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Federal Register, Volume 78 Issue 239 (Thursday, December 12, 2013)[Federal Register Volume 78, Number 239 (Thursday, December 12, 2013)]
[Proposed Rules]
[Pages 75679-75842]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-27200]
[[Page 75679]]
Vol. 78
Thursday,
No. 239
December 12, 2013
Part II
Commodity Futures Trading Commission
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17 CFR Parts 1, 15, 17, et al.
Position Limits for Derivatives; Proposed Rule
Federal Register / Vol. 78 , No. 239 / Thursday, December 12, 2013 /
Proposed Rules
[[Page 75680]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 15, 17, 19, 32, 37, 38, 140, and 150
RIN 3038-AD99
Position Limits for Derivatives
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
———————————————————————–
SUMMARY: The Commission proposes to amend regulations concerning
speculative position limits to conform to the Wall Street Transparency
and Accountability Act of 2010 (“Dodd-Frank Act”) amendments to the
Commodity Exchange Act (“CEA” or “Act”). The Commission proposes to
establish speculative position limits for 28 exempt and agricultural
commodity futures and option contracts, and physical commodity swaps
that are “economically equivalent” to such contracts. In connection
with establishing these limits, the Commission proposes to update some
relevant definitions; revise the exemptions from speculative position
limits, including for bona fide hedging; and extend and update
reporting requirements for persons claiming exemption from these
limits. The Commission proposes appendices that would provide guidance
on risk management exemptions for commodity derivative contracts in
excluded commodities permitted under the proposed definition of bona
fide hedging position; list core referenced futures contracts and
commodities that would be substantially the same as a commodity
underlying a core referenced futures contract for purposes of the
proposed definition of basis contract; describe and analyze fourteen
fact patterns that would satisfy the proposed definition of bona fide
hedging position; and present the proposed speculative position limit
levels in tabular form. In addition, the Commission proposes to update
certain of its rules, guidance and acceptable practices for compliance
with Designated Contract Market (“DCM”) core principle 5 and Swap
Execution Facility (“SEF”) core principle 6 in respect of exchange-
set speculative position limits and position accountability levels.
DATES: Comments must be received on or before February 10, 2014.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD99
by any of the following methods:
Agency Web site: http://comments.cftc.gov.
Mail: Secretary of the Commission, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW.,
Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow instructions for submitting comments.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
www.cftc.gov. You should submit only information that you wish to make
available publicly. If you wish the Commission to consider information
that is exempt from disclosure under the Freedom of Information Act, a
petition for confidential treatment of the exempt information may be
submitted according to the procedure established in Sec. 145.9 of the
Commission’s regulations (17 CFR 145.9).
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse, or remove any or all of
your submission from http://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the Freedom of Information Act.
FOR FURTHER INFORMATION CONTACT: Stephen Sherrod, Senior Economist,
Division of Market Oversight, at (202) 418-5452, [email protected];
Riva Spear Adriance, Senior Special Counsel, Division of Market
Oversight, at (202) 418-5494, [email protected]; David N. Pepper,
Attorney-Advisor, Division of Market Oversight, at (202) 418-5565,
[email protected], Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Position Limits for Physical Commodity Futures and Swaps
A. Background
1. CEA Section 4a
2. The Commission Construes CEA Section 4a(a) To Mandate That
the Commission Impose Position Limits
3. Necessity Finding
B. Proposed Rules
1. Section 150.1–Definitions
i. Various Definitions Found in Sec. 150.1
ii. Bona Fide Hedging Definition
2. Section 150.2–Position Limits
i. Current Sec. 150.2
ii. Proposed Sec. 150.2
3. Section 150.3–Exemptions
i. Current Sec. 150.3
ii. Proposed Sec. 150.3
4. Part 19–Reports by Persons Holding Bona Fide Hedge Positions
Pursuant to Sec. 150.1 of This Chapter and by Merchants and Dealers
in Cotton
i. Current Part 19
ii. Proposed Amendments to Part 19
5. Sec. 150.7–Reporting Requirements for Anticipatory Hedging
Positions
i. Current Sec. 1.48
ii. Proposed Sec. 150.7
6. Miscellaneous Regulatory Amendments
i. Proposed Sec. 150.6–Ongoing Responsibility of DCMs and SEFs
ii. Proposed Sec. 150.8–Severability
iii. Part 15–Reports–General Provisions
iv. Part 17–Reports by Reporting Markets, Futures Commission
Merchants, Clearing Members, and Foreign Brokers
II. Revision of Rules, Guidance, and Acceptable Practices Applicable
to Exchange-Set Speculative Position Limits–Sec. 150.5
A. Background
B. The Current Regulatory Framework for Exchange-Set Position
Limits
1. Section 150.5
2. The Commodity Futures Modernization Act of 2000 Caused
Commission Sec. 150.5 To Become Guidance on and Acceptable
Practices for Compliance with DCM Core Principle 5
3. The CFTC Reauthorization Act of 2008
4. The Dodd-Frank Act Amendments to CEA Section 5
i. The Dodd-Frank Act Added Provisions That Permit the
Commission To Override the Discretion of DCMs in Determining How To
Comply With the Core Principles
ii. The Dodd-Frank Act Established a Comprehensive New Statutory
Framework for Swaps
iii. The Dodd-Frank Act Added the Regulation of Swaps, Added
Core Principles for SEFs, Including SEF Core Principle 6, and
Amended DCM Core Principle 5
5. Dodd-Frank Rulemaking
i. Amended Part 38
ii. Amended Part 37
iii. Vacated Part 151
C. Proposed Amendments to Sec. 150.5
1. Proposed Amendments to Sec. 150.5 To Add References to Swaps
and Swap Execution Facilities
2. Proposed Sec. 150.5(a)–Requirements and Acceptable
Practices for Commodity Derivative Contracts That Are Subject to
Federal Position Limits
3. Proposed Sec. 150.5(b)–Requirements and Acceptable
Practices for Commodity Derivative Contracts That Are Not Subject to
Federal Position Limits
III. Related Matters
A. Considerations of Costs and Benefits
1. Background
i. Statutory Mandate To Consider Costs and Benefits
2. Section 150.1–Definitions
i. Bona Fide Hedging
ii. Rule Summary
iii. Benefits and Costs
[[Page 75681]]
3. Section 150.2–Limits
i. Rule Summary
ii. Benefits
iii. Costs
iv. Consideration of Alternatives
4. Section 150.3–Exemptions
i. Rule Summary
ii. Benefits
iii. Costs
iv. Consideration of Alternatives
5. Section 150.5–Exchange-Set Speculative Position Limits
i. Rule Summary
ii. Benefits
iii. Costs
iv. Consideration of Alternatives
6. Section 150.7–Reporting Requirements for Anticipatory
Hedging Positions
i. Benefits and Costs
7. Part 19–Reports
i. Rule Summary
ii. Benefits
iii. Costs
iv. Consideration of Alternatives
8. CEA Section 15(a)
i. Protection of Market Participants and the Public
ii. Efficiency, Competitiveness, and Financial Integrity of
Markets
iii. Price Discovery
iv. Sound Risk Management
v. Other Public Interest Considerations
B. Paperwork Reduction Act
1. Overview
2. Methodology and Assumptions
3. Information Provided by Reporting Entities/Persons and
Recordkeeping Duties
4. Comments on Information Collection
C. Regulatory Flexibility Act
IV. Appendices
A. Appendix A–Studies Relating to Position Limits Reviewed and
Evaluated by the Commission
I. Position Limits for Physical Commodity Futures and Swaps
A. Background
1. CEA Section 4a
Speculative position limits have been used as a tool to regulate
futures markets for over seventy years. Since the Commodity Exchange
Act of 1936,1 Congress has repeatedly expressed confidence in the use
of speculative position limits as an effective means of preventing
unreasonable and unwarranted price fluctuations.2
—————————————————————————
1 7 U.S.C. 1 et seq.
2 See, e.g., H.R. Rep. No. 421, 74th Cong., 1st Sess. 1
(1935); H.R. Rep. No. 624, 99th Cong., 2d Sess. 44 (1986).
—————————————————————————
CEA section 4a, as amended by the Dodd-Frank Act, provides the
Commission with broad authority to set position limits. When Congress
created the Commission in 1974, it reiterated that the purpose of the
CEA was to prevent fraud and manipulation and to control speculation.
Later, the Commodity Futures Modernization Act of 2000 (“CFMA”)
provided a statutory basis for exchanges to use pre-existing position
accountability levels as an alternative means to limit the burdens of
excessive speculative positions. Nevertheless, the CFMA did not weaken
the Commission’s authority in CEA section 4a to establish position
limits to prevent such undue burdens on interstate commerce.3 More
recently, in the CFTC Reauthorization Act of 2008, Congress gave the
Commission expanded authority to set position limits for significant
price discovery contracts on exempt commercial markets.4
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3 See Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (Dec. 21, 2000).
4 See Food, Conservation and Energy Act of 2008, Public Law
110-246, 122 Stat. 1624 (June 18, 2008).
—————————————————————————
In 2010, the Dodd-Frank Act expanded the Commission’s authority to
set position limits by amending CEA section 4a(a)(1) to authorize the
Commission to establish position limits not just for futures and option
contracts, but also for swaps that are economically equivalent to
covered futures and options contracts,5 swaps traded on a DCM or SEF,
swaps that are traded on or subject to the rules of a DCM or SEF, and
swaps not traded on a DCM or SEF that perform or affect a significant
price discovery function with respect to regulated entities (“SPDF
Swaps”).6 CEA section 4a(a)(1) further declares the Congressional
determination that: “[e]xcessive speculation in any commodity under
contracts of sale of such commodity for future delivery made on or
subject to the rules of contract markets or derivatives transaction
execution facilities, or swaps that perform or affect a significant
price discovery function with respect to registered entities causing
sudden or unreasonable fluctuations or unwarranted changes in the price
of such commodity, is an undue and unnecessary burden on interstate
commerce in such commodity.” 7
—————————————————————————
5 See infra discussion of economically equivalent.
6 CEA section 4a(a)(1) (as amended 2010) ; 7 U.S.C. 6a(a)(1).
7 Id.
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As described below, amended CEA section 4a(a)(2), Congress
directed, i.e., mandated, that the Commission “shall” establish
limits on the amount of positions, as appropriate, that may be held by
any person in agricultural and exempt commodity futures and options
contracts traded on a DCM.8 Similarly, as described below, in amended
CEA section 4a(a)(5),9 Congress mandated that the Commission impose
position limits on swaps that are economically equivalent to the
agricultural and exempt commodity derivatives for which it mandated
position limits in CEA section 4a(a)(2).
—————————————————————————
8 CEA section 4a(a)(2); 7 U.S.C. 6a(a)(2).
9 CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5).
—————————————————————————
With respect to the position limits that the Commission is required
to set, CEA section 4a(a)(3) guides the Commission in setting the level
of those limits by providing several criteria for the Commission to
address, namely: (i) To diminish, eliminate, or prevent excessive
speculation as described under this section; (ii) to deter and prevent
market manipulation, squeezes, and corners; (iii) to ensure sufficient
market liquidity for bona fide hedgers; and (iv) to ensure that the
price discovery function of the underlying market is not disrupted.10
—————————————————————————
10 CEA section 4a(a)(3); 7 U.S.C. 6a(a)(3).
—————————————————————————
CEA section 4a(a)(5) requires the Commission to establish, at an
appropriate level, position limits for swaps that are economically
equivalent to those futures and options that are subject to mandatory
position limits pursuant to CEA section 4a(a)(2).11 CEA section
4a(a)(5) also requires that the position limits on economically
equivalent swaps be imposed at the same time as mandatory limits are
imposed on futures and options.12
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11 CEA section 4a(a)(5); 7 U.S.C. 6a(a)(5).
12 See id.
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CEA section 4a(a)(6) requires the Commission to apply position
limits on an aggregate basis to contracts based on the same underlying
commodity across: (1) Contracts listed by DCMs; (2) with respect to
foreign boards of trade (“FBOTs”), contracts that are price-linked to
a contract listed for trading on a registered entity and made available
from within the United States via direct access; and (3) SPDF
Swaps.13
—————————————————————————
13 CEA section 4a(a)(6); 7 U.S.C. 6a(a)(6).
—————————————————————————
Furthermore, under new CEA section 4a(a)(7), Congress gave the
Commission authority to exempt persons or transactions from any
position limits it establishes.14
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14 CEA section 4a(a)(7); 7 U.S.C. 6a(a)(7).
—————————————————————————
2. The Commission Construes CEA Section 4a(a) To Mandate That the
Commission Impose Position Limits
The Commission concludes that, based on its experience and
expertise, when section 4a(a) of the Act is considered as an integrated
whole, it is reasonable to construe that section to mandate that the
Commission impose position limits. This mandate requires the Commission
to impose limits on futures contracts, options, and certain swaps for
agricultural and exempt commodities. The Commission also
[[Page 75682]]
concludes that the mandate requires it to impose such limits without
first finding that any such limit is necessary to prevent excessive
speculation in a particular market.
In ISDA v. CFTC,15 the district court concluded that section
4a(a)(1) of the Act “unambiguously requires that, prior to imposing
position limits, the Commission find that position limits are necessary
to `diminish, eliminate, or prevent’ the burden described in [section
4a(a)(1) of the Act].” 16 But the court further concluded that, even
if CEA section 4a(a)(1) standing alone required the Commission to make
a necessity determination as a prerequisite to imposing position
limits, it was plausible to conclude that sections 4a(a)(2), (3), and
(5) of the Act, which were added by Dodd-Frank, constituted a mandate,
requiring the Commission to impose position limits without making any
findings of necessity. The court ultimately determined that the Dodd-
Frank amendments, and their relationship to section 4a(a)(1) of the
Act, are “ambiguous and lend themselves to more than one plausible
interpretation.” 17 Thus, the court rejected the Commission’s
contention that section 4a(a) of the Act unambiguously mandated the
imposition of position limits without any finding of necessity.
—————————————————————————
15 International Swaps and Derivatives Association v. United
States Commodity Futures Trading Commission, 887 F. Supp. 2d 259
(D.D.C. 2012).
16 Id. at 270.
17 Id. at 281.
—————————————————————————
Having concluded that section 4a(a) of the Act is ambiguous, the
court could not rely on the Commission’s interpretation to resolve the
section’s ambiguity. As the court observed, the D.C. Circuit has held
that “ `deference to an agency’s interpretation of a statute is not
appropriate when the agency wrongly believes that interpretation is
compelled by Congress.’ ” 18 The court further held that, pursuant
to the law of the D.C. Circuit, it was required to remand the matter to
the Commission so that it could “fill in the gaps and resolve the
ambiguities.” 19 The court cautioned the Commission that, in
resolving the ambiguity of section 4a(a) of the Act, “ `it is
incumbent upon the agency not to rest simply on its parsing of the
statutory language.’ ” 20
—————————————————————————
18 Id. at 280-82, quoting Peter Pan Bus Lines, Inc. v. Fed.
Motor Carrier Safety Admin., 471 F.3d 1350, 1354 (D.C. Cir. 2006).
19 887 F. Supp. 2d at 282.
20 Id. at n.7, quoting PDK Labs. Inc. v. DEA, 362 F.3d 786,
797 (D.C. Cir. 2004).
—————————————————————————
The Commission now undertakes the task assigned by the court: using
its experience and expertise to resolve the ambiguity the district
court perceived in section 4a(a) of the Act. The most important
guidepost for the Commission in resolving the ambiguity is section
4a(a)(2) of the Act. That section, which is captioned “Establishment
of Limitations,” includes two sections that are critical to
understanding congressional intent. Subsection 4a(a)(2)(A) provides
that the Commission, in accordance with the standards set forth in
section 4a(a)(1) of the Act, shall establish limits on the amount of
positions, as appropriate, other than bona fide hedge positions that
may be held by any person with respect to physical commodities other
than excluded commodities.21 Subsection 4a(a)(2)(B) provides that for
exempt commodities, the limits “required” under subsection
4a(a)(2)(A) be established within 180 days of the enactment of section
4a(a)(2)(B) and that for agricultural commodities, the limits
“required” under subsection 4a(a)(2)(A) be established within 270
days of the enactment of section 4a(a)(2)(B).22
—————————————————————————
21 CEA section 4a(a)(2)(A); 7 U.S.C. 6a(a)(2)(A).
22 CEA section 4a(a)(2)(B); 7 U.S.C. 6a(a)(2)(B).
—————————————————————————
The court concluded that this section was ambiguous as to whether
the Commission had a mandate to impose position limits. The court
focused on the opening phrase of subsection (A)–“[i]n accordance with
the standards set forth in [section 4a(a)(1) of the Act].” The court
held that the term “standards” in section 4a(a)(2) of the Act was
ambiguous and could refer to the requirement in section 4a(a)(1) of the
Act that the Commission impose position limits “as [it] finds are
necessary to diminish, eliminate, or prevent” an unnecessary burden on
interstate commerce.23 Thus, the court held that it was plausible
that section 4a(a)(2) of the Act required the Commission to make a
finding of necessity as a precondition to imposing any position limit.
But the court held that it was also plausible that the reference to
“standards” did not incorporate such a requirement.
—————————————————————————
23 887 F. Supp. 2d at 274-76.
—————————————————————————
The Commission believes that it is reasonable to conclude from the
Dodd-Frank amendments that Congress mandated limits and did not intend
for the Commission to make a necessity finding as a prerequisite to the
imposition of limits. The Commission’s interpretation of its mandate is
also based on congressional concerns that arose, and congressional
actions taken, before the passage of the Dodd-Frank amendments. During
the years leading up to the enactment, Congress conducted several
investigations that concluded that excessive speculation accounted for
significant volatility and price increases in physical commodity
markets. A congressional investigation determined that prices of crude
oil had risen precipitously and that “[t]he traditional forces of
supply and demand cannot fully account for these increases.” 24 The
investigation found evidence suggesting that speculation was
responsible for an increase of as much as $20-25 per barrel of crude
oil, which was then at $70.25 Subsequently, Congress found similar
price volatility stemming from excessive speculation in the natural gas
market.26 Thus, these investigations had already gathered evidence
regarding the impact of excessive speculation, and had concluded that
such speculation imposed an undue burden on the economy. In light of
these investigations and conclusions, it is reasonable for the
Commission to conclude that Congress did not intend for it to duplicate
investigations Congress had already conducted, and did not intend to
leave it up to the Commission whether there should be federal limits.
Instead, Congress set short deadlines for the limits it “required,”
and directed the Commission to conduct a study of the limits after
their imposition and to report to Congress promptly on their effects.
Accordingly, the Commission believes that the better reading of the
Dodd-Frank amendments, in light of the congressional investigations and
findings made, is the Dodd-Frank amendments require the Commission to
impose position limits on physical commodity derivatives as opposed to
merely reaffirming the preexisting, discretionary authority the
Commission has long had to impose limits as it finds necessary.
Congress made the decision to impose limits, and it is for the
Commission to carry that decision out, subject to close congressional
oversight.
—————————————————————————
24 “The Role of Market Speculation in Rising Oil and Gas
Prices: A Need to Put the Cop Back on the Beat,” Staff Report,
Permanent Subcommittee on Investigations of the Senate Committee on
Homeland Security and Governmental Affairs, U.S. Senate, S. Prt. No.
109-65 at 1 (June 27, 2006).
25 Id. at 12; see also “Excessive Speculation in the Natural
Gas Market,” Staff Report, Permanent Subcommittee on Investigations
of the Senate Committee on Homeland Security and Governmental
Affairs, U.S. Senate at 1 (June 25, 2007) available at http://www.levin.senate.gov/imo/media/doc/supporting/2007/PSI.Amaranth.062507.pdf (last visited Mar. 18, 2013) (“Gas
Report”).
26 Gas Report at 1-2.
—————————————————————————
Based on its experience, the Commission concludes that Congress
could not have contemplated that, as a prerequisite to imposing limits,
the Commission would first make the sort of
[[Page 75683]]
necessity determination that the plaintiffs in ISDA v. CFTC argue
section 4a(a)(2) of the Act requires–i.e., a finding that, before
imposing any limit in any particular market, there is a reasonable
likelihood that excessive speculation will pose a problem in that
market, and that position limits are likely to curtail that excessive
speculation without imposing undue costs.27 As the district court
noted, for 45 years after passage of the CEA, the Commission’s
predecessor agency made findings of necessity in its rulemakings
establishing position limits.28 During that period, the Commission
had jurisdiction over only a limited number of agricultural
commodities. The court cited several orders issued by the Commodity
Exchange Commission (“CEC”) between 1940 and 1956 establishing
position limits, and in each of those orders, the CEC stated that the
limits it was imposing were necessary. Each of those orders involved no
more than a small number of commodities. But it took the CEC many
months to make those findings. For example, in 1938, the CEC imposed
position limits on six grain products.29 Proceedings leading up to
the establishment of the limits commenced more than 13 months earlier,
when the CEC issued a notice of hearings regarding the limits.30
Similarly, in September 1939, the CEC issued a Notice of Hearing with
respect to position limits for cotton, but it was not until August 1940
that the CEC finally promulgated such limits.31 And the CEC began the
process of imposing limits on soybeans and eggs in January 1951, but
did not complete the process until more than seven months later.32
—————————————————————————
27 See 887 F. Supp. 2d at 273.
28 Id. at 269.
29 See 3 FR 3145, Dec. 24, 1938.
30 See 2 FR 2460, Nov. 12, 1937.
31 See 4 FR 3903, Sep. 14, 1939; 5 FR 3198, Aug. 28, 1940.
32 See 16 FR 321, Jan. 12, 1951; 16 FR 8106, Aug. 16, 1951;
see also 17 FR 6055, Jul. 4, 1952 (notice of hearing regarding
proposed position limits for cottonseed oil, soybean oil, and lard);
18 FR 443, Jan. 22, 1953 (orders setting limits for cottonseed oil,
soybean oil, and lard); 21 FR 1838, Mar. 24, 1956 (notice of hearing
regarding proposed position limits for onions), 21 FR 5575, Jul. 25,
1956 (order setting position limits for onions).
—————————————————————————
In the Commission’s experience (i.e., in the experience of its
predecessor agency), it took at least four months to make a necessity
finding with respect to one commodity. The process of making the sort
of necessity findings that plaintiffs urged upon the court with respect
to all agricultural commodities and all exempt commodities would be far
more lengthy than the time allowed by section 4a(a)(3) of the Act,
i.e., 180 or 270 days.
Dodd-Frank requires the Commission to impose position limits on all
exempt commodities within 180 days after enactment, and on all
agricultural commodities within 270 days.33 Because of these
stringent time limits, the Commission concludes that Congress did not
intend for the Commission to delay the imposition of limits until it
has first made antecedent, contract-by-contract necessity findings.34
—————————————————————————
33 Although the Commission did not meet these deadlines in its
first position limits rulemaking, it completed the task (in which
the Commission received and addressed more than 15,000 comments) as
expeditiously as possible under the circumstances.
34 Even if there were no mandate, the Commission would not
need to make the sort of particularized necessity findings advocated
by the plaintiffs in ISDA v. CFTC, and discussed by the district
court. When the Commission imposed limits pre-Dodd-Frank, it only
had to determine that excessive speculation is harmful to the market
and that limits on speculative positions are a reasonable means of
preventing price disruptions in the marketplace that place an undue
burden on interstate commerce. That is the determination that the
Commission made in 1981 when it required the exchanges to establish
position limits on all futures contracts, regardless of the
characteristics of a particular contract market. See 46 FR 50940
(“[I]t is the Commission’s view that this objective [“the
prevention of large and/or abrupt price movements which are
attributable to extraordinarily large speculative positions”] is
enhanced by speculative position limits since it appears that the
capacity of any contract market to absorb the establishment and
liquidation of large speculative positions in an orderly manner is
related to the relative size of such positions, i.e., the capacity
of the market is not unlimited.”). In the immediate wake of that
decision, Congress enacted legislation to give the Commission the
specific authority to enforce those omnibus limits. See CEA section
4a(e); 7 U.S.C. 6a(e).
—————————————————————————
Additional experience of the Commission confirms this
interpretation. The Commission has found, historically, that
speculative position limits are a beneficial tool to prevent, among
other things, manipulation of prices. Limits do so by restricting the
size of positions held by noncommercial entities that do not have
hedging needs in the underlying physical markets. In other words,
markets that have underlying physical commodities with finite supplies
benefit from the protections offered by position limits. This will be
discussed further, below.
For example, in 1981, the Commission, acting expressly pursuant to,
inter alia, what was then CEA Section 4a(1) (predecessor to CEA section
4a(a)(1)), adopted what was then Sec. 1.61.35 This rule required
speculative position limits for “for each separate type of contract
for which delivery months are listed to trade” on any DCM, including
“contracts for future delivery of any commodity subject to the rules
of such contract market.” 36 The Commission explained that this
action was necessary in order to “close the existing regulatory gap
whereby some but not all contract markets [we]re subject to a specified
speculative position limit.” 37 Like the Dodd-Frank Act, the 1981
final rule established (and the rule release described) that such
limits “shall” be established according to what the Commission termed
“standards.” 38 As used in the 1981 final rule and release,
“standards” meant the criteria for determining how the required
limits would be set.39 “Standards” did not include the antecedent
judgment of whether to order limits at all. The Commission had already
made the antecedent judgment in the rule that “speculative limits are
appropriate for all contract markets irrespective of the
characteristics of the underlying market.” 40 It further concluded
that, with respect to any particular market, the “existence of
historical trading data” showing excessive speculation or other
burdens on that market is not “an essential prerequisite to the
establishment of a speculative limit.” 41 The Commission thus
directed the exchanges to set limits for all futures contracts
“pursuant to the . . . standards of rule 1.61[.]” 42 And Sec. 1.61
incorporated the standards from then-CEA-section 4a(1)–an
“Aggregation Standard” (46 FR at 50943) for applying the limits to
positions both held and controlled by a trader and a flexibility
standard, allowing the exchanges to set “different and separate
position limits for different types of futures contracts, or for
different delivery months, or from exempting positions which are
normally known in the trade as `spreads, straddles or arbitrage’ or
from fixing limits which apply to such positions which are different
from limits fixed for other positions.” 43
—————————————————————————
35 46 FR 50938, 50944-45, Oct. 16, 1981. The rule adopted in
1981 tracked, in significant part, the language of Section 4a(1).
Compare 17 CFR 1.61(a)(1) (1982) with 7 U.S.C. 6a(1) (1976).
36 46 FR 50945.
37 Id. 50939; see also id. 50938 (“to ensure that each
futures and options contract traded on a designated contract market
will be subject to speculative position limits”).
38 Compare id. at 50941-42, 50945 with 7 U.S.C. 6a(a)(2)(A).
39 46 FR 50941-42, 50945.
40 Id. at 50941.
42 Id. at 50942.
43 Id. at 50945 (Sec. 1.61(a)). Compare 7 U.S.C. 6a(1)
(1976).
—————————————————————————
The language that ultimately became section 737 of the Dodd-Frank
Act, amending CEA section 4a(a), originated in substantially final form
in H.R. 977, introduced by Representative Peterson,
[[Page 75684]]
who was then Chairman of the House Agriculture Committee and who would
ultimately be a member of the Dodd-Frank conference committee.44 H.R.
977 appears influenced by the Commission’s 1981 rulemaking,
establishing that there “shall” be position limits in accordance with
the “standards” identified in CEA section 4a(a).45 Like the 1981
rule, H.R. 977 established (and the Dodd-Frank Act ultimately adopted)
a “good faith” exception for positions acquired prior to the
effective date of the mandated limits.46 The committee report
accompanying H.R. 977 described it as “Mandat[ing] the CFTC to set
speculative position limits” and the section-by-section analysis
stated that the legislation “requires the CFTC to set appropriate
position limits for all physical commodities other than excluded
commodities.” 47 This closely resembles the omnibus prophylactic
approach the Commission took in 1981, when the Commission required the
establishment of position limits on all futures contracts according to
“standards” it borrowed from CEA section 4a(1), and the Commission
finds the history and interplay of the 1981 rule and Dodd-Frank section
737 to be further evidence that Congress intended to follow much the
same approach as the Commission did in 1981, mandating position limits
as to all physical commodities.48
—————————————————————————
44 H.R. 977, 11th Cong. (2009).
45 7 U.S.C. 6.
46 Compare H.R. 977, 11th Cong. (2009) with 46 FR 50944.
47 H.Rept. 111-385, at 15, 19 (Dec. 19, 2009).
48 See Union Carbide Corp. & Subsidiaries v. Comm’r of
Internal Revenue, 697 F.3d 104, (2d Cir. 2012) (explaining that when
an agency must resolve a statutory ambiguity, to do so “ `with the
aid of reliable legislative history is rational and prudent’ ”
(quoting Robert A. Katzman, Madison Lecture: Statutes, 87 N.Y.U. L.
Rev. 637, 659 (2012)).
—————————————————————————
Consistent with this interpretation, which is based on the
Commission’s experience, CEA section 4a(a)(2)(A)’s phrase “[i]n
accordance with the standards set forth in [CEA section 4a(a)(1)]”
does not require a finding of necessity as a prerequisite to the
imposition of position limits, but rather has a different meaning.
Section 4a(a)(1) of the Act lists “standards” that the Commission
must consider, and has historically considered, when it imposes
position limits. It contains an aggregation standard, which provides
that, if one person controls the positions of another, or if those
persons coordinate their trading, then those positions must be
aggregated. And it contains a flexibility standard, providing the
Commission with the flexibility to impose different position limits for
different commodities, markets, delivery months, etc.49 Because the
Commission concludes that, when Congress amended section 4a(a) of the
Act and directed the Commission to establish the “required” limits,
it did not want, much less require the Commission to make an antecedent
finding of necessity for every position limit it imposes, the
“standards” the Commission must apply in imposing the limits required
by section 4a(a)(2) of the Act consist of the aggregation standard and
the flexibility standard of CEA section 4a(a)(1), the same standards
the Commission required the exchanges to apply the last time there was
a mandatory, prophylactic position limits regime.50
—————————————————————————
49 In its 1981 rulemaking in which the Commission required
exchanges to impose position limits, the Commission interpreted the
term “standards,” to not require exchanges to make any finding of
necessity with respect to imposing position limits. See 46 FR.
50941-42 (preamble), 50945 (text of Sec. 1.61(a)(2)).
50 The District Court expressed concern that, unless CEA
section 4a(a)(2) incorporated a necessity finding, then the language
referring to such a finding in CEA section 4a(a)(1) might be
rendered surplusage. 887 F. Supp. 2d at 274-75. That is, the court
believed that, unless a necessity finding were incorporated into any
limits required by CEA section 4a(a)(2), then the “finds as
necessary” language would serve no purpose in the CEA. But there is
no surplusage because CEA section 4a(a) only mandates position
limits with respect to physical commodity derivatives (i.e.,
agricultural commodities and exempt commodities). The mandate does
not apply to excluded commodities (i.e., intangible commodities such
as interest rates, exchange rates, or indexes, see CEA section
1a(19) (defining the term “excluded commodity”). As a result,
although a necessity finding does not apply with respect to physical
commodities as to which the Dodd-Frank Congress mandated position
limits, it still applies to any limits the Commission may choose to
impose with respect to excluded commodities. Thus, the mandate of
CEA section 4a(a) does not render the necessity language surplusage.
—————————————————————————
In addition, section 719 of the Dodd-Frank Act (codified at 15
U.S.C. 8307) provides that the Commission “shall conduct a study of
the effects (if any) of the position limits imposed” pursuant to CEA
section 4a(a)(2), that “[w]ithin 12 months after the imposition of
position limits,” the Commission “shall” submit a report of the
results of that study to Congress, and that, within 30 days of the
receipt of that report, Congress “shall” hold hearings regarding the
findings of that report. As explained above, if, as a precondition to
imposing position limits, the Commission were required to make the sort
of necessity determinations apparently contemplated by the district
court, the Commission would have to conduct time-consuming studies and
then determine as a matter of discretion whether a limit was necessary.
The Commission believes that, to comply with section 719 of the Dodd-
Frank Act, the Commission would then, within one year, have to conduct
another round of studies with respect to each contract as to which it
had imposed limits. The Commission does not believe that Congress would
have imposed such burdensome and duplicative requirements on the
Commission. Moreover, Congress would not have required the Commission
to conduct a study of the effects, “if any,” of position limits, and
would not have imposed a hearing requirement on itself, if the
Commission had the discretion to not impose any position limits at
all.51
—————————————————————————
51 When Congress requires an agency to promulgate a rule, it
frequently requires the agency to provide it with a report regarding
the impact of that rule. See, e.g., 15 U.S.C. 6502, 6506 (provisions
of the Children’s Online Privacy Protection Act, requiring the FTC
to promulgate implementing rules, and to report as to the impact
thereof); 47 U.S.C. 227(b), (h) (requiring the FCC to implement
rules restricting unsolicited fax advertising, and to report on
enforcement); 15 U.S.C. 78m(p) (requiring the SEC to issue rules
requiring disclosures regarding the use of certain “conflict
minerals” obtained from the Democratic Republic of Congo), and
section 1502(d) of the Dodd-Frank Act (requiring the Comptroller
General to report regarding the effectiveness of the conflict
minerals rule).
—————————————————————————
Further, Congress was careful to make clear that its mandate only
extends to agricultural and exempt commodities. If there were no
mandate, then the same standards that apply to position limits for
excluded commodities would also apply to agricultural and exempt
commodities and, basically, the Commission would have only permissive
authority to promulgate position limits for any commodity–the same
permissive authority that existed prior to the Dodd-Frank Act. Finding
that a mandate exists is the only way to give effect to the distinction
that Congress drew.
The legislative history of the Dodd-Frank amendments to CEA section
4a(a) confirms that Congress intended to make position limits mandatory
for agricultural and exempt commodities. As initially introduced, the
House version of the bill that became Dodd-Frank provided the
Commission with discretionary authority to issue position limits by
stating that the Commission “may” impose them.52 However, by the
time the bill passed the House, it dispensed with the permissive
approach in favor of a mandate, stating that the Commission “shall”
impose limits, and
[[Page 75685]]
in addition, the House added two new subsections, mandating the
imposition of limits for agricultural and exempt commodities with the
tight deadlines described above.53 Similarly, it was only after the
initial bill was amended to make position limits mandatory that the
House bill referred to the limits for agricultural and exempt
commodities as “required” in one instance.54 Furthermore, Congress
decided to include the requirement that the Commission conduct studies
on the “effects (if any) of position limits imposed” 55 to
determine if the required position limits were harming US markets only
after position limits went from discretionary to mandatory.56 To
remove all doubt, the House Report accompanying the House Bill also
made clear that the House amendments to the position limits bill
“required” the Commission to impose limits.57 The Conference
Committee adopted the provisions of the House bill with regard to
position limits and then strengthened them by referring to the position
limits as “required” an additional three times so that CEA section
4a(a), as enacted referred, to position limits as “required” a total
of four times.58
—————————————————————————
52 Initially, the House used the word “may” to permit the
Commission to impose aggregate positions on contracts based upon the
same underlying commodity. See H.R. 4173, 11th Cong. section
3113(a)(2) (as introduced in the House, Dec. 2, 2009) (“Introduced
Bill”); see also Brief of Senator Levin et al as Amicus Curiae at
10-11, ISDA v. CFTC, no. 12-5362 (D.C. Cir. Apr. 22, 2013), Document
No. 1432046 (hereafter “Levin Br.”).
53 Levin Br. at 11 (citing H.R. 4173, 111th Cong. section
3113(a)(5)(2), (7) (as passed by the House Dec. 11, 2009)
(“Engrossed Bill”)).
54 Id. at 12. (citing Engrossed Bill at section
3113(a)(5)(3)).
55 15 U.S.C. 8307.
56 See Levin Br. at 13-17; see also DVD: October 21, 2009
Business Meeting (House Agriculture Committee 2009), ISDA v. CFTC,
Dkt. 37-2 Exh. B (Apr. 13, 2012) at 59:55-1:02:18.
57 Levin Br. at 23 (citing H.R. Rep. No. 111-373 at 11
(2009)).
58 Levin Br. at 17-18.
—————————————————————————
Considering the text, purpose and legislative history of section
4a(a) as a whole, along with its own experience and expertise, the
Commission believes that it is reasonable to conclude that Congress–
notwithstanding the ambiguity the district court found to arise from
some of the words in the statute–decided that position limits were
necessary with respect to physical commodities, mandated the Commission
to impose them on physical commodities, and required that the
Commission do so expeditiously.59
—————————————————————————
59 The district court noted that CEA sections 4a(a)(2), (3),
and (5)(A) contain the words “as appropriate.” The court held that
it was ambiguous whether those words referred to the Commission’s
obligation to impose limits (i.e., the Commission shall, “as
appropriate,” impose limits), or to the level of the limits the
Commission is to impose. Because, as explained above, the Commission
believes it is reasonable to interpret CEA section 4a(a) to mandate
the imposition of limits, the words “as appropriate” must refer to
the level of limits, i.e., the Commission must set limits at an
appropriate level. Thus, while Congress made the threshold decision
to impose position limits on physical commodity futures and options
and economically equivalent swaps, Congress at the same time
delegated to the Commission the task of setting the limits at levels
that would maximize Congress’ objectives. See CEA sections
4a(a)(3)(A)-(B).
—————————————————————————
3. Necessity Finding
As explained above, the Commission concludes that the CEA mandates
the imposition of speculative position limits. Because of this mandate,
the Commission need not make a prerequisite finding that such limits
are necessary “to diminish, eliminate or prevent excessive speculation
causing sudden or unreasonable fluctuations or unwarranted changes in
the prices of” commodities under pre-Dodd-Frank CEA section 4a(a)(1).
Nonetheless, out of an abundance of caution in light of the district
court decision in ISDA v. CFTC, and without prejudice to any argument
the Commission may advance in any forum, the Commission proposes, as a
separate and independent basis for the proposed Rule, a preliminary
finding herein that such limits are necessary to achieve their
statutory purposes.60
—————————————————————————
60 The CEA does not define “excessive speculation.” But the
Commission has historically associated it with extraordinarily large
speculative positions. 76 FR at 71629 (referring to
“extraordinarily large speculative positions”).
—————————————————————————
Historically, speculative position limits have been one of the
tools used by the Commission to prevent, among other things,
manipulation of prices. Limits do so by restricting the size of
positions held by noncommercial entities that do not have hedging needs
in the underlying physical markets. By capping the size of speculative
positions, limits lessen the likelihood that a trader can obtain a
large enough position to potentially manipulate prices, engage in
corners or squeezes or other forms of price manipulation. The position
limits in this proposal are necessary as a prophylactic measure to
lessen the likelihood that a trader will accumulate excessively large
speculative positions that can result in corners, squeezes, or other
forms of manipulation that cause unwarranted or unreasonable price
fluctuations. In the Commission’s experience, position limits are also
necessary as a prophylactic measure because excessively large
speculative positions may cause sudden or unreasonable price
fluctuations even if not accompanied by manipulative conduct. Two
examples that inform the Commission’s determinations are the silver
crisis of 1979-80 and events in the natural gas markets in 2006.61
—————————————————————————
61 Since the 1920’s, Congressional and other official
governmental investigations and reports have identified other
instances of sudden or unreasonable fluctuations or unwarranted
changes in the price of commodities. See discussion below.
—————————————————————————
Position limits would help to deter and prevent manipulative
corners and squeezes, such as the silver price spike caused by the Hunt
brothers and their cohorts in 1979-80.
A market is “cornered” when an individual or group of individuals
acting in concert acquire a controlling or ownership interest in a
commodity that is so dominant that the individual or group of
individuals can set or manipulate the price of that commodity.62 In a
short squeeze, an excess of demand for a commodity together with a lack
of supply for that commodity forces the price of that commodity upward.
During a short squeeze, individuals holding short positions, i.e.,
sales for future delivery of a commodity,63 are typically forced to
purchase that commodity in situations where the price increases
rapidly, in order to exit their short position and/or cover,64 i.e.,
be able to deliver the commodity in accordance with the terms of the
sale.65
—————————————————————————
62 See CFTC Glossary, A Guide to the Language of the Futures
Industry (“CFTC Glossary”), available at http://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/glossary, which
defines a corner as “(1) [s]ecuring such relative control of a
commodity that its price can be manipulated, that is, can be
controlled by the creator of the corner; or (2) in the extreme
situation, obtaining contracts requiring the delivery of more
commodities than are available for delivery.”
63 See CFTC Glossary, which defines a “short” as “(1) [t]he
selling side of an open futures contract; (2) a trader whose net
position in the futures market shows an excess of open sales over
open purchases.”
64 See CFTC Glossary, which defines “cover” as “(1)
[p]urchasing futures to offset a short position (same as Short
Covering); . . . (2) to have in hand the physical commodity when a
short futures sale is made, or to acquire the commodity that might
be deliverable on a short sale” and offset as “[l]iquidating a
purchase of futures contracts through the sale of an equal number of
contracts of the same delivery month, or liquidating a short sale of
futures through the purchase of an equal number of contracts of the
same delivery month.”
65 See CFTC Glossary, which defines a “squeeze” as “[a]
market situation in which the lack of supplies tends to force shorts
to cover their positions by offset at higher prices.”
—————————————————————————
A rapid rise and subsequent sharp decline in silver prices occurred
from the second half of 1979 to the first half of 1980 when the Hunt
brothers 66 and colluding syndicates 67 attempted to corner the
silver market by hoarding silver and executing a short squeeze. Prices
deflated only after the Commodity Exchange, Inc. (“COMEX”)
[[Page 75686]]
and the Chicago Board of Trade (“CBOT”) imposed a series of emergency
rules imposing at various times position limits, increased margin
requirements, and trading for liquidation only on U.S. silver futures.
It was the consensus view of staffs of the Commission, the Board of
Governors of the Federal Reserve System, the Department of the Treasury
and the Securities and Exchange Commission articulated in an
interagency task force study of events in the silver market during that
period that “[r]easonable speculative position limits, if they had
been in place before the buildup of large positions occurred, would
have helped prevent the accumulation of such large positions and the
resultant dislocations created when the holders of those positions
stood for delivery.” 68 That is, speculative position limits would
have helped to prevent the buildup of the silver price spike of 1979-
80. The Commission believes that this conclusion remains correct.
“Moreover, by limiting the ability of one person or group to obtain
extraordinarily large positions, speculative limits diminish the
possibility of accentuating price swings if large positions must be
liquidated abruptly in the face of adverse price movements or for other
reasons.” 69
—————————————————————————
66 The primary silver traders in the Hunt family were Nelson
Bunker Hunt, William Herbert Hunt, and Lamar Hunt.
67 A group of individuals and firms trading through
ContiCommodity Services, Inc. and ACLI International Commodity
Services, Inc., both of which were FCMs.
68 Commodity Futures Trading Commission, Report To The
Congress In Response To Section 21 Of The Commodity Exchange Act,
May 29, 1981, Part Two, A Study of the Silver Market, at 173
(“Interagency Silver Study”).
69 Speculative Position Limits, 45 FR 79831, 79833, Dec. 2,
1980.
—————————————————————————
The Hunt brothers were speculators 70 who neither produced,
distributed, processed nor consumed silver. The corner began in early
1979, when the Hunt brothers accumulated large physical holdings of
silver by purchasing silver futures and taking physical delivery of
silver.71 By the fall of 1979, they had accumulated over 43 million
ounces of physical silver.72 In addition to their physical holdings,
in the fall of 1979 the Hunts and their cohorts held over 12 thousand
contracts for March delivery, representing a potential future delivery
to the hoard of another 60 million ounces of silver.73 In general,
the larger a position held by a trader, the greater is the potential
that the position may affect the price of the contract. Throughout late
1979, the Hunts continued to stand for delivery and took care to ensure
that their own holdings were not re-delivered back to them when
outstanding futures contracts settled.74 Thus, through this period,
silver prices climbed as the Hunts accumulated more financial and
physical positions and the available supply of silver decreased. As the
interagency working group observed, “[t]he biggest single source of
the change in demand for silver bullion during the last half of 1979
and the first quarter of 1980 came from the silver acquisitions of Hunt
family members and other large traders.” 75
—————————————————————————
70 Speculators seek to profit by anticipating the price
movement of a commodity in which a futures position has been
established. See CFTC Glossary, which defines a speculator as,
“[i]n commodity futures, a trader who does not hedge, but who
trades with the objective of achieving profits through the
successful anticipation of price movements.” In contrast, a hedger
is “[a] trader who enters into positions in a futures market
opposite to positions held in the cash market to minimize the risk
of financial loss from an adverse price change; or who purchases or
sells futures as a temporary substitute for a cash transaction that
will occur later. One can hedge either a long cash market position
(e.g., one owns the cash commodity) or a short cash market position
(e.g., one plans on buying the cash commodity in the future).” The
Hunts had no apparent industrial use for silver, although some
attribute their early activities in the silver market to an attempt
to hedge against Carter-era inflation and a defense against
potential confiscation of precious metals in the event of a national
crisis.
71 Typically, delivery occurs in only a small percentage of
futures transactions. The vast majority of contracts are liquidated
by offsetting transactions.
72 See, e.g., Matonis, Jon, Hunt Brothers Demanded Physical
Silver Delivery Too, available at http://www.rapidtrends.com/hunt-brothers-demanded-physical-silver-delivery-too/. To provide context,
at this time COMEX and CBOT warehouses held 120 million ounces of
silver.
73 Interagency Silver Study at 18.
74 It has been reported that they moved vast quantities of
silver to warehouses in Switzerland to prevent this possibility.
75 Interagency Silver Study at 77.
—————————————————————————
The exchanges and regulators were slow to react to events in the
silver market. However, to correct by then evident market imbalances,
in late 1979 the CBOT introduced position limits of 3 million ounces of
silver (i.e., 600 contracts) per trader and raised margin requirements.
Contracts over 3 million ounces were to be liquidated by February of
1980. On January 7, 1980, the larger COMEX instituted position limits
of 10 million ounces of silver (i.e., 2,000 contracts) per trader, with
contracts over that amount to be liquidated by February 18. Then, on
January 21, COMEX suspended trading in silver and announced that it
would only accept liquidation orders. The price of silver began to
decline. When the price of a commodity starts to move against the
cornerer, attempts by the cornerer to sell would tend to fuel a further
price move against the cornerer resulting in a vicious cycle of price
decline. The Hunts were eventually unable to meet their margin calls
and took a huge loss on their positions. The interagency working group
concluded that the data relating to the episode “support the
hypothesis that the deliveries and potential deliveries to large long
participants in the silver futures markets contributed to the rise and
fall in silver prices in both the cash and futures markets. The rise
appears to have been caused in part by the conversion of silver futures
contracts to actual physical silver. The subsequent fall in prices was
then exacerbated by the anticipated selling of some of the Hunt’s
physical silver by FCMs as well as the liquidation of Hunt group and
possibly . . . [other large traders’] futures positions.” 76
—————————————————————————
76 Interagency Silver Study at 133.
—————————————————————————
Figure 1 illustrates the rapid rise and sharp decline in the price
of silver during the period in question.77 In January of 1979, the
settlement price of silver was approximately $6.00 per troy ounce. By
August, the price had risen to over $9.00, an increase of over 50
percent. Through most of October and November 1979, silver traded
within a range of $15.00-$17.50 per troy ounce. On November 28, the
closing price rose above $18.00. In December of 1979, the price rose
above $30.00 and continued to climb until mid-January. On January 17,
1980, the closing price of silver reached its apex at $48.70 per troy
ounce, more than five times the August price. On January 21, the price
declined to $44.00; on January 22 the closing price slid to $34.00 per
troy ounce. Through March 7, 1980, silver traded in an approximate
range of $30.00-$40.00 per troy ounce. On March 10, silver closed below
$30.00. On March 17 and 18, silver closed below $20.00. After a brief
rebound above $22.00, by March 26 the price dropped to $15.80. On March
27, the price of silver hit a low of $10.80 per troy ounce, less than a
quarter of the high of $48.70 two months earlier. “After March 28,
silver prices stabilized for a while in the $12-$15 range. . . . During
April through December 1980, silver prices moved generally in a range
between $12 and $20 per ounce.” 78
—————————————————————————
77 See CFTC Glossary, which defines “spot price” as “[t]he
price at which a physical commodity for immediate delivery is
selling at a given time and place.” The prompt month is the nearest
month to the expiration date of a futures contract.
78 Interagency Silver Study at 35-36.
—————————————————————————
[[Page 75687]]
[GRAPHIC] [TIFF OMITTED] TP12DE13.000
Figure 2 shows the distortion in the price of silver futures
contracts due to the short squeeze during the run-up to the January 17
high and the effect of “burying the corpse” after the squeeze ended.
In January 1980, due to the hoarding of the Hunts and their cohorts,
physical supplies of silver were tight and the physical commodity was
expensive to deliver. Scarcity in the physical market for silver
distorted prices in the silver futures markets. The degree to which the
value of the front month contract exceeded the value of other contracts
was exaggerated. By April of 1980, because the Hunts and their cohorts
were forced to sell, physical supply had increased and silver was
comparatively cheaper to deliver. The front month contract was then
worth substantially less than other contracts. In contrast, assuming
equilibrium in production, use, and storage of silver, one would expect
the charted price spreads to look comparatively much flatter. That is,
there should not be that much difference between the price of the front
month contract and other contracts because silver should not be subject
to seasonality such as would affect crops. Moreover, because silver is
relatively cheap to store, the difference in the price of the front
month and other contracts should also be less sensitive to the cost of
carry.
[[Page 75688]]
[GRAPHIC] [TIFF OMITTED] TP12DE13.001
In section 4a(a)(1) of the Act, Congress identifies “sudden or
unreasonable fluctuations or unwarranted changes in the price of such
commodity” 79 as an indication that excessive speculation may be
present in a market for a commodity. The rapid rise and sharp decline
in the price of silver that commenced in August 1979 and was spent by
the end of March 1980 certainly fits the description advanced by
Congress. Nevertheless, the Commission, based on its experience and
expertise, does not believe that the burdens on interstate commerce are
limited solely to the temporary and unwarranted changes in price such
as those exhibited during the silver price spike that resulted, at
least in part, from the deliberate behavior of the Hunt brothers and
their cohorts.80 Indirect burdens on interstate commerce may arise as
a result of unwarranted changes in price such as occurred in this case.
Such burdens arise due to manipulation or attempted manipulation, or
they may result from the excessive size and disorderly trading of a
speculative, i.e., non-hedging, position.
—————————————————————————
79 7 U.S.C. 6a(a)(1).
80 The Interagency Silver Study identified three main factors
contributing to the price increases in silver at the time.
First, the state of the economy during the period in question
affected all precious metals including silver. . . .
Second, changes in the supply and demand of physical silver
affected the price of silver. . . .
Third, the accumulation of large amounts of both physical silver
and silver futures by individuals such as the Hunt family of Dallas,
Texas, had an effect on the price of silver directly and on the
expectations of others who became aware of these actions.
Interagency Silver Study at 2.
—————————————————————————
Sudden or unreasonable fluctuations or unwarranted changes in the
price of a commodity derivative contract may be caused by a trader
establishing, maintaining or liquidating an extraordinarily large
position whether in a physical-delivery or cash-settled contract.
Prices for commodity derivative contracts reflect expectations about
the price of the underlying commodity at a future date and, thus,
reflect expectations about supply and demand for that underlying
commodity. In contrast, the supply of a commodity derivative contract
itself is not limited to the supply of the underlying commodity.
Rather, the supply of a commodity derivative contract is a function of
the ability of a trader to induce a counterparty to take the opposite
side of the transaction.81 Thus, the capacity of the market (i.e.,
all participants) to absorb purchase or sale orders for commodity
derivative contracts is limited by the number of participants that are
willing to provide liquidity, i.e., take the other side of the order at
a given price. For example, a trader that demands immediacy in
establishing a long position larger than the amount of pending offers
to sell by market participants may cause the commodity derivative
contract price to increase, as market participants may demand a higher
price when entering new offers to sell. It follows that an
extraordinarily large position, relative to the size of other
participants’ positions, may cause an unwarranted price fluctuation.
—————————————————————————
81 In a commodity derivative contract, the two parties to the
contract have opposite positions. That is, for every long position
in a commodity derivative contract held by one trader, there is a
short position that another trader must hold.
—————————————————————————
In the spot month for a physical-delivery commodity derivative
contract, concerns regarding sudden or unreasonable fluctuations or
unwarranted changes in the price of that contract are heighted because
open positions in such a contract either: Must be satisfied by delivery
of the underlying commodity (which is of limited supply and, thus,
susceptible to corners or squeezes); or must be offset before delivery
obligations attach (that requires trading with another participant to
offset the open position).82 For example, a trader
[[Page 75689]]
holding an extraordinarily large long position, absent position limits,
could maintain a long position (requiring delivery beyond the limited
supply of the physical commodity) deep into the spot month. By
maintaining such an extraordinarily large position, such a trader may
cause an unwarranted increase in the price of the commodity derivative
contract, as holders of short positions attempt to induce a
counterparty to offset their position.
—————————————————————————
82 Regarding cash-settled commodity derivative contracts,
there are a variety of methods for determining the final cash
settlement price, such as by reference to (i) a survey price of cash
market transactions, or (ii) the final (or daily) settlement price
of a physical-delivery futures contract. For example, in the case of
a trader who holds an extraordinarily large position in a cash-
settled contract based on a survey of prices of cash market
transactions, where the price of the spot month cash-settled
contract is used by cash market participants in determining or
setting their cash market transaction prices, then an unwarranted
price fluctuation in that cash-settled commodity derivative contract
could result in distorted prices in cash market transactions and,
thus, an artificial final cash settlement price from a survey of
such distorted cash market transaction prices. Alternatively, for
example, in the case of a trader who holds an extraordinarily large
position in a cash-settled contract based on the final settlement
price of a physical-delivery futures contract, then a trader has an
incentive to mark the close of that physical-delivery futures
contract to benefit her position in the cash-settled contract.
—————————————————————————
Prices that deviate from the natural forces of supply and demand,
i.e., artificial prices, may occur when there is hoarding of a physical
commodity in an attempted or perfected manipulative activity (such as a
corner). If a price of a commodity is artificial, resources will be
inefficiently allocated during the time that the artificial price
exists. Similarly, prices that are unduly influenced by the size of a
very large speculative position, or trading that increases or reduces
the size of such very large speculative position, may lead to an
inefficient allocation of resources to the extent that such prices do
not allocate resources to their highest and best use. These burdens
were present during the Hunt brothers episode. The Interagency Silver
Study concluded that “the volatile conditions in silver markets and
the much higher price levels . . . affected the industrial and
commercial sectors of the economy to a greater extent than would have
been the case if silver price changes had been less turbulent.” 83
The Interagency Silver Study described several negative consequences of
resource misallocations that occurred during the silver price spike.
—————————————————————————
83 Id. at 150.
—————————————————————————
Significant changes took place in the use of silver as an
industrial input during silver’s price oscillation in 1979-80. In the
photography industry, the consumption of silver from the first quarter
of 1979 to the first quarter of 1980 fell by nearly one third.
Similarly, the use of silver in the production of silverware declined
by over one half in this period. In addition, numerous other uses of
silver exhibited sharp usage declines equivalent to or in excess of
these examples. These sharp reductions in silver use are indicative of
the general disruption caused by the sharp rise in silver prices. Since
the demand for silver in many of these uses is relatively price
inelastic, the substantial decline registered in the use of silver for
industrial purposes underscores the sizable magnitude of silver price
increases and the consequent disruption experienced by the industry.
Individual commercial operations using silver were also disrupted.
To illustrate, a major producer of X-ray film discontinued production
purportedly as a result of the sharply increased and erratic behavior
of the price of silver. In addition, there were reports that trading
firms failed financially in early 1980 due to losses incurred in silver
markets. Finally, the financial condition of small firms dependent on
silver products (hearing aid batteries, printing supplies, etc.)
deteriorated as a result of high silver prices and limited
supplies.84
—————————————————————————
84 Id. (footnotes omitted). James M. Stone, formerly Chairman
of the Commission, maintained that the negative effects of the price
spike on commercials were borne out in employment figures: “In the
case of silver, the employment impacts fell hardest upon the makers
of consumer products. According to the Department of Labor’s Bureau
of Labor Statistics some 6000 jobs in the jewelry, silverware and
plateware industries were lost between November of 1979 and February
of 1980.” Additional Comments on the Interagency Silver Study at 9
(“Stone Comments”).
—————————————————————————
Moreover, after the settlement price of silver peaked in mid-
January 1980, the ensuing “rapid decline of silver prices subjected
several FCMs and their parent companies to considerable financial
stress.” 85 In the view of the Commission and other regulators,
“[w]hile all FCMs carrying silver positions appear to have remained
solvent during the period in question, the potential for insolvency was
significant.” 86 The Interagency Silver Study described a cascade of
undesirable events;
—————————————————————————
85 Id. at 135.
86 Id. at 140.
Falling prices reduced the equity in the accounts of some large,
net long silver futures positions, necessitating margin calls.
Responsibility for the financial obligations of some of these
positions had to be assumed by FCMs when large margin calls went
unmet. A significant proportion of the loans to major silver longs,
collateralized by silver, had been made by some FCMs acting for
their parent companies. A major portion of this collateral was
rehypothecated for bank loans by these companies. The FCMs and their
parent companies were thus exposed to two related problems that
threatened them with insolvency–the losses on customer accounts and
the possibility that silver prices would fall to a point which would
cause the banks to demand payment on the hypothecated loans. . . .
The FCM was not only vulnerable because of its customers’ losses on
the futures contracts, but also because of the potential for a
decline in the value of loan collateral.87
—————————————————————————
87 Id. at 135-6 (footnote omitted).
The failure of an FCM with large silver exposures could have
adversely affected clients without positions in silver and potentially
other participants in the futures markets. The failure of a large FCM
could have negatively affected the various exchanges and potentially
the clearinghouses.88 The solvency of FCMs and other Commission
registrants crucial to properly functioning futures markets is clearly
within the Commission’s regulatory ambit. The failure of a commission
registrant in the context of unwarranted price spikes would be a burden
on interstate commerce.
—————————————————————————
88 See id. at 140-41. “Although the clearinghouses have
contingency plans to deal with insolvent members, to date these
plans have covered only the collapse of small FCMs. Conceivably, a
major default could result in assessments of members that might, in
turn, result in the insolvency of some members and the collapse of
the exchange.”
—————————————————————————
Fallout from the silver price spike in late 1979-early 1980
extended beyond the silver markets. “Banks, by extending credit for
futures market activity while accepting silver as collateral, exposed
themselves to higher than normal risks.” 89 Unusual activity was
also observed in other futures markets, such as precious metals and
commodities other than silver in which the Hunts were thought to have
had positions.90 “On March 27, 1980, the date on which the price of
silver dropped to its lowest point, $10.80 an ounce, a combination of
factors, including news of the Hunts’ problems in meeting margin calls,
the efforts of the Hunts to sell positions in various exchange-listed
securities in order to meet those calls, and the actions of the SEC in
suspending trading in Bache Group stock, appeared to have a direct
impact on the securities markets.” 91 Commenters noted the marked
changes in the rate of inflation concomitant with the rapid rise and
fall of the price of silver.92 Potential bank
[[Page 75690]]
failures, disruptions in other futures markets, disruptions in the
securities markets and volatile inflation rates would be additional
burdens on interstate commerce. In highlighting the ability of market
participants to accumulate extraordinarily large speculative positions,
thereby demoralizing the silver markets to the injury of producers and
consumers, the entirety of the Hunt brothers silver episode called into
question the adequacy of futures regulation generally and the integrity
of the futures markets.
—————————————————————————
89 Interagency Silver Study at 145. “Bank loans to major
silver traders were made both directly and indirectly through FCMs.
. . . Default on a major portion of these loans could have had a
significant effect on the overall banking industry, but particularly
on those banks where the loan concentration was the greatest.”
Testimony of Philip McBride Johnson, Chairman, Commodity Futures
Trading Commission, Before the Subcommittee on Conservation, Credit
and Rural Development, Committee on Agriculture, U.S. House of
Representatives, Oct. 1, 1981, at 19 (“Johnson Testimony”).
90 See Interagency Silver Study at 147-8. See also Johnson
Testimony at 18-21.
91 Interagency Silver Study at 148.
92 See Stone Comments at 9; Johnson Testimony at 20. Contra
Philip Cagan, “Financial Futures Markets: Is More Regulation
Needed?,” I J. Futures Markets 169, 181-82 (1981).
—————————————————————————
The Commission believes that if Federal speculative position limits
had been in effect that correspond to the limits that the Commission
proposes now, across markets now subject to Commission jurisdiction,
such limits would have prevented the Hunt brothers and their cohorts
from accumulating such large futures positions.93 Such large
positions were associated with the sudden fluctuations in price shown
in Figures 1 and 2. These unwarranted changes in price imposed an undue
and unnecessary burden on interstate commerce, as described in greater
detail on the preceding pages. If the Hunt brothers had been prevented
from accumulating such large futures positions, they would not have
been able to demand delivery on such large futures positions. The Hunts
therefore would have been unable to hoard as much physical silver. The
Commission’s belief is based on the following assessment:
—————————————————————————
93 See also Speculative Position Limits, 45 FR 79831, 79833,
Dec. 2, 1980 (“Had limits on the amount of total open commitments
which any trader or group can own been in effect, such occurrences
may have been prevented.”).
—————————————————————————
In order to approximate a single-month and all-months-combined
limit calculated using a methodology similar to that proposed in this
release 94 for silver during this time period, the Commission used
data regarding month-end open contracts from the Interagency Silver
Study.95 These month-end open interest reports are for all silver
futures combined for the Chicago Board of Trade and the Commodity
Exchange in New York.96 Table 1 shows the month-end open interest for
all silver futures combined from August 1979 to April 1980. Using these
numbers, the average month-end open interest for this period is 190,545
contracts, and applying the 10, 2.5 percent formula to this average
would result in single-month and all-months-combined limits of 6,700
contracts. The Hunts would have exceeded this single-month limit in the
fall of 1979 when they and their cohorts held over 12,000 contracts for
March delivery.97 In addition, the Hunts and their cohorts held net
positions in silver futures on COMEX and CBOT that exceeded the
calculated all-months-combined limits on multiple occasions between
September 1975 and February 1980 as is shown in Table 2. Hence, if the
proposed rule had been in place, it could have limited the size of the
positions held by the Hunts and their cohorts as early as the autumn of
1975.
—————————————————————————
94 The formula for the non-spot-month position limits is based
on total open interest for all Referenced Contracts in a commodity.
The actual position limit level will be set based on a formula: 10
percent of the open interest for the first 25,000 contracts and 2.5
percent of the open interest thereafter. The 10, 2.5 percent formula
is identified in 17 CFR 150.5(c)(2).
95 Interagency Silver Study at 117.
96 During the time of the events discussed, silver bullion
futures contracts traded in the United States on the COMEX in New
York, the CBOT in Chicago, and the MidAmerica Commodity Exchange
(“MCE”) in Chicago. At this time, the COMEX and CBOT contracts
were each 5,000 troy ounces of silver, and MCE’s contract was 1,000
troy ounces. Month-end open interest numbers were not available for
MCE.
97 See discussion below.
—————————————————————————
There are two limitations to the data used in this analysis. First,
the month-end open interest data do not include open interest from the
MidAmerica Commodity Exchange. Second, the month-end open interest
numbers are for a short time-period starting at the end of August 1979.
If the proposed rule had been in place at the time of the Hunt brothers
price spike, the limits would have been calculated using data from two
years and would likely have used data from an earlier period which
could have caused the limit levels to be different. However, the
Commission believes that the calculated limits are a fair approximation
of the limits that would have applied during this time period.
Moreover, for speculative position limits not to have constrained the
Hunts at the end of 1975 when their net position was reported as 15,876
contracts, the average total open interest for the time period would
have had to be over 500,000 contracts (of 5,000 troy ounces). Moreover,
the average total open interest would have had to be over 900,000
contracts (of 5,000 troy ounces) before the all-months-combined limit
would have exceeded the maximum net position reported by the
Interagency Silver Study (24,722 for September 30, 1979). According to
the Interagency Silver Study, it was at this point that the Hunts began
acquiring large quantities of physical silver.98
—————————————————————————
98 Interagency Silver Study at 104.
Table 1–Month-End Open Interest for Chicago Board of Trade (CBOT) and the Commodity Exchange (COMEX), August
1979 Through April 1980, All Silver Futures Combined 99
—————————————————————————————————————-
CBOT open COMEX open Total open
Date interest interest interest
—————————————————————————————————————-
8/31/1979………………………………………………. 185,031 157,952 342,983
9/30/1979………………………………………………. 161,154 167,723 328,877
10/31/1979……………………………………………… 105,709 145,611 251,320
11/30/1979……………………………………………… 98,009 134,207 232,216
12/31/1979……………………………………………… 93,748 127,225 220,973
1/31/1980………………………………………………. 49,675 77,778 127,453
2/29/1980………………………………………………. 28,211 63,672 91,884
3/31/1980………………………………………………. 24,336 48,688 73,024
4/30/1980………………………………………………. 19,008 27,166 46,174
—————————————————————————————————————-
[[Page 75691]]
Table 2–Estimated Ownership of Silver by Hunt Related Accounts
[Contracts of 5,000 troy ounces] 100
—————————————————————————————————————-
Net futures Net futures Futures total
Date COMEX CBOT (from table)
—————————————————————————————————————-
9/30/1975………………………………………………. 6,917 4,560 11,077
12/31/1975……………………………………………… 6,865 9,011 15,876
3/31/1976………………………………………………. 6,092 5,324 11,416
6/30/1976………………………………………………. 4,061 (920) 3,141
9/30/1976………………………………………………. 3,890 578 4,468
12/31/1976……………………………………………… 3,910 571 4,481
3/31/1977………………………………………………. 3,288 259 3,547
6/30/1977………………………………………………. 4,540 816 5,356
9/30/1977………………………………………………. 5,277 1,518 6,795
12/31/1977……………………………………………… 5,826 2,016 7,344
3/31/1978………………………………………………. 6,459 2,224 8,683
6/30/1978………………………………………………. 4,200 2,451 6,651
9/30/1978………………………………………………. 2,481 3,047 5,528
12/31/1978……………………………………………… 4,076 1,317 5,393
3/31/1979………………………………………………. 6,655 1,699 8,354
5/31/1979………………………………………………. 8,712 4,765 13,477
6/30/1979………………………………………………. 9,442 3,846 13,288
7/31/1979………………………………………………. 10,407 4,336 14,743
8/31/1979………………………………………………. 14,941 8,700 23,641
9/30/1979………………………………………………. 15,392 9,330 24,722
10/31/1979……………………………………………… 11,395 7,444 18,839
11/30/1979……………………………………………… 12,379 5,693 18,072
12/31/1979……………………………………………… 13,806 5,921 19,727
1/31/1980………………………………………………. 7,432 1,344 8,776
2/29/1980………………………………………………. 6,993 789 7,782
4/2/1980……………………………………………….. 1,056 388 1,444
—————————————————————————————————————-
The Commission finds that if the position limits suggested by this data
were applied as early as 1975, the Hunts would not have been able to
accumulate or hold their excessively large futures positions and
thereby the limits would have restricted their ability to cause the
price fluctuations and other harms described above.
—————————————————————————
99 Id. at 117.
100 Id. at 103.
—————————————————————————
Position limits would help to diminish or prevent unreasonable
fluctuations or unwarranted changes in the price of a commodity, such
as the extreme price volatility in the 2006 natural gas markets.101
—————————————————————————
101 For purposes of discussion, the following section recounts
certain findings about the 2006 natural gas markets by the staff of
the Permanent Subcommittee on Investigations of the United States
Senate (the “Permanent Subcommittee”). See generally Excessive
Speculation in the Natural Gas Market, Staff Report with Additional
Minority Staff Views, Permanent Subcommittee on Investigations,
United States Senate, Released in Conjunction with the Permanent
Subcommittee on Investigations, June 25 & July 9, 2007 Hearings
(“Subcommittee Report”). Separately, the Commission, on July 25,
2007, charged Amaranth Advisors LLC, Amaranth Advisors (Calgary) ULC
and its former head energy trader, Brian Hunter, with attempted
manipulation in violation of the Commodity Exchange Act. The charges
against the Amaranth entities were later settled, with a fine of
$7.5 million levied against them in August of 2009. See U.S.
Commodity Futures Trading Commission Charges Hedge Fund Amaranth and
its Former Head Energy Trader, Brian Hunter, with Attempted
Manipulation of the Price of Natural Gas Futures, July 25, 2007,
available at http://www.cftc.gov/PressRoom/PressReleases/pr5359-07;
Amaranth Entities Ordered to Pay a $7.5 Million Civil Fine in CFTC
Action Alleging Attempted Manipulation of Natural Gas Futures
Prices, August 12, 2009, available at http://www.cftc.gov/PressRoom/PressReleases/pr5692-09. The Commission enforcement action is still
pending against Brian Hunter. The discussion herein of the natural
gas events and Subcommittee Report shall not be construed to alter
any statements by or positions of the Commission and its staff in
the pending enforcement matter.
—————————————————————————
Amaranth Advisors L.L.C. (“Amaranth”) was a hedge fund that,
until its spectacular collapse in September 2006, held “by far the
largest positions of any single trader in the 2006 U.S. natural gas
financial markets.” 102 Amaranth’s activities are a classic example
of the market power that often typifies excessive speculation. “Market
power” in this context means the ability to move prices by exerting
outsize influence on expectations of supply and/or demand for a
commodity. Amaranth accumulated such large speculative natural gas
futures positions that it affected expectations of demand for physical
natural gas and prices rose to levels not warranted by the otherwise
natural forces of supply and demand for the commodity.103
—————————————————————————
102 Subcommittee Report at 67.
103 Amaranth was a pure speculator that, for example, could
neither make nor take delivery of physical natural gas.
—————————————————————————
“Prior to its collapse, Amaranth dominated trading in the U.S.
natural gas market. . . . All but a few of the largest energy companies
and hedge funds consider trades of a few hundred contracts to be large
trades. Amaranth held as many as 100,000 natural gas futures contracts
at once, representing one trillion cubic feet of natural gas, or 5% of
the natural gas used in the United States in a year. At times, Amaranth
controlled up to 40% of all of the open interest on NYMEX for the
winter months (October 2006 through March 2007). Amaranth accumulated
such large positions and traded such large volumes of natural gas
futures that it distorted market prices, widened price spreads, and
increased price volatility.” 104
—————————————————————————
104 Subcommittee Report at 51-52.
105 Subcommittee Report at 17.
—————————————————————————
Natural gas is one of the main sources of energy for the United
States. The price of natural gas has a pervasive effect throughout the
U.S. economy. In general, “[b]ecause one of the major uses of natural
gas is for home heating, natural gas demand peaks in the winter month
and ebbs during the summer months.” 105 During the summer months,
when demand for physical natural gas falls, the spot price of natural
gas tends to fall, with the excess physical supply being placed into
underground storage reservoirs for future use. During the winter, when
demand for natural gas exceeds production and the spot price tends to
increase, natural gas is removed from
[[Page 75692]]
underground storage and is consumed.106
—————————————————————————
106 See id.
—————————————————————————
Amaranth believed that winter natural gas prices would be much
higher than summer natural gas prices, notwithstanding an abundant
supply of natural gas in 2006. Seeking to profit from this view,
Amaranth engaged in spread trading: it bought contracts for future
delivery of natural gas in months where it thought prices would be
relatively higher and sold contracts for future delivery of natural gas
in months were it thought prices would be relatively lower.107
Amaranth primarily traded the January/November spread and the March/
April spread, although it took positions in other near months. When
Amaranth bet that the spread between the two contracts would increase,
it would make money by selling out of the position or the equivalent
underlying legs at a higher price than it paid. Amaranth’s positions
were extremely large.108 The Permanent Subcommittee found that
“Amaranth’s large positions and trades caused significant price
movements in key natural gas futures prices and price relationships.”
109 The Permanent Subcommittee also found that “Amaranth’s trades
were not the sole cause of the increasing price spreads between the
summer and winter contracts; rather they were the predominant cause.”
110
—————————————————————————
107 Amaranth sought to benefit from changes in the price
relationship between two linked contracts. For instance, if a trader
is long the front month at 10 and short the back month at 8, the
spread is 2. If the price of the front month contract rises to 11,
the spread is 3 and the position has a gain. If the price of the
back month contract declines to 7, the spread is 3 and the position
has a gain. If the price of the front month contract rises to 11 and
the price of the back month contract declines to 7, the spread is 4
and the position has a gain. But if the front month contract falls
to 8 and the back month contract falls to 6, the spread does not
change.
108 “Amaranth also held large positions in other winter and
summer months spanning the five-year period from 2006-2010. In
aggregate, Amaranth amassed an extraordinarily large share of the
total open interest on NYMEX. During the spring and summer of 2006,
Amaranth controlled between 25 and 48% of the outstanding contracts
(open interest) in all NYMEX natural gas futures contracts for 2006;
about 30% of the outstanding contracts (open interest) in all NYMEX
natural gas futures contracts for 2007; between 25 and 40% of the
outstanding contracts (open interest) in all NYMEX natural gas
futures contracts for 2008; between 20 and 40% of the outstanding
contracts (open interest) in all NYMEX natural gas futures contracts
for 2009; and about 60% of the outstanding contracts (open interest)
in all NYMEX natural gas futures contracts for 2010.” Subcommittee
Report at 52.
109 Subcommittee Report at 2.
110 Id. at 68 (emphasis in original).
—————————————————————————
Events in the 2006 natural gas markets demonstrate the burdens on
interstate commerce of extreme price volatility.
In section 4a(a)(1) of the CEA Congress causally links excessive
speculative positions with “sudden or unreasonable fluctuations or
unwarranted changes in the price of” such commodities. The precipitous
decline in natural gas prices from late-August 2006 until Amaranth’s
collapse in September 2006 demonstrates that link. The Permanent
Subcommittee found that “[p]urchasers of natural gas during the summer
of 2006 for delivery in the following winter months paid inflated
prices due to Amaranth’s speculative trading” and that “[m]any of
these inflated costs were passed on to consumers, including residential
users who paid higher home heating bills.” 111 Such inflated costs
are clearly a burden on interstate commerce. In the words of the
Permanent Subcommittee, “[t]he Amaranth experience demonstrates how
excessive speculation can distort prices of futures contracts that are
many months from expiration, with serious consequences for other market
participants.” 112 The Permanent Subcommittee findings support the
imposition of speculative position limits outside the spot month.
Commercial participants in the 2006 natural gas markets were reluctant
or unable to hedge.113 Speculators withdrew liquidity from a market
viewed as artificially expensive.114 To relieve the burdens on
interstate commerce posed by positions as large as Amaranth’s, Congress
directed the Commission to set position limits to, among other things,
ensure sufficient market liquidity for bona fide hedgers.115
—————————————————————————
111 Id. at 6.
112 Id. at 4.
113 See id. at 114.
114 See id. at 71-77.
115 7 U.S.C. 6a(a)(3)(B)(iv).
—————————————————————————
“Amaranth held as many as 100,000 natural gas contracts in a
single month, representing 1 trillion cubic feet of natural gas, or 5%
of the natural gas in the entire United States in a year. At times
Amaranth controlled 40% of all of the outstanding contracts on NYMEX
for natural gas in the winter season (October 2006 through March 2007),
including as much as 75% of the outstanding contracts to deliver
natural gas in November 2008.” 116 Position limits that would
prevent the accumulation of such overly large speculative positions in
deferred commodity contracts would help to prevent unreasonable
fluctuations or unwarranted changes in the price of a commodity that
may occur when a speculator must substantially reduce its position
within a short period of time to the extent the price of such commodity
during the unwind period does not reflect fundamental values.117
Moreover, position limits would help to prevent disruptions to market
integrity caused by the corrosive perception that a market is unfair or
prices in a market do not reflect the fundamental forces of supply and
demand as occurred during 2006 in the natural gas markets. Commodity
markets where artificial volatility discourages participation are less
likely to produce “a market consensus on correct pricing.” 118
—————————————————————————
116 Subcommittee Report at 2.
117 This is because, among other things, the speculator’s
influence on expectations of demand is reduced as the speculator is
no longer willing and able to hold such a large net position in
futures contracts.
118 Subcommittee Report at 119.
—————————————————————————
Based on certain assumptions described below, the Commission
believes that if Federal speculative position limits had been in effect
that correspond to the limits that the Commission proposes now, across
markets now subject to Commission jurisdiction, such limits would have
prevented Amaranth from accumulating such large futures positions and
thereby restrict its ability to cause unwarranted price effects. Using
non-public data reported to the Commission under Part 16 of the
Commission’s regulations for open interest 119 for natural gas
contracts, the Commission calculated the single-month and all-months-
combined limits using the same methodology as proposed in this release
for the period January 1, 2004 to December 31, 2005. The results of
this analysis are presented in Table 3 below, which shows that the
resulting single-month and all-months combined limits would have each
been 40,900 contracts.
—————————————————————————
119 See 17 CFR 16.01.
[[Page 75693]]
Table 3–Open Interest and Calculated Limits for NYMEX Natural Gas January 1, 2004, to December 31, 2005
——————————————————————————————————————————————————–
Open interest
Core referenced futures contract Year (daily Open interest Limit (daily Limit (month Limit
average) (month end) average) end)
——————————————————————————————————————————————————–
NYMEX Natural Gas………………………………… 2004 851,763 839,330 23,200 22,900 40,900
2005 1,559,335 1,529,252 40,900 40,200 …………..
——————————————————————————————————————————————————–
Using non-public data reported to the Commission under Part 17 of
the Commission’s regulation for large trader positions,120 the
Commission also calculated Amaranth’s positions 121 as they would be
calculated under the proposed rule for the period January 1, 2005 to
September 30, 2006. During this time, Amaranth’s net position would
have exceeded the limits for the single month and for all-months-
combined on multiple days, starting as early as June 2006. It is
important to note that ICE did not report market open interest for its
swap contracts or for large traders to the Commission during this time
period, so the Commission cannot exactly replicate the calculations in
the proposed rule. However, even if ICE had the same amount of open
interest in futures-equivalent terms as all of the NYMEX natural gas
contracts listed in 2005,122 the calculated limit would be 79,900
contracts. According to the Subcommittee Report, Amaranth would have
exceeded this limit at the end of July 2006 with its holding of 80,000
long contracts in the January 2007 delivery month.123 Moreover, the
Subcommittee Report also shows that Amaranth tended to trade in the
same direction for the same delivery month on ICE and NYMEX. Hence, the
Commission believes that had the proposed rule been in effect in 2006,
Amaranth would not have been able to build such large positions in
natural gas futures and swaps and thereby limits would have restricted
Amaranth’s ability to cause harmful price effects that limits are
intended to prevent.124
—————————————————————————
120 See 17 CFR 17.00.
121 Because the Commission’s calculations are based on non-
public information, the results of this analysis may be different
from calculations based on publicly available information, including
information contained in the Subcommittee Report.
122 Since the main natural gas swap contracts on ICE are one
quarter of the size of the NYMEX Henry Hub Natural Gas Futures
contract, this would mean that the open interest for natural gas
contracts on ICE would have to be four times the open interest for
natural gas contracts on NYMEX.
123 See Subcommittee Report at 79.
124 According to the Subcommittee Report, Amaranth reduced its
positions on NYMEX as directed by NYMEX in August 2006, and at the
same time, increased its corresponding positions on ICE. See
Subcommittee Report at 97-98.
—————————————————————————
Position limits would prevent the accumulation of extraordinarily
large positions that could potentially cause unreasonable price
fluctuations even in the absence of manipulative conduct.
As the above examples illustrate, position limits are vital tools
to prevent the accumulation of speculative positions that can enable
market manipulation. But these examples also show that limits are
necessary to achieve a broader statutory purpose — to prevent price
distortions that can potentially occur due to excessively large
speculative positions even in the absence of manipulative conduct.
The text of section 4a(a)(1) of the Act itself establishes its
broader purpose: It authorizes limits as the Commission finds are
necessary to prevent price distortions that can potentially occur due
to excessive speculation (i.e. excessively large speculative
positions), without regard to whether it is manipulative.125 The
Commission has long interpreted the provision as authorizing limits to
achieve this broader purpose and it has long found that limits are
necessary to do so.
—————————————————————————
125 See 7 U.S.C. 6a(a)(1).
—————————————————————————
For example, in the 1981 Rule requiring exchanges to set limits for
all commodities, noted above, the Commission found that “historical
and current reason for imposing position limits on individual contracts
is to prevent unreasonable fluctuations or unwarranted changes in the
price of a commodity which may occur by allowing any one trader or
group of traders acting in concert to hold extraordinarily large
futures positions.” 126 In a 2010 rulemaking, the Commission stated
that “[f]rom the earliest days of federal regulation of the futures
markets, Congress made it clear that unchecked speculative positions,
even without intent to manipulate the market, can cause price
disturbances. To protect markets from the adverse consequences
associated with large speculative positions, Congress expressly
authorized the [Commission] to impose speculative position limits
prophylactically.” 127
—————————————————————————
126 46 FR 50938, 50939, Oct. 16, 1981.
127 75 FR 4144, 4145-46, Jan. 26, 2010.
—————————————————————————
The Commission reiterated this view before Congress in 1982 in
opposing industry amendments to the CEA that would have required that
limits are necessary to prevent manipulation, corners or squeezes.
Former Commission Chair Philip McBride Johnson told Congress that
position limits were “predicated on several different sections of the
Commodity Exchange Act which pertain to orderly markets and the terms
`manipulation, corners or squeezes’ refer to only one class of market
disruption which the limits established under this rule are intended to
diminish or prevent. For instance, CEA section 4a contains the
Congressional finding that excessive speculation in the futures markets
can cause sudden or unreasonable fluctuations or unwarranted changes in
the price of commodities. Accordingly, a requirement that the
Commission make the suggested finding concerning `manipulation,
corners, or squeezes’ prior to requiring a contract market to establish
speculative limits could significantly restrict the application of the
current rule and undermine its more comprehensive regulatory purpose of
preventing excessive speculation which arises from extraordinarily
large positions.” 128
—————————————————————————
128 Futures Trading Act of 1982: Hearings on S. 2109 before
the S. Subcomm. on Agricultural Research, 97th Cong. 44 (1982).
—————————————————————————
Congress effectively ratified the Commission’s interpretation in
1982. As it explained: “the Senate Committee decided to retain [CEA
section] 4a language concerning the burden which excess speculation
places on interstate commerce. This was due to the Committee’s belief
that speculative limits, in addition to their role in preventing
manipulations, corners, or squeezes, are also important regulatory
tools for preventing unreasonable fluctuations or unwarranted changes
in commodity prices that may arise even in the absence of
manipulation.” 129
—————————————————————————
129 S. Rep. 97-384 at 45 (1982).
—————————————————————————
The Commission has long found and again finds, based on its
experience, that unchecked speculative positions can potentially
disrupt markets. In general, the larger a position held by a trader,
the greater is the potential that the position may affect the price of
the contract. The Commission reaffirms that, “the capacity of any
contract to absorb the
[[Page 75694]]
establishment and liquidation of large speculative positions in an
orderly manner is related to the relative size of such positions, i.e.,
the capacity of the market is not unlimited.” 130 When positions
exceed the capacity of markets to absorb and liquidate them,
unreasonable price fluctuations and volatility can potentially occur.
“[B]y limiting the ability of one person or group to obtain
extraordinarily large positions, speculative limits diminish the
possibility of accentuating price swings if large positions must be
liquidated abruptly in the face of adverse price movements or for other
reasons.” 131 As former Commission Chair McBride Johnson explained
to Congress regarding the silver crisis: “It seems clear from the
silver crisis that the orderly imposition of speculative limits before
a crisis develops is one of the more promising means of solving such
difficulties in the future . . . .” 132 This statement is equally
true of the natural gas events of 2006. Had the Hunt brothers and
Amaranth been prevented from amassing extraordinarily large speculative
positions in the first place, their ability to cause unwarranted price
fluctuations and volatility and other harmful market effects
attributable to such positions would have been restricted.
—————————————————————————
130 46 FR 50938, Oct. 16, 1981 (adopting then Sec. 1.61 (now
part of Sec. 150.5)).
131 45 FR at 79833.
132 Futures Trading Act of 1982: Hearings on S. 2109 before
the S. Subcomm. on Agricultural Research, 97th Cong. 44 (1982).
—————————————————————————
The Commission requests comment on all aspects of this section.
Studies and Reports
In addition to those cited previously, the Commission has reviewed
and evaluated additional studies and reports (collectively,
“studies”) about various issues relating to position limits. A list
of studies that the Commission has reviewed is in appendix A to this
preamble.
Some studies discuss whether or not excessive speculation exists,
the definition of excessive speculation, and/or whether excessive
speculation has a negative impact on derivatives markets.133 Those
studies that do generally discuss the impact of position limits do not
address or provide analysis of how the Commission should specifically
implement position limits under section 4a of the CEA.134 Some
studies may be read to support the imposition of Federal speculative
position limits; others suggest that speculative position limits will
be ineffective; still others assert that imposing speculative position
limits will be harmful. There is a demonstrable lack of consensus in
the studies.
—————————————————————————
133 76 FR at 71663.
134 Id. at 71664.
—————————————————————————
Many of the studies were focused on the impact of speculative
activity in futures markets, e.g., how the behavior of non-commercial
traders affected price levels. Such studies did not provide a view on
position limits in general or on the Commission’s implementation of
position limits in particular. Some studies have found little or no
evidence of excessive speculation unduly moving prices,135 while
others conclude there is significant evidence of the impact of
speculation in commodity markets.136 Even studies that questioned
whether speculation affects prices were often equivocal.137 Still
other studies have determined that while speculation may not cause a
price movement, such activity may increase price pressures, thereby
exacerbating the price movement.138
—————————————————————————
135 See, e.g., Harris, Jeffrey and Buyuksahin, Bahattin, “The
Role of Speculators in the Crude Oil Futures Market,” June 16,
2009, at 2, 19 (“We find that the changing net positions of no
specific trader groups lead to price changes . . . .” and “we fail
to find the causality from these [speculative] traders’ positions to
prices.”); Byun, Sungje, “Speculation in Commodity Futures Market,
Inventories and the Price of Crude Oil,” January 17, 2013, at 3, 33
(noting that “ . . . evidence among researchers is inconsistent”
but that “we conclude there does not exist sufficient evidence on
the potential contribution of financial investors in the crude oil
market.”); Irwin, Scott H.; Sanders, Dwight R.; and Merrin, Robert
P., “Devil or Angel: The Role of Speculation in the Recent
Commodity Price Boom,” August 1, 2009, at 17 (“There is little
evidence that the recent boom and bust in commodity prices was
driven by a speculative bubble . . . Economic fundamentals, as
usual, provide a better explanation for the movements in commodity
prices.”).
136 See, e.g., Singleton, Kenneth J., “Investor Flows and the
2008 Boom/Bust in Oil Prices,” March 23, 2011, at 2-3 (Singleton
presents “ . . . new evidence that . . . there were economically
and statistically significant effects of investor flows on futures
prices.”); Tang, Ke and Xiong, Wei, “Index Investment and
Financialization of Commodities,” November 1, 2012, at 72 (“As a
result of the financialization process, the price of an individual
commodity is no longer determined solely by its supply and demand.
Instead, prices are also determined by the aggregate risk appetite
for financial assets and the investment behavior of diversified
commodity index investors.”); Manera, Matteo, Nicolini, Marcella,
and Vignati, Ilaria, “Futures Price Volatility in Commodities
Markets: The Role of Short-Term vs Long-Term Speculation,” April 1,
2013, at 15 (“We find that speculation significantly affects the
volatility of returns, although in contrasting ways. The scalping
index has a positive and significant coefficient in the variance
equation, suggesting that short term speculation has a positive
impact on volatility.”).
137 Compare Technical Committee of the International
Organization of Securities Commissions, Task for on Commodity
Futures Markets Final Report, March 1, 2009, at 3 (“economic
fundamentals, rather than speculative activity, are a plausible
explanation for recent price changes in commodities”) with id. at 8
(“short term expectations can be influenced by sentiment and
investor behavior, which can amplify short-term price fluctuations,
as in other asset markets”). Another study opining that speculative
activity in general may reduce volatility nevertheless conceded that
the authors could not rule out the possibility that a single trader
might implement strategies that move prices and increase volatility.
Brunetti, Celso and Buyuksahin, Bahattin, “Is Speculation
Destabilizing?,” April 22, 2009, at 4, 22-23; see also Irwin, et
al., “The Performance of CBOT Corn, Soybean, and Wheat Futures
Contracts after Recent Changes in Speculative Limits,” July 29,
2007, at 1, 6 (concluding that there was “no large change in”
price volatility after speculative limits were increased, but
cautioning that “[w]ith limited observations available for the
period following the change in speculative limits . . . ,
conclusions about the impact on volatility are tentative. Additional
observations will be required across varying scenarios of supply,
demand, and price level, to have full confidence in the
conclusions.”) (emphasis added); Parsons, John E., “Black Gold &
Fool’s Gold: Speculation in the Oil Futures Market,” September 1,
2009, at 108 (position limits will not prevent asset bubbles from
forming, but they are “necessary to insure the integrity of the
market”).
138 See, e.g., Hamilton, James D., “Causes and Consequences
of the Oil Shock of 2007-08,” April 1, 2009, at 258 (Hamilton
raises “the possibility that miscalculation of the long-run price
elasticity of oil demand . . . was one factor in the oil shock of
2007-2008, and that speculative investing in oil futures may have
contributed to that miscalculation.”); Juvenal, Luciana and
Petrella, Ivan, “Speculation in the Oil Market,” June 1, 2012,
(“While global demand shocks account for the largest share of oil
price fluctuations, speculative shocks are the second most important
driver.”).
—————————————————————————
Several studies did generally address the concept of position
limits as part of their discussion of speculative activity. The authors
of some of these works expressed views that speculative position limits
were an important regulatory tool and that the CFTC should implement
limits to control excessive speculation.139 For example,
[[Page 75695]]
one author opined that “ . . . strict position limits should be placed
on individual holdings, such that they are not manipulative.” 140
Another stated, “[s]peculative position limits worked well for over 50
years and carry no unintended consequences. If Congress takes these
actions, then the speculative money that flowed into these markets will
be forced to flow out, and with that the price of commodities futures
will come down substantially. Until speculative position limits are
restored, investor money will continue to flow unimpeded into the
commodities futures markets and the upward pressure on prices will
remain.” 141 The authors of one study claimed that “[r]ules for
speculative position limits were historically much stricter than they
are today. Moreover, despite rhetoric that imposing stricter limits
would harm market liquidity, there is no evidence to support such
claims, especially in light of the fact that the market was functioning
very well prior to 2000, when speculative limits were tighter.” 142
—————————————————————————
139 See, e.g., Greenberger, Michael, “The Relationship of
Unregulated Excessive Speculation to Oil Market Price Volatility,”
January 1, 2010, at 11 (On position limits: “The damage price
volatility causes the economy by needlessly inflating energy and
food prices worldwide far outweighs the concerns about the precise
application of what for over 70 years has been the historic
regulatory technique for controlling excessive speculation in risk-
shifting derivative markets.”.); Khan, Mohsin S., “The 2008 Oil
Price “Bubble”,” August 2009, at 8 (“The policies being
considered by the CFTC to put aggregate position limits on futures
contracts and to increase the transparency of futures markets are
moves in the right direction.”); U.S. Senate Permanent Subcommittee
on Investigations, “Excessive Speculation in the Wheat Market,”
June 2009, at 12 (“The activities of these index traders constitute
the type of excessive speculation the CFTC should diminish or
prevent through the imposition and enforcement of position limits as
intended by the Commodity Exchange Act.”); U.S. Senate Permanent
Subcommittee on Investigations, “Excessive Speculation in the
Natural Gas Market,” June 25, 2007, at 8 (The Subcommittee
recommended that Congress give the CFTC authority over ECMs, noting
that “[to] ensure fair energy pricing, it is time to put the cop
back on the beat in all U.S. energy commodity markets.”); United
Nations Conference on Trade and Development, “The Global Economic
Crisis: Systemic Failures and Multilateral Remedies,” March 1,
2009, at 14, (The UNCTAD recommends that “ . . . regulators should
be enabled to intervene when swap dealer positions exceed
speculative position limits and may represent `excessive
speculation’.); United Nations Conference on Trade and Development,
“The Financialization of Commodity Markets,” July 1, 2009, at 26
(The report recommends tighter restrictions, notably closing
loopholes that allow potentially harmful speculative activity to
surpass position limits.).
140 de Schutter, Olivier, “Food Commodities Speculation and
Food Price Crises,” September 1, 2010, United Nations Special
Report on the Right to Food, at 8.
141 Masters, Michael and White, Adam, “The Accidental Hunt
Brothers: How Institutional Investors are Driving up Food and Energy
Prices,” July 31, 2008, at 3.
142 Medlock, Kenneth and Myers Jaffe, Amy, “Who is In the Oil
Futures Market and How Has It Changed?,” August 26, 2009, Baker
Institute for Public Policy, at 8.
—————————————————————————
Not all of the reviewed studies viewed position limits in a
positive light. One study claimed that position limits will not
restrain manipulation,143 while another argued that position limits
in the agricultural commodities have not significantly affected
volatility.144 Another study noted that while position limits are
effective as an anti-manipulation measure, they will not prevent asset
bubbles from forming or stop them from bursting.145 A study cautioned
that while limits may be effective in preventing manipulation, they
should be set at an optimal level so as to not harm the affected
markets.146 Another study claimed that position limits should be
administered by DCMs, as those entities are closest to and most
familiar with the intricacies of markets and thus can implement the
most efficient position limits policy.147 Another study suggested
eliminating position limits, arguing that increasing ex-post penalties
for manipulation would be more effective at deterring manipulative
behavior.148 One study noted the similar efforts under discussion in
European markets.149
—————————————————————————
143 Ebrahim, Muhammed and Rhys ap Gwilym, “Can Position
Limits Restrain Rogue Traders?,” March 1, 2013, Journal of Banking
& Finance, at 27 (“. . . binding constraints have an unintentional
effect. That is, they lead to a degradation of the equilibria and
augmenting market power of Speculator in addition to other agents.
We therefore conclude that position limits are not helpful in
curbing market manipulation. Instead of curtailing price swings,
they could exacerbate them.”).
144 Irwin, Scott H.; Garcia, Philip; and Good, Darrel L.,
“The Performance of CBOT Corn, Soybean, and Wheat Futures Contracts
after Recent Changes in Speculative Limits,” July 29, 2007, at 16
(“The analysis of price volatility revealed no large change in
measures of volatility after the change in speculative limits. A
relatively small number of observations are available since the
change was made, but there is little to suggest that the change in
speculative limits has had a meaningful overall impact on price
volatility to date.”).
145 Parsons, John E., “Black Gold & Fool’s Gold: Speculation
in the Oil Futures Market,” September 1, 2009, at 30 (“Restoring
position limits on all nonhedgers, including swap dealers, is a
useful reform that gives regulators the powers necessary to ensure
the integrity of the market. Although this reform is useful, it will
not prevent another speculative bubble in oil. The general purpose
of speculative limits is to constrain manipulation . . . Position
limits, while useful, will not be useful against an asset bubble.
That is really more of a macroeconomic problem, and it is not
readily managed with microeconomic levers at the individual exchange
level.”).
146 Wray, Randall, “The Commodities Market Bubble: Money
Manager Capitalism and the Financialization of Commodities,”
October 1, 2008, at 41, 43 (“While the participation of traditional
speculators offers clear benefits, position limits must be carefully
administered to ensure that their activities do not “demoralize”
markets. . . . The CFTC must re-establish and enforce position
limits.”).
147 CME Group, Inc., “Excessive Speculation and Position
Limits in Energy Derivatives Markets,” CME Group White Paper, at 6
(“Indeed, as the Commission has previously noted, the exchanges
have the expertise and are in the best position to fix position
limits for their contracts. In fact, this determination led the
Commission to delegate to the exchanges authority to set position
limits in non-enumerated commodities, in the first instances, almost
30 years ago.”) (available at http://www.cmegroup.com/company/files/PositionLimitsWhitePaper.pdf).
148 Pirrong, Craig, “Squeezes, Corpses, and the Anti-
Manipulation Provisions of the Commodity Exchange Act,” October 1,
1994, at 2 (“The efficiency of futures markets would be improved,
and perhaps substantially so, by eliminating position limits . . .
and relying upon revitalized, harm-based sanctions to deter market
manipulation.”).
149 European Commission, “Review of the Markets in Financial
Instruments Directive,” December 1, 2010, at 82 note 282
(“European Parliament . . . calls on the Commission to develop
measures to ensure that regulators are able to set position limits
to counter disproportionate price movements and speculative bubbles,
as well as to investigate the use of position limits as a dynamic
tool to combat market manipulation, most particularly at the point
when a contract is approaching expiry. It also requests the
Commission to consider rules relating to the banning of purely
speculative trading in commodities and agricultural products, and
the imposition of strict position limits especially with regard to
their possible impact on the price of essential food commodities in
developing countries and greenhouse gas emission allowances.”).
—————————————————————————
Studies that militate against imposing any speculative position
limits appear to conflict with the Congressional mandate (discussed
above) that the Commission impose limits on futures contracts, options,
and certain swaps for agricultural and exempt commodities. Such studies
also appear to conflict with Congress’ determination, codified in CEA
section 4a(a)(1), that position limits are an effective tool to address
excessive speculation as a cause of sudden or unreasonable fluctuations
or unwarranted changes in the price of such commodities.150
—————————————————————————
150 7 U.S.C. 6a(a)(1)-(2).
—————————————————————————
In any case, these studies overall show a lack of consensus
regarding the impact of speculation on commodity markets and the
effectiveness of position limits. While there is not a consensus, the
fact that there are studies on both sides, in the Commission’s view,
warrants erring on the side of caution. In light of the Commission’s
experience with position limits, and its interpretation of
congressional intent, it is the Commission’s judgment that position
limits should be implemented as a prophylactic measure, to protect
against the potential for undue price fluctuations and other burdens on
commerce that in some cases have been at least in part attributable to
excessive speculation.
In this regard, the Commission has found two studies of actual
market events to be helpful and persuasive in making its alternative
necessity finding.151 The first is the inter-agency report on the
silver crisis.152 This report, by a joint task force of the staffs of
the Commission, the Board of Governors of the Federal Reserve System,
the Department of the Treasury and the Securities and Exchange
Commission, provides an in-depth description and analysis of the silver
crisis, the Hunt brothers’ build-up of massive positions, the
manipulative
[[Page 75696]]
conduct that those massive positions enabled, the resulting extreme
price volatility, and consequent harms to the economy. The second is
the PSI Report on Excessive Speculation in the Natural Gas market.153
As a Congressional report issued following hearings, it is more helpful
and persuasive than academic and other studies in indicating how
Congress views limits as necessary to prevent the adverse effects of
excessively large speculative positions. The PSI Report is also more
helpful because it thoroughly studied actual market events involving a
vital energy commodity, natural gas, examined how Amaranth’s buildup of
massive speculative positions by itself created a risk of market harms,
documented how Amaranth sought to avoid existing limits, and analyzed
how its ability to do so was a cause of the attendant extreme price
volatility documented in the report.
—————————————————————————
151 Another study of actual market events analyzed position
limits in the context of the “Flash Crash” of May 6, 2010. While
this study concluded that position limits would not have prevented
the crash, and that price limits were more effective, it measured
the impacts of potential limits on certain financial contracts not
implicated in the instant rulemaking. Lee, Bernard; Cheng, Shih-Fen;
and Koh, Annie, “Would Position Limits Have Made any Difference to
the ‘Flash Crash’ on May 6, 2010,” November 1, 2010, at 37.
152 U.S Commodity Futures Trading Commission, “Part Two, A
Study of the Silver Market,” May 29, 1981, Report to The Congress
in Response to Section 21 of The Commodity Exchange Act.
153 U.S. Senate Permanent Subcommittee on Investigations,
“Excessive Speculation in the Natural Gas Market,” June 25, 2007.
—————————————————————————
The Commission requests comment on its discussion of studies and
reports. It also invites commenters to advise the Commission of any
additional studies that the Commission should consider, and why.
B. Proposed Rules
1. Section 150.1–Definitions
i. Various Definitions Found in Sec. 150.1
The Commission proposes to amend the definitions of “futures-
equivalent,” “independent account controller,” “long position,”
“short position,” and “spot month” found in Sec. 150.1 of its
regulations to conform them to the concepts and terminology of the CEA,
as amended by the Dodd-Frank Act.154 The Commission also is proposing
to add to Sec. 150.1, definitions for “basis contract,” “calendar
spread contract,” “commodity derivative contract,” “commodity index
contract,” “core referenced futures contract,” “eligible
affiliate,” “entity,” “excluded commodity,” “intercommodity
spread contract,” “intermarket spread positions,” “intramarket
spread positions,” “physical commodity,” “pre-enactment swap,”
“pre-existing position,” “referenced contract,” “spread
contract,” “speculative position limit,” “swap,” “swap dealer”
and “transition period swap.” In addition, the Commission is
proposing to move the definition of bona fide hedging from Sec. 1.3(z)
into part 150, and to amend and update it. Moreover, the Commission
proposes to delete the definition for “the first delivery month of the
`crop year.’ ” The Commission notes that several terms that are not
currently in part 150 are not included in the current rulemaking
proposal even though definitions for those terms were adopted in
vacated part 151. The Commission does not view definition of these
terms as necessary for clarity in light of other revisions proposed
herein. The terms not currently proposed include “swaption” and
“trader.” 155 Separately, the Commission is making a non-
substantive change to list the definitions in alphabetical order rather
than by use of assigned letters. This last change will be helpful when
looking for a particular definition, both in the near future, in light
of the additional definitions proposed to be adopted, and in the
expectation that future rulemakings may adopt additional definitions.
—————————————————————————
154 In a separate proposal approved on the same date as this
proposal, the Commission is proposing amendments to Sec. 150.4–
aggregation of positions (“Aggregation NPRM”) (Nov. 5, 2013),
including amendments to the definitions of “eligible entity” and
“independent account controller.”
155 “Swaption” was defined in vacated part 151 to mean “an
option to enter into a swap or a physical commodity option.”
“Trader” was defined in vacated part 151 to mean “a person that,
for its own account or for an account that it controls, makes
transactions in Referenced Contracts or has such transactions
made.” The Commission notes that while vacated part 151 and several
places in current part 150 use the term “trader,” the term
“person” is currently used in both Sec. 1.3(z) and in other
places in part 150. The amendments in both the Aggregation NPRM and
this NPRM use the term “person” in a manner consistent with its
current use in part 150.
—————————————————————————
a. Basis Contract
While the term “basis contract” is not defined in current Sec.
150.1, a definition was adopted in vacated Sec. 151.1. The definition
adopted in Sec. 151.1 defined basis contract as “an agreement,
contract or transaction that is cash-settled based on the difference in
price of the same commodity (or substantially the same commodity) at
different delivery locations.” When it adopted part 151, the
Commission noted that a swap based on the difference in price of a
commodity (or substantially the same commodity) at different delivery
locations was a “basis contract and therefore not subject to the
limits adopted therein.156
—————————————————————————
156 76 FR 71626, 71631 (n. 49), Nov. 18, 2011.
