CFTC Approves Final Position Limits for Physical Commodity Futures and Swaps under Dodd-Frank | Practical Law

CFTC Approves Final Position Limits for Physical Commodity Futures and Swaps under Dodd-Frank | Practical Law

On October 18, 2011, the CFTC approved final rules under the Dodd-Frank Act setting position limits for physical commodity futures contracts and economically equivalent futures, options and swaps.

CFTC Approves Final Position Limits for Physical Commodity Futures and Swaps under Dodd-Frank

by PLC Finance
Published on 20 Oct 2011 • USA (National/Federal)
On October 18, 2011, the CFTC approved final rules under the Dodd-Frank Act setting position limits for physical commodity futures contracts and economically equivalent futures, options and swaps.
On October 18, 2011, the CFTC approved final rules on position limits for certain physical commodity futures contracts that are traded on or subject to the rules of a designated contract market (DCM). The final regulations, mandated by the Dodd-Frank Act, establish spot-month and non-spot-month limits on speculative positions in 28 physical commodity futures contracts and their economically equivalent futures, options and swaps (collectively, Referenced Contracts). The rules set out requirements for aggregation of positions across accounts and retains the existing CFTC independent account controller (IAC) exemption for disaggregation of client account positions from proprietary positions codified in 17 CFR 150.3(a)(4).

Spot-month Position Limits

Spot-month position limits will be set at 25% of estimated deliverable supply and will be applied separately for Referenced Contracts that require physical delivery and cash settled Referenced Contracts in the same commodity. This means, for instance, that a trader's position in all cash-settled futures and swaps in Referenced Contracts will be combined to determine whether the trader's aggregate position in cash-settled Referenced Contracts on that commodity is below the limits.
The final rules require DCMs to submit estimates of deliverable supply to the CFTC every other year for every Referenced Contract. The CFTC will use this information to estimate deliverable supply for a particular commodity in resetting the position limits.
The spot-month limits will be effective 60 days after the term "swap" is further defined under the Dodd-Frank Act and will be based on the spot-month position limit levels currently in place at DCMs. These limits will be adjusted biennially for agricultural contracts and annually for energy and metal contracts.
The term "spot-month" does not refer to a calendar month. Rather, the term refers to the trading period immediately preceding the delivery period for physically delivered futures contracts and cash-settled swaps and futures contracts that are linked to the physically delivered Referenced Contract. The length of this period varies, depending on the Referenced Contract, as described in Regulation 151.3 of the Commodity Exchange Act (CEA), appended to the final rules. See page 71686 of the Federal Register for a list of trading periods for various Referenced Contracts.

Non-spot-month Position Limits

Non-spot-month position limits for Referenced Contracts will be fixed at:
  • 10% of open interest in the first 25,000 contracts.
  • 2.5% of open interest for all further contracts.
Open interest for a particular Referenced Contract is the sum of all open positions under all outstanding futures, cleared swaps and uncleared swaps for that particular Referenced Contract. This formula has historically been used to set position limits on futures exchanges.
The non-spot-month position limits for the nine "legacy" agricultural Referenced Contracts have been established by the CFTC and are set out in a chart on page 71687 of the Federal Register. Legacy contracts are contracts that are already subject to federal position limits. The nine legacy agricultural Referenced Contracts include:
  • Corn and Mini-corn.
  • Oats.
  • Soybeans and Mini-soybeans.
  • Wheat and Mini-wheat.
  • Soybean Oil.
  • Soybean Meal.
  • Hard Red Spring Wheat.
  • Cotton No. 2.
  • Hard Winter Wheat.
The non-spot-month position limits for the nine legacy agricultural Referenced Contracts will be effective 60 days after the term "swap" is further defined under the Dodd-Frank Act. For all other Referenced Contracts, an effective date will be set after the CFTC has received one year of open interest data on cleared and uncleared physical commodity swaps under the swaps large trader reporting rules (see Legal Updates, CFTC Finalizes Large-trader Reporting Regs, Defines "Agricultural Commodity" and CFTC Suspends Large-trader Position Reporting for Physical Commodity Swaps under Dodd-Frank).

Position Visibility

A person holding or controlling positions, separately or in combination, net long or net short, in specific Referenced Contracts that equal or exceed levels outlined in a table on page 71691 of the Federal Register in all months or in any single month (including the spot month) must comply with additional reporting requirements regarding position visibility. These requirements entail submitting a 401 filing to the CFTC containing certain information regarding the Referenced Contract, including:
  • A list of dates within the applicable calendar quarter on which the person held or controlled a position that equalled or exceeded the visibility levels in the table.
  • Separately by futures, options and swaps, the gross long and gross short futures equivalent positions in all months of the applicable Referenced Contract(s) in excess of the visibility levels in the table.
  • If applicable, by commodity referenced price, the gross long and gross short uncleared swap positions in all months basis of the applicable Referenced Contract(s) futures-equivalent basis in excess of the visibility levels in the table.

