On March 23, the Commodity Futures Trading Commission (CFTC or “Commission”) adopted final rules and rule amendments to implement the CFTC Reauthorization Act of 2008 (“Reauthorization Act”). The Reauthorization Act and these implementing rules establish a new regulatory category — exempt commercial markets (ECMs), on which significant price discovery contracts (SPDCs) are traded. The proposed rules, published on December 12, 2008, and open to comment through February 10, 2009, were summarized in an Alston & Bird advisory, available at http://www.alston.com/fisap_CFTC_proposed_rules_ECMs. The new rules will become effective on April 22, 2009. This advisory discusses the notable distinctions between the proposed and final rules.
What Is the Chief Effect of the Final Rules for Market Participants?
The final rule and rule amendments place greater self regulatory obligations on exempt commercial markets, particularly in relation to monitoring and enforcing compliance with the rules of their market. Traders will be most affected by the position limits imposed on cleared SPDCs.
How Do the Final Rules Differ From the Proposed Rules?
The Commission proposed using four criteria when identifying whether a contract is an SPDC: price linkage, arbitrage, material price reference and material liquidity. No one factor would control, however, and the Commission would have wide discretion in determining whether a contract is an SPDC. Generally, the Commission proposed to look at whether the trading volume of an ECM contract is high enough to affect regulated markets, whether the contract serves as an independent price reference used by the public, whether the contract’s settlement terms are linked to the settlement price of a contract traded on a Designated Contract Market or whether the contract can be used to effectively arbitrage between markets.
The Commission would make this determination by issuing an order, after publication in the Federal Register, of an invitation to the ECM and other interested persons to provide written data and views relevant to the Commission’s determination. The Commission would learn of potential new SPDCs through its own information and surveillance activities, in addition to the proposed requirement that ECMs notify the Commission that a contract potentially may serve as an SPDC.
Commenters expressed concern over the lack of a clear timetable for the issuance of the order. The Commission amended the final rule to specify that, “after prompt consideration,” such an order shall be issued within a “reasonable period of time after the close of the comment period.”
Grace Period for ECM Compliance
The Commission proposed that, if it determined that an ECM was trading SPDCs, the ECM be allotted a grace period for compliance of 90 days for initial SPDCs, or 15 days for subsequently identified SPDCs. The final rules extend the 15-day grace period for subsequently identified SPDCs to 30 days. The 90-day period for initial SPDCs remains unchanged.
Speculative Position Limits and Accountability Levels
The Commission proposed that ECMs be required to adopt position limits or position accountability levels for cleared SPDCs. Once a trade exceeds an established limit, the ECM would initiate an investigation to determine whether the individual’s position is bona fide and, if not, order the trader to reduce the position. The Commission anticipates that SPDCs would be subject to spot month speculative position limits. The Commission also proposed that uncleared SPDCs would be subject to a new measure of trading activity, the “volume accountability level,” which would operate in a manner similar to position accountability rules.
Commenters expressed concerns over the different position limit and accountability levels for cleared and uncleared SPDCs. A primary objection was that creating separate categories may enable traders to distort their positions by holding a combination of cleared and uncleared positions, even on the same market.
The Commission agreed that the issue merits further investigation and deferred adopting final rules with respect to uncleared SPDCs. The Commission intends to issue a future notice of proposed rulemaking specifically addressing uncleared trades on ECMs.
Large Trader Position Reporting
The CFTC also proposed to impose large trader position reporting requirements with respect to cleared contracts that have been found to be an SPDC. ECMs would be required to provide clearing member reports for SPDCs to the Commission. The reported information would be required to include settlement prices, price range, volume, open interest and other pertinent market information. In addition, the Commission proposed to require ECMs to provide trade data on a daily basis, including data that would identify the trader for each transaction executed on the market. The Commission will use this data in its trade practice, market and financial surveillance programs.
Commenters expressed concern over the scope of the proposed reporting rules, and the Commission amended the final rules to define the terms “futures” and “options contracts” (solely for the purpose of the reporting rules) as contracts executed on or subject to the rules of reporting markets, and all agreements, contracts and transactions that are treated by DCOs as fungible with such contracts. This definition is intended to clarify that the reporting rules apply to ECMs that list SPDCs, to SPDCs and to transactions that are treated as fungible with SPDCs by DCOs.
Self-Regulatory Oversight and Reporting by ECMs
The Commission proposed that an ECM trading SPDCs be required to monitor and enforce compliance with the rules of its market in order to prevent manipulation, price distortion and disruption of the delivery or cash-settlement process. It also proposed that all ECMs file quarterly reports about the terms and conditions for all contracts traded on the facility, whether or not the contract has been found to be an SPDC. Additionally, all ECMs must submit weekly reports for contracts that average five trades per day or more. The Commission largely adopted these requirements as proposed.