able to rely on bona fide hedging status, their trading activity
would cause them to otherwise exceed federal limits.
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\600\ The existing bona fide hedging definition in Sec. 1.3
provides that no transactions or positions shall be classified as
bona fide hedging unless their purpose is to offset price risks
incidental to commercial cash or spot operations. (emphasis added).
Accordingly, the proposed definition would merely move this
requirement to the proposed definition's revised ``economically
appropriate test'' requirement.
\601\ For example, in promulgating existing Sec. 1.3, the
Commission explained that a bona fide hedging position must, among
other things, ``be economically appropriate to risk reduction, such
risks must arise from operation of a commercial enterprise, and the
price fluctuations of the futures contracts used in the transaction
must be substantially related to fluctuations of the cash market
value of the assets, liabilities or services being hedged.'' Bona
Fide Hedging Transactions or Positions, 42 FR at 14832, 14833 (Mar.
16, 1977). Dodd-Frank added CEA section 4a(c)(2), which copied the
``economically appropriate test'' from the Commission's definition
in Sec. 1.3. See also 2013 Proposal, 78 FR at 75702, 75703.
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The Commission further would implement Congress's Dodd-Frank Act
amendments that eliminated the statutory bona fide hedge definition's
incidental test and orderly trading requirement by proposing to make
the same changes to the Commission's regulations. As discussed in the
preamble, the Commission preliminarily believes that these proposed
changes do not represent a change in policy or regulatory requirement.
As a result, the Commission does not identify any costs or benefits
related to these proposed changes.
ii. Proposed Enumerated Bona Fide Hedges
The Commission proposes enumerated bona fide hedges in Appendix A
to part 150 of the Commission's regulations to provide a list bona fide
hedges that would include: (i) The existing enumerated hedges; and (ii)
additional enumerated bona fide hedges. The Commission reinforces that
hedging practices not otherwise listed may still be deemed, on a case-
by-case basis, to comply with the proposed bona fide hedging definition
(i.e., non-enumerated bona fide hedges). As discussed further below,
the proposed enumerated bona fide hedges in Appendix A would be ``self-
effectuating'' for purposes of federal position limits levels, which
are expected to reduce delays and compliance costs associated with
requesting an exemption.
Additionally, as part of the Commission's proposal, the exchanges
would have discretion to determine, for purposes of their own exchange-
granted bona fide hedges, whether any of the proposed enumerated bona
fide hedges in proposed Appendix A to part 150 of the Commission's
regulations would be permitted to be maintained during the lesser of
the last five days of trading or the time period for the spot month in
such contract (the ``five-day rule''), and the Commission's proposal
otherwise would not require any of the enumerated bona fide hedges to
be subject to the five-day rule for purposes of federal position
limits. Instead, the Commission expects exchanges to make their own
determinations with respect to exchange-set limits as to whether it is
appropriate to apply the five-day rule for a particular bona fide hedge
type and commodity contract. The Commission has preliminarily
determined that exchanges are well-informed with respect to their
respective markets and well-positioned to make a determination with
respect to imposing the five-day rule in connection with recognizing
bona fide hedges for their respective commodity contracts. In general,
the Commission believes that, on the one hand, limiting a trader's
ability to establish a position in this manner by requiring the five-
day rule could result in increased costs related to operational
inefficiencies, as a trader may believe that this is the most opportune
time to hedge. On the other hand, the Commission believes that price
convergence may be particularly sensitive to potential market
manipulation or excessive speculation during this period. Accordingly,
the Commission preliminarily believes that
[[Page 11685]]
the proposal to not impose the five-day rule with respect to any of the
enumerated bona fide hedges for federal purposes but instead rely on
exchange's determination with respect to exchange-granted exemptions
would help to better optimize these considerations. The Commission
notes a potential cost for market integrity if exchanges fail to
implement a five-day rule in order to encourage additional trading in
order to increase profit, which could harm price convergence. However,
the Commission believes this concern is mitigated since exchanges also
have an economic incentive to ensure that price convergence occurs with
their respective contracts since commercial end-users would be less
willing to use such contracts for hedging purposes if price convergence
would fail to occur in such contracts as they may generally desire to
hedge cash market prices with futures contracts.
iii. Guidance for Measuring Risk on a Gross or Net Basis
The Commission proposes guidance in paragraph (a) of Appendix B to
part 150 on whether positions may be hedged on either a gross or net
basis. Under the proposed guidance, among other things, a trader may
measure risk on a gross basis if it would be consistent with the
trader's historical practice and is not intended to evade applicable
limits. The key cost associated with allowing gross hedging is that it
may provide opportunity for hidden speculative trading.\602\
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\602\ For example, using gross hedging, a market participant
could potentially point to a large long cash position as
justification for a bona fide hedge, even though the participant, or
an entity with which the participant is required to aggregate, has
an equally large short cash position that would result in the
participant having no net price risk to hedge as the participant had
no price risk exposure to the commodity prior to establishing such
derivative position. Instead, the participant created price risk
exposure to the commodity by establishing the derivative position.
---------------------------------------------------------------------------
Such risk is mitigated to a certain extent by the guidance's
provisos that the trader does not switch between net hedging and gross
hedging in order to evade limits and that the DCM documents
justifications for allowing gross hedging and maintains any relevant
records in accordance with proposed Sec. 150.9(d).\603\ However, the
Commission also recognizes that there are myriad of ways in which
organizations are structured and engage in commercial hedging
practices, including the use of multi-line business strategies in
certain industries that would be subject to federal position limits for
the first time under this proposal and for which net hedging could
impose significant costs or be operationally unfeasible.
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\603\ Under proposed Sec. 150.3(b)(2) and (e) and proposed
Sec. 150.9(e)(5), and (g), the Commission would have access to any
information related to the applicable exemption request.
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c. Spread Exemptions
Under existing Sec. 150.3, certain spread exemptions are self-
effectuating. Specifically, existing Sec. 150.3 allows for ``spread or
arbitrage positions'' that are ``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.'' \604\ Proposed Sec. Sec. 150.1 and 150.3
would amend the existing spread position exemption for federal limits
by (i) listing specific spread transactions that may be granted; and
(ii) other than for the listed spread positions, which would be self-
effectuating, requiring a person to apply for spread exemptions
directly with the Commission pursuant to proposed Sec. 150.3.\605\ In
addition, the proposed rule would permit spread exemptions outside the
same crop year and/or during the spot month.\606\
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\604\ 17 CFR 150.3. CEA section 4a(a)(1) provides the Commission
with authority to exempt from position limits transactions
``normally known to the trade'' as ``spreads'' or ``straddles'' or
``arbitrage'' or to fix limits for such transactions or positions
different from limits fixed for other transactions or positions.
\605\ The proposed ``spread transactions'' definition would list
the most common types of spread positions, including: Calendar
spreads, intercommodity spreads, quality differential spreads,
processing spreads (such as energy ``crack'' or soybean ``crush''
spreads), product or by-product differential spreads, and futures-
options spreads. Proposed Sec. 150.3(b) also would permit market
participants to apply to the Commission for other spread
transactions.
\606\ As discussed under proposed Sec. 150.3, spread exemptions
identified in the proposed ``spread transaction'' definition in
proposed Sec. 150.1 would be self-effectuating similar to the
status quo and would not represent a change to the status quo
baseline. The related costs and benefits, particularly with respect
to requesting exemptions with respect to spreads other than those
identified in the proposed ``spread transaction'' definition, are
discussed under the respective sections below.
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In connection with the spread exemption provisions, the Commission
is relaxing the prohibition for contracts during the same crop year
and/or the spot month so that exchanges are able to exempt spreads
outside the same crop year and/or during the spot month. There may be
benefits that result from permitting these types of spread exemptions.
For example, the Commission believes that permitting spread exemptions
not in the same crop year or during the spot month may potentially
improve price discovery as well as provide market participants with the
ability to use strategies involving spread positions, which may reduce
hedging costs.
As in the intermarket wheat example discussed below, the proposed
spread relief not limited to the same crop year month may better link
prices between two markets (e.g., the price of MGEX wheat futures and
the price of CBOT wheat futures). Put another way, permitting spread
exemptions outside the same crop year may enable pricing in two
different but related markets for substitute goods to be more highly
correlated, which, in this example, benefits market participants with a
price exposure to the underlying protein content in wheat generally,
rather than that of a particular commodity.
However, the Commission also recognizes certain potential costs to
permitting spread exemptions during the spot month, particularly to
extend into the last five days of trading. This feature could raise the
risk of allowing participants in the market at a time in the contract
where only those interested in making or taking delivery should be
present. When a contract goes into expiration, open interest and
trading volume naturally decrease as traders not interested in making
or taking delivery roll their positions into deferred calendar months.
The presence of large spread positions so close to the expiration of a
futures contract, which positions are normally tied to large liquidity
providers, may actually lead to disruptions in the price discovery
function of the contract by disrupting the futures/cash price
convergence. This could lead to increased transaction costs and harm
the hedging utility for end-users of the futures contract, which could
lead to higher costs passed on to consumers. However, the Commission
preliminarily believes that these concerns would be mitigated as
exchanges would continue to apply their expertise in overseeing and
maintaining the integrity of their markets. For example, an exchange
could refuse to grant a spread exemption if the exchange believed it
would harm its markets, require a participant to reduce its positions,
or implement a five-day-rule for spread exemptions, as discussed
above.\607\
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\607\ See supra Section IV.A.4.b.ii. (discussion of the five-day
rule).
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Generally, the Commission preliminarily finds that, by allowing
speculators to execute intermarket and intramarket spreads as proposed,
speculators would be able to hold a greater amount of open interest in
[[Page 11686]]
underlying contract(s), and therefore, bona fide hedgers may benefit
from any increase in market liquidity. Spread exemptions may also lead
to better price continuity and price discovery if market participants
who seek to provide liquidity (for example, through entry of resting
orders for spread trades between different contracts) receive a spread
exemption, and thus would not otherwise be constrained by a position
limit.
For clarity, the Commission has identified the following two
examples of spread positions that could benefit from the proposed
spread exemption:
Reverse crush spread in soybeans on the CBOT subject to an
intermarket spread exemption. In the case where soybeans are processed
into two different products, soybean meal and soybean oil, the crush
spread is the difference between the combined value of the products and
the value of soybeans. There are two actors in this scenario: the
speculator and the soybean processor. The spread's value approximates
the profit margin from actually crushing (or mashing) soybeans into
meal and oil. The soybean processor may want to lock in the spread
value as part of its hedging strategy, establishing a long position in
soybean futures and short positions in soybean oil futures and soybean
meal futures, as substitutes for the processor's expected cash market
transactions (the long position hedges the purchase of the anticipated
inputs for processing and the short position hedges the sale of the
anticipated soybean meal and oil products). On the other side of the
processor's crush spread, a speculator takes a short position in
soybean futures against long positions in soybean meal futures and
soybean oil futures. The soybean processor may be able to lock in a
higher crush spread because of liquidity provided by such a speculator
who may need to rely upon a spread exemption. In this example, the
speculator is accepting basis risk represented by the crush spread, and
the speculator is providing liquidity to the soybean processor. The
crush spread positions may result in greater correlation between the
futures prices of soybeans on the one hand and those of soybean oil and
soybean meal on the other hand, which means that prices for all three
products may move up or down together in a more correlated manner.
Wheat spread subject to intermarket spread exemptions.
There are two actors in this scenario: the speculator and the wheat
farmer. In this example, a farmer growing hard wheat would like to
reduce the price risk of her crop by shorting a MGEX wheat futures.
