On May 26, 2016, the Commodity Futures Trading Commission (the “CFTC”) voted unanimously to approve for public comment a supplement (the “Proposed Supplemental Notice”) to its December 2013 speculative position limits proposal that would permit exchanges to exempt certain types of hedging and spread positions from position limits, subject to various terms and conditions. Specifically, the Proposed Supplemental Notice would provide a process for an exchange to recognize certain positions in physical commodity derivatives as non-enumerated bona fide hedges or enumerated anticipatory bona fide hedges, as well as to exempt certain spread positions, in each case subject to CFTC review. Additionally, the CFTC is proposing to modify the general definition of “bona fide hedging position” for physical commodities and to delay the requirement to establish and monitor position limits on swaps for designated contract markets (each, a “DCM”) and swap execution facilities (each, a “SEF,” and together with DCMs, “exchanges”) that do not have access to sufficient swap position information. The Proposed Supplemental Notice will be open for public comment for thirty days following publication in the Federal Register, which is expected to occur shortly.
In the December 2013 speculative position limits proposal (the “December 2013 Position Limits Proposal”), the CFTC proposed revised speculative position limits for certain futures contracts, options and economically equivalent swaps on twenty-eight numerated physical commodities (i.e., enumerated agricultural, energy and metal commodities).1 The December 2013 Position Limits Proposal included a definition of “bona fide hedging position” which limited the scope of bona fide hedging strategies to a specific list of enumerated hedging strategies, and also eliminated certain spread exemptions. That definition of a bona fide hedging position included an incidental test and an orderly trading requirement as well.
Commenters to the December 2013 Position Limits Proposal urged the CFTC to permit exchanges to recognize non-enumerated hedging strategies as bona fide hedges instead of limiting bona fide hedging to a prescriptive list of enumerated hedging strategies, and to grant certain spread exemptions with regard to both exchange-set and federal position limits. Commenters also advocated that the CFTC eliminate the incidental test and the orderly trading requirement from the general definition of bona fide hedging position, and that the CFTC not require exchanges to establish position limits on swaps because, among other reasons, of the current impracticability of exchanges being able to monitor and enforce swap position limits.
In response, the CFTC is proposing first, to permit an exchange to submit to it for review rules or rule amendments under which the exchange could take action to recognize certain non-enumerated hedging strategies as bona fide hedging positions with regard to both exchange-set and federal position limits. Pursuant to the Proposed Supplemental Notice, a qualifying exchange would be able to: (i) recognize certain non-enumerated bona fide hedging positions (“NEBFHs”); and (ii) recognize certain enumerated anticipatory bona fide hedging positions. Positions recognized by an exchange as a NEBFH or an enumerated anticipatory bona fide hedge would not be subject to federal position limits (as well as exchange-set position limits), absent notice from the exchange or the CFTC.
Second, the CFTC is similarly proposing to allow exchanges to grant exemptions from federal and exchange-set position limits for certain spread positions, in each case subject to CFTC review. Such positions would include calendar spreads, quality differential spreads, processing spreads, and product or by-product differential spreads.
To be eligible to administer and implement such a process, an exchange would have to meet certain criteria, such as having at least one year of experience administering exchange-set position limits. As Commissioner Giancarlo observed, this proposal “leverages exchange expertise and resources to enable exemptions to be granted in an efficient and timely manner without sacrificing market integrity. The [CFTC] would remain the ultimate arbiter of exemptions from position limits by retaining the authority to review and reverse any exchange-granted exemption.”2
A market participant receiving any such exemption would have to renew it annually with the relevant exchange. In lieu of submitting an application to an exchange, a market participant also may continue to request an interpretative letter or exemptive relief from the CFTC.
Third, the CFTC is proposing to eliminate the incidental test and orderly trading requirement from the general definition of bona fide hedging position. In doing so, the CFTC noted that bona fide hedging positions must still be “economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise” involving price risk, and that an exchange may use its own discretion to condition its recognition of a bona fide hedging position on an orderly trading requirement.
Fourth, the CFTC is proposing a delay in the implementation of exchange-set position limits for swaps on exchanges that do not have access to sufficient swap position information to monitor and enforce such limits. As a practical matter, this aspect of the Proposed Supplemental Notice means that DCMs and SEFs will not be implementing a position limit regime for swaps, at least in the near future. It should be noted though that federal position limits would apply to swaps that are economically equivalent to futures contracts which are subject to federal position limits under the December 2013 Position Limits Proposal.
The CFTC is requesting comment on all aspects of the Proposed Supplemental Notice. In particular, the CFTC is soliciting comments on a series of sixty-eight specific items set forth therein.
The Proposed Supplemental Notice improves the CFTC’s December 2013 Position Limits Proposal in a number of significant respects. Among other things, it provides some needed flexibility to permit non-enumerated hedging strategies to be recognized as bona fide hedges and builds upon the exchanges’ long experience in granting exemptions from exchange-set position limits. Finally, Chairman Massad reiterated that the CFTC is working toward finalizing its rules on position limits this year.3