Introduction

I dissent from today’s position limits final rule (Final Rule).  The Final Rule fails to achieve the most fundamental objective of position limits: to prevent the harms arising from excessive speculation.  It is another disappointing chapter in the Commission’s 10-year saga to implement Congress’s mandate in the Dodd-Frank Act to impose speculative position limits in the energy, metals, and agricultural markets.  In a number of instances, the Final Rule appears more intent on limiting the actions and discretion of the Commission than it does on actually limiting such speculation.

As I previously observed, the proposed rule demoted the Commission from head coach to Monday-morning quarterback.  The Final Rule declares that the players on the field are the referees.  In this arena, the public interest loses.

I support effective position limits to restrain excessive speculation in physical commodity markets, coupled with legitimate bona fide hedge exemptions for commercial market participants.  The Final Rule, however, fails to address excessive speculation in several key respects:

First, the Final Rule impermissibly permits private entities to devise new bona fide hedge exemptions, while simultaneously constricting the Commission’s review and enforcement of such privately-created exemptions.

Second, the Final Rule fails to address trading at settlement (TAS) transactions.  The potential for market manipulation through the use of TAS is well documented.  The Final Rule was a valuable but wasted opportunity to address an important type of transaction in many commodity markets that, if abused, can present risks to orderly trading and price discovery.

Third, while the Final Rule eliminates the risk management exemptions that had been granted to a limited number of index funds, it also increases the non-spot month limits to accommodate the speculative positions of these funds in the futures markets.  Cumulatively, index funds can have a substantial price impact and exacerbate volatility.  Their monthly position rolls can also distort inter-month spreads.  Yet the Commission performed no assessment of the impact of potential increases in this type of speculation that these higher limits would permit.[1]

Fourth, the Final Rule misinterprets the Dodd-Frank Act and reverses decades of precedent by declaring, for the first time, that the Commission must make antecedent necessity findings on a commodity-by-commodity basis prior to imposing federal speculative position limits.

Physical Commodity Markets Benefit from Position Limits and Appropriate Bona Fide Hedge Exemptions

Position limits help prevent market manipulation and price distortion arising from excessively large speculative positions in futures, options, and swaps tied to physical commodities.  Section 4a of the CEA reflects Congress’s long-standing determination that excessive speculation in a commodity can cause “sudden,” “unreasonable,” or “unwarranted” fluctuations and changes in commodity prices.[2]  Section 4a directs the Commission to establish speculative position limits to address these harms, while also providing that such limits shall not apply to “transactions or positions which are shown to be bona fide hedging transactions or positions, as those terms are defined by the Commission . . . .”[3]

Experience from decades of limits in agricultural commodities teaches that a properly crafted position limits regime is an “effective prophylactic measure” to protect American businesses, consumers, and market participants that rely on physical commodity derivatives markets.[4]  The parameters of an effective position limits regime are well established.  They include: (1) meaningful limits on excessive speculation to help prevent market manipulation and price distortion; (2) recognition of bona fide hedging activities and exemptions to permit producers, end-users, merchants, and others to manage their commercial risks; and (3) clear divisions of responsibility, consistent with the CEA, that recognize the complimentary but distinct roles of exchanges, the Commission, and market participants in administering a position limits regime. 

Federal speculative position limits have been in place to protect derivatives markets since the 1930s.  The Commission or its predecessors adopted position limits for grains in 1938, cotton in 1940, and soybeans in 1951.  In 1981, the Commission adopted rules requiring exchange limits for all commodities for which there were no federal limits—a rule which notably did not require an antecedent, commodity-by-commodity necessity finding.  The Commission has also consistently relied on exchanges to help administer the position limits regime, including position accountability and enumerated bona fide hedge exemptions.

These efforts, spanning over 80 years, have helped prevent manipulation and price distortion through a complementary system that relies on the respective expertise of Commission, exchange, and market participant stakeholders.  The Final Rule discards this balance.  The Final Rule relies excessively on exchanges and market participants to permit positions as bona fide hedges, and in so doing impermissibly delegates the Commission’s statutory responsibility to determine what constitutes a bona fide hedge.[5]

Significant Flaws in the Final Rule

The Final Rule Permits Market Participants to Violate Federal Speculative Position Limits with No Prior Commission Recognition of a Bona Fide Hedge Exemption

The Final Rule explicitly permits market participants to violate federal speculative position limits with no bona fide hedge exemption from the Commission.  It impermissibly delegates the Commission’s statutory responsibility to define bona fide hedging to the very market participants with large speculative positions that section 4a is intended to restrain, as well as to the exchanges, who have no authority to determine what is a hedge under federal law.

First, the Final Rule authorizes market participants to create their own bona fide hedge exemptions and exceed speculative position limits for “sudden or unforeseen increases in their bona fide hedging needs.”  No prior approval from the Commission or an exchange is required to exceed the limits established by the Commission, and market participants may file their hedge applications up to five days after violating the applicable position limit.  The Final Rule offers no guardrails on what can be considered a “sudden or unforeseen” circumstance.  In an efficient market, all future price movements are inherently unforeseeable; that is the reason for hedging to begin with.[6]  Further, in today’s interconnected markets, where the speed of light is the limiting factor on the transmission of information, sudden and unforeseen circumstances arise virtually every millisecond.  This provision may swallow the Final Rule.

Second, the Final Rule authorizes a market participant to exceed federal speculative positon limits if an exchange permits it to exceed the exchange’s position limits.  In other words, an exchange determination can enable a market participant to violate federal limits even in the absence of a Commission determination.  Here again, the Final Rule ignores the Commission’s statutory responsibility to define bona fide hedging.  Exchanges have a critical role in any properly balanced position limits regime, but they are not authorized by the CEA to define federal hedge exemptions, nor are they authorized to green-light violations of federal position limits.

This process for market participants to “self-recognize” non-enumerated hedges that they wish had been enumerated under federal law undoes the existing, Commission-led procedures that have worked well for decades.

The Final Rule reflects a multi-year, iterative process of notice and comment rulemaking to comprehensively determine which practices should constitute bona fide hedging.  Members of the public and industry participants have enjoyed multiple opportunities to inform the Commission on this topic, including through additional proposed position limits rules in 2013 and twice in 2016.  The Final Rule’s enumerated hedges reflect the Commission’s extensive dialogue and reasoned deliberations, and they recognize a wide array of hedging practices identified by commenters.  To my knowledge, the Commission is not aware of any novel hedging practices that were not addressed during this rulemaking process.

Commission regulations currently allow for the recognition of non-enumerated bona fide hedges through a 30-day, Commission-led review process.  The Commission must recognize the requested hedge as bona fide before a market participant can put the hedge on the exchange and exceed position limits.  This process has worked well for decades.  The Final Rule replaces it with a new system that allows market participants to make their own bona fide hedge determinations and exceed federal position limits in advance of any reasoned, considered evaluation by the Commission.

• The 10 and 2 Day Review Periods are Inadequate for the Commission to Consider Applications for Exemptions after an Exchange Determination

The Final Rule attempts to cure the impermissible statutory delegation described above through crammed, after-the-fact reviews of market participants’ hedge applications and violations of position limits rules.

Market participants who request prospective non-enumerated bona fide hedge exemptions from an exchange may violate federal speculative position limits upon being granted the exemption.  The exchange must then forward the application and other materials to the Commission for the beginning of a constricted 10-day review period.

The Commission, for its part, must complete the difficult task of evaluating the law, facts, and circumstances with respect to cash market risks that have already been incurred and commodity positions that have already been posted on an exchange.  Commission determinations regarding the validity of positions that have already been entered into will be complicated by the commercial implications involved in unwinding such positions.  Further, in the event that the Commission determines to deny the application, the Commission must provide the applicant with notice and opportunity to respond.  In the case of positions established due to “sudden or unforeseen” events, the Final Rule calls for a two-day review.  This is an unrealistic and unworkable timeframe.  This fig leaf of a “review” cannot provide legal cover for the impermissible delegation.

• The Final Rule Adopts a Policy of Non-Enforcement for Position Limit Violations

Both the rule text and the preamble to the Final Rule leave no doubt that any person who puts on a position in excess of a position limit prior to receiving Commission approval of the exemption is in violation of the speculative position limits.  However, where an application for a non-enumerated bona fide hedge is submitted retroactively to either an exchange or the Commission due to “sudden or unforeseen circumstances,” or where an exchange has approved an application for an exemption from the exchange limit, the Commission limits its ability to prosecute such violations by declaring that, “as a matter of policy,” it will not pursue an enforcement action as long as the application was submitted in “good faith.”

The Final Rule does not define “good faith.”  Perhaps this is because the concept of good faith traditionally is used as a safe harbor to protect persons who reasonably believe they are acting in compliance with the law.  For example, when exercising its prosecutorial discretion for violations of the swap dealer business conduct standards, the Commission considers whether the swap dealer attempted in “good faith” to follow policies and procedures reasonably designed to comply with the CEA and Commission Regulations.[7] This application of the good faith doctrine is consistent with the long-established understanding of the term.[8]  In the Final Rule, however, the Commission turns this doctrine on its head and mandates prosecutorial discretion where a market participant knowingly acts in violation of the law by putting on a position in excess of the legal limit.