There, however, may be no hedger, such as a mill, that is immediately
available to trade at a desirable price for the farmer. There may be a
speculator willing to offer liquidity to the hedger; however, the
speculator may wish to reduce the risk of an outright long position in
MGEX wheat futures through establishing a short position in CBOT wheat
futures (soft wheat). Such a speculator, who otherwise would have been
constrained by a position limit at MGEX and/or CBOT, may seek
exemptions from MGEX and CBOT for an intermarket spread, that is, for a
long position in MGEX wheat futures and a short position in CBOT wheat
futures of the same maturity. As a result of the exchanges granting an
intermarket spread exemption to such a speculator, who otherwise may be
constrained by limits, the farmer might be able to transact at a higher
price for hard wheat than might have existed absent the intermarket
spread exemptions. Under this example, the speculator is accepting
basis risk between hard wheat and soft wheat, reducing the risk of a
position on one exchange by establishing a position on another
exchange, and potentially providing liquidity to a hedger. Further,
spread transactions may aid in price discovery regarding the relative
protein content for each of the hard and soft wheat contracts.
d. Conditional Spot Month Exemption Positions in Natural Gas
Proposed Sec. 150.3(a)(4) would provide a new federal conditional
spot month limit exemption position for cash-settled natural gas
contracts that would permit traders to acquire positions up to 10,000
NYMEX Henry Hub Natural Gas (NG) equivalent-size contracts (the federal
spot month limit in proposed Sec. 150.2 for NYMEX Henry Hub Natural
Gas (NG) referenced contracts is otherwise 2,000 contracts in the
aggregate across all one's net positions) per exchange that lists the
relevant natural gas cash-settled referenced contracts, along with an
additional futures-adjusted 10,000 contracts of cash-settled
economically equivalent swaps, as long as such person does not also
hold positions in the physically-settled natural gas referenced
contract.\608\ NYMEX, ICE, Nasdaq Futures, and Nodal currently have
rules in place establishing a conditional spot month limit exemption
equivalent to up to 5,000 contracts in NYMEX-equivalent size. By
proposing to include the conditional exemption for purposes of federal
limits on natural gas contracts, the Commission reduces the incentive
and ability for a market participant to manipulate a large physically-
settled position to benefit a linked cash-settled position.
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\608\ The NYMEX Henry Hub Natural Gas (NG) contract is the only
natural gas contract included as a core referenced futures contract
under this proposal.
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Further, the Commission has heeded natural gas traders' concerns
about disrupting market practices and harming liquidity in the cash-
settled contract, which could increase the cost of hedging and possibly
prevent convergence between the physical delivery futures and cash
markets.\609\ While a trader with a position in the physical-delivery
natural gas contract may incur costs associated with liquidating that
position in order to meet the conditions of the federal exemption, such
costs are incurred outside of the proposal, as the trader would have to
do so as a condition of the exchange-level exemption under current
exchange rules.\610\
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\609\ See 2016 Reproposal, 81 FR at 96862, 96863.
\610\ See ICE Rule 6.20(c) and NYMEX Rule 559.F. See, e.g.,
NASDAQ Futures Rule ch. v, section 13(a)(ii) and Nodal Exchange
Rulebook Appendix C (equivalent rules of NASDAQ and Nodal
exchanges).
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e. Financial Distress Exemption
Proposed Sec. 150.3(a)(3) would provide an exemption for certain
financial distress circumstances, including the default of a customer,
affiliate, or acquisition target of the requesting entity that may
require the requesting entity to take on, in short order, the positions
of another entity. In codifying the Commission's historical practice,
the proposed rule accommodates transfers of positions from financially
distressed firms to financially secure firms. The disorderly
liquidation of a position threatens price impacts that may harm the
efficiency and price discovery function of markets, and the proposal
would make it less likely that positions will be prematurely or
needlessly liquidated. The Commission has determined that costs related
to filing and recordkeeping are likely to be minimal. The Commission
cannot accurately estimate how often this exemption may be invoked
because emergency or distressed market situations are unpredictable and
dependent on a variety of firm and market-specific factors as well as
general macroeconomic indicators.\611\ The Commission, nevertheless,
believes that emergency or distressed market situations that might
trigger the need for this exemption will be infrequent, and that
codifying this historical practice
[[Page 11687]]
will add transparency to the Commission's oversight responsibilities.
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\611\ See 2016 Reproposal, 81 FR at 96862, 96863.
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f. Pre-Enactment and Transition Period Swaps Exemption
Proposed Sec. 150.3(a)(5) would also provide an exemption from
position limits for positions acquired in good faith in any ``pre-
enactment swap,'' or in any ``transition period swap,'' in either case
as defined in proposed Sec. 150.1. A person relying on this exemption
may net such positions with post-effective date commodity derivative
contracts for the purpose of complying with any non-spot-month
speculative positions limits, but may not net against spot month
positions. This exemption would be self-effectuating, and the
Commission preliminarily believes that proposed Sec. 150.3(a)(5) would
benefit both individual market participants by lessening the impact of
the proposed federal limits, and market liquidity in general as
liquidity providers initially would not be forced to reduce or exit
their positions.
The proposal would benefit price discovery and convergence by
prohibiting large traders seeking to roll their positions into the spot
month from netting down positions in the spot-month against their pre-
enactment swap or transition period swap. The Commission acknowledges
that, on its face, including a ``good-faith'' requirement in the
proposed Sec. 150.3(a)(5) could hypothetically diminish market
integrity since determining whether a trader has acted in ``good
faith'' is inherently subjective and could result in disparate
treatment among traders, where certain traders may assert a more
aggressive position in order to seek a competitive advantage over
others. The Commission believes the risk of any such unscrupulous
trader or exchange is mitigated since exchanges would still be subject
to Commission oversight and to DCM Core Principles 4 (``prevention of
market disruption'') and 12 (``protection of markets and market
participants''), among others. The Commission has determined that
market participants who voluntarily employ this exemption also will
incur negligible recordkeeping costs.
5. Process for the Commission or Exchanges To Grant Exemptions and Bona
Fide Hedge Recognitions for Purposes of Federal Limits (Proposed
Sec. Sec. 150.3 and 150.9) and Related Changes to Part 19 of the
Commission's Regulations
Existing Sec. Sec. 1.47 and 1.48 set forth the process for market
participants to apply to the Commission for recognition of certain bona
fide hedges for purposes of federal limits, and existing Sec. 150.3
sets forth a list of spread exemptions a person can rely on for
purposes of federal limits. However, under existing Commission
practices, spread exemptions and certain enumerated bona fide hedges
are generally self-effectuating and do not require market participants
to apply to the Commission for purposes of federal position limits,
although market participants are required to file Form 204 monthly
reports \612\ to justify certain position limit overages. Further, for
those bona fide hedges for which market participants are required to
apply to the Commission, existing regulations and market practice
require market participants to apply both to the Commission for
purposes of federal limits and also to the relevant exchanges for
purposes of exchange-set limits. The Commission has preliminarily
determined that this dual application process creates inefficiencies
for market participants.
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\612\ In the case of cotton, market participants currently file
the relevant portions of Form 304.
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Proposed Sec. Sec. 150.3 and 150.9, taken together, would make
several changes to the process of acquiring bona fide hedge
recognitions and spread exemptions for federal position limits
purposes. Proposed Sec. Sec. 150.3 and 150.9 would maintain certain
elements of the status quo while also adopting certain changes to
facilitate the exemption process.\613\
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\613\ In this section the Commission discusses the costs and
benefits related to the application process for these exemptions and
bona fide hedge recognitions. For a discussion of the costs and
benefits related to the scope of the exemptions and bona fide hedge
recognitions, see supra Section IV.A.5.a.iv.
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First, with respect to the proposed enumerated bona fide hedges,
proposed Sec. 150.3 would maintain the status quo by providing that
those enumerated bona fide hedges that currently are self-effectuating
for the nine legacy agricultural contracts would remain self-
effectuating for the nine legacy agricultural contracts for purposes of
federal position limits.\614\ Similarly, the enumerated bona fide
hedges for the proposed additional 16 contracts that would be newly
subject to federal position limits (i.e., those contracts other than
the nine legacy agricultural contracts) also would be self-effectuating
for purposes of federal position limits.
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\614\ Under the status quo, market participants must apply to
the Commission for recognition of certain enumerated anticipatory
bona fide hedges. The Commission's proposal also would make these
enumerated anticipatory bona fide hedges self-effectuating for the
nine legacy agricultural contracts.
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Second, for recognition of any non-enumerated bona fide hedge in
connection with any referenced contract, market participants would be
required to apply either directly to the Commission under proposed
Sec. 150.3 or through an exchange that adheres to certain requirements
under proposed Sec. 150.9. The Commission notes that existing
regulations require market participants to apply to the Commission for
recognition of non-enumerated bona fide hedges, and so the Commission's
proposal does not represent a change to the status quo in this respect
for the nine legacy agricultural contracts.
Third, proposed Sec. 150.3 would maintain the status quo by
providing that the most common spread exemptions for the nine legacy
agricultural contracts would remain self-effectuating. Similarly, these
common spread exemptions also would be self-effectuating for the
proposed additional 16 contracts that would be newly subject to federal
position limits. These common spread exemptions would be listed in the
proposed ``spread transaction'' definition under proposed Sec.
150.1.\615\
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\615\ The proposed ``spread transaction'' definition would
include a calendar spread, intercommodity spread, quality
differential spread, processing spread (such as energy ``crack'' or
soybean ``crush'' spreads), product or by-product differential
spread, or futures-option spread.
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Fourth, for any spread exemption not listed in the proposed
``spread transaction'' definition, market participants would be
required to apply directly to the Commission under proposed Sec.
150.3. There would be no exception for the nine legacy agricultural
products nor would market participants be permitted to apply through an
exchange under proposed Sec. 150.9 for these types of spread
exemptions.\616\
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\616\ As discussed below, the proposal would also eliminate the
Form 204 and the equivalent portions of the Form 304.
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The Commission anticipates that most--if not all--market
participants would utilize the exchange-centric process set forth in
proposed Sec. 150.9 with respect to applying for recognition of non-
enumerated bona fide hedges rather than apply directly to the
Commission under proposed Sec. 150.3 because market participants are
likely already familiar with the proposed processes set forth in Sec.
150.9, which is intended to leverage the processes currently in place
at the exchanges for addressing requests bona fide hedge recognitions
from exchange-set limits. In the sections below, the Commission will
discuss the costs and benefits related to both processes.
[[Page 11688]]
a. Process for Requesting Exemptions and Bona Fide Hedge Recognitions
Directly From the Commission (Proposed Sec. 150.3)
Under existing Sec. Sec. 1.47 and 1.48, and existing Sec. 150.3,
the processes for obtaining a recognition of a bona fide hedge or for
relying on a spread exemption, are similar in some respects and
different in other respects than the proposed approach. Existing
Sec. Sec. 1.47 and 1.48 require market participants seeking
recognition of non-enumerated bona fide hedges and enumerated
anticipatory bona fide hedges, respectively, for federal position
limits to apply directly to the Commission for prior approval.
In contrast, existing non-anticipatory enumerated bona fide hedges
and spread exemptions are self-effectuating, which means that market
participants are not required to submit any information to the
Commission for prior approval, although such market participants must
subsequently file Form 204 or Form 304 each month in order to describe
their cash market positions and justify their bona fide hedge position.
There currently is no codified federal process related to financial
distress exemptions or natural gas conditional spot month exemptions.
For those market participants that would choose to apply directly
to the Commission for recognition of non-enumerated bona fide hedges or
spread exemptions not included in the proposed ``spread transaction''
definition, which in each case would not be self-effectuating under the
proposal, proposed Sec. 150.3 would provide a process for the
Commission to review and approve requests. Under proposed Sec. 150.3,
any person seeking Commission recognition of these types of bona fide
hedges or a spread exemptions (as opposed to applying to using the
exchange-centric process under proposed Sec. 150.9 described below)
would be required to submit a request directly to the Commission and to
provide information similar to what is currently required under
existing Sec. Sec. 1.47 and 1.48.\617\
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\617\ For bona fide hedges and spread exemptions, this
information would include: (i) A description of the position in the
commodity derivative contract for which the application is
submitted, including the name of the underlying commodity and the
position size; (ii) information to demonstrate why the position
meets the applicable requirements for a bona fide hedge or spread
transaction; (iii) a statement concerning the maximum size of all
gross positions in derivative contracts for which the application is
submitted; (iv) for bona fide hedges, information regarding the
applicant's activity in the cash markets and swaps markets for the
commodity underlying the position for which the application is
submitted; and (v) any other information that may help the
Commission determine whether the position meets the applicable
requirements for a bona fide hedge position or spread transaction.
