Keynote Address of CFTC Commissioner J. Christopher Giancarlo before the 7th Annual Capital Link Global Commodities, Energy & Shipping Forum, New York, NY
Good Intentions Do Not Always Lead to Good Regulations
September 16, 2015
Good morning ladies and gentlemen. Thank you for your warm welcome.
Before I begin, let me say that my remarks reflect my own views and do not necessarily constitute the views of the Commodity Futures Trading Commission (CFTC or Commission), my fellow CFTC commissioners or the CFTC staff.
It is a pleasure to attend this conference that brings together so many important participants in the global commodity, energy and shipping markets. As some of you know, before I became a regulator I served for over a dozen years as a senior executive of a firm that operated markets for these important asset classes, including wet and dry freight contracts. So, I have an appreciation of the issues that you are discussing today. I also know how the business world approaches market issues. That is, with pragmatism. Problems are solved and commercial needs are met with smart thinking, lots of careful planning and precise execution.
So, when I left business a year ago I was unsure of what to expect working inside a government agency. What I discovered is that, in Washington, it doesn’t much matter whether a proposed solution will actually solve a problem – as long as it is conceived with good intentions. As long as Washington officials seem to have good intentions, many times they are excused from any adverse consequences of their actions, including regulations that may be disastrous for markets or the American public.
This morning, I would like to talk about a highly inadequate CFTC ruleset that, if enacted as proposed, will have a tremendous impact on the U.S. energy and agricultural sectors of our economy, which undoubtedly will include the shipping and freight industries that are so critical to getting energy and agricultural products to consumers. The rule is born of good intentions, yet is based on an incomplete understanding, faulty analysis and a mistrust of market forces and innovation. This rule should serve as a fountainhead of predictable adverse consequences. Of course, I am talking about the CFTC’s proposed rules on trading position limits. If left unchanged, the proposed rules will impose federal regulatory edicts in place of commercial judgment in everyday risk hedging activity.
In business, anyone who championed a rule with so many predictably bad outcomes would be looking for a new job. In Washington, they have been lauded for their “good intentions.”
The CFTC has been discussing position limits for a long time. In 2010, the Dodd-Frank Act amended the Commodity Exchange Act to authorize the Commission to set position limits for certain futures and options contracts and economically equivalent swaps contracts as the Commission finds necessary and appropriate to diminish, eliminate or prevent “excessive speculation.”1 In January 2011, the Commission proposed federal position limits for physical commodity futures and swaps pursuant to the authority granted in the Dodd-Frank Act.2 In November of that year, the Commission finalized those rules.3 However, on September 28, 2012, the U.S. District Court for the District of Columbia issued an order that generally vacated the final rule and remanded the matter to the Commission.4 Subsequently, the Commission proposed new position limits rules on December 12, 2013.5 The Commission is still considering this proposal.
One of the reasons we have been discussing position limits for such a long time is that the rules are so complex and concerns about their negative impact on the market and participants are so widespread. Thousands of pages of comments were sent to the CFTC during two official comment periods. It is not surprising that many of the comments received in response to the second rulemaking were similar to those received in response to the original (vacated) rule since the CFTC did not take material account of the initial comments and put forward a second proposal very similar to the first one. It is not too late for a more open minded CFTC Chairman and Commission to take true account of important public comments that were largely ignored in the 2013 re-proposal.
Given the continuing concerns, I have taken a deep dive into the issue. The Commission has five “advisory committees,” and I have the privilege of serving as the sponsor of the committee charged with examining issues critical to American oil, natural gas, coal, electricity and environmental markets. It’s known as the Energy and Environmental Markets Advisory Committee or “EEMAC.” It is interesting to note that the EEMAC is actually the only CFTC advisory committee created in the Dodd-Frank Act, which says to me that Congress believed our agency should thoroughly examine issues and rules impacting the energy markets given their importance to the American economy.
At a speech in January of this year, I pointed out that there was a complete lack of real data supporting the need to enact position limits to supposedly curb “excessive speculation,” especially around oil and gasoline prices.6 I made a commitment in that speech to have the EEMAC take a close look at the proposed rule. Since then, the EEMAC has met twice and held five panels as part of those meetings to discuss position limits.7 I will talk about some of the concerns discussed as part of those meetings and improvements that should be made in order to make the rule workable in just a moment.