—————————————————————————
Under the proposal, the definition for “basis contract” adopted
in Sec. 150.1 would expand upon the definition of basis contract
adopted in vacated part 151, by defining basis contract to mean “a
commodity derivative contract that is cash-settled based on the
difference in: (1) The price, directly or indirectly, of: (a) A
particular core referenced futures contract; or (b) a commodity
deliverable on a particular core referenced futures contract, whether
at par, a fixed discount to par, or a premium to par; and (2) the
price, at a different delivery location or pricing point than that of
the same particular core referenced futures contract, directly or
indirectly, of: (a) A commodity deliverable on the same particular core
referenced futures contract, whether at par, a fixed discount to par,
or a premium to par; or (b) a commodity that is listed in appendix B to
this part as substantially the same as a commodity underlying the same
core referenced futures contract.”
The Commission notes that the proposal excludes intercommodity
spread contracts, calendar spread contracts, and basis contracts from
the definition of “commodity index contract.”
The Commission is proposing appendix B to this part, Commodities
Listed as Substantially the Same for Purposes of the Definition of
Basis Contract. The Commission proposes to expand the definition of
basis contract to include contracts cash-settled on the difference in
prices of two different, but economically closely related commodities.
The basis contract definition in vacated part 151 targeted the location
differential. Now the Commission is proposing a basis contract
definition that would expand to include certain quality differentials
(e.g., RBOB vs. 87 unleaded).157 The intent of the expanded
definition is to reduce the potential for excessive speculation in
referenced contracts where, for example, a speculator establishes a
large outright directional position in referenced contracts and nets
down that directional position with a contract based on the difference
in price of the commodity underlying the referenced contracts and a
close economic substitute that was not deliverable on the core
referenced futures contract. In the absence of this expanded
definition, the speculator could then increase further the large
position in the referenced contracts. By way of comparison, the
Commission preliminarily believes there is greater concern that (i)
someone may manipulate the markets by disguise of a directional
exposure through netting down the directional exposure using one of the
legs of a quality differential (if that quality differential contract
were not exempted) than (ii) that someone may use certain quality
differential contracts that were exempted from position limits to
manipulate the
[[Page 75697]]
outright price of a referenced contract. Historically, manipulation has
occurred though use of outright positions (as in the case of the Hunt
brothers) or time spreads (Amaranth, for example, used calendar month
spreads), rather than quality or locational differentials.
—————————————————————————
157 The expanded basis contract definition is not intended to
include significant time differentials in prices of the two
commodities (e.g., the expanded basis contract definition would not
include calendar spreads for nearby vs. deferred contracts).
—————————————————————————
The Commission seeks comment on alternatives to the specification
of quality standards for substantially the same commodity, such as a
methodology to identify and define which differential contracts should
be excluded from position limits. (i) Should the Commission expand the
definition of basis contract to include any commodity priced at a
differential to any of its products and by-products? For example,
should a basis contract include a soybean crush spread contract or a
crude oil crack spread contract, regardless of the number of
components? (ii) Should the Commission expand the definition of basis
contract to include a product or by-product of a particular commodity,
priced at a differential to another product or by-product of that same
commodity? For example, should the basis contract definition include a
contract based on jet fuel priced at a differential to heating oil? Jet
fuel and heating oil are both products of the same commodity, namely
crude oil. (iii) Should the Commission expand the definition of basis
contract for a particular commodity to include other similar
commodities? For example, should the basis contract definition include
a contract based on the difference in prices of light sweet crude oil
and a sour crude oil that is not deliverable on the WTI contract?
b. Commodity Derivative Contract
The Commission proposes in Sec. 150.1(l) to define the term
“commodity derivative contract” for position limits purposes as
shorthand for any futures, option, or swap contract in a commodity
(other than a security futures product as defined in CEA section
1a(45)). Part 150 refers only to futures and options, while vacated
part 151 was drafted without the use of any similar concise phrase. It
was determined during the process of updating part 150 that the use of
such a generic term would be a useful way to streamline and simplify
references in part 150 to the various kinds of contracts to which the
position limits regime applies. As such, this new definition can be
found frequently throughout the Commission’s proposed amendments to
part 150.158
—————————————————————————
158 See, e.g., proposed amendments to Sec. 150.1 (the
definitions of: “basis contract,” the definition of “bona fide
hedging position,” “inter-market spread position,” “intra-market
spread position,” “pre-existing position,” “speculative position
limits,” and “spot month”), Sec. Sec. 150.2(f)(2), 150.3(d),
150.3(h), 150.5(a), 150.5(b), 150.5(e), 150.7(d), 150.7(f), appendix
A to part 150, and appendix C to part 150.
—————————————————————————
c. Commodity Index Contract
The term “commodity index contract” is not currently defined in
Sec. 150.1; a definition for the term was adopted in vacated part
151.159 Under the definition adopted in Sec. 151.1, commodity index
contract means “an agreement, contract, or transaction that is not a
basis or any type of spread contract, based on an index comprised of
prices of commodities that are not the same or substantially the same;
provided that, a commodity index contract used to circumvent
speculative position limits shall be considered to be a Referenced
Contract for the purpose of applying the position limits of Sec.
151.4.” 160
—————————————————————————
159 76 FR at 71685.
160 See id.
—————————————————————————
The Commission noted in the vacated part 151 final rulemaking that
the definition of “Referenced Contract” in Sec. 151.1 expressly
excluded commodity index contracts.161 The Commission also noted that
“if a swap is based on prices of multiple different commodities
comprising an index, it is a `commodity index contract.’ ” 162 As
the preamble pointed out, it would not, therefore, be subject to
position limits.163
—————————————————————————
161 Id. at 71656.
162 Id. at 71631 n.49.
163 Id. The Commission clarifies here, that, as was noted in
the vacated part 151 Rulemaking, if a swap is based on the
difference between two prices of two different commodities, with one
linked to a core referenced futures contract price (and the other
either not linked to the price of a core referenced futures contract
or linked to the price of a different core referenced futures
contract), then the swap is an “intercommodity spread contract,”
is not a commodity index contract, and is a Referenced Contract
subject to the position limits specified in Sec. 150.2. The
Commission further clarifies that, again as was noted in the vacated
part 151 Rulemaking, a contract based on the prices of a referenced
contract and the same or substantially the same commodity (and not
based on the difference between such prices) is not a commodity
index contract and is a referenced contract subject to position
limits specified in Sec. 150.2. See id.
—————————————————————————
The Commission proposes in the current rulemaking to add into Sec.
150.1 substantially the same definition for “commodity index
contract” as was adopted in vacated Sec. 151.1, with one change. The
proviso included in Sec. 151.1, which required treatment of a position
in a commodity index contract as a Referenced Contract if the contract
was used to circumvent speculative position limits, acted in the Sec.
151.1 definition as an anti-evasion provision, a substantive regulatory
requirement. Consequently, to provide greater clarity as to the effect
of the provision, the definition of “commodity index contract”
proposed in 150.1 mirrors that of the definition in 151.1, but with no
anti-evasion proviso. Instead, an anti-evasion provision, while similar
to that contained in Sec. 151.1, is included in proposed Sec.
150.2(h).164
—————————————————————————
164 See discussion below.
—————————————————————————
As in vacated part 151, and as noted above, the definition of
“referenced contract” proposed in the current rulemaking also
expressly excludes commodity index contracts. However, as the
Commission noted in the final part 151 Rulemaking, part 20 of the
Commission’s regulations requires reporting entities to report
commodity reference price data sufficient to distinguish between
commodity index contract and non-commodity index contract positions in
covered contracts.165 Therefore, for commodity index contracts, the
Commission intends to rely on the data elements in Sec. 20.4(b) to
distinguish data records subject to Sec. 150.2 position limits from
those contracts that are excluded from Sec. 150.2. This will enable
the Commission to set position limits using the narrower data set
(i.e., referenced contracts subject to Sec. 150.2 position limits) as
well as conduct surveillance using the broader data set.
—————————————————————————
165 76 FR at 71632.
—————————————————————————
d. Core Referenced Futures Contract
While current part 150 does not contain a definition of the term
“core referenced futures contracts,” a definition for the term was
adopted in vacated Sec. 151.1 as a simple short-hand phrase to denote
certain futures contracts, regarding which several position limit rules
were then applied. The definition adopted in Sec. 151.1 provided that
a core referenced futures contract was “a futures contract defined in
Sec. 151.2”; section 151.2 provided a list of 28 physical commodity
futures and option contracts.166
—————————————————————————
166 The Commission clarified in adopting Sec. 151.2, that
core referenced futures contracts included options that expire into
outright positions in such contracts. See 76 FR at 71631.
—————————————————————————
The Commission proposes to include in Sec. 150.1 the same
definition as was adopted in vacated Sec. 151.1–such that the
definition would cite to futures contracts listed in Sec. 151.2.167
—————————————————————————
167 The selection of the core referenced futures contracts is
explained in the discussion of proposed Sec. 150.2. See discussion
below.
—————————————————————————
e. Eligible Affiliate
The term “eligible affiliate,” used in proposed Sec.
150.2(c)(2), is not defined in current Sec. 150.1. The Commission
proposes to amend Sec. 150.1 to define an
[[Page 75698]]
“eligible affiliate” as “an entity with respect to which another
person: (1) Directly or indirectly holds either: (i) A majority of the
equity securities of such entity, or (ii) the right to receive upon
dissolution of, or the contribution of, a majority of the capital of
such entity; (2) reports its financial statements on a consolidated
basis under Generally Accepted Accounting Principles or International
Financial Reporting Standards, and such consolidated financial
statements include the financial results of such entity; and (3) is
required to aggregate the positions of such entity under Sec. 150.4
and does not claim an exemption from aggregation for such entity.”
168
—————————————————————————
168 See proposed Sec. 150.1.
—————————————————————————
The definition of “eligible affiliate” proposed in the current
NPRM qualifies persons as eligible affiliates based on requirements
similar to those recently adopted by the Commission in a separate
rulemaking. On April 1, 2013, the Commission provided relief from the
mandatory clearing requirement of section 2(h)(1)(A) of the Act for
certain affiliated persons if the affiliated persons (“eligible
affiliate counterparties”) meet requirements contained in Sec.
50.52.169 Under both Sec. 50.52 and the current proposed definition,
a person is an eligible affiliate if the person, directly or
indirectly, holds a majority ownership interest in the other
counterparty (a majority of the equity securities of such entity, or
the right to receive upon dissolution of, or the contribution of, a
majority of the capital of such entity), reports its financial
statements on a consolidated basis under Generally Accepted Accounting
Principles or International Financial Reporting Standards, and such
consolidated financial statements include the financial results of such
entity. In addition, for purposes of the position limits regime, an
eligible affiliate, as proposed in Sec. 150.1, must be required to
aggregate the positions of such entity under Sec. 150.4 and does not
claim an exemption from aggregation for such entity.170
—————————————————————————
169 See Clearing Exemption for Swaps Between Certain
Affiliated Entities, 78 FR 21749, 21783, Apr. 11, 2013. Section
50.52(a) addresses eligible affiliate counterparty status, allowing
a person not to clear a swap subject to the clearing requirement of
section 2(h)(1)(A) of the Act and part 50 if the person meets the
requirements of the conditions contained in paragraphs (a) and (b)
of Sec. 50.52. The conditions in paragraph (a) of Sec. 50.52
specify either one counterparty holds a majority ownership interest
in, and reports its financial statements on a consolidated basis
with, the other counterparty, or both counterparties are majority
owned by a third party who reports its financial statements on a
consolidated basis with the counterparties.
The conditions in paragraph (b) of Sec. 50.52 address factors
such as the decision of the parties not to clear, the associated
documentation, audit, and recordkeeping requirements, the policies
and procedures that must be established, maintained, and followed by
a dealer and major swap participant, and the requirement to have an
appropriate centralized risk management program, rather than the
nature of the affiliation. As such, those conditions are less
pertinent to the definition of eligible affiliate.
170 See proposed amendments to the definition of “eligible
affiliate” in proposed Sec. 150.1.
—————————————————————————
The Commission requests comment on the proposed definition. Is the
definition an appropriate one for purposes of the position limits
regime? Should the Commission consider adopting a definition that more
closely tracks the “eligible affiliate counterparties” definition
adopted in Sec. 50.52 or is the difference appropriate in light of the
differing regulatory purposes of the two regulations?
f. Entity
The current proposal defines “entity” to mean “a `person’ as
defined in section 1a of the Act.” 171 The term is not defined in
either current Sec. 150.1, but was defined in vacated Sec. 151.1; the
language proposed here tracks that adopted in Sec. 151.1. The term
“entity,” like that of “person,” is used in a number of contexts,
and in various definitions. Defining the term, therefore, provides a
clear and unambiguous meaning, and prevents confusion.
—————————————————————————
171 CEA section 1a(38); 7 U.S.C. 1a(38).
—————————————————————————
g. Excluded Commodity
The phrase “excluded commodity” was added into the CEA in the
CFMA, but was not defined or used in part 150. CEA section 4a(a)(2)(A),
as amended by the Dodd-Frank Act, utilizes the phrase “excluded
commodity” when it provides a timeline under which the Commission is
charged with setting limits for futures and option contracts other than
on excluded commodities.172
—————————————————————————
172 CEA section 4a(2)(A); 7 U.S.C. 6a(2)(A).
—————————————————————————
Part 151 included in the definition section of vacated Sec. 151.1,
a definition which simply incorporated into part 151 the statutory
meaning, as a useful term for purposes of a number of the changes made
by part 151 to the position limits regime. For example, the phrase was
used in vacated Sec. 151.11, in the provision of acceptable practices
for DCMs and SEFs in their adoption of rules and procedures for
monitoring and enforcing position accountability provisions; it was
also used in the amendments to the definition of bona fide
hedging.173 Similarly, the Commission believes that the adoption into
part 150 of the excluded commodity definition will be a useful tool in
addressing the same provisions, and so proposes to adopt into Sec.
150.1 the definition used in Sec. 151.1.174
—————————————————————————
173 See 17 CFR 1.3(z) as amended by the vacated part 151
Rulemaking.
174 See e.g., proposed Sec. 150.1 definitions for bona fide
hedging and proposed amendments to Sec. 150.5(b).
—————————————————————————
h. First Delivery Month of the Crop Year
The term “first delivery month of the crop year” is currently
defined in Sec. 150.1(c), with a table of the first delivery month of
the crop year for the commodities for which position limits are
currently provided in Sec. 150.2. The crop year definition has been
pertinent for purposes of the spread exemption to the single month
limit in current Sec. 150.3(a)(3), which limits spread positions in a
single month to a level no more than that of the all-months limit. The
Commission did not adopt this definition in vacated part 151.175 In
the current proposal, the Commission proposes to amend Sec. 150.1 to
delete the definition of “crop year.” The elimination of the
definition reflects the fact that the definition is no longer needed,
since the current proposal, like the approach adopted in part 151,
would raise the level of individual month limits to the level of the
all-month limits.
—————————————————————————
175 See 76 FR at 71685.
—————————————————————————
i. Futures Equivalent
The term “futures-equivalent” is currently defined in Sec.
150.1(f) to mean “an option contract which has been adjusted by the
previous day’s risk factor, or delta coefficient, for that option which
has been calculated at the close of trading and published by the
applicable exchange under Sec. 16.01 of this chapter.” 176 The
Commission proposes to retain the definition currently found in Sec.
150.1(f), while broadening it in light of the Dodd-Frank Act amendments
to CEA section 4a.177 The proposed amendments would also delete, as
unnecessary, the reference to Sec. 16.01 found in the current
definition.
—————————————————————————
176 17 CFR 150.1(f).
177 Amendments to CEA section 4a(1) authorize the Commission
to extend position limits beyond futures and option contracts to
swaps traded on a DCM or SEF and swaps not traded on a DCM or SEF
that perform or affect a significant price discovery function with
respect to regulated entities (“SPDF swaps”). 7 U.S.C. 6a(a)(1).
In addition, under new CEA sections 4a(a)(2) and 4a(a)(5),
speculative position limits apply to agricultural and exempt
commodity swaps that are “economically equivalent” to DCM futures
and option contracts. 7 U.S.C. 6a(a)(2) and (5).
—————————————————————————
As proposed, “futures equivalent” would be defined in Sec. 150.1
as “(1) An option contract, whether an option on a future or an option
that is a swap, which has been adjusted by an economically reasonable
and analytically supported risk factor, or delta coefficient, for that
[[Page 75699]]
option computed as of the previous day’s close or the current day’s
close or contemporaneously during the trading day, and; (2) A swap
which has been converted to an economically equivalent amount of an
open position in a core referenced futures contract.”
Vacated Sec. 151.1 did not retain a definition for “futures-
equivalent;” instead final part 151 referred to guidance on futures
equivalency provided in appendix A to part 20.178 The Commission
notes that while the part 20 “futures equivalent” definition is
consistent with the “futures-equivalent” definition proposed herein,
it addresses only swaps, and cites to, and relies on, the guidance
provided in appendix A to part 20.179 The definition proposed herein
addresses both options on futures and options that are swaps; it also
includes and expands upon clarifications that are incorporated into the
current definition regarding the computation time and the adjustment by
an economically reasonable and analytically supported risk factor, or
delta coefficient.
—————————————————————————
178 76 FR at 71633 (n. 67) (stating that “For purposes of
applying the limits, a trader shall convert and aggregate positions
in swaps on a futures equivalent basis consistent with the guidance
in the Commission’s appendix A to Part 20, Large Trader Reporting
for Physical Commodity Swaps.”). See also 76 FR 43851, 43865, Jul.
22, 2011.
179 See 17 CFR 20.1 (“Futures equivalent means an
economically equivalent amount of one or more futures contracts that
represents a position or transaction in one or more paired swaps or
swaptions consistent with the conversion guidelines in appendix A of
this part.”).
—————————————————————————
As noted above, the current Sec. 150.1(f) definition of “futures-
equivalent” is narrowly defined to mean “an option contract,” and
nothing else. Although certain contracts, from a practical standpoint,
may be economically equivalent to futures contracts, as that terms is
defined in Sec. 150.1, such products are not “futures-equivalent”
under the narrow definition of current Sec. 150.1(f) unless they are
options on those actual futures. Therefore, current Sec. 150.1(f) is
narrowly tailored to target only specifically enumerated futures
contracts on “legacy” agricultural commodities and their equivalent
options.
The current rulemaking, like vacated part 151, establishes federal
position limits and limit formulas for 28 physical commodity futures
and option contracts, or “core referenced futures contracts,” and
applies these limits to all derivatives that are directly or indirectly
linked to the price of a core referenced futures contracts, or based on
the price of the same commodity underlying that particular core
referenced futures contract for delivery at the same location or
locations as specified in that particular core referenced futures
contract, and defines such derivative products, collectively, as
“referenced contracts.” Therefore, the position limits amendments
proposed in this current rulemaking, similar to the position limits
regime established in vacated part 151, apply across different trading
venues to economically equivalent contracts, as that term is defined in
Sec. 150.1, that are based on the same underlying commodity. As
discussed supra, however, current part 150 defines “futures-
equivalent” narrowly to mean “an option contract,” and makes no
mention of broadly defined “referenced contracts.” Consequently, as
noted above, and consistent with these changes to the position limits
regime, including the applicability of aggregate position limits to
economically equivalent “referenced contracts” across different
trading venues, the Commission proposes to expand the strict “futures-
equivalent” standard set forth in current part 150.
j. Intercommodity Spread Contract
Current part 150 does not include a definition of the term
“intercommodity spread contract,” which was introduced and adopted in
vacated part 151. The Commission proposes to add into Sec. 150.1 the
definition adopted in Sec. 151.1,180 such that an “intercommodity
spread contract” means “a cash-settled agreement, contract or
transaction that represents the difference between the settlement price
of a referenced contract and the settlement price of another contract,
agreement, or transaction that is based on a different commodity.” The
Commission determined, however, to adopt the term “intercommodity
spread contract” as part of the definition of reference contract
rather than as a separate term, since the phrase “intercommodity
spread contract” is used solely for purposes of defining the term
“referenced contract.” The inclusion of the term as part of the
definition of referenced contract is intended to simplify the
definition section and make it easier to understand.
—————————————————————————
180 In vacated part 151, “intercommodity spread contract”
was defined to mean “a cash-settled agreement, contract or
transaction that represents the difference between the settlement
price of a Referenced Contract and the settlement price of another
contract, agreement, or transaction that is based on a different
commodity.” See vacated Sec. 151.1.
—————————————————————————
k. Intermarket Spread Position
The term “intermarket spread position” is not defined in current
part 150, and was not adopted in part 151. But in conjunction with the
amendments to part 150 to address the changes to CEA section 4a made by
the Dodd-Frank Act,181 the Commission proposes to add into Sec.
150.1 a definition for “intermarket spread position” to mean “a long
position in a commodity derivative contract in a particular commodity
at a particular designated contract market or swap execution facility
and a short position in another commodity derivative contract in that
same commodity away from that particular designated contract market or
swap execution facility.” Among the changes to CEA section 4a, new
section 4a(a)(6) of the Act requires the Commission to apply position
limits on an aggregate basis to contracts based on the same underlying
commodity across certain markets.182 The Commission believes that the
term “intermarket spread position” simplifies the proposed changes to
Sec. 150.5, which provide acceptable exemptions DCMs and SEFs may
choose to grant from speculative position limits.183
—————————————————————————
181 See e.g., discussions of Dodd-Frank changes to CEA section
4a above and below.
182 CEA section 4a(a)(6) requires the Commission to apply
position limits on an aggregate basis to (1) contracts based on the
same underlying commodity across DCMs; (2) with respect to foreign
boards of trade (“FBOTs”), contracts that are price-linked to a
DCM or SEF contract and made available from within the United States
via direct access; and (3) SPDF swaps. 7 U.S.C. 6a(a)(6). See also,
consideration of proposed changes to Sec. 150.2 for further
discussion.
183 See e.g., Sec. 150.5(a)(2)(B)(ii); see also
150.5(b)(5)(b)(iv).
—————————————————————————
l. Intramarket Spread Position
Neither current part 150, nor vacated part 151, includes a
definition of the term “intramarket spread contract.” The Commission
now proposes to add into Sec. 150.1 the definition, such that
“intramarket spread position” means “a long position in a commodity
derivative contract in a particular commodity and a short position in
another commodity derivative contract in the same commodity on the same
designated contract market or swap execution facility.”
Current part 150 includes exemptions for certain spread positions.
For example, current Sec. 150.3(a)(3) provides an exemption for spread
(or arbitrage) positions, but this exemption is limited to those
between single months for futures contracts and/or, options thereon, if
outside of the spot month, and only if in the same crop year. While
current Sec. 150.3(a)(3) limits the spread
[[Page 75700]]
exemption provided thereunder, the exemption under current Sec.
150.5(a) is not so limited. Instead, under current Sec. 150.5(a),
exchanges may exempt from position limits “positions which are
normally known in the trade as “spreads, straddles, or arbitrage. . .
.” 184 The Commission notes that the definition it now proposes for
“intramarket spread position” is a generic term, and not limited only
to futures and/or options thereon.185 In a similar manner to adoption
of the term “intermarket spread position,” the term “intramarket
spread position,” therefore, simplifies the Commissions amendments to
exemptions for spread positions, including proposed changes to Sec.
150.5, which, as noted above, provide acceptable exemptions DCMs and
SEFs may choose to grant from speculative position limits.
—————————————————————————
184 The Commission notes that the exemption provided in Sec.
150.5(a) for “positions which are normally known in the trade as
`spreads, straddles, or arbitrage,’ ” tracks CEA section 4a(a)(1).
7 U.S.C. 6a(a)(1). Also, various DCMs currently have rules in place
that provide exemptions for such as “spreads, straddles, or
arbitrage” positions. See, e.g., ICE Futures U.S. rule 6.27 and CME
rule 559.C.
185 For further discussion regarding the exemptions for
intramarket spread positions, see infra, discussion regarding Sec.
150.5(a)(2) and (b)(5).
—————————————————————————
m. Long Position
The term “long position” is currently defined in Sec. 150.1(g)
to mean “a long call option, a short put option or a long underlying
futures contract,” but the phrase was not retained in vacated Sec.
151.1. The Commission proposes to retain the definition, but to update
it to make it also applicable to swaps such that a long position would
include a long futures-equivalent swap.
n. Physical Commodity
The Commission proposes to amend Sec. 150.1 by adding in a
definition of the term “physical commodity” for position limits
purposes. Congress used the term “physical commodity” in CEA sections
4a(a)(2)(A) and 4a(a)(2)(B) to mean commodities “other than excluded
commodities as defined by the Commission.” Therefore, the Commission
interprets “physical commodities” to include both exempt and
agricultural commodities, but not excluded commodities, and proposes to
define the term as such.186
—————————————————————————
186 For position limits purposes, proposed Sec. 150.1 would
define “physical commodity” to mean “any agricultural commodity
as that term is defined in Sec. 1.3 of this chapter or any exempt
commodity as that term is defined in section 1a(20) of the Act.”
—————————————————————————
o. Referenced Contracts
Part 150 currently does not include a definition of the phrase
“Referenced Contract,” which was introduced and adopted in vacated
part 151.187 As was noted when part 151 was adopted, the Commission
identified 28 core referenced futures contracts and proposed to apply
aggregate limits on a futures equivalent basis across all derivatives
that [met the definition of Referenced Contracts’].” 188
—————————————————————————
187 Vacated Sec. 151.1 defined “Referenced Contract” to
mean “on a futures-equivalent basis with respect to a particular
Core Referenced Futures Contract, a Core Referenced Futures Contract
listed in Sec. 151.2, or a futures contract, options contract, swap
or swaption, other than a basis contract or contract on a commodity
index that is: (1) Directly or indirectly linked, including being
partially or fully settled on, or priced at a fixed differential to,
the price of that particular Core Referenced Futures Contract; or
(2) Directly or indirectly linked, including being partially or
fully settled on, or priced at a fixed differential to, the price of
the same commodity underlying that particular Core Referenced
Futures Contract for delivery at the same location or locations as
specified in that particular Core Referenced Futures Contract.”
188 76 FR at 71629.
—————————————————————————
The vacated Sec. 151.1 definition of Referenced Contracts
included: (1) The Core Referenced Futures Contract; (2) “look-alike”
contracts (i.e., those that settle off of the Core Referenced Futures
Contract and contracts that are based on the same commodity for the
same delivery location as the Core Referenced Futures Contract); (3)
contracts with a reference price based only on the combination of at
least one Referenced Contract price and one or more prices in the same
or substantially the same commodity as that underlying the relevant
Core Referenced Futures Contract; and (4) intercommodity spreads with
two components, one or both of which are Referenced Contracts.
According to the Commission, these criteria captured contracts with
prices that are or should be closely correlated to the prices of the
Core Referenced Futures Contract, as defined in vacated Sec.
151.1.189 In addition, the definition included categories of
Referenced Contract based on objective criteria and readily available
data (i.e., derivatives that are directly or indirectly linked to or
based on the same commodity for delivery at the same delivery location
as a Core Referenced Futures Contract).190 At that time, the
Commission clarified that a swap contract using as its sole floating
reference price the prices generated directly or indirectly from the
price of a single Core Referenced Futures Contract or a swap priced
based on a fixed differential to a Core Referenced Futures Contract,
were look-alike Referenced Contracts, and subject to the limits adopted
in vacated part 151.191 In addition, the definition included options
that expire into outright positions in such contracts.192
—————————————————————————
189 Id. at 71630.
190 Id. at 71630-31.
191 Id. at 71631 n.50 (“The Commission has clarified in its
definition of `Referenced Contract’ that position limits extend to
contracts traded at a fixed differential to a Core Referenced
Futures Contract (e.g., a swap with the commodity reference price
NYMEX Light, Sweet Crude Oil + $3 per barrel is a Referenced
Contract) or based on the same commodity at the same delivery
location as that covered by the Core Referenced Futures Contract,
and not to unfixed differential contracts (e.g., a swap with the
commodity reference price Argus Sour Crude Index is not a Referenced
Contract because that index is computed using a variable
differential to a Referenced Contract).”).
192 Id. at 71631.
—————————————————————————
In response to comments that the Commission should broaden the
scope of Referenced Contracts, the Commission noted that expanding the
scope of position limits based, for example, on cross-hedging
relationships or other historical price analysis would be problematic
as historical relationships may change over time and, additionally,
would require individualized determinations. In light of these
circumstances, the Commission determined that it was not necessary to
expand the scope of position limits beyond what was adopted. The
Commission also noted that the commenters did not provide specific
criteria or thresholds for making determinations as to which price-
correlated commodity contracts should be subject to limits, further
noting that it would consider amending the scope of economically
equivalent contracts (and the relevant identifying criteria) as it
gained experience in this area.193
—————————————————————————
193 Id.
—————————————————————————
The definition for “referenced contract” proposed in Sec. 150.1
mirrors the definition proposed in Sec. 151.1, with the delineation of
several related terms incorporated into the definition.194 The
[[Page 75701]]
beginning of the current definition parallels the definition in vacated
Sec. 151.1, differing only with the addition of a clarification that
the definition of “referenced contract” does not include guarantees
of a swap. This clarification is added into the list of products that
are not included in the definition.195 In the proposed definition,
“referenced contract” would not include “a guarantee of a swap, a
basis contract, or a commodity index contract.” 196 In addition, for
the sake of clarify, the proposal incorporates into the definition of
“referenced contract” several related terms. Consequently, the
definition for “referenced contract” delineates the meaning of
“calendar spread contract,” “commodity index contract,” “spread
contract,” and “intercommodity spread contract.” 197 The
incorporation of these terms into the definition of “referenced
contract” is intended to retain in one place the various parts and
meanings of the definition, thereby facilitating comprehension of the
definition.
—————————————————————————
194 In the current rulemaking, the term “referenced
contract” is defined in Sec. 150.1 to mean, on a futures-
equivalent basis with respect to a particular core referenced
futures contract, “a core referenced futures contract listed in
Sec. 151.2(d) of this part, or a futures contract, options
contract, or swap, other than a guarantee of a swap, a basis
contract, or a commodity index contract: (1) That is: (a) Directly
or indirectly linked, including being partially or fully settled on,
or priced at a fixed differential to, the price of that particular
core referenced futures contract; or (b) Directly or indirectly
linked, including being partially or fully settled on, or priced at
a fixed differential to, the price of the same commodity underlying
that particular core referenced futures contract for delivery at the
same location or locations as specified in that particular core
referenced futures contract; and (2) Where: (a) Calendar spread
contract means a cash-settled agreement, contract, or transaction
that represents the difference between the settlement price in one
or a series of contract months of an agreement, contract or
transaction and the settlement price of another contract month or
another series of contract months’ settlement prices for the same
agreement, contract or transaction; (b) Commodity index contract
means an agreement, contract, or transaction that is not a basis or
any type of spread contract, based on an index comprised of prices
of commodities that are not the same or substantially the same; (c)
Spread contract means either a calendar spread contract or an
intercommodity spread contract; and (d) Intercommodity spread
contract means a cash-settled agreement, contract or transaction
that represents the difference between the settlement price of a
referenced contract and the settlement price of another contract,
agreement, or transaction that is based on a different commodity.”
195 As defined in vacated Sec. 151.1, “Referenced Contract”
excludes “a basis contract or contract on a commodity index.” See
vacated Sec. 151.1.
196 The Commission proposes to exclude a guarantee of a swap
from the definition of a referenced contract due to regulatory
developments that occurred after the vacated part 151 Rulemaking. In
connection with further defining the term “swap” jointly with the
Securities and Exchange Commission, (see generally Further
Definition of “Swap,” “Security-Based Swap,” and “Security-
Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement
Recordkeeping, 77 FR 48208, Aug. 13, 2012 (“Product Definitions
Adopting Release”)), the Commission interpreted the term “swap”
(that is not a “security-based swap” or “mixed swap”) to include
a guarantee of such swap, to the extent that a counterparty to a
swap position would have recourse to the guarantor in connection
with the position. See id. at 48226. Excluding guarantees of swaps
from the definition of referenced contract should help avoid any
potential confusion regarding the application of position limits to
guarantees of swaps, which could impede the Commission’s efforts to
monitor compliance with the requirements of the CEA. In addition, if
the rules proposed in the Aggregation NPRM are adopted, it would
obviate the need to include guarantees of swaps in the definition of
referenced contracts.
197 Compare vacated Sec. 151.1 with proposed Sec. 150.1.
—————————————————————————
p. Short Position
The term “short position” is currently defined in Sec. 150.1(c)
to mean “a short call option, a long put option, or a short underlying
futures contract.” Vacated part 151 did not retain this definition.
The current proposal would amend the definition to state that a short
position means “a short call option, a long put option or a short
underlying futures contract, or a short futures-equivalent swap.” This
revised definition reflects the fact that under the Dodd-Frank Act, the
Commission is charged with applying the position limits regime to
swaps.
q. Speculative Position Limit
The term “speculative position limit” is currently not defined in
Sec. 150.1 and was not defined in vacated part 151. The Commission now
proposes to define the term “speculative position limit” to mean
“the maximum position, either net long or net short, in a commodity
derivatives contract that may be held or controlled by one person,
absent an exemption, such as an exemption for a bona fide hedging
position. This limit may apply to a person’s combined position in all
commodity derivative contracts in a particular commodity (all-months-
combined), a person’s position in a single month of commodity
derivative contracts in a particular commodity, or a person’s position
in the spot month of commodity derivative contacts in a particular
commodity. Such a limit may be established under federal regulations or
rules of a designated contract market or swap execution facility. An
exchange may also apply other limits, such as a limit on gross long or
gross short positions, or a limit on holding or controlling delivery
instruments.”
This proposed definition is similar to definitions for position
limits used by the Commission for many years; the various regulations
and defined terms included use of maximum amounts “net long or net
short,” which limited what any one person could “hold or control,”
“one grain on any one contract market” (or in “in one commodity” or
“a particular commodity”), and “in any one future or in all futures
combined.” For example, in 1936, Congress enacted the CEA, which
authorized the CFTC’s predecessor, the CEC, to establish limits on
speculative trading. Congress empowered the CEC to “fix such limits on
the amount of trading . . . as the [CEC] finds is necessary to
diminish, eliminate, or prevent such burden.” 198 The first
speculative position limits were issued by the CEC in December
1938.199 Those first speculative position limits rules provided in
Sec. 150.1 for limits on position and daily trading in grain for
future delivery, adopting a maximum amount “net long or net short
position which any one person may hold or control in any one grain on
any one contract market” as 2,000,000 bushels “in any one future or
in all futures combined.” 200
—————————————————————————
198 CEA section 6a(1) (Supp. II 1936).
199 3 FR 3145, Dec. 24, 1938.
200 17 CFR 150.1 (1938) (Part 150–Orders of The Commodity
Exchange Commission)(“Limits on position and daily trading in grain
for future delivery. The following limits on the amount of trading
under contracts of sale of grain for future delivery on or subject
to the rules of contract markets which may be done by any person are
hereby proclaimed and fixed, to be in full force and effect on and
after December 31, 1938: (a) Position limits. (1) The limit on the
maximum net long or net short position which any one person may hold
or control in any one grain on any one contract market, except as
specifically authorized by paragraph (a) (2), is: 2,000,000 bushels
in any one future or in all futures combined. (2) To the extent that
the net position held or controlled by any one person in all futures
combined in any one grain on any one contract market is shown to
represent spreading in the same grain between markets, the limit on
net position in all futures combined set forth in paragraph (a)(1)
may be exceeded on such contract market, but in no case shall the
excess result in a net position of more than 3,000,000.”).
—————————————————————————
Another example is found in the glossaries published by the
Commission for many years. Various Commission documents over the years
have included a glossary. For example, the Commission’s annual report
for 1983 includes in its glossary “Position Limit The maximum
position, either net long or net short, in one commodity future
combined which may be held or controlled by one person as prescribed by
any exchange or by the CFTC.” The version of the staff glossary
currently posted on the CFTC Web site defines speculative position
limit as “[t]he maximum position, either net long or net short, in one
commodity future (or option) or in all futures (or options) of one
commodity combined that may be held or controlled by one person (other
than a person eligible for a hedge exemption) as prescribed by an
exchange and/or by the CFTC.”
r. Spot Month
Vacated part 151 adopted an amended definition for “spot month”
that replaced the definition for spot month currently found in Sec.
150.1 by citing to the definition provided in Sec. 151.3. Vacated
Sec. 151.3 provided detailed lists of spot months separately for
agricultural, metals and energy commodities.
The Commission proposes to adopt a simplified update to the
definition of “spot month” by expanding upon the current Sec. 150.1
definition. The definition, as expanded, would specifically address
both physical-delivery contracts and cash-settled contracts, and
clarify the duration of “spot month.” Under the proposed changes, the
term “spot month” does not refer to a month of time. Rather, the
definition clarifies that the “spot
[[Page 75702]]
month” is the trading period immediately preceding the delivery period
for a physical-delivery futures contract as well as for any cash-
settled swaps and futures contracts that are linked to the physical-
delivery contract. The definition continues to define the spot month as
the period of time beginning at of the close of trading on the trading
day preceding the first day on which delivery notices can be issued to
the clearing organization of a contract market, while adding in a
clarification that this definition applies only to physical-delivery
commodity derivatives contracts. For physical-delivery contracts with
delivery beginning after the last trading day, the proposal defines the
spot month as the close of trading on the trading day preceding the
third-to-last trading day, until the contract is no longer listed for
trading (or available for transfer, such as through exchange for
physical transactions). This definition is consistent with the current
spot month for each of the 28 core referenced futures contracts. The
definition proposes similar, but slightly different language for cash-
settled contracts, providing that the spot month begins at the earlier
of the start of the period in which the underlying cash-settlement
price is calculated or the close of trading on the trading day
preceding the third-to-last trading day and continues until the
contract cash-settlement price is determined.201 In addition, the
definition includes a proviso that, if the cash-settlement price is
determined based on prices of a core referenced futures contract during
the spot month period for that core referenced futures contract, then
the spot month for that cash-settled contract is the same as the spot
month for that core referenced futures contract.202
—————————————————————————
201 For example, a “look-alike” contract that references a
calendar-month average of settlement prices would have the same
spot-month limit as the core referenced futures contract (CRFC) but
the limit would be in effect beginning with the first calendar day
of the cash-settlement period; a “look-alike” contract that
references a single day’s settlement price in the spot-month of the
CRFC would have a spot-month limit at the same level as the CRFC but
the limit would be in effect only during the spot month of the CRFC.
202 For example, the physical-delivery NYMEX Henry Hub Natural
Gas futures contract would have, as is currently the case for the
exchange spot month limit, a spot period beginning on close of
trading three business days prior to the last trading day of that
core referenced futures contract. The NYMEX Henry Hub Natural Gas
Penultimate Financial futures contract (which is cash-settled based
on the NYMEX Henry Hub Natural Gas Futures contract settlement price
on the business day preceding the last trading day for that
physical-delivery contract, and is currently subject to position
accountability effective on the last three trading days of the
futures contract), would have a spot month period that is the same
as that of the physical-delivery NYMEX Henry Hub Natural Gas futures
contract.
—————————————————————————
s. Spot-Month, Single-Month, and All-Months-Combined Position Limits
In addition to a definition for “spot month,” current part 150
includes definitions for “single month,” and for “all-months” where
“single month” is defined as “each separate futures trading month,
other than the spot month future,” and “all-months” is defined as
“the sum of all futures trading months including the spot month
future.”
Vacated part 151 retained only the definition for spot month, and,
instead, adopted a definition for “spot-month, single-month, and all-
months-combined position limits.” The definition provided that, for
Referenced Contracts based on a commodity identified in Sec. 151.2,
the maximum number of contracts a trader may hold was as provided in
Sec. 151.4.
In the current rulemaking proposal, as noted above, the Commission
proposes to amend Sec. 150.1 by deleting the definitions for “single
month,” and for “all-months.” Unlike the vacated part 151
Rulemaking, the current proposal does not include a definition for
“spot-month, single-month, and all-months-combined position limits.”
Instead, the current rulemaking proposes to adopt a definition for
“speculative position limits” that should obviate the need for these
definitions.203
—————————————————————————
203 See supra discussion of the proposed definition of
“speculative position limit.”
—————————————————————————
t. Spread Contract
Spread contract was defined in vacated part 151 as “either a
calendar spread contract or an intercommodity spread contract.” 204
The Commission proposes to add the same definition into Sec. 150.1 in
conjunction with the proposal to define “referenced contract.” 205
—————————————————————————
204 Vacated Sec. 151.1.
205 See supra discussion of proposed Sec. 150.1 “referenced
contract” definition.
—————————————————————————
The Commission also notes that while the proposed definition of
“referenced contract” specifically excludes guarantees of a swap,
basis contracts and commodity index contracts, spread contracts are not
excluded from the proposed definition of “referenced contract.” 206
—————————————————————————
206 The Commission notes that this is consistent with vacated
part 151. See, e.g., the final part 151 Rulemaking, which noted that
commodity index contracts, which by the definition in vacated Sec.
151.1 were expressly excluded from the definition of “Referenced
Contract,” were not spread contracts. 76 FR at 71656. See also, the
definition of “commodity index contract,” which is defined as “a
contract, agreement, or transaction “that is not a basis or any
type of spread contract, [and] based on an index comprised of prices
of commodities that are not the same nor substantially the same.”
Vacated Sec. 151.1.
—————————————————————————
u. Swap
The definitions of several terms adopted in vacated part 151 relied
on the statutory definition in some cases in conjunction with a further
definition adopted by the Commission in other rulemakings.207 Other
defined terms that rely on the statutory definition in included:
“entity,” “excluded commodity,” and “swap dealer.” Since the
adoption of part 151, the Commission, in a joint rulemaking with the
Securities and Exchange Commission, adopted a further definition for
“swap” in Sec. 1.3(xxx).208 Consequently, the definition of
“swap” proposed in the current rulemaking, while paralleling that of
the definition included in vacated Sec. 151.1, and while substantially
the same, additionally cites to the definition of “swap” found in
Sec. 1.3(xxx).
—————————————————————————
207 Under vacated Sec. 151.1, the term “[s]wap means `swap’
as defined in section 1a of the Act and as further defined by the
Commission.”
208 See 77 FR 48208, 48349, Aug. 13, 2012.
—————————————————————————
v. Swap Dealer
The term “swap dealer” is not currently defined in Sec. 150.1,
but was defined in vacated 151.1 to mean “ `swap dealer’ as that term
is defined in section 1a of the Act and as further defined by the
Commission.” 209 Similar to the definition of “swap,” the
Commission adopted a definition for “swap dealer” since part 151 was
finalized.210 Under the current proposal, Sec. 150.1 would be amend
to define “swap dealer” to mean “ `swap dealer’ as that term is
defined in section 1a of the Act and as further defined in section 1.3
of this chapter.” This revised definition reflects the fact that the
definition of “swap dealer,” while paralleling that of the definition
included in Sec. 151.1, and while substantially the same, additionally
cites to the definition of “swap dealer” found in Sec. 1.3(ggg).
—————————————————————————
209 See vacated Sec. 151.1.
210 77 FR 30596, May 23, 2012.
—————————————————————————
ii. Bona Fide Hedging Definition
The core of the Commission’s approach to defining bona fide hedging
over the years has focused on transactions that offset a recognized
physical price risk.211 Once a bona fide
[[Page 75703]]
hedge is implemented, the hedged entity should be price insensitive
because any change in the value of the underlying physical commodity is
offset by the change in value of the entity’s physical commodity
derivative position.
—————————————————————————
211 For an historical perspective on the bona fide hedging
provision prior to the Dodd-Frank amendments, see Testimony of
General Counsel Dan M. Berkovitz, Commodity Futures Trading
Commission, “Position Limits and the Hedge Exemption, Brief
Legislative History,” July 28, 2009, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement072809.
—————————————————————————
Because a firm that has hedged its price exposure is price neutral
in its overall physical commodity position, the hedged entity should
have little incentive to manipulate or engage in other abusive market
practices to affect prices. By contrast, a party that maintains a
derivative position that leaves them with exposure to price changes is
not neutral as to price and, therefore, may have an incentive to affect
prices. Further, the intention of a hedge exemption is to enable a
commercial entity to offset its price risk; it was never intended to
facilitate taking on additional price risk.
The Commission recognizes there are complexities to analyzing the
various commercial price risks applicable to particular commercial
circumstances in order to determine whether a hedge exemption is
warranted. These complexities have led the Commission, from time to
time, to issue rule changes, interpretations, and exemptions. Congress,
too, has periodically revised the Federal statutes applicable to bona
fide hedging, most recently in the Dodd-Frank Act. These complexities
will be further explored below.
a. Bona Fide Hedging History
Prior to 1974, the term bona fide hedging transactions or positions
was defined in section 4a(3) of the Act. That definition only applied
to agricultural commodities. When the Commission was created in 1974,
the Act’s definition of commodity was expanded. At that time, Congress
was concerned that the limited hedging definition, even if applied to
newly regulated commodity futures, would fail to accommodate the
commercial risk management needs of market participants that could
emerge over time. Accordingly, Congress, in section 404 of the
Commodity Futures Trading Commission Act of 1974, repealed the
statutory definition and gave the Commission the authority to define
bona fide hedging.212 In response to the 1974 legislation, the
Commission’s predecessor adopted in 1975 a bona fide hedging definition
in Sec. 1.3(z) of its regulations stating, among other requirements,
that transactions or positions would not be classified as hedging
unless their bona fide purpose was to offset price risks incidental to
commercial cash or spot operations, and such positions were established
and liquidated in an orderly manner and in accordance with sound
commercial practices.213 Shortly thereafter, the newly formed
Commission sought comment on amending that definition.214 Given the
large number of issues raised in comment letters, the Commission
adopted the predecessor’s definition with minor changes as an interim
definition of bona fide hedging transactions or positions, effective
October 18, 1975.215
—————————————————————————
212 Section 404 of Public Law 93-463, October 23, 1974, (CFTC
Act), amended section 4a(3) of the Act, deleting the statutory
definition of bona fide hedging position or transaction and
directing the newly-established Commission to issue a rule defining
that term.
213 Pending promulgation of a definition by the Commission,
the Secretary of Agriculture promulgated Sec. 1.3(z) pursuant to
section 404 of the CFTC Act. 40 FR 11560, Mar. 12, 1975. This
definition of bona fide hedging in new Sec. 1.3(z) deviated in only
minor ways from the hedging definition contained in section 4a(3) of
the Act. The Commodity Exchange Commission subsequently issued
conforming amendments to various rules. 40 FR 15086, Apr. 4, 1975.
214 40 FR 34627, Aug. 18, 1975. The Commission sought comment
on many issues, including whether to include in the definition of
bona fide hedging transactions and positions “the practice of many
traders which results in hedging of gross cash positions rather than
a net cash position–so-called `double hedging.’ ” Id. at 34628.
The Commission later noted “that net cash positions do not
necessarily measure total risk exposure and in such cases the
hedging of gross cash positions does not constitute `double
hedging.’ ” 42 FR 42748, 42750, Aug. 24, 1977.
215 40 FR 48688, Oct. 17, 1975. The Commission re-issued all
regulations, with rule 1.3(z) essentially unchanged, in 1976. 41 FR
3192, 3195, Jan. 21, 1976.
—————————————————————————
In 1977, the Commission proposed a revised definition of bona fide
hedging that largely forms the basis of the current definition of bona
fide hedging.216 The 1977 proposed definition set forth: (i) A
general definition of bona fide hedging positions under economically
appropriate circumstances and subject to other conditions (noted
below); (ii) an enumerated list of specific positions that conform to
the general definition; and (iii) a procedure to consider non-
enumerated cases.217 The 1977 proposal, as adopted, established the
concept of portfolio hedging and recognized cross-commodity hedges and
hedges of anticipated production or unfilled anticipated requirements,
provided such hedges were not recognized in the five last days of
trading in any particular futures contract (the “five-day rule” in
current Sec. 1.3(z)(2)).218
—————————————————————————
216 42 FR 14832, Mar. 16, 1977.
217 Id.
218 42 FR 42748, Aug. 24, 1977.
—————————————————————————
The general definition of bona fide hedging in current Sec.
1.3(z), as was the case when adopted in 1977, advises that a position
should “normally represent a substitute for . . . positions to be
taken at a later time in a physical marketing channel,” and requires
such position to be “economically appropriate to the reduction of
risks in the conduct of a commercial enterprise,” and where the risks
arise from the potential change in value of assets, liabilities or
services.219 Such bona fide hedges also must have a purpose “to
offset price risks incidental to commercial cash or spot operations”
and must be “established and liquidated in an orderly manner in
accordance with sound commercial practices.” Thus a bona fide hedge
exemption was appropriate where there was a demonstrated physical price
risk that had been recognized. This also applies, for example, to bona
fide hedge exemptions for unfilled anticipated requirements, where
processors or manufacturers are exposed to price risk on such unfilled
anticipated requirements necessary for their manufacturing or
processing.220
—————————————————————————
219 17 CFR 1.3(z)(1) (2010). The Commission cautions that the
e-CFR version of Sec. 1.3(z) reflects changes made by the vacated
2011 final rule.
220 The Commission notes that the definition of bona fide
hedging transactions or positions historically included an exemption
for unfilled anticipated requirements. As the Commission stated in
1974, in its proposal to adopt Sec. 1.3(z), the regulation on the
hedging definition proposed by the Secretary of Agriculture was
intended to comply with the intent of section 404 of Public Law 93-
463, enacted October 23, 1974, as stated in the Conference Report
accompanying HR. 13113, pp. 40-1. The Commission noted in its
proposal that the new statutory language was intended to allow
processors and manufacturers to hedge unfilled annual requirements.
39 FR 39731, Nov. 11, 1974.
—————————————————————————
The 1977 proposed definition did not include the modifying adverb
“normally” to the verb “represent.” 221 The Commission explained
in the 1977 preamble it intended to recognize bona fide hedging
positions “on the basis of net risk related to changes in the values
reflected on balance sheets.” 222 The Commission introduced the
adverb normally in the 1977 final rulemaking in order to make clear it
would recognize as bona fide such balance sheet hedging and “other [at
the time] relatively infrequent but potentially important examples of
risk reducing futures transactions” that would otherwise not have met
the general definition of bona fide hedging.223 The Commission noted:
“One form of balance sheet hedging would involve offsetting net
exposure to changes in currency exchange rates for the purpose of
stabilizing the domestic dollar accounting value of assets which are
held abroad. In the case of depreciable capital assets, such hedging
transactions
[[Page 75704]]
might not represent a substitute for subsequent transactions in a
physical marketing channel.” 224
—————————————————————————
221 See 42 FR 42748, Aug. 24, 1977.
222 Id.
223 42 FR at 42749.
224 Id. at 42749 (n. 1).
—————————————————————————
With respect to the five-day rule in current Sec. 1.3(z)(2) for
anticipatory hedges of unfilled anticipated requirements, the
Commission observed that historically there was a low utilization of
this provision in terms of actual positions acquired in the futures
market.225 For cross commodity and short anticipatory hedge
positions, the Commission did “not believe that persons who do not
possess or do not have a commercial need for the commodity for future
delivery will normally wish to participate in the delivery process.”
226
—————————————————————————
225 Id. at 42749. The five-day rule in current Sec. 1.3(z)(2)
for anticipatory hedges permits an exception for a person with a
long anticipatory hedging need, for up to two months unfilled
anticipated requirements.
226 Id.
—————————————————————————
In 1979, the Commission eliminated daily speculative trading volume
limits and concluded such daily trading limits were “not necessary to
diminish, eliminate or prevent excessive speculation.” 227 The
Commission noted eliminating daily trading limits had no effect on the
limits on the size of speculative positions which any one person may
hold or control on a single contract market. The Commission also noted
the speculative position limits apply to positions throughout the day
as well as to positions at the close of the trading session.228 The
Commission continues to apply position limits throughout the day and
will continue under this proposal.
—————————————————————————
227 44 FR 7124, Feb. 6, 1979.
228 Id. at 7125.
—————————————————————————
In the aftermath of the silver futures market crisis during late
1979 to early 1980,229 in 1981 the Commission adopted Sec. 1.61,
subsequently incorporated into Sec. 150.5, requiring DCMs to adopt
speculative position limits and providing an exemption for “bona fide
hedging positions as defined by a contract market in accordance with
Sec. 1.3(z)(1) of the Commission’s regulations.” 230 That rule
permits DCMs to limit bona fide hedging positions which it determines
are not in accord with sound commercial practices or exceed an amount
which the exchange determines may be established or liquidated in an
orderly fashion.
—————————————————————————
229 See, In re Nelson Bunker Hunt et al., CFTC Docket No. 85-
12.
230 46 FR 50938, 50945, Oct. 16, 1981. With the passage of the
Commodity Futures Modernization Act in 2000 and the Commission’s
subsequent adoption of the part 38 regulations covering DCMs in 2001
(66 FR 42256, Aug. 10, 2001), part 150’s approach to exchange-set
speculative position limits was incorporated as an acceptable
practice under DCM Core Principle 5–Position Limitations and
Accountability. 72 FR 66097, 66098 n.1, Nov. 27, 2007.
—————————————————————————
In 1986, in response to concerns raised in testimony regarding the
constraints on investment decisions imposed by position limits, the
House Committee on Agriculture, in its report accompanying the
Commission’s 1986 reauthorization legislation, instructed the
Commission to reexamine its approach to speculative position limits and
its definition of hedging.231 Specifically, the Committee Report
“strongly urge[d] the Commission to undertake a review of its hedging
definition . . . and to consider giving certain concepts, uses, and
strategies `non-speculative’ treatment . . . whether under the hedging
definition or, if appropriate, as a separate category similar to the
treatment given certain spread, straddle or arbitrage positions . . .
” 232 The Committee Report singled out four categories of trading
and positions that the Commission should consider recognizing as non-
speculative: (i) “Risk management” trading by portfolio managers as
an alternative to the concept of “risk reduction;” (ii) futures
positions taken as alternatives to, rather than as temporary
substitutes for, cash market positions; (iii) other positions acquired
to implement strategies involving the use of financial futures
including, but not limited to, asset allocation (altering portfolio
exposure in certain areas such as equity and debt), portfolio
immunization (curing mismatches between the duration and sensitivity of
assets and liabilities to ensure that portfolio assets will be
sufficient to fund the payment of liabilities), and portfolio duration
(altering the average maturity of a portfolio’s assets); and (iv)
certain options trading, in particular the writing of covered puts and
calls.233
—————————————————————————
231 House Committee on Agriculture, Futures Trading Act of
1986, H.R. Rep. No. 624, 99th Cong., 2d Sess. 44-46 (1986).
232 Id. at 46.
233 Id.
—————————————————————————
The Senate Committee on Agriculture, Nutrition and Forestry, in its
report on the 1986 CFTC reauthorization legislation, also directed the
Commission to reassess its interpretation of bona fide hedging.234
Specifically, the Senate Committee directed the Commission to consider
“whether the concept of prudent risk management [should] be
incorporated in the general definition of hedging as an alternative to
this risk reduction standard.” 235
—————————————————————————
234 Senate Committee on Agriculture, Nutrition and Forestry,
Futures Trading Act of 1986, S. Rep. No. 291, 99th Cong., 2d Sess.
at 21-22 (1986).
235 Id. at 22.
—————————————————————————
The Commission heeded Congress’s recommendation, and the Commission
issued two 1987 interpretive statements regarding the definition of
bona fide hedging. The first 1987 interpretative statement clarified
the meaning of current Sec. 1.3(z)(1).236 The Commission interpreted
the regulatory “temporary substitute” criterion 237 not to be a
necessary condition for classification of positions as hedging. The
Commission interpreted the “incidental test” 238 to be a
“requirement that the risks that are offset by a futures or option
hedge must arise from commercial cash market activities.” The
Commission also noted bona fide hedges could include balance sheet and
other trading strategies that are risk reducing, such as “strategies
that provide protection equivalent to a put option for an existing
portfolio of securities.” 239
—————————————————————————
236 See, Clarification of Certain Aspect of the Hedging
Definition, 52 FR 27195, Jul. 20, 1987 (July 1987 Interpretative
Statement).
237 In current Sec. 1.3(z)(1), the phrase “where such
transactions or positions normally represent a substitute for
transactions to be made or positions to be taken at a later time in
a physical marketing channel” has been termed the “temporary
substitute criterion.” (Emphasis added.)
238 In current Sec. 1.3(z)(1), the phrase “price risks
incidental to commercial cash or spot operations” has been termed
the “incidental test.”
239 52 FR at 27197.
—————————————————————————
The second 1987 interpretative statement provides assistance to an
exchange who may wish to recognize risk management exemptions from
exchange speculative position limit rules.240 “The Commission
note[d] that providing risk management exemptions to commercial
entities who are typically engaged in buying, selling or holding cash
market instruments is similar to a provision in the Commission’s
hedging definition, [namely], the risks to be hedged arise in the
management and conduct of a commercial enterprise.” 241 The
Commission believed that it would be consistent with the objectives of
section 4a of the Act and Sec. 1.61 [now incorporated as Sec. 150.5]
for exchange rules to exempt from speculative limits a number of risk
management positions in debt-based, equity-based and foreign currency
futures and options.242 Those positions included: Unleveraged long
positions (covered by cash set aside); short calls on securities or
currencies owned (i.e., covered calls); and long positions in asset
allocation strategies
[[Page 75705]]
covered by hedged debt securities or currencies owned.243
—————————————————————————
240 See, Risk Management Exemptions from Speculative Position
Limits Approved under Commission Regulation 1.61, 52 FR 34633, Sep.
14, 1987.
241 Id. at 34637.
242 Id. at 34636.
243 Id.
—————————————————————————
In 1987, the Commission also added an enumerated hedging position
for spread positions which offset unfixed-price cash sales and unfixed-
price cash purchases that are priced basis different delivery months in
a futures contract (that is, floating-price cash purchases coupled with
floating-price cash sales).244 In this regard, the Commission
extended the cross-commodity hedging provisions to offsets of such
coupled floating-price cash contracts that were not cash market
transactions in the same commodity underlying the futures
contract.245
—————————————————————————
244 52 FR 38914, 38919, Oct. 20, 1987.
245 Id. at 38922.
—————————————————————————
The Commission adopted federal limits on soybean meal and soybean
oil futures contracts in 1987, in response to a petition by the Chicago
Board of Trade.246 In the final rule, the Commission noted: “Crush
positions allow the processor to determine or fix his processing margin
in advance and are included within the exemptions permitted for
anticipatory hedging under Commission Rule 1.3(z)(2).” 247
Specifically, the Commission noted for a crush position established by
a soybean processor, the short positions in soybean oil and soybean
meal futures would be permitted to the extent of twelve months unsold
anticipated production; and the long positions in soybean futures would
be permitted to the extent of twelve months unfilled anticipated
requirements. The Commission declined to adopt an exemption for a
reverse crush position. The Commission stated its belief, based upon
comments received and its own analysis, “that there are important
differences between the crush and reverse crush positions from the
standpoint of bona fide hedging by soybean processors.” The results of
a crush position, plus or minus basis variation, are known once the
position is established. In contrast, the Commission noted with a
reverse crush spread position, “the intended results transpire only
if, and when, the futures markets reflect the expected or anticipated
more favorable crushing margin and the position can be lifted.”
Accordingly, the Commission noted it did not appear appropriate to
recognize the reverse crush spread position as an enumerated category
of bona fide hedging.248
—————————————————————————
246 Petition for rulemaking of the CBOT, dated July 24, 1986,
cited in 52 FR 6814, Mar. 5, 1987.
247 52 FR 38914, 38920, Oct. 20, 1987.
248 Id. The Commission noted at that time that the
determination of whether a reverse crush position is bona fide
hedging should be made on a case-by-case basis under Sec. 1.47.
—————————————————————————
In 2007, the Commission proposed a risk management exemption to
federal position limits, in addition to the bona fide hedging
exemption.249 A risk management position would have been defined as a
futures or futures equivalent position held as part of a broadly
diversified portfolio of long-only or short-only futures or futures
equivalent positions, that is based on either tracking a broadly
diversified index for clients or a portfolio diversification plan that
included an exposure to a broadly diversified index. In either case,
the exemption would have been conditioned on the futures positions
being passively managed, unleveraged, and outside of the spot month.
The Commission withdrew that proposal in 2008, citing a lack of
consensus.250
—————————————————————————
249 72 FR 66097, Nov. 27, 2007.
250 73 FR 32261, Jun. 6, 2008.
—————————————————————————
In March of 2009, the Commission issued a concept release on
whether to eliminate the bona fide hedge exemption for certain swap
dealers and create a new limited risk management exemption from
speculative position limits.251 The Commission explained that,
beginning in 1991, the Commission had granted bona fide hedge
exemptions under Sec. 1.47 to a number of swap intermediaries who were
seeking to manage price risk on their books as a result of their
serving as counterparties to their swap clients in commodity index swap
contracts or commodity swap contracts.252 The swap clients included
pension funds and other passive investors who were not using swaps to
offset risks in the physical marketing channel. In order to protect
itself from the risks of such swaps, the swap intermediary would
establish a portfolio of long futures positions in the commodities
making up the index or the commodity underlying the swap, in such
amounts as would offset its exposure under the swap transaction. By
design, the commodity index did not include contract months in the spot
month. The exemptions did not cover positions carried into the spot
month. The comments on the March 2009 concept release were about
equally divided between those who favored eliminating the bona fide
hedge exemption for swap dealers (or restricting the exemption to
positions offsetting swap dealers’ exposure to traditional commercial
market users) and those who favored retaining the swap dealer hedge
exemption in its current form, or some variation thereof.253
—————————————————————————
251 74 FR 12282, Mar. 24, 2009.
252 Id. at 12284.
253 The comments are available for review on the Commission’s
Web site at http://www.cftc.gov/LawRegulation/PublicComments/09-004.
—————————————————————————
In January of 2010, the Commission proposed an integrated
speculative position framework for the major energy contracts listed on
DCMs.254 The proposed rules would not have recognized futures and
option transactions offsetting exposure acquired pursuant to swap
dealing activity as bona fide hedges. Instead, upon compliance with
several conditions including reporting and disclosure obligations, the
proposed regulations would have allowed swap dealers to seek a limited
exemption from the proposed speculative position limits for the major
energy contracts.255 The proposed framework was withdrawn after
enactment of the Dodd-Frank Act, which the Commission interprets as
expanding the range of derivative contracts, beyond contracts listed on
DCMs, on which the Commission must impose position limits.
—————————————————————————
254 75 FR 4144, Jan. 26, 2010 (withdrawn 75 FR 50950, Aug. 18,
2010).
255 75 FR at 4152.
—————————————————————————
Since 1974, the Commission has had authority under the Act to
define the term bona fide hedging position. With the enactment on July
21, 2010 of the Dodd-Frank Act, section 4a(c)(1) of the Act,256
continues to provide that position limits do not apply to positions
shown to be bona fide hedging positions as defined by the
Commission.257
—————————————————————————
256 7 U.S.C. 6a(c)(1).
257 Id. The Dodd-Frank Act did not change the language found
in prior 7 U.S.C. 6a(c) (2010).
—————————————————————————
However, Dodd-Frank added section 4a(c)(2) of the Act, which the
Commission interprets as directing the Commission to narrow the bona
fide hedging position definition for physical commodities from the
definition found in current Sec. 1.3(z)(1), as discussed further
below.258 Separately, Dodd-Frank added section 4a(a)(7) of the Act to
give the Commission plenary authority to grant general exemptive relief
from the position limit rules.259
—————————————————————————
258 See infra discussion of “temporary substitute test.”
259 Section 4a(a)(7) of the Act provides: “The Commission, by
rule, regulation, or order, may exempt, conditionally or
unconditionally, any person or class of persons, any swap or class
of swaps, any contract of sale of a commodity for future delivery or
class of such contracts, any option or class of options, or any
transaction or class of transactions from any requirement it may
establish under this section with respect to position limits.” 7
U.S.C. 6a(a)(7).
—————————————————————————
On November 18, 2011, the Commission adopted part 151 to establish
a position limits regime for
[[Page 75706]]
twenty-eight exempt and agricultural commodity futures and options
contracts and the physical commodity swaps that are economically
equivalent to such contracts.260 In connection with issuing the part
151 limits, the Commission defined bona fide hedging transactions or
positions in Sec. 151.5(a) and enumerated eight transactions or
positions that would constitute bona fide hedging transactions or
positions and, thus, would be exempt from the part 151 limits.261
—————————————————————————
260 See generally 76 FR 71626, Nov. 18, 2011.
261 See 17 CFR 151.5(a)(2)(i)-(viii). The Commission also
recognized pass-through swaps and pass-through swap offsets as bona
fide hedging transactions. 17 CFR 151.5(a)(3)-(4).
—————————————————————————
In addition to the exemptions enumerated in Sec. 151.5(a)(2) and
(5) provided that, “Any person engaging in other risk reducing
practices commonly used in the market which they believe may not be
specifically enumerated in Sec. 151.5(a)(2) may request relief from
Commission staff under Sec. 140.99 of this chapter 262 or the
Commission under section 4a(a)(7) of the Act concerning the
applicability of the bona fide hedging transaction exemption.” 263
—————————————————————————
262 Section 140.99 sets out general procedures and
requirements for requests to Commission staff for exemptive, no-
action and interpretative letters.
263 17 CFR Sec. 151.5(a)(5).
—————————————————————————
On January 20, 2012, the Working Group of Commercial Energy Firms
(the “Working Group”) filed a petition pursuant to both section
4a(a)(7) of the Act and Sec. 151.5(a)(5) (the “Working Group
Petition”) 264 requesting that the Commission “grant exemptive
relief for [ten] classes of risk-reducing transactions described [in
the petition] to the extent that such transactions are not covered by
[Sec. Sec. ] 151.5(a)(1) or (2) of the Position Limit Rules or, in the
alternative, clarify that such classes of transactions qualify as `bona
fide hedging transactions or positions’ within the meaning of
[Sec. Sec. ] 151.5(a)(1) and (2); [(“Requests One-Ten”)] and provide
exemptive relief regarding the definition of (a) “spot month” set
forth in [Sec. ] 151.3(c) of the Position Limit Rules, and (b)
“swaption” set forth in [Sec. ] 151.1 of the Position Limit Rules
[(`Other Requests)].” 265 In connection with any relief ultimately
granted as a result of the Petition, the Working Group also requested
that the Commission “confirm that any relief granted is generally
applicable to the entire market.” 266
—————————————————————————
264 The Working Group Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/wgbfhpetition012012.pdf. The Working Group supplemented the
petition in a letter dated April 17, 2012, available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/workinggroupltr041712.pdf. As noted in their submission, the
Working Group is a diverse group of commercial firms in the energy
industry whose primary business activity is the physical delivery of
one or more energy commodities to, among others, industrial,
commercial and residential consumers. Members of the Working Group
and their affiliates actively trade futures and swaps and they
assert that they would be materially impacted by position limit
rules under part 151.
265 See Working Group Petition at 1.
266 See Working Group Petition at 3. In letters dated March
1,2012, and March 26, 2012, respectively, a group of three energy
trade associations (Edison Electric Institute, American Gas
Association, and Electric Power Supply Association), and the Futures
Industry Association submitted comments in support of the Working
Group Petition, available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/eei-aga-epsa_comments.pdf
and http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/fialtr032612.pdf.
—————————————————————————
In addition to the Working Group Petition, on March 13, 2012, the
American Petroleum Institute (“API”) also filed a petition pursuant
to both section 4a(a)(7) of the Act and Sec. 151.5(a)(5) (the “API
Petition”).267 The API Petition generally endorsed the Working Group
petition and requested that the Commission recognize as bona fide
hedging transactions certain routine energy market transactions that
are priced at monthly average index prices.268 The request in the API
Petition is essentially a restatement of Requests One through Three of
the Working Group Petition. The API Petition also requested relief for
pass-through swaps.
—————————————————————————
267 The API Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/apiltr031312.pdf. As noted in their submission, API is a national
trade association representing more than 450 oil and natural gas
companies. Its members transact in physical and financial, exchange-
traded, and over-the-counter markets primarily to hedge or mitigate
commercial risks associated with their core business of delivering
energy to wholesale and retail customers.
268 See API Petition at 1.
—————————————————————————
Further, the CME Group, on April 26, 2012, filed a petition
pursuant to section 4a(a)(7) of the Act and Sec. 151.5(a)(5) (the
“CME Petition”).269 The CME Petition generally requested that the
Commission recognize as bona fide hedging transactions certain
purchases by persons engaged in processing, manufacturing or feeding
that were permitted under Sec. 1.3(z)(2)(ii)(C) during the last five
trading days in physical-delivery contracts, not to exceed anticipated
requirements for that month and the next succeeding month. The request
in the CME Petition is substantively similar to Request Eight of the
Working Group Petition.
—————————————————————————
269 The CME Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/cmeltr042612.pdf.
—————————————————————————
With the court’s September 28, 2012, order vacating part 151, the
Commission now re-proposes a definition of bona fide hedging position.
b. Proposed Definition of Bona Fide Hedging Position
The Commission proposes to delete Sec. 1.3(z), the current
definition of “bona fide hedging transactions or positions,” and
replace it with a new definition of “bona fide hedging position” in
Sec. 150.1.270 Section 4a(c)(1) of the Act, as added by the Dodd-
Frank Act, authorizes the Commission to define bona fide hedging
positions “consistent with the purposes of this Act.” 271 The
proposed definition of bona fide hedging position builds on the
Commission’s history, both in administering a regulatory exemption to
federal limits and in providing guidance to exchanges in establishing
exchange limits, and is grounded for physical commodities on the new
requirements in section 4a(c)(2) of the Act, as amended by section 737
of the Dodd-Frank Act in July 2010.272
—————————————————————————
270 The proposed definition does not reference
“transactions” because the Commission has not had trading volume
limits on transactions since 1979. See generally Elimination of
Daily Speculative trading Limits, 44 FR 7124, Feb. 6, 1979.
271 7 U.S.C. 6a(c)(1).
272 7 U.S.C. 6a(c)(2).
—————————————————————————
Organization. The proposed definition of bona fide hedging position
is organized into six sections: an opening paragraph with two general
requirements for all hedges; and five numbered paragraphs (paragraphs
(1)-(5)). Paragraph (1) of the proposed definition sets forth
requirements for hedges of an excluded commodity, and incorporates
guidance on risk management exemptions that may be adopted by an
exchange.273 Paragraph (2) lists requirements for hedges of a
physical commodity. Paragraphs (3) and (4) list enumerated exemptions.
Paragraph (5) specifies the requirements for cross-commodity hedges.
—————————————————————————
273 Regarding the definition of bona fide hedging positions in
excluded commodities, the Commission notes this proposed definition
also would provide flexibility to exchanges adopting exemptions for
securities futures contracts consistent with Sec. 41.25(a)(3)(iii).
—————————————————————————
c. General Requirements for All Bona Fide Hedges–Opening Paragraph
The opening paragraph of the proposed definition sets forth two
general requirements for any legitimate hedging position: (i) The
purpose of the position must be to offset price risks incidental to
commercial cash operations (the “incidental test”); and
[[Page 75707]]
(ii) the position must be established and liquidated in an orderly
manner in accordance with sound commercial practices (the “orderly
trading requirement”). These general requirements are found in current
Sec. 1.3(z)(1).274
—————————————————————————
274 In relevant part, current Sec. 1.3(z)(1) provides:
“Notwithstanding the foregoing, no transaction or position shall be
classified as bona fide hedging for purposes of section 4a of the
Act unless their purpose is to offset price risks incidental to
commercial cash or spot operations and such position are established
and liquidated in an orderly manner in accordance with sound
commercial practices and [unless other] provisions [of this
definition] have been satisfied.” 17 CFR 1.3(z)(1). The second
characteristic was contained in vacated Sec. 151.5(a)(1)(v).
—————————————————————————
Incidental test. Consistent with its prior interpretation of the
incidental test under Sec. 1.3(z)(1), discussed above, the Commission
intends the proposed incidental test to be a requirement that the risks
offset by a commodity derivative contract hedging position must arise
from commercial cash market activities.275 The Commission believes
this requirement is consistent with the statutory guidance to define
bona fide hedging positions to permit hedging “legitimate anticipated
business needs.” 276 In the absence of a requirement for a
legitimate business need, the Commission believes it would be difficult
to distinguish between hedging and speculative activities. The
Commission believes the concept of commercial cash market activities is
also embodied in the economically appropriate test for physical
commodities in section 4a(c)(2) of the Act, discussed below. The
proposed incidental test amends the incidental test in current Sec.
1.3(z)(1) by clarifying that forward commercial operations may also
serve as the basis for a bona fide hedging position.277 This is
consistent with the Commission’s long-standing recognition of fixed-
price purchase and fixed-price sales contracts (which may specify
forward delivery dates) as the basis of certain enumerated hedges in
current Sec. 1.3(z)(2).
—————————————————————————
275 See, Clarification of Certain Aspect of the Hedging
Definition, 52 FR 27195, Jul. 20, 1987 (July 1987 interpretative
statement).
276 7 U.S.C. 6a(c)(1).
277 The incidental test was not contained in vacated Sec.
151.5(a)(1). This omission was not discussed in the preambles to the
proposed or final rule. However, the incidental test was retained in
amended Sec. 1.3(z)(1) for excluded commodities. 76 FR at 71683.
—————————————————————————
Orderly trading requirement. The proposed orderly trading
requirement is intended to impose on bona fide hedgers a duty of
ordinary care when entering, maintaining and exiting the market in the
ordinary course of business and in order to avoid as practicable the
potential for significant market impact in establishing, maintaining or
liquidating a position in excess of position limitations.278 The
Commission believes the proposed orderly trading requirement is
consistent with the policy objectives of position limits to diminish,
eliminate or prevent excessive speculation and to ensure that the price
discovery function of the underlying market is not disrupted.279 The
Commission believes the orderly trading requirement is particularly
important since the Commission intends to set the initial levels of
position limits at the outer bound of the range of levels of position
limits that may serve to maximize the statutory policy objectives.
Thus, bona fide hedgers likely would only need an exemption for
extraordinarily large positions.
—————————————————————————
278 Compare, section 4c(a)(5)(B) of the Act, which makes it
unlawful for any person to engage in any trading, practice, or
conduct on or subject to the rules of a registered entity that, for
example, demonstrates intentional or reckless disregard for the
orderly execution of transactions during the closing period. 7
U.S.C. 6c(a)(5)(B). Section 4c(a)(6) of the Act authorizes the
Commission to promulgate such “rules and regulations as, in the
judgment of the Commission, are reasonable necessary to prohibit . .
. any other trading practice that is disruptive of fair and
equitable trading.” 7 U.S.C. 6c(a)(6).
279 See sections 4a(3)(B)(i) and (iv) of the Act. 7 U.S.C.
6a(3)(B)(i) and (iv).
—————————————————————————
The Commission believes that negligent trading, practices, or
conduct should be a sufficient basis for the Commission to disallow a
bona fide hedging exemption. The Commission believes that an evaluation
of “orderly trading” should be based on the totality of the facts and
circumstances as of the time the person engaged in the relevant
trading, practices, or conduct–i.e., the Commission intends to
consider whether the person knew or should have known, based on the
information available at the time, he or she was engaging in the
conduct at issue.
The Commission proposes to apply its policy regarding orderly
markets for purposes of the disruptive trading practice prohibitions,
to its orderly trading requirement for purposes of position limits.
“The Commission’s policy is that an orderly market may be
characterized by, among other things, parameters such as a rational
relationship between consecutive prices, a strong correlation between
price changes and the volume of trades, levels of volatility that do
not dramatically reduce liquidity, accurate relationships between the
price of a derivative and the underlying such as a physical commodity
or financial instrument, and reasonable spreads between contracts for
near months and for remote months.” 280 Further, in fulfilling their
duty of ordinary care when entering, maintaining and exiting a
position, market participants should assess market conditions and
consider how their trading practices and conduct affect the orderly
execution of transactions when establishing, maintaining or liquidating
a position in excess of a speculative position limit.
—————————————————————————
280 See Interpretive Guidance and Policy Statement on
Antidisruptive Practices Authority, 78 FR 31890, 31895-96 (May 28,
2013) (available at http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2013-12365a.pdf).
—————————————————————————
d. Requirements and Guidance for Hedges in an Excluded Commodity–
Paragraph (1)
The proposed definition of bona fide hedging position for contracts
in an excluded commodity 281 includes the general requirements in the
opening paragraph and would require that the position is economically
appropriate to the reduction of risks in the conduct and management of
a commercial enterprise (the “economically appropriate” test) and is
either (i) specifically enumerated in paragraphs (3)-(5) of the
definition of bona fide hedging position; or (ii) recognized as a bona
fide hedging position by a DCM or SEF consistent with the guidance on
risk management exemptions in proposed appendix A to part 150.282
—————————————————————————
281 “Excluded commodity” is defined in section 1a(19) of the
Act. 7 U.S.C. 1a(19).
282 See the discussion below of proposed Sec. 150.5(b)(5),
requiring exchange hedge exemptions to exchange limits on contracts
in an excluded commodity to conform to the definition of bona fide
hedging position in Sec. 150.1. The Dodd-Frank Act expanded the
authority of the Commission with respect to core principles
applicable to exchange traded contracts in an excluded commodity,
but did not address directly the definition of bona fide hedging
positions for excluded commodities. The Dodd-Frank Act amended the
core principles for DCMs and established core principles for SEFs,
authorizing the Commission, by rule or regulation, to restrict the
reasonable discretion of the exchange in complying with core
principles. 7 U.S.C. 7(d)(1)(B) and 7b-3(f)(1)(B).
—————————————————————————
The economically appropriate test in section 4a(c)(2) of the Act,
applicable to physical commodities, also should apply to excluded
commodities because it has long been a fundamental requirement of a
bona fide hedging position.283 Current Sec. 1.3(z)(1) contains the
economically appropriate test.284
[[Page 75708]]
The Commission notes that the concept of the reduction of risk was long
embodied in the statutory concept of “offset” prior to 1974.285 The
economically appropriate test is discussed further, below.
—————————————————————————
283 See, e.g., the definition of bona fide hedging promulgated
by the Commission’s predecessor in Sec. 1.3(z) of its regulations
in 1975. 40 FR 11560, 11561, Mar. 12, 1975 (“Bona fide hedging
transactions or positions . . . shall mean sales of or short
positions in any commodity for future delivery . . . ,” (emphasis
added)).
284 The Commission adopted this requirement in Sec. 1.3(z)(1)
in 1977. 42 FR 42748, 42751, Aug. 24, 1977. Prior to that time, the
concept of economically appropriate to the reduction of risk in the
operation of a commercial enterprise was not separately articulated,
but was reflected in the incidental test (“unless their bona fide
purpose is to offset price risks incidental to commercial cash or
spot operations”) in Sec. 1.3(z)(1) as amended in 1975. 40 FR
11560, 11561, Mar. 12, 1975. Current Sec. 150.5(d) provides
guidance to DCMs that exchange regulations for bona fide hedging
position exemptions (including exemptions for excluded commodity
contracts) should be granted in accordance with current Sec.
1.3(z)(1). 17 CFR 150.5(d) See, for example, Chicago Mercantile
Exchange Rule 559.A., Bona Fide Hedging Positions, available at
http://www.cmegroup.com/rulebook/CME/I/5/5.pdf, that provides: “The
Market Regulation Department may grant exemptions from position
limits for bona fide hedge positions as defined by CFTC Regulation
Sec. 1.3(z)(1). Approved bona fide hedgers may be exempted from
emergency orders that reduce position limits or restrict trading.”
285 Prior to 1974, section 4a of the Act defined bona fide
hedging transactions as: “For the purposes of this paragraph, bona
fide hedging transactions shall mean sales of any commodity for
future delivery on or subject to the rules of any board of trade to
the extent that such sales are offset in quantity by the ownership
or purchase of the same cash commodity or, conversely, purchases of
any commodity for future delivery on or subject to the rules of any
board of trade to the extent that such purchases are offset by sales
of the same cash commodity.” 7 U.S.C. 6a (1940).
—————————————————————————
Under the proposed definition, an exchange would be permitted to
grant an exemption based on its rules that were consistent with the
enumerated exemptions in paragraphs (3)-(5) of the proposed definition
of bona fide hedging position. Current Sec. 1.3(z)(1) also requires a
bona fide hedging position to be either (i) an enumerated exemption in
current Sec. 1.3(z)(2) or (ii) a non-enumerated exemption under
current Sec. 1.3(z)(3) (a non-enumerated exemption may be granted
under current Sec. 1.47 as a risk management exemption). The
enumerated exemptions in paragraphs (3)-(5) of the proposed definition
of bona fide hedging position contain all of the enumerated exemptions
in current Sec. 1.3(z)(2). The specifically enumerated exemptions also
are discussed separately, below.
The Commission is proposing to incorporate as guidance in appendix
A to part 150 the concepts in the 1987 risk management exemptions
interpretative statement.286 The Commission believes that it would be
consistent with the objectives of section 4a of the Act for exchange
rules to exempt from speculative limits a number of risk management
positions in commodity derivative contracts in an excluded commodity.
Such risk management exemption positions would include, but not be
limited to, three types of exemptions for: (i) Unleveraged long
positions (covered by cash set aside); (ii) short calls on securities
or currencies owned (i.e., covered calls); and (iii) long positions in
asset allocation strategies covered by hedged debt securities or
currencies owned (i.e., unleveraged synthetic positions).287 The
Commission is proposing to withdraw the 1987 risk management exemption
interpretative statement in light of incorporating its concepts in
proposed appendix A to part 150, thus rendering that interpretative
statement redundant. The Commission requests comment on all aspects of
proposed appendix A to part 150.
—————————————————————————
286 52 FR 34633, Sep. 14, 1987.
287 Id. at 34626.
—————————————————————————
In addition, under the proposed guidance for excluded commodities
and as is currently the case, there need not be any temporary
substitute test for a bona fide hedging position in an excluded
commodity. This is consistent with the Commission’s July 1987
interpretative statement that the temporary substitute component need
not apply to a bona fide hedging position in an excluded
commodity.288
—————————————————————————
288 52 FR 27195, Jul. 20, 1987 (July 1987 Interpretative
Statement). See also House of Representatives Committee Report
quoted at 52 FR 34633, 34634, September 14, 1987, regarding
“futures positions taken as alternatives rather than temporary
substitutes for cash market positions.” H.R. Rep No. 624, 99th
Cong., 2d Sess. 1, 45-46 (1986). However, the Commission is
proposing to withdraw the July 1987 Interpretative Statement, since
the temporary substitute test was added by the Dodd-Frank Act as a
statutory requirement for a bona fide hedging position in a physical
commodity. 7 U.S.C. 4a(c)(2)(A)(i).
—————————————————————————
e. Requirements for Hedges in a Physical Commodity–Paragraph (2)
The Commission is proposing to implement the statutory directive of
section 4a(c)(2) of the Act in paragraph (2) of the proposed definition
of bona fide hedging position under Sec. 150.1. The proposed
definition for physical commodities would also include the general
requirements of the opening paragraph, as is the case under current
Sec. 1.3(z)(1) and as discussed above.
Section 4a(c)(2) of the Act directs the Commission to define what
constitutes a bona fide hedging position for futures and option
contracts on physical commodities listed by DCMs.289 The Commission
proposes to apply the same definition to (i) swaps that are
economically equivalent to futures contracts and (ii) direct-access
linked FBOT futures contracts that are economically equivalent to
futures contracts listed by DCMs.290 Applying the same definition to
economically equivalent contracts would promote administrative
efficiency. Applying the same definition to economically equivalent
contracts also is consistent with congressional intent as embodied in
the expansion of the Commission’s authority to apply position limits to
swaps (i.e., those that are economically equivalent to futures and
swaps that serve a significant price discovery function) and to direct-
access linked FBOT contracts.291
—————————————————————————
289 7 U.S.C. 6a(c)(2).
290 This is consistent with the approach the Commission took
in vacated Sec. 151.5. 76 FR 71643 n.168.
291 7 U.S.C. 6a(a)(5)-(6).
—————————————————————————
Paragraph (2)(i) of the proposed definition would recognize as bona
fide a position in a commodity derivative contract that (i) represents
a substitute for positions taken or to be taken at a later time in the
physical marketing channel (i.e., the “temporary substitute” test);
(ii) is economically appropriate to the reduction of risks (i.e., the
“economically appropriate” test); and (iii) arises from the potential
change in value of assets, liabilities or services (i.e., the “change
in value” requirement), provided the position is enumerated in
paragraphs (3) through (5) of the definition, as discussed below. This
subparagraph would incorporate the provisions of section 4a(c)(2)(A) of
the Act for futures and option contracts and also would include the
provisions of section 4a(c)(2)(B)(ii) of the Act, regarding swaps, by
using the term commodity derivative contracts, which includes swaps,
futures and futures option contracts.
Temporary substitute test. The temporary substitute test requires
that a bona fide hedging position must represent “a substitute for . .
. positions taken or to be taken at a later time in a physical
marketing channel.” 292 Paragraph (2)(i) of the proposed definition
incorporates the temporary substitute test of section 4a(c)(2)(A)(i) of
the Act. The express language of section 4a(c)(2)(A)(i) of the Act
requires the temporary substitute test to be a necessary condition for
classification of positions in physical commodities as bona fide
hedging positions. Section 4a(c)(2)(A) of the Act incorporates many
aspects of the general definition of bona fide hedging in current Sec.
1.3(z)(1). However, there are significant differences. Section
4a(c)(2)(A)(i) of the Act does not include the adverb “normally” to
modify the verb “represents” in the phrase “represents a substitute
for transactions made or to be made or positions taken or to be taken
at a later time in a physical marketing
[[Page 75709]]
channel.” 293 In addition, Congress provided explicit requirements
for recognizing swaps as bona fide hedging positions in section
4a(c)(2)(B), recognizing positions that reduce either the risk of swaps
that meet the requirements of section 4a(c)(2)(A) of the Act or swaps
that are executed opposite a counterparty whose transaction would
qualify as bona fide under section 4a(c)(2)(A) of the Act. The
statutory requirements are more stringent than the conditions for swap
risk management exemptions the Commission previously granted under
Sec. 1.3(z)(3) and Sec. 1.47. As discussed above, the Commission
granted risk management exemptions for persons to offset the risk of
swaps that did not represent substitutes for transactions or positions
in a physical marketing channel, neither by the intermediary nor the
counterparty. Thus, positions that reduce the risk of such speculative
swaps would no longer meet the requirements for a bona fide hedging
transaction or position under the new statutory criteria.
—————————————————————————
292 7 U.S.C. 6a(c)(2)(A)(i).
293 In contrast and as noted above, in current Sec.
1.3(z)(1), the phrase “where such transactions or positions
normally represent a substitute for transactions to be made or
positions to be taken at a later time in a physical marketing
channel” has been termed the “temporary substitute” criterion.
(Emphasis added.)
—————————————————————————
Economically appropriate test. Paragraph (2)(A)(ii) of the proposed
definition incorporates the economically appropriate test of section
4a(c)(2)(A)(ii) of the Act. This statutory provision mirrors the
provisions in current Sec. 1.3(z)(1). The Commission has provided
interpretations and guidance over the years as to the meaning of
“economically appropriate” in current Sec. 1.3(z)(1). For example,
the Commission has indicated that hedges of processing margins by a
processor, such as a soybean processor that establishes long positions
in the soybean contract and short positions in the soybean meal contact
and the soybean oil contract, may be economically appropriate.294
—————————————————————————
294 52 FR 38914, 38920, Oct. 20, 1987.
—————————————————————————
By way of example, a manufacturer may anticipate using a commodity
that it does not own as an input to its manufacturing process; however,
the manufacturer expects to change output prices to offset
substantially a change in price of the input commodity. For example,
processing by a soybean crush operation or a fuel blending operation
may add relatively little value to the price of the input commodity. In
such circumstances, it would be economically appropriate for the
processor to offset the price risks of both the unfilled anticipated
requirement for the input commodity and the unsold anticipated
production; such a hedge would, for example, fully lock in the value of
soybean crush processing. Alternatively, a processor may wish to
establish a calendar month hedge solely in terms of the input
commodity, to offset the price risk of the anticipated input commodity
and to cross-commodity hedge the unsold anticipated production. In such
an alternative, a processor has hedged the commercial enterprise’s
exposure to the value of the input commodity at the expected time of
acquisition and to the input commodity’s value component of the
processed commodity at the expected later time of production and sale.
Unfilled anticipated requirements, unsold anticipated production and
cross-commodity hedging are also discussed as enumerated hedges, below.
The Commission affirms that gross hedging may be appropriate under
certain circumstances, when net cash positions do not measure total
risk exposure due to differences in the timing of cash commitments, the
location of stocks, and differences in grades or types of the cash
commodity being hedged.295 By way of example, a merchant may have
sold a certain quantity of a commodity for deferred delivery in the
current year (i.e., a fixed-price cash sales contract) and purchased
that same quantity of that same commodity for deferred receipt in the
next year (i.e., a fixed-price cash purchase contract). Such a merchant
would be exposed to value risks in the two cash contracts arising from
different delivery periods (that is, from a timing difference). Thus,
although the merchant has bought and sold the same quantity of the same
commodity, the merchant may elect to offset the price risk arising from
the cash purchase contract separately from the price risk arising from
the cash sales contract, with each offsetting commodity derivative
contract regarded as a bona fide hedging position. However, if such a
merchant were to offset only the cash purchase contract, but not the
cash sales contract (or vice versa), then it reasonably would appear
the offsetting commodity derivative contract would result in an
increased value exposure of the enterprise (that is, the risk of
changes in the value of the cash commodity contract that was not offset
is likely to be higher than the risk of changes in the value of the
calendar spread difference between the nearby and deferred delivery
period) and, so, the commodity derivative contract would not qualify as
a bona fide hedging position.
—————————————————————————
295 42 FR 14832, 14834, Mar. 16, 1977.
—————————————————————————
In order for a position to be economically appropriate to the
reduction of risks in the conduct and management of a commercial
enterprise, the enterprise generally should take into account all
inventory or products that the enterprise owns or controls, or has
contracted for purchase or sale at a fixed price. For purposes of
reporting cash market positions under current part 19, the Commission
historically has allowed a reporting trader to “exclude certain
products or byproducts in determining his cash positions for bona fide
hedging” if it is “the regular business practice of the reporting
trader” to do so.296 The Commission has determined to clarify the
meaning of “economically appropriate” in light of this reporting
exclusion of certain cash positions.
—————————————————————————
296 See current Sec. 19.00(b)(1) (providing that “[i]f the
regular business practice of the reporting trader is to exclude
certain products or byproducts in determining his cash position for
bona fide hedging . . . , the same shall be excluded in the
report”). 17 CFR 19.00(b)(1).
—————————————————————————
Originally, the Commission intended for the optional part 19
reporting exclusion to cover only cash positions that were not capable
of being delivered under the terms of any derivative contract.297 The
Commission differentiated between “products and byproducts” of a
commodity and the underlying commodity itself, the former capable of
exclusion from part 19 reporting under normal business practices due to
the absence of any derivative contract in such product or
byproduct.298 This intention ultimately evolved to allow cross-
commodity hedging of products and byproducts of a commodity that were
not necessarily deliverable under the terms of any derivative
contract.299
—————————————————————————
297 43 FR 45825, 45827, Oct. 4, 1978 (explaining that the
allowance for eggs not kept in cold storage to be excluded from
reporting a cash position in eggs under part 19 “was appropriate
when the only futures contract being traded in fresh shell eggs
required delivery from cold storage warehouses.”).
298 See id. Prior to the Commission’s revision of the part 19
reporting exclusion for eggs, the exclusion allowed “eggs not in
cold storage or certain egg products” not to be reported as a cash
position. 26 FR 2971, Apr. 7, 1961 (emphasis added). Additionally,
the title to the revised exclusion read, “Excluding products or
byproducts of the cash commodity hedged.” See 43 FR 45825, 45828
(Oct. 4, 1978). So, in addition to a commodity itself that was not
deliverable under any derivative contract, the Commission also
recognized a separate class of “products and byproducts” that
resulted from the processing of a commodity that it did not believe
at the time were capable of being hedged by any derivative contract
for purposes of a bona fide hedge.
299 See 42 FR 42748, Aug. 24, 1977. Cross-commodity hedging is
discussed as an enumerated hedge, below.
—————————————————————————
[[Page 75710]]
The instructions to current Form 204 go a step further than current
Sec. 19.00(b)(1) by allowing for a reporting trader to exclude
“certain source commodities, products, or byproducts in determining [
] cash positions for bona fide hedging.” (Emphasis added.) In line
with its historical approach to the reporting exclusion, the Commission
does not believe that it would be economically appropriate to exclude
large quantities of a source commodity held in inventory when an
enterprise is calculating its value at risk to a source commodity and
it intends to establish a long derivatives position as a hedge of
unfilled anticipated requirements. As explained in the revisions to
part 19, discussed below, a source commodity itself can only be
excluded from a calculation of a cash position if the amount is de
minimis, impractical to account for, and/or on the opposite side of the
market from the market participant’s hedging position.
Change in value requirement. Paragraph (2)(A)(iii) of the proposed
definition incorporates the potential change in value requirement of
section 4a(c)(2)(A)(iii) of the Act. This statutory provision largely
mirrors the provisions in current Sec. 1.3(z)(1).300 The Commission
notes that it uses the term “price risk” to mean a “potential change
in value.” To satisfy the change in value requirement, the purpose of
a bona fide hedge must be to offset price risks incidental to a
commercial enterprise’s cash operations. The change in value
requirement is embedded in the concept of offset of price risks.
—————————————————————————
300 Compare 7 U.S.C. 6a(c)(2)(A)(iii) and 17 CFR 1.3(z)(1).
Note that Sec. 1.3(z)(1)(ii) uses the phrase “liabilities which a
person owes or anticipate incurring,” while section
4a(c)(2)(A)(iii)(II) uses the phrase “liabilities that a person
owns or anticipates incurring.” (Emphasis added.) The Commission
interprets the word “owns” to be an error and the word “owes” to
be correct.
—————————————————————————
Pass-through Swaps and Offsets. Subparagraph (2)(B) of the proposed
definition would recognize as bona fide a commodity derivative contract
that reduces the risk of a position resulting from a swap executed
opposite a counterparty for which the position at the time of the
transaction would qualify as a bona fide hedging position under
subparagraph (2)(A). This provision generally mirrors the provisions of
section 4a(c)(2)(B)(i) of the Act,301 and clarifies that the swap
itself is also a bona fide hedging position to the extent it is offset.
However, the Commission is proposing that it will not recognize as bona
fide hedges the offset of such swaps with physical-delivery contracts
during the lesser of the last five days of trading or the time period
for the spot month in such physical-delivery commodity derivative
contract (the “five-day” rule).
—————————————————————————
301 The Commission interprets the statutory provision that
requires that “the transaction would qualify as a bona fide hedging
transaction” to mean the swap position at the time of the
transaction would qualify as a bona fide hedging position. 7 U.S.C.
6a(c)(2)(B)(i).
—————————————————————————
The Commission is proposing to use its exemptive authority under
section 4a(a)(7) of the Act to net positions in futures, futures
options, economically equivalent swaps and direct-access linked FBOT
contracts in the same referenced contract for purposes of single month
and all-months-combined limits under proposed Sec. 150.2, discussed
below.302 Thus, a pass-through swap exemption would not be necessary
for a swap portfolio in referenced contracts that would automatically
be netted with futures and futures options in the same referenced
contract outside of the spot month under the proposed rules. The
Commission historically has permitted non-enumerated risk management
positions under Sec. 1.3(z)(3) and Sec. 1.47. Almost all exemptions
historically requested and granted under these provisions were for risk
management of swap positions related to the agricultural commodities
subject to federal position limits under part 150.
—————————————————————————
302 This is consistent with netting permitted in vacated Sec.
151.4(b) of swaps with futures for purposes of single-month and all-
months-combined limits. The Commission noted in that final
rulemaking that it did “not believe that including a risk
management provision is necessary or appropriate given that the
elimination of the class limits outside of the spot-month will allow
entities, including swap dealers, to net Referenced Contracts
whether futures or economically equivalent swaps.” 76 FR at 71644.
—————————————————————————
As noted above, the proposed rule would impose a five-day rule
during the spot-month. In the risk management exemptions for swaps
issued to date by the Commission under current Sec. 1.3(z)(3) and
Sec. 1.47, the exemptions for swap offsets did not run to the spot
month. As discussed above, the Commission has long imposed a five-day
rule in current Sec. 1.3(z)(2) for other exemptions. For example, for
hedges of unfilled anticipated requirements, the Commission observed
that historically there was a low utilization of this provision in
terms of actual positions acquired in the futures market.303 For
cross-commodity and short anticipatory hedge positions, the Commission
did not believe that persons who do not possess or do not have a
commercial need for the commodity for future delivery will normally
wish to participate in the delivery process.304 In the instant cases
of swaps, the Commission has observed generally low usage among all
traders of the physical-delivery futures contract during the spot
month, relative to the existing exchange spot-month position
limits.305 The Commission invites comments as to the extent to which
traders actually have offset the risk of swaps during the spot month in
a physical-delivery futures contract with a position in excess of an
exchange’s spot-month position limit.
—————————————————————————
303 42 FR 42748, Aug. 24, 1977.
304 Id. 42749.
305 Compare 76 FR at 71690. Vacated Sec. 151.5(a)(2)(3)
recognized a pass-through swap offset during the spot period as an
exception to the five-day rule if the “pass-through swap position
continues to offset the cash market commodity price risk of the bona
fide hedging counterparty.” Based on a review of open positions in
physical-delivery futures contracts, the Commission no longer
believes it necessary to recognize offsets of swaps in the last few
days of the expiring physical-delivery contract and has not provided
this additional provision in the current proposal. Rather, the
Commission has decided to forego this exception to the five-day rule
in the interest of ensuring that the price discovery function of the
underlying market is not disrupted during the last few days of the
spot period. Further, the Commission believes it would have been
administratively burdensome for a trader to demonstrate that its
counterparty continued to have a bona fide hedging need through the
spot period.
—————————————————————————
The Commission has reviewed its historical policy position
regarding the five-day rule for speculative limits in the spot month in
light of position information, including positions in physical-delivery
energy futures contracts.306 For example, the Commission reviewed
three years of confidential large trader data in cash-settled and
physical-delivery energy contracts. The review covered actual positions
held in the physical-delivery energy futures markets during the three-
day spot period, among all traders (including those who had received
hedge exemptions from their DCM). It showed that, historically, there
have been relatively few positions held in excess (and those few not
greatly in excess) of the spot month limits. Accordingly, the
Commission generally is not inclined to change its long-held policy
views regarding physical-
[[Page 75711]]
delivery futures contracts at this time.307
—————————————————————————
306 The Commission also relies upon the congressional shift
evidenced in the Dodd-Frank Act amendments to the CEA, that directed
the Commission, to the maximum extent practicable, in its
discretion, (i) to diminish, eliminate, or prevent excessive
speculation, (ii) to deter and prevent market manipulation,
squeezes, and corners, (iii) to ensure sufficient market liquidity
for bona fide hedgers, and (iv) to ensure that the price discovery
function of the underlying market is not disrupted. 7 U.S.C.
6a(a)(3)(B). The five-day rule would serve to prevent excessive
speculation as a physical-delivery contract nears expiration,
thereby deterring or preventing types of market manipulations such
as squeezes and corners and protecting the price discovery function
of the market. The restriction of the five-day rule does not appear
to deprive the market of sufficient liquidity for bona fide hedgers.
307 Nevertheless, the Commission requests comment on whether
the five-day rule should be waived for pass-through swaps and
offsets in the event a position of the bona fide counterparty in the
physical-delivery futures contract would have been recognized as a
bona fide hedging position. If so, should a person be required to
document the continuing bona fides of the counterparty to such swaps
through the spot period, that is, in addition to the time of the
transaction? Further, should a person also be required to have an
unfixed-price forward contract with the bona fide counterparty, so
that a person would have a bona fide need and ability to make or
take delivery on the physical-delivery futures contract, analogous
to the agent provisions in proposed paragraph (3)(iv) of the
definition of bona fide hedging position?
—————————————————————————
The Commission typically does not publish “general statistical
information” 308 regarding large trader positions in the expiring
physical-delivery energy futures contracts because of concerns that
such data may reveal information about the amount of market power a
person may need to “mark the close” 309 or otherwise manipulate the
price of an expiring contract.310
—————————————————————————
308 As authorized by CEA section 8(a)(1). 7 U.S.C. 12(a)(1).
309 Marking the close refers to, among other things, the
practice of acquiring a substantial position leading up to the
closing period of trading in a futures contract, followed by
offsetting the position before the end of the close of trading, in
an attempt to manipulate prices in the closing period.
310 The Commission gathers large trader position reports on
reportable traders in futures under part 17 of the Commission’s
rules. That data has historically remained confidential pursuant to
CEA section 8. The Commission does, however, publish summary
statistics for all-months-combined in its Commitments of Traders
Report, available on http://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm.
—————————————————————————
f. Trade Option Exemption
The Commission previously amended part 32 of its regulations to
allow commodity options to trade subject to the same rules applicable
to any other swap, unless the commodity option qualifies under the new
Sec. 32.3 trade option exemption.311 In order to qualify for the
trade option exemption, (i) both offeror and offeree must be a
producer, processor, or commercial user of, or merchant handling the
commodity that is the subject of the commodity option transaction, or
the products or byproducts thereof, and both offeror and offeree must
be offering or entering into the commodity option transaction solely
for purposes related to their business as such,312 and (ii) the
option is intended to be physically settled such that, if exercised,
the commodity option would result in the sale of an exempt or
agricultural commodity for immediate or deferred shipment or
delivery.313 Qualifying trade options are exempt from all
requirements of the CEA and Commission’s regulations, except for
certain enumerated provisions, including position limits.314
—————————————————————————
311 See 17 CFR 32.2; Commodity Options, 77 FR 25320 (Apr. 27,
2012).
312 Additionally, the offeror can be an eligible contract
participant (“ECP”) as defined in CEA section 1a(18).
313 The Commission noted in the preamble to the trade option
exemption that in determining delivery intent, market participants
could refer to the guidance provided for the forward contract
exclusion in the Product Definition rulemaking. See 77 FR at 25326.
This guidance conveyed that the Commission’s “Brent
Interpretation” is equally applicable to the forward exclusion from
the swap definition as it was to the forward exclusion from the
“future delivery” definition, which allows for subsequently,
separately negotiated book-out transactions to qualify for the
forward contract exclusion. See 77 FR 48208, 48228, Aug. 13, 2012
(citing Statutory Interpretation Concerning Forward Transactions, 55
FR 39188, Sep. 25, 1990).
314 See 17 CFR 32.3(b)-(d).
—————————————————————————
The Commission is making conforming changes to the trade option
exemption requirement that position limits still apply. Under Sec.
32.3(c)(2), “Part 151 (Position Limits)” of the Commission’s
regulations applies to every counterparty to a trade option “to the
same extent that [part 151] would apply to such person in connection
with any other swap.” The Commission is replacing the reference to
“Part 151,” now vacated, with “Part 150” to clarify that the
position limit requirements proposed herein still would be applicable
to trade options qualifying under the exemption.
The Commission also is requesting comment as to whether the
Commission should use its exemptive authority under CEA section
4a(a)(7) 315 to provide that the offeree of a commodity option
qualifying for the trade option exemption would be presumed to be a
“pass-through swap counterparty” for purposes of the offeror of the
trade option qualifying for the pass-through swap offset.316 Although
the Commission is proposing generally to net futures and swaps in
reference contracts in the same commodity under proposed Sec. 150.2,
as discussed below, the Commission notes that cross-commodity offsets
of pass-through swaps would not be recognized unless the counterparty
to the swap is a bona fide hedger. Would this presumption help offerors
determine the appropriateness of carrying out cross-commodity hedge
transactions?