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i. Existing Bona Fide Hedges That Currently Require Prior Submission to
the Commission Under Existing Sec. Sec. 1.47 and 1.48 for the Nine
Legacy Agricultural Contracts
Under the proposal, the Commission would maintain the distinction
between enumerated bona fide hedges and non-enumerated bona fide hedges
under proposed Sec. 150.3: (1) Enumerated bona fide hedges would
continue to be self-effectuating; (2) enumerated anticipatory bona fide
hedges would become self-effectuating so market participants would no
longer need to apply to the Commission; and (3) non-enumerated bona
fide hedges would still require market participants to apply for
recognition. Market participants that choose to apply directly to the
Commission for a bona fide hedge recognition (i.e., for non-enumerated
bona fide hedges) would be subject to an application process that
generally is similar to what the Commission currently administers for
the non-enumerated bona fide hedges and the enumerated anticipatory
bona fide hedges.\618\ With respect to enumerated anticipatory bona
fide hedges for the nine legacy contracts, for which market
participants currently are required to apply to the Commission for
recognition for federal position limit purposes, the Commission
preliminarily anticipates that the proposal would benefit market
participants by making such hedges self-effectuating.\619\ As a result,
market participants will no longer be required to spend time and
resources applying to the Commission. Further, for these enumerated
anticipatory hedges, existing Sec. 1.48 requires market participants
to submit either an initial or supplemental application to the
Commission 10 days prior to entering into the bona fide hedge that
would cause the hedger to exceed federal position limits.\620\ Under
existing Sec. 1.48, market participants could proceed with their
proposed bona fide hedges if the Commission does not notify a market
participants otherwise within the specific 10-day period. Because bona
fide hedgers could implement enumerated anticipatory bona fide hedges
without waiting the requisite 10 days, they may be able to implement
their hedging strategy more efficiently with reduced cost and risk. The
Commission acknowledges that making such bona fide hedges easier to
obtain could increase the possibility of excess speculation since
anticipatory exemptions are theoretically more difficult to
substantiate compared to the other existing enumerated bona fide
hedges. However, the Commission has gained significant experience over
the years with bona fide hedging practices in general and with
enumerated anticipatory bona fide hedging practices in particular, and
the Commission preliminarily has determined that making such hedges
self-effectuating should not increase the risk of excessive speculation
or market manipulation compared to the status quo.
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\618\ As noted above, under the existing framework market
participants are not required to apply for any type of bona fide
hedge recognition or spread exemption from the Commission for any of
the proposed additional 16 contracts that would be newly subject to
federal position limits (i.e., those contracts other than the nine
legacy agricultural contracts); rather, under the existing
framework, such market participants must apply to the exchanges for
bona fide hedge recognitions or exemptions for purposes of exchange-
set position limits. Accordingly, to the extent that market
participants would not need to apply to the Commission in connection
with any of the proposed additional 16 contracts, the Commission's
proposal would not impose additional costs or benefits compared to
the status quo.
\619\ As noted above, since market participants do not need to
apply to the Commission for bona fide hedge recognition for any of
the proposed additional 16 contracts that would be newly subject to
federal position limits, the Commission's proposal would not result
in any additional costs or benefits to the extent such bona fide
hedge recognitions would be self-effectuating.
\620\ Under the Commission's existing regulations, non-
anticipatory enumerated bona fide hedges are self-effectuating, and
market participants do not have to file any applications for
recognition under existing Commission regulations. However, bona
fide hedgers must file with the Commission monthly Form 204 (or Form
304 in connection with ICE Cotton No. 2 (CT)) reports discussing
their underlying cash positions in order to substantiate their bona
fide hedge positions.
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For non-enumerated bona fide hedges, existing Sec. 1.47 requires
market participants to submit (i) initial applications to the
Commission 30 days prior to the date the market participant would
exceed the applicable position limits and (ii) supplemental
applications (i.e., applications for a market participant that desire
to exceed the bona fide hedge amount provided in the person's previous
Commission filing) 10 days prior for Commission approval, and market
participants can proceed with their proposed bona fide hedges if the
Commission does not intervene within the specific time (e.g., either 10
days or 30 days).
Proposed Sec. 150.3 would similarly require market participants
seeking recognition of a non-enumerated bona fide hedge for any of the
proposed 25 core referenced futures contracts to apply to the
Commission prior to exceeding federal position limits, but proposed
Sec. 150.3 would not prescribe a certain time period by which a bona
fide hedger must apply or by which the
[[Page 11689]]
Commission must respond. The Commission preliminarily anticipates that
the proposal would benefit bona fide hedgers by enabling them in many
cases to generally implement their hedging strategies sooner than the
existing 30-day or 10-day waiting period, in which case the Commission
believes hedging-related costs would decrease. However, the Commission
believes that there could also be circumstances in which the overall
process could take longer than the existing timelines under Sec. 1.47,
which could increase hedging related costs if a bona fide hedger is
compelled to wait longer, compared to existing Commission practices,
before executing its hedging strategy.
On the other hand, the Commission also recognizes that there could
be potential costs to bona fide hedgers if under the proposal they are
forced either to enter into less effective bona fide hedges or to wait
to implement their hedging strategy, as a result of the potential
uncertainty that could result from proposed Sec. 150.3 not requiring
the Commission to respond within a certain amount of time. The
Commission believes this concern is mitigated to the extent market
participants utilize the proposed Sec. 150.3 process that would permit
a market participant that demonstrates a ``sudden or unforeseen''
increase in its bona fide hedging needs to enter into a bona fide hedge
without first obtaining the Commission's prior approval, as long as the
market participant submits a retroactive application to the Commission
within five business days of exceeding the applicable position limit.
The Commission preliminarily believes this ``five-business day
retroactive exemption'' would benefit bona fide hedgers compared to
existing Sec. Sec. 1.47 and 1.48, which requires Commission prior
approval, since hedgers that would qualify to exercise the five-
business day retroactive exemption are also likely facing more acute
hedging needs--with potentially commensurate costs if required to wait.
This provision would also leverage, for federal position limit
purposes, existing exchange practices for granting retroactive
exemptions from exchange-set limits.
On the other hand, the proposed five-business day retroactive
exemption could harm market liquidity and bona fide hedgers if the
applicable exchange or the Commission were to not approve of the
retroactive request, and the Commission subsequently required
liquidation of the position in question. As a result, such possibility
could cause market participants to either enter into smaller bona fide
hedge positions than they otherwise would or cause the bona fide hedger
to delay entering into its hedge, in either case potentially causing
bona fide hedgers to incur increased hedging costs.
However, the Commission preliminarily believes this concern is
partially mitigated since proposed Sec. 150.3 would require the
purported bona fide hedger to exit its position in a ``commercially
reasonable time,'' which the Commission believes should partially
mitigate any costs incurred by the market participant compared to
either an alternative that would require the bona fide hedger to exit
its position immediately, or the status quo where the market
participant either is unable to enter into a hedge at all without
Commission prior approval.
ii. Spread Exemptions and Non-Enumerated Bona Fide Hedges
Proposed Sec. 150.3 would impose a new requirement for market
participants to (1) apply either directly to the Commission pursuant to
proposed Sec. 150.3 or to an exchange pursuant to proposed Sec. 150.9
for any non-enumerated bona fide hedge; and (2) to apply directly to
the Commission pursuant to proposed Sec. 150.3 for any spread
exemptions not identified in the proposed ``spread transaction''
definition for any of the proposed 25 core referenced futures
contracts.\621\ As noted above, common spread exemptions (i.e., those
identified in the proposed definition of ``spread transaction'' in
proposed Sec. 150.1) would remain self-effectuating for the nine
legacy agricultural products and also would be self-effectuating for
the 16 proposed core referenced futures contracts.\622\ Unlike non-
enumerated bona fide hedges, for which market participants could apply
directly to the Commission under proposed Sec. 150.3 or through an
exchange under proposed Sec. 150.9, for spread exemptions not
identified in the proposed ``spread transaction'' definition, market
participants would be required to apply directly to the Commission
under proposed Sec. 150.3.
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\621\ As discussed below, for spread exemptions not identified
in the proposed ``spread transaction'' definition in proposed Sec.
150.3, market participants would be required to apply directly to
the Commission under proposed Sec. 150.3 and would not be able to
apply under proposed Sec. 150.9.
\622\ Existing Sec. 150.3(a)(2) does not specify a formal
process for granting either spread exemptions or non-anticipatory
enumerated bona fide hedges that are consistent with CEA section
4a(a)(1), so in practice spread exemptions and non-anticipatory
enumerated bona fide hedges have been self-effectuating.
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As noted above, proposed Sec. 150.3 also would maintain the status
quo and continue to require any non-enumerated bona fide hedge in one
of the nine legacy agricultural products to receive prior approval, and
similarly would require prior approval for such non-enumerated bona
fide hedges for the proposed additional 16 contracts that would be
newly subject to federal position limits.\623\ The Commission
anticipates that there will be no change to the status quo baseline
with respect to the most common spread exemptions since these
exemptions would be self-effecting for purposes of federal position
limits.
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\623\ The Commission discusses the costs and benefits related to
the proposed process for non-enumerated bona fide hedge recognitions
with respect to the nine legacy agricultural products in the above
section.
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To the extent market participants would be required to obtain prior
approval for a non-enumerated bona fide hedge or spread exemption for
any of the additional 16 contracts that would be newly subject to
federal position limits, the Commission recognizes that proposed Sec.
150.3 would impose costs on market participants who will now be
required to spend time and resources submitting applications to the
Commission (for certain spread exemptions) or to either the Commission
or an exchange (for non-enumerated bona fide hedges) for prior approval
for federal position limit purposes.\624\ Further, compared to the
status quo in which the proposed new 16 contracts are not subject to
federal position limits, the proposed process could increase
uncertainty since market participants would be required to seek prior
approval and wait up to 10 days. As a result, such uncertainty could
cause market participants to either enter into smaller spread or bona
fide hedging positions or do so at a later time. In either case, this
could cause market participants to incur additional costs and/or
implement less efficient hedging strategies. However, the Commission
preliminarily believes that proposed Sec. 150.3's framework would be
familiar to market participants that currently apply to the Commission
for bona fide exemptions for the nine legacy agricultural products,
which should serve to reduce costs for some market participants
associated with obtaining recognition of a bona fide hedge or spread
exemption from the Commission for federal limits for those market
[[Page 11690]]
participants.\625\ The Commission also preliminarily believes that this
analysis also would apply to the nine legacy agricultural contracts for
spread exemptions that are not listed in the proposed ``spread
transaction'' definition and therefore also would require market
participants to apply to the Commission for these types of spread
exemptions for the first time for the nine legacy agricultural
products. However, because the Commission preliminarily has determined
that most spread transactions would be self-effectuating (especially
for the nine legacy agricultural contracts based on the Commission's
experience), the Commission believes that the proposal would impose
only small costs with respect to spread exemptions for both the nine
legacy agricultural contracts as well as the proposed additional 16
contracts that would be newly subject to federal position limits.
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\624\ The Commission's Paperwork Reduction Act analysis
identifies some of these information collection burdens in greater
specificity. See supra Section IV.A.4.c. (discussing in greater
detail the cost and benefits related to spread exemptions).