Independent Account Controller (IAC) Exemption

The final rules set out requirements for aggregation of positions across accounts and retain the existing CFTC independent account controller (IAC) exemption for disaggregation of client account positions from proprietary positions. An IAC is defined in 17 CFR 150.1 as an individual that:
  • Meets certain threshold qualifications, such as being registered with the CFTC as a futures commission merchant (FCM), an introducing broker, a commodity trading advisor (CTA), or a general partner of a commodity pool.
  • Acts independently of both its clients and other IACs.
  • Is specifically authorized by an eligible entity to control trading decisions on behalf of, but without the day-to-day direction of, that entity. Eligible entities include:
    • commodity pool operators (CPOs).
    • operators of trading vehicles not defined by the CFTC as CPOs.
    • limited partners or shareholders in a commodity pool.
    • CTAs.
    • bank or trust companies.
    • savings associations.
    • insurance companies.
    • the separately organized affiliates of any of the above entities.
This aggregation exemption is a significant change from the proposed rules, which would have eliminated the IAC exemption entirely. Accordingly, eligible entities may, for the purpose of compliance with Dodd-Frank position limits, continue to rely upon the IAC exemption to disaggregate client positions which an IAC trades for another party pursuant to a fiduciary relationship. That is, only to the extent that one trades professionally for others can one use this IAC exemption to disaggregate the client positions held by the IAC from its own proprietary trading positions for purposes of compliance with the position limits rules.
In general, the aggregation requirement requires an eligible entity to aggregate, for purposes of compliance with the position limits rules, positions in all accounts:
  • In which it holds at least a 10% ownership or equity interest (either directly or indirectly).
  • For which it controls trading decisions.
This requirement is meant to prevent a single eligible entity from circumventing the position limits through common ownership or control of multiple accounts. The final rules clarify that, in the absence of a proper firewall separating the proprietary accounts of the eligible entity from the IAC, the eligible entity may not make use of the IAC exemption. The final rules also provide a limited exemption from the aggregation requirement for accounts associated with the underwriting of securities.
The CFTC will determine whether accounts may be disaggregated on a case-by-case basis. Eligible entities seeking to make use of the IAC aggregation exemption must file an application for relief with the CFTC. This application must set forth:
  • The circumstances that warrant disaggregation.
  • A certification that the applicant meets the conditions relevant to exemption.
While the final rule does not include a renewal requirement, eligible entities must file an updated or amended application in the event of a material change to the information provided.

Further Exemptions from Position Limits

The final position limits rules retain the current exemption for mere ownership interests in commodity pools. Under this exemption, a trader that is also a limited partner or shareholder in a commodity pool will generally not have to aggregate accounts if it does not control the commodity pool’s trading decisions. Therefore, a fund of funds manager who invests solely in funds or accounts managed by third parties maintaining Referenced Contracts would not have to aggregate positions under the final rules unless the fund of funds manager has side letter agreements giving the manager control over investment decisions of the funds or accounts in which the manager directs investment. The final rules also provide exemptions from position limits for:
  • Bona fide hedging transactions. The final rules expand this exemption from the original proposal to include certain anticipated merchandising transactions, royalties and service contracts.
  • Positions established in good faith before the effective date of the initial limits set by these final rules.

Economically Equivalent Contracts Subject to Position Limits

For purposes of the final rules, a swap may be economically equivalent to a futures contract, and therefore subject to aggregation for purposes of compliance with position limits, under any of the following circumstances:
  • It is a "look-alike" contract, meaning it settles by reference to the underlying referenced futures contract or contracts that are based on the same commodity for the same delivery location as the underlying futures contract.
  • Its reference price is based only on the combination of at least one Referenced Contract price and one or more prices in the same or substantially the same commodity that underlies the underlying futures contract referenced in the swap (provided that such a contract is not a locational basis swap).
  • It is an intercommodity spread contract with two reference price components, one or both of which are based on Referenced Contracts.
  • It is priced at a fixed differential to an underlying futures Referenced Contract.
The final rules also require quarterly position visibility reporting for traders exceeding a non-spot-month position visibility level in energy and metal Referenced Contracts.
For more information on these final rules, see the CFTC's fact sheet and Q&A.
For more information on the proposed rule, see Legal Update, CFTC Proposes Dodd-Frank Position Limits for Certain Commodity Futures and Derivatives. To learn more about swaps and derivatives provisions of the Dodd-Frank Act, see Practice Notes, Summary of the Dodd-Frank Act: Swaps and Derivatives and Road Map to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: Swaps and Derivatives.