CFTC Again Re-Proposes Position Limits in Speculative Commodity Contracts Under Dodd-Frank and Adopts Related Aggregation Rules | Practical Law

CFTC Again Re-Proposes Position Limits in Speculative Commodity Contracts Under Dodd-Frank and Adopts Related Aggregation Rules | Practical Law

The CFTC has proposed for a third time speculative limits on core physical commodity futures contracts and their economically equivalent futures, options, and swaps mandated under Title VII of the Dodd-Frank Act. The CFTC also adopted final amendments to rules on the aggregation of commodity positions for purposes of these speculative position limits.

CFTC Again Re-Proposes Position Limits in Speculative Commodity Contracts Under Dodd-Frank and Adopts Related Aggregation Rules

by Practical Law Finance
Published on 16 Dec 2016 • USA (National/Federal)
The CFTC has proposed for a third time speculative limits on core physical commodity futures contracts and their economically equivalent futures, options, and swaps mandated under Title VII of the Dodd-Frank Act. The CFTC also adopted final amendments to rules on the aggregation of commodity positions for purposes of these speculative position limits.
On December 5, 2016, the CFTC:
  • Re-proposed speculative position limits on core physical commodity futures contracts and their economically equivalent futures, options, and swaps under section 737 of Title VII of the Dodd-Frank Act, which amends Commodity Exchange Act (CEA) section 4a (2016 position limits proposal).
  • Adopted final amendments to rules on the aggregation of commodity positions for purposes of these speculative position limits (aggregation amendments).
This is the second time that the CFTC has proposed position limit rules since its 2011 final position limit rules were vacated by the US District Court for the District of Columbia in 2012 on grounds the CFTC failed to demonstrate that the rules were appropriate and necessary to curb commodity price volatility and manipulation, as required under section 737 of the Dodd-Frank Act (see Legal Update, CFTC Commodity Position Limits Rules Vacated by DC District Court).
The CFTC then re-proposed the position limit rules in November 2013 (see Legal Update, CFTC Re-proposes Position Limits for Speculative Commodity Derivatives). On May 26, 2016, the CFTC issued for public comment a supplement that modified the definition of "bona fide hedge" for purposes of exemption from speculative position limits (see Legal Update, CFTC Modifies Commodity Position Limits Proposal, Definition of Bona Fide Hedge).

Rules on Aggregation of Commodity Contracts for Purposes of Speculative Position Limits

The final aggregation amendments amend the CFTC's aggregation rules in CFTC regulations Part 150.4, which require the aggregation of all positions in accounts for which any person either:
  • by power of attorney or otherwise, directly or incorrectly controls trading; or
  • holds a 10% of greater ownership interest.
Positions in accounts in which two or more persons acting pursuant to an expressed or implied agreement, as well as positions held by one person in more than one account with substantially identical trading strategies must also be aggregated.
The aggregation amendments were initially proposed in November 2013 (see Legal Update, Re-proposed Commodity Position Limits Rules Detailed).
These rules were modified by a supplement to the proposed aggregation amendments in 2015 (2015 supplement) (see Legal Update, CFTC Proposes Modification to Dodd-Frank Commodity Position Limit Aggregation Rules).
The final aggregation amendments were adopted with minimal changes from the November 2013 proposal and the 2015 supplement.

Aggregation Exemptions

The final aggregation amendments adopt revised exemptions for certain positions from aggregation.
Under the final aggregation amendments:
  • Positions that are held by any person that is a limited partner of a commodity pool, a limited member of a commodity pool, a commodity pool shareholder, or other similarly situated commodity pool participant in which that person directly or indirectly holds a 10% or greater ownership or equity interest in the pooled account or positions need not aggregate the accounts or positions of the commodity pool with any other accounts or positions held or controlled by that person unless the person also controls the trading of the pool. Additionally, affiliates of the operator and any person that owns more than 25% of the pool must also aggregate their positions in certain circumstances, unless certain firewall requirements are met.
  • Positions in an owned entity (an entity in which the owner has a 10% or greater ownership or equity interest) need not be aggregated, provided that certain firewall requirements between the entity that controls trading and the owner are met, among other things.
  • Positions held by futures commission merchants (FCMs) and affiliates of FCMs in discretionary accounts need not be aggregated, provided that, among other things, the FCMs and affiliates of FCMs are minimally involved in account supervision and the trading strategy in the accounts is determined independently from any other account in which the FCM has a 10% or greater interest.
  • Client positions and positions carried by an authorized independent account controller (the IAC exemption), with respect to aggregation of positions held by an eligible entity, need not be aggregated, provided that certain conditions are met. However, spot month physical-delivery commodity contracts may not qualify for the IAC exception.
  • Certain positions held indirectly by underwriters (where the ownership of securities is based on the whole or part of an unsold allotment by a person as a participation in the distribution of the securities by the issuer or by an underwriter) and broker-dealers (where ownership of securities is acquired by the broker-dealer in the normal course of business) as well as positions for which information sharing would result in a violation of state or federal law need not be aggregated, provided that certain requirements are met.
Persons seeking an aggregation exemption are required to file notice with the CFTC containing certain required filings and other information as required under CFTC Part 150. Such notice will generally be effective upon submission.