Notably, the Commission describes its position not to enforce these violations as “a matter of policy.”  So although this non-enforcement policy is adopted as part of this rulemaking, it is nonetheless just that—a statement of policy.  As the Supreme Court has recognized, “general statements of policy,” or “statements issued by an agency to advise the public prospectively of the manner in which the agency proposes to exercise a discretionary power,” are not subject to the notice-and-comment procedures of the Administrative Procedure Act.[9]  Accordingly, the Commission may change this enforcement policy at any time without engaging in a notice-and-comment rulemaking.

Significantly, in its comment letter, the entity with the most experience in retroactive applications for hedge exemptions, the CME Group, pointed out to the Commission the importance of being able to take enforcement action for position limit violations that have occurred when retroactive applications are denied.  It stated:

Today at the exchange level, CME Group considers firms to be in violation of a position limit if they exceed a limit and the exemption application is denied.  We believe the Commission should implement this standard rather than permitting the proposed grace period for denial of an exemption application.  Otherwise, market participants with excessively large speculative positions could exploit the grace period accompanying an application for an exemption and intentionally go over the applicable limit without consequences—all the while disrupting orderly market operations.  In our experience, the prospect of having an application denied and being found in violation of position limits has worked to deter market participants from attempting to exploit the retroactive exemption process.[10]

Although the Final Rule is replete with deference to the experience of the exchanges in implementing the position limits regime, and creates a process specifically reliant upon the exchange’s expertise in granting hedge exemptions, here in the context of enforcing violations and deterring abuse, the Commission oddly rejects that expertise.

The Final Rule Fails to Address TAS Transactions or the Historic Collapse of WTI Crude Oil Futures

On April 20, 2020, the price of the May futures contract for West Texas Intermediate (WTI) crude oil traded on the New York Mercantile Exchange collapsed from $17.73 per barrel at the market open to a closing price of negative $37.63.  This single-day fall in prices of approximately $55 per barrel is unprecedented, and was accompanied by a massive disconnect between May crude oil futures and the price of crude oil in the physical market.

WTI crude oil futures are a key benchmark in global energy markets and can impact the overall U.S. economy.  Following the WTI event, I called upon the Commission to determine the causes of this unprecedented price movement and divergence from physical markets, and to work with CME to “take whatever measures may be appropriate to ensure that trading in the WTI futures contract is orderly and supports convergence of the futures and physical markets.”[11]  Almost six months later, the Commission has yet to complete its investigation or issue even preliminary results.  It should not take this long for the world’s leading derivatives regulator to understand the historic collapse of a benchmark contract that it has overseen for decades.

Independently of the Commission’s investigation, public commentary following the WTI event focused on TAS transactions and the well-known integrity concerns regarding TAS under certain market conditions.[12]  TAS transactions represent the purchase or sale of an underlying exchange commodity at the closing price for that commodity or at a specified differential.  Notably, exchange rules may permit TAS transactions to be netted intraday against futures positions in that commodity established via outright purchases and sales. Such netting could permit a trader to establish very large long or short positions in the outright futures contracts, while remaining below speculative position limits on a net basis.

The Final Rule recognizes the importance of netting practices and rules in several regards.  For example, it prohibits the spot-month netting of physically settled contracts with linked cash settled contracts.  The Final Rule explains that allowing such netting 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.”  The Final Rule is silent, however, with respect to any limitations on the netting of TAS with outright futures.

One commenter on the Final Rule reminded the Commission in significant detail of the market integrity issues associated with TAS orders.[13]  But even apart from the comment letters on the proposed rule, and apart from the WTI event, the potential for manipulation through the use of offsetting TAS contracts has been well-known.[14]  Further, the CFTC has direct experience with this issue:  it has brought two manipulation cases where WTI TAS orders were an integral part of the manipulative scheme.[15]  Given the Commission’s familiarity with the potential for manipulation and disruption of the price discovery process arising from an abuse of the TAS order type, the failure of the Final Rule to address in any manner these well-known dangers to market integrity is inexcusable.  

The Final Rule Misconstrues the CEA by Requiring Antecedent, Commodity-by-Commodity Necessity Findings Prior to Imposing Federal Position Limits.

The Final Rule misinterprets the Dodd-Frank Act and reverses decades of Commission interpretation and finds that an antecedent, commodity-by-commodity necessity finding is required prior to imposing federal speculative position limits.  The Final Rule further states that this “is the best interpretation” of CEA section 4a(a)(2), and that the Commission’s prior interpretations are “not compelling.” 

I addressed this issue extensively in my dissenting opinion on the proposed position limits rule, and I reiterate those views now.[16]; Neither the statutory language of CEA section 4a(a)(2), nor the district court’s decision in ISDA v. CFTC, require an antecedent necessity finding prior to imposing position limits. The Final Rule’s new interpretation, which the Commission concedes is a “change” from prior interpretations, is mistaken.[17]

As articulated in my prior dissent, the Final Rule’s interpretation of CEA section 4a(a)(2) “defies history and common sense.”[18]  Following hard on the heels of the 2008 financial crisis and the collapse of the Amaranth hedge fund in 2006, it is implausible that the drafters of the Dodd-Frank Act intended what the Commission has now adopted.  The Final Rule requires the Commission to believe that a Congress in the midst of the financial crisis, aware the CEA had never been interpreted to require predicate necessity findings for position limits, and engaged in a historic effort to regulate financial markets, would nonetheless make it harder for the Commission to impose federal speculative position limits.  The Commission’s revisionist legislative history is neither accurate nor credible.

Conclusion

The Final Rule departs from both legal interpretations and policy frameworks that have served commodity markets well for decades. 

Most significantly, the Final Rule impermissibly delegates the authority to recognize non-enumerated hedge exemptions; provides farcically short review periods for private-entity hedge determinations; attempts to enshrine a policy of non-enforcement for position limits violations; fails to address the well-known risks of TAS transactions; and reinterprets the CEA to require antecedent necessity findings prior to imposing federal position limits. 

I cannot support such a flawed rule.;

Introduction

The last time we gathered as a Commission to discuss position limits I used some of my time to speak a bit about the award winning movie, Ford v Ferrari.[1]  At that point, we were nearing the airing of the 92nd Academy Awards and this action-packed drama had earned four nominations—not to mention the distinction of being one of the few films I actually saw in a theater.  For those of you who have not found it in one of your quarantine movie queues, Ford v Ferrari tells the true story of American car designer Carroll Shelby and British-born driver Ken Miles who built a race car for Ford Motor Company—the GT40—and competed with Enzo Ferrari’s dominating, iconic red racing cars at the 1966 24 Hours of Le Mans.[2]  I used the film and racing metaphors throughout my speaking and written statements to highlight serious concerns that the proposed amendments to the CFTC rules addressing position limits (the Proposal) signified yet one more instance where the Commission seemed to be comfortable with deferring core, congressionally mandated duties to others and calling it a victory.[3]

We are here today to finalize the Proposal.[4]  In just short of nine months, we have come to terms with life during a global pandemic complete with economic turmoil and pockets of historic market volatility.  Amid the mere 60-day open comment period following the Proposal’s publication in the Federal Register (graciously extended by 16 days to May 15^th in light of the pandemic[5]), on April 20^th, the price of the West Texas Intermediate crude oil futures contract (WTI contract), a key benchmark in the energy and financial markets, experienced an unprecedented collapse one day prior to the last day of trading and expiration for May delivery.[6]  Defying market mechanics, the price of the contract fell from $17.73 per barrel at market open, to a closing settlement price of negative $37.63—with the price dropping approximately $40 in the last 20 minutes of trading.[7]  And, while we are still in recovery, with great fanfare after almost 10 years, the Commission is going to establish the position limits regime required under the Dodd-Frank Act.  I am reminded again of Ken who, at the 1966 24 Hours of Le Mans, went against his gut, giving way and leaving behind a milestone in car racing that to this day remains elusive.

If you have not seen the movie, this is a spoiler alert: Ken did not win Le Mans in ’66.  While he was one and a half laps ahead of two other GT40s, he was given orders to slow down so that the three Fords in the lead would cross the finish line in a dead heat formation.  Ken lost his well-deserved win because the 24 Hours of Le Mans awards the victory to the car that covers the greatest distance in 24 hours.  In the event of a tie, the rules provided that the car that had started farther down the grid had traveled the greater distance.  Ken’s GT 40 had started in the grid roughly 60 feet ahead of the GT40 driven by Bruce McLaren and Chris Amon, who were the declared winners. [8]

In the film, Ken seems to accept his loss with quiet dignity.  However, in reality he was fully aware that in many respects, he had been robbed.  From what I’ve read, Ken likely articulated his feelings a bit more colorfully. [9]

The point is that bringing something across the finish line doesn’t always equate to a success.  As detailed in my questions today, I believe that by going against our Congressional mandate and clear statutory intent by overly deferring to the exchanges, we have relinquished a claim to victory in this final position limits rule which in many ways has itself felt like the CFTC’s version of the 24 hours of Le Mans.  Therefore, I will go with my gut and not be part of the formation in supporting this final rule.

