Commodity Position Limits After Dodd-Frank

CFTC to Establish Energy Position Limits

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) includes a number of key provisions which will affect the investment management industry in important ways. For example, the Act includes a mandate for the CFTC to impose position limits across different markets, including the energy markets, the agricultural markets and with respect to trading in certain OTC derivatives. These new position limits must be implemented by CFTC orders or through rulemakings within the next six to nine months depending on the individual markets.

New CEA Section 4a(c)

The Act establishes new SEC Section 4a(c), portions of which we have reprinted below. Generally the new sections will require the CFTC to do the following:

  • establish limits on “exempt commodities” within 180 days of the passage of the Act. [The term “exempt commodity” is defined in CEA Section 1a(14) to generally include those commodities which are not financially based commodities and not agricultural commodities. Generally the import of this provision is to have the CFTC implement position limits on energy related commodities and futures.]
  • establish limits on agricultural commodities within 270 days of the passage of the Act.
  • establish the aggregate number or amount of positions in certain contracts based upon the same underlying commodity that may be held by any person, including any group or class of traders, for each month.

The above requirements are generally subject to “bona fide hedging” exemptions and the new Section 4a(c)(2) requires the CFTC to define what constitutes a bona fide hedging transaction.

* Please note the above is a broad generalization of the applicable new sections of the CEA

CFTC’s Previous Efforts to Set Energy Position Limits

To an extent, we will look to the CFTC’s prior efforts to see where they may land with respect to setting limits. In January 2010, the CFTC proposed position limits designed to prevent any one participant from developing a concentration of futures positions (see generally Federal Register Release 75 FR 4143). The proposed limits would have restricted the position energy traders could hold and addressed concerns many lawmakers had about the connection between those traders and rising energy prices. While the proposed limits only applied to four exchange-traded energy commodities (crude oil, natural gas, and two other types of fuel), the CFTC will be revisiting those efforts to meet the new, more expansive mandate under the Wall Street Reform Act. [Note: you can view previous comments from the public on this issue on the CFTC website.]  The CFTC will be working with other agencies, including the SEC, the Federal Reserve Board, and other regulators in its efforts.

Likely Impact

These mandates will have a significant impact on the energy futures market. In 2009, more than 377 million energy futures and options contracts were traded on CFTC-regulated exchanges and this number is anticipated to increase. Energy traders will now face position limits with respect to the energy contracts that were previously largely unregulated. In addition, it is important to note that under the Act, the CFTC can set position limits not only on persons, but also on any “group or class of traders”–which means it could apply a limit, for example, to all airlines in the aggregate. While we will not know the full impact for some time, when the limits are implemented there are likely to be some groups and individuals who will need to carefully monitor their positions.

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New CEA Provisions

Section 4a(a)(2) of the Commodity Exchange Act

‘‘(2) ESTABLISHMENT OF LIMITATIONS.—

‘‘(A) IN GENERAL.—In accordance with the standards set forth in paragraph (1) of this subsection and consistent with the good faith exception cited in subsection (b)(2), with respect to physical commodities other than excluded commodities as defined by the Commission, the Commission shall by rule, regulation, or order establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person with respect to contracts of sale for future delivery or with respect to options on the contracts or commodities traded on or subject to the rules of a designated contract market.

‘‘(B) TIMING.—

‘‘(i) EXEMPT COMMODITIES.—For exempt commodities, the limits required under subparagraph (A) shall be established within 180 days after the date of the enactment of this paragraph.

‘‘(ii) AGRICULTURAL COMMODITIES.—For agricultural commodities, the limits required under subparagraph (A) shall be established within 270 days after the date of the enactment of this paragraph.

‘‘(C) GOAL.—In establishing the limits required under subparagraph (A), the Commission shall strive to ensure that trading on foreign boards of trade in the same commodity will be subject to comparable limits and that any limits to be imposed by the Commission will not cause price discovery in the commodity to shift to trading on the foreign boards of trade.

‘‘(3) SPECIFIC LIMITATIONS.—In establishing the limits required in paragraph (2), the Commission, as appropriate, shall set limits—

‘‘(A) on the number of positions that may be held by any person for the spot month, each other month, and the aggregate number of positions that may be held by any person for all months; and

‘‘(B) to the maximum extent practicable, in its discretion—

‘‘(i) to diminish, eliminate, or prevent excessive speculation as described under this section;

‘‘(ii) to deter and prevent market manipulation, squeezes, and corners;

‘‘(iii) to ensure sufficient market liquidity for bona fide hedgers; and

‘‘(iv) to ensure that the price discovery function of the underlying market is not disrupted.

Section 4a(a)(6) of the Commodity Exchange Act

‘‘(6) AGGREGATE POSITION LIMITS.—The Commission shall, by rule or regulation, establish limits (including related hedge exemption provisions) on the aggregate number or amount of positions in contracts based upon the same underlying commodity (as defined by the Commission) that may be held by any person, including any group or class of traders, for each month across—

‘‘(A) contracts listed by designated contract markets;

‘‘(B) with respect to an agreement contract, or transaction that settles against any price (including the daily or final settlement price) of 1 or more contracts listed for trading on a registered entity, contracts traded on a foreign board of trade that provides members or other participants located in the United States with direct access to its electronic trading and order matching system; and

‘‘(C) swap contracts that perform or affect a significant price discovery function with respect to regulated entities.

Section 4a(a)(7) of the Commodity Exchange Act

‘‘(7) EXEMPTIONS.—The Commission, by rule, regulation, or order, may exempt, conditionally or unconditionally, any person or class of persons, any swap or class of swaps, any contract of sale of a commodity for future delivery or class of such contracts, any option or class of options, or any transaction or class of transactions from any requirement it may establish under this section with respect to position limits.’’.

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Cole-Frieman & Mallon LLP provides legal support and futures and commodities compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

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