—————————————————————————
315 7 U.S.C. 6a(a)(7).
316 See the proposed Sec. 150.1 definition of “bona fide
hedge exemption” at paragraph (2)(ii).
—————————————————————————
In addition, the Commission requests comments on whether adopting
such a presumption might allow use of the exemption to evade Commission
rules pertaining to swap transactions. Should the Commission adopt an
anti-evasion provision to address this concern? Furthermore, might some
additional safeguards be included to allow the Commission to provide
administrative simplicity through use of the presumption, while also
limiting use of the presumption to evade other regulations?
Further, the Commission requests comment on whether it would be
appropriate to exclude trade options from the definition of referenced
contracts and, thus, to exempt trade options from the proposed position
limits. If trade options were excluded from the definition of reference
contracts, then commodity derivative contracts that offset the risk of
trade options would not automatically be netted with such trade options
for purposes of non-spot month position limits. The Commission notes
that forward contracts are not subject to the proposed position limits;
however, certain forward contracts may serve as the basis of a bona
fide hedging position exemption, e.g., an enumerated bona fide hedging
position exemption is available for the offset of the risk of a fixed
price forward contract with a short futures position. Should the
Commission include trade options as one of the enumerated exemptions
(e.g., proposed paragraphs (3)(ii) and (iii) of the definition of bona
fide hedging position under proposed Sec. 150.1)? As an alternative to
excluding trade options from the definition of referenced contract,
should the Commission provide an exemption under CEA section 4a(a)(7)
that permits the offeree or offeror to submit a notice filing to
exclude their trade options from position limits? If so, why and under
what circumstances? Are there any other characteristics of trade
options or the parties to trade options that the Commission should
consider? Would any of these alternatives permit commodity options that
should be regulated as swaps to circumvent the protections established
in the Dodd-Frank Act for the forward contract exclusion for non-
financial commodities?
g. Enumerated Hedges–Paragraphs (3)-(5).
Proposed paragraph (1)(i) would require a bona fide hedging
position in an excluded commodity to be enumerated under paragraphs
(3), (4), or (5) of the definition or to be granted an exemption under
exchange rules consistent with the risk management guidance of appendix
A to part 150. Proposed paragraph (2)(i)(D) would require a bona fide
hedging position in
[[Page 75712]]
a physical commodity to be enumerated under paragraphs (3), (4), or (5)
of the definition. The Commission has historically enumerated
acceptable bona fide hedging positions in Sec. 1.3(z)(2) for physical
commodities. Each of the enumerated provisions is discussed below. For
convenience, the Commission is providing a summary comparison of the
various provisions of the proposed rule, vacated part 151, and current
rules, in Table 4 below.
Table 4–Proposed, Current, and Vacated Enumerated Bona Fide Hedges
—————————————————————————————————————-
Paragraph in proposed
definition of bona fide
Cash position underlying bona hedging position under Current Sec. 1.3(z) Vacated part 151
fide hedging position Sec. 150.1 and related and related provisions definition
provisions
—————————————————————————————————————-
Inventory and fixed-price cash (3)(i)………………. 1.3(z)(2)(i)(A)……… 151.5(a)(2)(i)(A).
commodity purchase contracts.
Fixed-price cash commodity sales (3)(ii)……………… 1.3(z)(2)(ii)(A) and (B) 151.5(a)(2)(ii)(A) and
contracts. (B).
Unfilled anticipated requirements (3)(C)(i)……………. 1.3(z)(2)(ii)(C)…….. 151.5(a)(2)(ii)(C).
for same cash commodity.
Unfilled anticipated requirements (3)(C)(ii)…………… N/A………………… N/A.
for resale by a utility.
Hedges by agents…………….. (3)(iv)……………… 1.3(z)(3)…………… 151.5(a)(2)(iv).
Discussed as example of
non-enumerated hedge.
Unsold anticipated production…. (4)(i)………………. 1.3(z)(2)(i)(B)……… 151.5(a)(2)(i)(B).
Offsetting unfixed-price cash (4)(ii)……………… 1.3(z)(2)(iii)………. 151.5(a)(2)(iii).
commodity sales and purchases. Scope expanded in
comparison to part 151.
Anticipated royalties………… (4)(iii)…………….. N/A………………… 151.5(a)(2)(vi).
Scope reduced in
comparison to part 151
to ownership of
royalties.
Services……………………. (4)(iv)……………… N/A………………… 151.5(a)(2)(vii).
Cross-commodity hedges……….. (5)…………………. 1.3(z)(2)(iv)……….. 151.5(a)(2)(viii).
Scope expanded to permit
cross-hedge of pass-
through swap in
comparison to part 151.
Pass-through swap offset……… (2)(ii)(A)…………… 1.3(z)(3) and 1.47…… 151.5(a)(3).
Non-enumerated exemption
for futures used in
risk management of
swaps.
Pass-through swap……………. (2)(ii)(B)…………… N/A, as not subject to 151.5(a)(4).
current federal limits.
Non-enumerated hedges………… 150.3(e)…………….. 1.3(z)(3) and 1.47…… 151.5(a)(5).
Filing for anticipatory hedges… 150.7……………….. 1.3(z) and 1.48……… 151.5(d).
—————————————————————————————————————-
N/A denotes not applicable.
For clarity, the proposed definition uses the terms long positions
and short positions in commodity derivative contracts as those terms
are proposed to be defined, rather than the terms purchases or sales of
any commodity for future delivery, used in current Sec. 1.3(z)(2).
These clarifications are for two reasons. First, the proposed
definition only addresses bona fide hedging positions, and does not
address bona fide hedging transactions. Although the language of
current Sec. 1.3(z)(2) was written to address purchase or sales
transactions, the Commission eliminated daily speculative trading
volume limits in 1979, as noted above.317 The Commission and its
predecessor has long interpreted the terms sales or purchases of
futures contracts in Sec. 1.3(z)(2) to mean short or long positions in
futures contracts in the context of position limits.318 Second, the
proposed definition would be applicable to positions in commodity
derivative contracts (i.e., futures, options thereon, swaps and direct-
access linked FBOT contracts) rather than only to futures and options
contracts. As noted above, the Commission preliminarily believes it
appropriate to apply the same definition of bona fide hedging positions
to all physical commodity derivative contracts subject to federal
limits.
—————————————————————————
317 44 FR 7124, Feb. 6, 1979.
318 The statutory definition of bona fide hedging in section
4a(3) of the Act (prior to the CFTC Act of 1974) used the terms
“sales of any commodity for future delivery . . . to the extent
that such sales are offset in quantity by the ownership or purchase
of the same cash commodity” and “purchases of any commodity for
future delivery . . . to the extent that such purchases are offset
by sales of the same cash commodity.” 7 U.S.C. 6a(3) (1940).
Following enactment of the CFTC Act, the Secretary of Agriculture’s
initial proposed definition of bona fide hedging transactions or
positions makes clear this understanding, as that definition
provided, in relevant part, for “sales of, or short positions in
any commodity for future delivery . . . to the extent that such
sales or short positions are offset in quantity by the ownership or
fixed-price purchase of the same cash commodity” and for
“purchases of, or long positions in, any commodity for future
delivery . . . to the extent that such purchases or long positions
are offset by fixed-price sales of the same cash commodity. . . .”
39 FR 39731, Nov. 11, 1974. The Commission adopted that same
language in its initial definition of bona fide hedging transactions
or positions. 40 FR 48688, 48689, Oct. 17, 1975. In both the
proposed and final rules in 1977, the Commission was silent as to
why it omitted the clarifying phrases “long positions” and “short
positions.” Proposed Rule, 42 FR 14832, Mar. 16, 1977; Final Rule,
42 FR 42748, Aug. 24, 1977.
—————————————————————————
The Commission notes that DCMs and SEFs may impose additional
conditions on holders of positions in commodity derivative contracts,
particularly in the spot month. The Commission has long relied on the
DCMs to protect the integrity of the exchange’s delivery process in
physical-delivery contracts. Congress recognizes this obligation,
including in core principle 5, which
[[Page 75713]]
requires DCMs to consider position limitations or position
accountability for speculators to reduce the potential threat of market
manipulation or congestion, especially during trading in the delivery
month.319 Exchanges will typically impose on large short position
holders in a physical-delivery contract a continuing obligation to
compare cash market and futures market prices in the spot month and to
liquidate the derivative position (i.e., buy back the short position)
if the commodity may be sold at a more favorable (higher) price in the
cash market. Further, exchanges will typically impose on large long
position holders in a physical-delivery contract a continuing
obligation to compare cash market and futures market prices in the spot
month and to liquidate the derivative position (i.e., sell the long
position) if the commodity may be purchased at a more favorable (lower)
price in the cash market. Exchanges can continue these practices under
the proposed rule.
—————————————————————————
319 7 U.S.C. 7(d)(5).
—————————————————————————
(1) Exemption-by-Exemption Discussion
Inventory and cash commodity purchase contracts–paragraph (3)(A).
Inventory and fixed-price cash commodity purchase contracts have long
served as the basis of a bona fide hedging position.320 This
provision is in current Sec. 1.3(z)(2)(i)(A). A commercial enterprise
is exposed to price risk if it has (i) obtained inventory in the normal
course of business or (ii) entered into a fixed-price purchase
contract, whether spot or forward, calling for delivery in the physical
marketing channel of a commodity; and has not offset that price risk.
For example, an enterprise may offset such price risk in the cash
market by entry into fixed-price sales contracts. An appropriate hedge
of inventory or a fixed-price purchase contract would be to establish a
short position in a commodity derivative contract to offset the risk of
such position. Such short position may be held into the spot month in a
physical-delivery contract if economically appropriate.321
—————————————————————————
320 See, e.g., 7 U.S.C 6a(3) (1970). That statutory definition
of bona fide hedging included “sales of, or short positions in, any
commodity for future delivery on or subject to the rules of any
contract market made or held by such person to the extent that such
sales or short positions are offset in quantity by the ownership or
purchase of the same cash commodity by the same person.”
321 For example, it would not appear to be economically
appropriate to hold a short position in the spot month of a
commodity derivative contract against fixed-price purchase contracts
that provide for deferred delivery in comparison to the delivery
period for the spot month commodity derivative contract. This is
because the commodity under the cash contract would not be available
for delivery on the commodity derivative contract.
—————————————————————————
A person can use a commodity derivative contract to hedge
inventories of a cash commodity that is deliverable on that physical-
delivery contract. Such a deliverable cash commodity inventory need not
be in a delivery location. However, the Commission notes that a DCM or
SEF may prudentially require such short positions holders to
demonstrate the ability to move the commodity into a deliverable
location, particularly during the spot month.322
—————————————————————————
322 Further, the Commission notes an exchange, pursuant to its
position accountability rules, may at any time direct a trader that
is in excess of accountability levels to reduce a position in a
contract traded on that exchange.
—————————————————————————
Once inventory has been sold, a person is permitted a commercially
reasonable time period, as necessary to exit the market in an orderly
manner, to liquidate a position in commodity derivative contracts in
excess of a position limit. Generally, the Commission believes such
time period would be less than one business day.
Cash commodity sales contracts–paragraph (3)(B). Fixed-price cash
commodity sales have long served as the basis of a bona fide hedging
position.323 This provision is in current Sec. 1.3(z)(2)(ii)(A) and
(B). A commercial enterprise is exposed to price risk if it has entered
into a fixed-price sales contract, whether spot or forward, calling for
delivery in the physical marketing channel of a commodity and has not
offset that price risk, for example, by entering into a fixed-price
purchase contract. An appropriate hedge of a fixed-price sales contract
would be to establish a long position in a commodity derivative
contract to offset the risk of such cash market contact. Such long
position may be held into the spot month in a physical-delivery
contract if economically appropriate.
—————————————————————————
323 See, e.g., 7 U.S.C. 6a(3)(1970). That statutory definition
of bona fide hedging included “purchases of, or long positions in,
any commodity for future delivery on or subject to the rules of any
contract market made or held by such person to the extent that such
purchases or long positions are offset by sales of the same cash
commodity by the same person.”
—————————————————————————
Unfilled anticipated requirements–paragraph (3)(C)(i). Unfilled
anticipated requirements for the same cash commodity have long served
as the basis of a bona fide hedging position.324 This provision
mirrors the requirement of current Sec. 1.3(z)(2)(ii)(C). An
appropriate hedge of unfilled anticipated requirements would be to
establish a long position in a commodity derivative contract to offset
the risk of such unfilled anticipated requirements.
—————————————————————————
324 See, e.g., 7 U.S.C. 6a(3)(C) (1970). That statutory
definition of bona fide hedging included “an amount of such
commodity the purchase of which for future delivery shall not exceed
such person’s unfilled anticipated requirements for processing or
manufacturing during a specified operating period not in excess of
one year: Provided, That such purchase is made and liquidated in an
orderly manner and in accordance with sound commercial practice in
conformity with such regulations as the Secretary of Agriculture may
prescribe.”
—————————————————————————
Under the proposal, such long positions may not be held into the
lesser of the last five days of trading or the time period for the spot
month in a physical-delivery commodity derivative contract (the five-
day rule), with the exception that a person may hold long positions
that do not exceed the person’s unfilled anticipate requirements of the
same cash commodity for the next two months. As noted above, the CME
Group and the Working Group pointed out that previously, persons
engaged in purchases of futures contracts have been permitted to hold
up to twelve months unfilled anticipated requirements of the same cash
commodity for processing, manufacturing, or feeding by the same person,
provided that such transactions and positions in the five last trading
days of any one futures do not exceed the person’s unfilled anticipated
requirements of the same cash commodity for that month and for the next
succeeding month.
Utility hedging unfilled anticipated requirements of customers–
paragraph (3)(iii)(B). The Commission is proposing a new exemption for
unfilled anticipated requirements for resale by a utility. This
provision is analogous to the unfilled anticipated requirements
provision of paragraph (3)(iii)(A), except the commodity is not for use
by the same person–that is, the utility–but rather for anticipated
use by the utility’s customers. The proposed new exemption would
recognize a bona fide hedging position where a utility is required or
encouraged to hedge by its public utility commission (“PUC”).
Request Six of the Working Group petition asked the Commission to
grant relief with respect to a long position in a commodity derivative
contract that arises from natural gas utilities’ desire to hedge the
price of gas that they expect to purchase and supply to their retail
customers. In support of its petition, the Working Group provided
evidence that hedging natural gas price risk, which includes some
combination of fixed-price supply contracts, storage and derivatives,
is a prudent risk management practice that limits volatility in the
prices ultimately paid by consumers.325
—————————————————————————
325 See, e.g., “Use of Hedging by Local Gas Distribution
Companies: Basic Considerations and Regulatory Issues,” K. Costello
and J. Cita, The National Regulatory Research Institute at the Ohio
State University (May 2001). All supporting materials provided by
the Working Group are available at http://sirt.cftc.gov/sirt/sirt.aspx?Topic=CommissionOrdersandOtherActionsAD&Key=23082.
—————————————————————————
[[Page 75714]]
Materials submitted in support of the Working Group petition 326
make it clear that the risk management transactions–fixed-price
contracts, storage, and derivatives–engaged in by a typical natural
gas utility to reduce risk associated with anticipated requirements of
natural gas are used to fulfill its obligation to serve retail
customers and are typically considered by the state PUC as prudent. The
PUC may indeed obligate the natural gas utility to hedge some portion
of the supply of natural gas needed to meet the needs of its customers
and may take regulatory action if the utility fails to do so. As a
result, in order to mitigate the impact of natural gas price volatility
on the cost of natural gas acquired to serve its regulated retail
natural gas customers, a utility may enter into long positions in
commodity derivative contracts to hedge a specified percentage of such
customers’ anticipated natural gas requirements over a multi-year
horizon. The utility’s PUC considers such hedging practices to be
prudent and has allowed gains and losses related to such hedging
activities to be retained by its regulated retail natural gas
customers.
—————————————————————————
326 Id.
—————————————————————————
The Commission recognizes the highly regulated nature of the
natural gas market, where state-regulated public utilities may have
rules or guidance concerning locking in the costs of anticipated
requirements for retail customers through a number of means, including
fixed-price purchase contracts, storage, and commodity derivative
contracts. Moreover, since the public utility typically does not
directly profit from the results of its hedging activity (because most
or all of the gains derived from hedging are passed on to customers,
e.g., through the price charged for natural gas), the utility has no
incentive to speculate.
The Commission invites comments on all aspects of this new
enumerated bona fide hedging exemption.
Hedges by agents–paragraph (3)(iv). The Commission is proposing an
enumerated exemption for hedges by an agent who does not own or has not
contracted to sell or purchase the offsetting cash commodity at a fixed
price, provided that the agent is responsible for merchandising the
cash positions that are being offset in commodity derivative contracts
and the agent has a contractual arrangement with the person who owns
the commodity or holds the cash market commitment being offset. The
Commission historically has recognized a merchandising transaction as a
bona fide hedge in the narrow circumstances of an agent responsible for
merchandising a cash market position which is being offset.327
—————————————————————————
327 This provision is included in current Sec. 1.3(z)(3) as
an example of a potential non-enumerated case. 17 CFR 1.3(z)(3).
Compare vacated Sec. 151.5(a)(2)(iv).
—————————————————————————
Other enumerated hedging positions–paragraph (4). Each of the
other enumerated hedging positions would be subject to the five-day
rule for physical-delivery contracts. The Commission reiterates the
intent of the five-day rule is to protect the integrity of the delivery
process in physical-delivery contracts. The reorganization into new
paragraph (4) of existing provisions in 1.3(z) subject to the five-day
rule is intended for administrative ease.
Unsold anticipated production–paragraph (4)(i). Unsold anticipated
production has long served as the basis of a bona fide hedging
position.328 This provision is in current Sec. 1.3(z)(2)(i)(B). The
Commission historically has recognized twelve months of unsold
anticipated production in an agricultural commodity as the basis of a
bona fide hedging position. Under the proposal, this twelve-month
restriction would not apply to physical-delivery contracts that were
not in an agricultural commodity.
—————————————————————————
328 See 7 U.S.C 6a(3)(A) (1940). That statutory definition of
bona fide hedging, enacted in 1936, included “the amount of such
commodity such person is raising, or in good faith intends or
expects to raise, within the next twelve months, on land (in the
United States or its Territories) which such person owns or
leases.”
—————————————————————————
The Commission is considering relaxing the five-day rule to permit
a person to hold a position in a physical-delivery commodity derivative
contract, other than in an agricultural commodity, through the close of
the spot month that does not exceed in quantity the reasonably
anticipated unsold forward production that would be available for
delivery under the terms of a physical-delivery commodity derivative
contract. For example, a person with a significant number of producing
natural gas wells may be highly certain that she can be a position to
deliver natural gas on the physical-delivery natural gas futures
contract.329 The Commission is considering permitting the exchange
listing the physical-delivery commodity derivative contract to
administer exemptions to the five-day rule upon application to such
exchange specifying the unsold forward production that could be moved
into delivery position. The Commission requests comment on this
alternative.
—————————————————————————
329 In contrast, prior to harvest, a farmer must plant and
manage a crop until it is ripe. Anticipated agricultural production
may not be available timely at a delivery location for a futures
contract. Thus, historically, only inventories of agricultural
commodities, rather than anticipated production, have been
recognized as a basis for a bona fide hedging position under the
five-day rule.
—————————————————————————
Offsetting unfixed-price cash commodity sales and purchases–
paragraph (4)(ii). Offsetting unfixed-price cash commodity sales and
purchases basis different delivery months in the same commodity
derivative contract have long served as the basis of a bona fide
hedging position. 330 This provision is in current Sec.
1.3(z)(2)(iii). The Commission explained a major rationale for this
exemption for spread positions was to facilitate commercial risk
shifting positions which may not have otherwise conformed to the
definition of bona fide hedging.331
—————————————————————————
330 The Commission added this enumerated exemption to the
definition of bona fide hedging in 1987. 52 FR 38914, Oct. 20, 1987.
331 51 FR 31648, 31650, September 4, 1986. “In particular, a
cotton merchant may contract to purchase and sell cotton in the cash
market in relation to the futures price in different delivery months
for cotton, i.e., a basis purchase and a basis sale. Prior to the
time when the price is fixed for each leg of such a cash position,
the merchant is subject to a variation in the two futures contracts
utilized for price basing. This variation can be offset by
purchasing the future on which the sales were based [and] selling
the future on which [the] purchases were based.” Id. (n. 3).
—————————————————————————
The proposed enumerated provision would be expanded from current
Sec. 1.3(z)(2)(iii) to include unfixed-price cash contracts basis
different commodity derivative contracts in the same commodity,
regardless of whether the commodity derivative contracts are in the
same calendar month.332 The Commission notes a commercial enterprise
may enter into the described transactions to reduce the risk arising
from either (or both) a location differential or a time differential in
unfixed price purchase and sale contracts in the same cash
commodity.333 The contemplated derivative transactions represent a
substitute for two transactions to be made at a later time in a
physical marketing channel: a fixed-price purchase and a fixed-price
sale of the
[[Page 75715]]
same cash commodity. The commercial enterprise intends to later take
delivery on one unfixed-price cash contract and to re-deliver the same
cash commodity on another unfixed-price cash contract. There may be no
substantive difference in time between taking and making delivery in
the physical marketing channel, but the derivative contracts do not
offset each other because they are in two different contracts (e.g.,
the NYMEX Light Sweet Crude Oil futures contract versus the ICE Europe
Brent crude futures) or two different instruments (e.g., swaps versus
futures). The contemplated derivative positions will offset the risk
that the difference in the expected delivery prices of the two unfixed-
price cash contracts in the same commodity will change between the time
the hedging transaction is entered and the time of fixing of the prices
on the purchase and sales cash contracts. Therefore, the contemplated
derivative positions are economically appropriate to the reduction of
risk.
—————————————————————————
332 The Working Group requested this expansion in Requests One
and Two.
333 A location differential is the difference in price between
two derivative contracts in the same commodity (or substantially the
same commodity) at two different delivery locations on the same (or
similar) delivery dates. A location differential also may underlie a
single derivative contract that is called a basis contract.
—————————————————————————
In the case of reducing the risk of a location differential, and
where each of the underlying transactions in separate derivative
contracts may be in the same contract month, the Commission notes that
a position in a basis contract would not be subject to position limits,
as discussed in the proposed definition of referenced contract.
The Commission notes that upon fixing the price of, or taking
delivery on, the purchase contract, the owner of the cash commodity may
hold the short derivative leg of the spread as a hedge against a fixed-
price purchase or inventory.334 However, the long derivative leg of
the spread would no longer qualify as a bona fide hedging position
since the commercial entity has fixed the price or taken delivery on
the purchase contract. Similarly, if the commercial entity first fixed
the price of the sales contract, the long derivative leg of the spread
may be held as a hedge against a fixed-price sale,335 but the short
derivative leg of the spread would no longer qualify as a bona fide
hedging position.
—————————————————————————
334 See proposed paragraph (3)(i) of the definition of bona
fide hedging position under Sec. 150.1.
335 See proposed paragraph (3)(ii) of the definition of bona
fide hedging position under Sec. 150.1.
—————————————————————————
Anticipated royalties–paragraph (4)(iii). The new enumerated
exemption would permit an owner of a royalty to lock in the price of
anticipated mineral production. The Commission initially recognized the
hedging of anticipated royalties in vacated Sec. 151.5(a)(2)(vi).336
That provision would have recognized “sales or purchases” in
commodity derivative contracts that would be “offset by the
anticipated change in value of royalty rights that are owned by the
same person . . . [and] arise out of the production, manufacturing,
processing, use, or transportation of the commodity underlying the
[commodity derivative contract], which may not exceed one year for
agricultural” commodity derivative contracts; such positions would be
subject to the five-day rule.
—————————————————————————
336 76 FR at 71689.
—————————————————————————
The Commission has reconsidered that exemption in vacated Sec.
151.5(a)(2)(vi) and now re-proposes it as an enumerated exemption for
short positions in commodity derivative contracts offset by the
anticipated change in value of mineral royalty rights that are owned by
the same person and arise out of the production of a mineral commodity
(e.g., oil and gas); such positions would be subject to the five-day
rule. This proposed exemption differs from the exemption in vacated
Sec. 151.5(a)(2)(vi) because it applies only to: (i) Short positions;
(ii) arising from production; and (iii) in the context of mineral
extraction.
A royalty arises as “compensation for the use of property . . .
[such as] natural resources, expressed as a percentage of receipts from
using the property or as an account per unit produced.” 337 A short
position is the proper offset of a yet-to-be received payment based on
a percentage of receipts per unit produced for a royalty that is owned.
This is because a short position fixes the price of the anticipated
receipts, removing exposure to change in value of the person’s share of
the production revenue.338 In contrast, a person who has issued a
royalty has, by definition, agreed to make a payment in exchange for
value received or to be received (e.g., the right to extract a
mineral). Upon extraction of a mineral and sale at the prevailing cash
market price, the issuer of a royalty remits part of the proceeds in
satisfaction of the royalty agreement. Thus, the issuer of a royalty
does not have price risk arising from that royalty agreement.
—————————————————————————
337 Black’s Law Dictionary, 6th Ed.
338 A short position fixes the price at the entry price to the
commodity derivative contract. For any decrease (increase) in price
of the commodity produced, the expected royalty would decline
(increase) in value, but the commodity derivative contract would
increase (decrease) in value, offsetting the price risk in the
royalty.
—————————————————————————
The Commission preliminarily believes that “manufacturing,
processing, use, or transportation” of a commodity does not conform to
the meaning of the term royalty. Further, while the Commission
recognizes that, historically, royalties have been paid for use of land
in agricultural production,339 the Commission has not received any
evidence of a need for a bona fide hedging exemption from owners of
agricultural production royalties. The Commission nonetheless invites
comment on all aspects of this new royalty exemption.
—————————————————————————
339 For example, corn “rents” were cited in An Inquiry into
the Nature and Causes of the Wealth of Nations, Smith, Adam, 1776,
at cp. 5, available at: http://www.gutenberg.org/files/3300/3300-h/3300-h.htm. This eBook is for the use of anyone anywhere at no cost
and with almost no restrictions whatsoever. You may copy it, give it
away, or re-use it under the terms of the Project Gutenberg License
included with this eBook or online at www.gutenberg.org.
—————————————————————————
Services–paragraph (4)(iv). The Commission is proposing the
hedging of services as a new enumerated hedge in subparagraph (4)(iv)
of the proposed definition. This new exemption is not without
Commission precedent. For example, in 1977, the Commission noted that
the existence of futures markets for both source and product
commodities, such as soybeans and soybean oil and meal, afford business
firms increased opportunities to hedge the value of services.340 The
Commission’s current proposal is similar to vacated Sec.
151.5(a)(2)(vii).341 That provision would have recognized “sales or
purchases” in commodity derivative contracts that would be “offset by
the anticipated change in value of receipts or payments due or expected
to be due under an executed contract for services held by the same
person . . . [and] the contract for services arises out of the
production, manufacturing, processing, use, or transportation of the
commodity underlying the [commodity derivative contract], which may not
exceed one year for agricultural” commodity derivative contracts; such
positions would be subject to the five-day rule. That provision also
made such positions subject to a provision for cross-commodity hedging,
namely that, “The fluctuations in the value of the position in
[commodity derivative contracts] are substantially related to the
fluctuations in value of receipts or payments due or expected to be due
under a contract for services.” 342
—————————————————————————
340 42 FR 14832, 14833, Mar. 16, 1977.
341 76 FR at 71689.
342 Vacated Sec. 151.5(a)(2)(vii)(B).
—————————————————————————
The Commission has reconsidered its proposed exemption in vacated
Sec. 151.5(a)(2)(vii) and now re-proposes an enumerated exemption that
is largely the same, save for deleting the cross-commodity hedging
provision in this enumerated exemption, as that provision is included
under the cross-
[[Page 75716]]
commodity hedging exemption, discussed below. Thus, the proposed
exemption would recognize “sales or purchases” in commodity
derivative contracts that are “offset by the anticipated change in
value of receipts or payments due or expected to be due under an
executed contract for services by the same person . . . [and] the
contract for services arises out of the production, manufacturing,
processing, use, or transportation of the commodity which may not
exceed one year for agricultural” commodity derivative contracts; such
positions would be subject to the five-day rule.
As the Commission previously noted and under this proposed
exemption, “crop insurance providers and other agents that provide
services in the physical marketing channel could qualify for a bona
fide hedge of their contracts for services arising out of the
production of the commodity underlying a [commodity derivative
contract].” 343 The Commission invites comment on all aspects of
this new services exemption.
—————————————————————————
343 76 FR at 71654.
—————————————————————————
(2) Cross-Commodity Hedges–Paragraph (5)
The proposed cross-commodity hedging provision would apply to all
enumerated hedges in paragraphs (3) and (4) of the definition of bona
fide hedging position, as well as to pass-through swaps under paragraph
(2).344 The Commission has long recognized cross-commodity hedging,
noting in 1977 that sales for future delivery of any product or
byproduct which is offset by the ownership of fixed-price purchase of
the source commodity would be covered by the general provisions for
cross-commodity hedging in Sec. 1.3(z)(2).345
—————————————————————————
344 Compare with vacated Sec. 151.5(a)(2)(viii), which
provided for cross-commodity hedges in enumerated positions but not
for pass-through swaps.
345 42 FR 14832, 14834, Mar. 16, 1977. The Commission noted
its belief that there is little commercial need to maintain cross-
hedge positions during the last five trading days of any expiring
contract. It believed the five-day restriction was necessary to
guarantee the integrity of the markets. The Commission considered
there was little commercial utility of such positions during the
last five days of trading to offset anticipated production, which at
that time was limited to agricultural commodities. The Commission
considered its responsibility for orderly markets and concluded not
to propose an enumerated exemption in the last five days of trading
for anticipatory production. See also 7 U.S.C. 6a(3)(B) (1970). That
statutory definition of bona fide hedging included “an amount of
such commodity the sale of which for future delivery would be a
reasonable hedge against the products or byproducts of such
commodity owned or purchased by such person, or the purchase of
which for future delivery would be a reasonable hedge against the
sale of any product or byproduct of such commodity by such person.”
Id.
—————————————————————————
Under the proposed enumerated exemption, cross-commodity hedging
would be conditioned on: (i) The fluctuations in value of the position
in the commodity derivative contract (or the commodity underlying the
commodity derivative contract) are substantially related to the
fluctuations in value of the actual or anticipated cash position or
pass-through swap (the “substantially related” test); and (ii) the
five-day rule being applied to positions in any physical-delivery
commodity derivative contract.346 As discussed above, the five-day
rule would not restrict positions in cash-settled contracts, but would
restrict only positions in physical-delivery commodity derivative
contracts. Thus, the Commission is protecting the integrity of the
delivery process in the physical-delivery contract. Further, as noted
above, few traders typically hold a position in excess of the position
limits during the last few days of the spot month. Hence, a cross-
commodity hedger who held a position deep into the spot month in excess
of the spot position limit likely would be large relative to all
traders. Such large positions may interfere with convergence of the
commodity derivative contract with the cash market price, since the
supply and demand expectations for cross-commodity hedgers may differ
from those of persons hedging price risks of the commodity underlying
the physical-delivery derivative.
—————————————————————————
346 Compare with current Sec. 1.3(z)(2)(iv), which requires
compliance with the substantially related test and with the five-day
rule, and does not provide an exception to the five-day rule for
cash-settled contracts.
—————————————————————————
Substantially related test. The Commission is proposing guidance on
the meaning of the substantially related test. The Commission is
proposing a non-exclusive safe harbor for cross-commodity hedges.347
The safe harbor would have two factors: (i) Qualitative; and (ii)
quantitative.
—————————————————————————
347 The Commission understands that cross-commodity hedges in
physical commodities are not generally recognized by accountants as
eligible for hedge accounting treatment.
—————————————————————————
Qualitative factor: As a first factor in assessing whether a cross-
commodity hedge is bona fide, the target commodity should have a
reasonable commercial relationship to the commodity underlying the
commodity derivative contract. For example, there is a reasonable
commercial relationship between grain sorghum (commonly called milo),
used as a food grain for humans or as animal feedstock, with corn
underlying a commodity derivative contract.348
—————————————————————————
348 See, e.g., “The Alternative Field Crops Manual,”
University of Minnesota, November 1989, available at http://www.hort.purdue.edu/newcrop/afcm/sorghum.html.
—————————————————————————
In contrast, there does not appear to be a reasonable commercial
relationship between a physical commodity and a stock price index;
while long-term price series of such commodities may be statistically
related by either inflation or measures of economic activity, such
disparate commodities do not appear to have the requisite commercial
relationship. Such correlation appears for this purpose to be spurious.
[[Page 75717]]
Quantitative factor: The target commodity should also be offset by
a position in a commodity derivative contract that provides a
reasonable quantitative correlation and in light of available liquid
commodity derivative contracts. The Commission will presume an
appropriate quantitative relationship exists when the correlation (R),
between first differences or returns in daily spot price series for the
target commodity and the price series for the commodity underlying the
derivative contract (or the price series for the derivative contract
used to offset risk), is at least 0.80 for a time period of at least 36
months.349 When less granular price series than daily are used, R
typically will be higher. Thus, price series data of at least daily
frequency should be used, if available.
—————————————————————————
349 By way of comparison, accounting practice may look to
goodness of fit (R2) to be at least 0.80. The proposed correlation
(R) of 0.80 corresponds to an R2 of 0.64, substantially less than
accounting practice. Further, accounting practice may look to the
coefficient (hedge ratio) from a regression analysis to be in the
range of negative 0.80 to 1.25. The Commission notes that the size
of this coefficient is dependent upon the unit of trading for the
hedging instrument and the unit of trading for the target of the
hedge. To the extent both may be expressed in similar terms, the
coefficient may fall within the range suggested by accounting
practice. However, given standardized hedging instruments such as
futures are fixed in terms of a particular price quote for a
commodity (such as in dollars per bushel) and the target of a cross-
commodity hedge may not have units fixed in the same terms (such as
in dollars per hundred weight), the hedge ratio will depend on a
fairly arbitrary choice of units to express the price series of the
target of the hedge. Thus, the Commission is not proposing any
particular safe harbor or requirement for a hedge ratio.
—————————————————————————
The Commission will presume that positions in a commodity
derivative contract that does not meet the safe harbor are not bona
fide cross-commodity hedging positions. However, a person may rebut
this presumption upon presentation of facts and circumstances
demonstrating a reasonable relationship between the spot price series
for the commodity to be hedged and either the spot price series for the
commodity underlying the commodity derivative contract or the price
series for the commodity derivative contract to be used for hedging. A
person should consider whether there is an actively traded commodity
derivative contract that would meet the safe harbor, in light of
liquidity considerations. A person may seek interpretative relief under
Sec. 140.99 for recognition of such a position as a bona fide hedging
position.
Generally, a regression or time series analysis of prices should be
performed to determine an appropriate hedge ratio.350 Many price
series are non-stationary because the prices increase with time and,
thus, do not revert to a mean (i.e., stationary) price level. A
regression on non-stationary data can give rise to spurious values for
the “goodness of fit” and other statistics.351 Thus, a quantitative
analysis should be performed using first differences or returns
(percentage price changes) so as to render the time series
stationary.352 However, the Commission is not proposing to condition
the substantially related test on any particular hedge ratio
methodology.
—————————————————————————
350 The Commission notes this safe harbor is intentionally
written in general terms. Appropriate hedge ratios may be determined
using an appropriate model, including but not limited to ordinary
lease squares (OLS), autoregressive conditional heteroscedasticity
(ARCH), generalized autoregressive conditional heteroscedasticity
(GARCH), or an error-correction model (ECM).
351 “Goodness of fit” is defined as: “A general term
describing the extent to which an econometrically estimated equation
fits the data. There are various ways of summarizing this concept,
including the coefficient of determination and adjusted R2.”
“The MIT Dictionary of Modern Economics,” 4th Ed. (1996).
352 See, e.g., “A Guide to Econometrics,” 5th Ed., The MIT
Press (2003), at p.319.
—————————————————————————
By way of example, the Commission believes that fluctuations in the
value of electricity contracts typically will not be substantially
related to fluctuations in value of natural gas. There may not be a
substantial relation, for example, because the marginal pricing in a
spot market may be driven by the price of something other than natural
gas, such as nuclear, coal, transmission, outages, or water/
hydroelectric power generation. Table 5 below shows illustrative simple
correlations, both in terms of levels and returns, between spot
electricity prices and natural gas (both spot Henry Hub prices and the
nearby NYMEX Henry Hub Natural Gas futures prices, assuming a roll to
the next deferred futures contract on the eleventh calendar day of each
month). These correlations are much lower than the proposed safe harbor
level of 0.80.
[[Page 75718]]
Table 5–Correlations–Spot Electricity Prices and Natural Gas (spot and futures) Prices January 2, 2009 to May
14, 2013
—————————————————————————————————————-
Price series: Correlations using: Henry Hub spot Henry Hub futures
—————————————————————————————————————-
Houston electricity…………….. Levels……………… 0.1333 0.0630
Returns…………….. 0.1264 0.0488
PJM electricity………………… Levels……………… 0.4415 0.2724
Returns…………….. 0.0987 0.0153
New England electricity…………. Levels……………… 0.3450 0.2422
Returns…………….. 0.1808 0.0121
—————————————————————————————————————-
Data sources: Henry Hub Gulf Coast Natural Gas Spot Price ($ per mmBTUs) and Natural Gas Futures Contracts ($
per mmBTU), source: US Energy Information Administration, available at http://www.eia.gov/dnav/ng/ng_pri_fut_s1_d.htm; Wholesale Day Ahead Prices at Selected Hubs, Peak (5/16/2013), source: US Energy Information
Administration, republished from the Intercontinental Exchange (ICE), available at http://www.eia.gov/electricity/wholesale/ electricity/wholesale/.
Alternatively, a generator of electricity that owns or leases a
natural gas generator may qualify for an unfilled anticipated
requirements bona fide hedge to meet a fixed price power commitment
(sale of electricity). The position that is hedged is the quantity
equivalent of natural gas through the generator to meet the contracted
fixed price power commitment.353 A natural gas hedge exemption can
also be applied to operating characteristics of the plant and sources
of revenue such as ancillary services.
—————————————————————————
353 A generator must also be able to satisfy any operating
constraints, including minimum production runs.
—————————————————————————
(3) Examples of Bona Fide Hedging Positions in Appendix B
The Commission is providing examples to illustrate enumerated bona
fide hedging positions. The Commission invites comment on all aspects
of the examples.
h. Non-Enumerated Hedging Exemptions
The Commission proposes to replace the existing procedures for
persons seeking non-enumerated hedging exemptions under current Sec.
1.3(z)(3) and Sec. 1.47 with proposed Sec. 150.3(e), discussed
further below, that would provide guidance for persons seeking non-
enumerated hedging exemptions through filing of a petition under
section 4a(a)(7) of the Act. As noted above, practically all non-
enumerated hedging exemption requests were from persons seeking to
offset the risk arising from swap books, which the Commission has
addressed in the proposed pass-through swaps and pass-through swap
offsets, and in the proposal to net positions in futures and swap
reference contracts for purposes of single-month and all-months-
combined position limits.
The Commission requests comment on industry practices involving the
hedging of risks of cash market activities in a physical commodity that
are not specifically enumerated in paragraphs (3), (4), and (5) of the
proposed definition of bona fide hedging position, the extent to which
such hedging practices reflect industry standards or best practices and
the particular sources of changes in value that such hedging positions
offset.
Under the proposal for hedges of physical commodities, additional
enumerated hedges could only be added to the proposed definition of
bona fide hedging position by way of notice and comment rulemaking.
Should the Commission adopt, as an alternative, an administrative
procedure that would allow the Commission to add additional enumerated
bona fide hedges without requiring notice and comment rulemaking? If
so, what procedures should be used? Is current Sec. 1.47 an
appropriate process? And what standards, in addition to the statutory
standards of CEA section 4a(c)(2), should be applicable to any such
administrative procedure? The Commission is particularly concerned
about the absence of standards in current Sec. 1.47. If the Commission
were to adopt such an administrative procedure, how should the
Commission address the factors in CEA section 4a(a)(3)(B) in such an
administrative procedure?
No Proposal of Unfilled Storage Capacity as an Anticipated
Merchandizing Hedge. The Commission is not re-proposing a hedge for
unfilled storage capacity that was in vacated Sec. 151.5(a)(2)(v).
That exemption would have permitted a person to establish as a bona
fide hedge offsetting sales and purchases of commodity derivative
contracts that did not exceed in quantity the amount of the same cash
commodity that was anticipated to be merchandized. That exemption was
limited to the current or anticipated amount of unfilled storage
capacity that the person owned or leased.
The Commission previously noted it had not recognized anticipated
merchandising transactions as bona fide hedges due to its historic view
that merchandizing transactions generally fail to meet the economically
appropriate test.354 The Commission explained, “A merchant may
anticipate that it will purchase and sell a certain amount of a
commodity, but has not acquired any inventory or entered into fixed-
price purchase or sales contracts. Although the merchant may anticipate
such activity, the price risk from merchandising activity is yet to be
assumed and therefore a transaction in [commodity derivative contracts]
could not reduce this yet-to-be-assumed risk.” In response to
comments, the Commission opined that, “in some circumstances, such as
when a market participant owns or leases an asset in the form of
storage capacity, the market participant could establish market
positions to reduce the risk associated with returns anticipated from
owning or leasing that capacity. In these narrow circumstances, the
transaction in question may meet the statutory definition of a bona
fide hedging transaction.”
—————————————————————————
354 76 FR at 71646.
—————————————————————————
With the benefit of further review, the Commission now sees a
strong basis to doubt that such a position generally will meet the
economically appropriate test. This is because the value fluctuations
in a calendar month spread in a commodity derivative contract will
likely have at best a low correlation with value fluctuations in
expected returns (e.g., rents) on unfilled storage capacity. There are
at least two factors that contribute to the size of a calendar month
spread.355 One factor is the cost of carry, comprised of the
anticipated storage cost plus the interest paid to finance purchase of
the physical
[[Page 75719]]
commodity over the time period of the calendar month spread.356 A
second factor, and likely the factor that most contributes to value
fluctuations in the calendar month spread, is the difference in the
anticipated supply and demand of a commodity on the different dates of
the calendar month spread. In this context, a calendar month spread
position would likely increase, rather than decrease, risk in the
operation of a commercial enterprise. Accordingly, for these reasons,
the Commission is not re-proposing to recognize a bona fide hedging
position based on an unfilled storage bin and any of a number of
commodities that a merchant might store in such bin.
—————————————————————————
355 A calendar month spread generally means the purchase of
one delivery month of a given futures contract and simultaneous sale
of a different delivery month of the same futures contract. See CFTC
Glossary, available at http://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/index.htm.
356 For a brief discussion of cost of carry, see, e.g.,
“Options, Futures, and Other Derivatives,” 3rd Ed., Hull, (1997)
at p. 67.
—————————————————————————
For example, the Commission recognizes there is commercial risk in
operating off-farm storage, including the risk that total grain
production may not be sufficient to ensure capacity utilization of such
storage. Business costs of providing off-farm storage include the fixed
cost of the storage facility and the variable costs for labor and fuel,
in addition to other costs such as insurance. However, as the
Commission noted above, based on its experience, the value fluctuations
in a calendar month spread in a commodity derivative contract will
likely have at best a low correlation with value fluctuations in
expected returns (e.g., rents) on unfilled storage capacity. Therefore,
the Commission requests comment on what positions in commodity
derivative contracts, if any, would offset the value changes in the
commercial risks (e.g., changes in anticipated rental income or changes
in other revenue streams) arising from a commodity storage business.
And for those positions that would offset value changes in the
commercial risks, what data should the Commission obtain to verify such
claims? By way of comparison, the Commission has recognized unsold
anticipated production and unfilled anticipated requirements for
processing, manufacturing or feeding, as the basis of a bona fide
hedging position.357 The Commission has required persons seeking to
claim such production or requirements exemptions to file statements
showing historical production or usage and anticipated production or
usage.358
—————————————————————————
357 See current Sec. 1.3(z)(2)(i)(B) and (C).
358 See current Sec. 1.48.
—————————————————————————
The Commission invites commenters to provide specific, empirical
analysis and data that would demonstrate how particular types of
transactions could reduce the value at risk of unfilled storage space
that could support such an exemption.
i. Summary of Disposition of Working Group Petition Requests
As noted above, the Working Group made ten requests for exemptions
under vacated part 151.359 The Commission summarizes and addresses in
a brief statement each request, below.
—————————————————————————
359 The Working Group Petition is available at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/wgbfhpetition012012.pdf.
—————————————————————————
Request One. Unfixed Price Transactions Involving a Non-Referenced
Contract: In a hedge of an unfixed price purchase and unfixed price
sale of a physical commodity in which one leg of the hedge is a
referenced contract and the other leg is a non-referenced contract, the
Working Group requests that the referenced contract leg of the hedge be
treated as a bona fide hedging position.
The proposed definition of bona fide hedging position would permit
Request One under proposed paragraphs (4)(ii)(B) and (5), discussed
above.
Request Two. Offsetting Unfixed Price Transactions Hedged with
Derivatives in the Same Calendar Month: The Working Group requests that
hedges of an unfixed price purchase and an unfixed price sale of a
physical commodity in which the separate legs of the hedge are in the
same calendar month, but which do not offset each other, because they
are in different contracts or for any other reason, be treated as bona
fide hedging positions.
The proposed definition of bona fide hedging position would permit
Request Two under proposed paragraphs (4)(ii)(B) and (5), discussed
above.
Request Three. Unpriced Physical Purchase or Sale Commitments: The
Working Group requests that referenced contracts used to lock in a
price differential where one leg of the underlying transaction is an
unpriced commitment to buy or sell a physical energy commodity, and the
offsetting sale or purchase has not been completed, be treated as bona
fide hedging transactions or positions.
This request would not be permitted under the proposed definition
of bona fide hedging position. The transaction described in Request
Three concerns a commercial entity that has entered into either an
unfixed-price sale or an unfixed-price purchase, but has not entered
into an offsetting purchase or sale contract. This differs from the
proposed enumerated bona fide hedge exemption provided in paragraph
(4)(ii) because both sides of the cash transactions have not been
contracted.
Locking in the spread for the same commodity between two markets is
prudent risk management when a commercial trader has a contractual
commitment both to buy and sell the physical commodity at unfixed
prices in the same two markets. A commercial merchant may expect to
match an unfixed-price purchase with an unfixed-price sale, regardless
of which came first, and at that point, will qualify for a hedge
exemption for the basis risk, under paragraphs (4)(ii) and (5), as
discussed in Requests One and Two, above.
However, a trader has not established a definite exposure to a
value change when that trader has established only an unfixed price
purchase or sales contract. This cash position fails the change in
value requirement. Considering the anticipated merchandizing
transaction, a merchant may assert her intention, but merchandizing
intentions alone are not sufficient to recognize a price risk (that is,
the yet-to-be established pair of unfixed-price cash purchase and sales
contracts). The Commission is concerned that exempting such a yet-to-be
established cash position would make it difficult or impossible for the
Commission to distinguish hedging from speculation. For example, a
trader could maintain a derivatives position, exempt from position
limits, until that trader enters into a subsequent cash market
transaction that results in a book-out of the first unfixed-price cash
market transaction. The trader could assert that changed conditions
resulted in a change in intentions. Since market prices are continually
changing to reflect new information and, thus, changing conditions, the
Commission believes an exemption standard based on merchandizing
intentions alone would be no standard at all.
The Commission recognizes there can be a gradation of probabilities
that an anticipated transaction will occur. However, the example above
offers no context in which to evaluate the nature or probability of an
anticipated merchandising transaction, and such context is essential to
determining the nature of any price risk that has been realized and
could support the existence of a bona fide hedge. The Commission notes
that in such cases, the only way to evaluate the nature of any price
risk would be for the Commission to be provided with particulars of the
transaction. This can be done, under the current proposal, either by
requesting a staff interpretive letter under Sec. 140.99 or seeking
CEA section 4a(a)(7) exemptive
[[Page 75720]]
relief. Furthermore, in instances where an entity can establish that
the nature of their commercial operation is such that they have
committed physical or financial resources towards the anticipated
transaction, they should consider whether they can avail themselves of
the exemption for unsold anticipated production or unfilled anticipated
requirements exemptions.
Request Four. Binding, Irrevocable Bids or Offers: The Working
Group requests that referenced contracts used to hedge exposure to
market price volatility associated with binding and irrevocable fixed-
price bids or offers be treated as bona fide hedging positions.
The contemplated transactions are not consistent with the
enumerated hedges in proposed paragraphs (3)(i), as a hedge of a
purchase contract, or (3)(ii), as a hedge of a sales contract, because
the cash transaction is tentative and, therefore, neither a sale nor a
purchase agreement.
In the Commission’s view, a binding bid or offer by itself is too
tenuous to serve as the basis for an exemption from speculative
position limits, since it is an uncompleted merchandising transaction
that, historically, has not been recognized as the basis for a bona
fide hedging transaction under Sec. 1.3(z)(2). Any related derivative
would cover a conditional price risk for a bid or offer that would
depend on that bid or offer being accepted and, therefore, would not be
economically appropriate to the reduction of risk. The commercial
entity submitting a binding, fixed-price bid or offer is essentially
subject to a contingent price risk.360 The Commission also
understands that some commercial entities submit bids or offers merely
to obtain information about the request for proposal, without an
intention of submitting a quote that is likely to be accepted.
—————————————————————————
360 For example, if the entity submits a fixed-price bid, it
runs the risk that either (a) it did not enter into a derivative
hedge position that would cover an accepted bid, and before its bid
was accepted, the cash market price decreased (so that it ends up
paying an above-market price); or (b) it did enter into a
derivatives position (a short position) that would cover an accepted
bid, and before its bid was rejected, the derivative price increased
so that the entity loses money when it lifts the short position.
Either outcome would create a loss for the commercial entity.
—————————————————————————
Moreover, the Working Group’s suggestion that the Commission
condition its relief on a good-faith showing and immediate
reclassification of the portion of the position not awarded against the
bid or offer does not protect the market against the prospect that
multiple participants may hold such a good-faith belief and may also
hold a position in the same direction as the cover transaction. If the
Commission were to grant relief with respect to such positions, then
all persons who made good-faith bids or offers on a particular cash
market solicitation would be eligible to enter into derivatives to
cover their potential exposure, in addition to holding speculative
positions on the same side of the market at the limit. Under such
relief, such persons, in the aggregate, could hold derivatives as cover
in an amount several times larger than the total amount to be awarded
under the solicitation. Undue volatility could result when the winning
bid is accepted and all the losing bidders simultaneously reduce their
total positions to get below the speculative position limit level.
In contrast, under the Commission’s proposed rules a commercial
entity may cover the risk of a yet to be accepted bid or offer,
provided its total position does not exceed the Commission’s
speculative position limits. Thus, when such person’s bid or offer is
not accepted and that person’s speculative position is appropriately
limited, that person need not liquidate any of its position to come
into compliance with limits. As discussed further below, the Commission
proposes to set speculative limits at relatively high levels. Thus, a
commercial entity is not likely to be constrained in covering bids or
offers unless it also has a relatively large speculative position on
the same side of the market.
Request Five. Timing of Hedging Physical Transactions: The Working
Group requests that referenced contracts used to hedge a physical
transaction that is subject to ongoing, good-faith negotiations, and
that the hedging party reasonably expects to conclude, be treated as
bona fide hedging transactions or positions.
As with Request Four, the contemplated transactions are not
consistent with the enumerated hedges in proposed paragraphs (3)(i), as
a hedge of a purchase contract, or (3)(ii), as a hedge of a sales
contract, because the cash transaction is tentative (here, subject to
negotiation) and, therefore, neither a sale nor a purchase agreement.
The Commission is concerned that a trader has not established a
definite exposure to a value change when that trader has only entered
into negotiations for a fixed-price purchase or sales contract. This
tentative cash position thus fails the change in value requirement.
Further, a trader could assert that changed conditions resulted in
a change in intentions and a failure to complete negotiations. Since
market prices are continually changing to reflect new information and,
thus, changing conditions, the Commission believes an exemption
standard based on merchandizing intentions alone (even if the merchant
were engaged in good faith negotiations) would be no standard at all.
In the case where the anticipated merchandizing transaction is
“naked,” or not backed by any existing physical exposure, the
Commission is not aware of a methodology for distinguishing naked
merchandizing from speculation. In the case of a firm bid or offer not
offset by existing physical exposure, an entity can, at the time the
bid or offer is accepted, enter into a corresponding hedge transaction
or, in the alternative, an entity can enter into a corresponding hedge
transaction at the time the bid or offer is made provided the entity
remains within the speculative position limits. The Commission invites
comment on why hedging in this manner is insufficient to offset
physical risks. The Commission asks that parties submitting comments
detail the nature of their merchandizing operations and how they
realize and account for physical risks related to anticipatory
merchandizing transactions not offset by anticipated production or
processing requirements. In particular, the Commission requests comment
on appropriate measures to address the risks for contingent bids or
offers. Under what circumstances should the Commission recognize
contingent bids or offers as the basis of a bona fide hedging position?
If the Commission were to do so, should only the expected value of the
risk of such position be recognized? And what would be an appropriate
methodology for distinguishing naked merchandizing from speculation?
How should the Commission address the varying ex ante subjective
probability of completion of such bids or offers? For example, is an ex
post measure of completion, e.g., the ratio of completed transactions
to bids or offers, an acceptable proxy to impute the probability of
acceptance for purposes of determining an ex ante hedge ratio,
regardless of the expected probability of completion on a particular
bid or offer? Should the Commission require a person, seeking to claim
an exemption based on contingent bids or offers, keep complete records
of all such cash market bids or offers? If so, what record format and
specific data elements should be kept?
Request Six. Local Natural Gas Utility Hedging of Customer
Requirements: The Working Group requests that long positions in
referenced contracts purchased by a state-regulated public
[[Page 75721]]
utility to hedge the anticipated natural gas requirements of its retail
customers be treated as bona fide hedging transactions or positions.
The proposed definition of bona fide hedging position would permit
Request Six under proposed paragraph (3)(iii)(B), discussed above.
Request Seven. Use of Physical-Delivery Referenced Contracts to
Hedge Physical Transactions Using Calendar Month Average Pricing: The
Working Group argues that referenced contracts used to hedge in
connection with calendar month average (“CMA”) pricing are not
speculative in nature and should be exempt from speculative position
limits. The Working Group requests that firms engaged in CMA-priced
transactions involving physical-delivery referenced contracts be
permitted to hold those positions through the spot month as bona fide
hedging positions.
The discussion below summarizes and addresses the petitioner’s
scenarios under Request Seven and notes the proposed exemptions that
would be applicable or the reasons for denial.
Summary of Scenario 1: Refinery hedging unfilled anticipatory
requirements for crude oil on a calendar month average basis and cross-
hedging the sale of anticipated processed distillate products 361
—————————————————————————
361 The petitioner separately requested relief for a seller of
crude oil on a CMA basis that had contracted to deliver crude oil
ratably to a refiner during a month at the daily average spot price.
That is, the seller entered into an unfixed price forward sales
contract to the refiner. Such a transaction would be covered by the
existing bona fide hedging rules. Such an unfixed price sales
contract would become partially fixed as each day in the month
locked in the daily spot price that would be used to fix the price
of deliveries in the forward delivery period. Thus, to the extent
the price of the forward contract was partially fixed, a seller
could use long positions in commodity derivative contracts to offset
the risk of the partially-fixed-price sales contract under the
provisions of proposed paragraph (3)(i).
—————————————————————————
The Working Group noted that a refinery may buy crude oil on a CMA
basis. The petitioner describes a three-step program whereby a refinery
might buy crude oil on a CMA basis and subsequently sell distillate
products on a CMA basis. First, on each trading day over approximately
a one month period prior to expiration of the nearby NYMEX light sweet
crude oil (WTI) futures contract, the refinery purchases futures
contracts in the nearby contract month and sells an equivalent amount
of futures in the next two deferred contract months in that same
futures contract. The resulting positions are calendar month spreads in
WTI futures contracts that are acquired at an average price over the
one-month period. Second, following the establishment of the spread
positions in WTI futures contracts, the refinery engages in exchange of
futures for physical commodity (EFP) transactions, obtaining a short
nearby WTI futures position in exchange for entering into cash market
contracts for purchase of crude oil at a fixed price over the following
calendar month.362 These nearby short WTI futures positions offset
the nearby long WTI futures positions of the calendar month spread.
Alternatively, the refinery stands for delivery on the nearby long WTI
futures positions. As a result, the refinery holds only short deferred
month WTI futures positions. Third, as the refinery takes deliveries of
crude oil over the following calendar month on the cash market
contracts (or alternatively under the physical delivery provisions of
the futures contracts), the refinery processes the crude oil then sells
the distillate products on the spot market. As the sales of distillate
products occur, the refinery buys back the short WTI futures positions
in the next two contract months.
—————————————————————————
362 Under NYMEX rules regarding EFP transactions in WTI
futures, the buyer and seller of futures must be the seller and
buyer of an approximately equivalent quantity of the physical
product underlying the futures. See NYMEX rule 200.20 (available at
http://www.cmegroup.com/rulebook/NYMEX/2/200.pdf), and NYMEX rule
538 (available at http://www.cmegroup.com/rulebook/NYMEX/1/5.pdf).
—————————————————————————
The contemplated long positions are consistent with proposed
paragraph (3)(iii) to the extent a refinery does not establish a long
position in excess of that refinery’s unfilled anticipated requirements
for crude oil for the next two months. Further, in the case of a
refinery, the Commission notes that, unless the refinery has fixed
price sales 363 or offsetting short positions of the expected
processed cash products, such contemplated long positions in WTI
futures alone may not be economically appropriate to the reduction of
risk in the conduct and management of a commercial enterprise; hence,
the Commission also views the short positions in WTI futures to be an
integral component of the contemplated calendar spreads.
—————————————————————————
363 A refinery with fixed price sales contracts may, as
appropriate, enter into a long position in commodity derivative
contracts as a bona fide hedging position or cross-commodity hedging
position under proposed paragraphs (3)(ii) and (5).
—————————————————————————
Regarding the short positions, the Commission considers the
economic consequences of the positions over two time periods: (1) the
period of time the refinery holds a calendar spread position (long
nearby and short deferred WTI contract months); and (2) the subsequent
period of time when the refinery holds only a short position in WTI
futures 364 and has a fixed price purchase contract on which it
receives crude oil that it processes into distillate products.
—————————————————————————
364 The refinery’s long position in WTI futures would be
liquidated as a result of the EFP transaction that established the
fixed price purchase contract.
—————————————————————————
Regarding the first time period, when considered as a whole with
the long positions covering the unfilled anticipated requirements, the
refinery’s short positions would be risk reducing transactions, and
therefore would qualify under proposed paragraphs (4)(i) and (5), so
long as the long futures positions (meeting the unfilled anticipated
requirements of paragraph (3)(iii)) fix the input price and the short
futures positions fix a significant portion of the price of the
expected output of petroleum distillate products that are not yet sold
at a fixed price. The refinery’s short position in referenced contracts
would be an economically appropriate cross-commodity hedge, as
contemplated by paragraph (5), to the extent the fluctuations in value
of the anticipated processed cash commodities (that is, the petroleum
distillates) are substantially related to fluctuations in value of the
referenced contracts in crude oil.365
—————————————————————————
365 Regarding the first time period, there is another
enumerated bona fide hedging exemption involving offsetting
commodity derivative contracts. Offsetting sales and purchases of
commodity derivative contracts would be recognized as bona fide
hedging positions to reduce the risk of unfixed price purchase and
sales contracts of the cash commodity (paragraph (4)(ii)). This
provision does not recognize positions as bona fide hedges under the
five-day rule (i.e., during the lesser of the last five days of
trading or the spot month for physical-delivery commodity derivative
contracts). The refinery short positions are not similar to
positions established to offset the risk of unfixed price sales and
purchases, in that the refinery has not entered into open price
purchase and sales contracts.
—————————————————————————
During the second time period, the refinery, for example, contracts
for the purchase of crude oil at a fixed price (as a result of the EFP
transaction) or subsequently holds crude oil in inventory (e.g.,
through taking delivery on the WTI futures contracts). Thus, the
refinery in the second time period initially holds a bona fide hedging
position under paragraph (3)(A). Once the crude oil is processed, the
refinery also may continue to hold short crude oil futures contracts as
a cross-hedge of distillate products under paragraph (5). Proposed
paragraph (5) permits a cross-commodity hedge when the fluctuations in
value of the position in the commodity derivative contract are
substantially related to the fluctuations in value of the actual or
anticipated cash
[[Page 75722]]
position. In this example, the aggregate price fluctuations of all of
the distillate products of crude oil are substantially related to the
price fluctuations of crude oil, with such prices expected to differ by
refining costs and an expected processing margin. Thus, the refinery in
the second time period holds a short futures position that is a bona
fide inventory hedge or a bona fide cross-commodity hedge permitted
under existing and proposed rules.
Summary of Scenario 2: Merchant short hedge of CMA price purchase
of crude oil from producer, and long position to cover anticipated re-
sale of crude oil at CMA.
In its January 20, 2012, petition, the Working Group gives the
example of a producer that sells oil at the price at which it was
valued (basis WTI futures) on each day it was extracted from the earth.
The buyer is an aggregator that pays each producer for crude oil on a
CMA basis for the production of the prior month. The aggregator seeks
to ensure the CMA selling price for the oil purchased from the
producers.
The aggregator sells the nearby WTI futures each trading day over a
one month period and buys an equivalent quantity of WTI futures
contracts in the subsequent two deferred WTI contract months.
Subsequently, the aggregator intends, in an EFP transaction, to
exchange long futures in the nearby contract month, for a sales
contract to be delivered ratably over the delivery period of that
nearby contract month. (The long futures from the EFP transaction would
offset the short WTI futures in the nearby contract month.) The
aggregator would sell the long futures contracts each day as oil is
delivered ratably during the month. By ratably selling the long futures
as the physical barrels are delivered, the aggregator effectively
realizes the price of the prompt barrel on that trading day.
Alternatively, in its April 17, 2012 supplement, the Working Group
argues that it should be sufficient that an aggregator wants to lock in
CMA pricing for a sales commitment by entering into the spread position
described above, regardless of the facts relating to the purchase side
of the transaction.
Because the aggregator is selling futures daily as the price on the
aggregator’s contractual purchase commitment is being fixed for each
day’s production, the aggregator builds a short futures position to
offset the crude oil it will eventually purchase from the producer
under the CMA cash contract at a price that is partially fixed each day
the short position is acquired. Once the aggregator is committed at a
fixed price to take delivery of the oil, the aggregator holds a bona
fide hedging position under paragraph (3)(A), which continues to be a
bona fide hedging position under that rule after the aggregator takes
delivery of the oil.
The Commission has not recognized as bona fide hedging a long
futures position (as a synthetic sales price for the same commodity),
when a person holds either inventory or a fixed-price purchase
contract, the price risk of which has been offset using a short futures
position. From the scenario and alternative presented, it is not clear
that there is a price risk that is being reduced. Rather, the
aggregator appears to seek to establish a sales price, without a
corresponding uncovered price risk in either inventory or fixed-price
sales or fixed-price purchase contracts. Thus, the transactions do not
satisfy the requirements of the proposed definition of bona fide
hedging position.
In considering the petition, the Commission reviewed its historical
policy position with respect to bona fide hedges in light of position
information regarding physical-delivery energy futures contracts. The
Commission reviewed three years of confidential large trader data in
cash-settled and physical-delivery energy contracts.366 The review
covered actual positions held in the physical-delivery energy futures
markets during the three-day spot period, among all traders (including
those who had received hedge exemptions from their D.C.M). It showed
that, historically, there have been relatively few positions held in
excess (and those few not greatly in excess) of the spot month limits.
Accordingly, the Commission does not propose to grant the Working
Group’s requests regarding Scenario 2.
—————————————————————————
366 The Commission typically does not publish “general
statistical information” as authorized by CEA section 8(a)(1)
regarding large trader positions in the expiring physical-delivery
energy futures contracts because of concerns that such data may
reveal information about the amount of market power a person may
need to “mark the close” or otherwise manipulate the price of an
expiring contract. Marking the close refers to, among other things,
the practice of acquiring a substantial position leading up to the
closing period of trading in a futures contract, followed by
offsetting the position before the end of the close of trading, in
an attempt to manipulate prices in the closing period. The
Commission gathers large trader position reports on reportable
traders in futures under part 17 of the Commission’s rules. That
data generally is confidential pursuant to section 8 of the Act. The
Commission does, however, publish summary statistics for all-months-
combined in its Commitments of Traders Report, available at http://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm.
—————————————————————————
Nonetheless, the Commission notes that a person desiring to
establish a synthetic sales price may hold a position subject to the
spot month limit, but cautions that such person should trade so as not
to disrupt the settlement price of the physical-delivery contract.
Working Group Petition Requests Eight, Nine, and Ten
Request Eight. Holding a Hedge Using a Physical-Delivery Contract
into the Spot Month; Generally: The Working Group requests that firms
that use physical-delivery referenced contracts (in commodities other
than metals or agriculture) as bona fide hedging transactions or
positions be permitted to hold these hedges into the spot month.
Request Nine. Holding a Cross-Commodity Hedge Using a Physical
Delivery Contract into the Spot Month: The Working Group requests that
firms that use physical-delivery referenced contracts as a cross-
commodity hedge be permitted to hold these hedges into the spot month.
Request Ten. Holding a Cross-Commodity Hedge Using a Physical-
Delivery Contract to Meet Unfilled Anticipated Requirements: 367 The
Working Group argued that the Commission should “reinstate” Sec.
1.3(z)(2)(ii)(C) 368 to permit firms to hold cross-commodity hedges
involving physical-delivery referenced contracts into the spot month in
order to meet their unfilled anticipated requirements.
—————————————————————————
367 Request Ten is similar to Request Eight, which also deals
with unfilled anticipated requirements. However, Request Eight deals
with requirements for the same commodity, whereas Request Ten
involves cross-hedging in a different commodity.
368 Prior to the court’s order vacating part 151, Sec. 1.3(z)
was amended to in November 2011 to apply only to excluded (i.e.,
financial, not physical) commodities. Therefore, by requesting that
this particular section of Sec. 1.3(z) be “reinstated,”
petitioner is asking that it be applied once again to physical
delivery (exempt and agricultural) commodities. However, Sec.
1.3(z)(2)(iv) has never permitted a cross-commodity hedge under
Sec. 1.3(z)(2)(ii)(C) to be held into the five last trading days.
—————————————————————————
The proposed definition of bona fide hedging position would permit
Request Eight under proposed paragraphs (3)(C), discussed above, for
hedges of unfilled anticipated requirements.369
—————————————————————————
369 The CME Petition also requested that the Commission
recognize as bona fide hedges positions held into the five last
trading days in physical-delivery referenced contracts that reduce
the risk of two months unfilled anticipated requirements in the same
cash commodity, as provided in Sec. 1.3(z)(2)(ii)(C).
—————————————————————————
However, the proposed definition does not recognize the other
requests as bona fide hedging positions. As discussed above, the
Commission continues to believe that, as a physical-delivery commodity
derivative contract approaches expiration, it is necessary to protect
orderly trading and the integrity of the markets. A person holding a
large physical-delivery futures position who
[[Page 75723]]
has no intention to make or take delivery may cause an unwarranted
price fluctuation by demanding to liquidate such position deep into the
delivery period in a physical-delivery agricultural contract or a metal
futures contract or during the three-day spot period in a physical-
delivery energy futures contract. Further, as noted above, a review of
large trader positions in physical-delivery energy futures contracts
does not show a current practice of traders holding large positions in
the spot period of the physical-delivery energy referenced contracts
relative to the exchange spot month limits.
The Commission invites comments on all aspects of the Working
Group’s petition and the Commission review.
2. Section 150.2–Position limits
i. Current Sec. 150.2
The Commission currently sets and enforces speculative position
limits with respect to certain enumerated agricultural products.370
Current Sec. 150.2 provides in its entirety that “[n]o person may
hold or control positions, separately or in combination, net long or
net short, for the purchase or sale of a commodity for future delivery
or, on a futures-equivalent basis, options thereon, in excess of
[enumerated levels].” 371 As such, the speculative position limits
set forth in current Sec. 150.2 apply only to specific futures
contracts traded on specific exchanges and, on a futures-equivalent
basis, to specific option contracts thereon.372 “Futures-
equivalent” is defined in current Sec. 150.1(f) as “an option
contract,” and nothing else.373 Accordingly, current Sec. 150.2
establishes federal position limits only for specifically enumerated
futures contracts on “legacy” agricultural commodities and options on
those futures contracts.
—————————————————————————
370 The “enumerated” agricultural products refer to the list
of commodities contained in the definition of “commodity” in CEA
section 1a; 7 U.S.C. 1a. This list of agricultural contracts
includes nine currently traded contracts: Corn (and Mini-Corn),
Oats, Soybeans (and Mini-Soybeans), Wheat (and Mini-wheat), Soybean
Oil, Soybean Meal, Hard Red Spring Wheat, Hard Winter Wheat, and
Cotton No. 2. See 17 CFR 150.2. The position limits on these
agricultural contracts are referred to as “legacy” limits because
these contracts on agricultural commodities have been subject to
federal positions limits for decades.
371 17 CFR 150.2. Footnote 1 to Sec. 150.2 adds, “for
purposes of compliance with these limits, positions in the regular
sized and mini-sized contracts shall be aggregated.” Id.
372 See id.
373 See 17 CFR 150.1(f).
—————————————————————————
In 2010, the Commission proposed to implement additional
speculative position limits for futures and option contracts in certain
energy commodities (“2010 Energy Proposal”).374 In the 2010 Energy
Proposal, the Commission included a discussion of past and present
position limits for certain agricultural contracts under part 150
stating that current Sec. 150.2 applies only to specific agricultural
futures and options contracts:
—————————————————————————
374 75 FR 4142, Jan. 26, 2010.
[t]he current Federal speculative position limits of regulation
150.2 apply only to specific futures contracts [and] (on a futures-
equivalent basis) specific option contracts. Historically, all
trading volume in a specific contract tended to migrate to a single
[futures] contract on a single exchange. Consequently, speculative
position limits that applied to a single [futures] contract and
options thereon effectively applied to a single market. The current
speculative position limits of regulation 150.2 for certain
agricultural contracts follow this approach.375
—————————————————————————
375 Id. at 4152-54.
The Commission withdrew the 2010 Energy Proposal when the Dodd-Frank
Act became law.376
—————————————————————————
376 75 FR 50950, Aug. 18, 2010.
—————————————————————————
The limited scope and applicability of the speculative position
limits in current Sec. 150.2, as well as in the 2010 Energy Proposal,
are inconsistent with the congressional shift evidenced in the Dodd-
Frank Act amendments to section 4a of the Act, upon which the
Commission relies in this release. Amended CEA section 4a(a)(1)
authorizes the Commission to extend position limits beyond futures and
option contracts to swaps traded on a DCM or SEF and swaps not traded
on a DCM or SEF that perform or affect a significant price discovery
function with respect to regulated entities (“SPDF swaps”).377
Further, new CEA section 4a(a)(5) requires that speculative position
limits apply to swaps that are “economically equivalent” 378 to DCM
futures and option contracts for agricultural and exempt commodities
under new CEA section 4a(a)(2).379 Similarly, new CEA section
4a(a)(6) requires the Commission to apply position limits on an
aggregate basis to contracts based on the same underlying commodity
across: (1) DCMs; (2) with respect to foreign boards of trade
(“FBOTs”), contracts that are price-linked to a DCM or SEF contract
and made available from within the United States via direct access; and
(3) SPDF swaps.380
—————————————————————————
377 7 U.S.C. 6a(a)(1).
378 Section 4a(a)(5) of the Act requires the Commission to
impose the same limits on “swaps” that are “economically
equivalent” to futures and options contracts. The statute does not
define the term. But the Commission construes it, consistent with
the policy objectives of the Dodd-Frank amendments, to require the
Commission to expeditiously impose limits on physical commodity
swaps that are price-linked to futures contracts, or to satisfy
other defined equivalence criteria. The Commission accordingly
construes the term “economically equivalent” to require swaps to
satisfy the definition of “referenced” contract in proposed Sec.
150.1. It requires that a swap be, among other things, “directly or
indirectly linked, including being partially or fully settled on, or
priced at a fixed differential to, the price of that particular core
referenced futures contract; or . . . directly or indirectly linked,
including being partially or fully settled on, or priced at a fixed
differential to, the price of the same commodity underlying that
particular core referenced futures contract for delivery at the same
location or locations as specified in that particular core
referenced futures contract . . .” Other similarities or
differences that exist between futures and swaps are not material to
the Commission’s interpretation of economic equivalence under 7
U.S.C. 6a(a)(5).
379 7 U.S.C. 6a(a)(2), (5).
380 7 U.S.C. 6a(a)(6). The Commission refers to this
requirement in section 4a(a)(6) of the Act as a requirement for
position aggregation.
—————————————————————————
In 2011, the Commission proposed and, after comment, adopted rules
to establish an expanded position limits regime pursuant to the mandate
contained in the Dodd-Frank Act amendments to CEA section 4a.381
However, in an Order dated September 28, 2012, the U.S. District Court
for the District of Columbia vacated the 2011 Position Limits
Rulemaking, with the exception of the revised position limit levels in
amended Sec. 150.2.382 Therefore, part 150 continues to apply, as
amended, as if part 151 had not been finally adopted by the
Commission.383
—————————————————————————
381 The Commission instructed market participants to continue
to comply with the existing position limit regime contained in part
150 and any applicable DCM position limits or accountability levels
until the compliance date for the position limits rules in new part
151. After such date, part 150 would have been revoked and
compliance with part 151 would have been required. 76 FR 71632.
382 See 887 F. Supp. 2d 259 (D.D.C. 2012).
383 The District Court’s order vacated the final rule and the
interim final rule promulgated in the 2011 Position Limits
Rulemaking, with the exception of the rule’s amendments to 17 CFR
150.2.
—————————————————————————
Vacated part 151 would have established federal position limits and
limit formulas for 28 physical commodity futures and option contracts,
or “Core Referenced Futures Contracts,” and would have applied these
limits to all derivatives that are directly or indirectly linked to the
price of a Core Referenced Futures Contract (collectively, “Referenced
Contracts”).384 Therefore, the position limits in vacated part 151
would have applied across different trading venues to economically
equivalent Referenced Contracts (as specifically defined in part 151)
that are based on the same underlying commodity, a concept known as
aggregate limits. Vacated
[[Page 75724]]
Sec. 151.1 defined “Referenced Contract” to mean:
—————————————————————————
384 76 FR at 71629.
on a futures equivalent basis with respect to a particular Core
Referenced Futures Contract, a Core Referenced Futures Contract
listed in Sec. 151.2, or a futures contract, options contract, swap
or swaption, other than a basis contract or commodity index
contract, that is: (1) Directly or indirectly linked, including
being partially or fully settled on, or priced at a fixed
differential to, the price of that particular Core Referenced
Futures Contract; or (2) Directly or indirectly linked, including
being partially or fully settled on, or priced at a fixed
differential to, the price of the same commodity underlying that
particular Core Referenced Futures Contract for delivery at the same
location or locations as specified in that particular Core
Referenced Futures Contract.385
—————————————————————————
385 Id. at 71685.
In addition to establishing federal position limits for all
Referenced Contracts, vacated part 151 would have, among other things,
implemented a new statutory definition of bona fide hedging
transactions, revised the standards for position aggregation, and
established position visibility reporting requirements.386
—————————————————————————
386 See generally 76 FR 71626, Nov. 18, 2011.
—————————————————————————
ii. Proposed Sec. 150.2
Proposed Sec. 150.2 would list spot month, single month, and all-
months-combined position limits for 28 core referenced futures
contracts. Consistent with section 4a(a)(5) of the Act, proposed Sec.
150.2 would apply such position limits to all referenced contracts (as
that term is defined in the proposed amendments to Sec. 150.1) 387
including economically equivalent swaps.388 Consistent with section
4a(a)(6) of the Act, proposed Sec. 150.2 would apply position limits
across all trading venues subject to the Commission’s jurisdiction.
Proposed Sec. 150.2 would also specify Commission procedures for
computing position limits levels.
—————————————————————————
387 See discussion of proposed Sec. 150.1 above.
388 Section 4a(a)(5) of the Act requires the Commission to
impose the same limits on “swaps” that are “economically
equivalent” to futures and options contracts. The statute does not
define the term. But the Commission construes it, consistent with
the policy objectives of the Dodd-Frank amendments, to require the
Commission to expeditiously impose limits on physical commodity
swaps that are price-linked to futures contracts, or to satisfy
other defined equivalence criteria. The Commission accordingly
construes the term “economically equivalent” to require swaps to
satisfy the definition of “referenced” contract in proposed Sec.
150.1. It requires that a swap be, among other things, “directly or
indirectly linked, including being partially or fully settled on, or
priced at a fixed differential to, the price of that particular core
referenced futures contract; or . . . directly or indirectly linked,
including being partially or fully settled on, or priced at a fixed
differential to, the price of the same commodity underlying that
particular core referenced futures contract for delivery at the same
location or locations as specified in that particular core
referenced futures contract. . . .” Other similarities or
differences that exist between futures and swaps are not material to
the Commission’s interpretation of economic equivalence under 7
U.S.C. 6a(a)(5).
—————————————————————————
a. Spot Month Limits
Proposed Sec. 150.2(a) provides that no person may hold or control
positions in referenced contracts in the spot month, net long or net
short, in excess of the level specified by the Commission for physical-
delivery referenced contracts and, specified separately, for cash-
settled referenced contracts.389 Proposed Sec. 150.2(a) requires
that a trader’s positions in the physical-delivery referenced contract
and cash-settled referenced contract are to be calculated separately
under the separate spot month position limits fixed by the Commission.
Therefore, a trader may hold positions up to the spot month limit in
the physical-delivery contracts, as well as positions up to the
applicable spot month limit in cash-settled contracts (i.e., cash-
settled futures and swaps), but a trader in the spot month may not net
across physical-delivery and cash-settled contracts. Absent such a
restriction in the spot month, a trader could stand for 100 percent of
deliverable supply during the spot month by holding a large long
position in the physical-delivery contract along with an offsetting
short position in a cash-settled contract, which effectively would
corner the market. The Commission will closely monitor the effects of
its spot-month position limits.
—————————————————————————
389 The Commission proposes to adopt an amended definition of
spot month in proposed Sec. 150.1 (as discussed above), simplified
from the spot-month definitions listed in vacated Sec. 151.3. The
term “spot month” does not refer to a month of time.
—————————————————————————
b. Single-Month and All-Months-Combined Limits
Proposed Sec. 150.2(b) provides that no person may hold or control
positions, net long or net short, in referenced contracts in a single-
month or in all-months-combined in excess of the levels specified by
the Commission. Proposed Sec. 150.2(b) permits traders to net all
positions in referenced contracts (regardless of whether such
referenced contracts are physical-delivery or cash-settled) when
calculating the trader’s positions for purposes of the proposed single-
month or all-months-combined position limits.390
—————————————————————————
390 The Commission would allow traders to net positions in
physical-delivery and cash-settled contracts outside the spot month
because the Commission is less concerned about corners and squeezes
outside the spot month. Permitting such netting will significantly
reduce the number of traders with positions over the levels of non-
spot month limits. The Commission discusses how many traders
historically held positions over the levels of non-spot month limits
below.
—————————————————————————
The Commission also proposes to amend Sec. 150.2 by deleting the
potentially ambiguous phrase “separately or in combination.” The
Commission first proposed adding the phrase “separately or in
combination” to Sec. 150.2 in 1992.391 While the text of current
Sec. 150.2 could be read in context to apply limits to futures or
option positions, separately or in combination, the preamble to that
rulemaking proposal stated otherwise, indicating the Commission was
proposing a “unified approach” to limits on futures and options
positions combined.392 When considering at that time whether to
extend the existing federal position limits on futures contracts also
to option contracts (on a futures equivalent basis), the Commission
explained that a unified futures and options level limit was “more
appropriate for several reasons” than position limits on futures that
are separate from position limits on options.393 Further, the
Commission noted in the 1992 preamble that “proposed Rule 150.2
provides that `[n]o person may hold or control net long or net short
positions in excess of the stated limits.” 394 Although the 1992
preamble stated the limit rule was to apply on a net basis to futures
and options combined, the regulatory text could be read to suggest a
different approach, i.e., applying to futures or options on both a
separate basis and a combined basis. The phrase “separately or in
combination” was not discussed in any subsequent Federal Register
notice.395
—————————————————————————
391 See Revision of Federal Speculative Position Limits,
Proposed Rules, 57 FR 12766, Apr. 13, 1992.
392 Id. at 12768.
393 Id. at 12769.
394 Id. at 12770.
395 Indeed, the Commission noted in 1993 when it adopted an
interim final rule that “as proposed, speculative position limits
for both futures and options thereon are being combined into a
single limit.” See interim final rule at 58 FR 17973, Apr. 7, 1993.
The Commission noted it “proposed to unify speculative position
limits for both futures and options thereon, reasoning that, because
price movements in the two markets are highly related, the unified
system more readily reflects the economic reality of a position in
its totality. Moreover, unified speculative limits provide the
trader with greater flexibility. Further, traders should find such a
unified speculative position limit easier to use and to understand.
Finally, as a consequence of the simpler structure, unified
speculative position limits would be easier to administer, resulting
in more accurate and timely market surveillance.” Id. at 17974.
In discussing comments on the 1992 proposed rule, the Commission
noted an objection by a DCM to the proposed unified futures and
options limits, preferring the DCM’s proposed separate futures and
options limits. Id. at 17976. The Commission discussed views of
other commenters regarding the proposed “unified limits.” Id. at
17977. The Commission concluded that it would adopt the unified
limits, noting it “will combine futures and option limits.” The
preamble also made clear the limits would not apply separately,
noting further that “because such positions would be netted
automatically under a unified speculative position limit, the
Commission is removing and reserving Sec. 150.3(a)(2) which exempts
from Federal speculative position limits positions in option
contracts which offset the futures positions.” Id. at 17978-79.
—————————————————————————
[[Page 75725]]
c. Selection of Initial Commodity Derivative Contracts in Physical
Commodities
As discussed above, the Commission interprets the CEA to mandate
position limits for futures contracts in physical commodities other
than excluded commodities (i.e., position limits are required for
futures contracts in agricultural and exempt commodities).
The Commission is proposing a phased approach to implement the
statutory mandate. The Commission is proposing in this release to
establish speculative position limits on 28 core referenced futures
contracts in physical commodities.396 The Commission anticipates that
it will, in subsequent releases, propose to expand the list of core
referenced futures contracts in physical commodities. The Commission
believes that a phased approach will (i) reduce the potential
administrative burden by not immediately imposing position limits on
all commodity derivative contracts in physical commodities at once, and
(ii) facilitate adoption of monitoring policies, procedures and systems
by persons not currently subject to positions limits (such as traders
in swaps that are not significant price discovery contracts).
—————————————————————————
396 The 28 core referenced futures contracts are: Chicago
Board of Trade Corn, Oats, Rough Rice, Soybeans, Soybean Meal,
Soybean Oil and Wheat; Chicago Mercantile Exchange Feeder Cattle,
Lean Hog, Live Cattle and Class III Milk; Commodity Exchange, Inc.,
Gold, Silver and Copper; ICE Futures U.S. Cocoa, Coffee C, FCOJ-A,
Cotton No. 2, Sugar No. 11 and Sugar No. 16; Kansas City Board of
Trade Hard Winter Wheat (on September 6, 2013, CBOT and the Kansas
City Board of Trade (“KCBT”) requested that the Commission permit
the transfer to CBOT, effective December 9, of all contracts listed
on the KCBT, and all associated open interest); Minneapolis Grain
Exchange Hard Red Spring Wheat; and New York Mercantile Exchange
Palladium, Platinum, Light Sweet Crude Oil, NY Harbor ULSD, RBOB
Gasoline and Henry Hub Natural Gas.
—————————————————————————
The Commission proposes, initially, to establish position limits on
these 28 core referenced futures contracts, and related swap and
futures contracts, on the basis that such contracts (i) have high
levels of open interest 397 and significant notional value of open
interest 398 or (ii) serve as a reference price for a significant
number of cash market transactions.399 Thus, in the first phase, the
Commission generally is proposing limits on those contracts that it
believes are likely to play a larger role in interstate commerce than
that played by other physical commodity derivative contracts.
—————————————————————————
397 Open interest for this purpose is the sum of open
contracts, as defined in Sec. 1.3(t), in futures contracts and in
futures option contracts converted to a futures-equivalent amount,
as defined in Sec. 150.1(f), and open swaps, as defined in Sec.
20.1, on a future equivalent basis, as defined in Sec. 20.1, where
such swaps are significant price discovery contracts as determined
by the Commission under Sec. 36.3(d).
398 Notional value of open interest for this purpose is open
interest times the unit of trading for the relevant futures contract
times the price of that futures contract.
399 The Commission, in the vacated part 151 Rulemaking,
selected for what was also intended as a first phase, the same 28
core referenced futures contracts on the same basis. 76 FR at 71629.
As was noted when part 151 was adopted, the 28 core referenced
futures contracts were selected on the basis that such contracts:
(1) had high levels of open interest and significant notional value;
or (2) served as a reference price for a significant number of cash
market transactions. Id.
—————————————————————————
In selecting the list of 28 core referenced futures contracts in
proposed Sec. 150.2(d), the Commission calculated the open interest
and notional value of open interest for all futures, futures options,
and significant price discovery contracts as of December 31, 2012 in
all agricultural and exempt commodities. The Commission identified
those commodities with the largest notional value of open interest and
open interest for agricultural commodities, energy commodities, and
metals commodities. The Commission then selected 16 agricultural
commodities, 4 energy commodities, and 5 metals commodities. Once these
commodities were selected, the Commission determined the most important
futures contract, or contracts, within each commodity, generally by
selecting the physical-delivery contracts with the highest levels of
open interest, and deemed these as the core referenced futures
contracts for which position limits would be established in this
release. As such, the Commission proposes in this release to set
position limits in 19 core referenced futures contracts for
agricultural commodities, 4 core referenced futures contracts for
energy commodities, and 5 core referenced futures contracts for metals
commodities. The Commission currently sets limits for 9 legacy
agricultural contracts under part 150.400
—————————————————————————
400 17 CFR 150.2.
—————————————————————————
In selecting the 16 agricultural commodities, the Commission used
oats as its baseline since oats has the lowest notional value of open
interest and the lowest open interest among the 9 legacy agricultural
contracts. Hence, the Commission selected all agricultural commodities
that have notional value of open interest and open interest that exceed
that of oats.401 The Commission has determined to defer consideration
of speculative position limits on contracts in other agricultural
commodities because the Commission must marshal its resources. The
Commission anticipates that it will consider speculative position
limits on contracts in other agricultural commodities in a subsequent
rulemaking.
—————————————————————————
401 While cheese has a notional value of open interest that is
higher than oats, it has an open interest that is lower than that of
oats (the open interest of the cheese contract was less than 10,000
contracts as of year-end 2012). Furthermore, all futures and options
contracts in cheese are on the same DCM (which currently has a
single month position limit set at 1,000 contracts) and had no Large
Trader Reporting for physical commodity swaps as reported under part
20 during January 2013. The Commission intends to address cheese
when it proposes, in subsequent releases, expansions to the list of
referenced contracts in physical commodities.
—————————————————————————
Table 6 below provides the notional value of open interest and open
interest for agricultural contracts by type of commodity contract
reported under the Commission’s reporting rules.402 With respect to
the type of commodity, it should be noted, for example, that “wheat”
refers to the general type of physical commodity, and includes
contracts listed on three different DCMs.
—————————————————————————
402 17 CFR Part 16. Commission staff computed notional values
of open interest from data reported under Sec. 16.01. Data reported
under Sec. 16.01 includes significant price discovery contracts in
compliance with core principle VI for exempt commercial markets,
app. B to part 36.
[[Page 75726]]
Table 6–Largest Agricultural Commodities Ranked by Notional Value of Open Interest in Futures, Futures Options,
and Significant Price Discovery Contracts, as of December 31, 2012
—————————————————————————————————————-
Type and rank within type by Number of Notional value of
notion value of open interest Commodity contracts open interest Open interest
—————————————————————————————————————-
Agricultural:
1……………………….. Soybeans…………. 6 $54.07 billion……. 765,030
2……………………….. Corn…………….. 6 $51.54 billion……. 1,545,135
3……………………….. Wheat……………. 10 $41.06 billion……. 767,006
4……………………….. Sugar……………. 5 $39.06 billion……. 896,082
5……………………….. Live Cattle………. 2 $19.91 billion……. 394,385
6……………………….. Coffee…………… 3 $13.89 billion……. 211,147
7……………………….. Soybean Oil………. 4 $11.01 billion……. 344,412
8……………………….. Soybean Meal……… 2 $10.46 billion……. 253,361
9……………………….. Cotton…………… 3 $9.75 billion…….. 234,367
10………………………. Lean Hogs………… 1 $9.68 billion…….. 280,451
11………………………. Cocoa……………. 1 $5.13 billion…….. 218,224
12………………………. Feeder Cattle…….. 1 $2.64 billion…….. 34,816
13………………………. Milk…………….. 3 $1.45 billion…….. 40,690
14………………………. Frozen Orange Juice.. 1 $609 million……… 29,652
15………………………. Rice…………….. 1 $445 million……… 14,783
16………………………. Cheese…………… 2 $282 million……… 8,601
17………………………. Oats…………….. 1 $187 million……… 10,755
—————————————————————————————————————-
For exempt commodity contracts, the Commission proposes to
initially select the commodities in the energy and metals markets that
have the largest open interest and notional value of interest. For
metals, the Commission proposes to initially target the 5 largest
commodities in terms of notional value of open interest, as listed in
Table 7 below, and selected 1 core referenced futures contract for each
of the 5 metals. In selecting these 5 core referenced futures
contracts, the Commission would establish federal position limits on
ninety-eight percent of the open interest in U.S. metals markets.
The next largest commodity in metals after palladium in terms of
notional value is iron ore, which has open interest that is about one-
quarter that of palladium.403 Furthermore, there are less than 50
reportable traders 404 in iron ore, while in the 5 selected metals,
each has more than 200 reportable traders. The Commission has
determined to defer consideration of speculative position limits on
contracts in iron ore and other metal commodities because the
Commission must marshal its resources. The Commission anticipates that
it will consider speculative position limits on contracts in iron ore
and other metal commodities in a subsequent rulemaking.
Table 7–Largest Metals Commodities by Notional Value of Open Interest in Futures, Futures Options, and
Significant Price Discovery Contracts, as of December 31, 2012
—————————————————————————————————————-
Type and rank within type by Number of Notional value of
notion value of open interest Commodity contracts open interest Open interest
—————————————————————————————————————-
Metals:
1……………………….. Gold…………….. 6 $100.41 billion…… 604,853
2……………………….. Silver…………… 5 $27.77 billion……. 180,576
3……………………….. Copper…………… 3 $13.28 billion……. 146,865
4……………………….. Platinum…………. 1 $4.78 billion…….. 61,467
5……………………….. Palladium………… 1 $2.08 billion…….. 32,293
—————————————————————————————————————-
For energy commodities, the Commission similarly proposes to select
the 4 largest commodities for this first phase of the expansion of
speculative position limits and selected 1 core referenced futures
contract in each of these 4 commodities. Each of these commodities has
a notional value of open interest in excess of $40 billion.
The fifth largest commodity in energy is electricity, and the
Commission has determined to defer consideration of speculative
position limits on contracts in electricity and other energy
commodities because the Commission must marshal its resources. The
Commission anticipates that it will consider speculative position
limits on contracts in electricity and other energy commodities in a
subsequent rulemaking.
—————————————————————————
403 The open interest in iron ore futures, futures options,
and significant price discovery contracts as of December 31, 2012,
was 8,195 contracts and the notional value of open interest was
$236.63 million.
404 A reportable trader is a trader with a reportable position
as defined in Sec. 15.00(p).
[[Page 75727]]
Table 8–Largest Energy Commodities by Notional Value of Open Interest in Futures, Futures Options, and
Significant Price Discovery Contracts, as of December 31, 2012
—————————————————————————————————————-
Type and rank within type by Number of Notional value of
notion value of open interest Commodity contracts open interest Open interest
—————————————————————————————————————-
Energy:
1……………………….. Crude Oil………… 76 $516.42 billion…… 6,188,201
2……………………….. Heating Oil/Diesel… 89 $470.69 billion…… 1,192,036
3……………………….. Natural Gas………. 216 $225.74 billion…… 21,335,777
4……………………….. Gasoline…………. 54 $46.13 billion……. 402,369
—————————————————————————————————————-
d. Setting Levels of Spot-Month Limits
Proposed Sec. 150.2(e)(1) establishes the initial levels of
speculative position limits for each referenced contract at the levels
listed in appendix D to this part. These levels would become effective
60 days after publication in the Federal Register of a final rule
adopted by the Commission. The Commission proposes to set the initial
spot month position limit levels for referenced contracts at the
existing DCM-set levels for the core referenced futures contracts
because the Commission believes this approach is consistent with the
regulatory objectives of the Dodd-Frank Act amendments to the CEA and
many market participants are already used to these levels.405
—————————————————————————
405 DCMs currently set spot-month position limits based on
their own estimates of deliverable supply. Federal spot-month limits
can, therefore, be implemented by the Commission relatively
expeditiously.
—————————————————————————
As an alternative to the initial spot month limits in proposed
appendix D to part 150, the Commission is considering setting the
initial spot month limits based on estimated deliverable supplies
submitted by the CME Group in correspondence dated July 1, 2013.406
Under this alternative, the Commission would use the exchange’s
estimated deliverable supplies and apply the 25 percent formula to set
the level of the spot month limits in a final rule if the Commission
verifies the exchange’s estimated deliverable supplies are reasonable.
For purposes of setting initial spot month limits in a final rule, in
the event the Commission is not able to verify an exchange’s estimated
deliverable supply for any commodity as reasonable, then the Commission
may determine to adopt the initial spot month limits in proposed
appendix D for such commodity, or such higher level based on the
Commission’s estimated deliverable supply for such commodity, but not
greater than would result from the exchange’s estimated deliverable
supply. The Commission requests comment on whether the initial spot
month limits should be based on the exchange’s July 1, 2013,
estimations of deliverable supplies, once verified. The spot month
limits that would result from the CME’s estimated deliverable supplies
are show in Table 9 below.
—————————————————————————
406 Letter from Terrance A. Duffy, Executive Chairman and
President, CME Group, to CFTC Chairman Gensler, Commissioner
Chilton, Commissioner Sommers, Commissioner O’Malia, Commissioner
Wetjen, and Division of Market Oversight Director Richard Shilts,
dated July 1, 2013 (available at www.cftc.gov). The Commission notes
the CME Group did not propose to set the level of spot month limits
using the 25 percent formula in this letter.
Table 9–Alternative Proposed Initial Spot Month Limit Levels for Certain Core Referenced Futures Contracts
(Based on CME Group Estimates of Deliverable Supply Submitted to the Commission on July 1, 2013)
—————————————————————————————————————-
Alternative
proposed spot-
month limit CME Group
Current spot- (25% of CME Group deliverable deliverable
Contract month limit deliverable supply estimate supply
supply rounded estimate in
up to the next contracts
100 contracts)
—————————————————————————————————————-
Legacy Agricultural
—————————————————————————————————————-
Chicago Board of Trade Corn (C)……. 600 1,000 19,590,000 bushels…… 3,918
Chicago Board of Trade Oats (O)……. 600 1,500 29,470,000 bushels…… 5,894
Chicago Board of Trade Soybeans (S)… 600 1,200 23,900,000 bushels…… 4,780
Chicago Board of Trade Soybean Meal 720 4,400 1,753,047 tons………. 17,531
(SM).
Chicago Board of Trade Soybean Oil 540 5,300 1,253,000 lbs……….. 20,883
(SO).
Chicago Board of Trade Wheat (W)…… 600 3,700 73,790,000 bushels…… 14,757
Kansas City Board of Trade Hard Winter 600 4,100 81,710,000 bushels…… 16,342
Wheat (KW).
—————————————————————————————————————-
Other Agricultural
—————————————————————————————————————-
Chicago Board of Trade Rough Rice (RR) 600 1,800 14,100,000 cwt………. 7,050
Chicago Mercantile Exchange Class III 1500 5,300 4,170,000,000 lbs……. 20,850
Milk (DA).
—————————————————————————————————————-
Energy
—————————————————————————————————————-
New York Mercantile Exchange Henry Hub 1,000 3,900 154,200,000 mmBtu……. 15,420
Natural Gas (NG).
[[Page 75728]]
New York Mercantile Exchange Light 3,000 12,100 48,100,000 barrels…… 48,100
Sweet Crude Oil (CL).
New York Mercantile Exchange NY Harbor 1,000 5,500 20,000,000 barrels…… 22,000
ULSD (HO).
New York Mercantile Exchange RBOB 1,000 7,300 29,000,000 barrels…… 29,000
Gasoline (RB).
—————————————————————————————————————-
Metal
—————————————————————————————————————-
Commodity Exchange, Inc. Copper (HG).. 1,200 1,700 161,850,000 lbs……… 6,474
Commodity Exchange, Inc. Gold (GC)…. 3,000 27,300 10,911,100 troy ounces.. 109,111
Commodity Exchange, Inc. Silver (SI).. 1,500 5,700 113,375,000 troy ounces. 22,675
New York Mercantile Exchange Palladium 650 1,500 578,900 troy ounces….. 5,789
(PA).
New York Mercantile Exchange Platinum 500 800 152,150 troy ounces….. 3,043
(PL).
—————————————————————————————————————-
The Commission is considering a further alternative to setting the
spot month limit at a level based on 25 percent of estimated
deliverable supply. This alternative would permit the Commission, in
its discretion, both for setting an initial spot month limit and
subsequent resets, to use the recommended level, if any, of the spot
month limit as submitted by each DCM listing a CRFC (if lower than 25
percent of estimated deliverable supply). Under this alternative, the
Commission would have discretion to set the level of any spot month
limit to the DCM’s recommended level, a level corresponding to 25
percent of estimated deliverable supply, or a level in proposed
appendix D. The Commission requests comment on all aspects of this
alternative. Specifically, is the Commission’s discretion in
administering levels of spot month limits appropriately constrained by
the choice, in its discretion, of the DCM’s recommended level or the
level corresponding to 25 percent of deliverable supply or a level in
proposed appendix D?
Proposed Sec. 150.2(e)(3) explains how the Commission will
calculate spot month position limit levels. The Commission proposes to
fix the levels of the spot-month limits for referenced contracts based
on one-quarter of the estimated spot-month deliverable supply in the
relevant core referenced futures contract, no less frequently than
every two calendar years.407 Under the proposal, each DCM listing a
core referenced futures contract would be required to report to the
Commission an estimate of spot-month deliverable supply, accompanied by
a description of the methodology used to derive the estimate and any
statistical data supporting the estimate.408 Proposed Sec.
150.2(e)(3) provides a cross-reference to appendix C to part 38 for
guidance on how to estimate deliverable supply.409 The Commission
proposes to utilize the estimated spot-month deliverable supply
provided by a DCM unless the Commission decides to rely on its own
estimate of deliverable supply.
—————————————————————————
407 Federal spot month limits have historically been set at
one-quarter of estimated deliverable supply. See, e.g., 64 FR 24038,
24041, May 5, 1999. Further, current guidance on complying with DCM
core principle 5 calls for spot month levels to be set at “no
greater than one-quarter of the estimated spot month deliverable
supply. . . .” 17 CFR 150.5(c)(1).
408 The timing for submission of such reports varies by
commodity type–see proposed Sec. 150.2(e)(ii)(A)-(D).
409 See 17 CFR part 38, appendix C, at section (b)(1)(i).
—————————————————————————
The Commission proposes to update spot-month limits every two years
for each of the 28 referenced contracts, and to stagger the dates on
which DCMs must submit estimates of deliverable supply. The Commission
has re-evaluated data on the frequency with which DCMs historically
have changed the levels of spot month limits in the 28 physical-
delivery core referenced futures contracts. Given the low frequency of
changes to DCM spot month limits, the Commission has reconsidered
requiring annual updates for referenced contracts in agricultural
commodities.410 When compared with annual updates to the spot month
position limits, biennial updates would reduce the burden on market
participants in updating speculative position limit monitoring
systems.411
—————————————————————————
410 In any event, core principle 5 in section 5(d)(5) of the
Act imposes a continuing obligation on a DCM, where the DCM has set
a position limit as necessary and appropriate, to ensure levels of
position limits are set to reduce the potential threat of market
manipulation or congestion (especially during the spot month). 7
U.S.C. 7(d)(5). Thus, a DCM appropriately would reduce the level of
its exchange-set spot month limit if the level of deliverable supply
declined significantly. Core principle 6 in section 5h(f)(6) of the
Act imposes a similar obligation on a SEF that is a trading
facility. 7 U.S.C. 7b-3(f)(6).
411 Proposed Sec. 150.2(e)(3) also provides the Commission
with flexibility to reset spot month position limits more frequently
than every two years, but the proposed rule would require DCMs to
submit estimated deliverable supplies only every two years. This
means, for example, that a DCM may with discretion provide the
Commission with updated estimated deliverable supplies and petition
the Commission to reset spot month limits more frequently than every
two years. Similarly, proposed Sec. 150.2(e)(4) provides the
Commission with flexibility to change non-spot month position limits
more frequently than every two years. This means, for example, that
a DCM may petition the Commission to reset non-spot month position
limits based on the most recent calendar-year’s open interest.
—————————————————————————
The term “estimated deliverable supply” means the amount of a
commodity that can reasonably be expected to be readily available to
short traders to make delivery at the
[[Page 75729]]
expiration of a futures contract.412 The use of estimated deliverable
supply to set spot-month limits is wholly consistent with DCM core
principles 3 and 5.413 Currently, in determining whether a physical-
delivery contract complies with core principle 3, the Commission
considers whether the specified contract terms and conditions may
result in an estimated deliverable supply that is sufficient to ensure
that the contract is not readily susceptible to price manipulation or
distortion. The Commission has previously indicated that it would be an
acceptable practice for a DCM to set spot-month limits pursuant to core
principle 5 based on an analysis of estimated deliverable
supplies.414 Accordingly, the Commission is adopting estimated
deliverable supply as the basis of setting spot-month limits.
—————————————————————————
412 As part of its recently published guidance for complying
with DCM core principle 3, the Commission provided guidance on how
to calculate deliverable supplies in appendix C to part 38 (at
paragraph (b)(1)(i)). 77 FR 36612, 36722, Jun. 19, 2012. Typically,
deliverable supply reflects the quantity of the commodity that
potentially could be made available for sale on a spot basis at
current prices at the contract’s delivery points. For a physical-
delivery commodity contract, this estimate might represent product
which is in storage at the delivery point(s) specified in the
futures contract or can be moved economically into or through such
points consistent with the delivery procedures set forth in the
contract and which is available for sale on a spot basis within the
marketing channels that normally are tributary to the delivery
point(s).
413 DCM core principle 3 specifies that a board of trade shall
list only contracts that are not readily susceptible to
manipulation. See CEA section 5(d)(3); 7 U.S.C. 7(d)(3). DCM core
principle 5 (discussed in detail below) requires a DCM to establish
position limits or position accountability provisions where
necessary and appropriate “to reduce the threat of market
manipulation or congestion, especially during the delivery month.”