However, some of the most impactful information we received at those two EEMAC meetings cuts at the heart of the argument that excessive speculators are to blame for changes to gas prices. Instead, we heard basic economic truth: global supply has outpaced demand, leading to lower oil prices.8 It’s basic economics at work, plain and simple. The EEMAC heard evidence that the run up in oil prices before the financial crisis did not bear any of the signs of excessive speculation.9 This discussion aligns with the same findings made by the CFTC’s chief economist in 2008 and discussed at the CFTC meeting in 2011 when the rules were finalized the first time.10 Similarly, the Committee heard powerful evidence that speculators are not responsible for the significant declines in oil prices over the last nine months.11
Since the EEMAC meeting in February, the now obvious slowing growth in China and the almost certain possibility of Iranian oil hitting the market, which was an unknown variable six months ago, has confirmed government predictions that we will see continued lower prices for the near term.12 In fact, figures released by the U.S. Energy Information Administration just last week show that, when indexed for inflation, we are paying $2.34 for a gallon of gas today versus $2.60 for a gallon of gas in 1976!13
And yet, the CFTC still may continue down a path to implement a policy based on a political narrative that has no basis in economic reality. It’s a true “emperor has no clothes” scenario.
Position Limits – Issues and Concerns with Proposed Rules
Now, other than the obvious economic indicators about the lack of need for position limits, I’ll talk for a few minutes about portions of the proposed rules covered at our meetings. The EEMAC heard evidence of a distinct lack of liquidity and widening bid-ask spreads farther out the curve, perhaps resulting from insufficient speculation, which the CFTC’s position limits proposal would exacerbate.14 EEMAC members reported that liquidity is often scarcest in some of the smaller markets, such as regional power and gas markets, where liquidity has started to dry up completely.15 One EEMAC member observed that: “I wish there were a lot more speculators in the market . . . it sounds like we may have an excessive hedging problem.”16
The EEMAC also focused closely on the CFTC’s sweeping proposals to circumscribe the bona fide hedging exemption to position limits. Congress intended that position limits target those who engage in “excessive speculation,” while leaving hedgers to their task of reducing risk in their businesses. Unfortunately, the EEMAC heard evidence that the CFTC’s proposal unduly focuses on “limiting the activity of commercials in hedging in the markets,” which in turn increases the risk of pricing commodities, the cost of which “is ultimately borne by consumers.”17
Most alarmingly, in a break from decades of precedent, the CFTC has proposed to limit the entire universe of transactions that receive up front bona fide hedging treatment. The CFTC has proposed a number of “enumerated” hedges, and if a transaction does not fall into one of these categories it is not entitled to the bona fide hedging exception to position limits even if the particular position is risk reducing and is a common, “bread and butter” transaction widely used in the market.18 To make matters worse, the CFTC has proposed to repeal its current system in which market participants may submit proposed risk reducing transactions and the CFTC reviews those on a timely basis to determine whether they will be considered bona fide hedging transactions.19
I am very concerned that the overall effect of the CFTC’s position limits framework is to impose a federal regulatory edict in place of business judgment in the course of everyday, business risk hedging activity. The CFTC must encourage – not discourage – commercial enterprises to adapt to developments and advances in hedging practices.
Position Limits – Potential Solutions
The EEMAC not only discussed the problems with position limits, but also proposed potential solutions. The EEMAC considered a framework for a CFTC authorization of the exchanges to grant bona fide hedging exemptions for legitimate risk reducing strategies. The authority would of course remain subject to CFTC oversight. Handled properly, this solution has the potential to make the current proposal more workable.
The EEMAC also explored the possibility that exchanges administer a position accountability regime as a way to soften the impact of declining liquidity outside of the spot period. This tool is essential because liquidity and available counterparties both diminish dramatically out the curve. Accountability helps ameliorate this problem by permitting those market participants willing to offer liquidity, which is very important to hedgers, to increase the size of their positions above pre-determined concentration points.20 Position accountability already includes safeguards to avoid harming market integrity, and would of course, include appropriate CFTC supervision.21
The EEMAC also discussed the necessity for the CFTC to review and update its deliverable supply estimates. The deliverable supply estimates the Commission proposes to use are terribly out of date. The Commission proposes to use 1983-vintage deliverable supply estimates in setting silver and gold spot-month position limits, and the comparatively recent 1996-era deliverable supply estimates for natural gas.22
In North America we have had a revolution in natural gas exploration and production since the mid-nineties,23 but at the CFTC we are using data that is 20 and 30 years out of date. It is absolutely critical that the CFTC update its deliverable supply estimates before it moves forward with a major rulemaking.
Finally, the EEMAC explored the possibility of adopting a phased federal position limits rule that would begin by covering the spot month.24 Many market participants have argued that even if position limits are necessary – and even if there is a congressional mandate to impose them – the CFTC should proceed cautiously.
A phased approach would avoid exacerbating the present liquidity problems outside of the spot month. A phased approach would also be useful for the CFTC, which will then have additional time to obtain better data about the OTC market for physical commodities, as well as conduct additional research and analysis to determine whether federal position limits are appropriate and necessary outside of the spot month.
