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CFTC Modifies Commodity Position Limits Proposal, Definition of Bona Fide Hedge
Practical Law Legal Update w-002-5410 (Approx. 5 pages)
CFTC Modifies Commodity Position Limits Proposal, Definition of Bona Fide Hedge
by Practical Law Finance
| Published on 02 Jun 2016 • USA (National/Federal) |
The CFTC issued for public comment a supplement to its December 2013 position limits proposal that modifies the definition of bona fide hedge for purposes of exemption from speculative position limits for physical commodity futures contracts and economically equivalent futures, options, and swaps. The supplement also modifies the procedures for seeking an exchange exemption for non-enumerated bona fide hedging.
On May 26, 2016, the CFTC issued for public comment a supplement to its December 2013 position limits re-proposal (2013 proposal) that modifies the definition of "bona fide hedge" for purposes of exemption from speculative position limits for physical commodity futures contracts and economically equivalent futures, options, and swaps (see Legal Update, CFTC Re-proposes Position Limits for Speculative Commodity Derivatives and Practice Note, The Dodd-Frank Act: Commodity Position Limits).
Bona fide hedge positions do not count toward speculative commodity position limits (see Practice Note, The Dodd-Frank Act: Commodity Position Limits: Overview of Position Limits Re-proposal: Bona Fide Hedging Positions).
The supplement also establishes procedures for seeking an exchange exemption for non-enumerated bona fide hedging and defines procedures for recognition of certain anticipatory bona fide hedge positions.
Aside from these changes, other aspects of the 2013 proposal remain the same or as may be modified (see Legal Update, CFTC Proposes Modification to Dodd-Frank Commodity Position Limit Aggregation Rules).
Public comment on the proposed supplement may be submitted electronically on the CFTC's website, and must be received within 30 days of publication in the Federal Register.
"Bona Fide Hedging" and Other Definitional Changes
The supplement to the 2013 proposal responds to many of the comments received on the 2013 proposal and includes amendments to certain relevant definitions, including a clear definition of "bona fide hedging" for physical commodities under Section 4a(c) of the CEA. The amendments include modification to the definitions of:
"Bona fide hedging": The changes to the definition of "bona fide hedging" more closely conform this term to the CEA's statutory language by eliminating the incidental test. Under the incidental test, to qualify as a bona fide hedge, the hedge was required to have been intended to offset price risk incidental to commercial cash or spot operations. Because the incidental test is embodied in the economically appropriate test, which requires that a bona fide hedge is economically appropriate to reduce risks and is a substitute for a transaction that the entity would otherwise have to enter into at a later time (for instance, by having to purchase the commodity on the spot market), it has been removed.
The revised definition in the supplement also removes the orderly trading requirement , which requires that bona fide hedges are established and liquidated in an orderly manner. This was removed because it is already directly addressed in Section 4c(a)(5) of the CEA.
"Futures equivalent": The 2013 proposal expanded the definition of "futures equivalent" beyond its prior definition (an option contract or series of contracts that could be converted to an amount that would be economically equivalent to a future using the previous day's risk factor (delta)) to include swaps that accomplish the same thing. The supplement would further clarify the definition of futures equivalent to:
- Include a futures contract which has been converted to an economically equivalent amount of an open position in a core referenced futures contract; and
- Clarify that, for purposes of calculating futures equivalents, an option contract must also be converted into an economically-equivalent amount of an open position in a core referenced futures contract.
"Intermarket spread positions" and "Intramarket spread positions": The supplement would expand the definitions for these two terms from the 2013 proposal to include positions in multiple commodity derivative contracts so that market participants would be able to establish an inter- or intra-market spread position for the proposed speculative commodity position limits and the related exemptions. The definitions would also be expanded to cover spread positions in the same or similar commodities (or their products or byproducts).
The supplement provides for a delay for DCMs and SEFs that lack access to sufficient swap-position information to fill the requirement to establish and monitor position limits on swaps.
Exchange Recognition of Bona Fide Hedges
The supplement includes new alternative processes for designated contract markets (DCMs) and swap execution facilities (SEFs) to recognize certain positions in commodity derivative contracts as non-enumerated bona fide hedges or enumerated anticipatory bona fide hedges, and to exempt from federal position limits certain spread positions subject to CFTC review. Specifically, the proposal would allow DCMs and SEFs, in addition to the CFTC, to review requests for recognition of:
- Non-enumerated bona fide hedging positions.
- Enumerated anticipatory bona fide hedging positions.
Non-Enumerated Bona Fide Hedging Positions
CFTC Regulation 1.3 (z)(2) (17 CFR 1.3(z)(2)) provides a list of enumerated bona fide hedging positions and CFTC Regulation 1.3(z)(3) (17 CFR 1.3(z)(3)) provides a procedure for market participants to seek recognition for non-enumerated bona fide hedges for contracts subject to speculative position limits under CFTC Regulation 150.2 (17 CFR 150.2). Under this regime, DCMs generally have granted non-enumerated bona fine hedging exemptions pursuant to exchange rules that incorporate the CFTC's definition of "bona fide hedging."
The 2013 proposal would replace CFTC Regulation 1.3(z)(3) with the proposed CFTC Regulation 150.3(e) (17 CFR 150.3(e)), which requires that the market participant file a petition under 7 USC 6a(a)(7) or request an interpretation under CFTC Regulation 140.99 (17 CFR 140.99), both of which require CFTC review.
Under the supplement, the proposed rules would allow an exchange (that is a self-regulatory organization (SRO) that is under commission oversight and that has rules subject to CFTC review) to establish rules under which the exchange could establish non-enumerated bona fide hedging positions that meet the general definition of a bona fide hedging position under 17 CFR 150.1. Recognition by an exchange would be subject to review by the CFTC, but would be effective until the CFTC reached a contrary decision and notified the market participant.
Enumerated Anticipatory Bona Fide Hedging Positions
Under the 2013 proposal, to qualify for the anticipatory bona fide hedging position exemption, market participants would have been required to file statements with the CFTC regarding the anticipatory hedge, which would become effective ten days after submission without CFTC action or inquiry (under proposed 17 CFR 150.7).
The supplement provides that, as an alternative to being able to file statements with the CFTC, market participants may also have exchanges, including DCMs and SEFs, review requests for recognition of enumerated anticipatory bona fide hedging exemptions (under proposed 17 CFR 150.11). These requests must be reviewed in accordance with rules filed with the CFTC by the exchange processing the review, but the CFTC rule would allow for a review period shorter than the ten days required for the CFTC under the proposed 17 CFR 150.7.
The supplement includes corresponding changes to certain regulations in the 2013 proposal regarding exemption from federal position limits and exchange-set position limits to account for these alternative processes.