From the May 01, 2010 issue of Futures Magazine • Subscribe!

CFTC position limits push could hit wall

The Commodity Futures Trading Commission (CFTC) push for more formal position limits could hit a snag as enactment of proposals likely will hinge on broader financial legislation, which is still up in the air. At the March hearings on the metals markets, the agency faced opposition from the futures industry, with many experts testifying that position limits could drive trading overseas. The industry, as well as CFTC commissioners themselves, expressed reservations on the proposals the CFTC put out on energy position limits in January.

“[Regulators] are walking a bit of a tightrope, trying to find the in-between to put the controls in place to oversee the market effectively without driving business away,” says Kevin McPartland, senior analyst at Tabb Group. “The [goal] is to make the market more transparent, but if they artificially limit trading, then price discovery will be less accurate rather than more.”

CME Group once again voiced its opposition to position limits at the hearings, as Thomas LaSala, global chief regulatory officer at CME Group, said position limits would shift business away from U.S. exchanges and into less regulated markets. He added that the exchange is best suited to police activity in its market, set position limits and grant hedge exemptions.

Futures industry veteran Henry Jarecki, chairman of Gresham Investment Management, pointed out that futures markets over the past two years were immune from troubles facing over-leveraged stock, bond, real estate and insurance markets “because they have avoided artificial constrains that have unforeseen consequences; instead they deal with leverage in a rational way. The futures markets structure…was what protected the futures markets and its customers and those who rely on it for price discovery.”
He added that metals investors limited in the futures markets will gain exposure through physical and OTC markets.

Frank McGhee, head precious metals dealer for Alliance Financial (see Cover story), estimated that $400-$500 of the price of gold is due to investments in exchange-traded funds (ETFs). The ETFs hold physical gold to back purchases.

In his testimony, Richard Strait, managing partner of Richard Strait, LLC, a guaranteed broker to Triland USA, said that under mandated position limits, users likely would go to less regulated offshore markets and global OTC markets, in which case a “black pool” of unregulated derivatives traffic could lead to a bubble, causing a negative financial chain reaction similar to what happened in global debt markets.
Gold, as opposed to most futures markets, has several liquid contracts traded on several exchanges globally.

“Any position limit in general is not a positive thing for a market quality, because if you [restrict] the people who provide liquidity, it’s going to affect the market in a negative fashion,” says Paul Zubulake, senior analyst at Aite Group. “The regulators should be concentrating on the manipulation aspect of it as opposed to limiting positions. Driving more markets overseas and into the dark [doesn’t] really benefit them.”

Any position limit proposal may depend on what happens with financial regulatory reform. “From a legislation perspective, it’s possible that we’ll see legislation passed to the President by the end of the summer. Worst-case scenario, we’ll see something passed before the November elections,” McPartland says.

Gary DeWaal, general counsel at Newedge, says, “Having some certainty of what’s going to happen with the bill is going to be the driver of [what happens with] the position limits. At the same time [CFTC Chairman Gary Gensler] is pushing for transparency in the OTC space, he inadvertently could be pushing for opaqueness in the traditional futures space, and that’s not what anybody wants.”

Zubulake expects additional CFTC mandated position limits to be enacted eventually. “We’re in an environment where the regulatory bodies are going to be making changes to make changes,” he says.
The CFTC’s proposal on position limits in the energy markets was already under duress by three of the agency’s own commissioners, and in a March comment letter, the Futures Industry Association said the proposed rules “would harm these public interests and should not be adopted” and the proposal “unjustifiably departs from CFTC practice and precedent.”

The CFTC’s proposal on position limits in the energy markets was already under duress by three of the agency’s own commissioners, and the Futures Industry Association (FIA) weighed in with some serious concerns as well. In a March comment letter, FIA said the proposed rules “would harm these public interests and should not be adopted” and the proposal “unjustifiably departs from CFTC practice and precedent.”

The FIA said that according to the Commodity Exchange Act, the CFTC is only allowed to limit speculation when it finds limits necessary to prevent price distortions, and the CFTC cited no evidence that speculation caused energy price distortions. The FIA said that the proposal would harm efficient hedging, take liquidity out of U.S. exchange markets and push trading to overseas markets out of the CFTC’s jurisdiction.

“The FIA raised good arguments about the legality of the process,” DeWaal says.

The FIA also agreed with a point that CFTC commissioners made in their comments: that the CFTC should wait until legislation out of Congress was finished before visiting position limit concerns. When the proposal was released, Commissioners Michael Dunn, Jill Sommers and Scott O’Malia agreed that the proposed limits could result in less transparency in the futures markets. Sommers said “forging ahead with federal limits in a piecemeal fashion is unwise.”

Industry insiders agree that Washington’s attack on “excessive speculation” in energy futures as a result of rising oil prices, which was in its heyday in the summer of 2008, could make a comeback this summer as the price of oil moves up.

“Blaming the speculators is going to be coming back this summer when zero interest rates are continuing to fuel the economy and fuel speculation in these markets, relating to high prices at the pump,” says Zubulake.

DeWaal agrees. “If crude starts moving to $100, it’s going to be hard to suppress the outcries in Congress to do something.”

McPartland says, “Washington needs an understanding from the investor community of how these markets operate on a day-to-day basis instead of just from a political perspective.”

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