CFTC Set to Propose Energy Position Limits and House Legislation Would Expand Authority

Following a series of hearings last July, the CFTC is set to propose energy position limits. The CFTC will consider issuance of a proposed rule on energy position limits and hedge exemptions on regulated futures exchanges, derivatives transaction execution facilities and electronic trading facilities. To the extent that money managers, hedge funds and swap dealers participate in the futures markets, noted CFTC Chair Gary Gensler, position limits have the potential to increase liquidity by reducing the positions of the largest traders. Position limits also can enhance liquidity by promoting more market participants rather than having one party that has so much concentration so as to decrease liquidity.

While the CFTC is authorized to set strict position limits in energy markets, it does not currently do so. Instead, the exchanges set energy position limits only in the last three days of trading to address manipulation and congestion. The exchanges, however, are not required by statute to set and enforce position limits to address the burdens of excessive speculation.

The exchanges currently use accountability levels to monitor the size of positions in the energy markets. But Mr. Gensler has cautioned that these should not be confused with position limits. Whereas position limits are strict restrictions on the size of a position a speculator can take, he noted, accountability levels are merely a way to provide the exchanges with additional oversight tools when a speculator’s position exceeds a certain size. If a position limit is a stop sign, he said, accountability levels should not be confused with yield signs. They are a way to alert the exchanges of growing positions.

The Commission will be wrestling with the question of whether to grant exemptions from position limits to persons using the futures markets to manage purely financial risks rather than risks arising from the actual use of a commodity. Although the statute directs the Commission to set position limits as necessary to prevent undue burdens on commerce, Congress has also clarified that position limits would not apply to bona fide hedgers. The statute provides the Commission with discretion to determine what constitutes a bona fide hedging transaction. Traditionally, bona fide hedging has involved offsetting commercial risks rather than purely financial risks.

As the Commission considers setting position limits on futures exchanges through regulation, the CFTC will work with Congress to secure additional authorities, including aggregate position limits, to prevent market participants from moving to the over-the-counter market or onto foreign exchanges. According to Chairman Gensler, the CFTC must be able to set aggregate limits on all persons trading OTC derivatives that perform or affect a significant price discovery function with respect to regulated markets that the Commission oversees. Such position limit authority should clearly empower the CFTC to establish aggregate position limits across markets in order to ensure that traders are not able to avoid position limits in a market by moving to a related exchange or market, including international markets.

Section 3113 of the House-passed Wall Street Reform and Consumer Protection Act, HR 4173, would authorize the CFTC to set aggregate position limits on swaps that perform or affect a significant price discovery function with respect to regulated markets, which assumedly means designated contract markets or alternative swaps execution facilities. Since the CFTC’s authority would apply whether a swap was standardized or not, the statute would give the CFTC adequate flexibility to apply its powers to preserve the integrity of the price discovery process as appropriate.

Section 3113 would also authorize the CFTC to establish aggregate position limits, including related hedge exemption provisions, in contracts based upon the same underlying commodity that may be held by any person, including any group or class of traders, for each month across contracts listed by designated contract markets and contracts traded on a foreign board of trade that provides members or other participants located in the United States with direct access to its electronic trading and order matching system.