A broad coalition of industry, trade and consumer advocacy groups has called on the Commodity Futures Trading Commission (CFTC) to narrowly interpret the sweeping Wall Street Reform Act when proposing and implementing rules.
The Commodity Markets Oversight Coalition (CMOC) said it supported a narrow exemption from clearing for bona fide hedgers of commercial risk in commodity markets, a strict definition of "commercial risk," setting position limits at low levels and with the agency imposing aggregate position limits.
The financial services industry -- hedge funds, investment banks and insurance companies -- fought to be included as bona fide hedgers, thus subject to the exemption, when Congress was drafting the legislation earlier this year (see Daily GPI, July 22). But while "these financial entities may have legitimate interest in hedging credit, business and balance sheet risks, they are not producers, distributors or end-users of physical commodities and so should not be included in any end-user exemption, the coalition said.
"These financial entities' so-called 'hedging' activities have dramatically increased volatility and uncertainty in commodity prices and have resulted in dramatic price swings that are injurious to traditional commodity end-users...The end-user exception should remain narrowly tailored to those businesses that produce, refine, process, market or consume an underlying commodity, and counterparties buying or selling a position to an end-user so long as that position is established to satisfying the demand of a bona fide end-user."
Moreover, the CMOC said the "definition of 'commercial risk' should be narrowly tailored to apply only to those entities whose businesses expose them to risk from physical commodity price fluctuations. 'Commercial risk' should not include risk that is purely financial in nature, including balance sheet risk. We reject the assertion that 'commercial risk' is essentially any business-related risk other than risk associated with the movement of physical commodity prices," the coalition said.
"The definition of 'commercial risk'...is critically important to insuring that the end-user exception is not interpreted so broadly as to undermine the intent of the [Dodd-Frank] Act."
The CMOC represents many parties that are considered bona fide hedgers under the Dodd-Frank Act, and thus exempt from the trading and clearing of derivatives. They include producers, processors, distributors, retailers, commercial and industrial end-users, as well as average U.S. commodity consumers.
In addition, "We commend the Commission and the Congress for acknowledging the need for position limits; however, we have lingering concerns. The formula proposed by the CFTC must result in position limits that are low enough to have a meaningful effect on excessive speculation and thereby bring renewed stability and confidence to the commodity markets," the coalition said.
The Dodd-Frank Act "clearly states that the Commission shall set position limits to diminish, eliminate or prevent 'excessive speculation.' We urge the Commission to consider carefully how they will ensure position limits deal adequately with excessive speculation. It is not enough to deal just with manipulation; excessive speculation will require a stricter approach," the CMOC said.
The CMOC criticized the agency's failure to proposed a aggregate limit on clearinghouse ownership. Individual company limits would be 5%. But, "without an aggregate cap on ownership, 11 dealer banks could band together, each take a 5% ownership as per the suggested cap, and collectively own a controlling stake in a clearinghouse. Such proposals run contrary to the congressional intent," of Dodd-Frank, the CMOC said.
According to a statement by the Office of the Comptroller of the Currency, the five largest banks currently control 96% of derivatives activity. Banks already control many clearinghouses and using a 5% rule with no aggregate class-based cap, they could simply bank together and take a controlling ownership by making minor adjustments to their current ownership stakes, it said.
With respect to its new anti-manipulation proposal, "We...commend the Commission for its recent request for information from the public regarding computerized/algorithm-based trading, including high-frequency trading and colocation; their application and use in the commodities markets, and whether or not they have a disruptive effect on market stability or function (see Daily GPI, Oct. 25)."
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