A Long Road, But a Fast Finish

It has been nine years since the Commission first set out to establish the position limits regime required by amendments to section 4a of the Commodity Exchange Act (the Act or CEA)[10] under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.[11]  While today’s final rule purports to respect Congressional intent and the purpose and language of CEA section 4a, in reality, it pushes the bounds of reasonable interpretation by overly deferring to the exchanges[12] and allowing them to take the lead in administering a position limits regime.

In passing the Dodd-Frank Act, Congress understood that for the derivatives markets in physical commodities to perform optimally, there needed to be limits on the amount of control exerted by a single person (or persons acting in agreement).  In fact, Congress has understood this need since at least 1936, when it first authorized the Commission’s predecessor to impose limits on speculative positions in order to prevent the harms caused by excessive speculation.  In tasking the Commission with establishing limits and the framework around their operation, Congress was aware of our relationship with the exchanges, but nevertheless opted for our experience and our expertise to meet the policy objectives of the Act.

Last January, as the Commission voted on the Proposal that is being finalized today, I warned that we seemed to be pushing to go faster and just get to the finish line, making real-time adjustments without regard to even trying for that “perfect lap.”[13]  Just nine months later, nothing has changed.  If anything, we seem to be further prioritizing just crossing the finish line over achieving a rule that actually follows Congressional intent and its first order priority: protecting market participants from excessive speculation.

Letting the Exchanges Make the Call

As I argued in regard to the proposal, my principal disagreement is with the Commission’s determination to in effect disregard the tenets supporting the statutorily created parallel federal and exchange-set position limit regime, and take a back seat when it comes to administration and oversight.[14]  Like Ken Miles, the Commission is relinquishing a rightful lead in an act of deference.  In doing so, the Commission claims victory for recognizing that the exchanges are better positioned in terms of resources, information, knowledge, and agility, and therefore ought to take the wheel. While this may seem like the logical move, it ignores that even if we operate as a team, our incentives and interests are not fully aligned.  Based on consideration of the Commission’s mission, and Congressional intent as evinced in the Dodd-Frank Act amendments to CEA section 4a and elsewhere in the Act, I continue to believe that (1) the Commission is required to establish position limits based on its reasoned and expert judgment within the parameters of the Act; (2) the Commission has not provided a rational basis for its determination not to establish federal limits outside of the spot month for referenced contracts based on commodities other than the nine legacy agricultural commodities; and (3) the Commission’s seemingly unlimited flexibility in deciding to (a) significantly broaden the bona fide hedging definition, (b) codify an expanded list of self-effectuating enumerated bona fide hedges, and (c) provide for exchange recognition of non-enumerated bona fide hedge exemptions with respect to federal limits, is both inexplicably complicated to parse and inconsistent with Congressional intent.

Not only does the final version of the rule fail to address these deficiencies in the proposal, it actually goes and makes many of these issues worse.

Ignoring a Mandate

Like the proposal, this final rule goes to great lengths to reconcile whether CEA section 4a(a)(2)(A) requires the Commission to make an antecedent necessity finding before establishing any position limit,[15] with the implication that if a necessity finding is required, then the Commission could rationalize imposing no limits at all.  Looking back at the record, what is necessary is that the Commission complies with the mandate in the Dodd-Frank Act.[16]  In the 2011 Proposal, the Commission provided a review of CEA section 4a(a)—interpreting the various provisions, giving effect to each paragraph, acknowledging the Commission’s own informational and experiential limitations regarding the swaps markets at that time, and focusing on the Commission’s primary mission of fostering fair, open and efficient functioning of the commodity derivatives markets.[17]  Of note, “Critical to fulfilling this statutory mandate,” the Commission pronounced, “is protecting market users and the public from undue burdens that may result from ‘excessive speculation.’”[18]  Federal position limits, as predetermined by Congress, are most certainly the only means towards addressing the burdens of excessive speculation when such limits must address a “proliferation of economically equivalent instruments trading in multiple trading venues.”[19]  Exchange-set position limits or accountability levels simply cannot meet the mandate.

In exercising its authority, the Commission may evaluate whether exchange-set position limits, accountability provisions, or other tools for contracts listed on such exchanges are currently in place to protect against manipulation, congestion, and price distortions.[20]  Such an evaluation—while permissible—is just one factor for consideration.  The existence of exchange-set limits or accountability levels, on their own, can neither predetermine deference nor be justified absent substantial consideration.  As I argued in my dissenting statement regarding the Proposal, the authority and jurisdiction of individual exchanges are necessarily different than that of the Commission.  They do not always have congruent interests to the Commission in monitoring instruments that do not trade on or subject to the rules of their particular platform or the market participants that trade them.  They do not have the attendant authority to determine key issues such as whether a swap performs or affects a significant price discovery function, or what instruments fit into the universe of economically equivalent swaps.  They are not permitted to define bona fide hedging transactions or grant exemptions for purposes of federal position limits.  It is therefore clear that CEA section 4a, as amended by the Dodd-Frank Act “warrants extension of Commission-set position limits beyond agricultural products to metals and energy commodities.”[21]

“If it ain’t broke, don’t fix it”

In spite of all of this—the foregoing mandate; the clear Congressional intent in CEA section 4a(a)(3)(A); and the Commission’s real experience and expertise (including its unique data repository)—the Commission’s final rule only maintains federal non-spot month limits for the nine legacy agricultural contracts (with questionably appropriate modifications), “because the Commission has observed no reason to eliminate them.”[22]  Essentially, the Commission concludes: “if it ain’t broke, don’t fix it.”  In keeping with this relatively riskless course of action, the Commission similarly concludes that federal non-spot month limits are not necessary for the remaining 16 proposed core referenced futures contracts identified in the Final Rule.

In so doing, the Commission ignores Congressional intent.  The Commission never considers that Congress directed the Commission to establish limits—not accountability levels.  The Commission’s observation that exchange-set accountability levels have “functioned as-intended” until this point in time ignores the wider purpose and function of aggregate position limits established by the Commission, and is shortsighted given the ever expanding universe of economically equivalent instruments trading across multiple trading venues.  As I pointed out in my dissenting statement regarding the Proposal, it seems odd to conclude that Congress envisioned that its painstaking amendments to CEA section 4a were a directive for the Commission to check the box that the current system is working perfectly.

Hedging on Bona Fide Hedging

Today’s Final Rule provides for significantly broader bona fide hedging opportunities that will be largely self-effectuating, and the Commission defers to the exchanges in recognizing non-enumerated bona fide hedging.  While I support enhancing the cooperation between the Commission and the exchanges, the Commission here is cooperating by dropping back.  The Commission’s decision to essentially give up primary authority to recognize non-enumerated bona fide hedges seems both careless and inconsistent with Congressional intent.

I raised these concerns last January when we voted on the Position Limits Proposal.  Unfortunately, rather than retaking the lead, the Commission further cedes authority to the exchanges.  The Proposal provided the Commission with the authority to reject an exchange’s grant of non-enumerated bona fide hedge recognition, and provided a window of ten business days (or two in the case of sudden or unforeseen circumstances) for the Commission to make this determination.  I pointed out in my dissent that this did not give the Commission nearly enough time or guidance to properly make a determination.  In today’s Final Rule, the Commission actually further reduces its ability to make an independent determination.  Now, market participants will be able to establish positions based upon an exchange’s non-enumerated bona fide hedge recognition during the Commission’s 10-day review period, and the Commission cannot determine that the person holding the position has committed a position limits violation during the Commission’s ongoing review or upon issuing its determination.  This reduces the Commission’s review to an ineffectual afterthought.

Trust the Process

A clear theme in my statements regarding our many rules over the last few years is this: process matters.  Sharing our viewpoints with the public matters.  Following the Administrative Procedure Act,[23] and giving the public an opportunity for meaningful comment on our proposals, matters.  We are at our best when we involve all five Commissioners and our many stakeholders in the process.

I want to thank the Chairman for consistently providing the Commissioners with drafts of proposed and final rules 30 days in advance of an open meeting.  I believe there have only been two major exceptions over the course of our many laps in the last year: the position limits proposal, and the position limits final rule.  In the case of the final rule, we did not receive a full draft until last Friday–six days before the open meeting.  This simply is not enough time for the Commission to engage in a fulsome discussion of the merits of the rule, and makes the final rule more or less a fait accompli.  Perhaps most perplexing is that we did not receive a draft of the cost benefit considerations until two weeks ago.  This is literally a rule where a prior iteration resulted in a court challenge–one that the Commission lost.[24]  If ever a rule required more consideration by the Commission itself, this would seem to be it.  Instead, the Commissioners actually had less time to review and consider the rule than we normally do.