CEA section 5(d)(5); 7 USC 7(d)(5). See also guidance and discussion
of estimated deliverable supply in Core Principles and Other
Requirements for Designated Contract Markets, Final Rule, 77 FR
36612, 36722, Jun. 19, 2012.
414 See 17 CFR 150.5(b).
—————————————————————————
The Commission proposes to adopt the 25 percent level of estimated
deliverable supply for setting spot-month limits because, based on the
Commission’s surveillance and enforcement experience, this formula
narrowly targets the trading that may be most susceptible to, or likely
to facilitate, price disruptions. The Commission believes this spot
month limit formula best maximizes the statutory objectives expressed
in CEA section 4a(a)(3)(B) of preventing excessive speculation and
market manipulation, ensuring market liquidity for bona fide hedgers,
and promoting efficient price discovery. This formula is consistent
with the longstanding acceptable practices for DCM core principle 5
which provide that, for physical-delivery contracts, the spot-month
limit should not exceed 25 percent of the estimated deliverable
supply.415 The Commission believes, based on its experience and
expertise, that the formula would be an effective prophylactic tool to
reduce the threat of corners and squeezes, and promote convergence
without compromising market liquidity.416
—————————————————————————
415 Id.
416 The Commission also has established requirements for a DCM
to monitor a physical-delivery contract’s terms and conditions as
they relate to the convergence between the futures contract price
and the cash price of the underlying commodity. 17 CFR 38.252. See
the preamble discussion of Sec. 38.252 in the final part 38
rulemaking. 77 FR 36612, 36635, June 19, 2012. The spot month limits
will be set at levels that target only extraordinarily large
traders. For example, the spot month limit for CBOT Wheat will be
set at 600 contracts. The contract size for CBOT Wheat is 5,000
bushels (~136 metric tons). The current price of a bushel of wheat
is approximately $7 per bushel. Therefore, a speculative trader
would be permitted to carry a ~$21 million position in wheat into
the spot month under the proposed position limits regime.
—————————————————————————
Furthermore, the Commission has observed generally low usage among
all traders of the physical-delivery futures contract during the spot
month, relative to the existing exchange spot-month position limits.
Thus, the Commission infers that few, if any, traders offset the risk
of swaps in physical-delivery futures contracts during the spot month
with positions in excess of the exchange’s current spot month
limits.417 The Commission invites comments as to the extent to which
traders actually have offset the risk of swaps during the spot month in
a physical-delivery futures contract with a position in excess of an
exchange’s spot-month position limit.
—————————————————————————
417 See 76 FR at 71635 (n. 100-01) (discussing data in CME
natural gas contract).
—————————————————————————
Additionally, the Commission imposes spot-month limits using the
same formula to restrict the size of positions in cash-settled
contracts that would potentially benefit from a trader’s distortion of
the price of the underlying referenced contract (or other cash price
series) that serves as the basis of cash settlement.418 The
Commission has found that traders with positions in look-alike cash-
settled contracts have an incentive to manipulate and undermine price
discovery in the physical-delivery contract to which the cash-settled
contract is linked by price. This practice is known as “banging” or
“marking the close,” 419 a manipulative practice that the
Commission prosecutes and that this proposal seeks to prevent.420
—————————————————————————
418 The Commission also has established requirements for DCMs
to monitor the pricing of cash-settled contracts. 17 CFR 38.253.
419 Section 4c(a)(5) of the Act lists certain unlawful
disruptive trading practices, including “any trading, practice, or
conduct on or subject to the rules of a registered entity that . . .
demonstrates intentional or reckless disregard for the orderly
execution of transactions during the closing period.” 7 U.S.C.
6c(a)(5)(B). “Banging” or “marking the close” is discussed in
the Commission’s Antidisruptive Practices Authority, Interpretive
guidance and policy statement, 78 FR 31890, 31894-96, May 28, 2013.
420 See, e.g., DiPlacido v. CFTC, 364 Fed. Appx. 657 (2d Cir.
2009) (upholding Commission finding that DiPlacido manipulated the
market where DiPlacido’s closing trades accounted for 14% of the
market).
—————————————————————————
In the final part 38 rulemaking, the Commission instructed DCMs,
when estimating deliverable supplies, to take into consideration the
individual characteristics of the underlying commodity’s supply and the
specific delivery features of the futures contract.421 In this
regard, the Commission notes that DCMs historically have set or
maintained exchange spot month limits at levels below 25 percent of
deliverable supply. Setting such a lower level of a spot month limit
may also serve the objectives of preventing excessive speculation,
manipulation, squeezes and corners, while ensuring sufficient market
liquidity for bona fide hedgers in the view of the listing DCM and
ensuring the price discovery function of the market is not disrupted.
Hence, the Commission observes that there may be a range of spot month
limits, including limits set at levels below 25 percent of deliverable
supply, which may serve as practicable to maximize these policy
objectives.
—————————————————————————
421 See 77 FR 36611, 36723, Jun. 12, 2012. DCM estimates of
deliverable supplies (and the supporting data and analysis) will
continue to be subject to Commission review.
—————————————————————————
e. Setting Levels of Single-Month and All-Months-Combined Limits
Proposed Sec. 150.2(e)(4) explains how the Commission would
calculate non-spot-month position limit levels, which the Commission
proposes to fix no less frequently than every two calendar years. In
contrast to spot month position limits which are set as a function of
estimated deliverable supply, the formula for the non-spot-month
position limits is based on total open interest for all referenced
contracts in a commodity. The actual position limit level will be set
based on a formula: 10 percent of the open interest for the first
25,000 contracts and 2.5 percent of the open interest thereafter.422
The Commission has used the 10, 2.5 percent formula in administering
the level of the legacy all-
[[Page 75730]]
months position limits since 1999.423 The Commission believes the
non-spot month position limits would restrict the market power of a
speculator that could otherwise be used to cause unwarranted price
movements. The Commission solicits comment on its single-month and all-
months-combined limits, including whether the proposed formula has
effectively addressed and will continue to address the Sec. 4a(a)(3)
regulatory objectives.
—————————————————————————
422 The Commission proposes to use the futures position limits
formula (the 10, 2.5 percent formula) to determine non-spot-month
position limits for referenced contracts. The 10, 2.5 percent
formula is identified in 17 CFR 150.5(c)(2).
423 See 64 FR 24038, 24039, May 5, 1999. The Commission
applies the open interest criterion by using a formula that
specifies appropriate increases to the limit level as a percentage
of open interest. As the total open interest of a futures market
increases, speculative position limit levels can be raised. The
Commission proposed using the 10, 2.5 percent formula in 1992. See
Revision of Federal Speculative Position Limits, Proposed Rules, 57
FR 12766, 12770, Apr. 13, 1992. The Commission implemented the 10,
2.5 percent formula in two steps, the first step in 1993 and the
second step in 1999. See Revision of Federal Speculative Limits,
Interim Final Rules, 58 FR 17973, 17978, Apr. 7, 1993. See also
Establishment of Speculative Position Limits, 46 FR 50938, Oct. 16,
1981 (“[T]he prevention of large or abrupt price movements which
are attributable to the extraordinarily large speculative positions
is a congressionally endorsed regulatory objective of the
Commission. Further, it is the Commission’s view that this objective
is enhanced by the speculative position limits since it appears that
the capacity of any contract to absorb the establishment and
liquidation of large speculative positions in an orderly manner is
related to the relative size of such positions, i.e., the capacity
of the market is not unlimited.”).
—————————————————————————
The Commission also proposes to estimate average open interest in
referenced contracts based on the largest annual average open interest
computed for each of the past two calendar years, using either month-
end open contracts or open contracts for each business day in the time
period, as the Commission finds in its discretion to be reliable.
(1) Initial Levels
For setting the levels of initial non-spot month limits, the
Commission proposes to use open interest for calendar years 2011 and
2012 in futures contracts, options thereon, and in swaps that are
significant price discovery contracts that are traded on exempt
commercial markets.
Table 10–Open Interest and Calculated Limits by Core Futures Referenced Contract, January 1, 2011, to December 31, 2012
——————————————————————————————————————————————————–
Open
Core referenced futures interest Open Limit Limit
Commodity type contract Year (daily interest (daily (month end) Limit
average) (month end) average)
———————————————————————————————————————————————
Legacy Agricultural……………… CBOT Corn (C)……….. 2011 2,063,231 1,987,152 53,500 51,600 53,500
…………………… 2012 1,773,525 1,726,096 46,300 45,100
CBOT Oats (O)……….. 2011 15,375 15,149 1,600 1,600 1,600
…………………… 2012 12,291 11,982 1,300 1,200
CBOT Soybeans (S)……. 2011 822,046 798,417 22,500 21,900 26,900
…………………… 2012 997,736 973,672 26,900 26,300
CBOT Soybean Meal (SM).. 2011 237,753 235,945 7,900 7,800 9,000
…………………… 2012 283,304 281,480 9,000 9,000
CBOT Soybean Oil (SO)… 2011 392,658 382,100 11,700 11,500 11,900
…………………… 2012 397,549 388,417 11,900 11,600
CBOT Wheat (W)………. 2011 565,459 550,251 16,100 15,700 16,200
…………………… 2012 572,068 565,490 16,200 16,100
ICE Cotton No. 2 (CT)… 2011 275,799 272,613 8,800 8,700 8,800
…………………… 2012 259,608 261,789 8,400 8,500
KCBT Hard Winter Wheat 2011 183,400 177,998 6,500 6,400 6,500
(KW).
…………………… 2012 155,540 155,074 5,800 5,800
MGEX Hard Red Spring 2011 55,938 54,546 3,300 3,300 3,300
Wheat (MWE).
…………………… 2012 40,577 40,314 2,900 2,900
Other Agricultural………………. CBOT Rough Rice (RR)…. 2011 21,788 21,606 2,200 2,200 2,200
…………………… 2012 15,262 14,964 1,600 1,500
CME Milk Class III (DA). 2011 55,567 57,490 3,300 3,400 3,400
…………………… 2012 47,378 47,064 3,100 3,100
CME Feeder Cattle (FC).. 2011 44,611 43,730 3,000 3,000 3,000
…………………… 2012 44,984 43,651 3,000 3,000
CME Lean Hog (LH)……. 2011 284,211 288,281 9,000 9,100 9,400
…………………… 2012 296,822 297,882 9,300 9,400
CME Live Cattle (LC)…. 2011 433,581 440,229 12,800 12,900 12,900
…………………… 2012 409,501 417,037 12,200 12,400
ICUS Cocoa (CC)……… 2011 191,801 198,290 6,700 6,900 7,100
…………………… 2012 202,886 206,808 7,000 7,100
ICE Coffee C (KC)……. 2011 174,845 176,079 6,300 6,300 7,100
…………………… 2012 204,268 207,403 7,000 7,100
ICE FCOJ-A (OJ)……… 2011 37,347 36,813 2,900 2,800 2,900
…………………… 2012 30,788 29,867 2,700 2,700
ICE Sugar No. 11 (SB)… 2011 814,234 806,887 22,300 22,100 23,500
…………………… 2012 855,375 862,446 23,300 23,500
ICE Sugar No. 16 (SF)… 2011 11,532 11,662 1,200 1,200 1,200
…………………… 2012 10,485 10,530 1,100 1,100
Energy…………………………. NYMEX Henry Hub Natural 2011 4,831,973 4,821,859 122,700 122,500 149,600
Gas (NG).
…………………… 2012 5,905,137 5,866,365 149,600 148,600
NYMEX Light Sweet Crude 2011 4,214,770 4,291,662 107,300 109,200 109,200
Oil (CL).
…………………… 2012 3,720,590 3,804,287 94,900 97,000
NYMEX NY Harbor ULSD 2011 559,280 566,600 15,900 16,100 16,100
(HO).
…………………… 2012 473,004 485,468 13,800 14,100
[[Page 75731]]
NYMEX RBOB Gasoline (RB) 2011 362,349 370,207 11,000 11,200 11,800
…………………… 2012 388,479 393,219 11,600 11,800
Metals…………………………. COMEX Copper (HG)……. 2011 134,097 131,688 5,300 5,200 5,600
…………………… 2012 148,767 147,187 5,600 5,600
COMEX Gold (GC)……… 2011 782,793 746,904 21,500 20,600 21,500
…………………… 2012 685,618 668,751 19,100 18,600
COMEX Silver (SI)……. 2011 179,393 172,567 6,400 6,200 6,400
…………………… 2012 165,670 164,064 6,100 6,000
NYMEX Palladium (PA)…. 2011 22,327 22,244 2,300 2,300 5,000
…………………… 2012 23,869 24,265 2,400 2,500
NYMEX Platinum (PL)….. 2011 40,988 40,750 2,900 2,900 5,000
…………………… 2012 54,838 54,849 3,300 3,300
——————————————————————————————————————————————————–
Given the levels of open interest for the calendar years of 2011
and 2012 for futures contracts and for swaps that are significant price
discovery contracts traded on exempt commercial markets, this formula
would result in levels for non-spot month position limits that are high
in comparison to the size of positions typically held in futures
contracts.424 Few persons held positions over the levels of the
proposed position limits in the past two calendar years, as illustrated
in Table 11 below. To provide the public with additional information
regarding the number of large position holders in the past two calendar
years, the table also provides counts of persons over 60, 80, 100, and
500 percent of the levels of the proposed position limits. Note that
the 500 percent line is omitted from Table 11 where no person held a
position over that level.
—————————————————————————
424 A review of preliminary swap open interest reported under
part 20 indicates that open interest in swap referenced contracts is
low, in comparison to futures open interest. Any open interest in
swap referenced contracts would serve to increase the levels of the
positions limits.
Table 11–Unique Persons Over Percentages of Proposed Position Limit Levels, January 1, 2011, to December 31,
2012
—————————————————————————————————————-
Unique persons over level
—————————————————————
Commodity type/core referenced Percent of Spot month
futures contract level (physical- Spot month Single month All months
delivery) (cash-settled)
—————————————————————————————————————-
Legacy Agricultural
—————————————————————————————————————-
CBOT Corn (C)………………. 60 243 4 9 16
80 167 * 6 8
100 53 * * 5
500 7 ………….. ………….. …………..
CBOT Oats (O)………………. 60 5 ………….. 15 15
80 4 ………….. 8 9
100 * ………….. 6 8
CBOT Soybeans (S)…………… 60 119 ………….. 14 17
80 88 ………….. 9 12
100 27 ………….. 6 8
500 9 ………….. ………….. …………..
CBOT Soybean Meal (SM)………. 60 52 * 20 35
80 32 * 9 16
100 12 * 6 9
CBOT Soybean Oil (SO)……….. 60 114 ………….. 31 37
80 70 ………….. 15 20
100 20 ………….. 10 12
500 * ………….. ………….. …………..
CBOT Wheat (W)……………… 60 46 ………….. 22 32
80 31 ………….. 14 16
100 14 ………….. 9 12
500 * ………….. ………….. …………..
ICE Cotton No. 2 (CT)……….. 60 12 ………….. 16 19
80 7 ………….. 11 14
100 6 ………….. 9 11
500 * ………….. ………….. …………..
KCBT Hard Winter Wheat (KW)….. 60 33 ………….. 36 40
80 18 ………….. 13 21
100 14 ………….. 9 13
500 * ………….. ………….. …………..
MGEX Hard Red Spring Wheat (MWE) 60 11 ………….. 17 24
80 10 ………….. 11 15
100 6 ………….. 9 9
—————————————————————————————————————-
[[Page 75732]]
Other Agricultural
—————————————————————————————————————-
CBOT Rough Rice (RR)………… 60 9 ………….. 7 9
80 6 ………….. 5 5
100 ………….. ………….. * *
CME Milk Class III (DA)……… 60 NA 6 * 19
80 NA 4 ………….. 14
100 NA * ………….. 7
CME Feeder Cattle (FC)………. 60 NA 76 4 13
80 NA 55 * 7
100 NA 16 * *
CME Lean Hog (LH)…………… 60 NA 52 20 30
80 NA 41 11 18
100 NA 28 7 13
500 NA * ………….. …………..
CME Live Cattle (LC)………… 60 37 ………….. 13 27
80 * ………….. 7 17
100 * ………….. 4 12
ICUS Cocoa (CC)…………….. 60 * ………….. 24 29
80 * ………….. 14 18
100 * ………….. 10 12
ICE Coffee C (KC)…………… 60 14 ………….. 19 24
80 13 ………….. 8 14
100 8 ………….. 5 6
500 2 ………….. ………….. …………..
ICE FCOJ-A (OJ)…………….. 60 8 ………….. 13 16
80 7 ………….. 9 9
100 6 ………….. 6 7
ICE Sugar No. 11 (SB)……….. 60 33 ………….. 28 31
80 23 ………….. 20 24
100 15 ………….. 12 18
500 * ………….. ………….. …………..
ICE Sugar No. 16 (SF)……….. 60 6 ………….. 10 16
80 5 ………….. 7 14
100 5 ………….. 7 13
—————————————————————————————————————-
Energy
—————————————————————————————————————-
NYMEX Henry Hub Natural Gas (NG) 60 177 221 * 5
80 131 183 ………….. …………..
100 61 148 ………….. …………..
500 ………….. 35 ………….. …………..
NYMEX Light Sweet Crude Oil (CL) 60 98 89 ………….. 4
80 72 62 ………….. *
100 39 33 ………….. *
500 ………….. ………….. ………….. …………..
NYMEX NY Harbor ULSD (HO)……. 60 76 45 9 18
80 53 35 6 15
100 33 24 5 8
500 ………….. * ………….. …………..
NYMEX RBOB Gasoline (RB)…….. 60 71 45 21 30
80 48 32 12 16
100 30 22 7 11
500 ………….. * ………….. …………..
—————————————————————————————————————-
Metals
—————————————————————————————————————-
COMEX Copper (HG)…………… 60 14 ………….. 29 28
80 13 ………….. 21 22
100 * ………….. 16 16
COMEX Gold (GC)…………….. 60 13 ………….. 24 21
80 9 ………….. 19 19
100 5 ………….. 12 12
COMEX Silver (SI)…………… 60 5 ………….. 25 21
80 * ………….. 15 13
100 * ………….. 10 9
NYMEX Palladium (PA)………… 60 6 ………….. 5 5
80 * ………….. * *
[[Page 75733]]
100 * ………….. * *
NYMEX Platinum (PL)…………. 60 11 ………….. 15 18
80 5 ………….. 11 12
100 * ………….. 9 10
—————————————————————————————————————-
Legend:
* means fewer than 4 unique owners exceeded the level.
— means no unique owners exceeded the level.
NA means not applicable.425
The Commission has also reviewed preliminary data submitted to it
under part 20. The Commission preliminarily has decided not to use the
data currently reported under part 20 for purposes of setting the
initial levels of the proposed single month and all-months-combined
positions limits. Instead, the Commission is proposing to set initial
levels based on open interest in futures, options on futures, and SPDC
swaps. Thus, the proposed initial levels represent lower bounds for the
initial levels the Commission may establish in final rules. The
Commission is providing the public with average open positions reported
under part 20 for the month of January 2013, in the table below. As
discussed below, the data reported during the month of January 2013,
reflected improved data reporting quality. However, the Commission is
concerned that the longer time series of this data has been less
reliable and thus has not used it for purposes of setting proposed
initial position limit levels.
—————————————————————————
425 Table notes: (1) Aggregation exemptions were not used in
computing the counts of unique persons; (2) the position data was
for futures, futures options and swaps that are significant price
discovery contracts (SPDCs).
Table 12–Swaps Reported Under Part 20–Average Daily Open Positions,
Futures Equivalent, January 2013
————————————————————————
Uncleared
Covered swap contract swaps Cleared swaps
————————————————————————
Chicago Board of Trade (“CBOT”) Corn.. 110,533 3,060
CBOT Ethanol………………………. * 15,905
CBOT Oats…………………………. ………….. …………..
CBOT Rough Rice……………………. ………….. …………..
CBOT Soybean Meal………………….. 20,594 …………..
CBOT Soybean Oil…………………… 35,760 …………..
CBOT Soybeans……………………… 39,883 1,306
CBOT Wheat………………………… 64,805 2,856
Chicago Mercantile Exchange (“CME”) ………….. …………..
Butter……………………………
CME Cheese………………………… ………….. …………..
CME Dry Whey………………………. ………….. …………..
CME Feeder Cattle………………….. * …………..
CME Hardwood Pulp………………….. ………….. …………..
CME Lean Hog………………………. 12,809 …………..
CME Live Cattle……………………. 17,617 …………..
CME Milk Class III…………………. ………….. …………..
CME Non Fat Dry Milk……………….. ………….. …………..
CME Random Length Lumbar……………. ………….. …………..
CME Softwood Pulp………………….. ………….. …………..
Commodity Exchange, Inc. (“COMEX”) 9,259 …………..
Copper Grade No. 1…………………
COMEX Gold………………………… 38,295 …………..
COMEX Silver………………………. 5,753 …………..
ICE Futures U.S. (“ICE”) Cocoa…….. 8,933 …………..
ICE Coffee C………………………. 3,465 …………..
ICE Cotton No. 2…………………… 14,627 …………..
ICE Frozen Concentrated Orange Juice…. * …………..
ICE Sugar No. 11…………………… 287,434 …………..
ICE Sugar No. 16…………………… ………….. …………..
Kansas City Board of Trade (“KCBT”) 2,565 …………..
Wheat…………………………….
Minneapolis Grain Exchange (“MGEX”) 2,419 …………..
Wheat…………………………….
NYSE LIFFE (“NYL”) Gold, 100 Troy Oz.. ………….. …………..
NYL Silver, 5000 Troy Oz……………. ………….. …………..
New York Mercantile Exchange (“NYMEX”) ………….. …………..
Cocoa…………………………….
NYMEX Brent Financial………………. 93,825 …………..
NYMEX Central Appalachian Coal………. ………….. …………..
NYMEX Coffee………………………. 2,320 …………..
NYMEX Cotton………………………. 8,315 …………..
[[Page 75734]]
NYMEX Crude Oil, Light Sweet………… 507,710 …………..
NYMEX Gasoline Blendstock (RBOB)…….. 10,110 …………..
NYMEX Hot Rolled Coil Steel…………. * …………..
NYMEX Natural Gas………………….. 1,060,468 96,057
NYMEX No. 2 Heating Oil, New York Harbor 35,126 …………..
NYMEX Palladium……………………. * …………..
NYMEX Platinum…………………….. * …………..
————————————————————————
Legend:
* means fewer than 1,000 futures equivalent contracts reported in the
category.
Leaders mean no contracts reported.
The part 20 data are comprised of positions resulting from cleared
and uncleared swaps, which are reported by different reporting
entities. Clearing members of derivative clearing organizations
(“DCOs”) have reported paired swap positions in cleared swaps since
November 11, 2011, and paired swap positions in uncleared swaps since
January 20, 2012. DCOs have also reported aggregate positions of each
clearing member’s house and customer accounts for each paired swap
since November 11, 2011. Data reports submitted by clearing members
have had various errors (e.g., duplicate records, inconsistent
reporting of data fields)–Commission staff continues to work with
these reporting entities to improve data reporting.
Beginning March 1, 2013, swap dealers that were not clearing
members were required to submit data reports under Sec. 20.4(c).
Additionally, some swap dealers began reporting such data voluntarily
prior to March 1, 2013.426 As these new reporters submitted position
data reports, the Commission observed a substantial increase in open
interest for uncleared swaps that appeared unreasonable; it became
apparent that part of this increase was caused by data reporting
errors.427 The Commission believes it would be difficult to
distinguish the true level of open interest because some reporting
errors may cause open interest to be underestimated while others may
cause open interest to be overestimated.
—————————————————————————
426 Further, other firms have begun to report under part 20
after March 1, 2013, following registration as swap dealers.
427 For example, reported total open interest in swaps, both
cleared and uncleared, linked to or based on NYMEX Natural Gas
futures contracts averaged approximately 1.2 million contracts
between January 1, 2013 and March 1, 2013 and approximately 97
million contracts between March 1 and May 31, 2013 (with a peak
value close to 300 million contracts).
—————————————————————————
Alternatively, the Commission is considering using part 20 data,
should it determine such data to be reliable, in order to establish
higher initial levels in a final rule.428 Further, the Commission is
considering using data from swaps data repositories, as practicable. In
either case, the Commission is considering excluding inter-affiliate
swaps, since such swaps would tend to inflate open interest.
—————————————————————————
428 Several reporting entities have submitted data that
contained stark errors. For example, certain reporting entities
submitted position sizes that the Commission determined to be 1000
times, or even 10,000 times, too large.
—————————————————————————
Based on the forgoing, the Commission believes the initial levels
proposed herein should ensure adequate liquidity for hedges yet
nevertheless prevent a speculative trader from acquiring excessively
large positions above the limits, and thereby help to prevent excessive
speculation and to deter and prevent market manipulation.
(2) Subsequent Levels
For setting subsequent levels of non-spot month limits, the
Commission proposes to estimate average open interest in referenced
contracts using data reported by DCMs and SEFs pursuant to parts 16,
20, and/or 45.429 While the Commission does not currently possess all
data needed to fully enforce the position limits proposed herein, the
Commission believes that it should have adequate data to reset the
overall concentration-based percentages for the position limits two
years after initial levels are set.430 The Commission intends to use
comprehensive positional data on physical commodity swaps once such
data is collected by swap data repositories under part 45, and would
convert such data to futures-equivalent open positions in order to fix
numerical position limits through the application of the proposed open-
interest-based position limit formula. The resultant limits are
purposely designed to be high enough to ensure sufficient liquidity for
bona fide hedgers and to avoid disrupting the price discovery process
given the limited information the Commission has with respect to the
size of the physical commodity swap markets, including preliminary data
collected under part 20 as of January 2013. The Commission further
proposes to publish on the Commission’s Web page such estimates of
average open interest in referenced contracts on a monthly basis to
make it easier for market participants to estimate changes in levels of
position limits.
—————————————————————————
429 Options listed on DCMs would be adjusted using an option
delta reported to the Commission pursuant to 17 CFR part 16; swaps
would be counted on a futures equivalent basis, equal to the
economically equivalent amount of core referenced futures contracts
reported pursuant to 17 CFR part 20 or as calculated by the
Commission using swap data collected pursuant to17 CFR part 45.
430 While the Commission has access to some data on physical-
commodity swaps from swaps data repositories, the Commission
continues to work with SDRs and other market participants to fully
implement the swaps data reporting regime.
—————————————————————————
f. Grandfather of Pre-Existing Positions
The Commission proposes in new Sec. 150.2(f)(2) to conditionally
exempt from federal non-spot-month speculative position limits any
referenced contract position acquired by a person in good faith prior
to the effective date of such limit, provided that such pre-existing
referenced contract position is attributed to the person if such
person’s position is increased after the effective date of such
limit.431 This conditional exemption for pre-existing positions is
consistent with the provisions of CEA section 4a(b)(2) in
[[Page 75735]]
that it is designed to phase in position limits without significant
market disruption, while attributing such pre-existing positions to the
person if such person’s position is increased after the effective date
of a position limit is consistent with the provisions of CEA section
22(a)(5)(B). Notwithstanding this exemption for pre-existing positions
in non-spot months, proposed Sec. 150.2(f)(1) would require a person
holding a pre-existing referenced contract position (in a commodity
derivative contract other than a pre-enactment and transition period
swaps as defined in proposed Sec. 150.1) to comply with spot month
speculative position limits.432 The Commission remains particularly
concerned about protecting the spot month in physical-delivery futures
contracts from squeezes and corners.
—————————————————————————
431 Such pre-existing positions that are in excess of the
proposed position limits would not cause the trader to be in
violation based solely on those positions. To the extent a trader’s
pre-existing positions would cause the trader to exceed the non-
spot-month limit, the trader could not increase the directional
position that caused the positions to exceed the limit until the
trader reduces the positions to below the position limit. As such,
persons who established a net position below the speculative limit
prior to the enactment of a regulation would be permitted to acquire
new positions, but the Commission would calculate the combined
position of a person based on pre-existing positions with any new
position.
432 Nothing in proposed Sec. 150.2(f) would override the
exemption set forth in proposed Sec. 150.3(d) for pre-enactment and
transition period swaps from speculative position limits. See
discussion of proposed Sec. 150.3(d) below.
—————————————————————————
Proposed Sec. 150.2(g) would apply position limits to foreign
board of trade (“FBOT”) contracts that are both: (1) Linked
contracts, that is, a contract that settles against the price
(including the daily or final settlement price) of one or more
contracts listed for trading on a DCM or SEF; and (2) direct-access
contracts, that is, the FBOT makes the contract available in the United
States through direct access to its electronic trading and order
matching system through registration as an FBOT or via a staff no
action letter.433 Proposed Sec. 150.2(g) is consistent with CEA
section 4a(a)(6)(B), which directs the Commission to apply aggregate
position limits to FBOT linked, direct-access contracts.434
—————————————————————————
433 Proposed Sec. 150.2(g) is identical in substance to
vacated Sec. 151.8. Compare 76 FR 71693.
434 See supra discussion of CEA section 4a(a)(6) concerning
aggregate position limits and the treatment of FBOT contracts.
—————————————————————————
3. Section 150.3–Exemptions
i. Current Sec. 150.3
CEA section 4a(c)(1) exempts bona fide hedging transactions or
positions, which terms are to be defined by the Commission, from any
rule promulgated by the Commission under CEA section 4a concerning
speculative position limits.435 Current Sec. 150.3, adopted by the
Commission before the Dodd-Frank Act was enacted, contains an exemption
from federal position limits for bona fide hedging transactions.436
Additionally, Dodd-Frank added section 4a(a)(7) to the CEA, which gives
the Commission authority to provide exemptions from any requirement the
Commission establishes under section 4a with respect to speculative
position limits.437
—————————————————————————
435 7 U.S.C. 6a(c)(1).
436 Bona fide hedging transactions and positions for excluded
commodities are currently defined at 17 CFR Sec. 1.3(z). As
discussed above, the Commission has proposed a new comprehensive
definition of bona fide hedging positions in proposed Sec. 150.1.
437 7 U.S.C. 6a(a)(7). Section 4a(a)(7) of the CEA provides
the Commission plenary authority to grant exemptive relief from
position limits. Specifically, under Section 4a(a)(7), the
Commission “by rule, regulation, or order, may exempt,
conditionally or unconditionally, any person, or class of persons,
any swap or class of swaps, any contract of sale of a commodity for
future delivery or class of such contracts, any option or class of
options, or any transaction or class of transactions from any
requirement it may establish . . . with respect to position
limits.”
—————————————————————————
The existing exemptions promulgated under pre-Dodd-Frank CEA
section 4a and set forth in current Sec. 150.3 are fundamental to the
Commission’s regulatory framework for speculative position limits.
Current Sec. 150.3 specifies the types of positions that may be
exempted from, and thus may exceed, the federal speculative position
limits. First, the exemption for bona fide hedging transactions and
positions as defined in current Sec. 1.3(z) permits a commercial
enterprise to exceed positions limits to the extent the positions are
reducing price risks incidental to commercial operations.438 Second,
the exemption for spread or arbitrage positions between single months
of a futures contract (and/or, on a futures-equivalent basis, options)
outside of the spot month, permits any trader’s spread position to
exceed the single month limit.439 Third, positions carried for an
eligible entity 440 in the separate account of an independent account
controller (“IAC”) 441 that manages customer positions need not be
aggregated with the other positions owned or controlled by that
eligible entity (the “IAC exemption”).442
—————————————————————————
438 17 CFR 150.3(a)(1). The current definition of bona fide
hedging transactions and positions in 1.3(z) is discussed above.
439 The Commission clarifies that a spread or arbitrage
position in this context means a short position in a single month of
a futures contract and a long position in another contract month of
that same futures contract, outside of the spot month, in the same
crop year. The short and/or long positions may also be in options on
that same futures contract, on a futures equivalent basis. Such
spread or arbitrage positions, when combined with any other net
positions in the single month, must not exceed the all-months limit
set forth in current Sec. 150.2, and must be in the same crop year.
17 CFR 150.3(a)(3).
440 “Eligible entity” is defined in current 17 CFR 150.1(d).
441 “Independent account controller” is defined in 17 CFR
150.1(e).
442 See 17 CFR 150.3(a)(4). See also discussion of the IAC
exemption in the Aggregation NPRM.
—————————————————————————
ii. Proposed Sec. 150.3
In this release, the Commission proposes organizational and
substantive amendments to Sec. 150.3, generally resulting in an
increase in the number of exemptions to speculative position limits.
First, the Commission proposes to amend the three exemptions from
federal speculative limits currently contained in Sec. 150.3. These
amendments would update cross references, relocate the IAC exemption
and consolidate it with the Commission’s separate proposal to amend the
aggregation requirements of Sec. 150.4,443 and delete the calendar
month spread provision which is unnecessary under proposed changes to
Sec. 150.2 that would increase the level of the single month position
limits. Second, the Commission proposes to add exemptions from the
federal speculative position limits for financial distress situations,
certain spot-month positions in cash-settled referenced contracts, and
grandfathered pre-Dodd-Frank and transition period swaps. Third, the
Commission proposes to revise recordkeeping and reporting requirements
for traders claiming any exemption from the federal speculative
position limits.
—————————————————————————
443 See Aggregation NPRM.
—————————————————————————
a. Proposed Amendments to Existing Exemptions
(1) New Cross-References
Because the Commission proposes to replace the definition of bona
fide hedging in 1.3(z) with the definition in proposed Sec. 150.1,
proposed Sec. 150.3(a)(1)(i) updates the cross-references to reflect
this change.444 Proposed Sec. 150.3(a)(3) would add a new cross-
reference to the reporting requirements proposed to be amended in part
19.445 As is currently the case for bona fide hedgers, persons who
wish to claim any exemption from federal position limits, including
hedgers, would need to satisfy the reporting requirements in part
19.446 As discussed elsewhere in this release, the Commission is
proposing amendments to update part 19 reporting.447 For purposes of
simplicity, the Commission is retaining the current placement of many
reporting requirements, including those related to claimed exemptions
from the federal position limits, within
[[Page 75736]]
parts 15-21 of the Commission’s regulations.448 Lastly, proposed
Sec. 150.3(i) would add a cross-reference to the updated aggregation
rules in proposed Sec. 150.4.449 The Commission proposes to retain
the current practice of considering entities required to aggregate
accounts or positions under proposed Sec. 150.4 to be the same person
when determining whether they are eligible for a bona fide hedging
position exemption.450
—————————————————————————
444 See supra discussion of the Commission’s revised
definition of bona fide hedging position in proposed Sec. 150.1.
445 See infra discussion of proposed revisions of 17 CFR part
19.
446 See 17 CFR part 19.
447 See infra discussion of proposed revisions of 17 CFR part
19.
448 The Commission notes this is a change from the
organization of vacated Sec. 151.5, that included both exemptions
and related reporting requirements in a single section.
449 See Aggregation NPRM.
450 See Aggregation NPRM. The Commission clarifies that
whether it is economically appropriate for one entity to offset the
cash market risk of an affiliate depends, in part, upon that
entity’s ownership interest in the affiliate. It would not be
economically appropriate for an entity to offset all the risk of an
affiliate’s cash market exposure unless that entity held a 100
percent ownership interest in the affiliate. For less than a 100
percent ownership interest, it would be economically appropriate for
an entity to offset no more than a pro rata amount of any cash
market risk of an affiliate, consistent with the entity’s ownership
interest in the affiliate.
—————————————————————————
(2) Deleting Exemption for Calendar Spread or Arbitrage Positions
The Commission proposes to delete the exemption in current Sec.
150.3(a)(3) for spread or arbitrage positions between single months of
a futures contract or options thereon, outside the spot month.451 The
Commission has proposed to maintain the current practice in Sec.
150.2, which the district court did not vacate, of setting single-month
limits at the same levels as all-months limits, rendering the
“spread” exemption unnecessary. The spread exemption set forth in
current Sec. 150.3(a)(3) permits a spread trader to exceed single
month limits only to the extent of the all months limit.452 Since
proposed Sec. 150.2 sets single month limits at the same level as all
months limits, the spread exemption no longer provides useful relief.
Furthermore, as discussed below in this release, the Commission would
codify guidance in proposed Sec. 150.5(a)(2)(B) that would allow a DCM
or SEF to grant exemptions for intramarket and intermarket spread
positions (as those terms are defined in proposed Sec. 150.1)
involving commodity derivative contracts subject to the federal
limits.453
—————————————————————————
451 In its entirety, 17 CFR 150.3(a)(3) sets forth an
exemption from federal position limits for [s]pread or arbitrage
positions between single months of a futures contract and/or, on a
futures-equivalent basis, options thereon, outside of the spot
month, in the same crop year; provided however, that such spread or
arbitrage positions, when combined with any other net positions in
the single month, do not exceed the all-months limit set forth in
Sec. 150.2.
452 See id.
453 As discussed above.
—————————————————————————
(3) Relocating Independent Account Controller (“IAC”) Exemption to
proposed Sec. 150.4
In a separate rulemaking, the Commission has proposed Sec.
150.4(b)(5) to replace the existing IAC exemption in current Sec.
150.3(a)(4).454 Proposed Sec. 150.4(b)(5) sets forth an exemption
for accounts carried by an IAC that is substantially similar to current
Sec. 150.3(a)(4). Thus, the Commission is proposing to delete the IAC
exemption in current Sec. 150.3(a)(4) because it is duplicative.
—————————————————————————
454 For purposes of simplicity, the IAC exemption would be
placed within the regulatory section providing for aggregation of
positions. See Aggregation NPRM.
—————————————————————————
b. Proposed Additional Exemptions From Position Limits
As discussed above, CEA section 4a(a)(7) provides that the
Commission may “by rule, regulation, or order . . . exempt . . . any
person or class of persons” from any requirement that the Commission
may establish under section 4a of the Act. Pursuant to this authority,
the Commission proposes to add new exemptions in Sec. 150.3 for
financial distress situations and qualifying positions in cash-settled
referenced contracts. The Commission also proposes to add guidance to
persons seeking exemptive relief for certain qualifying non-enumerated
risk-reducing transactions. Additionally, the Commission proposes to
grandfather pre-Dodd-Frank enactment swaps and transition swaps entered
into before from position limits.
(1) Financial Distress Exemption
The Commission proposes to add an exemption from position limits
for certain market participants in certain financial distress scenarios
to Sec. 150.3(b). During periods of financial distress, it may be
beneficial for a financially sound entity to take on the positions (and
corresponding risk) of a less stable market participant. The Commission
historically has provided for an exemption from position limits in
these types of situations, to avoid sudden liquidations that could
potentially reduce liquidity, disrupt price discovery, and/or increase
systemic risk.455 Therefore, the Commission now proposes to codify in
regulation its prior exemptive practices to accommodate situations
involving, for example, a customer default at a FCM, or in the context
of potential bankruptcy. The Commission historically has not granted
such an exemption by Commission Order due to concerns regarding
timeliness and flexibility. Furthermore, the Commission clarifies that
this exemption for financial distress situations is not a hedging
exemption.
—————————————————————————
455 See Release 5551-08, “CFTC Update on Efforts Underway to
Oversee Markets,” September 19, 2008 (available at http://www.cftc.gov/PressRoom/PressReleases/pr5551-08).
—————————————————————————
(2) Conditional Spot-Month Limit Exemption
Proposed Sec. 150.3(c) would provide a conditional spot-month
limit exemption that permits traders to acquire positions up to five
times the spot-month limit if such positions are exclusively in cash-
settled contracts. This conditional exemption would only be available
to traders who do not hold or control positions in the spot-month
physical-delivery referenced contract. Historically, the Commission and
Congress have been particularly concerned about protecting the spot
month in physical-delivery futures contracts.456 For example, new CEA
section 4c(a)(5)(B) makes it unlawful for any person to engage in any
trading, practice, or conduct on or subject to the rules of a
registered entity that demonstrates intentional or reckless disregard
for the orderly execution of transactions during the closing period.
The Commission interprets the closing period to be defined generally as
the period in the contract or trade when the settlement price is
determined under the rules of a trading facility such as a DCM or SEF,
and may include the time period in which a daily settlement price is
determined and the expiration day for a futures contract.457
—————————————————————————
456 See, for example, the guidance for DCMs to establish a
spot month limit in physical-delivery futures contracts that is no
greater than 25 percent of estimated deliverable supply in 17 CFR
150.5(b).
457 See Antidisruptive Practices Authority, Interpretive
guidance and policy statement, 78 FR 31890, 31894, May 28, 2013. See
also the discussion above of “banging the close” and the DiPlacido
case.
—————————————————————————
This proposed conditional exemption for cash-settled contracts
generally tracks exchange-set position limits currently implemented for
certain cash-settled energy futures and swaps.458 The
[[Page 75737]]
Commission has examined market data on the effectiveness of conditional
spot-month limits for cash-settled energy futures swaps, including the
data submitted as part of the prior position limits rulemaking,459
and preliminarily believes that the conditional approach effectively
addresses the Sec. 4a(a)(3) regulatory objectives. Since spot-month
limit levels for cash-settled referenced contracts will be set at no
more than 25% of the estimated spot-month deliverable supply in the
relevant core referenced futures contract, the proposed conditional
exemption would therefore permit a speculator to own positions in cash-
settled referenced contracts equivalent to no more than 125% of the
estimated deliverable supply.
—————————————————————————
458 For example, this is the same methodology for spot-month
speculative position limits that applies to cash-settled Henry Hub
natural gas contracts on NYMEX and ICE, beginning with the February
2010 contract months (with the exception of the exchange-set
requirement that a trader not hold large cash commodity positions).
In response to concerns regarding increasing trading volumes in
standardized swaps, in 2008 Congress amended section 2(h) of the Act
to establish core principles for exempt commercial markets
(“ECMs”) trading swap contracts that the Commission determined to
be significant price discovery contracts (“SPDCs”). 7 U.S.C.
2(h)(7) (2009). See also section 13201 of the Food, Conservation and
Energy Act of 2008, H.R. 2419 (May 22, 2008). Core principle (IV)
directed ECMs to “adopt, where necessary and appropriate, position
limitations or position accountability for speculators . . . to
reduce the potential threat of market manipulation or congestion,
especially during trading in the delivery month.” 7 U.S.C.
2(h)(7)(C)(ii)(IV)(2009). Under the Commission’s rules for ECMs
trading SPDCs, the Commission provided an acceptable practice that
an ECM trading a SPDC that is economically-equivalent to a contract
traded on a DCM should set the spot-month limit at the same level as
that specified for the economically-equivalent DCM contract. 17 CFR
part 36 (2010). In practice, for example, ICE complied with this
requirement by establishing a spot month limit for its natural gas
SPDC at the same level as the spot month limit in the economically-
equivalent NYMEX Henry Hub Natural Gas futures contract. Both ICE
and NYMEX established conditional spot month limits in their cash-
settled natural gas contracts at a level five times the level of the
spot month limit in the physical-delivery futures contract.
459 See 76 FR 71635 (n. 100-01)(discussing data for the CME
natural gas contract).
—————————————————————————
As proposed, this broad conditional spot month limit exemption for
cash-settled contracts would be similar to the conditional spot month
limit for cash-settled contracts in proposed Sec. 151.4.460 However,
unlike proposed Sec. 151.4, proposed Sec. 150.3(c) would not require
a trader to hold physical commodity inventory of less than or equal to
25 percent of the estimated deliverable supply in order to qualify for
the conditional spot month limit exemption. Rather, the Commission
proposes to require enhanced reporting of cash market holdings of
traders availing themselves of the conditional spot month limit
exemption, as discussed in the proposed changes to part 19, below.461
The Commission preliminarily believes that an enhanced reporting regime
may serve to provide sufficient information to conduct an adequate
surveillance program to detect and potentially deter excessively large
positions or manipulative schemes involving the cash market.
—————————————————————————
460 With respect to cash-settled contracts, proposed Sec.
151.4 incorporated a conditional spot-month limit permitting traders
without a hedge exemption to acquire position levels that are five
times the spot-month limit if such positions are exclusively in
cash-settled contracts (i.e., the trader does not hold positions in
the physical-delivery referenced contract) and the trader holds
physical commodity positions that are less than or equal to 25
percent of the estimated deliverable supply. See Proposed Rule, 76
FR 4752, 4758, Jan. 26, 2011.
461 See infra discussion of proposed revisions to part 19.
—————————————————————————
The Commission notes that the proposed conditional spot month limit
is a change of course from the expanded spot month limit that was only
for natural gas referenced contracts in vacated Sec. 151.4.462 In
proposing to expand the scope of derivatives contracts for which the
conditional spot month limit is available, the Commission has
reconsidered the risks to the market of permitting a speculative trader
to hold an expanded position in a cash-settled contract when that
speculative trader also is active in the underlying physical-delivery
contract. The Commission preliminarily believes the conditional natural
gas spot month limits of the exchanges generally have served to further
the purposes Congress articulated for positions limits in sections
4a(a)(3)(B) and 4c(a)(5)(B) of the Act, such as deterring market
manipulation, ensuring the price discovery function of the underlying
market is not disrupted, and deterring disruptive trading during the
closing period. The Commission notes those exchange-set conditional
limits, as is the case for the proposed rule, prohibit a speculative
trader who is holding an expanded position in a cash-settled contract
from also holding any position in the physical-delivery contract.
—————————————————————————
462 Under vacated Sec. 151.4, the Commission would have
applied spot-month position limits for cash-settled contracts using
the same methodology as applied to the physical-delivery core
referenced futures contracts, with the exception of natural gas
contracts, which would have a class limit and aggregate limit of
five times the level of the limit for the physical-delivery Core
Referenced Futures Contract. 76 FR 71635.
—————————————————————————
The proposed conditional exemption would satisfy the goals set
forth in CEA section 4a(a)(3)(B) by: Eliminating all speculation in a
physical-delivery contract during the spot period by a trader availing
herself of the conditional spot month limit exemption; ensuring
sufficient market liquidity in the cash-settled contract for bona fide
hedgers, in light of the typically rapidly decreasing levels of open
interest in the physical-delivery contract during the spot month as
hedgers exit the physical-delivery contract; and protecting the price
discovery process in the physical-delivery contract from the risk that
traders with leveraged positions in cash-settled contracts (in
comparison to the level of the limit in the physical-delivery contract)
would otherwise attempt to mark the close or distort physical-delivery
prices to benefit their leveraged cash-settled positions. Thus, the
exemption would establish a higher conditional limit for cash-settled
contracts than for physical delivery contracts, so long as such
positions are decoupled from positions in physical delivery contracts
which set or affect the value of such cash-settled positions.
The Commission preliminarily believes this proposed exemption would
not encourage price discovery to migrate to the cash-settled contracts
in a way that would make the physical-delivery contract more
susceptible to sudden price movements near expiration. The Commission
has observed, repeatedly, that open interest in physical-delivery
contracts typically declines markedly in the period immediately
preceding the spot month. Open interest typically declines to minimal
levels prior to the close of trading in physical-delivery contracts.
The Commission notes a hedger with a long position need not stand for
delivery when the price of a physical-delivery contract has adequately
converged to the underlying cash market price; rather, such long
position holder may offset and purchase needed commodities in the cash
market at a comparable price that meets the hedger’s specific location
and quality needs. Similarly, the Commission notes a hedger with a
short position need not give notice of intention to deliver and deliver
when the price of a physical-delivery contract has adequately converged
to the underlying cash market price; rather, such short position holder
may offset and sell commodities held in inventory or current production
in the cash market at a comparable price that is consistent with the
hedger’s specific storage location and quality of inventory or
production.463 Concerns regarding corners and squeezes are most acute
in the markets for physical contracts in the spot month, which is why
speculative limits in physical delivery markets are generally set at
levels that are stricter during the spot month. The Commission seeks
comment on whether a conditional spot-month
[[Page 75738]]
limit exemption adequately protects the price discovery function of the
underlying physical-delivery market. Further, the Commission solicits
comment on its conditional spot month limit, including whether it is
advisable to expand this conditional limit to all contracts.
Additionally, the Commission solicits comment on whether the
conditional spot-month limit has effectively addressed and will
continue to address the CEA section 4a(a)(3) regulatory objectives. Are
there other concerns or issues regarding the proposed conditional spot
month limit exemption that the Commission has not addressed?
—————————————————————————
463 Once the price of a physical-delivery contract has
converged adequately to cash market prices, long and short position
holders typically offset physical-delivery contracts. Prior to such
adequate convergence, the Commission has observed when a physical-
delivery contract is trading at a price above prevailing cash market
prices, commercials with inventory tend to sell contracts with the
intent of making delivery, causing physical-delivery prices to
converge to cash market prices. Similarly, the Commission has
observed when a physical-delivery contract is trading at a price
below prevailing cash market prices, commercials with a need for the
commodity or merchants active in the cash market tend to buy the
contract with the intent of taking delivery, causing physical-
delivery prices to converge to cash market prices.
—————————————————————————
While traders who avail themselves of a conditional spot month
limit exemption could not directly influence particular settlement
prices by trading in the physical-delivery referenced contract, the
Commission remains concerned about such traders’ activities in the
underlying cash commodity. Accordingly, the Commission proposes new
reporting requirements in part 19, as discussed below.464 The
Commission invites comment and empirical analysis as to whether these
reporting requirements adequately address concerns regarding: (1)
Protecting the price discovery function of the physical-delivery
market, including deterring attempts to mark the close in the physical-
delivery contract; and (2) providing adequate liquidity for bona fide
hedgers in the physical-delivery contracts. In light of these two
concerns, the Commission is also proposing alternatives to the
conditional spot-month limit exemption, as discussed below, including
the possibility that it would not adopt the proposed conditional spot-
month limit exemption.
—————————————————————————
464 See infra discussion of proposed revisions of part 19.
—————————————————————————
As one alternative to the proposed conditional spot month limit,
the Commission is considering whether to restrict a trader claiming the
conditional spot-month limit exemption to positions in cash-settled
contracts that settle to an index based on cash-market transactions
prices. This would prohibit traders from claiming a conditional
exemption if the trader held positions in the spot-month of cash-
settled contracts that settle to prices based on the underlying
physical-delivery futures contract. If the Commission adopted this
alternative instead of the proposal, would the physical-delivery
futures contract market be better protected? Why or why not?
The Commission is also considering a second alternative to the
proposed conditional spot month limit: Setting an expanded spot-month
limit for cash-settled contracts at five times the level of the limit
for the physical-delivery core referenced futures contract, regardless
of positions in the underlying physical-delivery contract. This
alternative would not prohibit a trader from carrying a position in the
spot-month of the physical-delivery contract. Consequently, this
alternative would give more weight to protecting liquidity for bona
fide hedgers in the physical-delivery contract in the spot month, and
less weight to protecting the price discovery function of the
underlying physical-delivery contract in the spot month.465 Given
Congressional concerns regarding disruptive trading practices in the
closing period, as discussed above, would this second alternative
adequately address the policy factors in CEA section 4a(a)(3)(B)?
—————————————————————————
465 This second alternative would effectively adopt for all
commodity derivative contract limits certain provisions of vacated
Sec. 151.4 (that would have been applicable only to contracts in
natural gas). As noted above, under vacated Sec. 151.4, the
Commission would have applied a spot-month position limit for cash-
settled contracts in natural gas at a level of five times the level
of the limit for the physical-delivery Core Referenced Futures
Contract in natural gas. Id.
—————————————————————————
The Commission is also considering a third alternative: Limiting
application of an expanded spot-month limit to a trader holding
positions in cash-settled contracts that settle to an index based on
cash-market transactions prices. Under this third alternative, cash-
settled contracts that settle to the underlying physical-delivery
contract would be restricted by a spot-month limit set at the same
level as that of the underlying physical-delivery contract. The
Commission is considering an aggregate spot-month limit on all types of
cash-settled contracts set at five times the level of the limit of the
underlying physical-delivery contract for this alternative to the
proposed conditional spot month limit. Would this third alternative
adequately address the policy factors in CEA section 4a(a)(3)(B)? Would
this third alternative better address such policy factors than the
second alternative?
The Commission requests comment on all aspects of the proposed
conditional spot limit and the three alternatives discussed above,
including whether conditional spot month limit exemptions should vary
based on the underlying commodity. Should the Commission consider any
other alternatives? If yes, please describe any alternative in detail.
Would any of the proposed conditional spot month limit or the
alternatives be more or less likely to increase or decrease liquidity
in particular products? Would anti-competitive behavior be more or less
likely to result from any of the proposed conditional spot month limit
or the alternatives? Does any of the proposed conditional spot month
limit or the alternatives increase the potential for manipulation? If
yes, please provide detailed arguments and analyses.
(3) Exemption for Pre-Dodd-Frank Enactment Swaps and Transition Period
Swaps
Proposed Sec. 150.3(d) would provide an exemption from federal
position limits for (1) swaps entered into prior to July 21, 2010 (the
date of the enactment of the Dodd-Frank Act of 2010), the terms of
which have not expired as of that date, and (2) swaps entered into
during the period commencing July 22, 2010, the terms of which have not
expired as of that date, and ending 60 days after the publication of
final Sec. 150.3 in the Federal Register.466 However, the Commission
would allow both pre-enactment and transition swaps to be netted with
commodity derivative contracts acquired more than 60 after publication
of final Sec. 150.3 in the Federal Register for the purpose of
complying with any non-spot-month position limit.
—————————————————————————
466 This exemption is consistent with CEA section 4a(b)(2).
The time period for transition swaps for purposes of position limits
differs from the time period for transition swaps for purposes of
swap data recordkeeping and reporting requirements. In both cases,
the time periods for transition swaps begins on the date of
enactment of the Dodd-Frank Act. However, the time periods for
transition swaps end prior to the compliance date for each relevant
rule. Swap data recordkeeping and reporting requirements for pre-
enactment and transition period swaps are listed in 17 CFR part 46.
—————————————————————————
(4) Other Exemptions for Non-Enumerated Risk-Reducing Practices
The Commission notes that the enumerated list of bona fide hedging
positions as set forth in proposed Sec. 150.1 represents an expanded
list of exemptions that has evolved over many years of the Commission’s
experience in administering speculative position limits. The Commission
has carefully expanded the list of exemptions in light of the statutory
directive to define a bona fide hedging position in section 4a(c)(2) of
the Act.
The Commission previously permitted a person to file an application
seeking approval for a non-enumerated position to be recognized as a
bona fide hedging position under Sec. 1.47. The Commission proposes to
delete Sec. 1.47 for several reasons. First, Sec. 1.47 did not
provide guidance as to the standards the Commission would use to
determine whether a position was a bona fide
[[Page 75739]]
hedging position. Second, in the Commission’s experience, the
overwhelming number of applications filed under Sec. 1.47 were from
swap intermediaries seeking to offset the risk of swaps. Section
4a(c)(2) of the Act addresses the application of the bona fide hedging
definition to certain positions that reduce risks attendant to a
position resulting from certain swaps. As discussed in the definitions
section above, those statutory provisions have been incorporated into
the proposed definition of a bona fide hedging position under Sec.
150.1; further, as discussed in the position limits section above, the
provisions of proposed Sec. 150.2 include relief outside of the spot
month to permit automatic netting of swaps that are referenced
contracts with futures contracts that are referenced contracts and,
where appropriate, to recognize as a bona fide hedging position the
offset of certain non-referenced contract swaps with futures that are
referenced contracts.467 Third, Sec. 1.47 provided specific, limited
timeframes (of 30 days or 10 days) for the Commission to determine
whether the position may be classified as bona fide hedging. The
Commission preliminarily believes it should not constrain itself to
such limited timeframes for review of potentially complex and novel
risk-reducing transactions.
—————————————————————————
467 All the exemptions granted by the Commission pursuant to
Sec. 1.47 involving swaps were restricted to recognition of the
futures offset as a bona fide hedging position only outside of the
spot month.
—————————————————————————
Nevertheless, the Commission proposes in Sec. 150.3(e) to provide
guidance to persons seeking exemptive relief. A person that engages in
risk-reducing practices commonly used in the market that the person
believes may not be included in the list of enumerated bona fide
hedging transactions may apply to the Commission for an exemption from
position limits. As proposed, market participants would be guided in
Sec. 150.3(e) first to consult proposed appendix C to part 150 to see
whether their practices fall within a non-exhaustive list of examples
of bona fide hedging positions as defined under proposed Sec. 150.1.
A person engaged in risk-reducing practices that are not enumerated
in the revised definition of bona fide hedging in proposed Sec. 150.1
may use two different avenues to apply to the Commission for relief
from federal position limits: The person may request an interpretative
letter from Commission staff pursuant to Sec. 140.99 468 concerning
the applicability of the bona fide hedging position exemption, or the
person may seek exemptive relief from the Commission under section
4a(a)(7) of the Act.469
—————————————————————————
468 17 CFR 140.99 defines three types of staff letters–
exemptive letters, no-action letters, and interpretative letters–
that differ in scope and effect. An interpretative letter is written
advice or guidance by the staff of a division of the Commission or
its Office of the General Counsel. It binds only the staff of the
division that issued it (or the Office of the General Counsel, as
the case may be), and third-parties may rely upon it as the
interpretation of that staff. See description of CFTC Staff Letters,
available at http://www.cftc.gov/lawregulation/cftcstaffletters/index.htm.
469 See supra discussion of CEA section 4a(a)(7).
—————————————————————————
(5) Previously Granted Risk Management Exemptions
Until about mid-2008, the Commission accepted and approved filings
pursuant to Sec. 1.3(z) and Sec. 1.47 for recognition of transactions
and positions described in such filings as bona fide hedging for
purposes of compliance with Federal position limits. Since then, the
Division of Market Oversight (the “Division”), on behalf of the
Commission, has only considered revisions to previously recognized
filings.470 Prior to the Dodd-Frank Act and pursuant to authority
delegated to it under Sec. 140.97,471 the Division recognized a
broad range of transactions and positions as bona fide hedges based on
facts and representations contained in such filings.472 In seeking
these determinations and exemptions from Federal position limits,
filers would furnish information to demonstrate, among other things,
that the described transactions and positions were economically
appropriate to the reduction of risk exposure attendant to the conduct
and management of a commercial enterprise.473 On this basis, the
Division provided relief to dealers, market makers and “risk
intermediaries” facing not only producers and consumers of commodities
but hedge funds, pension funds and other financial institutions who
lacked the capacity to make or take delivery of, or otherwise handle, a
physical commodity.474 The exemptions granted by the Division were
not limited to futures to offset price risks associated with commodity
index swaps that could be hedged in the component futures contracts.
Filers obtained exemptions for futures transactions used to hedge price
risks from transactions involving options, warrants, certificates of
deposit, structured notes and various other structured products and
hybrid instruments referencing commodities or embedding transactions
linked to the payout or performance of a commodity or basket of
commodities (collectively, “financial products”). In sum, the
Division provided relief to “persons using the futures markets to
manage risks associated with financial investment portfolios” and
granted exemptions from speculative position limits to a broad range of
“trading strategies to reduce financial risks, regardless of whether a
matching transaction ever took place in a cash market for a physical
commodity.” 475 In
[[Page 75740]]
recognizing such trading strategies as bona fide hedges, the Commission
was responding to Congressional direction476 to update its approach
at a time when many sought to encourage what was then thought to be
benign or beneficial financial innovation. In hindsight, the sum of
these determinations may have exceeded what would be appropriate “to
permit producers, purchasers, sellers, middlemen, and users of a
commodity or product derived therefrom to hedge their legitimate
anticipated business needs” and adequate “to prevent unwarranted
price pressures by large hedgers.” 477
—————————————————————————
470 On May 29, 2008, the Commission announced a number of
initiatives to increase transparency of the energy futures markets.
In particular, the Commission would review the trading practices of
index traders in the futures markets. CFTC Press Release 5503-08,
May 29, 2008, available at http://www.cftc.gov/PressRoom/PressReleases/pr5503-08. On June 3, 2008, the Commission announced
policy initiatives aimed at addressing concerns raised at an April
22, 2008 roundtable regarding events affecting the agricultural
futures markets. Among other things, the Commission withdrew
proposed rulemakings that would have increased the Federal
speculative position limits on certain agricultural futures
contracts and created a risk-management hedge exemption from the
Federal speculative position limits for agricultural futures and
options contracts. At the time, Acting Chairman Lukken and
Commissioners Dunn, Sommers and Chilton said, “. . . the Commission
will be cautious and guarded before granting additional exemptions
in this area.” CFTC Press Release 5504-08, June 3, 2008, available
at http://www.cftc.gov/PressRoom/PressReleases/pr5504-08.
471 17 CFR 140.97.
472 Almost all requests pursuant to Sec. 1.47 have been for
“risk-management” exemptions. See generally Risk Management
Exemptions from Speculative Position Limits Approved under
Commission Regulation 1.61, 52 FR 34633, Sep. 14, 1987;
Clarification of Certain Aspects of the Hedging Definition, 52 FR
27195, Jul. 20, 1987. The Commission first approved a request for a
risk-management exemption in 1991. The Commission has also approved
a request by a foreign government to recognize certain positions
associated with a governmental agricultural support program that
would be consistent with the examples of bona fide hedging positions
in proposed appendix B to part 150.
473 Section 1.3(z)(1) includes the language, “economically
appropriate to the reduction of risks in the conduct and management
of a commercial enterprise.” 17 CFR 1.3(z)(1). Section 1.47(b)(2)
includes the language, “economically appropriate to the reduction
of risk exposure attendant to the conduct and management of a
commercial enterprise.” 17 CFR 1.47(b)(2).
474 The Commission notes that both the filings received by the
Commission requesting such exemptions and the responding exemption
letters issued by the Division are confidential in light of section
8 of the Act since, as noted above, the filings included information
that described transactions and positions in order to demonstrate,
among other things, that the transactions and positions were
economically appropriate to the reduction of risk exposure attendant
to the conduct and management of a commercial enterprise, while the
Division’s responding letters included information regarding the
nature of the price risks that the transactions would entail.
475 Staff Report, S. Permanent Subcomm. on Investigations,
“Excessive Speculation in the Wheat Market,” S. Hrg. 111-155 (Jul.
21, 2009) at 13 (“Wheat Report”). The Wheat Report was issued
before the Dodd-Frank Act became law.
476 See generally CFTC Staff Report on Commodity Swap Dealers
& Index Traders with Commission Recommendations (Sep. 2008) at 13-15
(“Index Trading Report”).
477 7 U.S.C. 6a(c)(1).
—————————————————————————
The Commission now proposes a definition of bona fide hedging
position that would apply to all referenced contracts, and proposes to
remove Sec. 1.47.478 The Commission is also proposing in Sec.
150.3(f) that risk-management exemptions granted by the Commission
under Sec. 1.47 shall not apply to swap positions entered into after
the effective date of a final position limits rulemaking, i.e.,
revoking the exemptions for new swap positions.479 This means that
certain transactions and positions (and, by extension, persons party to
such transactions or holding such positions) heretofore exempt from
Federal position limits may be subject to Federal position limits. This
is because some transactions and positions previously characterized as
“risk-management” and recognized as bona fide hedges are inconsistent
with the revised definition of bona fide hedging positions proposed in
this release and the purposes of the Dodd-Frank Act amendments to the
CEA.480 As noted above, some pre-Dodd-Frank Act exemptions recognized
offsets of risks from financial products. But the Commission now
proposes to incorporate the “temporary substitute” test of section
4a(c)(2)(A)(i) of the Act in paragraph (2)(i) of the proposed
definition of bona fide hedging position.481 Financial products are
not substitutes for positions taken or to be taken in a physical
marketing channel. Thus, the offset of financial risks arising from
financial products is inconsistent with the proposed definition of bona
fide hedging for physical commodities. Moreover, the Commission
interprets CEA section 4a(c)(2)(B) as a direction from Congress to
narrow the scope of what constitutes a bona fide hedge.482 Other
things being equal, a narrower definition of bona fide hedging would
logically subject more speculative positions to Federal limits.
—————————————————————————
478 Section 1.3(z), the definition of bona fide hedging
transactions and positions for excluded commodities, was revised
(but retained as amended) by the vacated part 151 Rulemaking.
Section 1.47 of the Commission’s regulations was removed and
reserved by the vacated part 151 Rulemaking. On September 28, 2012,
the District Court for the District of Columbia vacated the part 151
Rulemaking with the exception of the amendments to Sec. 150.2. 887
F. Supp. 2d 259 (D.D.C. 2012). Vacating the part 151 Rulemaking,
with the exception of the amendments to Sec. 150.2, means that as
things stand now, it is as if the Commission had never adopted any
part of the part 151 Rulemaking other than the amendments to Sec.
150.2. That is, the definition of bona fide hedging transactions and
positions in Sec. 1.3(z) remains unchanged, and Sec. 1.47 is still
in effect. As discussed above, the new definition of bona fide
hedging positions in proposed Sec. 150.1 is different from the
changes to Sec. 1.3(z) adopted by the Commission in the vacated
part 151 Rulemaking. See 76 FR 71683-84. The Commission proposes to
delete Sec. 1.47 for several reasons, as discussed above. Proposed
Sec. 150.3(e) would provide guidance for persons seeking non-
enumerated hedging exemptions through filing of a petition under
section 4a(a)(7) of the Act, 7 U.S.C. 6a(a)(7), replacing the
current process, as discussed above, under Sec. 1.3(z)(3) and Sec.
1.47 of the Commission’s regulations.
479 This approach is consistent with the limited exemption to
provide for transition into position limits for persons with
existing Sec. 1.47 exemptions under vacated Sec. 151.9(d) adopted
in the vacated part 151 Rulemaking. See 76 FR 71655-56. This limited
grandfather is similarly designed to limit market disruption.
480 Section 4a(c)(1) of the CEA authorizes the Commission to
define bona fide hedging transactions or positions “consistent with
the purposes of this Act.” 7 U.S.C. 6a(c)(1).
481 Section 4a(c)(2)(A)(i) of the Act provides that the
Commission shall define what constitutes a bona fide hedging
position as a position that represents a substitute for transactions
made or to be made or positions taken or to be taken at a later time
in a physical marketing channel. 7 U.S.C. 6a(c)(2)(A)(i). The
proposed definition of bona fide hedging position requires that, for
a position in a commodity derivative contracts in a physical
contract to be a bona fide hedging position, such position must
represent a substitute for transactions made or to be made or
positions taken or to be taken, at a later time in a physical
marketing channel. See supra discussion of the temporary substitute
test.
482 See discussion above.
—————————————————————————
Many of the Commission’s bona fide hedging exemptions prior to the
Dodd-Frank Act provided relief from Federal speculative position limits
for persons acting as intermediaries in connection with index trading
activities.483 For example, a pension fund enters into a swap to
receive the rate of return on a particular commodity index (such as the
Standard & Poor’s-Goldman Sachs Commodity Index or the Dow Jones-UBS
Commodity Index) with a swap dealer. The pension fund thus has a
synthetic long position in the index. The swap dealer, in turn, must
pay the rate of return on the index to the pension fund, and purchases
commodity futures contracts to hedge its short exposure to the index.
Prior to the Dodd-Frank Act, the swap dealer might have obtained a bona
fide hedge exemption for its position. This would no longer be the
case.
—————————————————————————
483 Index trading activities have emerged as an area of
special concern to both Congress and the Commission. See generally
the Wheat Report and the Index Trading Report. The Commission
continues to consider the concerns of commenters who argue that some
transactions and positions recognized before the Dodd-Frank Act as
bona fide hedging may, in fact, facilitate excessive speculation.
See, e.g., Testimony of Michael W. Masters before the Commodity
Futures Trading Commission, Aug. 5, 2009, available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/hearing080509_masters.pdf; Comment Letter from Better Markets,
Inc., Mar. 28, 2013, available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=34010&SearchText=Better%20Markets. The
speculative position limits that the Commission now proposes do not
directly address these concerns as they relate to commodity index
funds, commodity index speculation and passive investment in the
commodity derivatives markets. The speculative position limits that
the Commission proposes apply only to transactions involving one
commodity or the spread between two commodities (e.g., the purchase
of one delivery month of one commodity against the sale of that same
delivery month of a different commodity). They do not apply to
diversified commodity index contracts involving more than two
commodities. This means that index speculators remain unconstrained
on the size of positions in diversified commodity index contracts
that they can accumulate so long as they can find someone with the
capacity to take the other side of their trades. These commenters
assert that such contracts, which this proposal does not address,
consume liquidity and damage the price discovery function of the
market. Contra Bessembinder et al., “Predatory or Sunshine Trading?
Evidence from Crude Oil Rolls” (working paper, 2012) available at
http://business.nd.edu/uploadedFiles/Faculty_and_Research/Finance/Finance_Seminar_Series/2012%20Fall%20Finance%20Seminar%20Series%20-%20Hank%20Bessembinder%20Paper.pdf.
—————————————————————————
The effect of revoking these exemptions for intermediaries may be
mitigated in part by the absence of class limits in the proposed
rules.484 The
[[Page 75741]]
absence of class limits means that market participants will be able to
net economically equivalent derivatives contracts that are referenced
contracts, i.e., futures against swaps, outside of the spot month,
which would have the effect of reducing the size of a net position,
perhaps below applicable speculative limits, in the case of an
intermediary who enters into multiple swap positions in individual
commodities to replicate a desired commodity index exposure in lieu of
executing a swap on the commodity index.485 Netting would also permit
larger speculative positions in futures alone outside of the spot month
for traders who did not previously have a bona fide hedge exemption,
but who have positions in swaps in the same commodity that would be
netted against futures in the same commodity.486 Declining to impose
class limits might seem to be at cross-purposes with narrowing the
scope of the bona fide hedging definition. However, the Commission is
concerned that class limits could impair liquidity in futures or swaps,
as the case may be. For example, a speculator with a large portfolio of
swaps near a particular class limit would be assumed to have a strong
preference for executing futures transactions in order to maintain a
swaps position below the class limit. If there were many similarly
situated speculators, the market for such swaps could become less
liquid. The absence of class limits should decrease the possibility of
illiquid markets for contracts subject to Federal speculative position
limits. Economically equivalent swaps and futures contracts outside of
the spot month are close substitutes for each other. The absence of
class limits should allow greater integration between the swaps and
futures markets for contracts subject to Federal speculative position
limits, and should also provide market participants with more
flexibility when both hedging and speculating.
—————————————————————————
484 In the vacated part 151 Rulemaking Proposal, the
Commission proposed to create two classes of contracts for non-spot
month limits: (1) Futures and options on futures contracts and (2)
swaps. The proposed part 151 rule would have applied single-month
and all-months-combined position limits to each class separately.
The aggregate position limits across contract classes would have
been in addition to the position limits within each contract class.
The class limits were designed to diminish the possibility that a
trader could have market power as a result of a concentration in any
one submarket and to prevent a trader that had a flat net aggregate
position in futures and swap from establishing extraordinarily large
offsetting positions. 76 FR at 71642. In response to comments
received on the proposed part 151 rule, the Commission determined to
eliminate class limits from the final rule. This is because the
Commission believed that comments regarding the ability of market
participants to net swaps and futures positions that are
economically equivalent had merit. The Commission believed that
concerns regarding the potential for market abuses through the use
of futures and swaps positions could be addressed adequately, for
the time being, by the Commission’s large trader surveillance
program. The Commission stated in the vacated part 151 Rulemaking
that it would closely monitor speculative positions in Referenced
Contracts and may revisit this issue as appropriate. 76 FR 71643.
The Commission has determined to omit class limits from the rules
proposed in this release for the same reasons that it eliminated
class limits in the vacated part 151 Rulemaking.
485 Netting of commodity index contracts with referenced
contracts would not be permitted because a commodity index contract
is not a substitute for a position taken or to be taken in a
physical marketing channel.
486 For example, a swap intermediary seeking to manage price
risk on its books from serving as a counterparty to swap clients in
commodity index swap contracts or commodity swap contracts could
establish a portfolio of long futures positions in the commodities
in the index or the commodity underlying the swap above applicable
speculative limits if it had obtained a risk-management exemption.
If the Commission adopts this proposal, the intermediary would not
be able to hedge above the limits pursuant to the exemption, but
could net economically equivalent contracts, which would have the
effect of reducing the size of the position below applicable
speculative limits.
—————————————————————————
c. Proposed Recordkeeping Requirements
Proposed Sec. 150.3(g) specifies recordkeeping requirements for
persons who claim any exemption set forth in proposed Sec. 150.3.
Persons claiming exemptions under proposed Sec. 150.3 must maintain
complete books and records concerning all details of their related
cash, forward, futures, options and swap positions and
transactions.487 Furthermore, such persons must make such books and
records available to the Commission upon request under proposed Sec.
150.3(h), which would preserve the “special call” rule set forth in
current Sec. 150.3(e). This “special call” rule sets forth that any
person claiming an exemption under Sec. 150.3 must, upon request,
provide to the Commission such information as specified in the call
relating to the positions owned or controlled by that person; trading
done pursuant to the claimed exemption; the commodity derivative
contracts or cash market positions which support the claim of
exemption; and the relevant business relationships supporting a claim
of exemption.488
—————————————————————————
487 Such positions and transactions include anticipated
requirements, production and royalties, contracts for services, cash
commodity products and by-products, and cross-commodity hedges.
488 In order to capture information relating to swaps
positions, the term “futures, options” in 17 CFR 150.3(e) would be
replaced in proposed Sec. 150.3(g) with the broader term
“commodity derivative contracts” (defined in proposed Sec.
150.1).
—————————————————————————
The proposed rules concerning detailed recordkeeping and special
calls would help to ensure that any person who claims any exemption set
forth in Sec. 150.3 can demonstrate a legitimate purpose for doing so.
4. Part 19–Reports by Persons Holding Bona Fide Hedge Positions
Pursuant to Sec. 150.1 of This Chapter and by Merchants and Dealers in
Cotton
i. Current Part 19
The market and large trader reporting rules are contained in parts
15 through 21 of the Commission’s regulations.489 Collectively, these
reporting rules effectuate the Commission’s market and financial
surveillance programs by providing information concerning the size and
composition of the commodity futures, options, and swaps markets,
thereby permitting the Commission to monitor and enforce the
speculative position limits that have been established, among other
regulatory goals. The Commission’s reporting rules are implemented
pursuant to the authority of CEA sections 4g and 4i, among other CEA
sections. Section 4g of the Act imposes reporting and recordkeeping
obligations on registered entities, and obligates FCMs, introducing
brokers, floor brokers, and floor traders to file such reports as the
Commission may require on proprietary and customer positions executed
on any board of trade.490 Section 4i of the Act requires the filing
of such reports as the Commission may require when positions equal or
exceed Commission-set levels.491
—————————————————————————
489 17 CFR parts 15-21.
490 See CEA section 4g(a); 7 U.S.C. 6g(a).
491 See CEA section 4i; 7 U.S.C. 6i.
—————————————————————————
Current part 19 of the Commission’s regulations sets forth
reporting requirements for persons holding or controlling reportable
futures and option positions which constitute bona fide hedge positions
as defined in Sec. 1.3(z) and for merchants and dealers in cotton
holding or controlling reportable positions for future delivery in
cotton.492 In the several markets with federal speculative position
limits–namely those for grains, the soy complex, and cotton–hedgers
that hold positions in excess of those limits must file a monthly
report pursuant to part 19 on CFTC Form 204: Statement of Cash
Positions in Grains,493 which includes the soy complex, and CFTC Form
304 Report: Statement of Cash Positions in Cotton.494 These monthly
reports, collectively referred to as the Commission’s “series ’04
reports,” must show the trader’s positions in the cash market and are
used by the Commission to determine whether a trader has sufficient
cash positions that justify futures and option positions above the
speculative limits.495
—————————————————————————
492 See 17 CFR part 19. Current part 19 cross-references a
provision of the definition of reportable position in 17 CFR
15.00(p)(2). As discussed below, that provision would be
incorporated into proposed Sec. 19.00(a).
493 Current CFTC Form 204: Statement of Cash Positions in
Grains is available at http://www.cftc.gov/idc/groups/public/@forms/documents/file/cftcform204.pdf.
494 Current CFTC Form 304 Report: Statement of Cash Positions
in Cotton is available at http://www.cftc.gov/idc/groups/public/@forms/documents/file/cftcform304.pdf.
495 In addition, in the cotton market, merchants and dealers
file a weekly CFTC Form 304 Report of their unfixed-price cash
positions, which is used to publish a weekly Cotton On-call report,
a service to the cotton industry. The Cotton On-Call Report shows
how many unfixed-price cash cotton purchases and sales are
outstanding against each cotton futures month.
—————————————————————————
ii. Proposed Amendments to Part 19
The Commission proposes to amend part 19 so that it conforms with
the Commission’s proposed changes to part
[[Page 75742]]
150. First, the Commission proposes to amend part 19 by adding new and
modified cross-references to proposed part 150, including the new
definition of bona fide hedging position in proposed Sec. 150.1.
Second, the Commission proposes to amend Sec. 19.00(a) by extending
reporting requirements to any person claiming any exemption from
federal position limits pursuant to proposed Sec. 150.3. The
Commission proposes to add three new series ’04 reporting forms to
effectuate these additional reporting requirements. Third, the
Commission proposes to update the manner of part 19 reporting. Lastly,
the Commission proposes to update both the type of data that would be
required in series ’04 reports, as well as the time allotted for filing
such reports.
For purposes of clarity and simplicity, the Commission seeks to
retain the current organization of grouping many reporting
requirements, including those related to claimed exemptions from the
federal position limits, within parts 15-21 of the Commission’s
regulations. The Commission notes this is a change from the
organization of vacated Sec. 151.5, which included both exemptions and
related reporting requirements within a single section.
a. Amended Cross-References
As discussed above, the Commission has proposed to replace the
definition of bona fide hedging transaction found in Sec. 1.3(z) with
a new proposed definition of bona fide hedging position in proposed
Sec. 150.1. Therefore, proposed part 19 would replace cross-references
to Sec. 1.3(z) with cross-references to the new definition of bona
fide hedging positions in proposed Sec. 150.1.
Proposed part 19 will be expanded to include reporting requirements
for positions in swaps, in addition to futures and options positions,
for any part of which a person relies on an exemption. Therefore,
positions in “commodity derivative contracts,” as defined in proposed
Sec. 150.1, would replace “futures and option positions” throughout
amended part 19 as shorthand for any futures, option, or swap contract
in a commodity (other than a security futures product as defined in CEA
section 1a(45)).496 This amendment would harmonize the reporting
requirements of part 19 with proposed amendments to part 150 that
encompass swap transactions.
—————————————————————————
496 See discussion above.
—————————————————————————
Proposed Sec. 19.00(a) would eliminate the cross-reference to the
definition of reportable position in Sec. 15.00(p)(2). In this regard,
the current reportable position definition essentially identifies
futures and option positions in excess of speculative position limits.
Proposed Sec. 19.00(a) simply makes clear that the reporting
requirement applies to commodity derivative contract positions
(including swaps) that exceed speculative position limits, as discussed
below.
b. List of Persons Who Must File Series ’04 Reports Extended To Include
Any Person Claiming an Exemption Under Proposed Sec. 150.3
The reporting requirements of current part 19 apply only to persons
holding bona fide hedge positions and merchants and dealers in cotton
holding or controlling reportable positions for future delivery in
cotton.497 The Commission proposes to extend the reach of part 19 by
requiring all persons who wish to avail themselves of any exemption
from federal position limits under proposed Sec. 150.3 to file
applicable series ’04 reports.498 Collection of this information
would facilitate the Commission’s surveillance program with respect to
detecting and deterring trading activity that may tend to cause sudden
or unreasonable fluctuations or unwarranted changes in the prices of
the referenced contracts and their underlying commodities. By
broadening the scope of persons who must file series ’04 reports, the
Commission seeks to ensure that any person who claims any exemption
from federal speculative position limits can demonstrate a legitimate
purpose for doing so. The list of positions set forth in proposed Sec.
150.3 that are eligible for exemption from the federal position
includes, but is not limited to, bona fide hedging positions (including
pass-through swaps and anticipatory bona fide hedge positions),
qualifying spot month positions in cash-settled referenced contracts,
and qualifying non-enumerated risk-reducing transactions.
—————————————————————————
497 See 17 CFR part 19. Current part 19 cross-references the
definition of reportable position in 17 CFR 15.00(p).
498 Furthermore, anyone exceeding the federal limits who has
received a special call must file a series ’04 form.
—————————————————————————
Series ’04 reports currently refers to Form 204 and Form 304, which
are listed in current Sec. 15.02.499 The Commission proposes to add
three new series ’04 reporting forms to effectuate the expanded
reporting requirements of part 19. The Commission will avoid using any
form numbers with “404” to avoid confusion with the part 151
Rulemaking.500 Proposed Form 504 would be added for use by persons
claiming the conditional spot month limit exemption pursuant to
proposed Sec. 150.3(c).501 Proposed Form 604 would be added for use
by persons claiming a bona fide hedge exemption for either of two
specific pass-through swap position types, as discussed further
below.502 Proposed Form 704 would be added for use by persons
claiming a bona fide hedge exemption for certain anticipatory bona fide
hedging positions.503
—————————————————————————
499 17 CFR 15.02.
500 Forms 404, 404A and 404S were required under provisions of
vacated part 151.
501 See supra discussion of proposed Sec. 150.3(c).
502 Proposed Form 604 would replace Form 404S (as contemplated
in vacated part 151).
503 The updated definition of bona fide hedging in proposed
Sec. 150.1 incorporates several specific types of anticipatory
transactions: unfilled anticipated requirements, unsold anticipated
production, anticipated royalties, anticipated services contract
payments or receipts, and anticipatory cross-commodity hedges. See,
paragraphs (3)(iii), (4)(i), (iii), and (iv), and (5), respectively,
of the Commission’s amended definition of bona fide hedging
transactions in proposed Sec. 150.1 as discussed above.
—————————————————————————
c. Manner of Reporting
(1) Excluding Certain Source Commodities, Products or Byproducts of the
Cash Commodity Hedged
For purposes of reporting cash market positions under current part
19, the Commission historically has allowed a reporting trader to
“exclude certain products or byproducts in determining his cash
positions for bona fide hedging” if it is “the regular business
practice of the reporting trader” to do so.504 The Commission has
determined to clarify the meaning of “economically appropriate” in
light of this reporting exclusion of certain cash positions.505 In
order for a position to be economically appropriate to the reduction of
risks in the conduct and management of a commercial enterprise, the
enterprise generally should take into account all inventory or products
that the enterprise owns or controls, or has contracted for purchase or
sale at a fixed price. For example, in line with its historical
approach to the reporting exclusion, the Commission does not believe
that it would be economically appropriate to exclude large quantities
of a source commodity held in inventory when an enterprise is
calculating its value at risk to a source commodity and it intends to
establish a long derivatives position as
[[Page 75743]]
a hedge of unfilled anticipated requirements. Therefore, under proposed
Sec. 19.00(b)(1), a source commodity itself can only be excluded from
a calculation of a cash position if the amount is de minimis,
impractical to account for, and/or on the opposite side of the market
from the market participant’s hedging position.506
—————————————————————————
504 See 17 CFR 19.00(b)(1) (providing that “[i]f the regular
business practice of the reporting trader is to exclude certain
products or byproducts in determining his cash position for bona
fide hedging . . ., the same shall be excluded in the report”).
505 See supra discussion of the “economically appropriate
test” as it relates to the definition of bona fide hedging
position.
506 Proposed Sec. 19.00(b)(1) adds a caveat to the
alternative manner of reporting: when reporting for the cash
commodity of soybeans, soybean oil, or soybean meal, the reporting
person shall show the cash positions of soybeans, soybean oil and
soybean meal. This proposed provision for the soybean complex is
included in the current instructions for preparing Form 204.
—————————————————————————
Originally, the Commission intended for the optional part 19
reporting exclusion to cover only cash positions that were not capable
of being delivered under the terms of any derivative contract.507 The
Commission differentiated between “products and byproducts” of a
commodity and the underlying commodity itself, the former capable of
exclusion from part 19 reporting under normal business practices due to
the absence of any derivative contract in such product or
byproduct.508 This intention ultimately evolved to allow cross-
commodity hedging of products and byproducts of a commodity that were
not necessarily deliverable under the terms of any derivative
contract.509 The instructions to current Form 204 go a step further
than current Sec. 19.00(b)(1) by allowing for a reporting trader to
exclude “certain source commodities, products, or byproducts in
determining [ ] cash positions for bona fide hedging.” (Emphasis
added.)
—————————————————————————
507 43 FR 45825, 45827, Oct. 4, 1978 (explaining that the
allowance for eggs not kept in cold storage to be excluded from
reporting a cash position in eggs under part 19 “was appropriate
when the only futures contract being traded in fresh shell eggs
required delivery from cold storage warehouses.”).
508 Prior to the Commission revising the part 19 reporting
exclusion for eggs, see id., the exclusion allowed “eggs not in
cold storage or certain egg products” not to be reported as a cash
position. 26 FR 2971, Apr. 7, 1961 (emphasis added). Additionally,
the title to the revised exclusion reads: “Excluding products or
byproducts of the cash commodity hedged.” See 43 FR 45825, 45828,
Oct. 4, 1978. So, in addition to a commodity itself that was not
deliverable under any derivative contract, the Commission also
recognized a separate class of “products and byproducts” that
resulted from the processing of a commodity that it did not believe
at the time was capable of being hedged by any derivative contract
for purposes of a bona fide hedge.
509 See 42 FR 42748, Aug. 24, 1977. Cross-commodity hedging is
discussed as an enumerated hedge, below.
—————————————————————————
The Commission’s proposed clarification of the Sec. 19.00(b)(1)
reporting exclusion would prevent the definition of bona fide hedging
positions in proposed Sec. 150.1 from being swallowed by this
reporting rule. For it would not be economically appropriate behavior
for a person who is, for example, long derivative contracts to exclude
inventory when calculating unfilled anticipated requirements. Such
behavior would call into question whether an offset to unfilled
anticipated requirements is, in fact, a bona fide hedging position,
since such inventory would fill the requirement. As such, a trader can
only underreport cash market activities on the opposite side of the
market from her hedging position as a regular business practice, unless
the unreported inventory position is de minimis or impractical to
account for. By way of example, the alternative manner of reporting in
proposed Sec. 19.00(b)(1) would permit a person who has a cash
inventory of 5 million bushels of wheat, and is short 5 million bushels
worth of commodity derivative contracts, to underreport additional cash
inventories held in small silos in disparate locations that are
administratively difficult to count. This person could instead opt to
calculate and report these hard-to-count inventories and establish
additional short positions in commodity derivative contracts as a bona
fide hedge against such additional inventories.
(2) Cross-Commodity Hedges
Proposed Sec. 19.00(b)(2) sets forth instructions, which are
consistent with the provisions in the current section, for reporting a
cash position in a commodity that is different from the commodity
underlying the futures contract used for hedging.510 A person who is
unsure of whether a commodity may serve as the basis of a cross-
commodity hedge should refer to the deliverable commodities listed by
the relevant DCM under the terms of a particular core referenced
futures contract. Persons who wish to avail themselves of cross-
commodity hedges are required to file an appropriate series ’04
form.511
—————————————————————————
510 Proposed Sec. 19.00(b)(2) would add the term commodity
derivative contracts (as defined in proposed Sec. 150.1). The
proposed definition of cross-commodity hedge in proposed Sec. 150.1
is discussed above.
511 Vacated Sec. 151.5(g) would have required the filing of a
Form 404, 404A, or 404S by persons availing themselves of cross-
commodity hedges.
—————————————————————————
Under vacated Sec. 151.5(g), traders engaged in hedging commercial
activity (or hedging swaps that in turn hedge commercial activity) that
did not involve the same quantity or commodity as the quantity or
commodity associated with positions in referenced contracts that are
used to hedge would have been obligated to submit a description of the
conversion methodology each time they cross-hedged.512 In lieu of
that, the Commission proposes to instead maintain the special call
status concerning such information as set forth in current Sec.
19.00(b)(3).513 Furthermore, since proposed Sec. 19.00(b)(3) would
maintain the requirement that cross-hedged positions be shown both in
terms of the equivalent amount of the commodity underlying the
commodity derivative contract used for hedging and in terms of the
actual cash commodity (as provided for on the appropriate series ’04
form), the Commission will be able to determine the hedge ratio used
merely by comparing the reported positions. Thus, the Commission will
be positioned to review whether a hedge ratio appears reasonable in
comparison to, for example, other similarly situated traders, without
requiring reporting of the conversion methodology.
—————————————————————————
512 See 76 FR at 71692.
513 See discussion below.
—————————————————————————
(3) Standards and Conversion Factors
Proposed Sec. 19.00(b)(3) maintains the requirement that standards
and conversion factors used in computing cash positions for reporting
purposes must be made available to the Commission upon request.
Proposed Sec. 19.00(b)(3) would clarify that such information would
include hedge ratios used to convert the actual cash commodity to the
equivalent amount of the commodity underlying the commodity derivative
contract used for hedging, and an explanation of the methodology used
for determining the hedge ratio.
(4) Examples of Completed ’04 Forms
To assist filers in completing Forms 204, 304, 504, 604 and 704,
illustrative examples are provided in appendix A to part 19, adjacent
to the blank forms and instructions. Once finalized, filers would be
able to contact Commission staff in the Office of Data and Technology
(ODT) and/or surveillance staff in the Division of Market Oversight for
additional guidance.
d. Information Required and Timing
Proposed Sec. 19.01(b)(3) would require series `04 reports to be
transmitted using the format, coding structure, and electronic data
transmission procedures approved in writing by the Commission or its
designee.514
—————————————————————————
514 For example, the Commission is considering requiring that
series ’04 reports should be sent to the Commission via FTP, unless
otherwise specifically authorized by the Commission or its designee.
Prior to submitting series ’04 reports, persons would contact the
CFTC at (312) 596-0700 to obtain the CFTC trader identification code
required by such reports. Further instructions on submitting ’04
reports may be found at http://www.cftc.gov/Forms/index.htm. If
submission through FTP is impractical, the reporting trader would
contact the Commission at (312) 596-0700 for further instruction.
CFTC Form 204 reports with respect to transactions in wheat,
corn, oats, soybeans, soybean meal and soybean oil would no longer
be sent to the Commission’s office in Chicago, IL.
Similarly, CFTC Form 304 reports with respect to transactions in
cotton would no longer be sent to the Commission’s office in New
York, NY.
—————————————————————————
[[Page 75744]]
(1) Bona Fide Hedgers and Cotton Merchants and Dealers
Current Sec. 19.01(a) sets forth the data that must be provided by
bona fide hedgers (on Form 204) and by merchants and dealers in cotton
(on Form 304).515 The Commission proposes to continue using Forms 204
and 304, which will feature only minor changes to the types of data to
be reported.516 To accommodate open price pairs, proposed Sec.
19.01(a)(3) would remove the modifier “fixed price” from “fixed
price cash position” and would add a specific request for data
concerning open price contracts. The Commission would maintain
additional reporting requirements for cotton but will incorporate the
monthly reporting, including the granularity of equity, certificated
and non-certificated cotton stocks, on Form 204. Weekly reporting for
cotton will be retained as a separate report made on Form 304 for the
collection of data required by the Commission to publish its weekly
public cotton “on call” report on www.cftc.gov.
—————————————————————————
515 Vacated Sec. 151.5 would have set forth the application
procedure for bona fide hedgers and counterparties to bona fide
hedging swap transactions that seek an exemption from the
Commission-set Federal position limits for Referenced Contracts.
Under vacated Sec. 151.5, had a bona fide hedger sought to claim an
exemption from position limits because of cash market activities,
then the hedger would have submitted a Form 404 filing pursuant to
vacated Sec. 151.5(b). The Form 404 filing would have been
submitted when the bona fide hedger exceeded the applicable position
limit and claimed an exemption or when its hedging needs increased.
Similarly, parties to bona fide hedging swap transactions would have
been required to submit a Form 404S filing to qualify for a hedging
exemption, which would also have been submitted when the bona fide
hedger exceeded the applicable position limit and claimed an
exemption or when its hedging needs increased.
516 The list of data required for persons filing on Forms 204
and 304 would be relocated from current Sec. 19.01(a) to proposed
Sec. 19.01(a)(3).
—————————————————————————
Proposed Sec. 19.01(b) would maintain the requirement that reports
on Form 204 be submitted to the Commission on a monthly basis, as of
the close of business on the last Friday of the month.517
Accordingly, commercial firms would measure their respective cash
positions on one day a month, as they currently do for Form 204, and
submit a monthly report, as currently provided in Sec. 19.01. Proposed
Sec. 19.02 provides that Form 304, but not Form 204, must be filed
weekly to provide data for the Commission’s weekly cotton “on call”
report. The Commission would continue to utilize its special call
authority in addition to the regular reporting on ’04 forms to ensure
that it has sufficient information.
—————————————————————————
517 Compare proposed Sec. 19.01(b) with 17 CFR 19.01(b).
Additionally, compare proposed Sec. 19.01(b) with vacated Sec.
151.5(c) which would have required that any person holding a
derivatives position in excess of a position limit record and
ultimately report information about such person’s cash positions in
the relevant commodity for each day that its derivatives position
exceeds the applicable position limit.
—————————————————————————
(2) Conditional Spot-Month Limit Exemption
Proposed Sec. 19.01(a)(1) would require persons availing
themselves of the conditional spot month limit exemption (pursuant to
proposed Sec. 150.3(c)) to report certain detailed information
concerning their cash market activities for any commodity specially
designated by the Commission for reporting under Sec. 19.03 of this
part. While traders who avail themselves of this exemption could not
directly influence particular settlement prices by trading in the
physical-delivery referenced contract, the Commission remains concerned
about such traders’ activities in the underlying cash commodity.
Accordingly, proposed Sec. 19.01(b) would require that persons
claiming a conditional spot month limit exemption must report on new
Form 504 daily, by 9 a.m. Eastern Time on the next business day, for
each day that a person is over the spot month limit in certain special
commodity contracts specified by the Commission.518 The scope of
reporting–purchase and sales contracts through the delivery area for
the core referenced futures contract and inventory in the delivery
area–differs from the scope of reporting for bona fide hedgers, since
the person relying on the conditional spot month limit exemption may
not be hedging any position.
—————————————————————————
518 Additionally, data under this provision may be required by
way of special call, in addition to special commodity reporting.
—————————————————————————
Initially, the Commission would require reporting on new Form 504
for conditional spot month limit exemptions in the natural gas
commodity derivative contracts only. Based on its experience in
surveillance of natural gas commodity derivative contracts, the
Commission believes that enhanced reporting is warranted.519 The
Commission would wait to impose similar reporting requirements for
persons claiming conditional spot month limit exemptions in other
commodity derivative contracts until the Commission gains additional
experience with the limits in proposed Sec. 150.2. In this regard, the
Commission will closely monitor the reporting associated with
conditional spot month limit exemptions in natural gas and may require
reporting on Form 504 for other commodity derivative contracts in the
future in response to market developments and to facilitate
surveillance.520
—————————————————————————
519 The Commission has observed dramatic instances of
disruptive trading practices in the natural gas markets. See United
States CFTC v. Amaranth Advisors, LLC, 2009 U.S. Dist. LEXIS 101406
(S.D.N.Y. Aug. 12, 2009). The Commission endeavors to balance the
cost of similar enhanced reporting for the other 27 commodities
against its experience with observing disruptive trading practices.
520 See proposed Sec. 19.03.
—————————————————————————
(3) Pass-Through Swap Exemption
Under the definition of bona fide hedging position in proposed
Sec. 150.1, a person who uses a swap to reduce risks attendant to a
position that qualifies as a bona fide hedging position may pass-
through those bona fides to the counterparty, even if the person’s swap
position is not in excess of a position limit.521 As such, positions
in commodity derivative contracts that reduce the risk of pass-through
swaps would qualify as bona fide hedging positions.
—————————————————————————
521 See supra discussion of the proposed definition of bona
fide hedging position.
—————————————————————————
Proposed Sec. 19.01(a)(2) would require a person relying on the
pass-through swap exemption who holds either of two position types to
file a report with the Commission on new Form 604. The first type of
position is a swap executed opposite a bona fide hedger that is not a
referenced contract and for which the risk is offset with referenced
contracts. The second type of position is a cash-settled swap executed
opposite a bona fide hedger that is offset with physical-delivery
referenced contracts held into a spot month, or, vice versa, a
physical-delivery swap executed opposite a bona fide hedger that is
offset with cash-settled referenced contracts held into a spot month.
These reports on Form 604 would explain hedgers’ needs for large
referenced contract positions and would give the Commission the ability
to verify the positions were a bona fide hedge, with heightened daily
surveillance of spot month offsets. Persons holding any type of pass-
through swap position other than the two described above would report
on Form 204.522
—————————————————————————
522 Persons holding pass-through swap positions that are
offset with referenced contracts outside the spot month (whether
such contracts are for physical delivery or are cash-settled) need
not report on Form 604 because swap positions will be netted with
referenced contract positions outside the spot month pursuant to
proposed Sec. 150.2(b).
—————————————————————————
[[Page 75745]]
(A) Non-Referenced Contract Swap Offset
Proposed Sec. 19.01(a)(2)(i) lists the types of data that a person
who executes a pass-through swap that is not a referenced contract and
for which the risk is offset with referenced contracts must report on
new Form 604. Such data requirements include details concerning the
non-referenced contract in terms of commodity reference price,523
notional quantity, gross long or short position in terms of futures-
equivalents in the core referenced futures contract, and gross long or
short position in the referenced contract used to offset risk.524
Under proposed Sec. 19.01(b), persons holding a non-referenced
contract swap offset would submit reports to the Commission on a
monthly basis, as of the close of business of the last Friday of the
month. This data collection would permit staff to identify offsets of
non-referenced-contract pass-through swaps on an ongoing basis for
further analysis. The Commission believes collection of this data will
be less burdensome on reporting entities than complying with special
calls.
—————————————————————————
523 As defined in 17 CFR 20.1, a commodity reference price is
the price series used by the parties to a swap or swaption to
determine payments made, exchanged, or accrued under the terms of
that swap or swaption.”
524 In contrast to vacated Sec. 151.5(f) and (g), proposed
Sec. 19.01(a)(2)(i) would not require the person to submit a
description of the conversion methodology each time he or she cross-
hedged.
—————————————————————————
(B) Spot Month Swap Offset
Under proposed Sec. 150.2(a), a trader in the spot month may not
net across physical-delivery and cash-settled contracts for the purpose
of complying with federal position limits.525 If a person executes a
cash-settled pass-through swap that is offset with physical-delivery
contracts held into a spot month (or vice versa), then, pursuant to
proposed Sec. 19.01(a)(2)(ii), that person must report additional
information concerning the swap and offsetting referenced contract
position on new Form 604. A person need not file a Form 604 if he or
she executes a cash-settled pass-through swap that is offset with cash-
settled referenced contracts, or, vice versa, a physical delivery pass-
through swap offset with physical delivery referenced contracts.526
Pursuant to proposed Sec. 19.01(b), a person holding a spot month swap
offset would need to file on Form 604 as of the close of business on
each day during a spot month, and not later than 9 a.m. Eastern Time on
the next business day following the date of the report. The Commission
notes that pass-through swap offsets would not be permitted during the
lesser of the last five days of trading or the time period for the spot
month. However, the Commission remains concerned that a trader could
hold an extraordinarily large position early in the spot month in the
physical-delivery contract along with an offsetting short position in a
cash-settled contract, which may disrupt the price discovery function
of the underlying physical delivery core referenced futures contract.
Hence, the Commission proposes to introduce this new daily reporting
requirement within the spot month to identify and monitor such
offsetting positions.
—————————————————————————
525 See supra discussion of proposed Sec. 150.2(a).
526 To provide clarity in filings, a person may report cash-
settled referenced contracts used for bona fide hedging in a
separate filing from physical-delivery referenced contracts used for
bona fide hedging.
—————————————————————————
5. Section 150.7–Reporting Requirements for Anticipatory Hedging
Positions
For reasons discussed above, the revised definition of bona fide
hedging in proposed Sec. 150.1 incorporates hedges of five specific
types of anticipated transactions: unfilled anticipated requirements,
unsold anticipated production, anticipated royalties, anticipated
services contract payments or receipts, and anticipatory cross-
hedges.527 The Commission proposes reporting requirements in new
Sec. 150.7 for traders seeking an exemption from position limits for
any of these five enumerated anticipated hedging transactions. Proposed
Sec. 150.7 would build on, and replace, the special reporting
requirements for hedging of unsold anticipated production and unfilled
anticipated requirements in current Sec. 1.48.528
—————————————————————————
527 See paragraphs (3)(iii), (4)(i), (iii), and (iv), and (5),
respectively, of the Commission’s amended definition of bona fide
hedging transactions in proposed Sec. 150.1 as discussed above.
528 See 17 CFR 1.48. See also definition of bona fide hedging
transactions in current 17 CFR 1.3(z)(2)(i)(B) and (ii)(C),
respectively.
—————————————————————————
i. Current Sec. 1.48
Current Sec. 1.48 provides a procedure for persons to file for
bona fide hedging exemptions for anticipated production or unfilled
requirements when that person has not covered the anticipatory need
with fixed-price commitments to sell a commodity, or inventory or
fixed-price commitments to purchase a commodity. The Commission has
long been concerned that distinguishing between what is the reduction
of risk arising from anticipatory needs, and what is speculation, may
be exceedingly difficult if anticipatory transactions are not well
defined. Therefore, for more than fifty years, the position limit rules
have set discrete reporting requirements in Sec. 1.48 for persons
wishing to avail themselves of certain anticipatory bona fide hedging
position exemptions.529 When first promulgated in 1956, Sec. 1.48
set forth reporting requirements for persons hedging anticipated
requirements for processing or manufacturing.530 In 1977, Sec. 1.48
was amended to include similar reporting requirements for a second type
of anticipatory hedge transaction: unsold anticipated production.531
Thereafter, the Commission did not substantively amend Sec. 1.48 until
it adopted a new position limits regime in 2011.532
—————————————————————————
529 See Hedging Anticipated Requirements for Processing or
Manufacturing under Section 4a(3) of the Commodity Exchange Act, 21
FR 6913, Sep. 12, 1956.
530 Id. The statutory definition also provided an anticipatory
production hedge for twelve months agricultural production. 7 U.S.C.
6a(3)(A) (1940) (1970). The statutory definition was deleted in
1974, as discussed above in the definition of bona fide hedging
position.
531 See Definition of Bona Fide Hedging Requirements and
Related Reporting Requirements, 42 FR 42748, Aug. 24, 1977. The
Commission stated at that time that this amended reporting
requirement was intended to conform Sec. 1.48 to the updated
definition of bona fide hedging in Sec. 1.3(z), and to limit the
potential for market disruption. Id. at 42750.
532 See generally 76 FR 71626, November 18, 2011. Prior to
compliance dates, the rule was vacated, as discussed below.
—————————————————————————
In January 2011, the Commission published a notice of proposed
rulemaking to replace existing part 150, in its entirety, with a new
federal position limits rules regime in the form of new part 151.533
Proposed Sec. 151.5 would have established exemptions from position
limits for bona fide hedging transactions or positions in exempt and
agricultural commodities.534 The referenced contracts subject to the
proposed position limit framework would have been subject to the bona
fide hedge provisions of proposed Sec. 151.5 and would have no longer
been subject to the definition of bona fide hedging transactions in
Sec. 1.3(z), which would have been retained only for excluded
commodities.535 Proposed Sec. 151.5(c) specified reporting and
approval requirements for traders seeking an anticipatory hedge
exemption, incorporating the current requirements of Sec. 1.48 (and
thereby rendering Sec. 1.48
[[Page 75746]]
duplicative).536 However, in an Order dated September 28, 2012, the
United States District Court for the District of Columbia vacated part
151.537 The District Court decision had the effect of reinstating
Sec. Sec. 1.3(z) and 1.48.538 Therefore, Sec. Sec. 1.3(z) and 1.48
continue to apply as if part 151 had not been finally adopted by the
Commission.
