On December 5, 2016, the Commodity Futures Trading Commission (the CFTC) voted unanimously to repropose regulations implementing limits on speculative futures and swaps positions (the Reproposed Position Limit Rules), including position limits for 25 core physical agricultural, metals and energy commodity futures contracts (Core Referenced Futures Contracts) traded pursuant to the rules of a designated contract market (DCM) and their “economically equivalent” options and swaps. In a separate vote, the CFTC unanimously approved final aggregation rules (the Final Aggregation Rules) that will be applicable to the CFTC’s existing position limits regime, and if adopted, the Reproposed Position Limit Rules. The Reproposed Position Limits Rules will be open for a 60-day public comment period upon publication in the Federal Register, which has not occurred as of the date of this Sidley Update.
Background
Excessive speculation in commodity markets has long been viewed by Congress and the CFTC as creating the potential for market abuse and price distortions. To address this threat, Section 4a(4) of the Commodity Exchange Act (CEA) provides the CFTC with broad authority to set position limits. The current position limits regime and aggregation rules are set forth in Part 150 (the Existing Rules) of the CFTC’s regulations. The CFTC adopted further regulations in October 2011, but those regulations were vacated by court order prior to their implementation. In response to the vacating of the previous rulemaking, the CFTC proposed to amend existing aggregation rules in November 2013 and derivative position limits in December 2013 (the 2013 Position Limit Proposal). For an overview of the issues raised in the December 2013 Position Limit Proposal and prior rulemaking efforts, please consult previous Sidley Updates.1 Subsequently, the CFTC issued further proposals regarding aggregation in September 2015 and regarding position limits in May 2016.
Reproposal of Position Limits
Position Limits
The Reproposed Position Limit Rules generally would set initial spot-month position limits at a level based on 25 percent of the deliverable supply of the commodity underlying each Core Referenced Futures Contract. DCMs would provide to the CFTC estimates of deliverable supplies, which the CFTC would verify. However, DCMs would also retain the ability to adopt limits lower than those set by the CFTC. The Reproposed Position Limit Rules would set non-spot month position limits (i.e., positions in a single month or all months combined) at 10 percent of the open interest for the first 25,000 contracts and 2.5 percent of the open interest thereafter. The spot-month limits being proposed by the CFTC are generally at or above levels previously proposed and the proposed non-spot month limits are above previously proposed levels (see Appendix). The CFTC would subsequently reset spot and non-spot month position limits at least every two years. The CFTC is not reproposing position limits on three cash-settled core referenced futures contracts that were included in the 2013 Position Limit Proposal (CME Class III Milk, Feeder Cattle and Lean Hogs) because it is not yet clear whether limits should be applicable and the CFTC seeks to consider proper calculation methods for these contracts.
Bona Fide Hedging Definition and Exemption
The Reproposed Position Limit Rules would revise parts of the CFTC’s “bona fide hedging position” definition consistent with past proposals (including elimination of the incidental test2 and orderly trading requirement3). For “excluded” commodities, which generally include rates and financial interests, the CFTC further clarifies the discretion of DCMs to determine risk management exemptions. For physical commodities, the CFTC proposes to amend the definition to more closely conform to Section 4a(c) of the CEA. It also proposes an application process for recognition of non-enumerated bona fide hedging positions without need for petitioning the CFTC. The revised definition applies the five-day rule4 to four types of enumerated hedges and withdraws the safe harbor quantitative test for cross-commodity hedges. The CFTC is also proposing other changes to the definition of bond fide hedging.
Implications for DCMs/SEFs
The Reproposed Position Limit Rules set requirements and practices for DCMs and swap execution facilities (SEFs) to set position limits. However, establishment and monitoring of swaps limits would be delayed if a DCM or SEF lacks sufficient information about swaps positions.
Final Regulations on Aggregation of Positions
The Existing Rules governing position aggregation require that, absent an exemption, a person must aggregate all positions in nine agricultural commodities5 in which a person, directly or indirectly, holds an ownership or equity interest of 10 percent or greater, as well as positions in accounts over which the person controls trading. The Final Aggregation Rules retain current CFTC exemptions for (i) eligible entities that delegate control of a client account to an independent account controller; (ii) futures commission merchants who hold discretionary accounts or manage customer trading programs; and (iii) most passive commodity pool participants. The Final Aggregation Rules also provide new exemptions for (i) market participants, such as parent companies, that hold at least a 10 percent interest in an owned entity, where the two entities have written procedures that enforce their trading independence from each other; (ii) underwriting and broker-dealer activities; and (iii) situations where information sharing would violate law, as supported by a written memorandum of law. Market participants must file a notice with the CFTC to rely, or continue to rely, on these revised exemptions. The Final Aggregation Rules will be effective February 14, 2017.
Conclusion
Final position limit rules may differ significantly from the proposed rules, particularly in light of the fact that Chairman Massad will no longer be chairman effective in early 2017. Comments on the Reproposed Position Limit Rules must be submitted no later than 60 days after publication in the Federal Register, which has not occurred as of the date of this Sidley Update.
1 Previous Sidley Updates on the CFTC’s position limits rulemakings: Try and Try Again: CFTC Proposed to Replace Vacated Position Limits Rules with New Rules (Nov. 26, 2013).
2 The incidental test requires, for a position to be recognized as a bona fide hedging position, that the purpose is to offset price risks incidental to commercial cash, spot or forward operations.
3 The orderly trading requirement mandates that such a bona fide hedging position is established and liquidated in an orderly manner in accordance with sound commercial practices.
4 The five-day rule would not recognize as bona fide hedges an offset in physical-delivery contracts during the shorter of the last five days of trading or the time period for the spot month in such physical-delivery commodity derivative contracts.
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