When we focus on just getting to the finish line, and do not take the time for meaningful consideration and dialogue, we risk failing to take into account everything that we should in our rulemakings.  Subsequent to the issuance of the Position Limits Proposal, there was a major market event resulting from the ongoing pandemic that may have important implications for our position limits regime.  As the NYMEX Light Sweet Crude Oil (CL) contract, also known as the WTI contract, neared expiration in April 2020, the contract experienced extreme volatility, with the market trading below zero for the first time.  The Commission received at least eight comments that addressed this event; a number of commenters noted that the extreme volatility was driven by speculators.  The speculators, unable to physically deliver upon expiration for various reasons, had no choice but to exit the contract at whatever price was available.  Commission staff continues to review and analyze this event, and the rule today recognizes that the analysis may impact the rule itself.  Today’s preamble states: “The Commission will continue to analyze the events of April 20 to evaluate whether any changes to the position limits regulations may be warranted in light of the circumstances surrounding the volatility in the WTI contract.”[25]  This begs the question–if the Commission is currently in the midst of this analysis, why not wait to finalize position limits until the analysis is complete?

Conclusion

Before concluding, I want to acknowledge and thank the Commission staff who worked on the Proposal, today’s final rule, and every related study, matter, and undertaking to support it for the better part of 10 years.  You were the design team, the engineers, the production team and the pit crew.  You kept us on course at a pace set by our Chairman, and you have performed at the top of your field.

Back in ’66, by holding back, Ken Miles lost the win at Le Mans, which denied him the “Triple Crown” of endurance racing: the 24 Hours of Daytona, the 12 Hours of Sebring, and the 24 Hours of Le Mans.  No driver has won all three races in the same year, [26] and Ken missed out because he was part of a team and Ford had been good to him. [27]  He committed and moved forward without the victory that should have been his because he was the best driver that day.  I am committed to vote and move forward, even if it means giving up the triple crown of the day. But I will not go against my gut.

[1] Statement of Dissent by Commissioner Rostin Behnam Regarding Position Limits for Derivatives; Proposed Rule, https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement013020 (the Dissent).

[2] Ford v Ferrari, Fox Movies, https://www.foxmovies.com/movies/ford-v-ferrari (Last visited Oct. 13, 2020).

[3] Dissent.

[4] See Position Limits for Derivatives, 85 FR 11596 (Feb. 27, 2020).

[5] See Press Release Number 8146-20, CFTC, CFTC Extends Certain Comment Periods in Response to COVID-19 (Apr. 10, 2020), https://www.cftc.gov/PressRoom/PressReleases/8146-20; Extension of Currently Open Comment Periods for Rulemakings in Response to the COVID-19 Pandemic, 85 FR 22690, 22691 (Apr. 23, 2020).

[6] See Statement of Commissioner Dan M. Berkovitz on Recent Trading in the WTI Futures Contract before the Energy and Environmental Markets Advisory Committee Meeting (May 7, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement050720 .

[7] See Bloomberg News, The 20 Minutes that Broke the U.S. Oil Market, Bloomberg (Apr. 25, 2020), https://www.bloomberg.com/news/articles/2020-04-25/the-20-minutes-that-broke-the-u-s-oil-market?sref=DzeLiNol.

[8] Press Release, Ford Division News Bureau, For Immediate Release at 8 (July 5, 1966), made available in PDF at Wikipedia, the Free Encyclopedia, 1966 24 Hours of Le Mans, at https://en.wikipedia.org/wiki/1966_24_Hours_of_Le_Mans.

[9] Matthew Phelan, What’s Fact and What’s Fiction in Ford v. Ferrari, Slate (Nov. 18, 2019), https://slate.com/culture/2019/11/ford-v-ferrari-fact-vs-fiction-le-mans-ken-miles.html.

[10] See Position Limits for Derivatives, 76 FR 4752 (proposed Jan. 26, 2011) (the 2011 Proposal).

[11] The Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203 § 737, 124 Stat. 1376, 1722-25 (2010) (the Dodd-Frank Act).

[12] Unless otherwise indicated, the use of the term “exchanges” throughout this statement refers to designated contract markets (DCMs) and swap execution facilities (SEFs).

[13] Dissent.

[14] Id.

[15] See Final Rule at III.

[16] The Commission’s analysis in support of its denial of a mandate misconstrues form over substance and assumes the answer it is looking for.  The Commission seems to suggest that it is free to ignore a Congressional mandate if it determines that Congress is wrong about the underlying policy.  See Final Rule at III.A.

[17] 76 FR at 4752-54.

[18] Id. at 4753.

[19] Id. at 4754-55.

[20] See 76 FR at 4755.

[21] Id.

[22] Final Rule at II.B.2.i.

[23] 5 U.S.C. 553(b).

[24] Int’l Swaps & Derivatives Ass’n v. U.S. Commodity Futures Trading Comm’n, 887 F. Supp. 2d 259 (D.D.C. 2012).

[25] Final Rule at I.G.

[26] Martin Raffauf, Porsche and the Triple Crown of endurance racing, Porsche Road & Race (Dec. 7, 2018), https://www.porscheroadandrace.com/porsche-and-the-triple-crown-of-endurance-racing/.

[27] Phelan, supra note 9.

I support today’s final rule that extends the last phase of compliance for initial margin requirements to September 1, 2022.  In light of the unprecedented economic and social impacts of COVID-19 and the potential market disruption that could result from a large number of entities coming into scope on September 1, 2021, I strongly support an additional one year deferral for these firms.  As I have noted previously, given the large number of firms covered by the final compliance phases, the estimated 7,000 initial margin relationships that need to be negotiated, and the small overall percentage of swap activity these firms represent, a one year delay for these firms is appropriate in order to facilitate an efficient, orderly transition for the market into the uncleared margin regime.  In addition, today’s final rule also ensures the Commission is consistent with the BCBS-IOSCO recommended margin framework and with actions taken by U.S. prudential regulators to extend the margin compliance schedule.[1]

Overview

I am pleased to support the final rulemaking to amend Rule 3.10(c) in order to clarify, among other things, that a non-U.S. person does not have to register as a commodity pool operator (CPO) with respect to its operation of offshore commodity pools for non-U.S. participants that trade in U.S. derivatives markets, even if that CPO also operates other commodity pools with U.S. participants for which it is registered (or claims an exclusion or exemption from registration).

The Pool-by-Pool Approach

I firmly believe that the rule amendments we are adopting today reflect the right public policy.  These amendments will update Rule 3.10(c) to better align it with the realities of the modern international investment management environment.  Many large CPOs with substantial assets under management are located outside the United States and operate internationally to benefit their clients in what is a global derivatives market.  A rule in which a CPO outside the United States with many different commodity pools could have to register with the Commission with respect to offshore pools that have no U.S. participants simply because it also operates other pools in which U.S. persons do participate is often unworkable from an operational standpoint.

It also makes little sense from a regulatory standpoint, as reflected in the Commission’s longstanding and oft-cited policy originally stated over 30 years ago:

“‘[G]iven this agency’s limited resources, it is appropriate at this time to focus [the Commission’s] customer protection activities upon domestic firms and upon firms soliciting or accepting orders from domestic users of the futures markets and that the protection of foreign customers of firms confining their activities to areas outside this country, its territories, and possessions may best be for local authorities in such areas.’”[1]

Thus, today’s rulemaking carries on the Commission’s tradition of deference to our international colleagues to regulate individuals and activities in their own countries where their regulatory interest is paramount.  As I have said before, the Commission’s historical commitment to appropriate deference (which also is sometimes referred to as “mutual recognition”), “is a demonstration of international comity – an expression of mutual respect for the important interests of foreign sovereigns.”[2]  Mutual recognition also reflects the shared goals of global authorities seeking to achieve the most effectively regulated markets through coordination rather than duplication.

When a commodity pool with a non-U.S. CPO has U.S. participants, or when a commodity pool’s CPO is in the United States, we regulate accordingly.  But the Commission should not impose registration and regulatory requirements on non-U.S. CPOs with respect to their operation of offshore commodity pools for non-U.S. participants.  In such circumstances, the protection of the foreign pool participants is best left to our international counterparts, as their regulatory interest is greater than ours.[3]  That result makes sense, and will be achieved by the application of Rule 3.10(c) on a pool-by-pool basis.

And it turns out that doing so is not very controversial.  We did not receive any comment letters opposing the pool-by-pool approach to the registration of non-U.S. CPOs operating offshore commodity pools. 