\625\ The Commission preliminarily anticipates that the proposed
application process in Sec. 150.3(b) could slightly reduce
compliance-related costs, compared to the status quo application
process to the Commission under existing Sec. Sec. 1.47 and 1.48,
because proposed Sec. 150.3 would provide a single, standardized
process for all bona fide hedge and spread exemption requests that
is slightly less complex--and more clearly laid out in the proposed
regulations--than the Commission's existing application processes.
Nonetheless, since the Commission anticipates that most market
participants would apply directly to exchanges for bona fide hedges
and spread exemptions when provided the option under proposed Sec.
150.9, the Commission believes that most market participants would
incur the costs and benefits discussed thereunder.
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While the Commission has years of experience granting and
monitoring spread exemptions and enumerated and non-enumerated bona
fide hedges for the nine legacy agricultural contracts, as well as
overseeing exchange processes for administering exemptions from
exchange-set limits on such commodities, the Commission does not have
the same level of experience or comfort administering bona fide hedge
recognitions and spread exemptions for the additional 16 contracts that
would be subject to the proposed federal position limits and the new
proposed exemption processes for the first time. Accordingly, the
Commission preliminarily recognizes that permitting enumerated bona
fide hedges and spread recognitions identified in the proposed ``spread
transaction'' definition for these additional 16 contracts might not
provide the purported benefits, or could result in increased costs,
compared to the Commission's experience with the nine legacy
agricultural products.
The Commission also preliminarily believes that the proposal will
benefit market participants by providing market participants the option
to choose the process for applying for a non-enumerated bona fide hedge
(i.e., either directly with the Commission or, alternatively, through
the exchange-centric process discussed under proposed Sec. 150.9
below) for the additional 16 contracts that would be newly subject to
federal position limits that would be more efficient given the market
participants unique facts, circumstances, and experience.\626\ If a
market participant chooses to apply through an exchange for federal
position limits pursuant to proposed Sec. 150.9, the market
participant would also receive the added benefit of not being required
to also submit another application directly to the Commission. The
Commission anticipates that most market participants would apply
directly to exchanges for non-enumerated bona fide hedges, pursuant to
the proposed streamlined process Sec. 150.9, as explained below, in
which case the Commission believes that most market participants would
incur the costs and benefits discussed thereunder. The Commission also
preliminarily believes that this analysis also would apply with respect
to non-enumerated bona fide hedges for the nine legacy agricultural
contracts.
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\626\ As noted above, market participants seeking spread
exemptions not listed in the proposed ``spread transaction''
definition in proposed Sec. 150.1 would be required to apply
directly with the Commission under proposed Sec. 150.3 and would
not be permitted to apply under proposed Sec. 150.9. The Commission
preliminarily recognizes that these types of spread exemptions are
difficult to analyze compared to either the spread exemptions
identified in proposed Sec. 150.1 or bona fide hedges in general.
Accordingly, the Commission preliminarily has determined to require
market participants to apply directly to the Commission. Further,
compared to the spread exemptions identified in proposed Sec.
150.1, the Commission anticipates relatively few requests, and so
does not believe the proposed application requirement will impose a
large aggregate burden across market participants.
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iii. Exemption-Related Recordkeeping
Proposed Sec. 150.3(d) would require persons who avail themselves
of any of the foregoing exemptions to maintain complete books and
records relating to the subject position, and to make such records
available to the Commission upon request under proposed Sec. 150.3(e).
These requirements would benefit market integrity by providing the
Commission with the necessary information to monitor the use of
exemptions from speculative position limits and help to ensure that any
person who claims any exemption permitted by proposed Sec. 150.3 can
demonstrate compliance with the applicable requirements. The Commission
does not expect these requirements to impose significant new costs on
market participants, as these requirements are in line with existing
Commission and exchange-level recordkeeping obligations.
iv. Exemption Renewals
Consistent with existing Sec. Sec. 1.47 and 1.48, with respect to
any Commission-recognized bona fide hedge or Commission-granted spread
exemption pursuant to proposed Sec. 150.3, the Commission would not
require a market participant to reapply annually for bona fide
hedges.\627\ The Commission preliminarily believes that this will
reduce burdens on market participants but also recognizes that not
requiring market participants to annually reapply ostensibly could harm
market integrity since the Commission would not directly receive
updated information with respect to particular bona fide hedgers or
exemption holders prior to the trader excessing the applicable federal
limits.
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\627\ As discussed below, with respect to exchange-set limits
under proposed Sec. 150.5 or the exchange process for federal
limits under proposed Sec. 150.9, market participants would be
required to annually reapply to exchanges.
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However, the Commission preliminarily believes that any potential
harm would be mitigated since the Commission, unlike exchanges, has
access to aggregate market data, including positions held by individual
market participants. Further, proposed Sec. 150.3 would require a
market participant to submit a new application if any information
changes, or upon the Commission's request. On the other hand, market
participants would benefit by not being required to annually submit new
applications, which the Commission preliminarily believes will reduce
compliance costs.
v. Exemptions for Financial Distress and Conditional Natural Gas
Positions
Proposed Sec. 150.3 would codify the Commission's existing
informal practice with respect to exemptions for financial distress and
conditional spot month limit exemption positions in natural gas. The
same costs and benefits described above with respect to applications
for bona fide hedge recognitions and spread exemptions would also
apply. However, to the extent the Commission currently allows
exemptions related to financial distress, the Commission preliminarily
has determined that the costs and benefits with respect to the related
application process already may be recognized by market participants.
[[Page 11691]]
b. Process for Market Participants To Apply to an Exchange for Non-
Enumerated Bona Fide Hedge Recognitions for Purposes of Federal Limits
(Proposed Sec. 150.9) and Related Changes to Part 19 of the
Commission's Regulations
Proposed Sec. 150.9 would provide a framework whereby a market
participant could avoid the existing dual application process described
above and, instead, file one application with an exchange to receive a
non-enumerated bona fide hedging recognition, which as discussed
previously would not be self-effectuating for purposes of federal
position limits. Under this process, a person would be allowed to
exceed the federal limit levels following an exchange's review and
approval of an application for a bona fide hedge recognition or spread
exemption, provided that the Commission during its review does not
notify the exchange otherwise within a certain period of time
thereafter. Market participants who do not elect to use the process in
proposed Sec. 150.9 for purposes of federal position limits would be
required to request relief both directly from the Commission under
proposed Sec. 150.3, as discussed above, and also apply to the
relevant exchange, consistent with existing practices.\628\
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\628\ As noted above, the Commission preliminarily anticipates
that most, if not all, market participants will use proposed Sec.
150.9, rather than proposed Sec. 150.3, where permitted.
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i. Proposed Sec. 150.9--Establishment of General Exchange Process
Pursuant to proposed Sec. 150.9, exchanges that elect to process
these applications would be required to file new rules or rule
amendments with the Commission under Sec. 40.5 of the Commission's
regulations and obtain from applicants all information to enable the
exchange to determine, and the Commission to verify, that the facts and
circumstances support a non-enumerated bona fide hedge recognition. The
Commission initially believes that exchanges' existing practices
generally are consistent with the requirements of proposed Sec. 150.9,
and therefore exchanges would only incur marginal costs, if any, to
modify their existing practices to comply. Similarly, the Commission
preliminarily anticipates that establishing uniform, standardized
exemption processes across exchanges would benefit market participants
by reducing compliance costs. On the other hand, the Commission
recognizes that exchanges that wish to participate in the processing of
applications with the Commission under proposed Sec. 150.9 would be
required to expend resources to establish a process consistent with the
Commission's proposal. However, to the extent exchanges have similar
procedures, such benefits and costs may already have been realized by
market participants and exchanges.
The Commission preliminarily believes that there are significant
benefits to the proposed Sec. 150.9 process that would be largely
realized by market participants. The Commission preliminarily has
determined that the use of a single application to process both
exchange and federal position limits will benefit market participants
and exchanges by simplifying and streamlining the process. For
applicants seeking recognition of a non-enumerated bona fide hedge,
proposed Sec. 150.9 should reduce duplicative efforts because
applicants would be saved the expense of applying in parallel to both
an exchange and the Commission for relief from exchange-set position
limits and federal position limits, respectively. Because many
exchanges already possess similar application processes with which
market participants are likely accustomed, compliance costs should be
decreased in the form of reduced application-production time by market
participants and reduced response time by exchanges.
As discussed above, in connection with the recognition of bona fide
hedges for federal position limit purposes, current practices set forth
in existing Sec. Sec. 1.47 and 1.48 require market participants to
differentiate between (i) enumerated non-anticipatory bona fide hedges
that are self-effectuating, and (ii) enumerated anticipatory bona fide
hedges and non-enumerated bona fide hedges for which market
participants must apply to the Commission for prior approval. Under the
proposal, the Commission would no longer distinguish among different
types of enumerated bona fide hedges (e.g., anticipatory versus non-
anticipatory enumerated bona fide hedges), and therefore, would not
require exchanges to have separate processes for enumerated
anticipatory positions under proposed Sec. 150.9 for the nine legacy
agricultural contracts. The Commission's proposal would also eliminate
the requirement for bona fide hedgers to file Form 204 or Form 304, as
applicable, with respect to any bona fide hedge, whether enumerated or
non-enumerated.\629\ The Commission preliminarily expects this to
benefit market participants by providing a more efficient and less
complex process that is consistent with existing practices at the
exchange-level.
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\629\ See infra Section II.H.3. (discussion of proposed changes
to part 19 eliminating Form 204 and portions of Form 304).
---------------------------------------------------------------------------
On the other hand, the Commission recognizes proposed Sec. 150.9
would impose new costs related to non-enumerated bona fide hedges for
the additional 16 contracts that would be newly subject to federal
position limits. Under the proposal, market participants would now be
required to submit applications to receive prior approval for federal
position limits purposes. However, since the Commission preliminarily
understands that exchanges already require market participants to
submit applications and receive prior approval under exchange-set
limits for all types of bona fide hedges, the Commission does not
believe proposed Sec. 150.9 would impose any additional incremental
costs on market participants beyond those already incurred under
exchanges' existing processes. Accordingly, the Commission
preliminarily believes that any costs already may have been realized by
market participants.
Further, the Commission preliminarily believes that employing a
concurrent process with exchanges to oversee the non-enumerated bona
fide hedges that would not be self-effectuating for federal position
limits purposes would benefit market integrity by ensuring that market
participants are appropriately relying on such bona fide hedges and not
entering into such positions in order to attempt to manipulate the
market or evade position limits. However, to the extent that exchange
oversight, consistent with Commission standards and DCM core
principles, already exists, such benefits may already be realized.
ii. Proposed Sec. 150.9--Exchange Expertise, Market Integrity, and
Commission Oversight
For non-enumerated bona fide hedge recognitions that would require
the Commission's prior approval, the proposal would provide a framework
that utilizes existing exchange resources and expertise so that fair
access and liquidity are promoted at the same time market
manipulations, squeezes, corners, and any other conduct that would
disrupt markets are deterred and prevented. Proposed Sec. 150.9 would
build on existing exchange processes, which the Commission
preliminarily
[[Page 11692]]
believes would strengthen the ability of the Commission and exchanges
to monitor markets and trading strategies while reducing burdens on
both the exchanges, which would administer the process, and market
participants, who would utilize the process. For example, exchanges are
familiar with their market participants' commercial needs, practices,
and trading strategies, and already evaluate hedging strategies in
connection with setting and enforcing exchange-set position limits;
accordingly, exchanges should be able to readily identify bona fide
hedges.\630\
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\630\ For a discussion on the history of exemptions, see 2013
Proposal, 78 FR at 75703-75706.
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For these reasons, the Commission has preliminarily determined that
allowing market participants to apply through an exchange under
proposed Sec. 150.9, rather than directly to the Commission as
required under existing Sec. 1.47, is likely to be more efficient than
if the Commission itself initially had to review and approve all
applications. The Commission preliminarily considers the increased
efficiency in processing applications under proposed Sec. 150.9 as a
benefit to bona fide hedgers and liquidity providers. By having the
availability of the exchange's analysis and view of the markets, the
Commission would be better informed in its review of the market
participant and its application, which in turn may further benefit
market participants in the form of administrative efficiency and
regulatory consistency. However, the Commission recognizes additional
costs for exchanges required to create and submit these real-time
notices. To the extent exchanges already provide similar notice to the
Commission or to market participants, or otherwise are required to
notify the Commission under certain circumstances, such benefits and
costs already may have been realized.
