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Groups Say Position Limits Should Focus on Spot-Month Physical Contracts

Unless revised, the Commodity Futures Trading Commission's (CFTC) proposed rulemaking on position limits for derivatives would have the unintended consequence of needlessly limiting commodity trading and harming liquidity and price discovery in the derivatives markets, the Natural Gas Supply Association (NGSA) and the National Corn Growers Association (NCGA) said in comments filed at the CFTC Monday.

"Position limits must be set in the right place and in the right way, and the CFTC's current proposal aims, but misses the mark, on both counts," said Jenny Fordham, NGSA's vice president of markets.

"We share the commission's commitment to well functioning markets. In that spirit, our comments put forth several constructive suggestions to improve the proposed rule in a way that will protect market liquidity and price discovery, without hindering the CFTC's ability to address any excessive speculation or manipulation."

Foremost, the two trade groups suggested that "position limits should focus on physical delivery contracts in the spot month only, rather than including cash-settled contracts or contracts out of the spot month." This change would put the commission's focus squarely on the contracts with greatest potential for impact on physical commodity markets, they said.

And "when spot-month position limits are imposed, the commission should properly account for all sources of supply, such as LNG [liquefied natural gas] and storage, based on deliverability; and position limits should ensure a workable bona fide hedge exemption. For example, rather than daily reporting for those using the bona fide exemption, the rule should require reporting when a trader's position first exceeds a limit or when the trader's hedging need increases," said the NGSA and NCGA.

The commission's proposed rule on hard position limits, which was adopted in mid-January, 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 (see Daily GPI, Jan. 14).

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.

Nonspot-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.

Likewise Craig Pirrong, a professor of finance and energy markets and director of the Global Energy Management Institute at the University of Houston, found the CFTC proposal on position limits to be "fundamentally flawed," and urged the CFTC to withdraw it.

"It is fundamentally flawed because it is far too expansive. It will constrain severely trading activity that poses none of the dangers that the commission has identified in the [proposal]. It will impair unnecessarily liquidity in the over-the-counter derivatives markets, thereby burdening legitimate speculators, investors and hedgers. Moreover, there are serious logical inconsistencies in the spot-month limits the commission proposes," he said.

"The legitimate policy objectives that the commission has identified can be achieved without burdening legitimate trading activity as its proposed rule would. In particular, a position accountability regime would target the specific threats that certain kinds of speculative activity can sometimes present without limiting legitimate and beneficial speculative activity. All-month limits are over-inclusive, and unnecessarily and inefficiently restrict legitimate trading activity."

A position accountability system "can identify large positions, thereby permitting a more detailed determination of whether a holder of such a position is a single entity, or a levered entity, or especially a single levered entity who would pose the kind of disorderly liquidation threat that the commission highlights. Based on such information , it would be possible for the commission, or a self-regulatory entity operating subject to the commission's regulations, to take action targeted to the actual threat posed -- if any."

The deadline for comments on the CFTC proposal was Monday (March 28).

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