The Affiliate Contribution Exception

Interestingly, what generated at least as much comment was the Commission’s related proposal to establish an “Affiliate Contribution Exception.”  This exception provides that initial seed capital contributed by a U.S. entity to an affiliated non-U.S. CPO’s offshore commodity pool will not require the non-U.S. CPO to register with respect to that offshore pool.  In other words, despite its seed capital contribution, the U.S. affiliate would not be considered a “participant” in the commodity pool for purposes of Rule 3.10(c) so that, if all others that have contributed are non-U.S. persons, the CPO will not be required to register.

As proposed, the Affiliate Contribution Exception included certain conditions, and the Commission also requested comment on some possible additional guardrails to prevent abuse of the Exception.  We did not receive any comments opposing the Affiliate Contribution Exception, nor did we receive any voicing support for the suggested additional guardrails.

On the other hand, we did receive comments expressing the view that our proposal was too narrow.  These market participants objected to an Exception that only applied to seed capital contributed at or near the offshore commodity pool’s inception.  They requested a broader exception for capital invested at any time to establish or provide ongoing support to the pool or to attract and retain non-US investors.

We are declining to expand the Affiliate Contribution Exception beyond the scope of what was proposed.  I agree that in adopting a registration exception that does not exist in our rules today, it is appropriate to begin on a limited basis.  The Affiliate Contribution Exception will allow U.S. seed money to an affiliated non-US CPO so that it can test its trading strategies and develop a track record when launching a new commodity pool, without triggering a registration requirement.  Going forward, I am open to hearing from market participants about specific circumstances in which they believe a broader exception might be warranted. 

Staff Advisory 18-96

In a similar vein, there is one other issue that we are not addressing in this rulemaking, but that I hope the Commission will consider in the not-too-distant future.  As some may recall, the amendments to Rule 3.10(c) that we are finalizing here actually arose out of a different proposed rulemaking that we issued in 2018,[4] which would have codified a staff action known as Advisory 18-96[5] that provides certain relief to both U.S. and non-U.S. CPOs.  As a result of the rulemaking we are adopting today, non-U.S. CPOs will no longer need to rely on the relief in Advisory 18-96.  Unfortunately, though, the 2018 proposal to codify Advisory 18-96 with respect to U.S. CPOs has slipped through the cracks while we have been addressing non-U.S. CPOs in this rulemaking. 

Advisory 18-96, among other things, provides relief for registered U.S. CPOs from disclosure, reporting, and certain recordkeeping requirements in connection with their operation of offshore commodity pools.  However, it only provides relief from requirements that were in effect when the Advisory was issued in 1996.  Absent codification in a rulemaking by the Commission, it does not apply to requirements adopted since then – one notable example being the requirement to file Form CPO-PQR.

Accordingly, it is my hope that the Commission can find room on its agenda during the coming months to propose, and request public comment on, a codification of staff Advisory 18-96 with respect to U.S. CPOs.  Those of us who were Commissioners at the time all voted to issue such a proposal in 2018, and we should now finish what we started.

Conclusion

I am pleased to support today’s final rulemaking.  I want to thank the staff for the time and effort they have put into answering questions and addressing comments about this rulemaking from me and my team.

[1] Registration and Compliance Requirements for Commodity Pool Operators and Commodity Trading Advisors, 83 Fed. Reg. 52902, 52904 (Oct. 18, 2018) (footnotes omitted) (the “2018 proposal”), quoting Exemption from Registration for Certain Foreign Persons, 72 Fed. Reg. 63976, 63976-77 (Nov. 14, 2007) (citing 48 Fed. Reg. 35248, 25261 (Aug. 3, 1983)).

[2] Statement of Commissioner Dawn D. Stump Regarding Foreign Board of Trade Registration Applications of Euronext Amsterdam, Euronext Paris, and European Energy Exchange, Nov. 5, 2019, available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement110519.

[3] To be sure, the Commission has a regulatory interest when an offshore commodity pool – even one with a non-US CPO and non-US participants – trades in US derivatives markets.  In these circumstances, we monitor that trading and impose the same requirements (e.g., large trader reporting) as in the case of any other trader in our markets. 

[4] See 2018 proposal, 83 Fed. Reg. at 52902.

[5] Advisory 18-96, “Offshore Commodity Pools—Relief for Certain Registered CPOs From Rules 4.21, 4.22 and 4.23(a)(10) and (a)(11) and From the Location of Books and Records Requirement of Rule 4.23” (Division of Trading and Markets, April 11, 1996), available at https://www.cftc.gov/sites/default/files/opa/press96/opacpo-advi.htm.

I am voting for the final rule amending regulation 3.10(c) (Final Rule).  Regulation 3.10(c) provides an exemption from registration to foreign persons who operate commodity pools (CPO) located outside of the United States.  The Final Rule makes pragmatic adjustments to certain conditions for claiming the exemption that will allow the Commission to focus its limited resources on protecting U.S. persons who participate in commodity pools, rather than on commodity pools operated outside the U.S. in which non-U.S. persons participate.

A fundamental goal of the Commission’s registration and regulation of CPOs is the protection of U.S. customers.[1]  The CFTC has long held that CPOs trading commodity interests in our markets are not required to register as CPOs if they are located offshore and only operate pools for non-U.S. persons.[2]  In 2007, the Commission codified the exemption in regulation 3.10(c).

The Final Rule: (i) exempts non-U.S. CPOs from registration and regulation with respect to individual commodity pools that do not solicit from U.S. persons or have U.S. investors;[3] (ii) provides that this exemption for some pools may be used with other exemptions or exclusions; and (iii) provides a safe harbor to non-U.S. CPOs in the event that U.S. persons inadvertently become participants in the offshore pools, provided that a number of conditions are met to minimize that possibility.  Lastly, the Final Rule permits U.S. affiliates of non-U.S. CPOs to contribute “initial capital” to exempt offshore pools without being treated as “participants” in the pools themselves if certain conditions are satisfied. 

In my statement for the proposed amendments to regulation 3.10(c), I noted some concern that the U.S. affiliate provision might result in persons in the U.S. investing—either knowingly or unknowingly—in unregulated foreign commodity pools if they invested in the U.S. affiliates.  The proposal included specific “anti-evasion” provisions that would prevent certain “bad actors” from using the exemption and prohibit the marketing of the U.S. affiliate as a vehicle for U.S. commodity interest investments.[4]  At my request, several questions regarding potential abuse of the U.S. affiliate provision were included in the proposed rule.

The letters commenting on the proposed rule generally expressed support.  A joint letter from asset management industry associations addressed the questions in the proposal regarding the U.S. affiliate provision and provided rationales in support thereof.  The letter explained that the initial capital investments from U.S. affiliates intended to help demonstrate fund performance or facilitate fund operations, for example, are not the types of investments that need the full array of customer protections provided for individual commodity pool investors. 

Furthermore, comment letters explained how the conditions in the U.S. affiliate provision, coupled with the anti-evasion provisions (with some modifications), balance the flexibility needed by CPOs to make prudent capital allocation decisions with preventive measures reducing the likelihood of abuse.  While it is possible that some less than forthright actors could attempt to use the regulation 3.10(c) exemption to skirt the CPO registration requirements when soliciting commodity interest investments from U.S. persons, the Final Rule has appropriate restrictions that will facilitate enforcement when necessary.

In conclusion, the Final Rule makes prudent, limited amendments that reduce the burdens on the Commission’s limited resources while maintaining the necessary protections intended for U.S. commodity pool participants.  I would like to thank the commenters for their contribution to improving the Final Rule and the CFTC staff for working with my office to address my concerns.

Overview

With all that has transpired in our country and in our lives this year, it feels like ages ago that we gathered together in person to consider proposing amendments to update the Commission’s rules regarding position limits back at the end of January.  At the time, I said that there were three guideposts by which I would evaluate that proposal: First, is it reasonable in design?  Second, is it balanced in approach?  And third, is it workable in practice for both market participants and for the Commission?

Since I believed the answer to each of these questions was yes, I supported issuing the proposal.  And by and large, my belief has been confirmed by the comments we received from those who trade in this country’s derivatives markets.  In the months since January, we have heard from all corners of the marketplace–agricultural interests, energy interests, managed fund advisors, and dealers that provide liquidity, to name a few–that have voiced support for the fundamental architecture of the position limits framework that we proposed.  Their support stands in stark contrast to the serious concerns they had expressed about the several previous position limit proposals put forward by the Commission during the past decade.

Of course, each interest had its issues with one aspect or another in the proposal.  That is to be expected, given the varied and sometimes divergent objectives for our position limit rules set out in the Commodity Exchange Act (CEA).[1]  Congress has tasked us with adopting position limits that: 1) on the one hand, diminish, eliminate or prevent excessive speculation in derivatives and deter and prevent market manipulation, squeezes, and corners; while on the other hand, and simultaneously 2) ensuring sufficient market liquidity for bona fide hedgers and ensuring that the price discovery function of the underlying market is not disrupted and does not shift to foreign competitors.

