Market participants spar over position limits

by Jay Sjerven
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WASHINGTON — Disagreement over how or even whether the Commodity Futures Trading Commission (C.F.T.C.) should set speculative position limits in commodity derivative markets remained as wide after a two-month comment period on the agency’s proposed rule on the subject as they were before. The C.F.T.C. published in the Jan. 28, 2011, Federal Register its proposed rule on setting position limits for derivatives, including commodity-related over-the-counter swaps not previously regulated, as required under the Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act).

In its proposal, the C.F.T.C. said it planned to establish position limits on physical commodity derivatives in two phases. In the first phase, it would establish spot-month position limits only, and those would be based on deliverable supply determined by and levels currently set by designated contract markets, such as the C.M.E. Group, the Kansas City Board of Trade and the Minneapolis Grain Exchange.

During the transition to the second phase, the C.F.T.C. would gather information from participants in swap markets that currently are not regulated but will be under the Dodd-Frank Act. In the absence of such information, establishing appropriate position limits embracing swaps as well as futures and options traded on commodity exchanges would not be possible.

In the second phase, the C.F.T.C. would establish spot-month position limits based on its determination of deliverable supply as well as set position limits outside the spot month. The C.F.T.C. proposed to set spot-month position limit levels at 25% of deliverable supply for a given commodity; in other words, no one “speculator” would be able to hold a position reflecting more than 25% of the deliverable supply.

The non-spot month position limit for each contract would ensure that no one speculative entity would hold more than 10% of open interest in the contract below the first 25,000 contracts or more than 2.5% of open interest above the 25,000-contract threshold.

The C.F.T.C.’s proposed rules would retain the “legacy” all-months-combined position limits for enumerated agricultural commodities — wheat, corn and soy complex futures contracts — as an exception to the general open interest-based formula that would apply to setting position limits for other commodity contracts. The only change under the proposed rule was the single-month limit for those agricultural contracts would be increased to the same level as the “legacy” all-months-combined limit with the elimination of the calendar month spread exemption.

The commission requested comment on whether the legacy position limits for the enumerated agricultural commodities should be retained or if the derivatives should be treated as any other under its proposal. And if the legacy limits are to be retained, the C.F.T.C. asked whether position limits should be increased from current levels as recently proposed by the Chicago Board of Trade.

The C.F.T.C. proposals elicited nearly 5,800 comments, and the commodity exchanges and users of the principal

agricultural contracts weighed in.

The Commodity Markets Council, whose members include the principal commodity futures exchanges and their industry counterparts, said it was “deeply concerned” if the proposed rule is adopted “market liquidity would be lost.”

Christine Cochran, president of the C.M.C., said the council’s members generally supported the use of position limits but only where necessary. She added that the C.M.C. supports raising the existing position limits in the agricultural contracts, which, she pointed out, were based on open interest in 2004.

“Therefore, to the extent the commission finds the imposition of limits necessary and appropriate, we urge the commission to apply the same formula that it applies to other commodity contracts,” she said.

At the same time, she urged the commission to maintain position limit parity across the three wheat markets.

Matt Bruns, chairman of the National Grain and Feed Association’s risk management committee, commended the C.F.T.C. for proposing to retain existing futures market speculative limits for grains, oilseeds, grain products and the meat complex. Mr. Bruns said the N.G.F.A. also supported the agency’s proposal to provide hedge exemptions for non-bona fide swap participants only if their swap transactions or positions represent cash transactions and offset a bona fide counterparty’s cash market risks.

“The measure of whether (speculative) position limit changes are appropriate now should not be based solely on higher open-interest levels, which have been driven in part by new investment capital participation that has contributed to impaired performance and lack of convergence,” Mr. Bruns said. “Position limits should not be increased from current levels until the agency and the industry are convinced that agricultural futures markets are performing their price-discovery and risk management roles adequately for traditional market participants, the bona fide commercial hedgers.”

Robb MacKie, president and chief executive officer of the American Bakers Association, urged the C.F.T.C. to keep position limits in the wheat market at current levels. Mr. MacKie said increasing speculative limits may result in increasing hedging margins, which would force small businesses to allocate more financial resources to this portion of their business to the detriment of core business needs.

Mr. MacKie also asserted the “A.B.A. strongly urges C.F.T.C. to move forward with removing the hedge exemption status from all index funds operating within the wheat futures markets, keeping the limits at the current levels, while ensuring that index funds cannot receive such exemptions in the future. Designating all index funds as non-commercial participants will allow the market to once again react appropriately to fundamental factors.”

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