The Commodity Futures Trading Commission (CFTC) last Thursday closed out its final meeting of the year by putting off consideration of the most controversial of its proposed regulatory reforms — setting limits on the amount of speculative trading of derivative swaps by a single entity — and making it highly unlikely that the agency will meet the congressionally mandated deadline for imposing position limits.

The Dodd-Frank Wall Street Reform Act, which President Obama signed into law in July, requires the Commission to impose position limits on exempt commodities (metals and energy) by no later than Jan. 17, 2011, and on agricultural commodities by no later than April 17, 2011 (see NGI, July 26). The next scheduled meeting for possible consideration of a proposal on position limits is Jan. 13.

“No vote was taken” on position limits last Thursday, 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.

“We’re not all the way where I think we need to be,” said Commissioner Bart Chilton. “It’s just appropriate to let this one ripen a little more,” Gensler said.

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.

Forty traders in referenced energy contracts may be affected by the proposed spot-month position limits, and 10 traders in reference energy contracts would be impacted by the all-months-combined and single-month position limits, according to the CFTC.

Commissioner Jill Sommers opposed setting position limits at this time, saying “we do not have [the] data to effectively set position limits.” In an attempt to appease the concerns, 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.

Gensler raised the idea of the formula when he and Chilton testified before the House Agriculture Committee’s subcommittee on general farm commodities and risk management last Wednesday. Republicans on the subcommittee expressed reservations about the CFTC moving forward with all -months’ position limits for swaps until the agency has collected further data on the extent of the market. However, they indicated the agency could proceed with a rule on front-month position limits on derivative swaps, since it already has experience with front-month position limits on commodities traded on the futures market.

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.

Industry witnesses raised the same issue at the House hearing. Jim Collura, representing the New England Fuel Institute and end-users in the Commodity Markets Oversight Coalition, said he expected to see different regulation for index funds compared to traditional market speculators.

Gensler acknowledged that it would take time before the proposal setting position limits would be in place given the required 60-day comment period and the expectation there could be hundreds of comments to be considered. He asked the staff whether the agency had the authority in the interim to obtain information from market participants with significant positions. A staff member said the Commission could easily obtain data on traders’ speculative limits via the agency’s already existing “special call authority.”

Currently, designated contract markets (DCM), which are regulated futures market exchanges, operate under position limits. The Dodd-Frank Act would expand the CFTC’s regulatory authority to include imposing position limits in 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 on traders who appear to have exceeded the limits.

Chilton agreed that “there are certain steps [the CFTC] may take to get a trader down.” He said there were actions the Commission could take in January, if it became necessary.

For example, if a trader were to exceed the limit for single-month and all-months-combined position limits, the Commission’s Large Trader Reporting Systems 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.”

There are ways the Commission “could set a price point, a level at which we would have tightened regulatory oversight,” Chilton told the House agriculture subcommittee. That oversight might involve “a special call for swaps data, to see where the positions are netted. And if traders are actually above the certain position point, then use all our authorities, our emergency authorities, our trading authorities, working with the exchanges, ICE [IntercontinentalExchange] and CME [CME Group], to get their net positions down, maybe in swaps, maybe in options, maybe in futures.”

By 4-1, the Commission approved 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’s SEF definition stems 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 organizations (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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