Reasonable minds will always differ as to exactly where to draw the line among these statutory objectives.  But while we must always strive for perfection, we cannot permit that aspiration to paralyze us from acting to improve our rule sets.  The final position limit rules before us smooth some of the rough edges in the proposal, and they address the areas in which I expressed some misgivings at the time.  They incorporate valuable input we have received from the exchanges that operate the markets and the businesses that trade in those markets.

And above all, the final rulemaking is reasonable in design, balanced in approach, and workable in practice.  For these reasons, I am pleased to support it.

Bona Fide Hedging and Spread Transactions:  Policy and Process

In commenting on the proposal in January, I noted two areas that I felt could be improved: 1) the list of enumerated bona fide hedging transactions and positions; and 2) the process for reviewing hedging transactions outside of that list.  I want to briefly address each of these concerns, in turn.

Enumerated Bona Fide Hedges

The CEA prohibits the Commission from adopting position limit rules that apply to bona fide hedging transactions or positions, as such terms are defined by the Commission.  It gives the Commission the authority to define the term “bona fide hedging transactions and positions” to “permit producers, purchasers, sellers, middlemen, and users of a commodity or a product derived therefrom to hedge their legitimate anticipated business needs . . .”[2]  Congress thereby recognized the critical function of our derivatives markets in enabling those whom we all depend upon to deliver goods and services to hedge their risks–both risks they currently bear as well as those they reasonably anticipate.[3]  

The Commission’s proposal recognized this as well, as it expanded the list of “enumerated” bona fide hedging transactions that are identified in our current rules.  Positions taken as a result of these enumerated hedging transactions constitute bona fide hedging, and therefore are not subject to federal speculative position limits.  This expansion of the list of enumerated bona fide hedges is entirely appropriate (indeed, it is long overdue).  Hedging practices at companies that produce, process, trade, and use agricultural, energy, and metals commodities have become far more sophisticated, complex, and global over time, and the Commission’s list of enumerated hedging practices to which its position limit rules do not apply has failed to keep pace with these realities.

And given Congress’ recognition of the appropriateness of hedging legitimate anticipated business needs,[4] the proposal also added, at my request, anticipatory merchandising as an enumerated bona fide hedge.  There is no policy basis for distinguishing hedging risks of anticipated merchandising from hedging risks of other activities in the physical supply chain.

Yet, I was concerned in January that our proposed list of enumerated bona fide hedges still might not be as robust as it should be.  We needed input on this question from market participants–especially those in the energy and metals sectors where we are applying federal position limits for the first time.  And that input was nearly unanimous in recommending that hedging the risk of unfixed-price forward transactions be added to the list of enumerated bona fide hedges.

Hedges of offsetting unfixed-price cash commodity sales and purchases have historically been recognized as an enumerated bona fide hedge under our rules, and that was carried over in the proposal, too.  These are hedges of risk incurred where a market participant has both bought and sold the underlying cash commodity at unfixed prices.  We received many comments, though, urging us to include as an enumerated bona fide hedge those situations in which the purchase or sale, but not both, is an unfixed-price forward transaction.  Some commenters asked that the historical enumerated hedge for offsetting unfixed-price cash commodity sales and purchases be expanded to cover unfixed-price cash commodity sales or purchases; others asked the Commission to create a new, stand-alone enumerated bona fide hedge category for these unfixed-price transactions.  The final rulemaking concludes that neither step is necessary because, as suggested by still other commenters, commercial market participants may qualify for one of the enumerated anticipatory bona fide hedges that will be available, to the extent of their demonstrated anticipated need.[5]

Spread Transactions

Although the treatment of spread transactions for purposes of federal position limits is distinct from the treatment of bona fide hedging transactions, I would like to take a short detour to note an important similarity between the two.  That is, we also received numerous comments suggesting that the proposed definition of a spread transaction, which would be exempt from federal position limits, was too narrow.

At the suggestion of commenters, the final rulemaking adds the well-established categories of intra-market, inter-market, and intra-commodity spreads to the list of defined spreads that fall outside the federal position limits regime.  The release notes that as a result, the spread transaction definition captures most, if not all, spread exemptions currently granted by exchanges and used by market participants.  The rulemaking appropriately recognizes that these spread positions simply do not raise the type of concerns that position limits are intended to address.

The Non-Enumerated Bona Fide Hedge Recognition Process

Getting the list of enumerated bona fide hedges right is important because they are “self-effectuating” for purposes of federal position limits.  In other words, a trader need not count positions that result from enumerated bona fide hedging transactions towards the federal position limits, and does not need to apply to the Commission for approval (although the trader still must receive approval from the relevant exchange to exceed exchange-set limits).

Other hedging practices, generally referred to as “non-enumerated” hedges, can still be recognized as bona fide hedging, but only after a review process.  A trader can either ask the exchange and the Commission to separately review and approve the proposed non-enumerated hedging activity for purposes of exchange and federal limits, respectively, or it can follow what the rulemaking calls a “streamlined” process.  Under that process, if an exchange recognizes a non-enumerated transaction as a bona fide hedge for purposes of the exchange’s position limits, the Commission would then review the exchange’s bona fide hedge recognition for application to federal limits as well.  The Commission must notify the exchange and market participant of any denial within 10 business days, or 2 business days in the case of an application based on a sudden or unforeseen increase in the trader’s bona fide hedging needs (although that timeline can be extended if the Commission issues a stay or requests additional information).

In January, I expressed reservations about whether this 10/2-day process would be workable in practice for either market participants or the Commission because it appeared to be both too long and too short: 1) too long to be workable for market participants that may need to take a hedge position quickly; and 2) too short for the Commission to meaningfully review the relevant circumstances related to the exchange’s recognition of the hedge as bona fide.  But while some commenters took the “too long” view and others took the “too short” view, the majority of commenters were generally supportive of this process.

The final rulemaking adopts the 10/2-day process, with an adjustment recommended by several commenters as well as participants in a meeting of the Commission’s Energy and Environmental Markets Advisory Committee (EEMAC)[6] that discussed the position limits proposal.  That is, the final rulemaking now provides that a trader can exceed federal limits based on the exchange’s approval of the non-enumerated hedge while the Commission is conducting its assessment.  This is not a delegation of authority to the exchange, since the Commission will still make the final determination whether positions resulting from the non-enumerated hedging transaction should count towards federal position limits.  Thus, a trader that exceeds federal limits in reliance on the initial exchange determination runs the risk that the Commission will later deny the requested non-enumerated hedge.  In that event, the trader will have to reduce the position to come into compliance with limits within a commercially reasonable period of time.

Is it a perfect process?  It is not.  My preference would have been that recognition of non-enumerated hedges be the responsibility of the exchanges, which are most familiar with both their own markets and the hedging practices of participants in those markets.  The Commission, in turn, has the tools it needs to monitor this process through its routine, ongoing review of the exchanges.  But those who participate in the markets have generally expressed the view that this is a reasonable, balanced, and workable process.  And so, I support it.

Response to Commenter Objections

Before concluding, I would like to briefly respond to a couple of points raised by commenters that were critical of the proposed position limit rules.  Some commenters argued that: 1) the amendments to the CEA’s position limit provisions that were enacted as part of the Dodd-Frank Act[7] constitute a mandate for the Commission to establish federal position limits without having to make an antecedent finding that such limits are necessary to achieve the CEA’s objectives; and 2) the rules we are adopting improperly abdicate Commission responsibilities with respect to federal position limits to the exchanges.

The Commission’s Mandate to Impose Position Limits it Finds are Necessary

As I read the statute, the CEA’s position limit provisions, as amended by the Dodd-Frank Act, mandate the Commission to impose position limits that it finds are necessary.  The basis for my view is set out in detail in my statement in support of the proposal last January, which included an explanatory graphic.  Both of these documents are available on the Commission’s website for those who are interested,[8] and so I will not repeat that analysis here.  Suffice it to say, though, that I have not seen anything in the comment letters we received that changes my view.

The Role of the Exchanges

I fundamentally disagree with the suggestion that the amended position limit rules that we are adopting in any way reflect an inappropriate reliance by the Commission on the exchanges.  My disagreement is rooted in several considerations.

First, the CEA itself states without limitation that it is the purpose of the CEA to serve the public interests described in the statute “through a system of effective self-regulation of trading facilities, clearing systems, market participants and market professionals under the oversight of the Commission.”[9]  This is an overarching statement of purpose by Congress, and is the lens through which all other provisions of the CEA–including its position limit provisions–must be interpreted.  And nothing in the amendments to those position limit provisions enacted as part of the Dodd-Frank Act indicate otherwise.

Second, the rules we are adopting do not delegate any authority of the Commission to the exchanges.  With respect to applications for non-enumerated bona fide hedges in particular, the Commission will be informed by an exchange’s determination whether to recognize the hedge for purposes of exchange-set limits.  But the determination whether to do so with respect to federal limits is the Commission’s alone to make, and a trader who trades in reliance on an exchange determination risks having to reduce the position if the Commission subsequently disagrees with the exchange’s determination.

