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October 18, 2011

Divided CFTC OKs commodity-trading caps

WASHINGTON (MarketWatch) — A split Commodity Futures Trading Commission on Tuesday approved long-awaited rules limiting trading in the commodities market, seeking to curb excessive speculation and potential manipulation.

The new rules limit the number of commodity contracts that any investor can hold in agriculture, energy or metals contracts.

Position limits have been the subject of heated debate in Washington in recent years, as backers of such caps have complained that large financial investors taking huge stakes in commodity futures and options contracts have driven up the price of heating oil, gasoline, diesel and jet fuel.

The proposal, which was introduced in January, was approved by a 3 to 2 vote by the five-person commission. The Dodd-Frank Act, written in response to the financial crisis of 2008, mandated the limitations.

The commission approved the rule nine months past a deadline set for the agency by the statute to approve speculation-limit rules for some commodities.

“A position-limits regime in the commodity futures and swaps markets is a critical component of comprehensive regulatory reform of the derivatives markets,” said CFTC Chairman Gary Gensler.

As expected, it was criticized as over-reaching by Republicans and too accommodating to big banks by some Democrats.

The approval comes after the CFTC postponed two scheduled meetings to vote on approving the proposal. The most recent meeting was canceled, in part, due to an inability to obtain the votes necessary for approval.

The rule allows a single trader to hold spot month positions equal to 25% of the estimated physical, deliverable supply of a given commodity, such as crude, gasoline or heating oil.

Trading on exchanges such as Nymex, ICE and CME would be subject to the 25% spot-month limit caps within about 60 days for nonswaps. However, limits for trading done off exchanges aren’t expected to go into effect until late 2012 or 2013, in part because regulators must still collect data on the size of the over-the-counter swaps market.

The CFTC has the authority to review the caps and make changes if regulators determine they are too high or low, and agency officials must write a study on the impact of the rules and provide it to Congress within 12 months of the rule’s approval.

The rule also sets nonspot-month position limits, also known as the cash-settled market, for 10% of open interest in that contract up to the first 25,000 contracts and 2.5% after surpassing that threshold.

The CFTC estimates that roughly 84 traders in agricultural-futures contracts, 85 traders in energy contracts and 12 traders in precious-metals contracts will be affected by the proposed restrictions. Many of these investors trade more than 100% of the deliverable supply of a particular commodity, such as oil.

Democratic commissioner Bart Chilton voted for the measure, arguing that single trading firms have controlled large chunks of a particular market and that this leads to manipulation. He added that he would have imposed even stricter restrictions if he didn’t have to compromise with other commissioners.

“We’ve seen 30%, 35%, 40% of a market controlled by one entity. It’s not theoretical. In my view whether that can manipulate the markets. I’ve seen it. It can happen. With this rule that will end,” Chilton said.

Backing Chilton’s comments, Sen. Bernie Sanders, an independent of Vermont, raised concerns in a letter to the CFTC that the limits weren’t stringent enough. He said a single trader should only be permitted to hold a spot month position of 5% of the physical delivery supply of a given commodity, such as oil — significantly less than the 25% of the physical market approved by the CFTC.

Sanders also raised concerns that the rules allow big banks to escape position limits by letting them trade a large amount of commodity futures employing hedging exemptions. He said big banks shouldn’t be treated the same as end users, such as airlines, who hedge their commodity investments as a risk-reducing strategy.

Conservative opposition

Republican commissioners were opposed to the measure, arguing that the agency doesn’t have enough market data to adopt it, and that it would not limit volatility in the markets.

Republican commissioner Jill Sommers voted against the rule, noting that she didn’t believe that position limits will control prices or volatility. “This commission will be blamed when this final rule does not lower food or commodity costs,” she said.

Scott O’Malia, the CFTC’s other Republican commissioner, also voted no. He said the commission’s cost-benefit analysis to develop position limits was “inadequate.”

“The commission has over-reached its interpretation in its statutory mandate to set position limits. The commission does not provide a legally sound, comprehensively rational basis on empirical evidence on a final rule,” O’Malia commented.

Michael Dunn, a Democratic commissioner, grudgingly voted in favor of the rule, despite having reservations. He said he voted for the caps because he wanted to “follow the law,” but added that no one has brought the agency “any reliable economic analysis that excessive speculation” is impacting the market the CFTC regulates.

“If we limit participation in these markets through position limits, producers may receive inaccurate market signals when making production decisions,“ according to Dunn. “If this occurs, the prices we all pay for our groceries and to heat our homes may become more volatile. Position limits may actually lead to higher prices for the commodities we consume on a daily basis.”

Break for large traders

The final rule eases up on a requirement that large traders must aggregate all the positions held by funds of which they have a stake for the purposes of limits, something providing a relief to big institutions. The agency has delayed approval of this provision until it collects more data about the derivatives industry. Observers don’t expect this provision to be approved until mid-2013.

Sanders called such a delay “obscene,” noting that Americans need relief from artificially high gasoline and heating-oil prices “now.” He said it was unacceptable for Goldman Sachs Group Inc. (NYSE:GS)  and Morgan Stanley (NYSE:MS)  and other major financial institutions to receive hedging exemptions and not have to abide by the position-limits rule.

The vote comes after the CFTC held a conference that looked at, among other things, whether financial activity in the futures market can significantly destabilize oil prices. That’s what a a Belgium-based academic told the U.S. futures regulator at the conference.

However, University of California economics professor James Hamilton countered that what’s broadly driving the price of oil has been stagnating global production of crude in the face of big increases in world incomes and a spike in demand for oil products in emerging markets, not financial speculation.

It also comes as progressive watchdog group Better Markets put out a report last week examining speculative commodity trading and calling for the banning of commodity index funds. The report contends that commodity trading conducted by financial institutions is “causing market disruptions that have increased prices for American families and farmers.”

Better Markets also said commodity index funds should be banned because they have “resulted in rising prices and costs,” and have “disrupted the futures and physical commodity markets.”

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