In a party-line 3-2 vote, the CFTC proposed (see here) applying federal speculative position limits to 25 "core referenced futures contracts," including futures and options linked to those contracts and economically equivalent swaps. The 25 core contracts include 16 related to agriculture, five related to metals, and four related to energy. With the exception of nine of the agriculture products, the federal limits would apply only during the stop month; however, the relevant exchanges (i.e. CBOT, MGEX, ICE, COMEX and NYMEX, depending on the product) would be required to set non-spot month limits in the other contracts.
The position limits would not apply to location basis contracts, commodity index contracts, swap guarantees and certain trade options.
Hedging exemptions would be available for positions that satisfy all three of the following tests: (i) the temporary substitute text; (ii) the economically appropriate test; and (iii) the change in value requirement. The CFTC also stated that it would be open to recognizing hedges that did not meet these requirements. Exemptions from federal position limits would be available for certain types of spread transactions (e.g., calendar spreads). Other exemptions would also be available, including for positions where one company takes over the positions of a second company that is in financial distress. As a general matter, the CFTC has somewhat liberalized the process of seeking an exemption.
"Necessary" Position Limits
CEA Section 4(a)(1) provides that "excessive speculation" may create "unwarranted changes in the price" of commodities, which is an "undue and unnecessary burden on interstate commerce." Under that provision, the CFTC shall establish such rules as it finds are "necessary to diminish, eliminate or prevent such burden."
Formerly, the CFTC had taken the position that CEA Section 4(a)(2)(A) overrode the "necessary" language in Section 4(a)(1), and had directed the CFTC to establish position limits even in the absence of a finding that the limits were necessary. The new proposal requires that the CFTC find that a position limit is necessary before it may be imposed. (See page 230 of the Proposing Release.)
As detailed in the release, the CFTC had previously issued a position limits proposal in 2013, a supplemental proposal in 2016, and a 2016 reproposal. The CFTC states that that comment letters on the former proposals are no longer relevant.
At a CFTC Open Commission Meeting, CFTC Chair Heath Tarbert supported the proposal for protecting Americans against "some of the most nefarious machinations" in the U.S. derivatives market by preventing "excessive speculation." Commissioner Brian Quintenz agreed, stating that the proposal "elegantly balances" the policy interests within the statute by focusing exclusively on spot-month position limits in the proposed set of physically-settled contracts. Commissioner Dawn D. Stump determined the proposal to generally be "workable for both market participants and the [CFTC]." She called for improvements on (i) the list of enumerated hedging transactions and positions, and (ii) the system for reviewing hedging practices outside of the list.
CFTC Commissioner Rostin Behnam disagreed with the proposal, claiming that it "pushes the bounds of reasonable interpretation" by deferring to exchanges and undermining Congress's intent that the CFTC set position limits even in the absence of any finding of necessity. Commissioner Dan M. Berkovitz also dissented, warning that the proposal "ignores" the Dodd-Frank Act and reverses "decades of legal interpretations of the Commodity Exchange Act" by (i) abruptly increasing position limits, (ii) not allowing the CFTC to monitor the increases, and (iii) failing to provide sufficient explanations for other "key approaches" in the proposal.
Comments must be submitted within 90 days after publishing the proposal in the Federal Register.
While there is much that will be debated in terms of the substantive requirements that the CFTC must set (including the numbers, the application to non-spot months, the reporting requirements and exemptive procedures), perhaps the most important issue relates to the proposed requirement that the CFTC should not impose a position limit in the absence of finding that such a limit is "necessary." Both sides made their statutory arguments as to why such a finding was either (i) needed (the Republicans) or (ii) irrelevant (the Democrats). Ultimately, each side favored the statutory reading that favored its philosophical position (Republicans for regulation only to the extent that the need for the regulation can be demonstrated; Democrats for regulation as a prophylactic measure to prevent potential injury). The divide is not easily bridged or settled.
Over the course of the longer debate, there are a fair number who have viewed virtually all of the position limit regulations as useless exercises in political showmanship. See, e.g., Statement of former CFTC Commissioner Michael V. Dunn (Oct. 18, 2011). Even those who are doubtful as to the utility of the regulations may still view the current proposal as making something much worse unlikely. For more on the policy and political issues involved, note the writings of Craig Pirrong (a/k/a the Streetwise Professor), in particular, his recent article: Position Limits: What a Long Strange Trip It's Been.
One of the disappointing aspects in what is an otherwise much-improved version of the CFTC's effort in this area is the persistence of an argument by some members of the Commission that the CFTC need not show that imposing new limits is necessary to achieve certain statutory goals.
In some ways, it seems nothing has changed since 2013 when CFTC Chair Gary Gensler called upon the agency's General Counsel to substantiate the view that the CFTC had no discretion here, and the General Counsel (who is now a Commissioner) obliged by stating that requiring the CFTC to find that such limits were "necessary" or "appropriate" (as called for in the statute) "makes little sense." Even if it were legally correct, such a position would seem to be unwise from a policy perspective given the fact, as all current members of the CFTC concede, that the imposition of such limits will impose substantial costs on the market and its participants. That said, it is not legally correct. The position is at odds with the Commodity Exchange Act, which requires the CFTC to consider a proposed rule's costs and benefits before promulgating it. See CEA Sec 15(a). When a Commissioner states that a necessity finding is unnecessary for such a major rulemaking, what he is really saying is that he is opposed to cost/benefit analysis for any rule "mandated" by Congress.
The problem with the rationale that position limits, in general, to prevent price distortions caused by excessive speculation is that there is a dearth of empirically rigorous evidence to support the view that speculation causes undue price movements in the energy markets. To the contrary, the CFTC's own economists found in 2008 that oil prices rose inversely to swap dealer and index fund activity in energy derivatives; i.e., that speculation actually was beneficial, and the CFTC's own Energy and Environmental Markets Advisory Committee in 2016 found that such position limits as a regulatory tool for energy markets amounted to "a solution to a nonexistent problem." Indeed, given the rapid and persistent decline in oil and natural gas, it would seem that these markets could use a little more speculation today. See, e.g., Brad Schaffer, "Where Have All the Oil 'Speculators' Gone?" The Wall Street Journal, Jan. 26, 2016.
Commissioner Quintenz addressed this lack of evidence. He stated:
"I am aware that there is significant skepticism in the marketplace and among academics as to whether position limits are an appropriate tool to guard against extraordinary price movements caused by extraordinarily large position size."
And the studies reviewed by the CFTC in connection with the 2013 proposal
"demonstrate lack of consensus in the [academic studies] as to the effectiveness of position limits."
On this latter point, it's too bad that Mr. Quintenz didn't take a closer look. In fact, the CFTC economists did not actually evaluate the substance of the issue in 2013; they merely counted the number of studies for and against, and concluded that there was no consensus. In other words, they engaged in no serious qualitative assessment. The prior position limit proposal, in effect, rested on the conclusion that a quantitative tie argued in favor of regulation.
Mr. Quintenz could have made the case that there really is no compelling academic consensus favoring position limits to limit speculation; and that the CFTC's own economics branch analysis of speculation in the energy markets in 2008 concluded that speculation did not adversely affect prices when energy prices spiked but, in fact, were beneficial.