Finance Professor Weighs in on Derivatives Market Concentration and Position Limits
Commentary by Bob Zwirb
University of Houston Finance Professor Craig Pirrong analyzed CFTC Commissioner Dan Berkovitz's recent speech on issues related to competition in the swaps derivatives market and speculative position limits.
Mr. Pirrong praised Mr. Berkovitz for citing the Federal Reserve's implementation of the liquidity ratio as an example of government action, making it difficult for futures commission merchants to operate. However, he criticized Mr. Berkovitz's support for Dodd-Frank reforms that "have in fact likely increased concentration" by increasing fixed regulatory costs for those operating in this sector.
As for position limits, Mr. Pirrong argued that by Mr. Berkovitz's "own admission, the proposed limits won't address the supposed ill that led Congress to legislate them in the first place"; i.e., to prevent harm caused by an excessive "collective level of speculation." Nor, according to Mr. Pirrong, will they prevent the kinds of manipulations that have occurred in recent years. He also criticized the introduction of a new rationale for such limits - to prevent a single market participant from distorting the market price of a commodity - by labeling this a "bait-and-switch" from the original reason that Congress authorized position limits.
Finally, Mr. Pirrong analyzed the real-world examples cited by Mr. Berkovitz and others in support of such limits - i.e., the episodes involving the Hunt brothers (silver), Ferruzzi (soybeans) and Amaranth (natural gas) - and concluded that they do not provide intellectual support for position limits because none of those episodes would have been prevented had limits been in place.
Commentary
Back in 2011, former CFTC Commissioner Michael Dunn expressed a fear that the CFTC's effort to impose position limits would "at best . . . [be] a cure for a disease that does not exist or at worst, a placebo for one that does." Whether or not his assessment is ever realized, it's certainly true that the rationale for such limits has shifted over time, as Commissioner Berkovitz's offer of yet another justification illustrates. Whether this constitutes a regulatory "bait-and-switch," as Professor Pirrong argues, the fact remains that the search for a consistent and compelling rationale for a broad position limits regime remains elusive.
As to the Commissioner's analysis of competition, one is reminded of a sign that for a number of years adorned Louie's Pizza, a popular pizza stand on the boardwalk at Rehoboth Beach, Delaware, explaining why it accepts payment only in cash, which went something like this: "We have an agreement with Mellon Bank. They don't make pizza, and we don't extend credit." While the CFTC is obliged by the CEA to "take into consideration" antitrust objectives in its oversight of the derivatives markets, perhaps it would be better for all concerned if the agency instead entered into a similar understanding with the DOJ regarding such oversight and the enforcement of the antitrust laws.
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CFTC Commissioner Dan M. Berkovitz advised the CFTC to focus on (i) increasing competition in the derivatives markets and (ii) setting speculative position limits with exemptions for bona fide hedging activities.