Another potential solution I am hopeful will be adopted at the Commission before a position limits rule is finalized is a change to the requirement that a market participant must aggregate trading positions across subsidiaries in which they have no control over or may have only invested in on a short-term basis. It simply is not workable as proposed. The 2013 proposal requires a market participant to apply for permission from the CFTC before it can disaggregate a position if the participant owns more than 50 percent of an entity, even if it has zero control or influence over that entity. It simply doesn’t make sense, and I am hopeful that a workable solution will allow companies to maintain positions in the market without having to aggregate as long as they do not, cannot and will not control the trading strategies, employees or market positions of a separate legal entity within one global conglomerate.
The position limits rulemaking is a significant undertaking and both the CFTC and its staff are struggling to get it right. I will be guided by two major principles. First, follow the data. The only way to determine whether additional federal position limits are necessary or appropriate is to draw upon current and accurate data and confirm that any final rule will facilitate price discovery, maintain liquidity and not unduly disrupt functioning markets. We should all agree that basing such an important rulemaking on twenty or thirty-year-old data is an embarrassment. It is simply unacceptable in a modern, market economy.
Second, we need to weigh the costs and benefits. There is no doubt that new position limits will impose very expensive compliance costs that will be borne by hedgers and end-users. Moreover, as an EEMAC member observed, these rules are likely to result in higher costs for consumers of energy and will be felt most heavily by low-income Americans.25
And we cannot ignore the fact that those higher costs will come at a time of enormous job losses in American commodity and related markets. It is estimated that job cuts in the petroleum industry are approaching 200,000 worldwide.26 Meanwhile, large industrial employers, such as Caterpillar27 and John Deere28 are laying off large numbers of American workers due to falling commodity prices and the corresponding lack of demand for their tractors, bulldozers, combines and implements.
And we must be aware of the additional costs to the taxpayer: administering a position limits regime like the one proposed will take a considerable amount of taxpayer dollars – dollars that the CFTC does not have in times of austere federal budgeting.
Along these lines, I would like to make a brief point about my trip this summer to the Midwest where I met with many agricultural producers, including dairymen, pork producers and row crop farmers, as well as businesses that service them, such as John Deere. It should come as no surprise that the number one concern of agricultural producers is what price they will get paid for their harvest or product. The spot price they are paid for what they produce is what puts food on their tables. It was easy to understand their heighted concern about the steep drop in worldwide commodity prices.29 It led me to ask the CFTC Office of the Chief Economist (OCE) for some basic data covering the 28 commodities covered by the CFTC’s proposed position limits. The information they provided me was stark: across the 28 commodities that will be covered by the proposed position limits rules, there has been a dramatic, forty-plus percent decrease in prices since December 2010.30
It is apparent that many American agricultural producers have reduced their hedging activity in the past few years, making them more vulnerable to volatile price swings in U.S. commodity markets. If and when the Commission moves forward with new position limits, we must be absolutely certain that we do not make it more difficult for American agricultural and energy producers to protect themselves against 40 percent declines in commodity prices.
If the current collapse in commodity prices continues and the position limits rules are not made workable, we may be imposing burdens on American agriculture and commodity markets at precisely the wrong time. Can we really justify such burdens on the basis of Washington’s “good intentions?”
Let me close by noting that a few weeks ago, the distinguished Cato Institute issued a policy analysis on why so many Federal Government programs are failures. Among other insights, the analysis noted that most Federal policies rely on top-down planning and guess work with no price system to guide decision making and very little knowledge about complex systems.31
That is an apt characterization of the ruleset I have discussed today. Yet, the CFTC has neither the business proficiency nor the institutional capability to substitute its dictates for the commercial judgement of business owners and hedgers when it comes to basic risk management.
At some point, the issue is philosophical: Do entrepreneurs and business men and women retain the economic liberty to make decisions in the best interest of their businesses, shareholders and customers? Or, should the central government proscribe those choices down to a small set of allowable options pre-selected by a group of Washington bureaucrats? Has the pendulum swung too far from American free enterprise to federal government control of markets and market participants? Except for those holding them, are good intentions causing bad outcomes for participants in American commodity markets?
We must do everything we can to not let flawed government regulations prevent commodity markets from operating effectively at a time of plunging commodity prices, growing joblessness in the commodity sector and sub-par economic growth. That means not imposing a regulator’s edict in place of the everyday commercial judgement of business owners and hedgers when it comes to basic risk management.
However good the intentions, it is time to stop holding back our businesses, markets and our fellow citizens from prosperity.
Thank you very much for your time.
1 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010); CEA section 4a(a)(1) and (2); 7 U.S.C. 6a(a)(1) and (2). Section 737 of the Dodd-Frank Act amended Section 4a of the CEA.
2 Position Limits for Derivatives, 76 FR 4752 (Jan. 26, 2011).
3 Position Limits for Futures and Swaps, 76 FR 71626 (Nov. 18, 2011).
4 International Swaps and Derivatives Association v. United States Commodity Futures Trading Commission, 887 F. Supp. 2d 259 (D.D.C. 2012).
