The U.S. derivatives regulator on Tuesday reintroduced a plan to curb commodity market speculation, reviving a crucial Wall Street reform after a judge knocked down an earlier version of its rules on position limits.
The Commodity Futures Trading Commission proposal will set caps on the number of contracts that a single trader can hold in energy, metal and agricultural markets, a measure aimed at capping speculation that some blamed for the spike in raw material and food prices prior to the 2008 financial crisis.
The redrafted rules sought to answer some of the deficits that a judge pointed out last year. The agency cited two of the biggest cases of market manipulation in history — the Hunt Brothers’ silver corner and hedge fund Amaranth’s natural gas bet — as evidence of why curbs were necessary.
The new rules will also make it easier for big banks such as Goldman Sachs Group and Barclays to remain in the market by allowing them to exclude positions held by entities in which the banks own minority stakes — a key trigger for the banks to sue the agency.
They may now ignore positions held by affiliates in which they own up to 50 per cent of the shares but do not control — far above the 10 per cent in an earlier rule — or in affiliates in which they own more than 50 per cent but which are not consolidated.
“The… restriction that was in before was very excessive and that was a sensible adjustment,” said Craig Pirrong, a finance professor at the University of Houston who has been critical of efforts to set limits on positions.
The rules have been one of the most hotly debated aspects of the 2010 Dodd-Frank law and is re-emerging as some of the largest global banks face political pressure to reduce their control over commodities markets.
Still, the plan could prove to be far less rigorous than feared by markets, data provided by the world’s largest futures exchange the CME Group showed.
The maximum position traders would be allowed to hold could in some cases dramatically rise rather than become tighter, the numbers showed, in one specific contract almost 10 times as much as is currently the case.
Reuters had first reported the main changes in the CFTC’s newly drafted rule.
Also at the meeting, Democrat Commissioner Bart Chilton announced he would soon leave the agency, creating a possible power vacuum if no successor is found soon for chairman Gary Gensler, who also leaves this year.
With his shoulder-long peroxide blond hair, and his ubiquitous references to pop culture in speeches, Chilton is a striking figure amongst financial regulators — as well as a strong proponent of position limits.
Position limits have long been used in agricultural markets to curb speculation, but Congress gave the CFTC far greater powers to impose them after the crisis. The agency will now extend the practice to oil, gas and metals markets.
The calculation method the CFTC uses remains similar: traders may hold futures and swaps amounting to 25 per cent of the estimated deliverable supply of the underlying commodity in the spot-month contract.
The estimates will be provided by CME and revised regularly, the CFTC said.
The financial industry’s fight to fend off new limits may be losing some of its vigor as large pension funds and other institutional investors — which plowed more than US$400 billion into raw material markets over the past decade — show signs of cooling interest in the asset class.
The limits were partly a response to the 2008 surge in oil and grain prices, which some blamed on the influx of new capital. But with investor appetite waning, traders are less likely to breach the new limits.
The rule also provides a better legal argument to underscore why the CFTC thinks Congress has mandated it to implement the position limits, something that the U.S. district court had said was ambiguous.
On top of that, the agency also provided a finding of why position limits were necessary to curb speculation — something the court had not specifically asked for but that it said it was doing anyway to be on the safe side.
Staff at the agency had found that they were necessary by looking at the manipulation of the silver market by the Hunt Brothers in 1979 and the cornering of the natural gas market by hedge fund Amaranth in the 2000s.
While the redrafted rule eases a major irritant for big banks by lowering the thresholds for aggregating positions, it threatens to create a new rift with commodity merchants such as Cargill looking to hedge certain transactions.
“The CFTC’s new proposal will likely be at least as controversial as the last. Commercial users will likely have difficulties with the narrowed definition of hedging,” said a former CFTC staffer who worked on the rule.
The text of the rule proposal changes details of what can legally be defined as hedging, an activity that is exempted from position limits under the Dodd-Frank law. It kept certain exemptions, but removed others.
Commercial commodity traders would no longer be allowed to take derivative positions in anticipation of having to pay rent for storage facilities that were in fact empty and were not actually needed, CFTC staff said at the meeting.
Staff had found no evidence that rents were related to market prices, and had therefore proposed not to exempt this type of anticipatory hedging. But other forms will still be allowed, the CFTC staffers said.
The new rule also reintroduced so-called conditional limits, which allow traders to hold five times the limit in cash-settled contracts, provided that they do not hold a single position in physical-settled contracts.
— Douwe Miedema is a Reuters correspondent covering financial regulation in Washington, D.C.