—————————————————————————
533 Proposed Rule, 76 FR 4752, Jan. 26, 2011. The final
rulemaking for new Part 151 required DCMs to comply with Part 150
until such time that the Commission replaces Part 150 with the new
Part 151. See 76 FR 71632.
534 76 FR 71643.
535 76 FR 71644.
536 Id. This rulemaking would have removed and reserved Sec.
1.48.
537 See 887 F. Supp. 2d 259 (D.D.C. 2012).
538 See Georgetown Univ. Hosp. v. Bowen, 821 F.2d 750, 757
(D.C. Cir. 1987) (“This circuit has previously held that the effect
of invalidating an agency rule is to `reinstate the rules previously
in force.’ ”).
—————————————————————————
ii. Proposed Sec. 150.7
a. Reporting Requirements for Anticipatory Hedging Positions
The Commission’s revised definition of bona fide hedging in
proposed Sec. 150.1 would enumerate two new types of anticipatory bona
hedging positions. Two existing types of anticipatory hedges would be
carried forward from the existing definition of bona fide hedging in
current Sec. 1.3(z): hedges of unfilled anticipated requirements and
hedges of unsold anticipated production, as well as anticipatory cross-
commodity hedges of such requirements or production.539 Proposed
Sec. 150.1 would expand the list of enumerated anticipatory bona fide
hedging positions to include hedges of anticipated royalties and hedges
of anticipated services contract payments or receipts, as well as
anticipatory cross-commodity hedges of such contracts.540 As
discussed above, Sec. 1.48 has long required special reporting for
hedges of unfilled anticipated requirements and hedges of unsold
anticipated production because the Commission remains concerned about
distinguishing between anticipatory reduction of risk and speculation.
Such concerns apply equally to any position undertaken to reduce the
risk of anticipated transactions. Hence, the Commission proposes to
extend the special reporting requirements in proposed Sec. 150.7 for
all types of enumerated anticipatory hedges that appear in the
definition of bona fide hedging positions in proposed Sec. 150.1.
—————————————————————————
539 See current definition of bona fide hedging transactions
at 17 CFR 1.3(z)(2)(i)(B) and (ii)(C), respectively. Cross-commodity
hedges are permitted under 17 CFR 1.3(z)(2)(iv). Compare with
paragraphs (3)(iii) and (4)(i), respectively, of the definition of
bona fide hedging positions in proposed Sec. 150.1, discussed
above.
540 See sections (4)(iii) and (iv) and (5), respectively, of
the definition of bona fide hedging positions in proposed Sec.
150.1, discussed above.
—————————————————————————
For purposes of simplicity, the proposed special reporting
requirements for anticipatory hedges would be placed within the
Commission’s position limits regime in part 150, and alongside the
Commission’s updated definition of bona fide hedging positions in
proposed Sec. 150.1. Thus, the Commission is proposing to delete the
reporting requirements for anticipatory hedges in current Sec. 1.48
because that section is duplicative.
b. New Form 704
The Commission proposes to add a new series ’04 reporting form,
Form 704, to effectuate these additional and updated reporting
requirements for anticipatory hedges. Persons wishing to avail
themselves of an exemption for any of the anticipatory hedging
transactions enumerated in the updated definition of bona fide hedging
in proposed Sec. 150.1 would be required to file an initial statement
on Form 704 with the Commission at least ten days in advance of the
date that such positions would be in excess of limits established in
proposed Sec. 150.2. Advance notice of a trader’s intended maximum
position in commodity derivative contracts to offset anticipatory risks
would allow the Commission to review a proposed position before a
trader exceeds the position limits and, thereby, would allow the
Commission to prevent excessive speculation in the event that a trader
were to misconstrue the purpose of these limited exemptions.541 The
trader’s initial statement on Form 704 would provide a detailed
description of the person’s anticipated activity (i.e., unfilled
anticipated requirements, unsold anticipated production, etc.).542
Under proposed Sec. 150.7(b), the Commission may reject all or a
portion of the position as not meeting the requirements for bona fide
hedging positions under proposed Sec. 150.1. To support this
determination, proposed Sec. 150.7(c) would allow the Commission to
request additional specific information concerning the anticipated
transaction to be hedged. Otherwise, Form 704 filings that conform to
the requirements set forth in proposed Sec. 150.7 would become
effective ten days after submission. Proposed Sec. 150.7(e) would
require an anticipatory hedger to file a supplemental report on Form
704 whenever the anticipatory hedging needs increase beyond that in its
most recent filing.
—————————————————————————
541 Further, advance filing may serve to reduce the burden on
a person who exceeds position limits and who may then otherwise be
issued a special call to determine whether the underlying
requirements for the exemption have been met. If the Commission were
to reject such an exemption, such a person would have already
violated position limits.
542 Proposed 150.7(d)(2) would require additional information
for cross hedges, for reasons discussed above.
—————————————————————————
c. Annual and Monthly Reporting Requirements
Proposed Sec. 150.7(f) would add a requirement for any person who
files an initial statement on Form 704 to provide annual updates that
detail the person’s actual cash market activities related to the
anticipated exemption. With an eye towards distinguishing bona fide
hedging of anticipatory risks from speculation, annual reporting of
actual cash market activities and estimates of remaining unused
anticipated exemptions beyond the past year would enable the Commission
to verify whether the person’s anticipated cash market transactions
closely track that person’s real cash market activities. Proposed Sec.
150.7(g) would similarly enable the Commission to review and compare
the actual cash activities and the remaining unused anticipated hedge
transactions by requiring monthly reporting on Form 204. Absent monthly
filing, the Commission would need to issue a special call to determine
why a person’s commodity derivative contract position is, for example,
larger than the pro rata balance of her annually reported anticipated
production.
As is the case under current Sec. 1.48, proposed Sec. 150.7(h)
requires that a trader’s maximum sales and purchases must not exceed
the lesser of the approved exemption amount or the trader’s current
actual anticipated transaction.
d. Delegation
The Commission is proposing to delete current Sec. 140.97, which
delegates to the Director of the Division of Market Oversight or his
designee authority regarding requests for classification of positions
as bona fide hedging under current Sec. Sec. 1.47 and 1.48. For
purposes of simplicity, this delegation of authority would be placed in
proposed Sec. 150.7(j), within the Commission’s position limits regime
in part 150.
6. Miscellaneous Regulatory Amendments
i. Proposed Sec. 150.6–Ongoing Application of the Act and Commission
Regulations
The Commission is proposing to amend existing Sec. 150.6 to
conform the provision with the general applicability of part 150 to
SEFs that are trading facilities, and concurrently making non-
substantive changes to clarify the provision. The provision, as amended
and clarified, provides this part shall only be construed as having an
effect on
[[Page 75747]]
position limits and that nothing in part 150 shall affect any provision
promulgated under the Act or Commission regulations including but not
limited to those relating to manipulation, attempted manipulation,
corners, squeezes, fraudulent or deceptive conduct, or prohibited
transactions.543 For example, by requiring DCMs and SEFs that are
trading facilities to impose and enforce exchange-set speculative
position limits, the Commission does not intend for the fulfillment of
such requirements alone to satisfy any other legal obligations under
the Act and Commission regulations of DCMs and SEFs that are trading
facilities to detect and deter market manipulation and corners. In
another example, a market participant’s compliance with position limits
or an exemption does not confer any type of safe harbor or good faith
defense to a claim that he had engaged in an attempted manipulation, a
perfected manipulation or deceptive conduct.
—————————————————————————
543 The Commission notes that amended Sec. 150.6 matches
vacated Sec. 151.11(h).
—————————————————————————
ii. Proposed Sec. 150.8–Severability
The Commission is proposing to add Sec. 150.8 to address the
severability of individual provisions of part 150. Should any
provision(s) of part 150 be declared invalid, including the application
thereof to any person or circumstance, Sec. 150.8 provides that all
remaining provisions of part 150 shall not be affected to the extent
that such remaining provisions, or the application thereof, can be
given effect without the invalid provisions.544 The Commission
believes it is prudent to include a severability clause to avoid any
further delay, as practicable, in carrying out Congress’ mandate to
impose position limits in a timely manner.
—————————————————————————
544 The Commission notes that proposed Sec. 150.8 matches
vacated Sec. 151.13.
—————————————————————————
iii. Part 15–Reports–General Provisions
The Commission is proposing to amend the definition of the term
“reportable position” in current Sec. 15.00(p)(2) by clarifying
that: (1) Such positions include swaps; (2) issued and stopped
positions are not included in open interest against a position limit;
and (3) special calls may be made for any day a person exceeds a limit.
Additionally, the Commission is proposing to amend Sec. 15.01(d) by
adding language to reference swaps positions. Lastly, the Commission is
proposing to amend the list of reporting forms in current Sec. 15.02
to account for new and updated series ’04 reporting forms, as discussed
above.545
—————————————————————————
545 See discussion of new and amended series ’04 reports
above.
—————————————————————————
iv. Part 17–Reports by Reporting Markets, Futures Commission
Merchants, Clearing Members, and Foreign Brokers
The Commission is proposing to amend current Sec. 17.00(b) to
delete aggregation provisions, since those provisions are duplicative
of aggregation provisions in Sec. 150.4.546 Proposed Sec. 17.00(b)
would provide that “[e]xcept as otherwise instructed by the Commission
or its designee and as specifically provided in Sec. 150.4 of this
chapter, if any person holds or has a financial interest in or controls
more than one account, all such accounts shall be considered by the
futures commission merchant, clearing member or foreign broker as a
single account for the purpose of determining special account status
and for reporting purposes.” In addition, proposed Sec. 17.03(h)
would delegate to the Director of the Division of Market Oversight or
his designee the authority to instruct persons pursuant to proposed
Sec. 17.03.547
—————————————————————————
546 In a separate proposal approved on the same date as this
proposal, the Commission is proposing amendments to Sec. 150.4–
aggregation of positions. See Aggregation NPRM (Nov. 5, 2013).
547 In a separate final rulemaking (Oct. 30, 2013), the
Commission adopted amendments to Sec. 17.03; the current proposal
would amend Sec. 17.03 further by adding proposed Sec. 17.03(h).
—————————————————————————
II. Revision of Rules, Guidance, and Acceptable Practices Applicable to
Exchange-Set Speculative Position Limits–Sec. 150.5
A. Background
Pursuant to 17 CFR part 150, the Commission administers speculative
position limits on futures contracts for certain agricultural
commodities.548 Prior to the CEA’s amendment in 1974, which expanded
its jurisdiction to all “services, rights and interests” in which
futures contracts are traded, only certain designated agricultural
commodities could be regulated. Both prior to and after the 1974
amendments to the Act, futures markets that traded commodities not so
enumerated applied speculative position limits by exchange rule, if at
all. In 1981, the Commission promulgated Sec. 1.61, which required
that, absent an exemption, exchanges must adopt and enforce speculative
position limits for all contracts that are not subject to the
Commission-set limits.549 The Commission has periodically reviewed
and updated its policies and rules pertaining to each of the three
basic elements of the regulatory framework for speculative position
limits, namely, the levels of the limits, the exemptions from them (in
particular, for hedgers), and the policy on aggregating accounts.550
—————————————————————————
548 See 17 CFR Part 150.
549 See Establishment of Speculative Position Limits, 46 FR
50938, Oct. 16, 1981, and 17 CFR 1.61 (removed and reserved May 5,
1999). Section 1.61 permitted exchanges to adopt and enforce their
own speculative position limits for those contracts that were
covered by Commission-set speculative position limits, as long as
the exchange limits were not higher than those set by the
Commission. Furthermore, CEA section 4a(e) provides that a violation
of a speculative position limit established by a Commission-approved
exchange rule is also a violation of the Act. Thus, the Commission
can enforce directly violations of exchange-set speculative position
limits as well as those provided under Commission rules.
550 Initially, for example, the Commission redefined
“hedging” (see 42 FR 42748, Aug. 24, 1977), and raised speculative
position limits in wheat (see 41 FR 35060, Aug. 19, 1976).
Subsequently, for example, the Commission solicited public comment
on, and subsequently approved, exchange requests for exemptions for
futures and option contracts on certain financial instruments from
the requirement specified by former Sec. 1.61 that speculative
position limits be specified for all contracts. See 56 FR 51687,
Oct. 15, 1991.
—————————————————————————
In 1999, the Commission relocated several of the rules and policies
concerning exchange-set-position limits from Sec. 1.61 to current
Sec. 150.5, thereby incorporating within part 150 most Commission
rules relating to speculative position limits. The Commission codified
as rules within Sec. 150.5 various staff policies and administrative
practices that had developed over time. These policies and practices
related to the speculative position limit levels that the staff had
routinely recommended for approval by the Commission for newly
designated futures and option contracts, as well as the magnitude of
increases to the limit levels that it would approve for already-traded
contracts. The Commission also codified within Sec. 150.5 various
exemptions from the general requirement that exchanges must set
speculative position limits for all contracts. The exemptions included
permitting exchanges to substitute position accountability rules for
position limits for physical commodity derivatives outside the spot
month in high volume and liquid markets.551
—————————————————————————
551 See 17 CFR 150.5. See also Revision of Federal Speculative
Position Limits and Associated Rules, Final Rules, 64 FR 24038,
24040-42, May 5, 1999. As noted in the notice of proposed rulemaking
for Sec. 150.5, promulgating these policies within a single section
of the Commission’s rules would increase significantly their
accessibility and clarify their terms. See 63 FR 38537, Jul. 17,
1998.
—————————————————————————
Less than two years after the Commission promulgated Sec. 150.5,
the Commodity Futures Modernization Act
[[Page 75748]]
of 2000 (“CFMA”) 552 amended the CEA to include a set of core
principles that DCMs must comply with at the time of application, and
on an ongoing basis after designation,553 including DCM core
principle 5, which requires exchanges to adopt position limits or
position accountability levels where necessary and appropriate to
reduce the threat of market manipulation or congestion.554 The CFMA
further amended the CEA to provide DCMs with “reasonable discretion”
in determining how to comply with each core principle, including core
principle 5 regarding exchange-set position limits.555 Since 2000,
the Commission has continued to maintain Sec. 150.5, but only as
guidance on, and acceptable practices for, compliance with DCM core
principle 5. The Commission did not amend Sec. 150.5 following passage
of the CFMA.
—————————————————————————
552 Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (Dec. 21, 2000). By enacting the CFMA,
Congress intended “[t]o reauthorize and amend the Commodity
Exchange Act to promote legal certainty, enhance competition, and
reduce systemic risk in markets for futures and over-the-counter
derivatives . . . .” Id.
553 See CEA section 5(d); 7 U.S.C. 7(d). The CEA, as amended
by the CFMA, required a DCM applicant to demonstrate its ability to
comply with 18 core principles.
554 CEA section 5(d)(5); 7 U.S.C. 7(d)(5).
555 DCM core principle 1 states, among other things, that
boards of trade “shall have reasonable discretion in establishing
the manner in which they comply with the core principles.” This
“reasonable discretion” provision underpinned the Commission’s use
of core principle guidance and acceptable practices. See former CEA
section 5(d)(1)(amended in 2010); U.S.C. 7(d)(1). As discussed
above, the Dodd-Frank Act subsequently amended DCM core principle 1
to specifically provide the Commission with discretion to determine,
by rule or regulation, the manner in which boards of trade comply
with the core principles.
—————————————————————————
In 2010, the Dodd-Frank Act amended the CEA to explicitly provide
that the Commission may mandate the manner in which DCMs must comply
with the core principles.556 Specifically, the Dodd-Frank Act amended
DCM core principle 1 to include the condition that “[u]nless otherwise
determined by the Commission by rule or regulation,” boards of trade
shall have reasonable discretion in establishing the manner in which
they comply with the core principles.557
—————————————————————————
556 See CEA section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B).
557 See id. Congress limited the exercise of reasonable
discretion by DCMs only where the Commission has acted by
regulation.
—————————————————————————
Additionally, the Dodd-Frank Act amended DCM core principle 5 to
require that, for any contract that is subject to a position limitation
established by the Commission pursuant to CEA section 4a(a), the DCM
“shall set the position limitation of the board of trade at a level
not higher than the position limitation established by the
Commission.” 558 Furthermore, the Dodd-Frank Act added CEA section
5h to provide a regulatory framework for Commission oversight of
SEFs.559 Under SEF core principle 6, which parallels DCM core
principle 5, Congress required that SEFs adopt for each swap, as is
necessary and appropriate, position limits or position
accountability.560 In addition, Congress required that, for any
contract that is subject to a Federal position limit under CEA Section
4a(a), the SEF shall set its position limits at a level no higher than
the position limitation established by the Commission.561
—————————————————————————
558 See CEA section 5(d)(5)(B) (amended 2010); 7 U.S.C.
7(d)(5)(B).
559 See CEA section 5h; 7 U.S.C. 7b-3.
560 CEA section 5h(f)(6); 7 U.S.C. 7b-3(f)(6).
561 Id.
—————————————————————————
In view of these Dodd-Frank Act amendments, the Commission proposes
several amendments to update and streamline the part 150 regulations.
First, the Commission proposes new and amended clarifying definitions
in Sec. 150.1 that relate particularly to position limits. Second, the
Commission proposes to amend Sec. 150.5 to include SEFs and swaps.
Third, the Commission proposes to codify rules and acceptable practices
for compliance with DCM core principle 5 and SEF core principle 6
within amended Sec. 150.5(a) for commodity derivative contracts that
are subject to the federal position limits set forth in Sec. 150.2.
Lastly, the Commission proposes to codify rules and revise guidance and
acceptable practices for compliance with DCM core principle 5 and SEF
core principle 6 within amended Sec. 150.5(b) for commodity derivative
contracts that are not subject to the Federal position limits set forth
in Sec. 150.2.
B. The Current Regulatory Framework for Exchange-Set Position Limits
1. Section 150.5
The Commission currently sets and enforces position limits pursuant
to its broad authority under CEA section 4a 562 and does so only with
respect to certain enumerated agricultural products.563 In 1981, the
Commission promulgated what was then 17 CFR 1.61 (re-codified in 1999
as 17 CFR 150.5), which required that, absent an exemption, exchanges
must adopt and enforce speculative position limits for all futures
contracts that were not subject to Commission-set limits.564
—————————————————————————
562 CEA section 4a, as amended by the Dodd-Frank Act, provides
the Commission with broad authority to set position limits. 7 U.S.C.
6a. See supra discussion of CEA section 4a.
563 The position limits on these agricultural contracts are
referred to as “legacy” limits, and the listed commodities are
referred to as the “enumerated” agricultural commodities. This
list of agricultural contracts includes Corn (and Mini-Corn), Oats,
Soybeans (and Mini-Soybeans), Wheat (and Mini-wheat), Soybean Oil,
Soybean Meal, Hard Red Spring Wheat, Hard Winter Wheat, and Cotton
No. 2. See 17 CFR 150.2.
564 46 FR 50938, Oct. 16, 1981. The Commission stated the
purpose of such limits was to prevent “excessive speculation . . .
arising from those extraordinarily large positions which may cause
sudden or unreasonable fluctuations or unwarranted changes in the
price” of commodity futures. Id. at 50945. Former Sec. 1.61(a)(2)
specified that limits shall be based on “such factors that will
accomplish the purposes of this section. As appropriate, these
factors shall include position sizes customarily held by speculative
traders in the market . . . , which shall not be extraordinarily
large relative to total open positions in the contract market . . .
[or] breadth and liquidity of the cash market underlying each
delivery month and the opportunity for arbitrage between the futures
market and cash market in the commodity underlying the futures
contract.” 17 CFR 1.61 (removed and reserved on May 5, 1999).
—————————————————————————
The Commission’s 1981 rule requiring that exchanges set position
limits was a watershed in its approach to position limits. The
Commission first concluded that multiple provisions of the CEA vested
it with authority to direct that exchanges impose position limits.565
The Commission explained that section 4a “represents an express
Congressional finding that excessive speculation is harmful to the
market, and a finding that speculative limits are an effective
prophylactic measure.” 566 Relying on those Congressional findings,
the Commission directed exchanges to impose speculative position limits
on all futures contracts subject to their jurisdiction.567
—————————————————————————
565 46 FR 50938, 50939-40, Oct. 16, 1981.
566 Id. at 50940.
567 Id. at 50945.
—————————————————————————
In adopting this prophylactic approach, the Commission explained
that comments it had received during the rulemaking that questioned
“the general desirability of [position] limits [were] contrary to
Congressional findings in sections 3 and 4a of the Act and considerable
years of Federal and contract market regulatory experience.” 568 The
Commission also explained that:
—————————————————————————
568 Id. at 50940.
the prevention of large and/or abrupt price movements which are
attributable to extraordinarily large speculative positions is a
Congressionally endorsed regulatory objective of the Commission.
Further . . . this objective is enhanced by speculative position
limits since it appears that the capacity of any contract market to
absorb the establishment and liquidation of large speculative
positions in an orderly manner is related to the relative size of
the positions,
[[Page 75749]]
i.e., the capacity of the market is not unlimited.569
—————————————————————————
569 Id.
Citing the recent disruption in the silver market, the Commission
insisted that position limits be imposed prophylactically for all
futures and options contracts, irrespective of the unique features of
the cash market underlying a particular derivative.570 Thus, the
Commission concluded that “speculative limits are appropriate for all
contract markets,” 571 and directed exchanges to impose them on an
“omnibus basis,” 572 that is, on all futures contracts.573
—————————————————————————
570 Id. at 50940-41. The Commission stated it would consider
the particular characteristics of the cash markets in setting limit
levels, but required that all futures contracts have position
limits. Id. at 50941.
571 Id. at 50941.
572 Id. at 50939.
573 See 17 CFR 1.61(a)(1) (1982). In addition, Sec. 1.61
permitted exchanges to adopt and enforce their own speculative
position limits for those contracts that have federal speculative
position limits, as long as the exchange limits were not higher than
those set by the Commission.
—————————————————————————
Congress ratified the Commission’s construction of section 4a and
its promulgation of Sec. 1.61 in the Futures Trading Act of 1982 574
when it enacted section 4a(e) of the Act, which provides that limits
set by exchanges and approved by the Commission are subject to
Commission enforcement.575
—————————————————————————
574 The Futures Trading Act of 1982, Public Law 97-444, 96
Stat. 2294 (1983).
575 See id; see also 7 U.S.C. 6a(e).
—————————————————————————
During the 1990s, the Commission allowed exchanges to replace
position limits with position accountability levels with respect to
certain derivatives outside the spot month.576 Position
accountability levels are not fixed limits, but rather position sizes
that trigger an exchange review of a trader’s position and at which an
exchange may remediate perceived problems, such as preventing a trader
from increasing his position or forcing a reduction in a position. In
January 1992, the Commission approved the CME’s request for an
exemption from the position limits requirements and permitted the CME
to establish position accountability for a variety of financial
contracts. Initially, the Commission limited its approval of position
accountability to financial instruments (i.e., excluded commodities)
that had a high degree of liquidity. Six months later, the Commission
determined it would also allow position accountability to be used for
highly liquid energy and metals contracts.577
—————————————————————————
576 See Speculative Position Limits–Exemptions from
Commission Rule 1.61, 56 FR 51687, Oct. 15, 1991; and Speculative
Position Limits–Exemptions from Commission Rule 1.61, 57 FR 29064,
Jun. 30, 1992.
577 See 57 FR 29064, Jun. 30, 1992.
—————————————————————————
In 1999, the Commission simplified and reorganized its rules
relating to speculative position limits by removing and reserving Sec.
1.61 and relocating several of its rules and policies concerning
exchange-set-position limits to new Sec. 150.5, thereby incorporating
within part 150 most Commission rules relating to speculative position
limits.578 The Commission codified within Sec. 150.5 various staff
policies and administrative practices that had developed over time
relating to: (1) The speculative position limit levels that the staff
routinely had recommended for approval by the Commission for newly
designated futures and option contracts; (2) the magnitude of increases
to the limit levels that it would approve for traded contracts; and (3)
various exemptions from the general requirement that exchanges set
speculative position limits for all contracts, such as permitting
exchanges to substitute position accountability rules for position
limits for high volume and liquid markets.579 The Commission
explained that codifying the prior administrative practices as part of
new Sec. 150.5 would make the applicable standard for exchange-set
position limits more transparent and thereby make compliance easier for
exchanges to achieve.580
—————————————————————————
578 64 FR 24038, 24040, May 5, 1999. As noted in the notice of
proposed rulemaking for Sec. 150.5, promulgating these policies
within a single section of the Commission’s rules would increase
significantly their accessibility and clarify their terms. See
Revision of Federal Speculative Position Limits and Associated
Rules, Proposed Rules, 63 FR 38537, Jul. 17, 1998.
579 64 FR at 24040-42. As the Commission explained, the open-
interest criterion and numeric formula used by the Commission in its
1991 proposed amendment of Commission-set speculative position
limits provided the most definitive guidance by the Commission on
acceptable levels for speculative position limits for tangible
commodities and, along with several other commonly accepted
measures, had been widely followed as a matter of administrative
practice when reviewing proposed exchange speculative position
limits under Commission rule 1.61. Id. at 24040. Additionally, in
reviewing new contracts for tangible commodities, the staff had
relied upon the Commission’s formulation providing for a minimum
level of 1,000 contracts for non-spot month speculative position
limits. Id. Moreover, the Commission had routinely approved a level
of 5,000 contracts in non-spot months for designation of financial
futures and energy contracts, and that level had become a rule of
thumb as a matter of administrative practice. Id.
580 Id.
—————————————————————————
Under Sec. 150.5(a), the Commission required each exchange to
“limit the maximum number of contracts a person may hold or control,
separately or in combination, net long or net short, for the purchase
or sale of a commodity for future delivery or, on a futures-equivalent
basis, options thereon.” 581 The Commission noted that this
provision does not apply to contracts for which position limits are set
forth in Sec. 150.2 or to a futures or option contract on a major
foreign currency.582 Furthermore, nothing in Sec. 150.5(a) was to be
construed to prohibit an exchange from setting different limits for
different futures contracts or delivery months, or from exempting
positions normally known in the trade as spreads, straddles, or
arbitrage.583
—————————————————————————
581 17 CFR 150.5(a).
582 Id.
583 Id.
—————————————————————————
In Sec. 150.5(b), the Commission presented explicit numeric
formulas and descriptive standards for the speculative position limit
levels that it found to be appropriate for new contracts.584 For
physical delivery contracts, the spot month limit level must be no
greater than one-quarter of the estimated spot month deliverable
supply, calculated separately for each month to be listed.585 For
cash-settled contracts, the Commission presented a descriptive
standard: “the spot month limit level must be no greater than
necessary to minimize the potential for manipulation or distortion of
the contract’s or the underlying commodity’s price.” 586 Individual
non-spot-month or all-months-combined levels for such newly-designated
contracts must be no greater than 1,000 contracts for tangible
commodities other than energy products,587 and no greater than 5,000
contracts for energy products and non-tangible commodities, including
contracts on financial products.588 In Sec. 150.5(c), the Commission
codified mandatory numeric formulas and descriptive standards for
subsequent adjustments to spot, individual and all-months-combined
position limit levels.589
—————————————————————————
584 See 17 CFR 150.5(b). The Commission explained that the
proposed limit levels for new contracts, which were based upon the
formula and associated minimum levels used by the Commission in its
1992 proposed rulemaking, had long been used as a matter of informal
administrative practice. 64 FR 24040.
585 17 CFR 150.5(b)(1).
586 Id.
587 17 CFR 150.5(b)(2).
588 17 CFR 150.5(b)(3).
589 17 CFR 150.5(c).
—————————————————————————
The Commission explained that these explicit numeric formulas grew
from administrative practices that had long required a deliverable
supply of at least four times the spot month speculative position
limit.590 The Commission
[[Page 75750]]
further explained that the descriptive standards for exchange-set
limits in Sec. 150.5 grew from staff experience that had demonstrated
that many commodities, particularly intangible commodities, have
sufficiently large deliverable supplies to meet this standard without
requiring a spot month level that is lower than the individual month
level.591
—————————————————————————
590 64 FR at 24041 (citing 62 FR 60831, 60838, Nov. 13, 1997).
A spot month speculative position limit that exceeds this amount
enhances the susceptibility of the contract to market manipulation,
price distortion or congestion. Except for cash-settled contracts,
Commission staff had used this standard to review every new
contract, or proposals to increase existing exchange speculative
position limits, since 1981, when Sec. 1.61 was issued. Id.
591 64 FR at 24041. For other commodities, however, especially
commodities having strong seasonal characteristics, spot month
speculative position limits are required to be set at a level lower
than the individual month limit for all or some trading months. Id.
Accordingly, codification of the standard only made explicit the
standard which, since 1981, had been applied to, and met by, every
physical delivery futures contract at the time of initial review and
upon subsequent increases to the spot month speculative position
limit. Id.
—————————————————————————
In Sec. 150.5(d), the Commission explicitly precluded exchanges
from applying exchange-set speculative position limits rules to bona
fide hedging positions as defined by an exchange in accordance with
Sec. 1.3(z)(1).592 However, that section also provided an exchange
with the discretion to limit bona fide hedging positions that it
determines are “not in accord with sound commercial practices or
[that] exceed an amount which may be established and liquidated in an
orderly fashion.” 593 Under Sec. 150.5(d)(2), the Commission
explicitly required traders to apply to the exchange for any exemption
from its speculative position limit rules.594 Furthermore, under
Sec. 150.5(f), an exchange is compelled to grant additional exemptions
to positions acquired in good faith prior to the effective date of any
exchange position limits rule.595 In addition to the express
exemptions specified in Sec. 150.5, Sec. 150.5(f) permitted an
exchange to propose other exemptions consistent with the purposes of
Sec. 150.5.596
—————————————————————————
592 17 CFR 150.5(d)(1); 17 CFR 1.3(z).
593 17 CFR 150.5(d)(1).
594 17 CFR 150.5(d)(2). In considering whether to grant such
an application for exemption, exchanges must take into account
whether the hedging position is not in accord with sound commercial
practices or exceeds an amount which may be established and
liquidated in an orderly fashion. See id.
595 17 CFR 150.5(f). This exemption also applies to positions
acquired in good faith prior to the effective date of any exchange
position limits rule by a person that is registered as a futures
commission merchant or as a floor broker under authority of the Act
except to the extent that transactions made by such person are made
for or on behalf of the account or benefit of such person.
596 Id.
—————————————————————————
In Sec. 150.5(e), the Commission codified its existing policies
concerning the classes of contracts for which an exchange could replace
the required speculative position limit with a position accountability
rule.597 Under Sec. 150.5(e), at least twelve months after a
contract’s initial listing for trading, an exchange could apply to the
Commission to substitute for the position limits required under part
150 an exchange rule requiring traders to be accountable for large
positions.598 The Commission explained that the type of position
accountability rule that applies to a particular contract under Sec.
150.5(e) is determined by the liquidity of the futures market, the
liquidity of the cash market and the Commission’s oversight
experience.599 The Commission further explained that it used Sec.
150.5(e) to restate these criteria with greater clarity and precision,
particularly in measuring the necessary levels of liquidity of the
futures and option markets.600 Furthermore, for purposes of Sec.
150.5(e), trading volume and open interest must be calculated by
combining the month-end futures and its related option contract, on a
delta-adjusted basis, for all months listed during the most recent
calendar year.601
—————————————————————————
597 17 CFR 150.5(e). Position accountability rules impose a
level that triggers distinct reporting responsibilities by a trader
at the request of the applicable exchange.
598 Id. The Commission explained that a trading history of at
least 12 months must first be established before a futures contract
can meet the proposed rule’s liquidity requirements. See Proposed
Rule, 63 FR 38525, 38529, Jul. 17, 1998.
599 Revision of Federal Position Limits and Associated Rules,
Proposed Rule, 63 FR 38525, 38530, Jul. 17, 1998. The Commission
explained that a liquid market is one which has sufficient trading
activity to enable individual trades coming to a market to be
transacted without significantly affecting the price. Id. A high
degree of liquidity in the futures and option markets better enables
traders to arbitrage these markets with the underlying cash markets.
Id. Where the underlying cash markets in turn are very liquid and
have extremely large deliverable supplies, the threat of market
manipulation or distortions caused by large speculative positions is
lessened. Id.
600 See 17 CFR 150.5(e)(1)-(3); see also Proposed Rule, 63 FR
38525, 38530, Jul. 17, 1998.
601 17 CFR 150.5(e)(4).
—————————————————————————
Lastly, the Commission codified its aggregation policy relating to
exchange-set position limits in Sec. 150.5(g).602
—————————————————————————
602 To determine whether any person has exceeded the limits
established under this section, all positions in accounts for which
such person by power of attorney or otherwise directly or indirectly
controls trading shall be included with the positions held by such
person; such limits upon positions shall apply to positions held by
two or more person acting pursuant to an express or implied
agreement or understanding, the same as if the positions were held
by a single person. 17 CFR 150.5(g).
—————————————————————————
2. The Commodity Futures Modernization Act of 2000 Caused Commission
Sec. 150.5 To Become Guidance on and Acceptable Practices for
Compliance With DCM Core Principle 5
Just over a year after the Commission promulgated Sec. 150.5, the
Commodity Futures Modernization Act of 2000 603 amended the CEA to
establish DCMs as a registration category and create a set of 18 core
principles with which DCMs must comply.604 DCM core principle 5
requires exchanges to adopt position limits or position accountability
levels “where necessary and appropriate to reduce the threat of market
manipulation or congestion.” 605 Under the CFMA, DCM core principle
1 gave DCMs “reasonable discretion” in determining how to comply with
the core principles.606 The CFMA, however, did not change the
treatment of the enumerated agricultural commodities, which remain
subject to Federal speculative position limits. Moreover, the CFMA did
not alter the Commission’s authority in CEA section 4a to establish
position limits. The core principles regime set forth in the CFMA had
the effect of undercutting the prescriptive rules of Sec. 150.5
because DCMs were afforded “reasonable discretion” in determining how
to comply with the position limits or accountability requirements of
core principle 5. Nevertheless, the Commission has retained current
Sec. 150.5 as guidance on, and acceptable practices for, compliance
with DCM
[[Page 75751]]
core principle 5.607 The Commission did not amend Sec. 150.5
following passage of CFMA.
—————————————————————————
603 CFMA, Public Law 106-554, 114 Stat. 2763. By enacting the
CFMA, Congress intended “[t]o reauthorize and amend the Commodity
Exchange Act to promote legal certainty, enhance competition, and
reduce systemic risk in markets for futures and over-the-counter
derivatives, and for other purposes.” Id.
604 See CEA section 5(d); 7 U.S.C. 7(d). DCMs were first
established under the CFMA as one of two forms of Commission-
regulated markets for the trading of contracts for sale of a
commodity for future delivery or commodity options (the other being
registered DTEFs). In addition, the CFMA provided for two markets
exempt from regulation: Exempt boards of trade (“EBOTs”) and
exempt commercial markets (“ECMs”). See A New Regulatory Framework
for Trading Facilities, Intermediaries and Clearing Organizations,
Notice of Proposed Rulemaking, 66 FR 14262, Mar. 9, 2001; Final
Rulemaking, 66 FR 42256, Aug. 10, 2001.
605 CEA sections 5(d)(1), (5); 7 U.S.C. 7(d)(1), (5).
606 CEA section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B). The
Commission also undertakes due diligence reviews of each exchange’s
compliance with the core principles during rule and product
certification reviews and periodic examinations of DCMs’ compliance
with the core principles under Rule Enforcement Reviews. As
discussed above, DCM core principle 1 was amended by the Dodd-Frank
Act to give the Commission authority to determine, by rule or
regulation, the manner in which boards of trade must comply with the
core principles.
607 Guidance provides DCMs and DCM applicants with contextual
information regarding the core principles, including important
concerns which the Commission believes should be taken into account
in complying with specific core principles. In contrast, the
acceptable practices are more specific than guidance and provide
examples of how DCMs may satisfy particular requirements of the core
principles; they do not, however, establish mandatory means of
compliance. Acceptable practices are intended to assist DCMs by
establishing non-exclusive safe harbors. The safe harbors apply only
to compliance with specific aspects of the core principle, and do
not protect the exchange with respect to charges of violations of
other sections of the CEA or other aspects of the core principle. In
applying Sec. 150.5 as guidance and acceptable practices, most
exchanges, in exercising their “reasonable discretion,” have
continued to impose strict position limits in the spot month and to
apply position accountability standards in non-spot months.
—————————————————————————
In August 2001, the Commission adopted part 38 to govern trading on
DCMs post-CFMA. Under Sec. 38.2, DCMs operating under part 38 were
“exempt from all Commission rules not specifically reserved” 608
and Sec. 38.2 did not reserve Sec. 150.5.609 Accordingly, DCMs
operating under part 38 in the post-CFMA environment have not been
required to comply with Sec. 150.5. In this same rulemaking, the
Commission adopted appendix B to part 38 as guidance on and acceptable
practices for compliance with the DCM core principles, including core
principle 5.610 Within appendix B to part 38, the Commission advised
DCMs to, among other things, adopt spot-month limits for markets based
on commodities having more limited deliverable supplies, or where
otherwise necessary to minimize the susceptibility of the market to
manipulation or price distortions.611 The Commission also advised
DCMs on how they should set spot-moth limit levels and instructed DCMs
that they could elect not to adopt all-months-combined and non-spot
month limits.612 Appendix B to part 38 was subsequently amended in
June 2012 to delete the guidance and acceptable practices section
relevant to compliance with DCM core principle 5 in deference to parts
150 and 151.613
—————————————————————————
608 17 CFR 38.2 (amended June 19, 2012); see also A New
Regulatory Framework for Trading Facilities, Intermediaries and
Clearing Organizations, Final Rules, 66 FR 42256, 42257, Aug. 10,
2001.
609 See id.
610 17 CFR part 38 app. B (2002); see also 66 FR 42256, Aug.
10, 2001.
611 Id.
612 Id.
613 See Core Principles and Other Requirements for Designated
Contract Markets, Final Rule, 77 FR 36611, 36639, Jun. 19, 2012. The
Commission published the final rules for Position Limits for Futures
and Swaps on November 18, 2011, which required DCMs to comply with
part 150 (Limits on Positions) until such time that the Commission
replaces part 150 with the new part 151 (Limits on Positions). Id.
—————————————————————————
3. The CFTC Reauthorization Act of 2008
In the CFTC Reauthorization Act of 2008, Congress, among other
things, expanded the Commission’s authority to set position limits to
include significant price discovery contracts (“SPDCs”) on exempt
commercial markets (“ECMs”).614 The Reauthorization Act’s
provisions regarding ECMs were based largely on the Commission’s
recommendations for improving oversight of ECMs whose contracts perform
or affect a significant price discovery function. The legislation
significantly expanded the Commission’s regulatory authority over ECMs
by adding section 2(h)(7) 615 to the CEA, establishing criteria for
the Commission to consider in determining whether a particular ECM
contract performs a significant price discovery function, and providing
for greater regulation of SPDCs traded on ECMs. The Reauthorization Act
also required ECMs to adopt position limit and accountability level
provisions for SPDCs, authorized the Commission to require the
reporting of large trader positions in SPDCs, and established core
principles governing ECMs with SPDCs. The core principles applicable to
ECMs with SPDCs were largely derived from selected DCM core principles
and designation criteria set forth in CEA section 5, and Congress
intended that they be construed in a like manner.616
—————————————————————————
614 CFTC Reauthorization Act of 2008, incorporated as Title
XIII of the Food, Conservation and Energy Act of 2008, Public Law
110-246, 122 Stat. 1651 (June 18, 2008).
615 CEA sections 2(h)(3)-(7) were deleted by the Dodd-Frank
Act on July 15, 2011, thus eliminating the ECM category.
616 See Joint Explanatory Statement of the Committee of
Conference, H.R. Rep. No. 110-627, 110 Cong., 2d Sess. at 985
(2008). Section 723 of the Dodd-Frank Act subsequently repealed the
ECM SPDC provisions. See Section 723 of the Dodd-Frank Act, Pub. L.
111-203, 124 Stat. 1376 (2010).
—————————————————————————
Much like DCM core principle 5, ECM core principle IV of CEA
section 2(h)(7)(C) required electronic trading facilities to adopt
where necessary and appropriate, position limits or position
accountability provisions, especially during trading in the delivery
month, and taking into account fungible positions at a derivative
clearing organization.617
—————————————————————————
617 CEA section 2(h)(7)(C) (amended 2010).
—————————————————————————
In a Notice of Final Rulemaking in March 2009, the Commission
adopted Appendix B to Part 36 as guidance on and acceptable practices
for compliance with ECM core principles.618 The guidance on and
acceptable practices for compliance with ECM core principle IV
generally tracked those for DCM core principle 5 as listed in Sec.
150.5.619 Furthermore, the Commission indicated within this Notice of
Final Rulemaking that Sec. 150.5 was not binding on DCMs once part 38
was finalized.620 The Commission rejected a commenter’s suggestion
that a proposed ECM-SPDCs core principle for position limits and
accountability should adopt the existing standards in CEA section
4a(b)(2) (barring trading or positions in excess of federal limits)
and, especially, incorporate a broader good faith exemption in Sec.
150.5(f).621 The Commission responded that section 4a(b)(2) applies
to federal limits, not exchange-set limits.622 The Commission further
explained that Sec. 150.5(f) “no longer has direct application to
DCM-set limits” because “the statutory authority governing [those]
limits is found in CEA section 5(d)(5)–DCM core principle 5.” 623
That core principle does not, the Commission explained, contain any of
the exemptive language found in CEA section 4a or Sec. 150.5(f).624
The Commission observed that the part 38 rules specifically exempt DCMs
and DCM-traded contracts from all rules other than those specifically
reserved in Sec. 38.2, and Sec. 38.2 did not retain
[[Page 75752]]
Sec. 150.5(f).625 Accordingly, the Commission explained, “the part
150 rules essentially constitute guidance for DCMs administering
position limit regimes, [and] Commission staff in overseeing such
regimes has not required that position limits include an exemption for
positions acquired in good faith.” 626
—————————————————————————
618 Significant Price Discovery Contracts on Exempt Commercial
Markets, Final Rulemaking, 74 FR 12178, Mar. 23, 2009; See also 17
CFR part 36 app. B (2009).
619 For example, ECMs were advised to adopt spot-month limits
for SPDCs. If there was an economically-equivalent SPDC, or a
contract on a DCM, then the spot-month limit should be set at the
same level as that specified for such other contract. If there was
not an economically-equivalent SPDC or contract traded on a DCM,
then in the case of a physical delivery contact, the spot-month
limit should be set based upon an analysis of deliverable supplies
and the history of spot-month liquidations and at no more than 25
percent of the estimated deliverable supply or, in the case of a
cash settlement provision, the spot month limit should be set at a
level that minimizes the potential for price manipulation or
distortion in the significant price discovery contract itself; in
related futures and options contracts traded on a DCM or DTEF; in
other significant price discovery contracts; in other fungible
agreements, contracts and transactions; and in the underlying
commodity. ECMs were also advised to adopt position accountability
provisions for non-spot month and all-months combined or, in lieu of
position accountability, an ECM could establish non-spot individual
month position limits and all-months-combined position limits for
its SPDC. See 17 CFR part 36 app. B (2009).
620 See 74 FR 12178, 12183, Mar. 23, 2009.
621 See id.
622 See id.
623 See id.
624 See id; see also CEA Section 4a and 17 CFR 150.5(f).
625 See 74 FR 12178, 12183, Mar. 23, 2009; see also 17 CFR
Part 38. The Commission acknowledged that the acceptable practices
in former appendix B to part 38 incorporate many provisions of Sec.
150.5, but not Sec. 150.5(f).
626 74 FR 12183. In a 2010 notice of proposed rulemaking, the
Commission similarly noted that former appendix B to part 38
“specifically reference[d] part 150” in order to provide
“guidance” to DCMs on how to comply with the core principle on
position limits/accountability. 75 FR 4144, 4147, Jan. 26, 2010.
—————————————————————————
4. The Dodd-Frank Act Amendments to CEA Section 5
On July 21, 2010, President Obama signed The Dodd-Frank Wall Street
Reform and Consumer Protection Act.627 The legislation was enacted to
reduce risk, increase transparency, and promote market integrity within
the financial system by, among other things, enhancing the Commission’s
rulemaking and enforcement authorities with respect to all registered
entities and intermediaries subject to the Commission’s oversight.628
The Dodd-Frank Act repealed certain sections of the CEA, amended
others, and added many new provisions and vastly expanded the
Commission’s jurisdiction. The Commission has finalized 65 rules,
orders, and guidance to implement sweeping changes to the regulatory
framework established by the Dodd-Frank Act.629 This proposed
rulemaking would make several conforming amendments to part 150 of the
Commission’s regulations, most prominently to Sec. 150.5, in order to
integrate that section more fully within the statutory framework
created by the Dodd-Frank Act.
—————————————————————————
627 See generally the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).
628 Furthermore, the Dodd-Frank Act amended the DCM core
principles by: (1) Eliminating the eight criteria for designation as
a contract market; (2) amending most of the core principles,
including incorporating the substantive requirements of the
designation criteria; and (3) adding five new core principles.
Accordingly, all DCMs and DCM applicants must comply with a total of
23 core principles as a condition of obtaining and maintaining
designation as a contract market.
629 77 FR 66288, Nov. 2, 2012. See also amendments to CEA
section 4a, discussed above.
—————————————————————————
i. The Dodd-Frank Act Added Provisions That Permit the Commission To
Override the Discretion of DCMs in Determining How To Comply With the
Core Principles
As discussed above, DCM core principle 1, set out in CEA section
5(d)(1), states that boards of trade “shall have reasonable discretion
in establishing the manner in which they comply with the core
principles.” 630 However, section 735 of the Dodd-Frank Act amended
section 5(d)(1) of the CEA to include the proviso that “[u]nless
otherwise determined by the Commission by rule or regulation . . . ,”
boards of trade shall have reasonable discretion in establishing the
manner in which they comply with the core principles.631 In view of
amended CEA section 5(d)(1), which gives the Commission authority to
determine, by rule or regulation, the manner in which boards of trade
must comply with the core principles, the Commission has proposed a
number of new and revised rules, guidance, and acceptable practices to
implement the new and revised Dodd-Frank Act core principles.
—————————————————————————
630 CEA section 5(d)(1); 7 U.S.C. 7(d)(1).
631 See CEA section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B).
—————————————————————————
ii. The Dodd-Frank Act Established a Comprehensive New Statutory
Framework for Swaps
The Dodd-Frank Act tasked the Commission with overseeing the U.S.
market for swaps (except for security-based swaps). Title VII of the
Dodd-Frank Act amended the CEA to establish a comprehensive new
regulatory framework for swaps, including requirements for SEFs.632
This new regulatory framework includes: (1) Registration, operation,
and compliance requirements for SEFs; and (2) fifteen core principles
with which SEFs must comply. As a condition of obtaining and
maintaining their registration as a SEF, applicants and registered SEFs
are required to comply with the SEF core principles and with any
requirement that the Commission may impose by rule or regulation.633
The Dodd-Frank Act also amended the CEA to provide that, under new
section 5h, the Commission may determine, by rule or regulation, the
manner in which SEFs comply with the core principles.634
—————————————————————————
632 The SEF definition is added in section 721 of the Dodd-
Frank Act, amending CEA section 1a. 7 U.S.C. 1a(50).
633 See CEA section 5h, as enacted by section 733 of the Dodd-
Frank Act; 7 U.S.C. 7b-3.
634 See id.; see also SEF core principle 1 at CEA section
5h(f)(1)(B); 7 U.S.C. 7b-3(f)(1)(B).
—————————————————————————
iii. The Dodd-Frank Act Added the Regulation of Swaps, Added Core
Principles for SEFs, Including SEF Core Principle 6, and Amended DCM
Core Principle 5
The Dodd-Frank Act added a core principle concerning position
limitations or accountability for SEFs, SEF core principle 6, which
parallels DCM core principle 5.635 SEF core principle 6 requires SEFs
that are trading facilities to set, “as is necessary and appropriate,
position limitations or position accountability for speculators” 636
for each contract executed pursuant to their rules. Furthermore, for
contracts subject to Federal position limits imposed by the Commission
under CEA section 4a(a), CEA section 5h(f)(6)(B) 637 requires SEFs
that are trading facilities to set and enforce speculative position
limits at a level no higher than those established by the Commission.
—————————————————————————
635 Compare CEA section 5h(f)(6); 7 U.S.C. 7b-3(f)(6) with CEA
section 5(d)(5); 7 U.S.C. 7(d)(5).
636 CEA section 5h(f)(6)(A); 7 U.S.C. 7b-3(f)(6).
637 7 U.S.C. 7b-3(f)(6) as added by the Dodd-Frank Act.
—————————————————————————
The Dodd-Frank Act similarly amended DCM core principle 5 by adding
that for any contract that is subject to a position limit established
by the Commission pursuant to CEA section 4a(a), the DCM shall set the
position limit of the board of trade at a level not higher than the
position limitation established by the Commission.638
—————————————————————————
638 See CEA section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B). DCM core
principle 5 under CEA section 5(d)(5) requires that DCMs adopt for
each contract, as is necessary and appropriate, position limitations
or position accountability.
—————————————————————————
5. Dodd-Frank Rulemaking
To implement section 735 of the Dodd-Frank Act, the Commission has
proposed a number of new and revised rules, guidance, and acceptable
practices to implement the new and revised DCM core principles. In
doing so, the Commission has evaluated the preexisting regulatory
framework for overseeing DCMs, which consisted largely of guidance and
acceptable practices, in order to update those provisions and to
determine which core principles would benefit from having new or
revised derivative regulations. Based on that review, and in view of
the Dodd-Frank Act’s amendment to section 5(d)(1) of the CEA, which
grants the Commission authority to determine, by rule or regulation,
the manner in which boards of trade comply with the core principles,
the Commission has proposed revised guidance and acceptable practices
for some core
[[Page 75753]]
principles and, for other core principles, has proposed to codify rules
in lieu of guidance and acceptable practices.
i. Amended Part 38
In January 2011, the Commission published a notice of proposed
rulemaking to replace existing part 150, in its entirety, with a new
federal position limits rules regime in the form of new part 151.639
Just one month prior to this publication, the Commission published a
notice of proposed rulemaking to amend part 38 to establish regulatory
obligations that each DCM must meet in order to comply with section 5
of the CEA, as amended by the Dodd-Frank Act. Accordingly, the
Commission proposed Sec. 38.301 to require that each DCM must comply
with the requirements of part 151 as a condition of its compliance with
DCM core principle 5.640 The Commission later adopted a revised
version of Sec. 38.301 with an additional clause that requires DCMs to
continue to meet the requirements of part 150 of the Commission’s
regulations–the current position limit regulations–until such time
that compliance would be required under part 151.641 The Commission
explained that this clarification would ensure that DCMs are in
compliance with the Commission’s regulations under part 150 during the
interim period until the compliance date for the new position limits
regulations of part 151 would take effect.642 The Commission further
explained that new Sec. 38.301 was based on the Dodd-Frank amendments
to the DCM core principles regime, which collectively provide that DCM
discretion in setting position limits or position accountability levels
is limited by Commission regulations setting limits.643
—————————————————————————
639 Position Limits for Derivatives, Proposed Rule, 76 FR
4752, Jan. 26, 2011. The final rulemaking for vacated part 151
required DCMs to comply with part 150 until such time that the
Commission replaces part 150 with the new part 151. See 76 FR at
71632.
640 75 FR 80571, 80585, Dec. 22, 2010.
641 77 FR 36611, 36639, Jun. 19, 2012. The Commission mandated
in final Sec. 38.301 that, in order to comply with DCM core
principle 5, a DCM must “meet the requirements of parts 150 and 151
of this chapter, as applicable.” See also 17 CFR 38.301.
642 77 FR at 36639.
643 Id. See also CEA sections 5(d)(1) and 5(d)(5) (amended
2010), and discussion supra of Dodd-Frank amendments to the DCM core
principles.
—————————————————————————
However, in an Order dated September 28, 2012, the United States
District Court for the District of Columbia vacated part 151.644 The
District Court’s decision did not affect the applicability of part
150.645 Therefore, part 150 continues to apply as if part 151 had not
been finally adopted by the Commission, and Sec. 150.5 continues to
apply as non-exclusive guidance and acceptable practices for compliance
with DCM core principle 5. In light of the foregoing, the Commission
could not, without notice, interpret Sec. 150.5 as a pre-requisite for
compliance with core principle 5. Additionally, the Commission is
proposing to amend Sec. 38.301 by deleting the reference to vacated
part 151. Proposed Sec. 38.301 would maintain the requirement that
DCMs meet the requirements of part 150, as applicable.
—————————————————————————
644 See 887 F. Supp. 2d 259 (D.D.C. 2012).
645 See id generally.
—————————————————————————
ii. Amended Part 37
Similarly, in the Commission’s proposal to adopt a regulatory
scheme applicable to SEFs, under proposed Sec. 37.601,646 the
Commission proposed to require that SEFs establish position limits in
accordance with the requirements set forth in part 151 of the
Commission’s regulations.647 In the SEF final rulemaking, the
Commission revised Sec. 37.601 to state that until such time that
compliance is required under part 151, a SEF may refer to the guidance
and/or acceptable practices in appendix B of part 37 to demonstrate to
the Commission compliance with the requirements of core principle 6.
—————————————————————————
646 Current Sec. 37.601 provides requirements for SEFs that
are trading facilities to comply with SEF core principle 6 (Position
Limits or Accountability).
647 Core Principles and Other Requirements for Swap Execution
Facilities, 76 FR 1214 (proposed Jan. 7, 2011).
—————————————————————————
In light of the District Court vacatur of part 151, the Commission
proposes to amend Sec. 37.601 to delete the reference to vacated part
151. Instead, this rulemaking proposes to require that SEFs that are
trading facilities meet the requirements of part 150, which are
comparable to the DCM’s requirement, since, as proposed, Sec. 150.5
would apply to commodity derivative contracts, whether listed on a DCM
or on a SEF that is a trading facility. In addition, the Commission
proposes to amend appendix B to part 37, which provides guidance on
complying with core principles, both initially and on an ongoing basis,
to maintain SEF registration.648 Since this rulemaking proposes to
require that SEFs that are trading facilities meet the requirements of
part 150, the proposed amendments to the guidance regarding SEF core
principle 6 would reiterate that requirement. For SEFs that are not
trading facilities, to whom core principle 6 is not applicable under
the statutory language, the proposal would provide that part 150 should
be considered as guidance.
—————————————————————————
648 Appendix B to Part 37–Guidance on, and Acceptable
Practices in, Compliance with Core Principles.
—————————————————————————
iii. Vacated Part 151
As discussed above, the United States District Court for the
District of Columbia vacated part 151 of the Commission’s
regulations.649 Because the District Court’s decision did not affect
the applicability of part 150, current Sec. 150.5 remains as guidance
and acceptable practices for compliance with DCM core principle 5 and
SEF core principle 6. The Commission continues to rigorously enforce
compliance with these core principles.
—————————————————————————
649 See 887 F. Supp. 2d 259 (D.D.C. 2012).
—————————————————————————
Vacated Sec. 151.11 would have required DCMs and SEFs to adopt
position limits for Referenced Contracts, and would have established
acceptable practices for establishing position limits and position
accountability for certain non-referenced contracts and excluded
commodities.650 Specifically, vacated Sec. 151.11(a) would have
required DCMs and SEFs to set spot month limits, with exceptions for
securities futures and some excluded commodities.651 Under vacated
Sec. 151.11(a)(1), the Commission would have required DCMs and SEFs to
establish spot-month limits for Referenced Contracts at levels no
greater than the federal position limits (established pursuant to
vacated Sec. 151.4).652 For contracts other than Referenced
Contracts (including other physical commodity contracts), it would be
acceptable practice under vacated Sec. 151.11(a)(2) for DCMs and SEFs
to set position limits at levels no greater than 25 percent of
estimated deliverable supply.653 Additionally, under vacated Sec.
151.11(c), DCMs and SEFs would have had discretion to establish
position accountability levels in lieu of position
[[Page 75754]]
limits for excluded commodities under certain circumstances.654
—————————————————————————
650 See 76 FR at 71659-61.
651 76 FR at 71659.
652 76 FR at 71659-60. For Referenced Contracts, DCMs and SEFs
would have been similarly required under vacated Sec. 151.11(b) to
set single non-spot-month and all-months limits for Referenced
Contracts at levels no higher than the federal position limits
(established pursuant to vacated Sec. 151.4). Id. For non-
referenced contracts, it would be acceptable practice under vacated
Sec. 151.11(b)(2) for DCMs and SEFs to impose limits based on ten
percent of the average combined futures, swaps and delta-adjusted
option month-end open interest for the most recent two calendar
years up to 25,000 contracts, with a marginal increase of 2.5
percent thereafter based on open interest in the contract and
economically equivalent contracts traded on the same DCM or SEF. 76
FR 71661.
653 76 FR at 71660. Furthermore, for non-referenced contracts,
vacated Sec. 151.11(b)(3) would have allowed as an acceptable
practice the provision of speculative limits for an individual
single-month or in all-months-combined at no greater than 1,000
contracts for non-energy physical commodities and at no greater than
5,000 contracts for other commodities. Id.
654 Id. Position accountability levels could be used in lieu
of position limits only if the contract involves either a major
currency or certain excluded commodities (such as measures of
inflation, or other macroeconomic measures) or an excluded commodity
that: (1) Has an average daily open interest of 50,000 or more
contracts, (2) has an average daily trading volume of 100,000 or
more contracts, and (3) has a highly liquid cash market. Id. Compare
this vacated provision with current 17 CFR 150.5(e). As for physical
commodities, under vacated Sec. 151.11(c), the Commission would
have allowed a DCM or SEF to establish position accountability rules
as an acceptable alternative to position limits outside of the spot
month for physical commodity contracts when a contract has an
average month-end open interest of 50,000 contracts and an average
daily volume of 5,000 contracts and a liquid cash market. Id.
—————————————————————————
Vacated Sec. Sec. 151.11(e) and 151.11(f) would have required DCMs
and SEFs to follow the same account aggregation and bona fide exemption
standards set forth by vacated Sec. Sec. 151.5 and 151.7 with respect
to exempt and agricultural commodities.655 With respect to a DCM’s or
SEF’s duty to administer hedge exemptions, the Commission intended that
DCMs and SEFs administer their own position limits under Sec.
151.11.656 Accordingly, the Commission had required under this
vacated rulemaking that DCMs and SEFs create rules and procedures to
allow traders to claim a bona fide hedge exemption, consistent with
vacated Sec. 151.5 for physical commodity derivatives and Sec.
1.3(z), as was amended in the vacated rulemaking, for excluded
commodities.657
—————————————————————————
655 Id. Furthermore, under vacated Sec. 151, the Commission
would have removed the procedure to apply to the Commission for bona
fide hedge exemptions for non-enumerated transactions or positions
under Sec. 1.3(z)(3). Id. DCMs and SEFs would have been able to
recognize non-enumerated hedge transactions subject to Commission
review. Id. Additionally, DCMs and SEFs could continue to provide
exemptions for “risk-reducing” and “risk-management”
transactions or positions consistent with existing Commission
guidelines. Id. (citing Clarification of Certain Aspects of Hedging
Definition, 52 FR 27195, Jul. 20, 1987; and Risk Management
Exemptions from Speculative Position Limits Approved under
Commission Regulation 1.61, 52 FR 34633, Sep. 14, 1987). Vacated
Sec. 151.11(f)(2) would have required traders seeking a hedge
exemption to comply with the procedures of the DCM or SEF for
granting exemptions from its speculative position limit rules. 76 FR
71660-61.
656 76 FR at 71661.
657 Id. Vacated Sec. 151.11 contemplated that DCMs and SEFs
would administer their own bona fide hedge exemption regime in
parallel to the Commission’s regime.
—————————————————————————
C. Proposed Amendments to Sec. 150.5
To implement section 735 of the Dodd-Frank Act regarding DCMs, the
Commission continues to adopt new and revised rules, guidance, and
acceptable practices to implement the DCM core principles added and
revised by the Dodd-Frank Act. The Commission continues to evaluate its
pre-Dodd-Frank Act regulations and approach to oversight of DCMs, which
had consisted largely of published guidance and acceptable practices,
with the aim of updating them to conform to the new Dodd-Frank Act
regulatory framework. Based on that review, and pursuant to the
authority given to the Commission in amended sections 5(d)(1) and
5h(f)(1) of the CEA, which permit the Commission to determine, by rule
or regulation, the manner in which boards of trade and SEFs,
respectively, must comply with the core principles,658 the Commission
is proposing several updates to Sec. 150.5 to promote compliance with
DCM core principle 5 and SEF core principle 6.
—————————————————————————
658 See CEA sections 5(d)(1)(B) and 5h(f)(1)(B); 7 U.S.C.
7(d)(1)(B) and 7b-3(f)(1)(B).
—————————————————————————
First, the Commission proposes amendments to the provisions of
Sec. 150.5 to include SEFs and swaps. Second, the Commission proposes
to codify rules and revise acceptable practices for compliance with DCM
core principle 5 and SEF core principle 6 within amended Sec. 150.5(a)
for contracts subject to the federal position limits set forth in Sec.
150.2. Lastly, the Commission proposes to codify rules and revise
guidance and acceptable practices for compliance with DCM core
principle 5 and SEF core principle 6 within amended Sec. 150.5(b) for
contracts not subject to the federal position limits set forth in Sec.
150.2.
As noted above, the CFMA core principles regime concerning position
limitations or accountability for exchanges had the effect of
undercutting the mandatory rules promulgated by the Commission in Sec.
150.5. Since the CFMA amended the CEA in 2000, the Commission has
retained Sec. 150.5, but only as guidance on, and acceptable practice
for, compliance with DCM core principle 5.659 However, the Commission
did not amend the text of Sec. 150.5 following passage of CFMA,
leaving language in place that could suggest that the rules originally
codified within Sec. 150.5 remain mandatory for exchanges. To correct
this potential misimpression, the Commission now proposes several
amendments to Sec. 150.5 to clarify that certain provisions of Sec.
150.5 are non-exclusive guidance on, and acceptable practice for,
compliance with DCM core principle 5.
—————————————————————————
659 See id.
—————————————————————————
Additionally, the Commission is proposing several conforming
amendments to Sec. 150.5 in order to integrate that section more fully
with the statutory framework created by the Dodd-Frank Act. The
Commission, pursuant to the factors enumerated in section 4a(a)(3) of
the Act, has endeavored to maximize the objectives of preventing
excessive speculation, deterring and preventing market manipulation,
ensuring that markets remain sufficiently liquid so as to afford end
users and producers of commodities the ability to hedge commercial
risks, and promoting efficient price discovery. These proposed
clarifying revisions to Sec. 150.5 should also provide exchanges with
sufficient flexibility to address the divergent and changing conditions
in their respective markets.
Within amended Sec. 150.5(a), the Commission proposes to codify a
set of rules and revise acceptable practices for compliance with DCM
core principle 5 and SEF core principle 6 for contracts that are
subject to the federal position limits set forth in Sec. 150.2. Within
amended Sec. 150.5(b), the Commission proposes to codify rules and
revise guidance and acceptable practices for compliance with DCM core
principle 5 and SEF core principle 6 for contracts that are not subject
to the federal position limits set forth in Sec. 150.2.
Unlike current Sec. 150.5, which contains only non-exclusive
guidance on and acceptable practices for compliance with DCM core
principle 5 (despite the presence of language that connotes mandatory
rules), proposed Sec. 150.5 contains a mix of rules that would be
mandatory for compliance with DCM core principle 5 and SEF core
principle 6, coupled with guidance and acceptable practices for
compliance with those core principles. Accordingly, the Commission
urges the reader to pay special attention to the language in proposed
Sec. 150.5 that distinguishes mandatory rules (indicated by terms such
as “must” and “shall”) from guidance and acceptable practices
(indicated by terms such as “should” or “may”).
Additionally, the Commission proposes to amend Sec. 150.5 to
implement uniform requirements for DCMs and SEFs relating to hedging
exemptions across all types of contracts, including those that are
subject to federal limits. The Commission also proposes to require DCMs
and SEFs to have aggregation policies that mirror the federal
aggregation provisions.660 Hedging exemptions and position
aggregation exemptions, if not uniform with the Commission’s
requirements,
[[Page 75755]]
may serve to permit a person to obtain a larger position on a
particular DCM or SEF than would be permitted under the federal limits.
For example, if an exchange were to grant an aggregation position to a
corporate person with aggregate positions above federal limits, that
exchange may permit such person to be treated as two or more persons.
The person would avoid violating exchange limits, but may be in
violation of the federal limits. The Commission believes that a DCM or
SEF, consistent with its responsibilities under applicable core
principles, may serve an important role in ensuring compliance with
federal positions limits and thereby protect the price discovery
function of its market and guard against excessive speculation or
manipulation. In the absence of uniform hedging and position
aggregation exemptions, DCMs or SEFs may not serve that role. The
Commission notes that hedging exemptions and aggregation policies that
vary from exchange to exchange would increase the administrative burden
on a trader active on multiple exchanges, as well as increase the
administrative burden on the Commission in enforcing exchange-set
position limits.
—————————————————————————
660 Aggregation exemptions are, in effect, a way for a trader
to acquire a larger speculative position. The Commission believes
that it is important that the aggregation rules set out, to the
extent feasible, “bright line” standards that are capable of easy
application by a wide variety of market participants while not being
susceptible to circumvention.
—————————————————————————
The essential features of the proposed amendments to Sec. 150.5
are summarized below.
1. Proposed Amendments to Sec. 150.5 To Add References to Swaps and
Swap Execution Facilities
As discussed above, the Dodd-Frank Act created a new type of
regulated marketplace, SEFs, for which it established a comprehensive
regulatory framework. A SEF must comply with fifteen enumerated core
principles and any requirement that the Commission may impose by rule
or regulation.661 The Dodd-Frank Act provides that the Commission
may, in its discretion, determine by rule or regulation the manner in
which SEFs comply with the core principles.662
—————————————————————————
661 See supra discussion of SEF core principles.
662 See CEA section 5h(f)(1)(B); 7 U.S.C. 7b-3(f)(1)(B).
—————————————————————————
For contracts that are subject to federal position limits imposed
under CEA section 4a(a), new CEA section 5h(f)(6)(A) 663 requires
that SEFs set “as is necessary and appropriate, position limitations
or position accountability for speculators” for each contract executed
pursuant to their rules.664 New CEA section 5h(f)(6)(B),665
requires SEFs that are trading facilities to set and enforce
speculative position limits at a level no higher than those established
by the Commission.666 The Commission recognizes that SEFs may need to
contract with derivative clearing organizations in order to comply with
SEF core principle 6. The Commission invites comments on the
practicability and effectiveness of such arrangements. In addition, the
Commission invites comment as to whether the Commission should use its
exemptive authority under CEA section 4a(a)(7) to exempt SEFs from the
requirements of CEA section 5h(f)(6)(B). If so, why and to what extent?
—————————————————————————
663 As added by section 723 of the Dodd-Frank Act.
664 A similar duty is imposed on DCMs under CEA section
5(d)(5)(A); 7 U.S.C. 7(d)(5)(A).
665 As added by section 723 of the Dodd-Frank Act.
666 This requirement for SEFs parallels that for DCMs as
listed in the CEA section 5(d)(5)(B); 7 U.S.C. 7(d)(5)(B).
—————————————————————————
The Commission carefully considered both the novel nature of SEFs
and its experience in overseeing DCMs’ compliance with core principles
when determining which SEF core principles to address with rules that
would provide more certainty to the marketplace, and which core
principles to address with guidance or acceptable practices that might
provide more flexibility. The Commission has determined that the policy
purposes effectuated by establishing uniform requirements for
aggregation and bona fide hedging exemptions for DCM contracts are
equally present in SEF markets.667 Accordingly, the Commission has
determined to amend Sec. 150.5 to present essentially identical
standards for establishing rules and acceptable practices relating to
position limits (and accountability levels) for DCMs and SEFs.
—————————————————————————
667 See core principle 6 for SEFs, CEA section 5h(f)(6)(A); 7
U.S.C. 7b-3(f)(6)(A). The Commission notes that section 4a(a)(2) of
the CEA requires the Commission to establish speculative position
limits on physical commodity DCM contracts as appropriate, but did
not extend this requirement to SEF contracts. See discussion above.
—————————————————————————
2. Proposed Sec. 150.5(a)–Requirements and Acceptable Practices for
Commodity Derivative Contracts That Are Subject to Federal Position
Limits
Proposed Sec. 150.5(a) adds several requirements that a DCM or SEF
must adhere to when setting position limits for contracts that are
subject to the federal position limits listed in Sec. 150.2.668
Proposed Sec. 150.5(a)(1) specifies that a DCM or SEF that lists a
contract on a commodity that is subject to federal position limits must
adopt position limits for that contract at a level that is no higher
than the federal position limit.669 Exchanges with cash-settled
contracts price-linked to contracts subject to federal limits must also
adopt those limit levels.
—————————————————————————
668 As discussed above, 17 CFR 150.2 provides limits for
specified agricultural contracts in the spot month, individual non-
spot months, and all-months-combined.
669 Proposed Sec. 150.5(a)(1) is in keeping with the mandate
in core principle 5 as amended by the Dodd-Frank Act. See CEA
section 5(d)(1)(B); 7 U.S.C. 7(d)(1)(B). SEF core principle 6
parallels DCM core principle 5. Compare CEA section 5h(f)(5); 7
U.S.C. 7b-3(f)(5) with CEA section 5(d)(5); 7 U.S.C. 7(d)(5).
—————————————————————————
Proposed Sec. 150.5(a)(2) prescribes the manner in which a DCM or
SEF that lists a contract on a commodity that is subject to federal
position limits must adopt hedge exemption rules. Proposed Sec.
150.5(a)(2)(i) cross-references the definition of bona fide hedging, as
proposed in amended Sec. 150.1, as the regulation governing bona fide
hedging positions.670 Proposed Sec. 150.5(a)(2)(ii) clarifies the
types of spread positions for which a DCM or SEF may grant exemptions
from the federal limits by cross-referencing the definitions of
intermarket and intramarket spread positions in proposed Sec.
150.1.671 To be eligible for exemption under proposed Sec.
150.5(a)(2)(ii), intermarket and intramarket spread positions must be
outside of the spot month for physical delivery contracts, and
intramarket spread positions must not exceed the federal all-months
limit when combined with any other net positions in the single month.
Proposed Sec. 150.5(a)(2)(iii) would require traders to apply to the
DCM or SEF for any exemption from its speculative position limit
rules.672 Proposed Sec. 150.5(a)(2)(iii) also preserves the
exchange’s ability to limit bona fide hedging positions which it
determines are not in accord with sound commercial practices, or which
exceed
[[Page 75756]]
an amount that may be established and liquidated in an orderly
fashion.673
—————————————————————————
670 Compare 17 CFR 150.5(d) which explicitly precludes
exchanges from applying exchange-set speculative position limits
rules to bona fide hedging positions as defined by the exchange in
accordance with Sec. 1.3(z)(1).
671 The Commission has proposed to maintain the current
practice in 17 CFR 150.2 of setting single-month limits at the same
levels as all-months limits, rendering the “spread” exemption in
17 CFR 150.3 unnecessary. However, since DCM core principle 5 allows
exchanges to set more restrictive limits than the federal limits, a
DCM or SEF may set the single month limit at a level lower than that
of the all-month limit, an exemption for intramarket spread position
may be useful. See CEA section 5(d)(5); 7 U.S.C. 7(d)(5). An
exemption for intramarket spread positions would be unnecessary if
the DCM or SEF sets the single month limit at the same level as the
all-months limit.
Additionally, the duplicative term “arbitrage” would be
removed because CEA section 4a(a)(1) explains that “the word
`arbitrage’ in domestic markets shall be defined to mean the same as
`spread’ or `straddle.’ ” 7 U.S.C. 6a(a)(1).
672 Hence, proposed Sec. 150.5(a)(2)(C) would codify as a
requirement for DCMs and SEFs the acceptable practice concerning
application for exemption listed in 17 CFR 150.5(d)(2).
673 Proposed Sec. 150.5(a)(2)(C) presents guidance that
largely mirrors the guidance provided in the second half of 17 CFR
150.5(d), with edits to specify DCMs and SEFs.
—————————————————————————
Proposed Sec. 150.5(a)(3)(i) requires a DCM or SEF to exempt from
speculative position limits established under Sec. 150.2 a swap
position acquired in good faith prior to the effective date of such
limits.674 However, proposed Sec. 150.5(a)(3)(i) would allow a
person to net such a pre-existing swap with post-effective date
commodity derivative contracts for the purpose of complying with any
non-spot-month speculative position limit. Furthermore, proposed Sec.
150.5(a)(3)(ii) requires a DCM or SEF to exempt from non-spot-month
speculative position limits established under Sec. 150.2 any commodity
derivative contract acquired in good faith prior to the effective date
of such limit. However, such a pre-existing commodity derivative
contract position must be attributed to the person if the person’s
position is increased after the effective date of such limit.675
—————————————————————————
674 The Commission is exercising its authority under CEA
section 4a(a)(7) to exempt pre-Dodd-Frank and transition period
swaps from speculative position limits (unless the trader elects to
include such a position to net with post-effective date commodity
derivative contracts). Such a pre-existing swap position will be
exempt from initial spot month speculative position limits.
675 Notwithstanding any pre-existing exemption adopted by a
DCM or SEF that applies to speculative position limits in non-spot
months, a person holding pre-existing commodity derivative contracts
(except for pre-existing swaps as described above) must comply with
spot month speculative position limits. However, nothing in proposed
Sec. 150.5(a)(3)(B) would override the exclusion of pre-Dodd-Frank
and transition period swaps from speculative position limits.
—————————————————————————
The Commission proposes to require DCMs and SEFs to have
aggregation polices that mirror the federal aggregation
provisions.676 Therefore, proposed Sec. 150.5(a)(4) requires DCMs
and SEFs to have aggregation rules that conform to the uniform
standards listed in Sec. 150.4.677
—————————————————————————
676 See supra discussion concerning aggregation.
677 Proposed Sec. 150.5(a)(4) references 17 CFR 150.4 as the
regulation governing aggregation for contracts subject to federal
position limits and would replace 17 CFR 150.5(g). See supra the
Commission’s explanation for implementing uniform aggregation
standards across DCMs and SEFs.
—————————————————————————
A DCM or SEF would continue to be free to enforce position limits
that are more stringent that the federal limits. The Commission
clarifies that federal spot month position limits do not to apply to
physical-delivery contracts after delivery obligations are
established.678 Exchanges generally prohibit transfer or offset of
positions once long and short position holders have been assigned
delivery obligations. Proposed Sec. 150.5(a)(6) would clarify
acceptable practices for a DCM or SEF to enforce spot month limits
against the combination of, for example, long positions that have not
been stopped, stopped positions, and deliveries taken in the current
spot month.679
—————————————————————————
678 Therefore, federal spot month position limits do not apply
to positions in physical-delivery contracts on which notices of
intention to deliver have been issued, stopped long positions,
delivery obligations established by the clearing organization, or
deliveries taken.
679 For example, an exchange may restrict a speculative long
position holder that otherwise would obtain a large long position,
take delivery, and seek to re-establish a large long position in an
attempt to corner a significant portion of the deliverable supply or
to squeeze shorts. Proposed Sec. 150.5(b)(9) would set forth the
same acceptable practices for contracts not subject to federal
limits.
—————————————————————————
3. Proposed Sec. 150.5(b)–Requirements and Acceptable Practices for
Commodity Derivative Contracts That Are Not Subject to Federal Position
Limits
The Commission sets forth in proposed Sec. 150.5(b) requirements
and acceptable practices applicable to DCM- and SEF-set speculative
position limits for any contract that is not subject to federal
position limits, including physical and excluded commodities.680
—————————————————————————
680 For position limits purposes, proposed Sec. 150.1(k)
would define “physical commodity” to mean any agricultural
commodity, as defined in 17 CFR 1.3, or any exempt commodity, as
defined in section 1a(20) of the Act. Excluded commodity is defined
in section 1a(19) of the Act.
—————————————————————————
As discussed above, the Commission proposes to revise Sec. 150.5
to implement uniform requirements for DCMs and SEFs relating to hedging
exemptions across all types of commodity derivative contracts,
including those that are not subject to federal position limits. The
Commission further proposes to require DCMs and SEFs to have uniform
aggregation polices that mirror the federal aggregation provisions for
all types of commodity derivative contracts, including for contracts
that are not subject to federal position limits. As explained above,
hedging exemptions and aggregation policies that vary from exchange to
exchange would increase the administrative burden on a trader active on
multiple exchanges, as well as increase the administrative burden on
the Commission in monitoring and enforcing exchange-set position
limits.
Therefore, proposed Sec. 150.5(b)(5)(i) would require any hedge
exemption rules adopted by a designated contract market or a swap
execution facility that is a trading facility to conform to the
definition of bona fide hedging position in proposed Sec. 150.1. In
addition to this affirmative rule, proposed Sec. 150.5(b)(5) would set
forth acceptable practices for DCMs and SEFs to grant exemptions from
position limits for positions, other than bona fide hedging positions,
in contracts not subject to federal limits. Such exemptions generally
track the exemptions set forth in proposed Sec. 150.3, and are
suggested as acceptable practices based on the same logic that
underpins the proposed Sec. 150.3 exemptions.681 It would be
acceptable practice for a DCM or SEF to grant exemptions under certain
circumstances for financial distress, intramarket and intermarket
spreads, and qualifying cash-settled contract positions in the spot
month.682 Additionally, proposed Sec. 150.5(b)(5)(ii) would set
forth an acceptable practice for a DCF or SEF to grant a limited risk
management exemption for contracts on excluded commodities pursuant to
rules submitted to the Commission, and consistent with the guidance in
new appendix A to part 150.683
—————————————————————————
681 See supra discussion of the Sec. 150.3 exemptions.
682 See id.
683 New appendix A to part 150 is intended to capture the
essence of the Commission’s 1987 interpretation of its definition of
bona fide hedge transactions to permit exchanges to grant hedge
exemptions for various risk management transactions. See Risk
Management Exemptions From Speculative Position Limits Approved
Under Commission Regulation 1.61, 52 FR 34633, Sep. 14, 1987. The
Commission specified that such exemptions be granted on a case-by-
case basis, subject to a demonstrated need for the exemption. It
also required that applicants for these exemptions be typically
engaged in the buying, selling, or holding of cash market
instruments. See id. Additionally, the Commission required the
exchanges to monitor the exemptions they granted to ensure that any
positions held under the exemption did not result in any large
positions that could disrupt the market. See id. The term “excluded
commodity” is defined in CEA section 1(a)(19).
—————————————————————————
Proposed Sec. 150.5(b)(6) and (7) set forth acceptable practices
relating to pre-enactment and transition period swap positions (as
those terms are defined in proposed Sec. 150.1),684 and to commodity
derivative contract positions acquired in good faith prior to the
effective date of mandatory federal speculative position limits.
—————————————————————————
684 See supra discussion of pre-enactment and transition
period swap positions.
—————————————————————————
Additionally, for any contract that is not subject to federal
position limits, proposed Sec. 150.5(b)(8) requires the DCM or SEF to
conform to the uniform federal aggregation provisions.685 This
proposed requirement generally mirrors the requirement in proposed
Sec. 150.5(a)(4) for contracts that are subject to federal position
limits by requiring the DCM or SEF to have
[[Page 75757]]
aggregation rules that conform to Sec. 150.4.
—————————————————————————
685 Proposed Sec. 150.5(b)(7) would replace 17 CFR 150.5(g)
as it relates to contracts that are not subject to federal position
limits.
—————————————————————————
The Commission proposes in Sec. 150.5(b) to generally update and
reorganize the set of acceptable practices listed in current Sec.
150.5 as it relates to contracts that are not subject to the federal
position limits. For existing and newly established DCMs and newly
established SEFs, these acceptable practices generally concern how to:
(1) Set spot-month position limits; (2) set individual non-spot month
and all-months-combined position limits; (3) set position limits for
cash-settled contracts that use a reference contract as a price source;
(4) adjust position limit levels after a contract has been listed for
trading; and (5) adopt position accountability in lieu of speculative
position limits.
For a derivative contract that is based on a commodity with a
measurable deliverable supply, proposed Sec. 150.5(b)(1)(i)(A) updates
the acceptable practice in current Sec. 150.5(b)(1) whereby spot month
position limits should be set at a level no greater than one-quarter of
the estimated deliverable supply of the underlying commodity.686
Proposed Sec. 150.5(b)(1)(i)(A) clarifies that this acceptable
practice for setting spot month position limits would apply to any
commodity derivative contract, whether physical-delivery or cash-
settled, that has a measurable deliverable supply.687
—————————————————————————
686 Proposed Sec. 150.5(b)(1)(i)(A) is consistent with the
Commission’s longstanding policy regarding the appropriate level of
spot-month limits for physical delivery contracts. These position
limits would be set at a level no greater than 25 percent of
estimated deliverable supply. The spot-month limits would be
reviewed at least every 24 months thereafter. The proposed
deliverable supply formula narrowly targets the trading that may be
most susceptible to, or likely to facilitate, price disruptions. The
formula seeks to minimize the potential for corners and squeezes by
facilitating the orderly liquidation of positions as the market
approaches the end of trading and by restricting swap positions that
may be used to influence the price of referenced contracts that are
executed centrally.
687 In general, the term “deliverable supply” means the
quantity of the commodity meeting a derivative contract’s delivery
specifications that can reasonably be expected to be readily
available to short traders and saleable to long traders at its
market value in normal cash marketing channels at the derivative
contract’s delivery points during the specified delivery period,
barring abnormal movement in interstate commerce. Proposed Sec.
150.1 would define commodity derivative contract to mean any
futures, option, or swap contract in a commodity (other than a
security futures product as defined in CEA section 1a(45)).
—————————————————————————
For a derivative contract that is based on a commodity without a
measurable deliverable supply, proposed Sec. 150.5(b)(1)(i)(B) would
codify as guidance that the spot month limit level should be no greater
than necessary and appropriate to reduce the potential threat of market
manipulation or price distortion of the contract’s or the underlying
commodity’s price.688
Proposed Sec. 150.5(b)(1)(ii)(A) preserves the existing acceptable
practice in current Sec. 150.5(b)(2) whereby individual non-spot or
all-months-combined levels for agricultural commodity derivative
contracts that are not subject to the federal limits should be no
greater than 1,000 contracts at initial listing. The proposed rule
would also codify as guidance that the 1,000 contract limit should be
taken into account when the notional quantity per contract is no larger
than a typical cash market transaction in the underlying commodity, or
reduced if the notional quantity per contract is larger than a typical
cash market transaction.689 Additionally, proposed Sec.
150.5(b)(1)(ii)(A) would codify that if the commodity derivative
contract is substantially the same as a pre-existing DCM or SEF
commodity derivative contract, then it would be an acceptable practice
for the DCM or SEF to adopt the same limit as applies to that pre-
existing commodity derivative contract.690
—————————————————————————
688 This descriptive standard is largely based on the language
of DCM core principle 5 and SEF core principle 6. The Commission
does not suggest that an excluded commodity derivative contract that
is based on a commodity without a measurable supply should adhere to
a numeric formula in setting spot month position limits.
689 The Commission explained what it considers to be a
“typical cash market transaction” in the preamble for final part
151 (subsequently vacated): “[f]or example, if a DCM or SEF offers
a new physical commodity contract and sets the notional quantity per
contract at 100,000 units while most transactions in the cash market
for that commodity are for a quantity of between 1,000 and 10,000
units and exactly zero percent of cash market transactions are for
100,000 units or greater, then the notional quantity of the
derivatives contract offered by the DCM or SEF would be atypical.
This clarification is intended to deter DCMs and SEFs from setting
non-spot-month position limits for new contracts at levels where
they would constitute non-binding constraints on speculation through
the use of an excessively large notional quantity per contract. This
clarification is not expected to result in additional marginal cost
because, among other things, it reflects current Commission custom
in reviewing new contracts and is an acceptable practice for core
principle compliance and not a requirement per se for DCMs or
SEFs.” See 76 FR 71660.
690 In this context, “substantially the same” means a close
economic substitute. For example, a position in Eurodollar futures
can be a close economic substitute for a fixed-for-floating interest
rate swap.
—————————————————————————
Proposed Sec. 150.5(b)(1)(ii)(B) preserves the existing acceptable
practice, set forth in current Sec. 150.5(b)(3), for DCMs to set
individual non-spot or all-months-combined limits at levels no greater
than 5,000 contracts at initial listing, but would apply this
acceptable practice on a wider scale to both exempt and excluded
commodity derivative contracts.691 Proposed Sec. 150.5(b)(1)(ii)(B)
would codify as guidance for exempt and excluded commodity derivative
contracts that the 5,000 contract limit should be applicable when the
notional quantity per contract is no larger than a typical cash market
transaction in the underlying commodity, or should be reduced if the
notional quantity per contract is larger than a typical cash market
transaction. Additionally, proposed Sec. 150.5(b)(1)(B)(ii) would
codify a new acceptable practice for a DCM or SEF to adopt the same
limit as applies to the pre-existing contract if the new commodity
contract is substantially the same as an existing contract.
—————————————————————————
691 In contrast, 17 CFR 150.5(b)(3) lists this as an
acceptable practice for contracts for energy products and non-
tangible commodities. Excluded commodity is defined in CEA section
1a(19), and exempt commodity is defined CEA section 1a(20).
—————————————————————————
Proposed Sec. 150.5(b)(1)(iii) sets forth that if a commodity
derivative contract is cash-settled by referencing a daily settlement
price of an existing contract listed on a DCM or SEF, then it would be
an acceptable practice for a DCM or SEF to adopt the same position
limits as the original referenced contract, assuming the contract sizes
are the same. Based on its enforcement experience, the Commission
believes that limiting a trader’s position in cash-settled contracts in
this way diminishes the incentive to exert market power to manipulate
the cash-settlement price or index to advantage a trader’s position in
the cash-settled contract.692
—————————————————————————
692 With respect to cash-settled contracts where the
underlying product is a physical commodity with limited supplies,
enabling a trader to exert market power (including agricultural and
exempt commodities), the Commission has viewed the specification of
speculative position limits to be an essential term and condition of
such contracts in order to ensure that they are not readily
susceptible to manipulation, which is the DCM core principle 3
requirement.
—————————————————————————
Proposed Sec. 150.5(b)(2)(i) updates the acceptable practices in
current Sec. 150.5(c) for adjusting limit levels for the spot month.
For a derivative contract that is based on a commodity with a
measurable deliverable supply, proposed Sec. 150.5(b)(2)(i) maintains
the acceptable practice in current Sec. 150.5(c) to adjust spot month
position limits to a level no greater than one-quarter of the estimated
deliverable supply of the underlying commodity, but would apply this
acceptable practice to any commodity derivative contract, whether
physical-delivery or cash-settled, that has a measurable deliverable
supply. For a derivative contract that is based on a commodity without
a measurable deliverable supply, proposed Sec. 150.5(b)(1)(i)(B) would
codify as
[[Page 75758]]
guidance that the spot month limit level should not be adjusted to
levels greater than necessary and appropriate to reduce the potential
threat of market manipulation or price distortion of the contract’s or
the underlying commodity’s price. Proposed Sec. 150.5(b)(2)(i) would
codify as a new acceptable practice that spot month limit levels be
reviewed no less than once every two years.
Proposed Sec. 150.5(b)(2)(ii) maintains as an acceptable practice
the basic formula set forth in current Sec. 150.5(c)(2) for adjusting
non-spot-month limits at levels of no more than 10% of the average
combined futures and delta-adjusted option month-end open interest for
the most recent calendar year up to 25,000 contracts, with a marginal
increase of 2.5% of the remaining open interest thereafter. Proposed
Sec. 150.5(b)(2)(ii) would also maintain as an alternative acceptable
practice the adjustment of non-spot-month limits to levels based on
position sizes customarily held by speculative traders in the contract.
Proposed Sec. 150.5(b)(3) generally updates and reorganizes the
existing acceptable practices in current Sec. 150.5(e) for a DCM or
SEF to adopt position accountability rules in lieu of position limits,
under certain circumstances, for contracts that are not subject to
federal position limits. This proposed section reiterates the DCM’s
authority, with conforming changes for SEFs, to require traders to
provide information regarding their position when requested by the
exchange.693 Proposed Sec. 150.5(b)(3) would codify a new acceptable
practice for a DCM or SEF to require traders to consent to halt from
increasing their position in a contract if so ordered. Proposed Sec.
150.5(b)(3) would also codify a new acceptable practice for a DCM or
SEF to require traders to reduce their position in an orderly manner.
—————————————————————————
693 Compare 17 CFR 150.5(e)(2)-(3).
—————————————————————————
Proposed Sec. 150.5(b)(3)(i) would maintain the acceptable
practice for a DCM or SEF to adopt position accountability rules
outside the spot month, in lieu of position limits, for an agricultural
or exempt commodity derivative contract that: (1) has an average month-
end open interest of 50,000 contracts and an average daily volume of
5,000 or more contracts during the most recent calendar year; (2) has a
liquid cash market; and (3) is not subject to federal limits in Sec.
150.2–provided, however, that such DCM or SEF should adopt a spot
month speculative position limit with a level no greater than one-
quarter of the estimated spot month deliverable supply.694
—————————————————————————
694 17 CFR 150.5(e)(3) applies this acceptable practice to a
“tangible commodity, including, but not limited to metals, energy
products, or international soft agricultural products.” Also,
compare the “minimum open interest and volume test” in proposed
Sec. 150.5(b)(3)(i) with that in current Sec. 150.5(e)(3).
—————————————————————————
For an excluded commodity derivative contract that has a highly
liquid cash market and no legal impediment to delivery, proposed Sec.
150.5(b)(3)(ii)(A) would maintain the acceptable practice for a DCM or
SEF to adopt position accountability rules in the spot month in lieu of
position limits. For an excluded commodity derivative contract without
a measurable deliverable supply, proposed Sec. 150.5(b)(3)(ii)(A)
would codify an acceptable practice for a DCM or SEF to adopt position
accountability rules in the spot month in lieu of position limits
because there is not a deliverable supply that is subject to
manipulation. However, for an excluded commodity derivative contract
that has a measurable deliverable supply, but that may not be highly
liquid and/or is subject to some legal impediment to delivery, proposed
Sec. 150.5(b)(3)(ii)(A) sets forth an acceptable practice for a DCM or
SEF to adopt a spot-month position limit equal to no more than one-
quarter of the estimated deliverable supply for that commodity, because
the estimated deliverable supply may be susceptible to manipulation.
Furthermore, proposed Sec. 150.5(b)(3)(ii) would remove the “minimum
open interest and volume” test for excluded commodity derivative
contracts generally.695 Proposed Sec. 150.5(b)(3)(ii)(B) would
codify an acceptable practice for a DCM or SEF to adopt position
accountability levels for an excluded commodity derivative contract in
lieu of position limits in the individual non-spot month or all-months-
combined.
—————————————————————————
695 The “minimum open interest and volume” test, as
presented in 17 CFR 150.5(e)(1)-(2), need not be used to determine
whether an excluded commodity derivative contract should be eligible
for position accountability rules in lieu of position limits in the
spot month.
—————————————————————————
Proposed Sec. 150.5(b)(3)(iii) adds a new acceptable practice for
an exchange to list a new contract with position accountability levels
in lieu of position limits if that new contract is substantially the
same as an existing contract that is currently listed for trading on an
exchange that has already adopted position accountability levels in
lieu of position limits.696
—————————————————————————
696 See supra discussion of what is meant by “substantially
the same” in this context.
—————————————————————————
Proposed Sec. 150.5(b)(4) maintains the acceptable practice that
for contracts not subject to federal position limits, DCMs and SEFs
should calculate trading volume and open interest as established in
current Sec. 150.5(e)(4).697 Proposed Sec. 150.5(b)(4) would build
upon these standards by accounting for swaps in reference contracts on
a futures-equivalent basis.698
—————————————————————————
697 For SEFs, trading volume and open interest for swaptions
should be calculated on a delta-adjusted basis.
698 “Futures-equivalent” is a defined term in proposed Sec.
150.1 that accounts for swaps in referenced contracts.
—————————————————————————
III. Related Matters
A. Considerations of Costs and Benefits
1. Background
Generally, speculative position limits cap the size of positions
that a person may hold or control in commodity derivative contracts for
speculative purposes.699 First authorized in 1936,700 position
limits are not a new regulatory tool for containing speculative market
activity. The Commission and its predecessors have directly set limits
for futures and options contracts on certain agricultural commodities
since 1938. Additionally, for approximately 20 years from 1981 until
the Commodity Futures Modernization Act (“CFMA”) 701 amended the
CEA to substitute a core-principles-based, self-regulatory model for
futures exchanges, Commission rules required exchanges to set position
limits (or, in certain
[[Page 75759]]
specified cases, position accountability levels) for futures and
options contracts not subject to Commission-imposed limits.702
Through amendments to the CEA over more than 75 years and a number of
legislative reauthorizations, the Commission’s basic authority to
establish speculative position limits, now codified in CEA section
4a(a), has remained constant.703
—————————————————————————
699 Derivative contracts–i.e., futures, options and swaps–
may not transfer any ownership interest in the underlying commodity,
but their prices are substantially derived from the value of the
underlying commodity. Those who purchase or sell derivatives do so
either to hedge or speculate. Generally, hedging is the use of
derivatives markets by commodity producers, merchants or end-users
to manage their exposure to fluctuation in the price of a commodity
that a producer or user intends to use or produce; speculation, in
contrast, is the use of derivative markets to profit from price
appreciation or depreciation in the underlying commodity. Because
the limits only restrict positions obtained for speculative
purposes, this discussion refers interchangeably to “position
limits,” “speculative position limits,” or “speculative
limits.”
700 Congress first granted the CEC, a Commodity Futures
Trading Commission predecessor, authority to set speculative
position limits as part of the New Deal reforms enacted in the
Commodity Exchange Act of 1936. Public Law 74-765, 49 Stat. 1491,
1492 (codified at 7 U.S.C. 6a(1) (1940)). Specifically, Congress
authorized the CEC to “fix such limits on the amount of trading . .
. which may be done by any person as the [CEC] finds is necessary to
diminish, eliminate, or prevent such burden.” Congress exempted
positions attributable to bona fide hedging. Unless otherwise
indicated, references in this discussion to the “Commission” mean
the Commodity Futures Trading Commission as well as its predecessor
agencies, including the CEC.
701 Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (Dec. 21, 2000).
702 See, e.g., 46 FR 50938, 50940, Oct. 16, 1981. As discussed
above, following enactment of the CFMA, which among other things
afforded DCMs discretion to set appropriate position limits under
DCM core principle 5, these rules, then contained in Sec. 150.5,
became ineffective as requirements; they were retained, however, as
guidance and acceptable practices for DCMs to use in meeting their
core principle 5 compliance obligations. 74 FR 12178, 12183, Mar.
23, 2009.
703 One of these amendments, the Commodity Futures Trading Act
of 1974, created the CFTC and granted it expanded jurisdiction
beyond the certain enumerated agricultural products of its
predecessor to all “services, rights, and interests” in which
futures contracts are traded. Public Law 93-463, 88 Stat. 1389
(1974).
—————————————————————————
The backdrop for this basic authority is a public record replete
with Congressional and other official governmental investigations and
reports–issued over more than 80 years–critical of the harm
attributed to “excess speculation” in derivative markets. From the
1920s through 2009, a litany of official government investigations,
hearings and reports document disruptive speculative behavior; 704
several of the earliest link the behavior to artificial price effects
and impaired commodity distribution efficiency, and recommend mandatory
position limits as a tool to curb speculative abuses and their ill-
effects. The statute reflects and responds to the centerpiece concern
of these hearings and reports. Indeed, CEA section 4a(a)(1) states
Congress’s express determination that excessive commodity speculation
causing sudden or unreasonable price fluctuations or unwarranted
changes in commodity prices is an undue and unnecessary burden on
interstate commerce, and mandates that the Commission set position
limits, including prophylactic limits, to diminish, eliminate, or
prevent this burden.705
—————————————————————————
704 See, e.g., Federal Trade Commission, “Report of the
Federal Trade Commission on the Grain Trade,” vol. VI, at 60-62
(1924)(documenting a number of “violent fluctuations of price”
over the preceding 30 years evidencing “the close connection
between extreme fluctuations in annual average prices of cash grain
and unusual speculative activity in the futures market”); id. vol.
VII, at 293-294 (1926)(recommending limitation on individual open
interest because the “very large trader . . . [w]hether he is more
often right than wrong . . . and whether influenced by a desire to
manipulate or not . . . can cause disturbances in the market which
impair its proper functioning and are harmful to producers and
consumers”); Grain Futures Administration, “Fluctuations in Wheat
Futures,” S. Doc. No. 69-135, at 1,6 (1926) (investigation of
“wide and erratic [1925 wheat futures] price fluctuations . . .
were largely artificial[,] were caused primarily . . . by heavy
trading on the part of a limited number of professional speculators
[that] completely disrupted the market and resulted in abnormal
fluctuations . . . felt in every other large grain market in the
world;” concludes that limitations on the extent of daily trading
by speculators are “inevitable . . . if there is to be eliminated
from the market those hazards which are so unmistakably reflected as
existing whenever excessively large lines are held by
individuals”); 1932 Annual Report of the Chief of the Grain Futures
Admin., at 4, 8 (describing the 16 percent drop in May wheat prices
during a 21-day period as illustrative of the price impact of
“short selling by a few large traders;” again stresses the need
for legislation authorizing limitations to eliminate “the economic
evils incident to market domination by a few powerful operators
trading for speculative account”); 1950 Annual Report of the
Administrator of the Commodity Exchange Authority, at 14-15
(speculative operations by a small number of traders holding a large
proportion of long contracts “distorted egg future prices in
October 1949 and disrupted orderly marketing of the commodity
causing financial losses;” notes that enforcement of speculative
limits is a “strong deterrent to excessive speculation by large
traders”); Commodity Futures Trading Commission, Report To The
Congress In Response To Section 21 Of The Commodity Exchange Act,
May 29, 1981, Part Two, A Study of the Silver Market (addressing
silver market corner discussed above); “The Role of Market
Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back
on the Beat,” Staff Report, Permanent Subcommittee on
Investigations of the Senate Committee on Homeland Security and
Governmental Affairs, U.S. Senate, S. Rpt. No. 109-65 at 1 (June 27,
2006) (addressing speculation and price increases in oil and gas
markets) [hereinafter “Oil & Gas Report”]; “Excessive Speculation
in the Natural Gas Market, Staff Report,” Permanent Subcommittee on
Investigations of the Senate Committee on Homeland Security and
Governmental Affairs, U.S. Senate, at 1 (June 25, 2007) (addressing
speculation, price increases and market distortion in natural gas
markets discussed above) [hereinafter “Gas Report”]; “Excessive
Speculation in the Wheat Market;” Staff Report, Permanent
Subcommittee on Investigations of the Senate Committee on Homeland
Security and Governmental Affairs, U.S. Senate, at 2 (June 24, 2009)
(addressing excessive speculation in wheat futures contracts by
commodity index traders) [hereinafter “Wheat Report”]; see also
Jerry W. Markham, “The History of Commodity Futures Trading and its
Regulation,” at 3-47 (1987) (summarizes numerous incidents of large
speculative trader abuse in an array of commodities from the
emergence of futures exchanges in the mid-1800s through the 1970s).
705 The roots of this statutory determination date back to
1922, when Congress found “sudden or unreasonable fluctuations in
the prices” of certain commodity futures transactions “frequently
occur as a result of [ ] speculation, manipulation or control” and
that “such fluctuations in prices are an obstruction to and a
burden upon” interstate commerce. Grain Futures Act of 1922, ch.
369 at section 3, 342 Stat. 998, 999 (1922), codified at 7 U.S.C. 5
(1925-26).
—————————————————————————
The longstanding statutory approach to position limit regulation
reflects two important concepts with direct bearing on the benefits and
costs involved in this rulemaking. First is the distinction between
speculative trading, for which limits are statutorily authorized, and,
as to derivatives for physical commodities, mandated, and bona fide
hedging, for which they are not.706 This distinction is important
because a chief purpose of position limits is to preserve the integrity
of derivative markets for the benefit of producers that use them to
hedge risk and consumers that consume the underlying commodities.
—————————————————————————
706 See CEA section 4a(c)(1); 7 U.S.C. 6a(c)(1).
—————————————————————————
Second is the distinction between speculation generally and
excessive speculation as addressed in CEA section 4a(a)(1). While, as
noted above, numerous government inquires have linked speculation at
excessive levels to abuses and burdens on commerce, below excessive
levels, speculation provides needed liquidity to derivative
markets.707
—————————————————————————
707 Hedgers do not always trade simultaneously in the same
quantities in opposing directions. That is, long and short hedgers
may trade at different times and with different quantities, often
making transactions between only hedgers unfeasible. Speculative
traders thus provide a trading partner for hedgers for whom there is
no feasible hedger counterparty. In so doing, speculators provide
valuable liquidity to the market.
—————————————————————————
In 2010 the Dodd-Frank Act 708 amended CEA section 4a(a). These
amendments responded to the 2008 financial crisis and came in the wake
of three Congressional reports within a three-year span finding
increased and/or “excessive” derivative market speculation linked to
increased and distorted prices. These reports recommended increased
statutory authority to, in the parlance of two of the reports, put the
Commission “back on the beat.” 709 Among other things, the Dodd-
Frank Act 710 expanded the Commission’s speculative position limit
authority under CEA section 4a to
[[Page 75760]]
mandate that the Commission: (i) establish limits on the amount of
positions, as appropriate, that may be held by any person in
agricultural and exempt commodity 711 futures and options contracts
traded on a DCM (CEA section 4a(a)(2));* * * 712 (ii) establish at an
appropriate level position limits for swaps that are economically
equivalent to those futures and options that are subject to mandatory
position limits pursuant to CEA section 4a(a)(2), and do so at the same
time as the CEA section 4a(a)(2) limits are established (CEA section
4a(a)(5)); and (iii) apply position limits on an aggregate basis to
contracts based on the same underlying commodity across enumerated
trading venues 713 (CEA section 4a(a)(6)).
—————————————————————————
708 Public Law 111-203, 124 Stat. 1376 (2010).
709 See, e.g., Wheat Report, at 15-16 (excessive speculation
in wheat futures contracts by commodity index traders contributed to
“unreasonable fluctuations or unwarranted changes” in wheat
futures prices, resulting in an abnormally large and persistent gap
between wheat futures and cash prices (the basis);” commerce was
unduly burdened; stiffened position limit regulation for index
traders recommended); Gas Report, at 3-7 (“[t]he current regulatory
system was unable to prevent [the hedge fund] Amaranth’s excessive
speculation in the 2006 natural gas market;” the experience
demonstrated “how excessive speculation can distort prices” and
have “serious consequences for other market participants;” and the
Commission should be put “back on the beat”); Oil & Gas Report, at
6-7 (heavy speculation in commodity energy markets contributed to
rising U.S. energy prices, distorting the historical relationship
between price and inventory; recommends putting the CFTC “back on
the beat” to police these markets by eliminating the “Enron”
loophole that limited it from doing so). In the interval between the
two reports addressed to energy market speculation and the Dodd-
Frank Act amendments, Congress also expanded the Commission’s
authority to set position limits for significant price discovery
contracts on exempt commercial markets. See Food, Conservation and
Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (2008).