Third, the exchanges know their markets.[10]  They have a comprehensive understanding of the traders that participate in those markets as well as current hedging practices in agricultural, energy, and metals commodities.  Indeed, the expertise of the exchanges makes them uniquely well-suited to make the initial determination on requests for non-enumerated bona fide hedges in real-time.

Finally, I return once again to my foundational principles: Reasonable, balanced, and workable.  A system in which a business must put its economic needs and risk management efforts on hold while the Commission undertakes to learn about its operations and hedging activities in order to pass upon a request for a non-enumerated bona fide hedge violates all three principles.

Conclusion

After nearly a decade of trying, we stand on the cusp of amending the Commission’s position limit rules, which are sorely in need of updating.  Before us is a thorough and well-reasoned final rulemaking release that considers the extensive comments we received, and clearly presents the Commission’s rationale in addressing those comments and adopting the rules in the form that we are adopting them.  The fact that this release is before us less than nine months after we issued the proposal–in the midst of a pandemic, no less–is a tribute to the dedication, perseverance, and analytical capabilities of the professionals in the Commission’s Division of Market Oversight, Office of General Counsel, and Chief Economist’s Office.  Their work on this rulemaking has been nothing short of amazing.

My fellow Commissioners and I have each publicly committed that we would work to finish a position limits rulemaking.  The time has come to fulfill that commitment.  The release that staff has presented is reasonable in design, balanced in approach, and workable for both market participants and the Commission.  I am pleased to support it.

I am pleased to support today’s final rule that expands an existing exemption from registration for foreign commodity pool operators (CPOs) trading on U.S. markets on behalf of foreign investors.  Building on previously granted staff no-action relief, the final rule creates new possibilities for fund managers, appropriately focuses the Commission’s resources and customer protection activities upon domestic firms and U.S. customers, and provides for simplified compliance.  For example, the final rule permits non-U.S. CPOs to claim the exemption on a pool-by-pool basis, which I believe is appropriate given that many large, foreign CPOs operate both U.S. and non-U.S. pools.  The final rule also permits a foreign fund manager to satisfy the exemption’s requirement that its pool does not contain funds of U.S. customers by complying with certain safe harbors, such as fund documentation requirements.  In doing so, the final rule recognizes that the manner in which fund interests are sold in the real world often makes it impossible for a fund manager to make a blanket attestation that there is no U.S. investment in a given commodity pool.

Finally, for the first time, the final rule would permit U.S. affiliates of foreign pools to contribute initial capital to those pools.  Allowing U.S. affiliates to contribute seed money to offshore pools operated by their affiliated non-U.S. CPOs should facilitate innovation and fund development by enabling those offshore pools to establish a performance history for solicitation purposes.

The last time we gathered as a Commission to discuss position limits I used some of my time to speak a bit about the award winning movie, Ford v Ferrari.[1]  At that point, we were nearing the airing of the 92nd Academy Awards and this action-packed drama had earned four nominations—not to mention the distinction of being one of the few films I actually saw in a theater.  For those of you who have not found it in one of your quarantine movie queues, Ford v Ferrari tells the true story of American car designer Carroll Shelby and British-born driver Ken Miles who built a race car for Ford Motor Company—the GT40—and competed with Enzo Ferrari’s dominating, iconic red racing cars at the 1966 24 Hours of Le Mans.[2]  I used the film and racing metaphors throughout my speaking and written statements to highlight serious concerns that the proposed amendments to the CFTC rules addressing position limits (the Proposal) signified yet one more instance where the Commission seemed to be comfortable with deferring core, congressionally mandated duties to others and calling it a victory.[3]

We are here today to finalize the Proposal.  In just short of nine months, we have come to terms with life during a global pandemic complete with economic turmoil and pockets of historic market volatility.  Amid the mere 60-day open comment period following the Proposal’s publication in the Federal Register (graciously extended by 16 days to May 15th in light of the pandemic[4]), on April 20th, the price of the West Texas Intermediate crude oil futures contract (WTI contract), a key benchmark in the energy and financial markets, experienced an unprecedented collapse one day prior to the last day of trading and expiration for May delivery.[5]  Defying market mechanics, the price of the contract fell from $17.73 per barrel at market open, to a closing settlement price of negative $37.63—with the price dropping approximately $40 in the last 20 minutes of trading.[6]  And, while we are still in recovery, with great fanfare after almost 10 years, the Commission is going to establish the position limits regime required under the Dodd-Frank Act.  I am reminded again of Ken who, at the 1966 24 Hours of Le Mans, went against his gut, giving way and leaving behind a milestone in car racing that to this day remains elusive.

If you haven’t seen the movie, this is a spoiler alert: Ken did not win Le Mans in ’66.  While he was one and a half laps ahead of two other GT40s, he was asked to slow down so that the three Fords in the lead would cross the finish line in a dead heat formation.  Ken lost his well-deserved win because the 24 Hours of Le Mans awards the victory to the car that covers the greatest distance in 24 hours.  In the event of a tie, the rules provided that the car that had started farther down the grid had traveled the greater distance.  Ken’s GT40 had started in the grid 60 feet ahead of the GT40 driven by Bruce McLaren and Chris Amon, who were the declared winners.[7]

In the film, Ken seems to accept his loss with quiet dignity.  However, in reality he was fully aware that in many respects, he had been robbed.  From what I’ve read, Ken likely articulated his feelings a bit more colorfully.[8]

The point is that bringing something across the finish line doesn’t always equate to a success.  As detailed in my questions today and written statement, I believe that by going against our Congressional mandate and clear statutory intent by overly deferring to the exchanges, we have relinquished a claim to victory in this final position limits rule, which in many ways has itself felt like the CFTC’s version of the 24 hours of Le Mans.  Therefore, I will go with my gut and not be part of the formation in supporting this final rule.

Before turning to the other matters before the Commission today, I do wish to acknowledge and thank the Commission staff who worked on the Proposal, today’s final rule, and every related study, matter, and undertaking to support it for the better part of 10 years.  You were the design team, the engineers, the production team and the pit crew.  You kept us on course at a pace set by our Chairman, and you have performed at the top of your field.

There are two other final rules before the Commission today, and I am pleased to say that I will be supporting both.

First, the Commission will vote to extend by one year the implementation schedule for the margin requirements for uncleared swaps (CFTC Margin Rule) by postponing the compliance date for the final phase, known as phase 6, to September 1, 2022.  Throughout the various regulatory maneuvers this year that resulted in bifurcating the final compliance phase and will ultimately extend the implementation schedule by two years, the Commission addressed transition risks associated with implementation of the CFTC Margin Rule as well as the circumstances of the COVID-19 pandemic with workable, targeted solutions aimed at ensuring our policies remain intact.  As we have now passed the ten-year anniversary of the Dodd-Frank Act, it is clear that the risks that the CFTC Margin Rule seeks to address have not morphed into anything of lesser concern—and indeed, it may be quite the opposite.

I expect that covered entities will work diligently in the time they have been given to come into compliance.  We are collectively working towards goals of continuity, resiliency, and normalcy.  The Commission’s open engagement and willingness to address appropriate concerns—a hallmark of our agency—ought not to be tread upon or used to undermine core reforms at a time when the very relief we have provided addresses market volatility and stress.

I would like to commend the ongoing work of our CFTC staff in demonstrating its analytical expertise in evaluating and validating the need for the sixth phase of compliance and for the two-year extension of the implementation schedule.  I would also like to thank you all for working towards regulatory harmonization with respect to margin for uncleared swaps by engaging in significant data-driven efforts with our domestic and international counterparts through the BCBS/IOSCO Working Group on Margining Requirements (WGMR).

Second, the Commission will vote on a final rule revising, among other things,[9] the conditions for the registration exemption under Commission regulation 3.10(c) available to non-U.S. commodity pool operators or “CPOs” (the 3.10 Exemption).  The amendments expand the 3.10 Exemption to non-U.S. commodity pool operators or “CPOs” who operate both qualifying offshore commodity pools and other commodity pools.  More specifically, going forward, a non-U.S. CPO may claim the 3.10 Exemption with respect to a qualifying offshore commodity pool, while maintaining another exemption from CPO registration, relying on an exclusion, or even registering as a CPO, with respect to its operation of other commodity pools—a practice known as “stacking.”  Such non-U.S. CPOs may also utilize a safe-harbor with respect to offshore commodity pools that take certain actions to prevent participation by U.S. persons, and may receive seed money from U.S. affiliates during the initial capitalization period of such off-shore pools without impacting their eligibility for the 3.10 Exemption.

The amendments to the 3.10 Exemption stem from two separate rulemaking proposals that spanned a roughly four-year period and, among other things, address policy positions that were ripe for consideration.  As amended, the 3.10 Exemption will further reflect the increasingly global nature of this space and clarify the Commission’s approach with respect to its oversight of foreign intermediaries that are not engaged in commodity interest activities on behalf of U.S. customers.

