(Reuters) - The U.S. futures regulator has modified its plan to limit excessive speculation in the commodity markets by clamping down on how many contracts a larger speculative trader can control, according to a draft of the final rule obtained by Reuters.
Here are details of the major changes the Commodity Futures Trading Commission is considering for its final rule:
* The CFTC is eliminating the proposed category of referenced paired contracts, namely, those based on “substantially the same supply and demand fundamentals”.
* For non-spot month limits for non-enumerated agricultural, energy and metals referenced contracts — which are dependent on open interests and thus dependent on swaps positional data — the CFTC will initially set such limits after 12 months of data has been collected.
* The CFTC said in light of the above referenced timeframe for implementation, the compliance date for all spot-month limits and non-spot-month legacy limits shall be 60 days after the term swap is defined.
CASH-SETTLED AND PHYSICALLY SETTLED
* The CFTC will keep the proposed spot-month position limit provisions, but will make a few changes. It said the final rules provide that the spot-month position limit for cash-settled contracts will be set at five times the level of the spot-month limit in the relevant core referenced, physically settled contract.
* The CFTC will eliminate the proposed conditional limit (i.e., the condition that the trader may not have any position in the physically settled Referenced Contracts). The agency said it agreed with comments it received urging it to gain further experience with swaps to ensure adequate liquidity for bona fide hedging transactions and positions before imposing restrictive conditions on people holding both cash-settled and physical delivery referenced contracts.
* Under the final rule a speculative trader may hold only 5,000 cash-settled contracts in total (since a trader must add its NYMEX cash-settled natural gas futures contract position (NN) to its ICE Henry Hub Physical Basis Contract (LD1) position) under the conditional spot month limit. Further, other economically equivalent contracts would be aggregated with a trader’s cash-settled contracts in NN and LD1.
* The proposed rule aggregates the related cash-settled contracts, whether swaps or futures. The CFTC said for example, a trader under current rules may hold a position equivalent to 5,000 Henry Hub Natural Gas contracts in each of the NN and LD1 contracts (10,000 in total).
* The CFTC said a trader must at all times fall within the class limit for the core referenced physical delivery contract, the five times limit for cash-settled referenced contracts in the same commodity, and the five times aggregate limit.
CHANGES TO SPOT, NON-SPOT MONTH LIMITS
* The CFTC will update the spot-month limits every two years instead of annually, and stagger the dates on which estimates of deliverable supply shall be submitted by the designated contract markets.
* The initial non-spot month position limits, under the initial non-spot month limits for non-legacy agricultural, energy, and metals referenced contracts will be calculated and published after the CFTC has received data sufficient to determine average all-months-combined aggregate open interest for a full 12-month period.
* The aggregate open interest will be derived from various sources, including data received from designated contract markets, and data regarding linked, direct-access foreign board of trade contracts.
* To set initial limits, the CFTC will use reasonable working assumptions about positions in various market segments. The agency will strive to set non-spot month limits in an expedited manner while ensuring it has sufficient swaps data to properly estimate open interest levels.
* Position limits on legacy contracts will be set at levels proposed by CME Group. It would be a measured approach to increasing limits.
* The CFTC will use the CME Group’s all-months-combined petition level as the basis for increasing the non-spot month limits. Based on 2009 average month-end open interest, the petition levels result in limits that are from 23 percent to 85 percent higher than proposed.
* To maintain parity, the CFTC will increase limits on wheat at the Minneapolis Grain Exchange and the Kansas City Board of Trade to the levels of the wheat contract at the CBOT.
EASIER TO CLAIM A PASS-THROUGH SWAP EXEMPTION
* The rule would reduce the burden of claiming a pass-through swap exemption.
* Counterparties would be required to obtain from their counterparty a representation the swap, in its good-faith belief, would qualify as an enumerated hedge.
* Representation must be made at the inception, i.e., execution of swap and the bona fide hedger must keep records to support the representation for at least two years following expiration of the swap.
* The party making such a representation shall keep all relevant books and records supporting the representation for at least two years following expiration of the swap.
* Entities required to aggregate accounts or positions will be considered as the same person when determining eligibility for the bona fide hedging exemption.
* New language is intended to make aggregation and bona fide hedging provisions consistent.
* For example, a holding company that owns a large enough share of an operating company would need to aggregate its positions with those of the holding company in order to determine if they are in compliance with position limits.
NO RESTRICTIONS ON HEDGING CASH-SETTLED CONTRACTS
* The CFTC eliminates all restrictions on holding a bona fide hedge position for cash-settled contracts. It would narrow the restriction on holding a bona fide hedge position in physical delivery contracts.
* Rule reaffirms CFTC requirement to aggregate positions that a trader owns in more than one account, including accounts held by entities in which that trader owns a 10 percent or greater equity interest.
* For example, a financial holding company is required to aggregate house accounts (that is, proprietary trading positions of the company) across all wholly owned subsidiaries.
* Eligible entities, such as mutual funds, banks, CPOs, CTAs, and insurance companies, may disaggregate customer positions or accounts that are managed by an independent account controller (IAC) from its proprietary positions, outside of the spot months.
* In determining if an IAC trades independently, the CFTC will consider whether there is a functional separation between the proprietary trading desk of the eligible entity and the desk responsible for trading on behalf of the managed client accounts.
* The CFTC also will consider the degree of separation between the research functions supporting a firm’s proprietary trading desk and the client trading desk.
* A firm’s research can be available to an IAC but its recommendations may not be substituted for independently derived decisions on trading. If the person overseeing the account routinely follows the firm’s trading advice, the ensuing trades will be evidence the account is controlled by the firm.
* Rule will retain the current disaggregation exemption for interests in commodity pools. The exemption originally was a response to the growth of professionally managed futures trading accounts and pooled futures investment.
* Disaggregation for ownership in commodity pools, subject to appropriate safeguards, can provide flexibility to the markets, while at the same time protecting them from the undue accumulation of large speculative positions owned by a single person or entity.
* To accommodate compliance costs, the position visibility level would be raised to approximately 50 percent of the projected aggregate position limit, based on current futures and swaps open-interest data, with the exception of New York Mercantile Exchange light sweet crude oil and New York Mercantile Exchange Henry Hub natural gas contract.
* For the NYMEX and light sweet crude oil and Henry Hub natural gas contracts, the visibility levels are set lower to approximate the point where 10 traders, on an annual basis, would be subject to position visibility reporting requirements.