710 Dodd-Frank Act section 737(a).
711 As defined in CEA section 1a(20), “exempt commodity”
means a commodity that is neither an agricultural commodity nor an
“excluded commodity.” Excluded commodities, in turn, are defined
in CEA section 1a(19) to encompass specified groups of financial and
occurrence-based commodities. Accordingly, exempt commodities
include energy products and metals. The Dodd-Frank mandate in CEA
section 4a(a)(2) to impose limits applies to all agricultural and
exempt commodities (collectively, physical commodities). This
mandate does not apply to excluded commodities, which are primarily
intangible commodities, like financial products.
712 The Commission’s statutory interpretation of its mandate
under CEA section 4a(a)(2) is discussed in detail above. A separate
provision added by the Dodd-Frank Act directs the Commission with
respect to factors to consider in establishing the levels of
speculative position limits that are mandated by CEA section
4a(a)(2). See CEA section 4a(a)(3); 7 U.S.C. 6a(a)(3).
713 Specifically, as enumerated these are: (1) contracts
listed by DCMs; (2) with respect to FBOTs, contracts that are price-
linked to a contract listed for trading on a registered entity and
made available from within the United States via direct access; and
(3) SPDF Swaps.
—————————————————————————
Additionally, the Dodd-Frank Act requires DCMs and SEFs to set
position limits for any contract subject to a Commission-imposed limit
at a level not higher than the Commission’s limit.714 Finally, the
Dodd-Frank Act, through new CEA section 4a(c)(2), requires that the
Commission define bona fide hedging positions pursuant to an express
framework for purposes of exclusion from position limits. The
Commission’s approach, historically, to exercising its statutory
position limits authority has been to set or order limits
prophylactically to deter all forms of manipulation and to diminish,
eliminate, or prevent excessive speculation.715 It has done so
through regulations comprised of three primary components: (1) The
level of the limits, which set a threshold that restricts the number of
speculative positions that a person may hold in the spot-month, in any
individual month, and in all months combined; (2) the standards for
what constitute bona fide hedging versus speculative transactions, as
well as other exemptions; and (3) the accounts and positions a person
must aggregate for the purpose of determining compliance with the
position limit levels. These rules now reside in part 150 of the
Commission’s regulations.716 The rules proposed herein would amend
part 150 and make certain conforming amendments to related reporting
requirements in parts 15, 17 and 19. They would do so in a manner that
represents an extension of the Commission’s historical approach towards
the first two components: limit levels and exemptions. The third
component, aggregation, is addressed in a separate Commission
rulemaking.717
—————————————————————————
714 See Dodd-Frank Act sections 735(b) (amending CEA section
5(d)(5)) and 733 (adding CEA section 5h, subsection (f)(6) of which
specifies SEF’s core principle obligation with respect to position
limitations or accountability).
715 See, e.g., 46 FR 50938, 50940, Oct. 16, 1981. In this
release adopting Sec. 1.61, the Commission articulated its
interpretation that the CEA authorized prophylactic speculative
position limits. One year later, Congress enacted the Futures
Trading Act of 1982, Public Law 97-444, 96 Stat. 2294, 2299-
2300(1982), which, inter alia, amended the CEA to “clarify and
strengthen the Commission’s” position limits authority. S. Rep. 97-
384, at 44 (1982). Congress enacted this strengthening amendment
with awareness of the Commission’s prophylactic interpretation and
approach, and after rejecting amendments that would have
circumscribed the Commission’s authority. See, e.g., Futures Trading
Act of 1982: Hearings on S. 2109 before the S. Subcomm. on
Agricultural Research, 97th Cong. 28, 29, 44-45, 337, 340-45 (1982)
(oral and written statements of Commission Chair Phillip McBride
Johnson and Commodity Exchange Executive Vice Chair Lee Berendt
concerning, inter alia, the Commission’s omnibus approach to
position limits); S. Rep. 97-384, at 44-45, 79 (discussing rejected
amendments).
716 As discussed above, the District Court for the District of
Columbia vacated part 151 of the Commission’s regulations, which
would have replaced part 150. As a result, part 150 remains in
effect.
717 See Aggregation NPRM.
—————————————————————————
i. Statutory Mandate To Consider Costs and Benefits
CEA section 15(a) 718 requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders. CEA section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations.719
—————————————————————————
718 7 U.S.C. 19(a).
719 In ICI v. CFTC, 2013 WL 3185090, at *8 (D.C. Cir. 2013),
the United States Court of Appeals for the D.C. Circuit held that
CEA section 15(a) imposes no duty on the Commission to conduct a
quantitative economic analysis: “Where Congress has required
“`rigorous, quantitative economic analysis,”’ it has made that
requirement clear in the agency’s statute, but it imposed no such
requirement here [in the CEA].” Id. (citation omitted).
—————————————————————————
The Commission considers the costs and benefits resulting from its
discretionary determinations with respect to the CEA section 15(a)
factors.
Accordingly, the discussion that follows identifies, and considers
against the five CEA section 15(a) factors, benefits and costs to
market participants and the public that the Commission expects to flow
from these proposed rules relative to the statutory requirements of the
CEA and the Commission’s regulations now in effect. The Commission has
attempted to quantify the costs and benefits of these regulations where
feasible. Where quantification is not feasible the Commission
identifies and considers costs and benefits qualitatively.
Beyond specific questions interspersed throughout its discussion,
the Commission generally requests comment on all aspects of its
consideration of costs and benefits, including: identification and
assessment of any costs and benefits not discussed therein; data and
any other information to assist or otherwise inform the Commission’s
ability to quantify or qualify the benefits and costs of the proposed
rules; and, substantiating data, statistics, and any other information
to support positions posited by commenters with respect to the
Commission’s consideration of costs and benefits.
The following consideration of benefits and costs is generally
organized according to the following rules proposed in this release:
definitions (Sec. 150.1),720 federal position limits (Sec. 150.2),
exemptions to limits (Sec. 150.3), position limits set by DCMs and
SEFs (Sec. 150.5), anticipatory hedging requirements (Sec. 150.7),
and reporting requirements (Sec. 19.00). For each rule, the Commission
summarizes the proposed rule and considers the benefits and costs
expected to result from it.721 The Commission then considers the
benefits and costs of the proposed rules collectively in light of the
five public
[[Page 75761]]
interest considerations of CEA section 15(a).
—————————————————————————
720 Many of the revised or new definitions do not
substantively affect the Commission’s considerations of costs and
benefits on their own merit, but are considered in conjunction with
the sections of the rule that implement them.
721 The proposed rules also include amendments to 17 CFR parts
15 and 17, as discussed supra. The Commission preliminarily believes
these amendments are not substantive in nature and do not have cost
or benefit implications. The Commission welcomes comment on any
potential costs or benefits of the changes to parts 15 and 17.
—————————————————————————
2. Section 150.1–Definitions
Currently, Sec. 150.1 defines terms for operation within the
various rules that comprise part 150. As described above, the
Commission proposes formatting, organizational, and other non-
substantive amendments to these definitional provisions that, subject
to consideration of any relevant comments, it does not view as having
benefit or cost implications.722 But, with respect to a number of
definitions, the Commission proposes substantive amendments and
additions. With the exception of the term “bona fide hedging
position,” for which the benefits and costs of the proposed Sec.
150.1 definition are considered in the subsection directly below, any
benefits and costs attributable to substantive definitional changes and
additions proposed in Sec. 150.1 are considered in the discussion of
the rule in which such new or amended terms would be operational.
—————————————————————————
722 See supra discussion of proposed amendments to Sec.
150.1.
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i. Bona Fide Hedging
Proposed Sec. 150.1 would include a definition of the term “bona
fide hedging positions”–which operates to distinguish hedging
positions from those that are speculative and thus subject to position
limits, both federal and exchange-set, unless otherwise exempted by the
Commission. Hedgers present a lesser risk of burdening interstate
commerce as described in CEA section 4a because their positions are
offset in the physical market. CEA section 4a(c) has long directed that
no Commission rule, regulation or order establishing position limits
under CEA section 4a(a) apply to bona fide hedging as defined by the
Commission.723 The proposed definition would replace the definition
now contained in Sec. 1.3(z) to implement that statutory
directive.724
—————————————————————————
723 CEA section 4a(c)(1); 7 U.S.C. 6a(c)(1).
724 Currently, 17 CFR 1.3(z), defines the term “bona fide
hedging transactions and positions.” Originally adopted by the
newly formed Commission in 1975, a revised version of Sec. 1.3(z)
took effect two years later. This 1977 revision largely forms the
basis of the current definition of bona fide hedging. A history of
the definition of bona fide hedging is presented above. With the
adoption of the proposed definition of “bona fide hedging
positions” in Sec. 150.1, Sec. 1.3(z) would be deleted.
—————————————————————————
Generally, the current definition of bona fide hedging in Sec.
1.3(z) advises that a position should “normally represent a substitute
for . . . positions to be taken at a later time in a physical marketing
channel” and requires such position to be “economically appropriate
to the reduction of risks in the conduct of a commercial enterprise”
where the risks arise from the potential change in value of assets,
liabilities, or services.725 Such bona fide hedges must have a
purpose “to offset price risks incidental to commercial cash or spot
operations” and must be “established and liquidated in an orderly
manner in accordance with sound commercial practices.”
—————————————————————————
725 17 CFR 1.3(z)(1). The Commission cautions that the e-CFR
2012 version of this provision reflects changes made by the now-
vacated Part 151 rule.
—————————————————————————
This general definition thus provides general components of the
type of position that constitute a bona fide hedge position. The
criterion that such a position should “normally represent a substitute
for . . . positions to be taken at a later time in a physical marketing
channel” has been deemed the “temporary substitute” criterion. The
requirement that such position be “economically appropriate to the
reduction of risks in the conduct of a commercial enterprise” is
referred to as the “economically appropriate” test. The criterion
that hedged risks arise from the potential change in value of assets,
liabilities, or services is commonly known as the “change in value”
requirement or test. The phrase “price risks incidental to commercial
cash or spot operations” has been termed the “incidental test.” The
criterion that hedges must be “established and liquidated in an
orderly manner” is known as the “orderly trading requirement.” 726
—————————————————————————
726 See supra for additional explanation of these terms.
—————————————————————————
The current definition also describes a non-exclusive list of
transactions that satisfy the definitional criteria and therefore
qualify as bona fide hedges; these “enumerated hedging transactions”
are located in Sec. 1.3(z)(2). For those transactions that may fit the
definition but are not listed in Sec. 1.3(z)(2), current Sec.
1.3(z)(3) provides a means of requesting relief from the Commission.
The Dodd-Frank Act amended the CEA in ways that require the
Commission to adjust its current bona fide hedging definition.
Specifically, the Dodd-Frank Act added section 4a(c)(2) of the Act,
which the Commission interprets as directing the Commission to narrow
the bona fide hedging position definition for physical commodities from
the definition found in current Sec. 1.3(z)(1).727
Dodd-Frank also provided direction regarding the bona fide hedging
criteria for swaps contracts newly under the Commission’s jurisdiction.
Specifically, new CEA sections 4a(a)(5) and (6) require the Commission
to impose limits on an aggregate basis across all economically
equivalent contracts, excepting in both cases bona fide hedging
positions. CEA section 4a(c)(2)(B) describes which swap offset
positions may qualify as bona fide hedges. Finally, new CEA section
4a(a)(7) provides the Commission with authority to grant exemptive
relief from position limits. The Commission proposes to amend its
definition of bona fide hedging under the authority and direction of
amended CEA section 4a(c) and the other provisions added by the Dodd-
Frank Act. To the extent a change in the definition represents a
statutory requirement, it is not discretionary and thus not subject to
CEA section 15(a).
ii. Rule Summary
Like current Sec. 1.3(z), the proposed Sec. 150.1 bona fide
hedging definition employs a basic organizational model of stating
general, broadly applicable requirements for a hedge to qualify as bona
fide,728 and then specifying certain particular (“enumerated”)
hedges that are deemed to meet the general requirements.729
Generally, the proposed definition is built around the same criteria as
are currently found in Sec. 1.3(z), including the temporary substitute
and economically appropriate criteria. Thus, the proposed definition is
substantially similar to the current definition, with limited changes
to accommodate altered statutory requirements regarding bona fide
hedging as well as accomplish discretionary improvements. The proposed
definition also reflects organizational changes to better accommodate
the extension of speculative position limits to all economically
equivalent contracts across all trading venues. To the extent the
proposed definition carries over requirements currently resident in the
Sec. 1.3(z) definition, it does not represent a change from current
practice and therefore should not pose incremental benefits or costs.
—————————————————————————
728 Compare 17 CFR 1.3(z)(1) (“General Definition”) with the
proposed Sec. 150.1 definition of bona fide hedging opening
sentence and paragraphs (1) and (2) (respectively, “Hedges of an
excluded commodity” and “Hedges of a physical commodity”).
729 Compare 17 CFR 1.3(z)(2)(“Enumerated Hedging
Transactions”) with the proposed Sec. 150.1 definition of bona
fide hedging paragraphs (3) and (4) (respectively, “Enumerated
hedging positions” and “Other enumerated hedging positions”).
—————————————————————————
The proposed definition has been relocated from Sec. 1.3(z) to
Sec. 150.1 in order to facilitate reference between sections of part
150. The proposed
[[Page 75762]]
definition of bona fide hedging position is also re-organized into six
sections, starting with an opening paragraph describing the general
requirements for all hedges followed by five numbered paragraphs.
Paragraph (1) of the proposed definition describes requirements for
hedges of an excluded commodity,730 including guidance on risk
management exemptions that may be adopted by an exchange. Paragraph (2)
describes requirements for hedges of a physical commodity. Paragraphs
(3) and (4) describe enumerated exemptions. Paragraph (5) describes
cross-commodity hedges.
—————————————————————————
730 An “excluded commodity” is defined in CEA section
1a(19). The definition includes financial products such as interest
rates, exchange rates, currencies, securities, credit risks, and
debt instruments as well as financial events or occurrences.
—————————————————————————
The following discussion is meant to highlight the essential
components of each section of the proposed definition. A full
discussion of the history and policy rationale of each section may be
found supra.731
—————————————————————————
731 See discussion above.
—————————————————————————
a. Opening Paragraph
The opening paragraph of the proposed definition incorporates the
incidental test and the orderly trading requirement, both found in the
current Sec. 1.3(z)(1). The Commission intends the proposed incidental
test to be a requirement that the risks offset by a commodity
derivative contract hedging position must arise from commercial cash
market activities. The Commission believes this requirement is
consistent with the statutory guidance to define bona fide hedging
positions to permit the hedging of “legitimate anticipated business
needs.” 732 The incidental test allows the Commission to distinguish
between hedging and speculate activities by defining the former as
requiring a legitimate business need.
—————————————————————————
732 7 U.S.C. 6a(c)(1).
—————————————————————————
The proposed orderly trading requirement is intended to impose on
bona fide hedgers the duty to enter and exit the market carefully in
the ordinary course of business. The requirement is also intended to
avoid to the extent possible the potential for significant market
impact in establishing or liquidating a position in excess of position
limits. This requirement is particularly important because, as
discussed below, the Commission proposes to set the initial levels of
position limits at the outer bound of the range of levels of limits
that may serve to balance the statutory policy objectives in CEA
section 4a(a)(3) for limit levels. As such, bona fide hedgers likely
would only need an exemption for very large positions. The orderly
trading requirement is intended to prevent disorderly trading,
practices, or conduct from bona fide hedgers by encouraging market
participants to assess market conditions and consider how the trading
practices and conduct affect the orderly execution of transactions when
establishing or liquidating a position greater than the applicable
position limit.733
—————————————————————————
733 As discussed supra, the Commission believes that negligent
trading, practices, or conduct should be a sufficient basis for the
Commission to deny or revoke a bona fide hedging exemption.
—————————————————————————
b. Paragraph (1) Hedges of an Excluded Commodity
The first paragraph in the proposed definition addresses hedging of
an excluded commodity; it emanates from the Commission’s discretionary
authority to impose limits on intangible commodities. In general, in
addition to the requirements in the opening paragraph, proposed
paragraph (1) requires the position meet the economically appropriate
test and is either enumerated in paragraphs (3), (4), or (5) of the
proposed definition or is recognized by a DCM or SEF as a bona fide
hedge pursuant to exchange rules. The temporary substitute and change
in value criteria are not included in the proposed paragraph (1), as
these requirements are inappropriate in the context of certain excluded
commodities that lack a physical marketing channel.734
—————————————————————————
734 The Commission notes that DCMs currently incorporate the
temporary substitute and change in value criteria when the
contract’s underlying market has physical delivery obligations. The
proposal would not limit their ability to continue to do so when
appropriate.
—————————————————————————
Exclusively addressed to excluded commodity hedging, paragraph (1)
is relevant only for the purposes of exchange-set limits under Sec.
150.5 as proposed for amendment. As the Commission has determined to
focus the application of federal speculative position limits on 28
physical commodities and their related physical-delivery and cash-
settled referenced contracts, this paragraph does not affect the
imposition of federal speculative position limits and exemptions
thereto.
c. Paragraph (2) Hedges of a Physical Commodity
Proposed paragraph (2) of the definition enumerates what
constitutes a hedge for physical commodities, including physical
agricultural and exempt commodities both subject and not subject to
federal speculative position limits. In addition to the requirements in
the opening paragraph, proposed paragraph (2) requires that the
position satisfy the temporary substitute test, the economically
appropriate test, and the change-in-value test. These tests have been
incorporated into the revised statutory definition in CEA section
4a(c)(2) and essentially mirror the current definition in Sec.
1.3(z).735 The proposed paragraph (2) also requires the position
either be enumerated in proposed paragraphs (3), (4), or (5) or be a
pass-through swap offset or pass-through swap position as defined in
paragraph (2)(ii).
—————————————————————————
735 With respect to the temporary substitute test, the word
“normally” has been removed in the proposed definition in order to
conform with the stricter statutory standard in new CEA section
4a(c)(2). See discussion above.
—————————————————————————
Proposed paragraph (2) of the definition applies generally to
derivative positions that hedge a physical commodity and as such
includes swaps. Thus, the paragraph responds to the statutory
requirement in CEA section 4a(a)(5) that the Commission establish
limits on economically equivalent contracts, including swaps, excluding
bona fide hedging positions. The definition of a pass-through swap
offset position incorporates the definition in new CEA section
4a(c)(2)(B)(i), with the inclusion of the requirement that such
position not be maintained during the lesser of the last five days of
trading or the time period for the spot month for the physical-delivery
contract.
d. Paragraphs (3) and (4) Enumerated Hedging Positions
Proposed paragraph (3) lists specific positions that would fit
under the definition of a bona fide hedging position, including hedges
of inventory, cash commodity purchase and sales contracts, unfilled
anticipated requirements, and hedges by agents.736 Each of these
positions was described in Sec. 1.3(z), with the exception of
paragraph (iii)(B), which was added in response to the petition
submitted to the Commission by the Working Group of Commercial Energy
Firms.737
—————————————————————————
736 A detailed description of each enumerated position can be
found supra.
737 See discussion above.
—————————————————————————
Proposed paragraph (4) provides other enumerated hedging
exemptions, including hedges of unanticipated production, offsetting
unfixed price cash commodity sales and purchases, anticipated
royalties, and services, all of which are subject to the “five-day
rule.” The “five-day rule” is a provision in many of the enumerated
hedging positions that prohibits a trader from maintaining the
positions in any physical-delivery commodity derivative
[[Page 75763]]
contract during the lesser of the last five days of trading or the time
period for the spot month in such physical-delivery contract.738
Because each exemption shares this provision, the Commission is
proposing to reorganize such exemptions into proposed paragraph (4) for
administrative efficiency.
—————————————————————————
738 As discussed above, the purpose of the five-day rule is to
protect the integrity of the delivery and settlement processes in
physical-delivery contracts. Without this rule, high concentrations
of exempted positions can distort the markets, impairing price
discovery while potentially having an adverse impact on efforts to
deter all forms of market manipulation and diminish excessive
speculation.
—————————————————————————
Of the enumerated hedges in proposed paragraphs (4)(i) and (ii) are
currently in Sec. 1.3(z) and paragraph (4)(iv) codifies a hedge that
has historically been recognized by the Commission. Paragraph (4)(iii)
proposes a royalties exemption not now specified in Sec. 1.3(z).
e. Paragraph (5) cross-commodity hedges
Proposed paragraph (5) describes positions that would qualify as
cross-commodity bona fide hedges. The Commission has long recognized
cross-commodity hedging, stating in 1977 that such positions would be
covered under the general provisions of Sec. 1.3(z)(2).
The definition in proposed paragraph (5) would condition cross-
commodity hedging on: (i) whether the fluctuations in value of the
position in the commodity derivative contract are “substantially
related” to the fluctuations in value of the actual or anticipated
cash position or pass-through swap; and (ii) the five-day rule being
applied to positions in any physical-delivery commodity derivative
contract. The second condition, i.e. the application of the five-day
rule, would help to protect the integrity of the delivery process in
the physical-delivery contract but would not apply to cash-settled
contract positions.739
—————————————————————————
739 See discussion above.
—————————————————————————
iii. Benefits and Costs
Elements of the proposed definition that represent discretionary,
substantive modifications to the required manner in which bona fide
hedging have been defined under Sec. 1.3(z) include the following:
740 (i) Proposing requirements for hedges in an excluded commodity in
proposed paragraph (1); (ii) adding the five-day rule into the
statutory definition of pass-through swap as described in paragraph
(2)(ii)(A); (iii) applying the definition in proposed paragraph (2) to
positions in economically equivalent contracts in a physical commodity;
741 (iv) expanding paragraph (3)(III)(b) to incorporate hedges
encouraged by a public utility commission; (v) expanding paragraph
(4)(ii) to include offsetting unfixed-price cash commodity sales and
purchases that are basis different contracts in the same commodity,
regardless of whether the contracts are in the same calendar month;
(vi) adding paragraph (iii) to proposed paragraph (4) to enumerate
anticipated royalty hedges; and (vii) enumerating cross-commodity
hedges as a standalone provision in paragraph (5).
—————————————————————————
740 The Commission notes that the relocation of the definition
from Sec. 1.3(z) to part 150 is also discretionary. As noted above,
the placement is intended to facilitate compliance with the other
sections of part 150; the Commission does not believe, however, that
this action has substantive cost or benefit implications. Also, the
proposed definition incorporates and references elements of non-
binding guidance not encompassed by CEA section 15(a).
741 As discussed supra, CEA section 4a(a)(5) requires that the
Commission set speculative limits on the amount of positions,
“other than bona fide hedging positions . . . held by any person
with respects to swaps that are economically equivalent” to futures
and options. 7 U.S.C. 6a(a)(5). Subject to CEA section 4a(a)(2), the
Commission is exercising its discretion in defining bona fide
hedging in economically equivalent contracts in the same manner as
for futures and options in physical commodities. 7 U.S.C. 6a(a)(2).
—————————————————————————
a. Benefits
The Commission proposes the definition for excluded commodities in
paragraph (1) in order to provide a consistent definition of bona fide
hedging–i.e., a definition that incorporates the economically
appropriate test–for all commodities under the Commission’s
jurisdiction. The addition of paragraph (1) would provide exchanges
with a definition for bona fide hedging designed to provide a level of
assurance that the Commission’s policy objectives regarding bona fide
hedging are met at the exchange level as well as at the federal level,
and for excluded commodities as well as agricultural and exempt
commodities.
The Commission believes that the additions to the definition of
bona fide hedging proposed in this release provide additional necessary
relief to bona fide hedgers. This relief, in turn, will help to ensure
that market participants with positions hedging legitimate business
needs are properly recognized as hedgers under the Commission’s
speculative position limits regime. Thus, the Commission anticipates
that the addition of the enumerated position for anticipated royalties
and the expansion of the enumerated unfilled anticipated requirements
position provide additional means for obtaining a hedge exemption by
recognizing the legitimate business need in each position. The safe
harbor proposed in paragraph (5) is expected to provide clarity and
promote regulatory certainty for entities that use cross-commodity
hedging strategies. Further, the addition of the five-day rule to the
hedging definition for pass-through swaps helps the Commission to
ensure the integrity of the delivery process in the physical-delivery
contract and as a result to accomplish to the maximum extent
practicable the factors in CEA section 4a(a)(3). Finally, the
Commission believes using the same bona fide hedging exemptions in
economically equivalent contracts may facilitate administrative
efficiency by avoiding the need for market participants to manage and
apply different definitional criteria across multiple products and
trading venues.742 The Commission requests comment on its
consideration of the benefits of the proposed definition of bona fide
hedging. Has the Commission misidentified any of the benefits of the
proposed rule? Are there additional benefits the Commission ought to
consider regarding the proposed definition of bona fide hedging? Why or
why not?
—————————————————————————
742 Further, using the same exemptions in economically
equivalent contracts is consistent with the approach of the Dodd-
Frank Act section 737(a) amendment requiring that the Commission
establish limits for economically equivalent swap positions and
across trading venues, including direct-access linked FBOT
contracts. See 7 U.S.C. 6a(a)(5)-(6).
—————————————————————————
b. Costs
The Commission anticipates that there will be some small additional
costs associated with the proposed definition.
Entities may incur costs to the extent the proposed definition of a
bona fide hedging position in an excluded commodity requires an
exchange to adjust its policies for bona fide hedging exemptions or a
market participant to adjust its trading strategies for what is and is
not a bona fide hedge in an excluded commodity. The Commission expects
such costs to be negligible, as the definition is substantially the
same as the current definition under Sec. 1.3(z). Costs for exchanges
are also considered in the section of this release that discusses the
proposed amendments to Sec. 150.5.
In general, under other aspects of the Commission’s proposed
definition, market participants may incur costs to determine whether
their positions fall under one of the new or expanded enumerated
positions. In the event a position does not fit under any of the
enumerated positions, market
[[Page 75764]]
participants may incur costs associated with filing for exemptive
relief as described in the section discussing the costs of proposed
Sec. 150.3 or in altering speculative trading strategies as discussed
above. As trading strategies are proprietary, and the determinations
made by individual entities present a burden that is highly
idiosyncratic, it is not reasonably feasible for the Commission to
estimate the value of the burden imposed.
c. Request for Comment
The Commission requests comment on its consideration of the costs
of the proposed definition of bona fide hedging position. Are there
additional costs related to the Commission’s discretionary actions that
the Commission should consider? Has the Commission misidentified any
costs? Commenters are encouraged to submit any data that the Commission
should consider in evaluating the costs of the proposed definition.
d. Consideration of Alternatives
The Commission recognizes that alternatives exist to discretionary
elements of the definition of bona fide hedging positions proposed
herein. The Commission requests comments on whether an alternative to
what is proposed would result in a superior benefit-cost profile, with
support for any such position provided.
3. Section 150.2–Limits
i. Rule Summary
As previously discussed, the Commission interprets CEA section
4a(a)(2) to mandate that it establish speculative position limits for
all agricultural and exempt physical commodity derivative
contracts.743 The Commission currently sets and enforces speculative
position limits for futures and futures-equivalent options contracts on
nine agricultural products. Specifically, current Sec. 150.2 provides
“[n]o person may hold or control positions, separately or in
combination, net long or net short, for the purchase or sale of a
commodity for future delivery or, on a futures-equivalent basis,
options thereon, in excess of” enumerated spot, single-month, and all-
month levels for nine specified contracts.744 These proposed
amendments to Sec. 150.2 would expand the scope of federal position
limits regulation in three chief ways: (1) specify limits on 19
contracts in addition to the nine existing legacy contracts (i.e., a
total of 28); (2) extend the application of these limits beyond futures
and futures-equivalent options to all commodity derivative interests,
including swaps; and (3) extend the application of these limits across
trading venues to all economically equivalent contracts that are based
on the same underlying commodity. In addition, the proposed rule would
provide a methodology and procedures for implementing and applying the
expanded limits.
—————————————————————————
743 See supra discussion of the Commission’s interpretation of
this mandate.
744 These contracts are Chicago Board of Trade corn and mini-
corn, oats, soybeans and mini-soybeans, wheat and mini-wheat,
soybean oil, and soybean meal; Minneapolis Grain Exchange hard red
spring wheat; ICE Futures U.S. cotton No. 2; and Kansas City Board
of Trade hard winter wheat.
—————————————————————————
The Commission proposes to amend Sec. 150.2 to impose speculative
position limits as mandated by Congress in accordance with the
statutory bounds that define its discretion in doing so. First,
pursuant to CEA section 4a(a)(5) the Commission must concurrently
impose position limits on swaps that are economically equivalent to the
agricultural and exempt commodity derivatives for which position limits
are mandated in section 4a(a)(2). Second, CEA section 4a(a)(3) requires
that the Commission appropriately set limit levels mandated under
section 4a(a)(2) that “to the maximum extent practicable, in its
discretion,” accomplish four specific objectives.745 Third, CEA
section 4a(a)(2)(C) requires that in setting limits mandated under
section 4a(a)(2)(A), the “Commission shall strive to ensure that
trading on foreign boards of trade in the same commodity will be
subject to comparable limits and that any limits . . . imposed . . .
will not cause price discovery in the commodity to shift to trading on
the foreign boards of trade.” Key elements of the proposed rule are
summarized below.746
—————————————————————————
745 These objectives are to: (1) “diminish, eliminate, or
prevent excessive speculation;” (2) “deter and prevent market
manipulation, squeezes, and corners;” (3) “ensure sufficient
market liquidity for bona fide hedgers;” and (4) “ensure that the
price discovery function of the underlying market is not
disrupted.” 7 U.S.C. 6a(a)(3).
746 For a more detailed description, see discussion above.
—————————————————————————
Generally, proposed Sec. 150.2 would limit the size of speculative
positions,747 i.e., prohibit any person from holding or controlling
net long/short positions above certain specified spot month, single
month, and all-months-combined position limits. These position limits
would reach: (1) 28 “core referenced futures contracts,” 748
representing an expansion of 19 contracts beyond the 9 legacy
agricultural contracts identified currently in Sec. 150.2; 749 (2) a
newly defined category of “referenced contracts” (as defined in
proposed Sec. 150.1); 750 and (3) across all trading venues to all
economically equivalent contracts that are based on the same underlying
commodity.
—————————————————————————
747 Proposed Sec. 150.1 would include a consistent definition
of the term “speculative position limits.”
748 Proposed Sec. 150.1 also would define the term “core
referenced futures contract” by reference to “a futures contract
that is listed in Sec. 150.2(d).”
749 Specifically, in addition to the existing 9 legacy
agricultural contracts now within Sec. 150.2–i.e., Chicago Board
of Trade corn, oats, soybeans, soybean oil, soybean meal, and wheat;
Minneapolis Grain Exchange hard red spring wheat; ICE Futures U.S.
cotton No. 2; and Kansas City Board of Trade hard winterwheat–
proposed Sec. 150.2 would expand the list of core referenced
futures contracts to capture the following additional agricultural,
energy, and metal contracts: Chicago Board of Trade Rough Rice; ICE
Futures U.S. Cocoa, Coffee C, FCOJ-A, Sugar No. 11 and Sugar No. 16;
Chicago Mercantile Exchange Feeder Cattle, Lean Hog, Live Cattle and
Class III Milk; Commodity Exchange, Inc., Gold, Silver and Copper;
and New York Mercantile Exchange Palladium, Platinum, Light Sweet
Crude Oil, NY Harbor ULSD, RBOB Gasoline and Henry Hub Natural Gas.
750 This would result in the application of prescribed
position limits to a number of contract types with prices that are
or should be closely correlated to the prices of the 28 core
referenced futures contracts–i.e., economically equivalent
contracts–including: (1) “look-alike” contracts (i.e., those that
settle off of the core referenced futures contract and contracts
that are based on the same commodity for the same delivery location
as the core referenced futures contract); (2) contracts based on an
index comprised of one or more prices for the same delivery location
and in the same or substantially the same commodity underlying a
core referenced futures contract; and (3) inter-commodity spreads
with two components, one or both of which are referenced contracts.
The proposed “reference contract” definition would exclude,
however, a guarantee of a swap.
—————————————————————————
a. Sec. 150.2(a) Spot-Month Speculative Position Limits
In order to implement the statutory directive in CEA section
4a(a)(3)(A), proposed Sec. 150.2(a) would prohibit any person from
holding or controlling positions in referenced contracts in the spot
month in excess of the level specified by the Commission for referenced
contracts.751 Proposed Sec. 150.2(a) would require, in the
Commission’s discretion, that a trader’s positions, net long or net
short, in the physical-delivery referenced contract and cash-settled
referenced contract be
[[Page 75765]]
calculated separately under the spot month position limits fixed by the
Commission for each. As a result, a trader could hold positions up to
the applicable spot month limit in the physical-delivery contracts, as
well as positions up to the applicable spot month limit in cash-settled
contracts (i.e., cash-settled futures and swaps), but would not be able
to net across physical-delivery and cash-settled contracts in the spot
month.
—————————————————————————
751 As discussed supra, the Commission proposes to adopt a
streamlined, amended definition of “spot month” in proposed Sec.
150.1. The term would be defined as the trading period immediately
preceding the delivery period for a physical-delivery futures
contract and cash-settled swaps and futures contracts that are
linked to the physical-delivery contract. The definition proposes
similar but slightly different language for cash-settled contracts,
providing for the spot month to be the earlier of the period in
which the underlying cash-settlement price is calculated or the
close of trading on the trading day preceding the third-to-last
trading day, until the contract cash-settlement price is determined.
For more details, see discussion above.
—————————————————————————
b. Sec. 150.2(b) Single-Month and All-Months-Combined Speculative
Position Limits
Proposed Sec. 150.2(b) would provide that no person may hold or
control positions, net long or net short, in referenced contracts in a
single-month or in all-months-combined in excess of the levels
specified by the Commission. Proposed Sec. 150.2(b) would require
netting all positions in referenced contracts (regardless of whether
such referenced contracts are physical-delivery or cash-settled) when
calculating a trader’s positions for purposes of the proposed single-
month or all-months-combined position limits (collectively “non-spot-
month” limits).752
—————————————————————————
752 The Commission proposes to use the same level for single-
month and all-months-combined limits, and refers to those limits as
the “non-spot-month limits.” The spot month and any single month
refer to those periods of the core referenced futures contract.
—————————————————————————
c. Sec. 150.2(d) Core Referenced Futures Contracts
To be clear, the statutory mandate in Dodd-Frank section 4a(a)(2)
applies on its face to all physical commodity contracts. The Commission
is nevertheless proposing, initially, to apply speculative position
limits to referenced contracts that are based on 28 core referenced
futures contract listed in proposed Sec. 150.2(d). As defined in
proposed Sec. 150.1, referenced contracts are futures, options, or
swaps contracts that are directly or indirectly linked to a core
referenced futures contract or the commodity underlying a core
referenced futures contract.753
—————————————————————————
753 As discussed above, the definition of referenced contract
excludes any guarantee of a swap, basis contracts, and commodity
index contracts.
—————————————————————————
Proposed Sec. 150.2(d) lists the 28 core referenced futures
contracts on which the Commission is initially proposing to establish
federal speculative position limits. The list represents a significant
expansion of federal speculative position limits from the current list
of nine agricultural contracts under current part 150.754 The
Commission has selected these important food, energy, and metals
contracts on the basis that such contracts (i) have high levels of open
interest and significant notional value and/or (ii) serve as a
reference price for a significant number of cash market transactions.
Thus, the Commission is proposing limits to commence the expansion of
its federal position limit regime with those commodity derivative
contracts that it believes are likely to have the greatest impact on
interstate commerce. Because the mandate applies to all physical
commodity contracts, the Commission intends through supplemental
rulemaking to establish limits for all other physical commodity
contracts. Given limited Commission resources, it cannot do so in this
initial rulemaking.
—————————————————————————
754 17 CFR 150.2.
—————————————————————————
As discussed above,755 the Commission calculated the notional
value of open interest (delta-adjusted) and open interest (delta-
adjusted) for all futures, futures options, and significant price
discovery contracts as of December 31, 2012 in all agricultural and
exempt commodities in order to select the list of 28 core referenced
futures contracts in proposed Sec. 150.2(d). The Commission selected
commodities in which the derivative contracts had largest notional
value of open interest and open interest for three categories:
agricultural, energy, and metals. The Commission then designated the
benchmark futures contracts for each commodity as the core referenced
futures contracts for which position limits would be established.
Proposed Sec. 150.2(d) lists 19 core referenced futures contracts for
agricultural commodities, four core referenced futures contracts for
energy commodities, and five core referenced futures contracts for
metals commodities.
—————————————————————————
755 See discussion above.
—————————————————————————
d. Sec. 150.2(e) Levels of Speculative Position Limits
The Commission proposes setting initial spot month position limit
levels for referenced contracts at the existing DCM-set levels for the
core referenced futures contracts. Thereafter, proposed Sec.
150.2(e)(3) would task the Commission with recalibrating spot month
position limit levels no less frequently than every two calendar years.
The Commission’s proposed recalibration would result in limits no
greater than one-quarter (25 percent) of the estimated spot-month
deliverable supply 756 in the relevant core referenced futures
contract. This formula is consistent with the acceptable practices in
current Sec. 150.5, as well as the Commission’s longstanding practice
of using this measure of deliverable supply to evaluate whether DCM-set
spot-month limits are in compliance with DCM core principles 3 and 5.
The proposed rules separately restrict the size of positions in cash-
settled referenced contracts that would potentially benefit from a
trader’s potential distortion of the price of the underlying core
referenced futures contract.
—————————————————————————
756 The guidance for meeting DCM core principle 3 (as listed
in 17 CFR part 38 app. C) specifies that, “[t]he specified terms
and conditions [of a futures contract], considered as a whole,
should result in a `deliverable supply’ that is sufficient to ensure
that the contract is not susceptible to price manipulation or
distortion. In general, the term `deliverable supply’ means the
quantity of the commodity meeting the contract’s delivery
specifications that reasonably can be expected to be readily
available to short traders and salable by long traders at its market
value in normal cash marketing channels . . .” See 77 FR 36612,
36722, Jun. 19, 2012.
—————————————————————————
As proposed, each DCM would be required to supply the Commission
with an estimated spot-month deliverable supply figure that the
Commission would use to recalibrate spot-month position limits unless
it decides to rely on its own estimate of deliverable supply
instead.757
—————————————————————————
757 Proposed Sec. 150.2(e)(3)(ii) would require DCMs to
submit estimates of deliverable supply. DCM estimates of deliverable
supplies (and the supporting data and analysis) would continue to be
subject to Commission review.
—————————————————————————
In contrast to spot-month limits, which would be set as a function
of deliverable supply, the proposed formula for the non-spot-month
position limits is based on total open interest for all referenced
contracts that are aggregated with a particular core referenced
contract. Proposed Sec. 150.2(e)(4) explains that the Commission would
calculate non-spot-month position limit levels based on the following
formula: 10 percent of the largest annual average open interest for the
first 25,000 contracts and 2.5 percent of the open interest
thereafter.758 As is the case with spot month limits, the Commission
proposes to adjust single month and all-months-combined limits no less
frequently than every two calendar years.
—————————————————————————
758 Since 1999, the same 10 percent/2.5 percent methodology,
now incorporated in current Sec. 150.5(c)(2), has been used to
determine futures all-months position limits for referenced
contracts.
—————————————————————————
The Commission’s proposed average open interest calculation would
be computed for each of the past two calendar years, using either
month-end open contracts or open contracts for each business day in the
time period, as practical and in the Commission’s discretion.
Initially, the Commission proposes to set the levels of initial non-
spot-month limits using open interest
[[Page 75766]]
for calendar years 2011 and 2012 in futures contracts, options thereon,
and in swaps that are significant price discovery contracts and are
traded on exempt commercial markets. Using the 2011/2012 combined
levels of open interest for futures contracts and for swaps that are
significant price discovery contracts and are traded on exempt
commercial markets will result in non-spot month position limit levels
that are not overly restrictive at the outset; this is intended to
facilitate the transition to the new position limits regime without
disrupting liquidity. For example, the Commission is proposing a non-
spot-month limit for CBOT Wheat that represents the harvest from around
2 million acres (3,125 square miles) of wheat, or 81 million bushels.
The proposed non-spot-month limit for NYMEX WTI Light Sweet Crude Oil
represents 109.2 million barrels of oil. The Commission believes these
levels to be sufficiently high as to restrict excessive speculation
without restricting the benefits of speculative activity, including
liquidity provision for bona fide hedgers.
After the initial non-spot-month limits are set, the Commission
proposes subsequently to use the data reported by DCMs and SEFs
pursuant to parts 16, 20, and/or 45 to estimate average open interest
in referenced contracts.759
—————————————————————————
759 Options listed on DCMs would be adjusted using an option
delta reported to the Commission pursuant to 17 CFR part 16; swaps
would be counted on a futures equivalent basis, equal to the
economically equivalent amount of core referenced futures contracts
reported pursuant to 17 CFR part 20 or as calculated by the
Commission using swap data collected pursuant to 17 CFR part 45.
—————————————————————————
e. Sec. 150.2(f)-(g) Pre-Existing Positions and Positions on Foreign
Boards of Trade
The Commission proposes in new Sec. 150.2(f)(2) to exempt from
federal non-spot-month speculative position limits any referenced
contract position acquired by a person in good faith prior to the
effective date of such limit, provided that the pre-existing position
is attributed to the person if such person’s position is increased
after the effective date of such limit.760
—————————————————————————
760 See also the definition of the term “Pre-existing
position” incorporated in proposed Sec. 150.1 herein. Such pre-
existing positions that are in excess of the proposed position
limits would not cause the trader to be in violation based solely on
those positions. To the extent a trader’s pre-existing positions
would cause the trader to exceed the non-spot-month limit, the
trader could not increase the directional position that caused the
positions to exceed the limit until the trader reduces the positions
to below the position limit. As such, persons who established a net
position below the speculative limit prior to the enactment of a
regulation would be permitted to acquire new positions, but the
total size of the pre-existing and new positions may not exceed the
applicable limit.
—————————————————————————
Finally, proposed Sec. 150.2(g) would apply position limits to
positions on foreign boards of trade (“FBOT”s) provided that
positions are held in referenced contracts that settle to a referenced
contract and that the FBOT allows direct access to its trading system
for participants located in the United States.
ii. Benefits
The criteria set out in CEA section 4a(a)(3)(B)–namely, that
position limit levels (1) “diminish, eliminate, or prevent excessive
speculation;” (2) “deter and prevent market manipulation, squeezes,
and corners;” (3) “ensure sufficient market liquidity for bona fide
hedgers;” and (4) “ensure that the price discovery function of the
underlying market is not disrupted”–clearly articulate objectives
that Congress intended the Commission to accomplish, to the maximum
extent practicable, in setting limit levels in accordance with the
mandate to impose limits. The Commission is proposing to expand its
speculative position limits regime to include all commodity derivative
interests, including swaps; to impose federal limits on 19 additional
contract markets; and to apply limits across trading venues to all
economically equivalent contracts that are based on the same underlying
commodity.
In so doing, the proposed rules generally would expand the
prophylactic protections of federal position limits to additional
contract markets. Proposed Sec. 150.2(f) and (g) implement statutory
directives in CEA section 4a(b)(2) and CEA section 4a(a)(6)(B),
respectively, and are not acts of the Commission’s discretion. Thus,
the Commission is not required to consider costs and benefits of these
provisions under CEA section 15(a). Specific discussion of the benefits
of the other components of proposed Sec. 150.2 is below.
a. Sec. 150.2(a) Spot-Month Speculative Position Limits
As discussed above, CEA section 4a(a)(3)(A) now directs the
Commission to set limits on speculative positions during the spot-
month.761 It is during the spot-month period that concerns regarding
certain manipulative behaviors, such as corners and squeezes, become
most urgent.762 Spot-month position limits cap speculative traders’
positions, and therefore restrict their ability to amass market power.
In so doing, spot-month limits restrict the ability of speculators to
engage in corners and squeezes and other forms of manipulation. They
also prevent the potential adverse impacts of unduly large positions
even in the absence of manipulation, thereby promoting a more orderly
liquidation process for each contract.
—————————————————————————
761 7 U.S.C. 6a(a)(3)(A).
762 See discussion above.
—————————————————————————
The Commission has used its discretion in the manner in which it
implements the statutorily-required spot-month position limits so as to
achieve Congress’s objectives in CEA section 4a(a)(3)(B)(ii) to prevent
or deter market manipulation, including corners and squeezes. For
example, the Commission has used its discretion under CEA section
4a(a)(1) to set separate but equal limits in the spot-month for
physical-delivery and cash-settled referenced contracts. By setting
separate limits for physical-delivery and cash-settled referenced
contracts, the proposed rule restricts the size of the position a
trader may hold or control in cash-settled reference contracts, thus
reducing the incentive of a trader to manipulate the settlement of the
physical-delivery contract in order to benefit positions in the cash-
settled reference contract. Thus, the separate limits further enhance
the prevention of market manipulation provided by spot-month position
limits by reducing the potential for adverse incentives to manifest in
manipulative action.
b. Sec. 150.2(b) Single-Month and All-Months-Combined Speculative
Position Limits
CEA section 4a(a)(3)(A) further directs the Commission to set
limits on speculative positions for months other than the spot-
month.763 While market disruptions arising from the concentration of
positions remain a possibility outside the spot month, the above-
mentioned concerns about corners and squeezes and other forms of
manipulation are reduced because the potential for the same is reduced
outside the spot-month. Accordingly, the Commission has proposed to use
its discretion to require netting of physical-delivery and cash-settled
referenced contracts for purposes of determining compliance with non-
spot-month limits. The Commission deems it is appropriate to provide
traders with additional flexibility in complying with the non-spot-
months limits given their decreased risk of corners and squeezes.
Because this additional flexibility means market participants are able
to retain offsetting positions outside of the spot-month, liquidity
should not be
[[Page 75767]]
impaired and price discovery should not be disrupted.
—————————————————————————
763 7 U.S.C. 6a(a)(3)(A).
—————————————————————————
c. Sec. 150.2(e) Levels of Speculative Position Limits
The proposed methodology for determining the levels at which the
limits are set is consistent with the Commission’s longstanding
acceptable practices for DCM-set speculative position limits. Further,
the Commission’s proposal to set initial spot-month limits at the
current federal or DCM-set levels for each core referenced futures
contract means that any trading activity that is compliant with the
current position limits regime generally will continue to be compliant
under the first two years of the proposed rule.764
—————————————————————————
764 The Commission notes that the CME Group submitted an
estimate of deliverable supply that, if used by the Commission as a
base for setting initial levels of spot month limits, would result
in higher spot month limits than those currently proposed in
appendix D. See discussion above for more information.
—————————————————————————
The proposed rule is designed to result in speculative position
limit levels that prevent excessive speculation and deter market
manipulation without diminishing market liquidity. Specifically, levels
that are too low may be binding and overly restrictive, but levels that
are too high may not adequately protect against manipulation and
excessive speculation. The Commission believes that both standards–
i.e., spot month limits of not greater than 25 percent of deliverable
supply and the 10 and 2.5 percent formula for non-spot-month limits–
produce levels for speculative position limits that help to ensure that
both policy objectives–to deter market manipulation and excessively
large speculative positions and to maintain adequate market liquidity–
are achieved to the maximum extent practicable.
The Commission’s review of the number of potentially affected
traders indicates that the proposed rule will not significantly affect
market liquidity. Over the last two full years (2011-2012), an average
of fewer than 40 traders in any one of the 28 proposed markets exceeded
just 60 percent of the level of the proposed spot-month position limit.
An average of fewer than 10 of those traders exceeded 100 percent of
the proposed level of the spot-month limit.765 In several months over
the period, no trader exceeded the proposed level of the spot-month
limits and some months saw a much larger number of traders with
positions in excess of the proposed level of the spot-month limits.
Smaller numbers were revealed when observing traders’ positions in
relation to proposed levels for non-spot-month position limits–an
average of fewer than 10 traders exceeded 60 percent of the proposed
all-months-combined limit. The analysis reviewed by the Commission does
not account for hedging and other exemptions, which leads the
Commission to believe that the number of speculative traders in excess
of the proposed limit is even smaller. The relatively low number of
traders that may exceed proposed limits in non-spot-months is
indicative of the flexibility of the limit formula to account for
changes in market participation.
—————————————————————————
765 To put this figure in context, over the same period the
number of unique owners over at least one of the proposed limit
levels in the 28 proposed markets was 384, while 932 unique owners
were over 60 percent of at least one of the proposed limit levels.
In contrast, under the large trader reporting provisions of part 17,
there are thousands of traders with reportable positions as defined
in Sec. 15.00(p).
—————————————————————————
d. Request for Comment
The Commission welcomes comment on its considerations of the
benefits of proposed Sec. 150.2. What other benefits of the provisions
in Sec. 150.2 should the Commission consider? Has the Commission
accurately identified the potential benefits of the proposed rules?
iii. Costs
The expansion of Sec. 150.2 will necessarily create some
additional compliance costs for market participants. The Commission has
attempted, where feasible, to reduce such burdens without compromising
its policy objectives.
a. Sec. 150.2(a)-(b) Spot-Month, Single-Months, and All-Months-
Combined Speculative Position Limits; Other Considerations
Notwithstanding the above analysis of potentially affected traders,
the Commission anticipates that some market participants still may find
it necessary to reassess and modify existing trading strategies in
order to comply with spot- and non-spot-month position limits for the
28 commodities with applicable federal limits, though the Commission
believes much of these costs to be the direct result of the statutory
mandate to impose limits. The Commission anticipates any such costs
would be largely incurred by swaps-only entities, as futures and
options market participants have experience with position limits,
particularly in the spot-month, such that the costs of any strategic or
trading changes that needed to be made may have already been incurred.
These costs are not reasonably quantifiable by the Commission, due to
their highly variable and entity-specific nature, and because trading
strategies are proprietary, but to the extent an expanded position
limits regime alters the ways a trader conducts speculative trading
activity, such costs may be incurred.
Broadly speaking, imposing position limits raises the concerns that
liquidity and price discovery may be diminished, because certain market
segments, i.e., speculative traders, are restricted. The Commission has
endeavored to mitigate concerns about liquidity and price discovery, as
well as costs to market participants, by expanding limits to additional
markets incrementally in order to facilitate the transition to the
expanded position limits regime. For example, the Commission has
proposed to adopt current spot-month limit levels as the initial levels
in order to ensure traders know well in advance of the effective date
of the rule what limits will be on that date. The Commission also
expects a large number of swaps traders to avail themselves of the pre-
existing position exemption as defined in proposed Sec. 150.3. As
preexisting positions are replaced with new positions, traders will be
able to incorporate an understanding of the new regime into existing
and new trading strategies, which allows the burden of altering
strategies to happen incrementally over time. The preexisting position
exemption applies to non-spot-month positions entered into in good
faith prior to (i) the enactment of the Dodd-Frank Act or (ii) the
effective date of this proposed rule.
Implementing the statutory requirement of CEA section 4a(a)(6), the
aggregate limits proposed in Sec. 150.2 would impact, as described
above, market participants who are active across trading venues in
economically equivalent contracts. Under current practice, speculative
traders may hold positions up to the limit in each derivative product
for which a limit exists. In contrast, aggregate limits cap all of a
speculative market participant’s positions in derivatives contracts for
a particular commodity. In some circumstances, the aggregate limit will
prevent traders from entering into positions that would have otherwise
been permitted without aggregate limits.766 The proposed rule
incorporates features that provide
[[Page 75768]]
counterbalancing opportunities for speculative trading.
—————————————————————————
766 For example, a market participant has a position close to
the spot-month limit in the NYMEX cash-settled crude oil contract is
currently able to take the same size position in the ICE cash-
settled crude oil contract. The proposed rule would, in accordance
with the statutory requirement of CEA section 4a(a)(6), require that
the positions on NYMEX and ICE be aggregated for the purposes of
complying with the limit–effectively halving the limit.
—————————————————————————
First, the limits apply separately to physical-delivery and cash-
settled contracts in the spot-month. Physical-delivery core referenced
futures contracts have one limit; cash-settled reference contracts
traded on the same exchange, a different exchange, or over-the-counter
have a separate, but equal, limit. Therefore, a speculative trader may
hold positions up to the spot month limit in both the physical-delivery
core referenced futures contract, and a cash-settled contract (i.e.,
cash-settled future and/or swap).
The second feature is the proposed conditional spot-month limit
exemption. As discussed in a subsequent section of this release, the
conditional spot-month limit exemption allows a speculative trader to
hold a position in a cash-settled contract that is up to five times the
spot-month limit of the core referenced futures contract, provided that
trader does not hold any position in the physical-delivery core
referenced futures contract.
Finally, federal non-spot-month limits are calculated as a fixed
ratio of total open interest in a particular commodity across all
markets for referenced contracts. Because of this feature of the
Commission’s formula for calculating non-spot-month limit levels and of
the proposed rule’s application of non-spot-month limits on an
aggregate basis across all markets, the imposition of the required
aggregate limits should not unduly impact positions outside of the
spot-month, as evidenced by the relatively few number of traders that
would have been impacted historically, noted in table 11, supra.
b. Sec. 150.2(e) Levels of Speculative Position Limits
Market participants would incur costs to monitor positions to
prevent a violation of the limit level. The Commission expects that
large traders in the futures and options markets for the 28 core
referenced futures contracts have already developed some system to
control the size of their positions on an intraday basis, in compliance
with the longstanding position limits regimes utilized by both the
Commission on a federal level and DCMs on an exchange level and in
light of industry practices to measure, monitor, and control the risk
of positions. For these traders, the Commission anticipates a small
incremental burden to accommodate any physical commodity swap positions
that such traders may hold that would become subject to the position
limits regime. The Commission, subject to evidence establishing the
contrary, believes the burden will be minimal because futures and
options market participants are currently monitoring trading to track,
among other things, their positions vis-[agrave]-vis current limit
levels. For those participating in the futures and options markets, the
Commission estimates two to three labor weeks to adjust monitoring
systems to track position limits for referenced contracts, including
swaps and other economically equivalent contracts traded on other
trading venues. Assuming an hourly wage of $120,767 multiplied by 120
hours, this implementation cost would amount to approximately $14,000
per entity.
—————————————————————————
767 The Commission’s estimates concerning the wage rates are
based on 2011 salary information for the securities industry
compiled by the Securities Industry and Financial Markets
Association (“SIFMA”). The Commission is using $120 per hour,
which is derived from a weighted average of salaries across
different professions from the SIFMA Report on Management &
Professional Earnings in the Securities Industry 2011, modified to
account for an 1800-hour work-year, adjusted to account for the
average rate of inflation in 2012, and multiplied by 1.33 to account
for benefits and 1.5 to account for overhead and administrative
expenses. The Commission anticipates that compliance with the
provisions would require the work of an information technology
professional; a compliance manager; an accounting professional; and
an associate general counsel. Thus, the wage rate is a weighted
national average of salary for professionals with the following
titles (and their relative weight); “programmer (senior)” and
“programmer (non-senior)” (15% weight), “senior accountant”
(15%) “compliance manager” (30%), and “assistant/associate
general counsel” (40%). All monetary estimates have been rounded to
the nearest hundred dollars.
—————————————————————————
The incremental costs of compliance with the proposed rule would be
higher for speculative traders who have until now traded only or
primarily in swap contracts.768 Specifically, swaps-only traders may
potentially incur larger start-up costs to develop a compliance system
to monitor their positions in referenced contracts and to comply with
an applicable position limit. Though swaps-only market participants
have not historically been subject to position limits, swap dealers and
major swap participants (as defined by the Commission pursuant to the
Dodd-Frank Act) are required in Sec. 23.601 to implement systems to
monitor position limits.769 In addition, many of these entities have
already developed systems or business processes to monitor or control
the size of swap positions for a variety of business reasons, including
(i) managing counterparty credit risk exposure; and (ii) limiting and
monitoring the risk exposure to such swap positions. Such existing
systems would likely make compliance with position limits significantly
less burdensome, as they may be able to leverage current monitoring
procedures to comply with this rule. The Commission anticipates that a
firm could select from a wide range of compliance systems to implement
a monitoring regime. This flexibility allows the firm to tailor the
system to suit its specific needs in a cost-effective manner.
—————————————————————————
768 The Commission notes that costs associated with the
inclusion of swaps contracts in the federal position limits regime
are the direct result of changes made by the Dodd-Frank Act to
section 4a of the Act. The Commission presents a discussion of these
costs in order to be transparent regarding the effects of the
proposed rules.
769 See 17 CFR 23.601.
—————————————————————————
In the release adopting now-vacated part 151, the Commission
recognized the potentially firm-specific and highly variable nature of
implementing monitoring systems. In particular, the Commission
presented estimates of, on average, labor costs per entity ranging from
40 to 1,000 hours, $5,000 to $100,000 in five-year annualized capital/
start-up costs, and $1,000 to $20,000 in annual operating and
maintenance costs.770 The Commission explained that costs would
likely be lower for firms with positions far below the speculative
limits, but higher for firms with large or complex positions as those
firms may need comprehensive, real-time analysis.771 The Commission
further explained that due to the variation in both number of positions
held and degree of sophistication in existing risk management systems,
it was not feasible for the Commission to provide a greater degree of
specificity as to the particularized costs for swaps firms.772
—————————————————————————
770 See 76 FR at 71667. The presentation of costs on a five-
year annualized basis is consistent with requirements under the
Paperwork Reduction Act (“PRA”). See OMB Form 83-I requiring the
Commission’s Paperwork Reduction Act analysis be submitted with
“annualized” costs in all categories. Instructions for the form do
not provide instructions for annualizing costs; the Commission chose
to annualize over a five year period.
771 Id. (n. 401).
772 Id.
—————————————————————————
At this time, the Commission remains in the early stages of
implementing the suite of Dodd-Frank Act regulations addressing swap
markets now under its jurisdiction. The Commission is registering swap
dealers and major swaps participants for the first time. Much of the
infrastructure, including execution facilities, of the new markets has
only recently become operational, and the collection of comprehensive
regulatory data on physical commodity swaps is in its infancy. Because
of this, the Commission is unable to estimate with precision the likely
number of impacted swaps-only traders who would be subject to position
limits for the first time. However, the Commission
[[Page 75769]]
preliminarily believes that a relatively small number of swaps-only
traders will be affected. The Commission anticipates that most of the
traders in swaps markets that accumulate physical commodity swap
positions of a sufficiently high volume to engender concern for
crossing position limit thresholds either: Are required to register as
swap dealers or major swaps participants and as such already have
systems in place to monitor limits in accordance with Sec. 23.601; or,
are also active in futures markets and as such have the ability to
leverage existing strategies for monitoring limits.
Accordingly, for purposes of proposing these amendments to Sec.
150.2, the Commission again estimates that swaps entities will incur,
on average, labor costs per entity ranging from 40 to 1,000 hours;
between $25,000 and $500,000 in total (non-annualized) capital/start-up
costs and $1,000 to $20,000 in annual operating and maintenance costs.
These estimates provide a preliminary range of costs for monitoring
positions that reflects, on average, costs that market participants may
incur based on their specific, individualized needs.
Finally, proposed Sec. 150.2(e)(3)(ii) requires DCMs that list a
core referenced futures contract to supply to the Commission estimates
of deliverable supply. The Commission proposes to require staggered
submission of the deliverable supply estimates in order to spread out
the administrative burden of the proposed rules. Further, for contracts
with DCM-set limits, an exchange would have already estimated
deliverable supply in order to set spot-month position limit or
demonstrate continued compliance with core principles 3 and 5. Thus,
the Commission does not anticipate a large burden to result from the
proposed Sec. 150.2(e)(3)(ii). The Commission preliminarily believes
that, as estimated in accordance with the Paperwork Reduction Act
(“PRA”), the submission would require a labor burden of approximately
20 hours per estimate. Thus, a DCM that submits one estimate may incur
a burden of 20 hours for a cost, using the estimated hourly wage of
$120,773 of approximately $2,400. DCMs that submit more than one
estimate may multiply this per-estimate burden by the number of
estimates submitted to obtain an approximate total burden for all
submissions, subject to any efficiencies and economies of scale that
may result from submitting multiple estimates.
c. Request for Comment
Do the estimates presented accurately reflect the expected costs of
monitoring position limits under the proposed rule? Would the proposed
rule engender material costs for monitoring positions addition to those
the Commission has identified? Are the assumptions reflected in the
Commission’s consideration of the proposed rule’s costs to monitor
limits valid? If not, why and to what degree?
Is the Commission’s view that aggregate limits as proposed will not
create overly restrictive limit levels valid? Would the aggregated,
cross-exchange nature of the limits as proposed in Sec. 150.2 engender
material costs that the Commission has not identified?
Are there other cost factors related to operational changes that
the Commission should consider? What other factors should the
Commission consider?
The Commission requests that commenters submit data or other
information to assist it in quantifying anticipated costs of proposed
Sec. 150.2 and to support their own assertions concerning costs
associated with proposed Sec. 150.2.
iv. Consideration of Alternatives
The Commission recognizes there exist alternatives to its
discretionary proposals herein. These include the alternative of
setting initial levels for spot month speculative position limit based
on estimates of deliverable supply, as provided by the CME Group,
rather than at the levels proposed in appendix D. The Commission
requests comment on whether an alternative to what is proposed,
including setting initial limits based on a current estimate of
deliverable supply, would result in a superior benefit-cost profile,
with support for any such position provided.
4. Section 150.3–Exemptions
CEA section 4a(a)(7), added by the Dodd-Frank Act, authorizes the
Commission to exempt, conditionally or unconditionally, any person,
swap, futures contract, or option–as well as any class of the same–
from the position limit requirements that the Commission establishes.
Current Sec. 150.3 specifies three types of positions for exemption
from calculation against the federal limits prescribed by the
Commission under Sec. 150.2: (1) Bona fide hedges, (2) spreads or
arbitrage between single months of a futures contract (and/or, on a
futures-equivalent basis, options), and (3) those of an “eligible
entity” as that term is defined in Sec. 150.1(d) 774 carried in a
separate account by an independent account controller (“IAC”) 775
when specific conditions are met. The Commission proposes to make
organizational and conforming changes to Sec. 150.3 as well as several
substantive changes. By exempting positions that pose less risk of
unduly burdening interstate commerce from position limit regulation,
these substantive revisions would further the Commission’s mission
specified in CEA section 4a(a)(3).
—————————————————————————
774 For example, an operator of a commodity pool or certain
other trading vehicle, a commodity trading advisor, or another
specified financial entity such as a bank, trust company, savings
association, or insurance company.
775 IACs are defined currently in 17 CFR 150.1(e). Amendments
to that definition are being proposed in a separate release. See
Aggregation NPRM.
—————————————————————————
The proposed organizational/conforming changes consist of updating
cross references; 776 relocating the IAC exemption to consolidate it
with the Commission’s separate proposal to amend the aggregation
requirements of Sec. 150.4; 777 and deleting the calendar month
spread provision that, due to changes proposed under Sec. 150.2, would
be rendered unnecessary.778 These amendments will facilitate reader
ease-of-use and clarity. However, the Commission foresees little
additional impact from these non-substantive proposed amendments.
—————————————————————————
776 Specifically, as described above: a) proposed Sec.
150.3(a)(1)(i) would update the cross-references to the bona fide
hedging definition to reflect its proposed replacement in amended
Sec. 150.1 from its current location in Sec. 1.3(z); b) proposed
Sec. 150.3(a)(3) would add a new cross-reference to the reporting
requirements proposed to be amended in part 19; and c) proposed
Sec. 150.3(i) would add a cross-reference to the updated
aggregation rules in proposed Sec. 150.4.
777 See Aggregation NPRM. The exemption for accounts carried
by an IAC is set out in proposed Sec. 150.4(b)(5); adoption of that
proposal would render current Sec. 150.3(a)(4) duplicative.
778 More specifically, as discussed supra, the Commission
proposes to amend Sec. 150.2 to increase the level of single month
position limits to the same level as all months limits. As a result,
the spread exemption set forth in current Sec. 150.3(a)(3) that
permits a spread trader to exceed single month limits only to the
extent of the all months limit would no longer provide useful
relief.
—————————————————————————
The proposed substantive changes to Sec. 150.3 would revise an
existing exemption, add three additional exemptions, and revise
recordkeeping requirements. As summarized in the section below,
proposed Sec. 150.3 would: (i) Codify in Commission regulation the
statutory requirement of CEA section 4a(c)(1) that federal position
limits not apply to bona fide hedging as defined by the Commission;
(ii) add exemptions for financial distress situations, certain spot-
month positions in cash-settled reference contracts, and pre-Dodd-Frank
and transition period swaps; (iii) provide guidance for non-enumerated
exemptions, including the deletion of Sec. 1.47; and (iv) revise
recordkeeping
[[Page 75770]]
requirements for traders claiming any exemption from the federal
speculative position limits.
i. Rule Summary
a. Section 150.3(a) Bona Fide Hedging Exemption
As does current Sec. 150.3(a)(1), proposed Sec. 150.3(a)(1)(i)
will codify the statutory requirement that bona fide hedging positions
be exempt from federal position limits. To the extent that benefits and
costs would derive from the Commission’s proposed amendment in Sec.
150.1 to the definition of “bona fide hedging position” that is
discussed above. This proposed amendment would also require that the
anticipatory hedging requirements proposed in Sec. 150.7, the
recordkeeping requirements proposed in Sec. 150.3(g), and the
reporting requirements in proposed part 19 are met in order to claim
the exemption. Any benefits and costs attributable to these features of
the rule are considered below in the respective discussions of proposed
Sec. 150.7, Sec. 150.3(g) and Part 19.
b. Section 150.3(b) Financial Distress Exemption
Proposed Sec. 150.3(b) provides the means for market participants
to request relief from applicable speculative position limits during
times of market stress. The proposed rule allows for exemption under
certain financial distress circumstances, including the default of a
customer, affiliate, or acquisition target of the requesting entity,
that may require an entity to assume in short order the positions of
another entity.
c. Section 150.3(c) Conditional Spot-Month Limit Exemption
Proposed Sec. 150.3(c) would provide a conditional spot-month
limit exemption that permits traders to acquire positions up to five
times the spot month limit if such positions are exclusively in cash-
settled contracts. The conditional exemption would not be available to
traders who hold or control positions in the spot-month physical-
delivery referenced contract in order to reduce the risk that traders
with large positions in cash-settled contracts would attempt to distort
the physical-delivery price to benefit such positions.
The proposed conditional exemption is consistent with current
exchange-set position limits on certain cash-settled natural gas
futures and swaps.779 Both NYMEX and ICE have established conditional
spot month limits in their cash-settled natural gas contracts at a
level five times the level of the spot month limit in the physical-
delivery futures contract. Since spot-month limit levels for referenced
contracts will be set at no greater than 25 percent of the estimated
deliverable supply in the relevant core referenced futures contract,
the proposed exemption would allow a speculative trader to hold or
control positions in cash-settled referenced contracts equal to no
greater than 125 percent of the spot month limit.
—————————————————————————
779 See discussion above.
—————————————————————————
Historically, the Commission has been particularly concerned about
protecting the spot month in physical-delivery futures contracts
because they are most at risk for corners and squeezes. This acute risk
is the reason that speculative limits in physical-delivery markets are
generally set more restrictively during the spot month. The conditional
exemption, as proposed, would constrain the potential for manipulative
or disruptive activity in the physical-delivery contracts during the
spot month by capping speculative trading in such contracts; however,
in parallel cash-settled contracts, where the potential for
manipulative or disruptive activity is much lower, the conditional
exemption would broaden speculative trading opportunity, potentially
providing additional liquidity for bona fide hedgers in cash-settled
contracts.
In proposing the conditional limit, the Commission has examined
market data on the effectiveness of conditional spot-month limits in
natural gas markets, including the data submitted as part of the
rulemaking for now-vacated part 151.780 The Commission has also
examined market data in other contracts, and has observed that open
interest levels naturally decline in the physical-delivery contract
leading up to and during the spot month, as the contract approaches
expiration.781 Both hedgers and speculators exit the physical-
delivery contract in order to, for example, roll their positions to the
next contract month or avoid delivery obligations. Market participants
in cash-settled contracts, however, tend to hold their positions
through to expiration. This market behavior suggests that the
conditional spot-month limit exemption should not affect liquidity in
the spot month of the physical-delivery contract, as open interest is
rapidly declining.782 The exemption, would, however, provide the
opportunity for speculative trading to increase in the cash-settled
contract. The Commission preliminarily believes that while this
proposed exemption would remove certain constraints from speculative
trading in cash-settled contracts, it would not damage liquidity in the
aggregate, i.e., across physical-delivery and cash-settled contracts in
the same commodity. On this basis, the Commission preliminarily
believes a conditional limit in additional commodities is consistent
with the statutory direction to deter manipulation while ensuring
sufficient liquidity for bona fide hedgers without disrupting the price
discovery process.
—————————————————————————
780 See 76 FR at 71635 (n. 100-01).
781 See discussion above.
782 Traders participating in the physical-delivery contract in
the spot month are understood to have a commercial reason or need to
stay in the spot month; the Commission preliminarily believes at
this time that it is unlikely that the factors keeping traders in
the spot month physical-delivery contract will change due solely to
the introduction of a higher cash-settled contract limit.
—————————————————————————
The Commission’s current proposal would not restrict a trader’s
cash commodity position. Instead, the Commission proposes to require
enhanced reporting of cash market positions of traders availing
themselves of the conditional spot-month limit. As discussed in the
proposed changes to part 19, the Commission proposes to initially
require this enhanced reporting only for the natural gas contract until
it gains more experience administering the conditional spot month limit
in the other referenced contracts. The Commission preliminarily
believes that the proposed reporting regime in natural gas will provide
useful information that can be deployed by surveillance staff to detect
and potentially deter manipulative schemes involving the cash market.
d. Section 150.3(d) Pre-Enactment and Transition Period Swaps Exemption
To implement the statutory requirement of CEA section
4a(b)(2),783 proposed Sec. 150.3(d) would provide an exemption from
federal position limits for swaps entered into prior to July 21, 2010
(the date of the enactment of the Dodd-Frank Act), the terms of which
have not expired as of that date, and for swaps entered into during the
period commencing July 22, 2010, the terms of which have not expired as
of that date, and ending 60 days after the publication of final rule
Sec. 150.3 in the Federal Register, i.e., its effective date. The
Commission would allow both pre-enactment and transition swaps to be
netted with commodity derivative contracts acquired more than 60 days
after publication of final rule Sec. 150.3 in the Federal Register for
the purpose of
[[Page 75771]]
complying with any non-spot-month position limit.784 This exemption
facilitates the transition to full position limits compliance for
previously unregulated swaps markets. Allowing netting with pre-
enactment and transition swaps provides flexibility where possible in
order to lessen the impact of the regime on entities that trade swaps.
—————————————————————————
783 CEA section 4a(b)(2) states in part that “any position
limit fixed by the Commission . . . good faith prior to the
effective date of such rule, regulation or order.” 7 U.S.C.
6a(b)(2).
784 Because of concerns regarding manipulation during the
delivery period of a referenced contract, the proposed rule would
not allow pre- and post- enactment and transition swaps to be netted
for the purpose of complying with any spot-month position limit.
—————————————————————————
e. Section 150.3(e) and (f) Other Exemptions and Previously Granted
Exemptions
Proposed Sec. 150.3(e) and (f) provide information on other
exemptive relief not specified by other sections of Sec. 150.3. The
Commission previously permitted a person to file an application seeking
approval for a non-enumerated position to be recognized as a bona fide
hedging position under Sec. 1.47. Though the Commission is proposing
to delete Sec. 1.47, the Commission believes it is appropriate to
provide persons the opportunity to seek exemptive relief.
Proposed Sec. 150.3(e) provides guidance to persons seeking
exemptive relief. A person engaged in risk-reducing practices that are
not enumerated in the revised definition of bona fide hedging in
proposed Sec. 150.1 may use two different avenues to apply to the
Commission for relief from federal position limits. The person may
request an interpretative letter from Commission staff pursuant to
Sec. 140.99 785 concerning the applicability of the bona fide
hedging position exemption, or may seek exemptive relief from the
Commission under section 4a(a)(7) of the Act.786
—————————————————————————
785 17 CFR 140.99 defines three types of staff letters–
exemptive letters, no-action letters, and interpretative letters–
that differ in terms of scope and effect. An interpretative letter
is written advice or guidance by the staff of a division of the
Commission or its Office of the General Counsel. It binds only the
staff of the division that issued it (or the Office of the General
Counsel, as the case may be), and third-parties may rely upon it as
the interpretation of that staff.
786 See supra discussion of CEA section 4a(a)(7).
—————————————————————————
f. Section 150.3(g) and (h) Recordkeeping
Proposed Sec. 150.3(g)(1) specifies recordkeeping requirements for
persons who claim any exemption set forth in proposed Sec. 150.3.
Persons claiming exemptions under Sec. 150.3 would need to maintain
complete books and records concerning all details of their related
cash, forward, futures, options and swap positions and transactions.
Proposed Sec. 150.3(g)(1) is largely duplicative of other
recordkeeping obligations imposed on market participants, including
provisions in Sec. 1.35 and Sec. 18.05 as amended by the Commission
to conform with the Dodd-Frank Act.787 Proposed Sec. 150.3(g)(2)
require persons seeking to rely upon the pass-through swap offset
exemption to obtain a representation from its counterparty that the
swap qualifies as a bona fide hedging position and to retain this
representation on file. Similarly, proposed Sec. 150.3(g)(3) requires
a person who makes such a representation to maintain records supporting
the representation. Under proposed Sec. 150.3(h), all persons would
need to make such books and records available to the Commission upon
request, which would preserve the “call for information” rule set
forth in current Sec. 150.3(b).
—————————————————————————
787 77 FR 66288, Nov. 2, 2012.
—————————————————————————
ii. Benefits
In articulating exemptions from position limit requirements, Sec.
150.3 works in concert with Sec. 150.2 as it pertains to Commission-
specified federal limits and with certain requirements of Sec. 150.5
pertaining to exchange-set position limits. Functioning as an
integrated component within the broader position-limits regulatory
regime, the Commission believes the proposed changes to Sec. 150.3
accomplish, to the maximum extent practicable, the four objectives
outlined in CEA section 4a(a)(3). As such, the Commission perceives
these proposed amendments to offer significant benefits. These are
explained more specifically below.
a. Section 150.3(b) Financial Distress Exemption
In codifying the Commission’s historical practice of temporarily
lifting position limit restrictions, the proposed rule further
strengthens the benefits of accommodating transfers of positions from
financially distressed firms to financially secure firms or
facilitating other necessary remediation measures during times of
market stress. More specifically, due to the improved facility and
transparency with respect to the availability of this exemption, it
becomes less likely that positions will be prematurely or unnecessarily
liquidated. The disorderly liquidation of a position poses the threat
of price impacts that may harm the efficiency as well as the price
discovery function of markets. In addition, the availability of a
financial distress exemption provides market participants with a degree
of confidence that the Commission has the appropriate tools to
facilitate the transfer of positions expeditiously in times of market
uncertainty.
b. Section 150.3(c) Conditional Spot-month Limit Exemption
The conditional spot-month limit exemption provides speculators
with an opportunity to maintain relatively large positions in cash-
settled contracts up to but no greater than 125 percent of the spot-
month limit. By prohibiting speculators using the exemption in the
cash-settled contract from trading in the spot-month of the physical-
delivery contract, the proposed rules should further protect the
delivery and settlement process. In addition, the condition of the
exemption–i.e., a trader availing himself of the exemption may not
have any position in the physical-delivery contract–reduces the
ability for a trader with a large cash-settled contract position to
attempt to manipulate the physical-delivery contract price in order to
benefit his position. As such, the conditional spot-month limit
exemption would further three of the goals under CEA section 4a(a)(3)–
deterring market manipulation, and ensuring sufficient market liquidity
for bona fide hedgers, without disrupting the price discovery process.
The proposed rules are specifically intended to provide an
alternate structure to the one that is currently in place that also
meets the objectives to deter and prevent manipulation and to ensure
sufficient market liquidity. In this way, the conditional limit
exemption provides flexibility for market participants and the
Commission to meet the objectives outlined in CEA section 4a(a)(3). The
Commission expects that market participants will respond to the
flexibility afforded by the proposed exemption in order to fulfill
their needs in a manner that is consistent with their business
interests, although it cannot reasonably predict how markets, DCMs and
market participants will adapt. Accordingly, the Commission requests
comment on this exemption, its potential impacts on trading strategies,
competition, and any other direct or indirect costs to markets or
market participants and exchanges that could arise as a result of the
conditional spot-month limit exemption.
c. Section 150.3(d) Pre-Enactment and Transition Period Swaps Exemption
The pre-existing swaps exemption in proposed Sec. 150.3(d) is
consistent with CEA section 4a(b)(2). This exemption facilitates the
transition to full position
[[Page 75772]]
limits compliance for previously unregulated swaps markets. Allowing
netting with post-enactment swaps outside of the spot-month provides
flexibility where possible in order to lessen the impact of the regime
on entities that trade swaps.
d. Section 150.3(e)-(f) Other Exemptions and Previously Granted
Exemptions
The proposed amendments to Sec. 150.3(e) and the replacement of
existing Sec. 1.47 with new proposed Sec. 150.3(f) are essentially
clarifying and organizational in nature. As such they will confer
limited substantive benefits beyond providing market participants with
clarity regarding the process for obtaining non-enumerated exemptive
relief and promoting regulatory certainty for those granted exemptions
pursuant to Sec. 1.47.
e. Section 150.3(g) Recordkeeping
By requiring that market participants who avail themselves of the
exemptions offered under Sec. 150.3 maintain certain records to
document their exemption eligibility and make such records available to
the Commission on request, the rule reinforces proposed Sec. 150.2 and
Sec. 150.3 and helps to accomplish, to the maximum extent practicable,
the goals set out in CEA section 4a(a)(3)(B). Supporting books and
records are critical to the Commission’s ability to effectively monitor
compliance with exemption eligibility standards each and every time an
exemption is employed. Absent this ability, exemptions are more
susceptible to abuse. This susceptibility increases the potential that
position limits function in a diminished capacity than intended to
prevent excessive speculation and/or market manipulation.
f. Request for Comment
The Commission requests comments on its considerations of the
benefits associated with the proposed amendments to Sec. 150.3,
including data or other information to assist the Commission in
identifying the number and type of market participants that will
realize, respectively, the benefits identified and/or to monetize such
benefits. Has the Commission correctly identified market behavior and
incentives that affect or would likely be affected by the conditional
spot-month limit exemption? What other potential benefits could the
conditional spot-month limit exemption have for markets and/or market
participants? Will the exemptions proposed likely result in any
benefits, direct or indirect, for markets and/or market participants in
addition to those that the Commission has identified? If so, what, and
why and how will they result? Has the Commission misidentified or
overestimated any benefits likely to result from the proposed
exemptions? If so, which and/or to what extent?
iii. Costs
In general, the exemptions proposed in Sec. 150.3 do not increase
the costs of complying with position limits, and in fact may decrease
these costs by providing for relief from speculative limits in certain
situations. The exemptions are elective, so no entity is required to
assert an exemption if it determines the costs of doing so do not
justify the potential benefit resulting from the exemption. Thus, the
Commission does not anticipate the costs of obtaining any of the
exemptions to be overly burdensome. Nor does the Commission anticipate
the costs would be so great as to discourage entities from utilizing
available exemptions, as applicable.
Potential costs attendant to the proposed amendments to Sec. 150.3
are discussed specifically below.
a. Section 150.3(b) Financial Distress Exemption
The Commission anticipates the costs associated with the
codification of the financial distress exemption to be minimal. Market
participants who voluntarily employ these exemptions will incur costs
stemming from the requisite filing and recordkeeping obligations that
attend the exemptions.788 Along with performing its due diligence to
acquire a distressed firm, or positions held or controlled by a
distressed firm, an entity would have to update and submit to the
Commission a request for the financial distress exemption. The
Commission is unable at this time to accurately estimate how often this
exemption may be invoked, as emergency or distressed market situations
by nature are unpredictable and dependent on a variety of firm- and
market-specific idiosyncratic factors as well as general macroeconomic
indicators. Given the unusual and unpredictable nature of emergency or
distressed market situations, the Commission anticipates that this
exemption would be invoked infrequently, but is unable to provide a
more precise estimate. The Commission also assumes that codifying the
proposed rule and thus lending a level of transparency to the process
will result in an administrative burden that is less onerous than the
current regime. In addition, the Commission believes that in the case
that one firm is assuming the positions of a financially distressed
firm, the costs of claiming the exemption would be incidental to the
costs of assuming the position.
—————————————————————————
788 See supra considerations of costs and benefits of the
proposed amendments to part 19 and the Paperwork Reduction Act.
—————————————————————————
b. Section 150.3(c) Conditional Spot-month Limit Exemption
A market participant that elects to exercise this exemption, one
that is not available under current rules, will incur certain direct
costs to do so. A person seeking to utilize this exemption for the
natural gas market must file Form 504 in accordance with requirements
listed in proposed Sec. 19.01.789 If that person currently has any
position in the physical-delivery contract, such person may incur costs
associated with liquidating that position in order to meet the
conditions of the conditional spot-month limit exemption. As previously
discussed, the conditional spot month limit is designed to deter market
manipulation without disrupting the price discovery process. The
Commission does not have reason to believe that liquidity, in the
aggregate (across the core referenced and referenced contracts), will
be adversely impacted. However, the proposed rules are specifically
intended to provide an alternative to the position limit regime that is
currently in place for the purpose of deterring and preventing
manipulation and ensuring sufficient market liquidity; the Commission
expects that market participants will respond to the flexibility
afforded by the proposed exemption in order to fulfill their needs in a
manner that is consistent with their business interests, although it
cannot reasonably predict how markets, DCMs and market participants
will adapt. Accordingly, the Commission requests comment on this
exemption, its potential impacts on trading strategies, competition,
and any other direct or indirect costs to markets or market
participants and exchanges that could arise as a result of the
conditional spot-month limit exemption.
—————————————————————————
789 Specific costs associated with filing Form 504 are
considered above in the sections that implement that form, namely
the discussion of the costs and benefits of proposed amendments to
part 19 and the Paperwork Reduction Act .
—————————————————————————
c. Section 150.3(d) Pre-Enactment and Transition Period Swaps Exemption
The exemption offered in proposed Sec. 150.3(d) is self-executing
and would not require a market participant to file for relief. However,
a firm may incur costs to identify positions eligible for
[[Page 75773]]
the exemption and to determine if that position is to be netted with
post-enactment swaps for purposes of complying with a non-spot-month
position limit. Such costs would be assumed voluntarily by a market
participant in order to avail itself of the exemption, and the
Commission does not anticipate these costs to be overly burdensome.
d. Section 150.3(e)-(f) Other Exemptions and Previously Granted
Exemptions
Under the proposed Sec. 150.3(e), market participants electing to
seek an exemption other than those specifically enumerated, will incur
certain direct costs to do so. First, they will incur costs related to
petitioning the Commission under Sec. 140.99 of the Commission’s
regulations or under CEA section 4a(a)(7). To the extent these costs
may be marginally greater than a market participant would experience to
seek an exemption under the process afforded under current Sec. 1.47–
something the Commission cannot rule out at this time–the cost
difference between the two is attributable to this rulemaking.790
Further, market participants who had previously relied upon the
exemptions granted under Sec. 1.47 would be able to continue to rely
on such exemptions for existing positions. Going forward, market
participants would need to enter into a new position that fits within
applicable limits or are eligible for an alternate exemption, in which
case the participants may incur costs associated with applying for such
exemptions. The Commission is unable to ascertain at this time the
number of participants affected by these proposed regulations. The
Commission notes, however, that a decision to incur the costs inherent
in seeking relief is voluntary.
—————————————————————————
790 Alternatively, to the extent petitioning the Commission
under Sec. 140.99 or under CEA section 4a(a)(7) results in lower
costs relative to those necessary to utilize the current Sec. 1.47
process, the cost difference is a benefit attributable to this
rulemaking. The Commission requests comment concerning whether, and
to what degree, requiring petitions for exemption under Sec. 140.99
or under CEA section 4a(a)(7) in place of current Sec. 1.47 is
likely to result in any material cost difference.
—————————————————————————
e. Section 150.3(g) Recordkeeping
Finally, any person that elects to exercise an exemption provided
in proposed Sec. 150.3 would incur costs attributable to additional
recordkeeping obligations under proposed Sec. 150.3(e)-(g). The
Commission preliminarily believes that these costs will be minimal, as
participants already maintain books and records under a variety of
other Commission regulations and as the information required in these
sections is likely already being maintained as part of prudent
accounting and risk management policies and procedures. The Commission
preliminarily believes that, as estimated in accordance with the PRA, a
total of 400 entities will incur an annual labor burden of
approximately 50 hours each, or 20,000 total hours for all affected
entities, to comply with the additional recordkeeping obligations.
Using an estimated hourly wage of $120 per hour,791 the Commission
anticipates an annual burden of approximately $6,000 per entity and a
total of $2,400,000 for all affected entities.
—————————————————————————
791 The Commission’s estimates concerning the wage rates are
based on 2011 salary information for the securities industry
compiled by the Securities Industry and Financial Markets
Association (“SIFMA”). The Commission is using $120 per hour,
which is derived from a weighted average of salaries across
different professions from the SIFMA Report on Management &
Professional Earnings in the Securities Industry 2011, modified to
account for an 1800-hour work-year, adjusted to account for the
average rate of inflation in 2012, and multiplied by 1.33 to account
for benefits and 1.5 to account for overhead and administrative
expenses. The Commission anticipates that compliance with the
provisions would require the work of an information technology
professional; a compliance manager; an accounting professional; and
an associate general counsel. Thus, the wage rate is a weighted
national average of salary for professionals with the following
titles (and their relative weight); “programmer (senior)” and
“programmer (non-senior)” (15% weight), “senior accountant”
(15%) “compliance manager” (30%), and “assistant/associate
general counsel” (40%). All monetary estimates have been rounded to
the nearest hundred dollars.
—————————————————————————
f. Request for Comment
The Commission requests comment on its considerations of the costs
associated with the proposed changes to Sec. 150.3. Are there other
costs associated with new exemptions that the Commission should
consider? With respect to the proposed conditional spot-month limit
exemption, specifically, the Commission welcomes comments regarding the
potential cost impact on trading strategies, any other direct or
indirect costs to markets or market participants that could arise as a
result of it, and the estimated number of impacted entities.
iv. Consideration of Alternatives
The Commission recognizes that alternatives may exist to
discretionary elements of Sec. 150.3 proposed herein. The Commission
requests comment on whether an alternative to what is proposed would
result in a superior benefit-cost profile, with support for any such
position provided.
5. Section 150.5–Exchange-Set Speculative Position Limits
Current Sec. 150.5 addresses the requirements and acceptable
practices for exchanges in setting speculative position limits or
position accountability levels for futures and options contracts traded
on each exchange. As further described above,792 the CFMA’s
amendments to the CEA in 2000 gave DCMs discretion to set those limits
or levels within the statutory requirements of core principle 5.793
With this grant of statutory discretion, Sec. 150.5 became non-binding
guidance and accepted practice to assist the exchanges in meeting their
statutory responsibilities under the core principles.794
Subsequently, the Dodd-Frank Act scaled back the discretion afforded
DCMs for establishing position limits under the earlier CFMA
amendments. Specifically, among other things, the 2010 law: (1) amended
core principle 1 to expressly subordinate DCMs’ discretion in complying
with statutory core principles to Commission rules and regulations; and
(2) amended core principle 5 to additionally require that, with respect
to contracts subject to a position limit set by the Commission under
CEA section 4a, a DCM must set limits no higher than those prescribed
by the Commission.795 The Dodd-Frank Act also added parallel core
principle obligations on newly-authorized SEFs, including SEF core
principle 6 regarding the establishment of position limits.796
—————————————————————————
792 See discussion above.
793 CEA section 5(d)(5) (specifying DCM core principle 5
titled “Position Limits or Accountability”).
794 Specifically, in 2001, the Commission adopted in part 38
app. B (Guidance on, and acceptable Practices in, Compliance with
Core Principles), 66 FR 42256, 42280, Aug. 10, 2001, an acceptable
practice for compliance with DCM core principle 5 that stated
“[p]rovisions concerning speculative position limits are set forth
in part 150.” Current Sec. 150.5 states that each DCM shall
“limit the maximum number of contracts a person may hold or
control, separately or in combination, net long or net sort, for the
purchase or sale of a commodity for future delivery or, on a
futures-equivalent basis, options thereon,” with certain
exemptions. Exemptions from federal limits include major foreign
currencies and “spread, straddles or arbitrage” exemptions.
Current Sec. 150.5 expressly excludes bona fide hedging positions
from limits, but acknowledges that exchanges may limit positions
“not in accord with sound commercial practices or exceed an amount
which may be established and liquidated in an orderly fashion.”
795 Dodd-Frank Act section 735(b). CEA section 4a(e),
effective prior to, and not amended by, the Dodd-Frank Act, likewise
provides that position limits fixed by a board of trade not exceed
federal limits. 7 U.S.C. 6a(e).
796 Dodd-Frank Act section 733 (adding CEA section 5h; 7
U.S.C. 7b-3).
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[[Page 75774]]
i. Rule Summary
In light of these Dodd-Frank Act statutory amendments, the
Commission proposes to amend Sec. 150.5 to specify certain binding
requirements with which DCMs and SEFs must comply in establishing
exchange-set limits. 797 Specifically, proposed Sec. 150.5(a)(1)
would require that DCMs and SEFs set limits for contracts listed in
Sec. 150.2(d) at a level not higher than the levels specified in Sec.
150.2. Proposed Sec. 150.5(a)(5) and (b)(8) would require that
exchanges adopt aggregation rules that conform to proposed Sec. 150.4
for all contracts, including those contracts subject to federal
speculative limits. Proposed Sec. 150.5(a)(2)(i) and (b)(5)(i) would
require that exchanges conform their bona fide hedging exemption rules
to the proposed Sec. 150.1 definition of bona fide hedging for all
contracts, including those contracts subject to federal speculative
limits. Proposed Sec. 150.5(a)(2)(iii) and (b)(5)(iii) would require
that exchanges condition any exemptive relief from federal or exchange-
set position limits on an application from the trader.798 To the
extent an exchange offers exemptive relief for intra- and inter-market
spread positions for contracts subject to federal limits under proposed
Sec. 150.2, proposed Sec. 150.5(a)(2)(i) and (ii) would require that
the exchange provide such relief only outside of the spot month for
physical-delivery contracts and, with respect to intra-market spread
positions, on the condition that such positions do not exceed the all-
months limit. Finally, proposed Sec. 150.5(a)(4) would further
implement the statutory provision in CEA section 4a(b)(2) that exempts
pre-existing positions, while Sec. 150.5(a)(3) would require exchanges
to mirror the Commission’s exemption in proposed Sec. 150.3 for pre-
enactment and transition period swaps from exchange-set limits on
contracts subject to limits under proposed Sec. 150.2. Proposed Sec.
150.5(a)(3) would also require exchanges to allow the netting of pre-
enactment and transition swaps with post-effective date commodity
derivative contracts for the purpose of complying with any non-spot-
month position limit.
—————————————————————————
797 As discussed above, proposed Sec. 150.5 also would
continue to incorporate non-exclusive guidance and acceptable
practices for DCMs and SEFs with respect to setting limits with and
without a measurable deliverable supply, adopting position
accountability in lieu of a position limits scheme, and adjusting
limit levels, among other things. As non-binding guidance and
acceptable practices, these components of the rulemaking are not
binding Commission regulations or orders subject to the requirement
of CEA section 15(a).
798 The Commission notes that for contracts subject to federal
limits, exchange-granted exemptions would need to conform with the
standards in proposed Sec. 150.5(a)(2)(i) for hedge exemptions and
proposed Sec. 150.5(a)(2)(ii) for other exemptions.
—————————————————————————
Two of these proposed requirements–i.e., that for contracts
subject to limits specified in Sec. 150.2, DCMs and SEFs set limits no
higher than those specified in Sec. 150.2, and that pre-existing
positions must be exempted from exchange-set limits on contracts
subject to Sec. 150.2–exclusively codify statutory requirements, and
therefore reflect no exercise of Commission discretion subject to CEA
section 15(a). The other-listed requirements, however, do involve
Commission discretion, the costs and benefits of which are considered
below.
ii. Benefits
Functioning as an integrated component within the broader position-
limits regulatory regime, the Commission expects the proposed changes
to Sec. 150.5 would further the four objectives outlined in CEA
section 4a(a)(3).799 As explained more fully below, the Commission
believes these proposed amendments offer significant benefits.
—————————————————————————
799 CEA section 4a(a)(3)(B) applies for purposes of setting
federal limit levels. 7 U.S.C. 6a(a)(3)(B). The Commission considers
the four factors set out in the section relevant for purposes of
considering the benefits and costs of these proposed amendments
addressed to exchange-set position limits as well.
—————————————————————————
a. Section 150.5(a)(5) and (b)(8) Aggregation
CEA section 4a(a)(1) states that the Commission, “[in] determining
whether any person has exceeded such limits,” must include “the
positions held and trading done by any persons directly or indirectly
controlled” by such person. Pursuant to this statutory direction, the
Commission has proposed in a separate release amendments to its
aggregation policy, located in Sec. 150.4.800 The regulations
proposed in this release require that exchange-set limits employ
aggregation policies that conform to the Commission’s aggregation
policy both for contracts that are subject to federal limits under
Sec. 150.2 and those that are not, thus harmonizing aggregation rules
for all federal and exchange-set speculative position limits.
—————————————————————————
800 See Aggregation NPRM.
—————————————————————————
For contracts subject to federal speculative position limits under
proposed Sec. 150.2, the Commission anticipates that a harmonized
approach to aggregation will prevent confusion that otherwise might
result from allowing divergent standards between federal and exchange-
set limits on the same contracts. Further, the proposed approach would
prevent the kind of regulatory arbitrage that may impede the benefits
of the federal speculative position limits regime. The harmonized
approach to aggregation policies for limits on all levels eliminates
the potential for exchanges to use permissiveness in aggregation
policies as a competitive advantage and therefore prevents a “race to
the bottom,” which would impair the effectiveness of the Commission’s
aggregation policy. In addition, DCMs and SEFs are required to set
position limits at a level not higher than that set by the Commission.
Differing aggregation standards may have the practical effect of
lowering a DCM- or SEF-set limit to a level that is lower than that set
by the Commission. Accordingly, harmonizing aggregation standards
reinforces the efficacy and intended purpose of Sec. Sec.
150.5(a)(2)(iii) and (b)(5)(iii) by foreclosing an avenue to circumvent
applicable limits.
Moreover, by extending this harmonized approach to contracts not
included in proposed Sec. 150.2, the Commission is proposing a common
standard for all federal and exchange-set limits. The proposed rule
provides uniformity, consistency, and certainty for traders who are
active on multiple trading venues, and thus should reduce the
administrative burden on traders as well as the burden on the
Commission in monitoring the markets under its jurisdiction.
b. Section 150.5(a)(2)(i) and (b)(5)(i) Hedge Exemptions
The proposed rules also promote a common standard for bona fide
hedging exemptions by requiring such exemptions granted by an exchange
to conform with the proposed definition of bona fide hedging in Sec.
150.1. For contracts subject to federal limits under proposed Sec.
150.2, the proposed rules under Sec. 150.5(a)(2)(i) prescribe a
harmonized approach intended to prevent the confusion that may arise
should the same contract have differing standards of bona fide hedging
between the Commission’s federal standard and the standard on any given
exchange. As discussed above, the definition of bona fide hedging
proposed by the Commission in this release allows only positions that
represent legitimate commercial risk to be exempt from position limits.
Deviation from this definition could impede the effectiveness of the
Commission’s position limit regime by potentially allowing positions to
be improperly exempted from speculative limits.
Proposed Sec. 150.5(b)(5)(i) would extend this common standard of
bona fide hedging to contracts not subject to
[[Page 75775]]
federal speculative limits, thereby creating a single standard across
all trading venues that would reduce the administrative burden on
market participants trading on multiple trading venues and the burden
on the Commission of monitoring the markets under its jurisdiction.
c. Section 150.5(a)(2)(iii) and (b)(5)(iii) Application for Exemption
Proposed Sec. 150.5 requires traders to apply to the exchange for
any exemption from position limits. Requiring traders to apply to the
exchange affirms the position of the DCM or SEF as the front-line
regulator for position limits while providing the exchanges with
information that can be used to ensure the legitimacy of a trader’s
position with regards to its eligibility for exemptive relief. By
gathering information from traders’ applications for exemption,
exchanges will have a complete record of all exemptions requested,
granted, and denied, as well as information about the commercial
operations of traders who apply for exemptions. Because the Commission
has not specified a format for such exemption applications, exchanges
have flexibility to determine which information will best inform the
exchange’s self-regulatory operations and obligations.
The Commission understands that many DCMs are already requiring
applications for exemptive relief from speculative position
limits,801 and that SEFs are likely to adopt this practice as a
“best practice” for complying with core principles. As such, the
proposed rules codify an industry “best practice” regarding position
limits and promote the continuation of the benefits of that best
practice across all trading venues and all commodity derivative
contracts.
—————————————————————————
801 See, e.g., CME Rule 559; NYMEX Rule 559; CBOT Rule 559;
KCBT Rule 559; ICE Futures Rules 6.26, 6.27, and 6.29; and MGEX Rule
1504.00.
—————————————————————————
d. Section 150.5(a)(2)(ii) Other Exemptions
As discussed above, the Commission is proposing to set single-month
limits at the same levels as all-months limits, rendering the
“spread” exemption in current Sec. 150.3 unnecessary. However, since
DCM core principle 5 allows exchanges to set more restrictive levels
than those set by the Commission, a DCM or SEF may set the single month
limit at a lower level than that of the all-month limit. Further,
because federal limits apply across trading venues, exchanges may grant
spread exemptions for inter-market spreads across exchanges. As such,
the Commission is proposing Sec. 150.5(a)(2)(ii) to clarify the types
of spread positions for which a DCM or SEF may grant exemptions by
cross-referencing the definitions proposed in Sec. 150.1 802 and to
require that any such exemption be outside of the spot month for
physical-delivery contracts.
—————————————————————————
802 The terms “inter-market spread” and “intra-market
spread” are defined in proposed Sec. 150.1.
—————————————————————————
This exemption would provide exchanges with certainty regarding the
application of spread exemptions for contracts subject to federal
limits under proposed Sec. 150.2. Should an exchange decide to provide
exemptive relief for spread positions, the exemption described in Sec.
150.5(a)(2)(ii) promotes the intended goals of federal speculative
limits, including protection of the spot period in the physical-
delivery contract and exemption of positions as appropriate.
e. Section 150.5(a)(3) Pre-Enactment and Transition Period Swaps
Positions
Proposed Sec. 150.5(a)(3) requires DCMs and SEFs to exempt pre-
enactment and transition period swaps as defined in proposed Sec.
150.1 from exchange-set limits on contracts subject to federal limits
under proposed Sec. 150.2. This provision mirrors the exemption
proposed in Sec. 150.3 and requires that exchanges provide the same
relief as the Commission for pre-existing swaps positions.
Further, requiring that DCMs and SEFs allow netting of pre-and-post
enactment swaps outside of the spot month provides additional
flexibility on an exchange level for market participants in
transitioning to a position limits regime that includes swaps.
f. Request for Comment
The Commission requests comment on its consideration of the
benefits of proposed Sec. 150.5. Are there additional benefits that
the Commission should consider? Has the Commission misidentified any
benefits?
iii. Costs
DCMs presently have considerable experience in setting and
administering speculative position limits and hedge exemption programs
in line with existing Commission guidance and acceptable practices that
run parallel in most respects to the requirements that are incorporated
in the proposed rule. Accordingly, as a general matter, the Commission
anticipates minimal cost impact on DCMs from these proposed
requirements; relative to DCMs, the cost impact for SEFs as newly-
instituted entities may be somewhat greater.
The Commission notes that recently adopted Sec. 37.204 of the
Commission’s regulations allows SEFs the flexibility to contract with a
third-party regulatory service provider 803 to fulfill certain
regulatory obligations.804 The administration of position limits is
within the range of obligations eligible for outsourcing to a third-
party regulatory service provider. Presumably, a SEF will avail itself
of this flexibility if doing so results in lower costs for the entity.
In order to better inform itself with respect to the cost implications
of this proposed rule for SEFs, the Commission requests comment on the
likelihood of SEFs utilizing a third-party regulatory service provider
to comply with its position limits obligations and the expected dollar
costs of doing so. The Commission also requests comment on the expected
dollar costs of meeting the proposed rule’s requirement if a SEF
undertakes to perform the proposed rule’s obligations in-house rather
than outsourcing them.
—————————————————————————
803 Under Sec. 37.204, possible third-party regulatory
service providers include registered futures associations (such as
the National Futures Association (NFA)), registered entities (such
as DCMs or SEFs), and the Financial Industry Regulatory Authority
(FINRA).
804 See 78 FR 33476, 33516, Jun. 4, 2013.
—————————————————————————
The following discusses potential costs with respect to the
specific discretionary aspects of the rule to which they are
attributable.
a. Section 150.5(a)(5) and (b)(8) Aggregation and Sec. 150.5(a)(2)(i)
and (b)(5)(i) Hedge Exemptions
DCMs may incur costs to amend their current aggregation and bona
fide hedging policies to conform with proposed Sec. 150.4 and proposed
Sec. 150.1 respectively. Such costs may include burdens associated
with reviewing and evaluating current standards to assess differences
that must be addressed, employing legal counsel to aid in ensuring
conformity, and transitioning from an old standard to the new one.
Because the burden associated with this rule is proportional to the
divergence of a DCM’s current standard from the Commission’s proposed
standard, costs are specific and proprietary to each affected entity;
as such, the Commission is unable to estimate costs at this time within
a range of reasonable accuracy. It requests comment to assist it in
doing so.
SEFs, as newly-instituted entities, will be required to incur costs
to develop aggregation and bona fide hedging policies that conform to
the appropriate provisions as required
[[Page 75776]]
under proposed Sec. 150.5. Such costs are likely to include legal
counsel, as well as drafting and implementation of the new policy.
Because these entities are new and have not previously been subject to
the Commission’s oversight in this capacity, the Commission requests
comment regarding the costs associated with implementing the
appropriate policies.
b. Section 150.5(a)(2)(iii) and (b)(5)(iii) Application for Exemption
The Commission anticipates that DCMs will incur minimal costs to
administer the application process for exemption relief in accordance
with standards set forth in the proposed rule. As described above, the
Commission understands that requiring traders to apply for exemptive
relief comports with existing DCM practice. Accordingly, by
incorporating an application requirement that the Commission has reason
to understand most if not all active DCMs already follow, the rule
should have little cost impact for DCMs.
