CFTC Commissioner Criticizes Proposed Rules on Trading Position Limits
Commentary by Bob Zwirb
CFTC Commissioner J. Christopher Giancarlo warned against the potentially harmful effects of the CFTC's proposed rules on trading position limits. "If left unchanged, the proposed rules will impose federal regulatory edicts in place of commercial judgment in everyday risk hedging," he argued. The Commissioner delivered his remarks in a keynote address before the Capital Link Global Commodities, Energy and Shipping Forum.
Commissioner Giancarlo addressed specific concerns on position limits voiced at panel presentations before the Energy and Environmental Markets Advisory Committee ("EEMAC"). The Commissioner stated that EEMAC had considered the CFTC's proposed "enumerated" hedging proposals and concluded that they would limit transactions that received upfront bona fide hedging treatment. The Commissioner warned that the CFTC now proposes to repeal the current system in which market participants submit proposed risk-reducing transactions for CFTC review and determination as to whether they will be considered bona fide hedging transactions. The Commissioner urged the CFTC "to encourage – not discourage – commercial enterprises to adapt to developments and advances in hedging practices."
The Commissioner focused on the CFTC's proposals to circumscribe the bona fide hedging exemption to position limits. In his address, the Commissioner revealed that the EEMAC "heard evidence" of the CFTC proposal's focus on "'limiting the activity of commercials in hedging the markets,' which in turn increases the risk of pricing commodities."
Finally, the Commissioner noted that the EEMAC panels also discussed potential solutions regarding position limits, including a framework for the CFTC's authorization of the exchanges to grant bona fide hedging exemptions for legitimate risk-reducing strategies. They explored the possibility of exchanges administering a position accountability regime as a way to soften the impact of declining liquidity outside of the spot period.
Commentary
There has always been a serious disconnect between the effect of position limits and the CFTC's stated rationales for them. Prior to the financial crisis, the CFTC sought to extend the application of such limits from agricultural to energy commodities. The CFTC's rationale was that energy derivatives allegedly were inflating the price of oil and natural gas artificially. That rationale was abandoned in 2008, when the CFTC's own economists found that oil prices rose inversely to swap dealer and index fund activity in energy derivatives;i.e., that speculation was actually beneficial.
After the financial crisis, the CFTC stated (initially in vague terms) that limitssomehow were necessary to prevent systemic risk in the financial markets. No empirical evidence was ever given in support of this new rationale, which stretched credulity after one realized that the targets for the initial implementation of such limits – energy and metals – had nothing to do with the financial crisis. Eventually, that rationale, too, was abandoned in favor of a purely legal one: that Congress authorized the CFTC "to impose speculative position limits prophylactically." Even so, if the point of Dodd-Frank is to prevent another financial market crash, then what purpose is served by imposing limits on energy and metals? And if the CFTC ever decided to use its authority on financial derivatives, which played an arguable role in the crash, then how could such a crude tool for dealing with congestion and manipulation in various commodity futures markets be used to deal with the larger problem of systemic risk in the financial markets?
