LONDON In throwing out controversial new rules on position limits, just two weeks before they were due to go into effect, U.S. District Judge Robert Wilkins has delivered a stunning setback to the Commodity Futures Trading Commission (CFTC), and handed a significant victory to derivatives dealers and investors fiercely opposed to new restrictions.
The practical impact is to preserve the existing system. The CFTC will continue to enforce federal limits on speculation in agricultural products like corn, wheat and soy, while futures exchanges will continue to enforce spot-month limits and broader position accountability levels for energy items like crude oil, gasoline and natural gas.
The Commission must now decide whether to redraft the rules in a bid to comply with Wilkins' ruling, appeal to a higher court, or ask Congress to rewrite the Dodd-Frank language on position limits to resolve the "ambiguities" which appeared to trouble the judge so much.
But all those options will take time. Meanwhile the CFTC will be unable to enforce federal limits in the energy markets, which is the outcome derivatives dealers have been seeking to achieve.
WHAT HAPPENS NEXT?
The Commission could start working on a new rule, and start by asking itself whether the statute requires it to make a finding that limits are "necessary" and "appropriate", to comply with the judge's findings. But any rule will be subject to a future challenge on cost/benefit grounds (something which Wilkins declined to rule on this time).
The Commission could appeal in a bid to get Wilkins' decision overturned. But the Court of Appeals for the District of Columbia Circuit is notoriously conservative and unlikely to be a favorable venue for the Commission.
The final option is to seek new congressional legislation to remove the ambiguity that troubled Wilkins. It would be a simple matter to remove the references to "necessary" and "appropriate" from the law or to graft on a new explicit command that the Commission fix position limits and make clear that the CFTC has no discretion in the matter.
The obstacle is political. The Republican-controlled House of Representatives can be expected to block any attempt to amend the statute to make position limits mandatory. But for supporters of position limits, frustrated by the endless court challenges, new statutory language may be the only way to avoid a battle of attrition in the courts.
The most likely outcome is that those legislators who have pushed hardest on position limits, such as Bernie Sanders of Vermont (Independent) and Maria Cantwell of Washington (Democrat), will try to amend the law by attaching an amendment onto a must-pass bill that Republican leaders in the House would not want to lose.
Just as congressional Republicans have played a game of cat and mouse with the administration by offering a Keystone XL amendment to various pieces of must-pass legislation, supporters of position limits are now likely to adopt the same tactics to get the text of the law changed.
VERY NARROW RULING
In court, the International Swaps and Derivatives Association (ISDA) and Securities Industry and Financial Markets Association (SIFMA), acting on behalf of the dealers, challenged the position limits rules on five separate grounds.
The associations said the CFTC had failed to show position limits were "necessary" and "appropriate" to diminish, eliminate or prevent sudden and unwarranted fluctuations in commodity prices, as required by Section 6a(a)(1) of the Commodity Exchange Act as amended by Dodd-Frank.
In much broader and more contentious claims, they also argued the CFTC had failed to conduct a proper evaluation of the costs and benefits of the new rule, and had therefore violated the Administrative Procedure Act, which prohibits agencies from acting arbitrarily and capriciously.
Like a good jurist, however, Wilkins resolved the case on the narrowest possible basis open to him, striking down the position limits rule on "necessary" and "appropriate" grounds, and declining to consider the broader claims raised by the industry.
PARSING THE STATUTE
The Commodity Exchange Act, as amended by the Dodd-Frank Act, states simply: "The Commission shall, from time to time, after due notice and opportunity for hearing, by rule, regulation, or order, proclaim and fix such limits ... as the Commission finds may be necessary to diminish, eliminate or prevent" the burden of excessive speculation (7 USC 6a(a)(1)).
Later the law states: "the Commission shall by rule, regulation or order, establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person" (7 USC 6a(a)(2)(A)).
The Commission has focused on the congressional command represented by the word "shall". The CFTC has argued Congress gave it a firm instruction to impose position limits under Dodd-Frank and that it has no discretion in whether to apply them, only how to do so.
Even former Commissioner Michael Dunn, who voted for position limits but dismissed them as a "cure for a disease that does not exist" and a "placebo", believed the Commission had no choice in the matter.
"Congress has tasked the CFTC with preventing excessive speculation by imposing position limits. That is the law. The law is clear, and I will follow the law," he explained, in comments cited in the judgment.
The CFTC's position received some support from the judge. "There is no question, as the CFTC argues, that Congress used traditionally mandatory language throughout the Dodd-Frank amendments to Section 6a" Wilkins wrote.
In contrast, the industry argues that the law requires the Commission to first make a finding that such limits are "necessary" and "appropriate" before imposing them. Wilkins offered some support for that too, noting the court must "give effect, if possible, to every word Congress used," -- which includes the phrases about "necessary" and "appropriate," otherwise these words would be "mere surplusage".
QUESTION OF AMBIGUITY
The court declined to endorse either position fully. The readings favored by the CFTC and the derivatives dealers are both "plausible," according to Wilkins.
Nonetheless, he ruled that the CFTC had misdirected itself when it assumed that it had no discretion on whether to impose limits at all. It should have considered the ambiguity of the statute and exercised its own expertise and judgment in deciding whether it needed to make a necessity finding.
"The Dodd-Frank amendments to Section 6a are ambiguous and lend themselves to more than one plausible interpretation," Wilkins wrote.
"When a statute is ambiguous, it is incumbent upon the agency not to rest simply on its parsing of the statutory language. It must bring its experience and expertise to bear in light of the competing interests at stake."
"Although the court does not foreclose the possibility that the CFTC could, in the exercise of its discretion, determine that it should impose position limits without a finding of necessity and appropriateness, it is not plain and clear that the statute requires this result."
Wilkins did not rule that the agency must conduct a full cost/benefit analysis; he left that question open to a future court battle. He didn't even rule that the CFTC must make a finding of necessity before introducing position limits.
But he concluded the agency must at least show that it had given some thought to the ambiguous readings and whether they required a necessity finding before establishing a rule. As a result he ordered the agency to start again and use its own experience and expertise to determine how to apply the will of Congress.
"This court need not choose between the competing interpretations ... Because the position limits rule is based on the CFTC's erroneous conclusion that the (statute) is unambiguous on this issue ... the court must remand this rule to the agency".
With Dodd-Frank and the CFTC's interpretations struggling in the courts, which are unable to supply a clear meaning for the statute, the only hope for resolving the ambiguity about congressional intentions is probably fresh legislation.
(John Kemp is a Reuters market analyst. The views expressed are his own)
(Editing by Keiron Henderson)