For SEFs, the rules necessitate a compliant application regime,
which will require an initial investment similar to that which DCMs
have likely already made and need not duplicate. As noted above, the
Commission considers it highly likely that, in accordance with industry
best practices to comply with core principles and due to the utility of
application information in demonstrating compliance with core
principles, SEFs may incur such costs with or without the proposed
rules. Again, due to the new existence of these entities, the
Commission is unable to estimate what costs may be associated with the
requirement to impose an application regime for exemptive relief on the
exchange level. The Commission requests comment regarding the burden on
a SEF to impose a compliant application regime.
c. Section 150.5(a)(2)(ii) Other Exemptions
Proposed Sec. 150.5(a)(2)(ii) provides clarity on the imposition
of exemptions for spread positions on contracts subject to federal
limits under proposed Sec. 150.2 in accordance with new definitions
proposed in Sec. 150.1. The Commission notes again that the rules
would apply if the single-month limit is at a lower level than the all-
month limit, which would occur if a DCM or SEF determines to set more
restrictive levels for a single-month limit that what has been set by
the Commission, or if the exchange grants inter-market spread
exemptions. Thus, the Commission anticipates that a DCM or SEF that has
determined to set a more restrictive limit will have done so having
taken into account any burden imposed by the proposed rule. Further,
some trading venues already grant inter-market spread exemptions on
certain commodities; such entities may be able to leverage current
practices to extend such spread exemptions to other commodities as
appropriate.
The Commission expects small costs to be associated with
communicating and monitoring the appropriate conditions for exemption
as described in proposed Sec. 150.5(a)(2)(ii), namely that such
position must be solely outside of the spot-month of the physical-
delivery contract.
d. Request for Comment
The Commission requests comment on its considerations of the costs
of proposed Sec. 150.5. Are there additional costs that the Commission
should consider? Has the Commission misidentified any costs? What other
relevant cost information or data, including alternative cost
estimates, should the Commission consider and why?
iv. Consideration of Alternatives
The Commission recognizes that alternatives may exist to
discretionary elements of Sec. 150.5 proposed herein. The Commission
requests comment on whether an alternative to what is proposed would
result in a superior benefit-cost profile, with support for any such
position provided.
6. Section 150.7–Reporting Requirements for Anticipatory Hedging
Positions
The revised definition of bona fide hedging in proposed Sec. 150.1
incorporates hedges of five specific types of anticipated transactions:
unfilled anticipated requirements, unsold anticipated production,
anticipated royalties, anticipated services contract payments or
receipts, and anticipatory cross-hedges.805 The Commission proposes
reporting requirements in new Sec. 150.7 for traders seeking an
exemption from position limits for any of these five enumerated
anticipated hedging transactions. Proposed Sec. 150.7 would build on,
and replace, the special reporting requirements for hedging of unsold
anticipated production and unfilled anticipated requirements in current
Sec. 1.48.806
—————————————————————————
805 See, paragraphs (3)(iii), (4)(i), (iii), and (iv), and
(5), respectively, of the Commission’s amended definition of bona
fide hedging transactions in proposed Sec. 150.1.
806 See 17 CFR 1.48. See also definition of bona fide hedging
transactions in current 17 CFR 1.3(z)(2)(i)(B) and (ii)(C),
respectively.
—————————————————————————
Current Sec. 1.48 provides a procedure for persons to file for
bona fide hedging exemptions for anticipated production or unfilled
requirements when that person has not covered the anticipatory need
with fixed-price commitments to sell a commodity, or inventory or
fixed-price commitments to purchase a commodity. It reflects a long-
standing Commission concern for the difficulty of distinguishing
between reduction of risk arising from anticipatory needs and that
arising from speculation if anticipatory transactions are not well
defined.807 These same concerns apply to any position undertaken to
reduce the risk of anticipated transactions. To address them, the
Commission proposes to extend the special reporting requirements in
proposed Sec. 150.7 for all types of enumerated anticipatory hedges
that appear in the definition of bona fide hedging positions in
proposed Sec. 150.1.808
—————————————————————————
807 See Hedging Anticipated Requirements for Processing or
Manufacturing under Section 4a(3) of the Commodity Exchange Act, 21
FR 6913, Sep. 12, 1956.
808 For purposes of simplicity, the proposed special reporting
requirements for anticipatory hedges would be placed within the
Commission’s position limits regime in part 150, and alongside the
Commission’s updated definition of bona fide hedging positions in
proposed Sec. 150.1; rendered duplicative by these changes, current
Sec. 1.48 would be deleted. In another non-substantive change,
proposed Sec. 150.7(i) would replace current Sec. 140.97 which
delegates to the Director of the Division of Market Oversight or his
designee authority regarding requests for classification of
positions as bona fide hedging under current Sec. Sec. 1.47 and
1.48. For purposes of simplicity, this delegation of authority would
be placed within the Commission’s position limits regime in part
150.
—————————————————————————
The Commission proposes to add a new series ’04 reporting form,
Form 704, to effectuate these additional and updated reporting
requirements for anticipatory hedges. Persons wishing to avail
themselves of an exemption for any of the anticipatory hedging
transactions enumerated in the updated definition of bona fide hedging
in proposed Sec. 150.1 would be required to file an initial statement
on Form 704 with the Commission at least ten days in advance of the
date that such positions would be in excess of limits established in
proposed Sec. 150.2.
Proposed Sec. 150.7(f) would add a requirement for any person who
files an initial statement on Form 704 to provide annual updates that
detail the person’s actual cash market activities related to the
anticipated exemption. Proposed Sec. 150.7(g) would similarly enable
the Commission to review and compare the
[[Page 75777]]
actual cash activities and the remaining unused anticipated hedge
transactions by requiring monthly reporting on Form 204.
As is the case under current Sec. 1.48, proposed Sec. 150.7(h)
requires that a trader’s maximum sales and purchases must not exceed
the lesser of the approved exemption amount or the trader’s current
actual anticipated transaction.
i. Benefits and Costs
As noted above, the Commission remains concerned that
distinguishing whether an over-the-limit position is entered into in
order to reduce risk arising from anticipatory needs, or whether it is
speculative, may be exceedingly difficult if anticipatory transactions
are not well defined. The Commission proposes to add, in its
discretion, proposed Sec. 150.7 to collect vital information to aid in
this distinction. Advance notice of a trader’s intended maximum
position in commodity derivative contracts to offset anticipatory risks
would identify–in advance–a position as a bona fide hedging position,
avoiding unnecessary contact during the trading day with surveillance
staff to verify whether a hedge exemption application is in process,
the appropriate level for the exemption and whether the exemption is
being used in a manner that is consistent with the requirements. Market
participants can anticipate hedging needs well in advance of assuming
positions in derivatives markets and in many cases need to supply the
same information after the fact; in such cases, providing the
information in advance allows the Commission to better direct its
efforts towards deterring and detecting manipulation. The annual
updates in proposed Sec. 150.7(f) similarly allow the Commission to
verify on an ongoing basis that the person’s anticipated cash market
transactions closely track that person’s real cash market activities.
Absent monthly filing pursuant to proposed Sec. 150.7(g), the
Commission would need to issue a special call to determine why a
person’s commodity derivative contract position is, for example, larger
than the pro rata balance of her annually reported anticipated
production.
The Commission understands that there will be costs associated with
proposed Sec. 150.7(f) in the filing of Form 704. Costs of filing that
form are discussed in the context of the proposed part 19 requirements.
The Commission requests comments on its consideration of the costs
and benefits of proposed Sec. 150.7. Are there additional costs or
benefits the Commission should consider? What costs may be incurred
beyond those incurred to gather information and file Form 704? Should
the Commission consider alternatives to its annual updating
requirement? The Commission also recognizes that alternatives may exist
to discretionary elements of Sec. 150.7 proposed herein. The
Commission requests comments on whether an alternative to what is
proposed would result in a superior benefit-cost profile, with support
for any such position provided.
7. Part 19–Reports
CEA Section 4i authorizes the Commission to require the filing of
reports, as described in CEA section 4g, when positions equal or exceed
position limits. Current part 19 of the Commission’s regulations sets
forth these reporting requirements for persons holding or controlling
reportable futures and option positions that constitute bona fide hedge
positions as defined in Sec. 1.3(z) and in markets with federal
speculative position limits–namely those for grains, the soy complex,
and cotton. Since having a bona fide hedge exemption affords a
commercial market participant the opportunity to hold positions that
exceed a position limit level, it is important for the Commission to be
able to verify that when an exemption is invoked that it is done so for
legitimate purposes. As such, commercial entities that hold positions
in excess of those limits must file information on a monthly basis
pertaining to owned stocks and purchase and sales commitments for
entities that claim a bona fide hedging exemption.
In order to help ensure that the additional exemptions described in
proposed Sec. 150.3 are used in accordance with the requirements of
the exemption employed, as well as obtain information necessary to
verify that any futures, options and swaps positions established in
referenced contracts are justified, the Commission proposes to make
conforming and substantive amendments to part 19. First, the Commission
proposes to amend part 19 by adding new and modified cross-references
to proposed part 150, including the new definition of bona fide hedging
position in proposed Sec. 150.1.809 Second, the Commission proposes
to amend Sec. 19.00(a) by extending reporting requirements to any
person claiming any exemption from federal position limits pursuant to
proposed Sec. 150.3. The Commission proposes to add three new series
’04 reporting forms to effectuate these additional reporting
requirements. Third, the Commission proposes to update the manner of
part 19 reporting. Lastly, the Commission proposes to update both the
type of data that would be required in series ’04 reports, as well as
the time allotted for filing such reports.
—————————————————————————
809 These amendments are non-substantive conforming amendments
and should not have implications for the Commission’s consideration
of costs and benefits.
—————————————————————————
i. Rule Summary
a. Extension of Reporting Requirements
Proposed part 19 will be expanded to include reporting requirements
for positions in swaps, in addition to futures and options positions,
for any instance in which a person relies on an exemption. Therefore,
positions in “commodity derivative contracts,” as defined in proposed
Sec. 150.1, would replace “futures and option positions” throughout
amended part 19 as shorthand for any futures, option, or swap contract
in a commodity (other than a security futures product as defined in CEA
section 1a(45)).810
—————————————————————————
810 See supra discussion of proposed amendments to part 19.
—————————————————————————
The Commission also proposes to extend the reach of part 19 by
requiring all persons who avail themselves of any exemption from
federal position limits under proposed Sec. 150.3 to file applicable
series ’04 reports.811 The list of positions set forth in proposed
Sec. 150.3 that are eligible for exemption from the federal position
includes, but is not limited to, bona fide hedging positions (including
pass-through swaps and anticipatory bona fide hedge positions),
qualifying spot month positions in cash-settled referenced contracts,
and qualifying non-enumerated risk-reducing transactions.
—————————————————————————
811 Furthermore, anyone exceeding the federal limits who has
received a special call must file a series ’04 form.
—————————————————————————
The Commission currently requires two monthly reports, CFTC Forms
204 and 304, which are listed in current Sec. 15.02.812 The reports,
collectively referred to as the Commission’s “series ’04 reports,”
show a trader’s positions in the cash market and are used by the
Commission to determine whether a trader has sufficient cash positions
that justify futures and option positions above the speculative limits.
CFTC Form 204 is the Statement of Cash Positions in Grains, which
includes the soy complex, and CFTC Form 304 Report is the Statement of
Cash
[[Page 75778]]
Positions in Cotton.813 The Commission proposes to add three new
series ’04 reporting forms to effectuate the expanded reporting
requirements of part 19. Proposed CFTC Form 504, Statement of Cash
Positions for Conditional Spot Month Exemptions, would be added for use
by persons claiming the conditional spot month limit exemption pursuant
to proposed Sec. 150.3(c). Proposed CFTC Form 604, Statement of
Counterparty Data for Pass-Through Swap Exemptions, would be added for
use by persons claiming a bona fide hedge exemption for either of two
specific pass-through swap position types, as discussed further below.
Proposed CFTC Form 704, Statement of Anticipatory Bona Fide Hedge
Exemptions, would be added for use by persons claiming a bona fide
hedge exemption for certain anticipatory bona fide hedging positions.
—————————————————————————
812 17 CFR 15.02.
813 See supra discussion of series ’04 forms.
—————————————————————————
b. Manner of Reporting
For purposes of reporting cash market positions under current part
19, the Commission historically has allowed a reporting trader to
“exclude certain products or byproducts in determining his cash
positions for bona fide hedging” if it is “the regular business
practice of the reporting trader” to do so.814 Nevertheless, the
Commission believes that an entity, when calculating the value that is
subject to risks from a source commodity in order to establish a long
derivatives position as a hedge for unfilled anticipated requirements,
need take into account large quantities of a source commodity that it
may hold in inventory. Under proposed Sec. 19.00(b)(1), a source
commodity itself can only be excluded from a calculation of a cash
position if the amount is de minimis, impractical to account for, and/
or on the opposite side of the market from the market participant’s
hedging position.815
—————————————————————————
814 See 17 CFR 19.00(b)(1) (providing that “[i]f the regular
business practice of the reporting trader is to exclude certain
products or byproducts in determining his cash position for bona
fide hedging . . . , the same shall be excluded in the report”).
815 Proposed Sec. 19.00(b)(1) adds a caveat to the
alternative manner of reporting: when reporting for the cash
commodity of soybeans, soybean oil, or soybean meal, the reporting
person shall show the cash positions of soybeans, soybean oil and
soybean meal. This proposed provision for the soybean complex is
included in the current instructions for preparing Form 204.
—————————————————————————
Persons who wish to avail themselves of cross-commodity hedges are
required to file an appropriate series ’04 form. Proposed Sec.
19.00(b)(2) sets forth instructions, which are consistent with the
provisions in the current section, for reporting a cash position in a
commodity that is different from the commodity underlying the futures
contract used for hedging.816 Since proposed Sec. 19.00(b)(3) would
maintain the requirement that cross-hedged positions be shown both in
terms of the equivalent amount of the commodity underlying the
commodity derivative contract used for hedging and in terms of the
actual cash commodity (as provided for on the appropriate series ’04
form), the Commission will be able to determine the hedge ratio used
merely by comparing the reported positions. Thus, the Commission will
be positioned to review whether a hedge ratio appears reasonable in
comparison to, for example, other similarly situated traders.
—————————————————————————
816 Proposed Sec. 19.00(b)(2) would add the term commodity
derivative contracts (as defined in proposed Sec. 150.1). The
proposed definition of cross-commodity hedge in proposed Sec. 150.1
is discussed above.
—————————————————————————
Proposed Sec. 19.00(b)(3) maintains the requirement that standards
and conversion factors used in computing cash positions for reporting
purposes must be made available to the Commission upon request.
Proposed Sec. 19.00(b)(3) would clarify that such information would
include hedge ratios used to convert the actual cash commodity to the
equivalent amount of the commodity underlying the commodity derivative
contract used for hedging, and an explanation of the methodology used
for determining the hedge ratio.
c. Bona Fide Hedgers and Cotton Merchants and Dealers
Current Sec. 19.01(a) sets forth the data that must be provided by
bona fide hedgers (on Form 204) and by merchants and dealers in cotton
(on Form 304). The Commission proposes to continue using Forms 204 and
304, with minor changes to the types of data to be reported.817 Form
204 will be expanded to incorporate, in addition to all other positions
reportable under proposed Sec. 19.00(a)(1)(iii), monthly reporting for
cotton, including the granularity of equity, certificated and non-
certificated cotton stocks of cotton. Weekly reporting for cotton will
be retained as a separate report made on Form 304 for the collection of
data required by the Commission to publish its weekly public cotton
“on call” report on www.cftc.gov.
—————————————————————————
817 The list of data required for persons filing on Forms 204
and 304 would be relocated from current Sec. 19.01(a) to proposed
Sec. 19.01(a)(3).
—————————————————————————
Proposed Sec. 19.01(b) would maintain the requirement that reports
on Form 204 be submitted to the Commission on a monthly basis, as of
the close of business on the last Friday of the month.
d. Conditional Spot-Month Limit Exemption
Proposed Sec. 19.01(a)(1) would require persons availing
themselves of the conditional spot month limit exemption for natural
gas (pursuant to proposed Sec. 150.3(c)) to report certain detailed
information concerning their cash market activities. While traders
could not directly influence the settlement price in the physical-
delivery referenced contract due to the prohibition of holding
physical-delivery contract positions when invoking the conditional spot
month exemption, there is no similar restriction on holding the
underlying cash commodity. While the Commission is concerned about
traders’ activities in the underlying cash market of any derivative
contract, it is particularly concerned with respect to natural gas
where there is an existing conditional spot-month limit exemption.
Accordingly, proposed Sec. 19.01(b) would require that persons
claiming a conditional spot month limit exemption must report on new
Form 504 daily, by 9 a.m. Eastern Time on the next business day, for
each day that a person is over the spot month limit in certain
commodity contracts specified by the Commission. The scope of
reporting–purchase and sales contracts through the delivery area for
the core referenced futures contract and inventory in the delivery
area–differs from the scope of reporting for bona fide hedgers, since
the person relying on the conditional spot month limit exemption need
not be hedging a position.
Initially, the Commission would require reporting on new Form 504
for exemptions in the natural gas commodity derivative contracts
only.818 The Commission requests comment as to whether the costs and
benefits of the enhanced reporting regime support imposing this
requirement on additional commodity markets before gaining
[[Page 75779]]
additional experience with this exemption in other commodities.
—————————————————————————
818 The Commission believes that enhanced reporting for
natural gas contracts is warranted based on its experience in
surveillance of natural gas commodity derivative contracts. Absent
experiential evidence of current need beyond the natural gas realm,
the Commission proposes to initially not impose reporting
requirements for persons claiming conditional spot month limit
exemptions in other commodity derivative contracts until the
Commission gains additional experience with the limits in proposed
Sec. 150.2. However, the Commission retains its authority to issue
“special calls” under Sec. 18.05. The Commission will closely
monitor the reporting associated with conditional spot-month limit
exemptions in natural gas, as well as other information available to
the Commission for other commodities, and may require reporting on
Form 504 for other commodity derivative contracts in the future.
—————————————————————————
e. Pass-Through Swap Exemption
Under the definition of bona fide hedging position in proposed
Sec. 150.1, a person who uses a swap to reduce risks attendant to a
position that qualifies for a bona fide hedging transaction may pass-
through those bona fides to the counterparty, even if the person’s swap
position is not in excess of a position limit.819 As such, positions
in commodity derivative contracts that reduce the risk of pass-through
swaps would qualify as bona fide hedging transactions.
—————————————————————————
819 See supra discussion of definition of bona fide hedging
position in proposed Sec. 150.1.
—————————————————————————
Proposed Sec. 19.01(a)(2) would require a person relying on the
pass-through swap exemption who holds either of two position types to
file a report with the Commission on new form 604. The first type of
position is a swap executed opposite a bona fide hedger that is not a
referenced contract and for which the risk is offset with referenced
contracts. The second type of position is a cash-settled swap executed
opposite a bona fide hedger that is offset with physical-delivery
referenced contracts held into a spot month, or, vice versa, a
physical-delivery swap executed opposite a bona fide hedger that is
offset with cash-settled referenced contracts held into a spot month.
The information reported on Form 604 would explain hedgers’ needs
for large referenced contract positions and would give the Commission
the ability to verify that the positions were a bona fide hedge, with
heightened daily surveillance of spot month offsets. Persons holding
any type of pass-through swap position other than the two described
above would report on form 204.820
—————————————————————————
820 Persons holding pass-through swap positions that are
offset with referenced contracts outside the spot month (whether
such contracts are for physical delivery or are cash-settled) need
not report on Form 604 because swap positions will be netted with
referenced contract positions outside the spot month pursuant to
proposed Sec. 150.2(b).
—————————————————————————
f. Swap Off-Sets
Proposed Sec. 19.01(a)(2)(i) lists the types of data that a person
who executes a pass-through swap that is not a referenced contract and
for which the risk is offset with referenced contracts must report on
new Form 604. Under proposed Sec. 19.01(b), persons holding non-
referenced contract swap offset would submit reports to the Commission
on a monthly basis, as of the close of business of the last Friday of
the month. This data collection would permit staff to identify offsets
of non-referenced-contract pass-through swaps on an ongoing basis for
further analysis.
Under proposed Sec. 150.2(a), a trader in the spot month may not
net across physical-delivery and cash-settled contracts for the purpose
of complying with federal position limits.821 If a person executes a
cash-settled pass-through swap that is offset with physical-delivery
contracts held into a spot month (or vice versa), then, pursuant to
proposed Sec. 19.01(a)(2)(ii), that person must report additional
information concerning the swap and offsetting referenced contract
position on new Form 604. Pursuant to proposed Sec. 19.01(b), a person
holding a spot month swap offset would need to file on form 604 as of
the close of business on each day during a spot month, and not later
than 9 a.m. Eastern Time on the next business day following the date of
the report. The Commission notes that pass-through swap offsets would
not be permitted during the lesser of the last five days of trading or
the time period for the spot month. However, the Commission remains
concerned that a trader could hold an extraordinarily large position
early in the spot month in the physical-delivery contract along with an
offsetting short position in a cash-settled contract. Hence, the
Commission proposes to introduce this new daily reporting requirement
within the spot month to identify and monitor such offsetting
positions.
—————————————————————————
821 See supra discussion of proposed Sec. 150.2.
—————————————————————————
ii. Benefits
The reporting requirements allow the Commission to obtain the
information necessary to verify whether the relevant exemption
requirements are fulfilled in a timely manner. This is needed for the
Commission to help ensure that any person who claims any exemption from
federal speculative position limits can demonstrate a legitimate
purpose for doing so. In the absence of the reporting requirements
detailed in proposed part 19, the Commission would lack critical tools
to identify abuses related to the exemptions afforded in proposed Sec.
150.3 in a timely manner and refer them to enforcement. As such, the
reporting requirements are necessary for the Commission to be able to
perform its essential surveillance functions. These reporting
requirements therefore promote the Commission’s ability to achieve, to
the maximum extent practicable, the statutory factors outlined by
Congress in CEA section 4a(a)(3).
The Commission requests comment on its considerations of the
benefits of reporting under part 19. Has the Commission accurately
identified the benefits of collecting the reported information? Are
there additional benefits the Commission should consider?
iii. Costs
The Commission recognizes there will be costs associated with the
proposed changes and additions to the report filing requirements under
part 19. Though the Commission anticipates that market participants
should have ready access to much of the required information, the
Commission expects that, at least initially, market participants will
require additional time and effort to become familiar with new and
amended series ’04 forms, to gather the necessary information in the
required format, and to file reports in the proposed timeframes. The
Commission has attempted to mitigate the cost impacts of these reports.
Actual costs incurred by market participants will vary depending on
the diversity of their cash market positions, the experience that the
participants currently have regarding filing Form 204 and Form 304 as
well as a variety of other organizational factors. However, the
Commission has estimated average incremental burdens associated with
the proposed rules in order to fulfill its obligations under the
PRA.822
—————————————————————————
822 See PRA section below for full details on the Commission’s
estimates.
—————————————————————————
For Form 204, the Commission estimates that approximately 400
market participants will file an average of 12 reports annually at an
estimated labor burden of 2 hours per response for a total per-entity
hour burden of approximately 24 hours, which computes to a total annual
burden of 9,600 hours for all affected entities. Using an estimated
hourly wage of $120 per hour,823 the Commission estimates
[[Page 75780]]
an annual per-entity cost of approximately $2,900 and a total annual
cost of $1,152,000 for all affected entities.
—————————————————————————
823 The Commission’s estimates concerning the wage rates are
based on 2011 salary information for the securities industry
compiled by the Securities Industry and Financial Markets
Association (“SIFMA”). The Commission is using $120 per hour,
which is derived from a weighted average of salaries across
different professions from the SIFMA Report on Management &
Professional Earnings in the Securities Industry 2011, modified to
account for an 1800-hour work-year, adjusted to account for the
average rate of inflation in 2012, and multiplied by 1.33 to account
for benefits and 1.5 to account for overhead and administrative
expenses. The Commission anticipates that compliance with the
provisions would require the work of an information technology
professional; a compliance manager; an accounting professional; and
an associate general counsel. Thus, the wage rate is a weighted
national average of salary for professionals with the following
titles (and their relative weight); “programmer (senior)” and
“programmer (non-senior)” (15% weight), “senior accountant”
(15%) “compliance manager” (30%), and “assistant/associate
general counsel” (40%). All monetary estimates have been rounded to
the nearest hundred dollars.
—————————————————————————
For Form 304, the Commission estimates that approximately 400
market participants will file an average of 52 reports annually at an
estimated labor burden of 1 hours per response for a total per-entity
hour burden of approximately 52 hours, which computes to a total annual
burden of 20,800 hours for all affected entities. Using an estimated
hourly wage of $120 per hour,824 the Commission estimates an annual
per-entity cost of approximately $6,300 and a total annual cost of
$2,500,000 for all affected entities.
—————————————————————————
824 Id.
—————————————————————————
For the new Form 504, the Commission anticipates that approximately
40 market participants will file an average of 12 reports annually at
an estimated labor burden of 15 hours per response for a total per-
entity hour burden of approximately 180 hours, which computes to a
total annual burden of 7,200 hours for all affected entities. Using an
estimated hourly wage of $120 per hour,825 the Commission estimates
an annual per-entity cost of approximately $10,800 and a total annual
cost of $864,000 for all affected entities.
—————————————————————————
825 Id.
—————————————————————————
For the new Form 604, the Commission anticipates that approximately
200 market participants will file an average of 10 reports annually at
an estimated labor burden of 30 hours per response for a total per-
entity hour burden of approximately 300 hours, which computes to a
total annual burden of 60,000 hours for all affected entities. Using an
estimated hourly wage of $120 per hour,826 the Commission estimates
an annual per-entity cost of approximately $36,000 and a total annual
cost of $7,200,000 for all affected entities.
—————————————————————————
826 Id.
—————————————————————————
Finally, for the new Form 704, the Commission anticipates that
approximately 200 market participants will file an average of 10
reports annually at an estimated labor burden of 20 hours per response
for a total per-entity hour burden of approximately 200 hours, which
computes to a total annual burden of 40,000 hours for all affected
entities. Using an estimated hourly wage of $120 per hour,827 the
Commission estimates an annual per-entity cost of approximately $24,000
and a total annual cost of $4,800,000 for all affected entities.
—————————————————————————
827 Id.
—————————————————————————
The Commission requests comment regarding its consideration of
costs pertaining to the amendments to part 19. Has the Commission
accurately described the ways that market participants may incur costs?
Are there other costs, direct or indirect, that the Commission should
consider regarding the proposed part 19? How does the introduction of
the new series ’04 reports affect the likelihood that a trader may seek
an exemption? What other burdens may arise from the filing of these
reports? Are the Commission’s burden estimates under the PRA
reasonable? Why or why not? Commenters are encouraged to submit their
own estimates of costs, including labor burdens and wage estimates, for
the Commission’s consideration.
iv. Consideration of Alternatives
The Commission also recognizes that alternatives may exist to
discretionary elements of the part 19 reporting amendments proposed
herein. The Commission requests comments on whether an alternative to
what is proposed would result in a superior benefit-cost profile, with
support for any such position provided.
8. CEA Section 15(a)
As described above, the Commission interprets the revised CEA
section 4a as requiring the imposition of speculative position limits
during the spot-month, any single month, and all-months-combined on all
commodity derivative contracts, including swaps, that reference the
same underlying physical commodity on an aggregated basis across
trading venues. Section 15(a) of the Act requires the Commission to
evaluate the costs and benefits of its discretionary actions in light
of five enumerated factors that represent broad areas of market and
public concern. The Commission welcomes comment on its evaluation under
CEA section 15(a).
i. Protection of Market Participants and the Public
Broadly speaking, the Commission’s expansion of the federal
speculative position limits regime to include an additional 19 core-
referenced futures contracts (and the associated referenced contracts)
will extend protections afforded to the existing legacy contracts.
Namely, the limits are intended as a measure to prophylactically deter
manipulation and to diminish, eliminate, or prevent excessive
speculation in significant price discovery contracts. The proposed
limits in Sec. 150.2, the methodology used for determining limits at
the spot, single and all-months combined levels and the determination
of distinct levels in physically-delivered and cash-settled contracts
all support the Commission’s mission to prevent undue or unnecessary
burdens on interstate commerce resulting from excess speculation such
as the sudden or unreasonable fluctuations or unwarranted changes in
commodity prices. Further, by requiring that market participants who
avail themselves of the exemptions offered under Sec. 150.3 document
their exemption eligibility and make such records available on request
and through regular reporting to the Commission, the Commission is
protecting market participants–hedgers and speculators alike–from
another party abusing the exemptions reserved for eligible entities.
The Commission anticipates that market participants engaged in
speculative trading will incur costs to monitor their positions vis-a-
vis limit levels. The Commission expects that market participants will
need to invest additional time and effort to become familiar with new
and amended series ’04 forms, to gather the necessary information in
the required format, and to file reports in the proposed timeframes.
ii. Efficiency, Competitiveness, and Financial Integrity of Markets
Position limits help to prevent market manipulation or excessive
speculation that may unduly influence prices at the expense of the
efficiency and integrity of markets. The expansion of the federal
position limits regime to 28 core referenced futures contracts enhances
the buffer against excessive speculation historically afforded to the
nine legacy contracts exclusively, improving the financial integrity of
those markets. Moreover, the proposed limits in Sec. 150.2 promote
market competitiveness by preventing a trader from gaining too much
market power.
The stringently defined exemptions in Sec. 150.3 and the reporting
requirements assigned to those availing themselves of the exemptions
provided are the Commission’s first line of defense in ensuring that
participants transacting in the Commission’s jurisdictional markets are
doing so in a competitive and efficient environment.
In codifying the Commission’s historical practice of temporarily
lifting position limit restrictions, the proposed
[[Page 75781]]
Sec. 150.3(b) financial distress exemption strengthens the benefits of
accommodating transfers of positions from financially distressed firms
to financially secure firms or facilitating other necessary remediation
measures during times of market stress. In addition, it provides market
participants with a degree of confidence which contributes to the
overall efficiency and financial integrity of markets.
iii. Price Discovery
Market manipulation or excessive speculation may result in
artificial prices. So, in this sense, position limits might also help
to prevent the price discovery function of the underlying commodity
markets from being disrupted. On the other hand, imposing position
limits raises the concerns that liquidity and price discovery may be
diminished, because certain market segments, i.e., speculative traders,
are restricted. However, the Commission has mitigated some of these
concerns by proposing various exemptions to positions limits. In
addition, applying current DCM-set limits as federal limits means that
even though additional contract markets will be brought into the
federal position limits regime, the activity of speculative traders, at
least initially, will be no less restricted than under the current
regime.
iv. Sound Risk Management
Proposed exemptions for bona fide hedgers help to ensure that
market participants with positions that are hedging legitimate
commercial needs are properly recognized as hedgers under the
Commission’s speculative position limits regime. This promotes sound
risk management practices. In addition, the Commission has crafted the
proposed rules to ensure sufficient market liquidity for bona fide
hedgers to the maximum extent practicable, e.g., through the
conditional spot month limit exemption.
To the extent that monitoring for position limits requires market
participants to create internal risk limits and evaluate position size
in relation to the market, position limits may also provide an
incentive for market participants to engage in sound risk management
practices.
v. Other Public Interest Considerations
The regulations proposed under Sec. 150.5 require that exchange-
set limits employ policies that conform to the Commission’s general
policy both for contracts that are subject to federal limits under
Sec. 150.2 and those that are not, thus harmonizing rules for all
federal and exchange-set speculative position limits.
B. Paperwork Reduction Act
1. Overview
The PRA 828 imposes certain requirements on Federal agencies in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. Certain provisions of the
regulations proposed herein will result in amendments to approved
collection of information requirements within the meaning of the PRA.
An agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid control number issued by the Office of Management and Budget
(“OMB”). Therefore, the Commission is submitting this proposal to OMB
for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The
information collection requirements proposed in this proposal would
amend previously-approved collections associated with OMB control
numbers 3038-0009 and 3038-0013.
—————————————————————————
828 44 U.S.C. 3501 et seq.
—————————————————————————
If adopted, responses to these collections of information would be
mandatory. Several of the reporting requirements are mandatory in order
to obtain exemptive relief, and are thus mandatory under the PRA to the
extent a market participant elects to seek such relief. The Commission
will protect proprietary information according to the Freedom of
Information Act and 17 CFR part 145, headed “Commission Records and
Information.” In addition, the Commission emphasizes that section
8(a)(1) of the Act strictly prohibits the Commission, unless
specifically authorized by the Act, from making public “data and
information that would separately disclose the business transactions or
market positions of any person and trade secrets or names of
customers.” 829 The Commission also is required to protect certain
information contained in a government system of records pursuant to the
Privacy Act of 1974.830
—————————————————————————
829 7 U.S.C. 12(a)(1).
830 5 U.S.C. 552a.
—————————————————————————
Under the proposed regulations, market participants with positions
in a “referenced contract,” as defined in proposed Sec. 150.1, would
be subject to the position limit framework established under the
proposed revisions to parts 19 and 150. Proposed part 19 prescribes new
forms and reporting requirements for persons claiming a conditional
spot month limit exemption (proposed Form 504),831 a pass-through
swap exemption (proposed Form 604),832 or an anticipatory exemption
(proposed Form 704).833 The proposed amendments to part 19 also
update and change reporting obligations and required information for
Form 204 and Form 304.834 Proposed part 150 prescribes reporting
requirements for DCMs listing a core referenced futures contract 835
and traders who wish to apply for an exemption from DCM- or SEF-
established positions limits in non-referenced contracts,836 as well
as recordkeeping requirements for persons who claim exemptions from
position limits or are counterparties to a person claiming a pass-
through swap offset.837
—————————————————————————
831 See proposed Sec. Sec. 19.00(a)(1)(i) and 19.01(a)(1).
832 See proposed Sec. Sec. 19.00(a)(1)(ii) and 19.01(a)(2).
833 The requirement of filing a Form 704 in order to claim an
anticipatory exemption is stipulated in proposed Sec. 150.7(a) in
addition to its inclusion in proposed amendments to part 19. See
proposed Sec. Sec. 19.00(a)(1)(iv), 19.01(a)(4) and 150.7(a).
834 See proposed Sec. 19.01(a)(3).
835 See proposed Sec. 150.2(e)(3)(ii).
836 See proposed Sec. 150.5(b)(5)(C).
837 See proposed Sec. 150.3(g).
—————————————————————————
2. Methodology and Assumptions
It is not possible at this time to precisely determine the number
of respondents affected by the proposed rules. Many of the regulations
that impose PRA burdens are exemptions that a market participant may
elect to take advantage of, meaning that without intimate knowledge of
the day-to-day business decisions of all its market participants, the
Commission could not know which participants, or how many, may elect to
obtain such an exemption. Further, the Commission is unsure of how many
participants not currently in the market may be required to or may
elect to incur the estimated burdens in the future. Finally, many of
the regulations proposed herein are applying to participants in swaps
markets for the first time, and, as explained supra, the Commission’s
lack of experience with such markets and with many of the participants
therein hinders its ability to determine with precision the number of
affected entities.
These limitations notwithstanding, the Commission has made best-
effort estimations regarding the likely number of affected entities for
the purposes of calculating burdens under the PRA. The Commission used
its proprietary data, collected from market participants, to estimate
the number of respondents for each of the proposed obligations subject
to the PRA. As discussed supra,838 the
[[Page 75782]]
Commission analyzed data covering the two year period 2011-2012 to
determine how many participants would be over 60, 80, or 100 percent of
the proposed limit levels in each of the 28 core referenced futures
contracts, were such limit levels to be adopted as proposed.
—————————————————————————
838 See supra discussion of number of traders over the limits.
—————————————————————————
For purposes of the PRA, Commission staff determined the number of
unique traders over the proposed spot-month position limit level for
all of the 28 core referenced futures contracts combined. The
Commission also determined the number of traders over the non-spot-
month position limit level for all of the 28 core referenced futures
contracts combined. Staff then added those two figures and rounded it
up to the nearest hundred to arrive at an approximation of 400
persons.839 This base figure was then scaled to estimate, based on
the Commission’s expertise and experience in the administration of
position limits, how many participants may be affected by each specific
provision. The analysis reviewed by the Commission does not account for
hedging and other exemptions from position limits, which leads the
Commission to believe that the approximate number of traders in excess
of the limits is a very conservative estimate. The Commission welcomes
comment on its estimates, the methodology described above, and its
conclusion regarding the conservativeness of its estimates.
—————————————————————————
839 Staff believes that such rounding preserves the
reasonability of the estimate without creating a false impression of
precision.
—————————————————————————
The Commission’s estimates concerning wage rates are based on 2011
salary information for the securities industry compiled by the
Securities Industry and Financial Markets Association (“SIFMA”). The
Commission is using a figure of $120 per hour, which is derived from a
weighted average of salaries across different professions from the
SIFMA Report on Management & Professional Earnings in the Securities
Industry 2011, modified to account for an 1800-hour work-year, adjusted
to account for the average rate of inflation in 2012. This figure was
then multiplied by 1.33 to account for benefits 840 and further by
1.5 to account for overhead and administrative expenses.841 The
Commission anticipates that compliance with the provisions would
require the work of an information technology professional; a
compliance manager; an accounting professional; and an associate
general counsel. Thus, the wage rate is a weighted national average of
salary for professionals with the following titles (and their relative
weight); “programmer (average of senior and non-senior)” (15%
weight), “senior accountant” (15%) “compliance manager” (30%), and
“assistant/associate general counsel” (40%). All monetary estimates
have been rounded to the nearest hundred dollars. The Commission
welcomes public comment on its assumptions regarding its estimated
hourly wage.
—————————————————————————
840 The Bureau of Labor Statistics reports that an average of
32.8% of all compensation in the financial services industry is
related to benefits. This figure may be obtained on the Bureau of
Labor Statistics Web site, at http://www.bls.gov/news.release/ecec.t06.htm. The Commission rounded this number to 33% to use in
its calculations.
841 Other estimates of this figure have varied dramatically
depending on the categorization of the expense and the type of
industry classification used (see, e.g., BizStats at http://www.bizstats.com/corporation-industry-financials/finance-insurance-52/securities-commodity-contracts-other-financial-investments-523/commodity-contracts-dealing-and-brokerage-523135/show and Damodaran
Online at http://pages.stern.nyu.edu/~adamodar/pc/datasets/
uValuedata.xls) The Commission has chosen to use a figure of 50% for
overhead and administrative expenses to attempt to conservatively
estimate the average for the industry.
—————————————————————————
3. Information Provided by Reporting Entities/Persons and Recordkeeping
Duties
For purposes of assisting the Commission in setting spot-month
limits no less frequently than every two years, proposed Sec.
150.2(e)(3)(ii) adds an additional burden cost to information
collection 3038-0013 by requiring DCMs to supply the Commission with an
estimated spot-month deliverable supply for each core referenced
futures contract listed. The estimate must include documentation as to
the methodology used in deriving the estimate, including a description
and any statistical data employed. The Commission estimates that the
submission would require a labor burden of approximately 20 hours per
estimate. Thus, a DCM that submits one estimate may incur a burden of
20 hours for a cost, using the estimated hourly wage of $120, of
approximately $2,400. DCMs that submit more than one estimate may
multiply this per-estimate burden by the number of estimates submitted
to obtain an approximate total burden for all submissions, subject to
any efficiencies and economies of scale that may result from submitting
multiple estimates. The Commission welcomes comment regarding the
estimated burden on DCMs that will result from proposed Sec. 150.2(e).
Proposed Sec. 150.3(g)(1) adds an additional burden cost to
information collection 3038-0013 by requiring any person claiming an
exemption from federal position limits under part 150 to keep and
maintain books and records concerning all details of their related
cash, forward, futures, options and swap positions and transactions to
serve as a reasonable basis to demonstrate reduction of risk on each
day that the exemption was claimed. These records must be
comprehensive, in that they must cover anticipated requirements,
production and royalties, contracts for services, cash commodity
products and by-products, and cross-commodity hedges. Proposed Sec.
150.3(g)(2) requires any person claiming a pass-through swap offset
hedging exemption to obtain a representation that the swap qualifies as
a pass-through swap for purposes of a bona fide hedging position.
Additionally, proposed Sec. 150.3(g)(3) requires any person
representing to another person that a swap qualifies as a pass-through
swap for purposes of a bona fide hedging position, to keep and make
available to the Commission upon request all relevant books and records
supporting such a representation for at least two years following the
expiration of the swap.
The Commission estimates that approximately 400 traders will claim
an average of 50 exemptions each per year that fall within the scope of
the recordkeeping requirements of proposed Sec. 150.3(g). At
approximately one hour per exemption claimed to keep and maintain the
required books and records, the Commission estimates that industry will
incur a total of 20,000 annual labor hours amounting to $2,400,000 in
additional labor costs. The Commission requests public comment
regarding the burden associated with the recordkeeping requirements of
proposed Sec. 150.3(g) and its estimates thereto.
Proposed Sec. 150.5(b)(5)(iii) adds an additional burden cost to
information collection 3038-0013 by requiring traders who wish to avail
themselves of any exemption from a DCM or SEF’s speculative position
limit rules that is allowed for under Sec. 150.5(b)(5)(A)-(B) to
submit an application to the DCM or SEF explaining how the exemption
would be in accord with sound commercial practices and would allow for
a position that could be liquidated in an orderly fashion. As noted
supra, the Commission understands that requiring traders to apply for
exemptive relief comports with existing DCM practice; thus, the
Commission anticipates that the codification of this requirement will
have the practical effect of incrementally increasing, rather than
creating, the burden of applying for such exemptive relief. The
Commission estimates that approximately 400 traders will claim
exemptions from DCM or
[[Page 75783]]
SEF-established speculative position limits each year, with each trader
on average making 100 related submissions to the DCM or SEF each year.
Each submission is estimated to take 2 hours to complete and file,
meaning that these traders would incur a total burden of 80,000 labor
hours per year for an industry-wide additional labor cost of
$9,600,000. The Commission welcomes all comment regarding the estimated
burden on market participants wishing to avail themselves of a DCM or
SEF exemption.
Proposed Sec. 19.01(a)(1) adds an additional burden cost to
information collection 3038-0009 for persons claiming a conditional
spot month limit exemption pursuant to Sec. 150.3(c), by requiring the
filing of Form 504 for special commodities so designated by the
Commission under Sec. 19.03. A Form 504 filing shows the composition
of the cash position of each commodity underlying a referenced contract
that is held or controlled for which the exemption is claimed,842
including the “as of” date, the quantity of stocks owned of such
commodity, the quantity of fixed-price purchase commitments open
providing for receipt of such cash commodity, the quantity of fixed-
price sale commitments open providing for delivery of such cash
commodity, the quantity of unfixed-price purchase commitments open
providing for receipt of such cash commodity, and the quantity of
unfixed-price sale commitments open providing for delivery of such cash
commodity. The Commission estimates that approximately 40 traders will
claim a conditional spot month limit 12 times per year, and each
corresponding submission will take 15 labor hours to complete and file.
Therefore, the Commission estimates that the Form 504 reporting
requirement will result in approximately 7,200 total annual labor hours
for an additional industry-wide labor cost of $864,000. The Commission
requests comment on its estimates regarding new Form 504. In
particular, the Commission welcomes comment regarding the number of
entities who may partake of the conditional limit in natural gas and
would thus be required to file Form 504.
—————————————————————————
842 The Commission proposes that initially only the natural
gas commodity derivative contracts would be designated under Sec.
19.03 for Form 504 reporting. As such, the Commission’s estimates
reflect only the burden for traders in that commodity. The
Commission is not able to estimate the expanded cost of any future
Commission determination to designate another commodity under Sec.
19.03 as a special commodity for which Form 504 filings would be
required. See supra discussion regarding the proposed conditional
spot month limit.
—————————————————————————
Proposed Sec. 19.01(a)(2) adds an additional burden cost to
information collection 3038-0009 by requiring persons claiming a pass-
through swap exemption pursuant to Sec. 150.3(a)(1)(i) to file Form
604 showing various data depending on whether the offset is for non-
referenced contract swaps or spot-month swaps including, at a minimum,
the underlying commodity or commodity reference price, the applicable
clearing identifiers, the notional quantity, the gross long or short
position in terms of futures-equivalents in the core referenced futures
contracts, and the gross long or short positions in the referenced
contract for the offsetting risk position. The Commission estimates
that approximately 200 traders will claim a pass-through swap exemption
an average of ten times per year each. At approximately 30 labor hours
to complete each corresponding submission for a total burden to traders
of 60,000 annual labor hours, compliance with the Form 604 filing
requirements industry-wide will impose an additional $7,200,000 in
labor costs. The Commission requests comment on its estimates regarding
new Form 604. In particular, the Commission welcomes comment regarding
the number of entities who may utilize the pass-through swap exemption
and the burden incurred to file Form 604.
Proposed Sec. 19.01(a)(3) increases existing burden costs
previously approved under information collection 3038-0009 by expanding
the number of cash commodities that existing Form 204 covers.
Additionally, proposed Sec. 19.01(a)(3) requires additional data to be
reported on Form 204 and proposed Sec. 19.02 requires additional data
to be reported on existing Form 304 (call cotton). Both forms are
required to be filed when a trader accumulates a net long or short
commodity derivative position in a core referenced futures contract
that exceeds a federal limit, and inform the Commission of the trader’s
cash positions underlying those commodity derivative contracts for
purposes of claiming bona fide hedging exemptions.
The Commission estimates that approximately 400 traders will be
required to file Form 204 12 times per year each. At an estimated two
labor hours to complete and file each Form 204 report for a total
annual burden to industry of 9,600 labor hours, the Form 204 reporting
requirement will cost industry $1,200,000 in labor costs. The
Commission also estimates that approximately 400 traders will be
required to make a Form 304 submission for call cotton 52 times per
year each. At one hour to complete each submission (representing a net
increase of a half hour from the previous estimate) for a total annual
burden to industry of 20,800 labor hours, the Form 304 reporting
requirement will impose upon industry $2,500,000 in labor costs.
Previously, the Commission estimated the combined annual labor hours
for both forms to be 1,350 hours, which amounted to a total labor cost
to industry of $68,850 per annum.843 Therefore, the Commission is
increasing its net estimate of labor hours and costs associated with
existing Form 204 and Form 304 for collection 3038-0009 by 30,400 hours
and $3,700,000.844 The Commission requests comment with respect to
its estimates regarding the increased number of entities and additional
information required to file Forms 204 and 304.
—————————————————————————
843 This estimate was based upon an average wage rate of $51
per hour. Adjusted to the hourly wage rate used for purposes of this
PRA estimate, the previous total labor cost would have been
$202,500.
844 The Commission notes that the burdens associated with
Forms 204 and 304 in collection 3038-0009 represent a fraction of
the total burden under that collection.
—————————————————————————
Proposed Sec. 19.01(a)(4) adds an additional burden cost to
information collection 3038-0009 by requiring traders claiming
anticipatory exemptions to file Form 704 for the initial statement
pursuant to Sec. 150.7(d), the supplemental statement pursuant to
Sec. 150.7(e), and the annual update pursuant to Sec. 150.7(f), as
well as Form 204 monthly reporting the remaining unsold, unfilled and
other anticipated activity for the Specified Period in Form 704,
Section A. The Commission estimates that approximately 200 traders will
claim anticipatory exemptions every year an average of 10 times each.
At an estimated 20 labor hours to complete and file Form 704 for a
total annual burden to traders of 40,000 labor hours, the anticipatory
exemption filing requirement will cost industry an additional
$4,800,000 in labor costs. The Commission requests comment on its
estimates regarding new Form 704. In particular, the Commission
welcomes comment regarding the number of entities who may utilize the
anticipatory hedge exemption and the burden incurred to file Form 704.
4. Comments on Information Collection
The Commission invites the public and other federal agencies to
submit comments on any aspect of the reporting and recordkeeping
burdens discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission solicits comments in order to: (1) Evaluate
[[Page 75784]]
whether the proposed collections of information are necessary for the
proper performance of the functions of the Commission, including
whether the information will have practical utility; (2) evaluate the
accuracy of the Commission’s estimate of the burden of the proposed
collections of information; (3) determine whether there are ways to
enhance the quality, utility, and clarity of the information to be
collected; and (4) minimize the burden of the collections of
information on those who are to respond, including through the use of
automated collection techniques or other forms of information
technology. Comments may be submitted directly to the Office of
Information and Regulatory Affairs, by fax at (202) 395-6566 or by
email at [email protected]. Please provide the Commission
with a copy of comments submitted so that all comments can be
summarized and addressed in the final rule preamble. Refer to the
Addresses section of this notice for comment submission instructions to
the Commission. A copy of the supporting statements for the collection
of information discussed above may be obtained by visiting RegInfo.gov.
OMB is required to make a decision concerning the collection of
information between 30 and 60 days after publication of this release.
Consequently, a comment to OMB is most assured of being fully
considered if received by OMB (and the Commission) within 30 days after
the publication of this notice of proposed rulemaking.
C. Regulatory Flexibility Act
The Regulatory Flexibility Act (“RFA”) requires that Federal
agencies consider whether the rules they propose will have a
significant economic impact on a substantial number of small entities
and, if so, provide a regulatory flexibility analysis respecting the
impact.” 845 A regulatory flexibility analysis or certification
typically is required for “any rule for which the agency publishes a
general notice of proposed rulemaking pursuant to” the notice-and-
comment provisions of the Administrative Procedure Act, 5 U.S.C.
553(b).846 The requirements related to the proposed amendments fall
mainly on registered entities, exchanges, futures commission merchants,
swap dealers, clearing members, foreign brokers, and large traders.
—————————————————————————
845 5 U.S.C. 601 et seq.
846 5 U.S.C. 601(2), 603-05.
—————————————————————————
The Commission has previously determined that registered DCMs,
FCMs, SDs, MSPs, ECPs, SEFs, clearing members, foreign brokers and
large traders are not small entities for purposes of the RFA.847
While the requirements under the proposed rulemaking may impact non-
financial end users, the Commission notes that position limits levels
and filing requirements associated with bona fide hedging apply only to
large traders, while requirements to keep records supporting a
transaction’s qualification for pass-through swap treatment incurs a
marginal burden that is mitigated through overlapping recordkeeping
requirements for reportable futures traders (current Sec. 18.05) and
reportable swap traders (current Sec. 20.6(b)); furthermore, these
records are ones that such entities maintain, as they would other
documents evidencing material financial relationships, in the ordinary
course of their businesses.
—————————————————————————
847 See Policy Statement and Establishment of Definitions of
“Small Entities” for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18619, Apr. 30, 1982 (DCMs, FCMs, and large traders)
(“RFA Small Entities Definitions”); Opting Out of Segregation, 66
FR 20740, 20743, Apr. 25, 2001 (ECPs); Position Limits for Futures
and Swaps; Final Rule and Interim Final Rule, 76 FR 71626, 71680,
Nov. 18, 2011 (clearing members); Core Principles and Other
Requirements for Swap Execution Facilities, 78 FR 33476, 33548, June
4, 2013 (SEFs); A New Regulatory Framework for Clearing
Organizations, 66 FR 45604, 45609, Aug. 29, 2001 (DCOs);
Registration of Swap Dealers and Major Swap Participants, 77 FR
2613, Jan. 19, 2012, (SDs and MSPs); and Special Calls, 72 FR 50209,
Aug. 31, 2007 (foreign brokers).
—————————————————————————
Accordingly, the Chairman, on behalf of the Commission, hereby
certifies, pursuant to 5 U.S.C. 605(b), that the actions proposed to be
taken herein would not have a significant economic impact on a
substantial number of small entities.”
IV. Appendices
Appendix A–Studies relating to position limits reviewed and evaluated
by the Commission
1. Acharya, Viral V.; Ramadorai, Tarun; and Lochstoer, Lars,
“Limits to Arbitrage and Hedging: Evidence from Commodity
Markets,” January 8, 2013, Journal of Financial Economics.
2. Allen, Franklin; Litov, Lubomir; and Mei, Jianping, “Large
Investors, Price Manipulation, and Limits to Arbitrage: An Anatomy
of Market Corners,” June 30, 2006, Review of Finance.
3. Anderson, David; Outlaw, Joe L.; Bryant, Henry L.;
Richardson, James W.; Ernstes, David P.; Raulston, J. Marc; Welch,
J. Mark; Knapek, George M.; Herbst, Brian K.; and Allison, Marc S.,
“The Effects of Ethanol on Texas Food and Feed,” January 1, 2008,
The Agricultural and Food Policy Center Research Report 08-1, Texas
A&M University.
4. Antoshin, Sergei; Canetti, Elie; and Miyajima, Ken, Global
Financial Stability Report, “Financial Stress and Deleveraging,
Macrofinancial Implications and Policy,” October 1, 2008, Annex
1.2, Financial Investment in Commodities Markets, International
Monetary Fund.
5. Aurelich, Nicole M.; Irwin, Scott H.; and Garcia, Philip,
Bubbles, “Food Prices, and Speculation: Evidence from the CFTC’s
Daily Large Trader Data Files,” August 15, 2012, NBER Conference on
Economics of Food Price Volatility.
6. Avriel, Mordecai and Reisman, Haim, “Optimal Option
Portfolios in Markets with Position Limits and Margin
Requirements,” June 6, 2000, Journal of Risk.
7. Babula, Ronald A. and Rothenberg, John Paul, “A Dynamic
Monthly Model of U.S. Pork Product Markets: Testing for and
Discerning the Role of Hedging on Pork-Related Food Costs,” January
1, 2013, Journal of International Agricultural Trade and
Development.
8. Baffes, John and Haniotos, Tasos, “Placing the 2006/08
Commodity Boom into Perspective,” July 1, 2010, The World Bank
Policy Research Working Paper 5371.
9. Basu, Devraj and Miffre, Joelle, “Capturing the Risk Premium
of Commodity Futures: The Role of Hedging Pressure,” July 1, 2013,
Journal of Banking and Risk.
10. Bos, Jaap and van der Molen, Maarten, “A Bitter Brew? How
Index Fund Speculation Can Drive Up Commodity Prices,” June 6,
2010, Journal of Agricultural and Applied Economics.
11. Boyd, Naomi; Buyuksahin, Bahattin; Haigh, Michael; and
Harris, Jeffrey, “The Prevalence, Sources, and Effects of
Herding,” February 1, 2013, SSRN Abstract 1359251.
12. Breitenfellner, Andreas; Crespo Cuaresma, Jesus; and Keppel,
Catherine, “Determinants of Crude Oil Prices: Supply, Demand,
Cartel, or Speculation?,” October 1, 2009, Monetary Policy and the
Economy.
13. Brennan, Michael J. and Schwartz, Eduardo S., “Arbitrage in
Stock Index Futures,” January 1, 1990, The Journal of Business.
14. Brunetti, Celso and Buyuksahin, Bahattin, “Is Speculation
Destabilizing?,” April 22, 2009, SSRN Abstract 1393524.
15. Buyuksahin, Bahattin and Robe, Michel, “Does it Matter Who
Trades Energy Derivatives?,” March 1, 2012, Review of Environment,
Energy, and Economics.
16. Buyuksahin, Bahattin and Robe, Michel, “Speculators,
Commodities, and Cross-Market Linkages,” November 8, 2012, Working
Paper, U.S. Commodity Futures Trading Commission.
17. Buyuksahin, Bahattin and Robe, Michel, “Does `Paper Oil’
Matter?,” July 28, 2011, SSRN Abstract 1855264.
18. Buyuksahin, Bahattin; Harris, Jeffrey; Haigh, Michael;
Overdahl, James; and Robe, Michel, “Fundamentals, Trader Activity,
and Derivatives Pricing,” December 4, 2008, Working Paper, U.S.
Commodity Futures Trading Commission.
19. Byun, Sungje, “Speculation in Commodity Futures Market,
Inventories and the Price of Crude Oil,” January 17, 2013, Working
Paper, University of California at San Diego.
20. Cagan, Phillip, “Financial Futures Markets: Is More
Regulation Needed?,” August 7, 2006, Journal of Futures Markets.
[[Page 75785]]
21. Chan, Kalok and Fong, Wai Ming, “Trade Size, Order
Imbalance, and Volatility-Volume Relation,” August 1, 2000, Journal
of Financial Economics.
22. Chincarini, Ludwig, “The Amaranth Debacle: Failure of Risk
Measures or Failure of Risk Management?,” April 1, 2007, SSRN
Abstract 952607.
23. Chincarini, Ludwig, “Natural Gas Futures and Spread
Position Risk: Lessons from the Collapse of Amaranth Advisors
L.L.C.,” January 19, 2008, Journal of Applied Finance.
24. Chordia, Tarun; Subrahmanyam, Avanidhar; and Roll, Richard,
“Order Imbalance, Liquidity, and Market Returns,” July 1, 2002,
Journal of Financial Economics.
25. Cifarelli, Giulio and Paladino, Giovanna, “Oil Price
Dynamics and Speculation: a Multivariate Financial Approach,” March
1, 2010, Energy Economics.
26. Cifarelli, Giulio and Paladino, Giovanna, “Commodity
Futures Returns: A non-linear Markov Regime Switching Model of
Hedging and Speculative Pressures,” November 19, 2010, Working
Paper.
27. CME Group, Inc., “Excessive Speculation and Position Limits
in Energy Derivatives Markets,” CME Group White Paper.
28. Dahl, R.P., “Futures Markets: The Interaction of Economic
Analyses and Regulation: Discussion,” December 1, 1980, American
Journal of Agricultural Economics.
29. Dai, Min; Jin, Hanqing; and Liu, Hong, “Illiquidity,
Position Limits, and Optimal Investment,” March 15, 2009, SSRN
Abstract 1360423.
30. de Schutter, Olivier, “Food Commodities Speculation and
Food Price Crises,” September 1, 2010, United Nations Special
Report on the Right to Food.
31. Dutt, Hans R. and Harris, Lawrence E., “Position Limits For
Cash-Settled Derivative Contracts,” August 18, 2005, Journal of
Futures Markets.
32. Easterbrook, Frank, “Monopoly, Manipulation, and the
Regulation of Futures Markets,” April 1, 1986, The Journal of
Business.
33. Ebrahim, Muhammed and Rhys ap Gwilym, “Can Position Limits
Restrain Rogue Traders?,” March 1, 2013, Journal of Banking &
Finance.
34. Eckaus, R.S., “The Oil Price Really is a Speculative
Bubble,” June 1, 2008, MIT Center for Energy and Environmental
Policy Research.
35. Ederington, Louis and Lee, Jae Ha, “Who Trades Futures and
How: Evidence from the Heating Oil Market,” April 1, 2002, Journal
of Business.
36. Ederington, Louis; Dewally, Michael; and Fernando, Chitru,
“Determinants of Trader Profits in Futures Markets,” January 24,
2013, SSRN Abstract 1781975.
37. Edirsinghe, Chanaka; Naik, Vasanttilak; and Uppal, Raman,
“Optimal Replication of Options with Transaction Costs and Trading
Restrictions,” March 1, 1993, Journal of Financial and Quantitative
Analysis.
38. Einloth, James, “Speculation and Recent Volatility in the
Price of Oil,” August 1, 2009, SSRN Abstract 1488792.
39. Ellis, Katrina; Michaely, Roni; and O’Hara, Maureen, “The
Making of a Dealer Market: From Entry to Equilibrium in the Trading
of Nasdaq Stocks,” October 1, 2002, Journal of Finance.
40. European Commission, “Review of the Markets in Financial
Instruments Directive,” December 1, 2010, European Commission.
41. Fattouh, Bassam; Kilian, Lutz; and Mahadeva, Lavan, “The
Role of Speculation in Oil Markets: What Have We Learned So Far?,”
July 30, 2012, SSRN Abstract 2034134.
42. Frenk, David and Turbeville, Wallace, “Commodity Index
Traders and the Boom/Bust Cycle in Commodities Prices,” October 14,
2011, Better Markets.
43. Froot, Kenneth; Scharfstein, David; and Stein, Jeremy,
“Herd on the Street: Informational Inefficiencies in a Market with
Short Term Speculation,” February 1, 1990, NBER Working Paper.
44. Gilbert, Christopher, “Speculative Influences on Commodity
Futures Prices, 2006-2008,” March 1, 2010, United Nations
Conference on Trade and Development.
45. Gilbert, Christopher, “Commodity Speculation and Commodity
Investment,” March 1, 2010, University of Trento.
46. Gilbert, Christopher, “How to Understand High Food
Prices,” October 17, 2008, Journal of Agricultural Economics.
47. Gorton, Gary; Hayashi, Fumio; and Rouwenhorst, K. Geert,
“The Fundamentals of Commodity Futures Returns,” July 1, 2013,
Review of Finance.
48. Government Accountability Office, “Issues Involving the Use
of the Futures Markets to Invest in Commodity Indexes,” January 1,
2009, Government Accountability Office.
49. Greenberger, Michael, “The Relationship of Unregulated
Excessive Speculation to Oil Market Price Volatility,” January 1,
2010, Personal Web page.
50. Grosche, Stephanie, “Limitations Of Granger Causality
Analysis To Assess The Price Effects From The Financialization Of
Agricultural Commodity Markets Under Bounded Rationality,” January
31, 2012, Agricultural and Resource Economics, Discussion Paper.
51. Gupta, Bhaswar and Kazemi, Hossein, “Factor Exposures and
Hedge Fund Operational Risk: The Case of Amaranth,” November 19,
2009, SSRN Abstract 1509769.
52. Haigh, Michael S.; Hranaiova, Jana; and Overdahl, James A.,
“Hedge Funds, Volatility, and Liquidity Provision in Energy Futures
Markets,” April 1, 2007, The Journal of Alternative Investments.
53. Haigh, Michael S.; Hranaiova, Jana; and Overdahl, James A.,
“Price Dynamics, Price Discovery, and Large Futures Trader
Interactions in the Energy Complex,” April 1, 2005, Staff Research
Report, U.S. Commodity Futures Trading Commission.
54. Haigh, Michael; Harris, Jeffery; Overdahl, James A.; and
Robe, Michel, “Market Growth, Trader Participation and Pricing in
Energy Futures Markets,” February 1, 2007, Working Paper, U.S.
Commodity Futures Trading Commission.
55. Hamilton, James D., “Causes and Consequences of the Oil
Shock of 2007-08,” April 1, 2009, Brookings Papers on Economic
Activity.
56. Harris, Jeffrey and Buyuksahin, Bahattin, “The Role of
Speculators in the Crude Oil Futures Market,” June 16, 2009, SSRN
Abstract 1435042.
57. Harris, Lawrence E., “Circuit Breakers and Program Trading
Limits: What Have We Learned?,” December 9, 1997, Brookings
Institutions Press.
58. Harrison, J. Michael and Kreps, David M., “Speculative
Investor Behavior in a Stock Market With Heterogeneous
Expectations,” May 1, 1978, The Quarterly Journal of Economics.
59. Her Majesty’s Treasury, “Global Commodities: A Long Term
Vision for Stable, Secure, and Sustainable Global Markets,” June 1,
2008, Her Majesty’s Treasury.
60. Hirshliefer, David, “Residual Risk, Trading Costs, and
Commodity Futures Risk Premia,” June 6, 1988, Review of Financial
Studies.
61. Hoff, Christian, “Herding Behavior in Asset Markets,”
January 1, 2009, Journal of Financial Stability.
62. Interagency Task Force on Commodity Markets, “Interim
Report on Crude Oil,” July 1, 2008, Interagency Task Force on
Commodity Markets.
63. International Monetary Fund, “Is Inflation Back? Commodity
Prices and Inflation,” October 1, 2008, World Economic Outlook,
International Monetary Fund.
64. Irwin, Scott H.; Sanders, Dwight R.; and Merrin, Robert P.,
“Devil or Angel: The Role of Speculation in the Recent Commodity
Price Boom,” August 1, 2009, Journal of Agricultural and Applied
Economics.
65. Irwin, Scott H. and Sanders, Dwight R., “The Impact of
Index and Swap Funds on Commodity Futures Markets: Preliminary
Results,” August 1, 2010, OECD Food, Agriculture and Fisheries
Working Papers, No. 27.
66. Irwin, Scott H. and Sanders, Dwight R., “Index funds,
Financialization, and Commodity Futures Markets,” December 1, 2010,
Applied Economics Perspectives and Policy.
67. Irwin, Scott H.; Garcia, Philip; and Good, Darrel L., “The
Performance of CBOT Corn, Soybean, and Wheat Futures Contracts after
Recent Changes in Speculative Limits,” July 29, 2007, American
Agricultural Economics Association Selected Paper.
68. Jacks, David, “Populists vs. Theorists: Futures Markets and
the Volatility of Prices,” June 1, 2006, Explorations in Economic
History.
69. Juvenal, Luciana and Petrella, Ivan, “Speculation in the
Oil Market,” June 1, 2012, Federal Reserve Bank of St. Louis
Working Paper Series.
70. Khan, Mohsin S., “The 2008 Oil Price “Bubble”,” August
1, 2009, Peter G. Peterson Institute of International Economics.
71. Kilian, Lutz, “Not All Oil Price Shocks Are Alike:
Disentangling Demand and Supply Shocks in the Crude Oil Market,”
February 23, 2007, American Economic Review.
72. Kilian, Lutz and Lee, Thomas, “Quantifying the Speculative
Component in the Real Price of Oil: The Role of Global Oil
Inventories,” January 13, 2013, Working Paper, University of
Michigan.
73. Kilian, Lutz and Murphy, Daniel, “The Role of Inventories
and Speculative Trading
[[Page 75786]]
in the Global Market for Crude Oil,” March 1, 2010, Journal of
Applied Econometrics.
74. Knittel, Christopher R. and Pindyck, Robert S., “The Simple
Economics of Commodity Price Speculation,” April 1, 2013, National
Bureau of Economic Research Working Paper.
75. Korniotis, George, “Does Speculation Affect Spot Price
Levels? The Case of Metals With and Without Futures Markets,”
January 1, 2009, Finance and Economics Discussion Series, Federal
Reserve Board of Governors.
76. Koski, Jennifer L. and Pontiff, Jeffrey, “How Are
Derivatives Used? Evidence from the Mutual Fund Industry,” January
1, 1996, The Journal of Finance.
77. Kumar, Praveen and Seppi, Duane, “Futures Manipulation with
“Cash Settlement”,” September 1, 1992, Journal of Finance.
78. Kyle, Albert and Viswanathan, S., “How to Define Illegal
Price Manipulation,” May 1, 2008, American Economic Review.
79. Kyle, Albert S. and Wang, F. Albert, “Speculation Duopoly
with Agreement to Disagree: Can Overconfidence Survive the Market
Test?,” December 1, 1997, The Journal of Finance.
80. Lagi, Marco; Bar-Yam, Yavni; Bertrand, Karla Z.; and Bar-
Yam, Yaneer, “The Food Crises: A Quantitative Model Of Food Prices
Including Speculators And Ethanol Conversion,” March 27, 2012, New
England Complex Systems Institute.
81. Lee, Bernard; Cheng, Shih-Fen; and Koh, Annie, “Would
Position Limits Have Made any Difference to the ‘Flash Crash’ on May
6, 2010,” November 1, 2010, The Review of Futures Markets.
82. Lee, Bernard; Cheng, Shih-Fen; and Koh, Annie, “An Analysis
of Extreme Price Shocks and Illiquidity Among Systematic Trend
Followers,” June 15, 2010, Singapore Management University.
83. Leitner, Yaron, “Inducing Agents to Report Hidden Trades: A
Theory of an Intermediary,” January 1, 2012, Review of Finance.
84. Manera, Matteo, Nicolini, Marcella, and Vignati, Ilaria,
“Futures Price Volatility in Commodities Markets: The Role of
Short-Term vs Long-Term Speculation,” April 1, 2013, Universita di
Pavia Working Paper.
85. Markham, Jerry, “Manipulation of Commodity Futures Prices:
The Unprosecutable Crime,” June 6, 1991, Yale Journal on
Regulation.
86. Masters, Michael and White, Adam, “The Accidental Hunt
Brothers: How Institutional Investors are Driving up Food and Energy
Prices,” July 31, 2008, Self-Published.
87. Medlock, Kenneth and Myers Jaffe, Amy, “Who is In the Oil
Futures Market and How Has It Changed?,” August 26, 2009, Baker
Institute for Public Policy.
88. Mei, Jianping; Acheinkman, Jose; and Xiong, Wei,
“Speculative Trading and Stock Prices: An Analysis of Chinese A-B
Share Premia,” January 1, 2009, Annals of Economics and Finance.
89. Mobert, Jochen, “Do Speculators Drive Crude Oil Prices?,”
December 15, 2009, Deutsche Bank Research Working Paper Series.
90. Morris, Stephen, “Speculative Investor Behavior And
Learning,” November 1, 1996, The Quarterly Journal of Economics.
91. Mou, Yiqun, “Limits to Arbitrage and Commodity Index
Investment: Front-Running the Goldman Roll,” July 15, 2011,
Columbia University Working Paper.
92. Nissanke, Machinko, “Commodity Markets And Excess
Volatility: An Evaluation Of Price Dynamics Under
Financialisation,” February 1, 2011, University of London School of
Oriental and African Studies.
93. Parsons, John E., “Black Gold & Fool’s Gold: Speculation in
the Oil Futures Market,” September 1, 2009, Economia.
94. Phillips, Peter C.B. and Yu, Jun, “Dating the Timeline of
Financial Bubbles During the Subprime Crisis,” November 1, 2011,
Quantitative Economics.
95. Pierru, Axel and Babusiaux, Denis, “Speculation without Oil
Stockpiling as a Signature: A Dynamic Perspective,” April 1, 2010,
MIT Center for Energy and Environmental Policy Research.
96. Pirrong, Craig, “Squeezes, Corpses, and the Anti-
Manipulation Provisions of the Commodity Exchange Act,” October 1,
1994, Regulation.
97. Pirrong, Craig, “Manipulation of the Commodity Futures
Market Delivery Process,” July 1, 1993, The Journal of Business.
98. Pirrong, Craig, “The Self-Regulation of Commodity
Exchanges: The Case of Market Manipulation,” April 1, 1995, Journal
of Law and Economics.
99. Plante, Michael and Y[uuml]cel, Mine, “Did Speculation
Drive Oil Prices? Market Fundamentals Suggest Otherwise,” October
1, 2011, Economic Letter, Federal Reserve Bank of Dallas.
100. Plante, Michael and Y[uuml]cel, Mine, “Did Speculation
Drive Oil Prices? Futures Market Points to Fundamentals,” October
1, 2011, Economic Letter, Federal Reserve Bank of Dallas.
101. Plato, Gerald and Hoffman, Linwood, “Measuring the
Influence of Commodity Fund Trading on Soybean Price Discovery,”
January 1, 2007, NCCC-134 Conference on Applied Commodity Price
Analysis, Forecasting, and Market Risk Management.
102. Pliska, Stanley and Shalen, Catherine, “The Effects of
Regulation on Trading Activity and Return Volatility in Futures
Markets,” August 28, 2006, Journal of Futures Markets.
103. Robles, Miguel; Torero, Maximo; and von Braun, Joachim,
“When Speculation Matters,” February 1, 2009, IFPRI.
104. Rossi, Clifford V., “Analysis of CFTC Proposed Position
Limits on Commodity Index Fund Trading,” March 25, 2011, CME Group.
105. Routledge, Bryan R.; Seppi, Duane J.; and Spatt, Chester
S., “Equilibrium Forward Curves for Commodities,” June 1, 2000,
The Journal of Finance.
106. Sanders, Dwight R.; Boris, Keith; and Manfredo, “Hedgers,
Funds, and Small Speculators in The Energy Futures Markets: An
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107. Sanders, Dwight R.; Irwin, Scott H.; and Merrin, Robert P.,
“The Adequacy of Speculation in Agricultural Futures Markets: Too
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108. Sanders, Dwight R.; Irwin, Scott H.; and Merrin, Robert P.,
“Smart Money? The Forecasting Ability of CFTC Large Traders,”
January 1, 2009, Journal of Ag and Resource Economics.
109. Sanders, Dwight R.; Irwin, Scott H.; and Merrin, Robert P.,
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110. Shleifer, Andrei and Vishney, Robert W., “The Limits of
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111. Singleton, Kenneth J., “The 2008 Boom/Bust in Oil
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112. Singleton, Kenneth J., “Investor Flows and the 2008 Boom/
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113. Smith, James, “World Oil: Market or Mayhem?,” January 1,
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List of Subjects
17 CFR Part 1
Agricultural commodity, Agriculture, Brokers, Committees, Commodity
futures, Conflicts of interest, Consumer protection, Definitions,
Designated contract markets, Directors, Major swap participants,
Minimum financial requirements for intermediaries, Reporting and
recordkeeping requirements, Swap dealers, Swaps.
17 CFR Parts 15 and 17
Brokers, Commodity futures, Reporting and recordkeeping
requirements, Swaps.
17 CFR Part 19
Commodity futures, Cottons, Grains, Reporting and recordkeeping
requirements, Swaps.
17 CFR Part 32
Commodity futures, Consumer protection, Fraud, Reporting and
recordkeeping requirements.
17 CFR Part 37
Registered entities, Registration application, Reporting and
recordkeeping requirements, Swaps, Swap execution facilities.
17 CFR Part 38
Block transaction, Commodity futures, Designated contract markets,
Reporting and recordkeeping requirements, Transactions off the
centralized market.
17 CFR Part 140
Authority delegations (Government agencies), Conflict of interests,
Organizations and functions (Government agencies).
17 CFR Part 150
Bona fide hedging, Commodity futures, Cotton, Grains, Position
limits, Referenced Contracts, Swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR chapter I as follows:
PART 1–GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3,
8, 9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as
amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
Sec. 1.3 [Amended]
0
2. Amend Sec. 1.3 by removing and reserving paragraph (z).
Sec. Sec. 1.47 and 1.48 [Removed and Reserved]
0
3. Remove and reserve Sec. Sec. 1.47 and 1.48.
PART 15–REPORTS–GENERAL PROVISIONS
0
4. The authority citation for part 15 continues to read as follows:
Authority: 7 U.S.C. 2, 5, 6a, 6c, 6f, 6g, 6i, 6k, 6m, 6n, 7, 7a,
9, 12a, 19, and 21, as amended by Title VII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act, Pub. L. 111-203, 124
Stat. 1376 (2010).
0
5. Amend Sec. 15.00 by revising paragraph (p) to read as follows:
Sec. 15.00 Definitions of terms used in parts 15 to 19, and 21 of
this chapter.
* * * * *
(p) Reportable position means:
(1) For reports specified in parts 17 and 18, and Sec. 19.00(a)(2)
and (3), of this chapter any open contract position that at the close
of the market on any business day equals or exceeds the quantity
specified in Sec. 15.03 in either:
(i) Any one futures of any commodity on any one reporting market,
excluding futures contracts against which notices of delivery have been
stopped by a trader or issued by the clearing organization of a
reporting market; or
(ii) Long or short put or call options that exercise into the same
future of any commodity, or long or short put or call options for
options on physicals that have identical expirations and exercise into
the same physical, on any one reporting market.
(2) For the purposes of reports specified in Sec. 19.00(a)(1) of
this chapter, any position in commodity derivative contracts, as
defined in Sec. 150.1 of this chapter, that exceeds a position limit
in Sec. 150.2 of this chapter for the particular commodity.
* * * * *
0
6. Amend Sec. 15 .01 by revising paragraph (d) to read as follows:
Sec. 15.01 Persons required to report.
* * * * *
(d) Persons, as specified in part 19 of this chapter, either:
(1) Who hold or control commodity derivative contracts (as defined
in Sec. 150.1 of this chapter) that exceed a position limit in Sec.
150.2 of this chapter for the commodities enumerated in that section;
or
(2) Who are merchants or dealers of cotton holding or controlling
positions for future delivery in cotton that equal or exceed the amount
set forth in Sec. 15.03.
0
7. Revise Sec. 15.02 to read as follows:
Sec. 15.02 Reporting forms.
Forms on which to report may be obtained from any office of the
Commission or via the Internet (http://www.cftc.gov). Forms to be used
for the filing of reports follow, and persons required to file these
forms may be determined by referring to the rule listed in the column
opposite the form number.
————————————————————————
Form No. Title Rule
————————————————————————
40………………………. Statement of Reporting 18.04
Trader.
71………………………. Identification of Omnibus 17.01
Accounts and Sub-accounts.
101……………………… Positions of Special 17.00
Accounts.
102……………………… Identification of Special 17.01
Accounts, Volume Threshold
Accounts, and Consolidated
Accounts.
204……………………… Cash Positions of Hedgers 19.00
(excluding Cotton).
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304……………………… Cash Positions of Cotton 19.00
Traders.
504……………………… Cash Positions for 19.00
Conditional Spot Month
Exemptions.
604……………………… Counterparty Data for Pass- 19.00
Through Swap Exemptions.
704……………………… Statement of Anticipatory 19.00
Bona Fide Hedge Exemptions.
————————————————————————
(Approved by the Office of Management and Budget under control numbers
3038-0007, 3038-0009, and 3038-0103)
PART 17–REPORTS BY REPORTING MARKETS, FUTURES COMMISSION
MERCHANTS, CLEARING MEMBERS, AND FOREIGN BROKERS
0
8. The authority citation for part 17, as amended November 18, 2013, at
78 FR 69230, effective February 18, 2014, continues to read as follows:
Authority: 7 U.S.C. 2, 6a, 6c, 6d, 6f, 6g, 6i, 6t, 7, 7a, and
12a, as amended by Title VII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
0
9. Amend Sec. 17.00 by revising paragraph (b) to read as follows:
Sec. 17.00 Information to be furnished by futures commission
merchants, clearing members and foreign brokers.
* * * * *
(b) Interest in or control of several accounts. Except as otherwise
instructed by the Commission or its designee and as specifically
provided in Sec. 150.4 of this chapter, if any person holds or has a
financial interest in or controls more than one account, all such
accounts shall be considered by the futures commission merchant,
clearing member or foreign broker as a single account for the purpose
of determining special account status and for reporting purposes.
* * * * *
0
10. Amend Sec. 17.03, as amended November 18, 2013, at 78 FR 69232,
effective February 18, 2014, by adding paragraph (h) to read as
follows:
Sec. 17.03 Delegation of authority to the Director of the Office of
Data and Technology or the Director of the Division of Market
Oversight.
* * * * *
(h) Pursuant to Sec. 17.00(b), and as specifically provided in
Sec. 150.4 of this chapter, the authority shall be designated to the
Director of the Division of Market Oversight to instruct an futures
commission merchant, clearing member or foreign broker to consider as a
single account for the purpose of determining special account status
and for reporting purposes all accounts one person holds or controls,
or in which the person has a financial interest.
0
11. Revise part 19 to read as follows:
PART 19–REPORTS BY PERSONS HOLDING POSITIONS EXEMPT FROM POSITION
LIMITS AND BY MERCHANTS AND DEALERS IN COTTON
Sec.
19.00 General provisions.
19.01 Reports on stocks and fixed price purchases and sales.
19.02 Reports pertaining to cotton on call purchases and sales.
19.03 Reports pertaining to special commodities.
19.04 Delegation of authority to the Director of the Division of
Market Oversight.
19.05-19.10 [Reserved]
Appendix Appendix A to Part 19–Forms 204, 304, 504, 604, and 704
Authority: 7 U.S.C. 6g(a), 6a, 6c(b), 6i, and 12a(5), as
amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
Sec. 19.00 General provisions.
(a) Who must file series ’04 reports. The following persons are
required to file series ’04 reports:
(1) Persons filing for exemption to speculative position limits.
All persons holding or controlling positions in commodity derivative
contracts, as defined in Sec. 150.1 of this chapter, in excess of any
speculative position limit provided under Sec. 150.2 of this chapter
and for any part of which a person relies on an exemption to
speculative position limits under Sec. 150.3 of this chapter as
follows:
(i) Conditional spot month limit exemption. A conditional spot
month limit exemption under Sec. 150.3(c) of this chapter for any
commodity specially designated by the Commission under Sec. 19.03 for
reporting;
(ii) Pass-through swap exemption. A pass-through swap exemption
under Sec. 150.3(a)(1)(i) of this chapter and as defined in paragraph
(2)(ii) of the definition of “bona fide hedging position” in Sec.
150.1 of this chapter, reporting separately for:
(A) Non-referenced-contract swap offset. A swap that is not a
referenced contract, as that term is defined in Sec. 150.1 of this
chapter, and which is executed opposite a counterparty for which the
swap would qualify as a bona fide hedging position and for which the
risk is offset with a referenced contract; and
(B) Spot-month swap offset. A cash-settled swap, regardless of
whether it is a referenced contract, executed opposite a counterparty
for which the swap would qualify as a bona fide hedging position and
for which the risk is offset with a physical-delivery referenced
contract in its spot month;
(iii) Other exemption. Any other exemption from speculative
position limits under Sec. 150.3 of this chapter, including for a bona
fide hedging position as defined in Sec. 150.1 of this chapter or any
exemption granted under Sec. 150.3(b) or (d) of this chapter; or
(iv) Anticipatory exemption. An anticipatory exemption under Sec.
150.7 of this chapter.
(2) Persons filing cotton on call reports. Merchants and dealers of
cotton holding or controlling positions for futures delivery in cotton
that are reportable pursuant to Sec. 15.00(p)(1)(i) of this chapter;
or
(3) Persons responding to a special call. All persons exceeding
speculative position limits under Sec. 150.2 of this chapter or all
persons holding or controlling positions for future delivery that are
reportable pursuant to Sec. 15.00(p)(1) of this chapter who have
received a special call for series ’04 reports from the Commission or
its designee. Persons subject to a special call shall file CFTC Form
204, 304, 504, 604 or 704 as instructed in the special call. Filings in
response to a special call shall be made within one business day of
receipt of the special call unless otherwise specified in the call. For
the purposes of this paragraph, the Commission hereby delegates to the
Director of the Division of Market Oversight, or to such other person
designated by the Director, authority to issue calls for series ’04
reports.
(b) Manner of reporting. The manner of reporting the information
required in Sec. 19.01 is subject to the following:
(1) Excluding certain source commodities, products or byproducts of
the cash commodity hedged. If the regular business practice of the
reporting person is to exclude certain source commodities, products or
byproducts in determining his cash positions for bona fide hedging
positions (as defined in Sec. 150.1 of this chapter), the same shall
be excluded in
[[Page 75789]]
the report, provided that the amount of the source commodity being
excluded is de minimis, impractical to account for, and/or on the
opposite side of the market from the market participant’s hedging
position. Such persons shall furnish to the Commission or its designee
upon request detailed information concerning the kind and quantity of
source commodity, product or byproduct so excluded. Provided however,
when reporting for the cash commodity of soybeans, soybean oil, or
soybean meal, the reporting person shall show the cash positions of
soybeans, soybean oil and soybean meal.
(2) Cross hedges. Cash positions that represent a commodity, or
products or byproducts of a commodity, that is different from the
commodity underlying a commodity derivative contract that is used for
hedging, shall be shown both in terms of the equivalent amount of the
commodity underlying the commodity derivative contract used for hedging
and in terms of the actual cash commodity as provided for on the
appropriate series ’04 form.
(3) Standards and conversion factors. In computing their cash
position, every person shall use such standards and conversion factors
that are usual in the particular trade or that otherwise reflect the
value-fluctuation-equivalents of the cash position in terms of the
commodity underlying the commodity derivative contract used for
hedging. Such person shall furnish to the Commission upon request
detailed information concerning the basis for and derivation of such
conversion factors, including:
(i) The hedge ratio used to convert the actual cash commodity to
the equivalent amount of the commodity underlying the commodity
derivative contract used for hedging; and
(ii) An explanation of the methodology used for determining the
hedge ratio.
Sec. 19.01 Reports on stocks and fixed price purchases and sales.
(a) Information required.–(1) Conditional spot month limit
exemption. Persons required to file ’04 reports under Sec.
19.00(a)(1)(i) shall file CFTC Form 504 showing the composition of the
cash position of each commodity underlying a referenced contract that
is held or controlled including:
(i) The as of date;
(ii) The quantity of stocks owned of such commodity that either:
(A) Is in a position to be delivered on the physical-delivery core
referenced futures contract; or
(B) Underlies the cash-settled core referenced futures contract;
(iii) The quantity of fixed-price purchase commitments open
providing for receipt of such cash commodity in:
(A) The delivery period for the physical-delivery core referenced
futures contract; or
(B) The time period for cash-settlement price determination for the
cash-settled core referenced futures contract;
(iv) The quantity of unfixed-price sale commitments open providing
for delivery of such cash commodity in:
(A) The delivery period for the physical-delivery core referenced
futures contract; or
(B) The time period for cash-settlement price determination for the
cash-settled core referenced futures contract;
(v) The quantity of unfixed-price purchase commitments open
providing for receipt of such cash commodity in:
(A) The delivery period for the physical-delivery core referenced
futures contract; or
(B) The time period for cash-settlement price determination for the
cash-settled core referenced futures contract; and
(vi) The quantity of fixed-price sale commitments open providing
for delivery of such cash commodity in:
(A) The delivery period for the physical-delivery core referenced
futures contract; or
(B) The time period for cash-settlement price determination for the
cash-settled core referenced futures contract.
(2) Pass-through swap exemption. Persons required to file ’04
reports under Sec. 19.00(a)(1)(ii) shall file CFTC Form 604:
(i) Non-referenced-contract swap offset. For each swap that is not
a referenced contract and which is executed opposite a counterparty for
which the transaction would qualify as a bona fide hedging position and
for which the risk is offset with a referenced contract, showing:
(A) The underlying commodity or commodity reference price;
(B) The applicable clearing identifiers;
(C) The notional quantity;
(D) The gross long or short position in terms of futures-
equivalents in the core referenced futures contract; and
(E) The gross long or short positions in the referenced contract
for the offsetting risk position; and
(ii) Spot-month swap offset. For each cash-settled swap executed
opposite a counterparty for which the transaction would qualify as a
bona fide hedging position and for which the risk is offset with a
physical-delivery referenced contract held into a spot month, showing
for such cash-settled swap that is not a referenced contract the
information required under paragraph (a)(2)(i) of this section and for
such cash-settled swap that is a referenced contract:
(A) The gross long or short position for such cash-settled swap in
terms of futures-equivalents in the core referenced futures contract;
and
(B) The gross long or short positions in the physical-delivery
referenced contract for the offsetting risk position.
(3) Other exemptions. Persons required to file ’04 reports under
Sec. 19.00(a)(1)(iii) shall file CFTC Form 204 reports showing the
composition of the cash position of each commodity hedged or underlying
a reportable position including:
(i) The as of date, an indication of any enumerated bona fide
hedging position exemption(s) claimed, the commodity derivative
contract held or controlled, and the equivalent core reference futures
contract;
(ii) The quantity of stocks owned of such commodities and their
products and byproducts;
(iii) The quantity of fixed-price purchase commitments open in such
cash commodities and their products and byproducts;
(iv) The quantity of fixed-price sale commitments open in such cash
commodities and their products and byproducts;
(v) The quantity of unfixed-price purchase and sale commitments
open in such cash commodities and their products and byproducts, in the
case of offsetting unfixed-price cash commodity sales and purchases;
and
(vi) For cotton, additional information that includes:
(A) The quantity of equity in cotton held by the Commodity Credit
Corporation under the provisions of the Upland Cotton Program of the
Agricultural Stabilization and Conservation Service of the U.S.
Department of Agriculture;
(B) The quantity of certificated cotton owned; and
(C) The quantity of non-certificated stocks owned.
(4) Anticipatory exemptions. Persons required to file ’04 reports
under Sec. 19.00(a)(1)(iv) shall file:
(i) CFTC Form 704 for the initial statement pursuant to Sec.
150.7(d) of this chapter, the supplemental statement pursuant to Sec.
150.7(e) of this chapter, and the annual update pursuant to Sec.
150.7(f) of this chapter; and
(ii) CFTC Form 204 monthly on the remaining unsold, unfilled and
other
[[Page 75790]]
anticipated activity for the Specified Period that was reported on such
person’s most recently filed Form 704, Section A pursuant to Sec.
150.7(g) of this chapter.
(b) Time and place of filing reports.–(1) General. Except for
reports filed in response to special calls made under Sec. 19.00(a)(3)
or reports required under Sec. 19.00(a)(1)(i), (a)(1)(ii)(B), or Sec.
19.01(a)(4)(i), each report shall be made monthly:
(i) As of the close of business on the last Friday of the month,
and
(ii) As specified in paragraph (b)(3) of this section, and not
later than 9 a.m. Eastern Time on the third business day following the
date of the report.
(2) Conditional spot month limit. Persons required to file ’04
reports under Sec. 19.00(a)(1)(i) shall file each report for special
commodities as specified by the Commission under Sec. 19.03:
(i) As of the close of business for each day the person exceeds the
limit during a spot period up to and through the day the person’s
position first falls below the position limit; and
(ii) As specified in paragraph (b)(3) of this section, and not
later than 9 a.m. Eastern Time on the next business day following the
date of the report.
(3) Electronic filing. CFTC ’04 reports must be transmitted using
the format, coding structure, and electronic data transmission
procedures approved in writing by the Commission.
Sec. 19.02 Reports pertaining to cotton on call purchases and sales.
(a) Information required. Persons required to file ’04 reports
under Sec. 19.00(a)(2) shall file CFTC Form 304 reports showing the
quantity of call cotton bought or sold on which the price has not been
fixed, together with the respective futures on which the purchase or
sale is based. As used herein, call cotton refers to spot cotton bought
or sold, or contracted for purchase or sale at a price to be fixed
later based upon a specified future.
(b) Time and place of filing reports. Each report shall be made
weekly as of the close of business on Friday and filed using the
procedure under Sec. 19.01(b)(3), not later than 9 a.m. Eastern Time
on the third business day following the date of the report.
Sec. 19.03 Reports pertaining to special commodities.
From time to time to facilitate surveillance in certain commodity
derivative contracts, the Commission may designate a commodity
derivative contract for reporting under Sec. 19.00(a)(1)(i) and will
publish such determination in the Federal Register and on its Web site.
Persons holding or controlling positions in such special commodity
derivative contracts must, beginning 30 days after notice is published
in the Federal Register, comply with the reporting requirements under
Sec. 19.00(a)(1)(i) and file Form 504 for conditional spot month limit
exemptions.
Sec. 19.04 Delegation of authority to the Director of the Division of
Market Oversight.
(a) The Commission hereby delegates, until it orders otherwise, to
the Director of the Division of Market Oversight or such other employee
or employees as the Director may designate from time to time, the
authority in Sec. 19.01 to provide instructions or to determine the
format, coding structure, and electronic data transmission procedures
for submitting data records and any other information required under
this part.
(b) The Director of the Division of Market Oversight may submit to
the Commission for its consideration any matter which has been
delegated in this section.
(c) Nothing in this section prohibits the Commission, at its
election, from exercising the authority delegated in this section.
Sec. Sec. 19.05-19.10 [Reserved]
Appendix A to Part 19–Forms 204, 304, 504, 604, and 704
Note: This Appendix includes representations of the proposed
reporting forms, which would be submitted in an electronic format
published pursuant to the proposed rules, either via the
Commission’s web portal or via XML-based, secure FTP transmission.
BILLING CODE 6351-01-P
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PART 32–REGULATION OF COMMODITY OPTION TRANSACTIONS
0
12. The authority citation for part 32 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6c, and 12a, unless otherwise noted.
0
13. Amend Sec. 32.3 by revising paragraph (c)(2) to read as follows:
Sec. 32.3 Trade options.
* * * * *
(c) * * *
(2) Part 150 (Position Limits) of this chapter;
* * * * *
PART 37–SWAP EXECUTION FACILITIES
0
14. The authority citation for part 37 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3, and 12a, as
amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376
0
15. Revise Sec. 37.601 to read as follows:
Sec. 37.601 Additional sources for compliance.
A swap execution facility that is a trading facility must meet the
requirements of part 150 of this chapter, as applicable.
0
16. In Appendix B to part 37, under the heading Core Principle 6 of
Section 5H of the Act, revise the introductory text of paragraph (B)
and paragraph (B)(2)(a) to read as follows:
Appendix B to Part 37–Guidance on, and Acceptable Practices in,
Compliance with Core Principles
* * * * *
CORE PRINCIPLE 6 OF SECTION 5H OF THE ACT–POSITION LIMITS OR
ACCOUNTABILITY
* * * * *
(B) Position limits. For any contract that is subject to a
position limitation established by the Commission pursuant to
section 4a(a) of the Act, the swap execution facility that is a
trading facility shall:
* * * * *
(2) * * *
(a) Guidance. A swap execution facility that is a trading
facility must meet the requirements of part 150 of this chapter, as
applicable. A swap execution facility that is not a trading facility
should consider part 150 of this chapter as guidance.
* * * * *
PART 38–DESIGNATED CONTRACT MARKETS
0
17. The authority citation for part 38 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,
6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as
amended by the Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376.
0
18. Revise Sec. 38.301 to read as follows:
Sec. 38.301 Position limitations and accountability.
A designated contract market must meet the requirements of part 150
of this chapter, as applicable.
PART 140–ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION
0
19. The authority citation for part 140 continues to read as follows:
Authority: 7 U.S.C. 2(a)(12), 13(c), 13(d), 13(e), and 16(b).
Sec. 140.97 [Removed and Reserved]
0
20. Remove and reserve Sec. 140.97.
PART 150–LIMITS ON POSITIONS
0
21. The authority citation for part 150 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6c, 6f, 6g, 6t, 12a, 19,
as amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
0
22. Revise Sec. 150.1 to read as follows:
Sec. 150.1 Definitions.
As used in this part–
Basis contract means a commodity derivative contract that is cash-
settled based on the difference in:
(1) The price, directly or indirectly, of:
(i) A particular core referenced futures contract; or
(ii) A commodity deliverable on a particular core referenced
futures contract, whether at par, a fixed discount to par, or a premium
to par; and
(2) The price, at a different delivery location or pricing point
than that of the same particular core referenced futures contract,
directly or indirectly, of:
(i) A commodity deliverable on the same particular core referenced
futures contract, whether at par, a fixed discount to par, or a premium
to par; or
(ii) A commodity that is listed in Appendix B of this part as
substantially the same as a commodity underlying the same core
referenced futures contract.
Bona fide hedging position means any position whose purpose is to
offset price risks incidental to commercial cash, spot, or forward
operations, and such position is established and liquidated in an
orderly manner in accordance with sound commercial practices, provided
that:
(1) Hedges of an excluded commodity. For a position in commodity
derivative contracts in an excluded commodity, as that term is defined
in section 1a(19) of the Act:
(i) Such position is economically appropriate to the reduction of
risks in the conduct and management of a commercial enterprise; and
(ii)(A) Is enumerated in paragraph (3), (4) or (5) of this
definition; or
(B) Such position is recognized as a bona fide hedging position by
the designated contract market or swap execution facility that is a
trading facility, pursuant to such market’s rules submitted to the
Commission, which rules may include risk management exemptions
consistent with Appendix A of this part; and
(2) Hedges of a physical commodity. For a position in commodity
derivative contracts in a physical commodity:
(i) Such position:
(A) Represents a substitute for transactions made or to be made, or
positions taken or to be taken, at a later time in a physical marketing
channel;
(B) Is economically appropriate to the reduction of risks in the
conduct and management of a commercial enterprise;
(C) Arises from the potential change in the value of–
(1) Assets which a person owns, produces, manufactures, processes,
or merchandises or anticipates owning, producing, manufacturing,
processing, or merchandising;
(2) Liabilities which a person owes or anticipates incurring; or
(3) Services that a person provides, purchases, or anticipates
providing or purchasing; and
(D) Is enumerated in paragraph (3), (4) or (5) of this definition;
or
(ii)(A) Pass-through swap offsets. Such position reduces risks
attendant to a position resulting from a swap in the same physical
commodity that was executed opposite a counterparty for which the
position at the time of the transaction would qualify as a bona fide
hedging position pursuant to paragraph (2)(i) of this definition (a
pass-through swap counterparty), provided that no such risk-reducing
position is maintained in any physical-delivery commodity derivative
contract during the lesser of the last five days of trading or the time
period for the spot month in such physical-delivery commodity
derivative contract; and
(B) Pass-through swaps. Such swap position was executed opposite a
pass-through swap counterparty and to the extent such swap position has
been offset pursuant to paragraph (2)(ii)(A) of this definition.
[[Page 75824]]
(3) Enumerated hedging positions. A bona fide hedging position
includes any of the following specific positions:
(i) Hedges of inventory and cash commodity purchase contracts.
Short positions in commodity derivative contracts that do not exceed in
quantity ownership or fixed-price purchase contracts in the contract’s
underlying cash commodity by the same person.
(ii) Hedges of cash commodity sales contracts. Long positions in
commodity derivative contracts that do not exceed in quantity the
fixed-price sales contracts in the contract’s underlying cash commodity
by the same person and the quantity equivalent of fixed-price sales
contracts of the cash products and by-products of such commodity by the
same person.
(iii) Hedges of unfilled anticipated requirements. Provided that
such positions in a physical-delivery commodity derivative contract,
during the lesser of the last five days of trading or the time period
for the spot month in such physical-delivery contract, do not exceed
the person’s unfilled anticipated requirements of the same cash
commodity for that month and for the next succeeding month:
(A) Long positions in commodity derivative contracts that do not
exceed in quantity unfilled anticipated requirements of the same cash
commodity, and that do not exceed twelve months for an agricultural
commodity, for processing, manufacturing, or use by the same person;
and
(B) Long positions in commodity derivative contracts that do not
exceed in quantity unfilled anticipated requirements of the same cash
commodity for resale by a utility that is required or encouraged to
hedge by its public utility commission on behalf of its customers’
anticipated use.
(iv) Hedges by agents. Long or short positions in commodity
derivative contracts by an agent who does not own or has not contracted
to sell or purchase the offsetting cash commodity at a fixed price,
provided that the agent is responsible for merchandising the cash
positions that are being offset in commodity derivative contracts and
the agent has a contractual arrangement with the person who owns the
commodity or holds the cash market commitment being offset.
(4) Other enumerated hedging positions. A bona fide hedging
position also includes the following specific positions, provided that
no such position is maintained in any physical-delivery commodity
derivative contract during the lesser of the last five days of trading
or the time period for the spot month in such physical-delivery
contract:
(i) Hedges of unsold anticipated production. Short positions in
commodity derivative contracts that do not exceed in quantity unsold
anticipated production of the same commodity, and that do not exceed
twelve months of production for an agricultural commodity, by the same
person.
(ii) Hedges of offsetting unfixed-price cash commodity sales and
purchases. Short and long positions in commodity derivative contracts
that do not exceed in quantity that amount of the same cash commodity
that has been bought and sold by the same person at unfixed prices:
(A) Basis different delivery months in the same commodity
derivative contract; or
(B) Basis different commodity derivative contracts in the same
commodity, regardless of whether the commodity derivative contracts are
in the same calendar month.
(iii) Hedges of anticipated royalties. Short positions in commodity
derivative contracts offset by the anticipated change in value of
mineral royalty rights that are owned by the same person, provided that
the royalty rights arise out of the production of the commodity
underlying the commodity derivative contract.
(iv) Hedges of services. Short or long positions in commodity
derivative contracts offset by the anticipated change in value of
receipts or payments due or expected to be due under an executed
contract for services held by the same person, provided that the
contract for services arises out of the production, manufacturing,
processing, use, or transportation of the commodity underlying the
commodity derivative contract, and which may not exceed one year for
agricultural commodities.
(5) Cross-commodity hedges. Positions in commodity derivative
contracts described in paragraph (2)(ii), paragraphs (3)(i) through
(iv) and paragraphs (4)(i) through (iv) of this definition may also be
used to offset the risks arising from a commodity other than the same
cash commodity underlying a commodity derivative contract, provided
that the fluctuations in value of the position in the commodity
derivative contract, or the commodity underlying the commodity
derivative contract, are substantially related to the fluctuations in
value of the actual or anticipated cash position or pass-through swap
and no such position is maintained in any physical-delivery commodity
derivative contract during the lesser of the last five days of trading
or the time period for the spot month in such physical-delivery
contract.
Commodity derivative contract means, for this part, any futures,
option, or swap contract in a commodity (other than a security futures
product as defined in section 1a(45) of the Act).
Core referenced futures contract means a futures contract that is
listed in Sec. 150.2(d).
Eligible affiliate. An eligible affiliate means an entity with
respect to which another person:
(1) Directly or indirectly holds either:
(i) A majority of the equity securities of such entity, or
(ii) The right to receive upon dissolution of, or the contribution
of, a majority of the capital of such entity;
(2) Reports its financial statements on a consolidated basis under
Generally Accepted Accounting Principles or International Financial
Reporting Standards, and such consolidated financial statements include
the financial results of such entity; and
(3) Is required to aggregate the positions of such entity under
Sec. 150.4 and does not claim an exemption from aggregation for such
entity.
Eligible entity means a commodity pool operator; the operator of a
trading vehicle which is excluded or which itself has qualified for
exclusion from the definition of the term “pool” or “commodity pool
operator,” respectively, under Sec. 4.5 of this chapter; the limited
partner, limited member or shareholder in a commodity pool the operator
of which is exempt from registration under Sec. 4.13 of this chapter;
a commodity trading advisor; a bank or trust company; a savings
association; an insurance company; or the separately organized
affiliates of any of the above entities:
(1) Which authorizes an independent account controller
independently to control all trading decisions with respect to the
eligible entity’s client positions and accounts that the independent
account controller holds directly or indirectly, or on the eligible
entity’s behalf, but without the eligible entity’s day-to-day
direction; and
(2) Which maintains:
(i) Only such minimum control over the independent account
controller as is consistent with its fiduciary responsibilities to the
managed positions and accounts, and necessary to fulfill its duty to
supervise diligently the trading done on its behalf; or
(ii) If a limited partner, limited member or shareholder of a
commodity pool the operator of which is exempt from registration under
Sec. 4.13 of this
[[Page 75825]]
chapter, only such limited control as is consistent with its status.
Entity means a “person” as defined in section 1a of the Act.
Excluded commodity means an “excluded commodity” as defined in
section 1a of the Act.
Futures-equivalent means
(1) An option contract, whether an option on a future or an option
that is a swap, which has been adjusted by an economically reasonable
and analytically supported risk factor, or delta coefficient, for that
option computed as of the previous day’s close or the current day’s
close or contemporaneously during the trading day, and;
(2) A swap which has been converted to an economically equivalent
amount of an open position in a core referenced futures contract.
Independent account controller means a person–
(1) Who specifically is authorized by an eligible entity, as
defined in this section, independently to control trading decisions on
behalf of, but without the day-to-day direction of, the eligible
entity;
(2) Over whose trading the eligible entity maintains only such
minimum control as is consistent with its fiduciary responsibilities
for managed positions and accounts to fulfill its duty to supervise
diligently the trading done on its behalf or as is consistent with such
other legal rights or obligations which may be incumbent upon the
eligible entity to fulfill;
(3) Who trades independently of the eligible entity and of any
other independent account controller trading for the eligible entity;
(4) Who has no knowledge of trading decisions by any other
independent account controller; and
(5) Who is
(i) Registered as a futures commission merchant, an introducing
broker, a commodity trading advisor, or an associated person of any
such registrant, or
(ii) A general partner, managing member or manager of a commodity
pool the operator of which is excluded from registration under Sec.
4.5(a)(4) of this chapter or Sec. 4.13 of this chapter, provided that
such general partner, managing member or manager complies with the
requirements of Sec. 150.4(c).
Intermarket spread position means a long position in a commodity
derivative contract in a particular commodity at a particular
designated contract market or swap execution facility and a short
position in another commodity derivative contract in that same
commodity away from that particular designated contract market or swap
execution facility.
Intramarket spread position means a long position in a commodity
derivative contract in a particular commodity and a short position in
another commodity derivative contract in the same commodity on the same
designated contract market or swap execution facility.