On the other hand, to the extent exchanges would become more
involved with respect to review and oversight of market participants'
bona fide hedges and spread exemptions, exchanges could incur
additional costs. However, as noted, the Commission believes most of
the costs have been realized by exchanges under current market
practice.
At the same time, the Commission also preliminarily recognizes that
this aspect of the proposal could potentially harm market integrity.
Absent other provisions, since exchanges profit from increased
activity, an exchange could hypothetically seek a competitive advantage
by offering excessively permissive exemptions, which could allow
certain market participants to utilize non-enumerated bona fide hedge
recognitions to engage in excessive speculation or to manipulate market
prices. If an exchange engaged in such activity, other market
participants would likely face greater costs through increased
transaction fees, including forgoing trading opportunities resulting
from market prices moving against market participants and/or preventing
the market participant from executing at its desired prices, which may
also further lead to inefficient hedging. However, the Commission
preliminarily believes that these hypothetical costs are unfounded
since under proposed Sec. 150.9 the Commission would review the
applications submitted by market participants for bona fide hedge
recognitions and spread exemptions; the Commission emphasizes that
proposed Sec. 150.9 is not providing exchanges with an ability to
recognize a bona fide hedge or grant an exemption for federal position
limit purposes in lieu of a Commission review. Rather, proposed Sec.
150.9(e) and (f) would require an exchange to provide the Commission
with notice of the disposition of any application for purposes of
exchange limits concurrently with the notice the exchange would provide
to the applicant, and the Commission would have 10 business days to
make its determination for federal position limits purposes (although,
in connection with ``sudden or unforeseen increases'' in bona fide
hedging needs, as discussed in connection with proposed Sec. 150.3,
proposed Sec. 150.9 would require the Commission to make its
determination within two business days).
On the other hand, the Commission also recognizes that there could
be potential costs to bona fide hedgers if under the proposal they are
forced to wait up to 10 business days for the Commission to complete
its review after the exchange's initial review--especially compared to
the status quo for the 16 commodities that would be subject to federal
limits for the first time under this release and currently are not
required to receive the Commission's prior approval. As a result, the
Commission preliminarily recognizes that a market participant could
incur costs by waiting during the 10 business day period or be required
to enter into a less efficient hedge, which would harm liquidity.
However, the Commission believes this concern is mitigated since
proposed Sec. 150.9, similar to proposed Sec. 150.3, would permit a
market participant that demonstrates a ``sudden or unforeseen''
increase in its bona fide hedging needs to enter into a bona fide hedge
without first obtaining the Commission's prior approval, as long as the
market participant submits a retroactive application to the Commission
within five business days of exceeding the applicable position limit.
In turn, the Commission would only have two business days (as opposed
to the default 10 business days) to complete its review for federal
purposes. The Commission preliminarily believes this ``five-business
day retroactive exemption'' would benefit bona fide hedgers compared to
existing Sec. 1.47, which requires Commission prior approval, since
hedgers that would qualify to exercise the five-business day
retroactive exemption are also likely facing more acute hedging needs--
with potentially commensurate costs if required to wait. This provision
would also leverage, for federal position limit purposes, existing
exchange practices for granting retroactive exemptions from exchange-
set limits.
On the other hand, the proposed five-business day retroactive
exemption could harm market liquidity and bona fide hedgers since the
Commission would be able to require a market participant to exit its
position if the exchange or the Commission does not approve of the
retroactive request, and such uncertainty could cause market
participants to either enter into smaller bona fide hedge positions
than it otherwise would or could cause the bona fide hedger to delay
entering into its hedge, in either case potentially causing bona fide
hedgers to incur increased hedging costs. However, the Commission
preliminarily believes this concern is partially mitigated since
proposed Sec. 150.9 would require the purported bona fide hedger to
exit its position in a ``commercially reasonable time,'' which the
Commission believes should partially mitigate any costs incurred by the
market participant compared to either an alternative that would require
the bona fide hedger to exit its position immediately, or the status
quo where the market participant either is unable to enter into a hedge
at all without Commission approval.
While existing Sec. 1.47 does not require market participants to
annually reapply for certain bona fide hedges, proposed Sec. 150.9
would require market participants to reapply at least annually with
exchanges for purposes of federal position limits. The Commission
recognizes that requiring market participants to reapply annually could
impose additional costs on those that are not currently required to do
so. However, the Commission believes that this is consistent with
industry practice
[[Page 11693]]
with respect to exchange-set limits and that market participants are
familiar with exchanges' exemption processes, which should reduce
related costs.\631\ Further, the Commission preliminarily believes that
market integrity would be strengthened by ensuring that exchanges
receive updated trader information that may be relevant to the
exchange's oversight.\632\ However, to the extent any of these benefits
and costs reflect current market practice, they already may have been
realized by exchanges and market participants.
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\631\ See infra Section IV.A.6. (discussing proposed Sec.
150.5).
\632\ In contrast, the Commission, unlike exchanges, has access
to aggregate market data, including positions held by individual
market participants, and so the Commission has preliminarily
determined that requiring market participants to apply annually
under proposed Sec. 150.3, absent any changes to their application,
would not benefit market integrity to the same extent.
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In addition, the proposed exchange-to-Commission monthly report in
proposed Sec. 150.5(a)(4) would further detail the exchange's
disposition of a market participant's application for recognition of a
bona fide hedge position or spread exemption as well as the related
position(s) in the underlying cash markets and swaps markets. The
Commission believes that such reports would provide greater
transparency by facilitating the tracking of these positions by the
Commission and would further assist the Commission in ensuring that a
market participant's activities conform to the exchange's rules and to
the CEA. The combination of the ``real-time'' exchange notification and
exchanges' provision of monthly reports to the Commission under
proposed Sec. Sec. 150.9(e)(1) and 150.5(a)(4), respectively, would
provide the Commission with enhanced surveillance tools on both a
``real-time'' and a monthly basis to ensure compliance with the
requirements of this proposal. The Commission anticipates additional
costs for exchanges required to create and submit monthly reports
because the proposed rules would require exchanges to compile the
necessary information in the form and manner required by the
Commission. However, to the extent exchanges already provide similar
notice to the Commission, or otherwise are required to notify the
Commission under certain circumstances, such benefits and costs already
may have been realized
iii. Proposed 150.9(d)--Recordkeeping
Proposed Sec. 150.9(d) would require exchanges to maintain
complete books and records of all activities relating to the processing
and disposition of any applications, including applicants' submission
materials, exchange notes, and determination documents.\633\ The
Commission preliminarily believes that this will benefit market
integrity and Commission oversight by ensuring that pertinent records
will be readily accessible, as needed by the Commission. However, the
Commission acknowledges that such requirements would impose costs on
exchanges. Nonetheless, to the extent that exchanges are already
required to maintain similar records, such costs and benefits already
may be realized.\634\
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\633\ Moreover, consistent with existing Sec. 1.31, the
Commission expects that these records would be readily accessible
until the termination, maturity, or expiration date of the bona fide
hedge recognition or exempt spread position and during the first two
years of the subsequent, five-year retention period.
\634\ The Commission believes that exchanges that process
applications for recognition of bona fide hedging transactions or
positions and/or spread exemptions currently maintain records of
such applications as required pursuant to other existing Commission
regulations, including existing Sec. 1.31. The Commission, however,
also believes that proposed Sec. 150.9(d) may impose additional
recordkeeping obligations on such exchanges. The Commission
estimates that each exchange electing to administer the proposed
process would likely incur a de minimis cost annually to retain
records for each proposed process compared to the status quo. See
generally Section IV.B. (discussing the Commission's PRA
determinations).
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iv. Proposed Sec. 150.9 (g)--Commission Revocation of Previously-
Approved Applications
The Commission preliminarily acknowledges that there may be costs
to market participants if the Commission revokes the hedge recognition
for federal purposes under proposed Sec. 150.9(f). Specifically,
market participants could incur costs to unwind trades or reduce
positions if the Commission required the market participant to do so
under proposed Sec. 150.9(f)(2).
However, the potential cost to market participants would be
mitigated under proposed Sec. 150.9(f) since the Commission would
provide a commercially reasonable time for a person to come back into
compliance with the federal position limits, which the Commission
believes should mitigate transaction costs to exit the position and
allow a market participant the opportunity to potentially execute other
hedging strategies.
v. Proposed Sec. 150.9--Commodity Indexes and Risk Management
Exemptions
Proposed Sec. 150.9(b) would prohibit exchanges from recognizing
as a bona fide hedge with respect to commodity index contracts. The
Commission recognizes that this proposed prohibition could alter
trading strategies that currently use commodity index contracts as part
of an entity's risk management program. Although there likely would be
a cost to change risk management strategies for entities that currently
rely on a bona fide hedge recognition for positions in commodity index
contracts, as discussed above, the Commission believes that such
financial products are not substitutes for positions in a physical
market and therefore do not satisfy the statutory requirement for a
bona fide hedge under section 4a(c)(2) of the Act.\635\ In addition,
the Commission further posits that this cost may be reduced or
mitigated by the proposed increased in federal position limit levels
set forth in proposed Sec. 150.2 or by the implementation of the pass-
through swap provision of the proposed bona fide hedge definition.\636\
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\635\ See supra Section III.F.6. (discussion of commodity
indices); see supra Section IV.A.4.b.i.(1). (discussion of
elimination of the risk management exemption).
\636\ See supra Section IV.A.4.b.i.(1). (discussion of the pass-
through swap exemption).
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c. Request for Comment
(48) The Commission requests comment on its considerations of the
benefits and costs of proposed Sec. 150.3 and Sec. 150.9. Are there
additional benefits or costs that the Commission should consider? Has
the Commission misidentified any benefits or costs? Commenters are
encouraged to include both quantitative and qualitative assessments of
these benefits and costs, as well as data or other information to
support such assessments.
(49) The Commission requests comment on whether a Commission-
administered process, such as the process in proposed Sec. 150.3,
would promote more consistent and efficient decision-making. Commenters
are encouraged to include both quantitative and qualitative
assessments, as well as data or other information to support such
assessments.
(50) The Commission recognizes there exist alternatives to proposed
Sec. 150.9. These include such alternatives as: (1) Not permitting
exchanges to administer any process to recognize bona fide hedging
transactions or positions or grant exempt spread positions for purposes
of federal limits; or (2) maintaining the status quo. The Commission
requests comment on whether an alternative to what is proposed would
result in a superior cost-benefit profile, with support for any such
position.
[[Page 11694]]
d. Related Changes to Part 19 of the Commission's Regulations Regarding
the Provision of Information by Market Participants
Under existing regulations, the Commission relies on Form 204 \637\
and Form 304,\638\ known collectively as the ``series `04'' reports, to
monitor for compliance with federal position limits. Under existing
part 19, market participants that hold bona fide hedging positions in
excess of federal limits for the nine legacy agricultural contracts
currently subject to federal limits under existing Sec. 150.2 must
justify such overages by filing the applicable report (Form 304 for
cotton and Form 204 for the other eight legacy commodities) each
month.\639\ The Commission uses these reports to determine whether a
trader has sufficient cash positions that justify futures and options
on futures positions above the speculative limits.
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\637\ CFTC Form 204: Statement of Cash Positions in Grains,
Soybeans, Soybean Oil, and Soybean Meal, U.S. Commodity Futures
Trading Commission website, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@forms/documents/file/cftcform204.pdf (existing Form 204).
\638\ CFTC Form 304: Statement of Cash Positions in Cotton, U.S.
