WASHINGTON U.S. futures regulator will unveil this week a broad framework for controlling speculation in commodity markets but will likely delay imposing detailed limits in the face of industry concerns that trading volumes would dry up.
Capping the number of contracts that a single speculator can hold is part of an almost three-year crusade to prevent another damaging surge in prices. But it has proven to be one of the most challenging parts of the Dodd-Frank U.S. financial reform act for the U.S. Commodity Futures Trading Commission to implement.
As a result, Chairman Gary Gensler seems set to take a measured approach at Thursday's hearing, possibly releasing only parts of the proposal and giving the agency more time to collect data on the $600 trillion swaps market, experts say.
"They've started to gather information about these markets but they don't have full transparency ... and there is some concern that you don't have the information you really need to come up with firm limits," said Dan Waldman, a partner with law firm Arnold & Porter and a former chief counsel at the CFTC.
Even if it takes a softer approach out of concern it may reduce liquidity, the limits would be the most aggressive measures yet by the CFTC to temper the impact of financial speculators in volatile commodities derivatives markets.
Major companies from BlackRock, which operates the iShares ETFs, to Goldman Sachs to Royal Dutch Shell are lobbying hard to prevent overly restrictive rules, which they say could reduce investment, curtail liquidity, increase volatility and undermine their hedging.
Gensler said last week the proposals would include two parts, one for the spot month and another for all months combined. He has asked if the agency had the legal ability to establish a formula, but wait to put the limits into force until it knows more about the size of swaps markets.
Industry watchers are looking to see how closely the new measures mirror those released in January, which attracted a barrage of criticism from most market participants, even though the absolute limit -- at 25 percent of deliverable supply in the spot month -- was not seen as particularly onerous.
"They are concerned about how bona fide hedges will be treated and applied, as well as how the CFTC applies its aggregation policy to parties transacting in exempt commodity markets," said Michael Sweeney, partner with Hunton & Williams.
In particular they will be asking:
* will the proposal be more or less onerous than limits that are already in place in agricultural markets, or the agency's energy markets proposal earlier this year?
* will the CFTC force companies to aggregate their holdings across all of their accounts, regardless of whether they are jointly controlled?
* how will exemptions be handled for companies that not only hedge their own physical price risk, but also run speculative books or offer swaps to customers?
At the heart of the issue is an ongoing debate over the role of large-scale investors and speculators in commodity markets, which until recent years were dominated by companies that produced, consumed or traded the physical commodity.
Supporters say large, passive investors are distorting the market, driving prices higher irrespective of fundamentals, and should be limited; critics say these speculators don't affect prices over the longer term, and worry that capping their involvement would curtail liquidity and drive up volatility.
The CFTC's focus on commodity market investors dates to early 2008, prior to the financial crisis, when the price of oil, wheat and other commodity surged to records. Growing pressure from consumers and lawmakers prompted the agency to propose limits for oil and gas futures markets this year.
But the plan, which drew opposition from three CFTC commissioners worried it would drive trading overseas or to less-regulated over-the-counter markets, was withdrawn after Congress gave the agency broader powers that included swaps.
The new, revised position limits plan will apply to all physical commodities including metals and agricultural goods, in addition to energy, and to both futures and swaps markets.
"Crude is around $90... I'm not saying it's speculators, but it's our job to do what we can and now we have the law on our side," CFTC Commissioner Bart Chilton, said last week.
For futures, limits will probably be based on open interest, and are expected to be high in the beginning, similar to what was proposed in January.
Limits for swaps -- and aggregate limits across futures and swaps -- are trickier. The CFTC will not know the size of swaps markets and who is trading them until it sets rules for the trading, clearing and reporting of swaps, and players implement them -- a process that will take months if not years.
The commissioners are likely to be at odds on Thursday, as they have through much of the rule-making process.
Republican Commissioner Jill Sommers has already said she opposes setting a formula without swaps data; others like Democrat Bart Chilton have urged the agency to move faster.
But Gensler's tough position was buttressed last week by a European Commission proposal that also would open the door to position limits on Europe's large commodities exchanges, despite opposition from the UK Financial Services Authority; a crack-down in Europe could help prevent traders from fleeing stricter U.S. regulations in search of laxer venues.
CFTC officials were subjected to a tight deadline by Congress, which gave them 180 days to have the new rule in place for energy and metals markets, and 270 days for limits for agricultural markets.
Even if the CFTC publishes the plans in the government's Federal Register this week, it must open them to a 30-day comment period before determining if any changes need to be made. That puts the agency close to the mid-January deadline for energy and metals.
Whatever the CFTC proposes on Thursday, it is expected to be released for public comment. The final vote, however, could be close with Democrat Michael Dunn, the longest serving commissioner, expected to be the deciding factor.
(Editing by Marguerita Choy)