WASHINGTON U.S. regulators this week will finalize their toughest crackdown yet on volatile oil and metal markets, concluding nearly four years of fierce debate over whether limits on speculative trade can tame prices.
As Wall Street bemoans the measure as a sop to politicians who have vilified speculators for driving grain and oil prices to painful peaks since 2008, the Commodity Futures Trading Commission will push through a groundbreaking rule to restrict the number of commodity contracts a trader can hold.
"I think both sides are going to be a little upset with this rule," Scott O'Malia, a Republican commissioner at the CFTC, told reporters at a Futures Industry Association conference in Chicago last week.
"I guess the old hallmark of policy is if you've offended everybody then you're in the right space."
For many big commodity traders, it will be a case of having won some battles after losing the war: the use of rigid caps on positions is one of the most contentious pieces of the Dodd-Frank financial overhaul law for many, and may force big players like Morgan Stanley to curb some customer business.
Yet a draft obtained by Reuters last month suggested banks and traders had won big concessions after lobbying hard against more oversight. Whether those measures are retained in the final version will be one of the most important facts to emerge from Tuesday's session, the latest in a rule-making marathon.
Assuming the rule is approved, the caps will mark the start of a new era, one that should eventually help answer the question of whether limits will cap prices by stemming the surge of investment into commodity markets -- or whether they will simply drive activity overseas, where rules are laxer.
While the limits are nominally intended to prevent market manipulation and excessive concentration, CFTC Chairman Gary Gensler has also been under intense political pressure to impose the measures as a way of tempering prices.
He has worked tirelessly to win support from the commissioners, and as Reuters reported last week, he finally won over enough votes to push through the rule on Tuesday.
In August, Senator Bernie Sanders, a staunch critic of oil speculators, intentionally released oil-trading data that exposed the extensive positions speculators held in the run-up to record prices in 2008. He has long criticized the CFTC for missing a January 2011 congressional deadline to finalize rules on speculators.
"The bottom line is that we have a responsibility to ensure that the price of oil is no longer allowed to be driven up by the same Wall Street speculators who caused the devastating recession that working families are now experiencing," Sanders said in a statement.
"That means that the CFTC must finally do what the law mandates and end excessive oil speculation once and for all."
But will position limits stop $5-a-gallon gasoline or prevent the cost of bread from skyrocketing?
Critics say no. Instead, they argue, it will harm U.S. markets by curtailing volume, increasing volatility and sending traders to overseas markets.
"Position limits are like short sale bans: it's trying to influence asset prices when they're not to your liking," said Remco Lenterman, a managing director at Amsterdam-based IMC Trading BV. "And the evidence is abundant that it's counterproductive."
"We have politicians trying to influence asset prices when they think they don't like the fact that they're too high, or the public doesn't like that they're too high," he added.
Critics say the CFTC has yet to produce economic analyses to connect speculators to spikes in oil prices.
The rule does have supporters in the private sector. Airlines and some farm groups have loudly complained that hedging is now near impossible because of the huge influx of money into commodity markets.
Just last week, more than 450 global economists pushed for action on position limits in order to curb the effect of excessive speculation on global food prices. In a letter to the Group of 20 finance ministers, they said excessive financial speculation is "contributing to increasing volatility and record food prices, exacerbating global hunger and poverty."
Much will depend, however, on just how tight those caps are set. A previous version of the rule published nearly two years ago suggested that no more than a handful of companies would have been affected by limits on oil and gas markets.
Dozens of academic, government and bank studies on the subject have differed on whether speculators influence prices long-term or whether they simply respond to market conditions.
That argument is likely to rage on for months if not years: The limits may be phased in gradually as the CFTC gets a better handle on the vast $600 trillion swaps market that is now under its authority.
"IT'S A LONG MARCH"
The draft final rule indicates the CFTC will still snag large passive index funds, which critics have blamed for causing a massive run-up in oil prices in 2008 by buying and holding futures contracts without regard to market fundamentals. Whether these changes remain in place in the final version voted on this week remains to be seen.
"I suspect there are going to be a large number of positive changes in the rule," said Paul Pantano, a partner at Cadwalader, Wickersham & Taft, pointing to changes in account control and easing of some reporting requirements.
"But until we see the final rule a lot of that could be changing. It's a long march," he said.
A paper from the St. Louis Federal Reserve released this month has said speculators were partially responsible for influencing the price of crude from 2004 to 2008.
After scouring through a host of economic and oil data to find the major factors, they found the surge was mainly driven by growing global thirst for oil. But traders also were to blame with 15 percent of the price increase due to so-called "financial speculative demand shocks."
During this same time, they found a rise in investing by hedge funds, large financial institutions, and other investors into the oil futures market, with assets allocated to commodity index trading strategies surging to $260 billion as of March 2008 from $13 billion four years earlier.
Exchanges and other traders have long argued that limits are unnecessary and will curtail market volume, reduce volatility and send traders fleeing to overseas markets. All this, they argue, would create a ripple felt from Wall Street down to main street.
"I want to see what is considered a hedge, and I want to see who can be the counterparty to certain hedges because we have a lot of farmers," said Tammy Botsford, vice president and deputy general counsel at Penson Futures, in an interview in ahead of the position limits release.
"Protecting their ability to participate in the (over the counter) market and the futures market, and not have them forced out of either, is important," she said.