(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON Nov 8 The U.S. Commodity Futures Trading
Commission (CFTC) is making another attempt to impose position
limits on 28 core futures contracts covering agricultural
products, energy and metals, after a U.S. court vacated its
first attempt due to procedural errors.
The court ordered the commission to use its "experience and
expertise" to resolve perceived ambiguities in the law on
position limits. The CFTC is now trying to do just that with a
much lengthier and more detailed notice of proposed rulemaking
justifying its decision, running to no fewer than 459 pages.
As the notice explains: "The commission now undertakes the
task assigned by the court: using its experience and expertise
to resolve the ambiguity the district court perceived in section
4a(a) of the Commodity Exchange Act." Section 4a(a) is the one
that deals with position limits.
EXPERIENCE AND EXPERTISE
In case there is any doubt about the diligence with which
the CFTC is approaching its homework, and to try to shelter it
from further judicial review, the rulemaking notice refers 21
times to the commission's "experience" and another six times to
its "experience and expertise".
The commission reminds readers it has been imposing position
limits as a tool to regulate agricultural futures markets for
more than 70 years.
"The commission concludes that, based on its experience and
expertise, when section 4a(a) of the act is considered as an
integrated whole, it is reasonable to construe that section to
mandate that the commission impose position limits.
"This mandate requires the commission to impose limits on
futures contracts, options and certain swaps ... The commission
also concludes that the mandate requires it to impose such
limits without first finding that any such limit is necessary to
prevent excessive speculation in a particular market."
MAKING A NECESSITY FINDING
However, in case a reviewing court is tempted to disagree
and require a necessity finding, the commission provides
real-world examples to illustrate why it believes position
limits are necessary to prevent deliberate market manipulation
or unintended price volatility.
It draws at length from a report into the Hunt Brothers
silver manipulation in 1979-80, prepared by the Treasury, the
Federal Reserve and the Securities and Exchange Commission, and
another report into fluctuations in natural gas prices caused by
hedge fund Amaranth in 2006, written by the Senate Permanent
Subcommittee on Investigations.
Lest anyone think the commission has not considered all
viewpoints and approached the issue with an open mind, the CFTC
lists no fewer than 134 academic studies relating to position
limits which it has reviewed and evaluated.
INVOKING CONGRESSIONAL POWER
Ultimately, the commission tries to arm itself with the
supreme lawmaking authority of Congress. The report begins with
the blunt declaration that: "Congress has repeatedly expressed
confidence in the use of speculative position limits as an
effective means of preventing unreasonable and unwarranted price
Later, the CFTC observes: "Congress (has) conducted several
investigations that concluded that excessive speculation
accounted for significant volatility and price increases in
physical commodity markets," particularly oil and gas.
Not all academic studies agree. But the CFTC invokes
congressional power: "Studies that militate against imposing any
speculative position limits appear to conflict with the
congressional mandate that the commission impose limits ... Such
studies also appear to conflict with Congress' determination,
codified in the Commodity Exchange Act, that position limits are
an effective tool to address excessive speculation."
AN IDEOLOGICAL LITMUS TEST
Position limits are probably the most emotive and polarising
issue in commodity regulation. The passion expended on the
issue, by both supporters and opponents, is far out of
proportion to their practical impact. Instead, limits have
become an ideological litmus test of whether someone is a
believer in free markets or regulation.
In agricultural markets, position limits have been enforced
by the CFTC since the 1930s and are no longer considered
If eventually extended to energy and metals markets, under
the commission's current proposals, their impact on volatility
is likely to be modest.
Position limits would help prevent corners and squeezes, as
well as the unintentional volatility associated with the
accumulation and liquidation of big positions like Amaranth's.
But they would not reduce the volatility associated with
commodity price bubbles, where a large number of speculators try
to trade in the same direction at the same time, driving prices
temporarily away from their fundamental equilibrium.
If limits will not be as effective as supporters hope, they
are unlikely to be as damaging as opponents fear. Critics have
not cited a single real-world instance in which limits have
harmed liquidity or prevented a commodity producer or consumer
from hedging their risk exposure effectively.
Nor can critics explain why a hedge fund such as Amaranth
should have needed to amass positions amounting to 5 percent of
all the natural gas consumed in the United States in a year, and
why such enormous positions, with their almost inevitable impact
on price formation, should not be restricted.
TIME TO BURY THE HATCHET?
The commission's first attempt to impose position limits was
invalidated by the U.S. District Court for the District of
Columbia on narrow procedural grounds.
The CFTC's own legal team "advised that the odds of winning
an appeal were quite good", according to Commissioner Mark
Wetjen, who strongly supported an attempt to overturn the
judge's ruling by appealing to a higher court.
Nonetheless, the federal court appeared hostile to many of
the commission's arguments. Even if the commission can cure the
procedural defects that sank its first rulemaking, its second
attempt could be vulnerable on other grounds.
So the question is whether the International Swaps and
Derivatives Association and the Securities Industry and
Financial Markets Association, which represent derivatives
dealers, will mount another legal challenge.
Position limits, like much of the rest of the 2010
Dodd-Frank Wall Street Reform and Consumer Protection Act, are
still bitterly resented among banks and derivatives dealers.
But hopes of repealing the law have vanished with President
Barack Obama's re-election and the Democratic Party's continuing
control of the Senate. Derivative dealers must contend with the
reality that Washington and the CFTC will be controlled by
Democrats for the next three years.
Passions may have cooled a little. Many of the largest banks
in commodity markets, who were the principal opponents of
position limits, have scaled back their operations and sought to
mend fences with regulators. Institutional investors, too, no
longer see commodities as a growth area that could be hampered
COMPROMISE OR CONFRONTATION?
The latest position limit proposals contain some significant
concessions to the industry.
Proposed limits, especially for energy, would be set at a
high level. Spot-month limits for gas and oil could be up to
four times higher than the limits currently fixed by exchanges.
Limits for other months and all-months combined would also be
generous. The proposals contain generous exemptions for hedgers.
The commission's own analysis shows fewer than three traders
would have exceeded the proposed overall limits on crude oil
during 2011 and 2012, and no traders in natural gas. Rather more
traders would be caught in smaller and less liquid markets for
gasoline and heating oil.
Many more crude and gas dealers, investors and hedgers would
be affected by the spot month limits, but in principle those are
less controversial because there is widespread agreement large
positions should be limited in the run-up to delivery to prevent
corners and squeezes.
For free-market purists, there can never be any
justification for limiting position size; the latest version of
the proposals must be as fiercely resisted as the first.
But perhaps calmer heads will prevail. The industry could
pocket its court win, declare victory, and accept a modified
version of the current proposals, safe in the knowledge limits
will be set at such a high level they will not constrain normal
The risk if the industry continues to resist position limits
tooth and nail is that Congress will have to clarify the law,
and the industry might like the answer a lot less.
(Editing by Dale Hudson)