WASHINGTON/NEW YORK Federal limits on commodity market speculation, the prospect of which has haunted Wall Street's big banks, pension funds and energy merchants for five years, may have died in the District of Columbia courts on Friday.
Just two weeks before the "position limits" rule was to take effect, U.S. District Judge Robert Wilkins rejected it and sent it back for an overhaul, a move that even some opponents said was surprisingly tough.
Wilkins said the Commodity Futures Trading Commission had failed to prove that it was necessary to impose new caps on speculative bets in 28 U.S. markets, including copper, corn and crude oil, to reduce price spikes and volatility.
CFTC Chairman Gary Gensler has several options for reviving the measure - one of the agency's hallmark reforms - including an appeal, a fresh round of rule-writing, or even asking Congress to amend it.
But each avenue is time-consuming and comes with potentially insurmountable obstacles. Some academics say the judge's ruling may have effectively killed the political will to pursue one of the most contentious pieces of the Dodd-Frank financial reforms.
"Even if Democrats win the White House, the rulemaking process will take years to complete and, my guess, the Democrat commissioners at the CFTC will probably have lost their appetite for this battle," says Jerry W. Markham, a law professor at the Florida International University at Miami and former chief counsel for the CFTC's enforcement division.
The limits were initially conceived in 2007, an era when the advent of $100-a-barrel crude oil and $8-a-bushel corn fueled a political firestorm. Some of the blame went to investors who were plowing billions into roaring raw material markets.
In response, the position limits provision went into the 2010 Dodd-Frank legislation as part of broader measures to rein in risky behavior on Wall Street.
While the major U.S. grain, oilseed and soft commodity markets had been subject to federal limits for decades, metal, energy and the over-the-counter swaps markets had not. The new measure would not only expand the limits, they would also close a loophole that had given big banks an exemption if they were hedging investment deals.
Five years later, the high prices have lost some of their shock value. While the amount of money being invested in commodity markets continues to rise, the rate of growth has slowed.
Those alarmed by still-high commodity prices are taking up different weapons: President Barack Obama has made no secret of his readiness to use strategic oil reserves to tamp down prices; those hurt by high grain prices are blaming a historic drought, not speculators, and targeting a federal mandate to blend ethanol into automotive fuel for relief.
A YEAR OR MORE ...
Academics and experts disagree over whether the ruling on position limits holds wider significance for the Dodd-Frank reforms, which are already running far behind schedule.
Some said the position limits setback might embolden the financial sector to challenge more rules; others said the ruling was too specific for this contentious case to set a precedent.
On Friday, Gensler said he was considering options for a next step, but did not indicate which way he was leaning.
Other regulators have made the calculation that it is not worth going through the lengthy and distracting appeals process.
Last year, the U.S. Securities and Exchange Commission chose not to challenge a court ruling that rejected its "proxy access" rule that would have made it easier for shareholders to nominate directors to corporate boards.
The ruling, which found the SEC did not properly weigh the economic benefits of the regulation against its costs, was the first rejection of a Dodd-Frank rule. Wilkins' is the second.
Despite the uphill battle, one commissioner has started a campaign for an appeal.
Democrat Bart Chilton plans to tell a United Nations-related food and agriculture group in Rome on Tuesday that the agency should immediately move to appeal, and seek a stay from the courts. That would allow the rule to go into effect until the Commission can draft another.
"Position limits are simply too important," he plans to say.
The CFTC has 60 days to appeal the ruling.
Even if the CFTC successfully appealed the decision, the International Swaps And Derivatives Association and the Securities Industry and Financial Markets Association could still come back to challenge the rule on one of the arguments that Wilkins did not touch upon in his ruling: that the CFTC failed to properly weigh the costs and benefits of the reform.
"That is a potential source of vulnerability of all the rules, and the court didn't provide any clarity on the standards to which the agency will be held," said Craig Pirrong, a University of Houston professor who has been critical of position limits.
The judge's ruling did not address the issue, since he found that the rule itself was out of sync with the law.
THE LONGER WAY
The appeals process may seem preferable to Gensler's other option: going back to the drawing board to prove the limits are indeed "necessary" to temper damaging price volatility, something Wilkins said in his ruling was required under the ambiguous wording of the law.
This could mean a lengthy staff review followed by another multi-month rulemaking process, and some experts say such proof may not even exist.
"(It) will be difficult to make such a finding as there is little economic support for such a conclusion." said Gregory Mocek, a former CFTC enforcement director who now works at law firm Cadwalader, Wickersham & Taft.
Several academic studies have so-far failed to prove a definitive link between speculation and increased or volatile prices, and in 2008 the CFTC's own economist said in an internal report that the evidence was not there.
Amending the law could be the most extreme option, but one that is likely to face stiff opposition if the Republicans retain control of the House after the November 6 elections, as is widely expected.
(Reporting By Jonathan Leff, Alexandra Alper and David Sheppard; Editing by Lisa Von Ahn and Alden Bentley)