Citing the apparent trading irregularities of Amaranth Advisors LLC and large positions taken by the United States Natural Gas Fund LP (UNG) as evidence of the need for aggressive action, the Commodity Futures Trading Commission (CFTC) last Thursday voted out a notice of proposed rulemaking (NOPR) that would set limits on speculative trading of exchange-traded futures and options contracts in major energy markets.
The vote to issue the proposed rule for comment was approved by 4-1 with Commissioner Jill E. Sommers dissenting. Sommers said the fact that the proposed rule would only be imposed on the regulated exchanges where the CFTC currently has jurisdiction would drive traders into the unregulated over-the-counter (OTC) markets. Commissioner Michael Dunn reluctantly voted to issue the rule so the CFTC could receive comments, but he said he was not committed to endorsing a final rule.
Dunn expressed alarm and said the CFTC was doing more harm than good with its action. "I am very concerned that...putting position limits [in place] without having over-the-counter authority and some type of agreement internationally ...that we will end up with less transparency in the marketplace than we currently have."
Steve Sherrod, acting director of surveillance, acknowledged that this was a possibility. But Commissioner Bart Chilton said he didn't think the proposal went so far as to force trading to migrate to OTC or foreign markets. "We have erred on the high side here" with the position limits, and that will help to avoid any migration, he noted.
Chairman Gary Gensler acknowledged that the proposed rule only would solve part of the problem, noting that legislation was working its way through Congress that would hand the CFTC additional authority with respect to OTC markets. By going ahead with position limits for the regulated futures markets, the CFTC would be putting pressure on Congress to complete legislation bringing OTC markets into the fold. Then, if the CFTC completes the rules for regulated exchanges, they could extend similar rules to the OTC market.
If the proposed position limits had been in effect in 2006, they would have trimmed Amaranth's positions in a single-month contract and all-months-combined [AMC] contract for a number of days, a CFTC staff official said (see NGI, Sept. 25, 2006). And UNG's trading activity last year would have been restricted as well, he added (see NGI, June 22, 2009). "We're...trying to address those large traders that have a large concentration of positions that would give them market power" in energy futures markets.
The proposed limits would apply to four energy markets: Henry Hub natural gas, light sweet crude oil (such as West Texas Intermediate), New York Harbor No. 2 heating oil and New York Harbor gasoline blend stock. They also would extending to energy trading on the CFTC-regulated exchanges, notably CME Group's New York Mercantile Exchange (Nymex) and the IntercontinentalExchange (ICE) in Atlanta. The proposal would offer exemptions for certain swap dealer risk management transactions while maintaining exemptions for bona fide hedging.
Sherrod estimated that 10 large traders across the four energy markets may be affected by the position limits prospectively, with the majority of them (seven) not being eligible for any exemptions. The CFTC said 23 large traders (only one natural gas trader) would have been affected in 2008 and 2009 had the proposed limits been in effect.
Only a "handful of those...purely appear to be speculators...They engage in commercial activity that would be [for] physical handlers of commodities, producers or swap dealers," an agency official said.
In the large natural gas and oil markets, which have many traders, "it's not surprising that we wouldn't trim very many positions," an official said. But "in the relatively smaller markets -- gasoline and heating oil -- more owners would have been stranded by these [position] limits."
As with its position limits for agricultural commodities, the CFTC proposes to set position limits across the same contract month groupings: AMC; single-month and spot month.
The AMC speculative position limit would be 10% of the first 25,000 contracts of open interest and 2.5% of open interest beyond 25,000 contracts. The single-month position limit would be set at two-thirds of the AMC position limit, the CFTC said. The approach for setting the level of the spot-month limit in the physical delivery contracts would be the same: 25% of the estimated deliverable supply.
To promote competition for a small reporting market, the AMC limit would be up to 30% of a contract's total open interest on that exchange. The single-month limit that would apply to a single exchange would be equal to two-thirds of the value -- or as much as 20% -- of the total open interest on that exchange.
The CFTC proposes to set two types of position limits: aggregate and class limits. An aggregate limit would bar a trader from "establishing large positions on the same side of the market across all contracts in a referenced energy commodity," Sherrod said. And a class limit would restrict a trader from "establishing extraordinary large positions on opposite sides of the market in physically delivered and cash-settled contracts in the same referenced energy commodity," he noted.
In the case of natural gas, for example, "we would establish a class limit for Nymex natural gas contracts that are physically delivered; a second class for Nymex natural gas contracts that are cash settled; and a third class for ICE...natural gas contracts that are also cash settled," an agency staffer said. "So a trader would face those three class limits as well as an aggregate limit for all three of those classes."
The proposal would eliminate the bona fide hedge exemption for swap dealers, but would maintain the exemption for bona fide (nonspeculative) hedgers. Instead swap leaders will be eligible for a limited risk management exemption, which would be capped at two times the otherwise applicable proposed position limit (an AMC or single-month limit), according to the CFTC. Swap dealers will have to apply to the CFTC for exemptions from speculative position limits, while bona fide hedgers can seek their exemptions from the exchanges.
ICE said the CFTC action "demonstrates progress toward the implementation of a carefully considered position limit and concentration regime for energy markets." Likewise, the CME Group said it "supports equitable application of aggregate position limits across CFTC-regulated designated contract markets and exempt commercial markets, CFTC-recognized foreign boards of trade and OTC energy market participants."
The CFTC NOPR will be subject to a 90-day comment period.
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