Commodity Futures Trading Commission website, available at http://www.cftc.gov/ucm/groups/public/@forms/documents/file/cftcform304.pdf
(existing Form 204). Parts I and II of Form 304 address fixed-price
cash positions used to justify cotton positions in excess of federal
limits. As described below, Part III of Form 304 addresses unfixed
price cotton ``on-call'' information, which is not used to justify
cotton positions in excess of limits, but rather to allow the
Commission to prepare its weekly cotton on-call report.
\639\ 17 CFR 19.01.
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As discussed above, with respect to bona fide hedging positions,
the Commission is proposing a streamlined approach under proposed Sec.
150.9 to cash-market reporting that reduces duplication between the
Commission and the exchanges. Generally, the Commission is proposing
amendments to part 19 and related provisions in part 15 that would: (i)
Eliminate Form 204; and (ii) amend the Form 304, in each case to remove
any cash-market reporting requirements. Under this proposal, the
Commission would instead rely on cash-market reporting submitted
directly to the exchanges, pursuant to proposed Sec. Sec. 150.5 and
150.9,\640\ or request cash-market information through a special call.
---------------------------------------------------------------------------
\640\ See supra Section II.G.3. (discussion of proposed Sec.
150.9). As discussed above, leveraging existing exchange application
processes should avoid duplicative Commission and exchange
procedures and increase the speed by which position limit exemption
applications are addressed. While the Commission would recognize
spread exemptions based on exchanges' application processes that
satisfy the requirements in proposed Sec. 150.9, for purposes of
federal limits, the cash-market reporting regime discussed in this
section of the release only pertains to bona fide hedges, not to
spread exemptions, because the Commission has not traditionally
relied on cash-market information when reviewing requests for spread
exemptions.
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The proposed cash-market and swap-market reporting elements of
Sec. Sec. 150.5 and 150.9 discussed above are largely consistent with
current market practices with respect to exchange-set limits and thus
should not result in any new costs. The proposed elimination of Form
204 and the cash-market reporting segments of the Form 304 would
eliminate a reporting burden and the costs associated thereto for
market participants. Instead, market participants would realize
significant benefits by being able to submit cash market reporting to
one entity--the exchanges--instead of having to comply with duplicative
reporting requirements between the Commission and applicable exchange,
or implement new Commission processes for reporting cash market data
for market participants who will be newly subject to position
limits.\641\ Further, market participants are generally already
familiar with exchange processes for reporting and recognizing bona
fide hedging exemptions, which is an added benefit, especially for
market participants that would be newly subject to federal position
limits.
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\641\ The Commission has noted that certain commodity markets
will be subject to federal position limits for the first time. In
addition, the existing Form 204 would be inadequate for reporting of
cash-market positions relating to certain energy contracts that
would be subject to federal limits for the first time under this
proposal.
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Further, the proposed changes would not impact the Commission's
existing provisions for gathering information through special calls
relating to positions exceeding limits and/or to reportable positions.
Accordingly, as discussed above, the Commission proposes that all
persons exceeding the proposed limits set forth in proposed Sec.
150.2, as well as all persons holding or controlling reportable
positions pursuant to existing Sec. 15.00(p)(1), must file any
pertinent information as instructed in a special call.\642\ This
proposed provision is similar to existing Sec. 19.00(a)(3), but would
require any such person to file the information as instructed in the
special call, rather than to file a series '04 report.\643\ The
Commission preliminarily believes that relying on its special call
authority is less burdensome for market participants than the existing
Forms 204 and 304 reporting costs, as special calls are discretionary
requests for information whereas the series `04 reporting requirements
are a monthly, recurring reporting burden for market participants.
---------------------------------------------------------------------------
\642\ See proposed Sec. 19.00(b).
\643\ 17 CFR 19.00(a)(3).
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6. Exchange-Set Position Limits (Proposed Sec. 150.5)
a. Introduction
Existing Sec. 150.5 addresses exchange-set position limits on
contracts not subject to federal limits under existing Sec. 150.2, and
sets forth different standards for DCMs to apply in setting limit
levels depending on whether the DCM is establishing limit levels: (1)
On an initial or subsequent basis; (2) for cash-settled or physically-
settled contracts; and (3) during or outside the spot month.
In contrast, for physical commodity derivatives, proposed Sec.
150.5(a) and (b) would (1) expand existing Sec. 150.5's framework to
also cover contracts subject to federal limits under Sec. 150.2; (2)
simplify the existing standards that DCMs apply when establishing
exchange-set position limits; and (3) provide non-exclusive acceptable
practices for compliance with those standards.\644\ Additionally,
proposed Sec. 150.5(d) would require DCMs to adopt aggregation rules
that conform to existing Sec. 150.4.\645\
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\644\ See 17 CFR 150.2. Existing Sec. 150.5 addresses only
contracts not subject to federal limits under existing Sec. 150.2
(aside from certain major foreign currency contracts). To avoid
confusion created by the parallel federal and exchange-set position
limit frameworks, the Commission clarifies that proposed Sec. 150.5
deals solely with exchange-set position limits and exemptions
therefrom, whereas proposed Sec. 150.9 deals solely with the
process for purposes of federal limits.
\645\ See 17 CFR 150.4.
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b. Physical Commodity Derivative Contracts Subject to Federal Position
Limits Under Sec. 150.5 (Proposed Sec. 150.5(a))
i. Exchange-Set Position Limits and Related Exemption Process
For contracts subject to federal limits under Sec. 150.2, proposed
Sec. 150.5(a)(1) would require DCMs to establish exchange-set limits
no higher than the level set by the Commission. This is not a new
requirement, and merely restates the applicable requirement in DCM Core
Principle 5.\646\
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\646\ See Commission regulation Sec. 38.300 (restating DCMs'
statutory obligations under the CEA Sec. 5(d)(5), 7 U.S.C.
7(d)(5)). Accordingly, the Commission will not discuss any costs or
benefits related to this proposed change since it merely reflects an
existing regulatory and statutory obligation.
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Proposed Sec. 150.5(a)(2) would authorize DCMs to grant exemptions
from such limits and is generally consistent with current industry
practice. The Commission has
[[Page 11695]]
preliminarily determined that codifying such practice would establish
important, minimum standards needed for DCMs to administer--and the
Commission to oversee--an effective and efficient program for granting
exemptions to exchange-set limits in a manner that does not undermine
the federal limits framework.\647\ In particular, proposed Sec.
150.5(a)(2) would protect market integrity and prevent exchange-granted
exemptions from undermining the federal limits framework by requiring
DCMs to either conform their exemptions to the type the Commission
would grant under proposed Sec. Sec. 150.3 or 150.9, or to cap the
exemption at the applicable federal limit level and to assess whether
an exemption request would result in a position that is ``not in accord
with sound commercial practices'' or would ``exceed an amount that may
be established or liquidated in an orderly fashion in that market.''
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\647\ This proposed standard is substantively consistent with
current market practice. See, e.g., CME Rule 559 (providing that CME
will consider, among other things, the ``applicant's business needs
and financial status, as well as whether the positions can be
established and liquidated in an orderly manner . . .'') and ICE
Rule 6.29 (requiring a statement that the applicant's ``positions
will be initiated and liquidated in an orderly manner . . .''). This
proposed standard is also substantively similar to existing Sec.
150.5's standard and is not intended to be materially different. See
existing Sec. 150.5(d)(1) (an exemption may be limited if it would
not be ``in accord with sound commercial practices or exceed an
amount which may be established and liquidated in orderly
fashion.'') 17 CFR 150.5(d)(1).
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Absent other factors, this element of the proposal could
potentially increase compliance costs for traders since each DCM could
establish different exemption-related rules and practices. However, to
the extent that rules and procedures currently differ across exchanges,
any compliance-related costs and benefits for traders may already be
realized. Similarly, absent other provisions, a DCM could
hypothetically seek a competitive advantage by offering excessively
permissive exemptions, which could allow certain market participants to
utilize exemptions in establishing sufficiently large positions to
engage in excessive speculation and to manipulate market prices.
However, proposed Sec. 150.5(a)(2) would mitigate these risks by
requiring that exemptions that do not conform to the types the
Commission may grant under proposed Sec. 150.3 could not exceed
proposed Sec. 150.2's applicable federal limit unless the Commission
has first approved such exemption. Moreover, before a DCM could permit
a new exemption category, proposed Sec. 150.5(e) would require a DCM
to submit rules to the Commission allowing for such exemptions,
allowing the Commission to ensure that the proposed exemption type
would be consistent with applicable requirements, including with the
requirement that any resulting positions would be ``in accord with
sound commercial practices'' and may be ``established and liquidated in
an orderly fashion.''
Proposed Sec. 150.5(a)(2) additionally would require traders to
re-apply to the exchange at least annually for the exchange-level
exemption. The Commission recognizes that requiring traders to re-apply
annually could impose additional costs on traders that are not
currently required to do so. However, the Commission believes this is
industry practice among existing market participants, who are likely
already familiar with DCMs' exemption processes.\648\ This familiarity
should reduce related costs, and the proposal should strengthen market
integrity by ensuring that DCMs receive updated information related to
a particular exemption.
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\648\ As noted above, the Commission believes this requirement
is consistent with current market practice. See, e.g., CME Rule 559
and ICE Rule 6.29. While ICE Rule 6.29 merely requires a trader to
``submit to [ICE Exchange] a written request'' without specifying
how often a trader must reapply, the Commission understands from
informal discussions between Commission staff and ICE that traders
must generally submit annual updates.
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Proposed Sec. 150.5(a)(2) also would require a DCM to provide the
Commission with certain monthly reports regarding the disposition of
any exemption application, including the recognition of any position as
a bona fide hedge, the exemption of any spread transaction or other
position, the revocation or modification or previously granted
recognitions or exemptions, or the rejection of any application, as
well as certain related information similar to the information that
applicants must provide the Commission under proposed Sec. 150.3 or an
exchange under proposed Sec. 150.9, including underlying cash-market
and swap-market information related to bona fide hedge positions. The
Commission generally recognizes that this monthly reporting requirement
could impose additional costs on exchanges, although the Commission
also preliminarily has determined that it would assist with its
oversight functions and therefore benefit market integrity. The
Commission discusses this proposed requirement in greater detail in its
discussion of proposed Sec. 150.9.\649\
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\649\ See supra Section IV.A.5.b.ii. (discussion of monthly
exchange-to-Commission report in proposed Sec. 150.5(a)).
---------------------------------------------------------------------------
Further, while existing Sec. 150.5(d) does not explicitly address
whether traders should request an exemption prior to taking on its
position, proposed Sec. 150.5(a)(2), in contrast, would explicitly
authorize (but not require) DCMs to permit traders to file a
retroactive exemption request due to ``demonstrated sudden or
unforeseen increases in its bona fide hedging needs,'' but only within
five business days after the trade and as long as the trader provides a
supporting explanation.\650\ As noted above, these provisions are
largely consistent with existing market practice, and to this extent,
the benefits and costs already may have been realized by DCMs and
market participants.
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\650\ Certain exchanges currently allow for the submission of
exemption requests up to five business days after the trader
established the position that exceeded a limit in certain
circumstances. See, e.g., CME Rule 559 and ICE's ``Guidance on
Position Limits'' (Mar. 2018).
