Monday, May 18, 2020

Comment period for CFTC’s controversial position limit proposal concludes despite COVID-19 pandemic-inspired chaos

By Brad Rosen, J.D.

The comment period for the CFTC’s long awaited and controversial position limits proposal concluded on May 15, 2020. The proposed rule, which was approved by the CFTC in a 3-2 vote along partisan lines on January 30, 2020, drew over 65 comment letters from an array of stakeholders, including trade associations, exchanges, and public interest groups. The proposal, which has been proposed and re-proposed several times since the passage of the Dodd-Frank Act nearly 10 years ago, seeks to conform to the CEA amendments of the Act.

A comment period like no other. The comment period for the proposal opened just as the COVID-19 coronavirus was starting to take hold across the United States and around the world resulting in severe societal disruptions and economic dislocations. While the CFTC voted to extend the comment period by a mere 15 days on April 9, 2020, Commissioner Dan Berkovitz asserted that market participants and the public needed more time in order to provide high-quality comments on the pending rulemaking in light of the crisis. The Commissioner declared that "not providing the public sufficient time to obtain additional perspective and develop meaningful comments in these extraordinary times is bad public policy."

Then on April 20, 2020, the oil markets experienced unprecedented turmoil as the price of the May crude oil futures contract plunged from $17.73 per barrel at the market open to a closing settlement price of negative $37.63 per barrel. These price moves shocked many market participants and observers, resulting in calls for heighted regulatory review and examination, as well as greater scrutiny within the context of the proposed position limit rule.

An overview of the comments. A majority of the comments, which were submitted from industry associations, end-users, traders, commercial participants, and exchanges were generally supportive of the proposed rules, while there were some calls for greater clarity or further regulatory relief. Not surprisingly, a number of commentators, writing on behalf public interest groups, expressed their strong disagreement with the proposed rule. A summary of some of the comments received by the CFTC follows.

FIA commends the proposed rule. The FIA commended the CFTC for proposing a workable and flexible rule. Specifically, the FIA noted its support for the following items:
  • The use of updated deliverable supply estimates to set spot month limits.
  • The decision not to impose position limits outside of the spot month for the energy, metals, and certain agricultural core referenced contracts (and related referenced contracts).
  • The targeted definition of economically equivalent swap.
  • The determination that the Commission must find that position limits are necessary before it is authorized to establish federal position limits. 
Additionally, the FIA proposed that the definition of a bona fide hedging transaction or position should be more flexible. It also suggested that the list of enumerated bona fide hedging transactions should be expanded and moved into the rule text.

Commodity Markets Council supportive of the proposed rule. The Commodity Markets Council is a trade association that brings together exchanges and their industry counterparts. Its members include commercial end-users that utilize the futures and swaps markets for agriculture, energy, metal, and soft commodities. The CMC expressed its general support for the rule and expressed its appreciation for the CFTC’s fresh approach to implementing the position limits provisions of Dodd-Frank. The CMC comment letter noted the following:
  • The proposed rule responds to many of the end-user concerns about prior Commission proposals raised by those who use futures markets to hedge risk exposures related to commercial activities in physical commodities.
  • CMC applauds the proposal for its implicit recognition that safeguarding market function is the paramount concern when implementing regulatory tools such as speculative position limits.
  • CMC also respects the Commission’s decision to undertake necessity findings to support its decisions and resulting position limits regime. 
CMC also expressed its concern that the proposal could result in several unintended consequences for the markets and their participants. Its concerns centered around relying on increased deference to exchanges and market participants in assessing risk and recognizing strategies for hedging risk exposures. In particular, CMC saw questions arising in connection with the expressed intent of the proposed rule and its potential implications for CMC members. As a consequence, CMC provided suggestions designed to achieve greater predictability in the rule, including the bona fide hedge definition, the list of enumerated hedges, and guidance provided in connection with the measurement of risk.

Better Markets says proposal continues to suffer from significant legal and policy deficiencies. In its comment letter, Better Markets, a self-described non-profit, non-partisan organization promoting the public interest in the financial markets, indicated its general support for the CFTC’s attention to public interest concerns related to speculative position limits. However, the organization starkly opposed the proposed rule’s deference to exchanges for establishing, administering, and monitoring position limits in accordance with minimal and often non-binding guidance. Moreover, Better Markets asserted that the proposal opened too many avenues to avoid, if not evade, meaningful federal and exchange-determined position limits through expanded exemptions and delegations of authorities. According to Better Markets, the proposal’s five most material deficiencies were as follows:
  • The federal spot month limits for derivatives on the 25 physical commodities subject to the most critical elements of the proposal would generally represent significant increases in permissible speculation.
  • The proposal would not establish federal position limits for non-spot-month derivatives contracts on 16 of the 24 physical commodities subject to the most critical elements of the proposal.
  • The proposal would dramatically expand (almost triple) the number of self-effectuating enumerated exemptions and, for the first time, recognize a broad exemption (read, loophole) for anticipatory merchandizing.
  • The proposal would implement a new process for recognizing non-enumerated hedging strategies that practically eliminates CFTC oversight.
  • The proposal would make necessity findings and interpret ambiguities in CEA section 4a as requiring such a finding before finalizing any position limits on derivatives on physical commodities. 
Bottom line, Better Markets concluded that under the CFTC’s newest proposal, the potential for implementing federal position limits that do not actually limit speculation remains too great.