The Commodity Futures Trading Commission (CFTC) Thursday punted the most controversial of its proposed regulations -- setting limits on the amount of speculative trading of derivative swaps by a single entity, abruptly adjourning its meeting after discussing a staff proposal. The next scheduled meeting is next year.
"No vote was taken," said a CFTC spokesman. The reason for not voting on position limits was not disclosed, nor would the spokesman say when a vote on the proposal would be held.
The Commission took a 10-minute break toward the end of the more than five-hour meeting, which included discussions of several other measures, and when it returned Chairman Gary Gensler abruptly adjourned the meeting and wished everyone a happy holiday. The assumption by observers was that Gensler didn't have the three votes needed to pass the proposal.
The draft of the proposed rule would limit the amount of positions in futures and options contracts and economically equivalent swaps, other than bona fide hedge positions, that may be held by any entity in one of the 28 covered commodities, including crude oil, natural gas, heating oil, and gasoline. It would set spot or front-month position limits at 25% of deliverable supply for a commodity, with a conditional spot-month limit of five times that amount for entities with positions exclusively in cash-settled contracts.
Non-spot month position limits (aggregate single-month and all-months-combined limits that would apply across classes, as well as single-month and all-months-combined position limits separately for futures and swaps) would be set for each referenced contract at 10% of open interest in that contract up to the first 25,000 contracts, and 2.5% thereafter.
Commissioner Jill Sommers opposed setting position limits at this time, saying "we do not have [the] data to effectively set position limits." To get around this, Gensler proposed that the CFTC establish a formula on how it would set position limits, and then decide the actual limits when the market data is available. Staff told Gensler the Commission would have the legal authority to do this.
Sommers said she also was concerned that the Commission was not setting different position limits for different classes of customers, such as swap dealers, exchange-traded funds and index clients.
Gensler acknowledged that it would take time before the proposal setting position limits was in place, and he asked the staff whether the agency had the authority in the interim to ask market participants with significant positions to supply information to the CFTC. A staff member said the Commission could easily obtain information on traders' speculative limits via the agency's "special call authority."
Currently, designated contract markets (DCM), which are regulated futures market exchanges, operate under position limits. The Dodd-Frank Wall Street Reform Act would expand the CFTC's regulatory authority over the over-the-counter (OTC) markets. Until the Commission establishes the new position limits, Gensler said he wanted the agency staff to closely review the position limits on DCMs and report those traders who appear to exceed the limits.
Commissioner Bart Chilton agreed that "there are certain steps [the CFTC] may take to get a trader down."
For example, if a trader were to get above the limit for single-month and all-months-combined position limits, the Commitments of Traders Report would identify that trader, he said. "These traders who go above that [level] would be on our radar screen," Chilton said. Staff agreed, noting that it would "shine a light on them to let them know that we're here."
The Commission approved 5-0 a proposed rule on swap execution facilities, (SEF), which were created under the Dodd-Frank Act to promote the trading of swap derivatives. "The proposed rule will provide for all market participants an ability to execute or trade with other market participants. It will afford market participants the ability to make firm bids or offers to all other market participants. It also will allow them to make indications of interest -- or what is often referred to as "indicative quotes" -- to other participants," Gensler said.
"These methods will provide hedgers, investors and Main Street businesses both the flexibility to execute and trade by a number of methods," he noted.
Commissioner Scott O'Malia noted that the CFTC reached a compromise solution on the definition of SEFs by delaying action for a week. "This compromise solution does not mandate a limit order book, but will allow participants to use a variety of trading systems and platforms, including order books, request for quote systems and voice-based systems. It mandates only one requirement: that all SEFs maintain an electronic screen that displays all firm and indicatives quotes to market participants. I believe this proposal preserves the ability of the end-users and the buy side to transaction large size [trades] in these currently opaque and illiquid markets," he said.
Sommers, however, believes that the Commission SEF definition stemmed from a narrow reading of the Dodd-Frank Act. "I believe that Congress intended a broad model for trading of swaps on SEF," she said, adding that she was "deeply disappointed" that alternative language was not included in the CFTC's proposal.
Also by a 5-0 vote, the Commission approve a proposal on the risk management requirements that entities must meet to become derivatives clearing organization (DCO), which would clear swap transactions. One of the requirements is a prospective DCO must meet a minimum capital requirement of $50 million, which Sommers called too restrictive.
O'Malia said he also had "some serious concerns about the rule on DCOs. [It] has new requirements that will likely change some clearing organizations' models regarding customer margining that will make it 'too costly to clear.' The rule requires gross margining of customer accounts, and clearing members report gross positions down to the beneficial owner level to the DCO. The rule also contains limitations on the permissible investment of all customer funds and assets invested by [a] clearing organization."
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