This final rule is brief in its delivery—less than one tenth the length of the final rule on position limits, but it reflects many years of staff experience and familiarity with the Commission’s historical positions and reasoning in addressing material policy issues raised by appropriately balancing the financial interests of foreign intermediaries and their customers with our commitment to the financial integrity of U.S. markets and U.S. customer protection.

I greatly appreciate the time and consideration that the staff of the Division of Swap Dealer and Intermediary Oversight (DSIO) gave to my comments and concerns throughout this rulemaking.  I also wish to thank the Office of General Counsel (OGC) staff for ensuring that we consistently adhere to the letter and spirit of the Commodity Exchange Act and Commission regulations.

Getting back to the topic on most of your minds, Ford v. Ferrari ended up taking home two Academy Awards for Best Sound Editing and Best Film Editing.[10]  Like today’s final rules amending the CFTC Margin Rule and the 3.10 Exemption, the film exhibited the finest editing and preservation of the aesthetic in multiple disciplines.  It ultimately lost Best Picture to Parasite,[11] a dark comedy thriller.  I will stop there with my comparisons.

In closing, I want to again thank the Chairman for his commitment to crossing the finish line on so many rules intended to implement core Dodd-Frank Act reforms.  As a five-member Commission, our goal is always to reach consensus.  However, like Ken Miles learned, consensus may not always equate to a victory or the success you were aiming for.  We can disagree on various aspects of the proposals before us, and nevertheless commit to moving forward.  We will do that today.  The important part is that we provide transparency through presentation and debate.

Back in ’66, by holding back, Ken lost the win at Le Mans, which denied him the “Triple Crown” of endurance racing: the 24 Hours of Daytona, the 12 Hours of Sebring, and the 24 Hours of Le Mans.  No driver has won all three races in the same year,[12] and Ken missed out because he was part of a team and Ford had been good to him.[13]  He committed and moved forward without the victory that should have been his because he was the best driver that day.  I am committed to vote and move forward, even if it means giving up the triple crown of the day. But I won’t go against my gut.

I am very proud to bring to a final vote the Commission’s rule on speculative position limits.  Like my fellow Commissioners and so many who have held these seats before us, I promised during my confirmation hearing that I would work to finalize this rule.  So to the Senate Committee on Agriculture, Nutrition, and Forestry, to the market participants who rely on futures markets, and to the American people, I am pleased to say—promise made, promise kept.

Today, we are removing a cloud that has hung over both the CFTC and the derivatives markets for a decade.  Market participants, particularly Americans who need these markets to hedge the risks inherent in their businesses, will finally have regulatory certainty.

Long Journey of Position Limits

Ralph Waldo Emerson is quoted as saying “Life is a journey, not a destination.”  Lucky for him, his journey did not involve position limits.  This rule has been one of the most difficult undertakings in CFTC history.

The Commission has issued five position limits proposals over the past 10 years.  The first was adopted in 2011, but vacated by the U.S. District Court for the District of Columbia before it took effect.  One proposal issued in 2013, and two more in 2016, were never finalized.  All told, those four proposals received thousands of comments from the public—the vast majority of which objected to the proposals for good reason.  Much ink was spilled, and many trees were felled over those proposals.

Finally, the Commission issued its fifth position limits proposal in January of this year.  Today we will finalize that rule.  But it is important to note we are not completely rejecting prior attempts.  Instead, we build on the good from previous proposals while recognizing and fixing their shortcomings.

Any position limits rule involves a balancing act.  To paraphrase a famous saying – You can please some of the people all the time, and all the people some of the time, but—as is certainly the case with position limits—you can’t please all the people all the time.

That is especially true given the three things the Commission is tasked with balancing for position limits:

1. whether position limits on a particular contract are more helpful than harmful;
2. which positions should be subject to the limits and which should not; and
3. at what levels position limits should be set to allow for liquid markets but not excessive speculation.

Recognizing Dead Ends

Prior position limits proposals ultimately failed because they were unable to strike the correct balance on these three points.

First, prior proposals were based on a plausible, but ultimately unsupportable, interpretation—“the mandate.”  The mandate would mean there is no balancing test; instead, all futures would be subject to federal limits.  Given the wide range of futures in our markets, this approach would require the CFTC to evaluate thousands of contracts.  It also would necessitate limits on everything—regardless of the benefits those limits would bring or the burdens they would impose.

Second, prior proposals failed to recognize all the ways that participants use futures markets to hedge price risks.  Agricultural, energy, and metal futures markets are vital to American businesses, which is why Congress explicitly excluded bona fide hedging positions from position limits.  Reading the term bona fide hedging too broadly risks inviting the wolf of speculative activity into the market wearing sheep’s clothing.  Reading it too narrowly creates the possibility of locking out the businesses that need these markets to manage their risks.  And taking away that ability to manage risk jeopardizes economic growth.

As a result, the Commission’s prior proposals were too restrictive on what constitutes bona fide hedging.  They threw up too many roadblocks for businesses to access futures markets.  Ultimately, an overly rigid interpretation of bona fide hedging stood in the way of finalizing a position limits rule.

Finally, prior proposals set limits that were both too low and too rigid.  Those limits did not balance the need for liquidity and price discovery against the risks of excessive speculation, which is the real mandate of Congress.  The proposed limits were frozen in time, not budging from limits last updated as far back as 1999.

Getting Back on the Right Path

Recognizing the missteps of the past yields a path to success.  Unlike prior position limits proposals that garnered a library of negative comment letters, this proposal is overwhelmingly supported by businesses and trade groups across many facets of our real economy.

There are several differences that will let today’s rule succeed where others failed.

First, the rule recognizes the limits of limits.  Position limits are one method to combat corners and squeezes, but that does not mean they are the singular tool that should always be deployed.  Position limits are like a medicine that can help cure a disease, but also carries potential side effects.  That is why Congress told us to use them only when “necessary.”  The necessity finding is like a doctor’s prescription—someone needs to evaluate the risks of the disease against the side effects.

In addition, the rule takes into account market participants’ needs.  As I have always said, position limits is the rare case where the exception is as important as the rule.  Today’s rule lays out a robust set of enumerated bona fide hedge exemptions to ensure that participants in the physical commodity markets can access the futures markets.  Building on the proposal, we have added clarity around unfixed price transactions and storage.

The rule also acknowledges the different ways people access the markets.  We have streamlined the process for pass-through swap exemptions, making it easier for dealers to provide liquidity to commercial users in the swaps market.  And the rule clarifies that someone can take a position during the Commission’s 10-day review period of an exchange-granted, non-enumerated exemption.  In short, we have built a robust set of enumerated exemptions and a workable non-enumerated exemption process.

The rule also strikes a balance with respect to the limits themselves.  The January proposal included significant increases to spot and non-spot limits for the legacy agricultural products.  Many commenters were concerned about these increases, particularly for non-spot limits.

The level of the non-spot limits in the final rule are a function of the significant growth in the market and the long delay in making adjustments.  Open interest in many of the legacy grains contracts has doubled or tripled since we last updated position limits, reflecting the usefulness of these contracts as a benchmark for cash market transactions and faith in CFTC-regulated markets.  The non-spot limits we are adopting are the same percentage of today’s open interest as the 2011 limits were compared to open interest back then.  Our markets have grown tremendously, and we cannot expect them to be subject to the same limits they were 10 years ago.

It is important to remember that federal position limits are a ceiling, not a floor.  Exchanges have their own limits, which can be no higher than what we specify.  And exchanges can calibrate those limits quickly to account for issues with deliverable supply or other cash market issues.  As we have seen play out over the past decade, the CFTC has a difficult time adjusting position limits.  Therefore, exchange-set limits are a way to fine tune position limits on a particular market within the outer bounds of the federal limits.  Similar to the process for granting non-enumerated exemptions, we are leveraging the knowledge of the exchanges as well as their ability to act more nimbly to respond to market needs.

Arriving at the Destination

Some of my colleagues may see these features of the final rule as a flaw.  While there are significant departures from prior proposals, after four failed attempts, that departure is exactly what we need.  The flexibility in the necessity finding, the exemption process, and the adjusted limits are what make this rule workable.  Otherwise, we are just repeating past mistakes and hoping for a different result—the very definition of insanity.

So let me conclude by saying that we have come a long way.  Today we have reached the end of an arduous journey.  We have learned from our mistakes and adjusted our approach.  We have balanced the interests of all the participants in these markets—some of which are in diametric opposition to one another.  Most importantly, we have crafted a workable and flexible system.  The rule sets hard limits, but leverages the flexibility of exchanges to adjust for a particular market.  The rule recognizes the variety of ways that businesses use these markets to hedge their risks, while recognizing how vital it is to have a method to address the unknown unknowns.  And the rule acknowledges that position limits are not always necessary and sets out a solid methodology for determining when they are.

I again want to thank the CFTC staff and my fellow Commissioners for their tireless commitment to finishing this journey.  I look forward to voting in favor of this final rule.