Long position means a long call option, a short put option or a
long underlying futures contract, or a long futures-equivalent swap.
Physical commodity means any agricultural commodity as that term is
defined in Sec. 1.3 of this chapter or any exempt commodity as that
term is defined in section 1a(20) of the Act.
Pre-enactment swap means any swap entered into prior to enactment
of the Dodd-Frank Act of 2010 (July 21, 2010), the terms of which have
not expired as of the date of enactment of that Act.
Pre-existing position means any position in a commodity derivative
contract acquired in good faith prior to the effective date of any
bylaw, rule, regulation or resolution that specifies an initial
speculative position limit level or a subsequent change to that level.
Referenced contract means, on a futures equivalent basis with
respect to a particular core referenced futures contract, a core
referenced futures contract listed in Sec. 150.2(d), or a futures
contract, options contract, or swap, and excluding any guarantee of a
swap, a basis contract, or a commodity index contract:
(1) That is:
(i) Directly or indirectly linked, including being partially or
fully settled on, or priced at a fixed differential to, the price of
that particular core referenced futures contract; or
(ii) Directly or indirectly linked, including being partially or
fully settled on, or priced at a fixed differential to, the price of
the same commodity underlying that particular core referenced futures
contract for delivery at the same location or locations as specified in
that particular core referenced futures contract; and
(2) Where:
(i) Calendar spread contract means a cash-settled agreement,
contract, or transaction that represents the difference between the
settlement price in one or a series of contract months of an agreement,
contract or transaction and the settlement price of another contract
month or another series of contract months’ settlement prices for the
same agreement, contract or transaction;
(ii) Commodity index contract means an agreement, contract, or
transaction that is not a basis or any type of spread contract, based
on an index comprised of prices of commodities that are not the same or
substantially the same;
(iii) Spread contract means either a calendar spread contract or an
intercommodity spread contract; and
(iv) Intercommodity spread contract means a cash-settled agreement,
contract or transaction that represents the difference between the
settlement price of a referenced contract and the settlement price of
another contract, agreement, or transaction that is based on a
different commodity.
Short position means a short call option, a long put option or a
short underlying futures contract, or a short futures-equivalent swap.
Speculative position limit means the maximum position, either net
long or net short, in a commodity derivatives contract that may be held
or controlled by one person, absent an exemption, such as an exemption
for a bona fide hedging position. This limit may apply to a person’s
combined position in all commodity derivative contracts in a particular
commodity (all-months-combined), a person’s position in a single month
of commodity derivative contracts in a particular commodity, or a
person’s position in the spot month of commodity derivative contacts in
a particular commodity. Such a limit may be established under federal
regulations or rules of a designated contract market or swap execution
facility. An exchange may also apply other limits, such as a limit on
gross long or gross short positions, or a limit on holding or
controlling delivery instruments.
Spot month means–
(1) For physical-delivery commodity derivative contracts, the
period of time beginning at the earlier of the close of trading on the
trading day preceding the first day on which delivery notices can be
issued to the clearing organization of a contract market, or the close
of trading on the trading day preceding the third-to-last trading day,
until the contract is no longer listed for trading (or available for
transfer, such as through exchange for physical transactions).
(2) For cash-settled contracts, spot month means the period of time
beginning at the earlier of the close of trading on the trading day
preceding the period in which the underlying cash-settlement price is
calculated, or the close of trading on the trading day preceding the
third-to-last trading day, until the contract cash-settlement price is
determined and published; provided however, if the cash-settlement
price is determined based on prices of a core referenced futures
contract during the spot month period for that core
[[Page 75826]]
referenced futures contract, then the spot month for that cash-settled
contract is the same as the spot month for that core referenced futures
contract.
Swap means “swap” as that term is defined in section 1a of the
Act and as further defined in Sec. 1.3 of this chapter.
Swap dealer means “swap dealer” as that term is defined in
section 1a of the Act and as further defined in Sec. 1.3 of this
chapter.
Transition period swap means a swap entered into during the period
commencing after the enactment of the Dodd-Frank Act of 2010 (July 21,
2010), and ending 60 days after the publication in the Federal Register
of final amendments to part 150 of this chapter implementing section
737 of the Dodd-Frank Act of 2010.
0
23. Revise Sec. 150.2 to read as follows:
Sec. 150.2 Speculative position limits.
(a) Spot-month speculative position limits. No person may hold or
control positions in referenced contracts in the spot month, net long
or net short, in excess of the level specified by the Commission for:
(1) Physical-delivery referenced contracts; and, separately,
(2) Cash-settled referenced contracts;
(b) Single-month and all-months-combined speculative position
limits. No person may hold or control positions, net long or net short,
in referenced contracts in a single month or in all months combined
(including the spot month) in excess of the levels specified by the
Commission.
(c) For purposes of this part:
(1) The spot month and any single month shall be those of the core
referenced futures contract; and
(2) An eligible affiliate is not required to comply separately with
speculative position limits.
(d) Core referenced futures contracts. Speculative position limits
apply to referenced contracts based on the core referenced futures
contracts listed in the following table:
Core Referenced Futures Contracts
————————————————————————
Core referenced
Commodity type Designated futures contract
contract market 1
————————————————————————
(1) Legacy Agricultural………
Chicago Board of
Trade.
Corn (C).
Oats (O).
Soybeans (S).
Soybean Meal (SM).
Soybean Oil (SO).
Wheat (W).
Kansas City Board
of Trade.
Hard Winter Wheat
(KW).
ICE Futures U.S…
Cotton No. 2 (CT).
Minneapolis Grain
Exchange.
Hard Red Spring
Wheat (MWE).
(2) Other Agricultural……….
Chicago Board of
Trade.
Rough Rice (RR).
Chicago Mercantile
Exchange.
Class III Milk
(DA).
Feeder Cattle
(FC).
Lean Hog (LH).
Live Cattle (LC).
ICE Futures U.S…
Cocoa (CC).
Coffee C (KC).
FCOJ-A (OJ).
U.S. Sugar No. 11
(SB).
U.S. Sugar No. 16
(SF).
(3) Energy………………….
New York
Mercantile
Exchange.
Light Sweet Crude
Oil (CL).
NY Harbor ULSD
(HO).
RBOB Gasoline
(RB).
Henry Hub Natural
Gas (NG).
(4) Metals………………….
Commodity
Exchange, Inc.
Gold (GC).
Silver (SI).
Copper (HG).
New York
Mercantile
Exchange.
Palladium (PA).
Platinum (PL).
————————————————————————
1 The core referenced futures contract includes any successor
contracts.
(e) Levels of speculative position limits. (1) Initial levels. The
initial levels of speculative position limits are fixed by the
Commission at the levels listed in Appendix D of this part and shall be
effective 60 days after publication in the Federal Register.
(2) Subsequent levels. (i) The Commission shall fix subsequent
levels of speculative position limits in accordance with the procedures
in this
[[Page 75827]]
section and publish such levels on the Commission’s Web site at http://www.cftc.gov.
(ii) Such subsequent speculative position limit levels shall each
apply beginning on the close of business of the last business day of
the second complete calendar month after publication of such levels;
provided however, if such close of business is in a spot month of a
core referenced futures contract, the subsequent spot-month level shall
apply beginning with the next spot month for that contract.
(iii) All subsequent levels of speculative position limits shall be
rounded up to the nearest hundred contracts.
(3) Procedure for computing levels of spot-month limits. (i) No
less frequently than every two calendar years, the Commission shall fix
the level of the spot-month limit no greater than one-quarter of the
estimated spot-month deliverable supply in the relevant core referenced
futures contract. Unless the Commission determines to rely on its own
estimate of deliverable supply, the Commission shall utilize the
estimated spot-month deliverable supply provided by a designated
contract market.
(ii) Each designated contract market in a core referenced futures
contract shall supply to the Commission an estimated spot-month
deliverable supply. A designated contract market may use the guidance
regarding deliverable supply in Appendix C of part 38 of this chapter.
Each estimate must be accompanied by a description of the methodology
used to derive the estimate and any statistical data supporting the
estimate, and must be submitted no later than the following:
(A) For energy commodities, January 31 of the second calendar year
following the most recent Commission action establishing such limit
levels;
(B) For metals commodities, March 31 of the second calendar year
following the most recent Commission action establishing such limit
levels;
(C) For legacy agricultural commodities, May 31 of the second
calendar year following the most recent Commission action establishing
such limit levels; and
(D) For other agricultural commodities, August 31 of the second
calendar year following the most recent Commission action establishing
such limit levels.
(4) Procedure for computing levels of single-month and all-months-
combined limits. No less frequently than every two calendar years, the
Commission shall fix the level, for each referenced contract, of the
single-month limit and the all-months-combined limit. Each such limit
shall be based on 10 percent of the estimated average open interest in
referenced contracts, up to 25,000 contracts, with a marginal increase
of 2.5 percent thereafter.
(i) Time periods for average open interest. The Commission shall
estimate average open interest in referenced contracts based on the
largest annual average open interest computed for each of the past two
calendar years. The Commission may estimate average open interest in
referenced contracts using either month-end open contracts or open
contracts for each business day in the time period, as practical.
(ii) Data sources for average open interest. The Commission shall
estimate average open interest in referenced contracts using data
reported to the Commission pursuant to part 16 of this chapter, and
open swaps reported to the Commission pursuant to part 20 of this
chapter or data obtained by the Commission from swap data repositories
collecting data pursuant to part 45 of this chapter. Options listed on
designated contract markets shall be adjusted using an option delta
reported to the Commission pursuant to part 16 of this chapter. Swaps
shall be counted on a futures equivalent basis, equal to the
economically equivalent amount of core referenced futures contracts
reported pursuant to part 20 of this chapter or as calculated by the
Commission using swap data collected pursuant to part 45 of this
chapter.
(iii) Publication of average open interest. The Commission shall
publish estimates of average open interest in referenced contracts on a
monthly basis, as practical, after such data is submitted to the
Commission.
(iv) Minimum levels. Provided however, notwithstanding the above,
the minimum levels shall be the greater of the level of the spot month
limit determined under paragraph (e)(3) of this section and 1,000 for
referenced contracts in an agricultural commodity or 5,000 for
referenced contracts in an exempt commodity.
(f) Pre-existing Positions–(1) Pre-existing positions in a spot-
month. Other than pre-enactment and transition period swaps exempted
under Sec. 150.3(d), a person shall comply with spot month speculative
position limits.
(2) Pre-existing positions in a non-spot-month. A single-month or
all-months-combined speculative position limit established under this
section shall not apply to any commodity derivative contract acquired
in good faith prior to the effective date of such limit, provided,
however, that if such position is not a pre-enactment or transition
period swap then that position shall be attributed to the person if the
person’s position is increased after the effective date of such limit.
(g) Positions on Foreign Boards of Trade. The aggregate speculative
position limits established under this section shall apply to a person
with positions in referenced contracts executed on, or pursuant to the
rules of a foreign board of trade, provided that:
(1) Such referenced contracts settle against any price (including
the daily or final settlement price) of one or more contracts listed
for trading on a designated contract market or swap execution facility
that is a trading facility; and
(2) The foreign board of trade makes available such referenced
contracts to its members or other participants located in the United
States through direct access to its electronic trading and order
matching system.
(h) Anti-evasion provision. For the purposes of applying the
speculative position limits in this section, a commodity index contract
used to circumvent speculative position limits shall be considered to
be a referenced contract.
(1) Delegation of authority to the Director of the Division of
Market Oversight. (i) The Commission hereby delegates, until it orders
otherwise, to the Director of the Division of Market Oversight or such
other employee or employees as the Director may designate from time to
time, the authority in paragraph (e) of this section to fix and publish
subsequent levels of speculative position limits.
(ii) The Director of the Division of Market Oversight may submit to
the Commission for its consideration any matter which has been
delegated in this section.
(iii) Nothing in this section prohibits the Commission, at its
election, from exercising the authority delegated in this section.
(iv) The Commission will periodically update these initial levels
for speculative position limits and publish such subsequent levels on
its Web site at: http://www.cftc.gov.
(2) Reserved.
0
24. Revise Sec. 150.3 to read as follows:
Sec. 150.3 Exemptions.
(a) Positions which may exceed limits. The position limits set
forth in Sec. 150.2 may be exceeded to the extent that:
(1) Such positions are:
(i) Bona fide hedging positions as defined in Sec. 150.1, provided
that for anticipatory bona fide hedge positions under paragraphs
(3)(iii), (4)(i), (4)(iii), and (4)(iv) of the bona fide hedging
position definition in Sec. 150.1 the person
[[Page 75828]]
complies with the filing procedure found in Sec. 150.7;
(ii) Financial distress positions exempted under paragraph (b) of
this section;
(iii) Conditional spot-month limit positions exempted under
paragraph (c) of this section; or
(iv) Other positions exempted under paragraph (e) of this section;
and that
(2) The recordkeeping requirements of paragraph (g) of this section
are met; and further that
(3) The reporting requirements of part 19 of this chapter are met.
(b) Financial distress exemptions. Upon specific request made to
the Commission, the Commission may exempt a person or related persons
under financial distress circumstances for a time certain from any of
the requirements of this part. Financial distress circumstances include
situations involving the potential default or bankruptcy of a customer
of the requesting person or persons, an affiliate of the requesting
person or persons, or a potential acquisition target of the requesting
person or persons.
(c) Conditional spot-month limit exemption. The position limits set
forth in Sec. 150.2 may be exceeded for cash-settled referenced
contracts provided that such positions do not exceed five times the
level of the spot-month limit specified by the Commission and the
person holding or controlling such positions does not hold or control
positions in spot-month physical-delivery referenced contracts.
(d) Pre-enactment and transition period swaps exemption. The
speculative position limits set forth in Sec. 150.2 shall not apply to
positions acquired in good faith in any pre-enactment swap, or in any
transition period swap, in either case as defined by Sec. 150.1,
provided, however, that a person may net such positions with post-
effective date commodity derivative contracts for the purpose of
complying with any non-spot-month speculative position limit.
(e) Other exemptions. Any person engaging in risk-reducing
practices commonly used in the market, which they believe may not be
specifically enumerated in the definition of bona fide hedging position
in Sec. 150.1, may request:
(1) An interpretative letter from Commission staff, under Sec.
140.99 of this chapter, concerning the applicability of the bona fide
hedging position exemption; or
(2) Exemptive relief from the Commission under section 4a(a)(7) of
the Act.
(3) Appendix C of this part provides a non-exhaustive list of
examples of bona fide hedging positions as defined under Sec. 150.1.
(f) Previously granted exemptions. Exemptions granted by the
Commission under Sec. 1.47 of this chapter for swap risk management
shall not apply to swap positions entered into after the effective date
of initial position limits implementing section 737 of the Dodd-Frank
Act of 2010.
(g) Recordkeeping. (1) Persons who avail themselves of exemptions
under this section, including exemptions granted under section 4a(a)(7)
of the Act, shall keep and maintain complete books and records
concerning all details of their related cash, forward, futures, futures
options and swap positions and transactions, including anticipated
requirements, production and royalties, contracts for services, cash
commodity products and by-products, and cross-commodity hedges, and
shall make such books and records, including a list of pass-through
swap counterparties, available to the Commission upon request under
paragraph (h) of this section.
(2) Further, a party seeking to rely upon the pass-through swap
offset in paragraph (2)(ii) of the definition of “bona fide hedging
position” in Sec. 150.1, in order to exceed the position limits of
Sec. 150.2 with respect to such a swap, may only do so if its
counterparty provides a written representation (e.g., in the form of a
field or other representation contained in a mutually executed trade
confirmation) that, as to such counterparty, the swap qualifies in good
faith as a “bona fide hedging position,” as defined in Sec. 150.1,
at the time the swap was executed. That written representation shall be
retained by the parties to the swap for a period of at least two years
following the expiration of the swap and furnished to the Commission
upon request.
(3) Any person that represents to another person that a swap
qualifies as a pass-through swap under paragraph (2)(ii) of the
definition of “bona fide hedging position” in Sec. 150.1 shall keep
and make available to the Commission upon request all relevant books
and records supporting such a representation for a period of at least
two years following the expiration of the swap.
(h) Call for information. Upon call by the Commission, the Director
of the Division of Market Oversight or the Director’s delegate, any
person claiming an exemption from speculative position limits under
this section must provide to the Commission such information as
specified in the call relating to the positions owned or controlled by
that person; trading done pursuant to the claimed exemption; the
commodity derivative contracts or cash market positions which support
the claim of exemption; and the relevant business relationships
supporting a claim of exemption.
(i) Aggregation of accounts. Entities required to aggregate
accounts or positions under Sec. 150.4 shall be considered the same
person for the purpose of determining whether they are eligible for a
bona fide hedging position exemption under paragraph (a)(1)(i) of this
section with respect to such aggregated account or position.
(j) Delegation of authority to the Director of the Division of
Market Oversight. (1) The Commission hereby delegates, until it orders
otherwise, to the Director of the Division of Market Oversight or such
other employee or employees as the Director may designate from time to
time, the authority in paragraph (b) of this section to provide
exemptions in circumstances of financial distress.
(2) The Director of the Division of Market Oversight may submit to
the Commission for its consideration any matter which has been
delegated in this section.
(3) Nothing in this section prohibits the Commission, at its
election, from exercising the authority delegated in this section.
0
25. Revise Sec. 150.5 to read as follows:
Sec. 150.5 Exchange-set speculative position limits.
(a) Requirements and acceptable practices for commodity derivative
contracts subject to federal position limits. (1) For any commodity
derivative contract that is subject to a speculative position limit
under Sec. 150.2, the designated contract market or swap execution
facility that is a trading facility shall set a speculative position
limit no higher than the level specified in Sec. 150.2.
(2) Exemptions. (i) Hedge exemption. Any hedge exemption rules
adopted by a designated contract markets or a swap execution facility
that is a trading facility must conform to the definition of bona fide
hedging position in Sec. 150.1.
(ii) Other exemptions. In addition to the express exemptions
specified in Sec. 150.3, a designated contract market or swap
execution facility that is a trading facility may grant other
exemptions for:
(A) Intramarket spread positions as defined in Sec. 150.1,
provided that such positions must be outside of the spot month for
physical-delivery contracts and must not exceed the all-months limit
set forth in Sec. 150.2 when combined
[[Page 75829]]
with any other net positions in the single month;
(B) Intermarket spread positions as defined in Sec. 150.1,
provided that such positions must be outside of the spot month for
physical-delivery contracts.
(iii) Application for exemption. Traders must apply to the
designated contract market or swap execution facility that is a trading
facility for any exemption from its speculative position limit rules.
The designated contract market or swap execution facility that is a
trading facility may limit bona fide hedging positions, or any other
positions that have been exempted pursuant to Sec. 150.3, which it
determines are not in accord with sound commercial practices, or which
exceed an amount that may be established and liquidated in an orderly
fashion.
(3) Pre-enactment and transition period swap positions. Speculative
position limits set forth in Sec. 150.2 shall not apply to positions
acquired in good faith in any pre-enactment swap, or in any transition
period swap, in either case as defined by Sec. 150.1. Provided,
however, that a designated contract market or swap execution facility
that is a trading facility shall allow a person to net such position
with post-effective date commodity derivative contracts for the purpose
of complying with any non-spot-month speculative position limit.
(4) Pre-existing positions. (i) Pre-existing positions in a spot-
month. A designated contract market or swap execution facility that is
a trading facility must require compliance with spot month speculative
position limits for pre-existing positions in commodity derivative
contracts other than pre-enactment and transition period swaps.
(ii) Pre-existing positions in a non-spot-month. A single-month or
all-months-combined speculative position limit established under Sec.
150.2 shall not apply to any commodity derivative contract acquired in
good faith prior to the effective date of such limit, provided,
however, that such position shall be attributed to the person if the
person’s position is increased after the effective date of such limit.
(5) Aggregation. Designated contract markets and swap execution
facilities that are trading facilities must have aggregation rules that
conform to Sec. 150.4.
(6) Additional acceptable practices. A designated contract market
or swap execution facility that is a trading facility may:
(i) Impose additional restrictions on a person with a long position
in the spot month of a physical-delivery contract who stands for
delivery, takes that delivery, then re-establishes a long position;
(ii) Establish limits on the amount of delivery instruments that a
person may hold in a physical-delivery contract; and
(iii) Impose such other restrictions as it deems necessary to
reduce the potential threat of market manipulation or congestion, to
maintain orderly execution of transactions, or for such other purposes
consistent with its responsibilities.
(b) Requirements and acceptable practices for commodity derivative
contracts that are not subject to the limits set forth in Sec. 150.2,
including derivative contracts in a physical commodity as defined in
Sec. 150.1 and in an excluded commodity as defined in section 1a(19)
of the Act–(1) Levels at initial listing. At the time of each
commodity derivative contract’s initial listing, a designated contract
market or swap execution facility that is a trading facility should
base speculative position limits on the following:
(i) Spot month position limits. (A) Commodities with a measurable
deliverable supply. For all commodity derivative contracts not subject
to the limits set forth in Sec. 150.2 that are based on a commodity
with a measurable deliverable supply, the spot month limit level should
be established at a level that is no greater than one-quarter of the
estimated spot month deliverable supply, calculated separately for each
month to be listed (Designated Contract Markets and Swap Execution
Facilities may refer to the guidance in paragraph (b)(1)(i) of Appendix
C of part 38 for guidance on estimating spot-month deliverable supply);
(B) Commodities without a measurable deliverable supply. For
commodity derivative contracts that are based on a commodity with no
measurable deliverable supply, the spot month limit level should be set
at a level that is necessary and appropriate to reduce the potential
threat of market manipulation or price distortion of the contract’s or
the underlying commodity’s price or index.
(ii) Individual non-spot or all-months-combined position limits.
(A) Agricultural commodity derivative contracts. For agricultural
commodity derivative contracts not subject to the limits set forth in
Sec. 150.2, the individual non-spot or all-months-combined levels
should be no greater than 1,000 contracts, when the notional quantity
per contract is no larger than a typical cash market transaction in the
underlying commodity. If the notional quantity per contract is larger
than the typical cash market transaction, then the individual non-spot
month limit or all-months combined limit level should be scaled down
accordingly. If the commodity derivative contract is substantially the
same as a pre-existing designated contract market or swap execution
facility commodity derivative contract, then the designated contract or
swap execution facility may adopt the same limit as applies to that
pre-existing commodity derivative contract;
(B) Exempt or excluded commodity derivative contracts. For exempt
commodity derivative contracts not subject to the limits set forth in
Sec. 150.2 or excluded commodity derivative contracts, the individual
non-spot or all-months-combined levels should be no greater than 5,000
contracts, when the notional quantity per contract is no larger than a
typical cash market transaction in the underlying commodity. If the
notional quantity per contract is larger than the typical cash market
transaction, then the individual non-spot month limit or all-months
combined limit level should be scaled down accordingly. If the
commodity derivative contract is substantially the same as a pre-
existing commodity derivative contract, then the designated contract
market or swap execution facility may adopt the same limit as applies
to that pre-existing commodity derivative contract.
(iii) Commodity derivative contracts that are cash-settled by
referencing a daily settlement price of an existing contract. For
commodity derivative contracts that are cash-settled by referencing a
daily settlement price of an existing contract listed on a designated
contract market or swap execution facility that is a trading facility,
the cash-settled contract should adopt the same spot-month, individual
non-spot-month, and all-months-combined position limits as the original
price referenced contract.
(2) Adjustments to levels. Designated contract markets and swap
execution facilities that are trading facilities should adjust their
speculative limit levels as follows:
(i) Spot month position limits. The spot month position limit level
should be reviewed no less than once every twenty-four months from the
date of initial listing and should be maintained at a level that is:
(A) No greater than one-quarter of the estimated spot month
deliverable supply, calculated separately for each month to be listed;
or
(B) In the case of a commodity derivative contract based on a
commodity without a measurable deliverable supply, necessary and
appropriate to reduce the potential threat of market manipulation or
price
[[Page 75830]]
distortion of the contract’s or the underlying commodity’s price or
index.
(ii) Individual non-spot or all-months-combined position limits.
Individual non-spot or all-months-combined levels should be no greater
than 10% of the average combined futures and delta-adjusted option
month-end open interest for the most recent calendar year up to 25,000
contracts, with a marginal increase of 2.5% thereafter, or be based on
position sizes customarily held by speculative traders on the contract
market. In any case, such levels should be reviewed no less than once
every twenty-four months from the date of initial listing.
(3) Position accountability in lieu of speculative position limits.
A designated contract market or swap execution facility that is a
trading facility may adopt a bylaw, rule, regulation, or resolution,
substituting for the exchange set speculative position limits specified
under this paragraph (b), an exchange rule requiring traders to consent
to provide information about their position upon request by the
exchange and to consent to halt increasing further a trader’s position
or to reduce their positions in an orderly manner, in each case upon
request by the exchange as follows:
(i) Physical commodity derivative contracts. On a physical
commodity derivative contract that is not subject to the limits set
forth in Sec. 150.2, having an average month-end open interest of
50,000 contracts and an average daily volume of 5,000 or more contracts
during the most recent calendar year and a liquid cash market, a
designated contract market or swap execution facility that is a trading
facility may adopt individual non-spot month or all-months-combined
position accountability levels, provided, however, that such designated
contract market or swap execution facility that is a trading facility
should adopt a spot month speculative position limit with a level no
greater than one-quarter of the estimated spot month deliverable
supply;
(ii) Excluded commodity derivative contracts–(A) Spot month. On an
excluded commodity derivative contract for which there is a highly
liquid cash market and no legal impediment to delivery, a designated
contract market or swap execution facility that is a trading facility
may adopt position accountability in lieu of position limits in the
spot month. For an excluded commodity derivative contract based on a
commodity without a measurable deliverable supply, a designated
contract market or swap execution facility that is a trading facility
may adopt position accountability in lieu of position limits in the
spot month. For all other excluded commodity derivative contracts, a
designated contract market or swap execution facility that is a trading
facility should adopt a spot-month position limit with a level no
greater than one-quarter of the estimated deliverable supply;
(B) Individual non-spot or all-months-combined position limits. On
an excluded commodity derivative contract, a designated contract market
or swap execution facility that is a trading facility may adopt
position accountability levels in lieu of position limits in the
individual non-spot month or all-months-combined.
(iii) New commodity derivative contracts that are substantially the
same as an existing contract. On a new commodity derivative contract
that is substantially the same as an existing commodity derivative
contract listed for trading on a designated contract market or swap
execution facility that is a trading facility, which has adopted
position accountability in lieu of position limits, the designated
contract market or swap execution facility may adopt for the new
contract when it is initially listed for trading the position
accountability levels of the existing contract.
(4) Calculation of trading volume and open interest. For purposes
of this paragraph, trading volume and open interest should be
calculated by:
(i) Open interest. (A) Averaging the month-end open positions in a
futures contract and its related option contract, on a delta-adjusted
basis, for all months listed during the most recent calendar year; and
(B) Averaging the month-end futures-equivalent amount of open
positions in swaps in a particular commodity (such as, for swaps that
are not referenced contracts, by combining the notional month-end open
positions in swaps in a particular commodity, including options in that
same commodity that are swaps on a delta-adjusted basis, and dividing
by a notional quantity per contract that is no larger than a typical
cash market transaction in the underlying commodity).
(ii) Trading volume. (A) Counting the number of contracts in a
futures contract and its related option contract, on a delta-adjusted
basis, transacted during the most recent calendar year; and
(B) Counting the futures-equivalent number of swaps in a particular
commodity transacted during the most recent calendar year.
(5) Exemptions–(i) Hedge exemption. Any hedge exemption rules
adopted by a designated contract market or a swap execution facility
that is a trading facility must conform to the definition of bona fide
hedging position in Sec. 150.1.
(ii) Other exemptions. In addition to the exemptions for bona fide
hedging positions that conform to paragraph (b)(5)(i) of this section,
a designated contract market or swap execution facility that is a
trading facility may grant other exemptions for:
(A) Financial distress. Upon specific request made to the
designated contract market or swap execution facility that is a trading
facility, the designated contract market or swap execution facility
that is a trading facility may exempt a person or related persons under
financial distress circumstances for a time certain from any of the
requirements of this part. Financial distress circumstances include
situations involving the potential default or bankruptcy of a customer
of the requesting person or persons, an affiliate of the requesting
person or persons, or a potential acquisition target of the requesting
person or persons;
(B) Conditional spot-month limit exemption. Exchange-set
speculative position limits may be exceeded for cash-settled contracts
provided that such positions should not exceed five times the level of
the spot-month limit specified by the designated contract market or
swap execution facility that is a trading facility and the person
holding or controlling such positions should not hold or control
positions in referenced spot-month physical-delivery contracts;
(C) Intramarket spread positions as defined in Sec. 150.1,
provided that such positions should be outside of the spot month for
physical-delivery contracts and should not exceed the all-months limit
when combined with any other net positions in the single month;
(D) Intermarket spread positions as defined in Sec. 150.1,
provided that such positions should be outside of the spot month for
physical-delivery contracts; and/or
(E) For excluded commodities, a designated contract market or swap
execution facility that is a trading facility may grant a limited risk
management exemption pursuant to rules submitted to the Commission,
consistent with the guidance in Appendix A of this part.
(iii) Application for exemption. Traders must apply to the
designated contract market or swap execution facility that is a trading
facility for any exemption from its speculative position limit rules.
In considering whether to grant such an application for exemption, a
designated contract market or swap execution facility that is a trading
facility should take into account
[[Page 75831]]
whether the requested exemption is in accord with sound commercial
practices and results in a position that does not exceed an amount that
may be established and liquidated in an orderly fashion.
(6) Pre-enactment and transition period swap positions. Speculative
position limits should not apply to positions acquired in good faith in
any pre-enactment swap, or in any transition period swap, in either
case as defined by Sec. 150.1. Provided, however, that a designated
contract market or swap execution facility that is a trading facility
may allow a person to net such position with post-effective date
commodity derivative contracts for the purpose of complying with any
non-spot-month speculative position limit.
(7) Pre-existing positions–(i) Pre-existing positions in a spot-
month. A designated contract market or swap execution facility that is
a trading facility should require compliance with spot month
speculative position limits for pre-existing positions in commodity
derivative contracts other than pre-enactment and transition period
swaps.
(ii) Pre-existing positions in a non-spot-month. A single-month or
all-months-combined speculative position limit should not apply to any
commodity derivative contract acquired in good faith prior to the
effective date of such limit, provided, however, that such position
should be attributed to the person if the person’s position is
increased after the effective date of such limit.
(8) Aggregation. Designated contract markets and swap execution
facilities that are trading facilities must have aggregation rules that
conform to Sec. 150.4.
(9) Additional acceptable practices. Particularly in the spot
month, a designated contract market or swap execution facility that is
a trading facility may:
(i) Impose additional restrictions on a person with a long position
in the spot month of a physical-delivery contract who stands for
delivery, takes that delivery, then re-establishes a long position;
(ii) Establish limits on the amount of delivery instruments that a
person may hold in a physical-delivery contract; and
(iii) Impose such other restrictions as it deems necessary to
reduce the potential threat of market manipulation or congestion, to
maintain orderly execution of transactions, or for such other purposes
consist with its responsibilities.
(c) Securities futures products. For security futures products,
position limitations and position accountability provisions are
specified in Sec. 41.25(a)(3) of this chapter.
0
26. Revise Sec. 150.6 to read as follows:
Sec. 150.6 Ongoing application of the Act and Commission regulations.
This part shall only be construed as having an effect on position
limits set by the Commission or a designated contract market or swap
execution facility. Nothing in this part shall be construed to affect
any other provisions of the Act or Commission regulations including but
not limited to those relating to manipulation, attempted manipulation,
corners, squeezes, fraudulent or deceptive conduct or prohibited
transactions.
0
27. Add Sec. 150.7 to read as follows:
Sec. 150.7 Requirements for anticipatory bona fide hedging position
exemptions.
(a) Statement. Any person who wishes to avail himself of exemptions
for unfilled anticipated requirements, unsold anticipated production,
anticipated royalties, anticipated services contract payments or
receipts, or anticipatory cross-commodity hedges under the provisions
of paragraphs (3)(iii), (4)(i), (4)(iii), (4)(iv), or (5),
respectively, of the definition of bona fide hedging position in Sec.
150.1 shall file Form 704 with the Commission in advance of the date
the person expects to exceed the position limits established under this
part. Filings in conformity with the requirements of this section shall
be effective ten days after submission, unless otherwise notified by
the Commission.
(b) Commission notification. At any time, the Commission may, by
notice to any person filing a Form 704, specify its determination as to
what portion, if any, of the amounts described in such filing does not
meet the requirements for bona fide hedging positions. In no case shall
such person’s anticipatory bona fide hedging positions exceed the
levels specified in paragraph (f) of this section.
(c) Call for additional information. At any time, the Commission
may request a person who has on file a Form 704 under paragraph (a) of
this section to file specific additional or updated information with
the Commission to support a determination that the Form 704 on file
accurately reflects unsold anticipated production, unfilled anticipated
requirements, anticipated royalties, or anticipated services contract
payments or receipts.
(d) Initial statement. Initial Form 704 concerning the
classification of positions as bona fide hedging pursuant to paragraphs
(3)(iii), or (4)(i), (4)(iii), (4)(iv) or anticipatory cross-commodity
hedges under paragraph (5) of the definition of bona fide hedging
position in Sec. 150.1 shall be filed with the Commission at least ten
days in advance of the date that such positions would be in excess of
limits then in effect pursuant to section 4a of the Act. Such
statements shall set forth in detail for a specified operating period,
not in excess of one year for an agricultural commodity, the person’s
anticipated activity, i.e., unfilled anticipated requirements, unsold
anticipated production, anticipated royalties, or anticipated services
contract payments or receipts, and explain the method of determination
thereof, including, but not limited to, the following information:
(1) Anticipated activity. For each anticipated activity:
(i) The type of cash commodity underlying the anticipated activity;
(ii) The name of the actual cash commodity underlying the
anticipated activity and the units in which the cash commodity is
measured;
(iii) An indication of whether the cash commodity is the same
commodity (grade and quality) that underlies a core referenced futures
contract or whether a cross-hedge will be used and, if so, additional
information for cross hedges specified in paragraph (d)(2) of this
section;
(iv) Annual production, requirements, royalty receipts or service
contract payments or receipts, in terms of futures equivalents, of such
commodity for the three complete fiscal years preceding the current
fiscal year;
(v) The specified time period for which the anticipatory hedge
exemption is claimed;
(vi) Anticipated production, requirements, royalty receipts or
service contract payments or receipts, in terms of futures equivalents,
of such commodity for such specified time period, not in excess of one
year for an agricultural commodity;
(vii) Fixed-price forward sales, inventory, and fixed-price forward
purchases of such commodity, including any quantity in process of
manufacture and finished goods and byproducts of manufacture or
processing (in terms of such commodity);
(viii) Unsold anticipated production, unfilled anticipated
requirements, unsold anticipated royalty receipts,, and anticipated
service contract payments or receipts the risks of which have not been
offset with cash positions, of such commodity for the specified time
period, not in excess of one year for an agricultural commodity; and
(ix) The maximum number of long positions and short positions in
[[Page 75832]]
referenced contracts expected to be used to offset the risks of such
anticipated activity.
(2) Additional information for cross hedges. Cash positions that
represent a commodity, or products or byproducts of a commodity, that
is different from the commodity underlying a commodity derivative
contract that is expected to be used for hedging, shall be shown both
in terms of the equivalent amount of the commodity underlying the
commodity derivative contract used for hedging and in terms of the
actual cash commodity as provided for on Form 704. In computing their
cash position, every person shall use such standards and conversion
factors that are usual in the particular trade or that otherwise
reflect the value-fluctuation-equivalents of the cash position in terms
of the commodity underlying the commodity derivative contract used for
hedging. Such person shall furnish to the Commission upon request
detailed information concerning the basis for and derivation of such
conversion factors, including:
(i) The hedge ratio used to convert the actual cash commodity to
the equivalent amount of the commodity underlying the commodity
derivative contract used for hedging; and
(ii) An explanation of the methodology used for determining the
hedge ratio.
(e) Supplemental reports. Whenever the amount which a person wishes
to consider as a bona fide hedging position shall exceed the amount in
the most recent filing pursuant to this section or such lesser amount
as determined by the Commission pursuant to paragraph (b) of this
section, such person shall file with the Commission a Form 704 which
updates the information provided in the person’s most recent filing and
supplies the reason for this change at least ten days in advance of the
date that person wishes to exceed such amount.
(f) Annual update. Each person that has filed an initial statement
on Form 704 for an anticipatory bona fide hedge exemption shall provide
annual updates on the utilization of the anticipatory exemption. Each
person shall report actual cash activity utilizing the anticipatory
exemption for the preceding year, as well as the cumulative utilization
since the filing of the initial or most recent supplemental statement.
Each person shall also provide a good faith estimate of the remaining
anticipatory exemption. Such reports shall set forth in detail the
person’s activity related to the anticipated exemption and shall
include, but not be limited to the following information:
(1) Information to be included:. For each anticipated activity:
(i) The type of cash commodity underlying the anticipated activity;
(ii) The name of the actual cash commodity underlying the
anticipated activity and the units in which the cash commodity is
measured;
(iii) An indication of whether the cash commodity is the same
commodity (grade and quality) that underlies a core referenced futures
contract or whether a cross-hedge will be used and, if so, additional
information for cross hedges specified in paragraph (d)(2) of this
section;
(iv) Actual production, requirements, royalty receipts or service
contract payments or receipts, in terms of futures equivalents, of such
commodity for the reporting month;
(v) Cumulative actual production, requirements, royalty receipts or
service contract payments or receipts, in terms of futures equivalents,
of such commodity since the initial or supplemental statement;
(vi) Estimated anticipated production, requirements, royalty
receipts or service contract payments or receipts, in terms of futures
equivalents, of such commodity for the remainder of such specified time
period, not in excess of one year for an agricultural commodity;
(vii) Fixed-price forward sales, inventory, and fixed-price forward
purchases of such commodity, including any quantity in process of
manufacture and finished goods and byproducts of manufacture or
processing (in terms of such commodity) for the reporting month;
(viii) Remaining unsold anticipated production, unfilled
anticipated requirements, unsold anticipated royalty receipts, and
anticipated service contract payments or receipts the risks of which
have not been offset with cash positions, of such commodity for the
specified time period, not in excess of one year for an agricultural
commodity; and
(ix) The maximum number of long positions and short positions in
referenced contracts expected to be used to offset the risks of such
anticipated activity for the remainder of the specified time period.
(2) Reserved.
(g) Monthly reporting. Monthly reporting of remaining anticipated
hedge exemption shall be reported on Form 204, along with reporting
other exemptions pursuant to Sec. 19.01(a)(3)(vii).
(h) Maximum sales and purchases. Sales or purchases of commodity
derivative contracts considered to be bona fide hedging positions under
paragraphs (3)(iii)(A) or (4)(i) of the bona fide hedging position
definition in Sec. 150.1 shall at no time exceed the lesser of:
(1) A person’s anticipated activity (including production,
requirements, royalties and services) as described by the information
most recently filed pursuant to this section that has not been offset
with cash positions; or
(2) Such lesser amount as determined by the Commission pursuant to
paragraph (b) of this section.
(i) Delegation of authority to the Director of the Division of
Market Oversight. (1) The Commission hereby delegates, until it orders
otherwise, to the Director of the Division of Market Oversight or such
other employee or employees as the Director may designate from time to
time, the authority:
(i) In paragraph (b) of this section to provide notice to a person
that some or all of the amounts described in a Form 704 filing does not
meet the requirements for bona fide hedging positions;
(ii) In paragraph (c) of this section to request a person who has
filed a Form 704 under paragraph (a) of this section to file specific
additional or updated information with the Commission to support a
determination that the Form 704 filed accurately reflects unsold
anticipated production, unfilled anticipated requirements, anticipated
royalties, or anticipated services contract payments or receipts; and
(iii) In paragraph (d)(2) of this section to request detailed
information concerning the basis for and derivation of conversion
factors used in computing the cash position provided in Form 704.
(2) The Director of the Division of Market Oversight may submit to
the Commission for its consideration any matter which has been
delegated in this section.
(3) Nothing in this section prohibits the Commission, at its
election, from exercising the authority delegated in this section.
0
28. Add Sec. 150.8 to read as follows:
Sec. 150.8 Severability.
If any provision of this part, or the application thereof to any
person or circumstances, is held invalid, such invalidity shall not
affect other provisions or application of such provision to other
persons or circumstances which can be given effect without the invalid
provision or application.
0
29. Add appendix A to part 150 to read as follows:
[[Page 75833]]
Appendix A to Part 150–Guidance on Risk Management Exemptions for
Commodity Derivative Contracts in Excluded Commodities
(1) This appendix provides non-exclusive interpretative guidance
on risk management exemptions for commodity derivative contracts in
excluded commodities permitted under the definition of bona fide
hedging position in Sec. 150.1. The rules of a designated contract
market or swap execution facility that is a trading facility may
recognize positions consistent with this guidance as bona fide
hedging positions. The Commission recognizes that risk reducing
positions in commodity derivative contracts in excluded commodities
may not conform to the general definition of bona fide hedging
positions applicable to commodity derivative contracts in physical
commodities, as provided under section 4a(c)(2) of the Act, and may
not conform to enumerated bona fide hedging positions applicable to
commodity derivative contracts in physical commodities under the
definition of bona fide hedging position in Sec. 150.1.
This interpretative guidance for core principle 5 for designated
contract markets, section 5(d)(5) of the Act, and core principle 6
for swap execution facilities that are trading facilities, section
5h(f)(6) of the Act, is illustrative only of the types of positions
for which a trading facility may elect to provide a risk management
exemption and is not intended to be used as a mandatory checklist.
Other positions might also be included appropriately within a risk
management exemption.
(2)(a) No temporary substitute criterion. Risk management
positions in commodity derivative contracts in excluded commodities
need not be expected to represent a substitute for a subsequent
transaction or position in a physical marketing channel. There need
not be any requirement to replace a commodity derivative contract
with a cash market position in order to qualify for a risk
management exemption.
(b) Cross-commodity hedging is permitted. Risks that are offset
in commodity derivative contracts in excluded commodities need not
arise from the same commodities underlying the commodity derivative
contracts. For example, a trading facility may recognize a risk
management exemption based on the net interest rate risk arising
from a bank’s balance sheet of loans and deposits that is offset
using Treasury security futures contracts or short-term interest
rate futures contracts.
(3) Examples of risk management positions. This section contains
examples of risk management positions that may be economically
appropriate to the reduction of risk in the operation of a
commercial enterprise.
(a) Balance sheet hedging. A commercial enterprise may have
risks arising from its net position in assets and liabilities.
(i) Foreign currency translation. Once form of balance sheet
hedging involves offsetting net exposure to changes in currency
exchange rates for the purpose of stabilizing the domestic dollar
accounting value of net assets and/or liabilities which are
denominated in a foreign currency. For example, a bank may make
loans in a foreign currency and take deposits in that same foreign
currency. Such a bank is exposed to net foreign currency translation
risk when the amount of loans is not equal to the amount of
deposits. A bank with a net long exposure to a foreign currency may
hedge by establishing an offsetting short position in a foreign
currency commodity derivative contract.
(ii) Interest rate risk. Another form of balance sheet hedging
involves offsetting net exposure to changes in values of assets and
liabilities of differing durations. Examples include:
(A) A pension fund may invest in short term securities and have
longer term liabilities. Such a pension fund has a duration
mismatch. Such a pension fund may hedge by establishing a long
position in Treasury security futures contracts to lengthen the
duration of its assets to match the duration of its liabilities.
This is economically equivalent to using a long position in Treasury
security futures contracts to shorten the duration of its
liabilities to match the duration of its assets.
(B) A bank may make a certain amount of fixed-rate loans of one
maturity and fund such assets through taking fixed-rate deposits of
a shorter maturity. Such a bank is exposed to interest rate risk, in
that an increase in interest rates may result in a greater decline
in value of the assets than the decline in value of the deposit
liabilities. A bank may hedge by establishing a short position in
short-term interest rate futures contracts to lengthen the duration
of its liabilities to match the duration of its assets. This is
economically equivalent to using a short position in short-term
interest rate futures contracts, for example, to shorten the
duration of its assets to match the duration of its liabilities.
(b) Unleveraged synthetic positions. An investment fund may have
risks arising from a delayed investment in an asset allocation
promised to investors. Such a fund may synthetically gain exposure
to an asset class using a risk management strategy of establishing a
long position in commodity derivative contracts that does not exceed
cash set aside in an identifiable manner, including short-term
investments, any funds deposited as margin and accrued profits on
such commodity derivative contract positions. For example:
(i) A collective investment fund that invests funds in stocks
pursuant to an asset allocation strategy may obtain immediate stock
market exposure upon receipt of new monies by establishing a long
position in stock index futures contracts (“equitizing cash”).
Such a long position may qualify as a risk management exemption
under trading facility rules provided such long position does not
exceed the cash set aside. The long position in stock index futures
contracts need not be converted to a position in stock.
(ii) Upon receipt of new funds from investors, an insurance
company that invests in bond holdings for a separate account wishes
to lengthen synthetically the duration of the portfolio by
establishing a long position in Treasury futures contracts. Such a
long position may qualify as a risk management exemption under
trading facility rules provided such long position does not exceed
the cash set aside. The long position in Treasury futures contracts
need not be converted to a position in bonds.
(c) Temporary asset allocations. A commercial enterprise may
have risks arising from potential transactional costs in temporary
asset allocations (altering portfolio exposure to certain asset
classes such as equity securities and debt securities). Such an
enterprise may hedge existing assets owned by establishing a short
position in an appropriate commodity derivative contract and
synthetically gain exposure to an alternative asset class using a
risk management strategy of establishing a long position in another
commodity derivative contract that does not exceed: the value of the
existing asset at the time the temporary asset allocation is
established or, in the alternative, the hedged value of the existing
asset plus any accrued profits on such risk management positions.
For example:
(i) A collective investment fund that invests funds in bonds and
stocks pursuant to an asset allocation strategy may believe that
market considerations favor a temporary increase in the fund’s
equity exposure relative to its bond holdings. The fund manager may
choose to accomplish the reallocation using commodity derivative
contracts, such as a short position in Treasury security futures
contracts and a long position in stock index futures contracts. The
short position in Treasury security futures contracts may qualify as
a hedge of interest rate risk arising from the bond holdings. A
trading facility may adopt rules to recognize as a risk management
exemption such a long position in stock index futures.
(ii) Reserved.
(4) Clarification of bona fides of short positions.
(a) Calls sold. A seller of a call option establishes a short
call option. A short call option is a short position in a commodity
derivative contract with respect to the underlying commodity. A bona
fide hedging position includes such a written call option that does
not exceed in quantity the ownership or fixed-price purchase
contracts in the contract’s underlying cash commodity by the same
person.
(b) Puts purchased and portfolio insurance. A buyer of a put
option establishes a long put option. However, a long put option is
a short position in a commodity derivative contract with respect to
the underlying commodity. A bona fide hedging position includes such
an owned put that does not exceed in quantity the ownership or
fixed-price purchase contracts in the contract’s underlying cash
commodity by the same person.
The Commission also recognizes as bona fide hedging positions
strategies that provide protection against a price decline
equivalent to an owned position in a put option for an existing
portfolio of securities owned. A dynamically managed short position
in a futures contract may replicate the characteristics of a long
position in a put option. Hedgers are reminded of their obligation
to enter and exit the market in an orderly manner.
[[Page 75834]]
(c) Synthetic short futures contracts. A person may establish a
synthetic short futures position by purchasing a put option and
selling a call option, when each option has the same notional
amount, strike price, expiration date and underlying commodity. Such
a synthetic short futures position is a short position in a
commodity derivative contract with respect to the underlying
commodity. A bona fide hedging position includes such a synthetic
short futures position that does not exceed in quantity the
ownership or fixed-price purchase contracts in the contract’s
underlying cash commodity by the same person.
0
30. Add appendix B to part 150 to read as follows:
Appendix B to Part 150–Commodities Listed as Substantially the Same
for Purposes of the Definition of Basis Contract
The following table lists core referenced futures contracts and
commodities that are treated as substantially the same as a
commodity underlying a core referenced futures contract for purposes
of the definition of basis contract in Sec. 150.1.
Basis Contract List of Substantially the Same Commodities
————————————————————————
Commodities
considered Source(s) for
Core referenced futures substantially the specification of
contract same (regardless of quality
location)
————————————————————————
NYMEX Light Sweet Crude Oil ………………..
futures contract (CL).
1. Light Louisiana NYMEX Argus LLS vs.
Sweet (LLS) Crude WTI (Argus) Trade
Oil. Month futures
contract (E5).
NYMEX LLS (Argus)
vs. WTI Financial
futures contract
(WJ).
ICE Futures Europe
Crude Diff–Argus
LLS vs WTI 1st Line
Swap futures
contract (ARK).
ICE Futures Europe
Crude Diff–Argus
LLS vs WTI Trade
Month Swap futures
contract (ARL).
NYMEX New York Harbor ULSD
Heating Oil futures
contract (HO).
1. Chicago ULSD….. NYMEX Chicago ULSD
(Platts) vs. NY
Harbor ULSD Heating
Oil futures
contract (5C).
2. Gulf Coast ULSD.. NYMEX Group Three
ULSD (Platts) vs.
NY Harbor ULSD
Heating Oil futures
contract (A6).
NYMEX Gulf Coast
ULSD (Argus) Up-
Down futures
contract (US).
NYMEX Gulf Coast
ULSD (Argus) Up-
Down BALMO futures
contract (GUD).
NYMEX Gulf Coast
ULSD (Platts) Up-
Down BALMO futures
contract (1L).
NYMEX Gulf Coast
ULSD (Platts) Up-
Down Spread futures
contract (LT).
ICE Futures Europe
Diesel Diff- Gulf
Coast vs Heating
Oil 1st Line Swap
futures contract
(GOH).
CME Clearing Europe
Gulf Coast ULSD(
Platts) vs. New
York Heating Oil
(NYMEX) Spread
Calendar swap
(ELT).
CME Clearing Europe
New York Heating
Oil (NYMEX) vs.
European Gasoil
(IC) Spread
Calendar swap
(EHA).
3. California Air NYMEX Los Angeles
Resources Board CARB Diesel (OPIS)
Spec ULSD (CARB no. vs. NY Harbor ULSD
2 oil). Heating Oil futures
contract (KL).
4. Gas Oil ICE Futures Europe
Deliverable in Gasoil futures
Antwerp, Rotterdam, contract (G).
or Amsterdam Area.
ICE Futures Europe
Heating Oil Arb–
Heating Oil 1st
Line vs. Gasoil 1st
Line Swap futures
contract (HOT).
ICE Futures Europe
Heating Oil Arb–
Heating Oil 1st
Line vs. Low
Sulphur Gasoil 1st
Line Swap futures
contract (ULL).
NYMEX NY Harbor ULSD
Heating Oil vs.
Gasoil futures
contract (HA).
NYMEX RBOB Gasoline futures ………………..
contract (RB).
1. Chicago Unleaded ………………..
87 gasoline.
NYMEX Chicago
Unleaded Gasoline
(Platts) vs. RBOB
Gasoline futures
contract (3C).
NYMEX Group Three
Unleaded Gasoline
(Platts) vs. RBOB
Gasoline futures
contract (A8).
2. Gulf Coast ………………..
Conventional
Blendstock for
Oxygenated Blending
(CBOB) 87.
NYMEX Gulf Coast
CBOB Gasoline A1
(Platts) vs. RBOB
Gasoline futures
contract (CBA).
NYMEX Gulf Coast Unl
87 (Argus) Up-Down
futures contract
(UZ).
3. Gulf Coast CBOB ………………..
87 (Summer
Assessment).
[[Page 75835]]
NYMEX Gulf Coast
CBOB Gasoline A2
(Platts) vs. RBOB
Gasoline futures
contract (CRB).
4. Gulf Coast ………………..
Unleaded 87 (Summer
Assessment).
NYMEX Gulf Coast 87
Gasoline M2
(Platts) vs. RBOB
Gasoline futures
contract (RVG).
NYMEX Gulf Coast 87
Gasoline M2
(Platts) vs. RBOB
Gasoline BALMO
futures contract
(GBB).
NYMEX Gulf Coast 87
Gasoline M2 (Argus)
vs. RBOB Gasoline
BALMO futures
contract (RBG).
5. Gulf Coast ………………..
Unleaded 87.
NYMEX Gulf Coast Unl
87 (Platts) Up-Down
BALMO futures
contract (1K).
NYMEX Gulf Coast Unl
87 Gasoline M1
(Platts) vs. RBOB
Gasoline futures
contract (RV).
CME Clearing Europe
Gulf Coast Unleaded
87 Gasoline M1
(Platts) vs. New
York RBOB Gasoline
(NYMEX) Spread
Calendar swap
(ERV).
6. Los Angeles ………………..
California
Reformulated
Blendstock for
Oxygenate Blending
(CARBOB) Regular.
NYMEX Los Angeles
CARBOB Gasoline
(OPIS) vs. RBOB
Gasoline futures
contract (JL).
7. Los Angeles ………………..
California
Reformulated
Blendstock for
Oxygenate Blending
(CARBOB) Premium.
NYMEX Los Angeles
CARBOB Gasoline
(OPIS) vs. RBOB
Gasoline futures
contract (JL).
8. Euro-BOB OXY NWE ………………..
Barges.
NYMEX RBOB Gasoline
vs. Euro-bob Oxy
NWE Barges (Argus)
(1000mt) futures
contract (EXR).
CME Clearing Europe
New York RBOB
Gasoline (NYMEX)
vs. European
Gasoline Euro-bob
Oxy Barges NWE
(Argus) (1000mt)
Spread Calendar
swap (EEXR).
9. Euro-BOB OXY FOB ………………..
Rotterdam.
ICE Futures Europe
Gasoline Diff–RBOB
Gasoline 1st Line
vs. Argus Euro-BOB
OXY FOB Rotterdam
Barge Swap futures
contract (ROE).
————————————————————————
0
31. Add appendix C to part 150 to read as follows:
Appendix C to Part 150–Examples of Bona Fide Hedging Positions for
Physical Commodities
A non-exhaustive list of examples meeting the definition of bona
fide hedging position under Sec. 150.1 is presented below. With
respect to a position that does not fall within an example in this
appendix, a person seeking to rely on a bona fide hedging position
exemption under Sec. 150.3 may seek guidance from the Division of
Market Oversight. References to paragraphs in the examples below are
to the definition of bona fide hedging position in Sec. 150.1.
1. Portfolio Hedge Under Paragraph (3)(i) of the Bona Fide Hedging
Position Definition
Fact Pattern: It is currently January and Participant A owns
seven million bushels of corn located in its warehouses. Participant
A has entered into fixed-price forward sale contracts with several
processors for a total of five million bushels of corn that will be
delivered by May of this year. Participant A has no fixed-price corn
purchase contracts. Participant A’s gross long cash position is
equal to seven million bushels of corn. Because Participant A has
sold forward five million bushels of corn, its net cash position is
equal to long two million bushels of corn. To reduce price risk
associated with potentially lower corn prices, Participant A chooses
to establish a short position of 400 contracts in the CBOT Corn
futures contract, equivalent to two million bushels of corn, in the
same crop year as the inventory.
Analysis: The short position in a contract month in the current
crop year for the CBOT Corn futures contract, equivalent to the
amount of inventory held, satisfies the general requirements for a
bona fide hedging position under paragraphs (2)(i)(A)-(C) and the
provisions associated with owning a commodity under paragraph
(3)(i).1 Because the firm’s net cash position is two million
bushels of unsold corn, the firm is exposed to price risk.
Participant A’s hedge of the two million bushels represents a
substitute for a fixed-price forward sale at a later time in the
physical marketing channel. The position is economically appropriate
to the reduction of price risk because the short position in a
referenced contract does not exceed the quantity equivalent risk
exposure (on a net basis) in the cash commodity in the current crop
year. Last, the hedge arises from a potential change in the value of
corn owned by Participant A.
—————————————————————————
1 Participant A could also choose to hedge on a gross basis.
In that event, Participant A could establish a short position in the
March Chicago Board of Trade Corn futures contract equivalent to
seven million bushels of corn to offset the price risk of its
inventory and establish a long position in the May Chicago Board of
Trade Corn futures contract equivalent to five million bushels of
corn to offset the price risk of its fixed-price forward sale
contracts.
—————————————————————————
2. Lending a Commodity and Hedge of Price Risk Under Paragraph (3)(i)
of the Bona Fide Hedging Position Definition
Fact Pattern: Bank B owns 1,000 ounces of gold that it lends to
Jewelry Fabricator J at LIBOR plus a differential. Under the terms
of the loan, Jewelry Fabricator J may later purchase the gold from
Bank B at a differential to the prevailing price of the Commodity
Exchange, Inc. (COMEX) Gold futures contract (i.e., an open-price
purchase agreement is embedded in the terms of the loan). Jewelry
Fabricator J intends to use the gold to make jewelry and reimburse
Bank B for the loan using the proceeds from jewelry sales and either
purchase gold from Bank B by paying the market price for gold or
return the equivalent amount of gold to Bank B by purchasing gold at
the market price. Because Bank B has retained the price risk on
gold, the bank is concerned about its potential loss if the price of
gold drops. The bank reduces the risk of a potential loss in the
value of the gold by establishing a ten contract short
[[Page 75836]]
position in the COMEX Gold futures contract, which has a unit of
trading of 100 ounces of gold. The ten contract short position is
equivalent to 1,000 ounces of gold.
Analysis: This position meets the general requirements for bona
fide hedging positions under paragraphs (2)(i)(A)-(C) and the
requirements associated with owning a cash commodity under paragraph
(3)(i). The physical commodity that is being hedged is the
underlying cash commodity for the COMEX Gold futures contract. Bank
B’s short hedge of the gold represents a substitute for a
transaction to be made in the physical marketing channel (e.g.,
completion of the open-price sale to Jewelry Fabricator J). Because
the notional quantity of the short position in the gold futures
contract is equal to the amount of gold that Bank B owns, the hedge
is economically appropriate to the reduction of risk. Finally, the
short position in the commodity derivative contract offsets the
potential change in the value of the gold owned by Bank B.
3. Repurchase Agreements and Hedge of Inventory Under Paragraph (3)(i)
of the Bona Fide Hedging Position Definition
Fact Pattern: Elevator A purchased 500,000 bushels of wheat in
April and reduced its price risk by establishing a short position of
100 contracts in the CBOT Wheat futures contract, equivalent to
500,000 bushels of wheat. Because the price of wheat rose steadily
since April, Elevator A had to make substantial maintenance margin
payments. To alleviate its cash flow concern about meeting further
margin calls, Elevator A decides to enter into a repurchase
agreement with Bank B and offset its short position in the wheat
futures contract. The repurchase agreement involves two separate
contracts: A fixed-price sale from Elevator A to Bank B at today’s
spot price; and an open-price purchase agreement that will allow
Elevator A to repurchase the wheat from Bank B at the prevailing
spot price three months from now. Because Bank B obtains title to
the wheat under the fixed-price purchase agreement, it is exposed to
price risk should the price of wheat drop. Bank B establishes a
short position of 100 contracts in the CBOT Wheat futures contract,
equivalent to 500,000 bushels of wheat.
Analysis: Bank B’s position meets the general requirements for a
bona fide hedging position under paragraphs (2)(i)(A)-(C) and the
provisions for owning the cash commodity under paragraph (3)(i). The
short position in referenced contracts by Bank B is a substitute for
a fixed-price sales transaction to be taken at a later time in the
physical marketing channel either to Elevator A or to another
commercial party. The position is economically appropriate to the
reduction of risk in the conduct and management of the commercial
enterprise (Bank B) because the notional quantity of the short
position in referenced contracts held by Bank B is not larger than
the quantity of cash wheat purchased by Bank B. Finally, the short
position in the CBOT Wheat futures contract reduces the price risk
associated with owning cash wheat.
4. Utility Hedge of Anticipated Customer Requirements Under Paragraph
(3)(iii)(B) of the Bona Fide Hedging Position Definition
Fact Pattern: Natural Gas Utility A is encouraged to hedge its
purchases of natural gas by the State Public Utility Commission in
order to reduce natural gas price risk to residential customers.
State Public Utility Commission considers the hedging practice to be
prudent and allows gains and losses from hedging to be passed on to
Natural Gas Utility A’s regulated natural gas customers. Natural Gas
Utility A has about one million residential customers who have
average historical usage of about 71.5 mmBTUs of natural gas per
year per residence. The utility decides to hedge about 70 percent of
its residential customers’ anticipated requirements for the
following year, equivalent to a 5,000 contract long position in the
NYMEX Henry Hub Natural Gas futures contract. To reduce the risk of
higher prices to residential customers, Natural Gas Utility A
establishes a 5,000 contract long position in the NYMEX Henry Hub
Natural Gas futures contract. Since the utility is only hedging 70
percent of historical usage, Natural Gas Utility A is highly certain
that realized demand will exceed its hedged anticipated residential
customer requirements.
Analysis: Natural Gas Utility A’s position meets the general
requirements for a bona fide hedging position under paragraphs
(2)(i)(A)-(C) and the provisions for hedges of unfilled anticipated
requirements by a utility under paragraph (3)(iii)(B). The physical
commodity that is being hedged involves a commodity underlying the
NYMEX Henry Hub Natural Gas futures contract. The long position in
the commodity derivative contract represents a substitute for
transactions to be taken at a later time in the physical marketing
channel. The position is economically appropriate to the reduction
of price risk because the price of natural gas may increase. The
commodity derivative contract position offsets the price risk of
natural gas that the utility anticipates purchasing on behalf of its
residential customers. As provided under paragraph (3)(iii), the
risk-reducing position qualifies as a bona fide hedging position in
the natural gas physical-delivery referenced contract during the
spot month provided that the position does not exceed the unfilled
anticipated requirements for that month and for the next succeeding
month.
5. Processor Margins Hedge Using Unfilled Anticipated Requirements
Under Paragraph (3)(iii)(A) of the Bona Fide Hedging Position
Definition and Anticipated Production Under Paragraph (4)(i) of the
Definition
Fact Pattern: Soybean Processor A has a total throughput
capacity of 200 million bushels of soybeans per year (equivalent to
40,000 CBOT soybean futures contracts). Soybean Processor A crushes
soybeans into products (soybean oil and soybean meal). It currently
has 40 million bushels of soybeans in storage and has offset that
risk through fixed-price forward sales of the amount of products
expected to be produced from crushing 40 million bushels of
soybeans, thus locking in its processor margin on one million metric
tons of soybeans. Because it has consistently operated its plants at
full capacity over the last three years, it anticipates purchasing
another 160 million bushels of soybeans to be delivered to its
storage facility over the next year. It has not sold the 160 million
bushels of anticipated production of crushed products forward.
Processor A faces the risk that the difference in price
relationships between soybeans and the crushed products (i.e., the
crush spread) could change adversely, resulting in reduced
anticipated processing margins. To hedge its processing margins and
lock in the crush spread, Processor A establishes a long position of
32,000 contracts in the CBOT Soybean futures contract (equivalent to
160 million bushels of soybeans) and corresponding short positions
in CBOT Soybean Meal and Soybean Oil futures contracts, such that
the total notional quantity of soybean meal and soybean meal futures
contracts are equivalent to the expected production from crushing
160 million bushels of soybeans into soybean meal and soybean oil.
Analysis: These positions meet the general requirements for bona
fide hedging positions under paragraphs (2)(i)(A)-(C) and the
provisions for hedges of unfilled anticipated requirements under
paragraph (3)(iii)(A) and unsold anticipated production under
paragraph (4)(i). The physical commodities being hedged are
commodities underlying the CBOT Soybean, Soybean Meal, and Soybean
Oil futures contracts. Long positions in the soybean futures
contract and corresponding short positions in soybean meal and
soybean oil futures contracts qualify as bona fide hedging positions
provided they do not exceed the unfilled anticipated requirements of
the cash commodity for twelve months (in this case 4 million tons)
as required in paragraph (3)(iii)(A) and the quantity equivalent of
twelve months unsold anticipated production of cash products and by-
products as required in paragraph (4)(i). Such positions are a
substitute for purchases and sales to be made at a later time in the
physical marketing channel and are economically appropriate to the
reduction of risk. The positions in referenced contracts offset the
potential change in the value of soybeans that the processor
anticipates purchasing and the potential change in the value of
products and by-products the processor anticipates producing and
selling. The size of the permissible long hedge position in the
soybean futures contract must be reduced by any inventories and
fixed-price purchases because they would reduce the processor’s
unfilled requirements. Similarly, the size of the permissible short
hedge positions in soybean meal and soybean oil futures contracts
must be reduced by any fixed-price sales because they would reduce
the processor’s unsold anticipated production. As provided under
paragraph (3)(iii)(A), the risk reducing long position in the
soybean futures contract that is not in excess of the anticipated
requirements for soybeans for that month and the next succeeding
month qualifies as a bona fide hedging position during the last five
days of trading in the physical-delivery referenced
[[Page 75837]]
contract. As provided under paragraph (4)(i), the risk reducing
short position in the soybean meal and oil futures contract do not
qualify as a bona fide hedging position in a physical-delivery
referenced contract during the last five days of trading in the
event the Soybean Processor A does not have unsold products in
inventory.
The combination of the long and short positions in soybean,
soybean meal, and soybean oil futures contracts are economically
appropriate to the reduction of risk. However, unlike in this
example, an unpaired position (e.g., only a long position in a
commodity derivative contract) that is not offset by either a cash
market position (e.g., a fixed-price sales contract) or derivative
position (e.g., a short position in a commodity derivative contract)
would not represent an economically appropriate reduction of risk.
This is because the commercial enterprise’s crush spread risk is
relatively low in comparison to the price risk from taking an
outright long position in the futures contract in the underlying
commodity or an outright short position in the futures contracts in
the products and by-products of processing. The price fluctuations
of the crush spread, that is, the risk faced by the commercial
enterprise, would not be expected to be substantially related to the
price fluctuations of either an outright long or outright short
futures position.
6. Agent Hedge Under Paragraph (3)(iv) of the Bona Fide Hedging
Position Definition
Fact Pattern: Agent A is in the business of merchandising
(selling) the cash grain owned by multiple warehouse operators and
forwarding the merchandising revenues back to the warehouse
operators less the agent’s fees. Agent A does not own any cash
commodity, but is responsible for merchandising of the cash grain
positions of the warehouse operators pursuant to contractual
arrangements. The contractual arrangements also authorize Agent A to
hedge the price risks of the grain owned by the warehouse operators.
For the volumes of grain it is authorized to hedge, the agent enters
into short positions in grain commodity derivative contracts that
offset the price risks of the cash commodities.
Analysis: The positions meet the requirements of paragraphs
(2)(1)(A)-(C) for hedges of a physical commodity and paragraph
(3)(iv) for hedges by an agent. The positions represent a substitute
for transactions to be made in the physical marketing channel, are
economically appropriate to the reduction of risks arising from
grain owned by the agent’s contractual counterparties, and arise
from the potential change in the value of such grain. The agent does
not own and has not contacted to purchase such grain at a fixed
price, but is responsible for merchandising the cash positions that
are being offset in commodity derivative contracts. The agent has a
contractual arrangement with the persons who own the grain being
offset.
7. Sovereign Hedge of Unsold Anticipated Production Under Paragraph
(4)(i) of the Bona Fide Hedging Position Definition and Position
Aggregation Under Sec. 150.4
Fact Pattern: A Sovereign induces a farmer to sell his
anticipated production of 100,000 bushels of corn forward to User A
at a fixed price for delivery during the expected harvest. In return
for the farmer entering into the fixed-price forward sale, the
Sovereign agrees to pay the farmer the difference between the market
price at the time of harvest and the price of the fixed-price
forward, in the event that the market price at the time of harvest
is above the price of the forward. The fixed-price forward sale of
100,000 bushels of corn reduces the farmer’s downside price risk
associated with his anticipated agricultural production. The
Sovereign faces commodity price risk as it stands ready to pay the
farmer the difference between the market price and the price of the
fixed-price contract. To reduce that risk, the Sovereign establishes
a long position of 20 call options on the Chicago Board of Trade
(CBOT) Corn futures contract, equivalent to 100,000 bushels of corn.
Analysis: Because the Sovereign and the farmer are acting
together pursuant to an express agreement, the aggregation
provisions of Sec. 150.4 apply and they are treated as a single
person for purposes of position limits. Taking the positions of the
Sovereign and farmer jointly, the risk profile of the combination of
the forward sale and the long call is approximately equivalent to
the risk profile of a synthetic long put.2 A synthetic long put
offsets the downside price risk of anticipated production. Thus, the
position of that person satisfies the general requirements for a
bona fide hedging position under paragraphs (2)(i)(A)-(C) and meets
the requirements for anticipated agricultural production under
paragraph (4)(i). The agreement between the Sovereign and the farmer
involves the production of a commodity underlying the CBOT Corn
futures contract. The synthetic long put is a substitute for
transactions that the farmer has made in the physical marketing
channel. The synthetic long put reduces the price risk associated
with anticipated agricultural production. The size of the
Sovereign’s position is equivalent to the size of the farmer’s
anticipated production. As provided under paragraph (4), the
Sovereign’s risk-reducing position would not qualify as a bona fide
hedging position in a physical-delivery futures contract during the
last five days of trading; however, since the CBOT Corn option will
exercise into a physical-delivery CBOT Corn futures contract prior
to the last five days of trading in that physical-delivery futures
contract, the Sovereign may continue to hold its option position as
a bona fide hedging position through option expiry.
—————————————————————————
2 Put-call parity describes the mathematical relationship
between price of a put and call with identical strike prices and
expiry.
—————————————————————————
8. Hedge of Offsetting Unfixed Price Sales and Purchases Under
Paragraph (4)(ii) of the Bona Fide Hedging Position Definition
Fact Pattern: Currently it is October and Oil Merchandiser A has
entered into cash forward contracts to purchase 600,000 of crude oil
at a floating price that references the January contract month (in
the next calendar year) for the ICE Futures Brent Crude futures
contract and to sell 600,000 barrels of crude oil at a price that
references the February contract month (in the next calendar year)
for the NYMEX Light Sweet Crude Oil futures contract. Oil
Merchandiser A is concerned about an adverse change in the price
spread between the January ICE Futures Brent Crude futures contract
and the February NYMEX Light Sweet Crude Oil futures contract. To
reduce that risk, Oil Merchandiser A establishes a long position of
600 contracts in the January ICE Futures Brent Crude futures
contract, price risk equivalent to buying 600,000 barrels of oil,
and a short position of 600 contracts in the February NYMEX Light
Sweet Crude Oil futures contract, price risk equivalent to selling
600,000 barrels of oil.
Analysis: Oil Merchandiser A’s positions meet the general
requirements for bona fide hedging positions under paragraphs
(2)(i)(A)-(C) and the provisions for offsetting sales and purchases
in referenced contracts under paragraph (4)(ii). The physical
commodity that is being hedged involves a commodity underlying the
NYMEX Light Sweet Crude Oil futures contract. The long and short
positions in commodity derivative contracts represent substitutes
for transactions to be taken at a later time in the physical
marketing channel. The positions are economically appropriate to the
reduction of risk because the price spread between the ICE Futures
Brent Crude futures contract and the NYMEX Light Sweet Crude Oil
futures contract could move adversely to Oil Merchandiser A’s
interests in the two cash forward contracts, that is, the price of
the ICE Futures Brent Crude futures contract could increase relative
to the price of the NYMEX Light Sweet Crude Oil futures contract.
The positions in commodity derivative contracts offset the price
risk in the cash forward contracts. As provided under paragraph (4),
the risk-reducing position does not qualify as a bona fide hedging
position in the crude oil physical-delivery referenced contract
during the spot month.
9. Anticipated Royalties Hedge Under Paragraph (4)(iii) of the Bona
Fide Hedging Position Definition and Pass-Through Swaps Hedge Under
Paragraph (2)(ii) of the Definition
a. Fact Pattern: In order to develop an oil field, Company A
approaches Bank B for financing. To facilitate the loan, Bank B
first establishes an independent legal entity commonly known as a
special purpose vehicle (SPV). Bank B then provides a loan to the
SPV. The SPV is obligated to repay principal and interest to the
Bank based on a fixed price for crude oil. The SPV in turn makes a
production loan to Company A. The terms of the production loan
require Company A to provide the SPV with volumetric production
payments (VPPs) based on a specified share of the production to be
sold at the prevailing price of crude oil (i.e., the index price) as
oil is produced. Because the price of crude oil may fall, the SPV
reduces that risk by entering into a
[[Page 75838]]
crude oil swap with Swap Dealer C. The swap requires the SPV to pay
Swap Dealer C the floating price of crude oil (i.e., the index
price) and for Swap Dealer C to pay a fixed price to the SPV. The
notional quantity for the swap is equal to the expected production
underlying the VPPs to the SPV. The SPV will receive a floating
price at index on the VPP and will pay a floating price at index on
the swap, which will offset. The SPV will receive a fixed price
payment on the swap and repay the loan’s principal and interest to
Bank B. The SPV is highly certain that the VPP production volume
will occur, since the SPV’s engineer has reviewed the forecasted
production from Company A and required the VPP volume to be set with
a cushion (i.e., a hair-cut) below the forecasted production.
Analysis: For the SPV, the swap between Swap Dealer C and the
SPV meets the general requirements for a bona fide hedging position
under paragraphs (2)(i)(A)-(C) and the requirements for anticipated
royalties under paragraph (4)(iii). The SPV will receive payments
under the VPP royalty contract based on the unfixed price sale of
anticipated production of the physical commodity underlying the
royalty contract, i.e., crude oil. The swap represents a substitute
for the price of sales transactions to be made in the physical
marketing channel. The SPV’s swap position qualifies as a hedge
because it is economically appropriate to the reduction of price
risk. The swap reduces the price risk associated with a change in
value of a royalty asset. The fluctuations in value of the SPV’s
anticipated royalties are substantially related to the fluctuations
in value of the crude oil swap with Swap Dealer C.
b. Continuation of Fact Pattern: Swap Dealer C offsets the price
risk associated with the swap to the SPV by establishing a short
position in cash-settled crude oil futures contracts. The notional
quantity of the short position in futures contracts held by Swap
Dealer C exactly matches the notional quantity of the swap with the
SPV.
Analysis: For the swap dealer, because the SPV enters the cash-
settled swap as a bona fide hedger under paragraph (4)(iii) (i.e., a
pass-through swap counterparty), the offset of the risk of the swap
in a futures contract by Swap Dealer C qualifies as a bona fide
hedging position (i.e., a pass-through swap offset) under paragraph
(2)(ii)(A). Since the swap was executed opposite a pass-through swap
counterparty and was offset, the swap itself also qualifies as a
bona fide hedging position (i.e., a pass-through swap) under
paragraph (2)(ii)(B). If the cash-settled swap is not a referenced
contract, then the pass-through swap offset may qualify as a cross-
commodity hedge under paragraph (5), provided the fluctuations in
value of the pass-through swap offset are substantially related to
the fluctuations in value of the pass-through swap.
10. Anticipated Royalties Hedge Under Paragraph (4)(iii) of the Bona
Fide Hedging Position Definition and Cross-Commodity Hedge Under
Paragraph (5) of the Definition
Fact Pattern: An eligible contract participant (ECP) owns
royalty interests in a portfolio of oil wells. Royalties are paid at
the prevailing (floating) market price for the commodities produced
and sold at major trading hubs, less transportation and gathering
charges. The large portfolio and well-established production history
for most of the oil wells provide a highly certain production stream
for the next 24 months. The ECP also determined that changes in the
cash market prices of 50 percent of the oil production underlying
the portfolio of royalty interests historically have been closely
correlated with changes in the calendar month average of daily
settlement prices of the nearby NYMEX Light Sweet Crude Oil futures
contract. The ECP decided to hedge some of the royalty price risk by
entering into a cash-settled swap with a term of 24 months. Under
terms of the swap, the ECP will receive a fixed payment and make
monthly payments based on the calendar month average of daily
settlement prices of the nearby NYMEX Light Sweet Crude Oil futures
contract and notional amounts equal to 50 percent of the expected
production volume of oil underlying the royalties.
Analysis: This position meets the requirements of paragraphs
(2)(i)(A)-(C) for hedges of a physical commodity, paragraph (4)(iii)
for hedges of anticipated royalties, and paragraph (5) for cross-
commodity hedges. The long position in the commodity derivative
contract represents a substitute for transactions to be taken at a
later time in the physical marketing channel. The position is
economically appropriate to the reduction of price risk because the
price of oil may decrease. The commodity derivative contract
position offsets the price risk of royalty payments, based on oil
production, that the ECP anticipates receiving. The ECP is exposed
to price risk arising from the anticipated production volume of oil
attributable to her royalty interests. The physical commodity
underlying the royalty portfolio that is being hedged involves a
commodity with fluctuations in value that are substantially related
to the fluctuations in value of the swap.
11. Hedges of Services Under Paragraph (4)(iv) of the Bona Fide Hedging
Position Definition
a. Fact Pattern: Company A enters into a risk service agreement
to drill an oil well with Company B. The risk service agreement
provides that a portion of the revenue receipts to Company A depends
on the value of the light sweet crude oil produced. Company A is
exposed to the risk that the price of oil may fall, resulting in
lower anticipated revenues from the risk service agreement. To
reduce that risk, Company A establishes a short position in the New
York Mercantile Exchange (NYMEX) Light Sweet Crude Oil futures
contract, in a notional amount equivalent to the firm’s anticipated
share of the expected quantity of oil to be produced. Company A is
highly certain of its anticipated share of the expected quantity of
oil to be produced.
Analysis: Company A’s hedge of a portion of its revenue stream
from the risk service agreement meets the general requirements for
bona fide hedging positions under paragraphs (2)(i)(A)-(C) and the
provisions for services under paragraph (4)(iv). The contract for
services involves the production of a commodity underlying the NYMEX
Light Sweet Crude Oil futures contract. A short position in the
NYMEX Light Sweet Crude Oil futures contract is a substitute for
transactions to be taken at a later time in the physical marketing
channel, with the value of the revenue receipts to Company A
dependent on the price of the oil sales in the physical marketing
channel. The short position in the futures contract held by Company
A is economically appropriate to the reduction of risk, because the
total notional quantity underlying the short position in the futures
contract held by Company A is equivalent to its share of the
expected quantity of future production under the risk service
agreement. Because the price of oil may fall, the short position in
the futures contract reduces price risk from a potential reduction
in the payments to Company A under the service contract with Company
B. Under paragraph (4)(iv), the risk-reducing position will not
qualify as a bona fide hedging position during the spot month of the
physical-delivery oil futures contract.
b. Fact Pattern: A City contracts with Firm A to provide waste
management services. The contract requires that the trucks used to
transport the solid waste use natural gas as a power source.
According to the contract, the City will pay for the cost of the
natural gas used to transport the solid waste by Firm A. In the
event that natural gas prices rise, the City’s waste transport
expenses will increase. To mitigate this risk, the City establishes
a long position in the NYMEX Henry Hub Natural Gas futures contract
in an amount equivalent to the expected volume of natural gas to be
used over the life of the service contract.
Analysis: This position meets the general requirements for bona
fide hedging positions under paragraphs (2)(i)(A)-(C) and the
provisions for services under paragraph (4)(iv). The contract for
services involves the use of a commodity underlying the NYMEX Henry
Hub Natural Gas futures contract. Because the City is responsible
for paying the cash price for the natural gas used under the
services contract, the long hedge is a substitute for transactions
to be taken at a later time in the physical marketing channel. The
position is economically appropriate to the reduction of price risk
because the total notional quantity of the long position in a
commodity derivative contract equals the expected volume of natural
gas to be used over the life of the contract. The position in the
commodity derivative contract reduces the price risk associated with
an increase in anticipated costs that the City may incur under the
services contract in the event that the price of natural gas
increases. As provided under paragraph (4), the risk reducing
position will not qualify as a bona fide hedge during the spot month
of the physical-delivery futures contract.
12. Cross-Commodity Hedge Under Paragraph (5) of the Bona Fide Hedging
Position Definition and Inventory Hedge Under Paragraph (3)(i) of the
Definition
Fact Pattern: Copper Wire Fabricator A is concerned about
possible reductions in the
[[Page 75839]]
price of copper. Currently it is November and it owns inventory of
100 million pounds of copper and five million pounds of finished
copper wire. Currently, deferred futures prices are lower than the
nearby futures price. Copper Wire Fabricator A expects to sell 150
million pounds of finished copper wire in February of the following
year. To reduce its price risk, Copper Wire Fabricator A establishes
a short position of 6000 contracts in the February COMEX Copper
futures contract, equivalent to selling 150 million pounds of
copper. The fluctuations in value of copper wire are expected to be
substantially related to fluctuations in value of copper.
Analysis: The Copper Wire Fabricator A’s position meets the
general requirements for a bona fide hedging position under
paragraphs (2)(i)(A)-(C) and the provisions for owning a commodity
under paragraph (3)(i) and for a cross-hedge of the finished copper
wire under paragraph (5). The short position in a referenced
contract represents a substitute for transactions to be taken at a
later time in the physical marketing channel. The short position is
economically appropriate to the reduction of price risk in the
conduct and management of the commercial enterprise because the
price of copper could drop. The short position in the referenced
contract offsets the risk of a possible reduction in the value of
the inventory that it owns. Since the finished copper wire is a
product of copper that is not deliverable on the commodity
derivative contract, 200 contracts of the short position are a
cross-commodity hedge of the finished copper wire and 400 contracts
of the short position are a hedge of the copper inventory.
13. Cross-Commodity Hedge Under Paragraph (5) of the Bona Fide Hedging
Position Definition and Anticipated Requirements Hedge Under Paragraph
(3)(iii)(A) of the Definition
Fact Pattern: Airline A anticipates using a predictable volume
of jet fuel every month based on scheduled flights and decides to
hedge 80 percent of that volume for each of the next 12 months.
After a review of various commodity derivative contract hedging
strategies, Airline A decides to cross hedge its anticipated jet
fuel requirements in ultra-low sulfur diesel (ULSD) commodity
derivative contracts. Airline A determined that price fluctuations
in its average cost for jet fuel were substantially related to the
price fluctuations of the calendar month average of the first nearby
physical-delivery NYMEX New York Harbor ULSD Heating Oil (HO)
futures contract and determined an appropriate hedge ratio, based on
a regression analysis, of the HO futures contract to the quantity
equivalent amount of its anticipated requirements. Airline A decided
that it would use the HO futures contract to cross hedge part of its
jet fuel price risk. In addition, Airline A decided to protect
against jet fuel price increases by cross hedging another part of
its anticipated jet fuel requirements with a long position in cash-
settled calls in the NYMEX Heating Oil Average Price Option (AT)
contract. The AT call option is settled based on the price of the HO
futures contract. The sum of the notional amounts of the long
position in AT call options and the long position in the HO futures
contract will not exceed the quantity equivalent of 80 percent of
Airline A’s anticipated requirements for jet fuel.
Analysis: The positions meet the requirements of paragraphs
(2)(i)(A)-(C) for hedges of a physical commodity, paragraph
(3)(iii)(A) for unfilled anticipated requirements and paragraph (5)
for cross-commodity hedges. The positions represent a substitute for
transactions to be made in the physical marketing channel, are
economically appropriate to the reduction of risks arising from
anticipated requirements for jet fuel, and arise from the potential
change in the value of such jet fuel. The aggregation notional
amount of the airline’s positions in the call option and the futures
contract does not exceed the quantity equivalent of anticipated
requirements for jet fuel. The value fluctuations in jet fuel are
substantially related to the value fluctuations in the HO futures
contract.
Airline A may hold its long position in the cash-settled AT call
option contract as a cross hedge against jet fuel price risk without
having to exit the contract during the spot month.
14. Position Aggregation Under Sec. 150.4 and Inventory Hedge Under
Paragraph (3)(i) of the Bona Fide Hedging Position Definition
Fact Pattern: Company A owns 100 percent of Company B. Company B
buys and sells a variety of agricultural products, including wheat.
Company B currently owns five million bushels of wheat. To reduce
some of its price risk, Company B establishes a short position of
600 contracts in the CBOT Wheat futures contract, equivalent to
three million bushels of wheat. After communicating with Company B,
Company A establishes an additional short position of 400 CBOT Wheat
futures contracts, equivalent to two million bushels of wheat.
Analysis: The aggregate short position in the wheat referenced
contract held by Company A and Company B meets the general
requirements for a bona fide hedging position under paragraphs
(2)(i)(A)-(C) and the provisions for owning a cash commodity under
paragraph (3)(i). Because Company A owns more than 10 percent of
Company B, Company A and B are aggregated together as one person
under Sec. 150.4. Entities required to aggregate accounts or
positions under Sec. 150.4 are the same person for the purpose of
determining whether a person is eligible for a bona fide hedging
position exemption under Sec. 150.3. The aggregate short position
in the futures contract held by Company A and Company B represents a
substitute for transactions to be taken at a later time in the
physical marketing channel. The aggregate short position in the
futures contract held by Company A and Company B is economically
appropriate to the reduction of price risk because the aggregate
short position in the CBOT Wheat futures contract held by Company A
and Company B, equivalent to five million bushels of wheat, does not
exceed the five million bushels of wheat that is owned by Company B.
The price risk exposure for Company A and Company B results from a
potential change in the value of that wheat.
0
32. Add appendix D to part 150 to read as follows:
Appendix D to Part 150–Initial Position Limit Levels
————————————————————————
Single
Contract Spot-month month and
all months
————————————————————————
Legacy Agricultural
————————————————————————
Chicago Board of Trade Corn (C)…………… 600 53,500
Chicago Board of Trade Oats (O)…………… 600 1,600
Chicago Board of Trade Soybeans (S)……….. 600 26,900
Chicago Board of Trade Soybean Meal (SM)…… 720 9,000
Chicago Board of Trade Soybean Oil (SO)……. 540 11,900
Chicago Board of Trade Wheat (W)………….. 600 16,200
ICE Futures U.S. Cotton No. 2 (CT)………… 300 8,800
Kansas City Board of Trade Hard Winter Wheat 600 6,500
(KW)…………………………………..
Minneapolis Grain Exchange Hard Red Spring 600 3,300
Wheat (MWE)…………………………….
————————————————————————
Other Agricultural
————————————————————————
Chicago Board of Trade Rough Rice (RR)…….. 600 2,200
Chicago Mercantile Exchange Class III Milk 1500 3,400
(DA)…………………………………..
Chicago Mercantile Exchange Feeder Cattle (FC) 300 3,000
Chicago Mercantile Exchange Lean Hog (LH)….. 950 9,400
[[Page 75840]]
Chicago Mercantile Exchange Live Cattle (LC).. 450 12,900
ICE Futures U.S. Cocoa (CC)………………. 1,000 7,100
ICE Futures U.S. Coffee C (KC)……………. 500 7,100
ICE Futures U.S. FCOJ-A (OJ)……………… 300 2,900
ICE Futures U.S. Sugar No. 11 (SB)………… 5,000 23,500
ICE Futures U.S. Sugar No. 16 (SF)………… 1,000 1,200
————————————————————————
Energy
————————————————————————
New York Mercantile Exchange Henry Hub Natural 1,000 149,600
Gas (NG)……………………………….
New York Mercantile Exchange Light Sweet Crude 3,000 109,200
Oil (CL)……………………………….
New York Mercantile Exchange NY Harbor ULSD 1,000 16,100
(HO)…………………………………..
New York Mercantile Exchange RBOB Gasoline 1,000 11,800
(RB)…………………………………..
————————————————————————
Metal
————————————————————————
Commodity Exchange, Inc. Copper (HG)………. 1,200 5,600
Commodity Exchange, Inc. Gold (GC)………… 3,000 21,500
Commodity Exchange, Inc. Silver (SI)………. 1,500 6,400
New York Mercantile Exchange Palladium (PA)… 650 5,000
New York Mercantile Exchange Platinum (PL)…. 500 5,000
————————————————————————
Issued in Washington, DC, on November 7, 2013, by the
Commission.
Melissa D. Jurgens,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Position Limits for Derivatives–Commission Voting
Summary and Statements of Commissioners
Appendix 1–Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Chilton and
Wetjen voted in the affirmative. Commissioner O’Malia voted in the
negative.
Appendix 2–Statement of Chairman Gary Gensler
I support the proposed rule to establish position limits for
physical commodity derivatives.
The CFTC does not set or regulate prices. The Commission is
charged with promoting the integrity of the futures and swaps
markets. The Commission is charged with protecting the public from
fraud, manipulation and other abuses.
Since the Commodity Exchange Act passed in 1936, position limits
have been a tool to curb or prevent excessive speculation that may
burden interstate commerce.
For a fuller understanding of this long history, refer to the
excellent testimony of our former General Counsel Dan Berkovitz from
July of 2009 titled: “Position Limits and the Hedge Exemption,
Brief Legislative History.”
In the Dodd-Frank Act, Congress directed the Commission to
impose limits on speculative positions in physical commodity futures
and options contracts and economically equivalent swaps.
The CFTC finalized a rule in October 2011 that addressed
Congress’ direction to prevent any single trader from obtaining too
large a share of the market to ensure that derivatives markets
remain fair and competitive. Last fall, a federal court vacated the
rule.
It is critically important, however, that these position limits
be established as Congress required.
The agency has historically interpreted our obligations to
promote market integrity to include ensuring that markets do not
become too concentrated. When the CFTC set position limits in the
past, it sought to ensure that the markets were made up of a broad
group of participants with no one speculator having an outsized
position. This promotes the integrity of the price discovery
function in the market by limiting the size of any one speculator’s
footprint in the market.
Position limits further protect the markets and clearinghouses,
as such limits diminish the possible burdens when any individual
participant may need to sell or liquidate a position in times of
individual stress.
Thus, position limits help to protect the markets both in times
of clear skies and when there is a storm on the horizon.
With a strong proposal ready for the Commission’s consideration
today, we determined that the best path forward to expedite position
limits implementation was to pursue the new rule and dismiss the
appeal of the court’s ruling, subject to the Commission’s approval
of this proposal.
Today’s proposed rule is consistent with congressional intent.
The rule would establish position limits in 28 referenced
commodities in agricultural, energy and metals markets as part of a
phased approach.
It would establish one position limits regime for the spot month
and another for single-month and all-months-combined limits.
Spot-month limits would be set for futures contracts that can be
physically settled, as well as those swaps and futures that can only
be cash settled. We are seeking additional comment on alternatives
to a conditional spot-month limit exemption with regard to cash-
settled contracts.
Single-month and all-months-combined limits, which the
Commission currently sets only for certain agricultural contracts,
would be reestablished in the energy and metals markets and be
extended to swaps. These limits would be set using a formula that is
consistent with that which the CFTC has used to set position limits
for decades. The limits will be set based upon data on the total
size of the swaps and futures market collected through the position
reporting rules for futures, options on futures, and swaps.
Consistent with congressional direction, the rule also would
allow for a bona fide hedging exemption for agricultural and exempt
commodities. Also following congressional direction, there is a
narrower exemption for swap dealers with regard to their use of
futures and swaps to facilitate the bona fide hedging of their
customers.
Today’s proposed position limits rule builds on over four years
of significant public input. In fact, this is the ninth public
meeting during my tenure as Chairman to consider position limits.
We held three public meetings on this issue in the summer of
2009 and got a great deal of input from market participants and the
broader public.
We also benefited from the more than 8,200 comments we received
in response to the January 2010 proposed rulemaking to reestablish
position limits in the energy markets.
We further benefited from input received from the public after a
March 2010 meeting on the metals markets. In response to the January
2011 proposal, we received more than 15,100 comments.
Appendix 3–Statement of Commissioner Bart Chilton
For two reasons, this is a significant day for me. I am reminded
of that great Etta James song, At Last.
The first reason is that, at last, we are considering what I
believe to be the signal rule of my tenure here at the Commission;
I’ve been working on speculative position
[[Page 75841]]
limits since 2008. The second reason today is noteworthy is that
this will be my last Dodd-Frank meeting. Early this morning, I sent
a letter to the President expressing my intent to leave the Agency
in the near future. I’ve waited until now–today–to get this
proposed rule out the door, and now–at last–with the process
coming nearly full circle, I can leave. It’s with incredible
excitement and enthusiasm that I look forward to being able to move
on to other endeavors.
With that, here is a bit of history on the position limits
journey that has led us, and me, to this day. The early spring of
2008 was a peculiar time at the Commission. None of my current
colleagues were here. I and my colleagues at that time watched Bear
Stearns fail. We had watched commodity prices rise as investors
sought diversified financial havens. When I asked Commission staff
about the influence of speculation on prices, some said speculative
positions couldn’t impact prices. It didn’t ring true, and as
numerous independent studies have confirmed since, it was not true.
I began urging the Commission to implement speculative position
limits under our then-existing authority. And I was, at that time,
the only Commissioner to support position limits. Given the
concerns, I urged Congress to mandate limits in legislation. A
Senate bill was blocked on a cloture vote that summer, but late in
the session, the House actually passed legislation. Finally, in
2010, as part of the Dodd-Frank law, Congress mandated the
Commission to implement position limits by early in 2011.
Within the Commission, I supported passing a rule that would
have complied with the time-frame established by Congress–by any
other name–federal law. A position limits rule was proposed in
January of 2011 and finally approved in November.
In September 2012, literally days before limits were to be
effective, a federal district court ruling tossed the rule out,
claiming the CFTC had not sufficiently provided rationale for
imposing the rule. We appealed and I urged us to address the
concerns of the court by proposing and quickly passing another new
and improved rule. I thought and hoped that we could move rapidly.
After months of delay and deferral, it became clear: We could not.
But today–at last–more than three years since Dodd-Frank’s
passage, we are here to take it to the limits one more time.
Thankfully, we have it right in the text before us. The
Commission staff has ultimately done an admirable job of devising a
proposed regulation that should be unassailable in court, good for
markets and good for consumers.
I thank everyone who has worked upon the rule: Steve Sherrod,
Riva Adriance, Ajay Sutaria, Scott Mixon, Mary Connelly, and many
others for their good work. In addition, I especially thank
Elizabeth Ritter, my Chief of Staff, Nancy Doyle, and also Salman
Banaei who has left the Agency for greener pastures. I thank them
for their tireless efforts on the single most important, and perhaps
to me the most frustrating, policy issue of my tenure with the
Commission. I have had the true honor of working with Elizabeth
since prior to my confirmation. I would be remiss if I did not
reiterate here what I have often said; nowhere do I believe there is
a brighter, smarter, more knowledgeable and hard-working derivatives
counsel. She has served the public and me phenomenally well. Thank
you, Elizabeth.
And finally to my colleagues, past and present, my respect to
those whom we have been unable to persuade to vote with us on this
issue, and my thanks to those who will vote in support of this
needed and mandated rule. At last!
Thank you.
Appendix 4–Dissenting Statement of Commissioner Scott D. O’Malia
I respectfully dissent from the Commission’s decision to approve
the Notice of Proposed Rulemaking for Position Limits for
Derivatives. I have a number of serious concerns with the position
limits proposed rule and its interpretation of section 4a(a) of the
Commodity Exchange Act (“CEA” or “Act”).1 Regrettably, this
proposal continues to chip away at the commercial and business
operations of end-users and the vital hedging function of the
futures and swaps markets.
—————————————————————————
1 7 U.S.C. 6a(a).
—————————————————————————
I cannot support the position limits proposed rule that is
before the Commission today because the proposal: (1) Fails to
utilize current, forward-looking data and other empirical evidence
as a justification for position limits; (2) fails to provide enough
flexibility for commercial end-users to engage in necessary hedging
activities; and (3) fails to establish a useful process for end-
users to seek hedging exemptions.
We are the experts, but where’s the evidence?
Recently, in connection with the Commission’s vote to dismiss
its appeal 2 of the vacated 2011 position limits rule,3 I
reiterated that the federal district court 4 had instructed the
Commission to go back to the drawing board and do its homework.5
As I have consistently stated, the Commission must perform a
rigorous and objective fact-based analysis in order to determine
whether position limits will effectively prevent or deter excessive
speculation.6 Not only that, but the Commission must also, in
establishing any limits, ensure that there is sufficient market
liquidity for hedgers and prevent disruption of the price discovery
function of the underlying market. Unfortunately, the position
limits rule that is being proposed today is not based upon a
careful, disciplined review of market dynamics or the new data
collected under our expanded oversight responsibilities provided for
by the Dodd-Frank Act.7
—————————————————————————
2 ISDA & SIFMA v. CFTC, No. 12-5362 (D.C. Cir.).
3 76 Fed. Reg. 71626 (Nov. 18, 2011).
4 Int’l Swaps & Derivations Ass’n v. CFTC, 887 F. Supp. 2d
259, 280-82 (D.D.C. 2012).
5 http://www.cftc.gov/PressRoom/SpeechesTestimony/omaliastatement102913.
6 http://www.cftc.gov/PressRoom/SpeechesTestimony/omaliadissentstatement111512.
7 Dodd-Frank Wall Street Reform and Consumer Protection Act,
Pub. L. 111-203, 124 Stat. 1376 (2010).
—————————————————————————
In its second attempt at establishing a broad position limit
regime that is in accordance with the statutory language amended by
Dodd-Frank, the Commission relies on a new legal strategy–but not
new data–in order to circumvent the spirit of the district court’s
decision. Surprisingly, the Commission now accepts that the
statutory language in CEA section 4a(a)(1) 8 is ambiguous and that
there is not a clear mandate from Congress to set position limits,
contrary to the arguments made by the Commission both in court and
in the vacated rule. Notwithstanding that concession, the proposed
rule now hides behind Chevron deference and invokes the Commission’s
“experience and expertise” in order to justify setting position
limits without performing an ex ante analysis using current market
data.9
—————————————————————————
8 7 U.S.C. 6a(a)(1).
9 NPRM pp. 12-14, 24, 32, 171.
—————————————————————————
I am troubled that the proposal uses only two examples from the
past–one of them as far back as the 1970s–to cobble together a
weak, after-the-fact justification that position limits would have
prevented market disruption. This is glaringly insufficient.
Instead, the Commission should have taken the time to analyze the
new data, especially from the swaps market, that has been collected
under the Dodd-Frank Act. It is especially troubling that the large
trader data being reported under Part 20 of Commission
regulations10 is still unreliable and unsuitable for setting
position limit levels, almost two full years after entities began
reporting data, and that we are forced to resort to using data from
2011 and 2012 as a poor and inexact substitute.
—————————————————————————
10 17 C.F.R. part 20.
—————————————————————————
Today, the Commission proposes to set position limits for the
futures and swaps markets in the future, not the past. I fail to see
how we can be “experts” if we do not have the data to back us up.
I fear that this reliance on a new legal strategy, instead of
evidence-based standards, does little to affirm the Commission’s
self-proclaimed “expertise” and could result in another long and
costly court challenge that will strain our limited resources.
Preserving Flexibility for Commercial End-Users
I am also concerned that the position limits proposed rule may
not preserve enough flexibility for commercial end-users to hedge
risks inherent in their business operations. Hedging is the
foundation of our markets, and the intent of the Dodd-Frank Act was
not to place excessive and unnecessary new regulatory burdens on
end-users and make it more complicated and more costly to undertake
risk management. That was strongly underlined in the letter sent to
the Commission by Senators Dodd and Lincoln in June 2010.11
—————————————————————————
11 Letter from Chairman Christopher Dodd, Committee on
Banking, Housing, and Urban Affairs, United States Senate, and
Chairman Blanche Lincoln, Committee on Agriculture, Nutrition, and
Forestry, United States Senate, to Chairman Barney Frank, Financial
Services Committee, United States House of Representatives, and
Chairman Colin Peterson, Committee on Agriculture, United States
House of Representatives (June 30, 2010).
—————————————————————————
[[Page 75842]]
Regrettably, the Commission’s rules implementing Dodd-Frank have
not adhered to that directive. This position limits proposal is just
the latest in this disturbing trend of narrowly interpreting the
statute to foreclose viable risk management functions that did not
contribute to the financial crisis. This trend is nowhere more
apparent than in how narrowly the proposal defines the concept of
bona fide hedging.
The position limits proposed rule does away with Commission
regulation 1.3(z),12 which has been in effect since the 1970s, and
sets forth new regulations that narrow the bona fide hedging
definition, in particular the treatment of anticipatory hedging.
This is despite the fact that the vacated position limits rule
explicitly recognized certain anticipatory hedging transactions as
falling within the statutory definition of bona fide hedging and
consistent with the purposes of section 4a of the Act, and provided
exemptions for such transactions given the condition that the trader
was “reasonably certain” of engaging in the anticipated activity.
In this proposal, based on an unsatisfactory “further review,” the
Commission has changed its mind and has scaled back exemptions for
anticipatory hedging. In all, the Commission has rejected half of
the common hedging scenarios described by a working group of end-
users in their petition for exemption.
—————————————————————————
12 17 CFR 1.3(z).
—————————————————————————
I question whether the Commission has fulfilled Congress’ intent
to protect end-users by proposing a new position limits rule that
articulates a far too narrow conception of bona fide hedging and
does not reflect the realities of end-users’ commercial and business
operations.
A Workable, Practical Process for Non-Enumerated Hedging Exemptions
I am especially troubled by the proposed rule’s elimination of
Commission regulations 1.3(z)(3) and 1.47,13 which is the
framework for market participants to seek a non-enumerated hedging
exemption. I question whether eliminating a workable, practical
process that has been outlined in Commission regulations for decades
will make it more difficult for end-users to seek exemptions for
legitimate hedging transactions and will cause unnecessary delay and
interference with business operations.
—————————————————————————
13 17 CFR 1.3(z)(3) and 1.47.
—————————————————————————
Aggregation Proposed Rule
While I believe that today’s aggregation proposed rule is more
responsive than the vacated rule to the realities that market
participants face in their utilization of the futures and swaps
markets, some important concerns still remain.
First, the aggregation standards in the proposal present
significant technology challenges for compliance, especially across
affiliates. I would support a phase-in period to meet those
challenges.
Second, I am concerned that there is insufficient consideration
and flexibility in the ownership tiers that are used as a proxy for
control. I would be interested in reviewing comments on pro rata
aggregation, banding/tiering of ownership interest instead of full
aggregation, and other issues with beneficial ownership. Further, I
question whether the possible exemption for ownership in excess of
50% is of use to any market participants, given the additional
conditions that are imposed.
Cost-Benefit Considerations
It is imperative that market participants carefully review the
new position limits and aggregation proposed rules and provide
comments. I especially encourage market participants to include any
comments on the cost impact of the proposed position limits. I would
also like to receive input from market participants about the cost
of changes to their operations that were undertaken in order to
prepare for compliance with the previous position limit rules,
before those rules were vacated by the court. While the Commission
failed to give enough weight to these consequences, I intend to
carefully consider the comments and the critical information they
provide in evaluating any draft final rule put before the
Commission.
Conclusion
It is rare to get a second chance to do things right. I am
disappointed by the Commission’s approach today because the
Commission has not taken advantage of the opportunity for a second
chance presented by the district court decision to vacate the 2011
position limits rule. The Commission has failed in its duty as a
responsible market regulator by not taking the time to gather the
evidence and establish sound justifications for position limits ex
ante that are based on data. Because of this failure, as well as the
narrowing of the bona fide hedging definition and the elimination of
the existing process for end-users to seek non-enumerated hedging
exemptions, I cannot support this proposal.
[FR Doc. 2013-27200 Filed 12-11-13; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: January 14, 2014
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