Re-Proposed Position Limits on Core Physical Commodity Futures Contracts and Economic Equivalents

Part 150 of the CFTC regulations caps the number of speculative commodity contracts one trader or group of affiliated traders may hold at any one time. These limits are already in place for so-called "legacy" contracts.
The 2016 position limits proposal includes:
  • Updates to certain definitions, including a new proposed definition of bona fide hedge for purposes of position limits rules (see Changes to Bona Fide Hedge Definition).
  • Speculative limits on 25 core physical commodity futures contracts and their economically equivalent futures, options, and swaps.
The term "economically equivalent" is defined in section 4(a)(a)(5) of the CEA and includes:
  • "Look-alike" contracts – contracts that settle off of the core referenced futures contract and contracts that are based on the same commodity for the same delivery location as the core referenced futures contract.
  • Contracts based on an index comprised of one or more prices for the same delivery location and in the same or substantially the same commodity underlying a core referenced futures contract.
  • Inter-commodity spreads with two components, one or both of which are referenced contracts.

Referenced Contracts and Initial Position Limits

The CFTC includes the following table in the 2016 position limits proposal (as Appendix D to CFTC Part 150) illustrating the proposed position limits in 25 core physical commodity futures contracts and their economically equivalent futures, options, and swaps. The spot-month and non-spot month (single and all-month) position limit levels would subsequently be adjusted every two years.
Note that the CFTC has deferred action on the following contracts:
  • Chicago Mercantile Exchange (CME) Class III Milk.
  • CME Feeder Cattle.
  • CME Lean Hogs.
Proposed Initial Position Limit Levels by Number of Contracts
Contract Type
Spot-Month
Single and All-Months
CBOT Corn¹
600
62,400
Chicago Board of Trade (CBOT) Oats¹
600
5,000
CBOT Soybeans¹
600
31,900
CBOT Soybean Meal¹
720
16,900
CBOT Soybean Oil¹
540
16,700
CBOT Wheat¹
600
32,800
CBOT Kansas City Hard Red Winter Wheat¹
600
12,000
Minneapolis Grain Exchange (MGEX) Hard Red Spring Wheat¹
1,000
12,000
Intercontinental Exchange (ICE) Futures US Cotton No. 2¹
1,600
9,400
CBOT Rough Rice
600
5,000
ICE Futures US Cocoa
5,500
10,200
ICE Futures UC Coffee
2,400
8,800
ICE Futures US FCOJ-A
2,800
5,000
ICE Futures US Sugar No. 11
23,300
38,400
ICE Futures US Sugar No. 16
7,000
7,000
CME Live Cattle
450
12,200
New York Mercantile Exchange (NYMEX) Henry Hub Natural Gas
2,000
200,900
NYMEX Light Sweet Crude Oil
10,400
148,800
NYMEX NY Harbor ULSD
2,900
21,300
NYMEX RBOB Gasoline
6,800
15,300
Commodity Exchange Inc. (COMEX) Gold
6,000
19,500
COMEX Silver
3,000
7,600
COMEX Copper
1,000
7,800
NYMEX Platinum
500
5,000
NYMEX Palladium
100
5,000
¹ Denotes legacy agricultural contract. Note the proposed limits on legacy agricultural contracts would modify the current speculative position limits for these contracts found in CFTC Part 150.2.

