CFTC Re-Proposes Position Limits On Physical Commodity Derivatives

Yesterday, the CFTC voted to approve a new position limits rule that resembles the agency’s previous short-lived rule (vacated and now abandoned after court challenge), albeit with certain significant changes.

Affected Contracts

The position limits will apply to 28 core futures contracts in physical commodities and their “economically equivalent” futures, options, and swaps. The 28 contracts include 19 agricultural contracts, 5 metal contracts, and the following four energy contracts:

(1) NYMEX Henry Hub Natural Gas (NG);
(2) NYMEX Light Sweet Crude Oil (CL);
(3) NYMEX RBOB Gasoline (RB); and
(4) NYMEX NY Harbor ULSD (HO).

The CFTC provided new clarification that a swap may be considered “economically equivalent” to a futures contract when it is:

(1) a “look-alike” contract
(2) a contract with a reference price based on “only the combination of at least one referenced contract price and one or more prices in the same or substantially the same commodity as that underlying the relevant core referenced futures contract, provided that such a contract is not a locational basis swap”;
(3) an intercommodity spread contract with two reference price components, one or both of which are based on referenced contracts; or
(4) a contract priced at a fixed differential to a core referenced futures contract.

Spot-Month Limits

Spot-month position limits will generally be set at 25% of estimated deliverable supply, applied separately to physical-delivery and cash-settled contracts in the same commodity. Traders with only cash-settled positions in a commodity in the spot month may be eligible for an exemption allowing them to hold up to five-times the level of the normal cash-settled limit. Initial spot-month limits will be based on limit levels currently in place at designated contract markets (DCMs) or on estimates of deliverable supply in a commodity submitted by a DCM. Subsequent levels will be adjusted at least every two years and will be based on deliverable supply.

Non-Spot-Month Limits

Non-spot-month position limits (applied to positions in all contract months combined or in a single contract month outside of the spot month) will be set at 10% of the contract’s first 25,000 contracts of open interest plus 2.5 percent of any open interest beyond that. Open interest will be based on the sum of open interest in futures and cleared and uncleared swaps. Initial non-spot-month position limits will be based on open interest in futures and swaps that are significant price discovery contracts. Subsequent levels will be adjusted at least every two years based on referenced contract open interest for a calendar year.

Bona Fide Hedge Exemptions

As before, bona fide hedge positions will be exempt from the position limits. However, statements by Commissioners O’Malia and Wetjen indicate that the bona fide hedge exemption for anticipatory hedges has been narrowed significantly and that the Section 1.47 process for seeking exemptions for non-enumerated hedges has been eliminated. These important aspects of the rule are sure to draw significant attention from end users who rely on the hedge exemption with respect to their own positions or are concerned about the effects of the position limits rule on market liquidity.

Aggregation of Positions Across Affiliates

The CFTC also released the text of its companion “aggregation” rule to the position limits rule, which is similar to its previous aggregation proposals. Subject to certain exemptions, the rule requires “all positions in accounts for which any person . . . controls trading or holds a 10 percent or greater ownership or equity interest” to be aggregated with the positions held and trading done by such person.

Exemptions from aggregation are available with respect to:

(1) Limited partners, limited members, shareholders or other similar types of pool participants holding 10 percent or greater ownership in a pool, subject to certain further requirements.

(2) Entities in which a person holds between a 10 percent and 50 percent ownership or equity interest, provided that such person and the owned entity: (A) do not have knowledge of the trading decisions of the other; (B) trade pursuant to separately developed and independent trading systems; (C) have and enforce written procedures to preclude each from having knowledge of, gaining access to, or receiving data about, trades of the other; (D) do not share employees that control the trading decisions of either; and (E) do not have risk management systems that permit the sharing of trades or trading strategy.

(3) Entities in which a person holds greater than 50 percent ownership, as long as the entity is not required to be consolidated on the person’s financial statements under GAAP, requirements (A) through (E) above are met, and certain certifications are made, subject to the approval of the CFTC.

(4) Subject to additional requirements: futures commission merchants, independent account controllers, underwriters, broker-dealers, persons for which the sharing of information associated with aggregation would create a reasonable risk of violation of other law, and higher-tier entities with respect to an owned entity that has already filed a notice of exemption.

In general, persons seeking to take advantage of these exemptions from the aggregation requirement must file a notice with the CFTC.

Impact of the Rule

The position limits rule has not been published yet, but is expected to allow for a 60-day comment period and to become effective 60 days after approval and publication in its final form. The rule is expected to provide an additional exemption for good faith pre-existing positions. The CFTC estimates that the rule will affect 400 traders, not taking into account the number for traders eligible for the various exemptions. This is estimated to include 148 traders with respect to spot-month position limits in referenced energy contracts and 11 with respect to non-spot month position limits in referenced energy contracts.