On January 13, 2011, the Commodity Futures Trading Commission ("CFTC") approved a Notice of Proposed Rulemaking ("NOPR") regarding the imposition of federally-mandated position limits for derivatives, including swaps, under the CFTC's new authority over derivatives markets pursuant to the Dodd Frank Act. At its last meeting in December, the CFTC had to table the same proposal after Commissioner Chilton voiced concerns that it did not go far enough in imposing position limits, and Commissioners Sommers and O'Malia voiced opposition to the plan.
The proposal approved by the CFTC on January 13 would impose position limits on physical delivery futures contracts and their "economically equivalent" derivatives (including swaps) in two phases: First, spot-month position limits only, based on deliverable supply determined by designated contract markets such as NYMEX; and second, spot-month position limits based on the Commission’s determination of deliverable supply, and position limits outside of the spot-month. Spot-month position limit levels would be set at 25% of deliverable supply (or higher for entities with positions only in cash-settled contracts), and non-spot-month position limits set at 10% of open interests in a given contract for the first 25,000 contracts, and 2.5% thereafter. It appears that all swaps which are deemed to fall under the similar futures contract umbrella will be included within the limits proposal. The limits would be subject to exemptions for bona fide hedging transactions, as well as exemptions for positions established in good faith prior to the limits' effective date.
It is still not entirely clear from the NOPR exactly what swaps will be covered by the proposed limits; however, it appears designed to apply to all linked, economically equivalent swaps, including bilateral OTC swaps that are exempt from clearing. Additionally, it does not appear that the position limits will be exchange-specific. Rather, as stated by the Commission, the "proposed spot limits would apply on an aggregate basis." The definition of Swap as set forth in the regulatory text refers to the Dodd Frank definition; the CFTC has yet to further develop that definition through an expected rulemaking.
For compliance with the position limits, positions in referenced contracts would be aggregated to a single account among firms where any upstream owner has direct or indirect ownership or equity of 10% or greater. The NOPR provides an opportunity to show that firms are under separate management, but indicates that the Commission does not expect to permit disaggregation unless a very strong showing is made.
The proposal seems fraught with tracking, compliance and enforcement issues. Since the covered swaps are not explicitly listed, there is no clarity as to the specific swaps/futures that must be aggregated to determine whether an entity has reached its position limit. Further, unlike exchange-traded, specific products, OTC swaps are not all standardized but still may be "linked" and thus subject to limits. It is unclear how or whether regulators will be able to survey compliance with position limits. Their visibility today is limited to exchange traded products. The CFTC does not currently track position limits compliance as that is a function of exchange compliance personnel. Unless there is more clarity in this area, compliance with these limits will be challenging and the ability to automate aggregation questionable.
It remains far from clear that the Commission will ultimately have the votes to enact a final rule on position limits. Commissioner Sommers was the lone Commissioner to vote against even issuing the NOPR; however, both Commissioners Dunn and O'Malia expressed great skepticism about the position limits proposal, and made clear that they were voting to put it out for comment but were far from convinced that they would support a final rule. Commissioner Dunn stated that he is not convinced the Commission has enough data about the swaps markets to enforce or even prescribe position limits at this time, and that there is no reliable economic analysis proving that position limits to curb excessive speculation in the swaps markets would have any favorable impact on commodity prices. Finally, Commissioner Dunn expressed his fear that "at best, position limits are a cure for a disease that does not exist . . . or at worst, a placebo for one that does."
The NOPR will be open for public comment, with comments due 60 days after publication in the Federal Register. Given the impact of the proposal, its ambiguity, and the lack of unanimity at the Commission level, it is important that interested persons file comments. The outcome of the proposal is still uncertain and comments will play a significant role in shaping any final rules, as well as whether position limits will be imposed at all.