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October 18, 2011

Summary of the Rule Establishing Position Limits

WHAT’S THE ISSUE? The Commodity Futures Trading Commission was mandated under the Dodd-Frank Act to impose position limits on agricultural, energy and other commodities for the purpose of “diminishing, eliminating or preventing” excessive speculation in commodities markets. Position limits are restrictions on the number of futures, swaps or options contracts that any individual trader, or group of traders, may hold.

WHY IS IT IMPORTANT? The issue affects everyone from businesses to households to the world’s poorest. Many academics and independent researchers have linked excessive speculation in commodities markets to higher and more volatile prices for food, energy and industrial input materials. Commodities were subjected to strong position limits for decades, but they were systematically eroded since the 1990s. At a time when the world’s economy is already suffering from the effects of the financial crisis, it is more important than ever to reinstate those protections that were established during the New Deal.

WHAT DID BETTER MARKETS ARGUE?  We presented independent research proving that excessive speculation is damaging commodities markets and proposed two main solutions. First, Better Markets argued for aggregate limit on the overall amount of speculation in any given commodity. Based on historical norms, we argued this should be set at 30 percent of open interest in a specific market.

Second, we provided compelling evidence gathered by ourselves and outside academics that so-called commodity index funds are the primary distorting force in the commodities markets today. The data suggests they should be banned, or severely restricted to a small fraction of open interest. A subsequent paper showed these funds since 2005 have triggered an upward price curve in the futures markets when they trade out of an expiring month contract and into a new future month (referred to as the “roll”). This has resulted in rising prices and costs, as well as a boom-and-bust cycle by changing the incentives of producers and consumers of commodities.

WHAT DID THE AGENCY DO?  The CFTC approved a final rule on Oct. 18, 2011, that would limit a given entity’s position to roughly 2.5 percent of each market. The rule did not target commodity index funds nor provide a market-wide cap. The rule would protect against manipulation by the individual limits, but still fall short of curbing excessive speculation. Better Markets has advocated additional steps the commission could take to improve the rule in the near term. It could enact specific restrictions on index funds as a “group or class” of traders in a new rule. The commission also should be able to adjust the limits more frequently, as the rule states that many key limits will only be reset on a two-year basis.  Finally, regulators should be able to adjust individual limits based on overall speculation in the market. But the simplest way of fulfilling the congressional mandate is to ban commodity index funds.

Proposed rule

Final rule

Summaries of Rules


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