Testing regulators, CME sticks toe in position limits water

NEW YORK Oct 17 (Reuters) - The CME Group on Wednesday canceled a proposal to increase position limits that may have pressed U.S. government regulators on the subject soon after a judge shot down a separate government proposal that would have tightened limits.

The futures exchange proposed an increase in position limits for certain natural gas contracts, but seemingly hit a raw nerve after a U.S. judge late last month sent back for revision a separate federal proposal to curb speculators using position limits.

"Based on additional discussions with the staff of the (U.S. Commodity Futures Trading Commission) we have determined not to change position limits in NYMEX last day financial natural gas contracts at this time, and our submission to the CFTC has been formally withdrawn," CME spokesman Damon Leavell said in an emailed statement.

The CME sets its own position limits though the line has blurred in recent months as the CFTC has worked to get its own set of position limits passed and CME has to remain within the guidelines of regulators.

The CME proposal was sent out to the market on Oct. 8 for 10 days of review and was subject to "self-certification" by the CFTC, meaning it "complies with the Commodity Exchange Act and the CFTC's regulations and associated policies."

This recent move to increase position limits came roughly one week after a U.S. district court judge struck down a CFTC position limits proposal.

The judge ruled that the Dodd-Frank Act did not give the CFTC a "clear and unambiguous mandate" to set limits without identifying where they were needed in some 28 physical agriculture, energy and metals markets.

The contracts in this CME proposal are different from the ones listed in the CFTC proposal but some market watchers say the agency is still sore from the judge's ruling.

"My initial thought is the CFTC smarting about position limits and they're not about to relax position limits in this environment," said Craig Pirrong, a University of Houston professor, who lectures on financial reform and is against position limits.

Steven Adamske, CFTC director of public affairs, said the agency had no further comment.

The New York Mercantile Exchange (NYMEX), which is owned by CME, requested to raise position limits from 1,000 to 5,000 contracts in the three days up to expiration in four financially-settled contracts: Henry Hub Natural Gas Look-Alike Last Day Financial futures, Henry Hub Natural Gas Last Day Financial futures, Daily Natural Gas options and Henry Hub Natural Gas Last Day Financial.

The Henry Hub Natural Gas Last Day Financial futures is the most liquid of the four contracts and is used by commercial players such as industrial end users to hedge another position, as one example.

The contract is one-quarter the size of the Henry Hub natural gas futures contract and average volume on Tuesday was in the mid-50,000 range, less than half that of the straight futures contract.

ICE COMPETITION, SQUEEZING MARKET

CME also faces increased pressure from competitors each trying to eek out volumes in a rough financial environment.

The Intercontinental Exchange is outpacing the exchange in trading volumes.

"This is a constraint that may be impeding that," Pirrong said. "I don't think it would make a huge difference but every little bit helps."

Still, the U.S. government's impending squeeze on the exchange in turn pressured market makers on position limits and drove at least one mammoth trader out, for good, this year.

John Arnold, who ran Houston-based Centaurus Energy had been hit with several small fines by the CME for violating position limits in futures contracts.

Arnold, arguably the largest natural gas trader in the market, who provided liquidity for trading among smaller players, closed his fund earlier this year.

Traders and market makers despaired over the loss.

"When Arnold gets back into natural gas trading, it will be time to get back into natural gas trading, until then, it's going to be a lousy market to trade, especially for big boys with lots of money," said one long-time trader who used to trade natural gas and now trades in other markets.