5 Position Limits for Derivatives, 78 FR 75680 (Dec. 12, 2013).
6 See Keynote Address of Commissioner J. Christopher Giancarlo, Commodity Markets Council, State of the Industry Conference, Jan. 26, 2015, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlos-3.
7 See generally February and July 2015 EEMAC Meetings, available at http://www.cftc.gov/About/CFTCCommittees/EnergyEnvironmentalMarketsAdvisory/emac_meetings.
8 See EEMAC Transcript at 21, Feb. 26, 2015 (Feb. EEMAC Tr.), available at http://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/emactranscript022615.pdf.
9 Feb. EEMAC Tr. at 29-34.
10 Dr. Jeffrey Harris, the CFTC’s then-Chief Economist, testified before Congress that there was “little evidence that changes in speculative positions are systematically driving up crude oil prices”; Tom Doggett, Congress Told Speculators Not Driving Up Oil Price, Reuters, Apr. 3, 2008, available at http://uk.reuters.com/article/2008/04/03/us-cftc-oil-speculators-idUKN0337748220080403; See also Open Meeting on the Ninth Series of Proposed Rulemakings Under the Dodd-Frank Act, Transcript at 7-9 (Jan. 13, 2011), where former Commissioner Mike Dunn registered his belief that price volatility in physical commodities is primarily driven by changes in supply and demand. Commissioner Dunn explained that “to date[,] CFTC staff has been unable to find any reliable economic analysis to support either the contention that excessive speculation is affecting the market[s] we regulate or that position limits will prevent excessive speculation.” Id. at 9.
11 Feb. EEMAC Tr. at 36-38.
12 See Presentation of U.S. Energy Information Administration Administrator Adam Sieminski at 12, Feb. 26, 2015, available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/generic/eemac022615_sieminski.pdf.
14 E.g. Feb. EEMAC Tr. at 81-83, 91-92, 95-96, 103-04 and 174-76.
15 Id. at 220-22.
16 Id. at 82-83.
17 Id. at 157-58 and 183.
18 Id. at 160-61.
19 Id. at 177-78.
20 Id. at 106-07.
21 Id. at 106-08 and 139-40; Rule Enforcement Review of the Chicago Mercantile Exchange and the Chicago Board of Trade at 39-50, Jul. 26, 2013, available at http://www.cftc.gov/idc/groups/public/@iodcms/documents/file/rercmecbot072613.pdf.
22 CME Comment Letter at 3 (Feb. 20, 2014).
23 See Presentation by Adam Sieminski, U.S. EIA, Lower Oil Prices and the Energy Outlook at 3, Jul. 2015, available at http://www.eia.gov/pressroom/presentations/sieminski_07132015.pdf.
24 See, e.g., MFA Comment Letter at 8-9, Mar. 30, 2015; Joint Natural Gas Supply Association & National Corn Growers’ Association Comment Letter at 2-4, Mar. 28, 2011.
25 Feb. EEMAC Tr. at 196-99.
26 Collin Easton, Energy Job Cuts Approaching 200,000 Worldwide, Fuel Fix, Sep. 8, 2015, available at http://fuelfix.com/blog/2015/09/08/energy-job-cuts-approaching-200000-worldwide/#33909101=0.
27 Layoffs Continue at Caterpillar Owing to Mining Slump, Zacks Equity Research, Aug. 28, 2015, available at http://www.zacks.com/stock/news/188176/layoffs-continue-at-caterpillar-cat-owing-to-mining-slump.
28 Matthew Patane, John Deere Layoffs Unlikely To Be The Last, Economists Say, Des Moines Register, Jan. 23, 2015, available at http://www.desmoinesregister.com/story/money/agriculture/2015/01/23/john-deere-iowa-layoffs/22210349.
29 See Ira Iosebashvili and Tatyana Shumsky, Investors Flee Commodities, The Wall Street Journal, Jul. 20, 2015, available at http://www.wsj.com/articles/investors-flee-commodities-1437434367; Veronica Brown and Pratima Desai, Speculators Show Global Commodities Rout Still Has Legs, Reuters, Jul. 27, 2015, available at http://www.reuters.com/article/2015/07/27/us-markets-commodities-rout-idUSKCN0Q11TJ20150727.
30 Data provided by the CFTC’s OCE showed a 42.6 percent decline in the 22 commodities covered by the Bloomberg Investible Commodity Index from December 2010 to July 2015. Similarly, information provided by the OCE for all 28 enumerated commodities included in the CFTC’s proposed position limits regime showed an analogous downward price trend from December 2010 to July 2015.
31 Chris Edwards, Policy Analysis: Why the Federal Government Fails, the Cato Institute, Jul. 27, 2015, available at http://www.cato.org/publications/policy-analysis/why-federal-government-fails.
Last Updated: September 16, 2015