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ii. Pre-Existing Positions
Proposed Sec. 150.5(a)(3) would require DCMs to impose exchange-
set position limits on ``pre-existing positions,'' other than pre-
enactment swaps and transition period swaps, during the spot month, but
not outside of the spot month, as long as any position outside of the
spot month: (i) Was acquired in good faith consistent with the ``pre-
existing position'' definition in proposed Sec. 150.1; \651\ and (ii)
would be attributed to the person if the position increases after the
limit's effective date. The Commission believes that this approach
would benefit market integrity since pre-existing positions that exceed
spot-month limits could result in market or price disruptions as
positions are rolled into the spot month.\652\ However, the Commission
acknowledges that, on its face, including a ``good-faith'' requirement
in the proposed ``pre-existing position'' definition could
hypothetically diminish market integrity since determining whether a
trader has acted in ``good faith'' is inherently subjective and could
result in disparate treatment of traders by a particular exchange or
across exchanges seeking a competitive advantage with one another. For
example, with respect to a particular large or influential exchange
member, an exchange could, in order to maintain the business
relationship, be incentivized to be more liberal with its conclusion
that the member obtained its position in ``good faith,'' or could be
more liberal in
[[Page 11696]]
general in order to gain a competitive advantage. The Commission
believes the risk of any such unscrupulous trader or exchange is
mitigated since exchanges would still be subject to Commission
oversight and to DCM Core Principles 4 (``prevention of market
disruption'') and 12 (``protection of markets and market
participants''), among others, and since proposed Sec. 150.5(a)(3)
also would require that exchanges must attribute the position to the
trader if its position increases after the position limit's effective
date.
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\651\ Proposed Sec. 150.1 would define ``pre-existing
position'' to mean ``any position in a commodity derivative contract
acquired in good faith prior to the effective date'' of any
applicable position limit.
\652\ The Commission is particularly concerned about protecting
the spot month in physical-delivery futures from corners and
squeezes.
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c. Physical Commodity Derivative Contracts Not Yet Subject to Federal
Position Limits Under Sec. 150.2 (Proposed Sec. 150.5(b))
i. Spot Month Limits and Related Acceptable Practices
For cash-settled contracts during the spot month, existing Sec.
150.5 sets forth the following qualitative standard: exchange-set
limits should be ``no greater than necessary to minimize the potential
for market manipulation or distortion of the contract's or underling
commodity's price.'' However, for physically-settled contracts,
existing Sec. 150.5 provides a one-size-fits-all parameter that
exchange limits must be no greater than 25 percent of EDS.
In contrast, the proposed standard for setting spot month limit
levels for physical commodity derivative contracts not subject to
federal position limits set forth in proposed Sec. 150.5(b)(1) would
not distinguish between cash-settled and physically-settled contracts,
and instead would require DCMs to apply the existing Sec. 150.5
qualitative standard to both.\653\ The Commission also proposes a
related, non-exclusive acceptable practice that would deem exchange-set
position limits for both cash-settled and physically-settled contracts
subject to proposed Sec. 150.5(b) to be in compliance if the limits
are no higher than 25 percent of the spot-month EDS.
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\653\ Proposed Sec. 150.5(b)(1) would require DCMs to establish
position limits for spot-month contracts at a level that is
``necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract's or the underlying
commodity's price or index.'' Existing Sec. 150.5 also
distinguishes between ``levels at designation'' and ``adjustments to
levels,'' although each category similarly incorporates the
qualitative standard for cash-settled contracts and the 25-percent
metric for physically-settled contracts. Proposed Sec. 150.5(b)
would eliminate this distinction. The Commission intends the
proposed Sec. 150.5(b)(1) standard to be substantively the same as
the existing Sec. 150.5 standard for cash-settled contracts, except
that under proposed Sec. 150.5(b)(1), the standard would apply to
physically-settled contracts.
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Applying the existing Sec. 150.5 qualitative standard and non-
exclusive acceptable practice in proposed 150.5(b)(1), rather than a
one-size-fits-all regulation, to both cash-settled and physically-
settled contracts during the spot month is expected to enhance market
integrity by permitting a DCM to establish a more tailored, product-
specific approach by applying other parameters that may take into
account the unique liquidity and other characteristics of the
particular market and contract, which is not possible under the one-
size-fits-all 25 percent EDS parameter set forth in existing Sec.
150.5. While the Commission recognizes that the existing 25 percent EDS
parameter has generally worked well, the Commission also recognizes
that there may be circumstances where other parameters may be
preferable and just as effective, if not more, including, for example,
if the contract is cash-settled or does not have a reasonably accurate
measurable deliverable supply, or if the DCM can demonstrate that a
different parameter would better promote market integrity or efficiency
for a particular contract or market.
On the other hand, the Commission recognizes that proposed Sec.
150.5(b)(1) could adversely affect market integrity by theoretically
allowing DCMs to establish excessively high position limits in order to
gain a competitive advantage, which also could harm the integrity of
other markets that offer similar products.\654\ However, the Commission
believes these potential risks would be mitigated since (i) proposed
Sec. 150.5(e) would require DCMs to submit proposed position limits to
the Commission, which would review those rules for compliance with
Sec. 150.5(b), including to ensure that the proposed limits are ``in
accord with sound commercial practices'' and that they may be
``established and liquidated in an orderly fashion''; and (ii) proposed
Sec. 150.5(b)(3) would require DCMs to adopt position limits for any
new contract at a ``comparable'' level to existing contracts that are
substantially similar (i.e., ``look-alike contracts'') on other
exchanges unless the Commission approves otherwise. Moreover, this
latter requirement also may reduce the amount of time and effort needed
for the DCM and Commission staff to assess proposed limits for any new
contract that competes with another DCM's existing contract.
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\654\ Since the existing Sec. 150.5 framework already applies
the proposed qualitative standard to cash-settled spot-month
contracts, any new risks resulting from the proposed standard would
occur only with respect to physically-settled contracts, which are
currently subject to the one-size-fits-all 25-percent EDS parameter
under the existing framework.
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ii. Non-Spot Month Limits/Accountability Levels and Related Acceptable
Practices
Existing Sec. 150.5 provides one-size-fits-all levels for non-spot
month contracts and allows for position accountability after a
contract's initial listing only for those contracts that satisfy
certain trading thresholds.\655\ In contrast, for contracts outside the
spot-month, proposed Sec. 150.5(b)(2) would require DCMs to establish
either position limits or position accountability levels that satisfy
the same proposed qualitative standard discussed above for spot-month
contracts.\656\ For DCMs that establish position limits, the Commission
proposes related acceptable practices that would provide non-exclusive
parameters that are generally consistent with existing Sec. 150.5's
parameters for non-spot month contracts.\657\ For DCMs that establish
[[Page 11697]]
position accountability, Sec. 150.1's proposed definition of
``position accountability'' would provide that a trader must reduce its
position upon a DCM's request, which is generally consistent with
existing Sec. 150.5's framework, but would not distinguish between
trading volume or contract type, like existing Sec. 150.5. While DCMs
would be provided the ability to decide whether to use limit levels or
accountability levels for any such contract, under either approach, the
DCM would have to set a level that is ``necessary and appropriate to
reduce the potential threat of market manipulation or price distortion
of the contract's or the underlying commodity's price or index.''
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\655\ As noted above, in establishing the specific metric,
existing Sec. 150.5 distinguishes between ``levels at designation''
and ``adjustments to [subsequent] levels.'' Proposed Sec.
150.5(b)(2) would eliminate this distinction and apply the
qualitative standard for all non-spot month position limit and
accountability levels.
\656\ DCM Core Principle 5 requires DCMs to establish either
position limits or accountability for speculators. See Commission
regulation Sec. 38.300 (restating DCMs' statutory obligations under
the CEA Sec. 5(d)(5)). Accordingly, inasmuch as proposed Sec.
150.5(b)(2) would require DCMs to establish position limits or
accountability, the proposal does not represent a change to the
status quo baseline requirements.
\657\ Specifically, the acceptable practices proposed in
Appendix F to part 150 would provide that DCMs would be deemed to
comply with the proposed Sec. 150.5(b)(2)(i) qualitative standard
if they establish non-spot limit levels no greater than any one of
the following: (1) Based on the average of historical positions
sizes held by speculative traders in the contract as a percentage of
open interest in that contract; (2) the spot month limit level for
that contract; (3) 5,000 contracts (scaled up proportionally to the
ratio of the notional quantity per contract to the typical cash
market transaction if the notional quantity per contract is smaller
than the typical cash market transaction, or scaled down
proportionally if the notional quantity per contract is larger than
the typical cash market transaction); or (4) 10 percent of open
interest in that contract for the most recent calendar year up to
50,000 contracts, with a marginal increase of 2.5 percent of open
interest thereafter.
These proposed parameters have largely appeared in existing
Sec. 150.5 for many years in connection with non-spot month limits,
either for levels at designation, or for subsequent levels, with
certain revisions. For example, while existing Sec. 150.5(b)(3) has
provided a limit of 5,000 contracts for energy products, existing
Sec. 150.5(b)(2) provides a limit of 1,000 contracts for physical
commodities other than energy products. The proposed acceptable
practice parameters would create a uniform standard of 5,000
contracts for all physical commodities. The Commission expects that
the 5,000 contract acceptable practice, for example, would be a
useful rule of thumb for exchanges because it would allow them to
establish limits and demonstrate compliance with Commission
regulations in a relatively efficient manner, particularly for new
contracts that have yet to establish open interest. The spot month
limit level under item (2) above would be a new parameter for non-
spot month contracts.
---------------------------------------------------------------------------
Proposed Sec. 150.5(b)(2) would benefit market efficiency by
authorizing DCMs to determine whether position limits or accountability
would be best-suited outside of the spot month based on the DCM's
knowledge of its markets. For example, position accountability could
improve liquidity compared to position limits since liquidity providers
may be more willing or able to participate in markets that do not have
hard limits. As discussed above, DCMs are well-positioned to understand
their respective markets, and best practices in one market may differ
in another market, including due to different market participants or
liquidity characteristics of the underlying commodities. For DCMs that
choose to establish position limits, the Commission believes that
applying the proposed Sec. 150.5 qualitative standard to contracts
outside the spot-month would benefit market integrity by permitting a
DCM to establish a more tailored, product-specific approach by applying
other tools that may take into account the unique liquidity and other
characteristics of the particular market and contract, which is not
possible under the existing Sec. 150.5 specific parameters for non-
spot month contracts. While the Commission recognizes that the existing
parameters may have been well-suited to market dynamics when initially
promulgated, the Commission also recognizes that open interest may have
changed for certain contracts subject to proposed Sec. 150.5(b), and
open interest will likely continue to change in the future (e.g., as
new contracts may be introduced and as supply and/or demand may change
for underlying commodities). In cases where open interest has not
increased, the exchange may not need to change existing limit levels.
But, for contracts where open interest have increased, the exchange
would be able to raise its limits to facilitate liquidity consistent
with an orderly market. However, the Commission reiterates that the
specific parameters in the proposed acceptable practices are merely
non-exclusive examples, and an exchange would be able to establish
higher (or lower) limits, provided the exchange submits its proposed
limits to the Commission under proposed Sec. 150.5(e) and explains how
its proposed limits satisfy the proposed qualitative standard and are
otherwise consistent with all applicable requirements.
The Commission, however, recognizes that proposed Sec. 150.5(b)(2)
could adversely affect market integrity by potentially allowing DCMs to
establish position accountability levels rather than position limits,
regardless of whether the contract exceeds the volume-based thresholds
provided in existing Sec. 150.5. However, proposed Sec. 150.5(e)
would require DCMs to submit any proposed position accountability rules
to the Commission for review, and the Commission would determine on a
case-by-case basis whether such rules satisfy regulatory requirements,
including the proposed qualitative standard. Similarly, in order to
gain a competitive advantage, DCMs could theoretically set excessively
high accountability (or position limit) levels, which also could
potentially adversely affect markets with similar products. However,
the Commission believes these risks would be mitigated since (i)
proposed Sec. 150.5(e) would require DCMs to submit proposed position
accountability (or limits) to the Commission, which would review those
rules for compliance with Sec. 150.5(b), including to ensure that the
exchange's proposed accountability levels (or limits) are ``necessary
and appropriate to reduce the potential threat of market manipulation
or price distortion'' of the contract or underlying commodity; and (ii)
proposed Sec. 150.5(b)(3) would require DCMs to adopt position limits
for any new contract at a ``comparable'' level to existing contracts
that are substantially similar on other exchanges unless the Commission
approves otherwise.
iii. Exchange-Set Limits on Economically Equivalent Swaps
As discussed above, swaps that would qualify as ``economically
equivalent swaps'' would become subject to the federal position limits
framework. However, the Commission is proposing to allow exchanges to
delay compliance--including enforcing position limits--with respect to
exchange-set limits on economically equivalent swaps. The proposed
delayed compliance would benefit the swaps markets by permitting SEFs
and DCMs that list economically equivalent swaps more time to establish
surveillance and compliance systems; as noted in the preamble, such
exchanges currently lack sufficient data regarding individual market
participants' open swap positions, which means that requiring exchanges
to establish oversight over participants' positions currently would
impose substantial costs and would be currently impracticable.
