BUILD YOUR OWN
With the writing on the wall, CME Group did not want to leave this to chance or to bureaucrats, so they designed their own position limits scheme and revealed it in a white paper
In a precursor to the proposal that could be loosely translated to “let the baby get his way,” CME Group stated, “Although the evidence is clear that speculative positions limits in the energy markets, beyond those already in place, are not warranted, we also recognize that confidence in the futures markets may be undermined by perceptions. Therefore CME Group is proposing the following recommendations.”
The recommendations include: each regulated exchange setting its own position limits for single months, combined and delivery period based on open interest; each exchange administering its own hedge exemption program subject to existing standards until common exemption standards are established by the CFTC; and the CFTC establishing a system for reporting OTC positions and aggregating on-exchange and OTC positions so the combined position could be subject to the limit.
Currently the CME Group’s Nymex and ICE face the same limits for their WTI contracts, which in WTI crude oil include position accountability levels of 10,000 for single-month futures, 20,000 combined and a 3,000 contract hard limit for the last three days of trading in the spot month.
CME Group is proposing a position limit scheme that would be based on the open interest of each exchange. They would set certain hard limits if other markets trading similar energy products agree to adopt comparable programs. “Each exchange and ECM, which is obligated to control excessive speculation, has an obligation under the CEA to set its own limits in proportion to liquidity, volume and open interest.”
CME Group argues that an exchange trading a contract with half the liquidity of a similar CME Group contract — if they faced one industry-wide position limit standard — would benefit from an equivalent limit double that of CME Group. “If Nymex with substantial volume, open interest and liquidity, sets its single-month position limit at 20,000 and an exchange with one-fourth of Nymex’s liquidity, volume and open interest, simply expropriates that number, traders would be able to exploit a position limit of 40,000, when the correct level should have been 25,000, with no more than 20,000 on Nymex and 5,000 on the less liquid exchange.”
ICE doesn’t see it that way. ICE General Counsel Jonathan Short, speaking before the Senate Agriculture Committee in December, said, “Congress and the CFTC should be careful to protect competition by setting aggregate limits across markets and leaving market participants with the choice to ‘spend’ that limit in the venue of their choice.”
Short said the CME Group proposal would “limit competition by inhibiting the development of liquidity in a competing market and locking in the relative market share of incumbent exchanges.”
Even worse for ICE is that under its current no-action letter (that ICE Futures Europe operates under), it is required to follow the position limit regime of CME because they settle their WTI cash settled contract to the Nymex WTI price. A spokesperson for ICE says that would allow CME Group to set levels disadvantageous to ICE. Nymex lists both a physically delivered and cash settled WTI contract but has little volume in the cash-settled contract (ICE only lists a cash contract) and could set a lower level for the cash contract according to the spokesperson.
Going further, ICE maintains that limits should be less restrictive for the financially settled contract. “Where a commodity is physically delivered, position limits make sense. Cash settled contracts settle on the price discovered in the physical markets and don’t represent a claim on the physical commodity; therefor, these positions tend not to be reflected in in the physical price,” the spokesperson adds.
In testimony before the Senate Agriculture Committee, CME Group Executive Chairman Terry Duffy reiterated CME Group’s position, saying, “Legislation should mandate that each [designated contract market] or Swap Execution Facility be required to set its own position limits based on and in proportion to its liquidity, volume, open interest. Any aggregate limits set by the CFTC should not permit free riding exchanges to set internal limits at the level of the aggregate limit, irrespective of the limits it should be setting based on its own liquidity, volume, and open interest.”
Duffy also pointed out that potential limits must include the OTC world. “Language must be added [to current legislation] to ensure that the CFTC refrains from placing hard position limits on regulated exchanges until such time that they are simultaneously placed on the OTC market and foreign boards of trade.”