Changes to Bona Fide Hedge Definition

The current definition of "bona fide hedging position" is found in CFTC regulation 1.3(z). The 2016 position limits proposal seeks to move the definition of a bona fide hedge into Part 150 and modify the definition to be narrowed from the current definition by incorporating the standards found in CEA section 4a(c)(2) (7 USC 6a(c)(2)).
Specifically, the 2016 position limits proposal would revise the definition of "bona fide hedging position" to eliminate:
A bona fide hedge under the 2016 position limits proposal is one that meets all of the following tests:
  • The temporary substitute test, meaning the hedge represents a substitute for a transaction made or position taken (or made or taken at a later time) in the physical market channel.
  • The economically appropriate test, meaning the hedge is economically appropriate in achieving a reduction in risk in the management of a commercial enterprise.
  • The change in value requirement, which arises from current or anticipated potential changes in asset values, liabilities, or services.
For more information on the above tests and bona fide hedging positions, see Practice Note, The Dodd-Frank Act: Commodity Position Limits: Bona Fide Hedging Positions.
Pass-through offset. The 2016 position limits proposal also recognizes as a bona fide hedge a "pass-through swap offset," meaning it reduces risk to a position from a swap executed opposite a counterparty to which the transaction would qualify as a bona fide hedging transaction as defined in the 2016 position limits proposal. The swap itself is also recognized as a bona fide hedging position to the extent it is an offset.
The 2016 position limits proposal applies the five-day rule to pass-through swaps and swaps off-sets, provided that a risk-reducing position is not maintained in any physical delivery commodity contract during the lesser of:
  • The last five days of trading; and
  • The time period for the spot period in the physical delivery commodity contract.
This is known as the five-day rule. The purpose of the five-day rule is to prevent carrying certain hedges (in this case, physical delivery contracts) into the last five days of trading.
Enumerated anticipatory bona fide hedges. The 2016 position limits proposal expands the list of enumerated anticipatory bona fide hedges to include four types of other enumerated hedging positions:
  • Hedges of unsold anticipated production.
  • Hedges of offsetting unfixed-price cash commodity sales and purchases.
  • Hedges of anticipated royalties.
  • Hedges of services.
The 2016 position limits proposal applies the five-day rule to these enumerated anticipatory bona fide hedges.
Cross-commodity hedges. Also in response to comments received, the CFTC withdrew the quantitative test for cross-commodity hedges for the purposes of defining a bona fide hedge position. The qualitative test therefore remains, meaning that under the 2016 position limits proposal, a bona fide cross-commodity hedge would be evaluated based, in part, on the market participant's own qualitative review of the cross-commodity hedge.
Commodity trade options. The 2016 position limits proposal adds a new section to the definition of bona fide hedge, which specifies that a commodity trade option adjusted on a futures-equivalent basis may be deemed a cash commodity purchase or sales contract for the purposes of recognition as a bona fide hedge.
Bona fide hedge appendices. The 2016 position limits proposal also adds appendices to CFTC Part 150. The 2016 position limits proposal appendices include:
  • A table illustrating the proposed position limits in 25 core physical commodity futures contracts and their economically equivalent futures, options, and swaps (see Referenced Contracts and Initial Position Limits).
  • Risk-management exemption guidance for commodity contracts in excluded commodities that are permitted under the revised definition of a bona fide hedging position.
  • Acceptable practices to set speculative position limits.
  • Fourteen fact patterns to assist market participants in understanding what qualifies as a bona fide hedging position under the 2016 position limits proposal definition.

Position Rules for Exchanges – DCMs and SEFs

In addition to updating CFTC rules and guidance, the 2016 position limits proposal also includes proposed updates to acceptable compliance practices for DCM core principle 5 and SEF core principle 6 with regard to speculative position limits and accountability levels set by an exchange.
DCMs core principle 5 concerns the ability to obtain information and SEF core principle 6 concerns position limits and accountability. For more information on core principles for DCMs and SEFs, see Legal Updates, Final Dodd-Frank Swap Execution Facility (SEF) Rules Adopted by CFTC and CFTC Issues Final Rules for Derivatives Clearing Organizations Under Dodd-Frank.
The 2016 position limits proposal also includes a process for DCMs and SEFs to:
  • Recognize commodity contracts as non-enumerated bona fide hedges or enumerate anticipatory bona fide hedges; and
  • Exempt certain arbitrage spread positions (also known as "straddles") from position limits (subject to CFTC review).
Finally, the 2016 position limits proposal re-proposes a delay of the requirement that DCMs and SEFs establish and monitor position limits on swaps. This delay would be applicable to DCMs and SEFs that lack sufficient access to swap information in order to be able to establish and monitor position limits.
Proposed Appendix E to part 150 provides guidance for DCMs and SEFs stating that they need not demonstrate compliance with core principle 5 (for DCMs) or core principle 6 (for SEFs), until such time that they have access to sufficient swap position information.
A DCM or SEF would have sufficient access to swap position information when it:
  • Has access to daily information about a market participant's open swap positions; or
  • Knows that it's market participants regularly engage in large volumes of speculative trading (knowledge can be obtained through market surveillance).
Once a DCM or SEF is deemed to have access to sufficient swap position information, the relief from core principle 5 and core principle 6 is no longer available. This guidance is not time limited.

Effective Dates and Comment Periods

The effective date for the final aggregation amendments is February 14, 2017.
The CFTC is accepting public comment on the 2016 position limits proposal. Comments may be submitted on the CFTC website and on the Federal eRulemaking Portal. Comments must be received by February 28, 2017 for the 2016 position limits proposal.

Final Comment

Congressional Democrats have suggested that the CFTC's release of another proposal on position limits rather than adopting a final rule is a failure to duly carry out the agency's duties under the current administration and the Dodd-Frank Act.
Likely incoming CFTC chairman Giancarlo, a current CFTC commissioner and the only Republican on the commission, has expressed opposition to speculative position limits as a liquidity drain. The 2016 position limits proposal therefore appears unlikely to be adopted as a final rule under the incoming administration and could be tabled, at least for the next four years.