Nonetheless, the Commission's preliminary determination to permit
exchanges to delay implementing federal position limits on swaps could
incentivize market participants to leave the futures markets and
instead transact in economically equivalent swaps, which could reduce
liquidity in the futures and related options markets, which could also
increase transaction and hedging costs. Delaying position limits on
swaps therefore could harm market participants, especially end-users
that do not transact in swaps, if many participants were to shift
trading from the futures to the swaps markets. In turn, end-users could
pass on some of these increased costs to the public at large.\658\
However, the Commission believes that these concerns would be mitigated
to the extent the Commission would still oversee and enforce federal
position limits even if the exchanges would not be required to do so.
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\658\ On the other hand, the Commission has not seen any
shifting of liquidity to the swaps markets--or general attempts at
market manipulation or evasion of federal position limits--with
respect to the nine legacy core referenced futures contracts, even
though swaps currently are not subject to federal or exchange
position limits.
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d. Position Aggregation
Proposed Sec. 150.5(d) would require all DCMs that list physical
commodity derivative contracts to apply aggregation rules that conform
to existing Sec. 150.4, regardless of whether the contract is subject
to federal position limits under Sec. 150.2.\659\ The Commission
believes
[[Page 11698]]
proposed Sec. 150.5(d) would benefit market integrity in several ways.
First, a harmonized approach to aggregation across exchanges that list
physical commodity derivative contracts would prevent confusion that
could result from divergent standards between federal limits under
Sec. 150.2 and exchange-set limits under Sec. 150.5(b). As a result,
proposed Sec. 150.5(d) would provide uniformity, consistency, and
reduced administrative burdens for traders who are active on multiple
trading venues and/or trade similar physical contracts, regardless of
whether the contracts are subject to Sec. 150.2's federal position
limits. Second, a harmonized aggregation policy eliminates the
potential for DCMs to use excessively permissive aggregation policies
as a competitive advantage, which would impair the effectiveness of the
Commission's aggregation policy and limits framework. Third, since, for
contracts subject to federal limits, proposed Sec. 150.5(a) would
require DCMs to set position limits at a level not higher than that set
by the Commission under proposed Sec. 150.2, differing aggregation
standards could effectively lead to an exchange-set limit that is
higher than that set by the Commission. Accordingly, harmonizing
aggregation standards reinforces the efficacy and intended purpose of
proposed Sec. Sec. 150.2 and 150.5 and existing Sec. 150.4 by
eliminating DCMs' ability to circumvent the applicable federal
aggregation and position limits rules.
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\659\ The Commission adopted final aggregation rules in 2016
under existing Sec. 150.4, which applies to contracts subject to
federal limits under Sec. 150.2. See Final Aggregation Rulemaking,
81 FR at 91454. Under the Final Aggregation Rulemaking, unless an
exemption applies, a person's positions must be aggregated with
positions for which the person controls trading or for which the
person holds a 10 percent or greater ownership interest. The
Division of Market Oversight has issued time-limited no-action
relief from some of the aggregation requirements contained in that
rulemaking. See CFTC Letter No. 19-19 (July 31, 2019), available at
https://www.cftc.gov/csl/19-19/download. Commission regulation Sec.
150.4(b) sets forth several permissible exemptions from aggregation.
---------------------------------------------------------------------------
To the extent a DCM currently is not applying the federal
aggregation rules in existing Sec. 150.4, or similar exchange-based
rules, proposed Sec. 150.5(d) could impose costs with respect to
market participants trading referenced contracts for the proposed new
16 commodities that would become subject to federal position limits for
the first time. Market participants would be required to update their
trading and compliance systems to ensure they comply with the new
aggregation rules.
e. Request for Comment
(51) The Commission requests comment on all aspects of the
Commission's cost-benefit discussion of the proposal.
7. Section 15(a) Factors \660\
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\660\ The discussion here covers the proposed amendments that
the Commission has identified as being relevant to the areas set out
in section 15(a) of the CEA: (i) Protection of market participants
and the public; (ii) efficiency, competitiveness, and financial
integrity of futures markets; (iii) price discovery; (iv) sound risk
management practices; and (v) other public interest considerations.
For proposed amendments that are not specifically addressed, the
Commission has not identified any effects.
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a. Protection of Market Participants and the Public
A chief purpose of speculative position limits is to preserve the
integrity of derivatives markets for the benefit of commercial
interests, producers, and other end- users that use these markets to
hedge risk and of consumers that consume the underlying commodities.
The Commission preliminarily believes that the proposed position limits
regime would operate to deter excessive speculation and manipulation,
such as squeezes and corners, which might impair the contract's price
discovery function and liquidity for hedgers--and ultimately, would
protect the integrity and utility of the commodity markets for the
benefit of both producers and consumers.
At this time, the Commission is proposing to include the proposed
25 core referenced futures contracts within the proposed federal
position limit framework. In selecting the proposed 25 core referenced
contracts, the Commission, in accordance with its necessity analysis,
considered the effects that these contracts have on the underlying
commodity, especially with respect to price discovery; the fact that
they require physical delivery of the underlying commodity; and, in
some cases, the potentially acute economic burdens on interstate
commerce that could arise from excessive speculation in these contracts
causing sudden or unreasonable fluctuations or unwarranted changes in
the price of the commodities underlying these contracts.\661\
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\661\ See supra Section III.F.2. (discussion of the necessity
findings as to the 25 core referenced futures contacts).
---------------------------------------------------------------------------
Of particular importance are the proposed position limits during
the spot month period because the Commission preliminarily believes
that deterring and preventing manipulative behaviors, such as corners
and squeezes, is more urgent during this period. The proposed spot
month position limits are designed, among other things, to deter and
prevent corners and squeezes as well as promote a more orderly
liquidation process at expiration. By restricting derivatives positions
to a proportion of the deliverable supply of the commodity, the spot
month position limits reduce the possibility that a market participant
can use derivatives, including referenced contracts, to affect the
price of the cash commodity (and vice versa). Limiting a speculative
position based on a percentage of deliverable supply also restricts a
speculative trader's ability to establish a leveraged position in cash-
settled derivative contracts, diminishing that trader's incentive to
manipulate the cash settlement price. As the Commission has determined
in the preamble, the Commission has concluded that excessive
speculation or manipulation may cause sudden or unreasonable
fluctuations or unwarranted changes in the price of the commodities
underlying these contracts.\662\ In this way, the Commission
preliminarily believes that the proposed limits would benefit market
participants that seek to hedge the spot price of a commodity at
expiration, and benefit consumers who would be able to purchase
underlying commodities for which prices are determined by fundamentals
of supply and demand, rather than influenced by excessive speculation,
manipulation, or other undue and unnecessary burdens on interstate
commerce.
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\662\ See supra Section III.F. (discussion of the necessity
finding).
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The Commission preliminarily believes that the proposed Commission
and exchange-centric processes for granting exemptions from federal
limits, including non-enumerated bona fide hedging recognitions, would
help ensure the hedging utility of the futures market for commercial
end-users. First, the proposal to allow exchanges to leverage existing
processes and their knowledge of their own markets, including
participant positions and activities, along with their knowledge of the
underlying commodity cash market, should allow for more timely review
of exemption applications than if the Commission were to conduct such
initial application reviews. This benefits the public by allowing
producers and end-users of a commodity to more efficiently and
predictably hedge their price risks, thus controlling costs that might
be passed on to the public. Second, exchanges may be better-suited than
the Commission to leverage their knowledge of their own markets,
including participant positions and activities, along with their
knowledge of the underlying commodity cash market, in order to
recognize whether an applicant qualifies for an exemption and what the
level for that exemption should be. This benefits market participants
and the public by helping assure that exemption levels are set in a
manner that meets the risk management needs of the applicant without
negatively impacting the futures and cash market for that commodity.
Third, allowing for exchange-granted spread exemptions could improve
liquidity in all months
[[Page 11699]]
for a listed contract or across commodities, benefitting hedgers by
providing tighter bid-ask spreads for out-right trades. Furthermore,
traders using spreads can arbitrage price discrepancies between
calendar months within the same commodity contract or price
discrepancies between commodities, helping ensure that futures prices
more accurately reflect the underlying market fundamentals for a
commodity. Lastly, the Commission would review each application for
bona fide hedge recognitions or spread exemptions (other than those
bona fide hedges and spread exemptions that would be self-effectuating
under the Commission's proposal), but the proposal would allow the
Commission to also leverage the exchange's knowledge and experience of
its own markets and market participants discussed above.
The Commission also understands that there are costs to market
participants and the public to setting the levels that are too high or
too low. If the levels are set too high, there's greater risk of
excessive speculation, which may harm market participants and the
public. Further, to the extent that the proposed limits are set at such
a level that even without these proposed exemptions, the probability of
nearing or breaching such levels may be negligible for most market
participants, benefits associated with such exemptions may be reduced.
Conversely, if the limits are set too low, transaction costs for
market participants who are near or above the limit would rise as they
transact in other instruments with higher transaction costs to obtain
their desired level of speculative positions. Additionally, limits that
are too low could incentivize speculators to leave the market and not
be available to provide liquidity for hedgers, resulting in ``choppy''
prices. It is also possible for limits that are set too low to harm
market efficiency because the views of some speculators might not be
reflected fully in the price formation process.
In setting the proposed limit levels, the Commission considered
these factors in order to implement to the maximum extent practicable,
as it finds necessary in its discretion, to apply the position limits
framework articulated in CEA section 4a(a) to set federal position
limits to protect market integrity and price discovery, thereby
benefiting market participants and the public.
b. Efficiency, Competitiveness, and Financial Integrity of Futures
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 proposed expansion of the
federal position limits regime to 25 core referenced futures contracts
(e.g., the existing nine legacy agricultural contracts and the 16
proposed new contracts) enhances the buffer against excessive
speculation historically afforded to the nine legacy agricultural
contracts exclusively, improving the financial integrity of those
markets. Moreover, the proposed limits in proposed Sec. 150.2 may
promote market competitiveness by preventing a trader from gaining too
much market power in the respective markets.
Also, in the absence of position limits, market participants may be
deterred from participating in a futures market if they perceive that
there is a participant with an unusually large speculative position
exerting what they believe is unreasonable market power. A lack of
participation may harm liquidity, and consequently, may harm market
efficiency.
On the other hand, traders who find position limits overly
constraining may seek to trade in substitute instruments--such as
futures contracts or swaps that are similar to or correlated with (but
not otherwise deemed to be a referenced contract), forward contracts,
or trade options--in order to meet their demand for speculative
instruments. These traders may also decide to not trade beyond the
federal speculative position limit. Trading in substitute instruments
may be less effective than trading in referenced contracts and, thus,
may raise the transaction costs for such traders. In these
circumstances, futures prices might not fully reflect all the
speculative demand to hold the futures contract, because substitute
instruments may not fully influence prices the same way that trading
directly in the futures contract does. Thus, market efficiency might be
harmed.
The Commission preliminarily believes that focusing on the proposed
25 core referenced futures contracts, which generally have high levels
of open interest and trading volume and/or have been subject to
existing federal position limits for many years, should in general be
less disruptive for the derivatives markets that it regulates, which in
turn may reduce the potential for disruption for the price discovery
function of the underlying commodity markets as compared to including
less liquid contracts (of course, only