Last year, it was Congress that was blaming speculators for increased volatility in the markets, and now, the Commodity Futures Trading Commission (CFTC) is shining the spotlight on speculators and asking the question, who is a “bona fide” hedger. In late July and early August, the CFTC held hearings to address the current application of and exemptions from position limits in energy markets.
While the panels purportedly were to collect information, there was little doubt that the Commission had reached some conclusions and the industry had already seen the writing on the wall.
In his statement before the CFTC, CME Group CEO Craig Donohue stated, “We are prepared to respond to those concerns by adopting a hard limit regime for those products, including single-month and all-months combined limits in addition to the current limits that apply during the last three trading days of the expiration month,” though he also noted, “efforts to control price or volatility by position limits is a failed strategy.”
CFTC Chairman Gary Gensler stated in remarks before the final panel that the CME Group’s “support for adoption of a hard limit regime… is a welcome change.” Also CFTC commissioner Bart Chilton was quoted in the Wall Street Journal amid the hearings saying that prior CFTC studies that indicated that index funds were not responsible for the 2008 spike in crude oil were based on “deeply
But in his opening statement Gensler called the hearing “an opportunity to determine how speculative position limits could be used to address excessive speculation, not how we can eliminate speculation.”
In testimony at the same hearing, Intercontinental Exchange (ICE) CEO Jeff Sprecher said “no quantitative study has shown that speculation in futures markets was the cause of increased energy commodity prices in the past year.”
The two main energy futures players, CME Group and ICE, disagree on who should apply such limits. Donohue noted, “position limits that are imprecise or wrongly administered will merely drive trading away from transparent markets and regulated clearing. … We believe that CME Group is in the best position to impose and administer position limits and hedge exemptions regarding the energy commodities.”
Sprecher recommended, “Any aggregate system of position limits, accountability levels and hedge exemptions should be set and administered by the CFTC.”
Addressing the hedge exemption Donohue stated that “denying or limiting [swap dealers’] access to futures markets will simply impede hedging activity by commercial market participants.” The CME’s recommended modified regime would include tailored hedge exemptions for swap dealers and index funds, and Donohue noted, “should alleviate external concerns that positions held by these investors and hedgers will increase price volatility or artificially inflate or deflate prices.”
Mark D. Young, who testified at the CFTC on behalf of the Futures Industry Association on August 5, said “If position limits replace or supersede accountability levels for energy and metals, FIA would be concerned that this switch could endanger the integrity of the price discovery process.”
Gary DeWaal, general counsel for Newedge, says “Controlling prices is considered a bad thing, but that’s what the regulators are trying to do right now. They saw an upward tick in prices and now they’re responding to that. Any control of prices is an artificial restriction on marketplace activity. Manipulative conduct is illegal and should be prosecuted, but excessive speculation is not a concept that exists under the Commodity Exchange Act and efforts to restrict speculation are wrong. But the train has left the station, and there will be hard limits on positions, and that can’t be avoided,” DeWaal adds.
Chairman of Gresham Investment Management Henry Jarecki, who created a fund offering a passive investment in a basket of commodities long before it became a mainstream investment, argued against the notion that these investments have an effect on price in his testimony. “It is obvious that the flows into index funds do not correlate with oil price increases. In some periods, for example, the correlations are indeed negative.” Jarecki added that any position limits should be applied at the customer level because funds are simply applying a passive strategy. “It is the customer, not we, who decides to purchase the commodity index and it is thus at the investor level that all position limits should be placed and enforced.”
Darin Newsom, senior analyst at DTN, says “If we put new restrictions in place making it more difficult for fund traders and non-commercial traders, it’s going to have an effect on the market. Longer-term, commodities have already had speculative interest in them. It’ll just send [traders] off in a different direction looking for a different way to get into these commodities.”
Paul Zubulake, senior analyst at Aite Group, thinks that the CFTC will enact position limits but not eliminate the hedge exemption. “It’s all about smart regulation, not to handcuff players that are legitimately in the industry but to go after abuses and market manipulation. You need the swap dealers in the market. They should have exemptions in certain circumstances,” he says.